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CANNON BALL REVIEW PART 4I. CURRENT LIABILITIES – ESTMATED LIABILITIESPREMIUMS:a) Net cost or expense per premium = Cost per premium + Distribution cost (-) Customer remittance b) Total premium expense = Units sold x estimate of redemption x Net cost (a) c) Premium liability = Premium expense less N...

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CANNON BALL REVIEW PART 4 I. CURRENT LIABILITIES – ESTMATED LIABILITIES PREMIUMS: a) Net cost or expense per premium = Cost per premium + Distribution cost (-) Customer remittance b) Total premium expense = Units sold x estimate of redemption x Net cost (a) c) Premium liability = Premium expense less Net cost of premiums distributed WARRANTY: a) Warranty Expense (accrual method) = Sales x total percentage of expected repairs b) Warranty Liability = Warranty expense less actual expenditures of cost of services performed CUSTOMER LOYALTY LIABILITY: a) Allocate the proceeds from the total sale of the grocery items and the loyalty points by using the stand-alone price of each component. b) The allocated amount for the groceries shall be recognized immediately as sales revenue because the groceries or other items have been delivered to customers. c) The amount allocated to the loyalty points shall be a liability. But amortized as revenue as loyalty points are redeemed in exchange for free groceries and discounts. Apply the ratio of number of loyalty points redeemed to the expected total loyalty points expected to be redeemed. This will be subject to changes in “accounting estimates” in later periods. Hence, the cumulative amounts shall be computed and the amounts recognized in prior years are deducted to compute for the current year’s revenue. Problems 1. To increase sales, Lamar Company inaugurated a promotional campaign on June 30, 2017. Lamar placed a coupon redeemable for a premium in each package of cereal sold at P300. Each premium cost P200. A premium is offered to customers who send in 5 coupons and a remittance of P50. The distribution cost per premium is P10. Lamar estimated that only 80% of the coupons issued will be redeemed. For the six months ended December 31, 2017, the following is available: Packages of cereal sold Premiums purchased Coupons redeemed

50,000 8,000 30,000

1. What is the 2017 premium expense? a. 1,280,000 b. 1,600,000 c. 1,200,000 d. 1,500,000 2. What is the estimated liability for premiums on December 31, 2017? a. 320,000 b. 1,500,000 c. 400,000 d. 1,280,000 2. Jim Company includes one coupon in each box of laundry soap it sells. A towel is offered as a premium to customers who send in 10 coupons and a remittance of P5. Data for the premium offer are: Boxes of soap sold Number of towels purchased at P50 per towel Number of towels distributed as premium Number of towels to be distributed as premium next period 1. What is the 2016 premium expense? a. 1,575,000 b. 1,710,000

c. 1,800,000 d. 1,900,000

2016 1,000,000 40,000 35,000 3,000

2017 1,500,000 65,000 58,000 5,000

PAGE 2 2. What is the December 31, 2016 premium liability? a. 150,000 b. 225,000 c. 450,000 d. 135,000 3. What is the 2017 premium expense? a. 2,835,000 b. 2,700,000 c. 2,925,000 d. 2,250,000 4. What is the December 31, 2017 premium liability? a. 225,000 b. 360,000 c. 315,000 d. 250,000 3. During 2017, Luciana Company introduced a new product carrying a two-year warranty against defects. The estimated warranty costs related to peso sales are 3% within 12 months following sale and 5% in the second 12 months following sale. Sales and actual warranty expenditures for the years ended December 31, 2016 and 2017 are as follows: 2016 2017

Sales 40,000,000 50,000,000

Actual expenditures 1,000,000 5,000,000

1. What is the 2016 warranty expense? a. 1,200,000 b. 3,200,000 c. 2,000,000 d. 1,000,000 2. What is the December 31, 2016 warranty liability? a. 1,000,000 b. 2,000,000 c. 1,200,000 d. 2,200,000 3. What is the 2017 warranty expense? a. 4,000,000 b. 1,500,000 c. 5,000,000 d. 2,500,000 4. What is the December 31, 2017 warranty liability? a. 3,000,000 b. 1,500,000 c. 1,900,000 d. 1,200,000 4. Jordan Company, a grocery retailer, operates a customer loyalty program. The entity grants program members loyalty points when they spend a specified amount on groceries. Program members can redeem the points for further groceries. The points have no expiry date. During 2016, the entity granted 10,000 points with a “stand alone price” fair value of P100. Management expects that 8,000 of these points will be redeemed. The 2016 sales amounted to P7,000,000 during the year based on its stand-alone selling price. On December 31, 2016, 4,000 points have been redeemed in exchange for groceries. In 2017, the management revised its expectations and now expects 9,000 points to be redeemed altogether. During 2017, the entity redeemed 4,100 points. 1. What is the total revenue recognized year ended December 31, 2016? a. 7,000,000 b. 6,125,000 c. 6,562,500 d. 6,200,000

PAGE 3 2. What is the revenue earned from loyalty points for the year ended December 31, 2017? a. 787,500 c. 350,000 b. 400,000 d. 410,000 ANSWERS: A,A,B,D,B,A,A,D,A,D,C,C II. CURRENT LIABILITIES - CONTINUED a) Provisions are liabilities with uncertain timing and amounts. b) Provisions are measured by using the best estimate of the amount to settle the obligation at the balance sheet date. c) If there is a large population of items related to the measurement of the provision, each possibility is weighted by its associated probability (expected value method) d) If there is a range of possible outcomes and each point in that range is as likely as any other, the midpoint of the range is used to measure the provision. e) The provision is discounted if the expected settlement is long-term. If the provision is contractually reimbursable, the loss is net of the reimbursement but the provision is the total or gross amount. f) Deferred income like the sale of gift certificates, subscriptions and advances from customers are increased by receipts and decreased by the amounts earned and cancellations or forfeitures by the customers making the payments. Problems 1. The following information relate to Merck Company. Company Merck’s statement of financial position date is December 31, 2016. Assume that company Merck’s financial statements are authorized for issue on March 31, 2017. • An amount of P350,000 owing to Company Z for services rendered during December, 2016. • Long-service leave, estimated to be P5,000,000, owing to employees in respect of past services. • Costs of P2,300,000 estimated to be incurred for relocating an employee from Merck’s head office location to another city. The staff member will physically relocate during January 201 7. • Provision of P200,000 for the overhaul of a machine. The overhaul is needed every five years and the machine was five years old as of December 30, 2016. • Damages awarded against Merck Company resulting from a court case decided on December 20, 2016. The judge has announced that the amount of damages will be set at a future date, expected to be in April 2017. Merck Company has received advice from its lawyers that the amount of the damages could be anything between P4,000,000 and P5,000,000 How much is Merck Company’s provision in its December 31, 2016 statement of financial position? a. 4,500,000 c. 9,850,000 b. 9,500,000 d. 12,000,000 2. Loyola Company issued a P5,000,000 notes payable on April 1, 2016 bearing an interest rate of 12% that is compounded annually on March 31, 2016. If the principal and the interest is payable on maturity date, what is the accrued interest to be reported on Loyola’s December 31, 2017 statement of financial position? a. 1,200,000 c. 1,104,000 b. 1,272,000 d. 1,000,000 3. John Company sells gift certificates redeemable only when merchandise is purchased. The certificates have an expiration date of two years after issuance date. Upon redemption or expiration, John recognizes the unearned revenue as realized. Data for 2017 are as follows: Unearned revenue, 1/1/2017 Gift certificates sold Gift certificates redeemed Estimated gift certificates not to be redeemed Cost of goods sold At December 31, 2017, what should John report as unearned revenue for gift certificates? a. 1,500,000 b. 2,000,000 c. 1,000,000 d. 500,000

2,500,000 6,000,000 6,500,000 500,000 60%

PAGE 4 4. Tints Company requires advance payments with special orders for machinery constructed to customer specifications. These advances are nonrefundable. Data for the year are: Customer advances Advances received with orders in 2017 Advances applied to orders shipped Advances applicable to orders canceled in 2017

6,800,000 9,000,000 8,700,000 2,600,000

The December 31, 2017 statement of financial position should report current liability for advances at a. 4,500,000 c. 6,400,000 b. 7,100,000 d. 4,400,000 5. On November 5, 2017, Pia Company’s truck was in an accident with an auto driven by John. Pia received notice on January 15, 2018, of a lawsuit for P4,000,000 damages for personal injuries suffered by John. Pia’s counsel believes it is probable that John will be awarded an estimated amount in the range between P2,000,000 and P3,000,000, and no amount is a better estimate of potential liability than any other amount. The accounting year, ends on December 31, and the 2017 financial statements were issued on March 31, 2018. What amount of provision should Pia accrue at December 31, 2017? a. 4,000,000 c. 2,000,000 b. 0 d. 2,500,000 6. Aretha Company carries P5,000,000 comprehensive public liability insurance with a P500,000 deductible clause. A suit for personal injury damages was brought against Aretha in 2017. Aretha's counsel believes it probable that the insurance company will settle out of court for an estimated amount of P3,000,000. 1. What is the amount of provision at December 31, 2017? a. 5,000,000 b. 0 c. 500,000 d. 3,000,000 2. What is the loss to be recognized in 2017? a. 0 b. 2,750,000 c. 500,000 d. 3,000,000 ANSWERS: B, C, A, A, D, D, C III. BONDS PAYABLE a) The issue price is a percentage of the face value (ex. 109 is 109% of face value) b) The amount received from the issuance is increased is by the accrued interest from the last interest date if the bonds are issued in between interest date. However, the interest is a payable and not included in the carrying amount of the bonds payable. c) Direct cost to issue the bonds or bond issue cost is included in the carrying amount of the bonds as a deduction if the “amortized cost” is used. But expensed if the FV option is used. FV option is means the CA is the FV through profit or loss. d) The net premium or total discount is amortized using the effective interest method under amortized cost and not amortized under the FV option. The following relevant formulas apply: • Interest expense = CA x effective rate • Interest paid or payable = Face value x nominal rate • Effective interest less nominal interest equals amortization • Amortization of the discount increases the CA while amortization of the premium decreases the CA. • Amortization always increases while interest expense increases if discount and decreases if premium. e) Under FV option, the difference in the FV and previous CA is recognized in profit or loss unless the change is a result of credit risk. This amount is included in OCI. f) Bonds with warrants whether detachable or non-detachable and convertible bonds are known as compound financial instruments. The issue price shall be allocated to the bonds payable first that is measured at FV and the balance shall be what is known as the equity component and recorded as share premium.

PAGE 5 Problems 1. On March 1, 2017, Jericho Company issued 5,000 of its P1,000 face value bonds at 110 plus accrued interest. Jericho Company paid bond issue cost of P100,000. The bonds were dated November 1, 2016, mature on November 1, 2027, and bear interest at 12% payable semiannually on November 1 and May 1. What is the net amount received by Jericho from the bond issuance? a. 5,500,000 b. 5,700,000 c. 5,600,000 d. 6,000,000 2. On January 1, 2017, Gears Company issued 10,000 of its 12%, P1,000 face value bonds for P10,600,000, including accrued interest. The bonds are dated October 1, 2016, mature on October 1, 2023 and pay interest annually on October 1. The bonds were issued through an underwriter to whom Gears paid bond issue cost of P150,000. On January 1 2017, what should Gears report as bonds payable? a. 10,000,000 b. 10,450,000 c. 10,150,000 d. 10,3 00,000 3

On January 1, 2017, Cool Company issued eight-year bonds with a face value of P500,000 and a stated interest rate of 6%, payable semiannually on June 30 and December 31. The bonds were sold to yield 8%. Table values are: Present value of 1 for 8 periods at 6% ................................................... Present value of 1 for 8 periods at 8% ................................................... Present value of 1 for 16 periods at 3% ................................................. Present value of 1 for 16 periods at 4% ................................................. Present value of annuity for 8 periods at 6 % ......................................... Present value of annuity for 8 periods at 8% ......................................... Present value of annuity for 16 periods at 3% ....................................... Present value of annuity for 16 periods at 4% ....................................... 1

The present value of the principal is a. 267,000 b. 270,000

.627 .540 .623 .534 6.210 5.747 12.561 11.652

c. 311,500 d. 313,500

2. The present value of the interest is a. 172,410 b. 174,780

c. 186,300 d. 188,415

3. The issue price of the bonds is a. 441,780 b. 442,410

c. 444,780 d. 499,800

4. On January 1, 2017, Lucian Company issued 9% bonds in the amount of P5,000,000 which mature on January 1, 2027. The bonds were issued for P4,800,000 but Lucian had to pay for a P107,000 bond issuance cost. The effective rate determined by Lucian is 10%. Interest is payable annually on December 31. Lucian uses the interest method of amortizing bond discount. In its December 31, 2017 statement of financial position, what amount should Lucian report as bonds payable? a. 5,000,000 b. 4,693,000 c. 4,712,300 d. 4,723,700 5. On January 1, 2017, Christian Company issued its 5-year, 5,000, 8% bonds that will mature on December 31, 2021 and pay interest annually at 110. Christian however had to incur P80,000 of bond issue cost. The effective rate on the same date was 6%. If Christian uses the effective interest method of amortization, what is the carrying amount of this bonds payable on December 31, 2017 a. 5,345,200 b. 5,300,000 c. 5,420,000 d. 5,375,600

PAGE 6 6. On June 30, 2017, Maury Company had outstanding 12%, P5,000,000 face value bonds maturing on June 30, 2022. Interest was payable semiannually every June 30 and December 31. On June 30, 2017, after amortization was recorded for the period, the unamortized bond discount and bond issue costs were P500,000 and P300,000, respectively. On that date, Maury acquired all its outstanding bonds on the open market at 96 and retired them. At June 30, 2017, what amount should Maury recognize as loss before income tax on redemption of bonds? a. 600,000 c. 400,000 b. 500,000 d. 800,000 7. On December 31, 2017, Michelle Company issued 5,000 of its 12%, 10-year P1,000 face value bonds with detachable stock warrants at 110. Each bond carried a non-detachable warrant for ten shares of Michelle's P100 par value ordinary shares at a specified option price of P120. Immediately after issuance, the market value of the bonds ex-warrants was P4,800,000 and the market value of the warrants were ascertained to be P1,200,000. For the issuance of the bonds, what amount should be the increase in shareholders equity? a. 600,000 c. 700,000 b. 1,100,000 d. 1,200,000 8. On December 31, 2017, Armor Company issued P5,000,000 face value, 5-year bonds at 109. Each P1,000 bond was issued with 10 non-detachable stock warrants, each of which entitled the bondholder to purchase one share of P100 par value common at P120. Immediately after the issuance, the market value of each warrant was P5. The stated interest rate on the bonds is 11% payable annually every December 31. However, the prevailing market rate of interest for similar bonds without the warrants is 12%. The present value of 1 at 12% for 5 periods is 0.57 and the present value of an ordinary annuity of 1 at 12% for 5 periods is 3.60. On December 31, 2017, what amount should Armor record as increase in stockholders’ equity as a result of the bond issuance? a. 620,000 c. 250,000 b. 440,000 d. 0 10. Kart Company issued 4,000 convertible bonds on January 1, 2017. The bonds have a three-year term and are issued at par with a face value of P1,000 per bond. Interest is payable annually in arrears at a nominal 6% interest rate. Each bond is convertible at anytime up to maturity into 100 ordinary shares with par value of P5. When the bonds are issued, the prevailing market interest rate for similar debt instrument without conversion option is 9%. What is the equity component of the issuance of convertible bonds on January 1, 2017? (Round off present value factors to two decimal places). a. 2,000,000 c. 312,800 b. 920,000 d. 0 11. On July 1, 2017, after recording interest and amortization, Hymn Company converted P5,000,000 of its 12% convertible bonds into 60,000 shares of P50 par value ordinary shares. On the conversion date the carrying amount of the bonds was P6,000,000, the market value of the bonds was P6,500,000, and Hymn’s ordinary shares was publicly trading at P150 per share. Hymn paid P300,000 in connection with the conversion and other stock issue costs. The equity component on issue date of the bonds was P800,000. What is the share premium from issuance should Hymn record as a result of the conversion? a. 3,000,000 c. 2,000,000 b. 2,700,000 d. 3,500,000 12.On January 1, 2017, Gomez Company received P5,385,000 for a P5,000,000 face amount, 12% bond, a price that yields 10%. The bond pays interest semiannually. The entity elected to use the fair value option for valuing financial liabilities. On the December 31, 2017, the fair value of the bonds was determined to be P5,100,000. It was also determined that P50,000 of the decline in fair value was because of the effect of credit risk. 1.What is the gain or loss that should be recognized in the 2017 income statement? a. 285,000 gain c. 235,000 loss b. 285,000 loss d. 235,000 gain 2. What is the 2017 interest expense? a. 536,963 b. 600,000 ANSWERS: B, B, A, B, A, C, A, A, C, A, C, B, D, B

c. 538,500 d. 646,200

PAGE 7 IV. OPERATING LEASE LESSOR AND LEASEBACK a) Lessees now must treat all leases as finance lease unless it is only 1 year or shorter and determined to be low value items. b) The lessor shall recognize lease or rental income using the straight-line method over the lease term. c) If the rentals are uneven (increasing or decreasing) or there is a period where rentals are not paid. The total amount of rentals is computed and divided equally over the lease term. d) Contingent rentals are recognized as additional income by the lessor using the accrual method. e) Lease bonuses or prepayments (additional lumpsum amount received at the inception or start of the lease) should be deferred and amortized as additional rental income over the lease term. f) Initial direct cost is capitalized as cost of the leased asset and amortized as expense over the lease term. g) The depreciation on the asset and other expenses related to the ownership of the asset like insurance and taxes shall be recognized as an expense by the lessor. h) Sale and leaseback transactions are now treated differently from the side of the lessee. • The lessee shall automatically recognize a lease liability and capitalize the “right of use asset” account for the asset sold and leased back. • There is no problem if the selling price is at fair value. If the selling price is above fair value, the difference shall be treated as a lease incentive or additional financing and shall be deducted from the lease liability and other components in computing for the right of use asset. If the selling price is below fair value, the difference shall be treated as a lease prepayment and therefore added in computing for the cost of the right of use asset. • The entity shall compute the “right of use retai...