SUBJECT INTERMEDIATE ACCOUNTING II

CHAPTER Chapter 1

LESSON TITLE Liabilities

LESSON OBJECTIVES
At the end of this module, you will be able to;
1. Define and demonstrate the concept of liabilities.
2. Describe the nature and type of current and noncurrent liabilities
3. Know the measurement of current and noncurrent liabilities and apply them
properly.
4. Demonstrate the rules regarding the issue of long-term debt falling due within
one year.
5. Apply the accounting treatment revolving around the issue of breach of
covenants attached to a long-term debt.
6. Demonstrate and apply the accounting rules and procedures for deferred
income such as gift certificate.
7. Describe and apply the formulas in computing bonus to officers and
employees

OVERVIEW

In Intermediate Accounting I, you have learnt about the rules and procedures in accounting for various
assets such as cash and equivalents, receivables, inventories, investments, property, plant and equipment, and
intangible assets. Hark back to the specific requirements for their measurement and valuation, it clearly indicates
varied and distinct rules and models used for each group.
Expect similar experience in dealing with Intermediate Accounting II. Basically, this department will allow
you to be reasonably conversant about different facets of accounting for liabilities and equity of a company under
corporate set-up. You will learn how these financial statement elements are initially and subsequently valued,
how are they being classified, and what disclosure requirements you need to show in the notes to financial
statements.
At the outset, an introduction about the concept of liability will be discussed to illustrate circumstances
that will give rise to its recognition. Extracts from relevant accounting standards and conceptual framework for
financial reporting will help you deal issues concerning measurements, presentation, and disclosures
requirements. Provisions about covenants being breached by the debtor will be tackled as well as some issues
about long-term debt falling due within one year. Models and formulas will be introduced and demonstrated
through hypothetical problems like those related to bonus computation. Needless to say, some liability
fundamental concepts which were deemed essential too will be shortly discussed together with the vital
theoretical concepts.

ACTIVITY

Activity No. 1: Read each of the following cases below. From the knowledge you gained from your previous
accounting subjects, spot the items that require recognition of liability and indicate a short phrase why you say
so.
• ABC has placed order of supplies from its suppliers. A notice was received shortly acknowledging
ABC’s order.
• ABC hired M to be assigned under R&D Group. M is in the process of complying it employment
requirement after signing its employment contract.
• ABC signed a 10%, 1-year, promissory note and issued to XYZ, its merchandise supplier.
• ABC received 1-year subscription fee from a customer even the services has yet to commence
by the end of the week.

Activity No. 2: Enumerated below are general account titles that may either fall under liability section of the
statement of financial position or not all. In your own understanding of the account title, how would you describe
the account and how are you going to classify it - current or noncurrent liability? Use your cumulative knowledge
you earned from all of your accounting courses.
 • Bond sinking fund
• Accrued rental expense
• Advances to supplier
• Bonds payable (requiring annual installment plus accrued interest on the entire amount)
• Deferred rental income

Activity No. 3: You have learned legal provisions from your ACT180 about breaching a term of an agreement.
Try recalling it and write it. Why do you think this is important in accounting for liability?

Activity No. 4: We often hear the word bonus during midterm or during Christmas season. Interview anyone who
receive bonus in the past and ask the following questions: How often do you receive bonus in a year? When do
you receive the bonus? Why do you receive bonus? How much bonus do you receive? Amount not necessary.
Ex., a fraction of salary, twice/ thrice of salary, etc., In what form do you receive it? Monetary or non-monetary?

ANALYSIS

1. Why does a business entity incur liability?

2. What elements must be present for a liability to be recognized? Does it mean that when one element is
missing, liability is not recognized? Briefly explain.
3. If all elements are present in a given transaction, what would be the proforma entry?
4. What are the criteria for a liability to be current? Non-current?
5. Assume that in 2016, you have an obligation with a local bank that will fall due in December 31, 2021.
Based on the liability classification criteria, how would you classify the obligation on (a) December 31,
2019 and on December 31, 2020?
6. Assume that in 2016, you have an obligation with a local bank that will fall due in December 31, 2021.
How would the classification of the obligation be affected by a refinancing agreement with the local bank
completed on the following dates?
a. December 31, 2020
b. January 2, 2021
7. Assume that in 2016, you have an obligation with a local bank that will fall due in December 31, 2021,
with an agreement that no monthly interest falls past due. As on December 31, 2019, the company has
not paid the monthly interest from October 31, 2019. How does this circumstance affect the classification
of the liability?
8. Except for officers and employees who are receiving fixed bonuses, why do you think the amount of
bonuses received by them differ in amount?

ABSTRACTION

Introduction

The elements of financial statements defined in the Conceptual Framework are:

(a) assets, liabilities and equity, which relate to a reporting entity’s financial position; and
(b) income and expenses, which relate to a reporting entity’s financial performance.

Those elements are linked to the economic resources, claims and changes in economic resources and
claims as comprehensively discussed under Chapter 1 – The Objective of General-Purpose Financial Reporting
of the Conceptual Framework of Financial Reporting. The table below indicates the elements of the financial
statements with their respective description and items from Chapter 1 into which they are related to:

Chapter 1 Item Element Description

Economic resource Asset A present economic resource
controlled by the
entity as a result of past events.
An economic resource is a right
that has the potential to produce
economic benefits.
 Chapter 1 Item Element Description
Liability A present obligation of the entity
to transfer an economic resource
as a result of past events.
Claim
Equity The residual interest in the assets
of the entity after deducting all its
liabilities.
Changes in economic resources Income Increases in assets, or decreases
and claims, reflecting financial in liabilities, that result in
performance increases in equity, other than
those relating to contributions from
holders of equity claims.
Expenses Decreases in assets, or increases
in liabilities, that result in
decreases in equity, other than
those relating to distributions to
holders of equity claims.
Other changes in economic - Contributions from holders of
resources and claims equity claims, and distributions to
them.

Exchanges of assets or liabilities

that do not result in increases or
decreases in equity.

Definition and Elements of Liability

A liability is a present obligation of the entity to transfer an economic resource as a result of past events.

For a liability to exist, three criteria must all be satisfied:

1. the entity has an obligation

• An obligation is a duty or responsibility that an entity has no practical ability to avoid.
• An obligation is always owed to another party (or parties).
• The other party (or parties) could be a person or another entity, a group of people or other entities,
or society at large.
• It is not necessary to know the identity of the party (or parties) to whom the obligation is owed.
• A requirement for one party to recognize a liability and measure it at a specified amount does not
imply that the other party (or parties) must recognize an asset or measure it at the same amount.
• Many obligations are established by contract, legislation or similar means and are legally
enforceable by the party (or parties) to whom they are owed.
• Obligations can also arise, however, from an entity’s customary practices, published policies or
specific statements if the entity has no practical ability to act in a manner inconsistent with those
practices, policies or statements. The obligation that arises in such situations is sometimes
referred to as a ‘constructive obligation’.
• In some situations, an entity’s duty or responsibility to transfer an economic resource is conditional
on a particular future action that the entity itself may take. Such actions could include operating a
particular business or operating in a particular market on a specified future date, or exercising
particular options within a contract. In such situations, the entity has an obligation if it has no
practical ability to avoid taking that action.
• In some cases, it is uncertain whether an obligation exists.

For example, if another party is seeking compensation for an entity’s alleged act of wrongdoing,
it might be uncertain whether the act occurred, whether the entity committed it or how the law
applies. Until that existence uncertainty is resolved—for example, by a court ruling—it is uncertain
whether the entity has an obligation to the party seeking compensation and, consequently,
whether a liability exists.
2. the obligation is to transfer an economic resource

• To satisfy this criterion, the obligation must have the potential to require the entity to transfer an
economic resource to another party (or parties). For that potential to exist, it does not need to be
certain, or even likely, that the entity will be required to transfer an economic resource—the
transfer may, for example, be required only if a specified uncertain future event occurs. It is only
necessary that the obligation already exists and that, in at least one circumstance, it would require
the entity to transfer an economic resource.

• An obligation can meet the definition of a liability even if the probability of a transfer of an economic
resource is low. Nevertheless, that low probability might affect decisions about what information
to provide about the liability and how to provide that information, including decisions about
whether the liability is recognized and how it is measured.

• Obligations to transfer an economic resource include, for example:

a) obligations to pay cash.
b) obligations to deliver goods or provide services.
c) obligations to exchange economic resources with another party on unfavorable terms.
Such obligations include, for example, a forward contract to sell an economic resource
on terms that are currently unfavorable or an option that entitles another party to buy an
economic resource from the entity.
d) obligations to transfer an economic resource if a specified uncertain future event occurs.
e) obligations to issue a financial instrument if that financial instrument will oblige the entity
to transfer an economic resource.

• Instead of fulfilling an obligation to transfer an economic resource to the party that has a right to
receive that resource, entities sometimes decide to, for example:
a) settle the obligation by negotiating a release from the obligation;
b) transfer the obligation to a third party; or
c) replace that obligation to transfer an economic resource with another obligation by
entering into a new transaction.
Either of the aforementioned situations, an entity has the obligation to transfer an economic
resource until it has settled, transferred or replaced that obligation.

3. the obligation is a present obligation that exists as a result of past events

• A present obligation exists as a result of past events only if:

a) the entity has already obtained economic benefits or taken an action; and
b) as a consequence, the entity will or may have to transfer an economic resource that it
would not otherwise have had to transfer.

• The economic benefits obtained could include, for example, goods or services. The action taken
could include, for example, operating a particular business or operating in a particular market. If
economic benefits are obtained, or an action is taken, over time, the resulting present obligation
may accumulate over that time.

• If new legislation is enacted, a present obligation arises only when, as a consequence of obtaining
economic benefits or taking an action to which that legislation applies, an entity will or may have
to transfer an economic resource that it would not otherwise have had to transfer.

• Similarly, an entity’s customary practice, published policy or specific statement gives rise to a
present obligation only when, as a consequence of obtaining economic benefits, or taking an
action, to which that practice, policy or statement applies, the entity will or may have to transfer
an economic resource that it would not otherwise have had to transfer.

• A present obligation can exist even if a transfer of economic resources cannot be enforced until
some point in the future.
 For example, a contractual liability to pay cash may exist now even if the contract does not require
a payment until a future date.

Similarly, a contractual obligation for an entity to perform work at a future date may exist now
even if the counterparty cannot require the entity to perform the work until that future date.

• An entity does not yet have a present obligation to transfer an economic resource if it has not yet
obtained economic benefits, or taken an action, that would or could require the entity to transfer
an economic resource that it would not otherwise have had to transfer.

For example, if an entity has entered into a contract to pay an employee a salary in exchange for
receiving the employee’s services, the entity does not have a present obligation to pay the salary
until it has received the employee’s services. Before then the contract is executory—the entity
has a combined right and obligation to exchange future salary for future employee services.

Recognition and Recognition Criteria of Liabilities

Recognition is the process of capturing for inclusion in the statement of financial position or the statement(s) of
financial performance an item that meets the definition of one of the elements of financial
statements—an asset, a liability, equity, income or expenses.

Recognition involves depicting the item in one of those statements—either alone or in aggregation with other
items— in words and by a monetary amount and including that amount in one or more totals in that statement.

The amount at which an asset, a liability or equity is recognized in the statement of financial position is referred
to as its ‘carrying amount’.

Classification of Liabilities

An entity shall classify a liability as current when:

a. it expects to settle the liability in its normal operating cycle;
b. it holds the liability primarily for the purpose of trading;
c. the liability is due to be settled within twelve months after the reporting period; or
d. the entity does not have an unconditional right to defer settlement of the liability for at least
twelve months after the reporting period.

An entity shall classify all other liabilities as non-current.

Some current liabilities, such as trade payables and some accruals for employee and other operating costs,
are part of the working capital used in the entity’s normal operating cycle. An entity classifies such operating
items as current liabilities even if they are due to be settled more than twelve months after the reporting
period.

When the entity’s normal operating cycle is not clearly identifiable, it is assumed to be twelve months.

Other current liabilities are not settled as part of the normal operating cycle, but are due for settlement within
twelve months after the reporting period or held primarily for the purpose of trading.

Examples are
• some financial liabilities classified as held for trading
• bank overdrafts
• the current portion of non-current financial liabilities
• dividends payable
• income taxes
• other non-trade payables.
 Financial liabilities that provide financing on a long-term basis (ie are not part of the working capital used in
the entity’s normal operating cycle) and are not due for settlement within twelve months after the reporting
period are non-current liabilities.

Liabilities can broadly be categorized into

1. Financial Liabilities
2. Non-Financial Liabilities

Whereas Financial Liabilities can be regarded as liabilities that are incurred as a result of normal discourse
of the business, where liabilities are mainly subdued in cash, non-financial liabilities are the opposite.

Common examples of financial liabilities representing a contractual obligation to deliver cash in the future
are:
a) trade accounts payable;
b) notes payable;
c) loans receivable an payable; and
d) bonds payable
On the other hand, non-financial liabilities are mainly contingencies; or not of financial transaction origin.
They mainly require non-cash obligations that need to be provided in order to settle the balance

Examples for non-financial liabilities include

a) deferred revenue
b) advances received
c) provisions
d) warranties
e) environmental liabilities
f) any customer liability accounts

Measurement of Liabilities

IFRS 9 - Financial Instruments, doesn't change the basic accounting model for financial liabilities under IAS 39.
Two measurement categories continue to exist:
1. Fair Value Thru Profit or Loss (FVTPL) - Financial liabilities held for trading are measured at FVTPL
2. Amortized cost - All other financial liabilities are measured at amortized cost unless the fair value option
is applied.

In practice however, current liabilities are measured at their face amount.

According to IAS 37, non-financial liabilities should be measured at amounts that would rationally be paid to
settle any present obligation or amount to transfer it to a third party on the balance sheet date. An entity is
supposed to recognize a non-financial liability when
a) the definition of a liability has been satisfied
b) the non-financial liability can be measured reliably.

The basis of estimating non-financial liabilities relied on the expected cash approach (in some books, this is
called expected value approach). In this regard, multiple cash flow scenarios are used which reflect the range of
all the possible outcomes, coupled with their respective probabilities. It is by this reason that the expected cash
flow approach is an approach that makes an appropriate basis for measuring liabilities and classes of similar
obligations for single corresponding obligations.

Additionally, it can also be seen that Non-Financial Liabilities can be measured before tax. In the same manner,
an entity is also supposed to include all the relevant risks and uncertainties. Similarly, the non-financial liability
should be canceled when the obligation is settled, or canceled. In the case where the Non-Financial Liability
cannot be measured properly, it shall make complete disclosure about certain disclosures so that relevant
information can be communicated to the users.

Long-Term Debt Falling Due Within One Year

An entity classifies its financial liabilities as current when they are due to be settled within twelve months after
the reporting period, even if:
a) the original term was for a period longer than twelve months, and
b) an agreement to refinance, or to reschedule payments, on a long-term basis is completed after the
reporting period and before the financial statements are authorized for issue.

Under Intermediate Accounting, IFRS 2nd Edition authored by Kieso, Weygandt, and Warfield, it is indicated that
portion of bonds, mortgage notes, and other long-term indebtedness that matures within the next fiscal year
except for long-term debts maturing currently, if they are to be:
1. Retired by assets accumulated that have not been shown as current assets,
2. Refinanced, or retired from the proceeds of a new debt issue, or
3. Converted into ordinary shares.

Refinancing of Financial Liability

The term refinance, or "refi" for short, refers to the process of revising and replacing the terms of an existing
credit agreement, usually as it relates to a loan or mortgage. When a business or an individual decides to
refinance a credit obligation, they effectively seek to make favorable changes to their interest rate, payment
schedule, and/or other terms outlined in their contract. If approved, the borrower gets a new contract that takes
the place of the original agreement.

If an entity expects, and has the discretion, to refinance or roll over an obligation for at least twelve months after
the reporting period under an existing loan facility, it classifies the obligation as non-current, even if it would
otherwise be due within a shorter period.

However, when refinancing or rolling over the obligation is not at the discretion of the entity (for example, there
is no arrangement for refinancing), the entity does not consider the potential to refinance the obligation and
classifies the obligation as current.

Illustration: (Adapted)

The CFO for ABC Corporation is discussing with the company’s chief executive officer issues related to the
company’s short-term obligations. Presently, both the current ratio and the acid-test ratio for the company are
quite low, and the chief executive officer is wondering if any of these short-term obligations could be reclassified
as long-term. The financial reporting date is December 31, 2020. Two short-term obligations were discussed,
and the following action was taken by the CFO.

Short-Term Obligation A:
ABC has a P500,000 short-term obligation due on March 1, 2021. The CFO discussed with its lender whether
the payment could be extended to March 1, 2023, provided Hendricks agrees to provide additional collateral. An
agreement is reached on February 1, 2021, to change the loan terms to extend the obligation’s maturity to March
1, 2023. The financial statements are authorized for issuance on April 1, 2021.

Short-Term Obligation B:
ABC also has another short-term obligation of P1,000,000 due on February 15, 2021. In its discussion with the
lender, the lender agrees to extend the maturity date to February 1, 2022. The agreement is signed on
December 18, 2020. The financial statements are authorized for issuance on March 31, 2021.

Instructions:
Indicate how these transactions should be reported at Dec. 31, 2020, on ABCs’ statement of financial position.

Answer:
For short-term obligation A, since the agreement was not in place as of the reporting date (December 31, 2020),
the obligation should be reported as a current liability.

For short-term obligation B, since the agreement was in place as of the reporting date (December 31, 2020), the
obligation is reported as a non-current liability.

Breach of Covenants
In legal and financial terminology, a covenant, is a promise in an indenture, or any other formal debt agreement,
that certain activities will or will not be carried out or that certain thresholds will be met.

When an entity breaches a provision of a long-term loan arrangement on or before the end of the reporting period
with the effect that the liability becomes payable on demand, it classifies the liability as current, even if the lender
agreed, after the reporting period and before the authorization of the financial statements for issue, not to demand
payment as a consequence of the breach.

An entity classifies the liability as current because, at the end of the reporting period, it does not have an
unconditional right to defer its settlement for at least twelve months after that date.

However, an entity classifies the liability as non-current if the lender agreed by the end of the reporting period
to provide a period of grace ending at least twelve months after the reporting period, within which the entity can
rectify the breach and during which the lender cannot demand immediate repayment.

Disclosure of Events as Non-Adjusting Events

In respect of loans classified as current liabilities, if the following events occur between the end of the reporting
period and the date the financial statements are authorized for issue, those events are disclosed as non-
adjusting events in accordance with IAS 10 - Events after the Reporting Period:
a. refinancing on a long-term basis;
b. rectification of a breach of a long-term loan arrangement; and
c. the granting by the lender of a period of grace to rectify a breach of a long-term loan
arrangement ending at least twelve months after the reporting period.

Deferred Revenue

Deferred revenue is the portion of a company's revenue that has not been earned, but cash has been collected
from customers in the form of prepayment. It is an obligation on a company's balance sheet that receives the
advance payment because it owes the customer products or services.

This item of obligation is not a financial liability because the outflow of economic benefits associated with it is the
delivery of goods and services rather than a contractual obligation to pay cash or another financial asset.

Deferred revenue is most common among companies selling subscription-based products or services that
require prepayments.

Examples of unearned revenue are:

In the case of a prepayment, a company's goods or services will be delivered or performed in a future period.
The prepayment is recognized as a liability on the balance sheet in the form of deferred revenue. When the good
or service is delivered or performed, the deferred revenue becomes earned revenue and moves from the balance
sheet to the income statement.

Deferred revenue may either be classified as current or noncurrent depending on the period it is expected to be
realized. For a 3-year deferred subscription revenue that exist at the end of the reporting period and expected to
be realized equally over the next three years, 1/3 of which will be classified current and the remaining fraction
as noncurrent.

Illustration:
On June 1, 2020, ABC Company, an owner of a building, leases it out to XYZ Company, a tenant, for only 1
year. ABC receives P360,000 as advance payment for the entire lease term from XYZ on the same date.
Revenues from advance payment of rent are recorded entirely as income upon receipt of cash.

June 1, 2020
Cash 360,000
Rental Income 360,000

December 31, 2020

Rental Income 210,000
Deferred Rental Revenue 210,000

On December 31, 2020,

Income Statement Rental Income 150,000
Balance Sheet Deferred Rental Revenue 210,000

Gift Certificates

RA109621 defines Gift Certificate as any instrument issued to any person , natural or juridical, for monetary
consideration, honored upon presentation at a single merchant or an affiliated group of merchants as payment
for consumer goods or services. The instrument be in a form of paper, card, code, or other device and shall
remain valid until the cessation of business of the issuer. Issuing a gift certificate that bears an expiry date is
unlawful.

Illustration:

ABC Company sold gift certificates (GC) to various clients during the year 2020 as follows:
Denomination Pieces Total
P 1,000 100 P100,000
P 500 300 P150,000
P 100 1,000 P100,000
The GC can be redeemed anywhere within the dry goods section of ABC Store. Based from company’s history
on GC redemption, all GCs will be completely redeemed by clients before the end of the year following the year
of issuance. By the end of 2020, the following GCs were redeemed as follows:
30% of P1,000 denomination
70% of P500 denomination
90% of P100 denomination

The average cost ratio of ABC is 60%.

Year 2020
Cash 350,000
Gift Certificate Liability 350,000
To record the sale of gift certificates during the year 2020

Gift Certificate Liability 225,000

Revenue 225,000
To record the redemption of gift certificates

Cost of sales 135,000

Inventory 135,000

By the end of 2020, the following accounts should have the balances as follow:
Gift Certificate Liability 125,000
 Revenue 225,000
Cost of sales 135,000

Note that when a company has a reasonable and valid expectation that a portion of the GC issued can no longer
be redeemed, the amount representing that portion, can be recognized as income.

Bonus

A bonus an amount of money added to wages on a seasonal basis, especially as a reward for good performance.
Whilst it can be given to a highly desired applicant by the employer, often it is given to employees with exceptional
performance as a result of superior earnings during a specified period of time. Bonus improves employees’ and
officers’ motivation, productivity and morale.

Bonus plans result to the recognition of bonus liability. While different companies use different bases, the most
common is income with the following variations:

a) Income before bonus and tax B=b%*(I)

b) Income before bonus but after-tax B=b%*(I-T) and T = t%*(I-B), since bonus is deducted to compute tax,
the substitute tax formula to bonus formula
c) Income after bonus but before tax B=b%*(I-B)
d) Income after bonus and tax B=b%*(I-B-T) and T=t%*(I-B), then substitute tax formula to bonus
formula
Where B=Bonus; b%=bonus rate; I=Income before bonus and tax; T=Tax; t%=tax rate

Always remember that bonus is an expense, so, it is deductible for purposes of computing the amount of tax.

Illustration
Assume the following amounts:
Sales 1,600,000
Cost of Sales 600,000
Operating expenses *(excluding bonus and tax) 150,000
Bonus rate 5%
Tax rate 30%

Step 1 Compute the amount of (I) income before bonus and tax. P850,000

Step 2 Compute bonus using the given formula above.

Step 3 Record using the proforma entry.

Bonus expense xx
Bonus Liability xx

Bonus rate 5% 5% 5% 5%
Tax rate 30% 30% 30% 30%
A B C D
I b4 B&T I b4 B after T I after B b4 T I after B and T
Income before bonus and tax 850,000.00 850,000.00 850,000.00 850,000.00
Less Bonus 42,500.00 30,203.00 40,476.00 28,744.00
Income after bonus, before tax 807,500.00 819,797.00 809,524.00 821,256.00
Less Tax 242,250.00 245,939.10 242,857.20 246,376.80
Net Income 565,250.00 573,857.90 566,666.80 574,879.20
Tax is computed by multipying 30% by the amount of Income after bonus, before tax.

A. B=I*b%
B=850,000*5%
B=42,500

B. B=b%*(I-T)
T=t%*(I-B)
Integrate tax (T) equation to the bonus (B) equation:
 B= b%*{ I - [ t%*(I-B)]} Using the tax equation, replace B by the amount
B=5%*{ 850,000 – [30%*(850,000-B)]} computed for bonus:
B=5%*[ 850,000 – (255,000-30%B) T=t%*(I-B)
B=5%*( 850,000 – 255,000+30%B) T=30%*(850,000-30,203)
B=42,500-12,750+.015B T=245,939.10
B-0.015B=29,750
0.985B=29,750
B=30,203

C. B=b%*(I-B)
B=5%*(850,000-B)
B=42,500-0.05B
B+0.05B=42,500
B=40,476

D. B=b%*(I-B-T)

T=t%*(I-B)
T=30%*(850,000-B)
T=255,000-0.3B

Integrate tax (T) equation to the bonus (B) equation:

B=b%*{I-B- [t%*(I-B)]} Using the tax equation, replace B by the amount
B=5%*[850,000 – B - (255,000-0.3B)] computed for bonus:
B=5%*(850,000 – B -255,000+0.3B) T=t%*(I-B)
B=42,500-0.05B-12,750+0.015B T=30%*(850,000-B)
B+0.05B-0.015B=42,500-12750 T=30%*(850,000-28,744)
1.035B=29,750 T=246,377
B=28,744

Presentation of Current and Noncurrent Liabilities

Under IAS/ PAS 1, states that as a minimum, the statement of financial position shall include line items that
present the following amounts as follows:
a) trade and other payables;
b) provisions;
c) financial liabilities (excluding amounts shown under a and b).

An entity shall present additional line items, headings and subtotals in the statement of financial position when
such presentation is relevant to an understanding of the entity’s financial position.

An entity shall present current and non-current liabilities, as separate classifications in its statement of financial
position in accordance with the criteria as indicated above under “Classification of Liabilities” except when a
presentation based on liquidity provides information that is reliable and more relevant. When that exception
applies, an entity shall present all assets and liabilities in order of liquidity.

An entity is permitted to present some of its liabilities using a current/non-current classification and others in
order of liquidity when this provides information that is reliable and more relevant. The need for a mixed basis of
presentation might arise when an entity has diverse operations.

For some entities, such as financial institutions, a presentation liabilities in increasing or decreasing order of
liquidity provides information that is reliable and more relevant than a current/non-current presentation because
the entity does not supply goods or services within a clearly identifiable operating cycle.

Whichever method of presentation is adopted, an entity shall disclose the amount expected to be settled after
more than twelve months for liability line item that combines amounts expected to be settled:
a. no more than twelve months after the reporting period, and
b. more than twelve months after the reporting period.

Information about expected dates of realization of liabilities is useful in assessing the liquidity and solvency of
an entity. IFRS 7 Financial Instruments: Disclosures requires disclosure of the maturity dates of financial
liabilities. Information on the expected date of settlement for liabilities such as provisions is also useful, whether
liabilities are classified as current or as non-current.

APPLICATION

1. Self-Check Activity

A google document will be shared to everyone under my IA classes, or MoD Chat will be activated to raise your questions and concerns
about the topic. As such, clarification about answers to Self-Check Activity and Homework will be entertained thru these platforms. I will
answer your query as fast as possible. They will remain active up until the duration of the course.

Answer the following cases and situations applying the applicable standards of accounting for liability. Answers
are provided at the end of each item.

Part I: Concepts and Theory

1. A liability is a present obligation of the entity to transfer an economic resource as a result of past and future events.
FALSE
2. For a liability to exist, the exact amount must be known. FALSE
3. An obligation to pay cash in the future must exist for a liability to be recorded. FALSE
4. ABC Company has received huge cash endowment from the government with the condition that ABC shall lay concrete
road on the main highway of the barrio and employing the locals. In this case, ABC has an obligation that has no
practical ability to avoid. TRUE
5. A liability may not be recorded until the identity of the recipient is known. FALSE
6. The currently maturing portion of long-term debt should be included in current liabilities if payment will require the use
of current assets. TRUE
7. Short-term obligations are excluded from a company’s current liabilities if (a) the company intends to refinance on a
long-term basis, and (b) the company has the ability to refinance. The ability to refinance must be demonstrated by
either (a) the issue of long-term obligations or equity securities after the balance-sheet date but before issuance of the
statements, or (b) a bona fide long-term financing agreement is entered into before the balance sheet is issued. TRUE
8. Accounts payable, notes payable, and sales tax payable are examples of nonlegal liabilities. FALSE
9. The interest element in an interest-bearing note payable is recognized by the borrower at the inception of the note.
FALSE
10. Obligations related to product warranties and premium offers are examples of loss contingencies, which are usually
accrued. TRUE
11. Conceptually, a company should record all liabilities at the present value of the future outlays that will be required.
TRUE
12. The most conceptually appropriate method of valuing a liability under the historical cost basis is to discount the amount
of expected cash outflows that are necessary to liquidate the liability using the market rate of interest at the date the
liability was initially incurred. TRUE
13. A company may exclude a short-term obligation from current liabilities if the firm intends to refinance the obligation on
a long-term basis. TRUE
14. GAAP requires that a company classify the entire amount of a long-term obligation as a current liability if a violation of
a provision of the debt agreement makes (or will make if the violation is not corrected) the liability callable within one
year from the balance sheet date or within one operating cycle. TRUE
15. A company may exclude a short-term obligation from current liabilities if it is paid off after the balance sheet date and
subsequently replaced by long-term debt before the balance sheet is issued. False
16. The ability to consummate the refinancing of a short-term obligation may be demonstrated by actually refinancing the
obligation by issuing a long-term obligation after the date of the balance sheet but before it is issued. TRUE
17. The initial sale of a gift card triggers the record of a liability, not as sales. This is a debit to cash and a credit to the gift
cards outstanding account. TRUE
18. If there is a reasonable expectation that a certain proportion of gift cards will not be used, this amount can be recognized
as revenue. TRUE

19. Jamison Company has the following obligations at December 31: For each obligation, indicate whether it should be
classified as a current liability. (Assume an operating cycle of less than one year.)
(a) Notes Payable for P100,000 due in 2 years – non-current liability
(b) 10 Year Mortgage Payable of P300,000 payable in ten P30,000 annual payments 30,000 current, 270,000 non-
current
(c) Interest Payable of P15,000 on the mortgage current
(d) Accounts Payable of P60,000 current

20. A current liability is a debt that can reasonably be expected to be paid: A

 A. within one-year or the operating cycle whichever is longer
B. out of cash currently on hand
C. between 6 months and 18 months
D. out of currently recognized revenues

21. Which of the following would most likely be classified as a current liability? A
A. Dividends Payable
B. Mortgage Payable as a single payment in 10 years
C. Bonds Payable in 5 years
D. Three-year notes payable

Part II: Application and Problem Solving

Below are series of hypothetical cases, adapted or self-made. Provide the requirement/s from each case.
Answers are provided at the end of this activity. It is suggested to answer with supporting accounting entry.

22. The balance in Cow Company’s accounts payable account at December 31, 2020 was P1, 170, 000 before any year-
end adjustments relating to the following:
• Goods were in transit from a vendor to Cow on December 31, 2020. The invoice cost was P65, 000 and the goods
were shipped FOB shipping point on December 29, 2020. The goods were received on January 2, 2021.
• Goods shipped FOB shipping point December 20, 2020 from a vendor to Cow, were lost in transit. The invoice
cost was P32, 500. On January 5, 2021, Cow filed a P32, 500 claim against the common carrier.
• Goods shipped FOB destination on December 21, 2020, from a vendor to Cow, were received on January 6, 2021.
The invoice cost was P19, 500.
What amount should Cow report as accounts payable on its December 31, 2020 balance sheet? 1,267,500

23. ABC Enterprise owes P200,000 on a truck purchased for use in the business. Assume the company makes timely
principal payments of P50,000 each year at December 31 plus interest at 18%.Which of the following is true? D
A. After the first payment is made, the company owes P150,000 plus three years' interest.
B. Just before the last payment is made, P50,000 will appear as a long-term liability on the balance sheet.
C. After the first payment, P150,000 would be shown as a long-term liability.
D. After the first payment is made, P50,000 would be shown as the current portion due on the long-term note.

24. Included in ABC Corp.'s liability account balances at December 31, 2020, were the following:
14% note payable issued October 1, 2020, maturing September 30, 2021 P375,000
16% note payable issued April 1, 2020, payable in six equal annual installments of P150,000
beginning April 1, 2021 900,000
ABC 's December 31, 2020 financial statements were issued on March 31, 2021. On January 15, 2021, the entire
P900,000 balance of the 16% note was refinanced by issuance of a long-term obligation payable in a lump sum. In
addition, on March 10, 2021, ABC consummated a noncancelable agreement with the lender to refinance the 14%,
P375,000 note on a long-term basis, on readily determinable terms that have not yet been implemented. On the
December 31, 2020 balance sheet, the amount of the notes payable that ABC should classify as short-term obligations
is 0

USE THE FF. DATA FOR THE NEXT TWO REQUIREMENTS:

ABC Co. has a contract with its COO to pay him a 5% bonus for 2020 and 2021. The applicable tax rate is 30% during
these two years.

25. In 2020, income before deductions for the bonus and income taxes was P400,000. If the bonus is based on income
before deduction of the bonus but after deduction of income tax, the bonus (to the nearest peso) is P14,221.

26. In 2021, income before deductions for the bonus and income taxes was P600,000. If the bonus is based on income
after deductions for the bonus and income tax, the bonus (to the nearest peso) is P20,290.

27. Barr Company’s salaried employees are paid biweekly. Occasionally, advances made to employees are paid back by
payroll deductions. Information relating to salaries for the calendar year 2017 is as follows:
12/31/16 12/31/17
Employee advances P12,000 P 18,000
Accrued salaries payable 65,000 ?
Salaries expense during the year 650,000
Salaries paid during the year (gross) 625,000
At December 31, 2017, what amount should Barr report for accrued salaries payable? P90,000.

28. Allen Corp.'s liability account balances at June 30, 2020 included a 10% note payable. The P3,000,000 note was dated
October 1, 2018 and is payable in three equal annual payments of P1,000,000 plus interest. The first interest and
principal payment was made on October 1, 2019. In Allen's June 30, 2020 statement of financial position, what amount
should be reported as accrued interest payable for this note? P150,000.
29. ABC Co. salaried employees are paid biweekly. Advances made to employees are paid back by payroll deductions.
Information relating to salaries follows:
12/31/20 12/31/19
Employee advances P24,000 P 36,000
Accrued salaries payable ? 45,000
Salaries expense during the year 400,000 420,000
Salaries paid during the year (gross) 385,000 390,000
In ABC’s December 31, 2020 balance sheet, accrued salaries payable was Answer: 60,000

30. ABC Co. pays all salaried employees on a biweekly basis. Overtime pay, however, is paid in the next biweekly period.
ABC accrues salaries expense only at its December 31 year end. Data relating to salaries earned in December 2020
are as follows:
Last payroll was paid on 12/26/20, for the 2-week period ended 12/26/20.
Overtime pay earned in the 2-week period ended 12/26/20 was P15,000.
Remaining work days in 2020 were December 29, 30, 31, on which days there was no overtime.
The recurring biweekly salaries total P270,000.
Assuming a five-day work week, ABC should record a liability at December 31, 2020 for accrued salaries of P96,000

31. ABC, Inc. is preparing its financial statements for the year ended December 31, 2020. Accounts payable amounted to
P560,000 before any necessary year-end adjustment related to the following:
• At December 31, 2020, ABC has a P80,000 debit balance in its accounts payable to Ross, a supplier, resulting
from a P100,000 payment for goods to be manufactured to ABC’s specifications. ABC has an existing obligation
to Ross which amounted to P20,000. Such amount represents the value of goods just acquired by ABC from
Ross. Previous experiences of ABC reveal that it pays all its trade obligations with available discount on the
last day of the discount period.
• A check with control number 189 in the amount of P100,000 was written to a vendor and recorded on December
25, 2020. The checks were mailed following the day it was written. However, when the bank statement arrived
on January 2, 2021, it was found out by ABC that such check has not yet presented for encashment. ABC
performs monthly bank reconciliation.
• A check amounted to P87,000 was written and recorded on December 29, 2020. The check was dated January
15, 2021.
• Another check was found inside the drawer of the disbursing officer at the end of December 2020. Such check
shows an amount of P73,000. It was not recorded by ABC yet.
What amount should ABC report as accounts payable in its December 31, 2020 balance sheet? Answer: 747,000

2. Homework (Do-It-Yourself at your own pace)

Answer the following cases and situations applying the applicable standards of accounting for liability. Answers
are provided on or before the next module is released.

Part I: Concepts and Theory

1. Which of the following represents a liability?

A. The obligation to pay for goods that a company expects to order from suppliers next year.
B. The obligation to provide goods that customers have ordered and paid for during the current year.
C. The obligation to pay interest on a five-year note payable that was issued the last day of the current year.
D. The obligation to distribute share of a company's own common stock next year as a result of a stock dividend
declared near the end of the current year.

2. Which of the following does not meet the definition of a liability?

A The signing of a three-year employment contract at a fixed annual salary
B An obligation to provide goods or services in the future
C A note payable with no specified maturity date
D An obligation that is estimated in amount

3. At December 31, 2020, ABC Sales & Service has a P100,000, 120-day note payable outstanding. The company has
followed the policy of replacing the note rather than repaying it over the last three years. The company's treasurer says
that this policy is expected to continue indefinitely, and the arrangement is acceptable to the bank to which the note was
issued. The proper classification of the note on the December 31, 2020, balance sheet is
A. dependent on the intention of management.
B. dependent on the actual ability to refinance.
C. current liability, unless specific refinancing criteria are met.
D. noncurrent liability.
4. ABC Co. has a P20,000, two-year note payable to Second City Bank that matures June 30, 2021. ABC's management
intends to refinance the note for an additional three years and is negotiating a financing agreement with Second City. In
order to exclude this note from current liabilities on its December 31, 2020, balance sheet, ABC Co. must
A. pay off the note and complete the refinancing before the 2020 financial statements are issued.
B. demonstrate an ability to refinance the obligation before the 2020 financial statements are issued.
C. complete the refinancing before the balance sheet date.
D. complete the refinancing before the note's maturity date.

5. T/F. If a liability has become payable on demand because an entity has breached an undertaking under a long-term loan
agreement on or before the reporting date, the liability is current, even if the lender has agreed, after the reporting date
and before the authorization of the financial statements for issue, not to demand payment as a consequence of the
breach.

6. T/F. The liability is classified as non-current if the lender agreed by the reporting date to provide a period of grace ending
at least 12 months after the end of the reporting period, within which the entity can rectify the breach and during which
the lender cannot demand immediate repayment.

7. Some borrowing agreements incorporate covenants which have the effect that the liability becomes payable on demand
if certain conditions related to the covenants are breached. In these circumstances, the liability is classified as noncurrent
when the lender has agreed by the end of the reporting period to provide of grace ending at least twelve months after
that date.

8. A long –term debt which is due to be settled within twelve months after the reporting period is classified as noncurrent
when an agreement to refinance or to reschedule payments on a long-term basis is completed on or before the end of
the reporting period and before the financial statement are authorized for issue.

9. Which of the following statements is false?

A. A debtor firm’s 12/31/20 statement of financial position is to be published 3/1/21. A portion of the debtor’s bonds
outstanding mature December 31 of each year; the portion due 12/31/21 is a current liability
B. A short term payable may be a current maturity of a long term liability, which arises when the next payment on such
debt will be within 12 months from the statement of financial position date
C. Interest may be recognized on a note even though the note does not explicit state an interest rate.
D. A two-year commercial note payable with no stated rate of interest would cause no interest to be recognized during
its time to maturity

10. Consider a media company that receives P1,200 in advance payment at the beginning of its fiscal year from a customer
for an annual newspaper subscription. Upon receipt of the payment, the company's accountants record a debit entry to
______ , and a credit entry to _________ . As the fiscal year progresses, the company sends the newspapers to its
customer and recognizes ______ each month by recording a debit entry to ______ , and a credit entry to ________ .

11. A bank loan spanning two years and carrying 2 equal installments payable at the end of each year would be classified
__________.
12. __________ arises from the purchase of inventory, supplies, or services on an open charge-account basis. The amount
to be recorded is based on the invoice received from the creditor. Expected answer is an account title.

A google document will be shared to everyone under my IA classes to raise your questions and concerns about the topic. I will answer
your query as fast as possible. This document will stay active up until the duration of the course.

Part II: Application and Problem Solving

Below are series of hypothetical cases, adapted or self-made. Provide the requirement/s from each case.
Answers are provided on or before the next module is released.

13. On July 1, 2020, ABC Manufacturing Co. issued a five-year note payable with a face amount of P250,000 and an interest
rate of 10 percent. The terms of the note require ABC to make five annual payments of P50,000 plus accrued interest,
with the first payment due June 30, 2021. With respect to the note, the current liabilities section of ABC's December 31,
2020, balance sheet should include

14. Included in ABC Corporation's liability account balances at December 31, 2020, were the following:
14 percent note payable issued October 1, 2020, maturing September 30, 2021 P250,000
16 percent note payable issued April 1, 2018, payable in six annual installments of
P100,000 beginning April 1, 2019 400,000
ABC's December 31, 2020, financial statements were issued on March 31, 2021. On January 15, 2021, the entire
P400,000 balance of the 16 percent note was refinanced by issuance of a long-term obligation payable in a lump sum.
In addition, on March 10, 2021, ABC consummated a noncancelable agreement with the lender to refinance the 14
percent, P250,000 note on a long-term basis, on readily determinable terms that have not yet been implemented. Both
 parties are financially capable of honoring the agreement, and there have been no violations of the agreement's
provisions. On the December 31, 2020, balance sheet, the amount of the notes payable that ABC should classify as
noncurrent obligations is

USE THE FF. DATA FOR THE NEXT TWO REQUIREMENTS:

ABC Company has income of P100,000 before considering the bonus expense. According to the terms of the bonus
agreement, ABC is to set aside 20 percent of its income for distribution to employees.
15. If ABC is to base bonus on net income after bonus, how much is the bonus?
16. Assume income of P100,000 computed without subtracting either the employees’ bonus or income taxes. The bonus is
to be based on income after deducting income taxes but before deducting the bonus. Compute the bonus.

USE THE FF. DATA FOR THE NEXT TWO REQUIREMENTS:

ABC Department Store sells gift certificates redeemable only when merchandise is purchased. These gift certificates have
no expiration date. Upon redemption, ABC recognizes the unearned revenue as realized. Information for 2020 is as follows:
Unearned revenue, 1/1 650,000
Gift certificates sold 2,250,000
Gift certificates redeemed 1, 950,000
Cost of goods sold 60%
17. On December 31, 2020 what amount should ABC report as unearned revenue?
18. Given the above information, what is the net income assuming the operating expenses amounted to 180,000 and enacted
tax rate is 30%?

USE THE FF. DATA FOR THE NEXT TWO REQUIREMENTS:

Ryan Company sells major household appliances service contracts for cash. The service contracts are for a one-year, two-
year, or three-year period. Cash receipts from contracts are credited to unearned service contract revenue. This account
had balance of P720,000 at December 31, 2020 before year-end adjustment. Service contract cost are charged as incurred
to the service contract expense account, which had a balance of P180,000 at December 31, 2020. Outstanding service
contracts at December 31, 2020 expire as follows:
During 2021 150,000
During 2022 225,000
During 2023 100,000
19. What amount should be reported as unearned service contract revenue in Ryan’s December 31, 2020 statement of
financial position?
20. Assume the applicable tax rate for the year 2020 is 30%, determine the net income.

21. ABC Company’s salaried employees are paid biweekly. Occasionally, advances made to employees are paid back by
payroll deductions. Information relating to salaries for the calendar year 2020 is as follows:
12/31/19 12/31/20
Employee advances P 24,000 P 36,000
Accrued salaries payable 182,000 ?
Salaries expense during the year 1,820,000
Salaries paid during the year (gross) 1,750,000
At December 31, 2020, what amount should ABC report for accrued salaries payable?

22. The liabilities section of the balance sheet of Honduras Company detailed the following:
Accounts payable 1,500,000
Notes payable – trade 2,000,000
Bank note payable – 10% 600,000
Bank note payable – 12% 1,000,000
Accrued expenses 400,000
Accrued interest payable 305,000
Mortgage note payable – 6% 3,000,000
Mortgage note payable – 8% 4,500,000
Bonds payable – 10%, due June 30, 2021 5,000,000

The 10% bank note payable is issued on March 1, 2020, payable on demand and interest is payable every 6 months.
The 12% bank note payable is a one-year note issued on January 2, 2020. On December 31, 2020, Honduras
negotiated with the bank to replace the note with a two-year 10% note to be issued on January 2, 2021.

The 6% 10-year mortgage note was issued on October 1, 2017. Terms of the note give the holder to demand payment
if the company fails to make a monthly interest payment. On December 31, 2020, Honduras is 3 months behind in
paying its required interest.

The 8%10-year mortgage note was issued on May 1, 2017. Principal and interest are payable annually on April 30. A
payment of P860,000 is due on April 30, 2021 and includes interest of P360,000. What is the total amount of current
liabilities on December 31, 2020?
23. QRS Corporation had accounts payable of P5,000,000 recorded in the general ledger as of December 31, 2020 before
consideration of the following unrecorded transactions:
Invoice Date Date
date Amount shipped received FOB terms
1-3-21 P400,000 12-22-19 12-24-19 Destination
1-2-20 650,000 12-28-19 1-2-20 Shipping point
12-26-20 600,000 1-2-20 1-3-20 Shipping point
1-10-21 450,000 12-31-20 1-5-20 Destination
In the December 31, 2020 statement of financial position, the accounts payable should be reported in the amount
of

24. ABC provided the following information on December 31, 2020:

Accounts payable after deducting debit balances in suppliers’
accounts of P100,000 P500,000
10% Note payable – due March 31, 2021 (interest is payable every March 31) 1,000,000
12% Note payable – due May 1, 2021 (interest is payable every May 31) 800,000
8% Bonds payable – due December 31, 2022, interest payable annually, 12-31 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. Interest on the 2 notes payable were not
yet accrued by ABC. Determine the total current liability

25. ABC provided the following information on December 31, 2020.

Stock dividend payable P2,000,000
Accounts payable 3,000,000
Payroll taxes withheld from employees 900,000
Bank overdraft, VAT Account at Philippine Bank 1,300,000
Accounts receivable with credit balance 750,000
Estimated expenses of meeting warranties on merchandise sold previously 450,000
Estimated damages as a result of unsatisfactory performance on a contract 1,300,000
Serial bonds, issued January 1, 2020 at par, bearing 12% interest, payable
In semi-annual installments of P500,000, every June 30 and December 30
To commence 2022. Interest is to be paid annually every December 31 5,000,000
Compute the total current liability

ASSESSMENT

Scheduled Online Quiz Through Moodle Platform

Instruction: Please check the announcement portion of Moodle for any announced assessment.

References:

Conceptual Framework for Financial Reporting

International Accounting Standard 1 - Presentation of Financial Statements
IAS 32 - Financial Instruments: Presentation
Intermediate Accounting Volume II, 2019 Edition, Valix, Peralta, Valix
Intermediate Accounting, IFRS 2nd Edition, Kieso, Weygandt, and Warfield
https://www.iasplus.com/en/standards/ifrs/ifrs9
https://www.investopedia.com/terms/r/refinance.asp
https://www.investopedia.com/terms/c/covenant.asp
https://www.wikiaccounting.com/non-financial-liabilities/
https://www.investopedia.com/ask/answers/032615/what-difference-between-deferred-revenue-and-accrued-
expense.asp
http://www.officialgazette.gov.ph/downloads/2023/12dec/20231219-RA-10962-RRD.pdf