INTRODUCTION TO LIABILITIES

INTERMEDIATE ACCOUNTING 2
WHAT ARE LIABILITIES?

◼ Liabilities are present obligations of an

entity to transfer an economic resource as
a result of past events.
ESSENTIAL CHARACTERISTICS OF ACCOUNTING LIABILITY

A. The entity has a present obligation.

∙An obligation is a duty or responsibility that an entity has no
practical ability to avoid.
∙The entity liable must be identified but it is not necessary
that the payee to whom the obligation is owed be identified.
∙The present obligation may be legal or constructive.
ESSENTIAL CHARACTERISTICS OF ACCOUNTING LIABILITY

A. The entity has a present obligation.

∙ Obligations may be legally enforceable as a consequence of binding
contract or statutory requirement. (e.g. accounts payable for goods
and services received)
∙ Constructive obligations also give rise to liabilities by reason of
normal business practice, custom and a desire to maintain good
business relations or act in an equitable manner.
ESSENTIAL CHARACTERISTICS OF ACCOUNTING LIABILITY

B. The obligation is to transfer an economic resource.

∙ The economic resource is the asset that represents a right

with a potential to produce economic benefits.
∙ Without payment of money, without transfer of noncash
asset, without performance of service, there is no accounting
liability.
ESSENTIAL CHARACTERISTICS OF ACCOUNTING LIABILITY

B. The obligation is to transfer an economic resource.

∙ When an entity declares cash dividend, there is an accounting liability

since there is an obligation to pay cash. But when an entity declares
share dividend, there is no accounting liability since the obligation is
to issue its own shares. Share capital is an equity item, hence, not
considered as noncash asset.
ESSENTIAL CHARACTERISTICS OF ACCOUNTING LIABILITY

C. The liability arises from past event.

∙ Liability is not recognized until it is incurred.
∙ The past event that leads to a legal or constructive obligation is
known as the obligating event.
∙ For example, the acquisition of goods on account gives rise to
accounts payable. The obligating event is the acquisition of goods.
 EXAMPLES OF LIABILITIES
◼ The common types of liabilities include the following:
a) Accounts payable to suppliers for the purchase of goods
b) Amounts withheld from employees for taxes and for contributions to the Social
Security System
c) Accruals for salaries, interest, rent, taxes, product warranties and profit sharing bonus
d) Cash dividends declared but not paid
e) Deposits and advances from customers
f) Debt obligations for borrowed funds - notes, mortgages, and bonds payable
g) Income tax payable
h) Unearned revenue
 CURRENT LIABILITIES

◼ PAS 1, paragraph 69, provides that an entity shall classify a liability as

current when:
a) The entity expects to settle the liability within the entity's operating cycle.
b) The entity holds the liability primarily for the purpose of trading.
c) The 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.
CURRENT LIABILITIES

◼Trade payables and accruals for employee and other operating

costs are part of the working capital used in the entity's normal
operating cycle, hence, classified as current even if settled more
than twelve months after the reporting period.
◼NOTE: When the entity's normal operating cycle is not clearly
identifiable, its duration is assumed to be twelve months.
 PRESENTATION OF CURRENT LIABILITIES

◼ Under paragraph 54 of PAS 1, as a minimum, the face of the statement of

financial position shall include the following line items for current
liabilities:
a) Trade and other payables
b) Current provisions
c) Short-term borrowing
d) Current portion of long term debt
e) Current tax liability
 PRESENTATION OF CURRENT LIABILITIES

◼ Estimated Liabilities
∙ are obligations which exist at the end of reporting period although their
amount is not definite
◼ Deferred Revenue
∙ also known as unearned revenue

∙ income already received but not yet earned

∙ classified as current liability if realizable within one year

◼ classified as noncurrent liability if realizable in more than one year

MEASUREMENT OF CURRENT LIABILITIES

◼Conceptually, all liabilities are initially measured at

present value and subsequently measured at amortized
cost.
◼However, in practice, current liabilities or short-term
obligations are measured, recorded and reported at their
face amount since the difference between the face amount
and the present value is usually not material and therefore
ignored.
 NON-CURRENT LIABILITIES

◼All liabilities not classified as current are classified as

noncurrent liabilities. Noncurrent liabilities include:
a) Noncurrent portion of long term debt
b) Finance lease liability
c) Deferred tax liability
d) Long-term obligation to officers
e) Long-term deferred revenue
 LONG-TERM DEBT FALLING DUE WITHIN ONE YEAR

◼A liability which is due to be settled within twelve months after

the reporting period is classified as current, even if:
a) The original term was for a period longer than twelve 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.
 LONG-TERM DEBT FALLING DUE WITHIN ONE YEAR

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