Chapt 23

CURRENT LIABILITIES
 Learning Objectives

1. State the recognition criteria for liabilities and their essential

characteristics.

2. Identify the characteristics of a financial liability.

3. Determine the initial and subsequent measurements of financial

and non-financial liabilities.

4. Determine the classifications of liabilities in the financial

statements.
 What is a liability?

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. (conceptual framework)
 What is a Liability?

Three essential characteristics

of an accounting liability:

1. Present obligation of a particular

entity.

2. Arises from past events.

3. Results in an outflow of
resources (cash, goods,
services).
 Financial and Non-financial liabiities

Financial liability – is any liability that is:

a. A contract obligation to deliver cash or other financial asset to

another entity.

a. A contractual obligation to exchange financial assets or financial

liabilities with another entity under conditions that are potentially
unfavorable to the entity; or

a. A contract that will or may be settled in the entity’s own equity

instruments and is not classified as the entity’s own equity
instrument.

Non-financial liability – is a liability other than a financial liability.

 Examples of financial liabilities

a. Payables such as accounts, notes, loans and bonds payable.

b. Lease liabilities.
c. Held for trading liabilities and derivative liabilities
d. Redeemable preference shares issued.
e. Security deposits and other returnable deposits.

The following are not financial liabilities:

a. Unearned revenues and warranty obligations that are to be
settled by future delivery of goods or provision of services.
b. Taxes, SSS, Philhealth, and Pag-ibig payables
c. Constructive obligations.
 Presentation of financial instruments

The issuer classifies a financial instrument, or its component parts

as a financial asset, a financial liability or an equity instrument in
accordance with the substance of the contract (rather than its legal
form) and the definitions of a financial asset, a financial liability and
an equity instrument.
 Presentation of financial instruments

When determining whether a financial instrument is a financial liability or

an equity instruments, the overriding consideration is whether the
instrument meets the definition of a financial liability.

Financial liability Equity instrument

 The entity has a contractual  The entity has no obligation to pay

obligation to pay cash or another cash or another financial asset or
financial asset or to exchange to exchange financial instrument
financial instruments under under potentially unfavorable
potentially unfavorable condition. condition.
 Presentation of financial instruments

A contract is not an equity instrument merely because it is to be settled

in the entity’s own equity instruments. The following guidance applies
when a contract requires settlement in the entity’s own equity
instruments:
Financial liability Equity instrument

 The contract requires the delivery*  The contract requires the delivery
of (a) a variable number of the (receipt) of a fixed number of the
entity’s own equity instruments in entity’s own equity instruments in
exchange for a fixed amount of exchange for a fixed amount of
cash or another financial asset or cash or another financial asset.
(b) a fixed number of the entity’s
own equity instruments in
exchange for a variable amount
of cash or another financial asset.
 Presentation of financial instruments

Financial liability Equity instrument

 Examples  Example: a share option that

a. Variable number for a fixed gives the holder a right to buy
amount: fixed number of the issuer’s
 a contract to deliver as many shares for a fixed price.
shares as are equal to the value of
a fixed amount of cash, say P1M;
or a fixed number of units of a
commodity, say 500 grams of gold
b. Fixed number for a variable
amount:
 a contract to deliver 1,000 own
equity instruments in exchange for
an amount of cash equal to the
value of 10 grams of gold
 Presentation of financial instruments

Legal form is also irrelevant when determining if a financial instrument is

a financial liability or an equity instrument. Some instruments are in the
form of shares of stocks but the issuer classifies them as financial
liabilities if they meet the definition of a financial liability.
Redeemable preference shares Callable preference shares

 are preferred shares which the  are preference shares which the
holder has the right to redeem at a issuer has the right to call at a set
set date. date.
 are classified as financial liability  are classified as equity
because when the holder instrument because the right to
exercises its right to redeem, the call is at the discretion of the issuer
issuer is mandatorily obligated to and therefore has no obligation to
pay for the redemption price. pay unless it chooses to call on the
shares.
 Example

The following are taken from the records of ACE Co. as of year-end.
AP 2,000 SSS cont pay 6,000
Utilities pay 7,000 Cash div pay 4,000
Accrued interest exp 6,000 Property div pay 7,000
Advances from cust 1,000 Share div pay 3,000
Unearned rent 9,000 Lease liability 35,000
Warranty obligations 5,000 Bonds payable 120,000
Income taxes pay 2,000 Discount on BP (15,000)
Preference shares issued 10,000 Security deposit 2,000
Constructive obligation 11,000 Redeemable pref shares 14,000
Obligation to deliver a Unearned interest on
variable number of receivables 3,000
own shares worth a
fixed amount of cash 10,000

Required: Determine the financial liabilities to be disclosed in the notes.

 Solution

AP 2,000
Utilities pay 7,000
Accrued interest payable 6,000
Obligation to deliver a variable number of own shares 10,000
Cash dividends payable 4,000
Finance lease liability 35,000
Bonds payable 120,000
Discount on bonds payable (15,000)
Security deposit 2,000
Redeemable preference shares 14,000
Total financial liabilities 185,000
 Recognition of liabilities

All of the following conditions must be met for an item to be

recognized as a liability:
1. It meets the definition of a liability
2. It is probable that an outflow of resources embodying economic
benefits will result from its settlement; and
3. The settlement amount can be measured reliably.

Recognition of financial liabilities

A financial liability is recognized only when the entity becomes a
party to the contractual provisions of the instrument
 Classification of financial liabilities
All financial liabilities are classified as subsequently measured at amortized
cost, except for the following:
a. Financial liabilities at fair value through profit or loss (FVPL) and derivative
liabilities – subsequently measured at fair value (e.g., designated or held for
trading).
b. Financial liabilities that arise when a transfer of a financial asset does not
qualify for derecognition – subsequently measured on a basis that reflects
the rights and obligations that the entity has retained.
c. Financial guarantee contracts and Commitments to provide a loan at a
below-market interest rate – subsequently measured at the higher of:
i. The amount of the loss allowance (12-month expected credit losses) and
ii. The amount initially recognized less, when appropriate, the cumulative
amount of income recognized in accordance with the principles of PFRS
15.
d. Contingent consideration recognized by an acquirer in a business
combination – subsequently measured at fair value through profit or loss.

Reclassification of financial liabilities after initial recognition is prohibited.

 Measurement of financial liabilities
Initial measurement
Financial liabilities are initially measured at fair value minus
transaction costs, except financial liabilities at FVPL whose
transaction costs are expensed immediately.

Subsequent measurement
FL classified at amortized cost are subsequently measured at
amortized cost.
FL classified as held for trading are subsequently measured at fair
value with changes in fair values recognized in profit or loss.
FL designated at FVPL are subsequently measured at fir values with
changes recognized as follows:
a. The amount of change in the fair value of the FL that is attributable
to changes in credit risk of that liability is presented on OCI, and
b. The remaining amount of change in the fair value of the liability is
presented in the profit or loss.
Initial and subsequent measurement of non-
financial liabilities
Non-financial liabilities are initially measured at the best estimate of
the amounts needed to settle those obligations or the measurement
basis required by other applicable standard, e.g. deferred tax
liabilities are measured under PAS 12 Income Taxes.

Examples of non-financial liabilities

a. Obligations arising from statutory requirements (e.g. income tax
payable)
b. Unearned or deferred revenues.
c. Warranty obligations
d. Commodity contracts that either cannot be settled in cash or
which are expected to be settled by commodity exchange.
Initial and subsequent measurement of non-
financial liabilities

Subsequently, non-financial liabilities are also to be measured at the

best estimate of the amounts needed to settle the obligations adjusted
for any changes on the expected settlement amounts. Adjustments are
treated as changes in accounting estimates and are accounted for
prospectively. Some non-financial liabilities are subsequently measured
in accordance with the requirements of other standards (e.g. deferred
tax liabilities are measured in accordance with PAS 12).
 Financial statement presentation

Liabilities are presented as either (a) current or (b) noncurrent on the

face of a classified statement of financial position. A classified
statement of financial position is one which shows current and
noncurrent distinctions.

When an entity presents an unclassified statement of financial

position (based on liquidity), disclosures of liabilities due within one
year and due beyond one year should nevertheless be made in the
notes.
 Current liabilities

Current liabilities are liabilities that are:

a. Expected to be settled in the entity’s normal operating cycle;
b. Held primarily for trading;
c. Due to be settled within 12 months after the reporting period; or
d. The entity does not have an unconditional right to defer settlement
of the liability for at least twelve months after the reporting period.

All other liabilities are classified as noncurrent.

 Examples of current liabilities

a. Financial assets measured at FVPL (i.e., designated or held for

trading )
b. Current portion of long-term notes, bonds, loans, and lease
liabilities
c. Trade accounts and notes payables
d. Other non-trade payables due within 12 months after end of
reporting period
e. Unearned income expected to be earned within 12 months after
end of reporting period
f. Bank overdrafts
 Trade and non-trade payables
Trade payables are obligations arising from purchases of inventory that are
to be sold in the ordinary course of business.

Other payables are classified as non-trade.

For trading or manufacturing entity, trade and non-trade payables that are
currently due are normally aggregated and presented as one line item under
the heading “Trade and other payables.”
 Trade payables are classified as current liabilities when they are
expected to be settled within the normal operating cycle or one year,
whichever is longer.
 Non-trade payables are classified as current liabilities only when they are
expected to be settled within one year.

Financial institutions need not classify their payables as trade or non-trade

because their statement of financial position is presented based on liquidity.
However, payables expected to be settled within one year and beyond one
year are disclosed in the notes.
 Examples of payables

 Accounts payables – obligations not supported by formal promises to

pay by the debtor
 Notes payables – obligations supported by promissory notes by the
debtor
 Loan payables – obligations supported also by promissory notes by
the debtor but normally represent obligations for loans obtained from
financing institutions
 Bonds payables – obligations issued by the debtor supported by
promises to pay made under seal
 Liabilities under trust receipts, e.g., before the corresponding liability
to the bank is paid, the goods are released to the buyer in trust for
the bank which advanced the money for importation of goods.
 Other payables arising from sources other than purchases and
borrowings such as dividends payable, taxes payable, remittances
payable, and accrued expenses.
 Refinancing agreement

Along-term obligation that is maturing within 12 months after the

reporting period is classified as current, even if a refinancing
agreement to reschedule payments on a long-term basis is
completed after the reporting period but before the financial
statements are authorized for issue.

However, the obligation is classified as noncurrent if the entity expects,

and has the discretion, to refinance it on a long-term basis under an
existing loan facility.

If the refinancing is not at the discretion of the entity, the financial

liability is current.
 Liabilities payable on demand

Liabilities that are payable on demand of the lender are classified as

current.

A long-term obligation may become payable on demand as a result of a

breach of a loan provision. Such an obligation is classified as current
even if the lender agreed, after the reporting period and before the
authorization of the financial statements for issue, not to demand
payment. This is because the entity does not have an unconditional
right to defer settlement of the liability for at least 12 months after the
reporting period.

However, the liability is noncurrent if the lender provides the entity by

the end of the reporting period (e.g., on or before December 31) a
grace period ending at least 12 months after the reporting period, within
which the entity can rectify the breach and during which the lender
cannot demand immediate repayment.
 General rule

A currently maturing obligation or an obligation that is payable on

demand is presented as current.
Exceptions: The following result to noncurrent classification:
 Refinancing is completed on or before the balance sheet date.
 Refinancing agreement takes place after the balance sheet date but
before the financial statements are authorized for issue and the entity
has the discretion to roll-over the liability on a long-term basis.
 Grace period to rectify a breach of agreement is received on or
before the balance sheet date.
 General rule

The occurrence of the following after the end of the reporting period
but before the financial statements are authorized for issue are
disclosed as non-adjusting events after the reporting period, meaning
the related liability will still be represented as current.
a. Refinancing on a long-term basis where management has no
discretion to refinance or roll over an obligation for at least 12
months after the reporting period under an existing loan facility;
b. Rectification of a breach of a long-term loan arrangement; and
c. The granting by the lender of a period of grace to rectify a breach of
a long-term loan arrangement ending at least 12 months after the
reporting period.
 Trade accounts payable

Accounts payable from purchases of inventory are recognized when

ownership over the goods are transferred to the buyer. Trade discounts
are excluded from the amount recognized for an account payable.
Cash discounts may or may not be excluded from the initial amount of
account payable recognized depending on whether the entity uses the
gross or net method of recording purchases.
 Unearned income

Unearned income represents cash received for items of income that are
not yet earned. Prior to earning process, these advances received are
classified as liabilities.

Examples of items that give rise to unearned income:

a. Advances received for future delivery of goods
b. Advances received for future provision of services
c. Gift certificates either for goods or services. Examples include
those sold by department stores and supermarkets to be redeemed
in goods and those sold by movie theaters and spa parlors to be
redeemed in services.
 Liability for deposits received

Liability for deposits received represents cash receipts that are held in
trust for other entities.

Examples of liabilities for deposits

a. Deposit liabilities of banks and other entities performing similar
functions
b. Deposits received for returnable containers such as bottles, crates,
trays, boxes, and similar items which contain the goods sold but
must be returned to the seller upon consumption of the goods.
c. Security deposits received from lessees
d. Deposits received from escrow agreements
e. Deposits for future subscription of the entity’s own equity instrument
to the extent that such deposits are repayable in cash
Deposit for future subscription of shares of
stocks
It is common in practice that entities receive from shareholders deposits
for future subscriptions of equity instruments.
The Philippine Corporation Code prohibits entities from issuing shares
in excess of their authorized capitalization. In order to issue additional
shares, an entity needs to:
a. amend its articles of incorporation to increase the capitalization (this
requires ratification by at least 2/3 of the outstanding capital stock),
and
b. file the amended articles with relevant regulatory body(ies) (e.g.,
SEC, and for banks, BSP) for approval.

The Standards provide the following guidance:

a. If the deposits are repayable in cash at any time prior to the
approval of the amended articles, the deposits are classified as
liability.
b. In the absence of such provision, the deposits are classified as
equity, preferably presented under contributed capital.
 Dividends payable

Under IFRIC 17, the liability to pay a dividend is recognized when the
dividend is appropriately authorized and is no longer at the discretion of
the entity, which is:
a. the date when the declaration of the dividend (e.g., by management
or the board of directors) is approved by the relevant authority
(e.g., the shareholders) if the jurisdiction requires such approval, or
b. the date when the dividend is declared (e.g., by management or
the board of directors) if the jurisdiction does not require further
approval.

Dividends declared by banks are subject to approval of the BSP.

Liability is recognized for cash dividends and property dividends but not
for share dividends.
 Problem 1

On December 31, 2019, Ace Company provided the following

information:
Accounts payable, including deposits and advances from
customer of P250,000 1,250,000
Notes payable, including notes payable to bank due on
December 31, 2021 of P500,000 1,500,000
Share dividends payable 400,000
Credit balances in customers’ accounts 200,000
Serial bonds payable in semiannual installment of
P500,000 5,000,000
Accrued interest on bonds payable 150,000
Contested BIR tax assessment – possible obligation 300,000
Unearned rent income 100,000

Required: Compute the total current liabilities on December 31, 2019.

 Problem 2
Bright Company provided the following information on December 31, 2019:
Notes payable:
Trade 3,000,000
Bank loans 2,000,000
Advances from officers 500,000
Accounts payable – trade 4,000,000
Bank overdraft 300,000
Dividends payable 1,000,000
Withholding tax payable 100,000
Mortgage payable 3,800,000
Income tax payable 800,000
Estimated warranty liability 600,000
Estimated damages payable by reason of breach of
contract 700,000
Accrued liabilities 900,000
Estimated premium liability 200,000
Claims for increase in wages by employees covered
in a pending lawsuit 3,500,000
Contract entered into for the construction of building 5,000,000

Required: Compute the total current liabilities on December 31, 2019.

 Problem 3
Best Company provided the following information on December 31, 2019:
Income taxes withheld from employees 900,000
Cash balance at National Bank 2,500,000
Cash overdraft at East Bank 1,300,000
Accounts receivable with credit balances 750,000
Estimated expenses of meeting warranties on merchandise
previously sold 500,000
Estimated damages as a result of unsatisfactory performance
on a contract 1,500,000
Accounts payable 3,000,000
Deferred serial bonds, issued at par and bearing interest
at 12%, payable in semiannual installment of P500,000
due April 1 and October 1 of each year, the last bond to be
paid on October 1, 2025. Interest is also paid
semiannually. 5,000,000
Stock dividend payable 2,000,000

Required: Compute the total current liabilities on December 31, 2019

 Problem 4

Better Company provided the following information on December 31, 2019:

Accounts payable after deducting debit balances in
suppliers’ accounts of P100,000 500,000
Accrued liabilities 50,000
Notes payable – due March 31, 2020 1,000,000
Notes payable – due May 1, 2020 800,000
Bonds payable – due December 31, 2021 2,000,000

On March 1, 2020 before the 2019 financial statements were issued, the
note payable of P1,000,000 was replaced by an 18-month note for the same
amount.

The entity is considering similar action on the P800,000 note due on May 1,
2020. The financial statements were issued on March 31, 2020.

Required:
1. Compute total current liabilities.
2. Compute total noncurrent liabilities.
 Problem

1. An entity’s liabilities include the following:

Accounts payable 500,000
Held for trading financial liabilities 1,000,000
Notes payable (P1M due in 20x3) 2,800,000
Unearned revenue 300,000
Dividends payable 800,000
Deferred tax liability 200,000

Required:
Compute total current liabilities
 Problem

2. Ever Company’s accounts payable balance at December 31, 2019, was

P2,200,000 before considering the following data:
• Goods shipped to Ever F.O.B. shipping point on December 22, 2019,
were lost in transit. The invoice cost of P40,000 was not recorded by
Ever. On January 1, 2020, Ever filed a P40,000 claim against the
common carrier.
• On December 27, 2019, a vendor authorized Ever to return, for full
credit, goods shipped and billed at P70,000 on December 3, 2019. The
returned goods were shipped by Ever on December 28, 2019. A
P70,000 credit memo was received and recorded by Ever on January 5,
2020.
• Goods shipped to Ever F.O.B. destination on December 20, 2019, were
received on January 6, 2020. The invoice cost was P50,000.

Required: What amount should Ever report as accounts payable in its

December 31, 2019, balance sheet?
 Problem

3. Best Co’s liabilities at December 31, 2019, were as follows:

• Accounts payable and accrued interest 1,000,000
• 12% note payable issued on November 1, 2018
maturing July 1, 2020 2,000,000
• 10% debentures payable, next annual principal
installment of P500,000 due February 1, 2020 7,000,000

On March 1, 2020, Best consummated a noncancelable agreement with the

lender to refinance the 12% note payable on a long-term basis, on readily
determinable terms that have not yet been implemented. Both parties are
financially capable of honoring the agreement’s provisions. Best’s
December 31, 2019 financial statements were issued on March 31, 2020.

Required: In its December 31, 2019 balance sheet, what amount should Best
report as current liabilities?
 Problem

4. Star Co. had the following amounts of long-term debt outstanding at

December 31, 2019:
• 14% term note, due 2020 30,000
• 11% term note, due 2022 1,070,000
• 8% note, due in 11 equal annual principal
payments, plus interest beginning December
31, 2020 1,100,000
• 7% guaranteed debentures, due 2022 1,000,000

Star’s annual sinking fund requirement on the guaranteed debentures is

P40,000 per year.

Required: What amount should Star report as current maturities of long-term

debt in its December 31, 2019 balance sheet?
 Problem

5. Taken from the records of Bright Company as of December 31, 2019 are the
following information:
• Long-term debt of P10,000,000 dated January 1, 2012 due December
31, 2020. Bright expects to refinance this liability on a long-term basis on
January 2020. The refinancing agreement was consummated on
February 2, 2020.
• Note payable due on January 1, 2022 amounting to P6,000,00. The note
is payable on demand.
• Bank loan of P14,000,000 due on December 31, 2024 wherein a breach
of loan covenant was committed by Bright during 2019. The Bank agreed
on December 31, 2019 to provide Bright a grace period to rectify the
breach ending December 31, 2020.
• Serial bonds dated January 1, 2019 totaling P10,000,000 payable in 10
annual installments.

Required: How much would be included in the current liabilities section of

Bright’s year-end financial statements?
 Problem

6. ACE Corporation’s liabilities at December 31, 2019 were as follows:

Accounts payable and accrued interest 2,000,000
5-year 10% Notes payable – due December 31, 2022 5,000,000

Part of the loan agreement is for ACE to appropriate a fixed amount out of
its accumulated profits and losses annually until the amount of appropriation
has equaled the face of the obligation. As of December 31, 2019, ACE has
yet to comply with the loan agreement.

Required: In its December 31, 2019 balance sheet, ACE should report
current liabilities at what amount?
 Problem

7. Refer to No. 6, assuming the lender agreed on December 31, 2019 to

provide a grace period of 12 months for the entity to rectify the breach and
assured ACE that no demand of payment is to be made within the grace
period, what amount of current liabilities should ACE report in its December
31, 2019 balance sheet?
 Problem

8. Excellent Department Store sells gift certificates, redeemable for store

merchandise that expires one year after their issuance. Excellent has the
following information pertaining to its gift certificates sales and redemptions:
Unearned at December 31, 2018 600,000
2019 sales 2,000,000
2019 redemptions of prior year sales 200,000
2019 redemptions of current-year sales 1,400,000

Excellent’s experience indicates that 10% of gift certificates sold will not be
redeemed.

Required: In its December 31, 2019 balance sheet, what amount should
Excellent report as unearned income?
 Problem

9. Tyron Company offers three payment plans on its 12-month contracts.

Information on the three plans and the number of children enrolled in each
plan for September 1, 2018 through August 31, 2019 contract year follows:
___________________________________________________________
Initial payment Monthly fees per No. of
Plan per child child children
___________________________________________________________
#1 500 - 15
#2 200 30 12
#3 50 9
36

Tyron received all initial payments on September 1, 2018, and P3,240 of

monthly fees during the period September 1 through December 31, 2018.

Required: In its December 31, 2018 balance sheet, what amount should
Tyron report as deferred revenue?
 Problem

10. Red Company must determine the December 31, 2018, year-end accruals
for advertising and rent expense. A P50,000 advertising bill was received
January 7, 2019, comprising cost of P35,000for advertisements in
December 2018 issues, and P15,000 for advertisements in January 2019
issues of the newspaper.

A store lease, effective December 31, 2017, calls for fixed rent of P120,000
per month, payable one month from the effective date and monthly
thereafter. In addition, rent equal to 5% of net sales over P6,000,000 per
calendar year is payable on January 31 of the following year. Net sales for
2018 were P9,000,000.

Required: How much are the accrued liabilities in the December 31, 2018
balance sheet?
 Problem

11. Able Company sells its products in reusable, expensive containers. The
customer charged a deposit for each container delivered and receives a
refund for each container returned within two years after the year of delivery.
Able accounts for the containers not returned within the time limit as being
retired by sale at the deposit amount. Information for 2019 is as follows:

Deposits for containers at December 31, 2018 from deliveries in:

2017 . 150,000
2018 430,000 580,000
Deposits for containers delivered in 2019 780,000
Deposits for containers returned in 2019 from deliveries in
2017 90,000
2018 250,000
2019 286,000 626,000

Required: What amount should Able report as a liability for deposits on

returnable containers at December 31, 2019?