RIZAL TECHNOLOGICAL UNIVERSITY

Cities of Mandaluyong and Pasig

LESSON 1

MODULE NO. 1: PROVISIONS, CONTINGENCIES AND

OTHER LIABILITIES

1. Provisions – Definition, Measurement and Recognition

2. Contingent Liability and Contingent Asset
3. Other Liabilities:
a. Accrued Liabilities
1. Premiums, Warranties, and Customer Loyalty Programs
2. Payroll Taxes and Value Added Tax
3. Liability for Bonuses
4. Refundable Deposits
b. Unearned Revenues
1. Unearned Revenue on Sale of Goods and Services
2. Gift Certificates Payable

Overview

This module is prepared for the students to understand the nature of

provisions, contingencies and other current liabilities.
This module discusses provisions, contingencies and other liabilities
such as liabilities on premiums, warranties, customer loyalty programs,
accrued liabilities (payroll taxes, VAT, gift certificates payable, liability for
bonuses and refundable deposits) and unearned revenue; its characteristics,
recognition and measurement (initial and subsequent) and presentation in the
financial statements.
This module will cover a brief discussion of the theory and standard
behind the topic, exercises and practice problem the cover the said topic.

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Cities of Mandaluyong and Pasig

Study Guide

This module is designed for the students to understand provisions,

contingencies and other liabilities. This module includes:
1. Topic Discussions - to be read by the students and to be discussed
in synchronous discussions to fully understand the topic.
2. Guided Exercises/Learning Activities - to be done simultaneously by
the instructor and the students during discussion to apply the lesson to
situations and problems in relation to the topic.
3. Assessment – to be accomplished by the students after the
discussion to test their skills and understanding to the subject matter.
4. Assignment – activity to be done by students to be submitted to the
instructor. This is to reinforce or advance the student’s learning. It is
relevant to the past, current, and future lessons.
To complete the requirements of this module, the students are required to:
1. Read and understand the topic discussion and the guided exercises
2. Accomplish the assessment.
3. Accomplish the assignment due on the deadline set.

Learning Outcomes

At the end of the discussion, the students are expected to:

1. Describe and distinguish provision from contingent liability and
contingent assets, as well as other liabilities.
2. Describe the initial recognition, initial measurement, subsequent
recognition, subsequent measurement, derecognition and financial
statement presentation of provisions and contingencies.
3. Calculate the correct amount of provision and other current liabilities
and its related accounts.

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 RIZAL TECHNOLOGICAL UNIVERSITY
Cities of Mandaluyong and Pasig

Topic Presentation

Recap on the Definition of Liabilities under Revised Conceptual Framework

Old Definition New Difinition

A present obligation of the entity A present obligation of the entity to
arising from past events, the transfer an economic resource as a
settlement of which is expected to result of past events. An obligation
result in an outflow from the entity is a duty of responsibility that the
of resources embodying economic entity has no practical ability to
benefits. avoid.

Provisions, Contingencies (Under PAS 37) and Other Liabilities

A. Provisions and Contingencies (PAS 37)
1. Provisions is a liability of uncertain timing or amount.
Recognition: An entity must recognize a provision if, and only if:
(a) a present obligation (legal or constructive) has arisen as a result of a past
event (the obligating event);
(b) an outflow of economic benefit to settle the obligation is probable (“more likely
than not”); and
(c) the amount of the obligation can be estimated reliably.

2. A contingent liability is either a: (a) possible obligation arising from past events
whose existence will be confirmed only by the occurrence or non-occurrence of
some uncertain future event not wholly within the entity’s control, or (b) present
obligation that arises from a past event but is not recognized because it is not
probable that an outflow of resources embodying economic benefits will be
required to settle the obligation, or the amount of the obligation cannot be
measured with sufficient reliability.
3. A contingent asset is a possible asset that arises from past events, and whose
existence will be confirmed only by the occurrence or non-occurrence of one or
more uncertain future events not wholly within the control of the entity.

Guidelines on Contingencies:

Probability CONTINGENT CONTINGENT

LIABILITY ASSET
VIRTUALLY More than 90% Recognize Recognize
CERTAIN (PROVISION) (ASSET)
PROBABLE 51% - 90% Recognize Disclose
(more likely than (PROVISION)
not)
POSSIBLE 5 % - 50% Disclose Ignore
REMOTE Less than 5% Ignore Ignore

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Cities of Mandaluyong and Pasig

4. Measurement of Provision
The amount recognized as a provision should be the BEST ESTIMATE of the
expenditure required to settle the present obligation at the financial reporting date,
taking into account the risk and uncertainties surrounding the circumstances that
relate to the provision:
a. EXPECTED VALUE (by weighing all possible outcomes by their associated
probabilities)
b. MIDPOINT (when there is continuous range of possible outcomes)
c. PRESENT VALUE (for long-term provisions)

5. Reimbursement
Where some or all of the expenditure required to settle a provision is
expected to be reimbursed by another party, the reimbursement shall be
recognized when, and only when, it is virtually certain that reimbursement
will be received if the entity settles the obligation. The reimbursement
shall be treated as a separate asset. The amount recognized for the
reimbursement shall not exceed the amount of the provision.

6. Restructuring
A provision for restructuring costs is recognized only when the general
recognition criteria for provisions are met (see no. 1). A restructuring
provision shall include only the direct expenditures arising from the
restructuring, which are those that are necessarily entailed by the
restructuring and not associated with the ongoing activities of the entity.
A restructuring provision does not include such costs as retraining or
relocating continuing staff, marketing; investment in new systems and
distribution networks.

Accrued Liabilities
A. Estimated Liabilities on After-Sales Transactions (Premium Liability,
Warranty Liability and Customer Loyalty Programs)
1. Premium Liability
Premiums are articles of value such as goods or in some cases cash
payments, given to customers as result of past sales or sales promotion
activities.
In order to stimulate the sales of their products, entities offer premium
coupons to customers in return for product labels, box tops, wrappers and
coupons.
When the merchandise is sold, a liability for the future distribution of the
premium arises and should be recognized.

Pro-forma Journal Entries

1. Purchase of premium Premiums inventory xxx
articles Cash/AP xxx
2. When the premiums are Premium expense xxx
distributed to customers Premiums inventory xxx

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3. At the end of the year, if Premium expense xxx

premiums are still Estimated premium liability xxx
outstanding

2. Warranty Liability
A warranty is a legal binding assurance that a product is, among other things
fit for use as represented, free from defective material and workmanship, and
meets statutory and/or other specifications.
Warranty is recorded at the time of sale based on best estimate. Estimate is
reviewed at a certain date and difference between estimate and actual cost is
accounted as change in accounting estimate to be treated as currently and
prospectively.

Two Approaches when accounting for warranties:

1. Accrual approach (supports Matching of Costs with Revenue)
2. Expense as incurred approach (when warranty cost is not substantial)

Pro-forma Journal Entries

1. When products with warranties Warranties expense xxx
are sold, recognize provision Estimated warranty liability xxx
2. Disbursement for warranty Estimated warranty liability xxx
Cash xxx
3. Actual cost exceeds estimate Warranties expense xxx
Cash xxx
4. Actual cost is less than estimate Estimated warranty liability xxx
Warranties expense xxx

B. Payroll taxes
Under Philippine laws, the entity as an employer are required to withhold from
the salaries of each employee the following:
a. Withholding taxes payable by the employee
b. Employee contribution to SSS, PhilHealth, and Pag-IBIG Fund
c. Other deductions such as union dues and group insurance as required by
contract

Pro-forma Journal Entries

1. To record the employer’s Salaries expense xxx
payment of salaries Cash xxx
Withholding taxes payable xxx
SSS Premiums Payable xxx
Pag-ibig Premiums Payable xxx
PhilHealth Premiums Payable xxx
2. To record the employer’s Employee benefit expense xxx
remittance of his/her SSS Premiums Payable xxx
corresponding share of Pag-ibig Premiums Payable xxx
statutory benefits mandated by PhilHealth Premiums Payable xxx
law

C. Value-added taxes or VAT

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Cities of Mandaluyong and Pasig

Under the National Internal Revenue Code, an entity is required to collect

value-added taxes from customers on sales of goods and services that are
VAT-able.

Pro-forma Journal Entries

1. To record the seller’s sales Cash/AR xxx
revenue that is VAT-able Output VAT xxx
Sales xxx
2. To record VAT-able goods and Input VAT xxx
services purchased Purchases/Asset/Expense xxx
Cash/AP xxx
3. Upon remittance to BIR for the Output VAT xxx
appropriate VAT, to record the Input VAT xxx
offsetting of output and input VAT payable xxx
VAT to determine the net
liability to BIR
4. To record payment of VAT VAT payable xxx
Cash xxx
D. Dividends Payable
These are amounts owed by a corporation to its shareholders as a result of
the board of directors’ action on the distribution of corporate earnings.
1. Cash dividends, property dividends and scrip dividends will result to a
creation of a current liability that is record on the date of declaration of
dividends.
2. Share dividends distributable are not classified as a liability because it will
not require outflow from the enterprise of resources embodying economic
benefits.

E. Liability for Bonuses (Estimated Liability)

Bonus is a gratuity given by entities to their employees as a gift or
compensation earned as reward upon achieving a goal such as exceeding
budgeted income during the year, meeting quotas, and having a superior
performance in a project or activity.
This compensation plan results in liability that must be measured and
reported in the financial statements. The bonus computation usually has four
variations:
1. Net income before bonus and tax

B = BR * NY
2. N
et income after bonus but before tax

3. B = BR * (NY-B) N
et
income after bonus and tax

B = BR * (NY – B – T)

T = TR * (NY – B)

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Cities of Mandaluyong and Pasig

4. Net income after tax but before bonus

B = BR * (NY -T)
T = TR * (NY – B)

Unearned Revenues
Unearned/deferred revenue is income already received but not yet earned.
Typical examples include advances received from customers for goods yet to
be delivered, services yet to be provided, gift certificates sold, and unearned
subscriptions.

Gift certificates (and gift cards) are often sold by a retailer to a buyer for
cash or being given by employer as reward. The holder can then redeem the
gift certificate or give it to another person who can redeem the gift certificate
for merchandise or services.

Pro-forma Journal Entries

1. When gift certificates are Cash xxx
sold Gift certificates payable xxx
2. When the gift certificates Gift certificates payable xxx
are redeemed Sales xxx
3. When the gift certificates Gift certificates payable xxx
expire or not redeemed Forfeited gift certificates xxx

Deposits and Advances

Deposits received represent cash received and held in behalf of other
entities such as clients and customers. Examples include deposit in escrow
accounts and refundable deposits on returnable containers.

Pro-forma Journal Entries

1. To record receipt of cash from Cash xxx
deposits Deposits (liability account) xxx
2. To record refunds of deposits Deposits xxx
Cash xxx
3. Assuming the customer fails to Deposits xxx
return the container/condition is Container xxx
not met Gain (if any) xxx

Customer Loyalty Programs under IFRS 15

Customer loyalty programs are designed to reward customers for past
purchases and to provide them with incentives to make further purchases. If a
customer buys goods or services, the entity grants the customer award
credits or often described as “points”.
Measurement: An entity shall account for the award credits as a separate
component of the initial sale transaction. Under IFRS 15, an entity shall
allocate the transaction price to each performance obligation identified in the
contract on a relative stand-alone selling price basis.

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Cities of Mandaluyong and Pasig

Recognition: The consideration allocated to the award credits is initially

recognized as unearned revenue and subsequently recognized as revenue
when the award credits are redeemed.

Guided Exercises / Learning Activities

PRACTICE PROBLEMS:
Requirements:
1. Choose the correct answer for the choices.
2. Provide the journal entries necessary and identify the classification of the
items in the financial statements.

PROVISIONS AND CONTINGENCIES

1. Luffytaro, Inc., a manufacturer of pirated signature hats has had a lawsuit filed
against it by Navy Blue Mfg., Inc., another manufacturer of signature hats.
The suit alleges copyright infringements by Luffytaro, Inc. and asks for
compensatory damages.

For the following situations, determine how Luffytaro, Inc. should report the
information concerning the lawsuit. The choices are: ACCRUE AND
DISCLOSE, DISCLOSE ONLY, ACCRUE ONLY, or IGNORE.

Situation Answer Journal Entry

a. Luffytaro’s legal counsel is convinced that the
likelihood of losing the case is probable, the
potential amount of the loss is estimated to be ₱
300,000.
b. Luffytaro’s legal counsel estimates that the
infringement case will result in a loss of ₱ 400,000
but considers the likelihood of losing the case as
remote.
c. Luffytaro’s legal counsel estimates that the
infringement case will result in a loss of ₱ 400,000
but considers the likelihood of losing the case
reasonably possible.
d. Luffytaro’s legal counsel is convinced that the
likelihood of losing the case is probable, the
potential amount of the loss, however, is currently
undetermined.
e. Luffytaro’s legal counsel is convinced that the
likelihood of losing the case is probable, the
potential amount of the loss, based on evidences,
are as follows, 20% that the liability would be ₱

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Cities of Mandaluyong and Pasig

300,000; 50% that the liability would be ₱ 400,000;

30% that the liability would be ₱ 500,000.
f. Luffytaro’s legal counsel is convinced that the
likelihood of losing the case is probable, the
potential amount of the loss, based on evidences,
would be around ₱ 500,000 to ₱ 1,500,000.
2. During 2020, Roronoa Company is the defendant in a patent infringement
lawsuit. The lawyers believe that there is 30% chance that the court will
dismiss the case and the entity will incur no outflow of economic benefits.
However, the court rules I favor of the claimant, the lawyers believe that that
there is 20% chance that the entity will be required to pay damages of ₱
200,000 and an 80% chance that the entity will be required to pay damages
of ₱ 100,000. Other outcomes are unlikely. The court is expected to rule in
late December 2021. There is no indication that the claimant will settle out of
court.
A 7% risk adjustment factor to the probability-weighted expected cash flows is
considered appropriate to reflect the uncertainties in the cash flow estimate.
An appropriate discount is 5% per year. The present value of 1 at 5% fore
one period is 0.95.

A. What is the undiscounted provision before risk adjustment on December

31, 2020?
a. 200,000 c. 150,000
b. 100,000 d. 84,000

B. What amount should be reported as provision for lawsuit on December

31, 2020?
a. 79,800 c. 89,880
b. 95,000 d. 85,386

Journal Entry Particulars Dr Cr Classification

in FS

PREMIUM LIABILITY

3. Vinsmoke Inc., a seller of soaps, includes one coupon in each box of laundry
soap it sells. A towel is offered as a premium to customers who sends 10
coupons and a remittance of ₱ 10.00. Distribution cost of premium is ₱ 5.00.
Experience indicates that only 30% of the coupons will be redeemed.

2020 2021
Boxes of soaps sold 2,000,000 2,500,000
Number of towels purchased at ₱ 50.00 each 50,000 80,000
Coupons redeemed 400,000 700,000

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Cities of Mandaluyong and Pasig

A. What is the premium expense for 2020?

a. 2,500,000 c. 1,800,000
b. 2,400,000 d. 2,700,000

B. What is the estimated premium liability on December 31, 2020?

a. 1,000,000 c. 800,000
b. 1,100,000 d. 900,000

C. What is the premium expense for 2021?

a. 3,000,000 c. 3,375,000
b. 3,750,000 d. 4,000,000

D. What is the estimated premium liability on December 31, 2021?

a. 1,000,000 c. 1,125,000
b. 1,250,000 d. 1,375,000

Journal Entry Particulars Dr Cr Classification

in FS

WARRANTY LIABILITY

4. During 2020, Kuma, Inc. introduced a new product carrying a two-year warranty
against defects. The estimated warranty costs related to peso are 4% within 12
months following sale and 6% in the second 12 months following sale. Kuma
reported sales for 2020 of ₱ 5,000,000 and ₱ 6,000,000. The actual expenditures
incurred and paid amounted to ₱ 150,000 for 2020 and ₱ 550,000 for 2021.

A. What is the warranty expense for 2021?

a. 650,000 c. 500,000
b. 600,000 d. 550,000

B. What is the estimated warranty liability on December 31, 2021?

a. 260,000 c. 240,000
b. 400,000 d. 100,000

Journal Entry Particulars Dr Cr Classification

in FS

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Cities of Mandaluyong and Pasig

CUSTOMER LOYALTY PROGRAMS UNDER IFRS 15

5. Thousand Sunny, Inc., a grocery retailer, operates a customer loyalty program.
The entity grants program member loyalty points when they spend a specified
amount of groceries. Program members can redeem their points for further groceries.
The points have no expiry date. During 2020, the sales amounted to ₱ 7,000,000
based on stand-alone selling price. During the year, the entity granted 10,000 points.
Management expected that only 80% or 8,000 points will be redeemed. The stand-
alone selling price of each loyalty point is estimated at ₱ 100.
On December 31, 2020, 4,800 points have been redeemed. In 2021, management
revised its expectations and now expected 90% or 9,000 points will be redeemed
altogether. During 2021, the entity redeemed 2,400 points.
A. What amount should be reported as sales revenue including the revenue
earned from points for 2020?
a. 7,000,000 c. 6,650,000
b. 6,125,000 d. 7,525,000

B. What is the revenue earned from loyalty points for 2021?

a. 700,000 c. 210,000
b. 175,000 d. 200,000

Journal Entry Particulars Dr Cr Classification

in FS

DEPOSITS RECEIVED (CONTAINER’S DEPOSIT)

6. Doflamingo Corp. requires deposits from customers for containers of goods sold.
The customers are refunded for the deposits received when the containers are
returned within two years from date of sale of the related goods. Deposits for
containers not returned within the time limit are regarded as proceeds from
retirement of containers. Information for 2020 are as follows:

Customers’ deposit at December 31, 2019, from deliveries in:

2018 ₱ 10,000
2019 90,000 ₱ 100,000

Deposits for container delivered in 2020 100,000

Deposits for containers returned in 2020 from deliveries in:

2018 ₱ 10,000
2019 40,000
2020 42,000 92,000

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Cities of Mandaluyong and Pasig

How much is the liability for the deposits on returnable containers on December 31,
2020?
a. 118,000 c. 108,000
b. 115,000 d. 100,000

Journal Entry Particulars Dr Cr Classification

in FS

LIABILITY FOR BONUSES

7. Katakuri, president of Ministry of Flour, Co., has an arrangement with the company
under which he receives 10% bonus each year. For the current year, the net income
before deducting even the provision for income taxes or the bonus is ₱ 5,500,000.
The bonus is deductible for tax purposes and the tax rate is 30%.
A. How much is Katakuri’s bonus if bonus is calculated based on net income before
bonus and income tax?
B. How much is Katakuri’s bonus if bonus is calculated based on net income after
bonus but before income tax?
C. How much is Katakuri’s bonus if bonus is calculated based on net income after
bonus and income tax?
D. How much is Katakuri’s bonus if bonus is calculated based on net income after
income tax but before bonus?

Journal Entry Particulars Dr Cr Classification

in FS

GIFT CERTIFICATES PAYABLE

8. Sabo Company sells gift certificates redeemable only when merchandise is
purchased. Upon redemption, Sabo Company recognizes revenue as realized.
Information for the current year is as follows:
Unearned revenue, January 1 650,000
Gift certificates sold 2,250,000
Gift certificates redeemed 1,950,000
Gift certificates unredeemed for a long time 100,000
Cost of goods sold 60%

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Cities of Mandaluyong and Pasig

What amount should be reported as unearned revenue at year end?

a. 510,000 c. 850,000
b. 570,000 d. 950,000

Journal Entry Particulars Dr Cr Classification

in FS

Assessment

(Additional Items only. Optional) Multiple

Choice: Choose the correct answer from the choices.

1. Marineford Corp. provides an incentive compensation plan under which its

president receives a bonus equal to 10% of the corporation’s income in
excess of ₱600,000, before income tax but after deduction of the bonus. If
income before income tax and bonus is ₱1,920,000 and the tax rate is 32%,
the amount of the bonus is
a. 120,000 c. 174,360
b. 132,000 d. 192,000

2. Zou Company requires refundable advance payments with special orders for
machinery constructed to customer’s specifications. Information for 2020 is as
follows:

Customer advances – balance, December 31, 2019 ₱ 885,000

Advances received with orders in 2020 1,380,000
Advances applied to orders shipped in 2020 1,230,000
Advances applicable to orders cancelled in 2014 375,000

What amount should Zou Company report as current liability for customer’s
deposits in December 31, 2020 statement of financial position?
a. None c. 1,035,000
b. 660,000 d. 1,110,000

3. Impel Down, Inc. is preparing the annual financial statements on December

31, 2020. Because of a recently proven health hazard in one of its products,
the Philippine government has clearly indicated its intention of requiring the
entity to recall all cans of this product sold in the last three months. The
management of the entity estimated that this recall would cost ₱ 490,000.
What accounting recognition should be accorded to this situation?
a. No recognition
b. Disclosure only in the notes
c. Expense of 580,000 and liability of 580,000
d. Expense of 580,000 and retained earnings restriction of 580,000

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4. Sabaody Co. sells televisions with a 2-year warranty. Past experience

indicates that 2% of the units sold will be returned during the warranty period
for repairs. The average cost of repairs under warranty is estimated to be
P100 per unit. During 2019, 6,000 units were sold at an average price of ₱
4,000. During the year, repairs were made on 35 units at a cost of P20,000.
Compute the amount of warranty expense.
a. 12,000 c. 18,000
b. 14,000 d. 20,000

5. Thriller Bark, Inc. provided warranty for all products sold during 2020. The
entity sold 200,000 units during the current year. It is estimated that 75% of
the products will have no defects. 15% of the products sold will have a minor
defect and 10% of the products will have a major defect. The cost of a minor
defect is ₱100 per unit while the cost of major defect is ₱300. The entity is
also involved in a tax dispute with BIR in 2020. Based on legal advice, there
is a 40% chance that the entity will lose the case and the entity have to pay ₱
500,000.

What total amount of provisions should be recorded on December 31, 2020?

a. 9,300,000 c. 9,000,000
b. 9,200,000 d. 9,500,000

6. East Blue Publication sells magazine subscriptions for a 1-year, 2-year or 3-

year period. Cash receipts from subscribers are credited to unearned
subscription revenue and this account had a balance of ₱ 1,700,000 on
January 1, 2020. The entity provided the following information for the year
ended December 31, 2020:
Cash receipts from subscribers 2,300,000
Subscription revenue credited on
December 31, 2020 1,500,000

On December 31, 2020, what amount should be reported as unearned

subscriptions revenue?
a. 1,100,000 c. 1,500,000
b. 2,500,000 d. 2,300,000

7. Dressrosa Corp. frequently distributes coupons to promote new products. On

October 1, 2020, the entity mailed 100,000 coupons for ₱ 45 off each box of
cereal purchased and expected 12,000 of these coupons to be redeemed
before the December 31, 2020 expiration date. It takes 30 days from the
redemption date for the entity to receive the coupons from the retailers. The
entity reimburses the retailers an additional ₱ 5 for each coupon redeemed.

On December 31, 2020, Dressrosa had paid retailers ₱ 250,000 related to

these coupons and had 5,000 coupons on hand that had not been processed
for payment.

What amount should be reported as liability for coupons on December 31,

2020?
a. 350,000 c. 250,000
b. 290,000 d. 225,000

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8. At year-end, Skypiea Inc. was suing a competitor for patent infringement. The
award from the probable favorable outcome could be reasonably estimated.
Skypiea’s financial statements should report the expected award as
a. Receivable and revenue
b. Disclosure only
c. Receivable and unearned revenue
d. Receivable and reduction of patent

9. Loguetown Corp. sells appliances that include a two-year warranty. Service

calls under the warranty are performed by an independent mechanic under
contract with the entity. Based on experience, warranty costs are estimated at
a certain amount for each appliance sold. When should the entity recognize
these warranty costs?
a. Evenly over the life of the warranty
b. When the service calls are performed
c. When payments are made to the mechanic
d. When the appliances are sold

10. Wano Company received an advance payment for special order goods that
are to be manufactured and delivered within six months. How should the
advance payment be reported in the statement of financial position?
a. Deferred charges
b. Contra asset account
c. Current liability
d. Noncurrent liability

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