Mark Louie P. Ramos ACTCY32S1 - Auditing and Assurance: Concepts and Applications 2

Mark Louie P.
Ramos
ACTCY32S1 - Auditing and Assurance: Concepts and Applications 2
Audit of Financial Liabilities & Debt Restructuring - Discussion

1. Describe the elements in the definition of liabilities
Liabilities are present obligations of an entity to transfer an economic resource as
a result of past events.
a. Present obligation – a duty r responsibility that an entity has no practical
ability to avoid. the entity or person liable must be identified but not necessary
that payee to whom the obligation is owed to be identified.
b. Transfer of economic resource – the obligation must be to pay cash,
transfer of non-cash or provide service at some future time.
c. Past events – The liability is not recognized until it is incurred.
2. Identify the different categories and classification of liabilities.

Financial liabilities are classified as:
1. Financial liabilities at amortized cost
2. Financial liabilities at fair value through profit or loss
 Designated as financial liabilities at fair value through profit or loss
 Held for trading
3. Financial liabilities that arise when a transfer of a financial asset does not qualify
for derecognition or when the continuing involvement approach applies
4. Financial guarantee contracts and commitments.
3. Describe the initial recognition, initial measurement, subsequent measurement,

reclassification, de recognition and financial statement presentation of liabilities.
a. Initial recognition
A liability is recognized in the statement of financial position when it is probable
that an outflow of resources embodying economic benefits will result from the
settlement of a present obligation and the amount of which the settlement will take place
can be measured reliably.
A liability shall be recognized as either a financial or non-financial liability. A
financial liability is any liability that is:
1. A contractual obligation, that includes to deliver cash or another financial asset
to another entity; or to exchange a financial assets or financial liabilities with
another entity under conditions that are potentially unfavorable to a entity, or
2. A contract that will or may be settled in the entity's own equity instruments that
is:
 a non-derivative for which the entity is or may be obliged to deliver a
variable number of the entity's own equity instruments, or
 a derivative that will or may be settled other than by the exchange of a
fixed amount of cash or another financial assets for a fixed number of
the entity's own equity instruments
Liabilities that do not fall in the above definition are termed as non-financial
liabilities.
b. Initial Measurement
Financial liabilities- Either as:
(a) Fair value or
(b) Fair value minus transaction cost
Non-financial liabilities- Either as:
(a) Best estimate or amounts needed to settle the obligations, or
(b) Measurement basis required by specific PFRS
c.Subsequent Measurement
Financial liabilities- Either as:
(a) Fair value or
(b) Amortized cost
Non-financial liabilities- Either as:
(a) best estimate or amounts needed to settle the obligations, or
(b) measurement basis required by specific PFRS
d.Reclassification of Financial Liabilities
PFRS 9 states that an entity shall not reclassify a financial liability.
e. De-Recognition of Liabilities
Financial liability is derecognized only when it is extinguished, cancelled or
expired in terms of liabilities covered by a contract and when in an exchange between
an existing borrower and lender of a debt instrument with substantially different terms or
substantial modification of the terms of an existing financial liability or a part thereof.
The difference between the carrying amount of an extinguished financial liability or
transferred to a third party as against the consideration paid is either a gain or loss on
derecognition and is reported in the profit or loss
f. Financial statement presentation
1. Current Liabilities - a liability is classified as current if
 It is expected to be settled within the entity's normal operating cycle
 It is expected to be settled within 12 months
 It is held for trading
 The entity has no unconditional right to defer payment for at least 12 months
from the reporting date
2. Non - Current Liabilities - a liability is classified as non-current if
 Other than current liabilities
 Specifically required by a particular standard to be classified in this category.
4.Identify and describe the different types of financial liabilities

Types of financial liabilities are classified as:
1. Current Liabilities - known as short-term liabilities, are debts or obligations that
need to be paid within a year. Current liabilities should be closely watched by
management to ensure that the company possesses enough liquidity from
current assets to guarantee that the debts or obligations can be met.
These includes Accounts payable, interest payable, income taxes
payable, bills payable, accrued expenses and short-term loans.
2. Non-current liabilities – known as long-term liabilities, are debts or obligations

due in over a year’s time. Long-term liabilities are an important part of a
company’s long-term financing. Companies take on long-term debt to acquire
immediate capital to fund the purchase of capital assets or invest in new capital
projects.
This includes bonds payable, long-term notes payable, deferred tax
liabilities, mortgage payable and capital lease.
3. Contingent liability – a possible obligation that arises from past event and
whose existence will be confirmed only by the occurrence or non-occurrence of
one or more uncertain future events not wholly within the control of the entity.
This includes lawsuits or warranties.
5. Describe the initial recognition, initial measurement, subsequent measurement,
reclassification, de recognition and financial statement presentation of financial
liabilities.
Initial Recognition
An entity may designate on its initial recognition, irrevocable designation a financial
asset as measured through profit or loss when:
 It eliminates or significantly reduces a measurement or recognition inconsistent
that would otherwise arise from measuring assets or liabilities or recognizing
gains or losses on them on a different base, or
 A group of financial asset or financial liabilities is being managed or its
performance is evaluated on a fair value basis.
Initial measurement
Financial liabilities measured through profit or loss shall be initially measured at
fair value. Any transaction cost incurred in relation to its issuance is treated as an
outright expense on the period they are incurred.
Subsequent measurement
Changes in fair value are recognized as either unrealized gain or loss on held for
trading financial liabilities at fair value through profit or loss is to be presented in profit or
loss.
Designated as at Fair Value Through Profit or Loss - Changes in fair value
are recognized as either unrealized gain or loss on the financial liability designated as
fair value through profit or loss is to be presented as follows:
 Change in fair value not attributable to change in the credit risk , unrealized gain
or loss is presented in the profit or loss
 Change in fair value is attributable to change in the credit risk:
o If it would create or enlarge an accounting mismatch in profit or
loss, present all unrealized gain or loss on the profit or loss;
o If it would not create or enlarge an accounting mismatch in profit or
loss, present all unrealized gain or loss attributable to changes in
the credit risk to the other comprehensive income
o Remaining amount of change in the fair value present all unrealized
gain or loss in the profit or loss.
Reclassification
PFRS 9 states that an entity shall not reclassify a financial liability
De-recognition
A financial liability should be removed from the statement of financial position
when and only when the financial liability is extinguished, discharged, cancelled or
expired. De-recognition gain or loss on held for financial liabilities at fair value through
profit or loss is computed at the difference between the consideration paid and the
carrying amount (fair value at the previous reporting date). However, for financial
liabilities designated as at far value through profit or loss, the amount presented in other
comprehensive income shall not be subsequently transferred to profit or loss. However,
the entity may transfer the cumulative gain or loss within equity.
Financial Statement Presentation
Financial liabilities through profit or loss should be presented in the current
liability section of the statement of financial position.
6.Describe and how do we apply a debt restructuring

Debt reconstructing is a situation where the creditor, for economic or legal
reasons related to the debtor’s financial difficulties, grants to the debtor concession that
would not otherwise be granted in a normal business relationship.
This includes debt forgiveness, asset swap, equity swap, and modification of
terms.
Old treatment New treatment
Old Liability Adjusted Same
Present Value of
Based on original effective rate Same
Modified Terms
Difference of old liability

Gain (loss) is recognized in
v. present value of Not recognized
the P/L for the period
modified terms
To be calculated based on new Original effective interest
Effective Interest Rate
cash flows rate

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Audit of Financial Liabilities & Debt Restructuring - Discussion

2. Identify the different categories and classification of liabilities.

3. Describe the initial recognition, initial measurement, subsequent measurement,

4.Identify and describe the different types of financial liabilities

2. Non-current liabilities – known as long-term liabilities, are debts or obligations

6.Describe and how do we apply a debt restructuring

Old treatment New treatment

Old Liability Adjusted Same

Difference of old liability

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