FINANCIAL LIABILITIES

NATURE AND DEFINITION OF LIABILITIES

According to the Revised Conceptual Framework for Financial Reporting, liability is a

present obligation of the entity to transfer an economic resource as a result of past events.

The essential characteristics of a liability are:

1. The entity has a present obligation

• An obligation is a duty or responsibility that an entity has no practical ability to avoid.

2. The obligation is to transfer an economic resource

• An economic resource is the asset that represents a right with a potential to produce
economic benefits.

• The obligation must be to pay cash, transfer noncash asset or provide service at some
future time.

3. The liability arises from a past event

• The liability is not recognized until it is incurred. This past event that leads to the
incurrence of a liability is known as the obligating event.

✓ The obligating event creates a present obligation because the entity has no realistic
alternative but to settle the obligation.

FINANCIAL STATEMENT PRESENTATION

A liability is classified as current when:

a) It is expected to be settled within the entity’s normal operating cycle;

b) It is expected to be settled within 12 months;

c) It is held for trading.

d) The entity has no unconditional right to defer payment for at least 12 months from the
reporting date

A liability is classified as noncurrent if it did not meet any of the conditions above.

CURRENTLY MATURING DEBT

A liability which is due to be settled within 12 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.

However, if the refinancing is completed on or before the end of the reporting period, 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.

COVENANTS

Covenants are attached to borrowing agreements which represent undertakings by the

borrower. These are restrictions on the part of the borrower. Under these covenants, if
certain conditions relating to the borrower’s financial situation are breached, the liability
becomes payable on demand.

BREACH OF COVENANTS

The liability is classified as current even if the lender has agreed, after the reporting period
and before the statements are authorized for issue, not to demand payment as a
consequence of the breach. However, the liability is classified as noncurrent if the lender
has agreed on or before the end of reporting period to provide a grace period ending at least
twelve months after the end of reporting period.

FINANCIAL LIABILITY

A financial liability is any liability that is a contractual obligation:

a) To deliver cash or other financial asset to another entity.

b) To exchange financial instruments with another entity under conditions that are
potentially unfavorable.

Examples of financial liabilities

1) Trade accounts payable

2) Notes and loans payable

3) Bonds payable

RECOGNITION PRINCIPLE

An entity shall recognize financial liability when and only when it becomes a party to the
contractual provisions of the instrument.

MEASUREMENT

Initial measurement

1. A financial liability is initially recognized at fair value, which is the transaction price.

2. A financial liability measured at amortized cost is initially recognized at fair value less
transaction costs.

Subsequent measurement

Except for financial liabilities that are measured at fair value, financial liabilities are
subsequently measured at amortized cost.

ACCOUNTS PAYABLE

Accounts payable (or trade accounts payable) are liabilities arising from purchase of
goods, materials, supplies or services on an open account basis. Theoretically, an entity
must recognize accounts payable when it acquired economic control over the goods
because this is the date when the entity becomes a party to the financial instrument.

➢ A purchase made towards the end of the accounting period, where goods are still in
transit, should be recognized as a liability when the shipping term is FOB shipping point.
Similarly, the liability is recognized upon receipt of goods when such are shipped FOB
destination.

NOTES PAYABLE

A promissory note is a written promise to pay a certain sum of money to the bearer at a
designated future time. This may arise from purchase of goods or services or borrowings
from financial institutions.
BONDS PAYABLE

A bond is a formal unconditional promise, made under seal, to pay a specified sum of
money at a determinable future date, to make periodic interest payment at a stated rate
until the principal sum is paid.

CLASSIFICATION OF BONDS

1. Term bonds – bonds with a single date of maturity.

2. Serial bonds (or installment bonds) – bonds with series of maturity dates instead of a
single one.

3. Convertible bonds – bonds that can be exchanged for shares of the issuing entity.

4. Callable bonds – bonds which may be called in for redemption prior to maturity date.

MEASUREMENT PRINCIPLES

INITIAL MEASUREMENT

Bonds payable classified as financial liability at amortized cost shall be initially measured
at fair value minus bond

issue costs. Normally, it is equal to the net proceeds from the issuance of bonds, excluding
accrued interest, if any.

Bond issue costs

These are transactions directly attributable to the issuance of bonds. These are as follows:

• Printing or engraving cost;

• Legal and accounting fee;

• Registration fee with regulatory authorities;

• Commission paid to agents and underwriters and other similar charges.

Bond issue costs are treated as an adjustment to:

• Discount on bonds payable as an addition to the account (initial measurement will

decrease)
• Premium on bonds payable as a deduction to the account (initial measurement will
increase)

ISSUANCE OF BONDS BETWEEN INTEREST DATES

• Accruing interest from the last interest payment date up to date of purchase shall be
accrued and paid

by the buyer or investor.

• Cash to be received by issuer = fair value + accrued interest to date of purchase

• Example:

- Interest payment dates: January 1 and July 1 of every year

▪ Date of purchase: May 1

▪ Interest for the period January through April shall be paid by the buyer or investor to the

issuer.

SUBSEQUENT MEASUREMENT

Bonds payable are subsequently measured at amortized cost using the effective interest
method.