Liabilities

CHAPTER 1: LIABILITIES
Liabilities – present obligations of an entity arising from past transactions or events, the
settlement of which is expected to result in an outflow from the entity of resources
embodying economic benefits.
Characteristics:
 Present obligation of a particular entity- the entity liable must be identified and the
payee is not necessary to be identified.
 Past event- the liability is not recognized until it is incurred. It must arise from a
past transaction or event (obligating event- the past event that leads to a legal or
constructive obligation).
 Outflow of future economic benefits – a liability is recognized if it involves payment
of money, transfer of noncash asset, or performance of service. Ex. Cash dividend.
Note: share dividend- not a liability because it is a transfer of entity’s own shares
(share capital, an equity item.). Thus, Share dividend payable is an equity account
rather a liability.
Examples:
1. Accounts payable
2. Amounts withhold from employees for taxes and contributions for SSS
3. Accruals for wages, interest, royalties, taxes, product warranties, premiums and
profit sharing plans.
4. Cash dividends(declared but not paid)
5. Customer’s deposit and advances FROM officers (advances TO officers – accounts
receivable)
6. Debt obligations for borrowed funds – notes, mortgages and bonds payable
7. Income tax payable
8. Unearned Revenue
9.
10.
Measurement:
Current liabilities – recorded and reported at face amount.
Noncurrent liabilities – Initial: Present value, subsequent: amortized cost
Note: Long term note payable (interest bearing- initially and subsequently
measured at amortized cost)
Current liabilities – a liability wherein it expects to settle liability within the entity’s
operating cycle, holds liability for the purpose of trading, due to be settled within twelve
months after the reporting period, and the entity DOES NOT have the unconditional right to
defer (extend) the settlement of the liability.
 Note: trade payables and accruals for employees are considered current even if it is
settled more than twelve months after the reporting period.
 Note: operating cycle not indicated; assumed to be twelve months
 Financial liabilities, bank overdraft, dividends payable, income taxes, other nontrade
payables – current liabilities (even if not settled on the operating cycle).
Noncurrent liabilities – a residual definition of current liabilities.
Examples: non-current portion of long term debt, finance lease liability, deferred tax
liability, long term obligation to entity officers, long term deferred revenue (as long as it is
long term).
Long term debt falling due within one year
A liability is still classified as current (settled within twelve months), even if:
 The original term was for a period longer than twelve months
 An agreement to refinance/reschedule payment on long term basis AFTER the
reporting period and BEFORE the financial statements are authorized
Note: ON or BEFORE the end of the reporting period – NONCURRENT
The entity has the discretion to refinance or roll over an obligation- NONCURRENT
The entity HAS AN UNCONDITIONAL RIGHT on the existing loan facility –
NONCURRENT
Covenants – restrictions on the borrower as to undertaking further borrowings, paying
dividends, etc.
 Breach of covenants: if it is breached, it becomes payable on demand.
The liability was current even if the lender has agreed after the reporting period and
before the statements are issued.
The liability was noncurrent if the lender has agreed on or before the end of the
reporting period (to provide a grace period- a period within which the entity can
rectify the breach and during which the lender cannot demand immediate
repayment.
Estimated liabilities – obligations which exist at the end of reporting period although their
amount is not definite. It is either current or noncurrent in nature.
Examples: premium, warranties, gift certificates, and bonus
CHAPTER 2 – PREMIUMS
Premiums – distribution of value such as toys, dishes, etc. as result of past sales or sales
promotion.
Accounting procedures (journal entries):
When the premiums are purchased: Debit Premium, Credit Cash
When the premiums are distributed to customers: Debit Premium Expense, Credit Cash
If premiums are still outstanding (end of the year): Debit Premium Expense, Credit Est.
Premium Liability
Customer Loyalty program – IRFS 15
Generally designed to reward customers for past purchases and to provide them
with incentives to make further purchases.
Measurement – fair value of the consideration received with respect to the initial sale shall
be allocated between the award credits and the sale based on relative stand-alone selling
price.
Note:
The entry: debit premium expense, credit estimated premium liability will be reversed at
the start of subsequent season, and the balance of the estimated liability will still be there.
CHAPTER 3 – WARRANTY LIABILITY
Warranty – providing free repair service or replacement during a specified period if the
products are defective.
Recognition: same criteria as liabilities in Chapter 1.
Two approaches:
Accrual approach
Journal entries:
Estimated warranty cost is recorded: Warranty Expense
Estimated Warranty Liability
Actual Warranty Cost is incurred and paid: Estimated Warranty Liability
Cash
Difference between estimate and actual cost- change of estimate (treated prospectively).
Thus, if the actual cost > estimate: debit Warranty Expense, credit Est. Warranty Liability
Actual cost<Estimate: Debit Est. Warranty Liability, Credit Warranty Expense
Expense as incurred approach – expensing warranty cost only when actually incurred.
- Simply recorded by debiting warranty expense and crediting cash.
Testing the accuracy of warranty liability
The estimated warranty to have an easier interpretation/ understanding of sales accruing
evenly during the year, it is fair to assume the following:
Jan 1(from Jan 1 20x1 – Dec. 31, 20x1 first contract, Jan 1,20x2 –Dec 31,20x2 second
contract) and July 1 (July 1, 20x1- June 30, 20x2 first contract, July 1,20x2 – June 30,20x3
second contract)
Estimated warranty liability – warranty costs AFTER the particular period.
After that, compare it with the estimated warranty liability per book to find out it is
increase or decrease in warranty liability.
Decrease – Debit Estimated Warranty liability, credit warranty expense
Increase – Debit warranty expense, credit estimated warranty liability
Sale of warranty
- Sale of extended warranty is recognized initially as deferred revenue, and
subsequently amortized using straight line over the life of the warranty contract.
- 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.
- The extended warranty contract starts only after the regular warranty contract.