FAR 20 – CURRENT LIABILITIES
TOPIC OUTLINE
Liabilities
CURRENT
LIABILITIES
Measurement
Classification
Definition
Essential
Characteristics
Current Liabilities
Non-Current
Liabilities
LECTURE NOTES
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 of Liabilities:
1. Liabilities are PRESENT OBLIGATION. It is NOT NECESSARY that the payee to
whom the obligation is owed be identified. What is important is that the entity
identifies itself as liable to another entity.
2. Liabilities arise from PAST TRANSACTIONS OR EVENTS. This means that the
liability is not recognized until it is incurred. The past event that leads to a present
obligation is called an Obligating Event.
An Obligating event is an event that creates a legal (settlement of the
obligation can be enforced by law or contract) or constructive obligation
(the event creates valid expectation on the part of other parties that the entity
will discharge the obligation, as in the case of constructive obligation)
because the entity has no realistic alternative but to settle the obligation
created by the event.
3. The settlement of the liability REQUIRES AN OUTFLOW of economic resources
embodying economic benefits.
Settlement may be in the form of:
(a) Payment of Cash
(b) Transfer/Payment of Non-Cash Assets;
(c) Provision of Future Services
Note: This characteristic is the main reason why STOCK DIVIDENDS
PAYABLE is NOT a LIABILITY but rather presented within EQUITY
in balance sheet.
MEASUREMENT
CLASSIFICATION
Initial
Measurement
Subsequent
Measurement
Amortized?
Financial
liabilities
at Fair
Value
through
FINANCIAL Profit or
LIABILITIES loss
(FVPL)
Financial
liabilities
at
Amortized
Cost
Fair Value
(FV)
Fair Value
Fair Value
minus
Transaction
Cost
(FV – TC)
Best Estimate
of Cash
Outflow
NON-FINANCIAL
LIABILITIES
No
Fair
Value
Changes
Yes
(Presented
in Profit or
Loss)
Interest
Expense is
based on
Nominal
Rate
Amortized
Cost
Yes
No
Effective
Rate
Best Estimate
of Cash
Outflow
Yes, if
measured at
present
value
No
Usually,
Effective
Rate if the
liability is
measured at
present
value
NOTES:
a. Transaction costs are expensed immediately if the financial liability is designated
initially as at fair value through profit or loss. Transaction costs are incremental cost
that are directly attributable to the issue of a financial liability.
b. Transaction costs include:
o Fees and commissions paid to agents, advisers, brokers and dealers.
o Levies by regulatory agencies and security exchanges.
o Transfer taxes and duties.
Transaction costs do not include:
o Debt premiums or discounts
o Financing costs
o Internal administrative or holding costs
c. Financial liabilities are classified as FVPL (1) through irrevocable designation or
(2) if the liability is held for trading (liabilities with an intention to repurchase them
in the near term)
d. The “amortized cost” of a financial liability is the amount at which the financial
liability is measured at initial recognition minus principal repayment, plus or minus
the cumulative amortization using the effective interest method of any difference
between the initial amount and the maturity amount.
FINANCIAL STATEMENTS CLASSIFICATIONS
An item of liability is classified as current liability if it met any of the following:
1. The entity expects to settle the liability within the entity’s normal operating cycle.
2. The entity holds the liability primarily for the purpose of trading.
3. The liability is due to be settled within twelve months after the reporting period.
4. The entity does not have an unconditional right to defer settlement of the liability
for at least twelve months after the reporting period.
NOTE: If an item did not meet any of the criteria above, it is classified as noncurrent liabilities.
Examples of Current Liabilities:
o
o
o
o
o
o
o
o
o
o
o
o
o
o
o
Trade and other payables (a)
Financial liabilities held for trading
Current portion of long-term debt
Short-term borrowing
Current provisions
Current tax liability
Bank overdraft
Credit balances in accounts receivable
Unearned income realizable within 12 months (b)
Accrued expenses
Long-term debt currently maturing
Refundable deposits (c)
Payroll taxes payable (d)
Value-added Taxes (VAT) payable (Output VAT less Input VAT)
Escrow liability (e)
Note: Non-trade payables are classified as current liabilities if are the due for settlement
within twelve months after the reporting period or held primarily for the purpose of being
traded.
REFINANCING OF CURRENTLY MATURING OBLIGATION:
GENERAL RULE: A currently maturing obligation is presented as CURRENT
LIABILITY.
EXCEPTIONS: (The liability is presented as NON-CURRENT LIABILITY if it met
any of the following conditions)
(1) The company has the prerogative/option/unconditional right to refinance the
liability.
(2) If there is no right but refinancing was completed on or before the balance sheet
date.
Refinancing may be done thru extension of maturity date or through issuance of bonds the
proceeds of which is used to settle the currently maturing obligation.
Here’s a clear guidance on the above concept, please see the following concept map:
With unconditional right to refinance
the liability (NON-CURRENT
LIABILITY)
But refinancing was made ON or
BEFORE year-end (NONCURRENT LIABILITY)
Without unconditional right to refinance
the liability
But refinancing was made AFTER
year-end (CURRENT LIABILITY)
RULES ON
REFINANCING
GENERAL RULE: If the company breached a covenant or contract, the long-term
obligation BECOMES IMMEDIATELY DEMANDABLE, thus presented as a CURRENT
LIABILITY.
EXCEPTIONS: (The liability is still presented a NON-CURRENT LIABILITY under
the following conditions)
(1) If the creditor agreed to give the debtor a grace period for at least 12 months after
the balance sheet and;
(2) The said grace period was provided on or before the balance sheet date.
To provide a clear guidance on the above concept, please see the following concept map:
BREACH OF CONTRACTS
BREACH OF
COVENANT
No grace period was
agreed upon (CURRENT
LIABILITY)
Grace period was agreed
upon
After balance sheet date
(CURRENT
LIABILITY)
On or before balance
sheet date
TRADE AND OTHER PAYABLES (a)
Grace period given was
lesson than 12 months
(CURRENT
LIABILITY)
Grace period given was
equal or more than 12
months
(NON-CURRENT
LIABILITY)
The frequently asked question regarding trade accounts payable is its adjusted balance. As
a guide in computing such, please see the below template:
SOLUTION GUIDE
Unadjusted balance
xx
Add: Post-date checks and unreleased checks
xx
Debit balances in AP (if the unadjusted balance is a net amount) xx
Less: Unrecorded purchase returns and allowances
(xx)
Discounts forfeited (under net method)
Effect of Freight terms
Adjusted balance
(xx)
xx(xx)
xx
In relation to freight terms, please see the following guide (Please see FAR 05-Inventories)
 If the goods were in transit to the entity and the freight term is
o FOB Shipping Point – Accounts Payable and purchases should be increased.
o FOB Destination – Ignore, purchases and accounts payable should be
increased upon arrival of the goods.
 In relation to freight cost, its effect on accounts payable depends on the freight terms
as well and are summarized below:
Effect on Account Payable?
FOB Shipping Point, Freight Collect
No Effect
FOB Shipping Point, Freight Prepaid
Increase
FOB Destination, Freight Prepaid
No Effect
FOB Destination, Freight Collect
Decrease
UNEARNED INCOME (b)
 Deferred revenue or unearned revenue is income already received but not yet
earned. Unearned income may come from:
 Goods (Advances from customer)
 Services (Unearned income from service contracts, unearned subscription
revenue)
 Use of entity’s resources (Unearned interest income, unearned rental income)
 Gift Certificates
Deferred revenue may be realizable within one year or in more than one year from the end
of reporting period.
If the deferred revenue is realizable within one year, it is classified as current liability.
Typical examples of current deferred revenue are unearned interest income, unearned rental
income and unearned subscription revenue. If the deferred revenue is realizable in more
than one year, it is classified as noncurrent liability. Typical examples of non-current
deferred revenue are unearned revenue from long-term service contracts and long-term
leasehold advances.
In relation to unearned income, the frequently asked questions are (1) Earned Portion
(Income); (2) Ending balance of unearned income. To answer such question, use the Taccount in relation to unearned income:
Unearned Income
Earned Portion
xx
Beginning Balance
xx
Cash receipts
xx
End. Balance
xx
For unearned income from gift certificates, please use the modified T-Account:
Gift Certificates Payable
Redemption (whether from prior or xx
Beginning Balance
xx
Cash receipts from sales
xx
End. Balance
xx
current year sales)
Expired Portion
xx
REFUNDABLE DEPOSITS (c)
Refundable deposits consist of cash or property received from customers but which are
refundable after compliance with certain conditions.
The frequently asked question regarding refundable deposits would be its ending balance
at balance sheet date. Use the following T-account as a guide in answering such questions:
Liability for Deposits
Deposits returned or applied
xx
Beginning Balance
xx
Deposits cancelled
xx
Cash receipts
xx
Deposits expired
xx
End. Balance
xx
PAYROLL TAXES PAYABLE (d)
Under our law, the entity as an employer is required to withhold from the salaries of each
employee the following:
ESCROW LIABILITY (e)
(a) Income tax payable by the employee
(b) Employee’s contribution to the Social Security System or SSS
(c) Employee’s contribution doe PhilHealth
(d) Employee’s contribution to the Pag-ibig Fund
Such amounts withheld from the salaries of the employees shall be recognized as “payroll
taxes payable” until remitted by the entity to the appropriate government authority. In
addition to the amounts withheld from the salaries of the employees, the entity is required
by law to make a contribution for SSS.
Escrow is the use of a third party, which holds an asset or funds before, they are transferred
from one party to another. The third party holds the funds until both parties have fulfilled
their contractual requirements. The frequently asked question regarding escrow liability is
its ending balance. To help in solving such, please use the following T-account:
Escrow Liability
Cash transfer or payments
xx
Beginning Balance
xx
Interest and other charges paid
xx
Cash receipts
xx
Interest income
xx
End. Balance
xx