Liabilities by Valix: Intermediate Accounting 2

Liabilities
by Valix
Intermediate Accounting 2
Definition
From New Conceptual Framework (March 2018)
- A liability is a present obligation of the entity to
transfer an economic resource as a result of past
events.
For a liability to exist, three criteria must all be
satisfied:
a. The entity has an obligation
b. The obligation is to transfer an economic resource
c. The obligation is a present obligation that exists as a
result of past events
Definition
From Old Conceptual Framework
- Liabilities are present obligations of an entity arising
from past transactions or events, the settlement of
which is expected to result in an outflow from the
entity of resources embodying economic benefits.
Definition
Essential characteristics of an accounting liability:
a. The liability is the present obligation of a particular
entity
b. The liability arises from a past event
c. The settlement of the liability requires an outflow of
resources embodying economic benefits
The obligation must be to pay cash, transfer noncash

asset or provide service at some future time.
Present Obligation
1. Legal Obligation
- A consequence of binding contract or statutory
requirement
- Example is payable for goods and services received
2. Constructive Obligation
- Give rise due to reason of normal business practice,
custom and desire to maintain good business relations
or act in an equitable manner
- Example is rectifying faults in the products even
after the warranty period
Past Event
- The liability must arise from a past transaction
- An obligating event creates a present obligation.
- An example is the acquisition of goods gives rise to
accounts payable. The obligating event is the
acquisition of goods.
Outflow of
Future Economic Benefits
Examples where there is an outflow of economic
benefits:
- An entity declares cash dividend
- When the entity is under the obligation to deliver
merchandise to the customer
- When the lessor (lessor has an obligation to perform
a service) receives advance rental from the lessee
Note the there is no accounting liability when an entity
declares stock dividend. Thus, stock dividend payable
is part of the equity, not an accounting liability.
Examples of Liabilities
1. Accounts payable to suppliers for the purchase of
goods or services
2. Amounts withheld from employees or other parties
for taxes and for contributions to the Social Security
System (SSS) or to pension funds
3. Accruals for wages, interest, royalties, taxes,
product warranties and profit-sharing plans
Examples of Liabilities
4. Dividends (not stock dividends) declared but not
paid
5. Deposits and advances from customers and officers
6. Debt obligations for borrowed funds - notes,
mortgages and bonds payable
7. Income tax payable
8. Unearned revenue
Initial Measurement of Liabilities
- An entity shall measure initially a financial liability
at fair value minus (in case of financial liability not
designated at fair value through profit or loss)
transaction costs that are directly attributable to the
issue of the financial liability
- Transaction costs are included in the initial
measurement of a financial liability measured at
amortized cost
- Transaction costs are expensed if the financial
liability is designated initially as at fair value through
profit or loss
Transaction Costs
Transaction Costs
- Incremental costs directly attributable to the issue of
a financial liability
Incremental Cost
- One that would not have been incurred if the entity
had not issued the financial liability
Transaction Costs
Examples of Transaction Costs
1. Fees and commissions paid to agents, advisers,
brokers and dealers
2. Levies by regulatory agencies and securities
exchanges
3. Transfer taxes and duties
Transaction Costs
Transaction Costs do not include:
1. Debt premiums
2. Financing costs
3. Internal administrative or holding costs
Fair Value of Financial Liability
- The amount that would be paid to transfer a liability
in an orderly transaction between market participants
at the measurement date
- (Conceptually) Equal to the present value of the
future cash payment to settle the obligation
- Present Value is the discounted amount of the future
cash outflow in settling an obligation using the market
rate of interest
Subsequent Measurement
of Liabilities
1. At amortized cost, using the effective interest
method
2. At fair value through profit or loss
Amortized Cost of a Financial Liability

- Amount at initial recognition minus principal
repayment plus or minus cumulative amortization
using the effective interest method
Measurement of Liabilities
Measurement of Noncurrent Liabilities
1. Bonds payable and noninterest-bearing note payable
are initially measured at present value and
subsequently measured at amortized cost
2. Interest-bearing note payable is initially and

subsequently measured at face amount
Measurement of Liabilities
Measurement of Current Liabilities
- Current liabilities or short-term obligations are not
discounted but measured at their face value. The
reason is that the discount is usually not material and
therefore ignored.
Fair Value Option
of Measuring Financial Liability
- At initial recognition, an entity may irrevocably
designate financial liability at fair value through profit
or loss when doing so results in more relevant
information.
- The liability is measured at fair value each year-end

and any change in fair value is recognized in profit or
loss.
Fair Value Option
of Measuring Financial Liability
- However, the change in fair value of financial
liability attributable to credit risk is recognized in
other comprehensive income.
- The amortization rules for discount or premium no

longer apply. The interest expense is recognized using
the nominal or stated rate.
Classification of Liabilities (PAS 1)
1. Current Liabilities
2. Noncurrent Liabilities
Current Liabilities
- An entity shall classify 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
c. The liability is due to be settled within twelve
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
Current Liabilities
When the entity’s normal operating cycle is not clearly
identifiable, its duration is assumed to be twelve
months.
Examples of Current Liabilities
1. Trade payables
2. Accruals for employee
3. Financial liabilities held for trading
- Example is a quoted debt instrument that the issuer
may buy back in the near term depending on changes
in fair value
Current Liabilities
4. Bank overdraft
5. Dividends payable
6. Income taxes
7. Other nontrade payables
8. Current portion of noncurrent financial liabilities
Noncurrent Liabilities
- The term “noncurrent liabilities” is a residual
definition. All liabilities not classified as current are
classified as noncurrent liabilities. Noncurrent
liabilities include:
1. Noncurrent portion of long-term debt
2. Finance lease liability
3. Deferred tax liability
4. Long-term obligation to entity officers
5. Long-term deferred revenue
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 and before the financial statements are
authorized for issue
Noncurrent Liabilities
Related to Refinancing
Cases related to refinancing where obligation is
classified as noncurrent:
a. The refinancing on a long-term basis is completed
on or before the end of the reporting period
b. The entity has the discretion to refinance or roll
over an obligation for at least twelve months after the
reporting period under an existing loan facility
Covenants
- Often attached to borrowing agreements which
represent undertakings by the borrower
- Restrictions on the borrower to undertaking further
borrowings
Breach of Covenants
- If certain conditions relating to the borrower’s
financial situation is breached, the liability becomes
payable on demand.
- 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 the
entity does not have an unconditional right to defer
settlement for at least twelve months after that date.
Breach of Covenants
- 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 that date.
- Grace period is a period within which the entity can
rectify the breach and during which the lender cannot
demand immediate repayment.
Nonadjusting Events
- With respect to loans classified as current liabilities,
the following events occurring between the end of the
reporting period and the date the financial statements
are authorized for issue shall qualify for disclosure as
non-adjusting events, meaning, the loans remain
current liabilities:
Nonadjusting Events
a. Refinancing on a long-term basis
b. Rectification of a breach of a long-term loan
agreement
c. The granting by the lender of a grace period to
rectify a breach of a long-term loan arrangement
ending at least twelve months after the reporting
period
Presentation of Current Liabilities
- Under PAS 1, as a minimum, the face of the
statement of financial position shall include the
following line items for current liabilities:
a. Trade and other payables
b. Current provisions
c. Short-term borrowing
d. Current portion of long-term debt
e. Current tax liability
Presentation of Current Liabilities
- “Trade and other payables” is a line item for
accounts payable, notes payable, accrued interest on
note payable, dividends payable and accrued expenses.
- The entity shall present additional line items on the

face of the statement of financial position when such
presentation is relevant to an understanding of the
entity’s financial position.
Estimated Liabilities
- Obligations which exist at the end of reporting
period although their amount is not definite
- Either current or noncurrent in nature
- Examples include estimated liability for premium,
award points, warranty, gift certificates and bonus
- An estimated liability is considered as “provision”
which is both probable and measurable

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Liabilities

The obligation must be to pay cash, transfer noncash

Amortized Cost of a Financial Liability

2. Interest-bearing note payable is initially and

- The liability is measured at fair value each year-end

- The amortization rules for discount or premium no

- The entity shall present additional line items on the

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