Intermediate Accounting 2

1
“LIABILITIES”

MS. MARY JOY F. LABAJO

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“LIABILITIES”

• To understand the concept of liabilities.

• To describe the nature and type of current and noncurrent liabilities.
• To know the measurement of current and noncurrent liabilities.
• To explain the issue of long-term debt falling due within one year.
• To explain the issue of breach of covenants attached to a long-term debt.
• To describe formulas in computing bonus to officers and employees.
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The Revised Conceptual Framework for Financial

Reporting provides the following definition of
liabilities:
Liabilities are present obligations of an entity to
transfer an, economic resource as a result of past
events.
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You cannot be held liable for anything that you have

no power over. Guilt, shame and blame make no
sense when circumstances are beyond your control.”
“You are not a burden to be endured. You are an asset
to be desired, preserved and celebrated.”
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Accordingly, the essential characteristics of an accounting liability

are:

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.
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b. The obligation is to transfer an economic resource.

This is the very heart of the definition of an accounting

liability. The economic resource is the asset that represents a
right with a potential to produce economic benefits.
Specifically, the obligation must be to pay cash, transfer
noncash asset or provide service at some future time.

c. The liability arises from a past event.

This means that the liability is not recognized until it is

incurred.
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Examples of liabilities
The more 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
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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 not discounted anymore but measured, recorded and
reported at face amount
The reason is that the discount or the difference between the
face amount and the present value is usually not material and
therefore Ignored.
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Measurement of noncurrent liabilities

 
Noncurrent liabilities, for example, bonds payable and noninterest-
bearing note payable, are initially measured at present value and
subsequently measured at amortized cost.
If the long-term note payable is interest-bearing, it is initially and
subsequently measured at face amount.
In this case, the face amount is equal to the present value of the
note payable.
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Current Liabilities
PAS l, paragraph 69, provides that an entity shall classify a
liability as current when:
a. The entity expects to settle the liability with 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,
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Noncurrent Liabilities
The term noncurrent liabilities is a residual definition,
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
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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.

However, if the refinancing on a long-term basis is completed on

or before the end o/ the reporting period, the refinancing is an
adjusting event and therefore the obligation is classified as
noncurrent.
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Covenants
 
Covenants are often attached to borrowing agreements which
represent undertakings by the borrower.

These covenants are actually restrictions on the borrower as to

undertaking further borrowings, paying dividends, maintaining
specified level of working capital and so forth.
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Breach of covenants
Under these covenants, if certain conditions relating to the
borrower's financial situation are breached, the liability
becomes payable on demand.
 
PAS 1, paragraph 74, provides that such a. liability is classified
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.
 
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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

The term trade and other payables is a line item for accounts
payable, notes payable, accrued interest on note payable,
dividends payable and accrued expenses.
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Estimated liabilities
 
Estimated liabilities are obligations which exist at the end of
reporting period although their amount IS not definite.
 
In many cases, the date when the obligation is due is not also
definite and in some instances, the exact payee cannot be
identified or determined.

Examples include estimated liability for premium, award

points, warranties, gift certificates and bonus.
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Deferred revenue
Deferred revenue or unearned revenue is income already
received but not yet earned.
 
Deferred revenue may be realizable within one year or in more
than one year after the end of the reporting period.
 
If the deferred revenue is realizable within one year, it is a
current liability.
 
If the deferred revenue is realizable in more than one year, it is
classified as noncurrent liability.
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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 expense.
 
Revenue from service contracts is recognized as earned over the service period
of the contracts.
The following transactions occur in the first year:
 
Cash receipts from service contracts sold 1,000,000
Service contract costs paid 500,000
Service contract revenue recognized 800,000
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Gift certificates payable

Many megamalls, department stores and supermarkets

sell gift certificates which are redeemable in
merchandise. The accounting procedures are:
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The Philippine Department of Trade and Industry ruled that gift

certificates no longer have an expiration period.

Bonus computation
 
Large entities often compensate key officers and employees by
way of bonus for superior income realized during the year.
 
The main purpose of this scheme is to motivate officers and
employees by directly relating their well-being to the success of
the entity.
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This compensation plan results in liability that must be

measured and reported in the financial statements. The bonus
computation usually has four variations:
 
1. Bonus is expressed as a certain percent of income before
bonus and before tax.
2. Bonus is expressed as a certain percent of income after
bonus but before tax.
3. Bonus is expressed as a certain percent of income after
bonus and after tax
4. Bonus is expressed as a certain percent of income after tax
but before bonus.
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Refundable deposits
 
Refundable deposits consist of cash or property received from
customers, but which are refundable after compliance with certain
conditions.
The best example of a refundable deposit is the customer deposit
required for returnable containers like bottles. drums, tanks and
barrels.
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Illustration
A deposit of P 10,000 is required from the customer for returnable containers.
The containers cost P8,000.
 
Cash 10,000
Containers' deposit 10,000
 
The containers' deposit account is usually classified as current Liability.
 
If the customer returns the containers, the deposit is simply refunded.
 
However, if the customer fails to return the containers, 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.
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“Laziness requires no effort, whereas work

requires dedication and perseverance.”

-Catherine Pulsifer