Liability - a present obligation of the entity to transfer economic resources as a result of past events.

Definition of liability has three aspect:

a. Obligation
b. Transfer of economic resources
c. Present obligation result from past event

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Obligation - a duty and responsibility that entity has no practical ability to avoid

Obligation is either:
a. Legal obligation - obligation that results from contract, legislation, or operation of law.
b. Constructive obligation - obligation that results from an entity's action: (past practice and
published policies) that create valid expectation.

Obligation - is always owed to another party. However it is not necessary that the identity of that party is
known. Example: obligation for environmental damages may be owed to the society at large.

An obligation to transfer economic resource may be:

a. Pay cash, deliver goods, or render service
b. Exchange assets with another party on unfavorable terms
c. Transfer asset if a specified(identified) uncertain future event occurs.
d. Issue a financial instrument that obliges entities to transfer economic resources.

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Transfer of an economic resource - liability is an obligation that has potential to require transfer of
economic resources to another party, not the future economic benefits that the obligation may cause to be
transferred.

The transfer may be required only if a specified uncertain future event occurs.

Liability can exist even if the probability of transfer of an economic resource is low, although that low
probability affects the decision on whether the liability is to be recognized, how it is measured, and what
information is provided about the liability, and how information is provided.

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Present obligation as a result of past events - the obligation must be a present obligation that exists as a
result of past events.

The present obligation exists as result of past event IF:

a. The entity has already obtained(acquire) economic benefits or taken an action

b. As a consequence, The entity will or may have to transfer economic resources that it would not
otherwise have had to transfer.

An entity present obligation arises for example:

a. The entity purchased and received goods and as a consequence will have to pay for the
purchase.
b. The entity has already taken an action contrary to the provision of law, as consequence the entity
will have to pay for the penalty.
c. The entity Already caused damage and entity has to pay for damage

I. Non callable future commitment gives rise to a present obligation only when it become
onerous(burdensome)
II. Irrevocable - not able to be changed, reversed, or recovered

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Executory Contracts - a contract that is equally unperformed neither party has fulfilled any of its
obligations, or both parties have partially (limited extent) fulfilled their obligations to an equal extent.

Executory contract - establishes a combined right and obligation to exchange economic resources, which
are INTERDEPENDENT and INSEPARABLE. The two constitute a single asset or liability.

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

I. Whether such an asset and liability is included in the financial statements depend on the
recognition criteria and the selected measurement basis, including any assessment of whether
the contract is onerous (burdensome).

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Recognition criteria

An Item is recognized if:

a. It meets the definition of liability
b. Recognizing it would provide useful information ( relevant and faithfully represented information)

I. Items that meet the definition of a liability but do not provide useful information are not
recognized, and vice versa.
II. Even if the liability is not recognized, information about it may still need to be disclosed in the
notes. The Item is referred to unrecognized liability.

Relevance

Recognition may not provide relevant information if:

a. It is uncertain whether a liability exists

b. A liability exists, but the probability of an outflow of economic benefits is low.

I. 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.

Faithful Representation

A liability must be measured for it to be recognized.

I. Often, measurement requires estimation and thus is subject to measurement uncertainty.

II. Reasonable measurement – is an essential part of financial reporting
III. Even a high level of measurement uncertainty does not necessarily preclude (prevent) an
estimate from providing useful information.

Financial Liabilities

a. Contractual obligation to deliver cash or another financial assets to another entity

b. Contractual obligation to exchange financial assets and financial liabilities with another entity
under conditions that are potentially unfavorable to the entity.
c. A contract that will or may be settled in the entity’s owner equity instruments and not classified as
the entity’s owner equity instrument.

Example of financial liabilites:

a. Payables such as accounts, notes, loans, bonds and accrued payables

b. Lease Payables
c. Held for trading liabilities and derivative liabilities.
d. Redeemable preference shares issued
e. Security Deposits and other returnable deposits.
Non Financial Liabilities

Is a liability other than a financial liabilities

Example of non financial liabilities:

a. Unearned revenues and warranty obligations that are to be settled through future delivery of
goods or provision of services.
b. Taxes, SSS, Philhealth, and PAG-IBIG payables
c. Constructive Obligation

I. b and c are not financial liabilities because they do not arise from contracts.

Commodity Contracts - that cannot be settled net in cash or another financial instrument but only through
commodity exchange ( coffee beans, oil, and the like) are not financial instruments.

Presentation of Financial instrument

the issuer classifies a financial instrument, or its component parts, as a financial asset, a financial liability,
or an equity instrument in accordance with the substance of the contract (rather than its legal form).

Equity instrument
is “any contract that evidences a residual interest in the assets of an entity after deducting all of its
liabilities.”

(Residual Interest - it's the interest calculated on your balance in the days between your statement being
issued and you making a full statement balance payment.)

This definition reflects the basic accounting equation “Assets - Liabilities = Equity”

Financial Liability
The entity has a contractual obligation to pay cash or another financial asset or to exchange financial
instruments under potentially unfavorable conditions.

Equity Instrument
The entity has no obligation to pay cash or another financial asset or to exchange financial instruments
under potentially unfavorable conditions.

I. A contract is not an equity instrument because It is to be settled in the entity's own equity
instrument.
Guidance applies when a contract requires settlement in the entity’s own equity instruments:

Financial liabilities -
The contract requires the delivery of:

a. A variable number of the entity’s own equity instruments in exchange for a fixed amount of cash
or another financial asset.
b. A fixed number of the entity’s own equity instrument in exchange for a variable amount of cash or
another financial asset.

Equity Instrument
The contract requires the delivery (receipt) of:

a. A fixed number of the entity’s own equity instrument in exchange for a fixed amount of cash or
another financial asset.

I. A contract to receive ( rather than to deliver) is a financial asset.

II. An essential feature of an equity instrument is the absence of contractual obligation to pay cash
or another financial asset.

Redeemable Preference Shares

Preferred stock which the holder has the right to redeem at a set date.

a. Classified as Financial Liability because when the holder exercises its right to redeem, the issuer
is mandatorily obligated to pay for the redemption price.

Callable Preference Shares

Preferred stock which the issuer has right to call at a set date.

a. Classified as Equity Instrument because the right to call is at the discretion of the issuer and
therefore has no obligation to pay unless it chooses to call on the shares.

Member Shares in cooperative entities and similar instruments are equity if:

a. The entity has unconditional right to refuse redemption of the members’s shares
b. Redemption is unconditionally prohibited by law or relevant regulation
Recognition of Financial Liabilities
A financial liability is recognized only when the entity becomes a party to the contractual provisions of the
instrument.

Classification of Financial Liabilities

I. Subsequently measured at amortized cost except:

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 liabilities that arise when a transfer of a financial asset does not qualify for derecognition
- subsequently measured on a basis that reflects the right 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:

- The amount of loss (12- month expected credit losses)

- 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 fair value through profit or loss.

Measurement of Financial Liabilities

I. Initial measurement at fair value minus transaction cost, except FVPL

II. The transaction cost is expensed immediately

Measurement of Non Financial Liabilities

I. Initially measured at the best estimate of the amount needed to settle those obligation or
measurement basis required by applicable standard (E.g. Deferred Tax Liabilities are measured
under PAS 12 Income Taxes)

Example 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 which are expected to be settled by
commodity exchange.
Financial Statement Presentation
I. Liabilities are presented (a) current or (b) non current on the face of a classified statement of
financial position.
Current Liabilities

I. Expected to be settled in the entity’s normal operating cycle

II. Held primarily for trading
III. Due to be settled within 12 months after the end of the reporting period
IV. The entity does not have the right at the end of the reporting period to defer settlement of the
liability for at least twelve months after the reporting period.

Example of Current Liabilities

a. Financial assets measured at FVPL (designated or held for trading)

b. Current portion of long-term notes, bonds, loans and lease liabilities
c. Trade payables and notes payable
d. Non trade payable due within 12 months after the end of reporting period
e. Unearned Income expected to be earned within 12 months after the end of the reporting period.
f. Bank overdraft - is considered a liability because it is an excess amount of money that is
withdrawn from an account as compared to the amount deposited and that results in a negative
account balance.
g. Credit balance in customers’ accounts - (Advances from customer)

Example of Non Current Liabilities

a. Deferred Tax liability

b. Contingent Liability - is not recognized but rather disclosed only in the notes.
c. Reserve for contingencies - is an appropriation of retained earnings
d. Deferred revenue and Unearned revenue both refer to income already collected but not yet
earned but Deferred rev. Can be used for a long term portion of unearned revenue.

Example of Not Liabilities

a. Share dividend payable (stock dividend payable) - not liability but an adjunct equity account (i.e
presented as addition to share capital)
b. The Guarantee on the loan - because it is not probable (i.e., It is possible only) that ABC will be
held liable for the guarantee.