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Liabilities

Liability
Present obligation
As a result of past transactions or events
Expected to result in an outflow of resources
embodying economic benefits

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Initial Recognition: Criteria

(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.

Types of Liabilities
1. Liabilities of definite timing and amount
2. Liabilities of uncertain timing and amount
(a.k.a. provisions covered by PAS 37)
3. Contingent liabilities

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Liabilities of Definite Timing and

Amount

Accounts payable
Accrued expenses
Salaries payable
Unearned revenues
Loans

Screen clipping taken: 8/2/2012, 11:54 PM

Globe 2011 Annual Report

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Customer Loyalty Programs

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IFRIC 13 Accounting for Customer

Loyalty Programmes

http://www.pwc.com/en_GX/gx/retail-consumer/pdf/ifric13_final_low.pdf

IFRIC 13 Accounting for Customer

Loyalty Programmes
Applies to entities that grant awards credits as
part of a sales transaction, including awards that
can be redeemed for goods and services not
supplied by the entity
Requires that the consideration received from
the sale be allocated to the award credit using
relative fair values; the portion allocated to the
award credit shall be considered deferred
revenue

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Provisions and Contingencies

A provision is a liability of uncertain timing or
amount
A contingent liability is either
1. A possible obligation whose existence will be
confirmed only by the occurrence or nonoccurrence of one or more future events not wholly
within the control of the entity; or
2. A present obligation that is not recognized because
at least one of the criteria for recognition is not
satisfied

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Provisions and Contingencies:

Examples
Provision

Contingent Liability

1. Provision for dismantling and

restoration costs

1. Loan guarantee

2. Provision for future warranty

claims

2. Meralcos liability for real estate

taxes on its electric poles, wires, etc.
(see excerpt).

3. Provision for damages arising from

a lawsuit that management believes
will be decided against the entity

3. Possible liabilities arising from

lawsuits & other 3rd party claims
against the company whose outcomes
are not determinable on balance sheet
date

4. Provision for employee pension

benefits

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Contingent Liability: Other Examples

Source: Meralco 2007 Annual Report

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Philex on Aug 1 decided to suspend operations after indications

that water and sediment were being discharged from one of two
underground tunnels that drain water from the penstock in the
tailing pond
Rehabilitation expected to cost P220M per month
So far, core income dropped by 26% to P2.11B in the first half on
the back of lower gold output
Philex took out $30M in business interruption insurance and
$50M in environment insurance following the incident

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Classification of Liabilities
Current liabilities
Expected to be settled in the entitys normal operating
cycle
Held primarily for trading
Due to be settled within 12 months after balance sheet
date
Entity does not have an unconditional right, as of
balance sheet date, to defer settlement of he liability
for at least 12 months after the balance sheet date

Non-Current Liabilities: Bonds Payable

Common types of bonds
Term and serial
Secured and unsecured
Registered and bearer (coupon)
Callable
Convertible
Zero-interest or deep-discount

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Accounting for Bonds

Issuance
At par, discount or premium
Bond issue costs
Convertible bonds

Accounting for interest and principal payments

Measurement on balance sheet date
Troubled debt restructuring

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Review: Price of a Bond

Q: What is the price of a 3-year, 10% bond with face
value of P5M when the prevailing market interest
rate is 12%?
A:
(500,000 x 0.893)+(500,000 x 0.797) + (5,500,000 x
0.712) = P4,759,817
Note: The bond sold at a discount (i.e., less than par
value) because its coupon rate is less than the
market interest rate.

Amortizing Bond Discount

Date

Interest paid

1/1/2008

Interest
expense

amortization

Amortized
cost
4,759,816.87

12/31/2008 500,000.00

571,178.02 71,178.02 4,830,994.90

12/31/2009 500,000.00

579,719.39 79,719.39 4,910,714.29

12/31/2010 500,000.00

589,285.71 89,285.71 5,000,000.00

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Bond Issued at a Premium

Q: What is the price of a 5-year, 10% P5M bond
paying annual interest every December 31 when
the annual market interest rate is 8%?
A: P5,399,271.00

Amortizing a Bond Premium

date

interest
paid

interest
expense

Amortization

1/1/2005
12/31/2005 500,000.00
12/31/2006 500,000.00
12/31/2007 500,000.00
12/31/2008 500,000.00
12/31/2009 500,000.00

cv
5,399,271.00

431,941.68
426,497.01
420,616.78
414,266.12
407,407.41

(68,058.32)
(73,502.99)
(79,383.22)
(85,733.88)

5,331,212.68
5,257,709.70
5,178,326.47
5,092,592.59

(92,592.59) 5,000,000.00

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Amortizing Both Principal and Interest:

Mortgage Loan
On January 1, 2008, Picard Inc. purchased a new
piece of equipment from LaForge Engineering to
expand its production facilities. The equipment was
purchased at a cost of P800,000. Picard financed
the purchase with an P800,000 mortgage to be
repaid in annual payments of P211,038** over 5
years at the rate of 10%. The first payment is to be
made on December 31, 2008.
---** P800,000/3.7908 (PV factor of an ordinary annuity for 5 periods at 10%)

Picard Inc.: Mortgage Amortization Schedule

Interest Principal
Payment Payment Payment

Cumulative Cumulative
Principal
Interest
Loan
Paid
Paid
Balance

10%

800,000

2008

211,038

80,000

131,038

131,038

80,000

668,962

2009

211,038

66,896

144,142

275,180

146,896

524,820

2010

211,038

52,482

158,556

433,736

199,378

366,264

2011

211,038

36,626

174,412

608,147

236,005

191,853

2012

211,038

19,185

191,853

800,000

255,190

(0)

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Measurement on Balance Sheet Date

Two alternatives:
Fair value for liabilities designated as such at the
time of borrowing
Amortized cost most commonly used
measurement basis for long-term debt; is the
present value of the cash payments expected to be
made for the liability based on the effective
borrowing cost when the liability was incurred

Troubled Debt Restructuring

Asset swap
Difference between the carrying amount of the liability
and the consideration paid shall be recognized in
profit or loss

Equity swap
Equity issued is measured at fair value or, if not
reliably measurable, at the fair value of the liability
extinguished.
Gain/loss recognized in profit and loss is allowed for
debt-equity swaps in a troubled debt restructuring
(IFRIC 19 )

Modification of debt terms

Gain or loss is recognized if there is substantial
modification of debt terms

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Asset Swap
Manila Bank loaned P10M to ABC Realty. On
the loans maturity on Dec. 31, 2012, Manila
Bank agreed to accept land with fair value of
P9M in full settlement of the P10M and 1-year
accrued interest at 12% or P1.2M. The land has a
carrying value of P10.5M in ABC Realtys books.
Determine the effect of the asset swap on ABC
Realtys financial condition and performance.

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Equity Swap
Assume that, instead of land, ABC Realty
offered, and Manila Bank accepted, 180,000 of
the formers common shares which have a par
value of P40 and a fair market value of P50.
Determine the effect of the debt-for-equity swap
on ABC Realtys financial condition and
performance.

Modification of Debt Terms

Forms of modification
Reduction of stated interest rate
Reduction of face amount of the debt
Reduction or condonation of accrued interest
Extension of maturity date
Moratorium on the payment of interest and/or
principal

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Modification of Debt Terms

A gain or loss is recognized when the original
liability is deemed extinguished and the
modified debt is deemed a new financial
liability.

Modification of Debt Terms

The original liability is deemed extinguished
when the modified loan terms are substantially
different from the original terms. The terms are
substantially different if the discounted present
value of the cash flows under the new terms is at
least 10% different from the discounted present
value of the remaining cash flows (or carrying
value) of the original financial liability.

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Illustration
Lets say the loan of ABC Realty with Manila
Bank was instead restructured and now has the
ff terms:

Revised principal of P7M from P10M

Condonation of accrued interest of P1.2M
Extension of maturity date to 12.31.2016
Reduction of interest rate from 12% to 8%

Illustration
The present value of the revised loan
is determined as follows:
PV of principal
PV of interest
Total PV of revised
loan
Carrying value of
existing loan
Gain from debt
restructuring

7,000,000

0.63552

560,000 3.03735

4,448,640
1,700,916
6,149,556
11,200,000
5,050,444

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Exercises
1. On Jan. 1, 2006, Phoenix Corp. purchased a
building for P15M. The firm made a 20%
downpayment and took out a mortgage
payable over 30 years at a rate of P88,051.70
monthly. The first payment is due Feb. 1, 06.
The mortgage interest rate is 8%. How will the
purchase of the building affect the accounting
equation?

Exercises
2. The Rugless Corp. issued P1M of bonds at a
price of 108.
(a) Determine the total cash the company received
from the bond issue.
(b) Did the bonds sell at par, at a discount, or at a
premium?
(c) For this bond, is the stated rate of interest
higher or lower than the market rate of interest?

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Exercises:
3. On Jan. 1, 06, Cobweb Corp. issued P1.5M of 10year term bonds with a stated rate of interest of
12%. The bonds pay interest semiannually on Jan
1 and July 1. At the time of this issue, the current
market interest rate was also 12%.
(a) How much cash did Cobweb receive when the
bond was issued?
(b) How much interest will be paid every 6
months?
(c) Assuming Cobweb has a Dec 31 year-end, what
adjustment will need to be made at the end of each
year?

Exercises:
4. On Jan. 1, 2006, the Old Spice Company issued
P300k of 10-year, 12% bonds at a price of 86.668.
The market interest rate on the bond issuance date
was 14%. The bonds pay interest semiannually on
Jan. 1 and July 1.
(a) How much cash did the company receive from the
issuance of the bonds?
(b) How much cash did the firm expend for interest
during 2006?
(c) How much interest expense did the company
report for 2006?
(d) How much total interest expense will the firm
incur over the 10-year life of these bonds?

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Exercises:
5. Determine the financial reporting implications
of the ff situations affecting Animaniacs Ltd., a
manufacturer of toys:
(a) A safety hazard related to one of its toy products
was discovered. It is considered probable that
liabilities have been incurred. On the basis of
past experience, a reasonable estimate of the
amount of loss can be made.

Exercises:
(b) This year, Animaniacs began promoting a new
toy by including a coupon, redeemable for a movie
ticket, in each toys carton. The movie ticket, which
cost AnimaniacsP30, is purchased in advance and
mailed to the customer when the coupon is received
by Animaniacs. Animaniacs estimated, based on
past experience, that 60% of the coupons will be
redeemed 45% of the coupons were actually
redeemed this year, and the remaining 15% of the
coupons are expected to be redeemed next year.

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Leases (PAS 17)

Definition of a lease
- an agreement whereby the lessor conveys to the
lessee in return for a payment or series of payments
the right to use an asset for an agreed period of time
Right to use (see IFRIC 4)
Ability to operate the asset or direct others to
operate the asset
Ability to control physical access to the asset
Ability to obtain or control significant output
of/benefits from the asset

Types of Lease
Operating lease a lease other than a finance
lease periodic payment is recognized as lease
expense by the lessee and lease income by the
lessor; an off-balance sheet transaction for the
lessee
Finance (or capital) lease a lease that transfers
substantially all the risks and rewards incidental
to ownership of an asset. Title may or may not
eventually be transferred. lessee recognizes an
asset and a liability; lessor derecognizes the leased
asset and recognizes a receivable

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Rewards of ownership
Benefits obtained from using
the asset to provide benefit or
service to the entity
Appreciation in residual value
or gains on the eventual sale of
the asset

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Risks of ownership
Unsatisfactory performance

Obsolescence

Idle capacity
Decline in residual value or
losses on eventual sale of the
asset
Uninsured damage and
condemnation of the asset

Conditions that usually accompany a

capital lease
Transfer of ownership at the end of the lease
term
Bargain purchase option
Lease term is 75% of assets economic life
Present value of lease payments are substantially
all ( 90%) of the fair value of the asset

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Impact on Financial Condition and

Performance
Operating Lease
- Annual lease payments are rent expense
Capital Lease
- Asset and liability recognized in the balance
sheet at the lower amount of the assets fair
value and the present value of minimum lease
payments
- Interest expense and depreciation are
recognized in the income statement of the lessee

Impact on Financial Condition and

Performance
On January 1, 2008, a company leases a
machinery for 4 years (its entire economic life) at
an annual rental of P100,000 payable at the end
of each year. The interest rate implicit in the lease
is 12%. Determine the impact of this transaction
on the companys financial condition and
performance.
Note: PV factor of an ordinary annuity for 4 years at 12% = 3.0373

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Amortization Schedule
Date

Payment

Interest

Cumulative Principal
Principal Principal Balance

1/1/2008

303,730.00

12/31/2008 100,000.00 36,447.60 63,552.40 63,552.40 240,177.60

12/31/2009 100,000.00 28,821.31 71,178.69 134,731.09 168,998.91
12/31/2010 100,000.00 20,279.87 79,720.13 214,451.22 89,278.78
12/31/2011 100,000.00 10,713.45 89,286.55 303,737.76

(7.76)

Lease: Exercises
1. Myra Company purchased a tractor on Jan. 1,
08 at a cost of P1.6M for the purpose of leasing
it. The tractor is estimated to have a useful life
of 5 years with a residual value of P100,000. On
April 1, 08, Myra entered into a lease contract
for the lease of the tractor for a term of 2 years
up to March 31, 2010. The lease is P50,000 a
month and the lessee paid P600,000, the lease
fee for one year. Determine the effects of these
transactions on the lessee and lessors financial
position and performance.

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Lease: Exercises
2. Overland Company closed a lease contract for
newly constructed terminals and freight storage
facilities on 1.1.08. Although the terminals have a
composite life of 10 years, the lease runs for 5
years with a favorable bargain purchase option
upon expiration of the lease. The annual rental is
P1M payable at the end of each year starting
12.31.08. The contract was negotiated to assure
the lessor a 10% rate of return. Determine the
effects of this transaction on the financial position
and performance of lessee and lessor.

Employee Benefits
Short-term employee benefits (includes bonuses
and compensated absences)
Post-retirement (pension) benefits

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Employee Benefits
Employee benefits are considered additional
compensation expense in the period in which the
service rendered resulted in the benefit earned
Post-employment (pension) benefits may result
in a significant liability to the company if
periodic contributions to a pension fund are not
made.

Types of Benefit Plans

Defined Contribution
Liability of the employer is limited to amount prescribed to
be contributed to a pension fund/plan

Defined Benefits
Liability of the employer is based on benefits promised to
be received upon employees retirement
Requires an actuarial estimate of the pension obligation
May be funded or unfunded
Pension asset (liability) in the Balance Sheet is mainly the
difference between the fair value of the pension fund (if
any) and the present value of the pension obligation
Factors affecting the pension liability include the
contributions to and return on pension plan assets,
employee salary levels and expected increases, the duration
of pension payments to retired employees

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Accounting Note: PAS 19 (Employee Benefits) Amendments effective 1.1.2013

Actuarial gains and losses and actual return on plan assets are recognised in the balance sheet
immediately with a charge or credit to OCI in the period in which they occur. No more
corridor.
Interest expense or income will be calculated on the net defined benefit liability (asset) by
applying the discount rate to the net defined benefit liability (asset). This replaces the interest
cost on the defined benefit obligation and the expected return on plan assets.

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