Professional Documents
Culture Documents
Present Obligation
Present Obligation
Present Obligation
Liabilities
Present obligation
An essential characteristic of a liability is that the entity has a present obligation.
The present obligation may be a legal obligation or a constructive
obligation.
Obligations may be legally enforceable as a consequence of binding contract
or statutory requirement. This is normally the case, for example, with 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 any quotable manner.
Past event.
Another essential characteristic of a liability is that the liability must arise from
a past transaction or event.
The past event that leads to illegal or constructive obligation is known as the
obligating event.
The obligating event creates a present obligation because the entity has no
realistic alternative but to settle the obligation created by the event.
For example, the acquisition of goods gives rise to accounts payable. The
obligating event is the acquisition of goods.
Examples of liabilities
a. Accounts payable to suppliers for the purchase of goods
b. Amount withheld from employees for taxes and for contributions to the
Social Security system
c. Accruals of salaries, interest, rent, taxes, product warranties and profit
sharing bonus.
d. Cash dividends declared but not paid
e. Deposits and advances from customers
f. That obligations for borrowed funds - notes, mortgages and bonds payable.
g. Income tax payable
h. Unearned revenue
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 their 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.
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. Entity holds the liability primarily for the purpose of trading.
c. The liability is due to be settled within 12 months after the reporting period.
d. The entity does not have an unconditional right to defer settlement of the
liability for at least 12 months after the reporting period.
Examples of such current liabilities are financial liabilities held for trading,
bank overdraft, dividends payable, income taxes, other non-trade payables
and current portion of non-current financial liabilities.
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
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 specific level of working
capital and so forth.
Breach of covenants
Under these covenants, if certain conditions relating to the borrower's
financial situation or breached the liability becomes payable on demand.
PAS 1, paragraphs event before, provides that such a liability is classified
as current even if the lender has agreed, after the reporting period and
before the statement are authorized for issue, not to demand payment as
a consequence of the breach.
This liability is classified as current because at the end of the reporting
period, the entity does not have an unconditional right to defer settlement
for at least 12 months after that date.
However, the liability is classified as noncurrent if the lender has agreed
on or before the end of the reporting period to provide a grace period
ending at 12 months after that date.
Estimated liabilities
Estimated liabilities are obligations which exist at the end of the 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.
But in spite of these circumstances, the existence of the estimated liabilities is
valid and unquestioned.
Estimated liabilities are either current or noncurrent in nature.
Examples include estimated liability for premium, award points, warranties,
gift certificates and bonus.
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.
Typical examples of current effort revenue or unearned interest income,
unearned rental income and unearned subscription revenue.
If the deferred revenue is realizable in more than one year, it is classified
as noncurrent liability.
Typical examples of noncurrent deferred revenue are unearned revenue
from long-term service contracts and long-term leasehold advances.
Illustration:
An entity sells equipment service contracts agreeing to service equipment for a 2
year. 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
Illustration:
Proof:
Income before bonus and before tax 4,400,000
Tax ((4,400,000-317,526) x 30% (1,224,742) Refundable
Income after bonus and after tax 3,175,258 deposits
Multiply by x 10% Refundabl
Bonus 317,526 e 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 refundable containers like bottles, drums, tanks and barrels.
Illustration:
A deposit of P10,000 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.