Module 1

<Current Liabilities>

<AEFAR 4>
<Intermediate Accounting Part 2>

This module is a combination of

synchronous & asynchronous learning
and will last for <2-3 > week/s
Pretest will be given via
Google Form in asynchronous test

< Carmelita J. Mercado>

<melitmercado2020@gmail.com Cp # 0967 274 3640.>
Instructor

February 3, 2021
Date Initiated
Februay17, 2021
Date of Completion
 SAN MATEO MUNICIPAL COLLEGE
General Luna St., Guitnang Bayan I, San Mateo, Rizal
Tel. No. (02) 997-9070
www.smmc.edu.ph

MODULE 1
AEFAR 4
CURRENT LIABILITIES, PROVISIONS AND CONTINGENCIES

MODULE SCHEDULE (This module is good for 2 weeks )

i. Synchronous Meeting: Feb. 3-17, 2022
ii. Asynchronous Meeting: (Individual Assignment with Peer Collaboration)

CONSULTATION HOURS
i. At your class hour during asynchronous meeting
ii. You can reach me at my email add: melitmercado2020@gmail. com or at our gc just
pm me.

LEARNING OBJECTIVES
At the end of the module, you are expected to:
1. define liabilities and explain their essential characteristics;
2. identify the recognition criteria for liabilities;
3. distinguish current liabilities from non-current liabilities;
4. distinguish provisions from contingent liabilities;
5. account for different current liabilities after initial recognition ;
6. measure and present current liabilities on the statement of financial position;
7. identify required disclosures for current liabilities and contingencies; and
8. understand the nature of contingent assets and identify disclosure requirements relating to contingent assets.

INFORMATION INPUTS:

1. What is current liability? What are the essential characteristics?

2. How are current liabilities distinguished from non-current liabilities
3. How are provisions distinguished from contingent liabilities?
4. How do we recognize current liability
5. How do we measure current liabilities,
a) initial recognition
b) Subsequent measurement.
6. What is the proper presentation of current liabilities in the statement of financial
position.
LEARNING ACTIVITIES

Assignment : Problems 1-1; 1--4 and 1- 5 of Chapter 1 of the Intermediate Accounting Volume 2 of Conrado
Valix and .partners.
Problems 2-1; 2-3 and 2—6 of chapter 2

ASSESSMENTS/EVALUATION
This might be in the form of:
i. Online quiz/zes (Google forms with timely as add-on)

ii. Diagnostic test: graded recitation

iii. Summative test : periodic exam

ASSIGNMENTS

LEARNING RESOURCES
Required Text book: Intermediate Accounting volume 2 by Nenita S. Robles and Patricia M. Empleo.
Financial Accounting Volume 2 by Conrado T. Valix , Jose F. Peralta and Christian Aris M. Valix 2020 Edition

MODULE PROPER

LIABILITIES

Liabilities represent amounts an entity owes for its debts or obligations. The international Accounting
Standards Board acknowledges the fact that information about expected dates of realization of assets and
liabilities is useful in assessing the liquidity and solvency of an entity (par. 65 , IAS 1 Presentation of Financial
Statements). That is the reason for the classification of assets and liabilities into current and non-current except
when a presentation based on liquidity provides information that is reliable and more relevant.

DEFINITION AND NATURE OF LIABILITIES

The IASB’s 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”.

From the definition given, a liability possesses the following essential characteristics:

 Present obligation
 Past event
 Probable outflow of resources embodying economic benefits.

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; or it may be an obligation acknowledged by an
enterprise because other parties are made to believe that it will carry out an undertaking or certain action.

An obligating event is one that results in an enterprise having no realistic alternative to settling that obligation. An
obligating event may be classified in either of the following:

1. Legal obligation; or
2. Constructive obligation

A legal obligation is one that derives from a contract (through its explicit or implicit terms), legislation, or other
operation of law.
Example of liabilities that arise from legal obligations are accounts payable ( arising from a contract with a
supplier), withholding taxes payable and value added taxes payable (arising from legislation and other operation )
A constructive obligation is 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 (par. 10, IAS 37, Provisions, Contingent Liabilities and Contingent
Assets). An example of a Liability that is recognized as a constructive obligation is provision for clean up costs
where the enterprise has a widely published policy of cleaning up all contamination that it causes.

Examples of Liabilities

A) Accounts payable to suppliers for the purchase of goods

B) Amounts withheld from employees for taxes and for contributions to the Social Security System
C) Accruals for Salaries, interests, taxes, product warranties and profit sharing bonus
D) Cash dividends declared but not paid
E) Deposits and advances from customers
F) Debt obligations for borrowed funds – notes, mortgages and bonds payable
G) Income tax payable
H) Unearned revenue

Liabilities arise only from past events or transactions. For example, the mere signing of a purchase contract with a
supplier does not give rise to a liability. The liability for salaries shall be recognized when the employees render
services to the entity.

The settlement of a present obligation involves the enterprise giving up resources embodying economic benefits in
order to satisfy the claim of the other party. Settlement of a present obligation may occur in a number of ways,
such as by:

 Payment of cash
 Transfer of other assets
 Provision of services
 Replacement of an obligation with another obligation; and
 Conversion of the obligation to equity.

In some exceptional cases, an obligation is settled through condonation by the creditor.

RECOGNITION OF LIABILITIES

A Liability is recorded and reported in the statement of financial position when a past event has occurred and
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.

An outflow of resources is considered probable when the event is more likely to occur than not to occur (i.e., the
probability of occurrence is more than 50%). In certain cases, an enterprise considers the opinions of experts or
the evidences provided by events after the reporting period.

Measurement is a sub-process in the process of recognition. Measurement is the assigning of peso amount to a
financial statement element. It is necessary, however, that the amount of the probable obligation be measured
with preciseness. The use of estimates may sometimes be essential and does not undermine the reliability of the
financial statements.

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

However, in practice, current liabilities or short-term obligations are not discounted anymore but measured,
recorded and reported at face amount. The reason is that the discount or the difference between the face amount
and the present value is usually not material and therefore ignored.

Measurement of non-current liabilities , for example, 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.

The “amortized cost measurement” , is taken up in a later chapter in relation to bonds payable.
CURRENT LIABILITIES:

PAS 1, par. 69, provides that an entity shall classify a 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.

Trade payables and accruals for employees and other operating costs are part of the working capital used in the
entity’s normal operating cycle. Such operating items are classified as current liabilities even if settled more than
twelve months after the reporting period.

NON-CURRENT LIABILITIES

Non-current liabilities- is a residual definition.

All liabilities not classified as current are classified as noncurrent liabilities. Noncurrent liabilities include:

a) Noncurrent portion of long-term debt

b) Finance lease liability
c) Deferred tax liability
d) Long-term obligation to officers
e) Long-term deferred revenues

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,

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.

Moreover, if 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, the obligation is classified as noncurrent even if it would otherwise
be due within a shorter period.

If the entity has an unconditional right under the existing loan facility to defer settlement of the liability for at least
twelve months after the reporting period, the obligation is considered part of the entity’s long-term refinancing.

Note that the refinancing or rolling over must be at the discretion of the entity.

Covenants are often attached to borrowing agreements which represents undertakings by the borrower.

Breach of covenants:

Under these covenants, if certain conditions relating to the borrower’s financial situation are breached, the liability
becomes payable on demand.

Presentation of Current liabilities :

Under par. 54 of 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 borrowings
d) Current portion of long-term debts
e) Current tax liability
Trade and other payables is a line item for accounts payable, notes payable, accrued interest on note payable,
dividends payable and accrued expenses.

Estimated liabilities

Estimated liabilities are obligations which exist at the end of the reporting period although their amount is not
definite. These are either current or noncurrent in nature.

Examples include estimated liability for premium, award points , warranties, gift certificates and bonus.
Deferred Revenue:

Deferred Revenue or unearned revenue is income already received but not yet earned. Deferred revenue may be
realizable within one year or in more than one year after the end of the reporting period.

If deferred revenue is realizable within one year, it is a current liability. Examples are: unearned interest income,
unearned rental income, unearned subscription revenue.

Typical examples of noncurrent deferred revenue are unearned revenue from long-term service contracts and long
—term leasehold advances.

Illustration:

An entity sells equipment service contracts agreeing to service equipment for a 2-year period.

Cash receipts from contracts are credited to Unearned service revenue and service costs are charged to service
contract expense.

The following transactions occur in the first year.

Cash receipts from service contracts sold P1,000,000

Service contracts cost paid 500,000
Service contact revenue recognized 800,000

Journal entries for the first year:

1) To record the cash receipts from service contracts sold.

Cash 1,000,000
Unearned service revenue 1,000,000

2) To record service contracts costs paid

Service contract expense 500,000
Cash 500,000

3) To record the service contract revenue recognized

Unearned Service revenue 800,000
Service contract revenue 800,000

Many megamalls, department stores and supermarkets sell gift certificates which are redeemable in merchandise.
The accounting procedures are:

1) When gift certificates are sold.

Cash xxxx
Gift Certificates payable xxxx

2) When gift certificates are redeemed

Gift certificates payable xxx
Sales xxx

3) When gift certificates expire or when gift certificates are not redeemed.
Gift certificates payable xxx
Forfeited gift certificates xxx
Bonus Computation

Large entities often compensate key officers and employees by way of bonus for superior income realized during
the year.
The main purpose of this scheme is to motivate officers and employees by directly relating their well- being to the
success of the entity.

This compensation plan results in liability that must be measured and reported in the financial statements. The
bonus computation usually has four variations:

1) Bonus is expressed as a certain percent of income before bonus and before tax
2) Bonus is expressed as a certain percent of income after bonus but before tax
3) Bonus is expressed as a certain percent of income after bonus and after tax
4) Bonus is expressed as a certain percent of income after tax but before bonus

Illustration:

Income before bonus and before tax P4,400,000

Bonus 10%
Income tax rate 30%

Case 1- Before bonus and before tax

Income before bonus and before tax 4,400,000

Multiply by 10%__

Bonus 440,000

Case 2 - After bonus but before tax

B= .10(4,400,000-B)
B= 440,000 - .10B
B + .10B = 440,000
1.10B = 440,000
B= 440,000/1.10
B = 400,000

Case 3 - After bonus and after tax

B = .1( 4,400,000 –B – T)

T - .30(4,400,000 – B)

B = .10(4,400,000-B -.30(4,400,000-B)

B = .10(4,400,000 -.B – 1,320,000 +.30B)

B = 440,000 -.10B -132,000 + .03B

B + .10B -.03B = 440,000-132,000

1.07B = 308,000
B = 308,000/1.07
B = 287,850
T = .30 ( 4,400,000 – 287,850 )
= 1,233,645

Case 4 - as certain percentage of income after tax but before bonus

B = .10(4,400,000-T)
T = .30( 4,400,000-B)
B = .10 (4,400,000 -.30(4,400,000 –B
B = .10(4,400,000 -1,320,000 +.30B)
B = 440,000 -132,000-.03B
B - .03B = 308,000
.97B = 308,000
B = 308,000/.97
B = 317,526
REFUNDABLE DEPOSITS

Refundable deposits – consist of cash or property received from customers but which are refundable after
compliance with certain conditions.

The best example of a refundable deposit is the customer deposit for returnable containers like bottles, drums,
tanks and barrels.

Illustration:

A deposit of P10,000 is required from the customer for returnable containers. The containers cost P8,000.
If the customer returns the containers, the deposit is simply refunded, however, if the customer fails to return the
containers, the deposit is considered as the sale price of the containers. The excess of the deposit over the cost
of the container is considered as gain.

Journal entry:

Cash 10,000
Container’ deposit 10,000
To record the refundable deposit on containers

PREMIUM LIABILITY

PREMIUMS are articles of value such as toys , dishes, silverwares and other goods given to customers as a result
of past sales or sales promotion activities. Entities offer premiums to customers in return for product labels, box
tops, wrappers and coupons.

Accordingly, when the merchandise is sold, an accounting liability for the future distribution of the of the premium
arises and should be given accounting recognition.

The accounting procedures for acquisition of premiums and recognition of the premium liability are as follows:

1) When premiums are purchased

Premiums xxx
Cash xxx

2) When premiums are distributed to customers

Premium expense xxx
Premiums xxx

3) At the end of the year, if premiums are still outstanding:

Premium expense xxx

Estimated premium liability xxx

Illustration:

An entity manufactures a certain product and sells it at P300 per unit.

A soup bowl is offered to customers on the return of 5 wrappers plus a remittance of P10.

The bowl costs P50.00 and it is estimated that 60% of the wrappers will be redeemed.

The data for the first year concerning the premium plan are summarized below:

Sales 10,000 units at P300. Each P3,000,000

Soup bowls purchased, 2,000 units at P50. 00 each 100,000
Wrappers redeemed 4,000

1) To record the sales:

Cash 3,000,000
Sales 3,000,000

2) To record the purchase of soup bowls:

 Premiums - Soup bowls 100,000
Cash 100,000

3) To record redemption of 4,000 wrappers

Cash ( 4,000 /5 x P10.00) 8,000

Premium Expense (800 xP40.00) 32,000
Premiums- Soup bowls 40,000

4) To record the liability for premiums at the end of the first year.

Premium Expense 16,000

Estimated premium Liability 16,000

10,000 units sold x 60% 6,000 /5 wrappers per bowl = 1,200

Soup bowls redeemed 800

Balance to be redeemed 400

Multiply by P 40

Estimated Premium Liability P16,000

Financial Statement Presentation:

Current Asset:
Premiums – soup bowls P60,000

Current Liability

Estimated Premium Liability P16,000

Distribution Cost:

Premium Expense ( 32,000 + 16,000 ) P48,000

CASH REBATE PROGRAM

Like any premium offer, the purpose of the cash rebate program is to stimulate sales.

Accordingly, the estimated amount of the cash rebate should be recognized both as an expense and an estimated
liability in the period of sale.

Illustration:

An entity offered P500 cash rebate on a particular model of TV set. The customer must present a rebate coupon
enclosed in every package sold plus the official receipt.

Past experience indicates that 40% of the coupons will be redeemed.

During the year, the entity sold 4,000 TV sets and total payments to customers amounted to P450,000.

1) To recognize the cash rebate program

Rebate expense P800,000

Estimated Rebate Liability P800,000
 Rebate coupons issued 4,000
Expected to be redeemed 40%

Coupon rebates to be redeemed 1,600

Cash rebate per coupon 500

Estimated rebate liability P800,000

2) To record the payment to customers:

Estimated rebate liability 450,000

Cash 450,000

CASH DISCOUNT COUPON

Like a premium offer and cash rebate program an expense and an estimated liability for the expected cash
discount should be recognized in the period of sale,

Illustration:

During the current year, an entity inserted in each package sold a coupon offering P300 off the purchase price of
a particular brand of product when the coupon is presented to retailers.

The retailers are reimbursed for the face amount of coupons plus 10% for handling. Previous experience
indicates that 30% of coupons will be redeemed.

During the current year, the entity issued coupons with face amount of P5,000,000 and total payments to retailers
amounted to P1,100,000.

1) To recognize the cash discount offer

Cash discount coupon expense 1,650,000
Estimated coupon liability 1,650,000

Face value of coupons to be received

5,000,000 x 30% 1,500,000

Multiply by (100% face plus 10% handling ) 110%

Total coupon liability 1,650,000

2) To record payments to retailers

Estimated coupon liability 1,100,000

Cash 1,100,000

CUSTOMER LOYALTY PROGRAM

Many entities use a customer loyalty program to build brand loyalty to retain their valuable customers and of
course increase sales volume. The customer loyalty program is generally designed to reward customers for past
purchases and to provide them with incentives to make further purchases.

If acustomer 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.

Measurement:
An entity shall account for the award credits as a separately component of the initial sale transaction. In other
words, the granting of award credits is effectively accounted for as a future delivery of goods or services.

IFRS 15, par. 74, provides that an entity shall allocate the transaction price to each performance obligation
identified in a contract on a relative stand-alone selling price basis.

In other words, the fair value of the consideration received with respect to the initial sale shall be allocated
between the award credit and the sale based on relative stand-alone selling price.

Stand –alone selling price is the price at which an entity would sell a promised good or service separately to a
customer.

Recognition

The consideration allocated to the award credits is initially recognized as deferred revenue and subsequently
recognized as revenue when the award credits are redeemed.

The amount of revenue recognized shall be based on the number of award credits that have been redeemed
relative to the total number expected to be redeemed. The estimated redemption rate is assessed each period.
The calculation of revenue to be recognized in any one period is made on a “cumulative basis” in order to reflect
the changes in estimate.

Illustration IFRS 15

The entity grants program members loyalty points when they spend a specified amount on groceries.
Program members can redeem the points for further groceries. The points have no expiry dates.

The sales during 2020 amounted to P9,000,000 based on stand-alone selling price. During 2020, the customers
earned 10,000 points. But management expects that 80% or 8,000 points of these will be redeemed. The stand-
alone selling price of each loyalty point is estimated at P100.

On December 31, 2020, 4,000 pts. have been redeemed in exchange for groceries.

In 2021, the management revised the expectations and now expects that 90% or 9,000 points will be redeemed
altogether.

During 2021, the entity redeemed 4,100 points. I 2022, a further 900 points are redeemed.

Management continues to expect that only 9,000 points will ever be redeemed, meaning, no more points will be
redeemed after 2022.

Allocation of transaction price

Product sales 9,000,000

Points –stand- alone selling price (10,000x100) 1,000,000

Total 10,000,000

Product sales (9,000,000/10,000,000 x 9,000,000 ) 8,1000,000

Points (1,000,000/10,000,000 x 9,000,000 ) 900,000

Total transaction price 9,000,000

Journal entries:

The initial sale in 2020 is recorded as follows:

Cash 9,000,000
Sales 8,100,000
Unearned Revenue – points 900,000

Redemption of 4,000 points in 2020

Unearned revenue – points 450,000

Sales 450,000

Revenue to be recognized in 2020

(4,000 /8,000 x 900,000) 450,000
Redemption of 4,100 points in 2021

Unearned revenue- points 360,000

Sales 360,000

Points redeemed in 2020 4,000

Points redeemed in 2021 4,100

Total points redeemed up to December 31, 2021 8,100

Cumulative revenue as of December 31, 2021.

( 8,100 / 9,000 x 900,000) 810,000

Revenue recognized in 2020 450,000

Revenue to be recognized in 2021 360,000

Redemption of 900 points in 2022

Unearned Revenue –points 90,000

Sales 90,000

Points redeemed in 2020 4,000

Points redeemed in 2021 4,100
Points redeemed in 2022 900
Total points redeemed to December 31, 2022 9,000

Cumulative revenue to December 31, 2022

( 9,000/9000 x 900,000 ) 900,000
Cumulative revenue to December 31, 2021 810,000

Revenue to be recognized in 2022 90,000

THIRD PARTY OPERATES LOYALTY PROGRAM

An entity , a retailer of electrical goods, participates in a customer loyalty program operated by an airline.

The entity grants program members one air travel points for every P1,000 spent on electrical goods.

Program members can redeem the points for travel with the airline subject to availability. The entity
pays the airline P60 for each point.

During the current year, the entity sold electrical goods for consideration totaling to P4,500,000 based on
Stand-alone selling price and granted 5,000 points with stand-alone selling price of P100 per point.

Selling Price Fraction Allocated

Product sales 4,500,000 45/50 4,050,000

Points (5,000x 100) 500,000 5/50 450,000

5,000,000 4,500,000

Revenue from points 450,000

Payments to airline 5,000points x60 ( 300,000 )

Net revenue from points 150,000

Therefore, revenue from points is recognized when the electrical goods are sold.

1) To record the initial sale

 Cash 4,500,000
Sales 4,050,000
Revenue from points 450,000

2) To record payment to airline

Loyalty program expense 300,000

Cash 300,000