Liabilities

1. In the audit of the Heats Corporation’s financial statements at December 31, 2005, the
chief accountant of the said corporation provided the following information:
Notes payable:
Arising from purchase of goods 304,000
Arising from 5 year-bank loans, on which marketable securities
valued at P600,000 have been pledged as security, P400,000 due
on June 30, 2006; P100,000 due on Dec. 31, 2006 500,000
Arising from advances by officers, due June 30, 2006 50,000
Reserve for general contingencies 400,000
Employees’ income tax withheld 20,000
Advances received from customers on purchase orders 64,000
Containers’ deposit 50,000
Accounts payable arising from purchase of goods,
net of debit balances of P30,000 170,000
Accounts receivable, net of credit balances P40,000 360,000

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Cash dividends payable 80,000

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Stock dividends payable 100,000

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Dividends in arrears on preferred stock, not yet declared 200,000

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Convertible bonds, due January 31, 2007 1,000,000

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First mortgage serial bonds, payable in semi-annual installments
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of P50,000, due April 1 and October 1 of each year 2,000,000
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Overdraft with Allied Bank 90,000
Cash in bank balance with PNB 390,000
Estimated damages to be paid as a result of unsatisfactory
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performance on a contract 160,000

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Estimated expenses on meeting guarantee for service

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requirements on merchandise sold 120,000

Estimated premiums payable 75,000
Deferred revenue 87,000
Accrued interest on bonds payable 360,000
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Common stock warrants outstanding 120,000

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Common stock options outstanding 210,000

Unused letters of credit 400,000
Deficiency VAT assessment being contested 500,000
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Notes receivable discounted 200,000

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On March 1, 2006, the P400,000 note payable was replaced by an 18-month note for the
same amount. Heats is considering similar action on the P100,000 note payable due on
December 31, 2006. The 2005 financial statements were issued on March 31, 2006.

On December 1, 2005, a former employee filed a lawsuit seeking P200,000 for unlawful
dismissal. Heats’ attorneys believe that the suit is without merit. No court date has been
set.

On January 15, 2006, the BIR assessed Heats an additional income tax of P300,000 for
the 2003 tax year. Heats’ attorneys and tax accountants have stated that it is likely that
the BIR will agree to a P200,000 settlement.

Based on the above and the result of your audit, compute for the following as of December
31, 2005:
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 1. Total current liabilities
a. P2,500,000 b. P2,100,000 c. P2,300,000 d. P2,400,000
2. Total noncurrent liabilities
a. P3,300,000 b. P2,900,000 c. P3,000,000 d. P3,400,000
3. Total liabilities
a. P5,200,000 b. P5,000,000 c. P5,400,000 d. P5,800,000

2. The following information relates to Sonic Company’s obligations as of December 31,

2005. For each of the numbered items, determine the amount if any, that should be
reported as current liability in Sonic’s December 31, 2005 balance sheet.

1. Accounts payable:
Accounts payable per general ledger control amounted to P5,440,000, net of P240,000
debit balances in suppliers’ accounts. The unpaid voucher file included the following
items that not had been recorded as of December 31, 2005:

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a) A Company – P224,000 merchandise shipped on December 31, 2005, FOB

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destination; received on January 10, 2006.

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b) B, Inc. – P192,000 merchandise shipped on December 26, 2005, FOB shipping

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point; received on January 16, 2006.

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c) C Super Services – P144,000 janitorial services for the three-month period ending
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d) MERALCO – P67,200 electric bill covering the period December 16, 2005 to
January 15, 2006.
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On December 28, 2005, a supplier authorized Sonic to return goods billed at P160,000
and shipped on December 20, 2005. The goods were returned by Sonic on December
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28, 2005, but the P160,000 credit memo was not received until January 6, 2006.

P2. Payroll:
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Items related to Sonic’s payroll as of December 31, 2005 are:

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Accrued salaries and wages P776,000

Payroll deductions for:
Income taxes withheld 56,000
SSS contributions 64,000
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Philhealth contributions 16,000

Advances to employees 80,000
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a. P776,000 b. P992,000 c. P832,000 d. P912,000

3. Litigation:
In May, 2005, Sonic became involved in a litigation. The suit is being contested, but
Sonic’s lawyer believes it is possible that Sonic may be held liable for damages
estimated in the range between P2,000,000 and P3,000,000, and no amount is a better
estimate of potential liability than any other amount.
a. P0 b. P2,000,000 c. P3,000,000 d. P2,500,000

4. Bonus obligation:
Sonic Company’s president gets an annual bonus of 10% of net income after bonus
and income tax. Assume the tax rate of 30% and the correct income before bonus and
tax is P9,600,000. (Ignore the effects of other given items on net income.)
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 a. P722,600 b. P395,000 c. P2,240,000 d. P628,000

5. Note payable:
A note payable to the Bank of the Philippine Islands for P2,400,000 is outstanding on
December 31, 2005. The note is dated October 1, 2004, bears interest at 18%, and is
payable in three equal annual installment of P800,000. The first interest and principal
payment was made on October 1, 2005.
a. P800,000 b. P908,000 c. P72,000 d. P872,000

6. Purchase commitment:
During 2005, Sonic entered in a noncancellable commitment to purchase 320,000 units
of inventory at fixed price of P5 per unit, delivery to be made in 2006. On December
31, 2005, the purchase price of this inventory item had fallen to P4.40 per unit. The
goods covered by the purchase contract were delivered on January 28, 2006.
a. P0 b. P1,600,000 c. P1,408,000 d. P192,000

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7. Deferred taxes:

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On December 31, 2005, Sonic’s deferred income tax account has a 2005 ending credit

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balance of P772,800, consisting of the following items:

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Caused by temporary differences in accounting Deferred tax

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For gross profit on installment sales P376,000 Cr.
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For depreciation on property and equipment 576,000 Cr
For product warranty expense 179,200 Dr
P772,800 Cr.
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a. P772,800 b. P952,000 c. P196,800 d. P0

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8. Product warranty:
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Sonic has a one year product warranty on selected items in its product line. The
estimated warranty liability on sales made during 2004, which was outstanding as of
December 31, 2004, amounted to P416,000. The warranty costs on sales made in
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2005 are estimated at P1,504,000. Actual warranty costs incurred during the current
2005 fiscal year are as follows:
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Warranty claims honored on 2004 sales P 416,000

Warranty claims honored on 2005 sales 992,000
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Total warranty claims honored P1,408,000

a. P0 b. P1,504,000 c. P96,000 d. P512,000
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9. Premiums:
To increase sales, Sonic Company inaugurated a promotional campaign on June 30,
2005. Sonic placed a coupon redeemable for a premium in each package of product
sold. Each premium costs P100. A premium is offered to customers who send in 5
coupons and a remittance of P30. The distribution cost per premium is P20. Sonic
estimated that only 60% of the coupons issued will be redeemed. For the six months
ended December 31, 2005, the following is available:

Packages of product sold 160,000

Premiums purchased 16,000
Coupons redeemed 64,000
a. P1,728,000 b. P1,152,000 c. P1,600,000 d. P576,000
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 10.Due to Five Six Finance company:
Sonic’s accounting records show that as of December 31, 2005, P1,280,000 was due
to Five Six Finance Company for advances made against P1,600,000 of trade accounts
receivable assigned to the finance company with recourse.
a. P0 b. P1,600,000 c. P320,000 d. P1,280,000

3. On January 2, 2004, the Suns, Inc. issued P2,000,000 of 8% convertible bonds at par.
The bonds will mature on January 1, 2008 and interest is payable annually every January
1. The bond contract entitles the bondholders to receive 6 shares of P100 par value
common stock in exchange for each P1,000 bond. On the date of issue, the prevailing
market interest rate for similar debt without the conversion option is 10%.

On December 31, 2005, the holders of the bonds with total face value of P1,000,000
exercised their conversion privilege. In addition, the company reacquired at 110, bonds
with a face value of P500,000.

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The balances in the capital accounts as of December 31, 2004 were:

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Common stock, P100 par, authorized 50,000 shares, issued

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and outstanding, 30,000 shares P3,000,000
Premium on common stock rs e 500,000
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Market value of the common stock and bonds were as follows:
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Date Bonds Common stock

December 31, 2004 118 40
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December 31, 2005 110 42

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QUESTIONS:
Based on the above and the result of your audit, answer the following:
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1. How much of the proceeds from the issuance of convertible bonds should be allocated
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to equity?
a. P634,000 b. P126,816 c. P221,664 d. P0
2. How much is the carrying value of the bonds payable as of December 31, 2004?
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a. P2,000,000 b. P1,389,400 c. P1,796,170 d. P1,900,502

3. How much is the interest expense for the year 2005?
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a. P160,000 b. P138,940 c. P179,617 d. P190,050

4. The entry to record the conversion on December 31, 2005 will include a credit to APIC
of
a. P365,276 b. P400,000 c. P307,893 d. P0
5. How much is the loss on bond reacquisition on December 31, 2005?
a. P50,000 b. P96,053 c. P67,362 d. P0

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 4. In connection with your audit of Ginebra Corporation’s financial statements for the year
2005, you noted the following liability account balances as of December 31, 2004:

Note payable, bank P 5,600,000

Liability under finance lease 430,000
Deferred income taxes 700,000

Transactions during 2005 and other information relating to Ginebra’s liabilities were as
follows:

a. The principal amount of the note payable is P5,600,000 and bears interest at 12%.
The note is dated April 1, 2004 and is payable in four equal annual installments of
P1,400,000 beginning April 1, 2005. The first principal and interest payment was
made on April 1, 2005.

b. The capitalized lease is for a ten-year period beginning December 31, 2002. Equal

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annual payments of P100,000 are due on December 31 of each year, and the 14%

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interest rate implicit in the lease known by Ginebra. The present value at December

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31, 2004 of the seven remaining lease payments (due December 31, 2005 through

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December 31, 2011) discounted at 14% was P430,000.

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c. Deferred income taxes are provided in recognition of timing differences between
financial and income tax reporting of depreciation. For the year ended December 31,
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2005, depreciation per tax return exceeded book depreciation by P312,500.
Ginebra’s effective income tax rate for 2004 was 32%.
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d. On July 1, 2005, Ginebra issued for P1,774,000, P2,000,000 face amount of its 10%,
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P1,000 bonds. The Bonds were issued to yield 12%. The bonds are dated July 1,
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2004 and will mature on July 1, 2014. Interest is payable annually on July 1. Ginebra
uses the interest method to amortize bond discount.

QUESTIONS:
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Based on the above and the result of your audit, determine the following
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1. Liability under finance lease as of December 31, 2005

a. P381,600 b. P390,200 c. P344,828 d. P330,000
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2. Total noncurrent liabilities as of December 31, 2005

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a. P5,610,440 b. P5,770,640 c. P5,931,328 d . P5,725,268

3. Current portion of long-term liabilities as of December 31, 2005

a. P1,445,372 b. P1,400,000 c. P1,500,000 d. P1,446,576

4. Accrued interest payable as of December 31, 2005

a. P484,440 b. P432,628 c. P532,628 d. P478,000

5. Total interest expense for the year 2005

a. P652,440 b. P707,068 c. P712,640 d. P699,760

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