INTEGRATED ACCOUNTING : FINANCIAL ACCOUNTING & REPORTING (P1)

INTEGRATED ACCOUNTING – FAR (P1)

MODULE 4 : LIABILITIES
This module identify the essential characteristics of an accounting liability, examples of
liabilities, the initial and subsequent measurement of current and noncurrent liabilities, debt
restructuring and its principles of derecognition. The non-Financial liabilities such as premiums
and warranties, unearned revenues for gift certificates and subscriptions, provisions and
contingencies.
4.1 Financial Liabilities
o Is any liability that is a contractual obligation to deliver cash or other financial
asset to another entity
o To exchange financial instruments with another entity under conditions that are
potentially unfavorable.
Examples of Financial Liabilities:
o Trade accounts payable
o Notes payable
o Loans payable
o Bonds payable
Examples of non-financial liabilities
o Deferred revenue and warranty obligations – because the outflow of economic
benefits is the delivery of goods and services rather than a contractual obligation
to pay cash
o Income tax payable – because it is imposed by law and non-contractual.
o Constructive obligations – because the obligations do not arise from contracts.

4.1.1 Accounts payable and other trade payables

4.1.1.1 Initial recognition
o An entity shall measure initially a financial liability at fair value
minus transaction costs that are directly attributable to the issue
of the financial liability.
o However, the transaction costs are expensed immediately if the
financial liability is designated initially at fair value through profit
or loss.
o Transaction costs include the following:

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  Fees and commissions paid to agents, advisers, brokers,
dealers
 Levies by regulatory agencies & security exchanges
 Transfer taxes and duties.
o Transaction does not include:
 Debt premiums or discounts
 Financing costs
 Internal administrative or holding costs
4.1.1.2 Subsequent measurement
o Provides that after initial recognition, an entity shall measure a
financial liability at:
 Amortized costs using the effective interest method –
simply stated, the difference between the face amount
and present value of the financial liability is amortized
using the effective interest method.
 Fair value through profit or loss – under this option, the
financial liability (example: bond payable) is measured at
fair value at every year-end and any change in fair value is
recognized in profit or loss.

Case Analysis 1 - Accounts Payable

TANGO Company disclosed the following liability account balances on December 31, 2020:
Accounts payable P 1,900,000
Bonds payable 3,400,000
Premium on bonds payable 200,000
Deferred tax liability 400,000
Dividends payable 500,000
Income tax payable 900,000
Note payable, due January 31, 2021 600,000
REQUIRED:
1. On December 31, 2020, what total amount should be reported as current liabilities ?

Case Analysis – Accounts Payable

681 APPLIANCE Company sells appliance service contracts agreeing to repair appliances for
two-year period. The past experience is that, of the total amount spent for repairs on service
contracts, 40% is incurred evenly during the first contract year and 60% is incurred evenly
during the second contract year.

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Receipts from service contract sales are P500,000 for 2020 and P600,000 for 2021. Receipts
from contracts are credited to unearned service revenue. All sales are made evenly during the
year.

REQUIRED:
1. What is the contract revenue for 2020 ?
2. What is the unearned revenue on December 31, 2020 ?
3. What is the contract revenue for 2021 ?
4. What is the unearned revenue on December 31, 2021 ?

4.1.2 Debt restructuring

4.1.2.1 Nature and forms
 Debt restructuring is a situation where the creditor grants to the debtor
concession that would not otherwise be granted in a normal business
relationship. Common forms are:
o Asset swap – transfer of any asset such as real estate, inventory or
investment by the debtor to the creditor in full settlement of an
obligation. Asset swap is treated as a derecognition of a financial
liability or extinguishment of an obligation.

Case Analysis – Asset SWAP

An entity provided the following balances at year-end:
Note payable - 2,000,000
Accrued interest payable - 400,000
At year-end, the entity transferred to the creditor land with carrying amount of
P1,500,000 and fair value of P2,200,000.

REQUIRED:
1. What is the amount of gain or loss on the extinguishment of debt ?
2. Prepare the journal entry to record the transaction.

o Equity swap – a transaction whereby a debtor and a 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 instrument to the creditor.

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Case Analysis – Equity Swap
An entity showed the following data at year-end:
Bonds payable - P 5,000,000
Accrued interest payable - 500,000
The entity issued share capital with a total par value of P2,000,000 and fair value of
P4,500,000 in full settlement of the bonds payable and accrued interest. On the other
hand, the fair value of the bonds payable is P4,700,000.

REQUIRED:
1. How much is the gain or loss on the extinguishment of debt using the fair value of shares ?
2. How much is the gain or loss on the extinguishment of debt using the fair value of Bonds
payable ?
3. How much is the gain or loss on the extinguishment of debt using the carrying amount of
bonds payable ?
4. What is the appropriate journal entries for each ?

 Modification of terms – may involve either the interest or maturity value

or both.
 Modification of interest may be a reduction of the interest rate,
forgiveness of unpaid interest or a moratorium on interest payment.

Case Analysis – Modification of Terms

On January 1, 2020, ABAKADA Company showed the following:

Note payable – due January 1, 2020 @ 14% 5,000,000
Accrued Interest payable 1,000,000
The company is granted by the creditor the following concessions on January 1, 2020:
a) The accrued interest of P1,000,000 is forgiven.
b) The principal obligation is reduced to P 4,000,000.
c) The new interest rate is 10% payable every December 31.
d) The new date of maturity is December 31, 2023.

Additional information:
a) The PV of the new note payable is equal to the PV of the new principal plus the PV of
the interest payments on the new liability.
b) The present value (PV) of 1 at 14% for 4 periods is 0.5921.
c) The present value (PV) of an ordinary annuity of 1 at 14% for 4 periods is 2.9137.

REQUIRED:
Prepare the appropriate journal entries with accompanying computations to record:
1. The extinguishment of the old note payable.

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 2. The interest payment on the new note payable for 2020.
3. To amortize the discount on note payable for 2020.

4.1.2.2 Principles of derecognition

o Approach 1 - The basic derecognition principle is that an entity
should derecognize a financial asset when it no longer qualifies as
an asset of the entity.
o Approach 2 – an entity to derecognized a financial asset or a pre-
defined component thereof if:
 The contractual rights to the cash flows from the asset
expire
 The entity transfers the asset
4.2 Non-Financial Liabilities
o Are mainly contingencies or types of liabilities that are not of financial
transaction origin. Examples include deferred revenue, advances received and
provisions that might have to be made as a result of these changes.
o Non-financial liabilities mainly require non-cash obligations that need to be
provided in order to settle the balance, which includes goods, services,
warranties, environmental liabilities.
o Non-financial liability can be best described as an obligation that is associated
with the retirement or maintenance of a long-lived asset in the future.

Measurement and Accounting Treatment (IAS 37)

 Non-financial liabilities should be measured at amounts that would rationally be
paid to settle any present obligation or amount to transfer it to a third party on
the balance sheet date.

4.2.1 Premiums
 Premiums are articles of value such as toys, dishes, silverware and other
goods given to customers as result of past sales or sales promotion
activities.

Case Analysis 3 – Premiums

XYZ manufactures Product X and sells it at P300 per unit. A bowl is offered to customers on the
return of 5 wrappers plus remittance of P10. The bowl costs P50 and is estimated that 60% of
the wrappers will be redeemed. The first year data concerning the premium plan is summarized
as:
Sales , 10,000 units at P300 each 3,000,000
Bowls purchased, 2,000 units @ P50 each 100,000
Wrappers redeemed 4,000

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REQUIRED:
1. What are the journal entries made in the first year to record the sales, premium purchases
and redemption ?
2. What is the amount of estimated liability at year-end ?
______________________________________________________________________________

4.2.2 Warranty
 Home appliances like TV sets, stereo sets refrigerators and the like are
often sold under guarantee or warranty to provide free repair service or
replacement during a specified period if products are defective.

There are two approaches in recording warranty expense:
o Accrual approach
Has the soundest theoretical support because it properly matches
cost and revenue.
o Expense as incurred approach
Is the approach of expensing warranty cost only when actually
incurred.
______________________________________________________________________________

Case Analysis 4 – Warranty (Accrual Approach)

BGC Company sells 1,000 units of TV sets at P9,000 each for cash. Each TV set is under
warranty for one year. The entity has estimated from past experiences that warranty
cost will probably average P500 per unit and that only 60% of the units sold will be
returned for repair. The company incurs P180,000 for repairs during the year.

REQUIRED:
1. What is the amount of warranty cost to be set up as estimated liability on the
warranty ?
2. Prepare the journal entries:
a) To record sales
b) To set up estimated liability on warranty
c) To record the payment of actual costs.

Case Analysis 5 – Warranty (Expense as Incurred Approach)

BCDA sells refrigerators that carry a 2-year warranty against defects. The sales and warranty
repairs are made evenly throughout the year. Based on past experience, the entity projects an
estimated warranty cost as a percentage of sales as follows:
First year of warranty - 4%
Second year of warranty - 10%

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 2020 2021
Sales 5,000,000 6,000,000
Actual warranty repairs 140,000 300,000

REQUIRED:
1. Prepare the journal entries in 2020 :
 To record sales:

 To record the warranty expense

 To record the actual warranty repairs:

2. Prepare journal entries for 2021.

 To record sales:

 To record the warranty expense

 To record the actual warranty repairs:

______________________________________________________________________________

4.2.3 Unearned revenues for gift certificates and subscription

4.3 Provisions and contingencies

 Provisions is an existing liability of uncertain timing or uncertain amount which
shall be recognized as a liability in the financial statements under the following
conditions:
o The entity has a present obligation (legal or constructive) as a result of
past events.
o It is probable that an outflow of resources would be required to settle the
obligation
o The amount of obligation can be measured reliably.
 Examples of provisions:
o Warranties – obligation arising from sale of product with warranty
o Environmental contamination – example is the cost of cleaning the entity
o Abandonment costs – an oil company initially purchases an oil field has
legal obligation to decommission the site at the end of its life.
o Court case – a provision is recognized for the best estimate of the
damages in a present obligation in case the entity losses the case.
o Guarantee – an entity gives a guarantee of certain borrowings of another
entity who at the end of the year files a petition for bankruptcy.

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 
Contingent Liability is a possible obligation 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 within the control of the entity,
thus not recognized because:
o It is not probable that an outflow of resources will be required to settle
the obligations
o The amount of the obligation cannot be measured reliably.
______________________________________________________________________________

Case Analysis – Decommissioning liability

ABC Mining Company extracts natural gas and oil in the Philippine Malampaya Deep.
On January 1, 2020, the entity constructed a drilling platform for P25,000,000 and is
required by Philippine law to remove and dismantle the platform at the end of its useful
life of 10 years.
The straight-line method is used in depreciating the drilling platform. The entity has
estimated that such decommissioning will cost P5,000,000. Based on a 12% discount
rate, the present value of 1 for 10 years is 0.322.

REQUIRED
1. What is the amount of decommissioning liability in 2020 ?
2. What is the amount of interest expense in 2020 ?
3. What is the amount of depreciation expense in 2020 ?
4. What is the amount of interest expense in 2021 ?
5. Prepare the journal entries in 2020 and 2021.

_____________________________________________________________________________

ADDITIONAL EXERCISES:

CASE 1
In an effort to increase sales, MAX Company inaugurates a sales promotional campaign on June
30, 2021. The entity placed a coupon redeemable for a premium in each package of cereal sold.
Each premium cost P20 and five coupons must be presented by a customer to receive a
premium. The entity estimated that 60% of the coupons issued would be redeemed. For the aix
months ended December 31, 2021, the following information is available:
Packages of Premiums Coupons
Cereal sold purchased redeemed
160,000 12,000 40,000

1. What is the estimated number of premiums ?

2. What is the estimated liability for premiums on December 31, 2021 ?

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CASE 2
During the current year, INDAY Company sold 500,000 boxes of cake mix under a new sales
promotional program. Each box contained one coupon, which entitled the customer to a baking
pan upon remittance of P40. The entity paid P50 per pan and P5 for handling and shipping and
estimated that 80% of the coupons would be redeemed even though only 300,000 coupons had
been processed during the year.

3. How much is the net premium expense ?

4. How many coupons are outstanding ?
5. What amount should be reported as liability for unredeemed coupons at year-end ?

CASE 3
In 2021, DAVID Company began selling a new calculator that carried a two-year warranty
against defects. The entity projected the estimated warranty cost as a percent of sales.
First year of warranty 4%
Second year of warranty 10%
Sales and actual warranty repairs were:
2021 2022
Sales 5,000,000 9,000,000
Actual warranty repairs 200,000 560,000

1. What is the amount of the estimated warranty liability on December 31, 2022 ?
2. What is the journal entry in connection with the warranty using the expense as incurred
approach.

CASE 4
MARCO Company sells washing machines that carry a three-year warranty against
manufacturer’s defects. Based on entity experience. Warranty costs are estimated at P300 per
machine. During the current year, the entity sold 2,400 washing machines and paid warranty
costs of P170,000.
1. What amount should be reported as warranty for the current year ?
2. What amount should be reported as estimated warranty liability at year-end ?

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CASE 5
TANGE Company issued 3-year 12% bonds payabale with face amount of P2,000,000. Interest is
payable semiannually April 1 and October 1. The bonds were issued on April 1, 2021 for
P2,101,520 which represent ts an effective interest cost of 10% per year.
1. Prepare an amortization table using the effective interest method.
2. Prepare journal entries for 2021 and 2022.

CASE 6
On January 1, 2021, MASBATE Company issued bonds payable with face amount of P6,000,000
with an 8% effective yield. The nominal rate of 6% is payable annually on December 31. The
bonds mature on every December 31 each year at the rate of P2,000,000 for three years.
Present value of 1 at 8%
One period 0.93
Two periods 0.86
Three periods 0.79

1. What is the market price or issue price of the bonds payable ?

2. What is the carrying amount of the bonds payable on December 31, 2021 ?

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