I.

TESTBANK
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
entitys financial statements should report the expected award as
a.
b.
c.
d.

Receivable and revenue

Receivable and reduction of patent
Receivable and deferred revenue
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
a. Recognize a provision for the possible obligation

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.
b.
c.
d.

I only
II only
Both I and II
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 lawsuits
probable outcome on the entitys financial statements for the current year?
a.
b.
c.
d.

No effect on either expense or liabilities

An increase in expense and no effect on liabilities.
No effect on expenses and an increase in liabilities
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.
b.
c.
d.

As a contingent current asset

As investment property
As a contingent asset and other comprehensive income
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 years 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 Moons attorney,
Suns 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

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
. 40 X 1,000,000 X 80
Expected cash flows
Multiply by risk adjustment factor (100% + 6%)
Adjusted cash flows
Multiply by PV of 1 at 10% for one period
Present value of cash flows

1,400,000
320,000
1,720,000
1.06
1,823,200
.91
1,659,112

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
Estimated cost of relocating an employee from head
office to a branch in another city (employee will
physically relocate in January 2016)
Estimated long service leave owing to employees
in respect of past services
Estimated cost of overhauling machine every 5 years
(the machine is 5 years old on December 31, 201

350,000
120,000
1,300,000
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
Long term service leave

1,300,000

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.