HANDOUT AP-2302 (PART 2)

AUDIT OF LIABILITIES
PROBLEM 1:
You Are engaged to audit the December 31, 2016 financial statements of SUPERB Company, a
manufacturer of household appliances. Your audit disclosed the following situations:

A. In June 2016, the company began producing and selling a new line of dishwasher. By the
end of the year, it had sold 120,000 to various dealers for P15,000 each. The product was
sold under a one year warranty, and the company estimates warranty costs to be P750
per dishwasher. Superb had paid out P30 million in warranty expenses as of December
31, 2016, which is also the amount shown as warranty expense in its income statement
for the current year.

B. In response to your letter of audit inquiry, Superb’s lawyer informed you that the company
is involved in a lawsuit for violating environmental laws regulating hazardous waste.
Although the litigation is pending, Superb’s lawyer is certain that Superb will most probably
have to pay cleanup costs and fines of P5,500,000. Superb neither accrued nor disclosed
this loss in the financial statements.

C. Superb is the defendant in a patent infringement suit by Luxury Company over the use of
a hydraulic compressor in several of its manufactured appliances. Superb’s lawyer
informed you that if the suit goes against your audit client, the loss may be as much as
P10 million. However, the lawyer believes that the loss of this is only possible. Superb did
not in any way disclose this pending litigation in its financial statements.

Based on the preceding information, answer the following questions:

1. What amount of warranty expense should be shown on Superb’s income statement for
the year ended December 31, 2016?
a. P 30,000,000
b. P 0
c. P 60,000,000
d. P 90,000,000

2. What amount of warranty liability should be shown on Superb’s statement of financial

position for the year ended December 31, 2016?
a. P 60,000,000
b. P 90,000,000
c. P 30,000,000
d. P 0

3. What amount of lawsuit liability should be shown on Superb’s statement of financial

position as a provision for the year ended December 31, 2016?
a. P 10,000,000
b. P 5,500,000
c. P 15,500,000
d. P 0

PROBLEM 2:
BUMBLEBEE Company purchases an equipment on July 1, 2020. The equipment’s cash price
is P79,000. The company signs a deferred payment contract that provides for a down payment of
P10,000 and an 8-year note for P103,472. The note is to be paid in 8 equal annual payments of

1|P age
HANDOUT AP-2302
MYLENE P. ALFANTA, CPA
P12,934. The payments include 10% interest and are made on June 30 of each year, beginning
June 30, 2021.

Based on the given information and the result o your audit, answer the following question:
1. The cost of equipment is:
a. P 69,000
b. P 79,000
c. P 103,472
d. P 113,472

2. The carrying amount of the note payable on December 31, 2021 is:
a. P 56,329
b. P 59,818
c. P 62,966
d. P66,115

3. The total interest expense for the year ended December 31, 2021 is:
a. P 5,982
b. P6,599
c. P6,612
d. P6,900

PROBLEM 3:
On January 1, 2020, SISTER Corporation issued 5,000 of its 5-year, P1,000 face value, 11%
bonds dated January 1 at an effective annual interest rate of 9%. Interest is payable each
December 31. Sister uses the effective interest method of amortization. On December 31, 2021,
the 3,000 bonds were extinguished early through acquisition in the open market by Sister for
P2,970,000 plus accrued interest.

Based on the above information and result of your audit, determine the following:
1. Issue Price of the Bonds on January 1, 2020:
a. P 4,630,655
b. P 5,000,000
c. P 5,282,135
d. P 5,388,835

2. Carrying Amount of the Bonds on December 31, 2020:

a. P 4,755,930
b. P 5,000,000
c. P 5,323,830
d. P 5,453,840

3. Gain on Early Retirement of Bonds on December 31, 2021:

a. Nil
b. P 116,442
c. P 181,785
d. P 266,811

2|P age
HANDOUT AP-2302
MYLENE P. ALFANTA, CPA
PROBLEM 4:
The following data were obtained from the initial audit of NEBULA Company:

Debit Credit Balance

Cash Proceeds from issue on January 1,
2016, of 1000, P1,000 bonds. The market rate
of interest on the date of issue was 12%. P 1,172,044 P 1,172,044

Bond Interest Expense:

Cash Paid, 01/02/16 P 75,000 P 75,000
Cash Paid, 07/01/16 75,000 150,000
Accrual, 12/31/16 75,000 225,000

Accrued Interest on Bonds:

Balance, 01/01/16 P 75,000 P 75,000
Accrual, 12/31/16 75,000 150,000

Treasury Bonds:
Redemption Price and Interest to date on
200 bonds permanently retired on
December 31, 2016 P 265,000 P 265,000

Based on the above information and result of your audit, determine the following:
1. Carrying Value of Bonds at December 31, 2016:
a. P 831,110
b. P 800,000
c. P 1,151,583
d. P 921,266

2. Loss on Bond Redemption:

a. P 4,683
b. P 19,683
c. P 15,000
d. P 34,683

3. Accrued Interest on Bonds at December 31, 2016:

a. P 75,000
b. P 135,000
c. P 60,000
d. P 52,500

4. Bond Interest Expense for the year ended December 31, 2016:
a. P 150,000
b. P 139,174
c. P 69,745
d. P 160,826

PROBLEM 5:
On January 2023, SUNSHINE Company issued a 3-year, 4000 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

3|P age
HANDOUT AP-2302
MYLENE P. ALFANTA, CPA
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, 2024.

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 Ordinary Annuity of 1 for 3 periods 2.67301 2.53130
Present Value of Annuity Due of 1 for 3 periods 2.83339 2.75911

Based on the above information and result of your audit, determine the following:
1. The liability component of the convertible debt is:
a. P 4,000,000
b. P 3,696,232
c. P 1,600,000
d. P 3,730,242

2. The equity component of the convertible debt is:

a. P 303,768
b. P 1,973,621
c. P 1,600,000
d. P 2,400,000

3. The interest expense to be reported on Sunshine Company’s income statement for the
year ended December 31, 2024 is:
a. P 101,000
b. P 110,107
c. P 240,000
d. P 341,000

4. The entry to record the bond conversion on December 31, 2024 should include a credit to
share premium – issuance of:
a. P 2,289,893
b. P 2,400,000
c. P 2,593,661
d. P 0

PROBLEM 6:
FEEL NA FEEL INCORPORATED has been producing quality appliances 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 FEEL NA FEEL as of March 31, 2022.

Bonds Payable:
FEEL NA FEEL issued P10,000,000 of 10% bonds on July 1, 2020. The prevailing market rate of
interest for these bonds was 12% on the date of issue. The bonds will mature on July 1, 2030.
Interest is paid semiannually on July 1 and January 1. Effective Interest Rate Method is used to
amortize the bond discount or premium.

Notes Payable:
FEEL NA FEEL has signed several long-term notes with financial institutions. The maturities of
these notes are given below. The total unpaid interest for all of these notes amounts to P600,000
on March 31, 2022.

4|P age
HANDOUT AP-2302
MYLENE P. ALFANTA, CPA
 Due Date Amount Due
April 1, 2022 P 400,000
July 1, 2022 600,000
October 1, 2022 300,000
January 1, 2023 300,000
April 2023 – March 31, 2024 1,200,000
April 2024 – March 31, 2025 1,000,000
April 2025 – March 31, 2026 1,400,000
April 2026 – March 31, 2027 800,000
April 2027 – March 31, 2028 1,000,000

Estimated Warranties:
FEEL NA FEEL has a one-year product warranty on some selected items on its product line. The
estimated warranty liability on sales made during the 2020 – 2021 fiscal year and still outstanding
as of March 31, 2021, amounted to P180,000. The warranty costs on sales made from April 1,
2021 to March 31, 2022, are estimated at P520,000. The actual warranty costs incurred during
2021 – 2022 fiscal year are as follows:

Warranty Claims honored on 2020-2021 sales P 180,000

Warranty Claims honored on 2021-2022 sales 178,000
Total Warranty Claims Honored P 358,000

Trade Payables:
Accounts Payable for suppliers, goods and services purchased on open account, amount to
P740,000 as of March 31, 2022.
Payroll Related Items:
Accrued Salaries and Wages P 300,000
Withholding Taxes Payable 94,000
Other Payroll Deductions 10,000

Miscellaneous Accruals:
Other Accruals not separately classified amount to P150,000 as of March 31, 2022.

Dividends:
On March 15, 2022, FEEL NA FEEL’s board of directors declared a cash dividend of P0.20 per
common share and a 10% common stock dividend. Both dividends were to be distributed on April
12, 2022 to common stockholders on record at the close of business on March 31, 2022. Data
regarding the common stock are as follows:

Par Value P 5.00 per share

Number of Issued and Outstanding Shares 6,000,000 shares

Market Values of Ordinary Shares:

March 15, 2022 22.00 per share
March 31, 2022 21.50 per share
April 12, 2022 22.50 per share

Based on the preceding information, answer the following questions:

1. How much was received by FEEL NA FEEL from the bonds issued on July 1, 2020?
a. P 8,852,960
b. P10,000,000
c. P10,500,000
d. P 10,647,040

5|P age
HANDOUT AP-2302
MYLENE P. ALFANTA, CPA
 2. What is the current portion of FEEL NA FEEL’s notes payable on March 31, 2022?
a. P, 2800,000
b. P 1,600,000
c. P 1,300,000
d. P 3,800,000

3. The balance of estimated warranty payable at March 31, 2022 is:

a. P 342,000
b. P 18,000
c. P 520,000
d. P 180,000

4. On March 31, 2022, the Statement of Financial Position of FEEL NA FEEL would report
total current liabilities of:
a. P 5,286,000
b. P 4,386,000
c. P 5,336,000
d. P 5,642,000

5. On March 31, 2022, the Statement of Financial Position of FEEL NA FEEL would report
total noncurrent liabilities of:
a. P 14,389,350
b. P 14,352,217
c. P 14,370,783
d. P 14,252,960

6|P age
HANDOUT AP-2302
MYLENE P. ALFANTA, CPA