ACA: 326 Updates on Financial Accounting Liabilities

Schedule: MW 1:30 – 3:00

LIABILITIES

1. Liability is a present obligation of the entity to transfer an economic resource as a result of past events.

2. Financial liability is any liability that is:

a) A contractual obligation to deliver cash or another financial asset to another entity

b) A contractual obligation to exchange financial assets or financial liabilities with another entity under
conditions that are potentially unfavorable to the entity; or
c) A contract that will or may be settled in the entity’s own equity instruments and is not classified as
the entity’s own equity instrument

3. Redeemable preference shares are classified as financial liabilities because the issuer is mandatorily
obligated to pay the redemption price when the holder exercises the right to redeem

INITIAL MEASUREMENT

1. Financial liabilities measured at fair value less transactions costs

2. Financial liabilities classified as FVPL are initially measured at fair value while the transaction costs are
expensed

SUBSEQUENT MEASUREMENT

1. Amortized cost

2. Financial liabilities classified as held for trading are subsequently measured at FVPL with changes
recognized as follows:

a) Through profit or loss

b) Amounts attributable to changes in the credit risk are presented in OCI

PRESENTATION

1. Liabilities are presented as either current or noncurrent

2. When line items are presented in the order based on liquidity, liabilities due within one year and beyond
one year should be disclosed

SHORT-TERM LIABILITIES

1. Current liabilities are liabilities that are:

a) Expected to be settled in the entity’s normal operating cycle;

b) Held primarily for trading;
c) Due to be settled within 12 months after the end of the reporting period; or
d) The entity does not have the right at the end of the reporting period to defer settlement of the
liability for at least twelve months after the reporting period (Refinancing Agreements and Breach of
Contract and Covenants)

2. Liabilities that are part of the entity’s normal operating cycle such as trade payables and accrued operating
costs are presented as current even if they are expected to be settled beyond 12 months after reporting date

3. Liabilities that are not part of the entity’s normal operating cycle such as non-trade payables are presented
as current only when they are expected to be settled within 12 months after reporting date

4. Noncurrent liabilities are liabilities that do not qualify as current liabilities (residual definition)
ACA: 326 Updates on Financial Accounting Liabilities
Schedule: MW 1:30 – 3:00

NOTES PAYABLE

1. Short-term notes are conceptually measured at present value but due to the immaterial amount of interest,
they are measured at face value. However, if the transaction contains a significant financing component, the
short-term note is measured at present value.

2. Interest-bearing long-term notes are measured at face value

3. Non-interest bearing long-term notes are measured at present value

4. Long-term notes with unreasonable interest rates are measured at present value

BONDS PAYABLE

1. As to maturity, serial bonds mature by installments while term bonds have a single maturity date.

2. Debenture bonds are those without collateral security

3. As to registration, registration bonds require that the bondholder be named in the books of the issuing
corporation while coupon or bearer bonds do not

4. Junk bonds are high risk and high yield bonds issued by corporations in financial distress

5. Treasury bonds are bonds issued by a corporation and reacquired by the same corporation. They are
presented as deduction from the balance of bonds payable.

6. Bond issuance costs:

a) Are transaction costs directly attributable to the issue of bonds

b) Are amortized through interest expense
c) Include printing and engraving cost, promotion cost, legal and accounting fees, registration fee,
commissions

7. Measurements:

a) Initially at fair value (present value) minus the issuance costs then subsequently at amortized cost
b) Initially at fair value with bond issuance costs expensed outright then subsequently at fair value with
changes through profit or loss

COMPOUND FINANCIAL INSTRUMENTS

1. A compound financial instrument contains both a liability and an equity element from the perspective of
the issuer

2. Examples of CFI are bonds issued with share warrants and convertible bonds

3. Accounting for the instruments:

a) The liability and equity components are accounted for separately

b) The price shall be allocated first to the liability component at an amount equal to the liability’s fair
value
c) The excess of the price over the amount to the liability shall be allocated to the equity component
ACA: 326 Updates on Financial Accounting Liabilities
Schedule: MW 1:30 – 3:00

Illustration.

1) On December 31, 20X1, ABC Co. has Accounts Payable of P1,000,000 and Inventory of P800,000 before
adjustment of the following:

a) Goods in transit from a vendor to ABC on December 31, 20X1 with an invoice cost of P50,000 purchased
FOB Shipping Point were not yet recorded. The goods were received on January 5, 20X2.
b) Goods shipped FOB Shipping Point from a vendor to ABC were lost in transit. The invoice cost of P20,000
was not yet recorded.
c) Goods shipped FOB Shipping Point from a vendor to ABC on December 31, 20X1, amounting to P8,000
were recorded and included in the year-end inventory count as goods in transit. Goods were received on
d) Goods in transit from a vendor to ABC on December 31, 20X1 with an invoice cost of P10,000 purchased
FOB Destination were not yet recorded. The goods were received on January 3, 20X2.
e) Goods with invoice cost of P15,000 were recorded and included in the year-end inventory count as “goods
in transit”. It was found out that the goods were shipped from a vendor under FOB destination.

What is the adjusted balance of Accounts Payable and Inventory?

2) On December 31, 20X1, ABC Co. has accounts payable of P1,000,000 and Inventory of P500,000 before
adjustment of the following:

a) Checks drawn for P12,000 were not yet released to payees; checks drawn for P5,000 were released to
payees but were postdated.
b) On December 28, 20X1, a vendor authorized ABC Co. to return for full credit goods costing P25,000. ABC
Co. returned the goods on December 31, 20X1 but recorded the related credit memo only on January 3,
20X2.
c) Goods shipped FOB Shipping Point, freight prepaid from a vendor on December 28, 20X1 was recorded
at the invoice of P14,000 on the shipment date. The related freight of P3,000 was not recorded.
d) Goods shipped FOB Destination, freight collect from a vendor were received and recorded on December
29, 20X1 at the invoice cost of P40,000. The related freight of P5,000 was recorded as an expense.

What is the adjusted balance of Accounts Payable and Inventory?

3) An entity sells monthly issues for a magazine. Subscriptions received after the November 1 cutoff date are held
for publication in the following year. Information on subscriptions is as follows:

Unearned revenue – January 1, 20X1 P3,000,000

Receipts from subscriptions during 20X1 (made evenly) P24,000,000

How much is the unearned revenue balance on December 31, 20X1 and Subscription revenue recognized for the
year 20X1?

4) An entity is preparing its December 31, 20X1 year-end financial statements and has gathered the following
information:

a) The bill for December’s utility costs of P30,000 was received and paid on January 10, 20X2
b) A P20,000 advertising bill was received on January 2, 20X2. Of the total billing, P15,000 pertain to
advertisements in December 20X1 and P5,000 pertain to advertisements in January 20X2.
c) A lease, effective December 16, 20X0, requires monthly rental of P100,000, payable one month after the
commencement of the lease and every month thereafter. In addition, rent equal to 5% of net sales over
P1,000,000 per year is payable on January 31, of the following year.
d) Total cash sales and collections on accounts amounted to P1,000,000. Accounts receivable has a net
increase of P200,000. Commissions of 15% of sales are paid on the same day cash is received from
customers.
How much is the total accrued liabilities as of December 31, 20X1?
ACA: 326 Updates on Financial Accounting Liabilities
Schedule: MW 1:30 – 3:00

5) On July 1, 20X1, ABC borrowed P1,000,000 and issued a one-year, note payable. The lender discounted the note
at 12%. Prepare journal entries under the following cases:

Case 1. The note is due in lump sum on June 30, 20X2.

Case 2. The note is due in equal quarterly installments starting September 30, 20X1

6) On October 1, 20X1, ABC issued a 2-year, 12%, P1,000,000 note payable in exchange for a piece of land. Principal
is due on October 1, 20X3 but interest is due annually. Prepare journal entries.

7) On January 1,20X1, ABC issued a three-year, 12%, P1,000,000 note payable in exchange for a piece of land.
Principal and interest are due on December 31, 20X3.

8) On January 1, 20X1, ABC acquired a piece of equipment in exchange for P1,000,000 cash and a noninterest-
bearing note of P1,000,000 due on January 1 20X4. The prevailing rate of interest for this type of note is 12%.

9) On January 1, 20X1, ABC acquired a piece of equipment in exchange for P100,000 cash and a P1,000,000
noninterest-bearing note that is due in 4 equal installments starting on December 31, 20x1. The prevailing interest
rate is 12%.

10) On January 1, 20X1, ABC acquired a piece of equipment in exchange for P100,000 cash and a P1,000,000
noninterest-bearing note that is due in 4 equal installments starting on January 1, 20x1. The prevailing interest
rate is 12%.

11) On January 1, 20X1, ABC issued a 3-year, P1,200,000 noninterest-bearing note payable due in equal semi-
annual payments starting on July 1, 20X1. The prevailing interest rate is 10%.

12) On January 1, 20X1, ABC issued a 3-year, P1,200,000 noninterest-bearing note payable due as follows:

December 31, 20X1 600,000

December 31, 20X2 400,000
December 31, 20X3 200,000

Total 1,200,000

The prevailing interest rate is 10%

13) On January 1, 20X1, ABC issued a 3-year, P1,000,000, 3% note payable in exchange for a machine. Principal is
due on January 1, 20X4 but interest is due annually every January 1. The prevailing interest rate for this type of
note is 12%.

14) On January 1, 20X1, ABC obtained a P1,000,000, 180-day bank loan at an annual rate of 10%. The loan
agreement requires ABC to maintain a P100,000 compensating balance in its bank account at the lending bank.
ABC would otherwise maintain a balance of only P50,000 in this account. The bank account earns interest at an
annual rate of 2%. Compute for the annual cost of borrowing in %.

15) On January 1, 20X1, ABC issued 1,000, P1,000, 10%, 3-year bonds for P951,963. Principal is due on December
31, 20X3 but interest is due annually every year-end. In addition, ABC incurred bond issue costs of P44,829. The
effective interest rate is 12% before adjustment for bond issue costs and 14% after adjustment for bond issue cost.

16) On April 1, 20X1, ABC issued 12%, P1,000,000 bonds dated January 1, 20X1. Prepare journal entries under the
following cases:

Case 1. The bonds were issued at 97 including accrued interest

Case 2. The bonds were issued at 97 excluding the accrued interest.

ACA: 326 Updates on Financial Accounting Liabilities
Schedule: MW 1:30 – 3:00

17) On January 1, 20X1, ABC issued new bonds with face amount of P10M for P10,800,000 and used the proceeds
to retire outstanding bonds with face amount of P8,000,000 and amortized discount of P340,000 and incurred
P50,000 direct costs on the retirement. ABC income tax rate is 30%.

18) On January 1, 20X1, ABC issued 5-year, 12%, P1,000,000 bonds for P1,075,816. Principal is due at maturity but
interest is due annually. The effective interest rate is 10%. On July 1, 20X3, ABC retired the bonds at 102, including
payment for accrued interest.

19) On January 1, 20X1, ABC issued 5-year, 12%, P1,000,000 bonds for P1,075,816. Principal is due at maturity but
interest is due annually. The effective interest rate is 10%. On July 1, 20X3, ABC retired the bonds at 102, including
payment for accrued interest.

20) On January 1, 20X1, ABC issued 10%, P3,000,000 bonds for P2,900,305. The principal matures in three equal
annual installments, payable at each year-end, plus interest on outstanding principal balance. The effective
interest rate is 12%.

21) On January 1, 20X1, ABC issued 10%, 3-year, P1,000,000 convertible bonds at 105. Each P1,000 bond is
convertible into 8 shares with par value of P100 per share. Principal is due at maturity but interest is due annually
at each year-end. On issuance date, the bonds were selling at a yield to maturity market rate of 12% without the
conversion option.

On December 31, 20X2, ABC converted all of the bonds incurring stock issuance costs of P20,000

22) On January 1, 20X1, ABC issued 3-year, 10%, P1,000,000 convertible bonds for P1,100,000. Principal is due at
maturity but interest is payable every year-end. The bonds are convertible into 6,000 ordinary shares with par
value of P100. At issuance date, the prevailing market rate of interest for similar debt without conversion feature
is 12%.

On December 31, 20X2, all convertible bonds were retired for P1,000,000. The prevailing interest rate for a similar
debt instrument without conversion feature as of December 31, 20X2 is 11%.

23) On January 1, 20X1, ABC issued 3-year, 10%, 1,000, P1,000 bonds at 97. Each bond has one detachable share
warrant entitling the holder to buy 10 shares of ABC with par value of P100 at P120 per share. Shortly after
issuance, the bonds were quoted at 95 ex-warrants.

24) On January 1, 20X1, ABC settled a P1,000,000 loan payable with an unamortized discount of P20,000 and an
accrued interest of P90,000 by transferring to the lender old equipment with cost of P3,000,000 and accumulated
depreciation of P2,200,000, and fair value of P90,000.

25) On January 1, 20X1, ABC settled a P1,000,000 loan payable by issuing to the lender 10,000 shares with par
value of P50 per share.

Case 1. Fair value of shares is at P120 per share.

Case 2. Fair value of the financial liability is P1,103,084.