MODULE 1 – FINANCIAL LIABILITY (Accounts Payable & Notes Payable)

LIABILITY
– present obligation of the entity to transfer an economic resource as result of past event.
– A present obligation arising from a past event, the settlement of which is expected to result in an
outflow from the enterprise of resources embodying economic benefits.

3 Essential Characteristics of Liability

1. A PRESENT OBLIGATION
OBLIGATION – duty or responsibility that the entity has no practical ability to avoid.
a. Legal obligation – derives from a contract, legislation or other operation of law.
b. Constructive obligation – derives from enterprise’s actions whereby an established pattern of
past practice, published policies or specific current statement, the enterprise has indicated to other
parties that it will accept certain responsibilities and as a result, the enterprise has created a valid
expectation on the part of those other parties that it will discharge those responsibilities.
2. A PAST EVENT
• The liability will arise if the entity acquires legally or constructively the title to the goods or when
services are already rendered.
3. TRANSFER OF ECONOMIC RESOURCES
- The settlement of a liability requires a transfer/outflow of economic resources which may be
settled in different ways:
 Payment of cash
 Transfer of other assets
 Render of services
 Replacement of an obligation with another obligation
 Conversion of obligation to equity
 Condonation by creditor
- An obligation may be extinguished by other means, such as a creditor waiving or forfeiting its
rights.

EXAMPLE OF LIABILITIES
 Accounts payable to suppliers for the purchase of goods
 Amounts withheld from employees for taxes and for contributions to government agencies such
as SSS, PHIC, and HDMF
 Accruals for wages, interest, royalties, taxes, product warranties, and profit-sharing plans
 Cash and property dividends declared but not paid (share dividends are EQUITY, not liability).
 Deposits and advances from customers
 Debt obligations for borrowed funds—notes payable, mortgage payable, and bonds payable
 Income taxes payable
 Unearned revenue

FINANCIAL LIABILITY – is any liability that is a contractual obligation

1. Contractual Obligation
a) To deliver cash or another financial asset to another entity, or
b) To exchange financial assets or financial liabilities to another entity under conditions that are
potentially unfavorable to the entity, or
2. A contract that will or may be settled in the entity’s own equity instruments and is:
c) will be settled in the entity’s own equity instruments and is a non-derivative for which the entity
may be obliged to deliver a variable number of the entity’s own equity instruments, or
d) that will or may be settled in the entity’s own equity instruments and is a derivative that will or
may be settled other than by exchange of a fixed amount of cash or a financial asset for a fixed
number of the entity’s own equity instrument.
 Other liabilities that did not meet the above requirements are non-financial liabilities.

INITIAL RECOGNITION: Transaction Price / Fair value

 For financial liabilities measured at amortized cost, any transaction costs directly attributable to
the issuance of the financial instrument is considered in the initial measurement.
 Fair values minus transaction costs (unless liabilities are classified at FVTPL, then fair value
only).
 If liabilities are classified at FVTPL, transaction costs are expensed outright.

SUBSEQUENT MEASUREMENT:
 Except for financial liabilities that are measured at fair value, financial liabilities are measured at
amortized cost.
 Changes in the fair value of financial liabilities at FVTPL are recognized in profit/loss.

CLASSIFICATION OF FINANCIAL LIABILITIES

1. Financial liabilities at amortized cost
2. Financial Liabilities at Fair Value through Profit or Loss
a. Irrevocably designated as financial liabilities at FVTPL (fair value option)
b. Held for Trading
3. Financial liabilities that arise when a transfer of a financial asset does not qualify for
derecognition or when the continuing involvement approach applies
4. Financial guarantee contracts and commitments

SOME EXAMPLES OF FINANCIAL LIABILITIES:

 Accounts payable
 Notes payable
 Bonds payable
 Mortgage payable
 Salaries Payable
 Accrued Interest Payable
 Utilities Payable
 Cash Dividend Payable

To be settled thru Provisions of services or delivery of non-cash assets

 Advances from customers
 Unearned revenues
 Deferred revenues
 Warranties payable
 Premiums payable
 Property dividends payable
 Unearned rent

Did not arise from a contract

 SSS Contributions payable
 HDMF Contributions payable
 PHIC Contributions payable
 Withholding taxes payable
 Income taxes payable
 Constructive obligations

PRESENTATION IN THE STATEMENT OF FINANCIAL POSITION:

 Financial liabilities are classified as current and non-current liabilities.
A liability is classified as current if:
a. It is expected to be settled within the entity’s normal
operating cycle.
Current b. It is expected to be settled within twelve months after
Liabilities the reporting period
c. It is held for trading
d. The entity has no unconditional right to defer payment
LIABILITIES for at least 12 months after the reporting date

Non-current liabilities are:

Non-current a. Other than current liabilities
liabilities b. Specifically required by a particular standard to be
classified in this category

CURRENT LIABILITIES NON-CURRENT LIABILITIES

- Trade payables - Non-current portion of long-term financial

- Accrual to employees and other operating liabilities
costs - Deferred revenue-noncurrent portion
- Customer’s credit balances - Finance lease liability
- Bank overdraft - Deferred tax liability
- Dividends payable (except share dividends) - Long-term obligations to company officers
- Income tax payable - Long-term deferred revenue
- Current portion of long-term financial - Long-term notes payable
liabilities - Bonds payable
- Accounts payable - Liability under finance lease not due within
- Short-term notes payable 12 months
- Liability under trust receipts
- Deposits and advances
- Deferred or unearned revenues
- Provisions expected to be settled within
twelve months

ILLUSTRATION: CLASSIFICATION OF LIABILITIES – STATEMENT OF FINANCIAL

POSITION
ABC Co. has the following liabilities as of December 31, 2020:
Trade accounts payable P600,000 Salaries and wages payable 25,000
Bonds payable 500,000 SSS premiums payable 22,500
Trade notes payable 100,000 Deferred revenue 20,000
Security deposit 100,000 Unearned rent 15,000
Cash dividends payable 80,000 Share dividend payable 15,000
Property dividends payable 75,000 Bank overdraft 10,000
Held for trading financial 60,000 Credit balance in customer 8,000
liabilities accounts
Income tax payable 50,000 Deferred tax liability 5,000
Advances from affiliates 50,000 Accrued expenses 5,000
Trade accounts payable granted to 30,000
officers

Additional information:
a. Deducted from the trade accounts payable are:
b. Excluded from the trade accounts payable are:
c. Bonds mature in five equal semi-annual installments
d. Security deposit was received from a lessee. The amount will be refunded on December 31, 2025.
e. The deferred tax liability arises from a temporary difference which will reverse in 2021.
Required:
a. Determine the amount to be reported in the December 31, 2020 financial statements as current
liabilities.

b. Determine the amount to be reported in the December 31, 2020 financial statements as non-
current liabilities.

ACCOUNTS PAYABLE
• Liabilities arising from the purchase of goods, materials, supplies, or services on an open charge-
account basis.
• Credit period varies from 30 to 120 days without any interest being charged on the deferred
payment.
• The accounts payable must be recognized in the books of the entity at the time it acquired
economic control over the goods ordered.
• Transfer of title depends on the terms of purchase (which could either be FOB Shipping point or
FOB Destination)
• May be subjected to cash discounts (incentives for early payment;ex. 2/10,n/30 or 2/10, 1/15,
n/30)

Accounting for Cash Discount

GROSS METHOD NET METHOD
- If the entity adopts the Periodic Inventory - If the entity adopts the Periodic Inventory
System, the Purchases account and the System, the Purchases and the
Accounts payable account are recorded Accounts payable account are recorded
at the gross invoice price while under at net of the cash discount while under
the Perpetual Inventory System, the Perpetual Inventory System, the
Merchandise Inventory and the Merchandise Inventory and the
Accounts payable accounts are Accounts payable accounts are
recorded at gross. recorded at net of cash discount.
- A cash discount taken is recognized only - The Purchase discount is recognized
at the time of payment as a credit to even not taken. Under the Periodic
Purchase Discount under Periodic Inventory System, If payment is done
Inventory System and a credit to after the discount period, a Purchase
Merchandise Inventory account if the discount lost is recognized, which is
Perpetual Inventory System was used. taken to profit or loss section of the
- Purchase Discount account is presented Statement of Comprehensive Income as
in the profit or loss section as a deduction part of finance cost and not capitalized to
to Purchases account under Periodic the inventory account.
Inventory System.

ILLUSTRATIVE PROBLEM
On January 1,2022, ABC Company purchased merchandise from DEF Company with trade discounts of
10% and 15%. The list price is P 500,000 with payment terms of 2/10, n/30.

A. Initial Recognition on January 1, 2022

Inventory System Gross Method Net Method
Initial Periodic System Purchase 382,500* Purchase 374,850**
Recognition Accounts Payable 382,500 Accounts Payable 374,850
on January
1, 2022
Perpetual System Inventory 382,500 Inventory 374,850
Accounts Payable 382,500 Accounts Payable 374,850
*500,000 x 90% x 85%
**500,000 x 90% x 85% x 98%

B. If the accounts payable is paid within the discount period, let’s say on January 5, 2022:
Inventory System Gross Method Net Method
ABC paid the Periodic System Purchase 382,500 Accounts Payable 374,850
accounts Purchase Discount 7,650* Cash 374,850
payable on Cash 374,850
January 5,
2022
Perpetual System Accounts Payable 382,500 Accounts Payable 374,850
Inventory 7,650* Cash 374,850
Cash 374,850
*382,500 x 2%

C. If payment is made beyond the discount period, let’s say on January 13, 2022:
Inventory System Gross Method Net Method
ABC paid Periodic System Accounts Payable 382,500 Accounts Payable 374,850
the accounts Cash 382,500 Purchase Discount Lost 7,650*
payable on Cash 382,500
January 13,
2022
Perpetual System Accounts Payable 382,500 Accounts Payable 374,850
Cash 382,500 Purchase Discount Lost 7,650**
Cash 374,850
*382,500 x 2%
**Purchase discount lost is not capitalized in Inventory. It is presented as either finance cost or other
expense.

What if ABC uses a fiscal year that ends January 10, 2022 as its reporting date and paid the
accounts payable on January 11, 2022?
An adjustment at year-end (Jan. 10, 2022) under the gross method pertaining to the cash discount must
be done because the discount period can still be availed until Jan 11, 2022 which is on the next
accounting period. A reversing entry regarding the adjustment on Jan. 10, 2022 can be done on the first
day of the next accounting period, so that payment can still be recorded in the usual manner. No
adjustment will be done under the net method because the purchase discount was already recognized at
the time of purchase.

NOTES PAYABLE
• A written promise to pay a certain sum of money to the bearer at a designated future time.
CHARACTERISTICS:
- Evidenced by a promissory note.
- It has an interest rate.
- Maturity value
- Maturity date
TYPES:
a.) Interest bearing (with realistic or unrealistic interest rates)
b.) Non-interest bearing

NOTES WITH REALISTIC INTEREST RATE

• Notes with realistic interest rates are those with stated rates that approximates the prevailing
market rate for similar obligations.
• Also, the fair value / present value of the note at the date of issuance is equal to its face value.
Basically, these are the interest-bearing notes.
• Some example of these notes may either be:
a.) Long-term notes with principal and interest payable periodically or
b.) Long-term notes with principal matures in lump sum and interest is payable periodically

ILLUSTRATIVE PROBLEM:
LONG TERM NOTES with principal and interest payable periodically

On January 1,2022, ACT Company issued a P 4,500,000, 10% promissory note for the purchase of an
equipment. Equal principal amount plus interest on the outstanding balance of the principal are payable
annually every December 31 starting December 31,2022. The company’s reporting date is every
December 31.

With this, the following amounts will be paid from 2022 to 2024:
Due date Outstanding Principal Principal Interest due (c) Total Amount
before annual payment Due (b) *(a) x % Due (b+c)
(a)
12/31/22 4,500,000 1,500,000 4.5M X 10% = 450,000 1,950,000
12/31/23 3,000,000 1,500,000 3M X 10% = 300,000 1,800,000
12/31/24 1,500,000 1,500,000 1.5M X 10% = 150,000 1,650,000

Entries in the books of act company:

At the end of each reporting period, the amount of notes payable that is due within one year shall be
classified as current liabilities. Thus, in the statement of financial position at Dec 31 of 2022, 2023 and
2024, the notes payable shall be classified as:

2022 2023 2024

Current Liabilities:
Notes Payable 1,500,000 1,500,000 0
Non-current Liabilities:
Notes Payable 1,500,000 0 0

WHAT IF THE NOTES WAS ISSUED DURING THE YEAR?

To illustrate, assuming the same problem but ACT Company issued on June 30, 2022 a P 4,500,000, 10%
promissory note for the purchase of an equipment. Equal principal amount plus interest on the
outstanding balance of the principal are payable annually every June 30 starting June 30, 2023. The
company’s reporting date is every December 31.

With this, the following amounts will be paid from 2023 to 2025:
Due date Outstanding Principal Principal Interest due (c) Total
before annual payment Due (b) *(a) x % Amount Due
(a) (b+c)
06/30/23 4,500,000 1,500,000 4.5M X 10% = 450,000 1,950,000
06/30/24 3,000,000 1,500,000 3M X 10% = 300,000 1,800,000
06/30/25 1,500,000 1,500,000 1.5M X 10% = 150,000 1,650,000

Entries in the books of act company:

At the end of each reporting period,the amount of notes payable as well as the interest accrued that is due
within one year shall be classified as current liabilities.
Dec. 31, 2022 Dec. 31, 2023 Dec. 31, 2024 Dec. 31, 2025
Current Liabilities:
Notes Payable
Interest payable
Non-current Liabilities:
Notes Payable

Thus, in the statement of financial position at Dec 31 of 2022, 2023 and 2024, the notes payable shall be
classified as:

ILLUSTRATIVE PROBLEM:
LONG TERM NOTES with principal matures in lump sum and interest is payable periodically

On January 1, 2022, ACT Company issued a 3-year, P 4,500,000, 10% promissory note for the purchase
of an equipment due on December 31,2024. Interest is payable annually every December 31.The
company’s reporting date is every December 31.

Entries in the books of act company:

At the end of each reporting period, the amount of notes payable as well as any interest accrued that is
due within one year shall be classified as current liabilities.
Thus, in the statement of financial position at Dec 31 of 2022, 2023 and 2024, the notes payable shall be
classified as:
2022 2023 2024
Current Liabilities:
Notes Payable 0 4,500,000 0
Interest payable 0 0 0
Non-current Liabilities:
Notes Payable 4,500,000 0 0

WHAT IF THE NOTES WAS ISSUED DURING THE YEAR?

The same problem but ACT Company issued on June 30, 2022, a 3-year, P4,500,000, 10% promissory
note for the purchase of an equipment due on June 30, 2025. Interest is payable annually every June 30.
The company’s reporting date is every December 31.

Entries in the books of act company:

At the end of each reporting period, the amount of notes payable as well as the interest accrued that is
due within one year shall be classified as current liabilities.
Thus, in the statement of financial position at Dec 31 of 2022, 2023 and 2024, the notes payable and
interest payable shall be classified as:
2019 2020 2021 2022
Current Liabilities:
Notes Payable 0 0 4,500,000 0
Interest payable
Non-current Liabilities:
Notes Payable 4,500,000 4,500,000 0 0