TESTBANK
I. MULTIPLE CHOICE
1.Which of the following statements is true in relation to the measurement of a provision?
I. The risks and uncertainties that inevitably surround many events and circumstances shall be taken into account in reaching the best estimate of a provision.
II. Where the effect of the time value of money is material, the amount of a provision shall be the present value of the expenditure expected to settle the obligation.
a. I only b. II only c. Both I and II d. Neither I nor II
2. Which of the following statements is incorrect concerning recognition of a provision?
a. Provisions shall be recognized for future operating losses.
b. A provision shall be used only for expenditures for which the provision was originally recognized.
c. Provision shall be reviewed at the end of each reporting period and adjusted to reflect the current best estimate.
d. If an entity has an onerous contract, the present obligation under the contract shall be recognized and measured as a provision.
3. At year-end, an entity was suing a competitor for patent infringement. The award from the probable favorable outcome could be reliably measured. The entity’s financial statements should report the expected award as
a. Receivable and revenue
b. Receivable and reduction of patent c. Receivable and deferred revenue d. Disclosure only
4. A competitor has sued an entity for unauthorized use of its patented technology. The amount that the entity may be required to pay to the competitor if the competitor succeeds in the lawsuit is determinable with reliability, and according to the legal counsel it is less than probable but more than remote that an outflow of the resources would be needed to meet the obligation. The entity that was sued shall at year-end
b. Set aside, as an appropriation, a contingency reserve, an amount based on the best estimate of the possible liability.
c. Make a disclosure of the possible obligation in the notes to financial statements
d. Make no provision or disclosure and wait until the lawsuit is finally decided and then expense the amount paid on settlement, if any.
5. Which of the following statements in relation to a contingent liability is true? I. A present obligation that arises from past events but cannot be reliably measured is a contingent liability.
II. An obligation as a result of the entity creating a valid expectation that it will discharge its responsibilities is a contingent liability.
a. I only b. II only c. Both I and II d. Neither I nor II
6. An entity has a self-insurance plan. Each year, the entity appropriated retained earnings for contingencies in an amount equal to insurance premiums saved less recognized losses from lawsuits and other claims. As a result of an accident in the current year, the entity is a defendant in a lawsuit in which it would probably have to pay measurable amount of damages. What are the effects of lawsuit’s probable outcome on the entity’s financial statements for the current year?
a. No effect on either expense or liabilities
b. An increase in expense and no effect on liabilities. c. No effect on expenses and an increase in liabilities d. An increase in both expenses and liabilities
7. Which of the following statements in incorrect concerning a contingent asset? a. A contingent asset is not recognized in the financial statements because
this may result to recognition of income that may never be realized.
b. The related gain arising from the contingent asset is recognized usually when it is realized.
c. When the realization of income is virtually certain, the related asset is no longer contingent asset and its recognition is appropriate.
d. A contingent asset is only disclosed when the occurrence of the future event is possible or remote.
8. An entity is closing one of its operating divisions, and the conditions for making restructuring provision have been met. The closure will happen in the first quarter of the next financial year. At the current year-end, the entity has announced the
formal plan publicly and is calculating the restructuring provision. Which of the following costs should be included in the restricting provision?
a. Relocation costs relating to staff moving to other divisions
b. Future operating losses of the divisions being closed up to the date of closure
c. Contractually required cots of restraining staff being made redundant from the division being closed
d. Restraining staff continuing to be employed
9. An entity signed an agreement with another entity which requires that if the latter does not meet certain contractual obligations, it must forfeit a piece of land to the former. How should the former report the land?
a. As a contingent current asset b. As investment property
c. As a contingent asset and other comprehensive income d. As a disclosure in the notes to financial statements.
10. A factory owned by an entity was destroyed by fire. The entity lodged an insurance claim for the value of the factory building and plant, and an amount equal to one year’s net profit. During the year, there were a number of meetings with the representatives of the insurance company. Finally, before year-end, it was decided that the entity would receive compensation for 90% of its claim. The entity received a letter that the settlement check for that amount had been mailed, but it was not received before year-end. How should the entity treat this in the financial statements?
a. Wait until next year when the settlement check is actually received and not recognized or disclose this receivable at all since at year-end it is a contingent asset.
b. Record 90% of the claim as a receivable as it is virtually cetin that the contingent asset will be received.
c. Record 100% of the claim as a receivable as it is virtually cetin that the contingent asset will be received, and adjust the 10% next year when the settlement check is actually received.
d. Disclose the contingent asset in the footnotes. ANSWER 1. c 2. a 3. d 4. c 5. a 6. d 7. d
8. c 9. d 10. b II. PROBLEMS
1. A Malaysian-based shipping entity lost an entire shipload of cargo valued at P5,000,000 on a voyage to Japan. It is however covered by an insurance policy. According to the report of the surveyor, the amount is collectible, subject to the deductible clause in the insurance policy. Before year-end, the shipping entity received a letter from the insurance entity that a check was in the mail for 90% of the claim.
The international freight forwarding entity that entrusted the shipping entity with the delivery of the cargo overseas has filed a lawsuit for P5,000,000, claiming the value of the cargo that was lost on high seas, and also consequential damages of P2,000,000 resulting from the delay.
According to the legal counsel for the shipping entity, it is probable that the shipping entity would have to pay the P5,000,000 but it is a remote possibility that it would have to pay the additional P2,000,000 claimed by the international freight forwarding entity, since this loss was specifically in the freight-forwarding contract.
What provision should be recognized by the shipping entity at year-end? a.7,000,000
b. 5,000,000 c.3,000,000 d. 0
Solution Answer b
Estimated liability for a lawsuit 5,000,000
The lawsuit claim of P5,000,000 is recognized as a provision because it is both probable and measurable. However, the additional claim of P2,000,000 is not recognized because it is remote.
2. On January 1, 2014, Moon Company owned a machine with cost of P2,000,000. The accumulated depreciation was P1,200,000, estimated residual value was P120,000 and fair value was P3,200,000. On January 5, 2014, this machine was irreparably damaged by Sun Company and became worthless. In September 2014, a court awarded damages of P3,200,000 against Sun in favor of Moon. On December 31, 2014, the final outcome of this case was awaiting appeal and was therefor uncertain. However, in the opinion of Moon’s attorney, Sun’s appeal would be denied. On December 31, 2014, what amount of gain should be accrued?
a. 320,000 b. 120,000
c. 200,000 d. 0
Solution Answer d 0
The contingent asset and related contingent gain are only disclosed, because the case is still under appeal by the defendant.
3. During 2014, Delavingne Company is the defendant in a breach of patent lawsuit. The lawyers believe there is an 80% chance that the court will not dismiss the case and the entity will incur outflow of benefits. If the court rules in favor of the claimant, the lawyers believe that there is a 70% chance that the entity will be required to pay damages of P2,500,000 and a 40% chance that the entity will be required to pay damages of P1,000,000. Other amounts of damages are unlikely. The court is expected to rule in late December 2015. There is no indication that the claimant will settle out of court.
A 6% risk adjustment factor to the cash flow is considered appropriate to reflect the uncertainties in the cash flow estimates. An appropriate discount rate is 10% per year. The present value of 1 at 10% for one period is 0.91. What is the measurement of the provision on December 31, 2014? a. 3,500,000 b. 1,823,200 c. 1,659,112 d. 0 Solution Answer c Weighted Probabilities: . 70 X 2,500,000 X 80 1,400,000 . 40 X 1,000,000 X 80 320,000
Expected cash flows 1,720,000
Multiply by risk adjustment factor (100% + 6%) 1.06
Adjusted cash flows 1,823,200
Multiply by PV of 1 at 10% for one period .91
4. Wolz Company sells motorcycle helmets. In 2015, the entity sold 5,000,000 helmets before discovering a significant defect in their construction. By December 31, 2015, two lawsuits had been filed against the entity. The first lawsuit, which the entity has little chance of winning, is expected to be settled out of court for P3,500,000 in January 2016. The legal counsel believed that the entity has a 50-50 chance of winning the second lawsuit, which is for P1,000,000. What is the accrued liability on December 31, 2015 as a result of the lawsuits? a. 3,500,000
b. 4,500,000 c. 6,000,000 d. 8,500,000 Solution Answer a
The loss on the first lawsuit is both probable and measurable and therefore can be accrued as a provision.
The loss on the second lawsuit is disclosed as a contingent liability because the loss is only possible.
5. Milagros Company issued the 2015 financial statements on March 1, 2016. The following data are provided by the entity for the year ended December 31, 2015:
Amount owing to another entity for services rendered
during December 2015 350,000 Estimated cost of relocating an employee from head
office to a branch in another city (employee will
physically relocate in January 2016) 120,000 Estimated long service leave owing to employees
in respect of past services 1,300,000 Estimated cost of overhauling machine every 5 years
(the machine is 5 years old on December 31, 201 170,000 What amount should be recognized as provision on December 31, 2015? a. 1,300,000
b. 1,420,000 c. 1,940,000 d. 1,590,000 Solution Answer a
A provision is a present obligation that is uncertain in amount or timing. The present obligation must be both probable and measurable.
The amount owing to another entity is a present obligation but technically it is not a provision because the amount is certain. Of course, it is an accrued liability. The estimated cost of relocating the employee is a future cost because it is to be incurred in January 2016. Thus, it is not included in December 31, 2015 provision.
The estimated cost of overhaul is not a provision because there is no present obligation. The entity may decide to sell the machine or not to repair it.
