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Liability is a present obligation of a company arising from

past events, the settlement of which is expected to result in
an outflow from the company of resources, embodying
economic benefits.
Three essential characteristics:
1. Present obligation.
2. Arises from past events.
3. Results in an outflow of resources (cash, goods, services).
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 Current liability
A current liability is reported if one of two
conditions exists:
1.Liability is expected to be settled within its
normal operating cycle; or
2.Liability is expected to be settled within 12
months after the reporting date.
The operating cycle is the period of time elapsing
between the acquisition of goods and services and
the final cash realization resulting from sales and
subsequent collections.
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 Typical Current Liabilities
1. Accounts payable.
6. Customer advances and
2. Notes payable. deposits.
3. Current maturities of long- 7. Unearned revenues.
term debt.
8. Sales and value-added taxes
4. Short-term obligations payable.
expected to be refinanced.
9. Income taxes payable.
5. Dividends payable.
10.Employee-related liabilities.
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 Accounts Payable (trade accounts payable)
Balances owed to others for goods, supplies, or services
purchased on open account.
•Time lag between the receipt of services or acquisition of
title to assets and the payment for them.
•Terms of the sale (e.g., 2/10, n/30 or 1/10, E.O.M.) usually
state period of extended credit, commonly 30 to 60 days.

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 Notes Payable
Written promises to pay a certain sum of money on a
specified future date.
•Arise from purchases, financing, or other transactions.
•Notes classified as short-term or long-term.
•Notes may be interest-bearing or zero-interest-bearing.

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Interest-Bearing Note Issued

Illustration: XYZ Bank agrees to lend Br100,000 on March 1, 2024,

to ABC Co. if ABC signs a Br100,000, 6 percent, four-month note.

Cash 100,000
Notes Payable 100,000

ABC Co prepares financial statements semiannually. June 30, 2024

Interest Expense 2,000
Interest Payable 2,000
At maturity (July 1, 2024), Landscape records
payment of the note and accrued interest as follows.

Notes Payable 100,000

Interest Payable 2,000
Cash 102,000
Zero Interest-Bearing Note Issued

Illustration: Illustration: On March 1, ABC Co issued a Br102,000,

four-month, zero-interest-bearing note to XYZ Bank. The present
value of the note is Br100,000. ABC records this transaction as
follows.

Cash 100,000
Notes Payable 100,000
If ABC Co prepares financial statements semiannually, it makes the
following adjusting entry to recognize interest expense and the increase in
the note payable of Br2,000 at June 30.

Interest Expense 2,000

Notes Payable 2,000
At maturity (July 1), ABC Co must pay the note, as follows

Notes Payable 102,000

Cash 102,000
(Accounts and Notes Payable)
The following are selected 2023 transactions of ABC Corporation.

1.Sept. 1 - Purchased inventory from XYZ Company on account for Br50,000.

ABC records purchases gross and uses a periodic inventory system.

2.Oct. 1 - Issued a Br50,000, 12-month, 8% note to XYZ Co in payment of

account.

3.Oct. 1 - Borrowed Br75,000 from Bank by signing a 12-month, zero-interest-

bearing Br81,000 note.
Prepare journal entries
Sales Tax or Value Added Tax:
•They are also known as consumption taxes which are paid
by consumers.
•Sales tax or value added taxes are recorded and reported on
balance sheet as current liability.
•If a company sells item subjected to value added tax, it
records the transaction as follows.
Cash…………………………..xxx
Sales………………………………..xxx
VAT Payable………………………..xxx 13
• The VAT is collected every time a business purchases products
from another business in the product’s supply chain.
• Illustration: consider the following transactions
a. ABC Farms Wheat Company grows wheat and sells it to XYZ
Baking for Br100,000.
b. XYZ Baking makes loaves of bread from this wheat and sells it to
Star Supermarket for Br150,000.
c. Star Supermarket sells the loaves of bread to consumers for
Br200,000.
VAT rate is 15% in all transaction
Required: determine the amount of VAT collected by government
from the above transactions. 14
Dividend Payable:
Amount owed by a corporation to its
stockholders as a result of board of directors’
authorization.
•Generally paid within three months.
•Undeclared dividends on cumulative
preference shares not recognized as a
liability.
•Dividends payable in the form of additional
shares are not recognized as a liability. 15
Current Maturities of Long-Term Debt
Portion of bonds, mortgage notes, and other long-term indebtedness
that matures within the next fiscal year.
Exclude long-term debts maturing currently if they are to be:
•Retired by assets accumulated that have not been shown as current
assets,
•Refinanced, or retired from the proceeds of a new debt issue, or
•Converted into ordinary shares.
Short-Term Obligations Expected to Be Refinanced
Exclude from current liabilities if both of the following conditions
are met:
•Must intend to refinance the obligation on a long-term basis.
•Must have an unconditional right to defer settlement of the liability
for at least 12 months after the reporting date.
 Example 1: (Refinancing of Short-Term Debt): The CFO for ABC
Corporation is discussing with the company’s chief executive officer
issues related to the company’s short-term obligations. Presently, both
the current ratio and the acid-test ratio for the company are quite low,
and the chief executive officer is wondering if any of these short-term
obligations could be reclassified as long-term. The financial reporting
date is December 31, 2014. Two short-term obligations were
discussed, and the following action was taken by the CFO.

Instructions: Indicate how these transactions should be reported at Dec.

31, 2014, on ABC Co’s statement of financial position.
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Short-Term Obligation A: ABC Co has a Br50,000 short-term obligation due on
March 1, 2015. The CFO discussed with its lender whether the payment could be
extended to March 1, 2017, provided ABC Co agrees to provide additional collateral.
An agreement is reached on February 1, 2015, to change the loan terms to extend the
obligation’s maturity to March 1, 2017. The financial statements are authorized for
issuance on April 1, 2015.

Liability of Refinance Liability Statement

Br50,000 completed due for Issuance
payment

Dec. 31, 2014 Feb. 1, 2015 Mar. 1, 2015 Apr. 1, 2015

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Short-Term Obligation B: ABC Co also has another short-term
obligation of Br120,000 due on February 15, 2015. In its discussion
with the lender, the lender agrees to extend the maturity date to
February 1, 2016. The agreement is signed on December 18, 2014. The
financial statements are authorized for issuance on March 31, 2015.

Refinance Liability of Liability Statement

completed Br120,000 due for Issuance
payment

Dec. 18, 2014 Dec. 31, 2014 Feb. 15, 2015 Mar. 31, 2015

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Customer Advances and Deposits
•Current liabilities may include returnable cash deposits
received from customers and employees.
•Companies may receive deposits from customers to
guarantee performance of a contract or service or as
guarantees to cover payment of expected future obligations.

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Unearned Revenues:
•Revenues received in cash before delivering goods or
services.
•They are initially treated as liability and then converted in
to revenue as time passes.
•Illustration: ABC insurance Company collected insurance
premium of Br 1,200,000 from customers on September 1,
2023. The insurance contract is renewable annually.
•Required: Record all necessary journal entries
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Unearned Revenues:
•Revenues received in cash before delivering goods or
services.
•They are initially treated as liability and then converted in
to revenue as time passes.
•Illustration: ABC insurance Company collected insurance
premium of Br 1,200,000 from customers on September 1,
2023. The insurance contract is renewable annually.
•Required: Record all necessary journal entries
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 Employee-Related Liabilities

Amounts owed to employees for salaries or

wages are reported as a current liability.

Current liabilities may include:

 Payroll deductions.
 Compensated absences.
24  Bonuses.
 Compensated Absences
Paid absences for vacation, illness and maternity
and paternity leaves.
Employer must accrue compensated absences if the
following conditions are fulfilled
a.If the right vests or accumulates
b.If payment of the compensation is probable
c.If
25 the amount is reasonably estimated
 Illustration: ABC Inc. began operations on January 1, 2015. The company
employs 10 individuals and pays each Br480 per week. Employees earned 2 unused
vacation weeks in 2015. In 2016, the employees used the vacation weeks, but now
they each earn Br540 per week. Amutron accrues the accumulated vacation pay on
December 31, 2015, as follows.

Salaries and Wages Expense 9,600

Salaries and Wages Payable 9,600
In 2016, it records the payment of vacation pay as follows.

Salaries and Wages Payable 9,600

Salaries and Wages Expense 1,200
26 Cash 10,800
 Profit-Sharing and Bonus Plans

Payments to certain or all employees in addition to

their regular salaries or wages.
Bonuses paid are an operating expense.
Unpaid bonuses should be reported as a current
liability.
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 PROVISIONS

Provision is a liability of uncertain timing or amount.

Reported either as current or non-current liability.
Common types are
Uncertainty about the
► Obligations related to litigation. timing or amount of
the future expenditure
required to settle the
► Warrantees or product guarantees. obligation.

► Business restructurings.
28 ► Environmental damage.
 Recognition of a Provision

Companies accrue an expense and related liability for a

provision only if the following three conditions are met:
1. Company has a present obligation (legal or constructive) as a result
of a past event;

2. Probable that an outflow of resources will be required to settle the

obligation; and
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3. A reliable estimate can be made.
 Measurement of Provisions

How does a company determine the amount to report for

a provision?
IFRS:
Amount recognized should be the best estimate of the expenditure
required to settle the present obligation.
Best estimate represents the amount that a company would pay to settle
the obligation at the statement of financial position date.
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 Common Types of Provisions

Common Types:

1. Lawsuits 4. Environmental

2. Warranties 5. Onerous contracts

3. Consideration payable 6. Restructuring

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 Common Types of Provisions

Litigation Provisions
Companies must consider the following in determining
whether to record a liability with respect to pending or
threatened litigation and actual or possible claims and
assessments.
1.The time period in which the underlying cause of action occurred.
2.The probability of an unfavorable outcome.
3.
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Ability to make a reasonable estimate of the amount of loss.
 Litigation Provisions

With respect to unfiled suits and unasserted claims and assessments,

a company must determine
1. the degree of probability that a suit may be filed or a claim or assessment
may be asserted, and

2. the probability of an unfavorable outcome.

If both are probable, if the loss is reasonably estimable, and if the cause for action is
dated on or before the date of the financial statements, then the company should
33 accrue the liability.
 Litigation Provisions

Example: ABC Company is involved in a lawsuit at December 31, 2015. (a) Prepare
the December 31 entry assuming it is probable that ABC Co will be liable for
Br900,000 as a result of this suit. (b) Prepare the December 31 entry, if any,
assuming it is not probable that ABC Co will be liable for any payment as a result of
this suit.
(a) Lawsuit Loss 900,000
Lawsuit Liability 900,000

(b) No entry is necessary. The loss is not accrued because it is not

probable that a liability has been incurred at 12/31/15.
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 Common Types of Provisions

Warranty Provisions

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.

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 Warranty Provisions

Companies often provide one of two types of warranties to customers:

Assurance-Type Warranty
A quality guarantee that the good or service is free from
defects at the point of sale.
 Obligations should be expensed in the period the goods are provided
or services performed (in other words, at the point of sale).

36 Company should record a warranty liability.
 Assurance-Type Warranty

Facts: Denson Machinery Company begins production of a new

machine in July 2015 and sells 100 of these machines for Br5,000 cash
by year-end. Each machine is under warranty for one year. Denson
estimates, based on past experience with similar machines, that the
warranty cost will average Br200 per unit. Further, as a result of parts
replacements and services performed in compliance with machinery
warranties, it incurs Br4,000 in warranty costs in 2015 and Br16,000 in
2016.
Question: What are the journal entries for the sale and the related
warranty costs for 2015 and 2016?
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 Assurance-Type Warranty

Solution: For the sale of the machines and related warranty costs in 2015 the entry
is as follows.
1. To recognize sales of machines and accrual of warranty liability:

July–December 2015

Cash 500,000
Warranty Expense 20,000
Warranty Liability 20,000
Sales Revenue 500,000
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 Assurance-Type Warranty

Solution: For the sale of the machines and related warranty costs in 2015 the entry is
as follows.
2. To record payment for warranties incurred:

July–December 2015
Warranty Liability 4,000
Cash, Inventory, Accrued Payroll 4,000
The December 31, 2015, statement of financial position reports Warranty Liability
as a current liability of Br16,000. The income statement for 2015 reports Warranty
Expense of Br20,000.
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 Assurance-Type Warranty

Solution: For the sale of the machines and related warranty costs in 2015 the entry
is as follows.
3. To record payment for warranty costs incurred in 2016 related to 2015
machinery sales:
January 1–December 31, 2016

Warranty Liability 16,000

Cash, Inventory, Accrued Payroll 16,000

At the end of 2016, no warranty liability is reported for the machinery sold in
2015.
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 Warranty Provisions

Companies often provide one of two types of warranties to

customers:
Service-Type Warranty
An extended warranty on the product at an additional cost.
 Usually recorded in an Unearned Warranty Revenue account.
 Recognize revenue on a straight-line basis over the period the
service-type warranty is in effect.

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 Service-Type Warranty

Facts: You purchase an automobile from Hamlin Auto for Br3000,000

on January 2, 2014. Hamlin estimates the assurance-type warranty costs
on the automobile to be Br70,000 (Hamlin will pay for repairs for the
first 36,000 miles or three years, whichever comes first). You also
purchase for Br90,000 a service-type warranty for an additional three
years or 36,000 miles. Hamlin incurs warranty costs related to the
assurance-type warranty of Br50,000 in 2014 and Br20,000 in 2015.
Hamlin records revenue on the service-type warranty on a straight-line
basis.
Question: What entries should Hamlin make in 2014 and 2017?
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 Service-Type Warranty

Solution:
1. To record the sale of the automobile and related warranties:

January 2, 2014

Cash (Br30,000 + Br900) 3,090,000

Warranty Expense 70,000
Warranty Liability 70,000
Unearned Warranty Revenue 90,000
Sales Revenue 3000,000
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 Service-Type Warranty

Solution:
2. To record warranty costs incurred in 2014:

January 2–December 31, 2014

Warranty Liability 50,000

Cash, Inventory, Accrued Payroll 50,000

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 Service-Type Warranty

Solution:
3. To record revenue recognized in 2017 on the service-type
warranty:

January 1–December 31, 2017

Unearned Warranty Revenue (Br90,000 ÷ 3) 30,000

Warranty Revenue 30,000
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 Common Types of Provisions

Consideration Payable
Companies often make payments (provide consideration) to
their customers as part of a revenue arrangement.
Companies offer premiums, coupon offers, and rebates to
stimulate sales.
Companies should charge the costs of premiums and coupons to
expense in the period of the sale that benefits from the plan.
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 Consideration Payable

Facts: Fluffy Cake Mix Company sells boxes of cake mix for Br3 per
box. In addition, Fluffy Cake Mix offers its customers a large durable
mixing bowl in exchange for Br1 and 10 box tops. The mixing bowl
costs Fluffy Cake Mix Br2, and the company estimates that customers
will redeem 60 percent of the box tops. The premium offer began in
June 2015. During 2015, Fluffy Cake Mix purchased 20,000 mixing
bowls at Br2, sold 300,000 boxes of cake mix for Br3 per box, and
redeemed 60,000 box tops.
Question: What entries should Fluffy Cake Mix record in 2015?
 Consideration Payable

Solution:
1. To record purchase of 20,000 mixing bowls at Br2 per bowl:

Premium Inventory (20,000 bowls x Br2) 40,000

Cash 40,000
 Consideration Payable

Solution:

2.Before Fluffy Cake Mix makes the entry to record the sale of the cake mix boxes, it
determines its premium expense and related premium liability. This computation is as
follows.
 Consideration Payable

Solution:
2.The entry to record the sale of the cake mix boxes and premium expense and
premium liability is as follows.

Cash (300,000 boxes x Br3) 900,000

Premium Expense 18,000
Sales Revenue 900,000
Premium Liability 18,000
 Consideration Payable

Solution:
3.To record the actual redemption of 60,000 box tops, the
receipt of Br1 per 10 box tops, and the delivery of the
mixing bowls:

Cash [(60,000 ÷ 10) x Br1] 6,000

Premium Liability 6,000
Premium Inventory [(60,000 ÷ 10) x Br2] 12,000
 Common Types of Provisions

Environmental Provisions

A company must recognize an environmental

liability when it has an existing legal obligation
associated with the retirement of a long-lived asset
and when it can reasonably estimate the amount of
the liability.
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 Environmental Provisions

Obligating Events. Examples of existing legal obligations,

which require recognition of a liability include, but are not
limited to:
► Decommissioning nuclear facilities,
► Dismantling, restoring, and reclamation of oil and gas properties,
► Certain closure, reclamation, and removal costs of mining facilities,
►
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Closure and post-closure costs of landfills.
 Environmental Provisions

Measurement. A company initially measures an environmental

liability at the best estimate of its future costs.

Recognition and Allocation. To record an environmental

liability a company includes
► the cost associated with the environmental liability in the carrying
amount of the related long-lived asset, and
► records a liability for the same amount.
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 Environmental Provisions

Illustration: On January 1, 2015, Wildcat Oil Company erected an oil platform.

Wildcat is legally required to dismantle and remove the platform at the end of its
useful life, estimated to be five years. Wildcat estimates that dismantling and removal
will cost Br1,000,000. Based on a 10 percent discount rate, the fair value of the
environmental liability is estimated to be Br620,920 (Br1,000,000 x .62092). Wildcat
records this liability on Jan. 1, 2015 as follows.

Drilling Platform 620,920

Environmental Liability 620,920
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 Environmental Provisions

Illustration: During the life of the asset, Wildcat allocates the asset
retirement cost to expense. Using the straight-line method, Wildcat
makes the following entries to record this expense.

December 31, 2015, 2016, 2017, 2018, 2019

Depreciation Expense (Br620,920 ÷ 5)124,184

Accumulated Depreciation—Plant Assets 124,184
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 Environmental Provisions

Illustration: In addition, Wildcat must accrue interest

expense each period. Wildcat records interest expense and
the related increase in the environmental liability on
December 31, 2015, as follows.
December 31, 2015
Interest Expense (Br620,920 x 10%) 62,092
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Environmental Liability 62,092
 Environmental Provisions

Illustration: On January 10, 2020, Wildcat contracts with Rig

Reclaimers, Inc. to dismantle the platform at a contract price of
Br995,000. Wildcat makes the following journal entry to record
settlement of the liability.
January 10, 2020
Environmental Liability 1,000,000
Gain on Settlement of Environmental Liability 5,000
Cash 995,000
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 Common Types of Provisions

Onerous Contract Provisions

“The unavoidable costs of meeting the obligations exceed the
economic benefits expected to be received.”

The expected costs should reflect the least net cost of exiting from the
contract, which is the lower of
1. the cost of fulfilling the contract, or

2. the compensation or penalties arising from failure to fulfill the contract.

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 Onerous Contract Provisions

Illustration: Sumart Sports operates profitably in a factory that it has leased and on
which it pays monthly rentals. Sumart decides to relocate its operations to another
facility. However, the lease on the old facility continues for the next three years.
Unfortunately, Sumart cannot cancel the lease nor will it be able to sublet the factory
to another party. The expected costs to satisfy this onerous contract are Br200,000. In
this case, Sumart makes the following entry.

Loss on Lease Contract 200,000

Lease Contract Liability 200,000
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 Onerous Contract Provisions

Assume the same facts as above for the Sumart example and the
expected costs to fulfill the contract are Br200,000. However, Sumart
can cancel the lease by paying a penalty of Br175,000. In this case,
Sumart should record the liability as follows.

Loss on Lease Contract 175,000

Lease Contract Liability 175,000

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 Common Types of Provisions

Restructuring Provisions

Restructurings are defined as a “program that is planned and

controlled by management and materially changes either
1. the scope of a business undertaken by the company; or

2. the manner in which that business is conducted.”

Companies are required to have a detailed formal plan for the restructuring and to
have raised a valid expectation to those affected by implementation or
announcement of the plan.
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 Restructuring Provisions

IFRS provides specific guidance related to certain costs and

losses that should be excluded from the restructuring provision.

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 Disclosure Related to Provisions

A company must provide a reconciliation of its beginning to ending

balance for each major class of provisions, identifying what caused
the change during the period.

In addition,
► Provision must be described and the expected timing of any outflows disclosed.

► Disclosure about uncertainties related to expected outflows as well as expected

reimbursements should be provided.
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 CONTINGENCIES

Contingent Liabilities

Contingent liabilities are not recognized in the financial statements

because they are
1. A possible obligation (not yet confirmed),

2. A present obligation for which it is not probable that payment will be made, or

3. A present obligation for which a reliable estimate of the obligation cannot be

made.
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 Contingent Liabilities

General guidelines for the accounting and reporting of contingent

liabilities.

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 CONTINGENCIES

Contingent Assets
A contingent asset is a possible asset that arises from past events and whose
existence will be confirmed by the occurrence or non-occurrence of uncertain future
events not wholly within the control of the company. Typical contingent assets are:
1. Possible receipts of monies from gifts, donations, bonuses.
2. Possible refunds from the government in tax disputes.
3. Pending court cases with a probable favorable outcome.

Contingent assets are not recognized on the statement of financial position.

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 Contingent Assets

The general rules related to contingent assets

Contingent assets are disclosed when an inflow of economic benefits is

considered more likely than not to occur (greater than 50 percent).
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 PRESENTATION AND ANALYSIS

Presentation of Current Liabilities

 Usually reported at their full maturity value.

 Difference between present value and the maturity
value is considered immaterial.

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