PLV – Junior Philippine Institute of Accountants

Accounting Scholastic Guild

FINANCIAL ACCOUNTING AND REPORTING - 1

INTRO TO LIABILITIES
LIABILITY - are present obligations of an entity to transfer an economic resource as
a result of past events.

Accordingly, the essential characteristics of an accounting liability are:

A. The entity has a present obligation.

An obligation is a duty or responsibility that an entity has no practical ability to
avoid. The entity liable must be identified but it is not necessary that the payee to
whom the obligation is owed be identified.

B. The obligation is to transfer an economic resource. This is the very heart of

the definition of an accounting liability, The economic resource is the asset that
represents a right with a potential to produce economic benefits. Specifically, the
obligation must be to pay cash, transfer non cash assets or provide service at some
future time.

C. The liability arises from a past event. This means that the liability is not
recognized until it is incurred.

PRESENT OBLIGATION - An essential characteristic of a liability is that the entity has

a present obligation.The present obligation may be a legal obligation or a constructive
obligation.

Examples:
Legal Obligation - Ex. Accounts payable, Loan, Notes payable.
Constructive obligation - Loyalty card, premiums.

TRANSFER OF ECONOMIC RESOURCE - Either cash or non cash asset may be

used to pay currently maturing obligations

PAST TRANSACTION - Another essential characteristic of a liability is that the

liability must arise from a past transaction or event. The past event that leads to a
legal or constructive obligation 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 created by the event.
NOTE:
Without payment of money, without transfer of non cash asset,
without performance of service, there is no accounting liability.

EXERCISE: LIABILITY OR NOT?

-Entity A intends to acquire goods in the future amounting to 400,000.

-Entity B operates a nuclear power plant. In the current year, a new law enacted penalizing
the improper disposal of toxic waste. No similar law existed in the prior year.

-Entity C enters into an irrevocable commitment with another party to acquire goods in the future,
on credit.

-Although not stated in the contract, Entity D has a publicly known policy of providing repair services
for the goods it sells. Entity D has consistently honoured this implied policy in the past.

-Entity F has caused environmental damages. Although no law exists penalizing such an act, Entity
F believes it has an obligation to rectify the damages. However, the entity of the party to whom the
obligation is owed cannot be specifically identified.

MEASUREMENT OF LIABILITY
 CURRENT LIABILITY
PAS 1, paragraph 69, provides that an entity shall classify a liability as
current when:
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 twelve months after the reporting period.

d. The entity does not have an unconditional right to defer settlement of the liability for
at least twelve months after the reporting period.

If the Operating cycle and Reporting period are not the same whichever is longer are
used to classify which accounts are current or not

NOTE: Trade payables and accruals for employee and other operating costs are part of
the working capital used in the entity's normal operating cycle. Such operating items are
classified as current liabilities even if settled more than twelve months after the
reporting period. (If silent its duration is assumed to be twelve months.)

NON-CURRENT LIABILITY

The term non current liabilities is a residual definition of the definition above. All liabilities
not classified as current are classified as noncurrent liabilities.

Example:
a. Noncurrent portion of long-term debt
b. Finance lease liability
c. Deferred tax liability
d. Long-term deferred revenue

A liability which is due to be settled within twelve 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 on a long-term basis is completed on or before the end of the
reporting period, the refinancing is an adjusting event and therefore the obligation is
classified as noncurrent.
Moreover, 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 even if it would otherwise be due within a shorter
period. Current → non current
NOTE : the refinancing or rolling over must be at the discretion of the entity

EXERCISE: Current or Non Current?

Easy Company provided the following information on December 31, 2020:

Notes payable:
Trade 3,000,000 Bank loans 2,000,000 Advances from officers 500,000
Accounts payable - trade 4,000,000 Bank overdraft 300,000 Dividends payable 1,000,000
Withholding tax payable 100,000 Mortgage payable 3,800,000 Income tax payable 800,000
Estimated warranty liability 600,000 Estimated damages payable by reason of breach of
contract 700,000 Accrued liabilities 900,000 Estimated premium liability 200,000 Claim for
increase in wages by employees 3,500,000 covered in a pending lawsuit
Contract entered into for the construction of building
5,000,000
Required: Compute the total current liabilities on December 31, 2020.

Multiple Company provided the following information on December 31, 2020:

Accounts payable after deducting debit balances in 500,000 suppliers' accounts of

P100,000
Accrued liabilities 50,000 Note payable - due March 31, 2021 1,000,000 Note payable - due
May 1, 2021 800,000 Bonds payable - due December 31, 2022 2,000,000

On March 1, 2021 before the 2020 financial statements were issued, the note payable of
P1,000,000 was replaced by an 18-month note for the same amount.
The entity is considering similar action on the P800,000 note due on May 1, 2021. The financial
statements were issued on March 31, 2021.
Required: Compute the total current and noncurrent liabilities.

COVENANTS - Covenants are often attached to borrowing agreements which represent

undertakings by the borrower. These covenants are actually restrictions on the borrower as to
undertaking further borrowings, paying dividends, maintaining specified level of working capital
and so forth.
Breach of covenants - Under these covenants, if certain conditions relating to the borrower's
financial situation are breached, the liability becomes payable on demand.

Illustration:
Company B is borrowing money from Company D that is payable every month, starting January
1,2023 maturing on December 31, they issue a contract that if Company B fails to pay the
amount, the entire liability becomes demandable.

PAS 1, paragraph 74, provides that such a 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.
Note:
The liability is classified as noncurrent if the lender has agreed on or before the end
 of the reporting period to provide a grace period ending at least twelve months after
that date. In this context, a grace period is a period within which the entity can
rectify the breach and during which the lender cannot demand immediate
repayment.

Presentation of current liabilities

Under Paragraph 54 of PAS 1, as a minimum, the face of the statement of

financial position shall include the following line items for current liabilities:
a. Trade and other payables
b. Current provisions

c. Short-term borrowing d. Current portion of long-term debt

e. Current tax liability
The term trade and other payables is a line item for accounts payable, notes payable,
accrued interest on note payable, dividends payable and accrued expenses.

ESTIMATED LIABILITIES - Estimated liabilities are obligations which exist at the end of
reporting period although their amount is not definite. In many cases, the date when the
obligation is due is not also definite and in some instances, the exact payee cannot be identified
or determined. But inspite of these circumstances, the existence of the estimated liabilities is
valid and unquestioned.(Estimated liabilities are either current or noncurrent in nature.)

Example:
Estimated liability for premium, award points, warranties, gift certificates and bonus.

DEFERRED REVENUE - Deferred revenue or unearned revenue is income already received

but not yet earned. Deferred revenue may be realizable within one year or in more than one
year after the end of the reporting period. If the deferred revenue is realizable within one year,
it is acurrent liability

EXAMPLE: current deferred revenue - unearned interest income, unearned rental income and
unearned subscription revenue.

NOTE: If the deferred revenue is realizable in more than one year, it is classified as
noncurrent liability.

EXAMPLE: noncurrent deferred revenue - unearned revenue from long-term service contracts
and long-term leasehold advances.

Illustration
An entity sells equipment service contracts agreeing to service equipment for a 2-year period.
Cash receipts from contracts are credited to unearned service revenue and service contract
costs are charged to service contract expense.
Revenue from service contracts is recognized as earned over the service period of the
contracts.

The following transactions occur in the first year:

Cash receipts from service contracts sold 1,000,000 Service contract costs
paid 500,000 Service contract revenue recognized 800,000

Journal entries for first year

1. To record the cash receipts from service contracts sold:
Cash 1,000,000
Unearned service revenue 1,000,000
2. To record the service contract costs paid:
Service contract expense 500,000
Cash 500,000

3. To record the service contract revenue recognized:

Unearned service revenue 800,000
Service contract revenue 800,000

GIFT CERTIFICATE PAYABLE - Many megamalls, department stores and supermarkets

sell gift certificates which are redeemable in merchandise.

The accounting procedures are:

1. When the gift certificates are sold:

Cash XXX
Gift certificates payable XXX
The latter account is a current liability.

2. When the gift certificates are redeemed:

Gift certificates payable XXX
Sales XXX

3. When the gift certificates expire or when gift certificates are not redeemed:
Gift certificates payable XXX
Forfeited gift certificates XXX

NOTE: The Philippine Department of Trade and Industry ruled that gift certificates no
longer have an expiration period.

BONUS COMPUTATION

1. Bonus is expressed as a certain percent of INCOME BEFORE BONUS AND BEFORE

TAX
2. Bonus is expressed as a certain percent of INCOME AFTER BONUS BUT BEFORE
TAX
3. Bonus is expressed as a certain percent of INCOME AFTER BONUS AND AFTER TAX
4. Bonus is expressed as a certain percent of INCOME AFTER TAX BUT BEFORE
 BONUS

ILLUSTRATION
Income before bonus and before tax 4,400,000
Bonus 10%
Income tax rate 30%

Solve all the cases using the given formulas:

CASE 1 - BEFORE BONUS and BEFORE TAX

B = (4,400,000)(10%)
B = 440,000

CASE 2 - AFTER BONUS but BEFORE TAX

B = 0.10 (4,400,000 - B)
B = 440,000 - 0.10B
B + 0.10B = 440,000
1.10B = 440,000
B = 440,000/1.10B
B = 400,000

CASE 3 - AFTER BONUS and AFTER TAX

B = 0.10 (4,400,000 - B - T)
T = 0.30 (4,400,000 - B)
B = 0.10 [4,400,000 - B - 0.30 (4,400,000 - B)]
B = 0.10 (4,400,000 - B - 1,320,000 + 0.30B)
B = 440,000 - 0.10B - 132,000 + 0.03B
B + 0.10B - 0.03B = 440,000 - 132,000
1.07B = 308,000
B = 308,000/1.07
B = 287,850

T = 0.30 (4,400,000 - 287,850)

T = 1,233,645

CASE 4 - AFTER TAX but BEFORE BONUS

B = 0.10 (4,400,000 - T)
T = 0.30 (4,400,000 - B)
B = 0.10 [4,400,000 - 0.30 (4,400,000 - B)]
B = 0.10 (4,400,000 - 1,320,000 + 0.30B)
B = 440,000 - 132,000 + 0.03B
B - 0.03B = 308,000
0.97B = 308,000
B = 308,000/0.97
B = 317,526

REFUNDABLE DEPOSITS - Cash or property received from the customers which are
refundable after compliance with certain conditions. It is usually classified as current
liability.
Illustration
A deposit of ₱5,000 is required from the customer for returnable containers. The containers cost
₱2,500.
Journal Entry:
Cash 5,000
Containers' deposit 5,000

Reference:
Peralta, J., Valix, C.H., & Valix, C. (2021). Intermediate Accounting 2. GIC Enterprises & Co.,
Inc.