Current_Liabilities.pptx;filename= UTF-8''Current Liabilities.pptx

Current Liabilities

In-depth Topic

Christian James Alegre

IntroductionLiabilities represent amounts an entity owes for its debts or obligation. 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 characteristics:1. Present Obligation;2. Arising from Past Events;3. Probable Outflow of Resources embodying economic benefit

IntroductionAn 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 requirements; 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; or2. Constructive Obligation

IntroductionA legal obligation is one that derives from a contract, legislation, or other operation of law.

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, and as a result, the enterprise has created a valid expectation on the part of those other parties that it will discharge those responsibilities.

IntroductionLiabilities arise only from past events or transactions. For example, the mere signing of a purchase agreement with a supplier does not give rise to a liability. The liability will only arise if the entity acquires legally or constructively the title to the goods from the supplier. The past event in that case is the acceptance by the entity of the goods delivered by the supplier. In a similar manner, the mere signing of an employment contract with an employee does not give rise to a liability. The liability for salaries shall be recognized when an employee renders services to the entity.

IntroductionThe 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:1. Payment of cash;2. Transfer of assets;3. Provision of services;4. Replacement of an obligation with another obligation; and5. Conversion of the obligation to equity.

IntroductionA liability is recorded and reported in the statement of financial position when the following condition 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.

Provisions and ContingencyObligations involving uncertainties are either provisions or contingent liabilities. A provision is an obligation whose existence is certain as of the end of the reporting period, and only the timing of settlement or the amount to be settled is uncertain. The amount of the obligation, however, is reliably estimable.

Provisions and ContingencyProvision Contingency

Definition A liability of uncertain timing or amount.

Either a possible obligation that arises from past event and whose existence will be confirmed only by the occurrence or non occurrence of one or more future events not wholly within the control of the enterprise or a present obligation that arises from past event but is not recognized because it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation or the amount cannot be measured reliably.

Recognition Recognized as a liability on the face of the statement of financial position.

Not recognized as a liability on the face of the statement of financial position.

Presentation Presented separately as a liability in statement of financial position.

Unless remote, disclosed in the notes to the financial statement.

Provisions and ContingencyThus, based on the given table, obligation involving uncertainties are accounted for as presented below

Probable

Possible

Remote

Reliably Measurable

Not Reliably Measurable

Record by debitingAn expense or loss andCrediting a liability

Disclosed in the notes To the financial statements

Ignore

Provisions and ContingencyMeasurement of Provisions

The amount recognized as a provision should be the best estimate of the expenditure required to settle the obligation at the end of the reporting period, considering:a. Judgment of the management of the enterprise;b. Experience of similar transaction; orc. Reports from independent experts.

If a single obligation is being measured, the amount to be recognized as a liability is the most likely outcome.

Provisions and ContingencyMeasurement of Provisions

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 statement of financial position is the amount actually settled subsequently.

Where the provision being measured involves a large population of items, the obligation is estimated by weighing all possible outcomes by their associated possibilities (statistical method called expected value). Where there is a continuous range of possible outcomes, the midpoint of the range is used.

Provisions and ContingencyIllustration

In September 2012, Howell filed a suit against Blue Company, alleging violation of patent rights and it is seeking damages of P7,000,000. Blue disclaims the charges and the legal counsel advises that as of the date of issuance of Blue Company’s financial statements, it is probable that the enterprise will not be found liable.


ABC Company operates in a city where there is no environmental legislation. However, the company has a widely published policy in which it undertakes to clean up all contamination it causes. As of the date of the issuance of its 2013 financial statements, a reasonable estimate of the cost of this clean up related to 2013 operations is P2,000,000.


As a result of an uninsured accident during the year 2013, personal injury suit for P3,000,000 has been filed against XYZ Company. It is the judgment of the company’s legal counsel that an unfavorable verdict will result in a loss ranging from P1,800,000 to P2,800,000. The lawyer believes the most reasonable estimate is P2,200,000.


GHI Company sells goods with warranty under which customers are covered for the cost of any manufacturing defects that become apparent within the first year after purchase. If minor defects were detected in all products sold, repair cost of P2,000,000 would result. If major defects were detected in all products sold, repair cost of P5,000,000 would result. The enterprise’s past experience and future expectation indicates that 60% of the goods sold have no defect, 30% of the goods sold have minor defects and 10% of the goods sold have major defects.


JKL is charged with multiple lawsuits because of an incident that happened in February 2015, causing death of about 80 persons due to stampede in a sales promotion program it was airing through Channel 6 on February 10, 2015. Based on similar incidents suffered by other entities, JKL’s legal counsels are of the opinion that it is probable that JKL would be found liable for the incident. As of the date of the issuance of the 2015 financial statements, a reasonable estimate of the obligation is between P16,000,000 to P24,000,000. Each point within the range is as likely as any other.

Classification of LiabilitiesAn enterprise shall classify a liability as current when: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 date; andd. It does not have an unconditional right to defer settlement of the

liability for at least twelve months after the reporting period.

Classification of LiabilitiesIllustration

Dorina Inc. has P4 million of notes payable due June 15, 2016. at December 31, 2015, Dorina signed an agreement to borrow up to P4 million to refinance the note payable on a two-year basis. The financing agreement called for the borrowing not to exceed 75% of the value of the collateral Dorina was providing. At the date of the issue of the December 31, 2015 financial statements, the value of the collateral was P4.8 million and was not expected to fall below this amount.


Dorina Inc. has P4 million of notes payable due June 15, 2016. At February 14, 2016, Dorina signed an agreement to borrow up to P4 million to refinance the notes payable on a long term basis. The financing agreement called for the borrowing not to exceed 75% of the value of the collateral Dorina was providing. The value of the collateral was P4.8 million and was not expected to fall below this amount. The financial statements are authorized for issuance on March 4, 2016.


In October 2011, Vivian Corp. acquired a special equipment from Carlo, Inc. by paying P1,000,000 down and signing a note with a face value of P4,000,000 due October 2014. Under the terms of the financing agreement, Vivian has the discretion to roll over the obligation for at least fifteen months. In October 2013, management decides to exercise its discretion to roll over the liability up to October 31, 2015.


In October 2011, Vivian Corp. acquired a special equipment from Carlo, Inc. by paying P1,000,000 down and signing a note with a face value of P4,000,000 due October 2013. The existing loan agreement does not carry a provision to refinance. In October 2013, Vivian was experiencing financial difficulty and was unable to pay the maturing obligation. On February 1, 2014, Carlo has agreed not to demand payment for at least 12 months as a consequence of the breach of the payment on the principal of the loan. The financial statements at and for the period ended December 31, 2013 were authorized for issue on March 31, 2014.


In October 2011, Vivian Corp. acquired a special equipment from Carlo, Inc. by paying P1,000,000 down and signing a note with a face value of P4,000,000 due October 2013. The existing loan agreement does not carry a provision to refinance. In October 2013, Vivian was experiencing financial difficulty and was unable to pay the maturing obligation. On December 31, 2013, Carlo signed an agreement to provide Vivian a grace period of 15 months from that date, during which period, Carlo will not demand immediate payment in order to give Vivian the chance to rectify the breach. The financial statements were authorized for issue on March 31, 2014.


In October 2011, Vivian Corp. acquired a special equipment from Carlo, Inc. by paying P1,000,000 down and signing a note with a face value of P6,000,000 due in installments of P1,000,000 plus annual interest o the balance of the principal at the rate of 10%, the first installment being due on September 30, 2012. The existing loan agreement does not carry a provision to refinance and further states that any failure to pay the required installment and interest will make the full amount of the loan due and demandable. Further, the full amount of the principal and accrued interest shall be subject to interest if 10%. As of December 31, 2013, Vilma Corporation is already 3 months behind in the payment of the 2013 annual installment and interest.

Classification of LiabilitiesIf the following events occur between the end of the reporting period and the date of the financial statements are authorized for issue, these events are disclosed as non-adjusting events in the notes to the financial statements:1. Refinancing on a long-term basis;2. Rectification of a breach of long-term loan agreement;3. The granting by the lender of a period of grace to rectify a breach

of a long-term loan arrangement ending at least twelve months after the reporting period.

Also, any liability that has been excluded from current liabilities as a result of refinancing should be described and disclosed in the notes to the financial statements.

Current LiabilitiesThe major item usually found under the current liabilities section of the statement of financial position includes:1. Accounts Payable;2. Short-term notes payable;3. Deposits and Advances;4. Liabilities under trust receipt;5. Current portion of long-term debt;6. Accrued Liabilities;7. Income taxes payable;8. Dividends payable;9. Deferred Revenue;10. Provisions expected to be settled within 12 months; and11. Credit balances in customer account.

Non-current LiabilitiesThe major item usually found under the non-current liabilities section of the statement of financial position includes:1. Bonds payable;2. Mortgage Loans Payable;3. Long-term Notes Payable;4. Liability under Finance Leases not due within 12 months;5. Long-term Deferred Revenue.

WarrantiesWarranty arrangement require the seller to correct any deficiency in quality, quantity or performance of the merchandise sold, to replace the item, or to refund the selling price over a specified period of time after the sale. Warranty expense is recognized based on associating cause and effect. To properly measure an enterprise’s profit for the period, the expected costs related to revenues of the period shall be recognized as expenses in the same period in which sales are recorded, even if the expenditure is to be incurred at a subsequent period.

WarrantiesIllustration

JVC Electronics sells DVD and VCD systems with a two-year warranty. JVC estimates warranty costs as a percentage of peso sales as follows: first year of warranty, 3%; second year of warranty, 8%. Sales and actual repairs for 2013 and 2014 are:Sales for 2013 P2,500,000Sales for 2014 P4,750,000Actual warranty repair 2013 P53,000Actual warranty repair 2014 P184,500

WarrantiesThe warranty liability account should be reviewed periodically to determine if the actual repairs approximate the estimate. This assumption is called occurred evenly throughout the year.

Premiums and CouponAs part of a company’s marketing strategy to increase sales, premiums are offered to customers in exchange for labels, coupons, box, tops, wrappers or any other evidence of purchase. The cost of these premiums should be matched as expenses against the revenues in the period of sale. At the end of the reporting period during which the sale is made, an estimate must be made of the end-of-year outstanding premium offers that will be presented for future redemption.

Premiums and CouponIllustration

A company launched a new sales promotional program. For every P10 product box tops returned to the Company, customers receive an attractive prize. The company estimates that only 60% of the product box tops reaching the consumer market will be redeemed. Additional information is as follows:

Units AmountSales of products in boxes 2,000,000 P90,000,000Purchase of premiums 100,000 P800,000Premiums distributed to customers 82,000

Customer Loyalty AwardsCertain companies grant their customers rewards for patronage of their products and services. Examples of this scheme are awarding of points to SM advantage cardholders, accumulation of mileage for Philippine Airlines Mabuhay Miles frequent flyers, and other privilege cards which entitle holders to exchange points accumulated from purchases for goods and services of the entity. Such points, therefore, are used by the customers as part or full payment for goods and services offered by the company.

Under IFRIC 13, Customer Loyalty Programme, the consideration received by an entity for goods sold is apportioned between the product or service and the customer loyalty awards redeemable in the future based on relative fair values.

Customer Loyalty AwardsIllustration

Assume that SM Corporation grants its customers 2 rewards points for each P100 sales. Each point is redeemable in the form of merchandise and is equivalent to P1. The points accumulate and may be used by the customer as part of payment to the merchandise purchases in the future. During the month of April 2014, 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. By the end of the first year, 40% has been redeemed and it is expected that 90% if the points granted will be redeemed. During the second year, the company redeemed an additional 40% and it revised tits estimate of total points expected to be redeemed at 95%. For the third year, additional 20% was redeemed.

Liability for BonusAs incentive to officers and managers, many companies establish a bonus agreement, with the bonus usually payable shortly after the end of the year. The amount of bonus may be based on the amount of revenue or profit of the enterprise. This bonus is, in effect, part of salaries and compensation expense and is reported as an operating expense of the company. The bonus, if unpaid at year end, should be accrued by debiting Compensation expense and crediting bonus payable. The amount of bonus, if based on profit, is computed using different possible formulas.

Liability for BonusIllustration

Assume the following data for ABC Corporation:

Profit before deducting bonus and tax is P2,000,000. Bonus rate is 10% and income tax rate is 30%. Compute the bonus and tax based on the following scenarios:1. Bonus is based on profit before deducting bonus and tax;2. Bonus is based on profit after bonus but before tax;3. Bonus is based on profit before bonus but after tax;4. Bonus is based on profit after bonus and tax

Deposits and advancesDeposits and advances consist of cash or property received but which are returnable to the depositor or which have been collected or otherwise accumulated to be remitted to third parties.

If deposits or advance results from the company’s operating activities, the liability is normally reported as current. If the deposit is nontrade and is expected to be refunded or paid after more than one year, the liability is reported as non-current.

Deposits and advancesIllustration

Assume the following data for ABC Corporation:

Description Amount

Balance of Deposits for returnable containers, 01/01/14 P250,000

Deposits received for containers of products sold during 2014 800,000

Deposits refunded during 2014 upon return of containers 720,000

Deposits forfeited for containers not returned within the prescribed period 60,000

Cost of containers not returned within the prescribed period 55,000

Accumulated depreciation on containers not returned within the prescribed period.

15,000

Unearned Service ContractThe recognition of revenue from service contract is measured by the passage of time or the lapsing of the service contract period. To illustrate, assume the following information.

ABC Service Company sells service contracts for computer units that cover a two-year period. The sales price of each contract is P750. ABC’s past experiences shows that of the total pesos spent for repairs in service contract, 40% is incurred evenly during the first contract year and 60% evenly during the second contract year. During 2013, ABC sold 1,000 contracts . Cost of servicing the units during 2013 amounted to P80,000. For 2014, additional service contracts of 1,200 were sold and that the repairs were made evenly during the year. Cost of servicing the contracts during 2014 were P220,000.

Gift Certificates OutstandingSome retail store sell gift certificates to customers that are redeemable in merchandise. The sale of gift certificates creates a liability in the books of the retail store. The liability is settled either by redemption of the certificates in exchange for merchandise sold or by expiration of gift certificates

Gift Certificates OutstandingIllustration

Assume the following data for SM Corporation for the year 2013.

Description Amount

Unearned Revenue from Gift Certificate Outstanding, January 1, 2013 P500,000

Gift certificates issued during the year 2,000,000

Gift certificates redeemed during the year 1,800,000

Gift certificates relating to the entity’s promo that expired during the year 25,000

Additional outstanding gift certificate expected to expire during 2014 12,000

Value Added TaxVAT are levied on the sale of goods and certain services. VAT must be collected from the customer by the seller and remitted on a monthly basis to the proper government authority. The VAT payable is reported as current liability until the VAT are remitted to the BIR in the following period. In cases when the input VAT exceeds the output VAT, the excess is set u as an asset. Such excess reduces the amount of VAT that will be remitted to the BIR in the succeeding periods.

Payroll TaxesEmployers are required by law to withhold from the salaries of each employee an amount representing income taxes payable by employee as well as the employee’s share for SSS premium, Philhealth contribution, Pag-ibig contribution, union dues and various other amounts payable by the employees to third parties. These amount withheld from employee’s salaries are reported as current liabilities of the withholding company until they are remitted to the appropriate third parties.

THANK YOU!

Current_Liabilities.pptx;filename= UTF-8''Current Liabilities.pptx

Documents

Transcript of Current_Liabilities.pptx;filename= UTF-8''Current Liabilities.pptx