PROVISION, CONTINGENT LIABILITY & INCOME TAXES

PROVISION

#1
In May 2021, Finn's company filed a lawsuit against Jake's company seeking 1,000,000 php damages for patent
infringement. Mr. Jake's lawyer believes that there is a 90% chance that the entity will be required to pay ang
estimated amount of 500,000 - 750,000 other outcomes are unlikely. The 2022 FS were issued on January 2023.
Are we going to recognize this provision in the book?
Answer: Provision is an existing liability of uncertain timing or uncertain amount, according to PAS 37,
paragraph 14, provide that a provision shall be recognized as liability in the FS under 3 conditions.
 The entity has a present obligation, legal or constructive, as a result of a past event.
 It is probable that an outflow of resources embodying economic benefits would be required to settle
the obligations.
 The amount of the obligation can be measured reliably.
In this case, there is a present obligation due to patent infringement of Jake company. It is also probable that an
outflow of resources is going to occur since there is a 90 % chance (higher than 50% which means it is
probable) that the entity will be going to pay 500,000-750,000 or with the amount of 625,000 measured reliable
using the expected disposal of asset measurement.

#2
On October 2, 2022 Panini company truck was involve in an accident with a car driven by Mr. Chowder. On
January 16 of the following year. The company received a notice of a lawsuit for 100,000 damages for personal
injuries suffered by Mr. Chowder. Panini's company legal counsel believes it is probable that Mr. Chowder will
be awarded an estimated amount of 50,000 to 75 000.
What is the measurement of the provision for lawsuit?
Answer: Using the expected disposal of asset as measurement.
(Lowest estimation + Highest estimation)/2
50,000 + 75,000 /2
125,000 / 2
= 62,500

#3
During 2023, Gumball company is the defendant in a law suit. Darwin, Gumball's lawyer, believes that there is
70% chance that the court will dismiss the case and the entity will incur no outflow of economic benefits, this is
with the help of Mr. Richard, company's employee.
However, if the court rules in favor of the claimant, there is 30% chance that he will pay 2,000,000 pesos. The
court is expected to rule in 2025.
What amount of the provision for lawsuit should be reported?
Answer: 0, because the chance that the court will dismiss the case is 70%, which means that it is only remote
that he will pay 2,000,000 pesos or there is only 30% chance that the entity will incur outflow of economic
benefits.

#4
During 2022, Courage company sold 50 units of 50" television and warrant all parts for a year. A company
estimated product warranty based on historical data and prior experience at 250,000 php.
How are we going to record the estimated product warranty provision?
Answer:
31 Dec. Warranty expense 250,000
2021 Provision for warranty expense 250,000

#5
On January 2, 2023, Eustace, a customer returned a television purchased last year for repair under warranty, for
which courage company incurred a cost repair including 700 for labor and 1,300 for the part a week later.
How will we going to record repair cost a week later?
Answer:
9 Jan. Provision for Warrant expense 2000
2023. Repair parts inventory 1200
Wages payable 800

#6
The Ben Company, sells a cellphone with a warranty under which customers are covered for the cost of repairs
of any manufacturing defects that becomes apparent within 1 year after purchase.
If minor defects are detached in all product sold repairs cost would be about php 500,000.
If major defects are defected are detached in all product sold repair cost of 3,000,000 would result.
The entity past experience and future expectations indicates that 50 % of cost sold will have no defects, 45 %
will have minor defects and 5% will have major repairs.
The expected value or cost of repairs is measured as follows:
Answer:
50 % sales 0
45 % sales (45 % × 500,000) 225,000
5 % sales (5 % × 3,000,000) 150,000
Total expected value of repair 375,000

Warranty expense 375,000

Warranty liability 375,000

#7
In February 17, 2023 Mojo company received a court order requiring the clean-up of environmental damages
caused by the company's factory and there is no other realistic alternative but to comply with the court order
expert hired by the company estimated that the cost of the clean-up will be 15 million pesos.
How will you record the provision?
Answer:
Environmental clean-up expense 15 M
Estimated liability 15M

#8
During 2022, Grizz Company guaranteed a supplier's P500,000 loan from a bank. On October 1, 2023, the
entity was notified that the supplier had defaulted on the loan and filed for bankruptcy protection. Counsel
believed that the entity would probably have to pay P250,000 under the guarantee.
What amount should be reported as liability on December 31, 2023?
Answer:
The guarantee should be accrued as a provision because the loss is probable and the amount can be reasonably
estimated, according to the counsel P250,000 is the best estimated amount.

#9
During 2021, Ice Company became involved in a tax dispute with the BIR. On December 31, 2021, the tax
advisor believed that an unfavorable outcome was probable and a reasonable estimate of additional taxes was
P500,000. After 2022 financial statements were issued, the entity received and accepted a BIR settlement offer
of P550,000.
What amount of accrued liability should have been reported on December 31, 2021?
Answer:
The reasonable estimate of P500,000 is recorded.
The accepted BIR offer is not recorded because it was made after the statement are issued. In 2022, when the
BIR settlement offers of P550,000 is accepted, an additional liability of P50,000 will be recognized.
#10
We had a budget for advertising services approved for this year with monthly breakdown. Total amount of the
budget was CU 130 000, however, until the year-end, we spent only CU 125 000. The bills from advertising
company total CU 115 000, with CU 10 000 still unbilled at the year-end.
Are we going to recognize a provision based on the budget?
Answer:
No, you cannot, unless you have some conditions in the contract with the advertising company about minimum
billing per year.
If there are no such conditions, then there’s no past event and neither constructive nor legal obligation for
payment was created.
Therefore, no provision based on the budget.

CONTINGENT LIABILITY

#1

On November 18, 2021, Pearl Inc. entered into a 1.5 million lawsuit with Ms. Puff Company over a potential
copyright infringement. Pearl Inc. feels this settlement is probable, so they record the liability as;
November 18, 2021
Legal Expense P 3.5 million
Accrued Liability P 3.5 million

Even though the court will be going to decide on March 12, of 2023.

On March 12, of 2023, as expected Pearl Inc. loss the case against Ms. Puff company, but instead of 3.5 million
the court decided that the actual cost of damages is less 1.5 million than what the Pearl Inc. have already
estimated.
How are we going to record the actual payment?
Answer:
Accrued Liability 2 million
Cash 2 million
Accrued Liability 1.5 million
Legal Expense 1.5 million
#2
Steve’s Sports store offers a one-year warranty on repairs and replacement for all the soccer goal they sell.
Steve’s Sports management notices that some of its soccer goals have rusted screws that require replacement,
but they have already sold goals with this problem to customers.
Can we consider this problem a contingent liability?
Answer:
There is a probability that someone who purchased the soccer goal may bring it in to have the screws replaced.
Not only does the contingent liability meet the probability requirement, it also meets the measurement
requirement.

#3
Suppose that Rigby Ltd. is a pharmaceutical company developing a formula of medicine that cures diabetes.
Cregg Ltd. filed a lawsuit of $1,500 million against Rigby Ltd. for theft of its patent at the same time. Rigby
Ltd. feels they will lose the lawsuit and have to pay Cregg Ltd.
In that case, how will Rigby Ltd. be going to records this contingent liability in their books of accounts?
Answer:
Legal expense 1,500,000
Accrued expense 1,500,000

#4
On December 15, 2022 Star company truck was involve in an accident with a car driven by an employee. On
January 23 of the following year, the company received a notice of a lawsuit for 100,000 damages for personal
injuries suffered by the employee. Star company legal counsel believes that there is a possible lost.
Are we going to assess this as contingent liabilities?
Answer:
Yes because, in order to be a contingent liability, it must be possible to estimate its value and have more than a
50% chance of being realized.

#5
A corporation is facing litigation. Their lawyers inform them that there is a 70% chance that the company will
not have to pay damages, and a 30% possibility of damages arising.
How should the management recognize such a liability?
Answer:
The possibility of an actual outflow of economic resources to meet a possible obligation is 30%. So, while such
an obligation arising is possible, it is not probable. So, the company can recognize this as a contingent liability
and disclose it in their notes to accounts. No accounting entry has to be passed.
#6
Assume that a company is facing a lawsuit from a rival firm for patent infringement. The company’s legal
department thinks that the rival firm has a strong case, and the business estimates a P 2 million loss if the firm
loses the case.
How would the firm post an accounting entry?
Answer:
Because the liability is both probable and easy to estimate, the firm posts an accounting entry on the balance
sheet.
Legal expense P 2 million
Accrued expense P 2 million

#7
A bike manufacturer offers a three-year warranty on bicycle seats, which cost 50 each. If the firm manufactures
1,000 bicycle seats in a year and offers a warranty per seat, the firm needs to estimate the number of seats that
may be returned under warranty each year.
If, for example, the company forecasts that 200 seats must be replaced under warranty for P 50
How are we going to record the warranty?
Answer:
Warranty liability P 10,000
Accrued warranty liability P 10,000

At the end of the year, the accounts are adjusted for the actual warranty expense incurred.

#8
To illustrate, assume that Micro Printing Company manufactures and sells high-speed laser printers for personal
computers.
The retail price per unit is P 1,200, and each printer is guaranteed that the firm will repair the unit free of charge
during 3-year period. During the 2022 the firm sold 2,000 printers.
Past experience indicates that Micro Printing will incur an average of 9,000 expense.
How are we going to record the estimated product warranty expense for 2022?
Answer:
Product Warranty Expense 9,000
Estimated Warranty Payable 9,000
#9
A construction company has got in a 3 years contract of building a bridge in Batanes, Batanes is prone to
different calamities, but in 3 years different calamities didn't cause any damages to the bridge, but since the
place is prone to different calamities there is a chance that the bridge will incur damages due to calamities.
Are we going to record contingent liability in our books?
Answer:
This is a situation where the chance of a future event is quite probable, but the estimation of liability is difficult.
The loss can’t be accurately measured. For this reason, the contingent liability can’t be recorded in the books,
but can be shown in the Foot Notes.

#10
On October 28, 2021, BOB Inc. entered into a lawsuit with Patrick Company over a potential copyright
infringement. Patrick company is seeking 2.5 million php settlement to be decided on March 12, of 2023. BOB
Inc. feels this settlement is probable.
On what date should BOB Inc. should recognize the liability and how much?
Answer:
Since the liability is probable, BOB company should record the liability now.

October 28, 2021

Legal Expense P 2.5 million
Accrued Liability P 2.5 million

And if the court rules are in favor with the compliant BOB Inc. should record,

March 21, 2023

Accrued liability P 2.5 million
Cash. P 2.5 million

INCOME TAXES

#1

Pluto’s Corporation reported a 500,000-gross income in accounting income but not in taxable income. The
temporary difference is expected to be reported the following year in 2023. The income tax rate is 40%.
 2022 2023
Accounting income 7,000,000 9,500,000
Taxable income 6,500,000 9,000,000
How do we get the amount of the income tax payable for the 2022?
Answer:
(Income Tax Payable = Income tax rate * Taxable income)
= 40% * 6,500,000
= 2,600,000 is the amount of Income tax payable for 2022.

#2
With the given provided below, compute for the deferred tax liability of Mickey’s Company.
2021 2022
Accounting income 5,000,000 8,000,000
Taxable income 4,000,000 7,000,000

Income tax rate is 25%

PAS 12, paragraph 15, stated that a deferred tax liability shall be recognized for all taxable temporary
differences. Deferred tax liability is the amount of income tax payable in future periods with respect to a taxable
temporary difference.
Answer:
Deferred tax liability = Total income tax expense – Current expense

Total income tax expense = (rate * accounting income 2021)

Current expense = (rate * taxable income 2021)

Total income tax expense (25% * 5,000,000) 1,250,000

Current expense (25% * 4,000,000) 1,000,000
Deferred tax liability = 250,000

#3
Donald’s Company reported a gross income on installment sale of P 750,000 in accounting income but not in
taxable income. This temporary difference is expected to be reported in taxable income in 2022. The income tax
rate is 30%.
How do we record Deferred tax liability for the year 2021 and 2022?
Answer:
Deferred tax liability (30% * 750,000) = 225,000

For 2021
Income tax expense 225,000
Deferred tax liability 225,000

Same for 2022

Income tax expense 225,000
Deferred tax liability 225,000

#4
How do we prepare a journal entry for the current tax expense of Mini Corp. for the year 2021 and 2022, with
the following given?
2021 2022
Accounting income 7,000,000 10,000,000
Taxable income 5,000,000 8,000,000

Income tax rate 45%.

Answer: Income tax payable = (income tax rate * taxable income)

For 2021
Income tax payable = (45% * 5,000,000)
Income tax payable = 2,250,000

Journal Entry
Income tax expense 2,250,000
Income tax payable 2,250,000

For 2022
Income tax payable = (45% * 8,000,000)
Income tax payable = 3,600,000

Journal Entry
Income tax expense 3,600,000
Income tax payable 3,600,000
#5
We are given that Tom Corporation’s income tax payable is P 450,000 and its tax rate is 30%, which means its
taxable income before taxes is?
Answer:
Income tax payable/Tax rate = Taxable income
450,000/30% = P 1,500,000

#6
How do we calculate the net income of Jerry’s Company with the given below;
P 700,000 Taxable income
P 250,000 Income tax payable
20% Income Tax rate
Answer:
Net Income = Income before taxes – Income tax expense
Net Income = P 700,000 – P 250,000
Net Income = P 450,000

Therefore, Jerry’s Company net income is P 450,000.

#7
Zoro’s Company received an advance payment for rent of 500,000 which was subject to tax but not reported in
accounting income until 2022. The income tax rate is 40%.
2021 2022
Accounting income 4,000,000 8,000,000
Taxable income 5,500,000 7,900,000
How to record the current tax expense for 2021?
Answer:
To record the current tax expense for 2021
Income tax expense 2,200,000
Income tax payable (40% * 5,500,000) 2,200,000

#8
Given the following below, compute the current expense for 2021.
 2020 2021
Accounting income 5,000,000 7,000,000
Taxable income 4,700,000 6,600,000

Income tax rate is 30%.

Answer:
(Current expense = income tax rate * taxable income)
= 30% * 6,600,000
Current expense = 1,980,000

#9
How do we calculate the decrease in deferred tax asset of Mikey’s Corporation for 2023 with the given below;
2022 2023
Accounting income 3,000,000 6,000,000
Taxable income 3,500,000 5,600,000

The income tax rate is 30%

Answer:
Total income tax expense – current expense = decrease in deferred asset
Total income tax expense (30% * 6,000,000) = 1,800,000
Current expense (30% * 5,600,000) = 1,680,000
1,800,000 – 1,680,000 = 120,000 is the decrease in deferred asset.

#10
Bruno’s Corporation received a 500,000 gross income subject to taxable income but not reported in accounting
income. The income tax rate is 40%.
2021 2022
Accounting income 3,000,000 9,500,000
Taxable income 3,500,000 9,000,000

What is the amount of income tax expense for the year 2021 and 2022?
For 2021
Income tax expense = income tax rate * taxable income
Income tax expense = 40% * 3,500,000
Income tax expense = 1,400,000

For 2022
Income tax expense = income tax rate * taxable income
Income tax expense = 40% * 9,000,000
Income tax expense = 3,600,000