FINANCIAL ACCOUNTING & REPORTING II

1
Accounting for Liabilities-Current Liabilities

Module 002 Accounting for liabilities-Current

Liabilities (Part 2)

Current Liabilities are company debts due within one year or one operating
cycle, whichever is greater. An operating cycle is the time it takes a company
to purchase inventory and convert it into cash from sales. Current Liabilities
include items such as accounts payable, short-term debt and taxes payable.
They are handled separately from Long Term Liabilities, which include long-
term borrowing, bonds payable and long-term lease obligations, which are
due in longer than one operating cycle or one year.
At the end of this module, you will be able to:
1. Define current liabilities
2. Distinguish current liabilities from non-current liabilities
3. Measure current liabilities
4. Account for different current financial liabilities

Current Liabilities
Presentation of current liabilities
Under IAS 1, the following line items shall be included in the face of the statement of
financial position:
a. Trade and other payables
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.
b. Current provisions
c. Short-term borrowing
d. Current portion of long-term debt
e. Current tax liability

Accounting for different current liabilities

Accounts payable/Trade payables
These are liabilities arising from the purchase of goods, materials, supplies or
services on an open charge account basis. These are generally classified as
current liabilities even if they are not due for settlement within twelve
months from the end of the reporting period, because settlement of these
obligations is expected within the entity’s normal operating cycle. These
include trade accounts and notes payable extended within the usual credit

Course Module
terms of the supplier, and accruals for employee’s wages and other operating
costs.
The credit time period generally varies from 30 to 120 days without any
interest being charged on the deferred payment.
Methods of Accounting for Cash Discounts
The agreement for the purchase of goods usually includes incentives for early
payment of the account; thus cash discounts are offered. The purchase
transaction may be recorded using either the gross method or the net
method.

Under the gross method, the Purchases account and the Accounts Payable
are recorded at the gross invoice price. A cash discount taken on purchases is
recorded upon payment as Purchases Discounts. Any balance of Purchase
discounts is reported in profit or loss as a deduction from gross purchases.

Illustration:
ABC Company prepaid the freight charges of P2,000. CFN paid the full
account on March 15, 2017. Assume further that CFN uses periodic inventory
system. Entries in the books of CFN to record the purchase and payment
under the gross and net methods are:
March 10, 2017

Gross method Net method

Purchases 200,000 Purchases 194,000

Freight-in 2,000 Freight-in 2,000
Accounts Payable 202,000 Accounts Payable 196,000

March 15, 2017

Gross method Net method

Accounts payable 202,000 Accounts payable 196,000

Purchase discount 6,000 Cash 196,000
Cash 196,000

If the account is paid beyond the discount period, the entry will be:

Gross method Net method

Accounts payable 202,000 Accounts payable 196,000

Cash 202,000 Purchase discount 6,000
Cash 202,000
 FINANCIAL ACCOUNTING & REPORTING II
3
Accounting for Liabilities-Current Liabilities

Note that the 3% cash discount is based on the cost of goods purchased, not
including freight cost.
If the payment is not made yet at the reporting date and the discount period
already lapsed, an adjusting entry is required to the recorded under the net
method as follows:
Purchase discount lost 6,000
Accounts payable 6,000
The adjusting entry brings the accounts payable balance to P202,000. The
adjustment is made to reflect in the accounts the true amount of the
resources expected to be given up upon settlement of the obligation in
subsequent period.
Notes Payable
Note bearing a realistic interest rate
A promissory note is a written promise to pay a certain sum of money to the
bearer at a designated future time. This may arise either by trade or the
borrowing of money from a bank or other transactions.
Since the note is interest bearing, the present value of the note at the time of
its issuance is its face value assuming that the stated rate approximates the
prevailing market interest rate. The issuance of this note is recorded as
follows:
Accounts payable xxx
Notes payable xxx
At maturity date, payment is made for the principal amount plus interest for
the entire term of the note as follows:
Notes payable xxx
Interest expense xxx
Cash xxx
If the amount is still outstanding at the end of the accounting period, an
accrued interest should be recorded for the period from the date of issuance
of the note to the end of the accounting period. Accrual of interest is recorded
as:
Interest expense xxx
Interest payable xxx
The above entry may be reversed at the beginning of the new accounting
period so the subsequent payment of the note and interest may be recorded
in the usual manner.

Course Module
Non-interest bearing note
A non-interest bearing note does not explicitly state an interest rate on the
face of the note but it doesn’t mean that there is no interest imputed on the
original obligation. A non-interest bearing note is simply written in a form
where interest is imputed on the face value of the note. Thus, the face value
represents the present value of the obligation plus the imputed interest for
the term of the note.
Illustration
On December 10, 2017, Mike Company purchased an equipment, paying
P100,000 down and issuing a one-year, non-interest-bearing note for
P200,000. There is no known market value for the equipment. The prevailing
market interest rate of similar transaction at the time is 12%.
The cost of equipment is computed as follows:
Downpayment P100,000
Present value of note * 178,571
Total cost of equipment 278,571
*P200,000*0.892857=178,571
The initial discount on notes payable is P21,429 (P200,000-P178,571).
To record the transaction on December 10, 2017,
Equipment 278,571
Discount on notes 21,429
Cash 100,000
Notes payable 200,000
Assuming that the company’s accounting year is the calendar year, an
adjusting entry is made on December 31, 2017.
Interest expense 5,357
Discount on notes(178,571*12%*3/12) 5,357
Upon payment December 10, 2018, the following journal entries are made:
Interest expense 16,072
Discount on notes 16,072
Notes payable 200,000
Cash 200,000

Note bearing an unrealistic interest rate

When the interest rate appearing on the face of the note is significantly
different from the market rate of similar notes, or when the consideration
received on account of the note issued has a fair value which is significantly
different from the face value of the note, the note bears an unrealistic interest
rate. In such cases, the note and the interest to be paid based on the stated
rate are discounted at the market rate of interest on the date of the issuance.
 FINANCIAL ACCOUNTING & REPORTING II
5
Accounting for Liabilities-Current Liabilities

If the rate stated on the face of the note is higher than the market rate of
interest, the discounted amount is higher than the face value of the note,
resulting in premium on notes payable. If the rate stated on the face of the
note is lower than the market rate of interest, the discounted amount is
lower than the note’s face value, resulting in discount on notes payable.

Illustration: Stated rate is more than the market rate

Assume that Reign Company purchased from Rayven Corp. a piece of an
equipment by issuing 14% one year note for P320,000 on May 1, 2017. There
is no equivalent cash price for this equipment, but the market rate of interest
for similar notes is 8%.
The present value of the future cash outflow to settle the obligation is:
Principal P320,000
Stated interest P320,000 x 14% x 1year 44, 800
Total future cash outflow P364,800
PV factor at 8% for 1 period 0.9259
PV of note P337,768
The following are the entries in 2017 related to the note, assuming
that the company reports on a calendar year basis:
2017
May 1 Equipment 337,768
Notes payable 320,000
Premium on notes 17,768
Dec. 31Interest expense* 18,014
Premium on interest expense 11,853
Interest payable** 29,867
*P337,768 x 8% x 8/12
**320,000 x 14% x 8/12
The computation of interest expense is based on the effective interest rate of
8% and on the present value of the obligation. Thus, on the income statement
for the year ended December 31, 2017, the interest expense will include
P18,014 related to the note.

Course Module
 Illustration: Stated rate is less than the market rate
Assume instead that the note bears a 5% interest rate, but the market rate of
interest on similar notes on May 1, 2017 is 10%.
The present value of the note on May 1, 2017 is computed as follows:
Face P320,000
Stated interest for one year 16,000
Total future cash outflow P336,000
PV factor at 10% for 1 period 0.9091
PV of future cash flow P305,458
The following are the entries related to the notes, assuming that the company
reports on calendar year basis.
2017
May 1 Equipment 305,458
Discount on notes 14,542
Notes payable 320,000
Dec 31 Interest expense* 20,364
Interest payable ** 10,667
Discount on notes 9,697
*305,458 x 10% x 8/12
**320,000 x 5% x 8/12
On December 31, 2017 statement of financial position, the liability on the
note is P325,822 computes as follows:
Notes payable P320,000
Interest payable 10,667
Discount on notes(14,542-9,697) (4,845)
P325,822

Glossary

Current liability: liability that is expected to be settled in the normal course of the
entity’s normal cycle, held for trading, expected to be settled within 12 months and the
entity does not have unconditional right to defer settlement for at least twelve months
after the reporting period.
Events after the reporting period: Events, favorable and unfavorable that occur
between the end of the reporting period and the date when the financial statements are
authorized for issue.
Operating cycle: The average length of time necessary for an entity to convert cash to
inventory, inventory to receivables and receivables to cash.
 FINANCIAL ACCOUNTING & REPORTING II
7
Accounting for Liabilities-Current Liabilities

References and Supplementary Materials

Books and Journals
1. Valix, C. T., Peralta, J. F., & Valix, C. M. (2017). Financial Accounting (2017 ed., Vol. 2).
Manila, Philippines: GIC Enterprises & Co., Inc.
2. Cabrera, M. B., & Ocampo, R. R. (n.d.). Financial Accounting & Reporting - Standards &
Application (2014-2015 ed., Vol. 2). Manila, Philippines: GIC Enterprises & Co., Inc.
3. IAS 39 - Financial Instruments: Recognition and Measurement
4. IAS 1 – Presentation of Financial Statements
Online Supplementary Reading Materials
1. Current Liabilities Section of the Balance Sheet;
http://businessecon.org/2013/12/current-liabilities-section-of-the-balance-sheet/;
October 19, 2017
2. Intermediate Accounting/Liabilities;
https://en.wikibooks.org/wiki/Intermediate_Accounting/Liabilities; October 20,
2017
3. Current and Non current Liabilities Examples;
http://www.svtuition.org/2012/09/current-and-non-current-liabilities.html;
October 20, 2017
4. Current Liabilities and Contingencies;
http://web.csulb.edu/~mdchase/300B_32C_CLiabAndPayroll.pdf; October 20, 2017
Online Instructional Videos
1. Current Liabilities: Definition & Examples;
http://study.com/academy/lesson/current-liabilities-definition-examples-quiz.html;
October 20, 2017

Course Module