Liabilities

A liability is now defined as “a present obligation of the entity to transfer an economic resource as a result of past events.” (Revised
Conceptual Framework)

Previously, liability was defined as “a present obligation of the entity arising from past events, the settlement of which is expected to
result in an outflow from the entity of resources embodying economic benefits”

Three aspects on the definition of liability

 Obligation
 Transfer of an economic resource
 Present obligations as a result of past events

Obligation
An obligation is “a duty or responsibility that the entity has no practical ability to avoid”.
An obligation is either:
1. Legal obligation – arises from contract (from operation of law-mandated or required)
2. Constructive Obligation – implied or arise from past practices where it creates valid expectations (known for public/doing it for
years)

Transfer of an economic resource- (potential to transfer)

- Need not to be certain (as long as there is change/potential to transfer, it can be considered as liability)
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 assets if a specified uncertain future event occurred; or
d. issue a financial instrument that obliges the entity to transfer an economic resource.

Present obligations as a result of past events

The obligation must be a present obligation that exists as a result of past events. A present obligation exists as a result of past events
if:
1. the entity has already obtained benefits or taken an action; and
2. As a consequence, the entity will or may have to transfer an economic resource that it would not otherwise have had to
transfer.

Identification of Present Obligation

 Intention to acquire goods in the future

 An entity operates a nuclear power plant. In the current year, a new law was enacted penalizing the improper disposal of toxic
waste. No similar law existed in prior years.

 An entity enters into an irrevocable commitment with another to acquire goods in the future, on credit.

 Although not stated in the sales contract, an entity has a publicly-known policy of providing free repair services for the goods it
sells. The entity has consistently honored this implied policy in the past.

 An entity obtained a loan from a bank. Repayment of the loan is due in 10-years’ time.

 An entity has caused environmental damages. Although no law exists penalizing such, the entity 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.

 An entity employed Mr. Juan.

Executory Contracts – contract that should be executed (combination of assets and liabilities)
Onerous – There’s value affected, there is consideration involved

Recognition of liabilities
An item is recognized as a liability when: (OLD)
1. It meets the definition of a liability;
2. It is probable that an outflow of resources embodying economic benefits will result from its settlement; and
3. The settlement amount can be measured reliably.

An item is recognized as a liability when: (NEW)

1. It meets the definition of a liability; and
2. Recognizing it would provide useful information, i.e., relevant and faithfully presented information

Financial liabilities
A financial liability is any liability that is a contractual obligation:
1. to deliver cash or another financial asset to another entity; or
2. to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavorable to the
entity; or
3. a contract that will or may be settled in the entity’s own equity instrument and is not classified as the entity’s own equity
instrument.
*variable # of equity instruments in exchange for fixed amount of cash or another FA
*fixed # of equity instruments in exchange for variable amount of cash or another FA
Examples of financial liabilities
 Payables such as accounts, notes, loans, bonds payable and accrued expenses that are payable in cash.
 Finance lease obligations.
 Liabilities held for trading such as obligations to deliver financial assets borrowed by a “short seller” (i.e., an entity that sells
financial assets it has borrowed and does not yet own).
 Preference shares issued with mandatory redemption.
 Security deposits received that are to be returned to tenants at the end of lease term.
 Obligations to deliver a variable number of own shares worth a fixed amount of cash.

The following are not financial liabilities

 Unearned revenues and warranty obligations that are to be settled by future delivery of goods or services, rather than cash.
 Taxes, SSS premiums, Phil health and other payables arising from statutory requirements and not from contracts.
 Commodity contracts that either cannot be settled in cash or which are expected to be settled by commodity exchange (e.g.,
coffee beans, gold bullion, oil, and the like). If a commodity contract is expected to be cash settled, it will be included as
financial liability on the part of the cash payor.
 Constructive obligations. These obligations do not arise from contracts.

Measurement of financial liabilities

Initial measurement – fair value minus transaction costs, except financial liabilities at FVPL whose transaction costs are expensed
immediately.

Subsequent measurement – amortized cost (except financial liabilities that are classified as held for trading and those that are
designated; these are subsequently measured at fair value)

Measurement of Non-financial liabilities

Non-financial liabilities are initially measured at the best estimate of the amounts needed to settle those obligations or the
measurement basis required by another applicable standard.
Examples:
Obligations arising from statutory requirements (e.g., income tax payable)
Unearned or deferred revenues
Warranty obligations
Commodity contracts that either cannot be settled in cash or which are expected to be settled by commodity exchange

Redeemable preference shares vs Callable preference shares

Redeemable preference shares are preferred stocks which the holder has the right to redeem at a set date.
- By substance, it is a liability
Callable preference shares are preferred stocks which the issuer has the right to call at a set date.
- By form and substance, it is a liability

Current liabilities
Current liabilities are liabilities that are:
a. Expected to be settled in the entity’s normal operating cycle;
b. Held primarily for trading;
c. Due to be settled within 12 months after the end of the reporting period; or
d. 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.

All other liabilities are classified as non-current.

Trade and non-trade payables

Trade payables are obligations arising from purchases of inventory that are to be sold in the ordinary course of business. Other
payables are classified as non-trade.
Trade payables are classified as current liabilities when they are expected to be settled within the normal operating cycle or one
year, whichever is longer.
On the other hand, non-trade payables are classified as current liabilities only when they are expected to be settled within one year.

Remember the following:

General rule: A currently maturing obligation is presented as current even if the obligation is refinanced on a long-term basis after
the balance sheet date.
Exceptions: The obligation is non-current if:
the entity has the right, as of the balance sheet date, to roll over the obligation on a long-term basis under an existing loan facility; or
the rollover on a long-term basis is completed on or before the balance sheet date.

General rule: An obligation that is payable on demand is presented as current.

Exception: The obligation is non-current if the lender agreed on or before the balance sheet date not to collect within the next 12
months (grace period)

Common Issues on Current Liabilities

 Unearned Income
 Unearned Revenue
 Deferred Revenue
 Unearned Subscription
 Gift certificates (PFRS 15)
 breakage (proportionate and remote method)
 Liability for deposits received

Dividends payable
Under IFRIC 17, the liability to pay a dividend is recognized when the dividend is appropriately authorized and is no longer at the
discretion of the entity, which is:
the date when the declaration of the dividend (e.g., by management or the board of directors) is approved by the relevant authority
(e.g., the shareholders) if the jurisdiction requires such approval, or
the date when the dividend is declared (e.g., by management or the board of directors) if the jurisdiction does not require further
approval.

APPLICATION

1. On December 31, 2021, the bookkeeper of Grand Company provided the following information:

Accounts payable, including deposits and advances

from customers of P500,000 P 2,500,000
Notes payable, including note payable to bank due
on December 31, 2023 for P1,000,000 3,000,000
Share dividends payable 800,000
Credit balance in customers' accounts 400,000
Serial bonds, payable in semiannual installments
of P1,000,000 10,000,000
Accrued interest on bonds payable 300,000
Contested BIR tax assessment 600,000
Unearned rent income 100,000

In the December 31, 2021 statement of financial position, how much current liabilities should be reported?
a) P6,800,000 c) P7,900,000
b) P7,300,000 d) P8,700,000

2. An analysis of Cool Company's liabilities disclosed the following:

Accounts payable, after deducting debit balances in

suppliers' accounts amounting to P22,500 (accounts
payable included non-trade liabilities of P32,500) P105,000
Accrued expenses 15,000
Credit balances of customers' accounts 13,500
Stock dividends payable 70,000
Claims for increase in wages and allowances by
employees of the company, covered in a pending lawsuit 125,000
Estimated liabilities for premiums 60,000

How much should be presented as total current liabilities in the statement of financial position?
a) P 6,000 c) P183,500
b) P168,500 d) P216,000

3. The balance in Coward Company's accounts payable account at December 31, 2021 was P1,170,000 before any year-end
adjustments relating to the following:

 Goods were in transit from a vendor to Coward on December 31, 2021. The invoice cost was P65,000 and the goods were
shipped FOB shipping point on December 29, 2021. The goods were received on January 2, 2022.
 Goods shipped FOB shipping point on December 20, 2021 from a vendor to Coward, were lost in transit. The invoice cost was
P32,500. On January 5, 2022, Coward filed a P32,5000 claim against the common carrier.
 Goods shipped FOB destination on December 21, 2021, from a vendor to Coward, were received on January 6, 2022. The
invoice cost was P19,500.
What amount should Coward report as accounts payable on its December 31, 2021 statement of financial position?

a) P1,202,500 c) P1,235,000
b) P1,222,000 d) P1,267,500

4. The balance in Stem Corporation's accounts payable account at December 31, 2021 was P1,350,000 before any necessary year-
end adjustments relating to the following:
Goods were in transit to Stem from a vendor on December 31, 2021. The invoice cost was P75,000. The goods were shipped FOB
shipping point on December 29, 2021 and were received on January 2, 2022.
 Goods shipped FOB destination on December 21, 2021, from a vendor to Stem, were received on January 6, 2022. The invoice
cost was P37,500.
 On December 27, 2021, Stem wrote and recorded checks totaling P60,000 which were mailed on January 10, 2022.
In Stem's December 31, 2021 statement of financial position, how much should be the accounts payable?
a) P1,410,000 c) P1,462,500
b) P1,425,000 d) P1,485,000

5. Echo Company sells office equipment contracts agreeing to service equipment for a two-year period. Cash receipts from contracts
are credited to unearned service contract revenue and service contract costs are charged to service contract expense as incurred.
Revenue from service contract is recognized as earned over the lives of the contracts.
Additional information for the year ended December 31, 2021 is as follows:
Unearned service contract revenue, January 1, 2021 P600,000
Cash receipts from service contracts sold 980,000
Service contract revenue recognized 860,000
Service contract expense 520,000

What amount should Echo report as unearned service contract revenue at December 31, 2021?
a) P460,000 c) P490,000
b) P480,000 d) P720,000

6. Offset Co. sells gift certificates as part of its sales promotion. During the year, Offset Co. sells gift certificates worth
₱500,000, of which ₱360,000 were redeemed. Based on Offset Co.’s past experience, 10% of gift certificates sold are never
redeemed. Under PFRS 15, what amounts of (1) total revenue and (2) liability should be reported in Offset Co.’s 2021 financial
statements?
a. 400,000; 100,000 c. 410,000; 90,000
b. 360,000; 90,000 d. 360,000; 100,000

7. DULL Co. has a 10%, ₱2,000,000 loan payable as of December 31, 2021 which will be maturing on July 1, 2022. Interest on
the loan is due every July 1 and December 31 and all the interests that have accrued in 2021 were paid on these scheduled dates. On
February 1, 2022, DULL Co. entered into a refinancing agreement with a bank to refinance the loan on a long-term basis. Both
parties are financially capable of honoring the agreement's provisions. The contract on the ₱2,000,000 loan payable does not state
any refinancing or roll over option. DULL’s 2021 financial statements were authorized for issue on March 15, 2022. In DULL’s 2021
financial statements, how much is presented as current liability in relation to the loan payable?
a. 2,100,000 b. 2,000,000 c. 100,000 d. 0

8. Eliot Corporation’s liabilities at December 31, 2008 were as follows:

Accounts payable and accrued interest 2,000,000
5-year 10% Notes payable – due December 31, 2011 5,000,000

Part of the loan agreement is for Elliot to appropriate a fixed amount out of its accumulated profits and losses annually until the
amount of appropriation has equaled the face amount of the obligation. Non-compliance will render the note as payable on demand
by the lender. As of December 31, 2008, Elliot Corporation has not yet complied with the loan agreement. What amount of current
liabilities should Elliot Corporation report in its December 31, 2008 statement of financial position?
a. 2,000,000 b. 5,000,000 c. 7,000,000 d. 0

9. FLUNK Co. requires advance payments for custom-built guitar effects, gadgets, and racks. The records of FLUNK show the
following:
Unearned revenue, January 1, 2021 ₱ 2,000,000
Advances received during 2021 20,000,000
Advances applied to orders shipped in 2021 16,000,000
Advances pertaining to orders cancelled in 2021 600,000

How much is presented as current liability assuming the advance payments received are non-refundable?
a. 4,500,000 b. 5,400,000 c. 6,000,000 d. 6,600,000

10. WAIVE Co. maintains escrow accounts and pays real estate taxes for its customers. Escrow funds are kept in interest-bearing
accounts. Interest, less a 10% service fee, is credited to the mortgagee’s account and used to reduce future escrow payments.
Information on escrow accounts is shown below:
Escrow accounts liability, January 1, 2021 400,000
Escrow payments received during 2021 3,000,000
Real estate taxes paid during 2021 1,000,000
Interest on escrow funds during 2021 200,000

How much is the current liability for the escrow accounts on December 31, 2021?
a. 2,580,000 b. 2,600,000 c. 2,400,000 d. 2,420,000