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LIABILITIES

ABIGAIL N. JACINTO, CPA, MMBM

 LIABILITIES

• This is a present obligation of an entity to transfer an economic resource as a

result of past events.
• Three essential characteristics:
a) It is a present obligation that entails a settlement by a probable future transfer or
use of cash, goods or services.
b) It is an avoidable obligation; and
c) The transaction or other event creating the obligation has already occurred.
CURRENT LIABILITIES
 CURRENT LIABILITIES

• Current liabilities are those obligations whose liquidation is reasonably

expected to require the use of existing resources that are classified as current
assets or the creation of other current liabilities.
• Current liabilities are reported in the financial statements at their maturity
value.
 ACCOUNTS PAYABLE

• Accounts payable represents obligations owed to others for goods, supplies,

and services purchased on an open account.
• Commonly known as trade accounts payable
• It is recorded to coincide with the receipt of goods or at the time the legal
title is passed to the buyer, not when the orders are placed.
• Accounts payable is not secured by collateral and is recorded net of cash
discounts.
 ACCOUNTS PAYABLE

• It matches with the recognition of inventory under the perpetual inventory

system, or purchases under the periodic inventory system.
• The terms of shipment are:
a) Goods shipped FOB Shipping point – the legal title is passed to the buyer when the
goods are shipped by the supplier to the common carrier.
b) Goods shipped FOB destination – the legal title is passed when the buyer receives
the goods.
 ACCOUNTS PAYABLE

• Recorded in two ways:

a) Gross price method – the AP is recorded at the invoice price. A discount is
recognized when it is taken.
b) Net price method – the AP recorded at the net amount. A discount recognized
whether taken or not.
 NOTES PAYABLE

• Notes payable are written promises to pay at a certain sum of money on a

specified date future date, which may arise from sales, financing, or other
transactions.
• May be short-term, or long-term
• May be interest-bearing, or noninterest-bearing
 ACCRUED LIABILITIES

• Accrued liabilities are expenses already incurred but have not been paid as of
year end.
• Examples:
• Interest on loans, for which payment to the lender has not been made yet
• Goods received and consumed or sold, for which no supplier invoice has been
received yet
• Services received, for which no supplier invoice has been received yet
• Wages incurred, for which payment to employees has not been made yet
 DIVIDENDS PAYABLE

• Corporations declare dividends, which are proportionate distributions of their

earnings to their shareholders.
• Cash dividends payable is recorded when cash dividend is declared since
once declared, a cash dividend is a binding obligation of an entity to pay its
shareholders.
• When a share dividend is declared, the share dividend distributable is recorded
and reported in the equity section. The share dividend distributable is not a
liability account. Dividends are discussed in detail in Chapter 10 Retained
Earnings.
 UNEARNED REVENUE

• Resulted from receipt of cash prior to its performance of services or issue of

merchandise.
• Unearned revenue is classified as a current liability on the statement of financial
position.
• Examples:
a) Rentals
b) Magazine subscriptions
c) Insurance premiums
 PROVISIONS

• Provisions are liabilities of uncertain timing or amount.

• The existence is certain; however, the amount can be determined only
approximately, or the specific person to whom payment will be made may not
be identified definitely.
• Conditions to recognize a provision:
1. The entity has a present obligation as a result of a past event
2. It is probable that an outflow of resources will be required to settle the obligation.
3. A reliable estimate can be made of the amount of the obligation
• Examples:
• Product warranties, and policy to make refunds to customers such as coupons and
premiums
 PRODUCT WARRANTIES

• When a company sells a product, it often provides a product warranty.

• Product warranties are promises made by a seller to a buyer to make good for
a deficiency of quality, quantity or performance in a product.
• Warranty expense is recognized in the period the sale is made.

Entry:
Warranty expense xxx
Warranty liability xxx
 PREMIUMS AND COUPONS

• To stimulate the sale of certain products, premiums and coupons are offered in
exchange for labels, box tops, wrappers, redeemable certificates, and other
evidence of purchase.
• A confirmation of a liability would be created when a customer actually
redeems a company’s coupons or collects their premium.
• The cost of the premium are charged to expense in the period of the sale of
the benefits from the premium plan.

Entry:
Premium expense xxx
Premium liability xxx
 CONTINGENT LIABILITIES

• Contingent liabilities are possible obligations whose existence will be

confirmed by uncertain future events that are not wholly within the control of
an entity.
• A contingent liability is not recognized in the statement of financial position.
However, unless the possibility of an outflow of economic resources is
remote, a contingent liability is disclosed in the notes to the financial
statements.
 CONTINGENT LIABILITIES

• Primary characteristics of contingency:

• An existing condition
• Uncertainty as to the ultimate effect of the condition
• Resolution of the uncertainty based on one or more future events
• Examples:
• Pending litigations
• Pending claims or assessments
• Guarantee of the indebtedness of others
NONCURRENT LIABILITIES
 NONCURRENT LIABILITIES

• Noncurrent liabilities or long term liabilities are obligations maturing beyond

one year or all other obligations not qualifying as current.
 BONDS PAYABLE

• Bonds payable represent an obligation of the issuing corporation to pay a sum of

money at a designated maturity date plus periodic interest at a specified rate on
the face value.
• Bonds are debt instruments issued by an entity to borrow funds from the
general public or institutional investors.
• Bonds may be sold through an underwriter who either:
a) guarantees a certain sum to the corporation and assumes the risk of sale or
b) agrees to sell the bond issue on the basis of a commission
• Corporations may sell bonds directly to a large financial institution without the aid
of an underwriter.
 BONDS PAYABLE

• Types of bonds
1. Secured bond – this is a bond issued with specific assets of the issuer pledged as
collateral for the bonds
2. Unsecured bonds or debenture bonds – this is a bond issued against the
general credit of the borrower. This bond is used extensively by large entities with
good credit ratings.
3. Term bond – it is a bond that matures at a single specified date.
4. Serial bond – this is a bond issued in which the principal is repaid (retired) in
regular installments over the life (maturity period) of the issue.
 BONDS PAYABLE

• Types of bonds
5. Registered bond – this bond is issued in the name of the owner. The transfer of
bonds requires the cancellation of the bonds by the entity and issuance of new
bonds.
6. Bearer or coupon bond – a bond that is not registered. Holders of bearers must
send in coupons to receive interest payments. May be transferred directly to
another party.
7. Convertible bond – a bond that can be converted into ordinary shares at the
bondholder’s option.
8. Callable bond – a bond subject to retirement at a stated amount prior to maturity
at the option of the issuer.
 BOND ISSUANCE

• The terms of the bond issue are set out in a legal document called bond
indenture.
• The indenture summarized the rights of the bondholders and the obligations
of the issuing entity,
• After the bond indenture is prepared, a bond certificate is made.
• A bond certificate provides information such as the name of the issuer and the
bond’s face value, contractual interest rate, and maturity date.
 BOND ISSUANCE

• Bonds are issued with a stated rate of interest expressed as a percentage of

the face value of the bonds.
• When bonds are sold for more than their face value (at a premium), or less
than their face value (at a discount), the interest rate actually earned is what
we know as effective yield or market rate of interest, and is set by
economic conditions in the investment market,
 DISCOUNTS AND PREMIUMS

• Results from a bond issue are recorded at the time the bonds are sold.
• The amounts recorded are amortized each time the bond interest is paid.
• The amortization of the discount increases the bond interest expense

Entry:
Interest expense xxx
Discount on bonds payable xxx

• The amortization of the premium decreases the bond interest expense

Entry:
Premium on bonds payable xxx
Interest expense xxx
 AMORTIZATION

• Bond discounts or premiums may be amortized using the straight-line method

• However, the preferred procedure is the effective interest method.
• This method computes for the interest cost for each period by multiplying the
effective interest rate to the carrying value of the bonds at the start of the
period.

A B C D
Interest
Date
earned Cash paid Amortization Carrying Amount
( D x ER ) ( FV x NR ) ( A - B) ( Previous CA + C )
 MORTGAGE PAYABLE

• The long-term financing instrument used to purchase property is called a

mortgage.
• The property itself serves as collateral for the mortgage until it is paid off.
• From the perspective of the borrower, the mortgage is considered a long-term
liability. Any potion of the debt that is not payable within the next 12 months is
classified as a short-term liability.
ANALYSIS OF LIABILITIES
 WORKING C APITAL

• This is the excess of the current assets over the current liabilities, which is a
measure of liquidity.
• Liquidity is the ability to pay maturing obligations and meet unexpected
needs for cash

Working capital Current assets – Current liabilities

 CURRENT RATIO

• This is also a measure of liquidity and can be used to compare the liquidity of
the companies of different sizes.
• The ideal current ratio is between 1.2 to 2.
• Current ratio below 1 means that the company does not have enough liquid
assets to cover its short-term liabilities.
 DEBT TO TOTAL ASSETS RATIO
AND
TIMES INTEREST EARNED RATIO

• These are the two ratios that provide information regarding the debt-paying
ability and long-run solvency of a company.
• Solvency is the ability to pay interest and principle on long-term debts as they
become due.
• The higher the debt to total assets ratio is, the greater the risk that a company
may be unable to pay its maturing debt.

Total liabilities
Debt to total assets ratio =
Total assets
 DEBT TO TOTAL ASSETS RATIO
AND
TIMES INTEREST EARNED RATIO

• A higher times interest earned ratio means that a company presents less of a
risk to investors and creditors in terms of solvency.
• Companies that have a times interest earned ratio of less than 2.5 (as a rule of
thumb) are considered a much higher risk for bankruptcy or default and,
therefore, financially unstable.

Income before income taxes + Interest expense

Times interest earned =
Interest expense
PRESENTATION
 PRESENTATION

STATEMENT OF FINANCIAL POSITION

Account Classification
Trade and other payables Current liabilities
Provisions Current liabilities
Current portion of long-term debt Current liabilities
Bonds payable Noncurrent liabilities
Mortgage payable Noncurrent liabilities
 PRESENTATION

INCOME STATEMENT
Account Classification
Warranty expense Distribution expense
Premium expense Distribution expense
Interest expense Finance cost
 END OF CHAPTER

Reference:
Salendrez, Herminigilda;Tubay, Jerwin; Paril, Alloysius Joshua; &
Menaje, Placido Jr. (2021). Basic Approach to Financial Accounting:
User’s Perspective (Revised Edition). C&E Publishing.