CHAPTER 2

CURRENT LIABILITIES

Ninia C. Pauig-Lumauan, MBA, CPA

1st Semester 2022-2023
Lyceum of Aparri

Intermediate Accounting Part 2

 DEFINITION OF LIABILITY

• Liability is “a present obligation of the

entity to transfer an economic resource as
a result of past events.” (Conceptual
Framework 4.26)
• The definition of liability has the following
three aspects:
a. Obligation
b. Transfer of an economic resource
c. Present obligation as a result of past
events Intermediate Accounting Part 2
 DEFINITION OF OBLIGATION
• An obligation is “a duty or responsibility that an
entity has no practical ability to avoid.” (Conceptual Framework
4.29)

• An obligation is either:
a. Legal obligation – an obligation that results
from a contract, legislation, or other operation
of law; or
b. Constructive obligation – an obligation that
results from an entity’s actions (e.g. Past
practice or published policies) that create a
valid expectation on others that the entity will
accept and discharge certain responsibilities.
Intermediate Accounting Part 2
 IMPORTANT POINTS IN A LIABILITY
• An obligation is always owed to another party.
However, it is not necessary that the identity of
the party is known. For example, an
environmental damages may be owed to the
society at large.
• One party’s obligation normally corresponds to
another party’s right. For example, a buyer’s
obligation to pay an accounts payable of P
100.00 normally corresponds to the seller’s right
to collect an accounts receivable of P 100.00.

Intermediate Accounting Part 2

 IMPORTANT POINTS IN A LIABILITY
• However, this accounting symmetry is not
maintained at all times because the Standards
sometimes contain different recognition and
measurement requirements for the liability of
one party and the corresponding asset of the
other party. For example, direct origination costs
result to different measurements of the lender’s
loan receivable and the borrower’s loan
payable. Similarly, a seller may be required to
recognize a warranty obligation but the buyer
would not recognize a corresponding asset for
the warranty. Intermediate Accounting Part 2
 TRANSFER OF AN ECONOMIC RESOURCE
• The liability is the obligation that has the potential
to require the transfer of an economic resource to
another party and not the future economic
benefits that the obligation may cause to be
transferred.
• Consequently, a liability can exist even if the
probability of a transfer of an economic resource
is low, although that low probability affects
decisions on whether the liability is to be
recognized, how it is measured, what information
is to be provided about the liability, and how that
information is provided. (Conceptual Framework 4.37 and 4.38)
Intermediate Accounting Part 2
 TRANSFER OF AN ECONOMIC RESOURCE
• An obligation to transfer an economic
resource may be an obligation to:
a. Pay cash, deliver goods or render service.
b. Exchange assets with another party on
unfavorable terms;
c. Transfer assets if a specified uncertain
future events occur, or
d. Issue a financial instrument that obliges
the entity to transfer an economic
resource. Intermediate Accounting Part 2
 PRESENT OBLIGATION AS A RESULT OF
PAST EVENTS
• The obligation must be a present obligation
that exists as a result of past events. A
present obligation exists as a result of past
events if:
a. The entity has already obtained economic
benefits or taken an action; and
b. As a consequence, the entity will or may
have to transfer an economic resource that
it would not otherwise have had to transfer.
(Conceptual Framework 4.43 )
Intermediate Accounting Part 2
 EXAMPLE 1
• Entity A intends to acquire goods in the
future.
Analysis:
Entity A has no present obligation. A
present obligation arises only when Entity
A:
a. Has already purchased and received the
goods; and
b. As a consequence, Entity A will have to pay
for the purchase price.
Intermediate Accounting Part 2
 EXAMPLE 2
• Although not stated in the sales contract,
Entity B has a publicly known policy of
providing free repair services for the
goods it sells. Entity B has consistently
honored this implied policy in the past.
Analysis:
Entity B has a present constructive
obligation to provide free service for the
goods it has already sold because:
Intermediate Accounting Part 2
 EXAMPLE 2
a. Entity B has already taken an action by
creating valid expectations on the
customers that it will provide free repair
services, and
b. As a consequence, Entity B will have to
provide those free services to its
customers.

Intermediate Accounting Part 2

 EXAMPLE 3
• Entity C employed Mr. Juan.
Analysis:
• Entity C has no present obligation until
after Mr. Juan has rendered services.
Before then, the contract is executory –
Entity C has a combined right and
obligation to exchange future salary for
Mr. Juan’s future services.

Intermediate Accounting Part 2

 EXECUTORY CONTRACTS

• An executory contract “is a contract that is

equally unperformed – neither party has
fulfilled any of its obligations, or both parties
have partially fulfilled their obligations to an
equal extent. (Conceptual Framework 4.56 )
• An executory contract establishes a
combined right and obligation to exchange
economic resources, which are
interdependent and inseparable. Thus, the
two constitute a single asset or liability.
Intermediate Accounting Part 2
 EXECUTORY CONTRACTS

• The entity has an asset if the terms of

the contract is favorable, a liability if the
terms is unfavorable. However, whether
such an asset or liability is included in the
financial statements depends on the
recognition criteria and the selected
measurement basis, including any
assessment of whether the contract is
onerous.
Intermediate Accounting Part 2
 EXECUTORY CONTRACTS
• The contract ceases to be executory when one
party performs its obligation. If the entity
performs first, the entity’s combined right and
obligation changes to an asset. If the other
party performs first, the entity’s combined
right and obligation changes to a liability. For
example:
• Entity C neither recognizes an asset nor a
liability upon entering the employment
contract with Mr. Juan because at that point,
the contract is executory.
Intermediate Accounting Part 2
 EXAMPLE OF EXECUTORY CONTRACT
• If Mr. Juan renders services, the contract ceases
to be executory, and Entity C’s combined right
and obligation changes to a liability – an
obligation to pay Mr. Juan’s salaries (e.g. Salaries
payable)
• If Entity C pays Mr. Juan’s salary in advance,
Entity C‘s combined right and obligation changes
to an asset – a right to receive the services or a
right to be reimbursed if the services are not
received. (e.g. Advances to employees)
Intermediate Accounting Part 2
 RECOGNITION CRITERIA
• An item is recognized if:
a. It meets the definition of a liability; and
b. Recognizing it would provide useful information,
i.e.. Relevant and faithfully represented information.
Both the criteria above must be met before an item
is recognized. Accordingly, items that meet the
definition of a liability but do not provide useful
information are not recognized, and vice versa.
However, even if a liability is not recognized,
information about it may still need to be disclosed
in the notes. In such cases, the item is referred to
as unrecognized liability.
Intermediate Accounting Part 2
 RELEVANCE

• Recognition may not provide relevant

information if, for example:
a. It is uncertain whether a liability exists, or
b. A liability exists, but the possibility of an
outflow of economic benefits is low.
(Conceptual Framework 5,12)
Existence uncertainty or low probability of an
outflow of economic benefits may result in, but
does not automatically lead to the non-
recognition of a liability. Other factors should
be considered.
Intermediate Accounting Part 2
 FAITHFUL REPRESENTATION
•A liability must be measured for it to be
recognized. Often, measurement requires
estimation and thus subject to measurement
uncertainty. The use of reasonable estimates is
an essential part of financial reporting and does
not necessarily undermine the usefulness of
information. Even a high level of measurement
uncertainty does not necessarily preclude an
estimate from providing useful information if
the estimate is clearly and accurately described
and explained.
Intermediate Accounting Part 2
 FINANCIAL AND NON FINANCIAL
LIABILITIES
• 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.
Intermediate Accounting Part 2
FINANCIAL AND NON FINANCIAL LIABILITIES
• Non financial liability – is a liability other than
a financial liability.
FINANCIAL LIABILITIES NON FINANCIAL LIABILITIES
a. Payables, such as accounts, a. Unearned revenues and warranty
notes, loans, bonds and obligations that are to be settled
accrued payables through future delivery of goods or
provision of services
b. Lease liabilities b. Taxes, SSS, Philhealth and PAGIBIG
payables
c. Held for trading and derivative c. Constructive obligations
liabilities
d. Redeemable preference shares
issued
e. Security deposits and other
returnable deposits

Intermediate Accounting Part 2

FINANCIAL AND NON FINANCIAL LIABILITIES
• Items (b) and (c) are not financial liabilities
because they do not arise from contracts.
• Commodity contracts that cannot be settled
net in cash or other financial instrument but
only through commodity exchange (e.g. Coffee
beans, gold bullion, oil and the like) are not
financial instruments.
• Commodity contracts that can be settled in
cash or other financial instrument are financial
instruments.

Intermediate Accounting Part 2

 PRESENTATION OF FINANCIAL INSTRUMENTS
• The issuer classifies a financial instrument or its
component parts, as a financial asset, financial
liability or an equity instrument in accordance
with the substance of the contract (rather than
its legal form) and the definitions of a financial
asset, a financial liability and an equity
instrument.
• Equity instrument – is “any contract that
evidences a residual interest in the assets of an
entity after deducting all of its liabilities.” (PAS 32.11)
Intermediate Accounting Part 2
 PRESENTATION OF FINANCIAL
INSTRUMENTS
• When determining whether a financial
instrument is a financial liability or an equity
instrument, the overriding consideration is
whether the instrument meets the definition
of a financial liability.
FINANCIAL LIABILITY EQUITY INSTRUMENT
The entity has a contractual The entity has no obligation to
obligation to pay cash or another pay cash or another financial asset
financial asset or to exchange or to exchange financial
financial instruments under instruments under potentially
potentially unfavorable condition. unfavorable condition.

Intermediate Accounting Part 2

PRESENTATION OF FINANCIAL INSTRUMENTS
• A contract is not an equity instrument merely
because it is to be settled in the entity’s own
equity instruments. The following guidance
applies when a contract requires settlement in
the entity’s own equity instruments:
Financial Asset/Financial Liability Equity Instrument
Variable number for a fixed Fixed number for a fixed amount
amount
Fixed number for a variable
amount
• A contract to receive (rather than to deliver) is
a financial asset.

Intermediate Accounting Part 2

 PRESENTATION OF FINANCIAL
INSTRUMENTS
FINANCIAL LIABILITY EQUITY INSTRUMENT
 The contract requires the delivery of (a) a variable The contract requires the
number of the entity’s own equity instruments in delivery (receipt) of a fixed
exchange for a fixed amount of cash or another number of the entity’s own
financial asset or (b) a fixed number of the entity’s own equity instruments in exchange
equity instruments in exchange for a variable amount for a fixed amount of cash or
of cash or another financial asset. another financial asset.

Examples: Example: A share option that

a) Variable number for a fixed amount: gives the holder a right to buy a
A contract to deliver as many shares as are equal fixed number of the issuer’s
to the value of a fixed amount of cash, say, P shares for a fixed price.
100,000 or a fixed number or units of a commodity,
say 50 grams of gold.

b) Fixed number for a variable amount

A contract to deliver 1,000 own equity instruments
in exchange for an amount of cash equal to the
value of 10 grams of gold.

Intermediate Accounting Part 2

 PRESENTATION OF FINANCIAL INSTRUMENTS
REDEEMABLE PREFERENCE SHARES
 Are preferred stocks which the
holder has the right to redeem at a set
date.
Are classified as financial liability
because when the holder exercises its
right to redeem, the issuer is
mandatorily obliged to pay for the
redemption price.
CALLABLE PREFERENCE SHARES
 Are preferred stocks which the issuer
has the right to call at a set date.
Are classified as equity instrument
because the right to call is at the
discretion of the issuer and therefore
has no obligation pay unless it chooses
to call on the shares.

Members’ shares in cooperative entities and similar instruments

are equity if:
a. The entity has an unconditional right to refuse redemption of
the members’ shares, or
b. Redemption is unconditionally prohibited by law or relevant
regulation
Intermediate Accounting Part 2
 CLASSIFICATION OF FINANCIAL LIABILITIES

• A financial liability is recognized only when

the entity becomes a party to the
contractual provisions of the instrument.
• All financial liabilities are classified as
subsequently measured at amortized cost,
except for the following:
a. Financial liabilities at fair value through
profit or loss (FVPL) and derivative
liabilities-subsequently measured at fair
value (e.g. designated or held for trading)
Intermediate Accounting Part 2
 CLASSIFICATION OF FINANCIAL LIABILITIES
b. Financial liabilities that arise when a transfer
of a financial asset does not qualify for
derecognition – subsequently measured on a
basis that reflects the rights and obligations
that the entity has retained.
c. Financial guarantee contracts and
commitments to provide a loan at a below-
market interest rate – subsequently
measured at the higher of:
i. the amount of the loss-allowance (12-
month expected credit losses); and
Intermediate Accounting Part 2
 CLASSIFICATION OF FINANCIAL LIABILITIES
ii. the amount initially recognized less,
when appropriate, the cumulative
amount of income recognized in
accordance with the principles of PFRS 15.
d. Contingent consideration recognized by
an acquirer in a business combination –
subsequently measured at a fair value
through profit or loss.
• Reclassification of financial liabilities after
initial recognition is prohibited.
Intermediate Accounting Part 2
 MEASUREMENT OF FINANCIAL LIABILITIES
• Initial Measurement
Financial liabilities are initially measured at
fair value minus transaction cost, except
financial liabilities at FVPL whose
transaction costs are expensed
immediately.
• Subsequent measurement
 Financial liabilities classified as amortized
cost are subsequently measured at
amortized cost. Intermediate Accounting Part 2
MEASUREMENT OF FINANCIAL LIABILITIES
Subsequent Measurement
Financial liabilities classified as held for
trading are subsequently measured at
fair value with changes in fair values
recognized in profit or loss.
Financial liabilities designated at FVPL
are subsequently measured in fair value
with changes in fair values recognized as
follows:
Intermediate Accounting Part 2
MEASUREMENT OF FINANCIAL LIABILITIES
Subsequent Measurement
a. The amount of change in the fair value
of the financial liability that is
attributable to changes in the credit risk
of that liability is presented in other
comprehensive income, and
b. The remaining amount of change in the
fair value of the liability is presented in
profit or loss.
Intermediate Accounting Part 2
 MEASUREMENT OF NONFINANCIAL
LIABILITIES
• Non-financial liabilities are initially
measured at the best estimate of the
amounts needed to settle those
obligations or the measurement basis
required by other applicable standard,
e.g., deferred tax liabilities are
measured under PAS 12 Income Taxes.

Intermediate Accounting Part 2

MEASUREMENT OF NONFINANCIAL LIABILITIES

Examples of non-financial liabilities:

a. Obligations arising from statutory
requirements (e.g., income tax payable)
b. Warranty obligations
c. Unearned or deferred revenues
d. Commodity contracts that either cannot
be settled in cash or which are expected
to be settled by commodity exchange.
Intermediate Accounting Part 2
MEASUREMENT OF NONFINANCIAL LIABILITIES

• Subsequently, non-financial liabilities are also

measured at the best estimate of the amounts
needed to settle the obligations adjusted for any
changes on the expected settlement amounts.
Adjustments are treated as changes in
accounting estimates and are accounted for
prospectively. Some non-financial liabilities are
subsequently measured in accordance with the
requirements of other standards (e.g., deferred
tax liabilities are measured in accordance with
PAS 12). Intermediate Accounting Part 2
 FINANCIAL STATEMENT PRESENTATION
• Liabilities are presented as either (a) current
or (b) noncurrent on the face of classified
statement of financial position. A classified
statement of financial position is one that
shows current and non current distinctions.
• When an entity presents an unclassified
statement of financial position (based on
liquidity), disclosures of liabilities due within
one year and due beyond one year should be
nevertheless made in the notes.
Intermediate Accounting Part 2
 CURRENT LIABILITIES
• Current liabilities are liabilities that are:
a. Expected to be settled in the entity’s
normal operating cycle
b. Held primary for trading
c. Due to be settled within 12 months
after the reporting period, or
d. The entity does not have an
unconditional right to defer settlement
of the liability for at least twelve
months after the reporting period.
Intermediate Accounting Part 2
 CURRENT LIABILITIES

• All other liabilities are classified as

noncurrent.
• “The operating cycle of an entity is the
time between the acquisition of assets
for processing and their realization in
cash or cash equivalents. When the
entity’s normal operating cycle is not
clearly identifiable, it is assumed to be 12
months.” (PAS 1.68)
Intermediate Accounting Part 2
 CURRENT LIABILITIES
• Liabilities that are settled as part of the entity’s
normal operating cycle (e.g., trade payables
and some accruals for employee and other
operating costs) are presented as current, even
if they are expected to be settled beyond 12
months after the reporting period.
• Liabilities that do not form part of the entity’s
normal operating cycle (e.g. Non-operating
liabilities) are presented as current only when
they are expected to be settled within 12
months after the reporting period.
Intermediate Accounting Part 2
 CURRENT LIABILITIES
• Examples of current liabilities:
a. Financial assets measured at FVPL (i.e.
Designated or held for trading)
b. Current portion of long term notes, bonds,
loans, and lease liabilities
c. Trade accounts and notes payables
d. Other non-trade payables due within 12 months
after end of reporting period
e. Unearned income expected to be earned within
12 months after end of the reporting period
f. Bank overdraftsIntermediate Accounting Part 2
 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.
• For trading or manufacturing entity, trade
and non-trade payables that are currently
due are normally aggregated and
presented as one line item under the
heading “Trade and other payables.”

Intermediate Accounting Part 2

 TRADE AND NON TRADE PAYABLES
• The reason for the trade and non-trade
distinctions is the differing rules when
classifying payables as current or non-
current.
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.
Intermediate Accounting Part 2
 TRADE AND NON TRADE PAYABLES
• Financial institutions need not classify
their payables as trade or non-trade
because their statement of financial
position is presented based on liquidity,
i.e. no current and non-current
distinction. However, payables are
expected to be settled within one year
and beyond one year are disclosed in the
notes.

Intermediate Accounting Part 2

 EXAMPLES OF PAYABLES
• Accounts Payable – obligations not
supported by formal promises to pay by the
debtor.
• Notes Payable – obligations supported by
promissory notes by the debtor.
• Loans Payable – usually used to connote
bank loans
• Bonds Payable – obligation issued by the
debtor supported by promises to pay made
under seal.
Intermediate Accounting Part 2
 EXAMPLES OF PAYABLES
• Liabilities under trust receipts, e.g., before
the corresponding liability to the bank is
paid, the goods are released to the buyer
in trust for the bank which advanced the
money for importation of goods.
• Other payables arising from sources other
than purchases and borrowings, such as
dividends payable, taxes payable,
remittances payable and accrued expenses.

Intermediate Accounting Part 2

 ILLUSTRATION 1: CURRENT LIABILITIES
ABC Co has the following liabilities as of December 31, 20x1:
a Trade accounts payable, net of debit balance in supplier’s 300,000
accounts of P 5,000, net of unreleased checks of P 4,000 and
net of postdated checks of P2,000
b Credit balance in customers’ accounts 2,000
c Financial liability designated as FVPL 50,000
d Bonds payable (maturing in 10 equal annual installments of 1,000,000
P100,000)
e 12%, 5-Year note payable issued on October 01, 20x1 100,000
f Deferred tax liability 5,000
g Unearned Rent 4,000
h Contingent Liability 10,000
i Reserve for Contingencies 25,000
Requirement: How much is the total liabilities?

Intermediate Accounting Part 2

 ILLUSTRATION 1: CURRENT LIABILITIES
ABC CO - SOLUTION:
a Trade accounts payable gross of debit balance, unreleased 311,000
check and postdated check (300k + 5K + 4K +2K)
b Advance from customers (Cr. Balance in customers’ accounts) 2,000
c Financial liability designated as FVPL 50,000
d Current portion of bonds payable 100,000
e Interest payable on the note on “e” (P 100,000 x 12% x 3/12) 3,000
f Unearned Rent 4,000
Total Current Liabilities 470,000
vvvvvvv

NOTES:
1 Deferred tax liabilities are always presented as non current when an
entity presents classified statement of financial position
2 Contingent liability is not recognized but rather disclosed only in the notes
3 Reserve for contingencies is an appropriation of retained earnings and
thus, presented in equity.
Intermediate Accounting Part 2
 ILLUSTRATION 2: CURRENT LIABILITIES
XYZ Co has the following liabilities as of December 31, 20x1.
a Trade accounts payable, including cost of goods received on 300,000
consignment of P 10,000
b Held for trading financial liabilities 50,000
c Deferred Revenue 20,000
d Bank Overdraft 10,000
e Income Tax Payable 50,000
f Accrued Expenses 5,000
g Share Dividend Payable 12,000
h Advances from affiliates payable in 15 months after year end 23,000
i Loan of BC, Inc guaranteed by XYZ – it is possible that XYZ 45,000
will be held liable for the guaranteeaa
Requirement: How much is the total current liabilities?

Intermediate Accounting Part 2

 ILLUSTRATION 2: CURRENT LIABILITIES
XYZ Co - SOLUTION
a Trade accounts payable, net of cost of goods sold 290,000
received on consignment (P 300,000-10,000)
b Held for trading financial liabilities 50,000
c Bank Overdraft 10,000
d Income Tax Payable 50,000
e Accrued Expenses 5,000
Total Current Liabilities 405,000
vvvvvvv

NOTES:
1 Deferred revenue is similar to unearned revenue except that deferred
revenue is long term.
2 Share dividends payable (stock dividends payable) is not a liability but
rather than an adjunct equity account (i.e. presented as addition to share
capital)
Intermediate Accounting Part 2
 ILLUSTRATION 2: CURRENT LIABILITIES
Example of Deferred Revenue
On December 31, 20x0, Entity A receives P 300,000 for a 3-year supply
contract, whereby Entity A shall deliver goods worth P 100,000 each year to
the customer. The entry is as follows:
Dec 31, Cash 300,000
20x0 Unearned Revenue 100,000
Deferred Revenue 200,000
The portion of the advanced collection applicable to 20x1 is credited to
unearned revenue, which is a current liability; the portions applicable to 20x2
and 20x3 are credited to deferred revenue, which is a non-current liability.

NOTES:
3 The guarantee on the loan is not recognized as a liability because it is not
probable (i.e. it is possible only) that XYZ will be held liable for the
guarantee.

Intermediate Accounting Part 2

 REFINANCING AGREEMENT
• A long term obligation that is maturing
within 12 months after the reporting
period is classified as current, even if
refinancing agreement to reschedule
payments on long term basis is completed
after the reporting period but before the
financial statements re authorized for
issue.
• However, the obligation is classified as
noncurrent if the entity expects, and has
the discretion to refinance it on long term
basis under an existing loan facility.
Intermediate Accounting Part 2
 REFINANCING AGREEMENT
• If the refinancing is not at the discretion
of the entity (for example, there is no
arrangement for refinancing) the
financial liability is current.
• Refinancing refers to the replacement of
an existing debt with a new one but with
different terms, e.g. Extended maturity
date or revised payment schedule.

Intermediate Accounting Part 2

 REFINANCING AGREEMENT
• A refinancing where the debtor is under
financial distress is called “troubled debt
restructuring.”
• Loan facility refers to a credit line.

Intermediate Accounting Part 2