CURRENT

LIABILITIES
Accounting Procedures
CLASSIFICATION OF CURRENT
LIABILITY
 The entity expects to settle the liability
within the entity’s operating cycle.
 The entity holds the liability primarily for the
purpose of trading.
 The liability is due to be settled within
twelve months after the reporting period.
 The entity does not have an unconditional
right to defer settlement of the liability for
at least twelve months after the reporting
period.
 Gift
Premiums
Certificates

Customer Refundable
Loyalty Program Deposits

Warranty Bonus

Deferred
Payroll Taxes Revenue

Value Added
Taxes
PREMIUMS
 These are articles of value given to
customers as result of past sales or sales
promotion activities.

Toys

Dishes

Silverware

Cash
Payments
PRO-FORMA ENTRIES
Upon purchase of Premiums xx
premiums: Cash xx

Upon distribution
Premium Expense xx
of premiums to
Premiums xx
customers:

Year-end Premium Expense xx

adjustment: Est. Premium Liability xx
Illustration:

In an effort to increase sales, Fox Company inaugurated a

sales promotional campaign on June 30, 2012. Fox
placed a coupon redeemable for a premium in each
package of cereal sold. Each premium cost Fox P20 and
five coupons must be presented by a customer to receive
a premium. Fox estimated that only 60% of the coupons
issued will be redeemed. For the six months ended Dec.
31, 2012, the following information is available:

Packages of Premiums Coupons

Cereal Sold Purchased Redeemed
160,000 12,000 40,000

What is the estimated liability for premiums on Dec. 31,

2012?
 Each package sold is entitled to 1 coupon.
Thus, since there were 160,000 sold
packages, there were 160,000 coupons
issued.
 Five (5) coupons are redeemable for 1
premium.
 Each premium costs P20.
 60% of the coupons issued are estimated to
be redeemed.
 40,000 coupons were already redeemed.
 Since the campaign started on June, 2012,
there is no outstanding estimated liability
from previous year.
How to calculate the estimated liability for
premiums:

Coupons to be redeemed (coupons issued x

est. rate of redemption)
Less: Coupons redeemed
Coupons outstanding
÷ no. of coupons needed to get 1 premium
Number of premiums

Estimated Liability = no. of premiums x cost

Solution:

Coupons to be redeemed (160,000x60%) 96,000

Less: Coupons redeemed
40,000
Balance 56,000
÷
5
Number of premiums 11,200

Estimated Liability = 11,200 x 20

= 224,000
Entries:

Premiums (12,000 x 20) 240,000

Cash 240,000

Premium exp.(40,000/5 x 20) 160,000

Premiums
160,000

Premium exp. 224,000

Est. premium liability 224,000
Illustration:

During 2012, May Company sold 500,000 boxes of cake

mix under a new sales promotional program. Each box
contains one coupon, which entitles the customer to a
baking pan upon remittance of P40. May pays P50 per
pan and P5 for handling and shipping. May estimates that
80% of coupons will be redeemed, even though only
300,000 coupons had been processed during 2011. What
amount should may report as a liability for unredeemed
coupons on Dec. 31, 2012?
How to calculate the estimated liability for
Unredeemed coupons:

Coupons to be redeemed (coupons issued x

est. rate of redemption)
Less: Coupons redeemed
Coupons outstanding
÷ no. of coupons needed to get 1 premium
Number of premiums
How to calculate the estimated liability for
Unredeemed coupons:

Purchase price of premium

Add: Handling and Shipping (Distribution cost)
Total
Less: Remittance from customer
Cost of Premium or Net premium expense

Estimated Liability = no. of premiums x cost

Solution:

Coupons to be redeemed (500,000x80%) 400,000

Less: Coupons redeemed 300,000
Coupons Outstanding 100,000

Purchase price of premium 50

Add: Handling and Shipping 5
Total 55
Less: Remittance from customer 40
Net premium expense 15

Liability for unredeemed coupons = 100,000 x 15

= 1,500,000
Strawberry

Orange
Exercise:

Strawberry company manufactures a special product. To

promote the sale of the product, a premium is offered to
customers who send in three wrappers and remittance of
P25. The distribution cost per premium is P5. Data for
the premium are:

2011 2012
Sales 4,000,000 5,000,000
Premium purchase at P80 each 400,000 416,000
No. of premiums distributed 4,000 5,500
No. of premiums to be
distributed in next period 200 500

What amount should be reported as premium expense for

2012?
Solution:

Premiums distributed in 2012 5,500

Premiums to be distributed in next period 500
Total 6,000
Premiums arising from 2011 sales
distributed in 2012 (200)
Premiums applicable to 2012 5,800

Premium expense = 5,800 x 60

= 348,000
Exercise:

Orange Company includes one coupon in each box of

laundry soap it sells. A towel is offered as a premium to
customers who send in 10 coupons and a remittance of
P20.

2011 2012
Boxes of soap sold 500,000 800,000
No. of towels purchased (P100/towel) 20,000 25,000
Coupons redeemed 140,000 200,000

Experience indicates that only 30% of the coupons will be

redeemed. What is the premium liability on Dec. 31,
2012?
Solution:

Coupons to be redeemed in 2011 and 2012

(1,300,000x30%) 390,000
Coupons redeemed in 2011 and 2012
(140,000 + 200,000) 340,000
Outstanding coupons – Dec. 31, 2012 50,000

Number of towels (50,000/10) 5,000

X cost of towel less remittance (100 - 20) 80
Premium liability – Dec. 31, 2012 400,000
CUSTOMER LOYALTY PROGRAM
 It is designed to reward customers for past
purchases and to provide them with
incentives to make further purchases.
RECOGNITION AND
MEASUREMENT
 Under IFRIC 13, an entity shall account for
the award credits as a “separately
component of the initial sale transaction.
 The fair value of the consideration received
with respect to the initial sale shall be
allocated between the award credits and the
sale.
 The award credits is measured at fair value.
RECOGNITION AND
MEASUREMENT
 The subsequent recognition of the amount
allocated to the award credits as revenue
depends on the following:

 The entity supplies the awards itself.

 A third party supplies the awards
THE ENTITY SUPPLIES THE
AWARDS ITSELF
 The consideration allocated to the award
credits is initially recognized as deferred
revenue and subsequently recognized as
revenue when the award credits are
redeemed.
 The amount of revenue shall be based on the
number of award credits that have been
redeemed relative to the total number
expected to be redeemed.
 The calculation of the revenue to be
recognized is made on a “cumulative basis”
in order to reflect the changes in estimate.
Illustration:

A grocery retailer operates a customer loyalty program. The

entity grants program members loyalty points when they
spend a specified amount on groceries. Program members
can redeem the points for further groceries. The points have
no expiry date.

During 2012, the entity granted 10,000 points. Management

expects that 80% or 8,000 of these points will be redeemed.
The fair value of each point is estimated at P100.

The sales during 2012 amounted to 8,000,000 including the

points. On Dec. 31, 2013, the entity redeemed 4,100 points.

In 2014, a further 900 points are redeemed. Management

continues to expect that only 9,000 points will ever be
redeemed, meaning, no more points will be redeemed after
2014.
Solution:

Total consideration 8,000,000

Less :Fair value of points(10,000x100) 1,000,000
Fair value of initial sale 7,000,000

Entry for initial sale in 2012:

Cash 8,000,000
Sales 7,000,000
Unearned revenue-points 1,000,000
Revenue to be recognized in 2012:

(Estimated points
to be redeemed x Unearned revenue
÷ Points redeemed)

= 4,000/8,000 x 1,000,000
= 500,000

Entry:
Unearned revenue-points 500,000
Sales 500,000
Revenue to be recognized in 2013:

Points redeemed in 2012 4,000

Points redeemed in 2013 4,100
Total points redeemed to Dec. 31, 2013 8,100

Cumulative revenue on Dec. 31, 2013

(8,100/9,000 x 1,000,000) 900,000
Revenue recognized in 2012 (500,000)
Revenue to be recognized in 2013 400,000

Entry: Unearned revenue-points 400,000

Sales 400,000
Revenue to be recognized in 2014:

Points redeemed in 2012 4,000

Points redeemed in 2013 4,100
Points redeemed in 2014 900
Total points redeemed to Dec. 31, 2014 9,000

Cumulative revenue on Dec. 31, 2014

(9,000/9,000 x 1,000,000) 1,000,000
Cumulative revenue on Dec. 31, 2013 (900,000)
Revenue to be recognized in 2014 100,000

Entry: Unearned revenue-points 100,000

Sales 100,000
A THIRD PARTY SUPPLIES THE
AWARDS
 The entity shall asses whether it is collecting
the consideration allocated to the award
credits on its own account as principal in the
transaction, or on behalf of the third party as
agent of the third party.
 The revenue from the award credits is
recognized at the initial point of sale.
A THIRD PARTY SUPPLIES THE
AWARDS
 If the entity is collecting the consideration as
principal in the transaction,
Revenue = gross consideration allocated
to award credits

 If the entity is collecting the consideration as

agent of the third party,
Revenue = consideration allocated to
award credits ― amount payable to third party
Illustration:

An entity, a retailer of electrical goods,

participates in a customer loyalty program
operated by an airline. The entity grants
program members one travel point for every
P1,000 spent on electrical goods. Program
members can redeem the points for travel with
the airline subject to availability.

The entity pays the airline P90 for each point.

During the current year, the entity sold
electrical goods for P5,000,000 and granted
5,000 points. The fair value of a point is P100.
If the entity has collected the consideration allocated to
points on its own account, the entry to record the initial
sale and fair value of the point is:

Cash 5,000,000
Sales 4,500,000
Revenue from points 500,000

Total consideration 5,000,000

Fair value of points (5,000 x 100) (500,000)
Consideration for the initial sale 4,500,000

The payment to the airline is separately accounted for as

expense as follows:

Loyalty program expense (5,000x90) 450,000

Cash 450,000
If the entity has collected the consideration on
behalf of the airline, the entry to record the
initial sale is as follows:

Cash 5,000,000
Sales 4,500,000
Liability for points 500,000

The entry to record the payment to the airline

is as follows:

Liability for points 500,000

Cash 450,000
Revenue from points 50,000
Exercise:

Esther company operates a customer loyalty

program. The entity grants loyalty points for goods
purchased. The loyalty points can be used by the
customers in exchange for goods of the entity. The
points have no expiry date. During 2012, the entity
issued 50,000 award credits. The fair value of the
award credits is reliably measured at P2,000,000.
In 2012, the entity sold goods to customers for a
total consideration of P9,000,000 including the fair
value of the award credits. The total award credits
expected too be redeemed are 80% in 2012 and 85%
in 2013. The award credits actually redeemed are
15,000 in 2012 and 7,950 in 2013. What is the
revenue earned from points in 2013?
Solution:
Points expected to be redeemed in 2012
(50,000 x 80%) 40,000

Revenue earned from points in 2012

(15,000/40,000 x 2,000,000) 750,000

Points expected to be redeemed in 2013

(50,000 x 85%) 42,500

Point redeemed in 2012 15,000

Points redeemed in 2013 7,950
Total points redeemed to date 22,950

Cumulative revenue earned to date

(22,950/42,500 x 2,000,000) 1,080,000
Revenue earned from points in 2012 (750,000)
Revenue earned from points in 2013 330,000
PAYROLL TAXES
 Under the Philippine law, the entity as an
employer is required to withhold from the
salaries of each employee the following:

a. Income tax payable by the employee

b. Employee’s contribution to SSS
c. Employee’s contribution for Philhealth
d. Employee’s contribution to Pag-ibig Fund
PAYROLL TAXES
 Other deductions may be made by the
employer from the salaries for union dues
and group insurance as required by contract.
 The entity is also required to make a
contribution for SSS, Philhealth and Pag-ibig
Fund representing its share in the benefits of
the employees.
Illustration:

An entity reported the following payroll of the employees

for the month of January:

Gross payroll 500,000

Less: Income tax withheld 20,000
SSS contribution 4,000
Philhealth contribution 2,000
Pag-ibig contribution 1,000
Net Payroll 473,000

In addition to the payroll for the month of January, the

entity is required to make the following contribution:

SSS 6,000
Philhealth 3,000
Pag-ibig 2,000
Total contribution 11,000
The entry to record the gross payroll is as follows:

Salaries 500,000
Withholding tax payable 20,000
SSS payable 4,000
Philhealth payable 2,000
Pag-ibig payable 1,000
Cash 473,000

The entry to record the employer’s contribution is as follows:

Payroll tax expense 11,000

SSS payable 6,000
Philhealth payable 3,000
Pag-ibig payable 2,000
The entry to record the remittance of the amounts withheld
and the payment of the additional contribution is:

Withholding tax payable 20,000

SSS payable (4,000+6,000) 10,000
Philhealth payable (2,000+3,000) 5,000
Pag-ibig payable (1,000+2,000) 3,000
Cash 38,000
 Melon

Grapes
Exercise:

Sonny Company reported gross payroll of P60,000 for the

month of january. The company paid the payroll net of the
following deductions:

Income tax 70,000

SSS 10,000
Philhealth 5,000
Pag-ibig 7,000

In addition, the entity recognized its additional contributions

for the ff. in relation to January payroll:

SSS 15,000
Philhealth 6,000
Pag-ibig 8,000

What is the payroll tax liability?

Solution:

Income tax 70,000

SSS (10,000+15,000) 25,000
Philhealth (5,000+6,000) 11,000
Pag-ibig (7,000+8,000) 15,000
Total payroll tax liability 121,000
Exercise:

Timothy Company’s payroll for the month of

Jan. 2011 is summarized as follows:

Total wages 500,000

Income tax withheld 60,000

All wages paid were subject to SSS. The tax

rates were 7% each for employee and employer.
The company remits payroll taxes on the 15th of
the following month ended Jan. 31, 2011, what
amount should be reported respectively as total
payroll tax liability and payroll tax expense?
Solution:

a.
Income tax withheld 60,000
SSS - employee (7%x500,000) 35,000
SSS - employer (7%x500,000) 35,000
Total payroll tax liability 130,000

b.
Payroll tax expense = 500,000 x 7%
= 35,000
VALUE ADDED TAXES (VAT)
 Under NIRC, an entity is required to collect
VAT from customers on sales of tangible
persona proerty and certain services.
 The VAT payable to the government is
classified as current liability.
 The VAT rate is equivalent to 12%.
Illustration:

During a month, an entity sold goods to

customers on account for P5,600,000 including
value added taxes of P600,000.

In the same month, the entity purchased goods

on account from suppliers for P2,240,000
including VAT of P240,000.
The entry to record the sale is:

Accounts receivable 5,600,000

Sales 5,000,000
Output VAT 600,000

The entry to record the purchase is:

Purchases 2,000,000
Input VAT 240,000
Accounts Payable 2,240,000
The entry to recognize the net liability at the
end of the month is as follows:

Output VAT 600,000

Input VAT 240,000
VAT payable 360,000

The entry to settle the liability is:

VAT Payable 360,000

Cash 360,000
Sweet Sour
Exercise:

Mikee Company operates a retail store. All items are sold subject
to a 12% VAT, which Mikee collects and records as sales revenue.
Miyuki files quarterly sales tax returns when due by the 20 th day
following the end of the sales quarter. However, in accordance
with state requirements, Mikee remits VAT collected by the 20th
day of the month following any month such collections exceed
P50,000. Mikee takes these payments as credits on the quarterly
sales tax return. The VAT paid by the Mikee are charged against
sales revenue. Following is a monthly summary appearing in the
first quarter 2011 sales revenue account:

Debit Credit
January - 560,000
February 60,000 392,000
March - 448,000

On March 31, 2011, what amount should be reported as VAT

payable?
Solution:

January 560,000
February 392,000
March 448,000
Sales including VAT 1,400,000
Sales excluding VAT (1,400,000/1.12) (1,250,000)
Output VAT 150,000
Payment of VAT in February (60,000)
VATpayable 90,000
Exercise:

Gomer Hotel collects 15% in city sales taxes on room rentals,

in addition to a P200 per room, per night, occupancy tax.
Sales taxes for each month are due at the end of the ff.
month, and occupancy taxes are due fifteen days after the
end of each calendar quarter. On January 3, 2012, Gomer
paid its Nov. 2011 sales taxes and its fourth quarter 2011
occupancy taxes. Additional information for the fourth
quarter of 2011 is as follows:

Room rentals Room nights

October 1,000,000 1,100
November 1,100,000 1,200
December 1,500,000 1,800

What amount should be reported respectively as sales taxes

payable and occupancy taxes payable on Dec. 31, 2011?
Solution:
a.
November room rentals 1,100,000
December room rentals 1,500,000
Total 2,600,000

Sales taxes payable = 15% x 2,600,000

= 390,000

b.
October 1,100
November 1,200
December 1,800
Fourth quarter room nights 4,100

Occupancy taxes payable = 200 x 4,100

= 820,000
GIFT CERTIFICATES PAYABLE
 The accounting procedures for gift
certificates are as follows:

Upon sale of gift Cash xx

certificates: Gift cert. payable xx

Upon redemption: Gift cert. payable xx

Sales xx

When gift Gift cert. payable xx

certificates expire: Forfeited gift cert. xx
Illustration:

Kirby Department Store sells gift certificates redeemable

only when merchandise is purchased. These gift certificates
have an expiration date of 2 years after issuance date. Upon
redemption or expiration, Kirby recognizes the unearned
revenue as realized.

Information for the current year is as follows:

Unearned revenue, Jan. 1, 2012 650,000

Gift certficates sold 2,250,000
Gift certificates redeemed 1,950,000
Expired gift certificates 100,000
Cost of goods sold 60%

On Dec. 31, 2012, what amount should be reported as

unearned revenue?
Solution:

Unearned revenue – Jan. 1, 2012 650,000

Add: Gift certificates sold 2,250,000
Total 2,900,000
Less: Gift certificates redeemed 1,950,000
Expired gift certificates 100,000 2,050,000
Unearned revenue – Dec. 31, 2012 850,000
Exercise:

Paul Department Store sells gift certificates,

redeemable for store merchandise, that expire one year
after their issuance. Paul has the ff. information
pertaining to its gift certificates sales and redemptions:

Unearned on Jan. 1, 2011 750,000

2011 sales 2,500,000
2011 redemptions of prior year sales 250,000
2011 redemptions of current year sales 1,750,000

Paul’s experience indicates that 10% of gift certificates

sold will not be redeemed.

In its Dec. 31, 2011 statement of financial position,

what amount should Paul reports as unearned revenue?
Solution:

2011 sales of gift certificates

2,500,000
2011 redemptions of current year sales
(1,750,000)
Expected gift cert. not to be redeemed
(10% x 2,500,000)
(250,000)
Unearned revenue – Dec. 31, 2011 500,000
REFUNDABLE DEPOSITS
 Refundable deposits consist of cash or
property received from customers but which
are refundable after compliance with certain
conditions.
Illustration:

Autumn Company operates a retail grocery store

that is required by law to collect refindable
deposits of P5 on soda cans. Information for the
current year follows:

Liability for refundable deposit – Jan. 1 150,000

Cans of soda sold 100,000
Soda cans returned 110,000

In the Dec. 31 statement of financial position, what

amount should be reported as current liability for
deposit?
Solution:

Liability for refundable deposit– Jan. 1150,000

Add: Deposit made (100,000x5)
500,000
Total
650,000
Less: Deposit refunded (110,000x5)
550,000
Liability for refundable deposit– Dec. 31
100,000
Exercise:
Jericho company sells its products in reusable containers. The
customer is charged to a deposit for each container delivered
and receives a refund for each container returned within 2
years after the year of delivery. Jericho accounts for the
containers not returned within the time limit as being retired
by sale at the deposit amount. Information for 2011 is as
follows:

Container deposits on Dec. 31, 2010 deliveries in:

2009 150,000
2010 430,000
Deposits for containers delivered in 2011 780,000
Deposit for containers returned in 2011 from deliveries in:
2009 90,000
2010 250,000
2011 286,000
In the Dec. 31, 2011 statement of financial position, what is
the liability for deposits on returnable containers?
Solution:

Container deposits on Dec. 31, 2010

from deliveries in 2010 430,000
Deposit for containers delivered in 2011 780,000
Total 1,210,000
Less: Deposit for containers returned
in 2011 from deliveries in:
2010 250,000
2011 286,000 536,000
Liability for container deposits– Dec. 31 674,000
BONUS
 As percentage of income before bonus
and before tax.
 As percentage of income after bonus but
before tax.
 As percentage of income after bonus and
after tax.
 As percentage of income after tax but
before bonus.
Illustration:

Income before bonus and before tax 4,400,000

Bonus 10%
Income tax rate 30%
Case 1 – Before bonus and before tax

Income before bonus and before tax 4,400,000

x Bonus rate 10%
Bonus 440,000
Case 2 – After bonus but before tax

Bonus = Bonus rate x (Net Income – Bonus)

B = .10 (4,400,000 – B)
B = 440,000 - .10B
B + .10B = 440,000
1.10B = 440,000
B = 440,000/1.10
B = 400,000

Proof:

Income before bonus and before tax 4,400,000

Less: Bonus 400,000
Income after bonus but before tax 4,000,000
x 10%
Bonus 400,000
Case 3 – After bonus and after tax

Bonus = Bonus rate x (Net Income – Bonus – Tax)

B = .10 (4,400,000 – B – T)

Tax = Tax rate x (Net Income – Bonus)

T = .30 (4,400,000 – B)

B = .10 [4,400,000 – B – .30 (4,400,000 – B)]

B = .10 (4,400,000 – B – 1,320,000 + .30B)
B = 440,000 – .10B – 132,000 + .03B
B + .10B – .03B = 440,000 – 132,000
1.07B = 308,000
B = 308,000/1.07
B = 287,850

T = .30 (4,400,000 – 287,500)

T = 1,233,645
Proof:

Income before bonus and before tax 4,400,000

Bonus (287,850)
Tax (1,233,645)
Income after bonus and after tax 2,878,505
x 10%
Bonus 287,850
Case 4 – After tax but before bonus

Bonus = Bonus rate x (Net Income – Tax)

B = .10 (4,400,000 – T)

Tax = Tax rate x (Net Income – Bonus)

T = .30 (4,400,000 – B)

B = .10 [4,400,000 – .30 (4,400,000 – B)]

B = .10 (4,400,000 – 1,320,000 + .30B)
B = 440,000 – 132,000 + .03B
B – .03B = 440,000 – 132,000
.97B = 308,000
B = 308,000/.97
B = 317,526

T = .30 (4,400,000 – 317,526)

T = 1,224,742
Proof:

Income before bonus and before tax 4,400,000

Tax (1,224,742)
Income after tax but before bonus 3,175,258
x 10%
Bonus 317,526
Grapes

Orange
Exercise:

The bonus agreement of Christian Company

provides that the general manager shall receive
annual bonus of 10% of the net income after
bonus and tax. The income tax rate is 30%. The
general manager received P280,000 for the
current year as bonus. What is the income
before bonus and tax?
Solution:

Bonus (10%) 280,000

÷ 10%
Income after bonus and tax (100%) 2,800,000

Income after bonus and tax (70%) 2,800,000

÷ 70%
Income after bonus but before tax (100%) 4,000,000

Income after bonus but before tax 4,000,000

Bonus 280,000
Income before bonus and tax 4,280,000
Exercise:

Chance Company has an agreement to pay its

sales manager a bonus of 5% of the income after
bonus and after tax. The income for the year
before bonus and tax is P5,250,000. The income
tax rate is 30% of the income after bonus. What
is the bonus for the year?
Solution:

Bonus = Bonus rate x (Net Income – Bonus – Tax)

B = .05 (5,250,000 – B – T)

Tax = Tax rate x (Net Income – Bonus)

T = .30 (5,250,000 – B)

B = .05 [5,250,000 – B – .30 (5,250,000 – B)]

B = .05 (5,250,000 – B – 1,575,000 + .30B)
B = 262,500– .05B – 78,750 + .015B
B + .05B – .015B = 262,500 – 78,750
1.035B = 183,750
B = 183,750/1.035
B = 177,536
DEFERRED REVENUE
 Deferred revenue or unearned revenue is
income already received but not yet earned.
 If deferred revenue is realizable within one
year, it is classified as current liability.
PRO-FORMA ENTRIES
To record cash Cash xx
receipts from service Unearned service rev. xx
contracts sold:

To record service Service contract expense xx

contract costs paid: Cash xx

To record the service

Unearned service rev. xx
contract revenue
Service contract rev. xx
recognized:
Illustration:

Jehu Company sells office equipment service contracts

agreeing to service equipment for a two-year period.
Cash receipts from contracts are credited to unearned
service contract revenue and service contract costs are
charged to service contract expense as incurred.
Revenue from service contracts is recognized as earned
over the lives of the contracts. Additional information
for the year ended Dec. 31, 2011 is as follows:

Unearned service contract revenue at Jan. 1 600,000

Cash receipts from service contracts sold 980,000
Service contract revenue recognized 860,000
Service contract expense 520,000

What amount should be reported as unearned service

contract revenue on Dec. 31, 2011?
Solution:

Unearned revenue – Jan. 1 600,000

Cash receipts from service contracts sold 980,000
Total 1,580,000
Less: Service contract revenue recognized 860,000
Unearned service contract revenue – Dec. 31 720,000

Entries:

Cash 980,000
Unearned service revenue 980,000

Service contract expense 520,000

Cash 520,000

Unearned service revenue 860,000

Service contract revenue 860,000
Soft

Crunchy
Exercise:

David Company sells equipment service contracts

that cover a two-year period. The sales price of
each contract is P600. David’s pat experience is
that, of the total pesos spent for repairs on
service contracts, 40% is incurred evenly during
the first contract year and 60% evenly during the
second contract year. Don sold 1,000 contracts
evenly throughout 2011.

In its Dec. 31, 2011 statement of financial

position, what amount should Don report as
deferred service revenue?
Solution:

First contract year (40% x 600,000) 240,000

Second contract year (60% x 600,000) 360,000
Total contracts sold in 2011 600,000

Total contracts sold in 2011 (1,000 x 600) 600,000

Less:Contracts earned in 2011 (240,000 x ½) 120,000
Deferred service revenue – Dec. 31, 2011 480,000
Exercise:

Samuel Company sells subscriptions to a specialized

directory that is published semiannually and shipped to
subscribers on April 1 and October 15. Subscriptions
received after March 31 and September 30 cut-off dates
are held for the next publication. Cash from subscribers
is received evenly during the year and is credited to
deferred revenue from subscriptions.

Data relating to 2011 are as follows:

Deferred revenue from subscriptions – Jan. 1 1,500,000

Cash receipts from subscribers 7,200,000

In the Dec. 31, 2011 statement of financial position,

what amount should be reported as deferred revenue
from subscription?
Solution:

Monthly subscriptions (7,200,000/12) 600,000

The subscriptions after the September 30 cut-off

are:

October 600,000
November 600,000
December 600,000
Total unearned
subscription revenue – Dec. 31 1,800,000
WARRANTY

 Accrual approach
 Expense as incurred approach
ACCRUAL APPROACH

 At the point of sale, a liability for

warranty costs arises.
PRO-FORMA ENTRIES
To set up the liability Warrant expense xx
on warranty at the Est. warranty liability xx
point of sale:

When actual
Est. warranty liability xx
warranty cost is
Cash xx
incurred and paid:
 NEED FOR ADJUSTMENT
 If the actual cost exceeds the estimate, the
difference is charged to warranty expense as
follows:
Warrant expense xx
Est. warranty liability xx

 If the actual cost is less than the estimate,

the difference is an adjustment to warranty
expense as follows:
Est. warranty liability xx
Warranty expense xx
EXPENSE AS INCURRED
APPROACH

 It is the approach of expensing warranty cost

only when actually incurred.
 The entry when actual warranty cost is
incurred is:

Warrant expense xx
Cash xx
Illustration:

Daniel Company sells 1,000 units of television

sets at P9,000 each for cash. Each television set
is under warranty for one year and the entity has
estimated from past experience that warranty
cost will probably average P500 per unit and that
only 60% of the units sold will be returned for
repair. The entity incurs P180,000 for repairs
during the year.
Solution:
Accrual approach:

Entries:

Cash 9,000,000
Sales 9,000,000

Warrant expense 300,000

Estimated warranty liability 300,000

Est. sets to be returned for repair (60%x1,000) 600

X warranty cost per unit 500
Estimated warranty cost 300,000

Estimated warranty liability 180,000

Cash 180,000
Expense as incurred approach:

Warranty expense 180,000

Cash 180,000
Illustration:

An entity sells refrigerators that carry a 2-year warranty

against defects. The sales and warranty repairs are
made evenly throughout the year. Based on the past
experience, the entity projects an estimated warranty
cost of sales as follows:

First year of warranty 4%

Second year of warranty 10%

Sales and actual warranty repairs for two years are as

follows:
2011 2012
Sales 5,000,000 6,000,000
Actual warranty repairs 140,000 300,000
Solution:

Entries for 2011:

Cash 5,000,000
Sales 5,000,000

Warranty expense 700,000

Est. warranty liability 700,000
(14% x 5,000,000)

Est. warranty liability 140,000

Cash 140,000
Entries for 2012:

Cash 6,000,000
Sales 6,000,000

Warranty expense 840,000

Est. warranty liability 840,000
(14% x 6,000,000)

Est. warranty liability 300,000

Cash 300,000
Estimated warranty liability as of Dec. 31, 2012:

Warranty expense:
2011 700,000
2012 840,000 1,540,000

Actual warranty repairs:

2011 140,000
2012 300,000 (440,000)
Est. warranty liability–Dec. 31, 2012 1,100,000
TESTING THE ACCURACY OF
WARRANTY LIABILITY
Sales made evenly

 The first contract year under a 2-year

warranty of the sales made on January 1, 2011
will be within January 1, 2011 to December
31, 2011, and the second contract year will be
within January 1, 2012 to December 31, 2012.

 The first contract year under a 2-year

warranty of the sales made on July 1, 2011
will be within July 1, 2011 to June 30, 2012,
and the second contract year will be within
July 1, 2012 to June 30, 2013.
Warranty expense related to 2011 sales:

2011
First contract year of Jan. 1, 2011 sales
(2,500,000 x 4%) 100,000
First contract year of July 1, 2011 sales
(2,500,000 x 4% x 6/12) 50,000

2012
First contract year of July1, 2011 sales
(2,500,000 x 4% x 6/12) 50,000
Second contract year of Jan.1, 2011 sales
(2,500,000 x 10%) 250,000
Second contract year of July 1, 2011 sales
(2,500,000 x 10% x 6/12) 125,000

2013
Second contract year of July 1, 2011 sales
(2,500,000 x 10% x 6/12) 125,000
Total warranty expense for 2011 700,000
Warranty expense related to 2012 sales

2012
First contract year of January 1, 2012 sales
(3,000,000 x 4%) 120,000
First contract year of July 1, 2012 sales
(3,000,000 x 4% x 6/12) 60,000

2013
First contract year of July 1, 2012 sales
(3,000,000 x 4% x 6/12) 60,000
Second contract year of January 1, 2012 sales
(3,000,000 x 10%) 300,000
Second contract year of July 1, 2012 sales
(3,000,000 x 10% x 6/12) 150,000

2014
Second contract year of July 1, 2012 sales
(3,000,000 x 10% x 6/12) 150,000
Total warranty expense for 2012 840,000
The warranty costs after December 31, 2012 represent the
estimated warranty liability on December 31, 2012.

2011 sales still under warranty after Dec. 31, 2012:

Second contract year of July 1, 2011 sales 125,000

2012 sales still under warranty after Dec. 31, 2012:

First contract year of July 1, 2012 sales 60,000
Second contract year of Jan. 1, 2012 sales 300,000
Second contract year of July 1, 2012 sales
(150,000+150,000) 300,000
Estimated warranty liability – Dec. 31, 2012 785,000
Estimated warranty liability per book (1,100,000)
Decrease in warranty liability (315,000)

Adjusting entry:

Estimated warranty liability 315,000

Warranty expense 315,000
Sweet Salty
Exercise:

During 2011, James Company introduced a new

product carrying a two- year warranty against defects.
The estimated warranty costs related to peso sales are
2% within 12 months following sale and 4% in the
second 12 months following sale. Sales are
P6,000,000 for 2011 and P10,000,000 for 2012. Actual
warranty expenditures are P90,000 for 2011 and
P300,000 for 2012. On December 31, 2012, what is
the estimated warranty liability?
Solution:

Warranty expense:
2011 (6% x 6,000,000) 360,000
2012 (6% x 10,000,000) 600,000 960,000

Actual warranty expenditures:

2011 90,000
2012 300,000 (390,000)
Est. warranty liability – Dec. 31, 2012 570,000
Exercise:

Peter Company estimates its annual warranty

expense at 2% of annual net sales. The net sales
for 2011 amounted to P4,000,000. On January 1,
2011, the warranty liability is P60,000 and the
warranty payments during 2011 totaled P50,000.
What is the warranty liability on December 31,
2011?
Solution:

Warranty liability – Jan. 1, 2011 60,000

Add: Warranty expense in 2011
(2% x 4,000,000) 80,000
Total 140,000
Less: Warranty payments during 2011 50,000
Warranty liability – Dec. 31, 2011 90,000
 Our Account God’s Account

Debit Credit Debit Credit

All DEBT or God’s
God’s
LIABILITIES FORGIVENESS
FORGIVENESS
Through
Through
JESUS’ DEATH
JESUS’ DEATH
Balance 0
SPENDING
ETERNITY
WITH GOD