UNANG PAHINA:

Financial Accounting and

Reporting
(Liabilities)
LIABILITY
 Obligation
 Legal – binding contract or statutory
 Constructive – by reason of normal business practice, customs, and a
desire to maintain good business relations or act in an equitable manner.
 Transfer of an economic resource
 Present obligation as a result of past events

Liabilities are classified as either:

A. Current liabilities
 Expected to be settled within the normal operating cycle
 Held primarily for trading
 Due to be settled within one year after the reporting period
 The entity does not have an unconditional right to defer settlement of the liability
for at least twelve months after the reporting period.

Examples of current liabilities:

1. Trade payables
2. Accruals for employee
3. Other operating cost
4. Financing liabilities held for trading
5. Bank overdraft
6. Dividends payable
7. Income taxes
8. Other nontrade payables
9. Current portion of noncurrent financial liabilities

B. Noncurrent liabilities
 All liabilities not classified as current. This includes:
1. Noncurrent portion of long-term debt
2. Finance lease liability
3. Deferred tax liability
4. Long-term obligation to officers
5. Long-term deferred revenue
Long-term debt falling due within one year

General rule:
A liability which is due to be settled within twelve months after the reporting period is
classified as current, even if:
1. The original term was for a period longer than twelve months.
2. An agreement to refinance or to reschedule payment on a long-term basis
is completed after the reporting period and before the financial statements
are authorized for issue.

Exception: It becomes noncurrent.

1. The entity has the discretion to refinance or roll over an obligation for at
least 12 months after the reporting date (balance sheet date).

2. Refinancing on a long-term basis is completed on or before the end

of the reporting period

Breach of Covenant

Covenants are often attached to borrowing agreements which represent under takings
by the borrower. These are actually restrictions on the borrower as to undertaking
further borrowings, paying dividends, maintaining specified level of working capital and
so forth.

General Rule: Generally, noncurrent.

Exception: Once contract is breached, it becomes current.

Exception to the Exception: It becomes noncurrent
1. On or before the end of the reporting date, lender agreed to provide
grade period of 12 months after the reporting date.
2. On or before the end of reporting date, lender agreed to waived the
breach of contract.

Presentation of Current Liabilities

PAS 1, paragraph 54, as a minimum, the face of the statement of the financial position
shall include the following line items for current liabilities: 3C-A-N-A-D-A-S

a. Trade and other payables (Accounts payable, notes payable,

accrued interest on note payable, dividends payable and accrued
expenses)
b. Current provisions
c. Short-term borrowing
d. Current portion of the long-term debt
e. Current tax liability

Note: No objection can be raised if the trade accounts and notes payable are
separately presented.

NOTES PAYABLE
 Obligations supported by promissory notes by the debtor

Initial measurement
 Notes payable are initially recognized at fair value minus transaction costs. The
fair value is determined as follows:

Type of payable Initial measurement Subsequent measurement

 Face amount; or  Face amount or

 Present value (if the expected settlement
transaction clearly amount if the initial
constitutes financing measurement is face
1. Short-term payable
and the imputed rate amount
of interest can be  Amortized cost if the
determined without initial measurement is
undue cost or effort) present value.

 Face amount or
2. Long-term payable with
 Face amount expected settlement
reasonable interest rate
amount
 3. Long-term noninterest-
bearing payable
 Present value  Amortized cost
4. Long-term payable with
unreasonable interest rate

 If the cash price equivalent is determinable, the note is initially measured at this
amount. The subsequent measurement is amortized cost.

 Stated interest rate (nominal rate, coupon rate, or face rate)

 rate appearing on the face of an interest-bearing note.

 Effective interest rate (imputed rate of interest, current market rate or yield
rate)
 rate used in present value computations.

A noninterest-bearing note has an unspecified principal and unspecified interest. These

elements are separated through present value computations.

Present value = Future cash flows x PV factor at x%

PV of ₱1 Used when the future cash flow is in lump sum.

PV of an ordinary Used when the future cash flows are in installments and the
annuity due of ₱1 first installment does not begin immediately.

PV of an annuity due Used when the future cash flows are in installments and the
of ₱1 first installment begins immediately.

Total interest expense recognized over the life of a noninterest-bearing note is equal to
the discount on note payable on initial recognition.

 Interest payable = Face amount x Nominal rate

  Interest expense = Present value x Effective interest rate

Origination fees are deducted from the carrying amount of the loan and subsequently
amortized using the effective interest method.

FINANCIAL LIABILITIES
 Any liability that is a contractual obligation to:
 Deliver cash or another financial asset or to exchange financial instruments
under conditions that are potentially unfavorable.
 Settle in the entity’s own equity instruments and is not classified as the
entity’s own equity instrument.

Illustration
The following are taken from the records of RAYA Co. as of year-end.
SSS contributions
Accounts payable 17,000 21,000
payable
Utilities payable 22,000 Cash dividends payable 19,000
Property dividends
Accrued interest expense 21,000 22,000
payable
Share dividends
Advances from customers 16,000 18,000
payable
Unearned rent 24,000 Lease liability 50,000
Warranty obligations 20,000 Bonds payable 135,000
Discount on bonds
Income taxes payable 17,000 (30,000)
payable
Preferences shares issued 25,000 Security deposit 17,000
Redeemable
Constructive obligation 26,000 preferences shares 29,000
issued
Obligation to deliver a variable number of Unearned interest on
25,000 18,000
own shares worth a fixed amount of cash receivables

Requirement:
Determine the financial liabilities to be disclosed in the notes.
Solution:
Accounts payable 17,000
Utilities payable 22,000
Accrued interest expense 21,000
Obligation to deliver a variable number of own shares worth a fixed amount of
25,000
cash
Cash dividends payable 19,000
Finance lease liability 50,000
Bonds payable 135,000
Discount on bonds payable (30,000)
Security deposit 17,000
Redeemable preference shares issued 29,000
Total financial liabilities 305,000

Classification of financial liabilities

All financial liabilities are classified as subsequently measured at amortized cost, except
for:
 Financial liabilities at fair value through profit or loss (FVPL) and derivative liabilities
shall be subsequently measured at fair value (e.g., designated or held for trading).
 Financial liabilities thar arise when a transfer of a financial asset does not qualify for
derecognition shall subsequently measure 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 shall subsequently measure at the higher of:
 the amount of the loss allowance (12-month expected credit losses); and
 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 shall
subsequently be measured at fair value through profit or loss.
 Reclassification of financial liabilities after initial recognition is prohibited.

Initial Recognition
 Financial liabilities are recognized when and only when the entity becomes party to
the contractual provisions of the instrument.
Financial liabilities are initially measured at fair value minus transaction costs, except
financial liabilities at fair value through profit or loss (FVPL) whose transaction costs are
expensed immediately.

BOND ISSUE COSTS

 Transaction costs directly attributable to the issue of bonds payable. Such costs
include printing and engraving cost, legal and accounting fee, registration fee with
regulatory authorities, commission paid to agents and underwriters and other similar
charges.
 Under PFRS 9, bond issue costs shall be deducted from the fair value or issue price
of bonds payable in measuring initially the bonds payable.
 Under the effective interest method of amortization, the bond issue cost must be
“lumped” with the discount on bonds payable and “netted” against the premium on
bonds payable.
 However, if the bonds are measured at fair value through profit or loss, the bond
issue costs are expensed immediately.

Recording interest on bonds

Accounting for interest expense on bonds requires recognition of two items, namely:
a. Payment of interest during the year
b. Accrual of interest at the end of the year

Issuance of bonds on interest date

On June 1, 2021, RAYA Co. issued bonds with a face amount of ₱6,000,000 at 98. The
bonds mature in 8 years and pay 12% interest semi-annually on June 1 and December
1. The straight line method is used for simplicity in amortizing discount on bonds
payable.

Journal entries
2021
June Cash (6,000,000 x 98%) 5,880,000
1
Discount on bonds payable 120,000
Bonds payable 6,000,000
Dec. 1 Interest expense 360,000
 Cash 360,000
Semiannual interest payment.
31 Interest expense 60,000
Accrued interest payable 60,000
Interest accrued for one month from December 1 to
December 31, 2021
(6,000,000 x 12% x 1/12 = 60,000)
31 Interest expense 8,750
Discount on bonds payable 8,750
Amortization of bond discount from June 1 to December
31, 2021
(₱120,000 / 8 years = ₱15,000
annual amortization, x 7/12 = ₱8,750)

The amortization of the bond discount or premium may be on every interest date or at
the end of every year.

In the given example, the amortization is made at the end of the year.

2022
Jan. 1 Accrued interest payable 60,000
Interest expense 60,000
June 1 Interest expense 360,000
Cash 360,000
Semiannual interest payment
Dec. 1 Interest expense 360,000
Cash 360,000
Semiannual interest payment
31 Interest expense 60,000
Accrued interest payable 60,000
Interest accrued for one month
31 Interest expense 15,000
Discount on bonds payable 15,000
Amortization of bond discount for one year, 2022
If a statement of financial position is prepared on December 31, 2022, the accrued
interest payable of ₱60,000 is classified as current liability.

The bonds payable should be classified as noncurrent liability:

Bonds payable 6,000,000
Discount on bonds payable ( 96,250)
Carrying amount 5,903,750

EFFECTIVE INTEREST METHOD

Effective Interest Method (Scientific method or Interest method) – a method that
PFRS 9 requires to be used on amortizing the discounts on bonds payable, premium on
bonds payable and bond issue cost.
2 Kinds of Interest Rate

 Nominal Rate – coupon or stated rate

 Effective Rate – yield or market rate
Premium = Effective Rate < Nominal Rate

Discount = Effective Rate > Nominal Rate

Effective Interest Expense = Effective Rate x Carrying Amount of the bonds

PREMIUM AMORTIZATION

Nominal Interest (nominal rate x face amount) Xx

Less: Effective Interest (effective rate x carrying amount) Xx

Premium amortization Xx

DISCOUNT AMORTIZATION

Effective Interest Xx

Less: Nominal Interest Xx

Discount amortization xx
Market price (issue price) = PV of bonds payable + PV of the total interest payments
PV of the principal bond liability = face amount x PV of 1 factor at the effective rate for a
number of interests periods
PV of the future interest payments = periodic nominal interest x PV of
an ordinary annuity of 1 factor at the effective rate for a number of
interest periods

Transaction costs – these are feed and commissions paid to agents, advisers, brokers
and dealers, levies by regulatory agencies and securities exchange, and transfer taxes
and duties. – includes bond issue costs.

Bond issue costs will increase discount on bonds payable and will decrease premium
on bonds payable.

DEBT RESTRUCTURING
Debt restructuring – is a situation where the creditor, for economic or legal reasons
related to the debtor’s financial difficulties, grants to the debtor concession that would
not otherwise be granted in a normal business relationship.
Types of Debt Restructuring
 Asset Swap

 is the transfer by the debtor to the creditor of any asset in full payment of
an obligation
 treated as a derecognition of a financial liability or extinguishment of an
obligation

 Carrying amount – consideration = recognized as profit or loss.

 Dacion en pago – when a mortgaged property is offered by the debtor in
full settlement of the debt
 Equity Swap
  Is a transaction whereby a debtor and creditor may renegotiate the terms
of a financial liability with the result that the liability is fully or partially
extinguished by the debtor issuing equity instruments to the creditor.
 Equity instruments shall be measured at the fair value of the equity
instruments issued, unless that fair value cannot be reliably recognized.

 If cannot be reliably recognized, the equity instrument shall be measured

in the order of priority:
 FV of equity instruments issued

 FV of liability extinguished
 Carrying amount of liability extinguished

 Modification of Terms
 This involves either the interest, maturity value or both.
 Interest concession may involve a reduction of interest rate, forgiveness of
unpaid interest or a moratorium on interest
 Maturity value concession may involve an extension of the maturity date
or a reduction of the principal amount

 Substantial modification of terms of an existing financial liability shall be

accounted for as an extinguishment of the old financial liability and
recognition of a new financial liability.
 Gain or loss on extinguishment is at least 10% of the old financial liability
in order to have substantial modification of terms.

 Carrying amount of old liability – PV of new or restructured liability = gain

or loss on extinguishment of debt.

LEASE (IFRS16 – Lease Standard)

 Defined as a contract or part of a contract that conveys the right to use the
underlying asset for a period of time in exchange for consideration. (Appendix
A)
 Convey the right to control the use of an identified asset. (Appendix B9)
  Typically identified by being explicitly specific in a contract or implicitly
specified when made available to the customer.

LESSEE – entity that obtains the right to use an underlying asset for a period of time in
exchange for consideration
 Shall recognize the right of use asset and lease liability at the commencement
date.
 Shall be accounted for as a finance lease.
 Permitted to apply the operating lease accounting.

Optional exemptions to not recognize an asset and lease liability:

Short-term lease – a lease that has a term of 12 months or less at the

commencement date of the lease; and
Low value lease – assess the value of an underlying asset based on the
value of the asset when it new regardless of the age of the asset.
Right of use asset – defined as an asset that represents the right of a lessee to use an
underlying asset over the lease term in a finance lease.
Initially measured at cost at commencement date.
 COST of right of use asset comprises of:
 PV of lease payments or the initial measurement of
the lease liability
 Lease payments made to lessor at/or before
commencement date
 Initial direct costs incurred by the lessee
 Estimate of cost of dismantling, removing and restoring the underlying
asset for which the lessee has a present obligation.

Cost Model shall be applied in measuring the right of use asset subsequently.

Cost less any Accumulated Depreciation and Impairment Loss

The right of use asset shall be presented as a separate line item in the statement of
financial position.

Other Measurement Models:

 Fair Value Model – Can be applied in investment property
 Revaluation Model – Can be applied in property, plant, and equipment
The Lease Liability shall be measured at the present value of lease payment at the
commencement date.
 The interest rate implicit in the lease shall be used to discount the lease
payments.
 Incremental borrowing rate of the lessee is used if the interest rate implicit
cannot be readily determined.
 Components of lease payments:
 Fixed lease payments
 Variable lease payments
 Exercise price of a purchase option if the lessee is reasonably certain
to exercise the option
 Amount expected to be payable by the lessee under a residual value
guarantee
 Termination penalties if the lease term reflects the exercise of a
termination option

LESSOR – entity that provides the right to use an underlying asset for
a period of time in exchange for consideration.
 Shall classify leases as either operating lease or a finance lease.

Operating Lease – is a lease that does not transfer substantially all the risks and
rewards incidental to ownership of an underlying asset.
Finance lease – is a lease that transfers substantially all the risks and rewards
incidental to ownership of an underlying asset.
 A lease would be classified as a finance lease by the lessor if any of the
following situations arises:
 The lease transfers ownership of the underlying asset to the lessee at
the end of the lease term
 The lessee has an option to purchase the asset at a price which is
expected to be sufficiently lower than the fair value at the date the
option becomes exercisable
 The lease term id for the major part of the economic life of the
underlying asset even if title is not transferred.
 The PV of the lease payments amounts to substantially all of the fair
value of the underlying asset at the inception of the lease.
The lessor shall recognize lease payments from operating lease as income either on a
straight line basis or another systematic basis.

 Otherwise stated, the periodic rental received by the lessor in an operating

lease is simply recognized as rent income.
 Presentation of the underlying asset subject to operating lease will be
presented in the statement of financial position according to the nature of the
asset
 The lessor bears all ownership or executor costs (e.g. depreciation of leased
property, real property taxes, insurance and maintenance)
 Initial direct cost shall be added to the carrying amount of the underlying
asset
 Security deposit refundable upon lease expiration shall be accounted for as a
liability.
 Lease bonus from lessee is recognized as unearned rent
income to be amortized over the lease term.

Refinancing – refers to the replacement of an existing debt with a new one but with
different terms (e.g. extended maturity date or a revised payment schedule). It involves
a fee or penalty.

Troubled debt structuring – a refinancing where debtor is under financial distress.

General Rule: A currently maturing obligation is presented as a current liability.
Exceptions: The obligation is a noncurrent liability when:
 Refinancing is completed on or before the balance sheet date
 Refinancing takes place after the balance sheet date and is at the
discretion of the entity under an existing loan facility

BOND - is a contract of debt whereby one party (issuer) borrows duns from another
party (investor)
Bond Indenture – Contractual agreement between the issuer and investor.
Types of Bonds

 Term bonds – bonds with a single date of maturity

 Serial Bonds – bonds with a series of maturity dates
 Mortgage bonds – bonds secured by a mortgage on real properties
  Collateral bonds – bonds secured by shares and bonds of other
corporation
 Debenture bonds – bonds without collateral security
 Registered bonds – require the registration of the name of the
bondholders on the books of the corporation
 Coupon or bearer bonds – unregistered bonds in the sense that the
name of the bondholder is not recorded on the entity books
 Convertible bonds – bonds that can be exchanged for shares of the
issuing entity
 Callable bonds – bonds which may be called in for
redemption prior to the maturity date
 Guaranteed bonds – bonds issued whereby another
party promises to make payment if the borrower fails
to do so
 Junk Bonds – high-risk, high-yield bonds issued by entities that are
heavily indebted or otherwise in weak financial condition
 Zero-coupon bonds – are bonds that pay no interest

INITIAL MEASUREMENT:
Not designated at fair value through profit or loss shall be measured at:

Fair value minus Bond issue cost

If designated at fair value through profit or loss, the bond issue costs are expense
SUBSEQUENT MEASUREMENT:
 At amortized cost, using the effective interest method
 At fair value through profit or loss

Amortized cost = Initial measurement minus Principal repayment, plus or minus

difference between the face amount and present value (i.e. discount or premium)
Discount and Premium on bonds payable are reported as adjustments to the liability
account.

Approaches in accounting for authorization and issuance of bonds:

 Memorandum approach
 Journal entry approach
Treasury bonds – are an entity’s own bonds originally issued and reacquired but not
cancelled.
 These bonds should be debited at face amount
 Cancel any unamortized premium or discount
 Accrued interest paid is charged to interest expense
 Acquisition cost – Carrying amount = gain or loss

Three Approaches in Amortizing Bond Premium and Bond Discount

 Straight line
 Bond outstanding method
 Effective interest method

Fair Value Option – measuring bonds payable initially at fair value and remeasured at
every year-end with any changes in fair value generally recognized in profit or loss.

 No amortization of bond premium or bond discount will be recognized. Any

transaction cost or bond issue cost will be expensed.
 Interest expense is recognized using the nominal or stated rate

Gain or losses on financial liability designated at FVPL shall be accounted for as

follows:
 The change in fair value attributable to the credit risk of the liability is
recognized in the other comprehensive income
 The remaining amount of the change in fair value is recognized in profit or
loss
If credit risk would create or enlarge an accounting mismatch, all gains and losses are
recognized in profit or loss

Employee Benefits
 Employee benefits are “all forms of consideration given by an entity in exchange
for service rendered by employees.” (PAS 19.8)
 Four categories of employee benefits under PAS 19:
 Short-term employee benefits
 Post-employment benefits
 Other long-term employee benefits
 Termination benefits
Short-term employee benefits
 Short-term employee benefits are employee benefits (other than termination
benefits) that are due to be settled within 12 months after the end of the period in
which the employees render the related service.
Recognition and measurement

 When an employee has rendered service to an entity during an accounting

period, the entity shall recognize the undiscounted amount of short-term
employee benefits expected to be paid in exchange for that service:
 as a liability (accrued expense), after deducting any amount already paid.
 as an asset (prepaid expense) if the amount paid is in excess of the
undiscounted amount of the benefits incurred; provided, the prepayment
will lead to a reduction in future payments or a cash refund; and
 as an expense, unless the employee benefit forms part of the cost of an
asset, e.g., as part of the cost of inventories or property, plant and
equipment.
Short-term compensated absences
 Short-term paid absences include vacation, holiday (e.g., regular and nonworking
holidays), maternity, paternity and sick leaves.

 Entitlement to paid absences may be either:

a. Accumulating - those that can be carried forward and used in future periods if not
used in the current period. Accumulating paid absences may be either:
i. Vesting - unused entitlement are paid in cash when the employee
leaves the entity (i.e., monetized).
ii. Non-vesting - unused entitlement are not monetized.
b. Non-accumulating - those that expire if not used in the current period and are
not paid in cash when the employee leaves the entity.
Profit- sharing and bonus plans

 Profit- sharing and bonuses are additional incentives given to employees for a
variety of reasons, the most obvious is to motivate the employees to be more
productive.
 Profit sharing and bonuses are recognized when
(a) the entity has a present obligation to pay for them and
(b) the cost can be measured reliably.
 Examples of bonus schemes and their formulas:
1. Bonus before bonus and before tax
B=P xBr

2. Bonus after bonus and before tax

B=P-

3. Bonus before bonus and after tax

B=P x

4. Bonus after bonus and after tax

B=P x

Where: B= Bonus
P= Profit
Br = Bonus rate or bonus percentage
Tr= Tax rate

Postemployment Benefits

 Postemployment Benefits are employee benefits which are payable after

completion of employment.
 It includes:
a. Retirement benefits (pensions, lump sum payments on retirement)
b. Postemployment life insurance
c. Postemployment medical care
 These plans are usually established as part of the remuneration package for its
employees.
 Post-employment benefit plan can be formal (e.g., explicitly stated in an
employment contract) or informal (i.e., not documented but implied from the
employer's past practice or the minimum requirement of law).
 A post-employment benefit plan can also be:
a. Contributory or Non-contributory; and
 b. Funded or Unfunded
c.

Contributory Non-contributory
 Both the employer and employee  Only the employer contributes
contribute to the retirement fund of the to the retirement fund of the
employee. employee.

Funded Unfunded
 The retirement is isolated from the employer’s  The employer
control and is transferred to a trustee (e.g., manages any
investment company) who undertakes to manage established fund and
the fund and pay directly the retiring employees. pays directly the
retiring employees.

 Post-employment benefits are classified as either defined contribution plan or

defined benefit plan, depending on its principal terms and conditions.

Defined contribution plan Defined benefit plan

 Is a postemployment benefit plan under  An entity’s obligation is to provide the

which an entity pays fixed contributions
into a separate entity.
 No legal or constructive obligation to pay
further contributions if the fund does not
hold sufficient assets to pay all employee
benefits.
 The contribution is definite but the benefit
is indefinite.
 Contribution may be a fixed amount, a
percentage of employer’s income, a
percentage of employee’s earnings or a
combination of these factors.
 Employee’s retirement benefit depends
on how the plan has been managed by
the trustee since they administer,
agreed benefits to employees.
 Employee is guaranteed a specific or
definite amount of benefit which is
usually related to his salary and
years of service.
 The benefit is definite but the
contribution is indefinite
 Entities must make contributions
such that the contribution plus
earnings would be sufficiently large to
cover the future retirement benefits.
 The entity assumes the investment
risk.
 manages and invests the funds
 Employees bear the investment risk.
 Once the defined contribution is paid, the
employer has no more obligation under
the plan.

Multiemployer plan

 This is classified as either a defined contribution plan or a defined benefit plan

that pools the assets contributed by various entities that are not under common
control and uses those assets to provide benefits to employees of more than one
entity.
State Plan

 A state plan is one that is established by law and operated by the government. It
is mandatory for all entities within its scope and is not subject to control or
influence by the entity.
 Examples include:
 Government Service Insurance System (GSIS), which covers government
employees;
 Social Security System (SSS), which covers those in the private sector.
 A state plan is accounted for similar to a multiemployer plan, i.e., classified as
either a defined contribution plan or a defined benefit plan.
Insured benefits

 An employer may pay insurance premiums to fund a post-employment benefit

plan.
 Such a plan is classified as either defined contribution plan or defined benefit
plan.
 It is a defined benefit plan if the employer retains the obligation to either pay
directly the benefits to the employee or make good any deficiency if the insurer
fails to pay in full the benefits.
Accounting for defined contribution plan
 The accounting for defined contribution plans is straightforward.
 Since the employer's obligation is limited to the amount that it has agreed to
contribute, it simply recognizes the contribution as an expense (unless it forms
 part of the cost of another asset) and a liability (if unpaid) when employees have
rendered service during the period.
 If the amount contributed exceeds the fixed amount of contribution, the excess is
treated as a prepaid asset.
 The amount of contribution is measured at an undiscounted amount if it is due
within 12 months; if due beyond 12 months, it is discounted.
 Actuarial valuations are not necessary; therefore, there are no actuarial gains or
losses.
Keynote:

 The accounting for defined contribution plans is straightforward - actuarial

computations are not required.
 Retirement benefits expense is equal to the agreed periodic contributions to the
fund.
Accounting for Defined Benefit Plan

a. Determine the deficit or surplus:

 FVPA < PV of DBO = Deficit
 FVPA > PV of DBO= Surplus

Fair Value of Plan Assets

Beg. xx
Return on plan assets xx xx Benefits paid

Contributions to the fund xx

xx End.

PV of Defined Benefit Obligation

xx Beg.
Benefits paid xx xx Current & Past Service Cost
xx Interest Cost

Actuarial gain xx Actuarial loss

End. xx
 b. Determine the Net defined liability/asset:
 Deficit = Net defined benefit liability
 Lower of surplus and asset ceiling = Net defined benefit asset

c. Determine the Defined Benefit Cost

Service Cost: (recognized in P/L)
 Current Service Cost xx
 Past Service Cost xx
 Any gain or loss on settlement xx xx

Net interest on the net defined benefit liability/asset: (recognized in P/L)

 Interest cost on the defined benefit obligation xx
 Interest income on plan assets xx
 Interest on the effect of the asset ceiling xx xx

Remeasurement of the net defined benefit liability/asset: (recognized in OCI)

 Actuarial (gains) and losses xx
 Difference between interest income on plan assets and return on plan assets xx

 Difference between interest on the effect and change in the effect xx xx

Defined benefit cost xx

Other long-term employee benefits

 Other long-term employee benefits are employee benefits (other than post-
employment benefits and termination benefits) that are due to be settled beyond 12
months after the end of the period in which the employees have rendered the
related service.
 Examples:
a. Long-term compensated absences, e.g., sabbatical leave
b. Jubilee or other long-service benefits
c. Long-term disability benefits
d. Profit-sharing, bonuses, and deferred compensation payable beyond 12 months
after the end of the period in which the benefits were earned

 Other long-term employee benefits are accounted for similar to defined benefit
plans except that all the components of the defined benefit cost are recognized in
profit or loss, including the remeasurements of the net defined benefit
liability/asset.

Termination benefits

 Termination benefits are those provided as a result of either

a. the entity's decision to terminate the employee before normal retirement date; or
b. the employee's decision to accept the employer's offer of benefits in exchange
for termination.
 The obligation to pay termination benefits arises from the employer's act of
terminating an employee rather than from employee service.
 Accordingly, benefits resulting from termination at the employee's request without
the employer's offer are not termination benefits but rather post-employment
benefits.
Recognition

 Termination benefits are recognized as a liability and expense at the earlier of

the following dates:
 When the entity can no longer withdraw the offer of those benefits; and
 When the entity recognizes restructuring costs under PAS 37 that involve
payment of termination benefits. (PAS 19.65)
Measurement

 Termination benefits are accounted for according to their nature.

 Termination benefits that are:
 payable within 12 months are accounted for as short-term benefits.
 payable beyond 12 months are accounted for as other long-term benefits.
 enhancement to post-employment benefits are accounted for as post-
employment benefits.
UNEARNED REVENUES ARISING FROM CONTRACTS, GIFT
CERTIFICATES, AND SUBSCRIPTION
Deferred Revenue

 Deferred revenue, also called unearned revenue, represents advanced collection

of income that is not yet earned.
 Therefore, it cannot yet be reported on the income statement. As a result, the
unearned amount must be deferred to the company's balance sheet where it
will be reported as a liability.
 Deferred revenue may be realizable within one year or in more than one year
after the end of the reporting period.

DEFERRED REVENUE
CURRENT LIABILITY NONCURRENT LIABILITY

Realizable DR within one-year Realizable DR more than one year

Typical examples are unearned interest Typical examples are unearned revenue
income, unearned rental income, and from long-term service contracts and long-
unearned subscription revenue. term leasehold advances.

Illustration 1– Sales of Services

RAYA entity sells equipment service contracts agreeing to service equipment for a 2-
year period.

Cash receipts from contracts are credited to unearned service revenue and service
contract costs are charged to service contract expenses.

Revenue from service contracts is recognized as earned over the service period of the
contracts.

The following transactions occur in the first year:

Cash receipts from service contracts sold 5,000,000

Service contract aid 260,000
Service contract revenue recognized 406,000

Journal entries for first year

1. To record the cash receipts from service contracts sold:

Cash 5,000,000
Unearned service revenue 5,000,000

2. To record the service contract costs paid:

Service contract expense 260,000
Cash 260,000

3. To record the service contract revenue recognized:

Unearned service revenue 406,000
Service contract revenue 406,000

Illustration 2 – Sales of Services

RAYA Co. sells service contracts that cover a 2-year period. The sales price of each
contract is P1,000. RAYA sold 1,000 contracts evenly throughout 20x1. RAYA’s past
experience shows that of the total pesos spent for repairs on service contracts, 40% is
incurred evenly during the first contract year and 60% evenly during the second contract
year.

Requirements:
a. How much are the current and noncurrent portions of the deferred revenue to be
presented in RAYA’s 20x1 statement of financial position?
b. How much is the service revenue recognized in 20x2?

Solution:

Because the contracts are sold evenly, the total receipts of P1M (1,000 x P1,000) are
averaged or divided by two.

Revenue is earned over the 2-year period as follows:

i. The first half is assumed to have been sold on January 1, 20x1 and will be earned
from January 1, 20x1 to December 31, 20x2.
ii. The second half is assumed to have been sold on December 31, 20x1 and will be
earned from January 1, 20x2 to December 31, 20x3.

20x1 20x2 20x3 Total

Percentage earned -1 year
st
40% 60%
Percentage earned -2 year
nd
40% 60%
First half (1M ÷ 2) 500,000 200,000 300,000
Second half (1M ÷ 2) 500,000 200,000 300,000
Earned portions 200,000 500,000 300,000 1,000,000
The shaded amounts pertain to the portions earned during the year.

Requirement (a): Current and Noncurrent portions - Dec. 31, 20x1

The current and noncurrent portions of the deferred revenue as of December 31, 20x1
are as follows: (amounts are taken from the table above)

Current portion (earned portion in 20x2) - (300K+ 200K) 500,000

Noncurrent portion (earned portion in 20x3) 300,000
Total (₱IM less earned portion in 20x1 of P200,000) 800,000

Requirement (b): Service revenue - 20x2

Service revenue in 20x2 (300K + 200K) 500,000

Observe that revenues are recognized over the periods the services are
rendered as indicated by the incurrence of costs of repairs on service contracts.

Illustration 3 – Sale of goods

RAYA Co. requires advance payments for custom-built guitar effects, gadgets, and
racks. The records of Raya Co. show the following:

Unearned revenue, January 1, 20x1 1,000,000

Advances received during 20x1 10,000,000
Advances applied to orders shipped in 20x1 8,000,000
Advances pertaining to orders cancelled in 20x1 300,000

Requirements:
Compute for the current liability assuming:
a. the advance payments received are non-refundable
b. the advance payments received are refundable.

Solutions:
Requirement (a): Advances are non-refundable

Unearned Income
1,000,000 Jan. 1, 20x1
Advances earned 8,000,000 10,000,000 Advances received
Orders cancelled 300,000
Dec. 31, 20x1 2,700,000

Answer to requirement (a): 2,700,000

Requirement (b): Advances are refundable

Unearned income - Dec. 31, 20x1 (see previous solution) 2,700,000
Liability for refundable deposits (Orders cancelled) 300,000
Total current liability for advances received 3,000,000

The advances pertaining to the cancelled orders remain as liability, not as

unearned income but as liability for refundable deposits.

Illustration 4.1 – Unearned subscription - Monthly

RAYA Co. sells monthly subscriptions for an industry publication. Subscriptions

received after the November 1 cut-off date are held for publication in the following year.
Receipts during 20x1 for subscriptions were made evenly. Information on subscriptions
is shown below:

Unearned revenue - January 1, 20x1 3,000,000

Receipts from subscriptions during 20x1 24,000,000

Requirements:
a. How much is the unearned revenue balance on December 31, 20x1?
b. How much is the revenue from subscriptions during 20x1?

Solutions:
Requirement (a): Unearned revenue - Dec. 31

Subscriptions received after the Nov. 1 cutoff date will receive none of the monthly
publications for the year. Accordingly, these represent the unearned revenue balance
as of December 31, 20xx1: > Unearned revenue, Dec. 31, 20x1= (24M x 2/12)
=4,000,000

Requirement (b): Subscriptions revenue - 20x1

 Subscriptions revenue, 20x1 = 3M+ (24Mx 10/12) = 23,0000,000

Unearned revenue
3,000,000 Jan. 1
Subscription revenue 20x1 (squeeze) 23,000,000 24,000,000 Receipts during 20x1

Dec. 31 (as computed) 4,000,000

Illustration 4.2 – Unearned subscription - Semi annual

RAYA Co. sells one-year subscriptions for an industry publication published semi
annually and shipped to subscribers on May 1 and November 1. Subscriptions received
after April 1 and October 1 cut-off dates are held for the next publication. Receipts
during 20x1 for subscriptions were made evenly. Information on subscriptions is shown
below:

Unearned revenue - January 1, 20x1 3,000,000

Receipts from subscriptions during 20x1 24,000,000

Requirement: Compute for the unearned revenue balance on December 31, 20x1.

RAYA Co offers two (semi annual) publications for subscription fee with the following
shipment and cut-off dates.
  Shipment dates May 1 Nov. 1
 Cutoff dates April 1 Oct. 1

 Receipts from Jan. I to April 1 will receive the 2 semi-annual publications for the
year. Therefore, no unearned revenue will arise from these receipts.

 Receipts from April 1 to Oct. 1 will receive 1 of the 2 semi-annual publications for
the year. Therefore, 50% of these receipts are unearned revenue.

 Receipts from Oct. 1 to Dec. 31 will receive none of semi-annual publications for
the year. Therefore, 100% of these receipts are unearned revenue.

The balance of unearned revenue as of December 31, 20x1 is computed as follows:

Receipts from April 1 to Oct. 1 (24Mx6/12) x 50% 6,000,000

Receipts from Oct. 1 to Dec. 31 [(24M3/12) x 100%] 6,000,000
Total unearned revenue - Dec. 31, 20x1 12,000,000

The beginning balance of unearned revenue is already earned during the period.
Thus, it has no effect on the ending balance of unearned revenue.

Illustration 5– Gift certificates

RAYA Co. has just opened a novelty store. Raya decided to sell gift certificates as part
of its sales promotion. Transactions relating to the gift certificates during the year are
shown below:
a. Sold gift certificates worth P100,000.
b. Gift certificates worth P80,000 were redeemed.
c. P10,000 gift certificates expired.
d. P2,000 gift certificates were estimated not to be redeemed.

Requirement: Provide the journal entries

a. Cash 100,000
Unearned revenue – gift certificates 100,000
b.b.Unearned revenue– gift certificates 80,000
Sales 80,000
 c.c.Unearned revenue– gift certificates 10,000
Other income – gift certificates forfeited 10,000
d.d.Unearned revenue– gift certificates 2,000
Other income – gift certificates forfeited 2,000

Illustration 6– Gift certificates

RAYA Co. sells gift certificates that expire one year after their issuance. Information on
gift certificates is shown below:

Gift certificates sold during 20x1 600,000

Unearned revenue - gift certificates, Jan. 1, 20x1 1,000,000
Prior year gift certificates redeemed in 20x1 400,000
Gift certificates sold and redeemed in 20x1 700,000

RAYA 's past experience indicates that 10% of gift certificates sold will not be
redeemed.

Requirement: Compute for the unearned revenue on Dec. 31, 20x1.

Solution:

Unearned revenue
ignored Beg. (from prior year)
Prior year gift certificates redeemed in
ignored
20x1
Gift certificates sold and redeemed in Gift certificates sold
700,000 1,000,000
20x1 during 20x2
Amount estimated not to be redeemed
100,000
(1M x 10%)
End. 200,000

The gift certificates sold in the prior year are ignored in the solution because they
are fully earned in the current year (i.e., one-year expiration). and thus, have no effect
on the ending balance of unearned revenue.
PROVISIONS AND CONTINGENCIES
 A provision is a liability of uncertain timing or amount.
 A provision is an event which is measurable and probable.
 Provisions differ from other liabilities because of the uncertainty about the timing
or amount of expenditure required in settlement.
 Unlike for other liabilities, provisions must be estimated. Although some other
liabilities are also estimated, their uncertainty is generally much less than for
provisions. Other liabilities, such as accruals, are reported as part of “Trade and
other payables” whereas provisions are reported separately.
Recognition:
An entity must recognize a provision if, and only if:
a. a present obligation (legal or constructive) has arisen as a result of a past
event (the obligating event);
b. an outflow of economic benefit to settle the obligation is probable (“more
likely than not”); and
c. the amount of the obligation can be estimated reliably.
 A contingent liability is either a:
a. possible obligation arising from past events whose existence will be
confirmed only by the occurrence or non-occurrence of some uncertain future
event not wholly within the entity’s control, or
b. present obligation that arises from a past event but is not recognized
because it is not
probable that an outflow of resources embodying economic benefits
will be required to settle the obligation,
or the amount of the obligation cannot be measured with sufficient
reliability.
 A contingent asset is a possible asset that arises from past events, and whose
existence will be confirmed only by the occurrence or non-occurrence of one or
more uncertain future events not wholly within the control of the entity.

Can it reliably Contingent Contingent

Probability
be measured? Liability Asset
Recognize
Virtually if: Yes
More than 90% Not Applicable (Provision)
Certain
If: No Disclose
 (Contingent
Asset)
Recognize
if: Yes
Probable More than 50% (Provision)
(more likely likely or Disclose Disclose
than not) substantially more If: No (Contingent
Liability)
Possible 50% or less Yes/No Disclose Ignore
Remote 10% or less Yes/No Ignore Ignore

Guidelines:

Measurement:
 Provisions are measured at the best estimate of the amount needed to settle
them at the end of the reporting period.

Nature of the Outflow Measurement basis

General rule Best Estimate
Involves a large population of items. Expected Value (Probability
Computed by weighting all possible outcomes by their Weighted Average)
associated probabilities.
Continuous range of possible outcomes. Each point in Mid-point
that range is as likely as any other.
For long-term provision Present Value

Reimbursement

 Where some or all of the expenditure required to settle a provision is expected to

be reimbursed by another party, the reimbursement shall be recognized when,
and only when, it is virtually certain that reimbursement will be received if the
entity settles the obligation.
 The reimbursement shall be treated as a separate asset.
 The amount recognized for the reimbursement shall not exceed the amount of the
provision.
Restructuring
 A provision for restructuring costs is recognized only when the general
recognition criteria for provisions are met.
 A restructuring provision shall include only the direct expenditures arising from
the restructuring, which are those that are necessarily entailed by the
restructuring and not associated with the ongoing activities of the entity.
 A restructuring provision does not include such costs as retraining or relocating
continuing staff, marketing; investment in new systems and distribution network.

Key notes:

 A provision is a liability of uncertain timing or amount. It is distinguished from

other liabilities on the basis of the uncertainty in its timing or amount. Provisions
necessarily require estimates.
 A provision is recognized if there is present obligation requiring outflow of
resources embodying economic benefit that is both probable and measured
reliably.
 Provisions are presented separately from other liabilities.
 A contingent liability is not recognized because it is a possible obligation or a
present obligation but with an improbable outflow or an outflow that cannot be
estimated reliably.
 Present obligation results from past events which either gives rise to a legal or a
constructive obligation.

 When measuring a provision, an entity uses: (a) best estimate, (b) expected
value, or (c) mid-point.
 When the provision arises from a single obligation, the estimate of the amount of
the individual most likely outcome adjusted to take account of the effect of other
possible outcomes
 When the provision involves a large population of items, the estimate of the
amount reflects the weighting of all possible outcomes by their associated
probabilities (i.e., expected value).
 Where there is a continuous range of possible outcomes, and each point in that
range is as likely as any other, the midpoint of the range is used.
 When the effect of time value of money is material, provisions should be
discounted to their present values using a current pre-tax discount rate.
 Where details of a proposed new law have yet to be finalized, an obligation
arises only when the legislation is virtually certain to be enacted as drafted.
  Gains from the expected disposal of assets shall not be taken into account in
measuring a provision.
 Reimbursements are considered only when their receipt is virtually certain.
 Changes in provisions are accounted for prospectively.
 Restructuring provision does not include the following: (a) retraining or relocating
continuing staff; (b) marketing; or (c) investment in new systems and distribution
networks.
 Identifiable future operating losses up to the date of a restructuring is not
included in a provision, unless they relate to an onerous contract
 Restructuring includes (a) sale or termination of a line of business; (b) the closure
of business locations in a country or region or the relocation of business activities
from one country or region to another; (c) changes in management structure, for
example, eliminating a layer of management; and (d) fundamental
reorganizations that have a material effect on the nature and focus of the entity's
operations.

Example cases of Provisions

Case Accounting Treatment

Liability for pending lawsuits, tax
assessment, government-imposed
penalties, and the like.
A defective product causes injury to
customers. No lawsuits have yet been
filed against the seller.
Environmental damages
Restructuring by sale of an operation
Restructuring by closure or
reorganization.
Warranty, Premiums, and Refunds
Recognize a provision if there is present
obligation and outflow is both probable and
estimable.
Present obligation arises from injury caused by
the customers. Provision is to recognize if
outflow is both probable and estimable.
Recognize a provision if the entity’s policy is to
clean up even if there is no legal requirement
to do so.
Recognize a provision only if a binding sale
agreement is obtained on or before the end of
the reporting period.
Recognize a provision only if a detailed formal
plan is adopted and announced publicly on or
before the end of the reporting period.
Recognize a provision at the point of sale if
there is legal or constructive obligation.
Guarantee for indebtedness of others.
Offshore oil rigs must be removed and
sea bed restored.
Recognize a provision only when the liability
for the guarantee becomes probable.
Recognize a provision only when the oil rig is
installed. The provision is added to the cost of
the asset.

Onerous (loss-making) contract Recognize a provision if outflow is both

probable and reliably estimated.
An entity must train its employees to No provision; there is no obligation to provide
increase productivity and efficiency. training.

An entity has a self-insurance policy No provision until an actual loss is incurred.

Major overhaul or repairs No provision; there is no obligating event,
unless commitment was made to a third party
for the overhaul or repair.

LIABILITIES ARISING FROM CUSTOMER LOYALTY PROGRAMS

Related standard: IFRS 15

 The customer loyalty program is generally designed to reward

customers for past purchases and to provide them with incentives to make
further purchases.

 If the customer buys goods or services, the entity grants the customer
award credits often described as “points”. The entity can redeem the
“points” by distributing to the customer free or discounted goods or
services.

Customer loyalty programs are used by entities to:

1) Build brand Loyalty
2) Retain their valuable Customers, and

3) To increase Sales volume

 Measurement: Separately component of the initial sale transaction.

 IFRS 15, paragraph 74, provides that an entity shall allocate the transaction
price to each performance obligation identified in a contract on a relative stand-
alone selling price basis.

 In other words, the fair value of the consideration received with respect to
the initial sale shall be allocated between the award credits and the sale based
on the relative stand-alone selling price.

 Stand-alone price – price at which an entity would sell a promised good or

service separately to a customer.

Recognition: Consideration allocated to the award credits  Deferred revenue

 The amount of revenue recognized shall be based on the number of award

credits that have been redeemed relative to the number expected to be
redeemed.

Journal Entry: Customer Loyalty Program

1) Initial sale

Cash xx
Sales xx
Unearned revenue points xx

2) Redemption of points

Unearned revenue –points xx

Sales xx

Journal Entries: Third party operates loyalty program

1) Initial sale

Cash xx
Sales xx
Revenue from points xx
2) Payment to third party (Loyalty program expense)

Loyalty program xx
expense
Cash xx

WARRANTIES
Related standard: PAS 37

 Warranty is the promise or guarantee that a manufacturer or similar party makes

regarding the condition of its product. It also refer to the terms and situations in
which repairs or exchanges will be made if the product does not function as
originally described or intended.

Recognition of a warranty provision:

 PAS 37. paragraph 14, provides that a provision shall be recognized as a

liability in the financial statements under the following conditions:
a) The entity has a present obligation, legal or constructive, as a result of a past
event.
b) It is probable that an outflow of resources embodying economic benefits would
be required to settle the obligation.
c) The amount of the obligation can be measured reliably.

Past event

 Obligating event

 Must have occurred

 Sale of the product give rise to a constructive obligation

Probable outflow of resources

 Outflow of resources embodying economic benefit in settlement

 There will be claims against the warranty
Reliable Estimate

 Amount  Best estimate

 No reliable estimate  No warranty liability will be recognized

Recognition:

Two methods in recording warranty expense

1. Accrual approach – has the soundest theoretical support because it follows the
matching principle.
2. Expense as incurred approach – approach of expensing warranty cost only when
actually incurred. This is justified on the basis of expediency when warranty cost
is not very substantial or when the warranty period is relatively short.

Journal entries: Accrual approach

1) Estimated warranty cost is recorded

Warranty expense xx
Estimated warranty liability xx

2) Actual warranty cost is subsequently incurred and paid

Estimated warranty liability xx

Cash xx

Adjustments
3) Actual > Estimated

Warranty expense xx
Estimated warranty xx
expense
4) Actual < Estimated

Estimated warranty liability xx

Warranty expense xx

Journal entries: Expense as incurred approach

1) Record sales

Cash xx
Sales xx

2) Record warranty expense

Warranty expense xx
Estimated warranty liability xx

3) Record actual warranty repairs

Estimated warranty liability xx

Cash xx

Journal entries: Sale of warranty

Cash xx
Sales xx
Unearned warranty revenue xx

-----END-----
Sources and References:

 Investopedia
 Valix, C..et. al (2019). Intermediate Accounting Volume 2
 Millan, Z. (2019). Intermediate Accounting 2. 2019 Edition. Bandolin Enterprise.
 Valix, C.T., Peralta, J. & Valix, C.A. (2019). Intermediate Accounting 2. 2019
Edition. GIC Enterprises & Co.