LESSON 4: LIABILITIES

Target:

At the end of the lesson, you will be able to:

 Understand the definition of liabilities

 Know the criteria for a liability to exist
 Learn the different types of liabilities

EXPLORE

Fill out the graphic organizer below by writing down what you know about Assets. You
may choose to answer using the following guide questions. Compare and discuss your
answers with a partner.

Guide questions:

 How do you define liabilities?

 What are the examples of liabilities?
 Is accounts payable considered liabilities?

EXAMINE

Definition of a 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:

a. the entity has an obligation

b. the obligation is to transfer an economic resource
c. the obligation is a present obligation that exists as a result of past events

Obligation

The first criterion for a liability is that 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.
If one party has an obligation to transfer an economic resource, it follows that another
party (or parties) has a right to receive that economic resource. However, a requirement
for one party to recognise a liability and measure it at a specified amount does not imply
that the other party (or parties) must recognise an asset or measure it at the same amount.
For example, particular Standards may contain different recognition criteria or
measurement requirements for the liability of one party and the corresponding asset of the
other party (or parties) if those different criteria or requirements are a consequence of
decisions intended to select the most relevant information that faithfully represents what it
purports to represent.

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’.

Transfer of an economic resource

The second criterion for a liability is that 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 unfavourable
terms. Such obligations include, for example, a forward contract to sell an economic
resource on terms that are currently unfavourable 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.

Present obligation as a result of past events

The third criterion for a liability is that 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.

Examples of liabilities include notes or loans payable, accounts payable, salaries and wages
payable, interest payable, and income taxes payable. This section is typically split into two
main sub-categories to show the difference between obligations that are due in the next 12
months, current liabilities, and obligations that mature in future years, long-term liabilities.

Current debt usually includes accounts payable and accrued expenses. Both of these types
of debts typically become due in less than 12 months. The long-term section includes all
other debts that mature more than a year into the future like mortgages and long-term
notes.

CHECK

A. True or False: Write T if you think the statement is true and F if it is false.

1. A liability is not a present obligation of the entity to transfer an economic resource

as a result of past events. F
2. The economic benefits obtained could include goods or services. T
3. Accrued salaries and wages are considered liabilities. T
4. Liabilities are classified as current and noncurrent. T
5. Notes payable is not a liability. F
6. Current liabilities are debts that are due in less than 12 months. T
7. Loans payable is always considered as noncurrent liability. F
 8. Liability is a duty or responsibility that an entity has no practical ability to avoid. T
9. Many obligations are established by contract, legislation or similar means and are
legally enforceable by the party or parties to whom they are owed. T
10. An obligation can meet the definition of a liability even if the probability of a
transfer of an economic resource is low. T

B. Identification: Identify and classify the asset accounts accordingly.

Problem 1

On December 31, 2019, the Magna Company provided the following details:

Cash and cash equivalent 500,000

Income tax payable 50,000
Accounts receivable 650,000
Inventories 800,000
Land 2,000,000
Building 1,500,000
Accumulated depreciation-building 500,000
Equipment 750,000
Accumulated depreciation-equipment 250,000
Machinery 1,000,000
Accumulated depreciation-machinery 300,000
Prepaid expenses 60,000
Investment in associate 1,200,000
Mortgage payable in quarterly installments of P200,000 1,600,000
Notes payable due in 24 months 1,000,000
Accounts payable 500,000
Accrued expenses 200,000
Share capital 2,500,000
Retained earnings 1,560,000

Compute the total amount of current assets that should be reported on December 31,
2019.

Problem 2

Given the same information above, compute the noncurrent assets that should be reported
on December 31, 2019.
Problem 3

The following account balances were taken from the records of Moon Company on
December 31, 2019.

Accounts payable 500,000

Accounts receivable 2,000,000
Loans payable in quarterly installments of P500,000 4,000,000
Accrued expenses 250,000
Cash on hand 80,000
Cash in bank 3,000,000
Equipment 800,000
Furniture and fixtures 500,000
Inventories 1,500,000
Long-term investments 2,000,000
Notes payable in monthly installements of P100,000 2,400,000
Notes receivable 1,000,000
Notes payable due in 16 months 1,500,000
Patent 50,000
Retained earnings approriated 600,000
Retained earnings unapproriated 680,000
Share capital 1,000,000

Compute the total amount of current and noncurrent liabilities that should be presented in
the Statement of Financial position as of December 31, 2019.

EQUIP

“Liabilities Explained Accounting Basics”

https://www.youtube.com/watch?v=fKRwT10Sszc

“Liabilities in Financial Accounting”

https://www.youtube.com/watch?v=Dhq_R5iDtW0

INTEGRATE

 What are the criteria for a liability to exist?

  Are all the criteria should be satisfy first before recording an obligation?

BUILD

Fill in the amount of the missing element of financial position.

Assets Liabilities Equity

a. 630,000 ? 380,000
b. 792,000 ? (80,000)
c. 450,000 ? 100,000
d. ? 600,000 (10,000)
e. 800,000 562,300 ?