CHAPTER

LIABILITIES
 Learning Outcomes

At the end of this chapter, you should be able to:

Describe the objective of having different types of
liabilities to users of accounting information
Define and classify different types of liabilities
Recognize different types of liabilities
Conduct initial measurement of different types of
liabilities
Present different types of liabilities in the financial
statements

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 Classification of Liabilities

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 Definition of Liabilities

An item is a liability when: Example:

(a) it is a present
obligation
(b) it is a result of past
transactions or other past
events
(c) it can be measured
reliably or using a
substantial degree of
estimation
A new machine was purchased from
a supplier on credit basis. The full
settlement will be made in 30 days.
The machine is bought for production
purpose.
Solution:
There is a present obligation resulted
from the purchase of the new
machine and the amount of
settlement can be measured reliably.
The obligation is a liability.

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 Objective of Providing
Information on Trade
Payables

Information on trade Example:

payables are useful to the
existing and potential
investors, lenders and
other creditors in helping
them making decisions
about the entity.
An entity purchases goods on credit
from its suppliers.
Solution:
Most entities choose trade payables
as their largest source of financing.
The information on trade payables is
useful for the suppliers to keep track
on the settlement for entity that hold
credit with them.

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 Definition and Classification of
Trade Payables
It is a one party’s contractual
obligation to pay cash to other
corresponding party.
Trade payables are classified as
current liabilities when:
(a) it is a present obligation
(b) it is a result of past
transactions or other past
events
(c) it can be measured reliably or
using a substantial degree of
estimation
(d) It is classified as cash or a cash
equivalent unless the assets are
restricted from being exchanged or
used to settle a liability for at least
after 12 months (after the reporting
period)
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Example:
An entity purchased goods on credit from
B and promised to settle the credit on day
30 after the purchase.
Solution:
There will be a payment of cash to B on
day 30 after the purchase. The amount
owed is a trade payable which is classified
as a current liabilities in the financial
statements. There will be an obligation to
pay cash/settle the credit on day 30 after
the purchase. B as another party has a
contractual right to receive the cash from
the entity.
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 Initial Recognition of Trade
Payables

An entity shall recognized Example:

trade payables in the
financial statement when
the entity becomes a party
to a contractual provisions
of the instruments.
An entity purchased goods on credit
from B and promised to settle the
credit on day 30 after the purchase.
Solution:
There is an obligation to pay
cash/settle the credit on day 30 after
the purchase. B as another party has
a contractual right to receive the cash
from the entity.

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 Initial Measurement of
Trade Payables

An entity shall measure Example:

trade payables at the fair An entity purchased goods amounting
value plus transaction to RM10,000 from its supplier. The
cost. entity agreed to settle the credit on
day 15 after the purchase.

Solution:
The trade payable would be recorded
as below:
Debit Purchases a/c 3,000
Credit Trade payables a/c 3,000

When cash is paid on day 15

Debit Trade payables 3,000
Credit Bank 3,000

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 Presentation of Trade
Payables

Trade payables are presented as an item of current liabilities in the

statement of financial position.

Example:

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 Objective of Providing
Information on Other
Current Liabilities
Information on other Example:
current liabilities are useful An entity owes its employees for
to the existing and salaries at the end of the accounting
potential investors, lenders period.
and other creditors in
helping them making Solution:
decisions about the entity. Information about other current
liabilities will help the users to asses
the ability of the entity in managing its
cash flows.

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 Definition and Classification of
Other Current Liabilities

It is a one party’s obligation to pay Example:

cash to other corresponding party. An entity has tax payable at the end of its
reporting date.
Trade payables are classified as
current liabilities when: Solution:
(a) it is a present obligation The entity has an obligation to pay cash to
(b) it is a result of past transactions or government for the tax payable in the next
other past events accounting period. The tax payable is
(c) it can be measured reliably or classified as a current liabilities.
using a substantial degree of
estimation
(d) classified as cash or a cash
equivalent unless the assets are
restricted from being exchanged or
used to settle a liability for at least
after 12 months (after the reporting
period)

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 Initial Recognition of Other
Current Liabilities

An entity shall recognized Example:

other current liabilities when:
(a) It is probable that an
outflow of resources
embodying economic benefits
will result from the settlement
of a present obligation.
(b) The amount of the
settlement can be measured
reliably.
An entity owes its employees,
RM5,000 for salaries at the end of the
accounting period.
Solution:
There will be an outflow of resources
resulting from the settlement of a
present obligation of RM5,000 in the
next accounting period and the
amount can be measured reliably.
RM5,000 will be recognized as a
current liability in the financial
statement.

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 Initial Measurement of Other
Current Liabilities

Other current liabilities are Example:

measured at historical cost An entity owes its employees,
which is the amount of RM5,000 for salaries at the end of the
proceeds received in accounting period.
exchange for the
obligation. Solution:
The accrued salaries can be recorded
as below:
Debit Salaries 5,000
Credit Accrued salaries 5,000

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 Presentation of Other Current
Liabilities

Other current liabilities are presented in the statement of financial position.

Example:

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 Objective of Providing
Information on Bonds

The entity discloses the Example:

information on bonds in its
financial statement
because it might help
them to diversify their
investments in the future,
as bonds offer the
potential for medium to
long-term business
growth. This information
can also help the existing
and potential investors
make decisions on current
and future investments.
An entity purchased a bond at 10%,
10 years, RM10,000 for RM10,500.
The market rate is 10%.
Solution:
Bond is an instrument used by the
entity to obtain cash. It provides
information about an entity having a
long-term contract with another party
for settlement of obligation. The cash
flows of the entity would be reduced
by the amount of the settlement for
the next 10 years.

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 Definition and Classification of
a Bond

Bond is a contract that Example:

gives rise to a financial
asset of one entity and a
financial liability or equity
instruments of another
entity.
Bond is classified as non-
current liabilities when it
does not meet the
definition of current
liabilities.
An entity purchased a bond at 10%,
10 years, RM10,000 for RM10,500.
The market rate is 10%.
Solution:
Bond is an instrument used by an
entity to obtain cash for business
activities. Bond creates contractual
obligation to deliver cash to another
entity. Bond is a non-current liabilities
because it is due to be settled more
than 12 months after the reporting
period.

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 Initial Recognition of Bonds

Bond is recognized when Example:

and only when the entity
becomes a party to a
contractual provisions of
the instruments.
Bond can be recognized
as a derivative financial
liabilities if its price follows
the market price.
An entity purchased a bond at 10%,
10 years, RM10,000 for RM10,500.
The market rate is 10%.
Solution:
The entity has become a party to a
contractual provision of the bond. The
contractual provision is to deliver cash
to another entity for settlement of
obligation.
The bond is also a derivative financial
instrument because the price follows
the market price of the bond.

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 Initial Measurement of Bonds

Bond is measured at its transaction price, that is the fair value of the
consideration given or received.
Example:
An entity issued RM10,000 bond at 10% interest rate and matures in five
years. The market rate is 10%.
Solution:
The total proceeds from a bond:
Debit Bank a/c 10,000
Credit Bond a/c 10,000

The interest is recognized every year:

Debit Bond interest expense a/c 1,000
Credit Bank a/c 1,000

*The total proceeds is computed using the present value table.

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 Presentation of Bonds

Bond is presented as an item of non-current liabilities in the statement of financial

position.

Example:

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 Objective of Providing
Information on Other
Non-current Liabilities
The entity presents Example:
information on other non- An entity has incurred a three-year
current liabilities so that bank loan to finance part of its new
the users of the financial construction.
information can evaluate
other liabilities that may Solution:
also have some impact on Information about the bank loan is
the financial performance useful to the users of the financial
of the entity. information to measure the efficiency
and liquidity of the entity in managing
its cash inflows and outflows in
settlement of the loan.

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 Initial Recognition and
Measurement of Other
Non-current Liabilities
Other non-current Example:
liabilities are recognized in An entity borrows RM1,000,000 from a bank for the
the financial statements purpose of its office building construction. The
when: interest rate is 10%. The term of financing is two
(a) It is probable that an years.
outflow of resources
embodying economic Solution:
benefits will result from the The bank loan is recognized as other non-current
settlement of a present liabilities because the cash is used for the purpose
obligation. of construction. After the completion of the building,
(b) The amount of the the building can be used by the administrative staff
settlement can be to manage the entity’s resources. And also, the
measured reliably. amount of the settlement is the initial value plus the
interest costs which can be measured reliably by
the entity.

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 Presentation of Other
Non-current Liabilities

Other non-current liabilities are presented as an item of non-current liabilities

in the statement of financial position.

Example:

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 Provision, Contingent
Liabilities and Contingent
Assets

Objective of providing Investors will evaluate an entity’s ability

information to pay them their dividends. A large
amount of provisions may indicate that
The users will be assisted the entity has difficulty in paying them
in understanding the large dividend.
nature, timing and amount
of such provisions and Creditors and lenders will evaluate the
contingencies. entity’s ability to repay them in the future.
A large amount of provisions may
indicate that the entity has difficulty in
paying the outstanding liability and it will
influence the decision of creditors and
lenders in providing future credit or
loans.

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 Definition of Provisions

Provisions are liabilities of Comparison between provisions and payables:

uncertain timing or
amount or both. A Payables are liabilities to pay for assets, goods
provision is classified as a or services that have been agreed to with the
liability because it has all supplier. Therefore, the timing and the amount
characteristics of a of the payment to be made are certain.
liability, i.e. a past
obligating event has On the other hand, provisions are liabilities that
occurred, the entity has a have uncertainty in terms of timing or amount or
present obligation (legal both. Examples of provisions include provisions
or constructive) and there for litigation, warranties or product guarantees
is a future outflow of and refunds. The seller has an obligation to
benefits. honour the warranty and refund the customer.

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 Initial Recognition of
Provisions

A provision should be Focus Eye Bhd provides warranty that accompanies

recognized when: the sale of its glasses frames to its customers.
Based on industry experience, it is estimated that
(a)an entity has a present the company would incur RM140,000 warranty cost
obligation (legal or during the year 20X5.
constructive) as a result of a
past event; Focus Eye Bhd has a present obligation
(b)it is probable that an (agreements in the warranty) arises from past event
outflow of resources (sale of frames to customers) to rectify defects in
embodying economic benefits the product, to exchange the defective frame with a
will be required to settle the new frame or to make a full refund to its customers
obligation; and (probable future outflow). The amount for provision
(c)a reliable estimate can be for warranty can be estimated reliably (RM140,000)
made of the amount of the by considering how much it would have to pay a
obligation. third party in an outsourcing contract to take over its
obligation to customers.

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 Measurement of Provisions
The amount recognized as a
provision shall be the best estimate of
the expenditure required to settle the
present obligation at the end of the
reporting period.
The entity has to estimate the
provision based on its experience of
similar transactions and reports from
professional experts.
The following factors may affect the
amount of provisions to be
recognized:
1.Best estimate
2.Risk and uncertainties
3.Present value
4.Future events
5.Expected disposal of assets
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Focus Eye Bhd sells its glasses frames with a warranty
under which the customers are covered for the cost of
repairs or defects within six months of purchase. The
entity estimates that the repair cost for major defects
and minor defects are RM200,000 and RM90,000
respectively. The entity’s past experience indicates that
there is 75% of probability that the goods has no
defect, 20% of minor and 5% of major repairs.
Focus Eye Bhd has a present legal obligation as a
result of selling the glasses frames. The obligation is
the warranty provided. The entity needs to incur repair
costs for the defective frame (probable future outflow).
The provision amount should be estimated and the
best estimate will be:
(75% × 0) + (20% × RM90,000) + (5% ×RM200,000)
= RM28,000
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 Contingent Liabilities

Contingent liabilities are: A customer initiated a legal proceedings

(a) a possible obligation that arises from past events
and whose existence will be confirmed only by the
occurrence or non-occurrence of one or more uncertain
future events not wholly within the control of the entity;
or
(b) a present obligation that arises from past events but
is not recognized because:
(i) it is not probable that an outflow of resources
embodying economic benefits will be required to
settle the obligation; or
(ii) the amount of the obligation cannot be
measured with sufficient reliability.
claiming damages of RM1,000,000 against
Focus Eye Bhd for misleading
advertisement. At the reporting date, the
lawyers of the entity were of the opinion that
there was a possibility that the entity would
lose the case.
Since the obligation is possible, the entity
has no present obligation that arises from
past event. Therefore, it cannot be classified
as a liability. Instead, it is classified as a
contingent liability.

Unless the possibility of an outflow of resources is The entity should disclose the nature of the
remote, an entity should disclose, at the contingent liability, the estimate of its
reporting date, the nature of a contingent liability financial effect, i.e. RM1,000,000, an
and where practicable, an estimate of its indication of uncertainties relating to the
financial effect, an indication of uncertainties amount or timing of any outflow and the
relating to the amount or timing of any outflow possibility of any reimbursement if
and the possibility of any reimbursement. practicable.

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 Contingent Assets
A contingent asset is a possible asset that
arises from past events and whose
existence will be confirmed only by the
occurrence or non-occurrence of one or
more uncertain future events not wholly
within the control of the entity.
An entity should not recognize a contingent
asset. A contingent asset should be
disclosed where an inflow of economic
benefits is probable. The disclosure
includes the nature of the contingent asset
and where practicable the estimated
financial effects of the asset.
 
When the realization of income is virtually
certain, then the related asset is not a
contingent asset and its recognition as an
asset is appropriate
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Focus Eye Bhd is taking legal action against
Company X for failing to deliver on contracts
for its product. The lawsuit is in the final
appeal. The legal advise is that it is probable
that they will win the case and will be
awarded RM600,000.
A contingent asset cannot be recognized as
asset, even though the gain is probable and
reliably estimated. The contingent asset
should only be recognized when it is certain
or virtually certain. It is disclosed, but care
should be taken to avoid misleading
information regarding the likelihood of the
gain.
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