CHAPTER 1: LIABILITIES

Definition: present obligation of an entity to transfer an economic resource as a result of past events.
a. Present obligation (legal or constructive)
b. Transfer of economic resource (cash dividends but not share dividends)
c. Past events (obligation events)

TYPES OF LIABILITIES: CURRENT LIABILITIES

Current liabilities, also known as short-term liabilities, are debts or obligations that need to be paid within
a year. Current liabilities should be closely watched by management to make sure that the company
possesses enough liquidity from current assets to guarantee that the debts or obligations can be met.

Examples of current liabilities:

 Accounts payable
 Interest payable
 Income taxes payable
 Bills payable
 Bank account overdrafts
 Accrued expenses
 Short-term loans

Current liabilities are used as a key component in several short-term liquidity

measures.  Below are examples of metrics that management teams and investors look
at when performing financial analysis of a company.

Examples of key ratios that use current liabilities are:

 The current ratio: Current assets divided by current liabilities

 The quick ratio: Current assets, minus inventory, divided by current liabilities

MEASUREMENT OF CURRENT LIABILITIES

Conceptually: initial at PV and subsequently at AC
BUT IN PRACTICE FA (FA-PV) Immaterial IGNORED
PAS 1, Paragraph 69
Settle liability within operating cycle
Holds liability for the purpose of trading
The liability is due to be settled within 12 months AFTER the reporting period
DOES NOT HAVE unconditional defer settlement of the liability for at least 12 months AFTER the
reporting period

TRADE PAYABLES WORKING CAPITAL (CURRENT LIAB)

ACCRUAL FROM EMPLOYEE Even if settled more than 12 months after the reporting
OTHER OPERATING COST period.

FINANCIAL LIABILITIES HELD FOR TRADING

BANK OVERDRAFT CL are not settled as part of normal operating cycle
DIVIDENDS PAYABLE but for settlement within 12 months after the
INCOME TAXES reporting period or held primarily for the purpose of
OTHER NONTRADE PAYABLES trading.
CURRENT PORTION OF (NCFL)

TYPES OF LIABILITIES: NON-CURRENT LIABILITIES

Non-current liabilities, also known as long-term liabilities, are debts or obligations that are due in over a
year’s time. Long-term liabilities are an important part of a company’s long-term financing. Companies
take on long-term debt to acquire immediate capital to fund the purchase of capital assets or invest in new
capital projects.

Long-term liabilities are crucial in determining a company’s long-term solvency. If companies are unable
to repay their long-term liabilities as they become due, then the company will face a solvency crisis.

List of non-current liabilities:

 Bonds payable
 Long-term notes payable
 Deferred tax liabilities
 Mortgage payable
 Capital leases

MEASUREMENT OF NONCURRENT LIABILITIES (residual definition)

All liabilities not classified as current are classified as noncurrent.
Noncurrent portion of long-term debt
Finance lease liability
Deferred tax liability
Long-term obligation to officers
Long-term deferred revenue
LONG-TERM DEBT FALLING DUE WITHIN ONE YEAR
A liability which is due to be settled within 12 months after the reporting period is classified as
CURRENT even if:
A. The original term was for a period longer than 12 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.

HOWEVER if the refinancing on a long-term basis is completed ON OR BEFORE THE END OF

REPORTING PERIOD, the refinancing is an adjusting event and therefore the obligation is classified as
NONCURRENT

MOREOVER, if the entity has the DISCRETION to refinance or roll over an obligation for at least 12
months after the reporting period under an existing loan facility, the obligation is classified as
NONCUREENT even if would otherwise due within a shorter period.

If the entity has an UNCONDITIONAL RIGHT under existing load facility to defer settlement of liability
for at least 12 months after the reporting period, the obligation is considered part of the entity’s long-term
financing.

COVENANTS and BREACH OF COVENANTS

 Are often attached to borrowing agreements which represent undertakings by the borrower
 These covenants are actually RESTRICTIONS on borrowers as undertaking further borrowings,
paying d ividends, maintaining specified level of working capital and so forth.
 Under the 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 liability is classified as CURRENT even if the lender has
agreed, AFTER THE REPORTING PERIOD and BEFORE THE STATEMENT ARE
AUTHIRUZED FOR ISSUE. Not to demand payment as a consequence of the breach.
 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
12 months after the date.
 GRACE PERIOD is a period within which the entity can rectify the breach and during which the
lender cannot demand immediate payment.

PRESENTATION OF CURRENT LIABILITIES

Under paragraph 54 of PAS 1, as minimum, the face of the financial statement of financial position shall
include the following line items for current liabilities:
TRADE AND OTHER PAYABLE LINE ITEM for AP, NP, AI on NP, DP, and AE
CURRENT PROVISIONS
SHORT-TERM BORROWING
CURRENT PORTION OF LONG-TERM DEBT
CURRENT TAX LIABILITY
ESTIMATED LIABILITIES
 Are obligations which exist at the end of the reporting period although their amount is not
definite
 Either CURRENT OR NONCURRENT
 For PREMIUMS, AWARD POINTS, WARRANTIES, GIFT CERT AND BONUS.

DEFERRED/UNEARNED REVENUE
 Income already received but not yet earned
 If REALIZED WITHIN 1 YEAR it is a CURRENT LIAB
 (unearned interest income, unearned rental income and unearned subscription revenue)
 NONCURRENT DEFERRED REVENUE (L-T service contracts and L-T leasehold advances)
Journal entry
1. To record the cash receipt from service contracts sold
Cash xxx
Unearned service revenue xxx
2. To record the service contract cost paid.
Service contract expense xxx
Cash xxx
3. To record service contract revenue recognized
Cash xxx
Service contract revenue xxx

GIFT CERTIFICATE PAYABLE

1. When gift cert are sold
Cash xxx
Current liability
Gift cert payable xxx
2. When the gift cert are redeemed
Gift cert payable xxx
Sales xxx
3. Expires or not redeemed The department of
Gift cert payable xxx trade and industry
Forfeited gift cert xxx ruled that gift cert no
expiration day
BONUS COMPUTATION
 Large entities often compensate key officers and employees by way of bonus for superior income
realized during the year.
 The main purpose of these is to motivate officers and employees by directly relating their well-
being to the success of the entity
 This compensation plan result in liability that must be measured and reported in the financial
statements
 The bonus compensation usually has four variations
Bonus is expressed as a certain percentage of INCOME BEFORE BONUS AND BEFORE TAX
IBBABT
Bonus is expressed as a certain percentage of INCOME AFTER BONUS BUT BEFORE TAX
IABBBT
Bonus is expressed as a certain percentage of INCOME AFTER BONUS AND AFTER TAX
IABAAT
Bonus is expressed as a certain percentage of INCOME AFTER TAX BUT BEFORE BONUS
IATBBB

B=r1(NI) r1= bonus rate NI= net income

Income before bonus and before tax xxx r1=B/NI
Multiply by x%
Bonus xxx NI=B/r1

B=r1(NI-B) r1= bonus rate NI= net income

Income before bonus and before tax xxx
Less: Bonus xxx
Income after bonus but before tax xxx B= r1x NI
Multiply by x% 1+r1
Bonus xxx

B=r1[(NI-B)-T] r1= bonus rate NIAT= net income after tax BRAT= bonus after tax
Income before bonus and before tax xxx
Bonus xxx B= r1x NIAT
Tax xxx
1+ BRAT
Income after bonus and after tax xxx
Multiply by xxx
Bonus xxx

B=r1(NI-T)
B= r1x NIAT
1-(r1xr2)
Income before bonus and before tax xxx
Tax xxx
Income after tax but before bonus xxx
Multiply by xxx
Bonus xxx

REFUNDABLE DEPOSITS
 Consist of cash or property received from customers but which are refundable after compliance
with certain conditions.
 The best example of refundable deposit is the customers deposit required for returnable
containers like bottles, drums, tanks and barrels.
Cash xxx
Containers deposit xxx Current Liability

If returned then the deposit is refunded

If not then deposit-cost=gain

 CHAPTER 2: PREMIUM LIABILITY (estimated liability)
 Are articles of value such as toys, dishes, silverware and other goods given to customer as result
of past sales or sales promotion activity.
 In order to stimulate the sale of their product, entities offer premiums to their customers in
return for product labels, box tops, wrappers and coupons.
 Accordingly, when the merchandise is sold, an accounting liability for the future distribution of
the premium arises and should be given accounting recognition
 The accounting procedures for the acquisition of premiums and recognition of premium liability
are as follows:
To record the sale
Cash xxx
Sales xxx
When the premium is purchased
Premium/Prem. inventory xxx
Cash xxx
When the premium asset is distributed to customers
Cash xxx
Prem. expense xxx Entry for distribution
Premium expense xxx
Cash xxx cost
Premiums xxx
At the end of the year, if premiums are still outstanding: (PROVISION for prem.)
Premium expense xxx
Estimated premium liability xxx
Wrappers to be redeemed (% times #of premiums) xxx
Less: premium redeemed xxx
Balance xxx

Premium to be distributed= balance/required premium.

Estimated premium liability= premium to be distributed x cost - down payment

FINANCIAL STATEMENT PRESENTATION

Current Asset
Premium (total-redeemed)
Current liability
Estimated premium liability
Distribution cost
Premium expense (accumulated expense)
CASH REBATE PROGRAM
 A variation of premium is cash rebate program which has become common place
 The cash register receipts, bar codes, rebate coupons and other proof of purchase often can be
mailed to the manufacturer for cash rebate
 Like any premium offer, the purpose of cash rebate program is to stimulate sale
 Accordingly, the estimated amount of cash rebate should be recognized both as an expense and
an estimated liability in the period of sale
To recognized cash rebate program
Rebate expense xxx
Estimated Rebate liability xxx
To record the payment to customer
Estimated rebate liability xxx
Cash xxx

CASH DISCOUNT COUPON

 Another variation of the premium offer is the cash discount coupon program
 The cash coupon program is a popular marketing tool for the purpose of stimulating sales
 Like premium offer and cash rebate program, an expense and estimated liability for the
expected cash discount should be recognized in the period of sale
To recognized cash rebate program
Cash discount expense xxx
Estimated coupon liability xxx
To record the payment to customer
Estimated coupon liability xxx
Cash xxx

CUSTOMER LOYALTY PROGRAM

 Many entity use customer loyalty program to build brand loyalty, retain their valuable customer
and course increase sales volume.
 Generally designated to reward customer for past purchases and to provide them with
incentives to make further purchase.
 If the customer buys goods or services. The entity grants the customer award credits often
describe as “points”
 The entity can redeem the “points” by distributing to customer free or discounted goods or
services.
 A customer loyalty program operates in variety of ways
 Customers may required to accumulate a specified minimum number of award credits or points
before they can redeemed.
MEASUREMENT of C.L.P
 An entity shall account for the reward credits as a SEPARATELY COMPONENT OF THE INITIAL
SALE TRANSACTION
 In other words, the granting of award credits is effectively accounted for as a FUTURE DELIVERY
OF GOODS OR SERVICES.
 IFRS 15, PARAGRAPH 74, provides that an entity shall allocate the transaction price to each
performance obligation identified in a contract on a relative stand-alone selling price basis
 In other words, THE FAIR VALUE OF THE CONSIDERARTION RECEIVED WITH RESPECT TO THE
INITAIL SALE SHALL BE ALLOCATED between the award credits and sale based on relative stand-
alone selling price

RECOGNITION of [Link]
 The consideration allocated to the award credits is initially recognized AS DEFEERED REVENUE
and subsequently recognized as revenue when the award credits are redeemed
 THE AMOUNT OF REVENUE RECOGNIZED SHALL BE BASED ON THE NUMBER OF AWARD
CREDITS THAT HAVE BEEN REDEEMED RELATIVE TO THE TOTAL NUMBER EXPECTED TO
REDEMMED.
 The estimated redemption rated is assessed each period. Changes in the total number expected
to be redeemed do not affect the total consideration for the award credits.
 Instead, the changes in the total number award credits expected to be redeemed shall be
reflected in the amount of revenue recognized in the current and future periods.
 In other words, the calculation of the revenue to be recognized in any period is made on a
“CUMULATIVE BASIS” in order to reflect the changes in estimate.
To record initial sale
Cash xxx
Cash+ stand alone price of credit
Sales xxx
Unearned revenue xxx
To record the redemption
Unearned revenue xxx
redeemed/estimated x unearned revenue
sales xxx
To record the redemption (estimate changed)
Unearned revenue xxx
Cumulative redeemed/new estimate x
sales xxx
unearned revenue – previous revenue

Cumulative revenue of previous year xxx After the change of estimate computation
Cumulative revenue of current year xxx of revenue in cumulative basis
Revenue for the current year xxx
THIRD PARTY OPERATED C.L.P
To record initial sale
Cash xxx
Sales xxx
Unearned revenue xxx
To record payment to 3rd party
Loyalty program expense xxx
Total points sold x price by 3rd party
cash xxx
WARRANTY LIABILITY
 Home appliances like television set, stereo set, radio set, refrigerator and the like are often sold
under guarantee or warranty to provide free repair service or replacement during a specified
period if the products are defective
 Such entity policy may involve significant cost on the part of the entity if the product sold is
proved to be defective in the future within the specified period of time.

RECOGNITION OF WARRANTY
PAS 37 paragraph 14, provides that a provision shall be recognized as a liability in the financial
statement under the following condition
a. The entity has a PRESENT OBLIGATION, legal or constructive, as a result of past event.
b. It is probable that an outflow of resource embodying economic benefit would be required to settle
the obligation.
C. The amount of the obligation can be measured reliably

ACCOUNTING FOR WARRANTY

Two approach in recording warranty expense
1. Accrual approach
2. Expense as incurred approach

ACCRUAL APPROACH
 Has the soundest theoretical support because it properly matches cost with revenue
To record the sale
Cash xxx
Sale xxx
To set up estimated liability
Warranty expense xxx
Estimated warranty liability xxx
WHEN ACTUAL WARRANTY COST IS SUBSEQUENTLY INCURED
Estimated warranty liability xxx
Cash xxx
 At a certain date the estimates is reviewed to determine its reasonableness and accuracy.
 The actual warranty cost is analysed to validate the original estimate
 Any difference between estimate and actual cost is a change in estimate and therefore treated
currently or prospectively, if necessary
 Thus IF THE ACTUAL COST EXCEEDS the estimate, the difference is charged to warranty expense
Warranty expense xxx
Estimated warranty liability xxx
 IF THE ACTUAL COST IS LESS THAN the estimate, the difference is adjustment to warranty
expense
 Estimated warranty liability
Warranty expense

EXPENSE AS INCURRED APPROACH

 The expense as incurred approach is the approach of expensing warranty cost only when
actually incurred
 This approach is justified on the basis of expediency when warranty cost is not very substantial
or when the warranty period is relatively short
WHEN ACTUAL WARRANTY COST IS SUBSEQUENTLY INCURED
Warranty expense xxx
Cash xxx

SALES MADE EVENLY

Warranty expense 20x0
20x0
First contract year 01-01 (half of total sales of the year)
(half sales x percentage that year) XXX
First contract year 07-01 (half of total sales of the year)
(half sales x percentage that year 6/12) XXX
20x1
First contract year 07-01 (half of total sales of the year)
(half sales x percentage that year 6/12) XXX
Second contract year 01-01 (half of total sales of the year)
(half sales x percentage that year) XXX
Second contract year 07-01 (half of total sales of the year)
(half sales x percentage that year 6/12) XXX
20x2
Second contract year 07-01 (half of total sales of the year)
(half sales x percentage that year 6/12) XXX
TOTAL WARRANTY EXPENSE 20X0 XXX

Estimated warranty liability XXX

Estimated warranty per book (XXX)
Decrease in warranty liability -xxx

Estimated warranty liability xxx

Warranty expense xxx
SALE OF WARRANTY
 Sometimes sold separately from the product sold
 When the products are sold, customers are entitled to usual manufacturer warranty during a
certain period
 HOWEVER the seller may offer an “extended warranty on the product sold but WITH
ADDITIONAL COST
 In such a case, the sale of the product with usual warranty is recorded separately from the sale
of the extended warranty
 The amount received from the sale of the extended warranty is recognized initially as DEFERRED
REVENUE and subsequently amortized using straight line over the life of the warranty contract.
 HOWEVER, if the cost are expected to be incurred in performing services under the extended
warranty contract, revenue is recognized in proportion to the cost to be incurred annually
Cash xxx
Sales xxx
Unearned warranty revenue xxx

Unearned revenue warranty xxx

Revenue(divided by #years) xxx