Module 2

Accounting for Financial Liabilities

Financial Liabilities
Liabilities A financial liability is a contractual
obligation:
A present obligation of an entity to
transfer an economic resource as a a. To deliver cash or another financial
result of a past event. asset to another entity, or

Characteristics of a liability:
b. To exchange financial assets or
1. A present obligation financial liabilities to another entity
2. Past event under potentially unfavorable
3. Transfer of an economic resource conditions to the entity, or

 Obligating Event c. That will or may be settled in the

 Legal obligations entity’s own equity instruments
Derives from a contract (through and is a non-derivative from which
its explicit or implicit terms, the entity may be obliged to deliver
legislation, or other operations of a variable number of the entity’s
laws own equity instruments, or

d. That will or may be settled in the

 Constructive Obligations entity’s own equity instruments
Derives from an enterprise’s and is a derivative that will or may
actions whereby an established be settled other than by the
pattern of past practice, published exchange of a fixed amount of cash
policies, or a sufficiently specific or a financial asset for a fixed
current statement, the enterprise number of the entity’s own equity
has indicated to other parties that instruments.
it will accept certain
responsibilities.
 Example of financial liabilities:
 Settlement of Liabilities o Accounts payable, notes payable,
o Payment of cash bonds payable, and mortgage
o Transfer of other assets payable.
o Provision of services
o Replacement of an obligation o Share rights, options, and warrants
with another obligation; and that an entity issues on a pro-rate
o Conversion of the obligation to basis to its existing owners and
equity impose on the entity to issue its
share capital are not financial
liabilities but are classified as equity.
 Initial Recognition An entity shall recognize the liability
for the goods purchased under the
An entity shall recognize a financial
terms F.O.B Destination when it receives
liability when and only when it becomes
the goods.
a party to the contractual provisions of
the instruments.

An entity recognizes a financial Accounting for Notes

liability at fair value, which is the
transaction price.
Payable
Financial liabilities also include in the  Nature of Notes Payable
initial measurement of the transaction A promissory note is a written promise
costs directly attributable to the to pay a certain sum of money to the
issuance of the financial instrument. bearer at a designated future time.

 Issues concerning Accounting for

 Measurement after initial recognition notes payable:
a. Note bearing a realistic interest
Except for financial liabilities that are rate (short or long-term)
measured at fair value, financial b. Note bearing an unrealistic interest
liabilities are subsequently measured at rate (short or long-term)
amortized cost. c. Non-interest-bearing note

 Note Bearing a realistic interest Rate

Accounting for Accounts An entity initially recognizes the note
Payable at face value, which equals its fair value
at the date of issuance, the stated
 Nature of Accounts Payable
interest rate approximates or equals to
Accounts payable, or trade accounts the prevailing market interest rate.
payable, arise from purchasing goods,
materials, supplies, or services on an
open charge-account basis.  Note Bearing an Unrealistic Interest
Rate
An entity must recognize the
accounts payable when it acquires A note bears an unrealistic interest rate
economic control over the goods when any one or both of these two
ordered because that is the date when situations exists:
the entity becomes a party to the
a. The interest rate appearing on the
financial instrument.
face of the note is significantly
different from the market rate of
similar notes;
 Terms of Shipments
b. The consideration received on
An enterprise shall recognize account of the note issued has a
accounts payable for goods in transit at fair value that is significantly
the end of the reporting period shipped different from the face value of the
F.O.B shipping point. note.
 Determining the selling price

The stated The bond sell:

interest rate is:
Below market rate At a discount
(Cash received is
less than principal
amount)
Equal to the At principal
market rate amount
(Cash received is
equal to the
principal amount)
Above market At a premium
rate (Cash received is
greater than
principal amount)