LESSON 1: INTRODUCTION TO LIABILITIES

Liabilities – are present obligations of an entity arising from past transactions or events,
the settlement of which is expected to result in an outflow from the entity of resources
embodying economic benefits.

ESSENTIAL CHARACTERISTICS:

1. As the present obligation of a particular entity (must be identified but the payee is
not necessarily be identified)
May be:

Legal obligation- (legally enforceable) consequence of binding contract or statutory

Constructive obligation- normal business practice, custom and a desire to maintain

2. Arises from a past event (liability is not recognized until it is incurred) Known as the
obligating event

3. Settlement of liability requires an outflow of resources embodying economic

- Cash dividend declaration is a crystallization of the definitive concept of an

- Share dividend payable is classified as part of equity rather than an accounting

Examples of Liabilities:
1. Accounts payable to suppliers for the purchase of goods
2. Amounts withheld from employees for taxes and for contributions to the social
security system
3. Accruals of wages, interest, royalties, taxes, product warranties and profit sharing
plans
4. Cash dividends declared but not paid
5. Deposits from customers and advances from officers
6. Debt obligations for borrowed funds – notes, mortgages and bonds payable
7. Income tax revenue
8. Unearned revenue (payment is already collected but service not yet rendered)

MEASUREMENT OF LIABILITIES:

Conceptually, all liabilities are initially measured at present value and subsequently
measured at amortized cost.

In practice, current liabilities or short-term obligations are not discounted anymore but
measured, recorded and reported at their face amount (it is because the discount or the
difference between the face amount and the present value is usually not material and
therefore ignored)
Non-current liabilities (ex. bonds payable and noninterest-bearing note payable) are
initially measured at present value and subsequently measured at amortized cost.
If the long term note payable is interest-bearing, it is initially and subsequently
measured at face amount. In this case, the face amount is equal to the present value of
the note payable.

CURRENT LIABILITIES:

- Settles the liability within the entity’s operating cycle

- Holds liability for the purpose of trading (financial liabilities held for trading,
bank overdraft, dividends payable, income taxes, other nontrade payables and
current portion of noncurrent financial liabilities)

- Due to be settled within 12 months after the reporting period

- Does not have right to defer settlement of the liability for at least 12 months
after the reporting period

Operating costs that are part of working capital used in the entity’s normal operating
cycle are classified as current liabilities even if settled more than 12 months after
reporting period.

When the entity’s normal operating cycle is not identified, it is assumed as 12 months.

Financial liabilities held for trading are financial liabilities that are incurred with an
intention to repurchase them in the near term. (ex. Quoted debt instrument)

NON – CRRENT LIABILITIES:

A residual definition

Ex.: noncurrent portion of long-term debt, finance lease liability, deferred tax liability
(tax that is due for the current period but not yet paid // tax due according to tax
accounting < according to financial accounting), long-term obligation to entity officers,
long-term deferred revenue

A liability which is due to be settled within twelve months after the reporting period is
classified as current, even if:

- Original term is longer than 12 months

However, if the refinancing on a long-term basis is completed on/or before the end
of the reporting period, the refinancing is an adjusting event and therefore the
obligation is classified as noncurrent, also if the entity has the discretion to
refinance
COVENANTS:

- attached to borrowing agreements which represent undertakings by the borrower

- restrictions on the borrower as to undertake further borrowings, etc.

Breach of covenants – if conditions relating to the borrower’s financial situation are

classified as current even if the lender has agreed, after the reporting period and before
the statements are authorized for issue, not to demand payments as a consequence of
the breach.

It is current because at the end of the reporting period, the entity does not have an
unconditional right to defer settlement for at least 12 months after that date.

Classified as noncurrent if the lender has agreed on or before the end of the reporting
period to provide a grace period ending at least 12 months after that date.

Grace period – a period within which the entity can rectify the breach and during which
the lender cannot demand immediate repayment

PRESENTATION OF CURRENT LIABILITIES:

The face of the statement of financial positional shall include the following line items for
current liabilities

1. Trade and other payables (line item for accounts payable, notes payable, accrued
interest on note payable, dividends payable and accrued expenses. Though, no objection
can be raised if the trade accounts and notes payable are separately presented)
2. Current provisions
3. Short-term borrowing
4. Current portion of long-term debt
5. Current tax liliability

ESTIMATED LIABILITES

Obligations which exist at the end of reporting period although their amount is not
definite, also the due date and the exact payee

But the existence of the estimated liabilities is valid and unquestioned Either current or
noncurrent
Ex. Estimated liability for premium, award points, warranties, gift certificates and bonus