CHAPTER 1

LIABILITIES
QUESTION 1-1
Define liabilities.
ANSWER 1-1
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.

QUESTION 1-2
What are the essential characteristics of an accounting
Iiability?
ANSWER

1-2

a. The liability is the present obligation

of a particular entity.

The entity liable ntust be id'entified'.It is not necessary that

the payee to whom the obligation is olved be identifi-ed-

b.

The liability arises from post transaction or euent.

it

is

c. The settlement of the liability requires an outflow

of

This means that the liability is not recognized until

incurred.
resources embodying economic benefits.

This is the very heart of the definition of an accounting

liability. The obligation must be to pay cosh', transfer noncash

ossel or prouide seruice at some future time.

,l

QUESTTON

1-3

Give exanrples of liabilities.

ANS\4IER'1-3
The more commorl types of liabfities include the following:

a. Accounts payable to suppliers for the purchase of goods or

b.

c.
d.
e.

f.
g.
h.

services
Amounts withheld from ernployees or other parties for taxes
and for contributions to the Social Security System or to
pension funds
Accruals for wages, interest, royalties, taxes, product
w'arranties and profit sharing plans
Dividends (not stock dividends) declared but not paid
Deposits and advances from customers, officers and
shareholders
Debt obligations for borrorved funds - notes, mortgages and
bonds payable
Incorne tax payable
Unearned revenue

QUESTTON 1-4
Explain the "initial measurement" of liabilities.
ANSWER 1-4
PFRS 9, paragraph 5.1.1, provides that an entity shall
measure initiolly a financial liability at its fair value minus,
in the case of financial liability not designoted at fair uolue
th,rou,gh profit or loss, transaction costs that are directly
attributable to the issue of the financial 1iability.

In other words, the transaction costs are included in the

initial measurement of a financial liability measured. at
amortized cost.

I
However, the transaction costs are expensed imrnediately
if the financial liability is designated initiol'ly o,s at fair ualue
through profit or loss.

Transaction costs are incremental costs that are d.irectly

attributable to the issue of a financial liability'
An incremental cost is one that would not have been incurred
if the entity had not issued the financiat liability'

Transaction costs include:

a.

b.
c.

Fees and. commissions paid to agents, advisers, brokers

and dealers
I-evies by regulatory agencies and securities exchanges
Transfer taxes and duties

Transaction costs do not include:

a.
b.

c.

Debt premiums or discounts

Financing costs
Internal administrative or holding costs

QUESTTON 1-5
what is the meaning of "fair value" of a financial liability?

ANSWER

1-5

Fair Value is the amount for which a liability is settled between

knowledgea-ble and willing parties in an arm's length
transaction.

In other word.s, the "fair value" of the liability is equal to the

present value of the future cash payment to settle the
obligation.
,,present value" is the discounted arnount of the
The term
future cashoutflow in settling an obligation using the market
rate of interest.

QUESTTON 1-6
Explain the "subsequent measurement" of liabilities.

-L\SWEB r4
PFRS.9, paragraph ?.8-,1, provides that after initial
rccognition, an entity
shall measure a

a- At

ri".""iui-ri"tiliiy:---

arnortized cost, using the effective interest method.

ualue through piofit o, 1o.".

b. At fair

QUESTTON 1-7

[hat is the meaning of "amortized

liability?

cost" of a financial

ANSWER r-7
The "amortized cost" of a financial Iiability is the
amount at
which the financiar riability i. *"r""."a
i;iti;i
il*"grritio,
minus.principal repaymerr!, plus or minus
"; the cumulative
amortization using the effective inter,e"t *u-trroa^^"r
difference between t[e initial amount and ih; ;;;;;-rmount.
""y

simply stated, th-e difference between the face amount and

present value of the financial liability is amortiz"a-".i"s
tlr"
effective interest method.

Actually, the difference between the face amount and present

yaluq is either discount or premium;1h;'G;;liliu""irr
liability.
QUESTTON 1_8
Explain the measurement of noncurrent liabilities.

ANSWER r-8
Noncurrent liabilitie.s, for exarnple, bond payable
and
noninterest' bearing
payabfi, ;e inrtiariy -m!uJ"""a rt
rote
present value and subsequentty measured.;i
ilil;fcost.

If the long-term note payabre is inta-est-be-aring, it is

and subseouentlv meaiyied at face ar"ount becais"i, initiany
thi.
the face amount i"
"u"",

"q"J;;thu

;;;;;;;i""

"r-tr* ""i"

p"vru".

QUESTTON l-e
Explain the measurement of atrrent liabilities.
ANSWER 1-9
Conceptually, alT liabilities are initially measured at present
value and subsequently measured at amortized cost'

However, in practice, cLlrrerut lio'bilities or short-term

obligations are not discounted anymore but measured and
reported at their 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.

QUESTTON 1-10

Explain the "fair value option" of measuring a financial

liability.
ANSWER 1-10
PFRS 9, paragraph 4.2.2, provides that at

initial recognition

an entity may irrevocably designate a financial liability

at fair ualue through profit or loss when doing so results in
more relevant information.

In other words, under the fair value option, the financial

Iiability, for example, bond payable, is measured at fair value
at ev.ery year-end and any change in fair value is recognized
in profrt or loss.

The amortization rules for issue cost, discount or premium

no longer aptrlY.

Accordingly, under the fair value option, the interest

expense is recognized using the nominal or stated interest
rate and not the effective interest rate.

QUESTTON 1-11
What are "estimated liabilities"?

ANS\IER 1-1r
Estintated liobi.lities are obligations which exist at the end
of reporting period although their arnou,t is not definite.

In many

cases, the date rvhen the obligation is due is not

also definite and in some instances, the exact payee cannot

be identified or determined. But inspile of these

circumstances, the existence of the estimated liabilities is
valid and unquestioned.
Estimated liabilities are either current or noncurrent in
,nature. Examples include estimated liability for prernium,
'award
points, warranties, gift certificates urrd bo.,rr*.

Under PAS 37, an estimated liability is considered as

"provision" which is both probable and measurable.

The subject matter of provision is discussed iengthily in

Chapter 2.

QUESTION 1-12
Explain an estimated premium iiability.
ANSWER 1-12
Premiunts are articles of value such as toys, dishes, silven'are,
and other goods and in some cases cash payments, given to
customers as result of past sales or sales promotion activities.

In order to stimulate the sale of their products, entities offer

premiums to customers in return for product labels, box tops,
wrappers and coupons.
Accordingly, when the merchandise in sold, an accounting
Iiabfity for the future distribution of the premium arises and
should be given accounting recognition.

QUESTTON 1-13
What is a customer loyaltY Program?
ANSWER 1-13
Many entities use a customer }oyalty program to build brand
loyalty, 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.
buys goods or services, the entity grants the
customer award credits often described ds "points".

If a customer

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.

QUESTION 1-14
Explain the recognition and measurement of the "points"
awarded under a customer loyalty program.
ANSWER 1-14
Under IFRIC 13, an entity shall account for the arvard
credits as a "separate 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".

Accord.ingly, the fair value of the consideration received with

respect to the initial sale shall be allocated between the
awald credits and the sale.

The consideraiton allocated to the award credits is measured

at fair value, meaning, the amount for rvhich the award
credits could be sold separately.

The subsequent recognition of the amount allocated to the

an-ard credits as revenue depends on the following:

a. The entity supplies the awards itsetf.

b. A third party supplies the awards.
QUESTTON 1-15
Explain the recognition of the award credits "if the entity
supplies the awards itself'.
ANSWER 1-15

If the entity

supplies the awards itself, the consideration

allocated to the award credits is initiary recognized as
deferred revenue and subsequently recognized r-.
when the award credits are rldeemed.
""rr".r"
The amount of reuenue recognized, shalt be based. on the
number of award credits that haue been redeented, rela.tiue
to the total number expected to be red,eemed,.

In other words, the calculation of the revenue to be

recognized in any one pgriod is made on a "cumulative basis"
in order to reflect the changes in estimate.
QUESTION 1-16
Explain the recognition of the award credits "if a third party
suppiies the awards".

ANSWER 1-16

If a third party supplies the awards, the entity shall assess

whether it is collecting the consideration allocated to the
award credits on its own account as principal in the
transaction, or on behalf of the third purty as alent of the
third party.

Whether as principal or agent, the revenue from the award

credits is recognized at the point of initial sale.
The reason is that at this point, the entity has already fuifilled
its obiigation to the customer by granting the arvard credits
and the third party is obliged to supply the au'ards and of
course entitled to receive consideration for doing so.

as principal in
the transaction, the amount of revenue is equal to the gross
consideration ailocated to the award credits.

If the entity is collecting the consideration

as agent of the
net arnount
to
the
third party, the amount of revenue is equal
retained on its own account.

If the entity is collecting the consideration

This net amount is the difference between the consideration

ailocated to the award credits and the amount payable to
the third party for supplying the awards.

QUESTION 1-17
Explain an estimated warranty liability.
ANSWER 1-17
Home appliances like television sets, stereo sets, ratio sets,
refrigerators and the Iike are often sold under guarantee or
warranty to provide free repair service or replacement
during a specified period if the products are defective.
Such entity policy may involve significant costs on the part
of the entity if the products sold prove to be defective in the
future within the specified period of time.

Accordingly, at the point of sale, a construetive obligation

arises and a liability is incurred-

QUESTION 1-18
Explain "payroll taxes payable".
ANSWER 1-18
Under our law, the entity as an empioyer is required to
withhold from the salaries of each ernployee the following:

a. Income tax payable by the employee

b. Employee's contribution to the Social

c.

d.

Security System

or SSS
Employee's contribution for Phithealth
Employee's contribution to the Pag-ibig Fund

Other deductions may be made by the employer from the

salaries of the employee for union dues and group insurance
as required by contract.
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, Philhealth and Pag-ibig fund
representing its share in the benefits of the employees.

QUESTION 1-19
Explain "value added taxes payable".
ANSWER 1-19

Under the National Internal Revenue Code, an entity is

required to collect value added taxes from customers on sales

of tangible personal property and certain services.

Such value added taxes collected shall be recognized. as
"value added taxes payable" and remitted monthly to the
'Bureau of Internal Revenue.
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QUESTION L-20
Explain "gift certificates payable".
ANSWER 1-20
Many megamalls, department stores and supermarkets sell
gift certificates which are redeemable in merchandise'
When the gift certificates are sold, the amount received is
initially recognized as unearned revenue or specifically "gift
certificates paYable".

The subsequent redemption of the gift certificates is

recognized by debiting gift certificates payable and crediting
sales revenue.

The gift certificates may expire in one or two years'

The gift certificates are forfeited as other income when not
presented for redemption during the specified period'

QUESTION 1-21
What are "refundable dePosits"?
ANSWER 1-21
Refund.able d,eposits consist of cash or property received from

but which are refundable after compliance with

".rrto*"rt
certain conditions.

The best example of a refundable deposit is the customer

deposit required for returnable containers like bottles,
drums, tanks and barrels'

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lr
t1

QUESTTON 1-22

What are the four variations in the bonus computation?

ANSWER 1-22

Large entities often compensate key officers and emproyees

by way of bonus for superior income realized during the year.

The main purpose of this scheme is to rnotivate 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 incom.e ofter

bonus and ofter tax.

4.

Bonus is expressed as a certain percent of income after

tax but before bonus.

QUESTTON 1-23
Explain a "deferred revenue".
ANSWER 1-23
Deferred revenue or unearned revenue is income alreadv
received but not yet earned
Deferred revenue may be realizable within one year or in
rnore than one year frorn the end of reporting period.

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If the deferred revenue is realizable lvitirin

classified as current liability'

one year,

it

is

unearned
Typical examples of current d'eferred reL'eruLLe are
interest income, unearned' rental income and unearned
subscriPtion revenue'

If the d'eferred revenue is reaiizable in nrore than

it is classified as noncurrent liability'

one year,

are
Typical examples of non'cut'ren't del'erred reuenue and
unearned' revenue from long-term service contracts

long-term Ieasehold advances'

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