Professional Documents
Culture Documents
Week 1–3 (Unit 1): Unit Learning Outcomes (ULO): At the end of the unit, you
are expected to:
a. Demonstrate the nature and measurement of liabilities.
b. Account for Premium Liability
c. Account for Warranty Liability
d. Demonstrate the accounting for provision and contingent liability
e. Demonstrate the accounting for depreciation.
Essential Knowledge
To perform the aforesaid big picture (unit learning outcomes) for the first two
(2) weeks of the course, you need to fully understand the following essential
knowledge that will be laid down in the succeeding pages. Please note that you are
not limited to exclusively refer to these resources. Thus, you are expected to utilize
other books, research articles and other resources that are available in the university’s
library e.g. ebrary, search.proquest.com etc.
I. Liabilities
Present obligation
✓ An essential characteristic of a liability is that the entity has a present obligation.
✓ The present obligation may be a legal obligation or a constructive
obligation.
✓ Obligations may be legally enforceable as a consequence of binding contract
or statutory requirement. This is normally the case, for example, with accounts
payable for goods and services received.
✓ Constructive obligations also give rise to liabilities by reason of normal business
practice, custom and a desire to maintain good business relations or act in any
quotable manner.
Past event.
✓ Another essential characteristic of a liability is that the liability must arise from
a past transaction or event.
✓ The past event that leads to illegal or constructive obligation is known as the
obligating event.
✓ The obligating event creates a present obligation because the entity has no
realistic alternative but to settle the obligation created by the event.
✓ For example, the acquisition of goods gives rise to accounts payable. The
obligating event is the acquisition of goods.
Examples of liabilities
a. Accounts payable to suppliers for the purchase of goods
b. Amount withheld from employees for taxes and for contributions to the
Social Security system
c. Accruals of salaries, interest, rent, taxes, product warranties and profit
sharing bonus.
d. Cash dividends declared but not paid
e. Deposits and advances from customers
f. That obligations for borrowed funds - notes, mortgages and bonds payable.
g. Income tax payable
h. Unearned revenue
Measurement of current liabilities
✓ Conceptually, all liabilities are initially measured at present value and
subsequently measured at amortized cost.
✓ However, in practice, current liabilities or short term obligations are not
discounted anymore but measured, recorded and reported at their face
amount.
✓ The reason is that the discount or the difference between the face amount and
the present value is usually not material and therefore ignored.
Current liabilities
✓ PAS 1, paragraph 69, provides that an entity shall classify a liability as current
when:
a. The entity expects to settle the liability within the entity’s operating cycle.
b. Entity holds reliability primarily for the purpose of trading.
c. The liability is due to be settled within 12 months after the reporting period.
d. The entity does not have an unconditional right to defer settlement of the
liability for at least 12 months after the reporting period.
✓ Examples of such current liabilities are financial liabilities held for trading, bank
overdraft, dividends payable, income taxes, other non-trade payables and
current portion of non-current financial liabilities.
Noncurrent liabilities
✓ The term noncurrent liabilities is a residual definition.
✓ All liabilities not classified as current are classified
as noncurrent liabilities. Noncurrent liabilities include:
a. Noncurrent portion of long term debt
b. finance lease liability
c. deferred tax liability
d. long term obligation to officers
e. long term deferred revenue
Covenants
✓ Covenants are often attached to borrowing agreements which represent
undertakings by the borrower.
✓ These covenants are actually restrictions on the borrower as to undertaking
further borrowings, paying dividends, maintaining specific level of working
capital and so forth.
✓ Breach of covenants
• Under these covenants, if certain conditions relating to the borrower's
financial situation or breached the liability becomes payable on demand.
• PAS 1, paragraphs event before, provides that such a liability is classified
as current even if the lender has agreed, after the reporting period and
before the statement are authorized for issue, not to demand payment as a
consequence of the breach.
• This liability is classified as current because at the end of the reporting
period, the entity does not have an unconditional right to defer settlement
for at least 12 months after that date.
• However, the liability is classified as noncurrent if the lender has agreed on
or before the end of the reporting period to provide a grace period ending at
12 months after that date.
Estimated liabilities
✓ Estimated liabilities are obligations which exist at the end of the reporting period
although their amount is not definite.
✓ In many cases, the date when the obligation is due is not also definite and in
some instances, the exact payee cannot be identified or determined.
✓ But in spite of these circumstances, the existence of the estimated liabilities is
valid and unquestioned.
✓ Estimated liabilities are either current or noncurrent in nature.
✓ Examples include estimated liability for premium, award points, warranties, gift
certificates and bonus.
Deferred revenue
✓ Deferred revenue or unearned revenue is income already received but not yet
earned.
✓ Deferred revenue may be realizable within one year or in more than one year
after the end of the reporting period.
✓ If the deferred revenue is realizable within one year it is a current liability.
✓ Typical examples of current effort revenue or unearned interest income,
unearned rental income and unearned subscription revenue.
✓ If the differed revenue is realizable in more than one year, it is classified as
noncurrent liability.
✓ Typical examples of noncurrent differed revenue are unearned revenue from
long-term service contracts and long-term leasehold advances.
Illustration:
An entity sells equipment service contracts agreeing to service equipment for a 2 year.
Cash receipts from contracts are credited to unearned service revenue and service
contract costs are charged to service contract expense.
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 1,000,000
Service contract costs paid 500,000
Service contract revenue recognized 800,000
Illustration:
Proof:
Income before bonus and before tax 4,400,000
Tax ((4,400,000-317,526) x 30%) (1,224,742)
Income after bonus and after tax 3,175,258
Multiply by x 10%
Bonus 317,526
Refundable deposits
✓ Refundable deposits consist of cash or property received from customers but
which are refundable after compliance with certain conditions.
✓ The best example of a refundable deposit is the customer deposit required for
refundable containers like bottles, drums, tanks and barrels.
Illustration:
A deposit of P10,000 is required from the customer for returnable containers. The
containers cost P8,000.
Cash 10,000
Containers’ deposit 10,000
The containers’ deposit account is usually classified as current liability. If the customer
returns the containers, the deposit is simply refunded. However, if the customer fails
to return the containers, the deposit is considered the sale price of the containers. The
excess of the deposit over the cost of the containers is considered as gain.
Self Help: You can also refer to the sources below to help
you further understand the lesson.
Valix, C.T., Peralta, J.F. &Valix, C.M. (2019). Intermediate Accounting. (2019 ed., Vol.
2). Manila: GIC Enterprises & Co., Inc.
Q and A
In this section you are going to list what boggles you in this unit. You may indicate
your questions but noting you have to indicate the answers after your questions is
being raised and clarified. You can write your questions below:
Keywords
Liabilities Transfer of economic resources
Present obligations Current liability
Past events Noncurrent liability