TOPIC 1: CURRENT LIABILITIES

Learning Objectives:
1. State the recognition criteria for liabilities.
LIABILITY  a present obligation (legal or constructive) of the entity to transfer an economic resource (i.e.,
payment of cash; transfer of non-cash assets or provision of future services) as a result of past events.

Recognition criteria: (new version under Conceptual Framework)

a. If it meets the definition of a liability; and
b. recognizing it would provide useful information, i.e., relevant and faithfully represented information.

2. Identify the characteristics of a financial liability.

FINANCIAL LIABILITY  is any liability that is
a. A contractual obligation to deliver cash or another financial asset to another entity;
b. A contractual obligation to exchange financial assets or financial liabilities with another entity under
conditions that are potentially unfavorable to the entity; or
c. A contract that will or may be settled in the entity’s own equity instruments and is not classified as the
entity’s own equity instrument (i.e., redeemable preference shares).

Recognition: A financial liability is recognized only when the entity becomes a party to the contractual
provisions of the instrument.

Examples:
a. Trade accounts payable or simply accounts payable
b. Notes payable
c. Loans payable
d. Bonds payable
e. Lease liability (PFRS 16)
f. Held for trading liabilities and derivative liabilities
g. Security deposits and other returnable deposits

NON-FINANCIAL LIABILITY  is a liability other than a financial liability. Examples are:

a. Deferred income and warranty obligations
b. Income tax payable and payroll taxes
c. Constructive obligations

A. FINANCIAL LIABILITIES
Initial measurement: Fair value (transaction price or present value or amortized cost) minus transaction costs,
except financial liabilities at FVPL whose transaction costs are expensed immediately.

Subsequent measurement:
 Financial liabilities classified as amortized cost are subsequently measured at amortized cost.
 Financial liabilities classified as held for trading are subsequently measured at fair value with changes in fair
value recognized in profit or loss.
 Financial liabilities designated at FVPL are subsequently measured at fair value with changes in fair values
recognized as follows:
a. The amount of change in the fair value of financial liability that is attributable to changes in the credit
risk of that liability is presented in OCI; and
b. The remaining amount of change in the fair value of the liability is presented in profit or loss.

B. NON-FINANCIAL LIABILITIES
Initial and subsequent: best estimate of cash outflows or if subject to amortization at present value using
effective interest rate.

3. State the initial and subsequent measurements of financial and non-financial liabilities.
As to measurement, liabilities are classified as:
 SUMMARY OF MEASUREMENT
Interest
Financial liabilities: Initial Subsequent Changes in FV Amortization
expense
a. FVPL FV FV ✔ X Nominal
b. Amortized cost FV - TC AC X ✔ Effective
Nonfinancial liabilities Best estimate Best estimate X ✔ if measured Nominal
initially at PV Effective

4. Classify liabilities as current and noncurrent

As to presentation, liabilities are classified as:
Current liabilities are liabilities that are:
a. Expected to be settled in the entity’s normal operating cycle (Operating liabilities);
Operating cycle  the time between the acquisition of assets for processing and their realization in
cash or cash equivalents. If not clearly identifiable, it is assumed that the entity’s normal operating
cycle is 12 months.
b. Held primarily for trading (Financial liabilities measured at FVPL)
c. 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 twelve
months after the reporting period.

Examples of current liabilities:

 Trade and other payables (a)
 Financial liabilities held for trading (pertaining to the issuer of the debt security)
 Current portion of long-term debt
 Short-term borrowings (12 months or less)
 Current provisions (estimates)
 Current tax liability
 Bank overdraft (excess of check disbursements over check deposits)
 Credit balances in accounts receivables (excess of total AR credit bal. over A/R debit bal.)
 Unearned/deferred income realizable within 12 months (b)
 Accrued expenses(c)
 Long-term debt currently maturing (d)
 Refundable deposits (e)
 Payroll taxes payable (f)
 VAT payable (Output VAT > Input VAT)
 Escrow liability (g)

All other liabilities are classified as noncurrent (residual definition). Examples are:
 Noncurrent portion of long-term debt
 Finance lease liability
 Deferred tax liability
 Long term obligation to officers
 Long term deferred revenue

TRADE AND OTHER PAYABLES (a)

Format to compute the adjusted balance of T&OP:
Unadjusted balance xxx
Add: Post-dated checks and undelivered checks xxx
Debit balances in A/P (if the unadjusted balance is a net amount) xxx
Purchase discount lost (under net method) xxx
Less: Unrecorded purchase returns and allowances (xxx)
Effect of freight terms xxx (xxx)
Adjusted balance xxx

In relation to freight terms:

 If the goods were in transit to the entity and the freight term is
 FOB Shipping Point – A/P and Purchases should be increased
 FOB Destination – Ignore, A/P and Purchases should only be increased upon the arrival of the goods.
 In relation to freight cost, its effect on accounts payable depends on the freight terms as well and are
Effects on Accounts Payable?
 FOB SP, Freight Collect No effect
 FOB SP, Freight Prepaid Increase
 FOB Dest., Freight Prepaid No effect
 FOB Dest., Freight Collect Decrease

Note: In relation to freight cost, FOB SP or Destination determine the party who is legally responsible to pay the
freight charge while freight collect or prepaid determine the party who actually pays the freight charge.

UNEARNED INCOME (b)

Deferred or unearned income is income already received but not yet earned. Deferred income may arise from:
a. Goods not yet delivered but collection were received in advance (Advances from customer)
b. Services not yet rendered but collection were already received (Unearned income from service contracts,
unearned subscription revenue)
c. Use of entity’s resources (Unearned interest income, unearned rental income)
d. Sale of gift certificates

Deferred revenue may be realizable within one year (current liability) or more than one year after the reporting
period (noncurrent liability). In relation to unearned income, the frequently asked questions are: (a) earned
portion (income); and (b) ending balance of unearned income. To answer such question, use the T-account in
relation to unearned income:

Unearned Income
Earned portion xxx Beginning balance xxx
Cash receipts xxx
Ending balance xxx

For unearned income from gift certificates, use the modified T-account:
Gift Certificates Payable
Redemption xxx Beginning balance xxx
Expired portion (breakage) xxx Cash receipts from sales xxx
Ending balance xxx

Pro-forma entries:
To record receipt of cash from advance orders:
Cash xxx
Unearned income xxx

To record application of advances to service provided or orders shipped:

Unearned income xxx
Sales (or other appropriate account) xxx

ACCRUED EXPENSES (C)

Accrued expenses are liabilities for expenses already incurred but not yet paid.
Examples are:
a. Salaries payable
b. Utilities payable
c. Dividends payable
- Under IFRIC 17, the liability to pay dividend is recognized when the dividend is appropriately
authorized and is no longer at the discretion of the entity which is:
a. The date when the declaration of the dividend is approved by the relevant authority if the
jurisdiction requires such approval, or
b. The date when the dividend is declared if the jurisdiction does not require further approval

Pro-forma entry:
Retained earnings xxx
Dividends payable xxx

Dividends payable xxx

Cash (or other appropriate account) xxx
d. Bonus payable
- a gratuity given by the entities to their employees as a gift or compensation earned as reward upon
achieving goals such as exceeding budgeted income during the year, meeting quotas, and having
superior performance in a project or activity.

Pro-forma entry:
Bonus expense xxx
Bonus payable xxx
To record the bonus incurred but not yet paid

Bonus payable xxx

Cash xxx
To record the payment of bonus

COMPUTATION OF BONUS PAYABLE:

Illustration:
Profit before bonus and before tax 4,400,000
Bonus rate 10%
Income tax rate 25%

Variations of bonus computation:

a. Bonus is expressed as a certain percent of income before bonus and before tax
Bonus (B) = Bonus rate x Profit
= 10% x 4.4M
B = 440,000
b. Bonus is expressed as a certain percent of income after bonus and before tax
Bonus (B) = Bonus rate x (Profit – B)
= 10% (4.4M – B)
B = 440k - .10B
B+.10B = 440k
1.10B = 440k
1.10 1.10
B = 400,000
c. Bonus is expressed as a certain percent of income after bonus and after tax
Bonus (B) = Bonus rate x [(Profit – B – TR (Profit – B)] or B = BR x [(Profit x (1-TR)] ÷ 1 + [(BR x (1-TR)}
= 10% [(4.4M – B - .25 (4.4M – B)]
B = 10% (4.4M - B – 1.1M + .25B)
B = 440k - .10B – 110k + .025B
B + .10B - .025B = 330k
1.075B = 330k
1.075 1.075
B = 306,977
d. Bonus is expressed as a certain percent of income after tax and but before bonus
Bonus (B) = Bonus rate x [(Profit – TR (Profit – B)] or B = = BR x [(Profit x (1-TR)] ÷ 1 – BR + [(BR x (1-TR)}
B = 10% [(4.4M - .25 (4.4M – B)]
B = 10% (4.4M – 1.1M + .25B)
B = 440k – 110k + .025B
B - .025B = 330k
.975B = 330k
.975 .975
B = 338,462

REFINANCING OF CURRENTLY MATURING OBLIGATION (d)

General rule: A currently maturing obligation is presented as CURRENT LIABILITY
Exceptions: (The liability is presented as noncurrent liability if it met any of the following conditions)
a. Refinancing on a long-term basis is completed or made ON OR BEFORE the end of the reportion period;
b. The entity has the unconditional right or discretion at the end of the reporting period to refinance or roll
over the liability.

Note: Refinancing refers to the replacement of an existing debt with a new one but with different terms.
BREACH OF CONTRACTS
General rule: If the entity breached a covenant or contract, the long-term obligation becomes immediately
demandable, thus presented as CURRENT LIABILITY.
Exceptions: (The liability is presented as noncurrent liability if it met any of the following conditions)
a. If the creditor has agreed to give the debtor a grace period for at least 12 months after the balance sheet
date; and
b. The said grace period was given ON OR BEFORE the balance sheet date.

REFUNDABLE DEPOSITS (e)

Refundable deposits consist of cash or property received from customers but which are refundable after
compliance with certain conditions. The best example is the returnable containers like bottles, drums, tanks
and barrels. The frequently asked question would be the ending balance at reporting date. Use the following T-
account:
Liability for Deposits
Deposits returned or applied xxx Beginning balance xxx
Deposits cancelled xxx Cash receipts xxx
Deposits expired xxx
Ending balance xxx

Pro-forma entries:
To record receipt of cash from deposits:
Cash xxx
Refundable deposits xxx

To record returned of deposits:

Refundable deposits xxx
Cash (or property) xxx

To record deposits expired and cancelled:

Refundable deposits xxx
Gain (other income) xxx

PAYROLL TAXES PAYABLE (f)

Under our law, the entity is required to withhold from the salaries of each employee the following:
a. Income tax payable by the employee (BIR)
b. Employees’ contribution to SSS, PHIC and HDMF

The amount withheld above shall be recognized as “payroll taxes payable” until remitted to the appropriate
government agency. In addition, the entity is required by law to make a contribution for SSS.

Pro-forma entries:
Salaries and wages (employees) xxx
Payroll expenses (employer) xxx
Payroll liability (Withholding taxes, SSS, PHIC, HDMF) xxx
Cash xxx

Remittances of payroll expenses to appropriate government agencies:

Payroll liability xxx
Cash xxx

ESCROW LIABILITY (g)

Escrow is the use of a third party, which holds an asset or funds before they are transferred from one party to
another. The third party holds the funds until both parties have fulfilled their contractual requirements.
The frequently asked question regarding escrow liability is its ending balance. Use the following T-account:
Escrow Liability
Cash transfers or payments xxx Beginning balance xxx
Interest and other charges paid xxx Cash receipts xxx
Interest income xxx
Ending balance xxx
Proforma entries:
To record cash receipts from another party:
Cash xxx
Escrow liability xxx

To record interest income earned on the above transaction:

Cash xxx
Escrow liability xxx

To record cash payment on behalf of another party:

Escrow liability xxx
Cash xxx

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