Understanding Accounting Liabilities: Present Obligations and Measurement, Exams of Financial Accounting

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MS. SHARON A. BACTAT sabactat@mmsu.edu.ph PROF. SUERTE R. DY srdy@mmsu.edu.ph

 To understand the concept of liabilities  To describe the nature and type of current and noncurrent liabilities  To know the measurement of current and noncurrent liabilities  To explain the issue of long-term debt falling due within one year  To explain the issue of breach of covenants attached to long-term debt  To describe formulas in computing bonus to officers and employees.

present obligation of an entity to transfer an

economic resource as a result of past event.

(Revised Conceptual Framework for Financial

Reporting)

 An obligation is a duty or responsibility that an entity has no practical ability to avoid.  Obligating event – one that results in an enterprise having no realistic alternative to settling that obligation. May be classified as legal or contractive.  LEGAL OBLIGATION – one that derives from contract (through implicit and explicit terms), legislation or other operation of law. (e.g. accounts payable (arising from a CONTRACT with a supplier); taxes payable (arising from LEGISLATION AND OTHER OPERATION OF LAW)  CONSTRUCTIVE OBLIGATION – one that derives from an enterprise’s actions whereby an established pattern of past practice, published policies or a sufficiently specific current statement, the enterprise has indicated to other parties that it will accept certain responsibilities and as a result, the enterprise has created a valid expectation on the part of those other parties that it will discharge those responsilities.

 Without payment of money, transfer of noncash assets performance of service, there is NO ACCOUNTING LIABILITY.  Declaration of cash dividends  Declaration of share dividends, no accounting liability (not a transfer of noncash asset since share capital is an equity item. Share dividends payable is classified as EQUITY rather than an accounting liability.

• Accounts Payable to suppliers for the purchase of goods;
• Amounts withheld from employees for taxes and for contributions to the Social Security System;
• Accruals for salaries, interest, rent taxes, product warranties and profit sharing bonus;
• Cash dividends declared but not paid;
• Deposits and advances from customers;
• Debt obligations for borrowed funds – notes, mortgages and bonds payable;
• Income Tax Payable;
• Unearned Revenue

 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 FACE AMOUNT (REASON: the discount or the

difference between the face amount and present value is

usually NOT MATERIAL and therefore IGNORED.

PAS 1 , par. 69 , provides that an entity shall classify a liability as current when:  The entity expects to settle the liability within the entity’s operating cycle.  The entity holds the liability primarily for the purpose of TRADING  The liability is due to be settled within 12 months after the reporting period  The entity DOES NOT HAVE an UNCONDITIONAL RIGHT to defer settlement of the liability for at least 12 months after the reporting period

 Trade payable and accruals for employees – part of the working capital (current assets and current liabilities) used in the entity’s operating cycle. Classified as CURRENT although it is due to be settled more than 12 months after the reporting period. OPERATING CYCLE not clearly identifiable, its duration is assumed to be 12 months.  Other current liabilities are not settled as part of the normal operating cycle but are due for settlement within 12 months after the reporting period or held primarily for the purpose of trading. (e.g. financial liabilities held for trading, bank overdraft, dividends payable, income taxes, other nontrade payables and current portion of long-term debt.)

CLASSIFIED AS CURRENT EVEN IF:

a. The original term was for a period longer than 12 months. b. An agreement to refinance or to reschedule payment on a long-term basis is complete after the reporting period and before the financial statements are authorized for issue. HOWEVER, see next slide

 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 classified as NONCURRENT.  THE ENTITY HAS A DISCRETION TO REFINANCE or roll over an obligation for at least 12 months after the reporting period under an existing loan facility, the obligation is classified as NONCURRENT even if it would otherwise be due within a shorter period

• refinancing or rolling over must be at the discretion of the entity

BREACHED PAYABLE ON DEMAND  CURRENT LIABILITY – 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 breach (REASON: since at the END of the REPORTING PERIOD , the entity DOES NOT HAVE AN UNCONDITIONAL RIGHT TO DEFER SETTLEMENT for at least twelve months after the date.  NONCURRENT LIABILITY – if the lender agreed ON OR BEFORE THE END OF THE REPORTING PERIOD TO PROVIDE GRACE PERIOD ending at least twelve months after that date.

Par. 54 of PAS 1, as a minimum, the face of the Statement of Financial Position (Balance Sheet) shall include the following line items:  Trade and other payables (line item for accounts payable, notes payable, accrued interest on notes payable, dividends payable and accrued expenses)  Current Provisions  Short-term Borrowing  Current Portion of Long-term Debt  Current Tax Liability