CHAPTER 1

LIABILITIES

Ninia C. Pauig-Lumauan, MBA, CPA

1st Semester 2022-2023
Lyceum of Aparri

INTERMEDIATE ACCOUNTING 2
 DEFINITION OF LIABILITIES
• The Conceptual Framework for Financial
Reporting provides the following
definition of liabilities:
“Liabilities are present obligations of an
entity arising from past transactions or
events, the settlement of which is
expected to result in an outflow from the
entity of resources embodying economic
benefits.”
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 DEFINITION OF LIABILITIES
• Accordingly, the essential characteristics
of an accounting liability are:
a. The liability is the present obligation of
a particular entity. The entity liable
must be identified. It is not necessary
that the payee to whom the obligation
is owed be identified.
b. The liability arises from a past event.
This means that the liability is not
recognized until it is incurred.
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 DEFINITION OF LIABILITIES
c. The settlement of the liability requires
an outflow of resources embodying
economic benefits. This is the very
heart of the definition of an accounting
liability. The obligation must be to pay
cash, transfer noncash asset or provide
service at some future time.
PRESENT OBLIGATION
• An essential characteristic of a liability is
that the entity has a present obligation.
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 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.

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 PRESENT OBLIGATION
• Constructive obligations also give rise to
liabilities by reason or normal business
practice, custom and a desire to maintain
good business relations or act in an
equitable manner.
PAST EVENT
• Another essential characteristic of a
liability is that the liability must arise from
a past transaction or event.
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 PAST EVENT

• The past event that leads to a legal 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.
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 PAST EVENT

• The receipt of a bank loan results in an

obligation to repay the loan.
The obligating event is the cash received
from the bank as a consequence of the
bank loan.
OUTFLOW OF FUTURE ECONOMIC BENEFITS
• Without payment of money, without
transfer of noncash asset, without
performance of service, there is no
accounting liability.
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OUTFLOW OF FUTURE ECONOMIC BENEFITS

• A crystallization of the definitive concept

of an accounting liability is when an entity
declares cash dividend.
• In such a case, there is an obligation to
pay cash, hence, accounting liability exists.
• But when an entity declares share
dividend, there is no accounting liability.

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OUTFLOW OF FUTURE ECONOMIC BENEFITS

• The obligation is to issue the entity’s own

shares. The issuance of the entity’s own
shares is not a transfer of noncash asset
because the share capital is an equity
item. Thus, share dividend payable is
classified as part of equity rather than an
accounting liability.

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 EXAMPLES OF LIABILITIES
• The more common types of liabilities
include the following:
a. Accounts payable to suppliers for the
purchase of goods.
b. Amounts withheld from employees for
taxes and for contributions to the
Social Security System/GSIS,
PhilHealth, and HDMF.

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 EXAMPLES OF LIABILITIES
c. Accruals for wages, interest, royalties,
taxes, product warranties and profit
sharing plans.
d. Cash dividends declared but not paid.
e. Deposits from customers and advances
from officers.
f. Debt obligations for borrowed funds –
notes, mortgages and bonds payable.
g. Income Tax payable
h. Unearned Revenue
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MEASUREMENT OF CURRENT LIABILITIES

• Conceptually, all liabilities are initially

measured at present value and
subsequently measured at amortized cost.
• However, in current practice, current
liabilities or short term obligations are not
discounted anymore but measured,
recorded and reported at their face
amount.
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 MEASUREMENT OF CURRENT LIABILITIES

• The reason is that the discount or the

difference between the face amount and
the present value is usually not materials
and therefore ignored.
MEASUREMENT OF NON CURRENT LIABILITIES
• Noncurrent liabilities, for example, bonds
payable and non-interest bearing note
payable are initially measured at present
value and subsequently measured at
amortized cost.
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 MEASUREMENT OF NON CURRENT LIABILITIES

• If the long-term note payable is interest-

bearing, it is initially and subsequently
measured at face amount.
• In this case, the face amount is equal to
the present value of the note payable.

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 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. The entity holds the liability primarily for
the purpose of trading.
c. The liability is due to be settled within
twelve months after the reporting
period. INTERMEDIATE ACCOUNTING 2
 CURRENT LIABILITIES

d. The entity does not have an unconditional

right to defer settlement of the liability for at
least twelve months after the reporting period.
• Trade payables and accruals for employee and
other operating costs are part of the working
capital used in the entity’s normal operating
cycle. Such operating items are classified as
current liabilities even if settled more than
twelve months after the reporting period.

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 CURRENT LIABILITIES
• When the entity’s normal operating cycle
is not clearly identifiable, its duration is
assumed to be twelve months.
• Other current liabilities are not settled as
part of the normal operating cycle but
are due for settlement within twelve
months after the reporting period or held
primarily for the purpose of trading.

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 CURRENT LIABILITIES
• 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.
• Financial liabilities held for trading are
financial liabilities that are incurred with an
intention to repurchase them in the near
term.
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 CURRENT LIABILITIES
• An example is a quoted debt instrument
that the issuer may buy back in the near
term depending on changes in fair value.
NONCURRENT LIABILITIES
• The term “noncurrent liabilities” is a
residual definition.
• All liabilities not classified as current are
classified as noncurrent liabilities.

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 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 entity officers
e. Long-term deferred revenue

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 LONG TERM DEBT FALLING DUE WITHIN 1 YEAR

• A liability which is due to be settled within

twelve months after the reporting period is
classified as current, even if:
a. The original term was for a period longer
that twelve months.
b. An agreement to refinance or to
reschedule payment on a long-term basis is
completed after the reporting period and
before the financial statements are
authorized for issue.
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 LONG TERM DEBT FALLING DUE WITHIN 1
YEAR
• However, 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 and
therefore the obligation is classified as
noncurrent.

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 LONG TERM DEBT FALLING DUE WITHIN 1
YEAR
• Moreover, if the entity has the discretion
to refinance or roll over an obligation for
at least twelve months after the
reporting period under an existing loan
facility, the obligation is classified as
noncurrent even if it would otherwise be
due within a shorter period.

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 LONG TERM DEBT FALLING DUE WITHIN 1
YEAR
• If the entity has an unconditional right
under the existing loan facility to defer
settlement of the liability for at least
twelve months after the reporting period,
the obligation is considered part of the
entity’s long term refinancing.
• Note that the refinancing or rolling over
must be at the discretion of the entity.
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 COVENANTS

• Covenants are often attached to the

borrowing agreements which represent
undertakings by the borrower.
• These covenants are actually restrictions
on the borrower as to undertaking
further borrowings, paying dividends,
maintaining specified level of working
capital and so forth.

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 BREACH OF COVENANTS
• Under these covenants, if certain
conditions relating to the borrower’s
financial situation are breached, the
liability becomes payable on demand.
• PAS 1, paragraph 74, provides that such a
liability is classified as current if the
lender has agreed after the reporting
period and before the statements are
authorized for issue, not to demand
payment as a consequence of the breach.
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 BREACH OF COVENANTS

• 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 twelve 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 least
twelve months after that date.
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 BREACH OF COVENANTS
• In this context, a grace period is a period
within which the entity can rectify the
breach and during which the lender
cannot demand immediate repayment.
PRESENTATION OF CURRENT LIABILITIES
• Under Paragraph 54 of PAS 1, as a
minimum, the face of the statement of
financial position shall include the
following line items for current liabilities:
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 PRESENTATION OF CURRENT LIABILITIES

a. Trade and other payables

b. Current provisions
c. Short term borrowing
d. Current portion of long term debt
e. Current tax liability
• The term “trade and other payables” is a
line item for accounts payable, notes
payable, accrued interest on note payable,
dividends payable and accrued expenses.
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 ESTIMATED LIABILITIES

• No objection can be raised if the trade

accounts and notes payable are separately
presented.
• Estimated liabilities are obligations which
exist at the end of 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.
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 ESTIMATED LIABILITIES
• But inspite 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.

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