ACYFARP: Accounting for Financial Liabilities

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78 Terms

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Liabilities

As defined by the Revised Conceptual Framework for Financial Reporting, are present obligations of an entity to transfer economic resources as a result of past events.

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Obligation

Is a duty or responsibility that an entity has not practical ability to avoid.

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True

(True or False) The entity liable must be identified, but the payee to whom the obligation is owed does not have to be identified.

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Economic Resource

Is the asset that represents a right with a potential to produce economic benefits (i.e., cash, non-cash property).

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Obligating Event

It is the past event that leads to the incurrence of a liability.

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Obligating Event

Creates a present obligation (legal or constructive) because the entity has no realistic alternative but to settle the obligation.

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Legal Obligation

An obligation arising from:

a. Contract

b. Legislation

c. Other operation of law

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Constructive Obligation

An obligation arising from an entity's actions in which the entity accepts certain responsibilities as a result of an established pattern of past practice or a written firm policy, and the entity is expected to fulfill those responsibilities.

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Financial Liabilities and Nonfinancial Liabilities

These are the two classifications of liabilities, according to nature.

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Financial Liability

Any liability that is a contractual obligation to:

a. Deliver cash or other financial asset to another entity.

b. Exchange financial instruments with another entity under conditions that are potentially unfavorable.

Examples include:

a. Accounts payable

b. Notes and loans payable

c. Bonds payable

d. Utilities payable

e. Interest payable

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Nonfinancial Liabilities

Liabilities that do not meet the criteria of financial liabilities.

Examples include:

a. Advances from customers

b. Income tax liabilities

c. Warranty obligations

d. Any constructive obligations

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Current Liability and Noncurrent Liability

Are the classifications of liabilities according to financial statement presentation.

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Current Liability

A liability classified as current when:

a. It is expected to be settled within the entity's normal operating cycle.

b. It is expected to be settled within 12 months.

c. It is held for trading.

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

Examples include:

a. Accounts payable

b. Customer's credit balance

c. Bank overdraft

d. Short-term payables

e. Current portion of long-term liabilities

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Non-Current Liabilities

Any liability that does not meet the criteria of current liabilities.

Examples include:

a. Bonds payable

b. Long-term notes payable

c. Deferred tax liability

d. Noncurrent portion of long-term debt

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Trade Liabilities and Non-Trade Liabilities

These are the two types of liabilities according to source.

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Trade Liabilities

Obligations arising from acquisition of goods or services from suppliers in the ordinary course of business.

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Trade Liabilities

Are considered as current liabilities.

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Non-Trade Liabilities

Obligations arising from sources other than acquisition of goods or services from suppliers in the ordinary course of business.

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Non-Trade Liabilities

Are considered as current if period of collectability from the reporting date is 12 months or less. Considered as noncurrent if the period of collectability from the reporting date is more than 12 months.

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Trade Liabilities

Are generally classified as current because of the concept of normal operating cycle.

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True

(True or False) If an entity's normal operating cycle is not clearly identifiable, it is assumed to be 12 months.

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True

(True or False) All trade liabilities and current non-trade liabilities are presented under one line item "Trade and Other Payables" in the current liabilities section of the Statement of Financial Position.

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Financial Liabilities

Shall be initially recognized only when an entity becomes a party to the contractual provisions of the financial statements.

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Non-Financial Liabilities

Shall be initially recognized when incurred.

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Initial Measurement of Financial Liabilities

Fair value less transaction costs

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Subsequent Measurement of Financial Liabilities

Amortized Cost

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Transaction Costs

Are incremental costs that are directly attributable to the acquisition, issuance, or disposal of a financial liability.

Includes the following:

a. Fees and commissions paid to agents, advisers, brokers, and dealers.

b. Levies by regulatory agencies and securities exchanges.

c. Transfer taxes and duties.

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Initial and Subsequent Measurement of Non-Financial Liabilities

Best estimate or amount needed to settle the liability. Measurement basis required by PFRS.

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Accounts Payable

These are liabilities arising from purchase of goods, materials, supplies or services to be used in the normal operating cycle of an entity on an open account basis or obligation not supported by formal promises to pay. Also known as trade accounts payables.

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Recognition of Accounts Payable

Entities usually recognize these accounts in the books when the goods are received or when the invoices are received from the supplier. An entity shall recognize such accounts when it acquires control over the goods because, in effect, that is the date when the entity becomes a party to the financial instrument.

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Measurement of Accounts Payable

At fair value, normally equivalent to the invoice price of the goods.

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Trade Discounts

These are discounts given to customers to encourage them to buy in bulk or large quantities. Also known as quantity discounts. It is usually stated in percentage form. These are deducted from the list price to arrive at the invoice price. These are not recognized for financial accounting purposes.

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Invoice Price

List Price - Trade Discounts

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Cash Discounts

These are given to credit customers to encourage them to pay their dues early. Known also as early payments discount.

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True

(True or False) Accounts payable is always recorded net of trade discounts.

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Gross Method and Net Method

These are the two methods in accounting for cash discounts.

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Gross Method

Purchases and accounts payable are recorded at gross invoice amount, meaning the cash discount offered is not yet deducted from the invoice amount.

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Gross Method

Cash discounts are recognized only when actually taken by the company.

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Gross Method

This is the most common and widely used method because it is simple to apply.

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Gross Methods

In this method of recognizing cash discounts, if a credit purchase is still unpaid as of the end of the reporting period and is still within the discount period, an adjusting entry is made to recognize the purchase discount related to that purchase. No adjusting entry is required when the outstanding account is already outside the discount period as of the end of the reporting period.

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Net Method

Is a method for recognizing cash discounts. Purchases and accounts payable are recorded at an amount net of the highest cash discount offered by the supplier. Cash discounts not taken by the company are debited to the purchase discounts lost account, which is classified as finance cost (interest expense) in the statement of comprehensive income.

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Net Method

In this method of accounting for cash discounts, if a credit purchase is still unpaid as of the end of the reporting period and is already outside the discount period, an adjusting entry is made to recognize the purchase discounts lost by debiting purchase discounts lost and crediting accounts payable. No adjusting entry is required when the outstanding account is still within the discount period as of the end of the reporting period.

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FOB Shipping Point - Timing of Inclusion in Accounts Payable

Upon shipment of the goods from the point of shipment.

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FOB Destination - Timing of Inclusion in Accounts Payable

Upon receipt of the goods at the point of destination.

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Freight Charges on Accounts Payable

These terms determine who should shoulder the charges, meaning, whoever owns the goods during the shipment should also pay for the freight.

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FOB Shipping Point

The buyer is responsible for the delivery charges.

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FOB Destination

The seller is responsible for the delivery charges.

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Freight Collect

The buyer made the actual payment for the freight.

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Freight Prepaid

The seller made the actual payment for the freight.

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Supplier's Debit Balances

These are debit balances in accounts payable resulting from overpayments, returns and allowances, and advance payments to suppliers.

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Supplier's Debit Balances

Classified as current assets unless the amount is immaterial in which case an offset may be made against the accounts payable account.

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Trade Accounts Payable - Financial Statement Presentation

Are presented in the current liabilities section of the statement of financial position under the heading "Trade and Other Payables".

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Notes Payable

A liability that is evidenced by a promissory note.

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Promissory Note

Is an unconditional promise in writing to pay a certain sum of money to the bearer at a designated future time.

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Notes Payable

It may arise from purchase of goods or services, from borrowing of funds from financial institutions, or other transactions.

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Face Amount

The initial measurement of short-term notes payable.

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Face Amount

The initial measurement of long-term interest bearing notes payable, that has a stated interest rate equivalent to the effective interest rate.

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Present Value of Future Cash Payments

The initial measurement of long-term interest bearing notes payable, that has a stated interest rate not equivalent to the effective interest rate.

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Present Value of Future Cash Payments

The initial measurement of long-term non-interest bearing notes payable.

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Present Value of Note Payable

Future Cash Inflows (Principal and Interest) x Present Value Factor (PV Factor)

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Non-Interest Bearing Note Payable - Principal is Collectible Lump-Sum at Maturity Date

Face Amount x PV of 1.

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Non-Interest Bearing Note Payable - Principal is Collectible at Installments

a. Collectible Every end of the Period:

Periodic collection x PV of Ordinary Annuity of 1

b. Collectible Every beg of the Period:

Periodic collection x PV of Ordinary Annuity Due of 1

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Interest Bearing Note - Stated Rate = Effective Rate

The present value of the note is simply equal to its face amount.

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Interest Bearing Note - Stated Rate ≠ Effective Rate

Present Value at Initial Recognition = Present Value of Face Amount + Present Value of Interest Collections (Periodic Interest x PV of Ordinary Annuity of 1)

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Face Amount < Present Value of Future Cash Payments

Premium on Notes Payable. This will result when the stated interest rate is higher than the effective interest rate at the date the note was issued.

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Face Amount > Present Value of Future Cash Payments

Discount on Notes Payable. This will result when the note is interest bearing and its stated interest rate is lower than the effective interest rate at the date the note was issued.

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Face Amount

The subsequent measurement of a short-term notes payable.

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Face Amount

The subsequent measurement of an interest-bearing note with a stated interest rate equivalent to the effective interest rate.

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Amortized Cost

The subsequent measurement of an interest bearing note with a stated interest rate not equivalent to the effective interest rate.

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Amortized Cost

The subsequent measurement of a non-interest bearing note payable.

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Amortized Cost

Outstanding face amount of note + Unamortized Premium - Unamortized Discount

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Amortization of Discount

Is an addition to interest expense.

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Amortization of Premium

Is a deduction from interest expense.

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Currently Maturing Obligation

General rule: Presented as a current liability.

Exception: The liability is presented as non-current if any of the following conditions are present:

a. The company has the prerogative/option/unconditional right to refinance the liability.

b. If there is no right but refinancing was completed on or before the balance sheet date.

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Refinancing

May be done through extension of maturity date or through issuance of bonds, the proceeds of which is used to settle the currently maturing obligation.

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Breach of Contracts

General rule: If the company has breached a covenant or contract, the long-term obligation becomes immediately demandable, thus presented as current liability.

Exceptions: The liability is non-current under the following conditions:

a. If the creditor agreed to give the debtor a grace period for at least 12 months after the balance sheet date.

b. The said grace period was provided on or before the balance sheet date.

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True

(True or False) An obligation that matures within one year shall be classified as current liability regardless of refinancing that was consummated after the end of reporting period and before issuance of financial statements. However, if the refinancing occurs on or before the end of reporting period, the obligation is classified as noncurrent liability

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True

(True or False) If an entity has the discretion to refinance an obligation for at least twelve months after the end of reporting period, it shall classify the obligation as noncurrent.