Provisions & Contingent Liabilities: John Bo S. Cayetano, CPA, MBA

Chapter 08
PROVISIONS &
CONTINGENT LIABILITIES
John Bo S. Cayetano, CPA, MBA

EXPECTED QUESTIONS:
 Loss from lawsuit
 Provision from lawsuit
 Premium expense
 Premium payable
 Warranty expense
 Warranty payable
Provision Contingent Liability
 A liability of the company.  A liability of the company.
 Uncertain timing and/or amount.  Uncertain timing and/or amount.
Example of Provision
Lawsuit Payable – the potential payment to plaintiff once
the court decided against the company or in the favor of the
plaintiff.
Premium Payable – the potential payment of promotional

Uncertain merchandise or free items once the company’s product is to be
purchased.
Warranty Payable – the potential payment of repair service

of product sold to customer once the said product become
broken.
Provision Contingent Liability
 A liability of the company.  A liability of the company.
 Uncertain timing and/or amount.  Uncertain timing and/or amount.
 Recorded in the balance sheet.  Not recorded in the balance sheet.
 Recognition requirement:  Recognition requirement:
Probable Probable
Measurable Measurable
Probable Versus Possible
The chances that the company will have to pay the liability is higher than
not to pay.
Probable Possible Probable
Chance that it will happen 60% 50% 50.1%
Chance that it will not happen 40% 50% 49.9%
Above 50% Probable

Chance
of
Happening
50% and below Possible
Measurable
The amount can be measured in peso (or other currency). As long as the
amount can be estimated reliably in peso it is measurable.
Provision Versus Contingent Liability
Probable Recorded in B.S.
LIABILITY
Disclose to notes
Possible
Not Probable
Remote No nothing
Common Types of Provision
Lawsuit Payable – the potential payment to plaintiff once

Other expense the court decided against the company or in the favor of
the plaintiff.
Premium Payable – the potential payment of promotional

Selling expense merchandise or free items once the company’s product is to be
purchased.
Warranty Payable – the potential payment of repair

Selling expense service of product sold to customer once the said product
become broken.
Journal Entry: How much?

Dr. Expense XX
Cr. Provision XX
Measurement of Provision
1ST Actual Amount - The confirmed amount that the
company paid or will have to pay.
Known before issuance
2ND Best Estimate - The company’s legal counsel estimated

amount to be paid in the future.
3RD Mid Point - The simple average amount of a

range of outcome:
(highest + lowest)  2
4TH - The weighted average amount of

Expected Value
multiple possible outcomes:
Scenario 01
Involve FS FS
Accident Date Issue
Nov. 1 Dec. 31 Mar. 31
Jan. 1 Dec. 31
2021 2021 2022
2021 2022
Actual Amount Known

Nov. 1, 2021 – The company was involved in an accident, on the same day the survivor sued the company and demanding
P1,000,000.
Dec. 31, 2021 – On FS preparation date, the lawsuit is still undecided. The company’s lawyer believe that it is probable
that the company will pay the survivor at estimated amount of P800,000.
Mar. 31, 2022 – The FS was issued to shareholders.
Scenario 01:
On Feb 14. 2021 the court decided that the company should pay P900,000.


range of outcome:

Expected Value
Scenario 01
Involve FS FS
Accident Date Issue
Jan. 1 Dec. 31
2021 2021 2022
2021 2022
Actual Amount Known

P1,000,000.
Scenario 01:
On Feb 14. 2022 the court decided that the company should pay P900,000.
Provision = P900,000
Scenario 02
Involve FS FS
Accident Date Issue
Jan. 1 Dec. 31
2021 2021 2022
2021 2022
Actual Amount Known

P1,000,000.
Scenario 02:
On April 15. 2021 the court decided that the company should pay P900,000.


range of outcome:

Expected Value
Scenario 02
Involve FS FS
Accident Date Issue
Jan. 1 Dec. 31
2021 2021 2022
2021 2022
Actual Amount Known

P1,000,000.
Scenario 02:
On April 15. 2021 the court decided that the company should pay P900,000.
Provision = P800,000
Scenario 03
Involve FS FS
Accident Date Issue
Jan. 1 Dec. 31
2021 2021 2022
2021 2022
P1,000,000.
Dec. 31, 2021 – On FS preparation date, the lawsuit is still undecided.
Scenario 03:
On December 31. 2021, the lawyer’s estimate is between 500,000 to 1,000,000
1ST Actual Amount - The confirmed amount that the company
paid or will have to pay.

3RD Mid Point - The simple average amount of a range

of outcome:

Expected Value
Scenario 03
Involve FS FS
Accident Date Issue
Jan. 1 Dec. 31
2021 2021 2022
2021 2022
P1,000,000.
Scenario 03:
On December 31. 2021, the lawyer’s estimate is between 500,000 to 1,000,000
Provision = [(500,000 + 1,000,000) / 2] = P750,000

Scenario 04
Involve FS FS
Accident Date Issue
Jan. 1 Nov. 1 Dec. 31 Mar. 31 Dec. 31
2021 2021 2021 2022 2022
P1,000,000.
Scenario 04:
On December. 31. 2021, the lawyer’s estimate is between 20,000 to 20,000,000.
Provision = -0- Unreasonable range = not measurable

Scenario 05
Involve FS FS
Accident Date Issue
Jan. 1 Dec. 31
2021 2021 2022
2021 2022
P1,000,000.

Scenario 05:
On Dec. 31. 2021, the lawyer’s estimate:
20% chance of paying 100,000
50% chance of paying 1,000,000


range of outcome:

Expected Value
Scenario 05
Involve FS FS
Accident Date Issue
Jan. 1 Dec. 31
2021 2021 2022
2021 2022
P1,000,000.

Scenario 05:
On Dec. 31. 2021, the lawyer’s estimate: 100,000 x 20%
20% chance of paying 100,000 500,000 x 30% = P670,000
50% chance of paying 1,000,000 1,000,000 x 50%
Recovery from Insurance
 If the property that suffered damaged was insured, the company can recover the value of
damage suffered. The amount of recovery is computed as follows:
Amount of damages XX
Deductible clause (portion of damages should by the company) (XX)
Recovery from insurance company XX
 The amount of recovery is recognize as gain and the amount of gain will offset the amount of
loss from damages.
 If this recovery is still uncollected, the company should recognize receivable from insurance
company. The receivable is cannot be offset to any provision.
Scenario 06
On Nov 1, 2021, an explosion in the factory of the company occurred. Ten factory workers lost
their both legs. A lawsuit was filed to court asking for compensation for what they suffered. The
lawyer’s estimated amount 90K with probable chance. Factory is insured with deductible clause
amounting to 30K. How much is provision & expense?
Provision Loss from lawsuit

Amount of Damage XX 90K
Recovery from Insurance (XX) 60K
Loss (Expense) XX 30K
Deductible Clause
Amount of Damage XX 90K
Deductible Clause (XX) 30K
Recovery from Insurance XX 60K
Lawsuit With Insurance
Liability Level of Priority
Question
Expense Deductible Clause

Number 01
Number 02
Number 03
Number 04
NOT MEASURABLE
Number 05
300,000 x 60% = 180,000

500,000 x 40% = 200,000
380,000
70%
266,000
Number 06
NOT PROBABLE
Number 07
Number 08
Number 09
Contingent Asset
A possible asset arising from a lawsuit where the company sued another
company for a compensation from damages suffered.
Virtually
certain
0% 50% 95% 100%
Possible Probable
Do nothing Disclose Record
To notes Asset/income
Number 09
Contingent Asset
A possible asset arising from a lawsuit where the company sued another
company for a compensation from damages suffered.
Virtually
certain
0% 50% 95% 100%
Possible Probable
Do nothing Disclose Record
To notes Asset/income
Number 09
EXPECTED QUESTIONS:
 Premium expense
 Premium payable
Premiums Payable
1. The obligation of the company to deliver promotional merchandise (a.k.a. the premium) like,
T-shirt, calendar planner, etc. This will give his/her right to collect a premium in the future.
The objective of which is to increase sales.
2. Usually in the problem, the customer is required to accumulate specific number of proof of
purchase (e.g., coupons, wrappers, bottle caps) the he/she will use to obtain (redeem) the
premium item.
3. The total expected value of the premium that the company is required to distribute to increase
the current year’s sale is recorded as premium expense.
4. After deducting the value of the distributed premium on the current year, the value of
undistributed premium is recorded as premium payable.
Premium Payable
Cash
Company Customer
Coupon Product sold
Journal: (Incurred) Premium Payable

Dr. Premium Expense. XX
Cr. Premium Payable XX XX Beginning
Distributed XX
XX Expense
Journal: (Payment/distribution)
Dr. Premium Payable XX XX Ending
Cr. Premium Inventory XX
Coupons
Company Customer
Premium
Premium Payable
In Units x Net cost / unit = In Peso
Add: Premium Expense XX x XX = XX
Less: Premium Distributed (XX) x XX = (XX)
Ending Premium Payable XX x XX = XX
Number of coupons distributed in the current year P XX

Times: Percentage of coupons expected to be used XX
Total number of coupons expected to be used XX
Divide: Number of coupons needed for one premium XX
Premium Expense P XX
Premium Payable
Method 1:
Coupons redeemed during the year XX

Divide: Number of coupons needed for 1 premium XX
Premium distributed (in units) XX
Premium Payable
Method 2:
Premium Inventory, beginning XX

Add: Purchases of premium XX
Less: Premium Inventory, ending XX
Premium Distributed XX
Premium Payable
Net cost per unit
Cost per premium (purchase price) XX

Add: Distribution cost per unit XX
Less: Cash receipt from customer XX
Net cost per unit XX
Number 10 and 11
Add: Premium Expense 60,000

XX x XX = XX
Number of coupons distributed in the current year XX

2,000,000
Times: Percentage of coupons expected to be used 30%
XX
600,000
Divide: Number of coupons needed for one premium XX10
Premium Expense 60,000
XX
Number 10 and 11

XX x XX = XX
Less: Premium Distributed (XX)

(40,000) x XX = (XX)
Ending Premium Payable 20,000 x XX = XX
Method 1:
Coupons redeemed during the year XX 400,000

Divide:
Divide: Number
Number of
of coupons
coupons needed
needed for
for 11 premium
premium XX 10
Premium distributed (in units) XX 40,000
Number 10 and 11

XX x 45
XX = XX
Less: Premium Distributed (40,000)

(XX) x XX
45 = (XX)
Ending Premium Payable 20,000 x 45

XX = XX
Net cost per unit
Cost per premium (purchase price) 50

XX
Add: Distribution cost per unit 5
XX
(10)
Net cost per unit 45
XX
Number 10 and 11

XX x 45
XX = XX
2,700,000

(40,000) x XX
45 = (1,800,000)
(XX)
Ending Premium Payable 20,000

XX x 45
XX = 900,000
Number 12 and 13
Beginning 20,000 x 45 = 900,000

XX x XX = XX

2,500,000
XX
750,000
Divide: Number of coupons needed for one premium XX10
XX
Number 12 and 13
Beginning 20,000 x 45 = 900,000

XX x XX = XX

(70,000) x XX = (XX)
Ending Premium Payable 25,000 x XX = XX
Method 1:
Coupons redeemed during the year XX 700,000

Divide:
Divide: Number
Number of
of coupons
coupons needed
needed for
for 11 premium
premium XX 10
Premium distributed (in units) XX 70,000
Number 12 and 13
Beginning 20,000 x 45 = 900,000

XX x 45 = 3,375,000

(70,000) x 45 = (3,150,000)
Ending Premium Payable 25,000 x 45 = 1,125,000

Number 14
Beginning Premium Payable XX x XX XX

XX x XX = XX

60,000
XX
24,000
5
XX
Number 14
Beginning Premium Payable XX x XX = XX

XX x XX = XX

(XX) x XX = (XX)
Method 2:
Premium Inventory, beginning XX

1,200
Add: Purchases of premium 6,000
XX
Less: Premium Inventory, ending 2,100
XX
Premium Distributed 5,100
XX
Number 14
Beginning Premium Payable 2,200

XX x XX
110 = 242,000
XX
XX

XX x 110
XX = 528,000
XX

(XX) x 110
XX = (XX)
(561,000)
Ending Premium Payable 1,900

XX x 110
XX = 209,000
XX
Net cost per unit

XX
Add: Distribution cost per unit -0-
XX
(50)
XX
Number 15
Beginning Premium Payable XX x XX XX
Add: Premium Expense ???

XX x XX = XX

3,125,000
Times: Percentage of coupons expected to be used XXN/A
Premium Expense XX
Number 15
Beginning Premium Payable 600

XX x XX
85 = 51,000
XX
XX
Add: Premium Expense Squeeze 2,000

XX x 85
XX = 170,000
XX
Less: Premium Distributed XX

(1,800)
(XX) x XX
85 = (XX)
(153,000)
Ending Premium Payable XX

800 x 85
XX = 68,000
XX
Net cost per unit

XX
Add: Distribution cost per unit XX5
(20)
XX
EXPECTED QUESTIONS:
 Premium expense
 Premium payable
Warranty Payable
1. The obligation of the company to deliver repair services to its customer for goods sold. The
objective of which is to increase the sales.
2. The total expected value of repair services to be rendered for the goods sold for the current
year is recorded as warranty expense.
3. Warranty services rendered for the current period is treated as payment of warranty
liability and for the services to be rendered in the future is record as warranty payable.
4. The cost of warranty services rendered for the current period is referred to as actual
warranty cost.
Warranty Payable
Cash
Company Customer
Warranty contract Product sold
Journal: (Incurred) Warranty Payable

Dr. Warranty Expense XX
Cr. Warranty Payable XX XX Beginning
Distributed XX
XX Expense
Journal: (Payment/distribution)
Dr. Warranty Payable XX XX Ending
Cr. Cash XX
Product return for repair

Company Customer
Repair service
Actual warranty cost
Warranty Expense & Warranty Payable
Warranty Expense XX
Less: Actual Warranty Cost (XX) Given in the problem
Ending Warranty Payable XX
Sales for the period XX

Times: Total percentage of warranty cost X%
Warranty expense XX
Warranty Expense & Warranty Payable
Year 1 Year 2 Year 3
Beginning Warranty Payable -- XX XX

Add: Warranty Expense XX XX
Less: Actual Warranty Cost (XX) (XX)
Ending Warranty Payable XX XX
Sales for the period XX

Times: Total percentage of warranty cost X%
Warranty expense XX
Number 17 and 18
2018 2019
Beginning Warranty Payable 2,100
Add: Warranty Expense XX

3,000 4,500
Less: Actual Warranty Cost (XX)

( 900) (3,450)
Ending Warranty Payable XX

2,100 3,150
2018 2019
Sales for the period XX30,00045,000

30,000
Times:
Times: Total
Total percentage
percentage of
of warranty
warranty cost X%
cost (7%+3%)
(7%+3%) 10%
10% 10%
Warranty expense XX3,000
3,000 4,500
Number 19 and 20
2014 2015 2016 2017
Beginning Warranty Payable XX XX XX
Add: Warranty Expense XX XX XX XX

744,842
Less: Actual Warranty Cost (XX) (XX) (XX) (XX)

(400,480)
Ending Warranty Payable XX XX XX XX
2016 2017
Sales for the period XX4,585,800 5,320,300

Times: Total percentage of warranty cost (7%+3%)
X% 14% 14%
Warranty expense XX642,012 744,842
Number 19 and 20
Sales 2014 3,280,000
Sales 2015 4,320,500 Cumulative Sales 17,506,600
Sales 2016 4,585,800
Warranty cost 14%
Sales 2017 5,320,300
Cumulative Warranty Expense 2,450,924
Actual Warranty (1,022,250)
Warranty Payable 1,428,674
Actual 2014 110,600
Cumulative Actual
Actual 2015 200,480
Warranty Cost
Actual 2016 310,690 1,022,250
Actual 2017 400,480
EXPECTED QUESTIONS:
 Premium expense
 Premium payable

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Chapter 08

John Bo S. Cayetano, CPA, MBA

Premium Payable – the potential payment of promotional

Warranty Payable – the potential payment of repair service

Probable Possible Probable

Chance that it will happen 60% 50% 50.1%

Chance that it will not happen 40% 50% 49.9%

Above 50% Probable

Probable Recorded in B.S.

Lawsuit Payable – the potential payment to plaintiff once

Premium Payable – the potential payment of promotional

Warranty Payable – the potential payment of repair

Journal Entry: How much?

2ND Best Estimate - The company’s legal counsel estimated

3RD Mid Point - The simple average amount of a

4TH - The weighted average amount of

Actual Amount Known

Mar. 31, 2022 – The FS was issued to shareholders.

2ND Best Estimate - The company’s legal counsel estimated

3RD Mid Point - The simple average amount of a

4TH - The weighted average amount of

Actual Amount Known

Mar. 31, 2022 – The FS was issued to shareholders.

Actual Amount Known

Mar. 31, 2022 – The FS was issued to shareholders.

2ND Best Estimate - The company’s legal counsel estimated

3RD Mid Point - The simple average amount of a

4TH - The weighted average amount of

Actual Amount Known

Mar. 31, 2022 – The FS was issued to shareholders.

Dec. 31, 2021 – On FS preparation date, the lawsuit is still undecided.

Mar. 31, 2022 – The FS was issued to shareholders.

2ND Best Estimate - The company’s legal counsel estimated

3RD Mid Point - The simple average amount of a range

4TH - The weighted average amount of

Provision = [(500,000 + 1,000,000) / 2] = P750,000

Mar. 31, 2022 – The FS was issued to shareholders.

Provision = -0- Unreasonable range = not measurable

Dec. 31, 2021 – On FS preparation date, the lawsuit is still undecided.

Mar. 31, 2022 – The FS was issued to shareholders.

2ND Best Estimate - The company’s legal counsel estimated

3RD Mid Point - The simple average amount of a

4TH - The weighted average amount of

Dec. 31, 2021 – On FS preparation date, the lawsuit is still undecided.

Mar. 31, 2022 – The FS was issued to shareholders.

Provision Loss from lawsuit

Liability Level of Priority

Expense Deductible Clause

300,000 x 60% = 180,000

Journal: (Incurred) Premium Payable

Add: Premium Expense XX x XX = XX

Less: Premium Distributed (XX) x XX = (XX)

Ending Premium Payable XX x XX = XX

Number of coupons distributed in the current year P XX

Add: Premium Expense XX x XX = XX

Less: Premium Distributed (XX) x XX = (XX)

Ending Premium Payable XX x XX = XX

Coupons redeemed during the year XX

Add: Premium Expense XX x XX = XX