LIABILITY Liabilities are present obligations of an entity arising from past transactions or events, the settlement of which is expected in an outflow from the entity of resources embodying economic benefits Essential Characteristics the liability is a present obligation the liability arises from a past event the settlement of the liability requires an outflow of resources embodying economic benefits Initial Measurement of Liability FV-Transaction Costs (Expensed if FV through P/L) fees & commission levies by regulatory agencies transfer taxes & duties not included debt premiums/ discounts financing costs internal administrative/holding costs FV Option *credit risk= OCI Subsequent measurement at amortized cost at fair value through P/L Measurement of Noncurrent liabilities Noncurrent liabilities are measured at present value and subsequently measure at amortized cost. If the long-term not is interest bearing, it is measure at face amount Measurement of Current liabilities- reported at face amount Current liabilities it is expected to be settled in the entity’s normal operating cycle it is held primarily for the purpose of trading it is due to be settled within twelve months after the balance sheet date the entity does not have an unconditional right to defer settlement of the liability for at least twelve months after the the blance sheet date
Noncurrent liabilities Liabilities not classified as current. These include the following: noncurrent portion of long term debt, capital lease liability, noncurrent deferred tax liability, long term obligations to company officers, long term deferred revenue Refinancing activity Current: between end of reporting period & date of authorization for issue of financial statement Noncurrent: on/before end of reporting period or the entity has discretion to refinance Breach of covenant PAS 1, par. 74, states that such 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 Liability is classified as noncurrent if the lender has agreed on or before the end of the reporting period to provide a grace period ending at least twelve months after that date.
PREMIUM AND WARRANTY LIABILITY Premiums are articles of value such as toys, dishes, silverware and other goods and in some cases cash payments given to customers as result of past sales or sales promotion Recognition of the premium liability are as follows When premiums are purchased Premiums XX Cash XX When premiums are distributed Premium expense XX Premiums XX If premiums are still outstanding Premium expense XX Estimated premium liability XX Computation of EWL To be redeemed XX Redeemed (XX) Balance XX Customer Loyalty Program (IFRS 15) Generally designed to reward customers for past transactions and t provide them incentives to make further purchases, Award Credits (points)-measured at fair value Deferred revenue, separately component of the initial sale transaction or future delivery of goods or sevices Estimated Warranty Liability- at the point of sale, a constructive obligation arises and a liability is incurred Expense as incurred approach- warranty expense is only recorded when incurred Accrual approach- the soundest theoretical support because it properly matchest the cost with the revenue Testing the accuracy of warranty liability- Sales made evenly Assumed that half of sales were made on the first period and that the other half of it were sold on the half of the period
Sale of Warranty- sold separately from the product sold or may offer the product sold but with an additional cost. Amount is recognized as deferred revenue. Accrued Liabilities and Deferred Revenue Payroll Tax Expense Under our law, the entity as an employer is required to withhold from the salaries of each employee the following: income tax payable by the employee employee contribution to the SSS employee contribution to the Philhealth employee contribution to the Pag-ibig fund Such amounts withheld from the salaries shall be recognized as payroll taxes payable until remitted by the entity to the appropriate government authority Value Added Taxes Payable Under the National Internal Revenue Code, the entity is required to collect value added taxes from customers on sales of tangible personal property and certain services Such value added taxes collected shall be recognized as value added taxes payable and remitted monthly to the BIR Gift Certificates Payable When the gifts certificates are sold, the amount received is initially recognized as unearned revenue or gifts certificate payable. The subsequent redemption of gift certificates is recognized by debiting gift certificates payable and crediting sales revenue. The DTI ruled that gift certificates no longer have an expiration period. GC’s may be forfeited as other income when not presented for redemption. Refundable Deposits Refundable deposits consist of cash or property received from customers but which are refundable after compliance with certain conditions. Bonus Computation- large entities compensate key officers and employees by way of bonus for superior income realized the year. The purpose is for motivation. bonus is expressed as a percent of income before bonus and tax bonus is expressed as a percent of income after bonus but before tax bonus is expressed as a percent of income after and tax bonus is expressed as a percent of income before bonus but after tax
PROVISION AND CONTINGENT LIABILITY PAS 37 par. 14 Provision is an existing liability of uncertain timing or amount. The liability does exist on balance sheet date but the amount or the date of obligation is due and in some cases the payee cannot be determined. It is the equivalent of estimated liability or a loss contingency that is accrued because it is both probable and measurable. Recognition of Provision according to PAS 37 par. 14 the following conditions must be met It is a present obligation. Legal or constructive as a result of past event Probable that an outflow of economic benefits is required to settle it The amount can be measured reliably Measurement of Provision The amount recognized as a provision should be the best estimate of the expenditure required to settle the present obligation at the balance sheet date. The estimates of outcome are determined by the judgment of the management. Where there is a continuous range of possible outcomes, the midpoint of the range is used The expected outflows- the range of outflows and their effects shall be taken into account by estimating the expected present value of the outflows Elements in the measurement of the present value of the obligation the expected outflows the time value of money the risk that the actual outflows might differ from the expected outflows Other measurement consideration the risks and uncertainties present value of an obligation future events expected disposal of assets reimbursements changes in provision
use of provision future operating loss onerous contract Examples of Provision warranty environmental contamination decommissioning or abandonment cost court case guarantee Decommissioning Liability The outflows include the amount that the entity would rationally pay a contractor if there’s an active market- the amount is the price that the entity estimates a contractor would charge if there’s no active market for the service- the amount if would charge another party at the future date to undertake the service Restructuring PAS 37 par. 10 defines restructuring as a program that is planned and controlled by management and materially changes either the scope of an enity or the manner in which that business is conducted. Provision for restructuring when the entity has a detailed formal plan for the restructuring the entity has raised valid expectation in the minds of those affected Amount of restricting provision A restructuring program shall include only direct expenditures arising from restructuring. The expenditures are necessarily entailed by the restructuring and not associated with the ongoing activities of the enity Contingencies Contingent liability- is a possible obligation that arises from past event and whose existence will be confirmed only by the occurrence or nonoccurrence of one or more uncertain future events not wholly within the control of the entity. Contingent asset- is a possible asset that arises from past event and whose existence will be confirmed only by the occurrence or nonoccurrence of one or more uncertain future events not wholly within the control of the entity. Degrees of probability Contingent Liability Contingent Asset according to PAS 37
Virtually certain 95% Provide Recognize Probable, above 50% Provide Disclose to note Possible 5% to 50% With disclosure No disclosure Remote, below 5% No disclosure No disclosure BONDS PAYABLE Bond is a contract of debt whereby one party called the borrower or issuer borrows funds from another party called the investor or bondholder Bond indenture- document which shows in detail the terms o the bond and the rights and duties of the borrower and other parties to the contract Types of bonds term bonds- bonds with single maturity date serial bonds- bonds with series of maturity date mortgage bond- bonds secured by mortgage or real properties collateral bonds- bonds secured by investments in stocks and bonds debenture bonds- bonds without collateral security registered bonds- requires the registration of the name of the bondholder on the books of the corporation coupon bonds- the name of the bondholder is not registered convertible bond- bonds that can be exchanged for equity shares of the entity callable bonds- bonds that can be called in for payment anytime guaranteed bond- bonds issued whereby another party guarantees to pay if the borrower fails to do so junk bonds- high risk high yield bonds commodity-backed binds- bonds redeemable in commodities such as oil Premium on bonds payable- sales price is more than the face value of the bonds Discount on bonds payable- the sales price is less than the face value of the bonds Bond issue costs- incremental costs that are directly attributable to the issue of the bonds payable. Measurement of bonds payable PFRS 9 par. 5.1.1 provides that bonds payable not designated at fair value through profit or loss shall be measure initially at fair value minus transaction costs. The fair value is equal to the present value of the future cash payments When bonds are designated at fair value through profit or loss, the bond issue costs are treated as expense immediately. The fair value of the bonds is the same as the issue price or net proceeds excluding accrued interests.
Subsequent measurement of bonds payable PFRS 9 par. 5.3.1- after initial recognition, bonds shall be measured at at amortized cost, using effective interest method at fair value through profit or loss Amortized cost of bonds payable The difference between the face amount and present value of the bonds payable is amortized using the effective interest method Fair value option Bonds payable are measure at fair value and remeasured at every year end at fair value and any changes in FV are recognized in profit or loss Any changes in FV attributable to the credit risk is recognized in OCI There is no more amortization and interest expense is based on the stated rate Bond retirement On maturity date Bonds payable XX Interest expense XX Cash XX Prior maturity 1. update amortization 2. compute for the balance of amortization 3. compute for the accrued interest if any 4. compute for cash consideration- retirement price plus accrued interest 5. compute the CA of the bonds 6. compute for the gain or loss- CA less retirement price 7. Bonds payable XX Interest expense XX Loss on retirement XX Discount on bonds XX Cash XX Treasury bonds-entity’s own bonds issued reacquired but not canceled Accounting for treasury bonds- when treasury bonds are reacquired, the treasury bonds account is debited and any related unamortized discount or premium is canceled, the difference between acquisition cost and the CA is treated as gain or loss. Any accrued interest paid is charged to interest expense. Treasury bonds are reported in the statement of financial position as deduction from bonds payable.
Bond refunding- premature retirement of old bonds by issuing new bonds Bond refunding charges- refunding charges include unamortized premium or discount, and redemption premium on the bonds being refunded PFRS 9 par. 3.3.1 states that bond refunding is an extinguishment of financial liability par. 3.3.3 further provides that the difference between the CA and the consideration paid shall be included in profit or loss. EFFECTIVE INTEREST METHOD Nominal rate- the rate appearing on the face of the bonds. Also known as coupon or stated rate. Effective rate- the rate that exactly discounts estimated cash future payments through the expected life of the bonds payable or when appropriate. Also known as yield or market rate. If the bonds are sold at face amount, the nominal rate and effective rate are the same. If the bonds are sold at a discount, the effective rate is higher than nominal rate. If the bonds are sold at a premium, the effective rate is lower than nominal rate. Effective interest method The effective interest method or simply interest method or other know as scientific method recognizes two kinds of interest, the nominal and effective rate. The annual amortization of premium or discount is computed by multiplying the face amount of the bonds payable by the nominal rate. The nominal interest expense is computed by multiplying the face amount of the bonds payable by the nominal rate. The effective interest method provides for an increasing amount of premium amortization but a decreasing amount of interest sexpense. Bond issue cost The calculation of effective interest rate shall include all transaction costs, premiums and discounts. Under the effective interest method, bond issue cost must be lumped with the discount on bonds payable and netted against the premium on bonds payable. Accordingly, bond issue costs will increase discount and decrease premium on bonds payable
COMPOUND FINANCIAL INSTRUMENTS PAS 32, par. 28 defines compound financial instrument as a financial instrument that contains both a liability and an equity element from the perspective of the issuer. Characteristics of a compound financial instrument There must be a contract There are at least two parties involved The contract shall give rise to a financial asset of one party and a financial liability or equity instrument of another party. Accounting for a compound financial instrument If the financial instrument contains both a liability and an equity component, PAS 32, par. 29, mandates that such components shall be accounted separately in accordance with substance of the contractual arrangement and the definition of a financial liability and an equity, Bonds payable issued with share warrants When bonds are sold with share warrants two securities are sold- the bonds and share warrants. Share warrants to the bonds may ne detachable or non-detachable. Allocation of issue price The bonds are assigned an amount equal to the market value of the bonds ex warrants regardless of the market value of the warrants. The residual amount or remainder of the issue price shall then be allocated to the warrants. If the bonds have no known market value ex-warrant, the amount allocated to the bonds is equal to the present value of the bonds payable. Convertible bonds Convertible bonds are those which give the holders the right to convert their bondholding into share capital or other securities of the issuing entity within a specified period of time Issue of a convertible bond
Classify the instrument or its component parts on initial recognition as a financial liability, a financial asset or an equity instrument with the substance of the contractual arrangement and the definitions of a financial liability, a financial asset and equity instrument. Allocation of issue price The bonds assigned an amount equal to the market value of the bonds without the conversion privilege. The residual amount of the issue price shall then be allocated to the conversion privilege or equity component. In the absence of market value without conversion privilege, the amount allocated to the bonds is equal to the present value of the bonds payable Conversion of a debt instruments The carrying value, which is equal to the face amount of the instrument plus or minus any unamortized premium or discount, is derecognized as a liability & will be recognized as equity. The equity component at the time of issue (of the compound instruments) remains in equity (although it may be transferred from one line item within equity to another0. No gain or loss is recognized on the conversion of debt equity Retirement of bonds prior maturity Non-convertible bonds= the unamortized cost(principal + any unamortized premiums or – any unamortized discount – any unamortized issue cost) of the bond – retirement price excluding any payment for accrued interest should be recognized in the profit or loss as a finance income or expense Convertible bonds= the redemption price + any transaction costs are allocated to the liability and equity components at the date of transaction. The method used in allocating the consideration pain and transaction costs to the separate components is consistent with that used in the original allocation to the separate components of the proceeds received when the convertible instrument was issued. The difference of the redemption price assigned to the debt part less the amortized cost of the debt is reported in the profit or loss as finance income or expense while the difference of the redemption price assigned to the equity part and the carrying value of the equity is reported directly inside the equity as a reserve (gain) or a change against the retained earnings (loss).
NOTE PAYABLE A promissory note is an unconditional promise in writing made by one person to another, signed by the maker, engaging to pay on demand or at a fixed or determinable future time a sum certain in money to order or to bearer. Initial measurement of note payable PFRS 9 par. 5.1.1 provides that a note payable shall be measured initially at fair value minus transaction costs that are directly attributable to the issue costs of the note. If the note is irrevocably designated at fair value through profit or loss, the transaction costs are expensed immediately. Subsequent measurement of note payable PFRS 9 par. 5.3.1 provides that after initial recognition, a note payable shall be measured at amortized costs using the effective interest method or at fair value through profit or loss. Amortized cost of note payable The difference between the face amount and present value of the note payable is amortized through interest expense using the effective interest method. Fair value option Under the fair value option, the note payable shall be measured initially at fair value and remeasured at every year end at fair value and any changes in fair valu are recognized in profit or loss. Any changes in fair value attributable to credit risk of note payable are recognized in other comprehensive income. No amortization of transaction cost, discount or premium. The interest expense is recognized using the nominal rate.
DEBT RESTRUCTURE Debt restructuring is a situation in which the creditor for economic or legal reasons related the debtor’s financial difficulties grants a concession to the debtor that it would not otherwise consider. That the concession either from an agreement between the creditor and the debtor or is imposed by the law or cout. Types of restructuring Asset swap- is the transfer of any asset such as real estate, inventory or investment by the debtor to the creditor in full settlement of an obligation. PFRS 9 par. 3.3.1 and 3.3.3, asset swap is treated as a derecognition of a financial liability or extinguishment of an obligation. The difference between the carrying amount of the financial liability over the carrying amount of the asset given is recognized in profit or loss USA GAAP, asset swap is recorded as if two transactions have taken place, the sale of the asset and the extinguishment if the liability. Accordingly, two gains or losses are recognized. The difference between the fair value and the carrying amount of the asset is the gain or loss from exchange while the difference between the carrying amount of the liability over the fair value of the asset is gain or loss from restructuring. Dacion en pago- arises when a mortgaged property is offered by the debtor in full settlement of the debt. The transaction is accounted for as an asset swap. Equity swap- the issuance of share capital by the debtor to the creditor in full or partial payment of an obligation. IFRIC 19 The equity instruments issued to extinguish a financial liability shall be measured at the following amounts in the order of priority 1. Fair value of equity instruments issued 2. Fair value of the liability extinguished 3. Carrying amount of the liability extinguished Such gain or loss on extinguishment shall be disclosed as a separate line item in the income statement.
Modification of terms Interest concession- may involve a reduction of the interest rate. Forgiveness of unpaid interest or a moratorium on interest payment Maturity value concession- may involve an extension of the maturity date or reduction of the amount to be paid at maturity Accounting for substantial modification PFRS 9 par. 3.3.2 provides that a substantial modification of terms of an existing financial liability shall be accounted for as an extinguishment of the old financial liability Under Application Guidance B3.3.6 of PFRS 9 there is substantial modification of terms if the gain or loss is at least 10% of the carrying amount of the liability. The difference between the present value of the new liability over the carrying amount of the liability is treated as gain or loss on extinguishment. The present value of the new liability shall be determined using the original effective interest method. Accounting for no substantial modification Application guidance B3.3.6, if the gain or loss is less than 10% of the old liability, there’s no substantial modification of terms. The gain or loss is not recognized because the modification is not an extinguishment of the old liability. The old liability is simply continued but with modified interest charges.
OPERATING LEASE PAS 17 par. 4 defines a lease as an agreement whereby the lessor conveys to the lessee for a payment or series of payments the right to use an asset for an agreed period of time Operating lease in the books of the lessee PAS 17 par. 33 provides that lease payments under an operating lease shall be recognized as an expense on a straight line basis over the lease term unless another systematic basis is more representative of the time pattern of the user’s benefit. 1. The lessee will not recognize the leased asset. 2. Rentals under operating leases should be charged to the income statement on a straight line basis over the term of the lease. 3. Any difference between the amounts charged and amounts paid should be adjusted to repayment accruals. 4. Any incentives given by the lessor should be recognized over the life of the lease on the straight line basis. 5. Any lease bonus is recognized as additional rent expense over the lease term. 6. Any leasehold improvement is depreciated over the lease term or life of asset whichever is shorter. Operating lease on the books of the lessor PAS 17, par. 50, lease income from operating lease on the part of the lessor shall be recognized on a straight line basis over the lease term, unless another systematic is more representative of the time pattern in which use benefit derived from the leased is diminished. 1. The periodic rental in an operating lease is recognized as rent income. 2. A lessor shall present in the statement of financial position. 3. The leased property remains as an asset of the lessor but he may pass on the lessee the payment for taxes, insurance and maintenance. 4. The depreciation for the leased shall be depreciated in a normal way. 5. Any security deposit shall be accounted for as a liability.
6. Any lease bonus is recognized as unearned rent income. 7. Initial direct costs of the lease may be spread over the life of the lease PAS 17 par. 33 & 50 provide where the operating lease requires unequal cahs payments, the total rental payments for the lease term shall be amortized uniformly on the straight line basis on the part of the lessee or rent income on the part of the lessor over the lease term. FINANCE LEASE Finance on the books of the lessee PAS 17, par. 12 states that lessees should recognize finance leases as assets and liabilities in their balance sheets at amounts equal at the inception of the lease to the fair value of the leased property or if lower at the present value of the minimum leased payments. In calculating the present value of the minimum lease payments the discount factor is the interest rate implicit in the lease, if this is practicable to determine, if not, the lessee’s incremental borrowing rate should be used. A contract of lease may lead to a finance lease if any of the following is met 1. The lease transfers ownership to the lessee by the end of the lease term. 2. The lessee has the option to purchase the asset at a bargain 3. The length is for the major part of the economic life of the asset even if the title is not transferred. Major implies over 75%. 4. At the inception of the lease, the present value of the minimum lease payments amounts at least substantially all of the fair value of the leased asset. Substantial implies 90% of the fair value of the asset. 5. The assets are of a specialized nature such that only the lessee can use them. Indicators of situations that individually or in combination could also lead to a lease being classified as finance lease 1. If the lessee can cancel the lease, the losses of the lessor in connection of the cancellation shall be incurred by the lessee. 2. Gains or losses from the change in FV of the residual accrue to the lessee. 3. The lessee has the ability to continue the lease for a secondary term at a rent that is substantially lower than the market rent. The cost of a leased asset acquired on a finance lease should be the present value of future minimum payments. Minimum payments include rental payments required over the lease term plus any amount to be paid for the residual value, either through bargain purchase or a guarantee of the residual value. Any executor costs such as maintenance, and taxes do not form part of the minimum
lease payments. There is a bargain purchase option if the price is less than the fair value of the asset upon the option exercise date, since the option price is is estimated to be the same fair value on option exercise date, therefore, the lease contract has no bargain purchase option. Initial direct costs are often incurred by the lessors and include amounts such as commissions, legal fees and internal costs that are incremental and directly attributable to negotiating and arranging a lease. For finance leases other than those involving manufacturer of dealer lessors, initial direct costs are included in the initial measurement of the fiancé lease receivable and reduce the amount of income recognized over the lease term, the interest rate implicit in the lease is defined in such a way that the initial direct cost are included automatically in the finance receivable, there is no need to add them separately. Cost incurred by manufacturer or dealer lessors in connection with negotiating and arranging a lease is excluded from the definition of initial direct costs. As a result they are excluded from the net investment in the lease and are recognized as an expense when the selling prfit is recognized, which for a finance lease is normally at the inception of the term. Depreciation on leased assets will depend on how the lease qualifies as a finance lease If the lease transaction met the criterion as either transferring ownership or containing a bargain purchase option, the asset is depreciated over the the estimated useful life If the transaction qualifies as finance lease because it met either the major part of useful life or because the present value of the minimum lease payments represented substantially all of the fair value of the asset, it must be depreciated over the lease term or life of the asset whichever is shorter. If there’s no reasonable certainty that the lease will obtain ownership by the end of the lease term, the asset should be fully depreciated over the shorter of the lease term or its useful life. Therefore, the leased asset should be fully depreciated voer the lease term.
DIRECT FINANCING LEASE AND SALES TYPE LEASE-LESSOR Direct financing lease is an arrangement between a financing entity and a lessee. The income of the lessor is only in the form of interest income. No dealer profit is recognized because the fair value and the cost of the asset are equal. A direct financing lease is the result of an entity’s need to finance the acquisition of an asset. In the absence of conventional financing, an entity may turn to a leasing entity for the lease of the desired asset. Accounting considerations Gross investment in the lease- equal to the gross rentals for the entire lease term plus the absolute amount of the residual value whether guaranteed or unguaranteed. This is the amount debited to lease receivable. Net investment in the lease- equal to the cost of the asset plus any direct cost incurred by the lessor. Unearned interest income- total financing revenue of the lessor which is the difference between the gross investment and net investment in the lease. Initial direct cost- added to the cost of the asset to get the net investment in the lease. Sales type lease involves the recognition of a manufacturer or dealer profit on the transfer of the asset to the lessee in addition to the recognition of interest income. Accounting consideration Gross investment- equal to the gross rentals for the entire lease term plus the absolute amount of the residual value whether guaranteed or unguaranteed. This is the amount debited to lease receivable. Net investment in the lease- equal to the present value of the gross rental plus the present value of the residual value, whether guaranteed or unguaranteed. Unearned interest income- total financing revenue of the lessor which is the difference between the gross investment and net investment. Sales- amount equal to the net investment or FV of asset whichever is lower.
Cost of goods sold- equal to the cost of the asset plus any initial direct cost. Gross profit- sales minus cost of goods sold Initial direct cost- amount is expensed immediately as a component of cost of goods sold. Actual sale of the leased asset- the difference between the carrying amount of the lease receivable is recognized in profit or loss. The carrying amount of the lease receivable is equal to the balance of the lease receivable minus the unearned interest income. SALE AND LEASBACK Sale and leaseback is an arrangement whereby one party sells a property to another party and then immediately leases the property back from to its new owner. The sell becomes the lesse and the purchaser becomes the lessor. The lease rent and the sale price are usually interdependent as they are negotiated as a package. The accounting treatment of a sale and leaseback transaction depends upon the typed of the lease involved. Sale and leaseback as a finance lease PAS 17 par. 59 provides that if the sale and leaseback transaction results in a finance lease, any excess of the sale proceeds over the carrying amount shall not be immediately recognized as income but deferred and amortized over the lease term. Any gain from sale and leaseback is deferred and amortized over the term Any loss on sale and leaseback is recognized immediately Sale and leaseback as an operating lease PAS 17 par. 61 provides the following rules if the leaseback is an operating lease. If the sale and leaseback is established at FV, any gain or loss on sale shall be recognized immediately. If the sale price is below fair value, any gain or loss shall also be recognized immediately. If the loss is compensated by future lease rental at below market value, the loss is deferred and amortized in proportion to the lease term. If the sale price is above fair value, the excess over the fair value is deferred and amortized over the lease term. PAS 63 further provides that the carrying amount of the asset is written down to fair value and the writedown is accounted for as an impairment loss.
