FINANCIAL LIABILITIES

NATURE AND DEFINITION OF LIABILITIES

According to the Revised Conceptual Framework for Financial Reporting, liability is a present obligation of
the entity to transfer an economic resource as a result of past events.

The essential characteristics of a liability are:

1. The entity has a present obligation
• An obligation is a duty or responsibility that an entity has no practical ability to avoid.

2. The obligation is to transfer an economic resource

• An economic resource is the asset that represents a right with a potential to produce
economic benefits.
• The obligation must be to pay cash, transfer noncash asset or provide service at some
future time.

3. The liability arises from a past event

• The liability is not recognized until it is incurred. This past event that leads to the
incurrence of a liability is known as the obligating event.
✓ The obligating event creates a present obligation because the entity has no realistic
alternative but to settle the obligation.

FINANCIAL STATEMENT PRESENTATION

A liability is classified as current when:
a) It is expected to be settled within the entity’s normal operating cycle;
b) It is expected to be settled within 12 months;
c) It is held for trading.
d) The entity has no unconditional right to defer payment for at least 12 months from the reporting
date

A liability is classified as noncurrent if it did not meet any of the conditions above.

CURRENTLY MATURING DEBT

A liability which is due to be settled within 12 months after the reporting period is classified as current,
even if:
a. The original term was for a period longer than twelve months.
b. An agreement to refinance or to reschedule payment on a long-term basis is completed after the
reporting period and before the financial statements are authorized for issue.

However, if the refinancing is completed on or before the end of the reporting period, the obligation is
classified as noncurrent.

If the entity has the discretion to refinance or roll over an obligation for at least twelve months after the
reporting period under an existing loan facility, the obligation is classified as noncurrent.

COVENANTS
Covenants are attached to borrowing agreements which represent undertakings by the borrower. These
are restrictions on the part of the borrower. Under these covenants, if certain conditions relating to the
borrower’s financial situation are breached, the liability becomes payable on demand.

BREACH OF COVENANTS
The liability is classified as current even if the lender has agreed, after the reporting period and before the
statements are authorized for issue, not to demand payment as a consequence of the breach. However,
the liability is classified as noncurrent if the lender has agreed on or before the end of reporting period to
provide a grace period ending at least twelve months after the end of reporting period.
FINANCIAL LIABILITY
A financial liability is any liability that is a contractual obligation:
a) To deliver cash or other financial asset to another entity.
b) To exchange financial instruments with another entity under conditions that are potentially
unfavorable.

Examples of financial liabilities

1) Trade accounts payable
2) Notes and loans payable
3) Bonds payable

RECOGNITION PRINCIPLE

An entity shall recognize financial liability when and only when it becomes a party to the contractual
provisions of the instrument.

MEASUREMENT

Initial measurement
1. A financial liability is initially recognized at fair value, which is the transaction price.
2. A financial liability measured at amortized cost is initially recognized at fair value less transaction
costs.

Subsequent measurement
Except for financial liabilities that are measured at fair value, financial liabilities are subsequently measured
at amortized cost.

ACCOUNTS PAYABLE

Accounts payable (or trade accounts payable) are liabilities arising from purchase of goods, materials,
supplies or services on an open account basis. Theoretically, an entity must recognize accounts payable
when it acquired economic control over the goods because this is the date when the entity becomes a
party to the financial instrument.
➢ A purchase made towards the end of the accounting period, where goods are still in transit, should
be recognized as a liability when the shipping term is FOB shipping point. Similarly, the liability is
recognized upon receipt of goods when such are shipped FOB destination.

NOTES PAYABLE

A promissory note is a written promise to pay a certain sum of money to the bearer at a designated future
time. This may arise from purchase of goods or services or borrowings from financial institutions.

BONDS PAYABLE

A bond is a formal unconditional promise, made under seal, to pay a specified sum of money at a
determinable future date, to make periodic interest payment at a stated rate until the principal sum is paid.

CLASSIFICATION OF BONDS
1. Term bonds – bonds with a single date of maturity.
2. Serial bonds (or installment bonds) – bonds with series of maturity dates instead of a single one.
3. Convertible bonds – bonds that can be exchanged for shares of the issuing entity.
4. Callable bonds – bonds which may be called in for redemption prior to maturity date.

MEASUREMENT PRINCIPLES
 INITIAL MEASUREMENT
Bonds payable classified as financial liability at amortized cost shall be initially measured at fair value minus
bond issue costs. Normally, it is equal to the net proceeds from the issuance of bonds, excluding accrued
interest, if any.

Bond issue costs

These are transactions directly attributable to the issuance of bonds. These are as follows:
• Printing or engraving cost;
• Legal and accounting fee;
• Registration fee with regulatory authorities;
• Commission paid to agents and underwriters and other similar charges.

Bond issue costs are treated as an adjustment to:

• Discount on bonds payable as an addition to the account (initial measurement will
decrease)
• Premium on bonds payable as a deduction to the account (initial measurement will
increase)

ISSUANCE OF BONDS BETWEEN INTEREST DATES

• Accruing interest from the last interest payment date up to date of purchase shall be
accrued and paid by the buyer or investor.
• Cash to be received by issuer = fair value + accrued interest to date of purchase
• Example:
- Interest payment dates: January 1 and July 1 of every year
• Date of purchase: May 1
• Interest for the period January through April shall be paid by the buyer
or investor to the issuer.

SUBSEQUENT MEASUREMENT
Bonds payable are subsequently measured at amortized cost using the effective interest method.

-END OF NOTES-

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 FAR – FINANCIAL LIABILITIES

REQUIRED:
a. Prepare journal entry on the date of conversion.

CONVERTIBLE BONDS – Redemption

12. On January 1, 2015, Effie Corporation issued a 10% convertible bonds with a face value of P4,000,000 maturing on
December 31, 2024. Each P1,000 bond is convertible into ordinary shares of Effie at a conversion price of P25 per
share. Interest is payable half-yearly in cash. At the date of issue, Effie could have issued nonconvertible debt with a
ten-year term bearing a coupon interest rate of 11%.

On January 1, 2020, the convertible bond has a fair value of P4,400,000. Effie makes a tender offer to the holders to
repurchase the bonds for P4,400,000. The holders of the P2,000,000 bonds have accepted the offer. At the date of
repurchase, Effie could have issued a nonconvertible debt with a five-year term bearing a coupon interest rate of 8%.

REQUIRED:
Based on the above information, compute for the following:
a. Proceeds from the issuance of convertible bonds to be allocated to the equity component.
b. Carrying amount of the bonds on December 31, 2019
c. Amount to be recognized in profit or loss as a result of the repurchase of the bonds on January 1, 2020 is
d. Decrease in equity as a result of repurchase of the bonds on January 1, 2020
e. The amount of gain or loss to be recognized assuming the remaining bondholders converted the bonds

Amortization Table:

NOTES PAYABLE – Issuance of Interest-Bearing Note – Lump Sum

13. On January 1, 2022, Aklan Co. acquired a machine from Antique Co. In lieu of cash payment, Aklan gave Antique a 3-
year, P600,000, 3% note payable. Principal is due on December 31, 2024 but interest is due annually every December
31. The prevailing interest rate for this type of note is 10%.
REQUIRED:
Compute for the carrying amount of the note payable on December 31, 2022.

Amortization Table:

NOTES PAYABLE – Issuance of Non-interest Bearing Note with One-time Payment of Principal

14. On January 1, 2022, Capiz Co. Acquired a machine from Guimaras Co. In lieu of cash payment, Capiz gave Guimaras a
3-year, P600,000 non-interest bearing note payable due on December 31, 2022. The prevailing rate of interest for
this type of note is 10%.

REQUIRED:
Compute for the carrying amount of the note payable on December 31, 2022.

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Amortization Table:

NOTES PAYABLE – Issuance of Non-interest Bearing Note with Cash Price Equivalent

15. On January 1, 2022, Oriental Co. acquired inventory with a list price of P800,000 and a cash price of P497,380 by
issuing 3-year P600,000 non-interest bearing note payable. Principal is due in equal payments every December 31
beginning on December 31, 2022. The effective rate of interest for the cash price is 10%.

REQUIRED:
a. The carrying amount of the note on initial recognition.
b. The carrying amount of the note for the year ended December 31, 2022.

Amortization Table:

LOAN PAYABLE

16. On January 1, 2022, Occidental Co. borrowed 10%, P2,500,000 five-year loan from the National Bank. Interests are
payable annually starting December 31, 2022. National charges 5% non-refundable loan origination fee representing
service fee. The computed effective rate based on interpolation is 11.39%.

REQUIRED:
Determine the following:
a. Carrying amount of the loan payable on January 1, 2022.
b. Carrying amount of the loan payable on December 31, 2022.

Amortization Table:

DEBT RESTRUCTURING – ASSET SWAP

17. Seneca Inc. provided the following balances on December 31, 2020:
Note payable P 1,500,000
Accrued interest expense 200,000
On December 31, 2020, the entity transferred to the creditor land at a cost of P1,500,000. As of this date, the land
has a fair value of P2,000,000.
REQUIRED:
a. Provide the necessary journal entries
b. Determine the amount of gain or loss to be recorded in the company’s income statement

18. Crane Co. owes Metrobank P2,000,000 plus accrued interest of P180,000. The unamortized discount on the loan is
P40,000. The debt is a 10-year, 12% loan. During 2020, Crane’s business deteriorated due to loss of demand for its
services. On December 31, 2020, Metrobank agrees to accept old equipment and cancel the entire debt. The equipment
has a cost of P6,000,000, accumulated depreciation of P4,400,000, and fair value of P1,800,000.
REQUIRED
a. Provide the necessary journal entries
b. Determine the amount of gain or loss to be recorded in the company’s income statement

DEBT RESTRUCTURING – EQUITY SWAP

19. Cinna Corporation showed the following data on December 31, 2020:

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Bonds payable P 4,500,000

Accrued interest expense 300,000
On December 31, 2020, the entity issued share capital with a total par value of P2,000,000. Both share capital issued
and bonds payable are quoted in an active market at P4,400,000 and P4,700,000, respectively. REQUIRED:
a. Provide the necessary journal entries
b. Determine the amount of share premium arising from this transaction

DEBT RESTRUCTURING – MODIFICATION OF TERMS

20. On January 1, 2022, an entity showed the following:

Note payable – due January 1, 2024 – 14% P 5,000,000
Accrued interest expense 700,000

The entity is granted by the creditor the following concessions on January 1, 2022: a.
The accrued interest of P700,000 is forgiven.
b. The principal obligation is reduced to P4,000,000.
c. The new interest rate is 10% payable every December 31.
d. The new maturity date is December 31, 2025.
e. The market rate of interest is 12% for similar liability.
f. The entity paid P150,000 to the creditor as arrangement fee for restructuring.

REQUIRED
• Prepare journal entries
• Determine the gain or loss on extinguishment

21. An entity had negotiated a restructuring of its 8% P6,000,000 note payable on December 31, 2022. There is no
accrued interest on the note. The creditor has reduced the principal obligation to P5,000,000 and extended the maturity
to 3 years on December 31, 2025. However, the new interest rate is 12% payable annually every December 31. The
entity paid P120,000 to the creditor as an arrangement fee. The new effective rate is 9% after considering the
arrangement fee.

REQUIRED:
• Prepare journal entries
• Determine the gain or loss on modification

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