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INTERMEDIATE ACCOUNTING 2
1. The accounting standards used in the Philippines are adapted from the standards issued by the
a. Federal Accounting Standards Board (FASB).
b. International Accounting Standards Board (IASB).
c. Philippine Institute of Certified Public Accountants (PICPA).
d. Democratic People's Republic of Korea Accounting Standards Committee (DPKRASC).

2. The PFRSs consist of all of the following except

a. PFRSs.
b. PASs.
c. Interpretations.
d. Conceptual Framework.

3. The issuance of financial reporting standards in the Philippines is the responsibility of the
a. PICPA
b. FRSC
c. AASC
d. CPE Council

4. On November 1, 20x1, a company purchased a new machine that it does not have to pay for
until November 1, 20x3. The total payment on November 1, 20x3, will include both principal and
interest. Assuming interest at a 10% rate, the cost of the machine would be the total payment
multiplied by what time value of money concept?
a. PV of annuity of ₱1. c. FV of annuity of ₱1.
b. PV of ₱1. d. FV of ₱1.

5. Interest payment dates of a bond issue are March 1 and September 1, 20x1. The bond was issued
on June 1, 20x1. Interest expense for the year ended December 31, 20x1 would be for:
a. four (4) months c. seven (7) months
b. six (6) months d. ten (10) months

6. When a note payable is issued for property, goods, or services, the note is initially measured at
a. the fair value of the property, goods, or services.
b. the fair value of the note.
c. using an imputed interest rate to discount all future payments on the note.
d. choice (a) except when this is not determinable, in which case, whichever is the more clearly
determinable between (b) and (c).

7. When a note payable is exchanged for property, goods, or services, the stated interest rate is
presumed to be fair unless
a. no interest rate is stated.
b. the stated interest rate is unreasonable.
c. the stated face amount of the note is materially different from the current cash sales price for
similar items or from current market value of the note.
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d. any of these.

8. When debt is issued at a discount, interest expense over the term of the debt equals the cash
interest paid:
a. Minus discount. c. Plus discount.
b. Minus discount minus face amount. d. Plus discount plus face amount.

9. Which of the following statements is true?

a. A noninterest-bearing note sometimes is called a discounted note because the cash received
is more than the face amount of the note.
b. A debtor’s December 31, 20x1 statement of financial position is to be published on March 31,
20x2. An obligation with a due date of December 31, 20x6 is also due on demand by the
creditor. At December 31, 20x1, there is no indication that the creditor intends to call in the
debt. The obligation is a current liability.
c. The market rate of interest is the interest rate used to determine the amount of cash interest
that will be paid on the principal.
d. A debtor’s December 31, 20x1 statement of financial position is to be published on March 31,
20x2. An obligation due December 31, 20x6 has a due date which can be accelerated by the
creditor to the present date if the current ratio falls below 2:1. The current ratio on December
31, 20x1 is 2.2:1. The obligation is a current liability.

10. A short-term note payable may include all of the following except:
a. trade notes payable. c. unearned revenue.
b. nontrade notes payable. d. a current maturity of a long-term liability.

11. Interest expenses are

a. incurred only on interest-bearing obligations
b. incurred due to passage of time.
c. not incurred on redeemable preference shares issued
d. incurred only when the effective interest rate is stated in the instrument

12. Which of the following is not true about the discount on short-term notes payable?
a. The Discount on Notes Payable account has a debit balance.
b. The Discount on Notes Payable account should be reported as an asset on the balance sheet.
c. When there is a discount on a note payable, the effective interest rate is higher than the
stated discount rate.
d. All of these are true.

13. Which of the following statements is not correct?

a. The principal amount of a debt is the cash or cash equivalent amount borrowed.
b. When a noncash asset is acquired and the stated rate of interest is different from the current
market rate of interest, the cost of the asset is the present value of the future cash payments
discounted at the current market rate of interest rather than at the stated interest rate.
c. A company that receives cash in an amount less than the face amount of a noninterest-
bearing note payable should record the note at its discounted present value.
d. The carrying amount of a noninterest-bearing note payable due in lump sum will decrease as
time goes by.
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Use the following information for the next five questions:

On January 1, 20x1, ABRIDGE TO SHORTEN Company issued a 4-year, ₱1,000,000 noninterest
bearing note payable due in four equal annual installments. The effective interest rate is 12%.
ABRIDGE prepared the following pro-forma amortization table on an electronic spreadsheet:
A B C D E
1 Date Cash paid Interest expense Amortization Present value
2 Jan. 1, 20x1        
3 Dec. 31, 20x1        
4 Dec. 31, 20x2        
5 Dec. 31, 20x3        
6 Dec. 31, 20x4        

14. The amount to be placed on cell E2 is

a. (1M ÷ 4 x PV of ordinary annuity of ₱1 @ 12%, n=4)
b. (1M x PV of ₱1 @12%, n=4)
c. (1M x PV of ordinary annuity of ₱1 @12%, n=4)
d. (1M x PV of ₱1 @12%, n=4) + (1M x 10% x PV of ordinary annuity of ₱1 @ 12%, n=4)

15. The amount to be placed on cell E6 is

a. (1M ÷ 4 x PV of ordinary annuity of ₱1 @ 12%, n=4) c. 1M
b. (1M x PV of ₱1 @12%, n=4) d. 0

16. Interest expense recognized in 20x2 is computed as

a. 12% x E3 c. C4 – D4
b. 12% x E4 d. 1M x 12%

17. The carrying amount of the note payable on December 31, 20x2 is equal to
a. E3 – D4 c. E4 – D4
b. E3 + D4 d. 1M

18. The value placed in cell B4 is equal to

a. 1M x 12% c. 1M – D3
b. 250,000 d. E4 – D5

19. The current portion of the note payable as of December 31, 20x2 is equal to
a. D4 c. D5
b. D3 d. E5

20. The noncurrent portion of the note payable as of December 31, 20x2 is equal to
a. E4 c. E3
b. D5 d. E5

Use the following information for the next nine questions:

On January 1, 20x1, HEARTEN ENCOURAGE CHEER Company issued a 4-year, ₱1,000,000,
noninterest-bearing note due on December 31, 20x4. The effective interest rate is 12%. HEARTEN
prepared the following pro-forma amortization table on an electronic spreadsheet:
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A B C D
Interest Discoun Present
Date
1 expense t value
2 Jan. 1, 20x1      
3 Dec. 31, 20x1      
4 Dec. 31, 20x2      
5 Dec. 31, 20x3      
6 Dec. 31, 20x4      

21. The amount to be placed on cell B4 is

a. 10% x E3 c. ₱1M ÷ 4
b. 12% x D3 d. same with B3

22. The amount to be placed on cell D2 is computed as

a. (1M x PV of ₱1 @12%, n=4) + (1M x PV of ordinary annuity of ₱1 @ 12%, n=4)
b. (1M x PV of ₱1 @12%, n=4)
c. (1M x PV of ordinary annuity of ₱1 @12%, n=4)
d. (1M x PV of ₱1 @12%, n=4) + (1M x 10% x PV of ordinary annuity of ₱1 @ 12%, n=4)

23. Interest expense recognized in 20x3 is computed as

a. 12% x D3 c. C4 – D4
b. 12% x D4 d. 1M x 12%

24. The amount to be placed in cell C3 is computed as

a. C2 + B3 c. equal to C4
b. C2 – B3 d. I’m confused

25. The carrying amount of the note payable on December 31, 20x2 is equal to
a. D3 – B4 c. B4 + C4
b. D3 + B4 d. D3 + C4

26. The current portion of the note payable as of December 31, 20x2 is equal to
a. D4 c. D5
b. D3 d. none

27. The noncurrent portion of the note payable as of December 31, 20x2 is equal to
a. E4 c. E3
b. D5 d. none of these

28. The sum of cell C4 and cell D4 is

a. equal to D3 c. 1M
b. equal to D5 d. none of these

29. The value of cell D6 is

a. equal to D3 c. 1M
b. equal to D5 d. zero
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30. Which of the following statements about noninterest-bearing notes is false?

a. The face amount of a noninterest-bearing note may include both the principal and interest as
a single amount to be paid back at maturity date.
b. The principal amount of a noninterest-bearing note is its future cash flows discounted at its
effective interest rate.
c. The effective rate on a short-term noninterest-bearing note, with a specified term, cannot be
determined unless it is given on the face of the note.
d. Noninterest bearing is not a descriptive designation for this type of note because such notes
do bear interest.

31. Inter Company sells its products in reusable, expensive containers. The customer charged a
deposit for each container delivered and receives a refund for each container returned within
two years after the year of delivery. Inter accounts for the containers not returned within the
time limit as being retired by sale at the deposit amount. Information for 2006 is as follows:

Deposits for containers at December 31, 2005 from deliveries in:

2004 P 150,000
2005 430,000 P 580,000
Deposits for containers delivered in 2006 780,000
Deposits for containers returned in 2006 form deliveries in:
2004 P 90,000
2005 250,000
2006 286,000 626,000

What amount should Inter Company report as a liability for deposits on returnable containers at
December 31, 2006?
a. 494,000
b. 644,000
c. 674,000
d. 734,000

C (430,000 + 780,000 – 250,000 – 286,000) = 674,000

32. Impressed Company, a division of Philippine Realty Corporation maintains escrow accounts
and pays real estate taxes for Philippine’s mortgage customers. Escrow funds are kept in
interest-bearing accounts. Interest, less a 10% service fee, is credited to the mortgagee’s account
and used to reduce future escrow payments. Additional information follows:

Escrow accounts liability, January 1, 2008 P 900,000

Escrow payments received during 2008 1,500,000
Real estate taxes paid during 2008 1,900,000
Interest on escrow funds during 2008 90,000

What amount should Impressed report as escrow accounts liability in its December 31, 2008 balance
sheet?
a. 491,000
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b. 500,000
c. 581,000
d. 590,000

C 900,000 + 1,500,000 – 1,900,000 + (90,000 x 90%) = 581,000

33. Gallery Department Store sells gift certificates, redeemable for store merchandise that expires
one year after their issuance. Gallery has the following information pertaining to its gift
certificates sales and redemptions:

Unearned at December 31, 2005 P 600,000

2006 sales 2,000,000
2006 redemptions of prior-year sales 200,000
2006 redemptions of current-year sales 1,400,000

Gallery’s experience indicates that 10% of gift certificates sold will not be redeemed.

In its December 31, 2006 balance sheet, what amount should Gallery report as unearned revenue?
a. 400,000
b. 600,000
c. 800,000
d. 1,000,000

A 2,000,000 – 1,400,000 – (2,000,000 x 10%) = 400,000

34. Ivy Co. operates a retail store. All items are sold subject to a 6% state sales tax, which Ivy collects
and records as sales revenue. Ivy files quarterly sales tax returns when due, by the 20th day
following the end of the sales quarter. However, in accordance with state requirements, Ivy
remits sales tax collected by the 20th day of the month following any month such collections
exceed ₱500. Ivy takes these payments as credits on the quarterly sales tax return. The sales taxes
paid by Ivy are charged against sales revenue. Following is a monthly summary appearing in
Ivy's first quarter 2002 sales revenue account:
Debit Credit
January - 10,600

February 600 7,420

March - 8,480
600 26,500

In its March 31, 20x2, balance sheet, what amount should Ivy report as sales taxes payable
a. 600 b. 900 c. 1,500 d. 1,590

B
Solution:
Total sales inclusive of sales tax (total credit) 26,500
6%/106
Multiply by: %
Total sales taxes collected 1,500
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Remittance of sales tax in February (600)

Sales taxes payable 900

35. On January 1, 20x1 WRECK RUIN Co. acquired land by issuing a three-year, 12%, ₱4,000,000
note payable. Principal and interest are due on December 31, 20x3. How much is the interest
expense in 20x2?
a. 1,017,600 c. 537,600
b. 960,000 d. 764,213

C (4,000,000 x 112% x 12%) = 537,600

36. Karma Company sells televisions at an average price of P7,500 and also offers to each customer a
separate 3-year warranty contract for P750 that requires the company to perform periodic
services and to replace defective parts. During 2006, the company sold 300 televisions and 270
warranty contracts for cash. It estimates the 3-year warranty costs as P200 for parts and P400 for
labor and accounts for warranties separately. Assume sales occurred on December 31, 2008,
income is recognized on the warranties, and straight line recognition of warranty revenues
occurs.

What amount of current and non-current liability relative to warranty revenue would appear on the
December 31, 2009 balance sheet, respectively?
a. 0 and 202,500
b. 67,500 and 135,000
c. 135,000 and 67,500
d. 202,500 and 0
B (P750 x 270)= P202,500 / 3 = P67,500 to be earned in 2009 (sale occurred on December 31, 2008) P135,000
(P67,500 x 2) will be earned in 2010 and 2011.

37. ABC Co. is contemplating on issuing a 12%, 3-year, ₱1,000,000 bonds. Principal is due at
maturity but interest is due semi-annually every July 1 and December 31. ABC determines that
the current market rate on January 1, 20x1 is 14%. How much is the estimated issue price of the
bonds assuming ABC issues bonds on January 1, 20x1?
a. 666,342
b. 285,992
c. 952,334
d. 962,563

Solution: Issue price of bonds = Present value of future cash flows

Future cash flows PV @ 7%, n=6 PV factors Present value
Principal 1M PV of ₱1 0.666342 666,342
Interest 60K PV of ordinary annuity of ₱1 4.766540 285,992
Estimated issue price of the bonds on Jan. 1, 20x1 952,334

Use the following information for the next three questions:

On January 1, 20x1, SCRAWNY SKINNY Co. issued 1,000, ₱4,000, 10%, 3-year bonds for ₱3,807,852.
Principal is due on December 31, 20x3 but interests are due annually every year-end. In addition,
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SCRAWNY incurred bond issue costs of ₱179,316. The effective interest rate is 12% before adjustment
for bond issue costs and 14% after adjustment for bond issue costs.

38. How much is the carrying amount of the note on initial recognition?
a. 3,628,536 b. 4,000,000 c. 3,635,340 d. 3,754,309

A (3,807,852 – 179,316) = 3,628,536

39. How much is the interest expense in 20x1?

a. 435,424 b. 576,240 c. 507,995 d. 400,000

C Solution:
Interest
Date payments Interest expense Amortization Present value
Jan. 1, 20x1 3,628,536
Dec. 31, 20x1 400,000 507,995 107,995 3,736,531

40. How much is the carrying amount of the note on December 31, 20x1?
a. 3,401,832 b. 3,391,580 c. 3,288,776 d. 3,736 ,531

D (See amortization table above)

41. Entity A issues convertible bonds with face amount of ₱2,000,000 for ₱2,600,000. Each ₱1,000
bond is convertible into 10 shares with par value of ₱60 per share. On issuance date, the bonds
are selling at 102 without the conversion option. What is the value allocated to the equity
component on initial recognition?
a. 2,040,000
b. 540,000
c. 560,000
d. 460,000

Solution:
Issue price 2,600,000
Fair value of debt instrument without equity feature (2M x 102%) (2,040,000)
Equity component 560,000

42. On September 30, 20x1, ADMONISH WARN Co. issued new bonds with face amount of ₱10M
for a net issuance proceeds of ₱43,200,000. ADMONISH used the proceeds to retire an existing
10-year, 12%, ₱32,000,000 bonds issued five years earlier. The bonds have an unamortized
discount of ₱1,360,000 as of September 30, 20x1. ADMONISH reacquired the entire outstanding
bonds at a call premium of ₱1,600,000. Costs incurred that are directly attributable to the
retirement amounted to ₱200,000. ADMONISH has an income tax rate of 30%. How much is the
gain (loss) on the retirement of the bonds to be recognized in 20x1?
a. 3,160,000) b. (2,960,000) c. 2,960,000 d. (3,160,000)

D
Solution:
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Jan. 1, Bonds payable – old 32,000,000

20x1 3,160,000
Loss on extinguishment of bonds (squeeze)
Discount on bonds payable – old 1,360,000
33,800,000
Cash in bank
(32M + 1.6M call premium + 200K reacquisition costs)

43. On January 1, 20x1, POTENT POWERFUL Co. issued 5-year, 12%, ₱4,000,000 bonds for
₱4,303,264. Principal is due at maturity but interests are due annually. The effective interest rate
is 10%. On July 1, 20x3, POTENT called in the entire bonds and retired them at 102. The
retirement price includes payment for any accrued interest. How much is the gain (loss) on the
extinguishment of the bonds?
a. 328,897 b. (328,896) c. (118,948) d. 118,948

A
Solution:
Date Interest payments Interest expense Amortization Present value
Jan. 1, 20x1 4,303,264
Dec. 31, 20x1 480,000 430,328 49,672 4,253,592
Dec. 31, 20x2 480,000 425,360 54,640 4,198,948
July 1, 20x3 240,000 209,948 30,052 4,168,896

Carrying amount of bonds retired: (see table above) 4,168,896

Retirement price (Call price):
Retirement price including payment for
accrued interest (4M x 102%) 4,080,000
Accrued interest (4M x 12% x 6/12) (240,000) 3,840,000
Gain on extinguishment of bonds 328,896

44. On January 1, 20x1, TIPSY UNSTEADY Co. issued 10%, ₱12,000,000 bonds for ₱11,601,220.
Principal on the bonds matures in three equal annual installments. Interest is also due annually
at each year-end. The effective interest rate on the bonds is 12%. How much is the carrying
amount of the bonds on December 31, 20x1?
a. 7,844,635 b. 7,793,366 c. 7,683,343 d. 7,543,341

B
Solution:
Interest on outstanding
Date Principal payments principal balance Interest payments Total payments
Dec. 31, 20x1 4,000,000 12,000,000 x 10% 1,200,000 5,200,000
Dec. 31, 20x2 4,000,000 8,000,000 x 10% 800,000 4,800,000
Dec. 31, 20x3 4,000,000 4,000,000 x 10% 400,000 4,400,000

Date Total payments Interest expense Amortization Present value

Jan. 1, 20x1 11,601,220
Dec. 31, 20x1 5,200,000 1,392,148 3,807,852 7,793,368

45. Liabilities arise from either legal or constructive obligation. Which of the following is a source of
constructive obligation?
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a. contract c. quasi-contract
b. law d. an established pattern of past practice

46. According to PAS 37, provisions are measured at

a. the entity’s best estimate of the settlement amount.
b. the expected value of the settlement amount.
c. the mid-point amount of a range of estimates.
d. any of these, whichever is most appropriate

47. According to PAS 37, a provision does not arise from

a. restructuring. c. product warranties.
b. future operating losses. d. constructive obligation.

48. According to PAS 37, a provision is

a. a present obligation that cannot be measured reliably.
b. a possible obligation that arises from past events.
c. a liability of uncertain timing or amount.
d. all of these

49. According to PAS 37, contingent liabilities are

a. recognized and disclosed.
b. always disclosed.
c. disclosed only, if their expected occurrence is probable.
d. not disclosed if their expected occurrence is remote.

50. Which of the following statements is correct?

a. A provision is recognized only when it represents a present obligation.
b. An event or transaction that meets both the “probable outflow of economic benefits” and
“reliable measurement” criteria is always recognized.
c. A contingent asset that is possible is ignored.
d. A contingent liability that is possible is ignored.

51. In 20x1, EXHAUSTIVE COMPLETE Co. received a court order requiring the cleanup of
environmental damages caused by one of EXHAUSTIVE’s factory. EXHAUSTIVE has no other
realistic alternative but to comply with the court order. Other entities have incurred around
₱60M for similar cleanup; however, EXHAUSTIVE’s best estimate of the cost of cleanup is ₱80M.
How much is the provision to be recognized?
a. 60M b. 80M c. 70M d. 0

B 80,000,000 – the best estimate

52. In 20x1, LUMINOUS SHINING Co. recalled a product due to a possible defect caused by a
malfunctioning factory equipment. The products recalled will be repaired free of charge.
LUMINOUS is uncertain whether all products recalled will have the possible defect. However,
the following estimate was made by LUMINOUS’s engineers and managerial accountants and
approved by the board of directors.
Repair cost Probabilit
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y
80,000,000 5%
60,000,000 20%
40,000,000 35%
20,000,000 40%
100%

How much is the provision to be recognized?

a. 38M b. 50M c. 48M d. 32M

A (80M x 5%) + (60M x 20%) + (40M x 35%) + (20M x 40%) = 38M

53. In 20x1, a lawsuit was filed against WINSOME CAUSING PLEASURE Co. for patent
infringement. The plaintiff is claiming ₱400M in damages. WINSOME’s legal counsel believes
that it is probable that WINSOME will lose the lawsuit and pay damages of not less than ₱40M
but not more than ₱400M. The probability of any amount within the range is as likely as any
other amount also within the range. The plaintiff has offered to settle the lawsuit out of court for
₱360M but WINSOME did not agree to the settlement. How much is provision to be reported in
WINSOME’s year-end financial statements?
a. 360M b. 220M c. 400M d. 40M

B (400M + 40M) ÷ 2 = 220M

54. A manufacturer gives warranties at the time of sale to purchasers of its product. Under the terms
of the contract of sale, the manufacturer undertakes to make good, by repair or replacement,
manufacturing defects that become apparent within one year from the date of sale. On the basis
of experience, it is probable (i.e., more likely than not) that there will be some claims under the
warranties.

Sales of ₱40 million were made evenly throughout 20X1.

At December 31, 20x1 the expenditures for warranty repairs and replacements for the product sold
in 20x1 are expected to be made 50% in 20x1 and 50% in 20x2. Assume for simplicity that all the 20x2
outflows of economic benefits related to the warranty repairs and replacements take place on June
30, 20x2.

Experience indicates that 95% of products sold require no warranty repairs; 3% of products sold
require minor repairs costing 10% of the sale price; and 2% of products sold require major repairs or
replacement costing 90% of sale price. The entity has no reason to believe future warranty claims
will be different from its experience.

At December 31, 20x1, the appropriate discount factor for cash flows expected to occur on June 30,
20x2 is 0.95238. Furthermore, an appropriate risk adjustment factor to reflect the uncertainties in the
cash flow estimates is an increment of 6 per cent to the probability-weighted expected cash flows.

How much is the warranty provision at December 31, 20x1?

a. 424,000 b. 840,000 b. 800,000 d. 752,000
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A
Solution:
The amount of the provision is estimated as follows:
Minor repairs (40M x 3% x 10%) 120,000
Major repairs (40M x 2% x 90%) 720,000
Total 840,000
Multiply by: Present value factor (given) 0.95238
Total 800,000
Multiply by: Risk adjustment (100% + 6%) 106%
Total 848,000
Multiply by: Amount to be settled in 20x2 50%
Warranty provision – Dec. 31, 20x1 424,000

Use the following information for the next two questions:

RISIBLE FUNNY Co. provides 3-year warranty for the products it sells. RISIBLE estimates that
warranty costs ₱400 per unit sold. As of January 1, 20x1, the liability for warranty has a balance of
₱800,000 for units sold in 20x0. During the year RISIBLE sold 5,000 units and actual warranty costs
incurred were ₱1,240,000.

55. How much is the warranty expense to be recognized in 20x1?

a. 2,000,000 b. 1,240,000 c. 3,240,000 d. 4,240,000

A (5,000 units sold x ₱400) = 2,000,000

56. How much is the balance of the warranty obligation as of December 31, 20x1?
a. 1,560,000 b. 2,000,000 c. 3,560,000 d. 2,800,000

A
Solution:
Estimated warranty liability
  800,000 Jan. 1, 20x1 (given)
Actual warranty costs 1,240,000 2,000,000  Warranty expense
Dec. 31, 20x1 1,560,000  

57. It is a type of retirement plan where the employer assures a definite amount of benefit to be
received by the employee. The risk that funds needed to pay the agreed benefits may be
insufficient is retained by the employer.
a. Defined contribution plan
b. Defined benefit plan
c. Leche plan
d. Plan vs. zombies

58. Entity A’s employees are entitled to six days paid sick leaves per year. Any unused sick leave is
converted to cash when the employee resigns or retires. The sick leave benefits are considered
a. vesting . c. non-accumulating.
b. non-vesting. d. monetizing.
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59. Compensated absences that can be carried forward and used in future periods if not fully used
in the current period of entitlement are referred to as
a. contributory. c. accumulating.
b. non-contributory. d. vesting.

60. Under a profit-sharing plan, Entity A agrees to pay its employees 5% of its annual profit. The
bonus shall be divided among the employees currently employed as at year-end. Relevant
information follows:

Profit for the year ₱8,000,000

Employees at the beginning of the year 8
Average employees during the year 7
Employees at the end of the year 6

If you are one of the employees of Entity A, how much bonus do you expect to receive?
a. 66,667 c. 50,000
b. 57,143 d. 0

A (8M x 5%) ÷ 6 employees currently employed as at year-end = 66,667

61. Under this post-employment benefit plan, the retirement benefit cost is equal to the contribution
due for the period.
a. Defined contribution plan c. State plan
b. Defined benefit plan d. Multi-employer plan

62. WASTREL SPENDTHRIFT Co. pays salaries twice a month and does not pay salaries in
advance. Employees work five days a week and compensation are computed on these working
days. In December 20x1, WASTREL Co. paid the second semi-monthly salaries on December 26
which falls on a Friday. The next non-working holiday is on New Year’s Day. WASTREL has 100
employees who earn ₱4,000 per day. WASTREL’s cost accountant identified that 70% of salaries
incurred pertain to the production of goods. How much is the accrued salaries as of December
31, 20x1?
a. 360,000 b. 840,000 c. 1,600,000 d. 1,200,000

D
Solution:
Working days after last salary payment (Dec. 29, 30, and 31)* 3
Multiply by: Number of employees 100
Multiply by: Average pay per day 4,000
Accrued salaries – December 31, 20x1 1,200,000
*December 27 and 28 fall on weekend

63. An entity has 100 employees, who are each entitled to five (5) working days of paid sick leave
for each year. Unused sick leave may be carried forward for one calendar year. Sick leave is
taken first out of the current year’s entitlement and then out of any balance brought forward
from the previous year (a LIFO basis). At December 30, 20x1, the average unused entitlement is
 P a g e | 14

two days per employee. The entity expects, based on past experience which is expected to
continue, that 92 employees will take no more than five days of paid sick leave in 20x2 and that
the remaining 8 employees will take an average of six and a half days each. The average salary
per day, per employee in 20x1 is ₱4,000 and it is not expected to change in 20x2. How much is
the accrued salaries as of December 31, 20x1?
a. 24,000 b. 48,000 c. 208,000 d. 0

B
Solution:
Total sick leave entitlement of employees in 20x2
(100 employees x 5 days each) 500
Sick leave expected to be taken in 20x2
(92 employees x 5 days each) (460)
Sick leave expected to be taken by the remaining 8
employees in 20x2 (8 x 6½ days each) (52)
Excess sick leave carried over from 20x1 (12)

12 x ₱4,000 = 48,000

64. On January 1, 20x1, PAGEANT SHOW Co. issued 10%, ₱12,000,000 bonds at a yield to maturity
interest of 18%. Principal and interest are due on December 31, 20x3. How much is the carrying
amount of the bonds on initial recognition?
a. 15,972,000 b. 9,721,052 c. 9,028,341 d. 9,183,273

B (12M x 110% x 110% x 110%) x PV of 1 @18%, n=3 = 9,721,052

65. On January 1, 20x1, VIGILANT WATCHFUL Co. issued its 10%, 3-year, ₱4,000,000 convertible
bonds for the face amount of ₱4,000,000. Each ₱4,000 bond is convertible into 8 shares with par
value of ₱400 per share. When the bonds were issued, they were selling at 98 without the
conversion option. VIGILANT incurred ₱200,000 transaction costs on the issue of the bonds.
How much is the equity component of the compound instrument?
a. 80,000 b. 200,000 c. 76,000 d. 123,489

C
Solution:
Issue price 4,000,000
Fair value of debt instrument without equity feature (4M x 98%) (3,920,000)
Equity component 80,000

Allocation of transaction
Component Allocated amounts from issue price Fraction costs
Debt component 3,920,000 3,920/4,000 196,000
Equity component 80,000 80/4,000 4,000
  4,000,000 4,000/4,000 200,000

80,000 – 4,000 = 76,000

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66. On January 1, 20x1, CRYSTALLINE TRANSPARENT Co. issued its 10%, 3-year, ₱4,000,000
convertible bonds at 105. Each ₱4,000 bond is convertible into 8 shares with par value per share
of ₱400. Principal is due on December 31, 20x3 but interests are due annually at each year-end.
When the bonds were issued, they were selling at a yield to maturity market rate of 12%without
the conversion option. On December 31, 20x2, all of the bonds were converted into equity.
Conversion costs incurred amounted to ₱80,000.

How much is the net increase in equity on December 31, 20x2 due to the conversion of the
bonds?
a. 3,392,148 +b. 3,234,998 c. 3,894,759 d. 3,848,571

D
Solution:
Future cash flows PV @ 12%, n=3 PV factors Present value
Principal 4M PV of ₱1 0.711780 2,847,120
Interest 400K PV of ordinary annuity of ₱1 2.401831 960,732
Fair value of debt instrument without conversion feature 3,807,852

The issue price is allocated to the liability and equity components as follows:
Issue price (4M x 105%) 4,200,000
Fair value of debt instrument without equity feature (3,807,852)
Equity component 392,148

The entry to record the issuance is as follows:

Jan. 1, Cash in bank (4M x 105%) 4,200,000
20x1 192,148
Disc. on bonds payable (4M – 3,807,852)
Bonds payable 4,000,000
Share premium – conversion feature 392,148

Amortization table:
Date Interest payment Interest expense Amortization Present value
Jan. 1, 20x1 3,807,852
Dec. 31, 20x1 400,000 456,942 56,942 3,864,794
Dec. 31, 20x2 400,000 463,775 63,775 3,928,569

The other pertinent entries prior to conversion are as follows:

Dec. 31, Interest expense 456,942
20x1
Discount on bonds payable 56,942
400,000
Cash in bank
Dec. 31, Interest expense 463,775
20x2
Discount on bonds payable 63,775
400,000
Cash in bank
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The entries on to record the conversion are as follows:

Dec. 31, Bonds payable 4,000,000
20x2 71,431
Disc. on bonds payable (4M – 3,928,569)
Share capital a 3,200,000
728,569
Share premium (squeeze)
to record the conversion of bonds into equity
Dec. 31, Share premium 80,000
20x2 80,000
Cash in bank
to record the share issuance costs
Dec. 31, Share premium – conversion feature 392,148
20x2 392,148
Share premium
to reclassify the equity component of the compound instrument within equity
a
(4M face amount ÷ ₱4,000) x 8 shares x ₱400 par value) = 3,200,000

Net increase in equity = credit to share capital of 3,200,000 + credit to share premium of 728,569 –
debit to share premium of 80,000 = 3,848,569

Use the following information for the next three questions:

On January 1, 20x1, ELABORATE COMPLICATED Co. issued 3-year, 10%, ₱4,000,000 convertible
bonds for ₱4,400,000. Principal is due at maturity but interest is payable every year-end. The bonds
are convertible into 6,000 ordinary shares with par value of ₱400. At issuance date, the prevailing
market rate of interest for similar debt without conversion feature is 12%.

On December 31, 20x2, all the convertible bonds were retired for ₱4,000,000. The prevailing rate of
interest on a similar debt instrument as of December 31, 20x2 is 11% without the conversion feature.

67. How much is gain (loss) on the extinguishment of the bonds on December 31, 20x2?
a. 35,392 b. (35,392) c. 32,413 d. (32,413)

B
Solution:
The fair value of the bonds without the conversion feature is computed as follows:
Future cash flows PV @ 12%, n=3 PV factors Present value
Principal 4M PV of ₱1 0.711780 2,847,120
Interest 400K PV of ordinary annuity of ₱1 2.401831 960,732
Fair value of debt instrument without equity feature 3,807,852

The issue price is allocated to the liability and equity components as follows:
Issue price 4,400,000
Fair value of debt instrument without equity feature (3,807,852)
Equity component 592,148

The entry to record the issuance of the bonds is as follows:

Jan. 1, 20x1 Cash in bank 4,400,000
Discount on bonds payable 192,148
4,000,000
 P a g e | 17

Bonds payable 592,148

Share premium – conversion feature

Amortization table:
Interest
Date payment Interest expense Amortization Present value
Jan. 1, 20x1 3,807,852
Dec. 31, 20x1 400,000 456,942 56,942 3,864,794
Dec. 31, 20x2 400,000 463,775 63,775 3,928,570

The other entries prior to retirement are as follows:

Dec. 31, 20x1 Interest expense 456,942
Discount on bonds payable 56,942
Cash in bank 400,000
Dec. 31, 20x2 Interest expense 463,775
Discount on bonds payable 63,775
Cash in bank 400,000

The fair value of the bonds without the conversion feature on retirement date (December 31, 20x2) is
computed as follows:
Future cash flows PV @ 11%, n=1 PV factors Present value
Principal 4M PV of ₱1 0.900901 3,603,604
Interest 400K PV of ordinary annuity of ₱1 0.900901 360,360
Fair value of debt instrument without equity feature 3,963,964

The retirement price is allocated to the liability and equity components as follows:
Total retirement price 4,000,000
Fair value of bonds without conversion feature – Dec. 31, 20x2 (3,963,964)
Equity component – debit to “share premium – conversion feature” 36,036

The gain or loss on extinguishment of bonds is computed as follows:

Carrying amount of bonds – Dec. 31, 20x2 3,928,570
Retirement price allocated to the bonds (3,963,964)
Loss on extinguishment of bonds (35,394)

68. How much is the net credit to “share premium” account on December 31, 20x2?
a. 556,110 b. 541,167 c. 514,571 d. 557,368

A
Solution:
The simple entries on December 31, 20x2 are as follows:
Dec. 31, Bonds payable 4,000,000
20x2
Loss on extinguishment of bonds (squeeze) 35,394
Discount on bonds (4M – 3,928,570) 71,430
Cash in bank (amt. allocated to the bonds) 3,963,964
to record the retirement of convertible bonds
 P a g e | 18

Dec. 31, Share premium – conversion feature 36,036

20x2
Cash in bank (amount allocated to equity) 36,036
to record the allocation of retirement price to equity component
Dec. 31, Share prem. - conversion feature (592,148 - 36,036) 556,112
20x2
Share premium 556,112
to record forfeiture of conversion feature of retired convertible bonds

69. How much is the net increase (decrease) in equity due to the retirement of the bonds on
December 31, 20x2?
a. (36,036) b. 36,036 c. (592,148) d. 0

A
Solution:
Debits to “sh. prem.– conversion feature”
(36,036 + 556,112) (592,148)
Credit to share premium 556,112
Net decrease in equity (36,036)

70. The mother of accounting is

a. Mrs. Fra Luka Gaga
b. Accountant Mama
c. Mommy Showpao
d. None of these

“
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