Learning Resource 1, Liabilities Lesson 1, Current and Noncurrent Liabilities

Learning Resource 1: Liabilities

Lesson 1
CURRENT AND NONCURRENT LIABILITIES

Learning Outcomes:

At the end of this lesson, the students shall be able to:

a. Explain the various concepts pertaining to current and noncurrent liabilities;
b. Demonstrate understanding of the concepts by applying them in solving related
problems;
c. Analyze crucial situations besetting the rigor in solving related problems; and
d. Check on the accuracy of solutions through the concepts and principles applicable
to current and noncurrent liabilities.

Activity 1
Discussion of Accounting Principles

1. Liabilities are present obligations of an entity to transfer an economic resource as a

result of past events (i.e., the Revised Conceptual Framework for Financial Reporting).

Given this information, the essential characteristics of an accounting liability include:

a. The entity has a present obligation
There is a responsibility on the part of the entity to pay the payee to whom the
obligation is owed.
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. 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.
The liability is not recognized until it is incurred.

2. The essential characteristic of a liability is that the entity has a present obligation.
a. The present obligation may be a legal obligation or a constructive obligation.
b. Legal obligation is a consequence of a binding contract or statutoty requirement (e.g.,
accounts payable for goods and services received).
c. Constructive obligation gives rise to liabilities by reason of normal business practice.

3. a. There is no accounting liability without payment of money, without transfer of

noncash asset, and/or without performance of service.
b. An accounting liability arises when an entity declares cash dividend: hence, the
obligation to pay cash.
c. When an entity declares share dividend, there is no accounting liability. The
obligation is to issue the entity’s own shares.
d. The issuance of the entity’s own shares is not a transfer of noncash asset because
the share capital is an equity item.

4. A liability must arise from a past transaction or event. The past transaction is an
obligating event which creates a present obligation.

For example, the acquisition of goods gives rise to accounts payable; or the receipt of a bank
loan results in an obligation to pay the loan.

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Learning Resource 1, Liabilities Lesson 1, Current and Noncurrent Liabilities

5. Common Types of Liabilities

 Accounts payable to suppliers for the purchase of goods
 Amounts withheld from employees for taxes, product warranties, and profit sharing bonus
 Accruals for salaries, interest, rent, taxes, product warranties, and profit sharing bonus
 Cash dividends declared but not paid
 Deposits and advances from customers
 Debt obligations for borrowed funds – notes, mortgages and bonds payable
 Income tax payable
 Unearned revenue

6. Measurement of Current Liabilities

a. All liabilities are initially measured at present value and subsequently measured at
amortized cost.
b. The discount or the difference between the face amount and the present value is
usually not material so it is ignored.

Current liabilities or short-term obligations are no longer discounted instead such are
measured, recorded and reported at face amount.

7. Measurement of Noncurrent Liabilities

a. Initially measured at present value and subsequently measured at amortized cost as
in the case of bonds payable and noninterest-bearing note payable.
b. Initially and subsequently measured at face amount as in the case of a long-term note
payable.

8. Current Liabilities (see PAS 1, paragraph 69)

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 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.

9. Noncurrent Liabilities
This is a residual notion which means that all liabilities not classified as current are
classified as noncurrent. These noncurrent liabilities include:
 Noncurrent portion of long-term debt
 Finance lease liability
 Deferred tax liability
 Long-term obligation to officers
 Long term deferred revenue

10. Long-term Debt Falling Due Within One Year

a. A liability which is due to be settled within 12 months after the reporting period is
classified as current, even if the original term was for a period longer than 12 months.
b. An agreement to refinance or to reschedule payment on a long-term basis is
completed after the reporting and before the financial statements are authorized for
issue.
c. 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—the obligation is classified as
noncurrent.
d. If the entity has the discretion to refinance or roll over an obligation for at least 12
months after the reporting period under an existing loan facility, the obligation is
classified as noncurrent even if it would be due within a shorter period.

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Learning Resource 1, Liabilities Lesson 1, Current and Noncurrent Liabilities

e. If the entity has an unconditional right under the existing loan facility to defer
settlement of the liability for at least 12 months after the reporting period, the obligation
is considered part of the entity’s long-term refinancing.

The refinancing or rolling over must be at the discretion of the entity.

11. Covenants
a. These are often attached to borrowing agreements which represent undertakings by
the borrower.
b. These are actually restrictions on the borrower as to undertaking further borrowings,
paying dividends, maintaining specified level of working capital, etc.
Putting it simply, covenants are agreements that must be followed by the borrower as
regards liability undertakings.

12. Breach of Covenants

a. Under the covenants or agreements, if certain conditions are breached or violated,
the liability becomes payable on demand.
b. As provided in PAS 1, paragraph 74, the liability that has become payable on demand
is classified as current even if the lender has agreed, after the reporting period and
before the financial statements are authorized for issue, not to demand payment as
consequence of the breach or violation.
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.
c. 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 least 12 months after that
date.
Take note, a grace period is a period within which the entity can rectify the breach and
during which the lender cannot demand immediate repayment.

13. Presentation of Current Liabilities

a. As a minimum, the face of the statement of financial position shall include the
following line items for current liabilities.
 Trade and other payables
 Current provisions
 Short-term borrowing
 Current portion of long-term debt
 Current tax liability

b. Trade and other payables is a line item for accounts payable, notes payable, accrued
interest on note payable, dividends payable and accrued expenses.
No objection can be raised if the trade accounts and notes payable are separately
presented.

14. Estimated Liabilities

a. These are obligations which exist at the end of reporting period although their amount
is not definite.
b. 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.

Given these circumstances, still the existence of the estimated liabilities is valid and
unquestioned.

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Learning Resource 1, Liabilities Lesson 1, Current and Noncurrent Liabilities

c. Estimated liabilities are either current or noncurrent.

Examples of estimated liabilities include estimated liability for premium, award points,
warranties, gift certificates, and bonus.

15. Deferred Revenue or Unearned Revenue

a. It is an income already received but not yet earned.
b. It is realizable within one year or in more than one year after the end of the reporting
period.
c. If it is realizable within one year, it is a current liability.
d. If it is realizable in more than one year, it is a noncurrent liability.
Examples of unearned revenue include unearned revenue from long-term service
contracts and long-term leasehold advances.

Activity 2
Application Exercises

You are provided with exercises that will demonstrate the application of accounting
principles discussed for current and noncurrent liabilities. Utilize an appropriate analysis to
be able to solve the exercises correctly and accurately.

Exercise L1.1
On December 31, 2020, Ryan Company provided the following information:
Accounts payable, including deposits and advances from
customers of P125,000. 625,000
Notes payable, including note payable to bank due on December
31, 2022 of P250,000 750,000
Share dividend payable 200,000
Credit balances in customers’ accounts 100,000
Serial bonds payable in semiannual installments of P250,000 2,500,000
Accrued interest on bonds payable 75,000
Contested BIR tax assessment – possible obligation 150,000
Deferred rent income 50,000

Required:
Compute the total current liabilities on December 31, 2020.

Solution to Exercise L1.1

Accounts payable 500,000
Deposits and advances from customers 125,000
Notes payable 500,000
Credit balances in customers’ accounts 100,000
Serial bonds payable 500,000
Accrued interest on bonds payable 75,000
Deferred rent income 50,000
Total current liabilities 1,850,000

Notes:
a. Accounts payable includes solely an obligation arising from purchases on account of merchandise
for trading purposes by the entity.

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Learning Resource 1, Liabilities Lesson 1, Current and Noncurrent Liabilities

b. Deposits and advances from customers is a current liability since none has been given yet in exchange to
such deposits and advances. As per the law on obligations and contracts, “no one is entitled to anything at
the expense of others”.
c. Only the note payable is a current liability. The note payable to bank is a noncurrent liability considering its
due date on December 31, 2022.
d. Serial bonds payable due for one year (P250,000 x 2) is the current liability.
e. The contested BIR tax assessment is a possible obligation. It only needs a disclosure in the statement of
financial position. There is an outflow of resources if the event is regarded as “probable” meaning it is more
than 50% likely or substantially more. A possible obligation is 50% or less likely to occur (see Provision for
Contingent Liability).
f. Deferred rent income or unearned rent income is a current liability.
g. Share dividend payable is not a current liability. The obligation here is to issue the entity’s own shares –
accounted for under shareholders’ equity.

Exercise L1.2
Paul Company provided the following information on December 31, 2020:
Notes payable: Trade 1,500,000
Bank loans 1,000,000
Advances from officers 250,000
Accounts payable – trade 2,000,000
Bank overdraft 150,000
Dividends payable 500,000
Withholding tax payable 50,000
Mortgage payable 1,900,000
Income tax payable 400,000
Estimated warranty liability 300,000
Estimated damages payable by reason of breach of contract 350,000
Accrued liabilities 450,000
Estimated premium liability 100,000
Claim for increase in wages by employees covered in a 1,750,000
pending lawsuit
Contract entered into for the construction of building 2,500,000

Required:
Determine the total current liabilities on December 31, 2020.

Solution to Exercise L1.2

Notes payable – trade 1,500,000
Notes payable – bank 1,000,000
Notes payable – officers 250,000
Accounts payable – trade 2,000,000
Bank overdraft 150,000
Dividends payable 500,000
Withholding tax payable 50,000
Income tax payable 400,000
Estimated warranty liability 300,000
Estimated damages payable 350,000
Accrued liabilities 450,000
Estimated premium liability 100,000
Total current liabilities 7,050,000

Notes:
a. Mortgage payable is a noncurrent liability.
b. Claim for increase in wages by employees is currently under litigation. It is not yet a liability pending
appropriate decision.
c. The contract entered into for the construction of building is not yet a liability since there is no
transfer of economic resource as none has been started yet in the construction of the building.

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Learning Resource 1, Liabilities Lesson 1, Current and Noncurrent Liabilities

Exercise L1.3
Apol Company provided the following information on December 31, 2020:
Accounts payable after deducting debit balances in supplier’s
accounts of P200,000. 1,000,000
Accrued liabilities 100,000
Note payable – due March 31, 2021 2,000,000
Note payable – due May 1, 2021 1,600,000
Bonds payable – due December 31, 2022 4,000,000

On March 1, 2021 before the 2020 financial statements were issued, the note payable of
P2,000,000 was replaced by an 18-month note for the same amount. The entity is
considering similar action on the P1,600,000 note due on May 1, 2021. The financial
statements were issued on March 31, 2021.

Required:
1. Ascertain the total current liabilities
2. Ascertain the total noncurrent liabilities

Solution to Exercise L1.3

1. Accounts payable 1,000,000
Accrued liabilities 100,000
Note payable – due May 1, 2021 1,600,000
Total current liabilities 2,700,000

2. Note payable – refinanced 2,000,000

Bonds payable – due December 31, 2022 4,000,000
Total noncurrent liabilities 6,000,000

Notes:
a. The note payable of P1,600,000 is still classified as current liability because the intent to refinance was not
consummated before the issuance of financial statements.
b. The note payable of P2,000,000 was replaced by an 18-month note before the issuance of financial
statements; hence, it is already classified as a noncurrent liability.

Exercise L1.4
Brilliant Company has an agreement to pay the sales manager a bonus of 5% of the
entity’s earnings. The income for the year before bonus and tax is P5,250,000. The
income tax rate is 30% of income after bonus.

Required:
Determine the bonus under each of the following independent assumptions:
1. Bonus is a certain percent of the income before bonus and before tax.
2. Bonus is a certain percent of income after bonus but before tax.
3. Bonus is a certain percent of income after bonus and after tax.
4. Bonus is a certain percent of income after tax but before bonus.

Solution to Exercise L1.3

Given data:
Income before bonus and before tax 5,250,000
Bonus 5%
Tax 30%

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1. Bonus is a certain percent of the income before bonus and before tax.
Income before bonus and before tax 5,250,000
Multiply by bonus rate .05
Bonus 262,500

2. Bonus is a certain percent of income after bonus but before tax.

B = .05 (5,250,000 – B)
B = 262,500 - .05B
B + .05B = 262,500
B = 262,500/1.05
B = 250,000

Proof:
Income before bonus and before tax 5,250,000
Less: Bonus 250,000
Income after bonus but before tax 5,000,000
Multiply by bonus rate .05
Bonus 250,000

3. Bonus is a certain percent of income after bonus and after tax.

B = .05 (5,250,000 – B - T)
T = .30 (5,250,000 – B)
B = .05 [5,250,000 – B - .30 (5,250,000 – B)]
B = .05 (5,250,000 – B – 1,575,000 + .30B)
B = 262,500 - .05B – 78,750 + .015B
B + .05B - .015B = 262,500 – 78,750
1.035B = 183,750
B = 183,750/1.035
B = 177,536
T = .30 (5,250,000 – 177,536)
T = 1,521,739
Proof:
Income before bonus and before tax 5,250,000
Bonus ( 177,536)
Tax (1,521,739)
Income after bonus and after tax 3,550,725
Multiply by Bonus rate .05
Bonus 177,536

4. Bonus is a certain percent of income after tax but before bonus.

B = .05 (5,250,000 – T)
T = .30 (5,250,000 – B)
B = .05 [5,250,000 - .30 (5,250,000 – B)]
B = .05 (5,250,000 – 1,575,000 + .30B)
B = 262,500 – 78,750 + .015B
B - .015B = 262,500 – 78,750
.985B = 183,750
B = 183,750/.985
B = 186,548
Proof:
Income before bonus and before tax 5,250,000
Tax (5,250,000 – 186,548 x 30%) (1,519,036)
Income after tax but before bonus 3,730,964
Multiply by Bonus rate .05
Bonus 186,548

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Learning Resource 1, Liabilities Lesson 1, Current and Noncurrent Liabilities

Activity 3
Evaluation Exercises

General Instructions: You are required to provide solutions/answers to the following

exercises. Supporting computations which are presented in good form shall be part of all
solutions. Answers/solutions to these exercises are to be submitted to the Professor through
her e-mail address or may be sent to her office/at home, whichever is convenient. Please
take note of the deadline of submission which will be communicated to all concerned
students.

A. Theoretical Exercises

Choose the correct answer by writing the corresponding letter-answer and a convincing
justification it is indeed the correct answer. However, an explanation shall be made as well
to the other possible answers which were not chosen. Briefly explain or provide justifiable
reason/s via applicable appropriate accounting principles discussed in Activity 1.

1. The most common type of liability is

a. One to be paid in cash and for which the amount and timing are known.
b. One that comes into existence due to a loss contingency.
c. One that must be estimated.
d. One that comes into existence due to a gain contingency.

2. Which is not a characteristic of a liability?

a. It represents a transfer of an economic resources.
b. It must be payable in cash.
c. It arises from present obligation to other entity.
d. It results from past transaction or event.

3. Classifying liabilities as either current or noncurrent helps creditors assess

a. Profitability c. The degree of an entity’s liabilities
b. The relative risk of an entity liabilities d. The amount of an entity’s liabilities

4. Which of the following is a characteristics of a current liability but not noncurrent

liability?
a. Unavoidable obligation.
b. Present obligation to transfer an economic resource.
c. Settlement is expected within the normal operating cycle or within 12 months,
whichever is longer.
d. The obligating event has already occurred.

9. Which of the following is not considered a characteristic of a liability?

a. Present obligation
b. Arises from past events
c. Results in a transfer of economic resource
d. Liquidation is reasonably expected to require use of current assets

10. Which of the following is not an acceptable presentation of current liabilities?

a. Listing current liabilities in the order of maturity
b. Listing current liabilities according to amount
c. Offsetting current liabilities against assets that are to be applied to their liquidation
d. Showing current liabilities in the order of liquidation preference

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11. An entity had a note payable due next year. After the end of reporting period and before
the issuance of the current year financial statement, the entity issued long-term bonds
payable. Proceeds from the bonds were used to repay the note when due. How should
the entity classify the note payable at the current year?
a. Current liability with separate disclosure of the note refinancing
b. Current liability with no disclosure required
c. Noncurrent liability with separate disclosure of the note refinancing
d. Noncurrent liability with no separate disclosure required

12. At year-end, an entity classified a note payable as current liability. Under what condition
could the entity reclassify the note payable from current to noncurrent?
a. If the entity has the intent and ability to reclassify the note before the end of
reporting period.
b. If the entity has executed an agreement to refinance the note before issuance of the
financial statements.
c. If the entity has the intent and ability to reclassify the note before the issuance of
the financial statements.
d. If the entity has executed an agreement to refinance the note before the end of
reporting period.

13. Which statement best describes the term liability?

a. An excess of equity over current assets
b. Resources to meet financial commitments when due
c. The residual interest in the assets of the entity
d. A present obligation arising from past event

14. What is the relationship between present value and the concept of a liability?
a. Present value is used to measure certain liabilities.
b. Present value is not used to measure liabilities.
c. Present value is used to measure all liabilities.
d. Present value is used to measure noncurrent liabilities only.

15. Advance payments from customers represent

a. Liabilities until the product is provided.
b. A component of shareholders’ equity.
c. Assets until the product is provided.
d. Revenue upon receipt of the advance payment.

B. Practical Exercises

Solve the following problems with supporting computations presented in good form:

1. Ryan Paul Company provided the following information on December 31, 2020:
Income taxes withheld from employees 450,000
Cash balance at Excellently Thrift Bank 1,250,000
Cash overdraft at Solid Bank 650,000
Accounts receivable with credit balance 375,000
Estimated expenses of meetings warranties on merchandise
previously sold 250,000
Estimated damages as a result of unsatisfactory performance on a
Contract 750,000
Accounts payable 1,500,000

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Deferred serial bonds, issued at par and bearing interest at 12%,

payable in semiannual installment of P250,000 due April 1 and 2,500,000
October 1 of each year, the last bond to be paid on October 1, 2026.
Interest is also paid semiannually
Stock dividend payable 1,000,000

Required:
Compute the total current liabilities on December 31, 2020.

2. Lilian Company is planning to refinance certain short-term obligations on a long term

basis. The 2020 financial statements are issued on March 15, 2021. On December 31,
2020, before reclassification of short-term debt, the liabilities are:
Accounts payable 3,500,000
Note payable-bank 6,000,000
Accrued expenses 2,000,000
Mortgage payable 2,000,000
Note payable - due in 2020 1,500,000
The entity intends to refinance P4,500,000 of the P6,000,000 bank note payable on a
long term basis.

Although the entire P6,000,000 is due on June 30, 2021, the bank has informally agreed
to extend the maturity date for P3,000,000 to June 30, 2022, if necessary.

On January 31, 2021, the entity issued share capital for P2,000,000, net of issue costs
and underwriting fees of P250,000.
On February 15, 2021, the entity entered into a financing agreement with a financially
capable commercial bank, permitting the entity to borrow up to P1,500,000.

Barrowings available at the entity’s option on April 1, 2021 will mature five years after
the loan date.

The entity used the entire proceeds of the issue of share capital to retire part of the
current note payable and now intended to draw down the entire available commitment
of the five-year debt on April 1, 2021.

Required:
1. Present the liabilities on December 31, 2020.
2. Describe any financial statement disclosures.

3. Brilliant Company reported the following liability balances on December 31, 2020.
12% note payable issued on March 1, 2019, maturing on March 1, 2021 2,500,000
10% note payable issued on October 1, 2019, maturing October 1, 2021 1,500,000

The financial statements were issued on March 31, 2021. On January 31, 2021, the
entire P2,500,000 balance of the 12% note payable was refinanced through issuance of
long-term obligation payable lump sum. Under the loan agreement for the 10% note
payable, the entity has the discretion to refinance the obligation for at least twelve
months after December 31, 2020.

What amount of the notes payable should be classified as current on December 31,
2020?

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4. On December 31, 2020, Legro Company had a P750,000 note payable outstanding due
July 31, 2021. The entity planned to refinance the note by issuing long-term bonds.

Because the entity temporarily had excess cash, it prepaid P250,000 of the note on
January 15, 2021. In February 2021, the entity completed a P1,500,000 bond offering.
The entity will use the bond offering proceeds to repay the note payable at maturity. On
March 31, 2021, the 2020 financial statements were authorized for issue.

What amount of the note payable should be included in current liabilities on December
31, 2020?

5. Carlo Company sells major household appliances service contracts for cash. The service
contracts are for a one-year, two-year period. Cash receipts from contracts are credited
to unearned contract revenue. This account had a balance of P720,000 on December
31, 2020 before year-end adjustment. Service contract costs are charged as incurred to
service contract expense account which had a balance of P180,000. Outstanding service
contracts on December 31, 2020 expire during 2021 P150,000, during 2022 P225,000
and during 2023 P100,000.

What amount should be reported as unearned contract revenue on December 31, 2020?

6. After three profitable years, Sheryl Company decided to offer a bonus to the branch
manager of 25% of income over P1,000,000 earned by the branch during the current
year.

The income for the branch was P1,600,000 before tax and before bonus for the current.
The bonus is computed on income in excess of P1,000,000 after deducting the bonus
but before deducting tax.

What is the bonus for the current year?

*****

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