MODULE 5 :

CURRENT LIABILITIES
Daizy P. Nicart, CPA
Liabilities
Liabilities are present obligation of an entity to transfer an
economic resource as a result of past events. (Revised
Conceptual Framework for Financial Reporting).

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Essential
Characteristics of An
Accounting Liability

❑ The liability is the present obligation of

a particular entity.
✓ the entity liable must be identified.
✓ Present obligation may be a legal
obligation or a constructive obligation.
➢ Legally enforceable - binding
contract or statutory requirement
➢ Constructive obligation – give rise to
liabilities by reason of normal
business practice, custom and a
desire to maintain good business
relations or act in an equitable
manner.
Essential
Characteristics of An
Accounting Liability

❑ The liability arises from past event.

✓ Not recognized until incurred.

✓ The past event that leads to a legal
or constructive obligation is know as
the obligating event.
Essential
Characteristics of An
Accounting Liability
❑ The settlement of the liability requires
an outflow of resources embodying
economic benefits.
✓ The obligation must be to pay cash,
transfer noncash asset or provide
service at some future time.
Example of Liabilities

o Accounts payable to suppliers.

o Amounts withheld from employees
(taxes, SSS, Pag-ibig, etc.)
o Accruals for wages, interests, taxes,
warranties, etc.
o Dividends (not stock dividends)
declared but not paid
o Deposits and advances from customers
and officers.
o Debt obligations for borrowed funds
o Income tax payable
o Unearned revenue
Measurement of Current
Liabilities
• Conceptually, all liabilities are initially measured at present
value and subsequently measured at amortized cost.

• Current liabilities or short-term obligations are not discounted

anymore but measured, recorded and reported at their face
amount.

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Current and Non-
current classification
Liabilities are classified as current when it
satisfies any of the following:
a. It is expected to be settled in the
entity’s normal operating cycle
b. It is held primarily for the purpose of
being traded;
c. It is due to be settled within twelve
months after the balance sheet date;
d. The entity does not have an
unconditional right to defer settlement
of the liability for at least twelve
months after balance sheet date
Current and Non-
current classification
NON-CURRENT LIABILITIES – are
liabilities not classified as current.
o Non-current portion of long-term debt
o Finance lease liability
o Deferred Tax Liability
o Long-term obligations to company
officers
o Long-term deferred revenue
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.

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Long term Debt falling due
within one year
❖ 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.

❖ 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.

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Covenants

o Covenants are often attached to

borrowing agreement which represent
undertakings by the borrower. These
are restrictions on the borrower as to
undertaking further borrowings, paying
dividends, maintaining specified level of
working capital and so forth.

o Under covenants, if certain conditions

relating to the borrower’s financial
situation is breached, the liability
becomes payable on demand.
Presentation of Current
Liabilities
• The face of the statement of financial
position shall include the following line
items for current liabilities:

1. Trade and other payables

2. Current provisions

3. Short-term borrowing

4. Current portion of long-term debt

5. Current tax liability

Estimated Liabilities

❑ Estimated liabilities are obligations which

exist at the end of reporting period although
their amount is not definite.

❑ The existence of the estimated liabilities is

valid and unquestioned.

❑ Estimated liabilities are either current or

noncurrent in nature.

❑ Examples : 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.

❑ If the deferred revenue is realizable within

one year, it is a current liability.

❑ Examples of deferred revenue: unearned

interest income, unearned rental income,
and unearned subscriptions revenue.

❑ If the deferred revenue is realizable within

one year, it is classified as non-current
liability (e.g. unearned revenue from long-
term service contracts and long-term
leasehold advances).
Deferred Revenue : Example
An entity sells equipment service To record the cash receipts from service contracts
sold
contracts agreeing to service
equipment for a 2-year period. Cash 1,000,000

Unearned service rev 1,000,000

The following transactions occur in
the first year :
To record the service contract costs paid

Cash receipts from service Service contract expense 500,000

1,000,000
contracts sold

Service contract costs paid 500,000 Cash 500,000

Service contract revenue

800,000
recognized
To record the service contract revenue recognized

Unearned service revenue 800,000

Service contract rev 800,000

Bonus Computation

Bonus computation has four variations :

❑ Bonus is expressed as a certain percent of

income before bonus and before tax

❑ Bonus is expressed as a certain percent of

income after bonus but before tax

❑ Bonus is expressed as a certain percent of

income after bonus and after tax

❑ Bonus is expressed as a certain percent of

income after tax but before bonus
 Bonus Computation
o Bonus is expressed as a certain percent
Illustration: of income after bonus but before tax
Bonus = 10% (I-B)
Income Before Bonus and
Before Tax (I) 4,400,00 Bonus = 10% (4,400,000 – B)
Bonus (B) 10%
Bonus = 400,000
Income Tax Rate (R) 30%
o Bonus is expressed as a certain percent
Note : Tax is a % of I-B of income after bonus and after tax

Bonus = 10% (I-B-T)

o Bonus is expressed as a certain Bonus = 10% (4,400,000 –B-T)

percent of income before bonus and Bonus = 287.850

before tax
o Bonus is expressed as a certain percent
Bonus = I x R
of income after tax but before bonus
Bonus = 4,400,000 x 10% Bonus = 10% (I-T)

Bonus = 440,000 Bonus = 10% (4,400,000 –T)

Bonus = 317,526
Refundable Deposits

❑ Refundable deposits consist of cash or property

received from customers but which are
refundable after compliance with certain
conditions.

❑ The containers’ deposit account is usually

classified as current liability.

❑ If the customer returns the containers, the

deposit is refunded.

❑ If the customer fails to return the containers,

the deposit is considered the sale price of the
containers and the excess of the deposit over
the cost of the containers is considered as gain.
EXERCISES
Problem 1-1 (Glare Company)
Problem 1-3 (Manchester Company)
Problem 1-5 (Cordillera Company)
Problem 1-16 (Cobb Company)
Problem 1-23 (Farr Company)
ASSIGNMENT
Problem 1-2 (Easy Company)
Problem 1-4 (Multiple Company)
Problem 1-6 (Intercon Company)
Problem 1-17 (Regal Company)
Problem 1-27 (Nature Company)
PREMIUM LIABILITY

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PREMIUM

❑ Premiums are article of value such as toys,

dishes, silverware and other goods given to
customers as result of past sales or sales
promotion activities.

❑ Accordingly, when the merchandise is sold, an

accounting liability for the future distribution of
the premium arises and should be given
accounting recognition.
PREMIUM
The Accounting procedures for the acquisition of premiums
and recognition of the premium liability are as follows:

When the premiums are purchased

Premiums xx

Cash xx

When the premiums are distributed to customers

Premium Expense xx

Premiums xx

At end of the year, for outstanding premiums

Premium Expense xx

Est. Premium Liability xx

Premium : Illustration
An entity manufacturers a certain product To record the Sales
and sells it at P300 per unit.
Cash 3,000,000

A soup bowl is offered to customers on the Sales 3,000,000

return of 5 wrappers plus a remittance of
P10. To record the purchase of the premiums

The bowl costs P50, and it is estimated Premiums-soup bowl 100,000

that 60% of the wrappers will be Cash 100,000
redeemed.
To record the redemption of the 4,000 wrappers
The data for the first year concerning the
premium plan are summarized below: 4,000 wrappers / 5 = 800 bowls distributed

Cash (800 x 10) 8,000

Sales, 10,000 units at P300
3,000,000
each
Premium Expense (800x40) 32,000
Soup bowls purchased, 2,000
100,000 Premium – soup bowls
units at P50 each 40,000
(800 x 50)
Wrappers redeemed 4,000
Premium : Illustration
An entity manufacturers a certain product To record the liability for the premiums at the end of
the first year:
and sells it at P300 per unit.
Premium Expense 16,000

A soup bowl is offered to customers on the Estimated Premium Liab 16,000

return of 5 wrappers plus a remittance of
P10.

Wrappers to be redeemed
The bowl costs P50, and it is estimated 6,000
(60% x 10,000 wrappers)
that 60% of the wrappers will be
redeemed. Less : Wrappers redeemed 4,000

Balance 2,000
The data for the first year concerning the Premiums to be distributed
premium plan are summarized below: 400
(2,000/5)

Estimated Liability (400 x 40) 16,000

Sales, 10,000 units at P300
3,000,000
each
Soup bowls purchased, 2,000
100,000
units at P50 each

Wrappers redeemed 4,000

Cash Rebate Program

❑ A variation of a premium offer is a cash rebate

program

❑ Cash register receipts, bar codes, rebate

coupons and other proof of purchase often can
be mailed to the manufacturer for cash rebates.

❑ The estimated amount of the cash rebate

should be recognized both as an expense and
an estimated liability in the period of sale.
Cash Rebate : Illustration
An entity offered P500 cash rebate on a To record the cash rebate program
particular model of TV set. The customers
must present a rebate coupon enclosed in Rebate expenses 800,000
every package sold plus the official
Estimated Rebate Liability 800,000
receipt.

Past experience indicates that 40% of the To record the payments to customers
coupons will be redeemed. Estimated Rebate Liability 450,000

During the current year, the entity sold Cash 450,000

4,000 TV sets and total payments to
customers amounted to P450,000.

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 800,000

Cash Discount Coupon

❑ The cash discount coupon program is a

marketing tools for the purpose of stimulating
sales.

❑ An expense and an estimated liability for the

expected cash discount should be recognized in
the period of sale.
Cash Discount Coupon :
Illustration
During the current year, and entity inserted Face amount of coupons to be
1,650,000
in each package sold a coupon offering redeemed (30% x 5,000,000)
P300 off the purchase price of a particular Multiply by (100% face plus 10%
110%
handling)
brand of product when the coupon is
presented to retailers. Total Coupon Liability 1,650,000

The retailers are reimbursed for the face To recognize the cash discount coupon offer
amount of coupons plus 10% for handling.
Previous experience indicates that 30% of Cash discount coupon expense 1,650,000
coupons will be redeemed.
Estimated Coupon Liability 1,650,000

During the current year, the entity issued

coupons with face amount of P5,000,000 To record the payments to retailers
and total payments to retailers amounted
Estimated Coupon Liability 1,100,000
to P1,100,000.
Cash 1,100,000
Customer Loyalty
Program
❑ The customer loyalty program is generally
designed to reward customers for past
purchases and to provide them with incentives
to maker further purchases.

❑ If a customers 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 customers free or discounted goods or
services.
Customer Loyalty
Program :
Measurement
❑ The entity shall account for the award credits as
a “separately component of the initial sale
transaction” or effectively as a “future delivery
of goods or services”

❑ The fair value of the consideration received with

respect to the initial sale shall be allocated
between the award credits and the sale based
on relative stand-alone selling price.

❑ The stand-alone selling price is the price at

which an entity would sell a promised good or
service separately to a customer.
Customer Loyalty
Program : 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.

Sale = Sale of goods (Revenue) + Fair Value of

Credits (Deferred Revenue)

❑ 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 calculation of the revenue to be recognized

in any one period is made on a “cumulative”
basis in order to reflect the changes in estimate
 Customer Loyalty Program:
Illustration
An entity, a grocery retailer, operates a customer Product Sales 9,000,000
loyalty program.
Points-stand alone selling price
1,000,000
(10,000 x 10 )
o The sales during 2020 amounted to
P9,000,000 based on stand-alone selling Total 10,000,000
price.
Product Sales (9M / 10M x 9M) 8,100,000
o During 2020, the customers earned 10,000
points.
Points (1M / 10M x 9M) 900,000
o But management expects that 80% or 8,000
of these points will be redeemed. Total Transaction Price 9,000,000
o The stand alone selling price of each loyalty
point is estimated at P100.
o On December 31, 2020, 4,000 points have To record the initial sale in 2020:
been redeemed in exchange for groceries.
Cash 9,000,000
o In 2021, management revised expectations
and now expects that 90% or 9,000 points
Sales 8,100,000
will be redeemed altogether.
o During 2021, the entity redeemed 4,100 Unearned Revenue-points 900,000
points. In 2022, a further 900 points were
redeemed.
o Management continues to expect that only
9,000 points will ever be redeemed,
meaning, no more points will be redeemed
after 2022.
 Customer Loyalty Program:
Illustration
An entity, a grocery retailer, operates a customer Redemption of Points in 2020:
loyalty program.
Unearned Revenue-points 450,000
o The sales during 2020 amounted to
P9,000,000 based on stand-alone selling Sales 450,000
price.
4,000/8,000 x 900,000
o During 2020, the customers earned 10,000
points.
Redemption of Points in 20201
o But management expects that 80% or 8,000
of these points will be redeemed. Unearned Revenue-points 360,000
o The stand alone selling price of each loyalty
point is estimated at P100. Sales 360,000
o On December 31, 2020, 4,000 points have
been redeemed in exchange for groceries. Points Redeemed in 2020 4,000
o In 2021, management revised expectations
and now expects that 90% or 9,000 points Points Redeemed in 2021 4,100
will be redeemed altogether.
o During 2021, the entity redeemed 4,100 Total Points Redeemed to Dec 31/21 8,100
points. In 2022, a further 900 points were
Cumulative Revenue on Dec 31 2021
redeemed. 810,000
(8,100/9,000 x 900,000)
o Management continues to expect that only
9,000 points will ever be redeemed, Revenue Recognized in 2020 (450,000)
meaning, no more points will be redeemed
after 2022. Revenue to be recognized in 2021 360,000
Customer Loyalty
Program : Third Party
Operates the Program
❑ Customer Loyalty programs that are operated
by third party, the revenue from points is
recognized when the goods are sold.

To record the initial salec

Cash xxx

Sales xxx

Revenue from points xxx

To record payment to the third partyc

Loyalty program expense xxx

Cash xxx
EXERCISES
Problem 2-1 (Miracle Company)
Problem 2-4 (Sony Company)
Problem 2-15 (Sharlene Company)
ASSIGNMENT
Problem 2-3 (Pop Company)
Problem 2-6 (Mill Company)
Problem 2-13 (Clam Company)
WARRANTY

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WARRANTY PROVISION

❑ Promise made by a seller to a buyer to make

good on a deficiency of quantity, quality, or
performance in a product.

❑ If it is probable that customers will make

warranty claims and a company can
reasonably estimate the costs involved, the
company must record an expense.

❑ The amount recognized as the warranty

provision should be the best estimate of the
expenditure to settle he present obligation.

❑ When no reliable estimate can be made, no

warranty liability is recognized.
 Accounting for
Warranty : Accrual
Approach
❑ The accrual approach has the soundest theoretical
support because it properly matches cost with revenue.

▪ Estimated warranty cost recording :

Warranty Expense xxx

Estimated Warranty Liability xxx

▪ Actual warranty cost recording :

Estimated Warranty Liability xxx

Cash xxx

▪ Adjustment of the difference between estimate and

actual cost

Estimated Warranty Liability xxx

Warranty Expense xxx

 Accounting for Warranty :
Accrual Approach
An entity sells 1,000 units of television Estimated sets to be returned (60% x
600 sets
1,000)
sets at P9,000 each for cash. Each
Multiply by estimated warranty cost
television set is under warranty for one 500
per set
year.
Estimated warranty cost 300,000

The entity has estimated from past

To set up the estimated liability on the warranty
experience that warranty cost will
probably average P500 per unit and that Warranty expense 300,000
only 60% of the units sold will be
returned for repair. Estimated warranty liability 300,000

The entity incurs P180,000 for repairs To record the payment of the actual cost:
during the year. Estimated warranty liability 180,000

To record the sales Cash 180,000

Cash 9,000,000

Sales 9,000,000
Accounting for
Warranty : Expense as
incurred approach
❑ The expense as incurred approach is the
approach of expensing warranty cost only
when actually incurred.

❑ This approach is justified on the basis of

expediency when warranty cost is not very
substantial or when the warranty period is
relatively short.
 Accounting for Warranty :
Expense as Incurred Approach
An entity sells refrigerators that carry To record the sales for 2020
a 2-year warranty against defects.
The sales and warranty repairs are Cash 5,000,000
made evenly throughout the year.
Sales 5,000,000

Based on past experience, the entity To record the warranty expense for 2020
projects an estimated warranty cost
as a percentage of sales as follows: Warranty Expense 700,000

Estimated warranty liability

700,000
First year of warranty 4% (14% x 5,000,000)

Second year of warranty 10% To record the actual warranty repairs for 2020

Estimated warranty liability 140,000

2020 2021 Cash 140,000

Sales 5,000,000 6,000,000

Warranty Expense 700,000
Actual warranty repairs 140,000 300,000 Actual warranty Expense (140,000)
Estimated Warranty Liability, end of
560,000
2020
 Accounting for Warranty :
Expense as Incurred Approach
An entity sells refrigerators that carry To record the sales for 2021
a 2-year warranty against defects.
The sales and warranty repairs are Cash 6,000,000
made evenly throughout the year.
Sales 6,000,000

Based on past experience, the entity To record the warranty expense for 2021
projects an estimated warranty cost
as a percentage of sales as follows: Warranty Expense 840,000

Estimated warranty liability

840,000
First year of warranty 4% (14% x 6,000,000)

Second year of warranty 10% To record the actual warranty repairs for 2021

Estimated warranty liability 300,000

2020 2021 Cash 300,000

Sales 5,000,000 6,000,000

Est. Warranty Liab – Beg of 2021 560,000
Actual warranty repairs 140,000 300,000 Warranty Expense 840,000
Actual warranty Expense (300,000)

Balance, 2021 end 1,100,000

Accounting for
Warranty

❑ At the end of the year, the estimated

warranty liability account may be analyzed
based on the percentage estimate to
determine whether the actual warranty costs
approximate the estimate.

❑ If the sales are made evenly during the year,

then it has to be taken into consideration in
the computation of the accrual such that the
sales made on July to December of year 1,
the year 1 warranty will be carried forward to
year 2 first half. (refer to sample problem for
better understanding)
Sale of Warranty

❑ A warranty is sometimes sold separately from the

product sold. The seller may offer an “extended
warranty” on the product sold but with additional
cost.

❑ In such a case, the sale of the product with the

usual warranty is recorded separately from the sale
of the extended warranty.

❑ The amount received from the sale of the extended

warranty is recognized initially as deferred revenue
and subsequently amortized using straight line over
the life of the warranty contract.

❑ If costs are expected to be incurred in performing

services under the extended warranty contract,
revenue is recognized in proportion to the costs to
be incurred annually.
Sale of Warranty : Illustration
An entity sold a product for To record the sale
P3,000,000. The regular warranty
period for the product is 2 years. Cash 3,060,000
The entity sold an additional
Sales 3,000,000
warranty of two years at a cost of
P60,000. Unearned warranty
60,000
revenue

The extended warranty contract

starts only after the expiration of the If the costs are incurred evenly, the unearned
warranty revenue is amortized at the end of the third
regular two-year warranty period. year as :

Unearned warranty revenue 30,000

Warranty revenue (60,000 /

30,000
2 years)
EXERCISES
Problem 3-1 (Socorro Company)
Problem 3-8(Hanna Company)
Problem 3-15 (Dubious Company)
ASSIGNMENT
Problem 3-9 (Pink Company)
Problem 3-11 (Mil3 Company)
Problem 3-12 (Bold Company)
Thank you!

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