Audit of Liabilities

7-1 Current Liabilities

The data below are from the records of ALMANOR, INC. on December 31, 2010:
Accounts Payable P 680,000
Cash balance, ABC Bank 1,240,000
Cash overdraft with XYZ Bank 80,000
Customers’ accounts with credit balances 25,000
Dividends in arrears on preference shares 400,000
Employees’ income tax payable 100,000
Estimated Warranty payable 50,000
Estimated premium claims outstanding 90,000
Income tax payable 400,000
Notes payable (issued in 2010 maturing in 20 semi-annual
Installments beginning on April 1, 2011) 4,000,000
Salaries payable 400,000

The amount to be shown as total current liabilities on Almanor’s statement of financial

position at December 31, 2010, is: P2,225,000

7-2 Recording Purchases: Gross Method to Net Method

SAIMAA CORP. records its purchases at gross amounts but wishes to change to
recording purchases net of purchases discounts. Discounts in purchases recorded from
January 1, 2010 to December 31, 2010, totaled P80,000. Of this amount, P8,000 is still
available in the accounts payable balance. The balance in Saimaa’s accounts as of and
for the year ended December 31, 2010, before conversion are:

Purchases P 4,000,000
Purchase discounts 32,000
Accounts Payable 1,200,000

1. The amount of purchase discounts lost to be recognized is: P40,000

2. The accounts payable balance should be reduced by: P 8,000
3. The purchases account should be reduced by: P80,000
4. The entry to record the conversion is:

Purchase discounts lost 40,000

Purchase discounts 32,000
Accounts payable 8,000
Purchases 80,000
7-3 Accrued Expenses

ANGLIN CORPORATION must determine the December 31, 2010, year-end accruals
for advertising and rent expenses. A P50,000 advertising bill was received January 10,
2011, comprising costs of P37,500 for advertisements in December 2010 issues, and
P12,500 for advertisements in January 2011 issues of the newspaper.

A store lease, effective December 16, 2009, calls for fixed rent of P120,000 per month,
payable one month from the effective date and monthly thereafter. In addition, rent
equal to 5% of net sales over P6,000,000 per calendar year is payable on January 31 of
the following year. Net sales for 2010 were P7,500,000.

What is the total accrued liabilities that should be reported by Anglin Corporation on its
statement of financial position as at December 31, 2010? P172,500

7-4 Bonus Computation

Ana Rosa, president of the APOKA COMPANY, has a bonus arrangement with the
company under which she receives 10% of the net income (after deducting taxes and
bonuses) each year. For the current year, the net income before deducting either the
provision for income taxes or the bonus is P4,650,000. The bonus is deductible for tax
purposes, and the tax rate is 30%.

1. Determine the amount of Ana Rosa’s bonus. B=P304,206

2. Compute the appropriate provision for income tax for the year. T=P1,303,738
3. Prepare the entry to record the bonus (which will be paid in the following year).

Bonus expense 304,206

Bonus Payable 304,206

7-5 Premiums

PUKAKI COMPANY sold 700,000 boxes of “puto mix” under a new sales promotional
program. Each box contains one coupon, which if submitted with P40, entitles the
customer to a kitchen knife. Pukaki pays P60 per knife and P5 for handling and
shipping. Pukaki estimates that 70% of the coupons will be redeemed, even though only
250,000 coupons had been processed during 2010.

How much should Pukaki report as liability for unredeemed coupons at December 31,
2010? P6,000,000
7-6 Premiums
In packages of its products, PLACID, INC. includes coupons that may be presented at
retail stores to obtain discounts on other Placid products. Retailers are reimbursed for
the face amount of coupons redeemed plus 10% of that amount for handling costs.
Placid honors requests for coupon redemption by retailers up to 3 months after the
consumer expiration date. Placid estimates that 60% of all coupons issued will
ultimately be redeemed. Information relating to coupons issued by Placid during 2010 is
as follows:

Consumer expiration date Dec. 31, 2010

Total payments to retailers as of Dec. 31, 2010 P165,000
Liability for unredeemed coupons as of Dec. 31, 2010 P 99,000

What is the total face amount of coupons issued by Placid, Inc. in 2010? P400,000

7-7 Liability for returnable containers

OMEGA COMPANY sells its products in expensive, reusable containers. The customer
is charged a deposit for each container delivered and receives a refund for each
container returned within two years after the year of delivery. Omega accounts for the
containers not returned within the time limit as being sold at the deposit amount.
Information for 2010 is as follows:

Containers held by customers at

December 31, 2009,
from deliveries in: 2008 85,000
2009 240,000 325,000
Containers delivered in 2010 430,000
Containers returned in 2010
from deliveries in: 2008 57,500
2009 140,000
2010 157,000 354,500

1. How much revenue from container sales should be recognized for 2010? P27,500
2. What is the total amount of Omega Company’s liability for returnable containers at
December 31, 2010? P373,000

7-8 Various Transactions Involving Current Liabilities

Described below are certain transactions of ASHBY COMPANY:

Feb 2 The company purchased goods from Happy Corp. for P150,000 subject to cash
discount terms of 2/10, n/30. The company records purchases and accounts
payable at net amounts after cash discounts. The invoice was paid on February
25.

Apr 1 The company purchased a truck for P120,000 from Broom Motors Corp., paying
P12,000 in cash and signing a one-year, 12% note for the balance of the
purchase price.

May 1 The company borrowed P240,000 from Manila Bank by signing a P276,000
noninterest-bearing note due one year from May 1.

Aug 1 The company’s board of directors declared a P900,000 cash dividend that was
payable on September 10 to shareholders of record on August 31.

1. Prepare all the journal entries necessary to record the transactions described above.

Feb 2 Purchases 147,000

Accounts Payable 147,000

Feb 25 Accounts Payable 147,000

Purchase discounts lost 3,000
Cash 150,000

Apr 1 Trucks 120,000

Cash 12,000
Note payable 108,000

May 1 Cash 240,000

Discount on note payable 36,000
Note payable 276,000

Aug 1 Retained earnings 900,000

Dividends payable 900,000

2. Assume that Ashby Company’s financial year ends on December 31 and that no
adjusting entries relative to the transactions above have been recorded. Prepare any
adjusting journal entries concerning interest that are necessary to present fair financial
statements at December 31.
 Dec 31 Interest expense 9,720
Interest payable 9,720

Interest expense 24,000

Discount in notes payable 24,000

7-9 Accounting for Warranties and Premiums

OLSON MUSIC EMPORIUM carries a wide variety of musical instruments, sound
reproduction equipment, recorded music, and sheet music. To promote the sale of its
products, Olsen uses two promotion techniques – premiums and warranties.

PREMIUMS
The premium is offered on the recorded and sheet music. Customers receive a coupon
for each P10 spent on recorded music and sheet music. Customers may exchange 200
coupons and P200 for a CD player. Olson pays P340 for each CD player and estimates
that 60% of the coupons given to customers will be redeemed. A total of 6,500 CD
players used in the premium program were purchased during the year and there were
1,200,000 coupons redeemed in 2010.

WARRANTIES
Musical instruments and sound reproduction equipment are sold with a one-year
warranty for replacement of parts and labor. The estimated warranty cost, based on
past experience, is 2% of sales. Replacement parts and labor for warranty work totaled
P1,640,000 during 2010.

Olson uses the accrual method to account for the warranty and premium costs for
financial reporting purposes. Olson’s sales for 2010 totaled P72,000,000 – P54,000,000
from musical instruments and sound reproduction equipment and P18,000,000 from
recorded music and sheet music. The balances in the accounts related to warranties
and premiums on January 1, 2010, were as shown below:

Inventory of premium CD players P399,500

Estimated premium claims outstanding 448,000
Estimated liability from warranties 1,360,000

Based on the preceding information, determine the amounts that will be shown on the
2010 financial statements for the following:

1. Warranty expense P1,080,000

2. Estimated liability from warranties P 800,000
3. Premium expense P 756,000
4. Inventory of premium CD players P 569,500
5. Estimated premium claims outstanding P 364,000

7-10 Accounting for Noninterest-bearing Note

On December 31, 2010, BAIKAL COMPANY acquired a piece of equipment from Seller
Company by issuing a P1,200,000 note, payable in full on December 31, 2014. Baikal’s
credit rating permits it to borrow funds from its several lines of credit at 10%. The
equipment is expected to have a 5-year life and a P150,000 salvage value. The present
value of 1 at 10% for 4 periods is 0.68301.

1. What is the equipment’s book value on December 31, 2012? P551,767

2. What is the carrying value of the note at December 31, 2012? P991,730

7-11 Accounting for Noninterest-bearing Note (Payable in Installments)

OHRID COMPANY purchased machinery on December 31, 2010, paying P80,000
down and agreeing to pay the balance in four equal installments of P60,000 payable
each December 31. Implicit in the purchase price is an assumed interest if 12%.

The following data are abstracted from the present value tables:

Present value of 1 at 12% for 4 periods 0.63552

Present value of an ordinary annuity of 1 at 12% for 4 periods 3.03735

1. What is the cost of the machinery purchased on December 31, 2010? P262,241
2. How much interest expense should be reported on Ohrid’s income statement for the
year ended December 31, 2011? P21,869
3. What is the carrying value of the note at December 31, 2012? P101,403

7-12 Note Payable

On October 1, 2010, BALATON CORP. issued a P500,000, 12-month, 12% note to
ABC Company in payment of account. On the same date, the company borrowed
P1,000,000 from the Asian Bank by signing a 12-month, noninterest-bearing note,
P1,120,000 note.

1. Prepare adjusting journal entries at December 31, 2010.

Dec 31 Interest expense 15,000

Interest payable 15,000

Interest expense 30,000

 Interest payable 30,000

2. What is the total/net liability to be reported on the December 31, 2010, statement of
financial position for:

a. the interest-bearing note? P 515,000

b. the noninterest-bearing note? P1,030,000

7-13 Note Payable: Adjustments for Interest

Described below are certain transactions of TUNIS COMPANY.

1. On April 1, the corporation bought a truck for P400,000 from General Motors
Company, paying P40,000 in cash and signing a one-year, 12% note for the balance of
the purchase price.

2. On May 1, the corporation borrowed P800,000 from Prudent Bank by signing a

P920,000 noninterest-bearing note due one year from May 1.

Prepare any adjusting journal entries to present fair financial statements at December
31.

Dec 31 Interest expense 32,400

Interest payable 32,400

Interest expense 80,000

Interest payable 80,000

7-14 Analyzing Various Transactions Involving Liabilities

In conjunction with your firm’s examination of the financial statements of BATUR, INC.
as of December 31, 2010, you obtained the information from the company’s voucher
register shown in the work paper below.

Item Entry Voucher Account

No. Date Reference Description Amount Charged
1 12/18/10 12-200 Supplies, shipped FOB destination,
12/15/10; received 12/17/10 P 15,000 Supplies on hand

2 12/18/10 12-203 Auto insurance, 12/15/10-12/15/11 22,000 Prepaid Insurance

3 12/21/10 12-209 Repairs services; received 12/20/10 19,000 Repairs & maintenance

4 12/26/10 12-212 Merchandise, shipped FOB shipping

point, 12/20/10; received 12/24/10 123,000 Inventory

5 12/21/10 12-210 Payroll, 12/7/10 – 12/21/10

(12 working days) 69,000 Salaries and wages

6 12/21/10 12-234 Subscription to industry magazine Dues & subscriptions

for 2011 5,000 expense (prepaid)

7 12/28/10 12-236 Utilities for December 2010 24,000 Utilities expense

8 12/28/10 12-241 Merchandise, shipped FOB destination,

12/24/10; received 1/2/11 111,500 Inventory (excluded)

9 12/28/10 12-242 Merchandise, shipped FOB destination,

12/24/10; received 1/2/11 84,000 Inventory (excluded)

10 1/2/11 1-1 Legal services; received 12/28/10 46,000 Legal and professional
fees expense (e-add)

11 1/2/11 1-2 Medical services for employees for

December 2010 25,000 Medical expense (add)

12 1/5/11 1-3 Merchandise, shipped FOB shipping

point, 12/29/10; received 1/4/11 55,000 Inventory (add)

13 1/10/11 1-4 Payroll, 12/21/10 – 1/5/11 (12 working

days in total, 4 working days in
January 2011) 72,000 Salaries and wages
(48k)

14 1/10/11 1-6 Merchandise, shipped FOB shipping

point, 1/2/11; received 1/6/11 64,000 Inventory

15 1/12/11 1-8 Merchandise, shipped FOB destination,

1/3/11; received 1/10/11 38,000 Inventory

16 1/13/11 1-9 Maintenance services; received 1/9/11 9,000 Repairs & maintenance

17 1/14/11 1-10 Interest on bank loan, 10/10/10 - 1/10/11 30,000 Interest

expense(26,739)

18 1/15/11 1-11 Manufacturing equipment; installed

12/29/10 254,000 Machinery &
equipment(add)
19 1/15/11 1-12 Dividend declared, 12/15/10 160,000 Dividends payable
(add)

Accrued liabilities as of December 31, 2010, were as follows:

Accrued payroll P48,000

Accrued interest payable 26,666
Dividends payable 160,000

The accrued payroll and accrued interest payable were reversed effective January 1,
2011.

Review the data given above and prepare journal entries to adjust the accounts on
December 31, 2010. Assume that the company follows FOB terms for recording
inventory purchases.

Dec 31, 2010 Insurance expense 917

Prepaid insurance 917

Prepaid dues and subscriptions 5,000

Dues and subscriptions expense 5,000

Accounts payable 111,500

Inventory 111,500

Accounts payable 84,000

Inventory 84,000

Legal and professional fees expense 46,000

Accounts payable 46,000

Medical expenses 25,000

Accounts payable 25,000

Inventory 55,000
Accounts payable 55,000

Machinery and Equipment 254,000

Accounts payable 254,000
7-15 Loss Contingency

On November 1, 2010, 69 passengers on CANYON AIRLINES Flight No. 143 were

injured upon landing when the plane skidded off the runway. Personal injury suits for
damages totaling P10,000,000 were filed on January 12, 2011, against the airline by 21
injured passengers. The airline carries no insurance. Legal counsel has studied each
suit and advised Canyon that it can reasonably expect to pay 70% of the damages
claimed. The financial statements for the year ended December 31, 2010, were
authorized for issue on February 12, 2011. During the past decade, the company has
experienced at least one accident per year and incurred average damages of
P4,100,000.

1. Prepare the journal entry that should be made as of December 31, 2010, to recognize
the loss.

Loss from uninsured accident 7,000,000

Liability for uninsured accident 7,000,000

7-16 Currently Maturing Debt Expected to be Refinanced

NAMEKUS COMPANY has the following three loans payable scheduled to be repaid in
February of next year. The company’s accounting year ends on December 31.

a. The company intends to repay Loan 1 for P100,000 when it comes due in
February. In the following October, the company intends to get a new loan for
P80,000 from the same bank.

b. The company intends to refinance Loan 2 for P150,000 when it comes due in
February. The refinancing agreement, for P180,000, will be signed in April, after
the financial statements for this year have been authorized for issue.

c. The company intends to refinance Loan 3 for P200,000 before it comes due in
February. The actual refinancing, for P175,000, took place in January, before the
financial statements for this year have been authorized for issue.

1. As of December 31 of this year, the total current liabilities to be reported on the

company’s statement of financial position should be: P450,000

2. As of December 31 of this year, the total noncurrent liabilities to be reported on the

company’s statement of financial position should be: P0
7-17 Short-term Loan Refinancing
The following items are based on the financial statements of CARMEL COMPANY.

Current assets P 750,000

Short-term loan payable 600,000
Total liabilities 3,000,000
Current ratio 1.5
Debt-equity ratio 1.5

1. Compute the following:

a. Total current liabilities P 500,000
b. Total shareholders’ equity P2,000,000
c. Total noncurrent liabilities P2,500,000

7-18 Debt Restructuring: Asset Swap

CAREY CO. owes P1,998,000 to Loan Shark Corp. The debt is a 10-year, 11% note.
Because Carey Co. is in financial trouble, Loan Shark Corp. agrees to accept land and
cancel the entire debt. The land has a book value of P800,000 and a fair market value
of P1,200,000.

What entry should be made by Carey Co. for the debt restructure?

Notes payable 1,998,000

Land 800,000
Gain on restructuring of debt 1,198,000

7-19 Debt Restructuring

NAKURU CORPORATION is having financial difficulty and therefore has asked Naawa
Bank to restructure its P3 million note outstanding. The present note has 3 years
remaining and pays a current rate of interest of 12%. The note was issued at its face
value.

Presented below are two independent situations. Prepare the journal entry that Nakuru
would make for each of the following types of debt restructuring.

a. Naawa Bank agrees to accept land in exchange for relinquishing its claim on this
note. The land has a book value of P2,000,000 and a fair value of P2,500,000.
b. Naawa Bank agrees to reduce the principal balance due to P2,000,000 and interest
rate to 10%.
The following present value factors are abstracted from the present value tables.
12% 10%
Present value of 1 for 3 periods 0.71178 0.75132
Present value of an ordinary annuity of 1 for 3 periods 2.40183 2.48685

a. Asset Swap
Notes Payable 3,000,000
Land 2,000,000
Gain on restructuring of debt 1,000,000

b. Substantial Modification of Terms

Note payable – old 3,000,000
Discount on notes payable 96,074
Note payable – new 2,000,000
Gain on debt restructuring 1,096,074

7-20 Classification of Debt

At December 31, 2010, KISU COMPANY’s liabilities include the following:

1. P10 million of 10% notes are due on March 31, 2015. The financing agreement
contains a covenant that requires Kisu to maintain current assets at least equal
to 200% of its current liabilities. As of December 31, 2010, Kisu has breached
this loan covenant. On February 10, 2011, before Kisu’s financial statements are
authorized for issue, Kisu obtained a period of grace from Mayumi Bank until
January 31, 2012, having convinced the bank that the company’s normal 3 to 1
ratio of current assets to current liabilities will be reestablished during 2011.

2. P15 million of non-cancelable 12% bonds were issued at face value on

September 30, 1989. The bonds mature on August 31, 2011. Kisu expects to
have sufficient cash available to redeem the bonds at maturity.

3. P20 million of 10% bonds were issued at face value on June 30, 1991. The
bonds mature on June 30, 2020, but bondholders have the option to call
(demand payment on) the bonds on June 30, 2011. However, the call option is
not expected to be exercised, given prevailing market conditions.

What portion of Kisu Company’s debt should be reported as noncurrent liability? P0

7-22 Analysis of Amortization Schedule

LARIO COMPANY issued a 10-year bonds on January 1, 2010. The company’s year-
end is December 31, and financial statements are prepared annually. The amortization
and interest schedule below reflects the bond issuance and the subsequent interest
payments and charges.

AMORTIZATION SCHEDULE
Interest Amount
Date Interest Paid Expense Unamortized Carrying Value
1/1/2010 -- -- P28,253 P471,747
12/31/2010 P55,000 P56,610 26,643 473,357
12/31/2011 55,000 56,803 24,840 475,160
12/31/2012 55,000 57,019 22,821 477,179
12/31/2013 55,000 57,261 20,560 479,440
12/31/2014 55,000 57,533 18,027 481,973
12/31/2015 55,000 57,837 15,190 484,810
12/31/2016 55,000 58,177 12,013 487,987
12/31/2017 55,000 58,558 8,455 491,545
12/31/2018 55,000 58,985 4,470 495,530
12/31/2019 55,000 59,470* -- 500,000
*Adjustment due to rounding.

1. What is the nominal (stated) interest rate of the bonds issued on January 1, 2010? 11%
2. What is the effective interest rate of the bonds issued on January 1, 2010? 12%
3. On the basis of the schedule presented, what is the journal entry to record the
issuance of the bonds on January 1, 2010?
Cash 471,747
Discount on bonds payable 28,253
Bonds payable 500,000

7-23 Classifying Liabilities

ELEANOR CORP. has been producing quality disposable diapers for more than two
decades. The company’s fiscal year runs from April 1 to March 31. The following
information relates to the obligations of Eleanor as of March 31, 2010.

BONDS PAYABLE

Eleanor issued P10,000,000 of 10% bonds on July 1, 2008. The prevailing market rate
of interest for these bonds was 12% on the date of issue. The bonds will mature on July
1, 2008. Interest is paid semiannually on July 1 and January 1. Eleanor uses the
effective interest rate method to amortize bond premium or discount.

The following present value factors are taken from the present value tables:
 Present value of 1 at 12% for 10 periods 0.32917
Present value of 1 at 6% for 20 periods 0.31180
Present value of an ordinary annuity of 1 at 12% for 10 periods 5.65022
Present value of an ordinary annuity of 1 at 6% for 20 periods 11.46992

NOTES PAYABLE
Eleanor has signed several long-term notes with financial institutions. The maturities of
these notes are given in the schedule below. The total unpaid interest for all of these
notes amounts to P600,000 on March 31, 2010.
Due Date Amount Due
April 1, 2010 P 400,000
July 1, 2010 600,000
October 1, 2010 300,000
January 1, 2011 300,000
April 1, 2011 – March 31, 2012 1,200,000
April 1, 2012 – March 31, 2013 1,000,000
April 1, 2013 – March 31, 2014 1,400,000
April 1, 2014 – March 31, 2015 800,000
April 1, 2015 – March 31, 2016 1,000,000
P7,000,000
ESTIMATED WARRANTIES
Eleanor has a one-year product warranty on some selected items in its product line. The
estimated warranty liability on sales made during the 2008-2009 fiscal year and still
outstanding as of March 31, 2009 amounted to P180,000. The warranty costs on sales
made from April 1, 2009 through March 31, 2010, are estimated at P520,000. The
actual warranty costs incurred during the current 2009-2010 fiscal year are as follows:
Warranty claims honored on 2008-2009 sales P180,000
Warranty claims honored on 2009-2010 sales 178,000
Total warranty claims honored P358,000

OTHER INFORMATION
1. TRADE PAYABLES
Accounts payable for supplies, goods and services purchased on open account
amount to P740,000 as of March 31, 2010.

2. PAYROLL RELATED ITEMS

Accrued salaries and wages P300,000
Withholding taxes payable 94,000
Other payroll deductions 10,000
Total P404,000
3. MISCELLANEOUS ACCRUALS
Other accruals not separately classified amount to P150,000 as of March 31, 2010.

4. DIVIDENDS
On March 15, 2010, Eleanor’s board of directors declared a cash dividend of P0.20
per ordinary share and a 10% stock dividend. Both dividends were to be distributed
on April 12, 2010, to the shareholders of record at the close of business on March 31,
2010. Data regarding Eleanor ordinary share capital are as follows:

Par value P 5.00 per share

Number of shares issued and outstanding 6,000,000 shares

Market values of ordinary shares:

March 15, 2010 P 22.00 per share
March 31, 2010 21.50 per share
April 12, 2010 22.50 per share

1. How much was received by Eleanor from the sale of the bonds on July 1, 2008?
P8,852,960
2. What is the current portion of Eleanor’s notes payable at March 31, 2010?
P1,600,000
3. The balance of the estimated warranties payable at March 31, 2010, is:
P342,000
4. On March 31, 2010, Eleanor’s statement of financial position would report total
current liabilities of: P5,286,000
5. On March 31, 2010, Eleanor’s statement of financial position would report total
noncurrent liabilities of: P14,370,783

7-24 Bond Redemption Prior to Maturity Date

The following data were obtained from the initial audit of HANSTEEN COMPANY:

15%, 10-year, Bonds Payable, dated January 1, 2009

Debit Credit Balance
Cash proceeds from issue on January 1, 2009
of 1,000, P1,000 bonds. The market rate of
interest on the date of issue was 12%. P1,172,044 P1,172,044

Bond Interest Expense

Cash paid, 1/2/10 P75,000 P75,000
Cash paid, 7/1/10 75,000 150,000
Accrual. 12/31/10 75,000 225,000
 Accrued Interest on Bonds
Balance, 1/1/10 P75,000 P75,000
Accrual. 12/31/10 75,000 150,000

Treasury Bonds
Redemption price and interest to date on 200
P265,00
bonds permanently retired on Dec. 31, 2010 0 P265,000

1. Carrying value of bonds payable at December 31, 2010: P921,266

2. Loss on bond redemption P 19,683
3. Accrued interest on bonds at December 31, 2010 P 60,000
4. Bond interest expense for the year ended December 31, 2010 P139,174

7-25 Bond Redemption Prior to Maturity Date

The long-term debt section of ELMO COMPANY’s statement of financial position as of
December 31, 2009, included 9% bonds payable of P400,000, less unamortized
discount of P32,000. Further examination revealed that these bonds were issued to
yield 10%. The amortization of the bond discount was recorded using the effective
interest method. Interest was paid on January 1 and July 1 of each year. On July 1,
2010, Elmo retired the bonds at 105 before maturity.

What is the amount of loss to be recognized on the retirement of bonds? P51,600

7-26 Bond Refunding

MALOMBE CORP. had outstanding P6,000,000 of 11% bonds (interest payable July 31
and January 31) due in 10 years. On July 1, it issued P9,000,000 of 10%, 15-year
bonds (interest payable July 1 and January 1) at 97. A portion of the proceeds was used
to call the 11% bonds at 103 on August 1. Unamortized bond discount and issue cost
applicable to the 11% bonds were P240,000 and P60,000, respectively.
Prepare journal entries to record the following:
a. sale of the new issue
Cash 8,730,000
Discount on bonds payable 270,000
Bonds payable 9,000,000

b. retirement of the old issue

Bonds payable 6,000,000
Loss on redemption of bonds 480,000
Cash 6,180,000
Discount on bonds payable 240,000
 Unamortized bond issue costs 60,000
7-27 Convertible Debt Issue
On January 1, 2010, DIAS COMPANY issued a 3-year, 4,000 convertible bonds at face
value of P1,000 per bond. Interest is to be paid annually in arrears at the stated coupon
rate of 6%. Each bond is convertible, at the holder’s option, into 200 P2 par value
ordinary shares at any time up to maturity. On the date of issuance, the prevailing
market interest rate for similar debt without the conversion privilege was 9%. On the
same date, the market price of one ordinary share was P3. The bonds were converted
on December 31, 2011.

The following present value factors are obtained from the present value tables:

6% 9%
Present value of 1 for 3 periods 0.83962 0.77218
Present value of an oridnary annuity of 1 for 3 periods 2.67301 2.5313
Present value of an annuity due of 1 for 3 periods 2.83339 2.75911

1. The liability component of the convertible debt is: P3,696,232

2. The equity component of the convertible debt is: P 303,768
3. The interest expense to be reported on Dias Company’s income statement for the
year ended December 31, 2011, is: P 341,000
4. The entry to record the bond conversion on December 31, 2011, should include a
credit to share premium – issuance of: P2,593,661

7-28 Deferred Tax Liability

EYASI, INC. began operating on January 1, 2010. At the end of the first year of
operations, Eyasi reported P7,500,000 income before income taxes on its income
statement but only P700,000 taxable income on its tax return. Analysis of the
P6,800,000 difference revealed that P6,200,000 was a permanent difference and
P600,000 was a temporary difference related to a current asset. At the end of 2011, the
accumulated temporary tax liability difference related to future years is P1,100,000. The
enacted tax rate is 30% for 2010 and 2011.

1. The journal entry to adjust the deferred tax liability at the end of 2011 should include
a: Credit to Deferred tax liability of P150,000.

2. Assume that at the end of 2011, the accumulated temporary tax liability difference
related to future years is P550,000. What journal entry should be made to adjust the
deferred tax liability at the end of 2011?

Deferred tax liability 15,000

 Income tax expense 15,000
7-29 Deferred Income Tax Asset and Liability
At December 31, 2009, GALILEE CORPORATION had a temporary difference (related
to depreciation) and reported a related deferred tax liability of P60,000 on its statement
of financial position. At December 31, 2010, Galilee has four temporary differences. An
analysis of these reveals the following:
Future Taxable (Deductible)
Amounts
Temporary Difference 2011 2012 Later Year
1. Use of straight-line depreciation for
accounting purposes and accelerated
depreciation for tax purposes P160,000 P220,000 P760,000

2. Rent collected in advance; recognized when

earned for accounting purposes and when received
for tax purposes. (380,000) --

3. Various expenses accrued when incurred for

accounting purposes; recognized for tax
purposes when paid. (90,000) -- --

4. Recognition of gain on installment sales

during the period of sale for accounting
purposes and during the period of collection for
tax purposes. 276,000 210,000 --
(P34,000) P430,000 P760,000
Assume that the company has income taxes of P435,000 due per the tax return for
2010. The installment receivable collectible in 2012 is classified as noncurrent. The
enacted tax rate is 30% for all periods.

1. What amount of deferred tax asset should be shown on Galilee’s statement of

financial position at December 31, 2010? P 141,000
2. What amount of deferred tax liability should be shown on Galilee’s statement of
financial position at December 31, 2010? P 487,800
3. How much is Galilee’s pretax accounting income for 2010? P2,406,000
4. How much is Galilee’s net income for 2010? P1,684,200

7-30 Deferred Income Tax Asset and Liability

The following data pertain to the CARROLL COMPANY.

1. At December 31, 2010, the company has a P900,000 liability reported for estimated
litigation claims. This P900,000 balance represents amounts that have been charged to
income but are not tax deductible until they are paid. The company expects to pay the
claims and thus have tax-deductible amounts in the future in the following manner:
Year Payments
2013 P 150,000
2014 690,000
2015 60,000
P 900,000
2. The company uses different depreciation methods for financial reporting and tax
purposes. Consequently, at December 31, 2010, the company has a cumulative
temporary difference due to depreciable property of P2,400,000. This P2,400,000
cumulative temporary difference is to result in taxable amounts in future years in the
following manner:
Year Amount
2011 P 480,000
2012 480,000
2013 480,000
2014 480,000
2015 480,000
P2,400,000
3. The income tax rate is 30%.
4. Taxable income for 2010 is P2,400,000. The company expects to report taxable
income for next five years.
5. No temporary differences existed at the end of 2009.

1. The deferred tax liability to be reported on Carroll’s statement of financial position at

December 31, 2010, is: P 720,000
2. The deferred tax asset to be reported on Carroll’s statement of financial position at
December 31, 2010, is: P 270,000
3. The amount of current income tax payable to be reported on Carroll’s statement of
financial position at December 31, 2010, is: P 720,000
4. Carroll’s pretax accounting income for 2010 is: P3,900,000
5. Carroll’s net income for 2010 is: P2,730,000

7-31 Deferred Income Tax Asset and Liability

KAMPESA, INC., in its first year of operations, has the following differences between
the carrying value and tax base of its assets and liabilities at the end of 2010:
Carrying Value Tax Base
Equipment (net) P800,000 P680,000
Estimated warranty liability 400,000 0
Kampesa estimates that the warranty liability will result in taxable amounts as shown
below:
Year Amount
2011 P 40,000
2012 60,000
2013 20,000

The company has taxable income of P1,040,000 for 2010. The income tax rate is 30%.

1. What amount of deferred tax liability should be reported on Kampesca’s statement of

financial position at December 31, 2010? P 36,000
2. What amount of deferred tax asset should be reported on Kampesca’s statement of
financial position at December 31, 2010? P120,000
3. What is the amount of income tax payable (current) to be reported on Kampesca’s
statement of financial position at December 31, 2010? P312,000
4. What is the total income tax expense for 2010? P228,000

7-32 Liability under Finance Lease

On December 31, 2009, LEMAN CO. signed a 10-year non-cancelable lease agreement
to lease a storage building from Storage Company. The following information pertains to
this lease agreement:

1. The agreement requires equal rental payments of P720,000 beginning on

December 31, 2009.
2. The fair value of the building on December 31, 2009, is P4,400,000.
3. The building has an estimated economic life 12 years, with an unguaranteed
residual value of P100,000. Leman depreciates similar buildings on the straight-
line method.
4. The lease is nonrenewable. At the termination of the lease, the building reverts to
the lessor.
5. Leman’s incremental borrowing rate is 12% per year. The lessor’s implicit arte
is not known by Leman.
6. The yearly rental payment includes P24,705 of executor costs related to taxes on
the property.

The following present value factors are for 10 periods at 12% annual interest rate:
Present value of an annuity due of 1 6.32825
Present value of an ordinary annuity of 1 5.65022
Present value of 1 0.32197
1. What amount should be capitalized as the cost of the lease storage building?
P4,400,000
2. What amount should be included in the current liabilities section of Leman’s
statement of financial position at December 31, 2010? P 280,818
3. What amount should be included in the noncurrent liabilities section of Leman’s
statement of financial position at December 31, 2010? P3,173,157
4. What is the total lease-related expenses to be reported on Leman’s income
statement for the year ended December 31, 2010? P 909,270

7-33 Liability under Finance Lease

JACOMO COMPANY enters into a lease agreement with Lessor Co. on July 1, 2010, to
lease a machine to be used in its manufacturing operations.

The following data pertain to this agreement:

1. The term of the non-cancelable lease is 3 years, with no renewal option and no
residual value at the end of the lease term. Payments of P212,024 are due on
July 1 of each year, beginning July 1, 2010.

2. The fair value of the machine on July 1, 2010, is P620,000. The machine has a
remaining economic life of 5 years, with no salvage value. The machine reverts
to the lessor upon termination of the lease.

3. Jacomo Company elects to depreciate the machine on the straight-line method.

4. Jacomo Company’s incremental borrowing rate is 10% per year, and it has no
knowledge of the implicit rate computed by the lessor.

5. The present value factor of an ordinary annuity of 1 for 3 periods at 10% per year
is 2.48685. The present value factor of an annuity due of 1 for 3 periods at 10%
is 2.73554.

How much lease liability should be recognized by Jacomo at the beginning of the lease
contract? P580,000