JPIA-HAU

FINANCIAL ACCOUNTING Covenants - undertakings by the borrower

or restrictions on the borrower
AND REPORTING 2 • Breach of covenants
Liabilities and Shareholders’ Equity o Violation on the covenants
undertaken
Overview of the Handouts: o Liability payable on demand
1. Liabilities o Classified as current unless if
2. Estimates – Premium and Warranty there is an agreement on or
3. Contingent Liabilities before the reporting period that
4. Notes Payable grace period ending twelve
5. Bonds Payable months after that date
6. Compound Financial Instrument
7. Share Capital and Other Shareholders’ Presentation
Equity Item • Trade and other payables line item for
accounts, notes, accrued interest, and
I. LIABILITIES dividends payable
• Current provisions
Liabilities - present obligations of an entity to
• Short term borrowing
transfer an economic resource as a result of
• Current portion of long-term debt
past events
• Current tax liability
• Present obligation - Duty that an entity
has no practical ability to avoid
Other Concerns
• Obligation to transfer an economic
• Estimated Liability - obligations which
resource - Transfer of asset or provide
exist at the end of the period though
service at some future time
their amount and sometimes the due
• Arises from past event - liability is not
date are not definite
recognized until it is incurred
• Deferred Revenue - income received
but not yet earned
Measurement
o Both might be current or
• Current Liabilities
noncurrent depending when they
o Conceptually measured at
will be incurred/realized
present value and subsequently
respectively.
measured at amortized cost
• Gift certificates – example of deferred
o Not discounted anymore
income
o Face amount
• Refundable deposits – cash or
• Noncurrent Liabilities
property received from customers but
o Bonds and noninterest bearing
which are refundable after compliance
notes are initially measured at
with certain conditions.
present value and subsequently
at amortized costs
Bonus
o Long term note is measured at
face amount • Bonus before bonus and tax
• Bonus after bonus and before tax
Current Liability • Bonus after bonus and tax
• Characteristics • Bonus before bonus and after tax
o Expects to settle within the
entity’s operating cycle II. ESTIMATES – PREMIUM AND
o Primarily on trading WARRANTY LIABILITY
o Due to be settled within twelve
months after reporting period Premiums – articles of value given to
o No unconditional right to defer customers as result of past sales or sales
settlement of the liability promotion activities. Used to stimulate sales.
• Long-term debt failing due within one
year Accounting procedures
o Current if (1) original term was a • Record sales
period longer than twelve months • Record purchase of premiums
(2) and agreement to refinance or • Record redemption
to reschedule is completed after • Record liability for premiums
the reporting period and before
the financial statements are Cash Rebate Program
authorized to issue • Recognize cash rebate programs
• Record payments of customer
FAR 2 Handout – Liabilities and Shareholders’ Equity
 JPIA-HAU
Cash Discount Coupon Recognition
• Recognize cash discount coupon • Present obligation, legal or
• Record payment of retailers constructive as a result of past event
• Probable outflow of resources
Customer Loyalty Program - entity grants • Amount of obligation can be
customer award credits often described as measured reliably
points. Accounted for separately from initial
sale transaction. The fair value of the Present Obligation
consideration received from initial sale shall be • Legal obligation - arising from
allocated between the award credits and sale contract, legislation or other operation of
based on stand-alone price. Accounting law
procedures for customer loyalty program are: • Constructive - derived from an entity s
• Allocate the transaction price action
• Record initial sale o It will accept certain
• Record redemptions responsibilities
o Valid expectation
Third Party Operated Loyalty Program
• Record initial sale Past Event
• Record payment to third party • No accounting provision for future event
• Obligating event leads to a present
Warranty – sale under guarantee to provide obligation
free repair service or replacement during a o Settlement of the obligation can
specified period if products defective be enforced by law
o Creates valid expectations
Recognition
• Present obligation (legal or Probable Outflow of Economic Benefits
constructive), as a result of past event • Probable to more likely than not to occur
• Probable outflow of resources • More than 50 likely
• Can be measured reliably • Possible 50 or less likely to occur
• Remote 10 or less likely to occur
Accounting for Warranty
• Accrual Approach Reliable Estimate
o Soundest theoretical support 1. Estimates are essential part of the
o Matching principle preparation of FS and does not
o Estimate is reviewed to undermine their reliability
determine reasonableness and 2. Use range of possible outcomes
accuracy 3. Where no reliable estimate can be
o Any difference change in made, no liability is recognized
estimate
• Expense as incurred approach Measurement of Provision
o Expensing warranty cost only • Best estimate amount that an entity
when actually incurred would rationally pay to settle the
o Warranty cost is immaterial obligation
o Warranty period is short • Single obligation is being measured
most like outcome adjusted to the effect
Sale of Warranty of other possible outcomes
• Warranty is sold separately from the • Range of possible outcomes midpoint
product • Large population of items weighting all
• Extended warranty additional cost possible outcomes
• Recorded separately
• Deferred income Other Measurement Considerations
• Amortized straight line over life of 1. Risks and uncertainties
warranty or revenue is recognized in 2. Present value of obligation
proportion to the costs to be incurred 3. Future events
annually 4. Expected disposal of assets
5. Reimbursements
III. CONTINGENT LIABILITIES 6. Changes in provision
7. Use of provision
Provisions - existing liability of uncertain 8. Future operating losses
timing or amount 9. Onerous contract

FAR 2 Handout – Liabilities and Shareholders’ Equity


Risks and Uncertainties
• Inevitably surround events and
circumstances shall be taken into
account
• Risks variability of outcome
• Increase the amount at which a liability
is measured
• Prudence caution is needed in making
judgment under conditions of
uncertainty
Present Value of Obligation
• Effect of time value of money is material
• Discount rate should be pretax rate that
reflects the current market assessment
• Discount rate should not reflect the risk
for which cash flow estimates have
already been adjusted
Future Events
• Affect the amount required to settle an
obligation shall be reflected in the
amount of a provision where there is a
sufficient evidence that they will occur
• Includes new legislation and changes in
technology
Expected Disposal of Assets
• Gains from expected disposal of assets
shall not be taken into account
• Recognize gain on disposal at the time
of the disposition of the assets
• Any cash inflows from disposal are
treated separately from the
measurement of the provision
Reimbursements
• Virtually certain
• Treated as separate asset and not
netted against the estimated liability
• Shall not exceed the amount of the
provision
• Income statement expense net of
reimbursement
Changes in Provision
• Provisions are reviewed every end of
the reporting period
• Adjusted to reflect the current best
estimate
• Reversed if no longer probable
• Discounting carrying amount of the
provision increases each period to
reflect passage of time
Use of Provision
• Used only for expenditures for which the
provision was originally recognized
FAR 2 Handout – Liabilities and Shareholders’ Equity
JPIA-HAU
• Expenditure charged against a
provision that was originally
recognized for another purpose
constitute financial reporting fraud
Future Operating Losses
• Provision shall not be recognized for
future operating losses
• A past event creating a present
obligation has not occurred
• Expectation of future operating losses
impairment test
Onerous Contract
• Unavoidable costs of meeting the
obligation under the contract exceed the
economic benefits expected to be
received under it
• Lower amount between the cost of
fulfilling the contract and the
• compensation or penalty arising from
failure to fulfill the contract
Examples of Provision
1. Warranties
2. Environmental contamination
3. Decommissioning or abandonment
costs
4. Court case
5. Guarantee
Restructuring
• Program that is planned and controlled
by management and materially changes
wither the scope of a business of an
entity or the manner in which that
business is conducted
• Events
o Sale or termination of line of
business
o Closure of business location
o Change in management structure
o Fundamental reorganization
Provision for Restructuring
• Required because a constructive
obligation may arise from the decision to
restructure
• Arises when two conditions are present:
o Detailed formal plan for
restructuring
o Valid expectation
Amount of Restructuring Program
• Include direct expenditures
• Excludes the following
o Cost of retraining or relocating
continuing staff
o Marketing or advertising program
to promote the new company
image

o Investment in new system and
distribution network
Contingent Liability
Contingent Liability – Possible obligation that
arises from past event and whose existence
will be confirmed only by the occurrence or
nonoccurrence of future events
• Possible obligation
o Arises from past event
o Confirmed by the occurrence or
nonoccurrence
o Not wholly within the control of
the entity
• Present obligation
o Arises from past event but not
recognized
o Not probable that an outflow of
resources
o Or the amount of obligation
cannot be measured reliably
Contingent Liability and Provisions
• Contingent Liability - either probable or
measurable but not both
• Provisions - probable and measurable
Treatment of Contingent Liability
• Shall not be recognized in the FS but
shall be disclosed only.
• Required disclosures
o Brief description
o Estimate of its financial effects
o Indication of the uncertainties
o Possibility of any reimbursement
Contingent Asset
• Possible asset that arises from past
event and whose existence will be
confirmed only by the occurrence and
nonoccurrence of future event/s
• Shall not be recognized because it may
result to an income that may never
realized
• Virtually certain recognition is
appropriate
• Disclosed when probable
• Possible or remote not disclosed
Decommissioning Liability
• Obligation to dismantle, remove and
restore an item of PPE as required by
law or contract
• Asset retirement obligation
Change in Decommissioning Liability
• Decrease in the liability is deducted from
the cost of the asset (If the decrease in
FAR 2 Handout – Liabilities and Shareholders’ Equity
JPIA-HAU
liability exceeds the carrying amount
recognized in P&L)
• Increase in liability is added to the
cost of the asset (Consider whether
this is an indication that the carrying
amount of the asset may not be fully
recoverable impairment test)
IV. NOTES PAYABLE
Notes Payable - liability account in which a
borrower’s written promise to pay to a lender is
recorded. The written note specifies the
principal amount, the date due, and the interest
to be paid.
Initial Measurement
• Irrevocably Designated
o Fair Value
o Transaction costs – expensed
outright
• Not designated to fair value through
profit or loss
o Fair value and directly
attributable costs
Subsequent Measurement
• Amortized cost - effective interest
method
• Fair value through P&L designated
irrevocably
Amortized Cost of Notes Payable
• Minus principal repayment
• Plus or minus the cumulative
amortization using the effective interest
method of any difference between the
face amount and present value of the
note payable
Types of Notes Payable
• Notes issued solely for cash – present
value is the cash proceeds
• Interest bearing note issued for property
– present value is the purchase price
(PV of the note)
• Non-interest-bearing note issued for
property
o Property = Cash price (PV of note
issued)
o Difference between the cash
price and the face of the note
issued represents imputed
interests
o Imputed interest no lender will
lend asset interest free
Bonds Payable Issued with Share Warrants
• Allocation of issue price
o Bonds = market value of the
bonds ex warrant

o Warrants = residual amount
• Unknown MV of bonds ex warrant
o Bond = PV of principal + PV of
future interest payments
Convertible Bonds
• Holders gives the right to convert their
bonds into shares
• Securities – bonds and conversion
privilege
• Allocation of price
o Bonds = market value of the
bonds without the conversion
privilege
o Conversion privilege=residual
amount
• Unknown MV of Bonds without the
conversion privilege
o Bond = PV of principal + PV of
future interest payments
Fair Value Option
• Gain or loss on financial liability
designated at fair value shall be
accounted for as follows:
o Change in fair value attributable
to credit risk is recognized in OCI
o The remaining amount of the
change in fair value is recognized
in P&L
V. BONDS PAYABLE
Types of Bonds
1. Term bonds - single date maturity and
sometimes require to establish a sinking
fund
2. Serial bonds – series of maturity dates
where principal is retired by installment
3. Secured Bonds – secured by a
mortgage or a collateral
4. Unsecured Bonds – they are not
secured by any mortgage or collateral
5. Registered Bonds – requires registration
if the bondholders
6. Coupon/bearer – unregistered bonds
7. Convertible Bonds – can be exchanged
for shares for issuing entity
8. Callable Bonds – may be called for
redemption prior to maturity date
9. Junk Bonds – high-risk, high-yield bonds
issued by heavily indebted entities
10. Zero-coupon Bonds – pay no interest
but bonds return in a form of a deep
discount
11. Guaranteed Bonds – issued whereby
another party promises to make
payment if the borrower fails to do so
Initial Measurement
FAR 2 Handout – Liabilities and Shareholders’ Equity
JPIA-HAU
• Fair value through profit or loss – fair
value
• Not designated as fair value through
profit or loss – fair value and directly
attributable cost
Subsequent Measurement
• Amortized cost (EIR method)
• Fair value through profit or loss
Amortized Cost
• It is the amount of bond liability less
principal repayment plus or minus
cumulative amortization using the
effective interest method
• Difference on face amount and present
value is either discount or premium
Accounting for Issuance of Bonds
• Memorandum approach
o Authorization of the bonds is
recorded in the general journal
using a memorandum entry
o Generally followed
• Journal Entry Approach
o Authorization of the bonds is
recorded in the general journal
using a journal entry
Issuance of Bonds
• Premium
o Sales price > Face amount
o Effective interest rate < Nominal
rate
o Premium is an addition to the
bond payable
• Discount
o Sales price < Face amount
o Effective interest rate > Nominal
rate
o Discount is a deduction to the
bond payable
• Bond Issue Cost
o Transaction costs directly
attributable to the issue of bonds
payable
o Deducted to the fair value or
issue price of bonds
o FV through P&L expensed
outright
• Recording Interest on Bonds
o Payment of interest during the
year
o Accrual of interest at the end of
the year
• On interest dates
o Issuing company collects the fair
value of the bonds
• Between Interest Dates
o Issuing company collects from
investors the interest that has

accrued since the last interest
payment date
o Corporation will pay the interest
for the entire interest period
Bond Retirement
• On maturity date - trustee of sinking
fund sells the securities and uses the
sinking fund cash to pay the
bondholders on the date of maturity
• Prior to maturity date - bonds are
reacquired prior to maturity date, they
are cancelled and permanently retire, or
held in the treasury
Treasury Bonds
• Entity s own bonds originally issued and
reacquired but not cancelled
• Debited at face amount
• Reissuance of treasury bonds
o At a premium - Bonds are
reissued higher than the face
value
o At a discount – Bonds are
reissued lower than the face
value
Bond Refunding
• Floating of new bonds and the proceeds
are used to pay the original bonds
• Premature retirement of old bonds by
issuing new bonds
• Also known as bond refinancing
Effective Interest Method
• Required by PFRS 9 to be the method
used in the amortization of bonds
• Also known as Interest method
VI. COMPOUND FINANCIAL
INSTRUMENT
Financial Instrument - According to PAS 32,
financial instrument is a contract that gives rise
to both a financial asset of one entity and a
financial liability or equity instrument of
another. Its characteristics are:
• Financial asset of one party and
financial liability or equity instrument to
another
• Two parties
• Contract
Financial Liability
• Contractual Obligation
o to deliver cash or another
financial asset
o to exchange financial instruments
with another entity under
conditions that are potentially
unfavorable
FAR 2 Handout – Liabilities and Shareholders’ Equity
JPIA-HAU
Equity Instrument
• Contract that evidences a residual
interest in the assets
Bonds Payable Issued with Share
Warrants
• Allocation of share warrants
o Bonds = market value of the
bonds ex warrant
o Warrants = residual amount
• Unknown market value of bonds without
warrants
o Bond = PV of principal + PV of
future interest payments
Convertible Bonds
• Allocation of share warrants
o Bonds = market value of the
bonds without the conversion
privilege
o Conversion privilege=residual
amount
• Unknown market value of bonds without
conversion privilege
o Bond = PV of principal + PV of
future interest payments
VII. SHARE CAPITAL AND OTHER
SHAREHOLDERS’ EQUITY ITEM
Definition of Terms
1. Corporation - Artificial being created by
operation of law, having the right of
succession and the powers, attributes,
and properties expressly authorized by
law or incident to its existence
2. By-laws - Rules of action adopted by the
corporation for its internal government
3. Corporators - Compose the corporation
whether shareholders or members or
both
4. Incorporators - Corporators mentioned
in the articles of incorporation as
originally forming and composing the
corporation
5. Shareholders – holders or owners of
shares
6. Members - corporators of a nonstock
corporation
7. Organization cost - cost incurred in
forming or organizing a corporation
8. Legal capital - Portion of the paid in
capital arising from issuance of share
capital which cannot be returned to the
shareholders in any form during the
lifetime of the corporation
9. Trust fund doctrine - Share capital of a
corporation is considered as trust fund
for the protection of creditors

10. Share capital - paid in capital
representing the total par or stated value
of the shares issued
11. Subscribed share capital - Authorized
share capital that has been subscribed
but not yet full paid (unissued)
12. Share premium - Representing excess
over the par or stated value
13. Retained earnings - Cumulative balance
of periodic earnings, dividend
distribution, and other capital
adjustments
14. Revaluation surplus - Excess of
revalued amount over carrying amount
15. Treasury shares - Corporation’s own
share that have been issued and then
reacquired
Variety of Ownership Interests
• Common stock represents basic
ownership interest:
o Bears ultimate risks of loss
o Receives the benefits of success
o Not guaranteed dividends nor
assets upon dissolution
• Preferred stock
o Created by contract, when
stockholders’ sacrifice certain
rights in return for other rights or
privileges, usually dividend
preference.
Accounting for Share Capital
• Memorandum method - no entry to
record authorized share capital
• Journal entry method - authorization to
issue share capital is recorded by
debiting unissued share capital and
crediting authorized share capital
Issuance of Shares
• Accounting issues
o Par value shares
o No par shares
o Shares issued in noncash
transactions
o Costs of issuing shares
Par Value Shares
• Corporations maintain accounts for
o Preferred Share or Common
Share
o Additional Paid in Capital/Share
Premium
No-par Shares
• Reason for issuance
o Avoids contingent liability
o Avoids confusion over recording
par value versus fair market
value
FAR 2 Handout – Liabilities and Shareholders’ Equity
JPIA-HAU
• Minimum consideration for issued or
stated value is P5
Share Issued for Non-cash Consideration
• The general rule Companies should
record share issued for services or
property other than cash on the
following order of priority:
o Fair value of the noncash
consideration received,
o Fair value of the shares issued
o Par value of the shares issued
• Direct costs incurred to sell stock, such
as:
o underwriting costs,
o accounting and legal fees,
o printing costs, and
o taxes.
• should be reported as a reduction of the
amounts paid in (additional paid in
capital/share premium)
Preferred Share
• Features often associated with preferred
stock:
o Preference as to dividends
o Preference as to assets in
liquidation
o Convertible into common stock
o Callable at the option of the
corporation
o Non-voting
• Specific Features of Preferred Share:
o Cumulative
o Participating
o Convertible
o Callable
o Redeemable
Treasury Share
• If a company buys back its own shares,
the repurchased shares are called
treasury share
• They have issued but not outstanding
status
• The acquisition of treasury reduces cash
and shareholders' equity, and treasury
share is a contra equity account
(subtracted from shareholders' equity)
• Companies buy back stock for various
reasons:
o To support the stock price
o To have available shares for
employee stock option plans
o To take off the market shares
which could be purchased by a
hostile buyer
Types of Dividends
• Cash dividends
 JPIA-HAU
o Board of Directors vote on the
declaration of cash dividends
o A declared cash dividend is a
liability
o Companies do not declare or pay
cash dividends on treasury stock
• Property dividends
o Dividends payable in assets other
than cash
o Restate at fair value the property
it will distribute, recognizing any
gain or loss
• Scrip dividends
o Issued in the form of a certificate
instead of cash
• Bond Dividend
o Shareholders have stronger claim
against the company
o Carry interest
• Stock dividends
o Issuance of own stock to
stockholders on a pro rata basis,
without receiving any
consideration
o When stock dividend is less than
20 25 percent of the common
shares outstanding, company
transfers fair market value from
retained earnings (small stock
dividend)
• Liquidating dividends
o Any dividend not based on
earnings reduces corporate paid
in capital
• Dividends require information
concerning three dates:
o Date of declaration
o Date of record
o Date of payment

Share Split
• No entry recorded for a share split
• Split up
o To reduce the market value of
shares
o Decrease par value and
increased number of shares
• Split down
o Increase market value of shares
o Increase par value and decrease
number of shares

FAR 2 Handout – Liabilities and Shareholders’ Equity