ACC 108 – CFE REVIEWER

Initial and Subsequent Measurement of Financial and Non-Financial Liabilities

Recognition Criteria for Liabilities 1. Initial Measurement – The valuation of the liability when it is first recognized.
A. It meets the definition of a liability 2. Subsequent Measurement – The valuation of the liability in future periods until it is
1. Present Obligation – A liability exists when an entity has a present obligation that settled.
arises from a past transaction or event. This obligation can be:
• Legal – Required by contract, law, or regulation (e.g., accounts payable, loans 1. Financial Liabilities
payable, tax liabilities). Category Initial Measurement Subsequent
• Constructive – Arises from the entity’s past practice or policies that create an Fair Value less Amortized
expectation (e.g., warranty obligations, bonuses promised to employees). Amortized Cost
Transaction Cost cost
2. Probable Outflow of Economic Resources – The settlement of the obligation must
Fair Value Through Profit or Loss
result in an outflow of resources (e.g., cash, goods, or services) that embodies Fair Value Fair Value
(FVTPL) and derivative liabilities
economic benefits.
➢ The entity must expect to settle the liability by transferring resources, such as cash,
goods, or services. The outflow must be probable, meaning there is a high likelihood ✓ Interest Expense in FVTPL = Face Amount x Nominal Rate
✓ Interest Expense in FVTAC = Present Value x Effective Interest Rate
of payment in the future.
✓ Transaction cost in FVTPL is expensed immediately
3. Reliable Measurement – The amount of the liability can be measured reliably.
➢ The liability must have a reasonable estimate of the amount required to settle the ✓ Reclassification after initial recognition is prohibited
obligation. If the amount cannot be measured reliably, the liability may not be
2. Non-Financial Liabilities
recognized but disclosed in the notes to financial statements.
A. Initial Measurement of Non-Financial Liabilities
B. Recognizing it would provide useful information, relevant and faithfully
presented Non-financial liabilities are usually measured based on the amount necessary to settle
the obligation. This depends on the type of liability:
*BOTH (a) and (b) criteria must be met
Type of Non-
Characteristics of a Financial Liability Financial Initial Measurement Subsequent Measurement
Financial liability is any liability that is: Liability
1. Contractual Obligation Adjusted if the estimated settlement
Provisions & Best estimate of
• A financial liability arises from a legally binding contract between two parties. amount changes. If the obligation
Contingent settlement amount,
• It requires one party (the debtor) to deliver cash or another financial asset to another becomes probable, it is recorded as a
Liabilities discounted if long-term.
party (the creditor). liability.
2. Future Economic Outflow Deferred
• The settlement of a financial liability results in an outflow of economic resources, Measured at the amount Recognized as revenue when the
Revenue
typically cash, financial instruments, or other assets. received for future service is performed or product is
(Unearned
• This means the company will use future resources to settle the obligation. services. delivered.
Income)
3. Settled Through Financial Assets
Measured at the tax
• A financial liability is settled by: Adjusted based on tax law changes or
Tax Liabilities amount payable based
o Paying cash deferred tax adjustments.
on laws.
o Transferring another financial asset (e.g., stocks, bonds)
o Exchanging financial instruments
Classification of Liabilities: Current vs. Non-Current Examples of Non-Current Liabilities:
Liability Description Example
1. Current Liabilities (Short-Term Liabilities) Long-Term Loans Loans or borrowings payable A company takes a ₱5M loan,
Definition: Current liabilities are obligations that are expected to be settled within one year Payable beyond one year. repayable in 5 years.
or the entity’s operating cycle, whichever is longer.
Debt securities issued to A company issues 10-year
Key Characteristics: Bonds Payable
investors, payable at maturity. bonds worth ₱10M.
✔ Due within 12 months from the reporting date.
Taxes owed in future periods due A company delays paying ₱2M
✔ Settled using current assets (e.g., cash, receivables). Deferred Tax Liabilities to temporary accounting in taxes due to depreciation
✔ Part of the normal operating cycle of the business. differences. rules.
Long-term rental obligations A company leases a building
Examples of Current Liabilities: Lease Liabilities
under a lease agreement. for 10 years.
Liability Description Example
Obligations to provide retirement A business promises pension
Amounts owed to suppliers for A business buys inventory on Pension Liabilities
Accounts Payable benefits to employees. payments to retirees.
goods/services received on credit. credit, payable in 30 days.
Provision for Lawsuits
Short-Term Loans A company takes a 6-month loan Estimated future payments for A company expects to pay
Borrowings due within one year. or Contingent
Payable of ₱500,000 from a bank. legal claims or potential losses. ₱1M for a pending lawsuit.
Liabilities
A company owes ₱50,000 in
Interest Payable Unpaid interest on loans or bonds.
accrued interest on its loans. Initial and Subsequent Measurement of Notes Payable and Loans Payable
Declared dividends not yet paid to A company declares a ₱1.5M Both notes payable and loans payable represent financial liabilities that an entity owes to
Dividends Payable
shareholders. dividend, payable in 3 months. lenders. They are initially recognized at fair value and subsequently measured based on
Taxes owed to the government for A corporation owes ₱300,000 in classification (e.g., amortized cost).
Income Tax Payable
the current period. income taxes due next quarter.
Salaries & Wages Unpaid salaries owed to Salaries for the last two weeks of 1. Notes Payable
Payable employees. the month, payable next month. Definition: Notes payable are written promises to pay a specific amount of money at a
future date, often including interest. They may be short-term (due within one year) or
Payments received for A customer prepays ₱100,000
Unearned Revenue long-term (due after one year).
services/products not yet for a service to be delivered in 6
(Deferred Revenue) INITIAL SUBSEQUENT
delivered. months.
a) Expected Settlement, if the
a) Face Amount or
2. Non-Current Liabilities (Long-Term Liabilities) initial measurement is Face
b) Present Value, if the
Definition: Non-current liabilities are obligations that are not expected to be settled within Short-term Amount
transaction contains significant
one year or the operating cycle. These liabilities are usually related to long-term financing b) Amortized Cost, if Present
financing components
and investments. Value
Key Characteristics: Long-term Face Amount Expected Settlement
✔ Due after 12 months from the reporting date. 1) Interest-bearing
a. Reasonable
✔ Often related to long-term financing or investments.
interest (SR = EIR)
✔ May involve interest payments over time.
 INITIAL SUBSEQUENT ➢ Present value represents the current worth of a future sum of money, discounted at
b. Non-reasonable Present Value Amortized Cost an appropriate interest rate. The two most common present value factors are:
interest (SR ≠ EIR) a. Present Value of a Single Sum (Lump Sum)
Used when a liability requires a one-time payment in the future.
2) Non-interest
Present Value Amortized Cost PV= FV / (1 + r)^n or PV=FV× 1/(1+r)^n
bearing
Where:
• PV = Present Value
2. Loans Payable
• FV = Future Value (amount to be paid in the future)
Definition: Loans payable represent amounts borrowed from financial institutions or lenders
• r = Discount rate (interest rate per period)
that must be repaid with interest over time. They can be short-term (due within one year)
• n = Number of periods until payment
or long-term (due after one year).
b. Present Value of an Annuity
A. Initial Measurement of Loans Payable
Used when a liability involves multiple payments over time (e.g., loans, leases).
• Initially measured at fair value (usually the principal amount received).
PV=P×(1−(1+r)n1)÷r
• If the loan is issued at a discount or incurs fees, these costs are deducted from the
Where:
loan amount and amortized over time.
• P = Periodic payment
• If the interest rate is below the market rate, the loan is recorded at its present value,
• r = Discount rate per period
and the difference is recognized as a discount.
• n = Number of periods
B. Subsequent Measurement of Loans Payable
• Measured at amortized cost using the effective interest method. ✔ Notes and Loans Payable – Recorded at present value using a single sum formula.
• Interest is recognized periodically. ✔ Bonds Payable – Includes PV of face value + interest payments (annuity).
• If issued at a discount, the discount is amortized over the loan term. ✔ Lease Liabilities – Uses PV of annuity for lease payments.
✔ Interest-free obligations – Discounted to present value at market rates.

Key Differences Between Notes Payable and Loans Payable Preparation of Amortization Tables
Criteria Notes Payable Loans Payable An amortization table is used to track the repayment of a liability (e.g., loans, bonds,
Written promise to pay a fixed Borrowed money from a bank or leases) over time, showing how payments are allocated between principal and interest.
Definition The most common method for amortization is the effective interest method, which spreads
amount at a future date. lender, repayable over time.
Interest Rate May or may not bear interest. Always has an interest component. the cost of a liability over time.

Fair value (principal or Fair value (principal or net of

Initial Measurement Components of an Amortization Table
discounted value). transaction costs).
Period The time frame for each payment (e.g., year, month).
Subsequent Amortized cost using effective Amortized cost using effective
Beginning
Measurement interest method. interest method. The remaining loan or bond liability at the start of each period.
Balance
Issuing a ₱500,000 note Taking a ₱1,000,000 loan from a
Example Interest calculated on the beginning balance using the effective
payable to a supplier. bank. Interest Expense
interest rate.
APPLICATION OF PRESENT VALUE FACTORS PROPERLY
The present value (PV) concept is applied when measuring financial and non-financial Payment The total payment due (fixed for loans, variable for bonds).
liabilities that are settled in the future. This is essential for liabilities that are not settled Principal Portion of the payment that reduces the liability (Payment - Interest
immediately but instead involve payments over time. Reduction Expense).
Ending Balance The remaining loan or bond liability after the principal reduction. Upon issuance, bonds payable are measured at fair value, which is the amount received
from investors. Bonds can be issued:
• At Par (Face Value) – Issued at their nominal value.
Observations:
• At a Discount – Issued below face value when the market rate is higher than the
✔ Interest expense is based on the carrying amount × market rate and it increases each
coupon rate.
year as the bond’s carrying amount increases.
• At a Premium – Issued above face value when the market rate is lower than the
✔ The discount on bonds payable is gradually amortized until the bond reaches its coupon rate
₱1,000,000 face value at maturity. 2. Subsequent Measurement of Bonds Payable
✔ The lease interest expense decreases as the liability reduces. • After issuance, bonds are measured using the Amortized Cost Method, which
✔ The principal repayment increases each year. spreads out any discount or premium over the bond's life using the Effective
✔ The ending balance reaches ₱0 at the end of the lease. Interest Method (EIM).
• The amortization process ensures that:
Accounting for Origination Fees on Loans Payable ✔ Discounts increase interest expense over time.
Loan origination fees are charges that a lender collects at the beginning of a loan ✔ Premiums reduce interest expense over time.
agreement. These fees cover administrative costs, underwriting, and processing. Under ✔ Bonds payable reach face value at maturity.
IFRS 9 - Financial Instruments and GAAP, loan origination fees are not immediately Key Formula for Interest Expense (EIM):
expensed but instead are amortized over the loan term using the effective interest • Interest Expense=Carrying Amount × Market Rate
method. ✔ Initial Measurement: Bonds are recorded at par, discount, or premium.
✔ Subsequent Measurement: Uses the Effective Interest Method for amortization.
1. Treatment of Loan Origination Fees ✔ Discounted Bonds: Increase interest expense over time, increasing the carrying amount.
Loan origination fees can be: ✔ Premium Bonds: Reduce interest expense over time, decreasing the carrying amount.
1. Direct Fees Paid by the Borrower – Deducted from the loan proceeds.
✔ At Maturity: The bond's carrying amount always reaches its face value (₱1,000,000).
2. Fees Charged and Deducted from Loan Principal – Recorded as a reduction of
the loan liability.
Accounting for Compound Financial Instruments
Key Accounting Principles:
A compound financial instrument is a financial instrument that has both equity and
✔ Amortized Over the Loan Term – Recognized as interest expense over time. liability components. These instruments require separate accounting treatment under
✔ Reduces the Carrying Amount of the Loan – The borrower records the loan net of IFRS 9 (Financial Instruments) and IAS 32 (Financial Instruments: Presentation).
origination fees.
✔ Effective Interest Rate (EIR) Method – The actual cost of the loan is higher than the What Are Compound Financial Instruments?
stated interest rate. A compound financial instrument contains both a debt (liability) and an equity
Initial and Subsequent Measurement of Bonds Payable element.
Bonds payable are long-term financial liabilities issued by a company to raise funds. The Common examples include:
accounting treatment follows IFRS 9 - Financial Instruments and GAAP, requiring: ✔ Convertible Bonds – Bonds that can be converted into company shares.
1. Initial Measurement – Recording the bond at fair value when issued.
✔ Convertible Preference Shares – Preference shares that can be converted into common
2. Subsequent Measurement – Using the amortized cost method (or fair value in
shares.
some cases) over time.
✔ Bonds with Warrants – Bonds issued with the right to purchase shares in the future.
1. Initial Measurement of Bonds Payable
Initial Measurement of Compound Financial Instruments This is governed by IFRS 9 - Financial Instruments and GAAP.
A. Split Between Liability and Equity
When a company issues a compound financial instrument, it must separate the liability When Should a Liability be Derecognized?
and equity portions using the residual method: A liability is removed when:
Liability Component=Present Value of Future Cash Flows (Discounted at Market Rate) 1. Settlement: The company pays the creditor in cash, assets, or services.
Equity Component=Total Proceeds−Liability Component 2. Extinguishment: The company is legally released from the obligation by the
Key Steps: creditor.
1. Calculate the Liability Component 3. Debt Exchange or Restructuring: The liability is replaced by another financial
• Discount all future payments (interest & principal) using the market interest rate for instrument.
a similar non-convertible debt. 4. Debt Forgiveness: The creditor waives the liability.
2. Calculate the Equity Component
Derecognition of Financial Liabilities (Loans, Bonds, Payables)
• Deduct the liability component from the total proceeds.
• This represents the value of the conversion feature (option to convert into shares).
A. Full Settlement of a Liability
If a liability is fully paid off, it is derecognized, and no gain or loss occurs.
Subsequent Measurement of Compound Financial Instruments B. Debt Extinguishment with Gain or Loss
Liability Component: If a company settles a liability for less than its carrying amount, a gain is recognized.
✔ Measured at amortized cost using the Effective Interest Method (EIM). C. Bond Buyback (Early Redemption of Bonds)
If a company buys back its own bonds before maturity, the difference between the
✔ Interest expense is recognized using the market rate at issuance (8%).
repurchase price and the bond’s carrying amount is recorded as a gain or loss.
✔ Interest paid (6%) is lower than interest expense (8%), so the liability increases over time.
Derecognition of Non-Financial Liabilities (Payables, Provisions, and Contingencies)
Equity Component: A. Settlement of Accounts Payable
✔ Not remeasured after initial recognition. When an obligation is fully paid, the liability is removed.
✔ Remains in equity until conversion or maturity. B. Reversal of Provisions
If a provision (e.g., for legal expenses) is no longer required, it is reversed.
✔ Separated into Liability and Equity Components at initial recognition. C. Write-off of Unclaimed Liabilities
✔ Liability is measured at present value of future cash flows using the market rate. Sometimes, small liabilities (e.g., old accounts payable) are no longer claimed by creditors
✔ Equity represents the conversion feature and remains unchanged after issuance. and must be written off
✔ Effective Interest Method is used to amortize the bond liability. ✔ Liabilities are removed when settled, forgiven, or legally extinguished.
✔ Upon conversion, the liability is reclassified to equity instead of being repaid in cash. ✔ Gains or losses are recognized when settlement differs from the carrying amount.
✔ Bond buybacks before maturity may result in a gain or loss.
Accounting for Derecognition of Liabilities ✔ Provisions can be reversed if the obligation is no longer required.
What is Derecognition of Liabilities? ✔ Write-offs of unclaimed liabilities increase income.
Derecognition of a liability occurs when a company removes a liability from its financial
statements because: Requirements for Offsetting Financial Assets and Financial Liabilities
✔ The liability has been settled (paid off). Offsetting refers to netting a financial asset and a financial liability in the financial
✔ The obligation has been legally released. statements, presenting only the net amount instead of showing both separately. Offsetting is
✔ The liability is extinguished due to restructuring or debt forgiveness.
strictly regulated under IFRS 9 (Financial Instruments) and IAS 32 (Financial ratios.
Instruments: Presentation) to ensure transparency. ✔ Entities must disclose offsetting policies in their financial statements.

Conditions for Offsetting Recognition Criteria for Provisions (IAS 37 - Provisions, Contingent Liabilities, and
Under IAS 32, a financial asset and a financial liability can only be offset if both of the Contingent Assets)
following criteria are met: A provision is a liability of uncertain timing or amount. It is recognized only if all three
A. Legally Enforceable Right to Offset certain conditions are met:
✔ The entity must have a legal right to offset the amounts. A. Present Obligation (Legal or Constructive)
✔ The right must be unconditional, enforceable at any time (even in bankruptcy or default). ✔ The company has a legal obligation (contract, law, regulation) or
B. Intention to Settle Net or Simultaneously ✔ A constructive obligation exists due to past practices or commitments creating a valid
✔ The company must intend to settle the amounts on a net basis or simultaneously expectation.
settle both the asset and liability. Example: A company is sued for damages, and based on legal advice, it is likely to lose.
✔ This ensures that offsetting reflects economic reality. This creates a present obligation.

Cases Where Offsetting is Allowed B. Probable Outflow of Economic Resources

Offsetting is commonly applied in: ✔ There must be a greater than 50% probability that the company will need to settle the
✔ Derivative Financial Instruments – Swaps, forwards, and options if a net settlement obligation.
agreement exists. ✔ The outflow can be in the form of cash, goods, or services.
✔ Cash Pooling Arrangements – When a company consolidates bank balances across Example: A company sells products with a one-year warranty, and based on past
accounts. experience, 5% of products require repairs. The company must recognize a warranty
✔ Repurchase Agreements (Repos) – If collateralized and legally enforceable. provision.

Cases Where Offsetting is NOT Allowed C. Reliable Estimate of the Obligation

Offsetting is not permitted if: ✔ The amount of the provision can be measured reliably.
The legal right to offset exists only in the event of bankruptcy. ✔ If no reliable estimate can be made, the obligation is disclosed as a contingent liability
The entity does not intend to settle net or simultaneously. instead.
The financial instruments are with different counterparties. Example: If a company estimates that future environmental cleanup costs will be
Presentation in Financial Statements around ₱2,000,000, it must recognize a provision. If the amount is highly uncertain, it may
✔ If offsetting conditions are met, the net amount is reported. be disclosed as a contingent liability instead.
✔ If offsetting is not allowed, both financial assets and liabilities must be shown separately.
✔ All three criteria must be met (Present Obligation, Probable Outflow, Reliable Estimate).
✔ Offsetting is only allowed if both legal enforceability and intent to settle net are ✔ Uncertain liabilities that do not meet recognition criteria are disclosed as contingent
present. liabilities.
✔ Not all financial assets and liabilities can be offset; proper agreements must be in ✔ Provisions impact both the income statement and balance sheet.
place.
✔ Presentation rules ensure transparency and prevent manipulation of financial Key Differences Between Provisions, Contingent Liabilities, and Contingent Assets
Criteria Provision Contingent Liability Contingent Asset Measurement Basis Description When Used?
A potential asset The most likely amount
A liability of uncertain A possible obligation Used when the outcome involves
arising from past Best Estimate expected to settle the
timing or amount, that is not recognized in a single settlement amount.
Definition events, recognized obligation.
recognized when an financial statements but
only when virtually Expected Value A weighted probability
obligation exists. disclosed if probable. Used when a range of outcomes
certain. Method/Probability approach applied to multiple
exists (e.g., warranty provisions).
Recognition in Yes, if all three No, only disclosed Weighted Average possible outcomes.
No, only disclosed
Financial recognition criteria are unless settlement is Computed by adding
unless virtually certain. Used when there is a continuous
Statements? met. remote. together the lowest and
Mid-point range of possible outcome and
Probable but not highest value of the range,
each is ass likely as any other
Probability of More likely than not Possible but uncertain certain (Likely to then dividing it by 2
Occurrence (>50%) (<50%) occur but not virtually Present Value Future cash outflows are
certain). Used for long-term provisions
(Discounted Cash Flow - discounted to their present
(e.g., decommissioning costs).
Must be measured No recognition, only No recognition, DCF) value.
Measurement
reliably and recorded estimated and unless inflow is The price that would be paid Rarely used but applicable for
Requirement
as a liability. disclosed. virtually certain. Fair Value to transfer the liability in a provisions involving market-
✔ Pending court case market transaction. based valuations.

✔ Warranty liabilities expected to result in a

✔ Lawsuits where
gain Accounting for Provisions
✔ Legal provisions outcome is uncertain
✔ Insurance claims A provision is a liability with uncertain timing or amount, recognized when certain
Examples ✔ Restructuring costs ✔ Potential penalties
pending approval conditions are met.
✔ Environmental ✔ Guarantees for third- A. Initial Recognition of a Provision
✔ Government grants
obligations party obligations
expected to be ✔ The provision is recorded as an expense and a liability in the financial statements.
received Impact on Financial Statements:
✔ Provisions are recognized in financial statements when an obligation is probable and ✔ Income Statement: Expense is recognized immediately.
measurable. ✔ Balance Sheet: A liability is created under "Provisions".
✔ Contingent Liabilities are not recorded but disclosed if there is a possible obligation. B. Adjusting a Provision (Increase or Decrease)
✔ Contingent Assets are not recorded unless virtually certain to be received. ✔ If new information suggests the provision should be increased, the company adjusts the
✔ Proper disclosures in notes are required to inform stakeholders. liability.
✔ If the estimated obligation decreases, the excess provision is reversed.
Available Measurement Bases for a Provision Impact:
Under IAS 37, provisions are measured based on the best estimate of the amount required ✔ Reducing a provision increases income, as less liability is expected.
to settle the obligation. The measurement depends on the nature of the provision and the C. Settlement of a Provision
level of uncertainty involved.
✔ When the company settles the obligation, the provision is removed from the books.

1. Available Measurement Bases for a Provision

Impact: • A company outsources IT services, and the provider uses its own servers.
✔ No further expense is recorded since the expense was already recognized earlier. The company does not control a specific asset, so this is not a lease.
✔ The liability is removed from the balance sheet.
D. Reversing an Unused Provision 2. Exceptions to Lease Identification
Some contracts are not classified as leases under IFRS 16, even if they involve an asset:
✔ If the provision is no longer needed, it must be reversed.
Impact: ✔ Short-Term Leases – Lease term ≤ 12 months without a purchase option.
✔ The reversal increases income in the current period. ✔ Low-Value Asset Leases – Assets like laptops, office furniture.
✔ The liability is removed from the balance sheet. ✔ Service Contracts – If the contract does not specify a particular asset.
Example: Renting an office printer for 6 months for ₱2,000/month.
Disclosure Requirements for Provisions Exempt from IFRS 16 recognition.
IAS 37 requires companies to disclose provisions in their financial statements, including:
✔ Nature of the obligation (e.g., legal case, warranty claims). 3. Lease vs. Service Contract: Key Differences
✔ Expected timing of settlement. Factor Lease Service Contract
✔ Estimate of financial impact. Asset Control Lessee controls use. Supplier controls the asset.
✔ Uncertainties affecting the amount. Identifiable Asset Specific asset is used. No specific asset identified.
Economic Lessee benefits from asset Supplier benefits from providing
Identification of a Lease (IFRS 16 - Leases) Benefits use. service.
A lease is a contract that gives the right to use an asset for a specific period in exchange for
Example (Service Contract):
payment. IFRS 16 - Leases provides the criteria for identifying whether a contract contains a
• A company signs a cleaning services contract for its office.
lease.
Not a lease because the company does not control a specific cleaning machine.
1. Definition of a Lease Under IFRS 16
4. Key Takeaways on Lease Identification
A contract is classified as a lease if it meets all three of the following conditions:
✔ A lease exists if there is an identifiable asset, control over usage, and economic
Criteria Description Example
benefits.
Identified The contract involves a specific, Leasing a particular building
✔ Short-term and low-value leases may be exempt.
Asset identifiable asset. or machine.
✔ Contracts must be analyzed to determine if they contain a lease or a service agreement.
Right to The lessee has the right to control the The lessee decides how and
Control asset's use during the lease period. when to use the asset.
Accounting for Leases by a Lessee Under IFRS 16
Economic The lessee obtains substantially all The lessee can generate Under IFRS 16 - Leases, lessees must recognize all leases (except short-term and low-
Benefits economic benefits from using the asset. income from the asset. value leases) on the balance sheet. This eliminates the previous distinction between
Example (Lease Identified): operating and finance leases for lessees.
• A company rents a specific warehouse for 5 years, with full control over its use.
• The lessee obtains all economic benefits from the warehouse. 1. General Recognition and Measurement Approach
This is a lease under IFRS 16. Lessees recognize:
Example (Not a Lease): ✔ Right-of-Use (ROU) Asset – Represents the lessee’s right to use the leased asset.
✔ Lease Liability – Represents the obligation to make future lease payments.
 Initial Measurement Subsequent Measurement Accounting for Leases by a Lessee Using the Recognition Exemption (IFRS 16)
Present value (PV) of lease Amortized Cost using the effective interest A lessee can elect to apply the recognition exemption if:
Lease Liability
payments method Exemption Type Criteria Examples
Subsequently measured using the cost Short-Term Lease term ≤ 12 months with no 6-month warehouse rental, 1-
model, except when: Lease purchase option. year office lease.
Right-of-Use a. It relates to a class of PPE, revaluation Low-Value Asset Asset is of low value when new, even if Laptops, small office furniture,
Initially measured at cost
Asset model Lease leased for multiple years. phones, printers.
b. Meets the definition of investment
property, fair value model
General Recognition (IFRS 16 Recognition Exemption
INITIAL Factor
Standard) (IFRS 16 Simplified)
Lease liability is measured at the present value (PV) of future lease payments
Assets/Liabilities
ROU Asset is measured at cost Yes (ROU Asset & Lease Liability) No (Expense Directly)
Recognized?
Lease Liability Annual Lease Payment
Applicable Leases Most leases except exemptions Short-term & low-value leases
Add: Initial Direct Costs Multiply by: PV Factor(PV of OA )
Restoration Costs + Depreciation & Yes (ROU asset depreciated, No (Lease payments
Less: Lease Incentives Purchase Option Interest? interest expense on liability) expensed immediately)
= Right-of-Use Asset Multiply by: PV Factor(PV of 1)
Journal Entry for Record lease expense
= Initial Lease Liability Record liability & depreciate ROU asset
Payment directly
SUBSEQUENT
Impact on Financial Statements:
A. Interest Expense Recognition (Using Effective Interest Rate Method)
• Under recognition exemption, lease expenses are recorded in the income
✔ Interest is accrued on the lease liability each period.
statement rather than the balance sheet.
✔ Lease payments reduce the liability. • This reduces total assets and liabilities, improving leverage ratios.
✔ Interest increases lease expense. ✔ Short-term and low-value leases are expensed directly, not capitalized.
✔ Principal payment reduces lease liability. ✔ No ROU asset or lease liability is recognized, simplifying accounting.
General Rule: ROU Asset is depreciated over the lease term or asset’s useful life, ✔ Used mainly for office rentals, laptops, small furniture, and temporary leases.
whichever is SHORTER. ✔ Straight-line expense recognition is required for fixed lease payments.
Exception: Depreciated over the useful life of asset when there is a:
a. transfer of ownership at the end of the lease term
Lease Classifications by a Lessor (IFRS 16 & ASC 842)
b. reasonable certainty of the lessee will exercise purchase option
Under IFRS 16 and ASC 842 (US GAAP), a lessor classifies leases into different
Under Cost Model, ROU Asset computed by: categories based on the transfer of risks and rewards. The classification determines how the
Cost lease is recognized in the lessor’s financial statements.
Less: Accumulated Depreciation
Accumulated impairment Losses 1. Lease Classifications Under IFRS 16
Add/Less: Remeasurement of Lease Liability
= ROU Asset, end
Lease Type Definition Accounting Treatment Indicator Description Example
Transfers substantially all risks Derecognize the asset and recognize a Ownership of the asset transfers to A company leases machinery
Finance Ownership
and rewards of ownership to the lease receivable. Interest income the lessee at the end of the lease and gains legal ownership after
Lease Transfer
lessee. recognized over the lease term. term. the final payment.
The lessor retains substantially The lessee has the right to
Operating Keep the asset on the balance sheet, Bargain Purchase A lessee can buy a ₱1,000,000
all risks and rewards of purchase the asset at a price
Lease recognize lease income over time. Option asset for ₱100,000 at lease end.
ownership. significantly lower than fair value.
Lease Term A company leases a truck for 8
The lease term is for most of the
2. Lease Classifications Under US GAAP (ASC 842) Covers Major years, and its total life is 10
asset’s useful life (typically ≥75%).
US GAAP provides three lease types for lessors: Asset Life years.
Lease Type Criteria Accounting Treatment The present value of lease
Present Value of A machine worth ₱5,000,000 has
Transfers ownership, has a purchase Derecognize the asset, recognize payments is ≥90% of the asset's
Sales-Type Lease Payments a lease PV of ₱4,800,000.
option, or lease term covers most of lease receivable, and record selling fair value.
Lease
the asset’s life. profit/loss. The leased asset is so customized A factory leases a specialized
Direct Derecognize the asset, recognize Specialized Asset that it has no alternative use to the machine that can only be used
Similar to a sales-type lease but
Financing lease receivable, and recognize lessor. for its specific process.
without immediate selling profit.
Lease interest income.
Keep the asset on the balance Additional Indicators That Support Finance Lease Classification
Operating The lessor retains asset ownership
sheet, recognize lease income over While the above five key indicators are the primary tests, additional indicators include:
Lease and risks.
time. ✔ Lessee bears maintenance and insurance costs, similar to ownership.
A. Finance Lease / Sales-Type Lease (IFRS & US GAAP) ✔ Lessee absorbs risk of loss if the asset becomes damaged.
✔ The lessor derecognizes the asset and records a lease receivable. ✔ Lease cannot be easily canceled without significant penalties.
✔ Interest income is recognized over time.
B. Operating Lease (IFRS & US GAAP) Accounting for a Finance Lease by a Lessor (IFRS 16 & ASC 842)
When a lease is classified as a finance lease (IFRS 16) or sales-type lease/direct
✔ The lessor keeps the asset on the balance sheet.
financing lease (ASC 842 - US GAAP), the lessor derecognizes the leased asset and
✔ Lease income is recognized on a straight-line basis.
recognizes a lease receivable instead.

Indicators of a Finance Lease (IFRS 16 & ASC 842 - US GAAP) 1. Initial Recognition of a Finance Lease by a Lessor
A finance lease (IFRS) or sales-type lease (US GAAP) is identified when substantially all
At Lease Commencement, the Lessor Recognizes:
risks and rewards of ownership are transferred from the lessor to the lessee.
✔ Lease Receivable = Present Value (PV) of lease payments.
Key Indicators of a Finance Lease ✔ Unearned Interest Income = Difference between gross lease payments and PV of lease
A lease is classified as a finance lease if any of the following conditions are met: receivable.
✔ Derecognition of the Leased Asset = Remove from balance sheet.
✔ The equipment is removed from the books. Factor Finance Lease (IFRS 16) Operating Lease (IFRS 16)
✔ Lease receivable is recorded at PV of future payments. Asset Derecognized, replaced with lease
Kept on balance sheet as PPE.
✔ Unearned interest is recognized over time as income. Recognition receivable.
Income Interest income recognized on Lease income recognized
2. Subsequent Measurement of a Finance Lease Recognition lease receivable. evenly over the lease term.
Each period, the lessor:
Balance Sheet
✔ Recognizes interest income on the lease receivable. Lease receivable is recorded. Asset remains in fixed assets.
Impact
✔ Reduces lease receivable as the lessee makes payments.
Depreciation Yes, asset is depreciated.
✔ Cash is received from the lessee. No, asset is removed.
✔ Part of the payment reduces the receivable.
Lessee Control Lessee effectively owns the asset. Lessor retains control and ownership.
✔ The remaining amount is recognized as interest income.

Differences Between Accounting Profit and Taxable Profit in Financial Statements

Accounting for an Operating Lease by a Lessor (IFRS 16 & ASC 842 - US GAAP)
The profit presented in financial statements (accounting profit) is often different from the
Under IFRS 16 and ASC 842 (US GAAP), a lessor classifies a lease as an operating
taxable profit reported for tax purposes. These differences arise due to variations in
lease if it does not transfer substantially all risks and rewards of ownership to the
accounting rules (IFRS/GAAP) and tax regulations.
lessee.
✔ The lessor retains ownership of the leased asset.
1. Key Differences Between Accounting Profit and Taxable Profit
✔ The asset remains on the lessor’s balance sheet as a fixed asset.
Factor Accounting Profit (Per IFRS/GAAP) Taxable Profit (Per Tax Laws)
✔ Lease income is recognized on a straight-line basis over the lease term.
The profit calculated for financial The profit used to calculate
Definition
reporting purposes. income tax liability.
1. Initial Recognition of an Operating Lease (Lessor Accounting)
Based on accrual accounting Based on tax laws (often cash
At Lease Commencement, the Lessor:
Basis (revenue when earned, expenses basis or specific tax
✔ Keeps the leased asset on the balance sheet as Property, Plant, and Equipment when incurred). adjustments).
(PPE).
Uses straight-line or declining Uses accelerated depreciation
✔ Recognizes lease income evenly over the lease term. Depreciation
balance based on useful life. or tax allowances.
✔ Depreciates the leased asset over its useful life.
Revenue Recognized when earned (e.g., IFRS Recognized based on tax laws
✔ Cash is received from the lessee. Recognition 15 rules). (may require cash receipt).
✔ Lease income is recorded in the income statement. Some expenses are not
Expenses Includes all business expenses (some
deductible (e.g., fines,
2. Subsequent Measurement of an Operating Lease Deduction provisions, accrued expenses).
entertainment).
Each year, the lessor:
Provisions and Allowed under accounting rules (e.g., Not deductible until actual
✔ Recognizes lease income on a straight-line basis.
Reserves warranty, legal provisions). payment is made.
✔ Depreciates the leased asset over its useful life.
✔ The leased asset remains on the lessor’s books and continues to be depreciated. Types of Differences Between Accounting Profit and Taxable Profit
A. Permanent Differences (Do Not Reverse)
✔ These arise because some income/expenses are never taxable or deductible. expenses.
✔ They do not create deferred tax assets or liabilities. ✔ Deferred tax assets arise when accounting expenses are recognized before tax
Examples of Permanent Differences: deductions.
Item Accounting Treatment Tax Treatment
Determination of the Tax Base of Assets and Liabilities (IAS 12 - Income Taxes)
Fines & Penalties Recorded as expense Not deductible The tax base of an asset or liability is the amount attributed to it for tax purposes, which
Dividend Income (from may differ from its carrying amount in the financial statements. This difference leads to
Recorded as income Often tax-exempt
subsidiaries) temporary differences, resulting in deferred tax assets (DTA) or deferred tax liabilities
Entertainment Expenses Recorded as expense Not deductible for tax (DTL).

✔ No deferred tax impact, as this expense will never be deductible. 1. Determining the Tax Base of Assets
Formula for Tax Base of an Asset:
B. Temporary Differences (Reverse Over Time) Tax Base=Amount Deductible for Tax Purposes in the Future
✔ These occur when tax and accounting treatments differ temporarily. ✔ If future tax deductions exist, the tax base is not zero.
✔ They create deferred tax assets (DTA) or deferred tax liabilities (DTL). ✔ If the asset is not deductible for tax purposes, the tax base is zero.
Examples of Temporary Differences: ✔ Deferred Tax Liability (DTL) arises because the tax base is lower than the carrying
Accounting amount.
Item Tax Treatment Effect
Treatment 2. Determining the Tax Base of Liabilities
Straight-line over 5 Accelerated (e.g., 3 DTL (tax Formula for Tax Base of a Liability:
Depreciation
years years for tax) deduction earlier) Tax Base=Carrying Amount−Future Tax Deduction
Recognized when Deductible only when DTA (expense ✔ If a liability is tax-deductible in the future, the tax base is lower than the carrying
Warranty Provisions
estimated paid later for tax) amount.
Unrealized Gains on Recorded in Not taxed until DTL (income ✔ If a liability is not deductible for tax purposes, its tax base equals its carrying amount.
Investments financials realized taxed later)
✔ Tax expense is recorded based on accounting profit, but the actual tax payable is Computation of Income Tax Expense and Current Tax Expense (IAS 12 - Income
lower, creating a deferred tax liability. Taxes)
Under IAS 12, income tax expense consists of current tax expense and deferred tax
✔ Accounting Profit (Income Statement):
expense.
Accounting Profit=Revenue−Expenses (per IFRS/GAAP)
✔ Taxable Profit (Tax Computation):
1. Formula for Income Tax Expense
Taxable Profit=Accounting Profit±Permanent Differences±Temporary Differences Income Tax Expense=Current Tax Expense+Deferred Tax Expense\text{Income Tax
✔ Total tax expense includes current tax and deferred tax adjustments. Expense} = \text{Current Tax Expense} + \text{Deferred Tax
✔ Accounting profit differs from taxable profit due to permanent and temporary Expense}Income Tax Expense=Current Tax Expense+Deferred Tax Expense
differences. ✔ Current Tax Expense = Tax payable on taxable income (computed per tax laws).
✔ Permanent differences do not reverse and do not create deferred tax adjustments. ✔ Deferred Tax Expense = Tax effect of temporary differences (DTA/DTL changes).
✔ Temporary differences create deferred tax assets (DTA) or liabilities (DTL).
✔ Deferred tax liabilities arise when tax deductions are taken earlier than accounting 2. Step-by-Step Computation Example
 Scenario: 1. Categories of Employee Benefits
A company reports: Category Description Examples
• Accounting Profit Before Tax: ₱1,500,000 Salaries, wages, bonuses,
• Permanent Differences (Non-Deductible Expenses): ₱100,000 Benefits payable within 12
Short-Term Benefits overtime, paid leave, medical
• Temporary Differences (Accelerated Depreciation - Tax Base < Carrying months of service.
insurance.
Amount): ₱200,000
Post-Employment Benefits provided after Pensions, retirement plans, post-
• Tax Rate: 30%
Benefits employment ends. employment medical benefits.
Step 1: Compute Taxable Income
Other Long-Term Benefits payable after 12 Long-service awards, sabbatical
Taxable Profit=Accounting Profit+Permanent Differences±Temporary Differences
=1,500,000+100,000−200,000 Benefits months but before retirement. leave, long-term disability benefits.
=1,400,000 Severance pay, voluntary
Compensation for early
Step 2: Compute Current Tax Expense Termination Benefits retirement incentives, redundancy
termination of employment.
Current Tax Expense=Taxable Profit×Tax Rate packages.
=1,400,000×30% Equity Stock options, share-based
Employee benefits settled
=420,000 Compensation payments, restricted stock units
through shares.
Step 3: Compute Deferred Tax Expense Benefits (RSUs).
Deferred Tax Expense= Temporary Difference × Tax Rate
= 200,000×30% Recognition Timing for Different Types of Employee Benefits
= 60,000 Employee Benefit
Step 4: Compute Total Income Tax Expense When is it Recognized? Example
Type
Income Tax Expense= Current Tax Expense + Deferred Tax Expense
Short-Term Immediately as an expense when the Salaries, paid leave,
=420,000+60,000
Benefits employee renders service. bonuses, overtime.
=480,000
Post-Employment Over the employee’s service period, Pension plans, retirement
Computation of Deferred Tax Assets (DTA) and Deferred Tax Liabilities (DTL) Benefits or when contributions are due. medical benefits.
✔ DTL results from taxable temporary difference (FI>TI) and (CA>TB) Other Long-Term Gradually accrued over time until Long-service awards,
✔ DTA results from deductible temporary differences and carryforward of unused tax credits Benefits payment. sabbatical leave.
and losses Termination When the company commits to Severance pay, voluntary
✔ DTA arises when future tax deductions increase taxable profit later (e.g., warranty Benefits providing them (cannot be reversed). retirement packages.
provisions).
✔ DTL arises when taxable income is deferred to a future period (e.g., depreciation timing A. Short-Term Employee Benefits
differences). ✔ Recognized immediately as an expense when the employee provides service.
✔ Total deferred tax impact affects the income tax expense in financial statements. ✔ No need to discount to present value (paid within 12 months).
✔ If unpaid, it appears as salaries payable in liabilities.
Identification of Items Included in Employee Benefits (IAS 19 - Employee Benefits) B. Post-Employment Benefits
Employee benefits refer to all forms of compensation provided by an employer in exchange
for services rendered by employees.
✔ Defined Contribution Plans – Recognized when the contribution is due. ✔ No future liability once payment is made.
✔ Defined Benefit Plans – Recognized over the employee’s service period, using Defined Benefit Plan (DBP)
actuarial valuation. ✔ Employer promises a specific pension amount upon retirement.
✔ Defined Benefit Plans require complex calculations and are adjusted each period based ✔ Benefits depend on salary, years of service, and actuarial calculations.
on actuarial gains/losses. ✔ Employer is liable for any shortfall in the pension fund.
C. Other Long-Term Employee Benefits ✔ Employer must account for future pension liabilities.
✔ Recognized over the service period as the benefit accrues. ✔ Adjustments are made for actuarial gains/losses based on fund performance.
✔ May require present value discounting if paid in the future.
D. Termination Benefits Plan Type Accounting Recognition Complexity
✔ Recognized immediately when the company commits to termination, even if payment is Defined Recognized as expense when
later. Simple (fixed contribution).
Contribution Plan paid.
✔ Cannot be reversed once communicated to employees. Liability recorded for future
✔ If employees leave gradually, the expense is recognized as employees accept the offer. Defined Benefit Complex (depends on salary,
payments, requires actuarial
Plan years of service, discount rate).
E. Equity Compensation Benefits valuation.
✔ Employee benefits settled through company shares.
Accounting for Defined Contribution Plans (IAS 19 - Employee Benefits)
Key Differences Between Defined Contribution and Defined Benefit Plans A Defined Contribution Plan (DCP) is a post-employment benefit where:
Feature Defined Contribution Plan Defined Benefit Plan ✔ The employer contributes a fixed amount (e.g., percentage of salary).
Who Bears ✔ The employee bears the investment risk—the final benefit depends on fund
Employee Employer
Investment Risk? performance.
Fixed employer contributions, benefit Guaranteed benefit based on ✔ The employer has no further obligation once the contribution is made.
Nature of Benefit
depends on fund performance. salary and years of service.
Accounting Expense recognized as contribution Requires actuarial valuation and Recognition of Defined Contribution Plan Expense
Treatment is made. liability recognition. ✔ The employer recognizes expense when contributions are due.
Obligation to pay future ✔ No actuarial valuation is required (unlike Defined Benefit Plans).
Employer ✔ If contributions are unpaid at the reporting date, they are recorded as a liability.
No obligation beyond contributions. benefits, even if fund is
Obligation
insufficient. Scenario 1: Employer Contributes Directly to the Pension Fund
401(k), SSS (Philippines), CPF Pension plans, retirement ✔ Expense is recognized immediately in the income statement.
Example
(Singapore). annuities. ✔ No liability remains after payment.
Scenario 2: Contribution Accrued but Not Yet Paid
Defined Contribution Plan (DCP) ✔ The liability remains until paid.
✔ Employer contributes a fixed amount to an employee’s retirement fund. When Payment is Made:
✔ Employee receives whatever amount accumulates from contributions and investment ✔ The liability is cleared.
returns.
✔ Employer has no further obligation after making contributions.
Financial Statement Effect ✔ If contributions exceed pension expense, a Net Pension Asset may be created.
Income Statement Pension expense recognized under operating expenses. C. Recognizing Actuarial Gains/Losses
Balance Sheet If unpaid, contributions appear as accrued liabilities. ✔ Actuarial Gains/Losses arise from changes in:
Contributions are recorded as cash outflows from operating • Salary increases
Cash Flow Statement • Employee turnover rates
activities.
• Discount rates
➢ These are recorded in Other Comprehensive Income (OCI), not in profit or loss.
Accounting for Defined Benefit Plans (IAS 19 - Employee Benefits)
A Defined Benefit Plan (DBP) is a post-employment benefit where: Financial Statement Effect
✔ The employer guarantees a specific pension amount upon retirement. Pension expense (current service cost, past service cost,
Income Statement
✔ The employer bears the investment risk—ensuring enough funds to meet future net interest).
obligations. Defined Benefit Obligation (liability) and Plan Assets (if
Balance Sheet
✔ The pension obligation is estimated using actuarial valuations. funded).
Unlike Defined Contribution Plans, DBPs require complex accounting because liabilities Other Comprehensive Income Actuarial gains/losses due to changes in pension
change due to salary growth, employee turnover, and discount rates. (OCI) estimates.
Employer contributions shown as financing or operating
Cash Flow Statement
Steps in Accounting for a Defined Benefit Plan outflows.
Step 1: Measure the Present Value of the Defined Benefit Obligation (DBO)
✔ The Defined Benefit Obligation (DBO) is the present value of future pension payments. Computation of the Net Defined Benefit Liability (Asset)
✔ It is estimated using actuarial valuations (e.g., Projected Unit Credit Method). PV of DBO
Step 2: Recognize the Fair Value of Plan Assets xx beg.
✔ Employers often invest in pension funds to finance the future liability. benefits paid xx xx current and past service cost
✔ The fund's balance is recorded as Plan Assets. xx interest cost (beg. x discount rate
Actuarial gain xx xx Actuarial loss – increase in PV of DBO
Step 3: Compute the Net Defined Benefit Liability or Asset
– decrease in xx
Net Defined Benefit Liability=DBO−Plan Assets
PV of DBO end
✔ If DBO > Plan Assets, the deficit is a Net Defined Benefit Liability.
✔ If Plan Assets > DBO, the surplus is a Net Defined Benefit Asset. FVPA
➢ Lower between the surplus and the asset ceiling beg. xx
Return on plan
A. Recognizing Pension Expense Plan asset xx xx benefits paid
Pension expense consists of: Contribution xx
✔ Current Service Cost – Cost of benefits earned during the period. To the fund xx end
✔ Past Service Cost – Adjustments due to plan changes.
✔ Net Interest Cost – Interest on DBO minus expected return on Plan Assets. ✔ DBO increased due to service cost, past service cost, interest, and actuarial losses.
B. Funding the Pension Plan ✔ Plan Assets grew with employer contributions and investment returns.
✔ When the employer contributes to the pension fund, the obligation is reduced. ✔ The Net Defined Benefit Liability represents the amount owed to employees after
deducting plan assets. ✔ Recognized as a liability over the employee’s service period.
✔ This amount is recorded as a liability on the balance sheet ✔ Measured like a defined benefit plan using actuarial valuation.
✔ No remeasurements in OCI – all actuarial gains/losses go to profit or loss.
Components of the Defined Benefit Cost (IAS 19 - Employee Benefits)
✔ If payments are made later, the liability is reduced
The defined benefit cost is the total expense recognized by an employer for a Defined
Benefit Plan (DBP). It consists of three main components:
Accounting for Termination Benefits
1. Service Cost – Cost of benefits earned by employees during the period.
✔ Definition:
(a) Current Service Cost
• Benefits provided when an employee’s contract is terminated.
(b) Past Service Cost
• Can be voluntary (early retirement incentives) or involuntary (severance pay,
(c) Any (gain) or loss on settlements
redundancy packages).
2. Net Interest Cost – Interest expense on the pension obligation, net of expected return on
✔ Examples:
plan assets.
• Severance Pay – Compensation for layoffs or job eliminations.
(a) Interest cost on the DBO (PVDBO,beg x discount rate)
• Voluntary Early Retirement Benefits – Offered to encourage early exits.
(b) Interest income on plan assets (FVPA,beg x discount rate)
Recognition & Measurement of Termination Benefits
(c) Interest on the effect of the asset ceiling
3. Remeasurements – Actuarial gains/losses and return differences on plan assets, ✔ Recognized immediately when the company commits to termination.
recognized in Other Comprehensive Income (OCI). ✔ Not linked to future service – the benefit is recognized as an expense upfront.
(a) Actuarial (gains) and losses ✔ If employees accept termination over time, expenses are recognized as accepted.
(b) Difference between interest income on plan assets ✔ If the termination occurs gradually (e.g., phased layoffs), recognition happens as
And return on plan assets employees leave.
(c) Difference between the interest on the effect of
the asset ceiling and the change in the effect of the asset ceiling Benefit Type Recognition Timing Accounting Treatment
Measured like a defined
Accounting for Other Long-Term Employee Benefits and Termination Benefits Other Long-Term Accrued over the employee’s
benefit plan, but all changes
Under IAS 19, Other Long-Term Employee Benefits and Termination Benefits are Employee Benefits service period.
go to profit or loss (no OCI).
accounted for differently from short-term benefits and defined benefit plans.
Recognized immediately Recognized as expense &
Termination Benefits
1. Accounting for Other Long-Term Employee Benefits when the employer commits. liability, settled when paid.
✔ Definition:
• Benefits payable after 12 months but before retirement.
• Unlike pensions, these are not funded and do not go through Other
Comprehensive Income (OCI).
✔ Examples:
• Long-Service Awards – Paid for completing certain years of service.
• Sabbatical Leave – Extended paid leave after a service period.
• Long-Term Disability Benefits – Disability pay extending beyond 12 months.
Recognition & Measurement of Other Long-Term Benefits