INTERMEDIATE ACCOUNTING 2

WEEK 1 LECTURE
AY 2020-2021
Chapter 1: Current liabilities

Learning objectives
1. State the recognition criteria for liabilities.
2. Identify the characteristics of a financial liability.
3. State the initial and subsequent measurements of financial and non-financial liabilities.
4. Classify liabilities as current and noncurrent.

Liability
Liability is a present obligation of the entity to transfer an economic resource as a result of past events.
The definition of liability has the following three aspects:
a) Obligation
b) Transfer of an economic resource.
c) Present obligation as result of past events.
Obligation
An obligation is a duty or responsibility that an entity has no practical ability to avoid.
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.
An obligation is always owed to another party. However, it is not necessary that the identity of that
party is known,
For Example: an obligation for environmental damages may be owned to the society at large.
One party’s obligation normally corresponds to another party’s right.
For example: direct obligation 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 corresponding asset
for that warranty.
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.
An obligation to transfer an economic resource may be an obligation to:
a. Pay cash, deliver goods, or render services.
b. Exchange assets with another party on unfavorable terms;
c. Transfer asset if a specified uncertain future events occurs.
d. Issue a financial instrument that obliges the entity to transfer an economic resource.
Present obligation as a result of past events
the obligation must be a present obligation that exist as a result of past events. A present obligation exist 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 not or may have to transfer an economic resource that it would
not otherwise have had to transfer.

Example: Entity A intends to acquire goods in the future.

Analysis:
a. Has already purchased and received the goods; and
b. As a consequence, Entity A will have to pay for the purchase price.

Example: Entity B enter into an irrevocable commitment with other party to acquire goods in the future,
on credit.
Analysis:
a. A non-cancellable future commitment give rise to a present obligation only when it becomes
onerous (i.e burdensome) for example, if the goods become obsolete before the delivery but
Entity B cannot cancel the contract without paying a substantial penalty.
Unless it becomes burdensome, no present obligation normally arises from future commitment.

Although not stated in the sales contract, Entity C has a publicly-know policy of providing free repair
service for goods it sells. Entity C has consistently honored this implied policy in the past.

Analysis: Entity C. has a present constructive obligation to provide free repair services for good it has
already sold because
a. Entity C has already taken an action by creating valid expectations on the customer that it will
provide free repair services and
b. As a consequence, Entity D will have to provide those free services.
 Entity D obtained a loan from a bank. Repayment of the loan is due in 10 years’ time.
Analysis:
Entity E has a present obligation because it has already received the loan proceeds, and has a
consequence, has to make repayment, even though the bank cannot enforce the repayment until a future
date.

Entity E has caused environmental damages. Although, no law exists penalizing such act, Entity E
believes it has an obligation to rectify the damages. However, the identity of the party to whom the
obligation is owed cannot be specifically identified.
Analysis Entity E has a present obligation because it has already caused the damages, and as a
consequence, has to rectify the damages even if the identity of the party to whom the obligation is owed
is not specifically known.

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. The entity has an
asset if the terms of the contract are favorable a liability if the terms are unfavorable.

Recognition Criteria
An item is recognized if:
a. It meets the definition of liability; and
b. Recognizing it would provide useful information, i.e relevant and faithfully represented
information.
Both 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 event 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.

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 probability of an outflow of economic benefits is low.
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.

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 mat be settled in the entity owns equity instruments and is not classified as
the entity’s own equipment instrument.
Non-Financial liability – is a liability other than a financial liability.
Examples of financial liabilities
a. Payables, such as accounts, notes, loans, bonds, and accrued payables.
b. Lease liabilities
c. Held for trading liabilities and derivative liabilities
d. Redeemable preference shares issued.
e. Security deposits and other returnable deposits.
The following are not financial liabilities:
a. Unearned revenues and warranty obligations that are to be settled through future delivery of goods
or provision if services.
b. Taxes, SSS, Philhealth, and Pag-IBIG payables
c. Constructive obligations.
Presentation of financial instruments
the issuer classifies a financial instrument, or an equity instruments 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.
This definition reflects the basic accounting equition “ASSET – LIABILITIES = EQUITY.”
Meets the definition of a financial liability.

Financial Liability Equity Instrument

The entity has a contractual obligation to pay cash The entity has no obligation to pay cash or another
or another financial assets or to exchange finacial financial asset or to exchange financial instruments
under potentially unfovarable condition.
 instruments under potentially unfavorable
condition.

Recognition of financial liabilities

A financial liability is recognized on when the entity becomes a party to the contractual provisions of the
instrument.
Classification of Financial Liabilities
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)
b. Financial laibilities that arise when a transfer of a financial aset does not qualify for ferecognition
-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.
i. The amount of the loss allowance (12 month expected credit losses)
d. Contigrnt consideration recognized b y an acquirer in a business combination – subsequently
measured at fair value through profit or loss.
Measureemnt of Financial Liabilities
Initial measurment
Financial liabilities are initially measured at fair value minus transaction costs except financial liabilities at
FVPL whose trasnsaction costs are expensed immediately.

Measurement of Non-financial Financial liabilities

Non-Financial liabilities are initially measured at the best estimateof non amounts needed to settle those
obligations or the measurement basis required by the other applicable standard
Example of non-financial liabilities.
a. Obligations arisng from statutory requirments.(income tax payable)
b. Warranty obligation
c. Unearned or deffered revenues
d. Commodity contracts that either cannot be setlled in cash or which are expected to be settled
by commodity exchange.
Liabilities are presented as either (A) current or (B) noncurrent on the face of classified statement of
financial position.
Example of current liabilities :
a. Financial assets measured at FVPL.
b. Current portion of longterm notes, bonds, loans and lease liabilities.
c. Trade accounts and note payables
 d. Other non-trade payables due to within 12 months after end of reporting period.
e. Unearned income expected to be earned to within 12 months after end of reporting period.
f. Bank overdraft.
Trade and non-payables
Trade payables are obligations arising from purchase of inventory that are to be sold in the ordinary course
of business.
Example of payables

• Account payable-obligations not supposed by formal promises to pay by the debtor.

• Note payable- obligations supported by promissory notes by debtor
• Loan payable- usually use o connote bank loans,
• Bond payable- obligations issued by the debtor supported by promises to pay made under seal.
• Liabilities under trust for the bank which advance the money for importaion goods.
• Other payables arising from sources other than purchases and borrowings, such as dividends
payable, tax payable, remittances payabke and accrued expense.
Refrenancing Agreement
A long-term obligation that is maturing within 12 months after the reporting period is classified as current,
eve if a refrenancing agreement to reschedule payments on a longterm basis is completed after the reporting
period but before the financial statements are authorize to issue.
Refrenancing refers to the replacement of an existing debt with a new one but with different terms, an
extended maturity date or revised payment schedule. A refinancing ormally entails a fee or penalty.
➢ Loan facility refers to credit line
Liabilities Payable on demand
Liabilities that are payable upon the demand of the lender are classified as current. A long -term obligation
may become payable on demand when loan provision is breached. Such an obligation is classified as current
even if the lender agreed after the reporting period but the before the financial statements are authorized for
issue not to demand payment. However the liability is noncurrent if the lender provides the entity by end
of the reporting period.

Trades accounts payable

Accounts payable from purchases of inventory are recognized when ownership over the goods is trnsferred
to buyer. The amount recognize excludes trade discount. Cash discounts are included if the entity uses the
gross method of recording purchases; they are excluded if the entity uses the net method.
Unearned income
Unearned income represents advanced collection of income that is not yet earned. Prior to earning, unearned
income is classified as liability. Examples:
 a. Advance received for future delivery goods or rendering of services.
b. Proceeds from sale of gift certificates redeemable in goods or services.
Liabilities for deposits received
Liability for deposits received represents cash receipts that are held in trust for other parties.
Examples:
a. Deposit Liabilities of banks and other entities performing similar function.
b. Deposit received for containers, such as bottles, cases, crates, trays, boxes and similar items that
contain the goods sold but must be returned to the seller upon consumption of the goods.
c. Security deposits received from lessees
d. Deposits received from escrow agreements
e. Deposits for future subscription of the entity’s own equity instrument to be extent that the deposit
are repayable in cash.
Accrued expense
Accrued expenses are liabilities for expense already incurrred but not yet paid. Salaries payable, utilities
payable, and the like).
Dividends Payable
The liability to pay dividend is recognized when the dividend is appropriately authorized and is no longer
at the at the discretion of the entity, which is:
a. The date when the declaration of the dividend (e,g. by the board of directors) is approved bt the
relevant authority.(e,g by the shareholders) if such approval is required; or
b. The date when dividend is declared. (e.g by the board of directors)if further approval is not required.
Liability for remittable collections
Liabilities may also arise from amounts colleced on behalf of third parties,
Examples:
a. Taxes withheld
b. SSS premiums, Philhealth, Pag-IBIG and similar contributions
c. Output value added taxes(VAT)
d. Collections made by an agent or broker on behalf of a principal.