FAR 2_Handout No.

1_Liabilities_Part 1

Definition of liabilities
 Present obligations of a particular entity
o Legal obligation – is based on a contractual provision or a statutory requirement
o Constructive obligation – arises by reason of normal business practice, custom and a desire to maintain
good business relations or act in an equitable manner
 Transfer of an economic resource
 Past events or transactions
o Obligating event – an event that leads to the recognition of a legal or constructive obligation
Recognition of liabilities
A present obligation, legal or constructive, resulting from a past event is recorded as a liability if:
a. It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation;
and
b. The amount of the obligation can be measured reliably

Measurement of liabilities
Classification of liabilities *Initial measurement ****Subsequent measurement
1. Current (short – term) Face amount **Amortized cost
2. Noncurrent (long – term) Present value ***Amortized cost
Note:
*Conceptually, all liabilities are measure initially at present value. However, due to the short – term nature of the current
liabilities, the face amount of the obligation is deemed equal to its present value.
**Amortized cost for current liabilities is equal to the amount at which the liability is measured initially (face amount)
minus principal repayments made.
***Amortized cost for noncurrent liabilities is equal to the amount at which the liability is measured initially (present
value) minus principal repayments, plus or minus the cumulative amortization using the effective interest method of any
difference between the face amount and present value of the bonds payable.
****Some liabilities are subsequently measured at fair value (e.g. bonds held for trading).

Classification of liabilities
Current if:
 It is to be settled within the operating cycle or 1 year, whichever is longer (trade liabilities)
 It is held for trading purposes
 It is to be settled within 12 months after the reporting period (non-trade liabilities)
 The liable entity does not have an unconditional right to defer settlement for at least twelve months after the reporting
date
Noncurrent (residual definition)

Presentation of liabilities (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; and (e)
Current tax liability

Noncurrent liabilities, on the other hand, typically include the following: (a) Noncurrent portion of long – term debt; (b)
Finance lease liability; (c) Deferred tax liability; (d) Long – term obligation to officers; and (e) Long – term deferred
revenue

Special Cases:
1. Long term debt falling due within one year
a. Current in the absence of a refinancing agreement or deferment of payment at the discretion of the borrower
b. Noncurrent if a refinancing arrangement is made on or before the end of the reporting date
c. Noncurrent if the discretion to defer payment is with the borrower
2. Obligation with covenants
a. Becomes immediately demandable (current) if an agreement in the covenant is breached
b. Noncurrent if a grace period is given on or before the end of the reporting period
3. Estimated liabilities are obligations which exist at the end of reporting period although their amount, the due date and
the exact payees are not definite.

Deferred Revenues – amount already collected from customers but remains unearned as at end of the reporting period

Gift Certificates Payable

1. Liability is recognized upon sale of the gift certificates.
2. Revenue is recognized along with the cancelation of the related liability upon redemption of the certificates
3. As per DTI ruling, gift certificates no longer have expiration dates. However, at the end of the reporting period, the
Company which sells the gift certificates can make an estimate of non-redemption in relation to long – outstanding gift
certificates. The amount estimated by the Company which will no longer be redeemed by customers shall be
accounted for as other income, under the account “Forfeited gift certificates” with a corresponding reduction in the
amount of the liability.

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Pro-forma Entries (gift certificates):

Entry upon sale of GCs: Entry upon redemption of GCs: Entry for long - outstanding GCs:
Cash xx Gift certificates payable xx Gift certificates payable xx
Gift certificates payable xx Sales xx Forfeited gift certificates xx

Refundable Deposits
1. A liability account is recognized upon receipt of the deposit.
2. The liability account is cancelled upon return of the deposit.
3. Unclaimed deposits are treated as consideration for the deemed sale of the related asset for which such deposits were
received, hence, a gain or loss on sale is also recognized, if there’s any.

Pro-forma Entries (refundable deposits):

Entry receipt of the deposit: Entry upon return of the deposit: *Entry for the deemed sale of containers:
Cash xx Liability for container’s deposit xx Liability for container’s deposit xx
Liability for container’s deposit xx Cash xx Returnable containers xx

Bonus Computation
1. Bonus is based on income before bonus and before tax
B = (Br) (INC)
2. Based on income after bonus but before tax Where:
(Br) (INC) B = bonus
B =
(1 + Br) Br = bonus rate
3. Based on income after bonus and after tax INC = income before bonus and
(Br) (INC) (1 – Tr) before tax
B = Tr = tax rate
1 + [ Br (1 - Tr)
4. Based on income after tax but before bonus
(Br) (INC) (1 – Tr)
B =
1 – [ (Br) (Tr) ]
Current Liabilities
Premiums
1. Recognition of premium expense and liability - upon sale of the items with redeemable coupons or proof of purchase in
exchange for premium articles
2. Amount of expense = cost of premium items plus distribution costs less remittance from customers
3. Estimated premium liability = estimated cost redemption less cost actual redemption

Pro-forma Entries (premiums):

Entry upon purchase of premiums: *Entry upon distribution of premiums: Adjusting entry for premium liability:
Premiums xx Premium expense xx Premium expense xx
Cash xx Premiums xx Estimated premium liability xx
Cash xx
* The net credit to cash is made if the distribution cost exceeds the amount of remittance from the customer. A net debit to
cash is made if it is otherwise. Cash is not affected if there is no distribution cost and remittance from the customer or if
both are of equal value.

Cash Rebate Program

1. Recognition of rebates expense and liability - upon sale of the items with “cash rebate offer”
2. Amount of expense = amount of cash rebate offer
3. Estimated rebate liability = estimated cost redemption less cost actual redemption

Pro-forma Entries (cash rebates):

Entry to recognize the cash rebate program: Entry to record the payment of rebates to customers:
Rebates expense xx Estimated rebate liability xx
Estimated rebate liability xx Cash xx

Cash Discount Coupon

1. Recognition of cash discount coupon expense and liability - upon sale of the items with “cash discount coupon offer”
2. Amount of expense = amount of cash discount coupon plus handling fee
3. Estimated coupon liability = estimated cost redemption less cost actual redemption

Pro-forma Entries (cash discount coupon):

Entry to recognize the cash discount coupon program: Entry to record the payments to retailers:
Cash discount coupon expense xx Estimated coupon liability xx
Estimated coupon liability xx Cash xx

Customer Loyalty Program (IFRS 15)

1. Recognition and initial measurement – initially recognized as deferred revenue and measured at the fair value of the
consideration received with respect to the initial sale, allocated between the award credits and the sale based on relative
stand – alone selling prices.
2. Subsequent recognition and measurement
a. The entity operates the loyalty program

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FAR 2_Handout No. 1_Liabilities_Part 1
i. Amount of revenue recognized shall be based on the number of award credits that have been redeemed relative
to the total number expected to be redeemed
b. A third party operates the loyalty program
i. Revenue is equal to the gross consideration received allocated to the award credits
ii. Loyal program expense is recognized equal to the payments made to the third party by the entity
iii. Net revenue from points is computed as the difference between the revenue from points and the loyalty program
expense
Pro-forma Entries (customer loyalty program):
The entity operates the loyalty program A third party operates the loyalty program
Entry to recognize the sale of goods with reward points: Entry to recognize the sale of goods with reward points:
Cash xx Cash xx
Sales xx Sales xx
Unearned revenue – points xx Revenue from points xx

Entry to recognize the sale of goods with reward points: Entry to record the payments to the third party:
Unearned revenue – points xx Loyalty program expense xx
Sales xx Cash xx

Warranty
Expense recognition
1. Accrual approach – expense is recorded upon sale of the items with an attached warranty provision
2. “Expense as incurred” approach – expense is recorded in the year of actual incurrence and payment of the related
warranty services
Pro-forma Entries (warranty):
Accrual approach “Expense as incurred”approach
Entry to recognize the estimated cost of warranty in the period of Upon sale of the goods with warranty services offer:
sale:
Warranty expense xx No entry
Estimated warranty liability xx

Entry upon subsequent incurrence and payment for warranty Entry upon subsequent incurrence and payment for warranty
services: services:
Estimated warranty liability xx Warranty expense xx
Cash xx Cash xx
*Any difference between the warranty estimate and the actual cost of warranty incurred and paid is a change in accounting estimate and
therefore treated currently and prospectively.
Testing the accuracy of warranty liability
To facilitate the process of testing the reliability of the warranty liability reported as at the end of the year, sales are
assumed to have been made evenly during the year.
Pro-forma computations
Warranty expense related to 2020 Sales
2020
First contract year of January 01, 2020 sales [ (2020 sales) (Year 1 Warranty rate) ]
First contract year of July 01, 2020 sales [ (2020 sales) (Year 1 Warranty rate) (1/2) ]
2021
First contract year of July 01, 2020 sales [ (2020 sales) (Year 1 Warranty rate) (1/2) ]
Second contract year of January 01, 2020 sales [ (2020 sales) (Year 2 Warranty rate) ]
Second contract year of July 01, 2020 sales [ (2020 sales) (Year 2 Warranty rate) (1/2) ]
2022
Second contract year of July 01, 2020 sales [ (2020 sales) (Year 2 Warranty rate) (1/2) ]
Warranty expense related to 2021 Sales
2021
First contract year of January 01, 2021 sales [ (2021 sales) (Year 1 Warranty rate) ]
First contract year of July 01, 2021 sales [ (2021 sales) (Year 1 Warranty rate) (1/2) ]
2022
First contract year of July 01, 2021 sales [ (2021 sales) (Year 1 Warranty rate) (1/2) ]
Second contract year of January 01, 2021 sales [ (2021 sales) (Year 2 Warranty rate) ]
Second contract year of July 01, 2021 sales [ (2021 sales) (Year 2 Warranty rate) (1/2) ]
2023
Second contract year of July 01, 2021 sales [ (2021 sales) (Year 2 Warranty rate) (1/2) ]
Sale of warranty (extended warranty)
1. The amount received from the sale of the extended warranty is recognized initially as deferred revenue and
subsequently amortized using straight line method over the life of the warranty contract.
2. However, if costs are expected to be incurred in performing services under the extended warranty contract,
revenue is recognized in proportion to the costs to be incurred annually.
Pro-forma Entries (extended warranty):
Entry upon sale with extended warranty: Entry to amortize the unearned warranty revenue at year-end
Cash xx Unearned warranty revenue xx
Sales xx Warranty revenue xx
Unearned warranty revenue xx

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