Chapter 1 - Liabilities & Chapter 4 - Contingent Liability - Copy
Chapter 1 - Liabilities & Chapter 4 - Contingent Liability - Copy
b. The - Economic resource → the asset that represents a right with a potential to
obligation is produce economic benefit
to transfer an - transfer cash/non-cash
economic - deliver goods/services
resource. Declares Cash dividends
Declares Share dividends (part of equity)
CL VS. NCL
CLASSIFICATION DEFINITION MEASUREMENT
CURRENT 1. expect to settle withing operating recorded at face amount
cycle ● Not discounted
2. holds primarily for the purpose of ● Face amount - present
trading value = immaterial,
3. due to be settled within 12 months ignore
4. no unconditional right to defer
settlement for at least 12 months after
reporting period (hindi pwedeng- ako
ang may utang, ako rin ang
magdedecide kung kailan ako
magbabayad)
PRESENTATION
line items for current liabilities are:
A. Trade and other payables
is a line item for accounts
payable, notes payable, accrued
interest on note payable,
dividends payable and accrued
expenses.
No objection can be raised if the
trade accounts and notes
payable are separately
presented.
B. Current provisions
C. Short-term borrowing
D. Current portion of long-term debt
E. Current tax liability
● DISCRETION TO REFINANCE:
If the entity has the classified as noncurrent even if it would otherwise be due within a
discretion to refinance or shorter period.
roll over an obligation for at ● Reason: the entity has an unconditional right under the
least twelve months after existing loan agreement to defer payment for at least
the reporting period under twelve months after the end of the reporting period.
an existing loan facility, ● Note that the refinancing or rolling over must be at the
discretion of the entity.
ILLUSTRATION
Covenants
● Are often attached to borrowing agreements which represent undertakings by the borrower.
● are actually restrictions on the borrower as to undertaking further borrowings, paying
dividends, maintaining specified level of working capital and so forth.
● if certain conditions relating to the borrower's financial situation are breached, the liability
becomes payable on demand (Current liability).
ESTIMATED LIABILITIES
exist at the end of reporting period (valid and unquestioned)
although the amount is not definite
due date is not definite or payee is not also identified
examples: estimated liability for premiums, award points, warranties, gift certificates and
bonus
GIFTS CERTIFICATES
redeemable in merchandise
has no expiration
REFUNDABLE DEPOSITS
● entity is the recipient of either cash or property which are bound to refund or recover by the latter
after compliance with certain conditions
● The best example = the customer deposit required for returnable containers like bottles,
drums, tanks and barrels.
Illustration: A deposit of P10,000 is required from the customer for returnable containers. The
containers cost P8,000.
Cash 10,000
BONUS COMPUTATION
given as incentives to employees either as a result of past performance or to motivate employees
4 variants of bonus computation:
income before bonus and before tax
income after bonus but before tax
income after bonus and after tax
income after tax but before bonus
Illustration:
Income before bonus and before tax - 4,400,000
Bonus - 10%
Income tax rate -25%
CASE 1:
income
income before bonus and before tax 4,400,000
before bonus
and before Tax rate x 10%
tax
Bonus 440,000
CASE 2: Formula:
income after Bonus = Bonus % (Income - Bonus)
bonus and
before tax B = 10% (4,400,000 - B)
B = 440,000 - 10%B
B + 10% B = 440,000
110%B = 440,000
110%B/110% = 440,000/110%
B = 400,000
Bonus 400,000
CASE 3: Formula:
income after Bonus = Bonus % (Income - Bonus - Tax)
bonus and Tax = Tax % (Income - Bonus)
after tax
B = 10% (4,400,000 - B - T)
T = 25% (4,400,000 - B)
7.5%B/7.5% = 330,000/107.5%
B = 306,977
T = 25% (4,400,000 - B)
T = 25% (4,400,000 - 306,977)
T = 25% x 4,093,023
T = 1,023,255
Bonus (306,977)
Tax (1,023,255)
Bonus 306,977
CASE 4: Formula:
income after Bonus = Bonus % (Income - Tax)
tax but Tax = Tax % (Income - Bonus)
before bonus
Bonus = 10% (4,400,000 - T)
Tax = 25% (4,400,000 - B)
B = 10% (4,400,000 - T)
B = 10% [4,400,000 - 25% (4,400,000 - B)]
B = 10% (4,400,000 - 1,100,000 + 25%B)
B = 440,000 - 110,000 + 2.5%B
B - 2.5% B = 440,000 - 110,000 = 330,000
97.5% B = 330,000
Tax (1,015,384)
Bonus 3,384,616
Bonus 338,462
51 - 90 Probable D R
10 - 50 Possible Ignore D
Past Event
obligating event - The past event that leads to a
present obligation
b. Probable Probable
Outflow of The event is more likely than not to occur,
resources is will occur > will not occur
required to more than 50% likely or substantially more
settle
obligations Possible - 50% or less likely to occur
Remote - 10% or less likely to occur
Measurement
● Best Estimate amount.
- of the expenditure required to settle the present obligation at the END of the reporting
period. The amount that an entity would rationally pay.
1. Single the individual most likely outcome adjusted for the effect of other possible
Obligation outcomes. → Best estimate
2. Continuous each point in that range is likely as any other → midpoint of the range
Range of (2,000,000 + 3,000,000 = 5,000,000 / 2 = 2,500,000)
possible
outcomes
The entity's past experience and future expectations indicate that 75% of the goods sold will have no
defects, 20% will have minor defects and 5% will have major defects.
The expected value or cost of repairs is measured by weighting all possible outcomes by their
associated probabilities.
Illustration 2
An entity is a defendant in a patent infringement suit.
o The lawyers believe that there is a 60% chance that the court will not dismiss the case and
the entity will incur an outflow of future economic benefits.
If the court rules against the entity and in favor of the claimant, the lawyers believe that there is
o a 30% chance the entity will be required to pay damages of P4,000,000 and
o a 70% chance that the damages will be P2,000,000.
A 10% risk adjustment factor to the probabilities of the expected cash flows is considered appropriate
to reflect the uncertainties in the cash flow estimate.
Measurement Considerations
The following items are taken into consideration in recognizing and measuring a provision:
1. Risks and Shall be taken into account in reaching the best estimate of a provision.
uncertainties.
Risk describes variability of outcome.
2. Present value Where the effect of the time value of money is material, → the amount of
of obligation provision shall be the present value of the expenditure expected to
settle the obligation.
The discount rate should be a pretax rate → reflects the current market
assessment of the time value of money and the risk specific to the liability.
Should NOT REFLECT THE RISK for which cash flow estimates have
already been adjusted.
3. Future events that affect the amount required to settle an obligation → shall be
reflected in the amount of a provision
there is a sufficient evidence that they will occur.
6. Changes in shall be reviewed at every end of the reporting period and adjusted to
provision reflect the current best estimate.
7. Use of shall be used only for expenditures for which the provision was
provision originally recognized.
9. Onerous If an entity has an onerous contract, the present obligation under the contract
contract shall be recognized and measured as a provision.
the unavoidable costs under a contract → represent the least net
cost of exiting from the contract.
o The lower amount between the cost of fulfilling the contract
and the compensation or penalty arising from failure to fulfill
the contract is the least cost of exiting from the contract.
Onerous contract
Dangerous/talo ka.
a contract in which the unavoidable costs of meeting the obligation
under the contract exceed the economic benefits expected to be
received under it.
Examples of Provision
1. Warranties The best estimate of the warranty cost is recognized as a provision
2. Environmental If an entity has an environmental policy such that other parties would expect
contamination the entity to clean up any contamination, or if the entity has broken current
environmental legislation then a provision for environmental damage
shall be made.
4. Court case A provision is recognized for the best estimate of the damages
there is a present obligation.
After a wedding in the current year, ten people died possibly as a result of
food poisoning from products sold by the entity.
Legal proceedings are started seeking damages from the entity.
When the entity prepares the financial statements for the current year
→ the lawyers advise that owing to the developments in the case, it is
probable that the entity would be found liable.
5. Guarantee A provision is recognized for the best estimate of the guarantee obligation
there is legal obligation arising from the obligating event which is the
guarantee.
____________________________________________________________________________________________________________
Contingent Liability
Two definition:
a. Is a POSSIBLE obligation.
That arises from past event
Existence will be confirmed only by the occurrence or nonoccurrence of one or more
uncertain future events
Not wholly within the control of the entity.
b. Is a PRESENT obligation.
that arises from past event but is NOT recognized
it is NOT probable that an outflow of resources embodying economic benefits will be
required to settle the obligation
or the amount of the obligation CANNOT be measured reliably.
● Not a liability
● Not recognized in FS but shall be DISCLOSED ONLY when probable OR measurable.
o RECOGNIZED WHEN: The amount of the loss can be reliably measured and it is probable
prior to issuance of financial statements that a liability has been incurred
● DISCLOSURE IS NOT REQUIRED/ IGNORE:
o Contingent liability that is REMOTE (10%)
Illustration:
● Present obligation: either PROBABLE or MEASURABLE; but NOT BOTH → CONTINGENT LIABILITY
▪ Do all people pass the CPA board exam?
▪ answerable by “yes” or “no”
● Present obligation: PROBABLE & MEASURED RELIABLY → PROVISION
▪ Do all people die?
▪ always answerable by “yes”
____________________________________________________________________________________________________________
Contingent Asset
Not recognized in FS as an asset but shall be DISCLOSED ONLY.
a possible asset
o arises from past event
o whose existence will be confirmed only by the occurrence or nonoccurrence of one or more
uncertain future events
o not wholly within the control of the entity
When the realization of income is virtually certain → the related asset is no longer contingent
asset
o its recognition → ASSET
A contingent asset
→ probable: DISCLOSURE REQUIRED
o Includes:
i. a brief description of the contingent asset
ii. an estimate of its financial effects