LIABILITIES ‘The Revised Conceptual provides the following de Liabilities are present obligations of an entity to transfer an economic resource as a result of past events. Framework for Financial Reportii finition of liabilities: ‘Accordingly, the essential characteristics of an accounting liability are: ‘a. The entity has a present obligation. ‘An obligation is a duty or responsibility that an entity has no practical ability to avoid. The entity liable must be identified but it is not necessary that the payee to whom the obligation is owed be identified. b. The obligation is to transfer an economic resource. This is the very heart of the definition of an accounting liability. ‘The economic resource is the asset that represents a right with a potential to produce economic benefit. Specifically, the obligation must be to pay cash, transfer noncash asset or provide service at some future time. c. The liability arises from a past event. This means that the liability is not recognized until it is incurred. Present obligation An essential characteristic of a liability is that the entity has a present obligation. The present obligation may be a legal obligation or & constructive obligation. ‘An obligation may be legally enforceable as a consequence of binding contract or statutory requirement. This is normally the case, for example, with accounts payable for goods and services received. A.constructive obligation also gives rise to liability by reason of normal business practice, custom and a desire to maintain ‘60d business relations or act in an equitable manner. 2Transfer of an economic resource Without payment of money, without transfor of noncash asset, without performance of service, there is no accounting liability. A crystallization of the definitive concept of an accounting liability is when an entity declares cash dividend In such a case, there is an obligation to pay cash, hence, accounting liability exists. But when an entity declares share dividend, there is no accounting liability. The obligation is to issue the entity's own shares. The issuance of the entity’s own shares is nota transfer of noncash asset because the share’capital is an equity item. Thus, share dividend payable is classified as part of equity rather than an accounting liability. Past event Another essential characteristic of a liability is that the liability must arise from a past transaction or event. ‘The past event that leads to a legal or constructive obligation is known as the obligating event. ‘The obligating event creates a present obligation because the entity has no realistic alternative but to settle the obligation created by the event. For example, the acquisition of goods gives rise to accounts payable. The obligating event is the acquisition of goods ‘The receipt of a bank loan results in an obligation to repay the loan. ‘The obligating event is the cash received from the bank as a consequence of the bank Joan. 3Examples of liabilities ‘ The more common types of liabilities include the following: Accounts payable to suppliers for the purchase of goods b. Amounts withheld from employees for taxes and for contributions to the Social Security System c. Accruals for salaries, interest, rent, taxes, product warranties and profit sharing bonus 4. Dividends payable in cash or noneash asset ©. Deposits and advances from customers f£ Debt obligations for borrowed funds — notes, mortgages and bonds payable e. Income tax payable h. Deferred or unearned revenue Measurement of current liabilities Conceptually, all liabilities are initially measured at present value and subsequently measured at amortized cost. However, in practice, current liabilities or short-term obligations are not discounted anymore but measured and reported at face amount. ‘The reason is that the discount or the difference between the face amount and the present value of the liability is usually not material and therefore ignored. Measurement, of noncurrent liabilities Noncurrent liabilities, for example, bonds payable and noninterest-bearing nove payable, are initially measured at present value and subsequently measured at amortized cost. If i long-term note payable is interest-bear ‘ing, it is initially and subsequently measured at face amount. In this case, the face an i resent value : e amount is @ ° cate, the is equal to the pi lue of ‘The amortized cost measuremen ter chal reasurement ler The ama ent is taken up ina later chaptCurrent liabilities PAS 1, paragraph 69, as amended provid classify a liability as current when: a. The entity expects to settle the liability within the entity's operating cycle. b. The entity holds the liability primarily for the purpose of. trading. The liability is due to be settled within twelve months after the reporting period. ad. The entity does not have the right at the end of the reporting period to defer settlement of the jiability for at least twelve ‘months after the reporting period. Trade payables and accruals for employee and other operating costs are part of the working capital used in the entity's normal operating cycle. Such operating items are classified as current liabilities even if ‘settled more than twelve months after the reporting period. les that an entity shall When the entity's normal operating cycle is not clearly identifiable, its duration is assumed to be twelve months. Other current liabilities are not settled as part of the normal operating cycle but are due for settlement within twelve months after the reporting period or held primarily for the purpose of trading. Such other current liabilities include financial liabilities held for trading, bank overdraft, dividends payable, income tax payable, other nontrade payables due within one year and current portion of noncurrent financial liabilities. Financial liabilities held for trading are financial liabilities that are incurred with an intention to repurchase them in the near term. ‘An example is a quoted debt instrument that the issuer may buy back in the near term depending on changes in fair value.Noncurrent liabilities The term noncurrent liabilities is a residual definition. t are classified a, liabilities not classified as current are. fied as hourrent Kabilities. Noneurrent liabilities include: Noncurrent portion of long-term debt Finance lease liability Deferred tax liability Long-term obligation to officers Long-term deferred revenue Sao gee Long-term debt falling due within one year A liability which is due to be settled within twelve months after the reporting period is classified as current, even if. a. The original term was for a period longer than twelve months. b. An agreement to refinance or to reschedule payment on a long-term basis is completed after the reporting period d before the financial statements are authorized for issue. However, ifthe refinancing on a long-term basis is completed on or pelore the end of the reporting period, the refinancing is a2 adjusting event and therefore the obligation is cleserset a8 Moncurrent, ility, the obligation is classifi i ied as noncurrent even if it would otherwise be due within a shorter period. The right to defer settlement for at least twelve months after the reportiy i period, "8 Period must exist at the end of the renoiing If the right is there 2" does not exist at the end of the reporting period; there is no potent, is classified eet Curent? Fefinance and therefore the LabiityCovenants Covenants are often attached to borrowing agreements which fepresent undertakings by the borrower. Covenants are actually restrictions on tke borrower such as undertaking further borrowings, paying dividends, maintaining specified level of working capital and so forth. Breach of covenants Under these 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 a liability is classified as current even if the lender has agreed, after the reporting period and before the statements are authorized for issue, not to demand payment as a consequence of the breach. This liability'is classified as current because at the end of the reporting period, the entity does not have the right to defer settlement for at least twelve months after the end of reporting period. 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 twelve months after the end of reporting period. ‘A grace period is a period within which the entity can rectify the breach and during which the lender cannot demand immediate repayment.n of current liabilities inimum, 4 of PAS 1, ag a mini Under Parapet position shall snluae the items for cu ‘a, Trade and other payables B Current provisions : rr § Sherent portion of long-term debt €. Current tax liability saline item for accounts r bles it ‘The term trade and ofher Posted interest on note payable, v tos payable, payable, newvable and accrued expenses No objection can be raised if the trade accounts and notes payable are separately presented. Estimated liabilities Estimated liabilities are obligations which exist at the end of reporting period although their amount is not definite. the date when the obligation is due is not also In many cases, e definite and in some instances, the exact payee cannot be identified or determined. But inspite of these circumstances, the existence of the estimated liabilities is valid and unquestioned. the face of the following line ities: Deferred revenue Deferred revenue or unearned is i | revenue is income alreas received but nat yet earned. Deferred rovenuo may S within one year or in moi cod of the repetnn ent re than one year after the If the deferred ii i: athi Cite deferied revenue is realizable within one year, it is @ Typical e: Pi xamples of current deferred revenue are unearned interest income, income, unear / ubecringngome, unearned rental income and unearned If the deferred revenue i , nui izable i itis clasitied ab noneurrent lability noe aM one Yee Typical exam ples of noncurrent deferred revenue are unearned revi enue fr long- ‘om long. ng-term leasehold crane term service contracts aM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 this scheme is to motivate officers and employees by directly relating their well-being to the success of the entity, The bonus compensation plan results in liability that must be measured and reported in the financial statements. Four variations of bonus computation 1. Bonus is expressed as a certain percent of income before bonus and before tax. 2, Bonus is expressed as a certain percent of income after bonus but before tax. 3. Bonus is expressed as a certain percent of income after bonus and after tax. 4 Bonus is expressed as a certain percent of income after tax but before bonus. Tlustration Income before bonus and before tax 4,400,000 Bonus 10% Income tax rate 25% Case 1 - Before bonus and before tax Income before bonus and before tax 4,400,000 Multiply by 10% Bonus 440,000Case 2 ~ After bonus but before tax B = .10 (4,400,000 ~ B) B = 440,000 ~ .10B B+ 10B = 440,000 1.108 = 440,000 B = 440,000/1.10 B = 400,000 Proof bonus and before tax 4,400,000 Income before bon an (ioe Income after bonus but before tax 4,000,000 Multiply by 10% Bonus 400,000 Case 3 - After bonus and after tax B = .10 (4,400,000 - B - T) T = .25 (4,400,000 - B) B -10 [4,400,000 — B - .25 (4,400,000 - B)} B -10 (4,400,000 — B — 1,100,000 + .25B) B 440,000 - .10B — 110,000 + .025B. B+ .10B - .025B = 440,000-110,000 1.075B = 330,000 B = 330,000/ 1.075 B = 306,977 T = .26 (4,400,000~ 306,977) T = 1,023,255 Proof Income before bonus and before tax 4,400,000 Tex (306,977) (1,023,255) Income after b e Malm gfter bonus and ater tax 8,069,768 Bonus 306,977Case 4 - After tax but before bonus B = .10 (4,400,000 - T) T = .25 (4,400,000 ~ B) B = .10 [4,400,000 - .26 (4,400,000 ~ B)] B = 10 (4,400,000 - 1,100,000 + .25B) B = 440,000 - 110,000 + .026B B - .025B = 440,000 ~ 110,000 975B = 330,000 B = 380,000/.976 B = 338,462 Proof | Income before bonus and before tax 4,400,000 Tax (4,400,000 — 338,462 x 25%) (1,015,384) Income after tax but before bonus 3,384,616 Multiply by 10% Bonus 338,462 Refundable deposits Refundable deposits consist of cash or property received from ‘customers but which are refundable after compliance with certain conditions. ‘The best example of a refundable deposit is the customer deposit required for returnable containers like bottles, drums, tanks and barrels. Illustration 'A deposit of P10,000 is required from the customer for returnable containers. The containers cost P8,000. 10,000 Containers’ deposit 10,000 ‘The containers’ deposit account is usually classified as current liability. If the customer returns the containers, the deposit is simply refunded. However, if the customer fails to return the containers, the deposit is considered the sale price of the containers. ‘The excess of the deposit over the cost of the containers is considered as gain. iL