INTERMEDIATE ACCOUNTING 2 MODULE

Past Event
The past event that leads to a legal or constructive obligation is
known as the obligating event. It creates present obligation because
INTERMEDIATE ACCOUNTING the entity has no realistic alternative but to settle the obligation

2 MODULE created by the event.

Examples of Liabilities
SCOPE a. Accounts payable to suppliers for the purchase of goods.
In this module, the learner is able to demonstrate understanding of b. Amounts withheld from employees for taxes and for
key concept, uses and importance of Intermediate Accounting in real contributions to the SSS.
business world. c. Accruals for salaries, interest, rent, taxes, product warranties
and profit sharing bonus.
This course is a thorough study of accounting to gain sound d. Cash dividend declared but not paid.
understanding of generally accepted accounting principles governing e. Deposits and advances from customers.
recognition and measurement of current and noncurrent liabilities; f. Debt obligations for borrowed funds- notes, mortgages and
provision and contingents; restructuring of debt; and disclosures of bonds payable
leases. g. Income tax payable
h. Unearned revenue
OooOooO
 MEASUREMENT OF LIABILITIES
Conceptually, all liabilities are initially measured at present value
Chapter 1: and subsequently measured at amortized cost.
LIABILITIES- Introduction  Current Liabilities or short-term obligations
- Are recorded and reported at face amount.
Objectives:
The learner should be able to understand and know:  Noncurrent liabilities
 The concepts of liabilities. - Bonds payable and non-interest bearing note payable are
 How to describe the nature and type of current and initially measured at present value and subsequently
noncurrent liabilities. measured at amortized cost.
 The measurement of current and noncurrent liabilities. - Long-term note payable (interest bearing) is initially and
 How to explain the issue of long-term debt falling due within subsequently measured at face amount or amount equal
one year. to its present value.

Start of Discussion  CURRENT LIABILITIES

PAS 1 provides that an entity shall classify a liability as current
when:
 LIABILITIES a. The entity expects to settle the liability within the entity’s
The Revised Conceptual Framework for Financial Reporting operating cycle.
provides the following definition of liabilities: b. The entity holds the liability primarily for the purpose of trading.
c. The liability is due to be settled within twelve (12) months after
Liabilities are present obligations of an entity to transfer an the reporting period.
economic resource as a result of past events. d. The entity does not have an unconditional right to defer
settlement of the liability for at least twelve months after the
Essential Characteristics of an accounting liability are: reporting period.
a. The entity has a present obligation.
b. The obligation is to transfer an economic resource.  NONCURRENT LIABILITIES
c. The liability arises from past event. All liabilities not classified as current are classified as noncurrent
liabilities. It includes:
Present obligation a. Non-current portion of long-term debt
The present obligation may be a legal obligation or a constructive b. Finance lease liability
obligation. c. Deferred tax liability
 Obligations may be legally enforceable as a consequence of d. Long-term obligation to officers
binding contract or statutory requirement, e. Long-term deferred revenue
 Constructive obligations also give rise to liabilities by reason of
normal business practice, custom and desire to maintain good Long-term debt falling due within one year
business relations or act in an equitable manner. A liability which is due to be settled within twelve months after the
reporting period is classified as current, even if:
Transfer of economic resource a. The original term was for a period longer than twelve months.
The economic resource is the asset that represents a right with a b. An agreement to refinance or to reschedule payment on a long-
potential to produce economic benefits. Specifically, the obligation term basis is completed after the reporting period and before
must be to pay cash, transfer noncash asset or provide service at the financial statements are authorized for issue.
some future time.
INTERMEDIATE ACCOUNTING 2 MODULE
Covenants - are often attached to borrowing agreements which
represent undertakings by the borrower. Gift Certificates Payable
Breach of Covenants Many megamalls, department stores and supermarkets sell gift
If certain conditions relating to the borrower’s financial situation is certificates which are redeemable in merchandise. The accounting
breached, the liability becomes payable on demand. procedures are:

Liability is classified as current even if the lender has agreed, after 1. When the gift certificates are sold.
the reporting period and before the statements are authorized for Cash xxx
issue, not to demand payment as a consequence of the breach. Gift certificates payable xxx

Liability is noncurrent if the lender has agreed on or before the end 2. When the gift certificates are redeemed.
of the reporting period to provide a grace period ending at least Gift certificates payable xxx
twelve months after that date. Sales xxx

Grace period is period within which the entity cannot rectify the 3. When the gift certificates expire or when gift certificates are not
breach and during which the lender cannot demand immediate redeemed.
repayment. Gift certificates payable xxx
Forfeited gift certificates xxx
 Presentation of Current Liabilities
a. Trade and other payables Bonus Computation
b. Current provisions The main purpose of bonus is to motivate officers and employees by
c. Short-term borrowings directly relating well-being to the success of the entity.
d. Current portion of long-term debt
e. Current tax liability The bonus computation usually has four variations:
Illustration:
Estimated Liabilities Income before bonus and tax 4,400,000
- Are obligations which exist at the end of reporting period Bonus 10%
although their amount is not definite. Income tax rate 30%
- Estimated liabilities are either current or noncurrent in nature.
1. Bonus is expressed as a certain percent of income before bonus
Deferred Revenue and before tax.
- Or unearned revenue is income already received but not yet
earned. Income before bonus and tax 4,400,000
- May be realized within one year or in more than one year after Multiply by 10%
the end of the reporting period. Bonus 440,000
- Deferred revenue can either be current or noncurrent liability.
2. Bonus is expressed as a certain percent of income after bonus
Illustration: but before tax.
An entity sells equipment service contracts agreeing to service
equipment for a 2-year period. Cash receipts from contracts are B = .10 (4,400,000 – B)
credited to unearned service revenue and service contract costs are B = 440,000 - .10B
charged to service contract expense. B + .10B = 440,000
1.10B = 440,000
Revenue from service contracts is recognized as earned over the B = 440,000/1.10
service period of the contracts. B = 400,000

The following transactions occur in the first year: 3. Bonus is expressed as a certain percent of income after bonus
Cash receipts from service contracts sold 1,000,000 and after tax.
Service contracts costs paid 500,000
Service contract revenue recognized 800,000 B = .10 (4,400,000 – B – T)
T = .30 (4,400,000 – B)
Journal Entries for the First year: B = .10 [4,400,000 – B – .30 (4,400,000 – B)]
1. To record the cash receipts from service contracts sold: B = .10 (4,400,000 – B – 1,320,000 + .30B)
Cash 1,000,000 B = 440,000 - .10B – 132,000 + .03B
Unearned service revenue 1,000,000 B + .10B - .03B = 440,000 – 132,000
1.07B = 308,000
2. To record the service contract costs paid. B = 308,000/ 1.07
Service contract expense 800,000 B = 287,850
Cash 800,000 T = .30 (4,400,000 – 287,850)
T = 1,233,645
3. To record the service contract revenue recognized.
Unearned service revenue 800,000 4. Bonus is expressed as a certain percent of income after tax but
Service contract revenue 800,000 before bonus.
INTERMEDIATE ACCOUNTING 2 MODULE

B = .10 (4,400,000 – T) On March 1, 2021 before the 2020 financial statements were issued,
T = .30 (4,400,000 – B) the note payable of 1,000,000 was replaced by an 18-month note
B = .10 [4,400,000 – .30 (4,400,000 – B)] for the same amount.
B = .10 (4,400,000 – 1,320,000 + .30B)
B = 440,000 – 132,000 + .03B The entity is considering similar action on the P800,000 note due on
B - .03B = 440,000 – 132,000 May 1, 2021. The financial statements were issued on March
.97B = 308,000 31,2021.
B = 308,000/.97
B = 317,526 Required:
Compute for the (1) total current liabilities and (2) total noncurrent
Refundable Deposits liabilities.
- Consists of cash or property received from customers but
which are refundable after compliance with certain  Problem 1-3
conditions. Christian Company has an agreement to pay its sales manager a
bonus of 5% of the income after bonus and after tax. The income
Illustration: for the year before bonus and tax is P5,250,000. The income tax
A deposit of P10,000 is required from the customer for returnable rate is 30% of income after bonus.
containers. The containers cost P8,000.
Required:
Cash 10,000 Determine the bonus under each of the four variations of bonus
Container’s deposit 10,000 computation.

-End of Discussion-
 Problem 1-4:
SELF-CHECK TEST: Dunne Company sells equipment service contracts that cover a two-
 Problem 1-1 year period. The sale price of each contract is P600. The past
F Company provided the following information on December 31, experience is that, of the total pesos spent for repairs on service
2020: contracts, 40% is incurred evenly during the first contract year and
60% evenly during the second contract year.
Note payable:
Trade 3,000,000 The entity sold 1,000 contracts evenly throughout 2020.
Bank loans 2,000,000
Advances from officers 500,000 Required:
Accounts payable-trade 4,000,000 1. What is the contract revenue for 2020?
Bank overdraft 300,000 2. What amount should be reported as deferred service revenue
Dividends payable 1,000,000 on December 31, 2020?
Withholding tax payable 100,000 3. What is the contract revenue for 2021?
Mortgage payable 3,800,000 4. What is the contract revenue for 2022?
Income tax payable 800,000
Estimated warranty liability 600,000
Estimated damages payable by  Problem 1-4
reason of breach of contract 700,000 Farr Company sells products with reusable and expensive containers.
Accrued liabilities 900,000 The customer is charged a deposit for each container delivered and
Estimated premium liability 200,000 receives a refund for each container returned within two years after
Claim for increase in wages by employees the year of delivery.
covered in a pending lawsuit 3,500,000
Contract entered into for the construction Containers held by customers on January 1, 2020 from deliveries in:
of building 5,000,000 2018 75,000
2019 215,000 290,000
Required: Containers delivered in 2020 390,000
Compute for the total current liabilities on December 31, 2020. Containers returned in 2020 from deliveries in:
2018 45,000
 Problem 1-2 2019 125,000
C Company provided the following information on December 2020 143,000 313,000
31,2020:
What is the liability for deposits on December 31, 2020?
Accounts payable after deducting debit
balances in supplier’s accounts of P100,000 500,000
Accrued liabilities 50,000  Problem 1-5
Note payable- due March 31, 2021 1,000,000 Disable Company had the following amounts of long-term debt
Note payable- due May 1, 2021 800,000 outstanding on December 31, 2020:
Bonds payable- due December 31, 2022 2,000,000
INTERMEDIATE ACCOUNTING 2 MODULE
14% note payable, due 2021 30,000 8. Which of the following is a characteristic of a current liability but
11% note payable, due 2023 1,070,000 not a noncurrent liability?
8% note payable, due in 11 equal annual principal a. Unavoidable obligation
payments, plus interest beginning December 31,2021 1,100,000 b. Present obligation to transfer an economic resource.
7% guaranteed debentures, due 2022 1,000,000 c. Settlement is expected within the normal operating cycle or
within 12 months, whichever is longer.
The annual sinking fund requirement on the guaranteed debentures d. The obligating event has already occurred.
is P40,000 per year.
9. Which of the following is not considered a characteristic of a
What total amount should be reported as current liabilities on liability?
December 31, 2020? a. Present obligation
b. Arises from past event
 Multiple Choice Questions c. Results in a transfer of economic resource
1. The most common type of liability is d. Liquidation is reasonably expected to require use of current
a. One that comes into existence due to a loss contingency assets
b. One that must be estimated
c. One that comes into existence due to a gain contingency 10. Which of the following is not an acceptable presentation of
d. One to be paid in cash and for which the amount timing are current liabilities?
known a. Listing current liabilities in the order of maturity
b. Listing current liabilities according to amount
2. Which is not a characteristic of a liability? c. Offsetting current liabilities against assets that are to be
a. It represents a transfer of an economic resource applied to their liquidation
b. It must be payable in cash d. Showing current liabilities in the order of liquidation
c. It arises from present obligation to other entity preference
d. It results from past transactions or event

3. Classifying liabilities as either current or noncurrent helps

creditors assess
Chapter 2:
a. Profitability
b. The relative risk of an entity’s liabilities PREMIUM LIABILITY
c. The degree of an entity’s liabilities
d. The amount of an entity’s liabilities Objectives:
The learner should be able:
4. Short-term obligation are reported as noncurrent if  To know the recognition of a premium liability.
a. The entity has a long-term line of credit  To know the recognition of a cash rebate program.
b. The entity has tentative plan to issue long-term bonds  To know the recognition of a cash discount offer program
payable  To understand the recognition and measurement of a
c. The entity has the discretion to refinance as long-term customer loyalty program.
d. The entity has the ability to refinance on a long-term basis

5. Which situation would not require that noncurrent liabilities be Start of Discussion
reported as current?
a. The long-term debt is callable by the creditor
b. The creditor has the right to demand payment due to a  PREMIUMS
contractual violation - Are articles of value such as toys, dishes, silverware and
c. The long-term debt matures within the upcoming year. other goods given to customers as result of past sales or
d. All of these require the current classification sales’ promotion activities.

6. Which of the following represents a liability? The accounting procedures for the acquisition of premiums and
a. The obligation to pay for goods that an entity expects to recognition of the premium liability are as follows:
order from suppliers next year
b. The obligation to provide goods that customers have ordered 1. When the premiums are purchased:
and paid for during the current year Premiums xxx
c. The obligation to pay interest on a five-year note payable Cash xxx
that was issued the last day of the year 2. When premiums are distributed to customers:
d. The obligation to distribute an entity’s own shares Premium expense xxx
Premiums xxx
7. Which does not meet the definition of a liability? 3. For the outstanding premiums at the end of the year:
a. The signing of an employment contract at fixed salary Premium expense xxx
b. An obligation to provide goods or services in the future Estimated premium liability xxx
c. A note payable with no specified maturity date
d. An obligation that is estimated in amount
Illustration:
INTERMEDIATE ACCOUNTING 2 MODULE
An entity manufactures a certain product and sells it at P300 per During the current year, the entity issued coupons with face
unit. A soup bowl is offered to customers on the return of 5 amount of P5,000,000 and total payments to retailers amounted
wrappers plus a remittance of P10. to P1,100,000.

The bowl costs P50, and it is estimated that 60% of the Computation:
wrappers will be redeemed. The data for the first year Face Amount of coupons to be redeemed
concerning the premium plan are summarized below: (5,000,000 x 30%) 1,500,000
Multiply by 110%
Sales, 10,000 units at P300 each 3,000,000 Total coupon Liability 1,650,000
Soup bowl’s purchased, 2,000 units at P50 each 100,000
Wrappers redeemed 4,000 Cash discount coupon expense 1,650,000
Estimated coupon liability 1,650,000
Computation:
Wrappers to be redeemed 6,000 Estimated Coupon liability 1,100,000
Less: Wrappers redeemed 4,000 Cash 1,100,000
Balance 2,000
 CUSTOMER LOYALTY PROGRAM (IFRS 15)
Premiums to be distributed 400 - It is generally designed to reward customers for past
Estimated liability 16,000 purchases and to provide them with incentives to make
further purchases.
- If a customer buy goods or services, the entity grants the
 CASH REBATE PROGRAM customer award credits often described as “points”.
The estimated amount of the cash rebate should be recognized
both as an expense and an estimated liability in the period of Measurement
sale. - Award credits should be accounted as a separate component
of the initial sale transaction.
Illustration: - The fair value of the consideration received with respect to
An entity offered P500 cash rebate on a particular model of TV the initial sale shall be allocated between the award credits
set. The customers must present a rebate coupon enclosed in and the sale based on relative stand-alone selling price.
every package sold plus the official receipt. Past experience
indicates that 40% of the coupons will be redeemed. Recognition
The consideration allocated to the award credits is initially
During the current year, the entity sold 4,000 TV sets and total recognized as deferred revenue and subsequently recognized as
payments to customers amounted to P450,000. revenue when the award credits are redeemed.

Computation: Illustration:
Rebate coupons issued 4,000 An entity, a grocery retailer, operates a customer loyalty program.
Expected to be redeemed 40% The entity grants program members loyalty points when they spend
Coupon rebates to be redeemed 1,600 a specified amount on groceries. Program members can redeem the
Cash rebate per coupon 500 points for further groceries. The points have no expiry date.
Estimated rebate liability 800,000
The sales during 2020 amounted to P9,000,000 based on stand-
alone selling price. during 2020, the customers earned 10,000
Rebate Expense 800,000 points. But management expects that 80% or 8,000 of these points
Estimated Rebate Liability 800,000 will be redeemed. The stand-alone selling price of each loyalty point
is estimated at P100.
Estimated Rebate Liability 450,000
Cash 450,000 On December 31, 2020, 4,000 points have been redeemed in
exchange for groceries. In 2021, the management revised
expectations and now expects that 90% or 9,000 points will be
 CASH DISCOUNT COUPON redeemed altogether.
It is a popular marketing tool for the purpose of stimulating
sales. During 2021, the entity redeemed 4,100 points. In 2022, a further
900 points are redeemed. Management continues to expect that
Illustration: only 9,000 points will ever be redeemed, meaning, no more points
During the current year, an entity inserted in each package sold will be redeemed after 2022.
a coupon offering P300 off of purchase price of a particular
brand of product when the coupon is presented to retailers. Allocation of Transaction Price:
Product Sales 9,000,000
The retailers are reimbursed for the face amount of coupons plus Points (10,000 x P100) 1,000,000
10% for handling. Previous experience indicates that 30% of Total 10,000,000
coupons will be redeemed.
Product Sales (9/10 x 9,000,000) 8,100,000
INTERMEDIATE ACCOUNTING 2 MODULE
Points (1/10 x 9,000,000) 900,000
Total transaction price 9,000,000
-End of Discussion-
Journal Entries:
The initial sale in 2020 is recorded as follows: SELF-CHECK TEST:
Cash 9,000,000  Problem 2-1
Sales 8,100,000 Cassie Company manufactures a special laundry soap. A towel is
Unearned revenue – points 900,000 offered as a premium to customers who send in two proof of
purchase seals from the soap boxes and a remittance of P20.
Redemption of 4,000 points in 2020 Distribution cost is P5 per towel. Data for the premium offer are:
Unearned revenue – points 450,000
Sales 450,000 2020 2021
Soap sales 2,500,00
3,125,000
Redemption of 4,100 points in 2021 0
Unearned revenue – points 360,000 Towel purchases, P100 per towel 175,000 200,000
Sales 360,000 Number of towels distributed as premium 1,000 1,800
Number of towels expected to be
600 800
Points redeemed in 2020 4,000 distributed in subsequent period
Points redeemed in 2021 4,100
Total points redeemed to December 31,2021 8,100 Required:
1. Prepare journal entries for 2020 and 2021.
Cumulative revenue on December 31, 2021 2. Statement classification of the account balances pertaining to the
(8,100/9,000 x 900,000) 810,000 premium plan.
Revenue recognized in 2020 450,000
Revenue to be recognized in 2021 360,000
 Problem 2-2
Redemption of 900 points in 2021 Erika Company operates a customer loyalty program. The entity
Unearned revenue – points 90,000 grants loyalty points for goods purchased. The loyalty points can be
Sales 90,000 used by the customers in exchange for goods of the entity. The
points have no expiry date.
 Third Party operates Loyalty Program
An entity participates in a customer loyalty program operated by During 2020, the entity issued 50,000 award credits and expects
an airline. The entity grants program members one air travel that 80% of these award credits shall be redeemed. The stand-alone
point for every P1,000 spent on electrical goods. selling price of the award credits granted is reliably measured at
P1,000,000.
Program members can redeem the points for travel with the
airline subject to availability. The entity pays the airline P60 per In 2020, the entity sold goods to customers for a total consideration
each point. of P7,000,000 based on stand-alone selling price. The award credits
redeemed and the total award credits expected to be redeemed
During the current year, the entity sold electrical goods for each year are as follows:
consideration totaling P4,500,000 based on stand-alone selling
price and granted 5,000 points with stand-alone selling price of Redeemed Expected to be redeemed
P100 per point. 2020 15,000 80%
2021 7,950 85%
Computation: 2022 2,550 85%
Selling Price Fraction Allocated 2023 15,000 90%
Product sales 4,500,000 45/50 4,050,000
Points 500,000 5/50 450,000 Required:
5,000,000 4,500,000 Prepare journal entries from 2020 to 2023.

Revenue from points 450,000  Problem 2-3

Payment to airline (300,000) Chloe Company offers customers a pottery cereal bowl if they send
Net revenue from points 150,000 in three boxtops from its products and P10. The entity estimated
that 60% of the boxtops will be redeemed.
 To record the initial sale:
Cash 4,500,000 During the current year, the entity sold 675,000 boxes and
Sales 4,050,000 customers redeemed 330,000 boxtops receiving 110,000 bowls. The
Revenue from points 450,000 cost of ech bowl id P25.

 To record payment to airline: Required:

Loyalty program expense 300,000 1. What is the premium expense for the current year?
Cash 300,000 2. What is the liability for outstanding premiums at year-end?
INTERMEDIATE ACCOUNTING 2 MODULE
PAS 37 provides that a provision shall be recognized as a liability
in the FS under the following conditions:
 Multiple Choice Questions 1. The entity has a present obligation as a result of past event.
1. Providing a monetary rebate program 2. It is probable that an outflow of resources embodying
a. Is accounted fro similarly to a premium offer economic benefits would be required to settle the obligation.
b. Creates an expense for the seller in the period of sale 3. The amount of the obligation can be measured reliably.
c. Creates a liability for the seller at the time of sale
d. All of these are correct
 Accounting for Warranty
2. Accounting for the cost of incentive program for customer a. Accrual approach
purchases The accrual approach has the soundest theoretical support
a. Requires probability estimation because it properly matches cost with revenue.
b. Follows the matching principle
c. Is a loss contingency situation  The estimated warranty cost is recorded as follows:
d. All of these are correct Warranty expense xxx
Estimated warranty liability xxx
3. The cost of customer premium offer should be charged to
expense  When actual warranty cost is subsequently incurred and paid:
a. When the related product is sold Estimated warranty liability xxx
b. When the premium offers expires Cash xxx
c. Over the life cycle of the product to which the premium
relates
 Any difference between estimate and actual cost is a change in
d. When the premium is claimed
estimate and therefore treated currently or prospectively, if
4. The accounting concept that requires recognition of a liability for necessary.
customer premium offer is  If actual cost > estimate:
a. Time period Warranty expense xxx
b. Prudence Estimated warranty liability xxx
c. Historical cost
d. Matching principle  If actual cost< estimate:
Estimated warranty liability xxx
5. Accounting for cost of incentive program for frequent customer Warranty expense xxx
purchases involves
a. Recording an expense and a liability each period
Illustration:
b. Recording a liability and a reduction of revenue each period
An entity sells 1,000 units of television sets at P9,000 each for cash.
c. Recording an expense and an asset reduction each period
d. Recording an expense and revenue each period Each television set is under warranty for one year.

The entity has estimated from past experience that warranty cost
will probably average P500 per unit and that only 60% of the units
Chapter 3: sold will be returned for repair. The entity incurs P180,000 for
WARRANTY LIABILITY repairs during the year.
Journal Entries:
Objectives:  To record sales.
The learner should be able: Cash 9,000,000
 To understand the nature and purpose of warranty. Sales 9,000,000
 To ascertain the recognition of an estimated warranty  To set up the estimated liability on the warranty.
liability. Warranty expense 300,000
 To know the measurement of an estimated warranty liability. Estimated warranty liability 300,000
 To test the reasonable accuracy of an estimated warranty
liability. Estimated sets to be returned 600 sets
x Estimated warranty cost per set 500____
Estimated warranty cost 300,000
Start of Discussion
 To record the payment of the actual cost.
 WARRANTY Estimated warranty liability 180,000
- Guarantee or warranty to provide free repair service or Cash 180,000
replacement during a specified period if the products are
defective.
b. Expense as incurred approach
 Recognition of Warranty Provision The approach of expensing warranty cost only when actually
incurred. This approach is justified on the basis of expediency
INTERMEDIATE ACCOUNTING 2 MODULE
when warranty cost is not very substantial or when the warranty (3,000,000 x 10% x 6/12) 150,000
period is relatively short.
2023
 Sales made evenly 2nd contract year of July 1, 2021 sales
To have an easier interpretation or understanding of sales (3,000,000 x 10% x 6/12) 150,000
accruing evenly during the year, it is fair to assume that half of
the sales were made on January 1 and the other half on July 1. Total warranty expense for 2021 840,000

Illustration:
An entity sells refrigerators that carry a 2-year warranty against The warranty costs after December 31, 2021 represent the
defects. The sales and warranty repairs are made evenly throughout estimated warranty liability on December 31, 2021.
the year.
2020 sales still under warranty after December 31, 2021:
Based on the past experience, the entity projects an estimated 2nd contract year of July 1, 2020 sales 125,000
warranty cost as a percentage of sales as follows:
2021 sales still under warranty after December 31, 2021:
First year of warranty 4% 1st contract year of July 1, 2021 sales 60,000
Second year of warranty 10% 2nd contract year of Jan. 1, 2021 sales 300,000
2nd contract year of July 1, 2021 sales 300,000
Estimated warranty liability – Dec. 31, 2021 785,000
2020 2021
Estimated warranty liability per book 1,100,000
Sales 5,000,000 6,000,000
Decrease in Warranty Liability (315,000)
Actual warranty repairs 140,000 300,000

Computations:
 Warranty expense related to 2020 sales: -End of Discussion-
2020 SELF-CHECK TEST:
1st contract year of Jan. 1, 2020 sales  Questions:
(2,500,000 x 4%) 100,000 1. Explain warranty.
1st contract year of July 1, 2020 sales 2. What are the conditions for the recognition of a warranty
(2,500,000 x 4% x 6/12) 50,000 provision?
3. Explain the accrual approach of accounting for warranty cost.
2021 4. Explain the expense as incurred approach of accounting for
1st contract year of July 1, 2020 sales warranty cost.
(2,500,000 x 4% x 6/12) 50,000 5. Explain the sale of an extended warranty.
2 contract year of Jan. 1, 2020 sales
nd

(2,500,000 x 10%) 250,000  Multiple Choice Questions:

2 contract year of July 1,2020 sales
nd 1. The accrual approach in accounting for warranty
(2,500,000 x 10% x 6/12) 125,000 a. Is required for income tax reporting.
b. Is frequently justified on the basis of expediency
2022 c. Finds the expense account being charged when the seller
2nd contract year of July 1,2020 sales performs in compliance with the warranty
(2,500,000 x 10% x 6/12) 125,000 d. Represents accepted practice and should be used whenever
the warranty is an integral and inseparable part of the sale
Total warranty expense for 2020 700,000
2. Which of the following is a characteristic of the accrual of
 Warranty expense related to 2021 sales: warranty but not the sale of warranty?
2021 a. Warranty liability
1st contract year of Jan. 1, 2021 sales b. Warranty expense
(3,000,000 x 4%) 120,000 c. Unearned warranty revenue
1 contract year of July 1, 2021 sales
st d. Warranty revenue
(3,000,000 x 4% x 6/12) 60,000
3. Which of the following best describes the accrual approach of
2022 accounting for warranty cost?
1st contract year of July 1, 2021 sales a. Expensed when paid
(3,000,000 x 4% x 6/12) 60,000 b. Expensed when warranty claims are certain
2 contract year of Jan. 1, 2021 sales
nd c. Expensed based on estimate in year of sale
(3,000,000 x 10%) 300,000 d. Expensed when incurred
2nd contract year of July 1, 2021 sales
INTERMEDIATE ACCOUNTING 2 MODULE
4. What is the classification of the estimated warranty liability in a 4. Analyze the estimated warranty liability account to ascertain
three-year warranty? whether actual warranty costs approximate the estimate. The
a. Noncurrent sales and warranty repairs are made evenly during the year.
b. Current 5. Prepare journal entry to correct estimated warranty liability on
c. Partly current and partly noncurrent December 31, 2021.
d. No need for disclosure

5. Which of the following best describes the expense as incurred  Problem 3-2
approach of accounting for warranty cost? Bald Company estimated the annual warranty expense at 2% of
a. Expensed based on estimate in year of sale annual net sales. The net sales for 2020 amounted to P4,000,000.
b. Expensed when liability is accrued On January 1, 2020, the warranty liability was P60,000 and the
c. Expensed when warranty claims are certain warranty payments during 2020 totaled P50,000.
d. Expensed when incurred
Required:
 Problem 3-1 1. What is the warranty expense for 2020?
In 2020, Dubsmash Company began selling new line of products 2. What is the warranty liability on December 31, 2020?
that carry a two-year warranty against defects.

Based upon past experience with other products, the entity

estimated warranty costs as percentage of peso sales.
Chapter 4:
First year of warranty 2% PROVISION – Contingent Liability
Second year of warranty 10%
Objectives:
The learner should be able:
2020 2021  To understand the nature of a provision.
Sales 5,000,000 7,000,000  To know the conditions for the recognition of a provision.
Actual warranty repairs 100,000 300,000  To know the measurement of a provision.
 To identify measurement considerations for a provision.
Required:  To know the requirements for the recognition of contingent
1. What is the warranty expense for 2020? asset.
2. What is the warranty liability on December 31, 2020?
3. What is the warranty expense for 2021?
4. What is the warranty liability on December 31, 2021? Start of Discussion

 PROVISION
 Problem 3-2 - It is an existing liability of uncertain timing or uncertain
In 2020, Dare Company began selling a new calculator that carried a amount. The essence of a provision is that there is
two-year warranty against defects. The entity projected the uncertainty about the timing or amount of the future
estimated warranty cost as a percent of sales. expenditure.
- A provision may be the equivalent of an estimated liability or
First year of warranty 4% a loss contingency that is accrued because it is both probable
Second year of warranty 10% and measurable.

Sales and actually warranty repairs were:  Recognition of Provision

2020 a. The entity has a present obligation.
2021 b. It is probable that an outflow of resources embodying
Sales 5,000,000 economic benefits would be required to settle the obligation.
9,000,000 c. The amount of the obligation can be measured reliably.
Actual warranty repairs 200,000
560,000  Measurement of Provision
- The amount recognized as a provision should be the best
Required: estimate of the expenditure required to settle the present
1. Prepare journal entries in connection with the warranty using the obligation at the end of reporting period.
“expense as incurred” approach. - BEST ESTIMATE is the amount that an entity would rationally
2. Prepare journal entries in connection with the warranty using the pay to settle the obligation at the end of reporting period or
“accrual” approach. to transfer it to a third party at that time.
3. Determine the estimated warranty liability on December
31,2021.  Single obligation – most likely outcome
INTERMEDIATE ACCOUNTING 2 MODULE
 Continuous range of possible outcomes – midpoint of the range  Examples of Provision:
is used. a. Warranties
 Large population of items – weighting all possible outcomes by b. Environmental contamination
their associated probabilities. c. Decommissioning or abandonment costs
d. Court case
***Note: The amount of the provision shall be discounted if the
e. Guarantee
effect of the time value of money is material.
 RESTRUCTURING
- A program that is planned and controlled by management
Illustration 1: (expected value method) and materially changes either the scope of a business of an
An entity sells goods with a warranty under which customers are
entity or the manner in which that business is conducted.
covered for the cost of repairs of any manufacturing defects that
become apparent within 6 months after purchase.
 Events that may qualify as restructuring include:
If minor defects are detected in all products sold, repair costs would a) Sale or termination of a line of business
be about P1,000,000. If major defects are detected in all products b) Closure of business or business relocation
sold, repair costs of P5,000,000 would result. c) Change in management structure
d) Fundamental reorganization of an entity that has a material
The entity’s past experience and future expectations indicate that or significant impact on its operations.
75% of the goods sold will have no defects, 20% will have minor
defects and 5% will have major defects.  Provision for Restructuring
- Recognition of the provision for restructuring is required
The expected value or cost of repairs is measured a follows:
because a constructive obligation may arise from the decision
20% sales 200,000
to restructure.
5% sales 250,000
Total expected value or cost of repairs 450,000
Two conditions for a constructive obligation for restructuring
arise:
Illustration 2: 1. The entity has a detailed formal plan.
An entity is a defendant in a patent infringement suit. The lawyers 2. The entity has raised valid expectation in the minds of those
believe that there is a 60% chance that the court will not dismiss the affected that the entity will carry out the restructuring by
case and the entity will incur an outflow of future economic benefits. starting to implement the plan and announcing the main
features to those affected by it.
If the court rule against the entity and in favour of the claimant, the
lawyers believe that there is a 30% chance the entity will be  Amount of Restructuring Provisions
required to pay damages of P4,000,000 and a 70% chance that the A restructuring provision shall include only DIRECT
damages will be P2,000,000.
EXPENDITURES arising from restructuring and not associated
with the ongoing activities of the entity.
A 10% risk adjustment factor to the probabilities of the expected
cash flows is considered appropriate to reflect the uncertainties in
the cash flow estimate. PAS 37 excludes the following expenditures from the
restructuring provision:
Measurement of Provision a. Cost of retraining or relocating staff.
Weighted Probabilities: b. Marketing or advertising program to promote the new
30% x P4,000,000 x 60% 720,000 company image
70% x P2,000,000 x 60% 840,000 c. Investment in new system and distribution network.
Expected cash outflow 1,560,000
Risk adjustment factor (10% x 1,560,000) 156,000  CONTINGENT LIABILITY
Estimated amount of Provision 1,716,000 - It is a possible obligation that arises from past event and
whose existence will be confirmed only by occurrence or
non-occurrence of one or more uncertain future events not
 Other measurement considerations:
wholly within the control of the entity.
1. Risks and uncertainties
- It is a present obligation that arises from past event but is
2. Present value of obligation
not recognized because it is not probable that an outflow of
3. Future events
resources will be required to settle an obligation or the aount
4. Expected disposal of assets
of obligation cannot be measured reliably.
5. Reimbursements
6. Changes in provision
 Treatment of Contingent Liability
7. Use of provision
- Shall not be recognized in the financial statements but shall
8. Future operating losses
be disclosed only.
9. Onerous contract
INTERMEDIATE ACCOUNTING 2 MODULE
 CONTINGENT ASSET  To understand the nature and purpose of a bond.
- It is a possible asset that arises from past event and whose  To identify the types of bond.
existence will be confirmed only by occurrence or non-  To know the measurement of bonds payable.
occurrence of one or more uncertain future events not wholly  To understand the concept of bond premium and bond
within the control of the entity. discount.
- A contingent asset shall not be recognized because this may  To describe the methods of amortizing bond premium and
result to recognition of income that may never be realized. discount.
 To apply the fair value option of measuring bonds payable.
- It is only disclosed when it is probable.

Start of Discussion
 DECOMMISSIONING LIABILITY
An obligation to dismantle, remove and restore an item of
property, plant and equipment as required by law or contract. It  BOND DEFINITION
is also called asset retirement obligation. A bond is a contract of debt whereby one party called the issuer
borrows funds from another party called the investor.

Illustration: A bond is evidenced by a certificate and the contractual

An entity extracts natural gas and oil in the Philippine Deep. On agreement between the issuer and investor is contained in a
January 1, 2020, the entity constructed a drilling platform for document known as “bond indenture”.
P25,000,000 and is required by Philippine Law to remove and
dismantle the platform at the end of its useful life of 10 years.  TYPES OF BONDS
The straight line method is used in depreciating the drilling platform.  Term bonds
The entity has estimated that such decommissioning will cost  Serial bonds
P5,000,000.  Mortgage bonds
 Collateral trust bonds
Based a 12% discount rate, the present value of 1 for 10 years is  Debenture bonds
0.322. Thus the present value of the decommissioning liability is  Registered bonds
P1,610,000.  Coupon or bearer bonds
 Convertible bonds
Journal Entries for 2020 and 2021:  Callable bonds
2020  Guaranteed bonds
 Junk bonds
Jan. 1 Drilling platform 26,610,00
0  Zero-coupon bonds
Cash 25,000,000
Decommissioning liability 1,160,000  FEATURES OF BOND ISSUE
a. A bond indenture or deed of trust is the document which
Dec. 31 Depreciation 2,661,000 shows in detail the terms of the loan and the rights and
Accu. Depreciation 2,661,000 duties of the borrower and other parties to the contract.
b. Bond certificates are used.
Dec. 31 Interest expense 193,200 c. If property is pledged as security for the loan, a trustee is
Decommissioning liability 193,200 named to hold title to the property serving as security.
d. A bank or trust entity is usually appointed as registrar or
2021
disbursing agent.
Dec. 31 Depreciation 2,661,000
Accu. Depreciation 2,661,000
 CONTENTS OF BOND INDENTURE
Dec. 31 Interest expense 216,384 The bond indenture is the contract between the bondholders and
Decommissioning liability 216,384 the borrower or issuing entity.
a. Characteristics of the bonds
b. Maturity date and provision for repayment
Settlement of Decommissioning Liability c. Period of grace allowed to issuing entity
-End of Discussion- d. Deposit to cover interest payments
e. Required debt to equity ratio

 SALE OF BONDS
Chapter 5: When an entity sells a bond issue, it undertakes to pay the face
BONDS PAYABLE amount of the bond issue on maturity date and the periodic
interest.
Objectives:
The learner should be able:
INTERMEDIATE ACCOUNTING 2 MODULE
Interest is usually payable semi-annually or every six months. The learner should be able:
There are certain bonds that pay interest annually or at the end  To define a promissory note.
of every bond year.  To know the initial measurement of note payable.
 To understand the subsequent measurement of note payable
 MEASUREMENT OF BONDS PAYABLE at amortized cost.
 Initial measurement  To understand the fair value option of measuring note
payable.
Bonds payable not designated at FV through profit or loss
 To know the accounting for note payable issued solely for
shall be measured initially at fair value minus transaction
cash, interest-bearing note payable and non-interest bearing
costs that are directly attributable to the issue of the bonds
note payable issued for property.
payable.

Bond issue costs shall be deducted from the fair value or

Start of Discussion
issue price of the bonds payable in measuring initially the
bonds payable.
 NOTE PAYABLE
If bonds are designated and accounted for at “fair value A promissory note is an unconditional promise in writing made
through profit and loss”, the bond issue costs are treated as by one person to another, signed by the maker, engaging to pay
expense immediately. on demand or at a fixed or determinable future time a sum
certain in money to order or to bearer.
 Subsequent Measurement
 INITIAL MEASUREMENT OF NOTE PAYABLE
a. At amortized cost using the effective interest method
 Note payable not designated at FVPL
b. At fair value through profit or loss
Fair Value of Note Payable
Less: Transaction costs
Amortized cost is the amount at which the bond liability is
measured initially minus principal repayment, plus or minus the  Note Payable designated irrevocably at FVPL
cumulative amortization using the effective interest method of Present Value of the future cash payments
any difference between the face amount and present value of
the bonds payable.  SUBSEQUENT MEASUREMENT OF NOTE PAYABLE
a. At amortized cost using the effective interest method
Discount or Premium is the difference between the face amount b. At FVPL, if the note payable is designated irrevocably as
and the present value of the bonds payable. measured at fair value through profit or loss.

 ACCOUNTING FOR ISSUANCE OF BONDS Amortized Cost of Note Payable

a. Memorandum Approach Initial Measurement
b. Journal Entry Approach - Principal repayment
±Amortization of Discount or Premium
-End of Discussion-

 ISSUANCE OF NOTE PAYABLE

SELF-CHECK TEST:
A. Note issued solely for cash
Supersonic Company was authorized to issue 12%, 10-year bond
with face amount of P7,000,000 on April 1, 2020. Interest on the When a note is issued for cash, the present value is equal to
bonds is payable semi-annually on April 1 and October 1 of each the cash proceeds.
year.
B. Interest bearing note issued for Property
The bonds were sold to underwriters on April 1,2020 at 106. The When a property or noncash asset is acquired by issuing a
entity amortizes discount or premium only at the end of the fiscal promissory note which is interest bearing, the property or
year, using the straight line method. asset is recorded at the purchase price.

Required: C. Noninterest bearing note issued for property

1. Prepare journal entries for 2020 and 2021 including When a non-interest bearing note is issued for propery, the
adjustments at the end of each year. Use memorandum property is recorded at the cash price of the property. It is
approach.
assumed to be the present value of th note issued.
2. Present bonds payable in the statement of financial position
on December 31, 2020.
D. No Cash Price
The asset is equal to the present value of the note payable
Chapter 6: using the effective interest method.
NOTES PAYABLE
 Fair Value Option of measuring Note Payable
Objectives:
INTERMEDIATE ACCOUNTING 2 MODULE
Gain or loss on financial liability designated at FVPL shall be  To understand the nature of a compound financial
accounted for as follows: instrument.
 To identify common forms of compound financial instrument.
a. The change in fair value attributable to the credit risk is  To know the accounting for a compound financial instrument.
recognized in OCI.
b. The remaining amount of the change in fair value is
recognized Start of Discussion
In profit or loss.
 FINANCIAL INSTRUMENT
The amounts recognized in OCI resulting from change in fair value Any contract that gives rise to both a financial asset of one entity
attributable to credit risk shall not be subsequently transferred to and a financial liability or equity instrument of another entity.
profit or loss. However, cumulative gain or loss recognized may be
transferred within the equity or retained earnings. Characteristics of a Financial Instrument
 There must be a contract.
There is no amortization of discount or premium on note payable.  There are at least two parties to the contract.
The interest expense is based on the nominal or stated interest rate.  The contract shall give rise to a financial asset of one party
The transaction cost is expensed immediately. and financial liability or equity instrument of another party.

-End of Discussion- Examples of Financial Instrument

1. Cash in the form of notes and coins.
2. Cash in the form of form of checks.
SELF-CHECK TEST:
3. Cash in bank
Problem 1: 4. Trade accounts
On September 1, 2020, Trinoma Entertainment borrowed 5. Notes and loans
P24,000,000 cash to fund a new Fun Park. The loan was granted by 6. Debt securities
Solid Bank under a noncommited short-term line of credit 7. Equity securities
arrangement.
 FINANCIAL LIABILITY
Trinoma issued a 9-month, 12% promissory note. Interest was Any liability that is a contractual obligation:
payable at maturity. The fiscal period is the calendar year.  To deliver cash or other financial asset to another entity.
 To exchange financial instruments with another entity under
Required: conditions that are potentially unfavourable.
1. Prepare the journal entry for the issuance of the note by
Nonfinancial Liabilities
Trinoma.
 Deferred revenue
2. Prepare the appropriate adjusting entry for the note on
 Income tax payable
December 31, 2020.  Constructive obligations
3. Prepare the journal entry for the payment of the note at
maturity.  EQUITY INSTRUMENT
Any contract that evidences a residual interest in the assets of
Problem 2:
an entity after deducting all of the liabilities.
On January 1, 2020, West Company acquired a tract of land for  COMPOUND FINANCIAL INSTRUMENT
P1,000,000. The entity paid P100,000 down and signed a two-year A financial instrument that contains both a liability and an equity
promissory note for the balance plus 10% interest compounded element from the perspective of the issuer.
annually. The note matures on January 1, 2022.  Bonds payable issued with share warrants.
 Convertible bonds payable.
Required:
Prepare the journal entries to record:  ACCOUNTING FOR COMPOUND INSTRUMENT
1. Purchase of land on January 1, 2020.  The liability and equity component of a compound financial
2. Accrued interest on December 31, 2020. instrument shall be accounted for separately.
3. Accrued interest on December 31, 2021.
4. Full payment of the note payable note on January 1, 2022.  MEASUREMENT:
Liability Component – Fair Value of the Liability
Equity Component – Total Consideration received from
Chapter 7: Issuance of the compound financial instrument less the FV of
Liability.
COMPOUND FINANCIAL INSTRUMENTS
A. Bonds Payable issued with Share Warrants
Objectives:  Two securities are sold – the bonds and the share warrants.
The learner should be able:  Share warrants attached to a bond may be detachable or
 To define financial instrument. non-detachable.
 To describe a financial liability and an equity instrument.
INTERMEDIATE ACCOUNTING 2 MODULE
Allocation of Issue Price On December 31, 2020, the entire bond issue was converted and on
 Bonds – Market value of the bonds ex-warrant, this date, the market value of the share is 120 and the market value
regardless of the market value of the warrants. of the bonds is 103.
 Share warrants – residual amount or remainder of the
issue price. The entity paid P200,000 as a result of the bond conversion.

B. Convertible Bonds Required:

Are those which give the holders the right to convert their Prepare journal entries for the conversion of the bonds on December
bondholdings into share capital or other securities of the issuing 31, 2020.
entity within a specified period of time.
Problem 3:
Accounting problems arise in two situations, namely: At the beginning of current year, Fence Company issued 12%
a. When the convertible bonds are originally issued. P5,000,000 nonconvertible bonds at 103 which are due in 5 years.
The issuance of convertible bonds shall be accounted for as
partly liability (bonds payable) and partly equity (conversion In addition, each P1,000 bond was issued 30 share warrants, each
privilege). of which entitled the bondholder to purchase for P50 one share of
Fence Company par value P25. Interest is payable annually every
b. When the convertible bonds are converted. end of the year.
The carrying amount of the bonds is equal to the face amount
plus accrued interest if not paid, plus unamortized premium or On the date of issuance, the market value of the share was P40 and
minus unamortized discount and bond issue cost. the market value of the warrant was P4.

There is no gain or loss on conversion at maturity. The market rate of interest for similar bonds ex-warrants is 14%.
The present value of 1 at 14% for 5 periods is 0.52 and the present
-End of Discussion- value of an ordinary annuity of 1 at 14% for 5 periods is 3.43.

Required:
SELF-CHECK TEST: 1. What amount should be recognized as discount or premium on
Problem 1: the original issuance of the bonds?
At the beginning of current year, Monic Company decided to issue 2. What is the equity component arising from the issuance of bonds
5,000 10-year bonds 8% P1,000 face amount each with warrants to payable?
acquire share capital at P30 per share. The interest on the bonds is 3. What amount is credited to share premium if all of the share
payable annually every December 31. warrants are exercised?

Each bond contains one warrant which can be used to acquire 4

shares of P25 par value share capital.
Chapter 8:
It is reliably determined that without warrants, the bonds would sell DEBT RESTRUCTURE
at 114.7 with a 6% effective yield. The bond price with warrants is
120. All warrants are exercised at year-end. Objectives:
The learner should be able:
Required:  To understand the nature and purpose of debt restructuring.
Prepare journal entries for the current year in connection with the  To identify the types of debt restructuring.
bond issuance and the exercise of the warrants. Use effective  To know the accounting for an asset swap, equity swap and
interest method of amortization. modification of terms of the old liability.
Problem 2:
Karen Company showed the following accounts on December 31,
2020:
Start of Discussion

Bonds Payable 5,000,000  DEBT RESTRUCTURING

Premium on bonds payable 250,000
A situation where the creditor, for economic or legal reasons
Share capital – 250,000 shares authorized and
related to the debtor’s financial difficulties, grants to the debtor
200,000 shares issued, P50 par 10,000,000
Share premium – issuance 2,000,000 concession that would not otherwise be granted in a normal
Share premium – conversion privilege 500,000 business relationship.
Retained earnings 2,500,000
The objective of the creditor in a debt restructuring is to make
The bonds are convertible into 10 shares of capital for every P1,000 the best of a bad situation or maximize recovery of investment.
bond.
 TYPES OF DEBT RESTRUCTURING
1. Asset Swap
INTERMEDIATE ACCOUNTING 2 MODULE
Transfer by the debtor to the creditor of any asset, such as real -End of Discussion-
estate, inventory, receivables, and investment, in full payment of
an obligation.
SELF-CHECK TEST:
 IFRS
 Total liability to be settled Youth Company is in financial trouble and could not meet maturing
instalments and interest on its bank loan of P5,000,000. The accrued
- Carrying Amount of the asset to be transferred
interest on the loan to date is P1,000,000.
Gain/Loss on Extinguishment of Debt
The entity and the bank agreed on a “dacion en pago” arrangement.
 US GAAP Thus, the mortgaged land and building were given by the entity as
 Fair Value of Asset full payment for the loan including accrued interest.
- Carrying Amount of Asset
Gain/Loss on exchange or disposal The cost of the land is P1,500,000 and the building, P6,000,000 with
accumulated depreciation of P1,800,000. The fair value of the land
 Total Liability to be Extinguished and building is about P5,900,000.
- Fair value of Asset___________
Gain/Loss on Debt restructuring Required:
1. Compute the gain or loss on extinguishment of debt.
2. Prepare journal entry to record the dacion en pago.
2. Dacion en Pago Accounting
Arises when a mortgaged property is offered by the debtor in full
Rainbow Company showed the following balances on December 31,
settlement of the debt. 2020:
This transaction shall be accounted for as an asset swap form of
debt restructuring. Note payable- due December 31, 2020 1,000,000
Accrued interest payable 200,000
3. Equity Swap
Issuance of share capital by the debtor in full or partial payment The entity is in financial distress and negotiates with the creditor for
of an obligation. the settlement of the note payable.

 Measurement of Share Capital Consequently, the entity transferred a patent to the creditor in full
1) Fair value of Shares satisfaction of the note payable. The patent has a carrying amount
2) Fair value of liability of P600,000 and a fair value of P1,100,000.
3) Carrying amount of liability
Required:
Prepare the journal entry to record the asset swap on the books of
Rainbow Company.
 Total Liability to be Extinguished 1. Under IFRS
- Proper Measurement of Equity 2. Under US GAAP
Gain/Loss from Extinguishment of Debt
Quest Company is threatened with bankruptcy due to the inability to
4. Modification of Terms meet interest payments and fund requirements to retire P5,000,000
- Reduction of principal balance note payable with accrued interest payable of P400,000.
- Reduction of interest rate
- Extension of the term of liability The entity has entered into an agreement with the creditor to
exchange equity instruments for the financial liability.
New or Modified Liability
The terms of the exchange are 300,000 ordinary shares with P5 par
- measured at Present Value value and P10 market value, and P25,000 preference shares with
- similar to asset swap or equity swap P10 par value and P60 market value. The fair value of the liability is
P4,800,000.
Total Old Liability
- Present value of New Liability Required:
Gain/Loss on Extinguishment Prepare the journal entry on the books of Quest Company to record
the settlement of the note payable:
a) If gain or loss is at least 10% of the total old liability, amount 1. If the fair value of the equity instruments is used.
is material or substantial. There’s extinguishment, 2. If the fair value of the liability is used.
cancellation of old and issuance of new. 3. If the carrying amount of the financial liability is used.
b) If less than 10%
 Before, immaterial no gain or loss
 Now, there’s gain or loss but since its not substantial,
modification treatment.
Chapter 9:
INTERMEDIATE ACCOUNTING 2 MODULE
LEASE ACCOUNTING Components of Lease Payments
1. Fixed lease payments
Objectives: 2. Variable lease payments
The learner should be able: 3. Exercise price of a purchase option if the lessee is reasonably
 To define a lease under the new lease standard. certain to exercise the option
 To know the optional application of operating lease on the 4. Amount expected to be payable by the lessee under a
part of lessee. residual value guarantee
 To recognize a right of use asset in a finance lease. 5. Termination penalties if the lease term reflects the exercise
 To understand the measurement of a right of use asset. of a termination option.
 To recognize a lease liability in a finance lease.
 To understand the measurement of a lease liability In a Depreciation of right of use asset
finance lease. - If the lease transfers ownership of the underlying asset to the
lessee at the end of lease term, the depreciation of the right of
use asset is based on the useful life of the underlying asset.
Start of Discussion LEASE MODIFICATION
Lessee shall account for the lease modification as a separate lease
 LEASE under the following conditions:
A contract or part of a contract that conveys the right to use the a. Modification increases the scope of the lease by adding the
underlying asset for a period of time in exchange for right to use an additional underlying asset.
consideration. b. Rental for the lease modification increases by an amount
commensurate with the increase in scope and equivalent to
To be a lease, a contract must convey the right to control the the current market rental.
use of an identified asset.
B. LEASE ACCOUNTING – LESSOR
 RIGHT TO CONTROL THE USE OF ASSET
 Obtain substantially all of the economic benefits from the use  OPERATING LEASE
of the identified asset. A lease that does not transfer substantially all the risks and
 Direct use of the identified asset. rewards incidental to ownership o an underlying asset.

1. Total Rentals (rent income) – amortized over lease term

a) Pattern of future payments
A. LESSEE ACCOUNTING
b) If no pattern, use straight line method
FINANCE LEASE
2. Lease Bonus
- All leases shall be accounted for by the lessee as a finance lease
- Deferred rent income, amortized as rent income over
under the new lease standard.
lease term.
- A lessee shall recognize a right of use asset and a lease liability.
3. Initial Direct Cost
Exception:
- Normally paid by the lessor.
Lessee is permitted to make an accounting policy election to apply
- Treatment – addition to carrying amount of underlying
the OPERATING LEASE accounting if the lease liability in two
asset and recognized as expense over the lease term.
optional exemptions:
1. Short-term lease
4. Security deposit
2. Low value lease
- Any refundable security deposit shall be accounted for
Finance Lease – Lessee
as a liability by the lessor.
 Initial measurement of the right of use asset:
 FINANCE LEASE
Right of Use Asset (RUA)
A lease that transfers substantially all the risks and rewards
- An asset that represents the right of a lessee to use an
incidental to ownership of an underlying asset.
underlying asset over the lease term in a finance lease.
- Measured at cost at commencement date.
Four Major Criteria:
1. Transfer of title
Cost of right of use asset:
2. Bargain Purchase option
PV of lease payments
- Below fair value at the end of the lease term
+ Lease payments made to lessor
3. Lease term forms a major part of the useful life of the asset
+ Initial direct costs incurred by lessee
- At least 75%
+ Estimate cost of dismantling, removing & restoring w/c
4. If present value of the minimum lease payment is a
lessee has present obligation__________________
substantial part of the FV of the asset – at least 90%.
 Subsequent Measurement of RUA
Finance lease is either:
Lessee shall measure the right of use asset applying the cost
 Direct Financing Lease
model.
INTERMEDIATE ACCOUNTING 2 MODULE
An arrangement between a financing entity and a lessee.  Selling Price > Fair Value of asset
Recognizes only interest income.  Excess of SP over FV
It is deferred and amortized over the lease term.
 Sales Type Lease  Any excess of FV over Carrying Amount
Recognizes interest income and gross profit. Recognized as gain immediately.
The lessor in a sales type lease is actually a manufacturer or
dealer that uses the lease as a means of facilitating the sale of  Carrying Amount > Fair value of Asset
product. - Carrying amount is written down to FV before applying
the first three in the checklist.
Direct Financing Sales Type Lease - Difference is treated as impairment loss.
Lease (dealer)
4. Finance Lease
Gross Minimum - If gain on the sale – deferred and amortized over lease
1. Gross Lease Payment term.
Same
investment + Any Gross Residual - If loss on sale – recognized immediately.
Value __________

Minimum Lease
-End of Discussion-
2. Net Cost of Asset Payment
investment + IDC paid by lessor + PV of Residual value
SELF-CHECK TEST:
3. Unearned Gross investment
At the beginning of current year, Ashe Company entered into a ten-
Interest - Net investment Same year noncancelable lease requiring year-end payments of
Income P1,000,000.
PV of Minimum lease
payment or Fair Value Ashe’s incremental borrowing rate is 12%, while the lessor’s implicit
4. Sales Not applicable interest rate, known to Ashe, is 10%.
of Asset, whichever is
lower
Cost of asset Present value factors for an ordinary annuity for ten periods are
- Any PV of 6.145 at 10% and 5.650 at 12%.
5. Cost of Goods Unguaranteed Res.
Not applicable
Sold Value On the same date, Ashe Company paid initial direct cost of P200,000
+ Initial direct cost in negotiating and securing the leasing arrangement. Ownership of
the property remains with the lessor at expiration of the lease. Te
Sales
leased property has an estimated economic life of 12 years.
6. Gross Profit Not applicable - Cost of Goods Sold
REQUIRED:
Expensed as cost of
7. Initial Direct Capitalized as net 1. What amount should be capitalized as cost of the right of use
goods sold.
Cost investment asset?
Lease receivable 2. What is the depreciation for the current year?
- Unearned interest 3. What is the lease liability at the end of the current year?
8. Lessor’s Asset Income_________
Same
(Receivable) Net investment in
the lease Learning Resources:

1. The Intermediate Accounting Series

C. SALES AND LEASEBACK
An arrangement whereby one party sells an asset to another Volume 2. (based on IFRS including IFRS effective 2018)
party and then immediately leases the asset back from the new 2017 Edition
owner. Nenita S. Robles/Patricia M. Empleo

1. Cash flow problems 2. Financial Accounting

2. Seller-lessee/ buyer-lessor Volume 2
2020 Edition
3. Operating lease
 If Selling price = Fair Value of Asset
Valix, Conrado; et al.
- Any gain/loss is recognized immediately.
- Ordinary disposal of an asset.

 Selling Price < Fair Value of asset

- Any gain or loss is recognized immediately.
- Loss on disposal will be compensated by future below market
rent. It is deferred and amortized over the lease term.
INTERMEDIATE ACCOUNTING 2 MODULE