FINANCIAL ACCOUNTING & REPORTING 2

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Accounting for Liabilities – Current Liabilities

Module 003 Accounting for Liabilities-Current

Liabilities (Part 3)

Probably the most accepted accounting definition of a liability is the one used
by the International Accounting Standards Board (IASB). The following is a
quotation from the International Financial Reporting Standards (IFRS)
Framework: "A liability is a present obligation of the enterprise arising from
past events, the settlement of which is expected to result in an outflow from
the enterprise of resources embodying economic benefits."
Types of liabilities found on a company's balance sheet include: current
liabilities like notes payable, accounts payable, interest payable, and salaries
payable. Liabilities can also include deferred revenue accounts for monies
received that may not be earned until a future accounting period.
At the end of this module, you will be able to:
1. Recognize current non-financial liabilities
2. Account for each current non-financial liabilities

Accounting of current non-financial liabilities

Accrued liabilities
Accrued liabilities consist of obligations for expenses incurred on or before
the reporting date but payable at a later date. Accrued liabilities include
those payables to specific persons and determinable with reasonable
accuracy. They also include provisions. Common examples of liabilities of this
nature are accrued salaries, accrued interests, accrued rentals and accrued
taxes. An accrued liability is taken up as an adjustment at year end by
charging an expense account and crediting an accrued liability account.
Warranty
Home appliances like television sets, ratio sets, refrigerators and the like are
often sold under the guarantee or warranty to provide free repair service or
replacement during a specified period if the products are defective.
Such entity policy may involve significant costs on the part of the entity if the
products sold prove to be defective in the future within the specified period
of time.

Accordingly, at the point of sale, a liability is incurred.

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There are two approaches followed in accounting for warranty cost, namely
“accrual” approach and “expense as incurred” approach.

Accrual Approach

The accrual approach has the soundest theoretical support because it

properly matches cost with revenue. This is recorded as follows:
Warranty expense xx
Estimated warranty liability xx

When actual warranty cost is subsequently incurred and paid the entry is:

Estimated warranty liability xx

Cash xx

At a certain date, the estimate is reviewed to determine its reasonableness

and accuracy. The actual warranty cost is analyzed to validate the original
estimate.

Any difference between estimate and actual cost is a change in estimate and
therefore treated currently or prospectively, if necessary. Thus, if the actual
cost exceeds the estimate, the difference is charged to warranty expense as
follows:

Warranty Expense xx
Estimated warranty liability xx

The subsequent payment of the warranty cost is then charged to the

estimated liability account. If the actual cost is less than the estimate, the
difference is an adjustment to the warranty expense as follows:

Estimated warranty liability xx

Warrant Expense xx

Illustration:

An entity sells 1,000 units of electric fan at P2,000 each for cash. Each set is
under warranty for one year and the entity has estimated from past
experience that warranty cost will probably average P100 per unit and that
only 60% of the units sold will be returned for repair. The entity incurs
P40,000 for repairs during the year.

The pertinent entries are:

1. To record the sales”
Cash 2,000,000
Sales 2,000,000
2. To set up the estimated liability on the warranty:
Warranty expense* 60,000
Estimated warranty liability 60,000
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*(60% x 1,000 sets) x P100 per unit

3. To record the payment of the actual cost:
Estimated warranty liability 40,000
Cash 40,000

The statement of financial position at the end of the year would report
estimated warranty liability of P20,000 as a current liability, and the income
statement for the year would show warranty expense of P60,000.

If the warranty runs over a period of more than one year, a portion of the
estimated warranty liability shall be reported as current liability and the
remaining portion as noncurrent liability and the remaining portion as
noncurrent liability.

Expense as incurred approach

The “expense as incurred approach “is the approach of expensing warranty
cost only when actually incurred.

This approach is popular in practice because it is the one recognized for

income tax purposes and frequently justified on the basis of expediency
when warranty cost is not very substantial or when the warranty period is
relatively short.

Premiums
Premiums are articles of value such as toys, dishes, silverware and other
goods and in some cases cash payments, given to customers as result of past
sales or sales promotion activities. In order to stimulate the sale of their
products, entities offer premiums to customers in return for product labels,
box tops, wrappers and coupons. Accordingly, when the merchandise in sold,
an accounting liability for the future distribution of the premium arises and
should be given accounting recognition. The cost of the premiums should be
matched as expenses against revenues on the period of sale.
The accounting procedures for the acquisition of premiums and recognition
of the premium liability are as follows:
1. When the premiums are purchased:
Premiums xx
Cash xx
2. When the premiums are distributed to the customers:
Premium expense xx
Premiums xx
3. At the end of the year, if premiums are still outstanding:
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 Premium expense xx
Estimated premium liability xx

Illustration
ABC Company manufactures and sells product at P300 per unit. A mug is
offered to customers on the return of 5 wrappers plus a remittance of P10.
The costs of the mug is P50 and is estimated that 60% of the wrappers will
be redeemed. The data for the first year are summarized below:
Sales, 10,000 units at P300 each 3,000,000
Mugs purchased, 2,000 units at P50 each 100,000
Wrappers redeemed 4,000

Entries for the first year and year-end adjustment are:

1. To record sales:
Cash 3,000,000
Sales 3,000,000
2. To record the purchase of the premiums:
Premiums-Mug 100,000
Cash 100,000
3. To record the redemption of 4,000 wrappers:
Cash (800x10) 8,000
Premium expense (800x50) 32,000
Premiums-Mug 40,000
4. To record the liability for the premiums at the end of the first year:
Premium expense 16,000
Estimated premium liability * 16,000
*Wrappers to be redeemed (60%x10,000) 6,000
Less: Wrappers redeemed 4,000
Balance 2,000
Premiums to be distributed (2,000/5) 400
Estimated liability (400x40) 16,000

Customer loyalty program

Customer loyalty program is mostly used by entities to build brand loyalty,
retain their valuable customers and of course, increase sales volume. This is
generally designed to reward customers for past purchases and to provide
them with incentives to make further purchases.
Under IFRIC 13, an entity shall account for the award credits as a “separately
component of the initial sale transaction”. In other words, the granting of
award credits is effectively accounted for as a “future delivery of goods or
services”.
Accordingly, the fair value of the consideration received with respect to the
initial sale shall be allocated between the award credits and the sale.
The consideration allocated to the award credits is measured at fair value,
meaning the amount for which the award credits could be sold separately.
The subsequent recognition of the amount allocated to the award credits as
revenue depends on the following:
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a. The entity supplies the award itself

If the entity supplies the award itself, the consideration allocated to the
award credits is initially recognized as deferred revenue and
subsequently recognized as revenue when the award credits are
redeemed.

b. A third party supplies the award

If an award is supplied by a third party, the amount received as
consideration for goods or services is recognized as revenue in full and
an expense is recognized for the points granted to customers.
Liability for Bonuses
As an incentive to officers and employees, many companies establish a bonus
agreement, with the bonus usually payable shortly after the end of the year.
This bonus, in effect, part of salaries or compensation expense and is
reported as an operating expense of the company.
Illustration:
Income of C Company is P2,000,000. This income is before deducting bonus
(B)and income tax (T). Bonus rate is 10% and income tax rate is 30%.
Case 1: Bonus is based on profit before deducting bonus and income tax.
B= 10% x 2,000,000 = P200,000
T= 30% x (2,000,000-200,000) = 540,000
Case 2: Bonus is based on profit after deducting bonus but before deducting
income tax
B= 10% x (2,000,000-B)
= 200,000-10%B
= 200,000/1.10 = 181,818
T= 30% (2,000,000-181,818) = 545,455
Deposits and advances
Deposits and advances consists of cash or property received which are
returnable to the depositor or which have been collected or otherwise
accumulated to be remitted to third parties.
Illustration:
Balance of deposits for returnable containers 1/10/2017 P250,000
Deposits received for containers of products sold in 2017 800,000
Deposits refunded during 2017 upon return of containers 720,000
Deposits not returned with prescribed period 60,000
Cost of containers not returned 55,000

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 Accumulated depreciation on containers not returned 15,000

The following are the entries to record the transactions:

1. Deposits on returnable containers received during the year
Cash 800,000
Customer deposits 800,000
2. Refunds to customer for container received
Customer deposits 720,000
Cash 720,000
3. Gain on sale of returnable containers deposit forfeited on containers not
returned within prescribe period
Customer deposits 60,000
Accumulated depreciation 15,000
Returnable containers 55,000
Gain on sale 25,000
Notice that the containers not returned within the prescribed period
are considered sold.

Unearned revenue
Unearned revenues are amounts collected in advance that have not yet been
earned and recorded as revenues pending completion of the earning process.
For these items, journal entries to record collection in advance and
subsequent recognition of revenue are made either based on liability method
or income method. Under the nominal approach or income method, the entry
for the advance collection of revenue is
Cash xxx
Revenue xxx
Under the liability method, the entry for the advance collection is
Cash xxx
Unearned revenue xxx
At the end of the accounting period, an adjusting entry is made to reflect the
amount earned and still unearned, thus:

Nominal approach Liability approach

To record the unearned portion To record the earned portion

Revenue xxx Unearned revenue xxx
Unearned revenue xxx Revenue xxx
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Unearned service contracts

Recognition of revenue from service contract is measured by the passage of
time or the lapsing of the service contract period.
Illustration:
X Corp sells service contracts for computer units that cover a two-year
period. The sales price each contract is P750. X experience shows that the
total pesos spent for repairs in service contracts, 40% is incurred evenly
during the first contract year and 60% during the second contract year.
During 2017, X sold 1,000 contracts. Cost of servicing the units during 2017
amounted to P80,000.
Journal entries during 2017 are as follows:
1. Sales of service contracts
Cash 750,000
Unearned service revenue 750,000
2. Costs incurred
Cost of service contract 80,000
Cash, Materials,etc. 80,000
3. Revenue for the period
Unearned service contract 150,000
Revenue (750,000 x ½ x 40%) 150,000
Gift certificates payable
Some retail stores sell gift certificate to customers which are redeemable in
merchandise. Accounting procedures are:
1. When the gift certificates are sold:
Cash xx
Gift certificate payable xx
2. When the gift certificates are sold
Gift certificate payable xx
Sales xx
3. When the gift certificate expire
Gift certificate payable xx
Forfeited gift certificate xx
Value-added Taxes
Value-added taxes are levied on the transfer of tangible personal property
and on certain services. It must be collected from the customer by the seller
and remitted on a monthly basis to the proper government authority (i.e
Bureau of Internal Revenue).
1. Sales revenue of the seller company is recorded as:
Cash/Accounts receivable xxx
Sales xxx

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 Output VAT xxx
2. When goods or services are acquired from companies subject to value
added tax, the entry is
Purchases/Asset/Expense xxx
Input VAT xxx
Cash/Accounts payable xxx
3. Upon remittance to the BIR of the appropriate value added taxes, the
balance of the input VAT is offset against the balance of the Output VAT,
the net amount represents the net liability to the BIR.
Output VAT xxx
Input VAT xxx
VAT Payable xxx

Glossary
Grace period: A period within which the entity can rectify the breach and during which
the lender cannot demand immediate repayment.
Measurement: Assigning of peso amount to a financial statement element.
Obligation: Duty or responsibility to act or perform in a certain way which may be legally
enforceable as a consequence of a binding contract or statutory requirement.
Obligating event: An event that creates a legal obligation or a constructive obligation
that results in an enterprise having no realistic alternative to settling the obligation.
Legal obligation: Derives from a contract, legislation or other operation of law.
Constructive obligation: Derives from an enterprise’s actions whereby an established
pattern of past practice, published policies or sufficiently specific current statement.
Probable: When an event is more likely to occur than not to occur.

References and Supplementary Materials

Books and Journals
1. Valix, C. T., Peralta, J. F., & Valix, C. M. (2017). Financial Accounting (2017 ed., Vol. 2).
Manila, Philippines: GIC Enterprises & Co., Inc.
2. Cabrera, M. B., & Ocampo, R. R. (n.d.). Financial Accounting & Reporting - Standards &
Application (2014-2015 ed., Vol. 2). Manila, Philippines: GIC Enterprises & Co., Inc.
3. IAS 37 - Provisions, Contingent Liabilities and Contingent Assets
Online Supplementary Reading Materials
1. Accounting for Product Warranties;
http://open.lib.umn.edu/financialaccounting/chapter/13-4-accounting-for-product-
warranties/; October 20, 2017
2. Reporting Current Liabilities Such as Gift Cards;
http://open.lib.umn.edu/financialaccounting/chapter/13-2-reporting-current-
liabilities-such-as-gift-cards/; October 20, 2017
3. Accounting for Product Warranties; http://www.understand-
accounting.net/AccountingforProductWarranties.html; October 20, 2017
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4. Accounting for Product Warranties;

https://2012books.lardbucket.org/books/business-accounting/s16-04-accounting-
for-product-warrant.html; October 20, 2017
Online Instructional Videos
1. What Is Accrued Liability?; http://www.investopedia.com/video/play/what-accrued-
liability/; October 20, 2017
2. Estimated Liabilities: Definition & Types;
http://study.com/academy/lesson/estimated-liabilities-definition-types.html;
October 20, 2017

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