Chapter 1 – Liabilities

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.

Essential characteristics:

1. As the present obligation of a particular entity (must be identified but the payee is not
necessarily be identified)
May be: Legal obligation- (legally enforceable) consequence of binding contract or
statutory requirement
Constructive obligation- normal business practice, custom and a desire to
maintain good business relations or act in an equitable manner
2. Arises from a past event (liability is not recognized until it is incurred)
Known as the obligating event
3. Settlement of liability requires an outflow of resources embodying economic benefits
Ex: Payment of money, transfer of noncash asset, performance of service, etc.
 Cash dividend declaration is a crystallization of the definitive concept of an accounting
liability
 Share dividend payable is classified as part of equity rather than an accounting liability

Examples of Liabilities:

1. Accounts payable to suppliers for the purchase of goods

2. Amounts withheld from employees for taxes and for contributions to the social security system
3. Accruals of wages, interest, royalties, taxes, product warranties and profit sharing plans
4. Cash dividends declared but not paid
5. Deposits from customers and advances from officers
6. Debt obligations for borrowed funds – notes, mortgages and bonds payable
7. Income tax revenue
8. Unearned revenue (payment is already collected but service not yet rendered)

Measurement of current liabilities:

Conceptually, all liabilities are initially measured at present value and subsequently measured at
amortized cost.

In practice, current liabilities or short-term obligations are not discounted anymore but measured,
recorded and reported at their face amount

(it is because the discount or the difference between the face amount and the present value is
usually not material and therefore ignored)
Measurement of noncurrent liabilities:

Non-current liabilities (ex. bonds payable and noninterest-bearing note payable) are initially
measured at present value and subsequently measured at amortized cost.

If the long term note payable is interest-bearing, it is initially and subsequently measured at face
amount. In this case, the face amount is equal to the present value of the note payable.

Current Liabilities

 Settles the liability within the entity’s operating cycle

 Holds liability for the purpose of trading (financial liabilities held for trading, bank overdraft,
dividends payable, income taxes, other nontrade payables and current portion of
noncurrent financial liabilities)
 Due to be settled within 12 months after the reporting period
 Does not have right to defer settlement of the liability for at least 12 months after the
reporting period

Operating costs that are part of working capital used in the entity’s normal operating cycle are classified
as current liabilities even if settled more than 12 months after reporting period.

When the entity’s normal operating cycle is not identified, it is assumed as 12 months

Financial liabilities held for trading are financial liabilities that are incurred with an intention to
repurchase them in the near term. (ex. Quoted debt instrument)

Noncurrent Liabilities

- A residual definition

Ex.: noncurrent portion of long-term debt, finance lease liability, deferred tax liability (tax that is due for
the current period but not yet paid // tax due according to tax accounting < according to financial
accounting), long-term obligation to entity officers, long-term deferred revenue

A liability which is due to be settled within twelve months after the reporting period is classified as
current, even if:

 Original term is longer than 12 months

 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 the
reporting period, the refinancing is an adjusting event and therefore the obligation is
classified as noncurrent, also if the entity has the discretion to refinance, etc. (p. 6)
Covenants – attached to borrowing agreements which represent undertakings by the borrower
- restrictions on the borrower as to undertake further borrowings, etc.

Breach of covenants – if conditions relating to the borrower’s financial situation are breached, the
liability becomes payable on demand

classified as current even if the lender has agreed, after the reporting period and before the statements
are authorized for issue, not to demand payments as a consequence of the breach.

It is current because at the end of the reporting period, the entity does not have an unconditional right
to defer settlement for at least 12 months after that date.

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 that date.

Grace period – a period within which the entity can rectify the breach and during which the lender
cannot demand immediate repayment

Presentation of Current liabilities:

The face of the statement of financial positional shall include the following line items for current
liabilities

1. Trade and other payables (lie item for accounts payable, notes payable, accrued interest on note
payable, dividends payable and accrued expenses. Though, no objection can be raised if the
trade accounts and notes payable are separately presented)
2. Current provisions
3. Short-term borrowing
4. Current portion of long-term debt
5. Current tax liability

Estimated liabilities

- Obligations which exist at the end of reporting period although their amount is not definite, also
the due date and the exact payee

But the existence of the estimated liabilities is valid and unquestioned

Either current or noncurrent

Ex. Estimated liability for premium, award points, warranties, gift certificates and bonus