CHAPTER 1: LIABILITIES

Liabilities - are present obligations of an entity to transfer an economic resource as a result of past events.

Essential Characteristics
a. The entity has a present obligation - the payor must be identified (the payee, amount and timing are
not necessary). Obligation is a duty or responsibility that an entity has no practical ability to avoid.
1. Legal - law or contract (e.g., income taxes)
2. Constructive - the entity has formed a liability
1. The payor has announced or obliged that it has a liability.
2. The payee accepted it and acknowledged that the entity will comply.
b. The obligation is to transfer an economic resource
1. Economic resource - is an asset (maybe cash or non-cash) or service coming from the entity.
Something of value that can benefit the payee.
c. The liability arises from a past event
1. Past event = obligating event
2. The liability is not recognized until it is incurred.
Example:
 Accounts payable to suppliers
 Amounts withheld from employees for taxes
 Accruals for salaries – this has yet to be paid, but service/work has already been incurred.
 Cash dividend declared but not paid
 Deposits and advances from customers
 Debt obligations for borrowed funds
 Income tax payable – refers to the entity’s unpaid tax liability
 Unearned revenue – the entity already has the cash payment, but the service is not yet rendered.

Measurement
Initially Subsequently

Interest Bearing (short term) Face Value Face Value

Non-Interest Bearing (short term) Face Value Face Value

Interest Bearing (long term) Face Value Face Value

Non-Interest Bearing (long term) Present Value Amortized Cost

*In general, when it talks about LIABILITIES (meaning it’s not specified): initial - present value and
subsequent - amortized cost

Terminologies:
1. Short-term: 12 months or less
2. Long-term: more than 12 months
3. Interest-bearing: written in the contract
4. Non-interest bearing: not stated in the contract (but there’s an interest implicitly). There’s an assumption
that the face value includes both principal and interest.
5. Face value: the amount written in the contract
6. Present value: process of discounting wherein the face value is separated from its interest.
7. Amortized cost: process of getting the original value of the principal value from its present value.
The short-term non-interest bearing that is initially and subsequently recorded at face value (just like the other
two) was because of the concept of materiality.

Current Liabilities
a. The entity expects to settle the liability within the entity’s operating cycle.
b. The entity holds the liability primarily for the purpose of trading.
c. The liability is due to be settled within 12 months after the reporting period (whether it is related to
trading or not).
1. If the problem is silent about the operating cycle - it is presumed that it is 12 months.
d. The entity does not have an unconditional right to defer settlement of the liability for at least 12
months after the reporting period (if there is, then it is non-current).
1. If you have the power to extend your settlement period, then it is a non-current liability.
2. If the extension is 11 months or less, then it is still a current liability.
Examples:
 Financial liabilities held for trading – financial liabilities that are incurred with an intention to
repurchase them in the near term.
 Bank overdraft – overdrafts are always certainly due to be repaid immediately.
 Dividends payable (cash)
 Income taxes
 Other nontrade payables and current portion of noncurrent financial liabilities

Non-Current Liabilities - residual definition

 Long-term debt falling within one year:
o The general rule is reclassifying the liability from non-current to current
 EXCEPT, when the entity has the unconditional right to defer the settlement - it will still
be treated as non-current.
 EXCEPT, when the payee would like to extend the settlement period in a formal way -
then it would be treated as non-current. But if in an informal way - then it is disregarded
by the payor and the general rule will prevail.
Examples:
 Noncurrent portion of long-term debt
 Finance lease liability – amount of the principal payable in a period greater than twelve months.
 Deferred tax liability – owed but are not due to be paid until a future date.
 Long-term obligation to officers
 Long-term deferred revenue

Refinancing or Extension
 Extending the liability
 Getting a new liability to pay an old liability

When the extension is agreed upon within the reporting period – there is reclassification.
When the extension is agreed upon after the reporting period - there’s no reclassification: if still applicable -
then reclassification is applied in the next operating cycle. (51:00 - https://www.youtube.com/watch?
v=X0nS9noYeNA&list=PLerzWq9nGRYcr65DVF7HIo_i4xU0SzpnS)
Non-adjusting events - disclosed in notes

Covenant - restrictions on the borrower as to undertake further borrowings, paying dividends, maintaining
specified level of working capital, etc. (these are borrowing agreements which represent undertakings by the
borrower)
Breach of Covenant:
 Failure to comply with the agreement
 From non-current to current: meaning it’s going to be payable on demand

Grace period - is the period within which the entity can rectify the breach and during which the lender cannot
demand immediate repayment. (Therefore, the liability can be classified as noncurrent)
 Given time to correct the errors/mistakes
 Even though the additional time/period given is 11 months or less, it will still be classified as
noncurrent.

Presentation of current liabilities

a. Trade and other payables
b. Current provisions
c. Short-term borrowings
d. Current portion of long-term debt
e. Current tax liability
*There’s no issue if the trade accounts and notes payable are presented in separate line item.

Deferred Revenue or Unearned Income

 Income already received but not yet earned
 No service has been rendered yet
 Deferred = delayed
 This account title is included in liabilities as the entity still needs to do/render its obligations
 When service has been performed, from liabilities - this account title will be converted to revenue
(income)

Liability Method:
Initial recognition = liability then converted into income
Income Method:
Initial recognition = income then converted into liability (if the service is not performed)

Estimated liabilities – are obligations which exist at the end of reporting period although their amount is not
definite. They can either be current or noncurrent in nature.

Gift Certificate (payable) - a voucher given as a present that is exchangeable for a specified cash value of goods
or service from a particular place of business.
General recognition: Current Liabilities

Accounting Entries
Sold gift certificate:
Cash xxx
Gift Certificate Payable xxx
Redeemed gift certificate:
Gift Certificate Payable xxx
Sales xxx
Unredeemed gift certificate:
Gift Certificate Payable xxx
Forfeited gift certificate (income) xxx

*The Philippine DTI ruled that gift certificates no longer have an expiration period.
Refundable Deposits - consist of cash or property received from customers but which are refundable after
compliance with certain conditions

Accounting Entries:
Cash xxx
Container’s deposit xxx
Containers’ deposit xxx
Cash xxx

Container’s deposit xxx

Container xxx
(If ever the container’s price is lower than the deposit, then a gain is recognized and vice versa)

Bonus - is a financial compensation that is above and beyond the normal payment expectations of its recipient.

Bonus Computation Variations

1. Before bonus and before tax: B = %(NI)
2. After bonus but before tax: B = %(NI-B)
3. After bonus and after tax: B = %(NI-B-T); T = %(NI-B)
4. Before bonus but after tax: B = %(NI-T); T = %(NI-B)

*If tax (T) is unknown, then it needs to be solved first.

Accounting Entries (end of the operating cycle: Dec.31)

Bonus Expense xxx
Bonus Payable xxx

Recognition: Current Liabilities

Constructive obligation as it is not required by the law