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Objectives
Define
Explain characteristics
Identify
Recognition criteria for liabilities Required disclosures for current liabilities and contingencies
Distinguish
Current liabilities from noncurrent liabilities Provisions from contingent liabilities
Objectives
Account
Different current liabilities after recognition
Measure
Current liabilities on the balance sheet
Definition
IASB Conceptual Framework for Financial Reporting defines liability as : Present obligation of an enterprise arising from past event, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.
Essential Characteristics
1. Present obligation 2. Past event 3. Probable outflow of resources embodying economic benefits
What is an Obligation?
Article 1156 An obligation is a juridical necessity to give, to do or not to do.
What is an Obligation?
An obligation is a duty or responsibility to act or perform in a certain way which may be legally enforceable as a consequence of a binding contract or statutory requirement.
the enterprise has indicated to other parties that it will accept certain responsibilities, the enterprise has created a valid expectation on the part of those other parties that it will discharge those responsibilities.
Settlement of Obligation
Settlement of a present obligation may occur in a number of ways, such as by
1. 2. 3. 4. Payment of cash; Transfer of assets; Provision of services; Replacement of obligation with another obligation; 5. Conversion of the obligation to equity.
Recognition of Liabilities
A liability is recorded and reported in the statement of financial position when the following conditions are met:
1. It is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation; and 2. The amount at which the settlement will take place can be measured reliably.
Contingent Liability
PAS 37, paragraph 10 defines contingent liability in two ways: 1. A contingent liability is a possible obligation that arises from past event and whose existence will be confirmed only by the occurrence or non-occurrence of one ore more uncertain future events not wholly within the entity's control
Contingent Liability
2. A contingent liability is a present obligation that arises from past event but is not recognized because it is not probable that a transfer of economic benefits will be required to settle the obligation or the amount of the obligation cannot be measured reliably.
Provision
Definition: A liability of uncertain timing or amount
Presented separately in the Unless remote, disclosed in statement of financial the notes to the financial position under liabilities statements
Probable
Not reliably measurable
Reasonably possible
Remote
Measurement of Liabilities
Liabilities are measured: 1. At amounts established in exchanges (amount to be paid or amount discounted); or 2. By estimates of a definitive character when the amount of the liability cannot be measured more precisely (provisions).
Measurement of Liabilities
The amount recognized as a provision should be the best estimate of the expenditure at the end of the period, considering
Judgment of the management of the enterprise Experience of similar transactions Reports from independent experts
Measurement of Liabilities
Where the amount of the obligation is still uncertain as of the end of the reporting period, but the obligation is settled subsequently before the issuance of the financial statements, the amount shown in the balance sheet is the amount actually settled subsequently.
Measurement of Liabilities
Where the provision being measured involves a large population of items, the obligation is estimated by weighting all possible outcomes by their associated possibilities (statistical method called expected value). Where there is a continuous range of possible outcomes, and each point is as likely as any other, the midpoint of the range is used.
Measurement of Liabilities
Where the effect of the time value of money is material, the amount of a provision should be the present value of the expenditures expected to be required to settle the obligation.
Measurement of Liabilities
Where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement should be recognized when, and only when, it is virtually certain that the reimbursement will be received if the enterprise settles the obligation. The reimbursement, if virtually certain, should be treated as a separate asset. The amount recognized for the reimbursement should not exceed the amount of the provision.
Classification of Liabilities
An enterprise shall classify a liability as current when (par. 69, IAS 1): a. It expects to settle the liability in its normal operating cycle; b. It holds the liability primarily for the purpose of trading; c. The liability is due to be settled within twelve months after the reporting period; or d. It does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting period.
2. Cash Discounts
Example: 3/10; n/30 Gross Method Net Method
3. Progressive Discounts
Example: 5:10:15
72.68 72.68
196,000
196,000
202,000 202,000
Note that the 3% cash discount is based on the cost of goods purchased, not including freight cost
2. Non-Interest Bearing
At maturity:
Notes Payable Interest Expense Cash xxx xxx
xxx
Dec 31
May 1
xxx xxx
Accrued Liabilities
Accrued liabilities consists of obligations for expenses incurred on or before the end of the reporting period but payable at a later date. Accrued liabilities include those payables to specific persons and determinable with reasonable accuracy. They also include provisions. Common examples of liabilities of this nature are accrued salaries, accrued interests, accrued rentals and accrued taxes. An accrued liability is taken up as an adjustment at year-end by charging an expense account and crediting an accrued liability account.
Utilities Expense Utilities Payable xxx xxx
Premiums
Premiums: articles of value such as toys, dishes, silverware and other goods and in some cases cash payments, given to customers as result of past sales or sales promotion activities.
In order to stimulate the sale of their products, entities offer premiums to customers in return for product labels, box tops, wrappers and coupons. Accordingly, when merchandise is sold an accounting liability for future distribution of premium arises and should be given accounting recognition
To illustrate, assume that Perandos Piglet Inc. launched a new sales promotional program. For every 10 product box tops returned to the company, customers receive an attractive prize. Perandos Piglet Inc. estimates that only 60% of the product box tops reaching the consumer will be redeemed.
90,000,000 90,000,000
Accordingly, at the point of sale an obligation arises and a liability is incurred. To illustrate the accounting for warranties, consider the following data: Perandos Piglet Inc. sells DVD and VCD systems with a two-year warranty. The company estimates warranty costs as a percentage of peso sales as follows: 1st year 3%; 2nd year 8%
Sales and Actual repairs for 2011 and 2012 are: Sales: 2011 P2,500,000; 2012- P4,750,000 Actual warranty repairs: 2011 P53,000; 2012- P184,500 Entries: 2011 Warranty Expense 275,000 Liability for Warranty 275,000 Liability for Warranty 53,000 Cash, etc. 53,000 Warranty Expense for 2011: 11%xP2,500,000
Liability for Warranty 53,000 Cash, etc. 53,000 Warranty Expense for 2012: 11%xP4,750,000 = 522,500
If a customer buys goods or services, the entity grants the customer award credits often described as points The entity can redeem the points by distributing to the customer free or discounted goods or services. A customer loyalty program operates in a variety of ways. Customers may be required to accumulate a specified minimum number of award credits or points before they can be redeemed.
The entity supplies the awards itself: Consideration allocated to the award credits is recognized as deferred revenue. Revenue is recognized when the award credits are redeemed.
To illustrate, assume the Perandos Piglet Inc. grants to its customers 2 reward points for each P100 sales. Each point is redeemable in the form of merchandise and equivalent to P1. The points accumulate and may be used by the customer as part payment for merchandise purchases in the future. During the month of April 2012, total sales of the company amounted to P24,000,000
Fair values of merchandise and the reward points are P23,520,000 and P480,000 respectively. Entries: Cash 24,000,000 Sales 23,520,000 Liability for Customer Loyalty 480,000
By the end of the first year, 40% of the points have been redeemed, and it is expected that only a total of 90% of the points granted will be redeemed by the customers. Perandos Piglet Inc. recognizes revenue for points redeemed at P213,333 (wchis is 40%/90% x 480,000) The entry for the redemption is: Liability for Customers Loyalty Awards 213,333 Sales 213,333
Third party supplies the award If the entity is collecting the consideration as principal in the transaction, the amount of revenue is equal to the gross consideration to the award credits. If the entity is collecting the consideration as agent of the third party, the amount revenue is equal to the net amount retained on its own account
For example, assume that Perandos Piglet Inc. participates in a customer loyalty programme operated by Ezer Steroids Co. It grants Perandos Piglet Inc. privelege cardholders one point for every P50 spent on bacon. Cardholders can redeem the points for reduction in selling prices of steroids to be bought at Ezer Steroids Co. Thus, Perandos Piglet Inc. upon sale of baco to customers, records the full amount of the consideration received as sales and recognizes an expense for points expected to be redeemed by customers of Ezer Steroids Inc.
Books of Perandos Piglet Inc. Upon sale of bacon Cash xxx sales xxx Upon redemption of points Premium Expense xxx Payable to Ezer xxx
Dividends Payable
Cash dividend payable is an amount owed by a corporation to its shareholders as a result of board of directors action on the distribution of corporate earnings in the form of cash. It is recorded as a current liability upon declaration.
Dividends in arrears are not recognized as liabilities because there is no obligating event. They are simply disclosed in the notes to financial statements A share dividend distributable , is not classified as liability in the balance sheet because it will not require outflow from the enterprises resources, it is merely an additional issuance of shares.
The liability is normally reported as current. But if the deposit is nontrade and expected to be refunded or paid after one year, the liability is reported as non-current.
To illustrate accounting for deposits and returnable containers, assume the information presented bellow: Balance of Deposits for returnable containers, 1/1/12 Deposits received for containers sold Deposits refunded Deposits forfeited for containers not returned Cost of containers not returned Accum depreciation on containers not returned
The entries for the foregoing transactions: Cash 800,000 Customer Deposits for Returnable Containers 800,000 Customer Deposits on Returnable Containers 720,000 Cash 720,000
Customer Deposits on Returnable Containers 60,000 Accum. Depreciation 15,000 Returnab Containers Gain on Sale of Returnable Containers
55,000 20,000
The resulting balance reported as Deposits on Returnable Containers in the above illustration is 270,000 computed as follows: (P250,000 + 800,000 720,000 60,000)
Unearned revenues
Unearned revenues are amounts collected in advance hat have not ye been earned and recorded as revenues pending completion of the earning process. These are collections in advance for interest, rent, magazine subscriptions, royalties, tickets, tokens, gifts certificates and service contracts.
Treatment for unearned revenues are either based on liability method or income method. Under the income method, the entry for advance collection of revenue is Cash Revenue xxx xxx