NCR CUP 1: FINANCIAL ACCOUNTING AND REPORTING

Elimination Round Questions and Answers

Note: All problem questions given to the contestants have no choices.

Easy
1. The premium on a three-year insurance policy expiring on December 31, 2019, was paid in total
on January 1, 2017. The original payment was initially debited to a prepaid asset account. The
appropriate journal entry has been recorded on December 31, 2017. The balance in the prepaid
asset account on December 31, 2017, should be

a. Zero.
b. The same as it would have been if the original payment had been debited initially to an
expense account.
c. The same as the original payment.
d. Higher than if the original payment had been debited initially to an expense account.

Answer: B
When the insurance policy was initially purchased, the entire balance was debited to a
prepaid asset account (i.e., prepaid insurance). The adjusting entry at December 31, 2017,
to recognize the expiration of one year of the policy would be:

Insurance expense (1/3 of original pymt.)

Prepaid insurance (1/3 of original pymt.)

After the adjusting entry, the prepaid asset account would contain 2/3 of the original
payment. If the original payment had instead been debited to an expense account (i.e.,
insurance expense), then the adjusting entry at December 31, 2017 would be Prepaid
insurance (2/3 of original pymt.) Insurance expense (2/3 of original pymt.) This alternate
approach would also result in 1/3 of the original payment being expensed in 2017 and 2/3
of the original payment being carried forward as a prepaid asset. Thus, answer (b) is
correct.

2. It is proper to recognize revenue prior to the sale of merchandise when

I. The revenue will be reported as an installment sale.
II. The revenue will be reported under the cost recovery method.

a. I only.
b. II only.
c. Both I and II.
d. Neither I nor II.

Answer: D
Under the installment method (case I) revenue (gross profit) is recognized after the sale, in
proportion to cash collected. Under the cost recovery method (case II), revenue (gross
profit) is again recognized after the sale, when cumulative receipts exceed the cost of the
asset sold. Therefore, revenue is not recognized prior to the sale of merchandise in either
case I or case II.
3. Which of the following is not one of the criteria for revenue recognition for sales of goods under
IFRS?

a. The significant risks and rewards of ownership of goods are transferred.

b. Payment has been received.
c. The entity does not retain either a continuing managerial involvement or control over
the goods.
d. The costs incurred can be measured reliably.

Answer: B
The requirement is to identify the item that is not one of the criteria for revenue
recognition for sales of goods under IFRS. Answer (b) is correct because it is not required
that payment has been received.

4. Net income is understated if, in the first year, estimated salvage value is excluded from the
depreciation computation when using the

Straight-line method Production or use method

a Yes No
.
b Yes Yes
.
c. No No
d No Yes
.

Answer: B
The depreciable base used to compute depreciation expense under both the straight-line
and production methods is equal to the cost less estimated salvage value of the asset.
Depreciation expense is overstated and net income is, therefore, understated when the
estimated salvage value is excluded from the depreciation computation under both of
these methods.

5. IFRS requires changes in accounting principles to be reported

a. On a prospective basis.
b. On a retrospective basis.
c. By restating the financial statements.
d. By a cumulative adjustment on the income statement.

Answer: B
The requirement is to identify the item that describes how changes in accounting
principles are reported under IFRS. Answer (b) is correct because IFRS requires changes
in accounting principles to be reported by giving retrospective application to the earliest
period presented.

6. In analyzing a company’s financial statements, which financial statement would a potential

investor primarily use to assess the company’s liquidity and financial flexibility?

a. Balance sheet.
b. Income statement.
c. Statement of retained earnings.
d. Statement of cash flows.

Answer: A
 Although the statement of cash flows provides information about liquidity, solvency, and
financial flexibility, a potential investor would primarily use the balance sheet to assess
liquidity and financial flexibility. The balance sheet helps users analyze the company’s
ability to use current assets to pay current liabilities (liquidity) and the company’s ability
to alter the amounts and timing of future cash flows to adapt to unexpected needs or to
take advantage of opportunities (flexibility)

7. How should the following costs affect a retailer’s inventory?

Freight-in Interest on inventory loan

a. Increase No effect
b. Increase Increase
c. No effect Increase
d. No effect No effect

Answer: A
The cost of inventory should include all expenditures (direct and indirect) incurred to
bring an item to its existing condition and location. Freight-in charges are thus
appropriately included in inventory costs. Interest cost shall not be capitalized for assets
that are in use or ready for their intended use in the earnings activities of the enterprise.
Thus, interest on an inventory loan should not be included in inventory (it should be
expensed as incurred).

8. The following information pertained to Red Co. for the year:

Purchases ₱102,800
Purchase discounts 10,280
Freight in 15,420
Freight out 5,140
Beginning 30,840
inventory
Ending inventory 20,560

What amount should Red Co. report as cost of goods sold for the year?

a. ₱102,800
b. ₱118,220
c. ₱123,360
d. ₱128,500

Answer: B
Red Co. should report cost of goods sold calculated as
Cost of goods sold (CGS) = Beg. Inventory + Net purchases* + Freight in – Ending
Inventory
CGS = 30,840 + 92,520** + 15,420 – 20,560
CGS = 118,220
Freight out is a selling expense and does not enter the calculation of cost of goods sold.
* Net purchase = Purchases – Purchase returns and allowances – Purchase discounts
** (102,800 – 10,280)

9. On January 2, 2017, JKL Company sold equipment with a carrying amount of ₱480,000 in
exchange for a ₱600,000 non-interest bearing note due January 2, 2020. There was no
established exchange price for the equipment. The prevailing rate of interest for a note of this
type was 10%. The present value of 1 at 10% for three periods is 0.7513.
 What is the carrying value of the note receivable as of December 31, 2017 Statement of Financial
Position?

a. ₱450,780
b. ₱495,858
c. ₱545,444
d. ₱600,000

Answer: B
Fair value of note on Jan. 2, 2017 (P600,000 x .7513) ₱450,78
0
Interest income for 2017 (450,000 x 10%) 45,078
Amortized cost of note receivable as of December 31, ₱495,85
2017 8

10. On December 1, 2016, AltiGo Co. purchased a ₱400,000 tract of land for a factory site. AltiGo
razed an old building on the property and sold the materials it salvaged from the demolition.
AltiGo incurred additional costs and realized salvage proceeds during December 2016 as follows:

Demolition of old building ₱50,000

Legal fees for purchase contract and recording ownership 10,000
Title guarantee insurance 12,000
Proceeds from sale of salvaged materials 8,000

In its December 31, 2016 balance sheet, AltiGo should report a balance in the land account of

a. ₱464,000
b. ₱460,000
c. ₱442,000
d. ₱422,000

Answer: A
Any cost involved in preparing land for its ultimate use (such as a factory site) is
considered part of the cost of the land. Before the land can be used as a building site, it
must be purchased (involving costs such as purchase price, legal fees, and title
insurance) and the old building must be razed (cost of demolition less proceeds from sale
of scrap). The total balance in the land account should be ₱464,000.

Purchase price ₱400,00

0
Legal fees 10,000
Title insurance 12,000
Net cost of demolition (₱50,000 – 42,000
₱8,000)
₱464,00
0
Average
1. The following trial balance of Reese Corp. at December 31, 2017 has been properly adjusted
except for the income tax expense adjustment.

DEBIT CREDIT
Cash P975,000
Accounts Receivable – net 2,695,000
Inventory 2,085,000
Property, plant and equipment – net 7,366,000
Accounts payable and accrued liabilities P1,801,000
Income taxes payable 654,000
Deferred tax liability 85,000
Ordinary Share Capital 2,350,000
Ordinary Share Premium 3,680,000
Retained earnings, January 1, 2017 3,450,000
Net Sales & other revenues 13,460,000
Costs and expenses 11,180,000
Income tax expenses 1,179,000
P25,480,000 P25,480,000
Other financial data for the year ended December 31, 2017:
 Included in accounts receivable is P1,200,000 due from a customer and payable in
quarterly installments of P150,000. The last payment is due December 29, 2019.
 The balance in the Deferred Income Tax Liability account pertains to a temporary
difference that arose in a prior year, of which P20,000 is classified as a current liability.
 During the year, estimated tax payments of P525,000 were charged to income tax
expense. The current and future tax rate on all types of income is 30%.

In Reese’s December 31, 2017 balance sheet, how much is the final retained earnings balance?

a. P4,551,000
b. P4,636,000
c. P5,076,000
d. P5,005,000

Answer: C
P3,450,000 + P13,460,000 – P11,180,000 – (P1,179,000 – P525,000) = P5,076,000

2. On the December 31, 2017 balance sheet of Seattle Co., the current receivables consisted of the
following:

Trade accounts receivable P60,000

Allowance for uncollectible accounts (2,000)
Claim against shipper for goods lost in transit (November 2017) 3,000
Selling price of unsold goods sent by Seattle on consignment at 130% of 26,000
cost (not included in Seattle 's ending inventory)
Security deposit on lease of warehouse used for storing some inventories 30,000
TOTAL P117,000

At December 31, 2017, the correct total of Seattle's current net receivables was

a. P61,000
b. P87,000
c. P91,000
d. P117,000
 Answer: A

P60,000 – P2,000 + P3,000 = P61,000.

3. Crab Corp.'s accounts payable at December 31, 2017, totaled P650,000 before any necessary
year-end adjustments relating to the following transactions:
 On December 27, 2017, Crab wrote and recorded checks to creditors totaling P350,000
causing an overdraft of P100,000 in Crab's bank account at December 31, 2017. The
checks were mailed out on January 10, 2018.
 On December 28, 2017, Crab purchased and received goods for P150,000, terms 2/10,
n/30. Crab records purchases and accounts payable at net amounts. The invoice was
recorded and paid January 3, 2018.
 Goods shipped f.o.b. destination on December 20, 2017 from a vendor to Crab were
received January 2, 2018. The invoice cost was P65,000.

At December 31, 2017, what amount should Crab report as total accounts payable?

a. P1,212,000
b. P1,147,000
c. P900,000
d. P800,000

Answer: B
P650,000 + P350,000 + P147,000 = P1,147,000

4. In March 2018, an explosion occurred at Winston Co.'s plant, causing damage to area properties.
By May 2018, no claims had yet been asserted against Winston. However, Winston's
management and legal counsel concluded that it was reasonably possible that Winston would be
held responsible for negligence, and that P4,000,000 would be a reasonable estimate of the
damages. Winston's P5,000,000 comprehensive public liability policy contains a P400,000
deductible clause. In Winston's December 31, 2017 financial statements, for which the auditor's
fieldwork was completed in April 2018, how should this casualty be reported?

a. As a note disclosing a possible liability of P4,000,000

b. As an accrued liability of P400,000
c. As a note disclosing a possible liability of P400,000
d. No note disclosure of accrual is required for 2017 because the event occurred in
2018

Answer: C
IAS 37 defines a possible obligation 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.

5. On January 1, 2017, Davao Co. issued its 10% bonds in the face amount of P4,000,000, which
mature on January 1, 2027. The bonds were issued for P4,540,000 to yield 8%, resulting in bond
premium of P540,000. Davao uses the effective-interest method of amortizing bond premium.
Interest is payable annually on December 31. At December 31, 2017, Davao's adjusted
unamortized bond premium should be

a. P540,000
b. P503,200
c. P486,000
d. P406,000

Answer: B
 P540,000 – [(P4,000,000 × .10) – (P4,540,000 × .08)] = P503,200.

6. Rochelle Co.'s prepaid insurance was P90,000 at December 31, 2018 and P45,000 at December
31, 2017. Insurance expense was P31,000 for 2018 and P27,000 for 2017. What amount of cash
disbursements for insurance would be reported in Rochelle's 2018 net cash provided by
operating activities presented on a direct basis?

a. P94,000
b. P76,000
c. P59,000
d. P31,000

Answer: B
P90,000 + P31,000 – P45,000 = P76,000.

7. The following are examples of non-adjusting events after the reporting period that would generally
result in disclosure, except:

a. announcing a plan to discontinue an operation

b. abnormally large changes after the reporting period in asset prices or foreign
exchange rates
c. commencing major litigation arising solely out of events that occurred after the
reporting period
d. the destruction of a major production plant by a fire before the reporting period

Answer: D
The destruction of a major production plant by a fire before the reporting period should be
considered as an adjusting event that would affect the period-end balances.

8. Remeasurements of the net defined benefit liability (asset) comprise of the following, except:

a. actuarial gains and losses

b. the return on plan assets, excluding amounts included in net interest on the net
defined benefit liability (asset)
c. any change in the effect of the asset ceiling, excluding amounts included in net
interest on the net defined benefit liability (asset)
d. None of the above

Answer: D
All of the above composed the remeasurements of the net defined benefit liability (asset).

9. The following are examples of contractual terms that result in contractual cash flows that are
solely payments of principal and interest on the principal amount outstanding, as defined in
PFRS 9, Financial Instruments, except:

a. A variable interest rate that consists of consideration for the time value of money, the
credit risk associated with the principal amount outstanding during a particular period
of time and other basic lending risks and costs, as well as a profit margin.
b. A conversion option wherein the instrument is convertible into fixed number of equity
instruments of the issuer.
c. A prepayment option wherein the prepayment amount substantially represents
unpaid amounts of principal and interest, which may include reasonable additional
compensation for the early termination.
d. An extension option wherein the terms of the extension option result in contractual
cash flows during the extension period that are solely payments of principal and
 interest on the principal amount outstanding, which may include reasonable
additional compensation for the extension of the contract.

Answer: B
PFRS 9 par. B4.1.11 enumerates a, c and d as examples of contractual terms that result in
contractual cash flows that are solely payments of principal and interest on the principal
amount outstanding. According to PFRS 9 par. B4.1.14 states that the contractual cash
flows of a bond that is convertible into a fixed number of equity instruments of the issuer
are not payments of principal and interest on the principal amount outstanding because
they reflect a return that is inconsistent with a basic lending arrangement, i.e., the return
is linked to the value of the equity of the issuer.

10. In assessing whether there is any indication that an asset may be impaired, an entity shall
consider, as a minimum, the following external sources of information:

a. observable indications that the asset’s value has declined during the period
significantly more than would be expected as a result of the passage of time or
normal use.
b. the carrying amount of the net assets of the entity is more than its market
capitalization
c. significant changes with an adverse effect on the entity have taken place during the
period, in the economic environment in which the entity operates
d. evidence is available of obsolescence or physical damage of an asset

Answer: D
Evidence is available of obsolescence or physical damage of an asset is an internal
source of information.

Difficult
1. Conn Co. reported a retained earnings balance of P400,000 at December 31, year 1. In August,
year 2, Conn determined that insurance premiums of P60,000 for the three-year period beginning
January 1, year 1, had been paid and fully expensed in year 1. Conn has a 30% income tax rate.
What amount should Conn report as adjusted beginning retained earnings in its year 2 statement
of retained earnings?

a. P420,000
b. P428,000
c. P440,000
d. P442,000

Answer: B
A correction of an error is treated as a prior period adjustment and is reported in the
financial statements as an adjustment to the beginning balance of retained earnings in the
year the error is discovered. The adjustment is reported net of the related tax effect. In
year 1, insurance expense of P60,000 was recorded. The correct year 1 insurance expense
was P20,000 (P60,000 × 1/3). Therefore, before taxes, 1/1/Y2 retained earnings is
understated by P40,000. The net of tax effect is P28,000 [P40,000 – (30% × P40,000)], so the
adjusted beginning retained earnings is P428,000 (P400,000 + P28,000).

2. On January 2, year 2, Air, Inc. agreed to pay its former president P300,000 under a deferred
compensation arrangement. Air should have recorded this expense in year 1 but did not do so.
Air’s reported income tax expense would have been P70,000 lower in year 1 had it properly
accrued this deferred compensation. In its December 31, year 2 financial statements, Air should
adjust the beginning balance of its retained earnings by
 a. P230,000 credit.
b. P230,000 debit.
c. P300,000 credit.
d. P370,000 debit.

Answer: B
The failure to record the P300,000 of deferred compensation expense in year 1 is
considered an error. The profession requires that the correction of an error be treated as a
prior period adjustment. Thus, the requirement is to determine the retroactive adjustment
that should be made to the beginning balance of the retained earnings for year 2
(including any income tax effect). The net adjustment to beginning retained earnings
would be a debit for P230,000 (P300,000 less the income tax benefit of P70,000).

3. On January 1, year 3, Roem Corp. changed its inventory method to FIFO from LIFO for both
financial and income tax reporting purposes. The change resulted in a P500,000 increase in the
January 1, year 3 inventory, which is the only change that could be calculated from the
accounting records. Assume that the income tax rate for all years is 30%. Retrospective
application would result in

a. An increase in ending inventory in the year 2 balance sheet.

b. A decrease in ending inventory in the year 3 balance sheet.
c. A decrease in net income in year 2.
d. A gain from cumulative effect of change on the income statement in year 3.

Answer: A
Retrospective application requires applying the new principle to the earliest period
presented if practicable. Because year 3 beginning inventory is the previous year’s ending
inventory, the new principle can be applied to the year 2 financial statements. This would
result in an increase in ending inventory in the balance sheet for year 2, a decrease in cost
of goods sold in year 2, and an increase in the beginning inventory, which would result in
a higher cost of goods sold and a lower net income for year 3.

4. Which of the following is considered a direct effect of a change in accounting principle?

a. Deferred taxes.
b. Profit sharing.
c. Royalty payments.
d. None of the above.

Answer: A
Deferred taxes is a direct effect from the change in accounting principle, and its effects
should be recorded in the earliest period presented, if practicable. Profit sharing and
royalty payments are indirect effects and should be reported in the period of the change.

5. Oak Co. offers a three-year warranty on its products. Oak previously estimated warranty costs to
be 2% of sales. Due to a technological advance in production at the beginning of year 3, Oak now
believes 1% of sales to be a better estimate of warranty costs. Warranty costs of P80,000 and
P96,000 were reported in year 1 and year 2, respectively. Sales for year 3 were P5,000,000.
What amount should be presented in Oak’s year 3 financial statements as warranty expense?

a. P 50,000
b. P 88,000
c. P100,000
d. P138,000
 Answer: A
A change in estimated warranty costs due to technological advances in production
qualifies as a change in accounting estimate. Changes in estimate are treated
prospectively; there is no retroactive restatement, and the new estimate is used in current
and future years. Therefore, in year 3, Oak should use the new estimate of 1% and report
warranty expense of P50,000 (P5,000,000 × 1%).

6. On January 1, year 1, Brecon Co. installed cabinets to display its merchandise in customers’
stores. Brecon expects to use these cabinets for five years. Brecon’s year 1 multistep income
statement should include

a. One-fifth of the cabinet costs in cost of goods sold.

b. One-fifth of the cabinet costs in selling, general, and administrative expenses.
c. All of the cabinet costs in cost of goods sold.
d. All of the cabinet costs in selling, general, and administrative expenses.

Answer: B
In year 1, Brecon Co. would report one fifth of the cabinet costs as depreciation expense
in selling, general, and administrative expenses. Four fifths of the cabinet cost would
remain capitalized as fixed assets at the end of year 1. The cabinets are considered fixed
assets and not a part of cost of goods sold.

7. A material loss should be presented separately as a component of income from continuing

operations when it is

a. An extraordinary item.
b. A discontinued component of the business.
c. Unusual in nature and infrequent in occurrence.
d. Not unusual in nature but infrequent in occurrence.

Answer: D
A material gain or loss that is unusual in nature or infrequent in occurrence, but not both,
should be presented as a separate component of income or loss from continuing
operations. Both discontinued operations and extraordinary items are reported separately
after income from continuing operations.

8. On November 1, year 2, management of Herron Corporation committed to a plan to dispose of

Timms Company, a major subsidiary. The disposal meets the requirements for classification as
discontinued operations. The carrying value of Timms Company was P8,000,000 and
management estimated the fair value less costs to sell to be P6,500,000. For year 2, Timms
Company had a loss of P2,000,000. How much should Herron Corporation present as loss from
discontinued operations before the effect of taxes in its income statement for year 2?

a. P0
b. P1,500,000
c. P2,000,000
d. P3,500,000

Answer: D
In discontinued operations, presentation of the income or loss from operations of the
component and the gain or loss on disposal is required. Since the company met the
requirements for “held for sale” status in year 2, the subsidiary should be written down to
its fair value less cost to sell. This would result in a loss of P1,500,000 (P8,000,000
carrying amount – P6,500,000 fair value). Therefore, the loss from discontinued operations
would be P3,500,000 (P2,000,000 loss from operations +
P1,500,000 loss on planned disposal).
9. If (P2,450) net of tax is the reclassification adjustment included in other comprehensive income in
the year the securities are sold, what is the gain (loss) that is included in income from continuing
operations before income taxes? Assume a 30% tax rate.

a. P(2,450)
b. P(3,500)
c. P 2,450
d. P3,500

Answer: D
If P2,450 (net of tax) is being deducted from other comprehensive income as a
reclassification adjustment, P2,450 must be the amount of unrealized gains (net of tax)
that have been recognized in other comprehensive income. The realized gains will then be
recognized in income from continuing operations before tax. The gains before tax effects
are P3,500 (P2,450 ÷ 70%).

10. When preparing a draft of its year 1 balance sheet, Mont, Inc. reported net assets totaling
P875,000. Included in the asset section of the balance sheet were the following: Treasury stock
of Mont, Inc. at cost, which approximates market value on December 31, P24,000 Idle machinery,
11,200 Cash surrender value of life insurance on corporate executives, 13,700Allowance for
decline in market value of noncurrent equity investments, 8,400
At what amount should Mont’s net assets be reported in the December 31, year 1 balance sheet?

a. P851,000
b. P850,100
c. P842,600
d. P834,500

Answer: A
Idle machinery (P11,200) and cash surrender value of life insurance (P13,700) are both
assets. The allowance for decline in market value of noncurrent marketable equity
securities (P8,400) is a contra asset that is properly included in the asset section of the
balance sheet (as a deduction). The only item listed which should not be included in the
asset section of the balance sheet is the treasury stock (P24,000). Although the treasury
stock account has a debit balance, it is not an asset; instead, it is reported as a contra
equity account. Therefore, the P24,000 must be excluded from the asset section, reducing
the net asset amount to P851,000 (P875,000 – P24,000).
 NCR CUP 1: FINANCIAL ACCOUNTING AND REPORTING
Clincher Round Questions and Answers
Note: All problem questions given to the contestants have no choices. These questions serve
also as substitute also to voided questions.

Easy
1. The original cost of an inventory item is below both replacement cost and net realizable value.
The net realizable value less normal profit margin is below the original cost. Under the lower of
cost or market method, the inventory item should be valued at

a. Replacement cost.
b. Net realizable value.
c. Net realizable value less normal profit margin.
d. Original cost.

Answer: D
Inventory is to be valued at the lower of cost or market. Under this method, market is
replacement cost provided that replacement cost is lower than net realizable value
(ceiling) and higher than net realizable value less the normal profit margin (floor). The
question does not specify whether replacement cost is above or below net realizable
value, but since the original cost is below both of these values, that information is
irrelevant.

2. Under IFRS which of the following is the definition of a “provision”?

a. A liability that is uncertain in timing or amount.

b. A liability that has definitely been incurred.
c. An asset that is uncertain as to its fair value.
d. An asset that is certain as to value.

Answer: A
Provisions are liabilities.

3. On January 2, year 4, Paye Co. purchased Shef Co. at a cost that resulted in recognition of
goodwill of P200,000. During the first quarter of year 4, Paye spent an additional P80,000 on
expenditures designed to maintain goodwill. In its December 31, year 4 balance sheet, what
amount should Paye report as goodwill?

a. P180,000
b. P200,000
c. P252,000
d. P280,000
Answer: B

A company should record as an asset the cost of intangible assets such as goodwill
acquired from other entities. Costs of developing intangible assets such as goodwill
“which are not specifically identifiable, have indeterminate lives, or are inherent in a
continuing business and related to an entity as a whole” should be expensed when
incurred. Therefore, only the P200,000 (and not the additional P80,000) should be
capitalized as goodwill. Goodwill should not be amortized.
Average
1. On January 2, year 1, Emme Co. sold equipment with a carrying amount of P480,000 in
exchange for a P600,000 noninterest-bearing note due January 2, year 4. There was no
established exchange price for the equipment. The prevailing rate of interest for a note of this
type at January 2, year 1, was 10%. The present value of P1 at 10% for three periods is 0.75. In
Emme’s year 1 income statement, what amount should be reported as interest income?

a. P 9,000
b. P45,000
c. P50,000
d. P60,000

Answer: B
The P600,000 noninterest-bearing note should be recorded at its present value of P450,000
(P600,000 × .75). The journal entry is

Loss on Sale of Equipment 30000

Note Receivable 600000
Discount on NR 150000
Equipment (net) 480000

At 12/31/Y1, interest income would be recognized using the effective interest method.
Using this method, interest is computing by multiplying the book value of the note
(P600,000 – P150,000 = P450,000) by the effective interest rate (P450,000 × 10% = P45,000).

2. The market price of a bond issued at a discount is the present value of its principal amount at the
market (effective) rate of interest

a. Less the PV of all future interest payments at the market (effective) rate of interest
b. Less the PV of all future interest payments at the rate of interest stated on the bond
c. Plus the PV of all interest payments at the market (effective) rate of interest
d. Plus the PV of all future interest payments at the rate of interest stated on the bond

Answer: C
The market price of a bond issued at any amount (par, premium, or discount) is equal to
the present value of all of its future cash flows, discounted at the current market
(effective) interest rate. The market price of a bond issued at a discount is equal to the
present value of both its principal and periodic future cash interest payments at the stated
(cash) rate of interest, discounted at the current market (effective) rate.

3. The following information pertains to Lee Corp.’s defined benefit pension plan for year 2:
Service cost P160,000 Actual and expected gain on plan assets 35,000 Unexpected loss on plan
assets related to a year 1 disposal of a subsidiary 40,000 Amortization of unrecognized prior
service cost 5,000 Annual interest on pension obligation 50,000 What amount should Lee report
as pension cost in its year 2 income statement?

a. P250,000
b. P220,000
c. P210,000
d. P180,000

Answer: D
The six elements which an employer sponsoring a defined benefit pension plan must
include in its net pension cost are service cost, interest cost, actual return on plan assets,
amortization of unrecognized prior service cost, deferral of unexpected gain or loss, and
 Service cost P160,000 Gain (actual and expected) on plan assets (35,000) Amortization
5,000 Interest 50,000 180,000 Gains and losses that arise from a single occurrence which
is not directly related to the operation of the plan should be reported as part of that
occurrence and not as part of the plan’s activity. Therefore, the P40,000 unexpected loss
on plan assets related to a year 2 disposal of a subsidiary should be reported as part of
the “loss on disposal” and not as part of the year 2 pension cost.

Difficult
1. On December 31, year 1, Lane, Inc. sold equipment to Noll, and simultaneously leased it back for
twelve years. Pertinent information at this date is as follows:
Sales price P480,000 Carrying amount 360,000 Estimated remaining economic life 15 years At
December 31, year 1, how much should Lane report as deferred gain from the sale of the
equipment?

a. P0
b. P110,000
c. P112,000
d. P120,000

Answer: D
Sale-leaseback arrangements are treated as though two transactions were a single
financing transaction, if the lease qualifies as a capital lease. Any gain or loss on the sale
is deferred and amortized over the lease term (if possession reverts to the lessor) or the
economic life (if ownership transfers to the lessee). In this case, the lease qualifies as a
capital lease because the lease term (twelve years) is 80% of the remaining economic life
of the leased property (fifteen years). Therefore, at 12/31/Y1, all of gain (P480,000 –
P360,000 = P120,000) would be deferred and amortized over twelve years. Since the sale
took place on 12/31/Y1, there is no amortization for year 1.

2. On June 30, year 1, Ank Corp. prepaid a P19,000 premium on an annual insurance policy. The
premium payment was a tax deductible expense in Ank’s year 1 cash basis tax return. The
accrual basis income statement will report a P9,500 insurance expense in year 1 and year 2.
Ank’s income tax rate is 30% in year 1 and 25% thereafter. In Ank’s December 31, year 1
balance sheet, what amount related to the insurance should be reported as a deferred income tax
liability?

a. P5,700
b. P4,750
c. P2,850
d. P2,375

Answer: D
For accounting purposes, prepaid insurance is P9,500 at 12/31/Y1. For tax purposes, there
was no prepaid insurance at 12/31/Y1, since the entire amount was deducted on the year 1
tax return. Therefore, the temporary difference is P9,500. This temporary difference will
result in a future taxable amount in year 2, when the tax rate is 25%. Therefore, at 12/31/Y1,
a deferred tax liability of P2,375 (25% × P9,500) must be reported.

3. On March 1, year 1, Rya Corp. issued 1,000 shares of its P20 par value common stock and 2,000
shares of its P20 par value convertible preferred stock for a total of P80,000. At this date, Rya’s
common stock was selling for P36 per share, and the convertible preferred stock was selling for
P27 per share. What amount of the proceeds should be allocated to Rya’s convertible preferred
stock?
 a. P60,000
b. P54,000
c. P48,000
d. P44,000

Answer: C
In a lump-sum issuance of common and preferred stock, the proceeds (P80,000) are
generally allocated based on the relative fair market values of the securities issued. The
FV of the convertible preferred stock is P54,000 (P27 × 2,000) and the FV of the common
stock is P36,000 (P36 × 1,000).