INTRODUCTION TO LIABILITIES

LIABILITIES
IFRS 9: Financial Liabilities
IAS 1: Presentation of Financial Statements
IAS 37: Provisions, Contingent Liabilities and Contingent Assets

In layman's terms, liabilities are considered to arise from the borrowing of funds by an entity or by a
person. However, in accounting, liabilities arise not just from borrowing of funds but also from many
other sources, as long as the criteria for the recognition of a liability are met.

According to the Conceptual Framework (the "Framework"), a liability is a present obligation of the
entity to transfer an economic resource as a result of past events. ALL of the following criteria shall
be met for a liability to exist: (OTP)
a. the entity has an obligation;
b. the obligation is to transfer an economic resource; and
c. the obligation is a present obligation that exists as a result of past events.

A. OBLIGATION
An obligation is a duty or responsibility which an entity has no practical ability to avoid. [Framework
4.29].
An obligation may arise from any of the following:
a) contract, laws, and regulations (collectively known as "legal obligation"); or
b) entity's customary practices, published policies or specific statements with an entity having no
practical ability to avoid ("constructive obligation"). It is not required to specifically recognize
the identity of the counter party for an obligation to exist. For example, estimated warranty
liability will still be recognized even though an entity does not know who of its customers will
ultimately claim its right under the warranty.

In addition, an obligation exists even if the exact amount of the obligation is unknown. provided that
it can be reliably estimated. Using warranties again as an example, related liability is recognized even
though its amount is based solely on a reliable estimate.

B. TRANSFER OF AN ECONOMIC RESOURCE

Obligations to transfer an economic resource include, for example:
1) obligations to pay cash - for accounts payable to suppliers, accrued expense, and borrowings
(i.e., loan and bond payables).
2) obligations to deliver goods or provide services - for income received advance or provision of
warranty coverage.
3) obligations to exchange economic resources with another party on unfavorable terms - for
derivative liabilities.
4) obligations to transfer an economic resource if a specified uncertain future event occurs - for
conditional obligations.

C. PRESENT OBLIGATION AS A RESULT OF PAST EVENTS

There shall be a present obligation as a result of past events for an entity to recognize a liability.
Obligations that will be incurred in the future shall not be recognized as there is no present
obligation to account for.

A good example of future obligation is when an entity orders an item of equipment on the date the
equipment was ordered, no obligation shall be recognized since the equipment is yet to be delivered
to the entity. It is only when the equipment was delivered to the entity that a liability is recognized
since there is already a past event (i.e., the receipt of the equipment from the supplier).

A present obligation exists as a result of past events only if:

a. the entity has already obtained economic benefits or taken an action; and
b. as a consequence, the entity will or may have to transfer an economic resource
that it would not otherwise have had to transfer.

The following are examples of ways an entity obtains economic benefits and the
resulting obligation:
a. An entity acquiring inventory will recognize a corresponding amount of liability (i.e., accounts
payable) if it has already taken title over the goods.
b. Utilities (e.g., electricity or water) provide an entity economic benefit as they are consumed. Because
of these consumed utilities, an entity will now be required to pay a corresponding amount to the
utilities provider (i.e., accrued expenses)'
 GENERAL CLASSIFICATIONS OF LIABILITIES
For accounting purposes, liabilities can be broadly classified into financial and non-financial
liabilities:

FINANCIAL LIABILITIES NON- FINANCIAL LIABILITIES

Financial liability is any liability that gives rise to a The following are considered as non-financial
contractual obligation: liabilities:

a) to deliver cash or another financial asset to a. Unearned income (income received in

another entity; advance) - the obligation of the entity is to
OR deliver goods or provide services to
b) to exchange financial assets or financial customers rather than delivering cash or
liabilities with another entity under conditions another financial asset.
that are potentially unfavorable to the entity.
[PAS 32.11]. b. Estimated warranty liability - the obligation
is to provide service to correct the defects or
The following are examples of liabilities that are malfunctions of products previously sold.
considered as financial liabilities:
1. accounts and trade payables c. Income tax payable, deferred tax payable,
2. notes payable and other tax liabilities - the obligation does
3. bonds and loans payable not arise from contracts but rather as a
4. derivative liability statutory requirement.

d. Constructive obligations - the obligation

does not arise from contracts but from the
expectations of relevant parties.

It should be noted that certain liabilities such as

lease liabilities and employee benefits appear to be
financial liabilities, but these are accounted
differently (different accounting standards) from
the rest of the "true" financial liabilities.

ACCOUNTING FOR FINANCIAL LIABILITIES ACCOUNTING FOR NON-FINANCIAL LIABILITIES

Initial Recognition: For non-financial liabilities, different accounting
➢ General Rule: FL@ FV-TC procedures are followed depending on the relevant
Generally, according to PFRS 9, financial accounting standard that applies. For example:
liabilities are initially measured at their fair a) Provisions are accounted for under PAS 37,
value less the transaction costs incurred. Provisions, Contingent Liabilities and
Contingent Assets
➢ Exception: FL@ FVTPL b) Lease liabilities are accounted for under
As a way of exception, an entity, on initial PFRS 16, Leases (see Chapters 9 to 11).
recognition, may irrevocably designate a c) Liabilities for employee benefits are
financial liability at fair value through profit or accounted for under PAS 19, Employee
loss (FVTPL) and recognize changes in the Benefits (see Chapters 12 and 12A).
liability's fair value in profit or loss. This
alternative is normally applicable to bonds Other non-financial liabilities are measured in the
payable as their fair values are reliably following manner:
determinable
a. Estimated amount to be incurred or paid to
Subsequent Recognition: Amortized Cost the counterparties (e.g., warranties income
Subsequently, financial liabilities are generally taxes payable or value-added tax payable);
measured at their amortized cost. or
b. Equal to the amount received from
The accounting for amortized cost is similar to customers that are not yet earned (e.g.,
investments at amortized cost, albeit the point of view advances from customers, unearned
is now on the issuer rather than the investor's point income, liability from gift certificates).
of view.

.
 FINANCIAL REPORTING OF LIABILITIES
Generally, in the entity's statement of financial position, liabilities are classified as
either current or non-current.

CRITERIA meaning RESIDUAL meaning

An entity shall classify a liability as current when: An entity shall classify all other liabilities as
a. it expects to settle the liability within its normal non-current. [PAS 1.69].
operating cycle; NOC
b. it holds the liability primarily for the purpose of
trading;
c. the liability is due to be settled within twelve
months after the reporting period;
or
d. it does not have an unconditional right to defer
settlement of the liability for at
least twelve months after the reporting period.

It should be noted that any one of these criteria is enough to classify a liability as current.

CRITERION 1 - It expects to settle the liability within its normal operating cycle.

The operating cycle of an entity is the time between the acquisition of assets for
processing and their realization in cash or cash equivalents.

NORMAL OPERATING CYCLE

Date of Realization of
Date of Selling the Goods on Credit Accounts Receivable INTO
Date of Acquisition of Goods Cash
for processing, to be sold later.

This criterion is made for trade payables such as the following:

a. accounts payable
b. notes payable for operating purposes
c. accrued operating expenses
d. unearned income; and
e. warranty liabilities.

These are normally classified as current even if they will be settled beyond 12 months after the reporting
date as long as it will be paid within the normal operating cycle.
For example, an account payable that is due to be paid in 15 months is still considered as current if the
entity's normal operating cycle is 18 months.

CRITERION 2 - Holds the liability primarily for the purpose of trading

A liability is considered as held for trading if (using the definition under PFRS 9):
1. it is acquired for the purpose of selling or repurchasing it in the near term;
2. on initial recognition is part of a portfolio of identified financial instruments
3. where there is evidence of recent actual pattern of short-term profit-taking; or
4. derivative (except those designated and effective hedging instrument).

Under this criterion and in the absence of additional information (i.e., silent treatment), financial liabilities
at FVTPL are usually classified as current. The reason for this is that, in the absence of contrary
information, the financial liabilities at FVTPL are assumed to be held for trading. Prime example of this is
the derivative liability.
However, financial liability at FVTPL that was irrevocably designated as such on
initial recognition is not necessarily considered as current mainly because it may not
be held for trading.

CRITERION 3 - The liability is due to be settled within (12) twelve months after the reporting period.
This criterion covers nontrade liabilities such as:
a) bank overdraft
b) dividends payable
c) current and deferred income taxes and indirect taxes
d) notes payable issued other than for operating purposes
e) loans and bonds payable (including accrued interest)
f) lease liabilities
g) pension liability

In the absence of additional information, bonds payable, mortgage payable, and pension liabilities are
normally classified as non-current liabilities.

For these liabilities to be considered as current, they must be settled within 12 months after the reporting
date, regardless of the original term of the liability.

This can be summarized as follows:

Scenarios Classification
Reporting date to Maturity date ≤12 months Current
Reporting date to Maturity date >12 months Non-current

Applying this principle, the following non-trade payables are current:

a) bank overdraft and dividends payable
b) current income tax payable and indirect taxes payable
c) accrued interest payable
d) notes, loans, and bonds payable maturing within 12 months after the reporting date, regardless of
the length of their original term.
e) portion of notes payable, loans payable, bonds payable, and lease liability that are due to be settled
within 12 months after the reporting date.

However, deferred tax liability is ALWAYS considered as non-current.

Illustration 1:

7-year bonds payable with maturity of July 1, 2024. P4,000,000

3-year bonds payable with maturity of December 31, 2025 2,000,000

5-year loan payable borrowed last October 1, 2019 5,000,000
4-year loan payable borrowed last April 1, 2022 1,000,000

10-year loan payable borrowed last June 30, 2023; principal is

10,000,000
payable in 10 equal annual installments starting on June 30, 2024
6-year loan payable with P400,000 semi-annual principal
payments 8,000,000
every January 1 and July 1 of each year
Accrued interest payable 625,000

Required: From these given liabilities, determine the amounts to be classified as current and non-current.

Solution:
Current Non-current
7-year bonds payable with maturity of July 1, 2024. P4,000,000
3-year bonds payable with maturity of December
2,000,000
31, 2025
5-year loan payable borrowed last October 1, 2019 5,000,000
4-year loan payable borrowed last April 1, 2022 1,000,000
10-year loan payable borrowed last June 30, 2023;
principal is
1,000,000 9,000,000
payable in 10 equal annual installments starting on
June 30, 2024
6-year loan payable with P400,000 semi-annual
principal payments every January 1 and July 1 of 800,000 7,200,000
each year
Accrued interest payable 625,000
TOTALS: P11,425,000 P19,200,000
CRITERION 4 - It does not have an unconditional right to defer settlement of the
Liability for at least twelve months after the reporting period/date.

As previously discussed, a liability that is due to be settled within 12 months is normally classified as
current, in the absence of both of the following:
a. unconditional right of the entity to defer the settlement of the liability; and
b. the deferment is at least twelve months after the reporting date.

The unconditional right of an entity can also mean "sole discretion" of the entity, which means that a
borrowing entity may make a decision without needing for an agreement with the other parties.

“Deferment” means extending the maturity date beyond the original one. If an entity has the sole discretion
to extend the maturity date, the period of extension shall also be considered in classifying the liability as
current or non-current. This deferment is also known as "refinancing".

Illustration 2. As of December 31, 2023, DELGADO Company had a loan payable maturing on June 30,
2024. The Company has the sole discretion to extend the maturity date up to June 30, 2025.

Based on this information, the loan payable shall be classified as non-current since it
Has an unconditional right to defer the settlement for at least 12 months after December 31, 2023. This is
regardless of the loan's original maturity date 2024, which is just six months after December 31, 2023.

Illustration 3. Going back to DELGADO Company, except that the maturity may be extended to June 30,
2025 provided the lender will agree.

Based on the revised information, the loans payable shall still be classified as current as the Company
because the agreement with the lender is needed to extend the maturity date to June 30, 2025.

Illustration 4. At the end of 2023, CANLAS Company had a bond payable on April 1, 2024. The Company
has the sole discretion to extend the maturity up to October 1, 2024.

The bond payable shall still be classified as current. Yes, there is an unconditional, right to defer the
maturity date, but the deferred maturity date of October 1, 2024 still less than twelve months from
December 31.2023. This only shows that it is important to consider the length of deferment, in addition to
assessing whether there is an unconditional right to defer.

Recall:
REFINANCING (LT Debt Falling due within 1 year)
- means replacement of an existing Debt with a new one but with different terms
- Example: Extended Maturity Date, Revised Payment Schedule.

General Rule: CL
Exception: NCL
1) When REFINANCING is made ON or BEFORE reporting date.
2) Debtor HAS DICRETION to refinance

REFINANCING

WITHIN 12 months

Maturity Date

CURRENT LAIBILITY

NON-CURRENT LAIBILITY

Reporting Date
 LIABILITIES BREACH OF COVENANTS AND GRACE PERIOD
Loans payable and bonds payable normally contain covenants that contain restrictions and/or
conditions that the borrower is required to follow. The purpose of these covenants is to highly
discourage the borrower from doing activities that may diminish its ability to pay the liability.

Recall: Obligations and Contract:

Debtor loses to the right to the period:
Insolvency
Guarantee lost
Impaired by his own acts
Violates undertaking
Absconds

WHEN GRACE PERIOD WAS GIVEN

WITHIN 12 months

Maturity Date

CURRENT LAIBILITY

NON-CURRENT LAIBILITY

Reporting Date

I. TRADE ACCOUNTS PAYABLE

Present obligations that are not supposedly by formal promises to pay by the
Description: debtor. These obligations normally arise from acquisitions of inventories to be
used in the normal operating cycle.

Recognition: When ownership of goods is transferred to the buyer.

Fair value, which is normally the invoice price of goods acquired and may not be
Measurement:
affected by related freight and cash discounts.
Normally included in the current liabilities section under the heading “Trade and
Presentation:
other payables”

List Price or Quoted Price PXX

LESS: Trade Discounts, Rebates and Other Similar Items (XX)
Initial Measurement (Gross Method of Recording Purchases) XX
LESS: Purchase Discount (XX)
Initial Measurement (Net Method whether Discount is taken or XX
not)
Pro-forma Journal Entries:
Gross Method Net Method
1) Acquisition: Purchases XX Purchases XX
AP (Gross) XX AP (Net) XX

2) Payment WITHIN the AP XX AP XX

Discount Period: Cash XX Cash XX
Purchase Discount XX

3) Payment BEYOND the AP XX AP XX

Discount Period: Cash XX Purchase Discount XX
Lost
Cash (Gross) XX

VALIDITY OF PURCHASE/PAYABLE:

FOB Shipping Point

When is it a valid purchase/ valid payable? When must we record a liability?

Upon Shipment

FOB Destination

Upon Receipt

EFFECTS of FREIGHT CHARGES in Accounts Payable:

Cases: Freight/Shipping Freight

Effect on Accounts
Fee SHOULD be ACTUALLY
Payable
paid by: paid by:
1) FOB Shipping Point,
Buyer Buyer -
Freight Collect
2) FOB Shipping Point,
Buyer Seller Addition to AP
Freight Prepaid
3) FOB Destination,
Seller Seller -
Freight Prepaid
4) FOB Destination,
Seller Buyer Reduction to AP
Freight Collect

Illustration:
On December 31, 2016, Bryant Co. has accounts payable of P4,000,000 before possible adjustment
for the following:
a) Goods in transit from a vendor to Bryant on December 31, 2016 with an invoice cost of
P200,000 purchased FOB Shipping Point was not yet recorded.
b) Goods shipped FOB shipping point from a vendor to Bryant was lost in transit. The invoice
cost of P80,000 was not yet recorded.
c) Goods shipped FOB shipping point from a vendor to Bryant on December 31, 2016 amounting
to P32,000 was recorded and included in the year-end physical count as "goods in transit."
d) Goods in transit from a vendor to Bryant on December 31, 2016 with an invoice cost of P40,000
purchased FOB destination was not yet recorded. The goods were received in January 2017.
e) Goods with invoice cost of P60,000 was recorded and included in the year-end physical count
as "goods in transit." It was found out that the goods were shipped from a vendor under FOB
destination.

Required:
Compute for the adjusted accounts payable on December 31, 2016.
ANSWER:
Unadjusted balance: P4,000,000
a ----Unrecorded purchases 200,000
b ----Unrecorded payables on purchases lost in
80,000
transit
e ----Purchases that should be recorded in the
(60,000)
next accounting period
Total: P4,220,000

OTHER ITEMS to be considered:

a) The accounts payable shall be reported gross of debit balances in the suppliers’ liabilities
accounts. The debit balances shall be separately reported as advances to suppliers (ie: an asset
account). The following is the pro-forma entry for reclassification if the account payable is net
of these amounts:
Advances to Suppliers XX
Accounts Payable XX

b) Credit balances in the customers’ accounts shall be reported as part of current liabilities (in
the unearned income account). The following is the pro-forma entry for reclassification if the
AR is net of these amounts:
Accounts Receivable XX
Unearned Income XX

c) The amount of bank overdraft that cannot be offset with the other bank account balances shall
be classified as part of current liabilities.
Cash in bank XX
Bank overdraft (liability) XX

Illustration:
As of December 31, 2023, TUAZON Company reported the following information
related to some of its account balances:

a. Accounts payable amounted to P900,000, while advances from customers amount to

P200,000. The accounts payable is net of P120,000 debit balances in suppliers’ accounts.
b. Deferred tax assets and deferred tax liabilities amounted to P300,000 and P450,000
respectively. Half of these deferred tax amounts will reverse during 2024. Income tax payable
for 2023 amounted to P 150,000.
c. Accounts receivable had a balance of P 1,200,000, net of credit balances in customer' accounts
of P 75,000.
d. Cash in bank had a balance of P 700,000, net of P 100,000 overdraft in one bank account. No
other bank accounts are maintained in that bank.
e. Estimated warranty liability amounted to P250,000.

The Company has the following information related to its loans payable:

Loan Face amount Interest rate Date of issuance Term

1 P4,000,000 6% 9/1/19 5 years
2 6,000,000 8% 4/1/21 4 years
3 5,000,000 9% 7/1/14 10 years
4 2,000,00 12% 10/1/18 6 years

All of the interest are payable annually. The payment of Loan 4's principal amount can be deferred
for at least two years after its maturity based solely on the Company's decision. The payment of Loan
3's principal amount can be deferred to July 1, 2027 if the lender agrees. The Company breached
Loan's 2 covenants; however, the lender granted grace period on January 10, 2024.

Required: Determine the amounts of current and noncurrent liabilities as of December 31, 2023.
 ANSWER:
Current Non-current
Accounts Payable, adjusted (P900K + P120K) P1,020,000
Deferred Tax Liabilities P450,000
Income Tax Payable 150,000
Advances from Customers 275,000
Bank overdraft 100,000
Estimated Warranty Liability 250,000
Loan 1
Maturity Sept. 1, 2024 or 5 years after Sept. 1, 2019 4,000,000

Loan 1
ACCRUED Interest payable
80,000
from Sept. 1, 2023 to Dec. 31, 2023
P4M x 6% x 4/12
Loan 2
Maturity of April 1, 2023 or 4 years after April 1, 2021 6,000,000

Loan 2
ACCRUED Interest payable
From April 1, 2023 to Dec. 31, 2023 360,000
P6M x 8% x 9/12

Loan 3
Maturity of July 1, 2024 or 10 years after July 1, 2014 5,000,000

Loan 3
ACCRUED Interest payable
From July 1, 2023 to Dec. 31, 2023 225,000
P5M x 9% x 6/12
Loan 4
2,000,000
Maturity of Oct. 1, 2024 or 6 years after Oct. 1, 2018
Loan 4 ACCRUED Interest payable
From October 1, 2023 to Dec. 31, 2023 60,000
P2M x 12% x 3/12
TOTALS: P17,520,000 P2,450,000

NOTES:
a. Deferred tax liabilities are always noncurrent regardless of the expected reversal of their effects.
b. Loan 2 is classified as current since there is a breach of covenants, and the grace period was
granted only on January 10, 2024 or after December 31, 2023.
c. Loan 3 is classified as current since the Company does not have the sole discretion since the
lender's agreement is necessary for the extension.
d. Loan 4 is classified as noncurrent since the Company has the sole discretion to extend the
maturity date of the loan.

II. BONUS PAYABLE

- Bonus is a gratuity given by entities to their employees as a gift
compensation earned as reward upon achieving a goal such as exceeding
budgeted income during the year, meeting quotas, and having a superior
performance in a project or activity. The primary purpose of this is to
encourage performance from officers and employees by directly associating
their success to company's success.

Formulas:

1) B = BR% ∙ NI
2) T = TR% ∙ (NI – T)

Formula #1: B = BR% ∙ (NI – B – T)

*If in the problem it mentions Net Income is “AFTER” Bonus and Tax
- this simply means that Bonus and Taxes were deducted when NI was multiplied to the
bonus rate.

“AFTER”- any word right after this word was deducted from NI.
“BEFORE”- any word that comes after this word, means that it wasn’t deducted.

Formula #2: T = TR% ∙ (NI – B)

= constant regardless if Net Income is “BEFORE” or “AFTER” either Bonus and/or Tax
Illustration:
Riel, president of the CPA Co., has an arrangement with the company under which she receives 10%
bonus each year. For the current year, the net income before deducting even the provision for income
taxes or the bonus is P5,500,000. The bonus is deductible for tax purposes and the tax rate is 30%

Required: Determine the amount of Riel's bonus and the appropriate provision for income tax for the
year under the following independent scenarios.
1) Bonus is calculated based on net income before bonus and income tax.
2) Bonus is calculated based on net income after bonus but before income
3) Bonus is calculated based on net income after bonus and income tax.
4) Bonus is calculated based on net income after income tax but before

ANSWER:
Bonus Tax
a. NI before Bonus and Tax P550,000 P1,485,000
b. NI after Bonus but before Tax P500,000 P1,500,000
c. NI after Bonus and Tax P359,813 P1,542,056
d. NI after Tax but before Bonus P396,907 P1,530,928

III. UNEARNED/DEFERRED REVENUE

This represents income already collected but not yet earned. This item shall be presented
as part of entity's liabilities and normally classified as current liabilities. Examples include
advances received from customers for goods yet to be delivered, services yet to be provided,
gift certificates sold, and subscriptions.
✓ Delivery of Goods
✓ Provision of Services
✓ Gift Certificates

Pro-forma journal entries:

1. To record receipt of cash from advance orders:
Cash XX
Unearned Revenue XX

2. To record application of advances to service provided or orders shipped:

Unearned Revenue XX
Sales or any appropriate account XX

Illustration:
UNEARNED REVENUE- Delivery of Goods
Gideon Co. requires advance payments for its products. The records of Gideon show the following:

Unearned Revenue, January 1, 2016 P500,000

Cash Received from Advances during 2016 2,500,000
Advances applied to orders shipped in 2016 1,800,000
Advances applicable to orders shipped in 2016 200,000

Required: Compute for the amount to be reported as Unearned Revenue

assuming the advance payments received are NON-REFUNDABLE.

ANSWER:

Unearned Revenue – Delivery of Goods

Advances applied to Shipments/Sales: P 1,800,000 Beginning: P 500,000
Orders cancelled: 200,000 Cash Received from Advances: 2,500,000
Ending: P 1,000,000

*Pro-forma entry to record advances applicable to orders cancelled:

NOTE: If the cash received in advance is REFUNDABLE, the amount applicable to orders cancelled is
still presented as part of liabilities.

Illustration:
UNEARNED REVENUE- Provision of Services

Scottie Company sells office equipment service contracts agreeing to service equipment for
a two-year period. Cash receipts from contracts are credited to unearned service contract
and service contract costs are charged to service contract expense as incurred.
Revenue from service contracts is recognized as earned over the lives of the
contracts. Additional information for the year ended December 31, 2016 is as follows:
 Unearned service contract at January 1 P200,000
Cash receipts from service contracts sold 440,000
Service contract revenue recognized 560,000
Service contract expense 280,000

Required: Compute for the amount to be reported as unearned service contract revenue at December
31, 2016 by Scottie.

ANSWER:
Unearned Revenue- Service Contract
Service contract revenue P560,000 Beginning: P200,000
RECOGNIZED:
Ending: 80,000 Cash receipts from Service 440,000
Contracts Sold

Illustration:
UNEARNED REVENUE- Gift Certificates

1) Piper Co. has just opened a coffee shop and decided to sell gift certificates
as part of its marketing and promotional strategy. The validity period for these
gift certificates during the year are shown below:

▪ Sold Gift Certificates worth P15,000.

▪ Gift Certificates worth P9,000 were redeemed.
▪ P1,000 Gift Certificates expired.

Required: Compute for the amount of unearned revenue to be presented as

current liability related to these gift certificates sold.

ANSWER:
Unearned Revenue- Gift Certificates
Gift Certificate P9,000 Beg. Jan. 1: -
REDEEMED:
End, Dec. 31: 5,000 Cash receipts from Service P15,000
Contracts Sold

2) Gale Department Store sells gift certificates redeemable only when

merchandise is purchased. These gift certificates have no expiration date. Upon
redemption or expiration, the entity recognizes the unearned revenue as
realized.

Information for the current year is as follows:

Unearned revenue, January 1, 2023 P650,000
Gift certificates sold 2,250,000
Gift certificates redeemed 1,950,000
Gift certificates expected not to be redeemed 100,000
Cost of goods sold 60%

Required: On December 31, 2023, what amount should be reported as unearned revenue?

ANSWER:
Unearned Revenue- Gift Certificates
Gift Certificate P1,950,000 Beg. Jan. 1: P650,000
REDEEMED:
Gift Certificate expected 100,000 Cash receipts from Service P2,250,000
NOT to be redeemed: Contracts Sold

End, Dec. 31: P850,000

 3) Iridescent Department Store sells gifts certificates, redeemable for store merchandise and with
no expiration date. The entity has the following information pertaining to the gift certificate
sales and redemptions:

Unearned revenue, January 1, 2023 P750,000

2023 sales 2,500,000
2023 redemptions of prior year sales 250,000
2023 redemptions of current year sales 1,750,000

Required: On December 31, 2023, what amount should be reported as unearned revenue?

ANSWER:
Unearned Revenue- Gift Certificates
Redemption of PRIOR Year P250,000 Beg. Jan. 1: P750,000
Sales:
Redemption of CURRENT 1,750,000 Sales of Gift Certificates: P2,500,000
Year Sales:

End, Dec. 31: P1,250,000

Illustration:
UNEARNED REVENUE- Subscriptions
Erwing Company sells sports magazine subscriptions of one-to-four-year periods. Cash receipts
from subscribers are credited to unearned revenue and this account had a balance of P4,800,000 on
December 31, 2016 before year-end adjustments. Outstanding subscriptions on December 31, 2016
expire as follows:

During 2017 P1,200,000

During 2018 1,000,000
During 2019 800,000
During 2020 400,000

Required: Compute for the amount of unearned revenue to be reported as current liability related to
these magazine subscriptions on December 31, 2016.

ANSWER:
Current Liability Non-current Liability:
To Expire in 2017: P1,200,000 To expire in 2018: P1,000,000
To expire in 2019: 800,000
To expire in 2020: 400,000
Total Non-current: P2,200,000

The difference of P1,400,000 (P4,800,000-P3,400,000) between the amount before adjustment and
total outstanding liabilities as of December 31, 2016 shall be recognized as earned revenue.

IV. DEPOSITS RECEIVED

- Deposits representing Cash Received and held in behalf of other entities such as clients
and customers. These items are recognized as liabilities and classified as to either
current or non-current depending their settlement dates. Examples include deposit in
escrow accounts and refundable deposits on returnable containers.

Examples:
a) Escrow Deposits
b) Returnable Containers
c) Security Deposit from LessEE in a lease agreement
d) Deposits from Shareholders for Future Subscription

Illustration:
Escrow Deposits
On the first day of each month, Griffin Company receives from a customer an escrow deposit of
P300,000 for value-added tax. Griffin records the P300,000 in an escrow liability account. The
customer's value-added tax for the year is estimated at P3,500,000, payable in equal installments on
the 25th day of each month. On January 1, 2016, the balance of the escrow account was P 200,000.
Required: Determine the amount Griffin should show as escrow liability behalf of this customer on
September 30, 2016.

ANSWER:
Escrow Liability
Cash Payments 9 months: P2,625,000 Beg. Jan. 1: P750,000
End, Dec. 31: P275,000 Cash Receipts for 9 months: P2,700,000

Illustration:
Returnable Containers
Kevin Co. sells its products in reusable containers. The customer is charged a deposit when
containers are delivered and receive a refund when containers are returned within
one year after the year of delivery. Deposits for containers not returned within the
time limit are accounted as regarded as proceeds from the sale of the containers.
Information for 2023 are as follows:

Container deposits at December 31, 2022, from deliveries in:

• 2021 P75,000
• 2022 90,000 P165,000
Deposits for containers in 2023 140,000
Deposit containers delivered in 2023 from deliveries in:
• 2021 P50,000
• 2022 60,000
• 2023 70,000 180,000

Required: Determine the amount of liability for deposits on returnable containers on December 31,
2023?

ANSWER:
Liability for Deposits
Cash Refunds for containers P180,000 Beg, Jan.1: P165,000
returned in 2023:
*Proceeds from sale of 25,000 Cash deposits from 140,000
containers: deliveries:
End, Dec. 31: P100,000

• This represents the balance from 2021 deliveries not returned as of December 31, 2023. This
is computed as follows: (P75,000 minus P25,000)
• Such amount is treated as Proceeds from Sale of Containers and not as Liability.

V. PROVISIONS and CONTINGENT LIABILITIES

In the previous topics, we have discussed liabilities (eg: Accounts Payable and Notes Payable) from
which an entity has a “Definite” Obligation. Definite in the sense that the amounts, timing, and
identity of the counterparty are all specifically identifiable without the need of high-level estimates
and assumptions.

However, not all liabilities possess these "definiteness" traits and may need additional analysis and
assumptions for their recognition and measurement due to related uncertainties. These liabilities
include, but are not limited to, the following:

• Liabilities arising from environmental damage caused by entity's operations.

• Claims of damages from faulty or hazardous products sold.
• Customers' claims from the entity's warranty over the products sold.
• Premium liability arising from entity's promotional programs.
• Asset retirement obligation (including restoration and rehabilitation costs).

The relevant standard in this chapter is the PAS 37, Provisions, Contingent Liabilities, and
Contingent Assets.

“Probable” in this context means more likely than not. If an event has MORE THAN 50% chance of
happening, it is said to be “probable” since it is understood the chance of it not happening is less
than 50% (i.e., complement of more than 50%).

“Remote” level of probability in this context shall be determined using judgement. (i.e., no quantitative
threshold).

Provisions involve the recognition and measurement of a liability.

A provision is a liability of uncertain amount or uncertain.

A provision is recognized when:
a) an entity has a present obligation (legal or constructive)
b) it is probable that an outflow of resources embodying economic benefits will be required to
settle the obligation; and
c) a reliable estimate can be made of the amount of the obligation.

If these conditions are not met, no provision shall be recognized.

Pro-forma journal entry:

Expense XX
Estimated Liability XX

A contingent liability is:

a. a possible obligation that arises from past events and whose existence will be confirmed only
by the occurrence or non-occurrence of one more uncertain future event not wholly within the
control of the entity, or
b. a present obligation that arises from past events but is not recognized because:
i. it is not probable that an outflow of resources embodying economic benefits will be
required to settle the obligation; or
ii. the amount of the obligation cannot be measured with sufficient reliability.

Relationship between provision and contingent liability:

In general sense, all provisions are contingent because they are uncertain in timing or amount. The
term "contingent" is used for items that are not recognized because their existence will be confirmed
by occurrence or occurrence of one or more uncertain future events not within the control of the
entity. The "contingent liability" is used for liabilities that do not meet the recognition criteria.

RECALL:

Provision Contingent Liability

1. Present obligation 1. Possible obligation
2. BOTH probable and measurable 2. EITHER probable or measurable
3. Recognized as a Regular Liability 3. Not recognized; Disclosed only