Intermediate Accounting 2 - Notes

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Intermediate Accounting Current liabilities

Liabilities 2 A. The entity expects to settle the liability within the entity’s operating cycle.
Present obligations of an entity to transfer an economic resource as a result of past Conversion of liabilities to accounts payable, to merchandise, to accounts
events. receivable, to cash, to repayment of liabilities. Irrespective of the term, as long as it is
included in the operating cycle, it is considered as current.
Essential Characteristics
A. The entity has a present obligation B. The entity holds the liability primarily for the purpose of trading.
The payor must be identified. The payee, amount and timing can be
unidentified since it is the payor only concern in the essential characteristics. C. The liability is due to be settled within 12 months after the reporting period.

Sources of obligations: D. The entity does not have an unconditional right to defer (extend) settlement of the
1. Legal – law gives rise the obligation. liability for at least 12 months after the reporting period.
1.1. Law
1.2. Contract Non-current liabilities
2. Constructive – you oblige yourself to incur an obligation. This happens when Residual definition
these 2 essential criteria meet: (1) Announcement and (2)
Assumption Long-term debt falling within 1 year
B. The obligation is to transfer an economic resource It is the reclassification of the long-term liabilities which under the current reporting
Economic resource is either an asset which may be cash or non-cash or service. period, it is only less than or equal to 1 year before it matures.

C. The liability arises from a past event Comprehensive Examples for Unconditional Right
“The payor incurred its debt in 2000 and it will mature on 2022. The current reporting
Measurement period is at 2021.”
Initially Subsequently
Short-term interest-bearing Face value Face value CASE 1: What will be the classification of the debt assuming that the payor does
Short-term non-interest-bearing Face value Face value not
have unconditional right to defer the settlement?”
Long-term interest-bearing Face value Face value The classification will be Current
Long-term non-interest-bearing Present value Amortized cost Liabilities
CASE 2: “Same scenario but the payor has an unconditional right to defer the
Note!!! settlement and the payor exercise his right. What will be the classification of the debt?”
Theoretically, the measurement is at present value. The classification will be Non-Current
Liabilities
Materiality CASE 3: “Same with case 2 but the payor is yet to exercise his right. What will be the
Ability of the information to affect decision classification of the debt?”
The classification will be Non-Current
Benefit over cost Liabilities
Cost should not be greater than benefit
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CASE 4: “Same scenario with case 3 but the unconditional right is carried by the Breach of covenant
payee. What will be the classification of the debt?” When the borrower did not follow the restrictions his creditor set.
The classification will be Current
Liabilities Comprehensive Examples for Breach of Covenant
Refinancing/Extension “The entity has a liability incurred in 2020. The maturity date is at 2030 and the
The entity has a debt and to pay its debt, the entity again borrows money from another reporting period is at 2021.’
financial institution.
CASE 1: “The breach of covenant happens on or before the reporting period. What
Date when the FS are authorized to issue will be the liability’s classification?”
The date when the FS can be issued or presented to anybody like the intended user. The classification will be Current liability because it will be payable on
demand.
Subsequent events/Events after the reporting period CASE 2: “The breach happened after the reporting period. What will be the
The date which is between the reporting period and the date when FS are authorized to liability’s classification?”
issue. The classification will be Non-current
liability.
Classification of Subsequent events Grace period
1. Adjusting events – happened before the reporting period and the subsequent event The period within which the entity can rectify (correct) the breach and during which
enlighten the occurrence of the event. the lender cannot demand immediate repayment.
2. Non-adjusting events – major event in the subsequent period
Comprehensive Examples for Breach of Covenant with Grace Period
Comprehensive Examples for Refinancing/Extension “The entity has a liability incurred in 2020. The maturity date is at 2030 and the
“The entity has a liability incurred in 2020. The maturity date is at 2022 and the reporting period is at 2021.’
current reporting period is at 2021.”
CASE 1: “The breach happened on or before the reporting period and the grace
CASE 1: “The payee and the payor talk about extension on or before the reporting period was granted by the same year which the breach occurs. What will be the liability’s
period and it was agreed that the extension will be more than 1 year. What will be the classification?”
liability’s classification?” The classification will be Non-current
The classification will be Non-Current liability.
Liabilities CASE 2: “The breach happened on or before the reporting period but the grace
CASE 2: “The payee and the payor talk about the extension after the period was given after the reporting period. What will be the liability’s classification?”
period.reporting
What will be the liability’s classification?” The classification will be Current
The classification will be Current Liabilities (a kind of disclosing event to be reflected liability
at the notes to financial statement) CASE 3: “The breach happened after the reporting period and the grace period was
granted by the same year which the breach occurs. What will be the liability’s
Covenant classification?”
Restrictions on the borrower as to undertake further borrowings, paying dividends, The classification will be Non-current
restricting specified level of working capital, etc. liability
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Deferred revenue/Unearned income Pro forma entries

Income already received but not yet earned. This is aligned with the Accrual 1. Sale of product which includes the thing to be refunded
Principle which states that income is earned when the services are rendered or the goods Cash xx
have been delivered regardless of when the cash is received. The entity must perform Customer’s deposit xx
services to offset its liability.
2. Redemption
Current liability examples Customer’s deposit xx
1. Unearned interest income Cash xx
2. Unearned rental income
3. Unearned subscription income 3. Not redeemed – there might be gain or loss
Customer’s deposit xx
Non-current liability Container xx
1. Long-term service contracts
2. Long-term leasehold advances Bonus
A financial compensation that is above and beyond the normal payment
Gift certificate expectations of its recipient. Generally, it is Current Liability which is a
A voucher given as a present that is exchangeable for a specified cash value of goods constructive obligation.
or service from a particular place of business. Generally, it is Current liability
Bonus computation variations
Pro forma entries 1. Bonus is expected as a certain percent of income before bonus and tax
1. Sale of gift certificate B = % (P)
Cash xx 2. Bonus is expected as a certain percent of income after bonus but before tax
Gift certificate payable xx B = % (P – B)
3. Bonus is expected as a certain percent of income after bonus and after tax
2. Redemption B = % (P – B – T)
Gift certificate payable xx or
Sales xx B = % {P – B – [% (P – B)]}
4. Bonus is expected as a certain percent of income before bonus but after tax
3. Not redeemed B = % (P – T)
Gift certificate payable xx or
Forfeited gift certificate xx B = % {[P – [% (P – B)]}

Returnable deposits Pro forma entries

Consist of cash or property received from customers but which are refundable after Bonus expense xx
compliance with certain conditions. Generally, it is Current Liability. Bonus payable xx
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Premiums
Articles of value such as toys, dishes, silverware and other goods given to customers 2. Payment of rebate
as a result of past sales or sales promotion activities. The things to return of are product Estimated rebate liability xx
labels, box tops, wrappers and coupons. Generally, it is Current Asset Cash xx

Estimated premium liability Sample formula

Obligations which exist at the end of reporting period although their amount is not Rebate coupon issued xx
definite. This is aligned with the Matching principle which states that the recognition of Redemption rate x xx
expense should be incurred as the income incurred. Generally, it is Current liability Coupon to be rebated xx
Cash rebate per coupon x xx
Pro forma entries Rebate liability xx
1. Purchased of premiums
Premiums xx Cash discount coupon
Cash xx Done for sales promotion

2. Redemption Pro forma entries

Premium expense xx 1. Estimation of rebate after the sale
Premium xx Discount coupon expense xx
Estimated coupon liability xx
3. Awaiting to be redeem
Premium expense xx 2. Payment of discount coupon
Estimated premium liability xx Estimated coupon liability xx
Cash xx
Cash rebate program
Done for sales promotion Subsequent changes in estimate
Use the accounting for changes in accounting estimates which is currently and
Rebates prospectively.
Those are retrospective payment which ultimately reduces the overall cost of a
product/service at a later date. This is when you buy product and after a later date, upon Customer loyalty program
buying the said product, considering the rebate, the price of it will be reduced. Commonly Many entities use a customer loyalty program to build brand loyalty, retain their
offered by credit card companies. valuable customers and of course increase sales volume. It is generally design to reward
customers for past purchases and to provide them with incentives to make further purchases.
They also provide after sales services.
Pro forma entries
1. Estimation of rebate after the sale
Rebate expense xx
Estimated rebate liability xx
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Measurement: Award Credits – Points Total points (unearned reveue – points)

Accounted for as separately component of the initial sale transaction

Fair value of the consideration received with respect to initial sales

INITIAL SUBSEQUENT

Actual Redemption Cumulative actual redemption

Sale of merchandise based on Award credits based on relative Expected total number of Expected total number of
relative stand-alone selling price stand-alone selling price credits to be redeemed credits to be redeemed

Pro forma entries

Cash xx Answer – previously recognized
Sales xx revenue = revenue this year
Unearned revenue – points xx
Third party operates customer loyalty program
Stand-along selling price The points given by the entity will be redeemed by the customer to a third party.
The price at which the entity would sell a promise goods or services separately to a
customer. Pro forma entries
1. Sale
Recognition: Unearned Revenue – Sales Cash xx
The amount of revenue recognized shall be based on the number of award credits Sales xx
that have been redeemed relative to the total number expected to be redeemed. Revenue from points xx

2. Payment to third party

Loyalty program expense xx
Cash xx

Warranty
A written guarantee, issued to the purchaser of an article by its manufacturer,
promising to repair or replace it if necessary, within a specified period of time.
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Pro forma entries Unearned warranty revenue xx

Expense as incurred approach Accrual approach Warranty revenue xx
1. Cash xx Cash xx
Sales xx Sales xx Amortization
2. Warranty expense xx Warranty expense xx It starts after the expiration of regular warranty period.
Cash xx Est. warranty liability xx
Provision
3. Est. warranty liability xx It is an existing liability of uncertain timing or uncertain amount.
Cash xx
Recognition
Note!!! a. The entity has a present obligation (legal or constructive) as a result of past event
Expense as incurred approach is used for tax purposes. The accrual approach is the b. It is probable that an outflow of resources embodying economic benefits would be
one suggested by the standard for it was aligned with the Matching principle required to settle the obligation
c. The amount of obligation can be measured reliably.
Warranty expense
Recorded in the year of sale What does probable means?
Based on sales (percentage, specific cost) The event is more likely than not to occur

Estimated warranty liability Certain – 100 =%

Beg balance xx Probable – more than 50% likely or substantially more
Expense xx Possible – 50% or less likely to occur
Actual repairs (xx) Remote – 10% or less likely to occur or very slight occurrence
Estimated liability xx Impossible – 0%

Testing the accuracy of warranty liability Measurement

The warranty period is considered in determining the total estimated liability. Management best estimate

Sales made evenly Best estimate

It is an assumption that all of the sale happened equally every day. The amount that an entity would rationally pay to settle the obligation at the end of
reporting period or to transfer it to a third party at that time.
Sale of warranty (sold separately)
Warranty itself was sold separately. “If single obligation is measured” – individual most likely outcome adjusted for the
effect of other possible outcomes.
Pro forma entries
Cash xx “If range of possible outcome” – the midpoint if the range is used assuming each point
Sales xx in that range is as likely as the other.
Unearned warranty revenue xx
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“If large population of items” – expected value method is used. It weighs all possible Contingent asset
outcomes by their associated possibilities. A possible asset that arises from past event and whose existence will be confirmed
only by the occurrence or non-occurrence of one or more uncertain future events not wholly
Other measurement considerations within the control of the entity.
1. Risks and uncertainties
2. Present value of obligation Liability Asset
3. Future events 1. Certain Recognized Recognized
4. Expected disposal of assets 2. Virtually certain Recognized Recognized
5. Reimbursements 3. Probable Recognized Disclosed
6. Changes in provision 4. Possible Disclosed Ignored
7. Use of provision 5. Remote Ignored Ignored
8. Future operating losses 6. Impossible Ignored Ignored
9. Onerous contract
Disclosure requirements
Contingent liability
Examples of provision a. Brief description of the nature of the contingent liability
1. Warranties b. An estimate of its financial effects
2. Environment contamination c. An indication of the uncertainties that exist
3. Decommissioning or abandonment cost d. Possibility of a reimbursement
4. Court case Contingent asset
5. Guarantee a. Brief description of the nature of the contingent asset
b. An estimate of its financial effects
Contingent liability Note!!!
A possible obligation that arises from past event and whose existence will be The difference between the treatment of contingent asset and contingent liability lies
confirmed only by the occurrence or non-occurrence of one or more uncertain future events on the accounting principle, conservatism. It states that there should not be an overstatement
not wholly within the control of the entity. of an entity’s income and all possible losses should be recognized.
A possible obligation that arises from 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 reliably.
It can either be probable or measurable but not
both.
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Restructuring Cost of PPE

Program that is planned and controlled by management and materially changes either 1. Purchase price
the scope of the business of an entity or the manner in which that business is conducted. 2. Directly attributable costs
3. Estimated cost of dismantling
a. Sale or termination of a line business
b. Closure of business location in a region or relocation of business activities from one Pro forma entries
location to another or relocation of headquarters from one country to another. 1. Purchase of PPE
c. Change in management structure, such as elimination of a layer of management or PPE xx
making all functional units autonomous Cash xx
d. Fundamental reorganization of an entity that has a material and significant impact on Dismantling liability (should be at PV) xx
its operation
2. Yearly depreciation
Provision for restructuring: Constructive obligation may arise Depreciation xx
1. The entity has a detailed formal plan for the restructuring Accumulated depreciation xx
a. The business being restructured
b. The principal location affected 3. Amortization of liability
c. The location function and appropriate number of employees who will be Interest expense xx
compensated for terminating their employment Dismantling liability xx
d. Date when the plan will be implemented
e. The expenditures that will be taken Changes in Estimate
1. If the liability increase
2. The entity has raised valid expectation in the minds of those affected that the entity Equipment xx
will carry out the restructuring by starting to implement the plan and announcing the Dismantling liability xx
main features to those affected by it.
2. If the liability decrease
Measurement: Restructuring provision Dismantling liability xx
Direct expenditures necessarily incurred for the restructuring and not associated with Equipment xx
ongoing activities
Exclusions: 3. Settlement
1. Cost of retraining and relocating continuing staff Accumulated depreciation xx
2. Marketing or advertising program to promote company image Equipment xx
3. Investment in new system and distribution network.
Dismantling liability xx
Decommissioning liability Cash xx
An obligation to dismantle, remove and restore an item of property, plant and
equipment as required by law or contract. It is also called as asset retirement obligation.
Generally, it is Non-current liability.
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Note!!!
Gain or loss on settlement of decommissioning liability may arise. At the settlement
date, when the estimate is greater than or lower than the actual payment, gain or loss will be
recognized.

When there are 2 income tax rates, the 2ndpriority will adjust since it can cater the 1 st
priority.