CHAPTER 8 - LIABILITIES

LIABILITY

• present obligation of an entity to transfer economic resources resulting from past events:

CHARACTERISTICS OF LIABILITY

1. Present obligation entailing settlement through transferring of cash, goods or services.

2. Unavoidable obligation

3. Transaction/event creating the obligation has occurred

CLASSIFICATION

Classified as current (short-term) & non-current (long-term) in the SFP

RECOGNIZED WHEN:

• Money, goods or services are received

• Legally enforceable claim against the company is established

• Corresponding assets, expenses or losses are recognized

MEASUREMENT

• Historical proceeds - how much spent related to a specific expense

• Net settlement value - how much was the agreed settled amount to be paid

• Net present value/ Discounted value (effective interest rate of valuation) - liability needs to be settled more than a year  

CURRENT LIABILITIES

• Obligations that are expected to be paid using current assets or by creating new short-term debts.

  • Liquidation within 12 months after reporting period or within reporting period

• TYPES OF CURRENT LIABILITIES:

  • Determinable - obligations having definition amount

• Accounts payable: arises from day to day operations. Obligations owed to others for goods, services and supplies purchased on open account (credit). 

  • FOB SP: title is passed to buyer when goods are shipped 

  • FOB Destination: title is passed when buyer receives goods

  • (Cheques issued before the end of period [outstanding check] to pay for past AP but not mailed should not be counted as cash payments.)

    • Extinguished obligation only when the check is encashed.

• Notes Payable: written promise to pay a certain sum of money on a specific future date arising from sales, financing or other transactions. (NOT RELATED TO DAY TO DAY OPERATIONS) 

  • Interest-bearing - reported as liability at FACE AMOUNT + interest payable

  • Non-interest bearing - does not state an interest rate on the face = needing to compute present value.

  • Interest = FV - PV (discount recorded as interest)

• Accrued Liabilities: expenses incurred but not yet paid as of year-end. 

• Failing to accrue expenses/establish liabilities at year end may:

  • Overstate net income for current period (lacks expense record despite being incurred), understated in the next period

  • Liabilities for the current period will be understated (di kase narecord kaya nakulangan)

• Dividends Payable: proportionate distributions of earnings to shareholder to be paid at a later time (CASH DIVIDENDS - recorded when declared) 

  • when a company issued dividends they check, announcement data (how much needs to  be issued), record date (checks ledger on who are stockholders to pay dividends to - sees how much dividends need to be paid), payment period (announces

• Unearned Revenues: transaction arising from company receiving cash in advance prior to performing service or issuing a merchandise (PAID FIRST before GOODS/SERVICES DELIVERED)

TYPES OF CURRENT LIABILITIES:
Estimated Liabilities: does not have exact amount of how much will be settled to the other party

• Provision: there needs to be something paid, BUT amount and when to pay is unclear. 3 conditions to recognize

  • Present obligation from past event

  • Probable outflow of resources will be required to settle - asset/new current liabilities

  • Reliable estimate can be made 

• Product Warranties: promises made by a seller to buyer to make good for deficiency in quality, quantity or performance in a product (estimates how many customers will avail warranties - how much will you shoulder due to deficiency) 

  • No. of units sold x cost of warranty x percentage of availment = estimated product warranty

• Premiums and Coupons: promotional products offered to stimulate sale of certain products

TYPES OF CURRENT LIABILITIES:

• Contingent Liabilities: possible obligations confirmed by uncertain future events that are not entirely controlled by the company. Dependent on whether or not the event will occur

• Must be: existing condition, uncertain, resolution of uncertainty is based from one or more future events

• Pending litigations, pending claims, guaranteed indebtedness

NON CURRENT LIABILITIES

• Obligations maturing beyond one year/ not qualifying as current. 

• Liabilities not payable within 12 months. 

TYPES OF NONCURRENT LIABILITIES

• Bonds Payable: issuing bonds by a corporation to pay sum of money at designated maturity + periodic interest at a specified rate on FACE VALUE. (debt instrument issued by an entity to borrow funds from institutional investors.)

• Types of Bonds: (SUTS ReBeCoCal)

  • Secured bonds: bond issued with specific asset as a collateral/form of payment

  • Unsecured: bond issued against the general credit of the borrower. 

  • Term bond: matures at a single specified date  (paid at maturity date) 

  • Serial bonds: principal amount is repaid in installment over the life of the issue 

  • Registered: issued in the name of the owner. Transfer of bonds requires cancellations by entities and issuance of new bonds. (one creditor is named)

  • Bearer/Coupon Bond: not registered. Holders must send in coupons to receive payment, whoever holds it can be paid to. 

  • Convertible bonds: can be converted to ordinary shares at bondholder’s option. 

  • Callable bond: subject to retirement at a stated amount before maturity

TYPES OF NONCURRENT LIABILITIES

• Mortgage Payable
  

• : long-term instrument used to purchase property. Property is collateral until mortgage is paid off

ANALYSIS OF LIABILITIES

• Liquidity

  • Working Capital: excess of current assets over current liabilities. Measure to determine ability of company to pay maturing obligations. 

    • CURRENT ASSET - CURRENT LIABILITY

  • Current ratio: compare liquidity of companies of different sizes.

    • CURRENT ASSETS/CURRENT LIABILITY

• Solvency: long term capacity to pay liabilities

  • Debt Ratio - how big is the asset financed by liability; Solvency - ability to pay interest and principle on long term debts.

    • TOTAL LIABILITIES/TOTAL ASSETS

  • Time-interest earned: how times a company can pay interest on its obligations

    • INCOME BEFORE INCOME TAXES + INTEREST EXPENSE/INTEREST EXPENSE