CURRENT LIABILITIES

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

Characteristics of liability:

a. The entity has a present obligation.

b. The obligation is to transfer an economic resource.
c. The liability arises from a past event.

Present Obligation

● Legal or constructive obligation

● Constructive obligations also give rise to liabilities by reason of normal business practice, custom
and desire to maintain good business relations or act in an equitable manner.
● May be legally enforceable as a consequence of binding contract or statutory requirement.

Transfer of an economic resource

● There is an obligation to pay cash, hence, accounting liability exists.

● When an entity declares a share dividend, there is no accounting liability.
● The obligation is to issue the entities own shares
● Issuance of the entities on shares is not a transfer of noncash assets because the share capital is an
equity item.
● Share dividend payable is part of equity rather than an accounting liability

Past event

● It leads to a legal or constructive obligation known as an obligating event.

● Obligating events creates a present obligation because the entity has no realistic alternative but to
settle the obligation created by the event.
● E.g. - the acquisition of good gies rises to accounts payable. The obligating event is the
acquisition of goods.

Examples of liability:

a. Accounts payable to suppliers for the purchase of goods

b. Amounts withheld from employees for taxes and SSS
c. Accruals for salaries, interest, rent, taxes, product warranties and profit sharing bonus
d. Deposits and advances from customers
e. Cash dividends declared but not paid
f. Debt obligations for borrowed funds- notes, mortgages and bonds payable
g. Income tax payable
 h. Unearned revenue

MEASUREMENT

Current Liabilities

● Conceptually, all liabilities are initially measured at present value and subsequently measured at
amortized cost.
● However, current liabilities are not discounted anymore but measured, recorded, and reported at
face amount.
● The difference between the face amount and the present value is usually not material and
therefore ignored.

Noncurrent Liabilities

● Bonds payable and noninterest bearing note payable are initially measured at present value and
subsequently measured at amortized cost.
● Long-term note payable is interest bearing, initially and subsequently measured at face amount.
● Face amount is equal to the present value of the note payable.

CURRENT LIABILITIES

a. The entity expects to settle the liability within the entity’s operating cycle.
b. Holds the liability primarily for the purpose of trading.
c. Liability is due to be settled within twelve months after the reporting period.
d. The entity does not have an unconditional right to defer settlement of the liability for at least
twelve months after the reporting period.

● Operating items are classified as current liabilities even if settled more than 12 months after the
reporting period.
● When an entity's normal operating cycle is not clearly identifiable, its duration is assumed to be
12 months.

NONCURRENT LIABILITIES

Noncurrent liabilities include;

a. Noncurrent portion of long-term debt

b. Finance lease liability
 c. Deferred tax liability
d. Long-term obligations to officers
e. Long-term deferred revenue

Long-term debt falling due within one year

A liability which is due to be settled within 12 months after the reporting period is classified as current,
even if:

a. Original term was for a period longer than 12 months.

b. 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.

If the refinancing on a long-term basis is completed on or before the end of the reporting period, the
refinancing is an adjusting event and therefore the obligation is noncurrent.

If the entity has the discretion to refinance over an obligation for at least 12 months after the reporting
period under an existing loan facility, the obligation is noncurrent even if it would otherwise be due
within a shorter period.

If the entity has an unconditional right under the existing loan facility to defer settlement of the liability
for at least 12 months after the reporting period, the obligation is considered part of the entity's long term
financing.

Refinancing must be at the discretion of the entity.

Covenants

● often attached to borrowing agreements which represent undertakings by the borrower.

● A restriction on the borrower as undertaking further borrowings, paying dividends, maintaining
specified levels of working capital.

Breach of covenants

If conditions relating to the borrower's financial situation are breached, the liability becomes payable on
demand.

Liability as current even if the lender has agreed, after the reporting period and before the statements are
authorized for issue, not to demand payment as a consequence of the breach.

● Liability as current because at the end of the reporting period, the entity does not have
unconditional right to defer settlement for at least 12 months after that date.
Liability as noncurrent if the lender has agreed on or before the end of the reporting period to provide a
grace period ending at least 12 months after that date.

● Grace period is a period within which the entity can rectify the breach and during which the
lender cannot demand immediate repayment.

Presentation of Current Liabilities

Statement of Financial position include the following line items for current liabilities:
a. Trade and other payables- a line item for accounts and notes payable,, accrued interest on note
payable, dividends payable, and accrued expenses.
b. Current provisions
c. Short-term borrowing
d. Current portion of long-term debt
e. Current tax liability

Estimated Liabilities

● Obligations which exist at the end of reporting period although their amount is not definite.
● Either current or noncurrent in nature
● 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.
● E.g.- estimated liability for premium, award points, warranties, gift certificates and bonus.

Deferred Revenue/Unearned Revenue

● Income already received but not yet earned.

● Realizable within one year or more than one year after the end of the reporting period..
● If realizable within one year, its current liability.
● E.g - unearned interest income, unearned rental income and unearned subscription revenue.

● If realizable more than one year, its noncurrent liability.

● E.g.- 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 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 ff. Transactions occur in the 1st year:

Cash receipts from service contracts sold 1,000,000

Service contract cost paid 500,000
Service contracts revenue recognized 800,000

Journal entries:

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

Cash 1,000,000
Unearned service revenue 1,000,000

2. To record the service contract cost paid.

Service contract expense 500,000

Cash 500,000

3. To record the services contract revenue recognized.

Unearned service revenue 800,000

Service contract revenue 800,000

Gift Certificates Payable

● Redeemable in merchandise.

1. When the gift certificates are sold:

Cash xxx
Gift certificates payable xxx
The latter accountis a current liability.

2. When the gift certificates are redeemed:

Gift certificates payable xxx
Sales xxx

3. When the gift certificates not redeemed:

Gift certificates payable xxx
Forfeited gift certificates xxx

The Philippine Department of Trade and Industry ruled that gift certificates no longer have an expiration
period.
Bonus Computation

● Entities often compensate key officers and employees by way of bonus for superior income
realized during the year:
● Measured and reported in the financial statement.

Bonus Variations:

1. Bonus of income before bonus and before tax.

2. Bonus of income after bonus but before tax.
3. Bonus of income after bonus and after tax.
4. Bonus of income after tax but before bonus.

Illustration:

Income before bonus and before tax 4,400,000

Bonus 10%
Income tax rate 30%

Case 1- Before bonus and before tax

4,400,000
x 10%
440,000 Bonus

Case 2- After bonus but before tax

Case 3- After bonus and after tax.

Case 4- After tax but before bonus

Refundable Deposits
 ● Consist of cash or property received from customers but which are refundable after compliance
with certain conditions.
● E.g.- Customer deposit required for returnable containers like bottles, drums, tanks, and barrels.

Illustration:

A deposit of 10,000 is required from the customer for returnable containers. The containers cost 8,000.

Cash 10,000
Containers deposit 10,000

● Container deposit accounts are usually current liability.

● If the customer returns the containers, the deposit is simply refunded. However, if the customer
fails to return the container, 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.

PREMIUM LIABILITY

Premiums are articles of value given to customers as a result of past sales or sales promotion activities.
In order to stimulate the sale of their products, entities offer premiums to customers in return for product
labels, box tops, wrappers and coupons.
When the merchandise is sold, an accounting liability for the future distribution of the premium arises and
should be given accounting recognition.

Acquisition of premiums and recognition of premium liability:

1. When the premium are purchased:

Premiums xxx
Cash xxx

2. When the premiums are distributed to customers:

Premium expense xxx
Premiums xxx

3. At the end of the year, if premiums are still outstanding:

Premium expense xxx
Estimated premium liability xxx

Illustration:
An entity manufactures a certain product and sells it at 300 per unit. A soup bowl is offered to customers
on the return of 5 wrappers plus a remittance of 10. The bowl cost 50 and it is estimated that 60% of the
wrappers will be redeemed.

Tha date for the first year concerning the premium plan:

Sales, 10,000 units at 300 each 3,000,000

Soup bowls purchased, 2,000 units at 50 each 100,000
Wrappers redeemed 4,000

To record the sales, premiums purchases, and redemption, and year end are:

1. To record sales:
Cash 3,000,000
Sales 3,000,000

2. To record the purchase of the premiums:

Premiums- soup bowls 100,000
Cash 100,000

3. To record the redemption of 4,000 wrappers:

Cash (800 x 10) 8,000
Premium expense (800 x 40) 32,000
Premiums- soup bowls (800 x 50) 40,000
(4,000 wrappers/5 = 800 bowls distributed)

4. To record the liability for the premiums at the end of the 1st year:
Premium expense 16,000
Estimated premium liability 16,000