MODULE 1

PCOA 008 – INTERMEDIATE ACCOUNTING II

Learning Outcomes:
At the end of this module, you are expected to:
 State the recognition criteria for liabilities.
 Identify the characteristics of financial liability.
 State the initial and subsequent measurements of financial and non-financial liabilities.
 Classify liabilities as current and noncurrent.

LIABILITY
Liability is a present obligation of the entity to transfer an economic resource as a result of
past event.
The definition of Liability has the following three aspects:
 Obligation
 Transfer of an economic resource
 Present obligation as a result of past events
Obligation
An obligation is a duty or responsibility that an entity has no practical ability to avoid.
An obligation is either:
 Legal obligation – an obligation that results from a contract, legislation, or other
operation of law; or
 Constructive obligation – an obligation that results from an entity’s actions that
create a valid expectation on others that the entity will accept and discharge certain
responsibilities.
Transfer of an economic resource
The liability is the obligation that has the potential to require transfer of an economic
resource to another party and not the future economic benefits that the obligation may cause to be
transferred. Thus, the obligation’s potential to use a transfer of economic benefits need not be
certain, or even likely.
Consequently, a liability can exist even if the probability of a transfer of an economic
resource is low, although that low probability affects decisions on whether the liability is to be

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 recognized, how it is measured, what information is to be provided about the liability, and how
that information is provided.
An obligation to transfer an economic resource may be an obligation to:
 Pay cash, deliver goods, or render services;
 Exchange assets with another party on unfavorable terms;
 Transfer assets if a specified uncertain future event occurs; or
 Issue a financial instrument that obliges the entity to transfer an economic resource.

Present obligation as a result of past events

The obligation must be a present obligation that exists as a result of past events. A present
obligation exists as a result of past events if:
 The entity has already obtained economic benefits or taken an action; and
 As a consequence, the entity will or may have to transfer an economic resource that it
would not otherwise have had to transfer.
Recognition criteria
An item is recognized if:
 It meets the definition of a liability; and
 Recognizing it would provide useful information, i.e., relevant and faithfully
represented information.
Both criteria above must be met before an item is recognized. Accordingly, items that meet
the definition of a liability but do not provide useful information are not recognized, and vice versa.
However, even if a liability is not recognized, information about it may still need to be disclosed
in the notes. In such cases, the item is referred to as unrecognized liability.
Relevance
Recognition may not provide relevant information if, for example:
 It is uncertain whether a liability exists; or
 A liability exists, but the probability of an outflow of economic benefits is low.
Existence uncertainty or low probability of an outflow of economic benefits may result in,
but does not automatically lead to, the non-recognition of a liability. Other factors should be
considered.
Faithful representation

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 A liability must be measured for it to be recognized. Often, measurement requires
estimation and thus subject to measurement uncertainty. The use of reasonable estimates is an
essential part of financial reporting and does not necessarily undermine the usefulness of
information. Even a high level of measurement uncertainty does not necessarily preclude an
estimate from providing useful information if the estimate is clearly and accurately described and
explained. However, an exceptionally high measurement uncertainty can affect the faithful
representation of liability.
Financial and Non-financial liabilities
Financial liability – is any liability that is:
 A contractual obligation to deliver cash or another financial asset to another entity;
 A contractual obligation to exchange financial assets or financial liabilities with
another entity under conditions that are potentially unfavorable to the entity; or
 A contract that will or may be settled in the entity’s own equity instrument and is
not classified as the entity’s own equity instrument.

Non-financial liability – is a liability other than financial liability.

Examples of financial liability
 Payables, such as accounts, notes,
loans, bonds, and accrued payables.
 Lease liabilities
 Held for trading liabilities and
derivatives.
 Redeemable preference shares issued.
 Security deposits and other returnable
deposits.
Example of non-financial liability
 Unearned revenues and warranty
obligations that are to be settled
through future delivery of goods or
provision of services.
 Taxes, SSS, Philhealth, and Pag-Ibig
payables
 Constructive obligations.

Presentation of financial instruments

The issuer classifies a financial instrument, or its component parts, as a financial asset, a
financial liability, or an equity instrument in accordance with the substance of the contract and the
definitions of a financial asset, a financial liability and an equity instrument.
 Equity instrument – is any contract that evidences a residual interest in the asset of an entity
deducting all of its liability.

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 When determining whether a financial liability is a financial liability or an equity
instrument, the overriding consideration is whether the instrument meets the definition of
a financial liability.
Financial liability Equity instrument
The entity has a contractual obligation to The entity has no obligation to pay or another
pay cash or another financial asset or to financial asset or to exchange financial
exchange financial instruments under instruments under potentially unfavorable
potentially unfavorable condition. condition.

 The contract requires the delivery of a
variable number of the entity’s own
equity instruments in exchange for a
fixed amount of cash or another
financial asset or a fix number of
entity’s own equity instruments in
exchange for a variable amount of
cash or another financial asset.
 The contract requires the delivery of a
fixed number of the entity’s own
equity instruments in exchange for a
fixed amount of cash or another
financial asset.

An essential feature of an equity instrument is the absence of a contractual obligation to

pay cash or another financial asset. This is true even if the holder of the instrument is entitled to
pro-rata share in dividends or of the net assets of the entity in cash of liquidation.
Legal form is also irrelevant when determining if a financial instrument is a financial
liability or an equity instrument. Some instruments are in the form of shares of stocks but the issuer
classifies them as financial liabilities if they meet the definition of a financial liability
Redeemable preference shares
 Are preferred stocks which the holder has the right to redeem at a set date.
 Are classified as financial liability because when the holder exercises its right to
redeem, the issuer is mandatorily obligated to pay for the redemption price.
Callable preference share
 Are preferred stocks which the issuer has the right to call at a set date.
 Are classified as equity instrument because the right to call is at the discretion of
the issuer and therefore has no obligation to pay unless it chooses to call on the
shares.
Recognition of financial liabilities
A financial liability is recognized only when the entity becomes a party to the contractual
provisions of the instrument.

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 Classification of financial liabilities
all financial liabilities are classified as subsequently measured at amortized cost, except
for the following.
 Financial liabilities at fair value through profit or loss (FVPL) and derivative
liabilities – subsequently measured at fair value. (designated or held for trading).
 Financial liabilities that arise when a transfer of a financial asset does not qualify
for derecognition – subsequently measured on a basis that reflects the rights and
obligations that the entity has retained.
 Financial guarantee contracts and commitments to provide a loan at a below-
market interest rate – subsequently measured at the higher of:
i. the amount of the loss allowance (12-month expected credit losses); and
ii. the amount initially recognized less, when appropriate, the cumulative
amount of income recognized in accordance with the principles of PFRS
15.
 Contingent consideration recognized by an acquirer in a business combination –
subsequently measured at fair value through profit or loss.
Reclassification of financial liabilities after initial recognition is prohibited.
Measurement of Financial Liabilities
Initial measurement
 Financial liabilities are initially measured at fair value minus transaction costs,
except financial liabilities at FVPL whose transaction costs are expensed
immediately.
Subsequent measurement
 Financial liabilities classified as amortized cost are subsequently measured at
amortized cost.
 Financial liabilities classified as held for trading are subsequently measured at fair
value with changes in fair values recognized in profit or loss.
 Financial liabilities designated at FVPL are subsequently measured at fair value
with changes in fair values recognized as follows:
a. The amount of change in the fair value of the financial liability that is
attributable to changes in credit risk of that liability is presented in other
comprehensive income, and
b. The remaining amount of change in the fair value of the liability is presented
in profit or loss.
Measurement of Non-financial liabilities

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 Initial measurement
 Non-financial liabilities are initially measured at the best estimate of the amounts
needed to settle those obligations or the measurement basis required by another
applicable standard.

Subsequent measurement
 Non-financial liabilities are also measured at the best estimate of the amounts
needed to settle the obligations adjusted for any changes on the expected settlement
amounts. Adjustments are treated as changes in accounting estimates and are
accounted for prospectively. Some non-financial liabilities are subsequently
measured in accordance with the requirements of other standards.
Financial statement presentation
Liabilities are presented either current or noncurrent on the face of classified statement of
financial position. A classified statement of financial position is one that shows current and
noncurrent distinctions.
When an entity presents an unclassified statement of financial position (based on liquidity),
disclosures of liabilities due within one year and due beyond one year should nevertheless be made
in the notes.
Current liabilities
Current liabilities are liabilities that are:
 Expected to be settled in the entity’s normal operating cycle;
 Held primarily for trading;
 Due to be settled within 12 months after the reporting period; or
 The entity does not have an unconditional right to defer settlement of the liability
for at least twelve (12) months after the reporting period.
All other liabilities are classified as noncurrent.
The operating cycle of an entity is the time between the acquisition of assets for processing
and their realization in cash or cash equivalents. When the entity’s normal operating cycle is not
clearly identifiable, it is assumed to be 12 months.
Liabilities that are settled as part of the entity’s normal operating cycle are presented as
current, even if they are expected to be settled beyond 12 months after the reporting period.
Liabilities that do not form part of the entity’s normal operating cycle are presented as
current only when they are expected to be settled within 12 months after the reporting period.

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 Trade and non-trade payables
Trade payables are obligations arising from purchases of inventory that are to be sold in
the ordinary course of business. Other payables are classified as non-trade.
For trading or manufacturing entity, trade and non-trade payables that are currently due are
normally aggregated and presented as one line item under the heading “trade and other payables.”
The reason for the trade and non-trade distinctions is the differing rules when classifying
payables as current or noncurrent.
 Trade payables are classified as current liabilities when they are expected to be
settled within the normal operating cycle or one year, whichever is longer.
 On the other hand, non-trade payables are classified as current liabilities only when
they are expected to be settled within one year.

Refinancing agreement
A long-term obligation that is maturing within 12 months after the reporting period is
classified as current, even if a refinancing agreement to reschedule payment on a long-term basis
is completed after the reporting period but before the financial statements are authorized to issue.
However, the obligation is classified as noncurrent if the entity expects, and has the
discretion, to refinance it on a long-term basis under an existing loan facility.
If the refinancing is not at the discretion of the entity, the financial liability is current.
*Refinancing refers to the replacement of an existing debt with a new one but with different
terms, an extended maturity date or revised payment schedule. Refinancing normally entails a fee
or penalty. A refinancing where the debtor is under financial distress is called “troubled debt
restructuring.”
**Loan facility refers to credit line.
Liabilities payable on demand
Liabilities that are payable upon the demand of the lender are classified as current.
A long-term obligation may become payable on demand when a loan provision is breached.
Such obligation is classified as current even if the lender agreed after the reporting period but
before the financial statements are authorized for issue not to demand payment. This is because
the entity does not have an unconditional right to defer settlement of the liability as of the end of
the reporting period.

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 However, the liability is noncurrent if the lender provides the entity by the end of the
reporting period a grace period 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.
Trade accounts payable
Accounts payable from purchases of inventory are recognized when the ownership of the
goods is transferred to the buyer. The amount recognized excludes trade discounts. Cash discounts
are included if the entity uses the gross method of recording purchases; they are excluded if the
entity uses the net method.
Unearned income
Unearned income represents advanced collection of income that is not yet earned. Prior to
earning, unearned income is classified as liability
Liability for deposits received
Liability for deposits received represents cash receipts that are held in trust for other parties.
1. Deposit liabilities of banks and other entities performing similar function
2. Deposits received for returnable containers, such as bottles, cases, crates, trays,
boxes, and similar items that contain the goods sold but must be returned to the
seller upon consumption of the goods.
3. Security deposits of the lessees
4. Deposits received from escrow agreements
5. Deposits for future subscription of the entity’s own equity instrument to the extent
that the deposits are repayable in cash.

Deposits for future subscription of shares of stocks

Deposits received for future subscription of the entity’s shares of stocks are classified as
either liability or equity as follows:
 If repayable in cash at any time prior to the issuance of the subscribed shared, the
deposits are classified as liability.
 If not repayable in cash, the deposits are classified as equity, preferably presented
under contributed capital.
Accrued expenses
Accrued expenses are liabilities for expenses already incurred but not yet paid.
Dividends payable

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 The liability to pay dividend is recognized when the dividend is appropriately authorized
and is no longer at the discretion of the entity, which is:
a. The date when the declaration of the dividend is approved by the relevant authority
if such approval is required; or
b. The date when the dividend is declared if further approval is not required.
Only cash and property dividends are recognized as liabilities. Stock dividends are not
liabilities; share dividends distributable is presented in equity as an addition to share capital.
*Dividends declared by banks are subject to the approval of the BSP
Liability for remittable collections
Liabilities may also arise from amounts collected on behalf of third parties. Examples:
a. Taxes withheld
b. SSS premiums, Philhealth, Pag-IBIG and similar contributions
c. Output value added taxes (VAT)
d. Collections made by an agent or broker on behalf of a principal.

Reference:

Millan, Z. V. (2020). Intermediate Accounting (Vol. 2). Bandolin Enterprise.

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 EXERCISES
PROBLEM 1
ABC Co. has the following liabilities as of December 31, 20x5.

a. Trade accounts payable, net of debit balance in supplier’s

account of P10,000, net of unreleased checks of P8,000, net of P
600,000
postdated checks of P4,000.

b. Credit balance in customer’s accounts 4,000

c. Financial liability designated at FVPL 100,000

d. Bonds payable (maturing in 10 equal annual installments of

2,000,000
P200,000)

e. 12%, 5-year note payable issued on September 30, 20x5 200,000

f. Deferred tax liability 10,000

g. Unearned rent
8,000

h. Contingent liability 20,000

i. Reserve for contingencies 50,000

How much is the total current liabilities?

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PROBLEM 2
XYZ Co. has the following liabilities as of December 20x0

Trade accounts payable, net of inventories received on consignment P

amounting to P10,000 300,000

Held for trading financial liabilities 150,000

Deferred revenue 300,000

Bank overdraft 10,000

Income tax payable 100,000

Accrued expenses 130,000

Share dividend payable 120,000

Loan of ABC Inc. guaranteed by XYZ Co. – it is possible that ABC

350,000
will be held liable for the guarantee

How much is the total current liabilities?

PROBLEM 3
On December 31, 2020, Glare company provided the following information:

Accounts payable, including deposits and advances from customer

P 1,250,000
of P250,000

Notes payable, including note payable to bank due on December 31, 1,500,000
2022 of P500,000

Share dividend payable 400,000

Credit balances in customer's accounts

200,000

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 Serial bonds payable in semiannual installment of P500,000
5,000,000

Accrued interest on bonds payable 150,000

Contested BIR tax assessment - possible obligation

300,000

Unearned rent income

100,000

Compute the total current liabilities on December 31, 2020

PROBLEM 4
Easy company provided the following information on December 31, 2020

Notes payable:

Trade 3,000,000

Bank loans 2,000,000

Advances from officers 500,000

Accounts payable - trade 4,000,000

Bank overdraft 300,000

Dividends payable 1,000,000

Withholding tax payable 100,000

Mortgage payable 3,800,000

Income tax payable 800,000

Estimated warranty liability 600,000

Estimated damages payable by reason of breach of contract 700,000

Accrued liabilities 900,000

Estimated premium liability 200,000

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 Claim for increase in wages by employees covered in a pending
lawsuit 3,500,000

Contract entered into for the construction of building 5,000,000

Compute the total current liabilities on December 31, 2020

PROBLEM 5
Manchester Company provided the following information on December 31, 2020

P
Income taxes withheld from employees 900,000

Cash balance at First State Bank 2,500,000

Cash overdraft at Harbor Bank 1,300,000

Accounts receivable with credit balance 750,000

Estimated expenses of meeting warranties on merchandise previously 5,000

sold

Estimated damages as a result of unsatisfactory performance on a 500,000

contract

Accounts payable 3,000,000

Deferred serial bonds payable, issued at par and bearing interest at

12%, payable in semiannual installment of P500,000 due April 1
and October 1 of each year. The last bond to be paid on October 1, 5,000,000
2026. interest is also to be paid semiannually

Stock dividends payable 200,000

Compute the total current liabilities as of December 31, 2020

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