Intermediate Accounting 2

Liabilities are present obligation of an entity to transfer an economic resource as a result of past events.

Financial Liability

A financial liability is any liability that is a contractual obligation:

a. to deliver cash or another financial asset to another entity; or

b. to exchange financial instruments with another entity under conditions that are potentially
unfavorable to the entity.

Examples of financial liability

1. Payables such as accounts, notes, loans, bonds payable and accrued expenses that are payable in
cash.

2. Finance lease obligations.

3. Liabilities held for trading such as obligations to deliver financial assets borrowed by a “short seller”
(i.e. an entity that sells financial assets it has borrowed and does not yet own).

4. Preference shares issued with mandatory redemption.

5. Security deposits received that are to be returned to tenants at the end of lease term.

6. Obligations to deliver a variable number of own shares worth a fixed amount of cash.

The following are not financial liabilities

1. Unearned revenues and warranty obligations that are to be settled by future delivery of goods or
services, rather than cash.

2. Taxes, SSS premiums, Philhealth and other payables arising from statutory requirements and not from
contracts.

3. Commodity contracts that either cannot be settled in cash or which are expected to be settled by
commodity exchange (e.g., coffee beans, gold bullion, oil, and the like). If a commodity contract is
expected to be cash settled, it will be included as financial liability on the part of the cash payor.

4. Constructive obligations. These obligations do not arise from contracts.

Current Liabilities

An entity shall classify a liability as current when:

1. it expects to settle the liability in its normal operating cycle;

2. it holds the liability primarily for the purpose of trading;

3. the liability is due to be settled within twelve months after the reporting period; or

4. the entity does not have an unconditional right to defer settlement of the liability for at least twelve
months after the reporting period.

Noncurrent Liabilities

This is a residual definition. All liabilities not classified as current liabilities are classified as current
liabilities.

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.

• 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.

Currently maturing long-term liabilities

General rule: Currently maturing long term liabilities are presented as current liabilities.

Exceptions:

1. Refinancing agreement fully completed on or before the reporting date should be reported as
noncurrent liability

2. Refinancing agreement after the reporting date but before the financial statements are authorized for
issue may be reported as non-current liability if the refinancing is at the discretion of the entity.

Breach of loan agreement

General rule: A liability that is payable on demand is a current liability.

Exception: It is presented as non-current liability if the lender provides the entity, on or before the
reporting date, a grace period ending at least 12 months after the reporting date to rectify a breach of
loan covenant.