INTERMEDIATE

ACCOUNTING 2
FINANCIAL LIABILITIES
PROF. CZARINA S. NAVEA
What is a LIABILITY?
-A present obligation of an entity to
transfer an economic resource as a result
of past event.

(2018 Conceptual Framework for Financial Reporting-IASB)

 OBLIGATION
(A duty or responsibility to act or perform)

 Legal Obligation
- derives from a contract, legislation or other operation of law

 Constructive Obligation
- derives from an enterprise’s actions that created a valid
expectation from other parties that it will accept and
discharge certain responsibilities.
 TRANSFER OF ECONOMIC RESOURCE
(Payment/Settlement)
• Cash Payment;
• Transfer of Other Assets;
• Provision of Services;
• Replacement of an obligation with another obligation; and
• Conversion of the obligation to equity
 PAST EVENT

 The transaction causing the liability should

have been occurred.
 FINANCIAL LIABILITIES
Contractual obligation:
• To deliver cash or another financial asset to another entity;

• To exchange financial assets or financial liabilities to another

entity under conditions that are potentially unfavorable to the
entity;
 FINANCIAL LIABILITIES
Contractual obligation:
• That will or may 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

• That will or may be settled in the entity’s own equity instruments and is a
derivative that will or may be settled other by exchange of a fixed amount of
cash or a financial asset for a fixed number of the entity’s own equity
instruments
Initial recognition and measurement

• at Fair Value (Transaction Price)

• at Amortized Cost (TP plus directly attributable costs)

Subsequent measurement
• at Fair Value
• at Amortized Cost
 ACCOUNTING FOR
ACCOUNTS PAYABLE
 Terms of Shipment of Purchases

• FOB Shipping Point, Freight Collect

• FOB Shipping Point, Freight Prepaid
• FOB Destination, Freight Collect
• FOB Destination, Freight Prepaid
 Terms of Shipment of Purchases

• FOB Shipping Point, Freight Collect

• FOB Shipping Point, Freight Collect
• FOB Shipping Point, Freight Collect
• FOB Shipping Point, Freight Collect
Methods of Accounting for Cash Discounts

•Gross Method
•Net Method
Cash Discounts apply only to invoice price
(excluding freight) and are indicated as: a/b; n/c
where:
a=% of discount, b=discount period, and c=credit period

example: 2/10, n/30 and 3/15, n/45

Illustration:

On September 13, 2021, ABC Corp., which adopts a periodic

inventory system, purchased merchandise from DEF Company with
an invoice price of P200,000.00 and freight charges of P2,000.00
with terms FOB shipping point, 3/10; n/30.
Entries in the books of ABC Corp. to record the purchase made on Sep.
13, 2021

GROSS METHOD NET METHOD

Purchases 200,000 Purchases 194,000

Freight-In 2,000 Freight-In 2,000
Accounts Payable 202,000 Accounts Payable 196,000
 Case 1:
ABC Corp. paid the full account on Sep. 20, 2021
GROSS METHOD NET METHOD

September 20, 2021 September 20, 2021

Accounts Payable 202,000 Accounts Payable 196,000

Purchase Discount 6,000 Cash 196,000
Cash 196,000
Case 2:
ABC Corp. paid the full account on Sep. 30, 2021
GROSS METHOD NET METHOD

Accounts Payable 202,000 Accounts Payable 196,000

Cash 202,000 Purchase Discounts Lost 6,000
Cash 202,000
Under the Net Method, if payment is not made yet at the reporting
date and the discount period has already LAPSED, an adjusting
entry is required to be recorded as follows:

Purchase Discounts Lost 6,000

Accounts Payable 6,000
ACCOUNTING FOR
NOTES PAYABLE
 Promissory Note
- A written promise to pay a certain sum of money to the bearer at
a designated future time

Kinds of Promissory Note

1) Interest-Bearing Note
a) Note Bearing a Realistic Interest Rate
b) Note Bearing an Unrealistic Interest Rate
2) Non-Interest Bearing Note
Note-Bearing Realistic Interest Rate
- The stated rate approximates the prevailing market rate for similar
obligations thus, the fair value (and also the present value) of the
note at the time of its issuance is equal to its face value.
 Long-term Notes – Principal matures in Lump-Sum with
Interest payable periodically

Illustration:
On August 31, 2021, the JKL Corporation issued a three year
P3,000,000, 12% promissory note for a machinery purchased. The
interest on this note is payable annually on its anniversary date. The
company reports on a calendar year.
 JKL Corporation
2021 Debit Credit
31 Aug Machinery 3,000,000
Notes Payable 3,000,000

31 Dec Interest Expense 120,000

Interest Payable 120,000
(P3 Million*12% = P360,000 * 4/12 = P120,000)
 Presentation in the Statement of Financial
Position
2021
Current Liabilities
Notes Payable -
Interest Payable 120,000
Non-Current Liabilities
Notes Payable 3,000,000
 JKL Corporation
2022 Debit Credit
31 Aug Interest Expense 240,000
Interest Payable 120,000
Cash 360,000

31 Dec Interest Expense 120,000

Interest Payable
120,000
(P3 Million*12% = P360,000 * 4/12 = P120,000)
 Presentation in the Statement of Financial
Position
2021 2022
Current Liabilities
Notes Payable - -
Interest Payable 120,000 120,000
Non-Current Liabilities
Notes Payable 3,000,000 3,000,000
 JKL Corporation
2023 Debit Credit
31 Aug Interest Expense 240,000
Interest Payable 120,000
Cash 360,000

31 Dec Interest Expense 120,000

Interest Payable
120,000
(P3 Million*12% = P360,000 * 4/12 = P120,000)
 Presentation in the Statement of Financial
Position
2021 2022 2023
Current Liabilities
Notes Payable - - 3,000,000
Interest Payable 120,000 120,000 120,000
Non-Current Liabilities
Notes Payable 3,000,000 3,000,000 -
 JKL Corporation
2024 Debit Credit
31 Aug Interest Expense 240,000
Interest Payable 120,000
Notes Payable 3,000,000
Cash 3,360,000
 Long-term Notes – Principal and Interest are payable
periodically

Illustration:
On August 31, 2021, the MNO Corporation issued a P3,000,000,
12% promissory note for a machinery purchased. Equal principal
amount of P1,000,000 plus interest on the unpaid balance of the
principal are payable annually every August 31 starting August 31,
2022. The Company reports on a calendar year basis.
 MNO Corporation
2021 Debit Credit
31 Aug Machinery 3,000,000
Notes Payable 3,000,000
31 Dec Interest Expense 120,000
Interest Payable 120,000
(P3 Million*12% = P360,000 * 4/12 = P120,000)
 Presentation in the Statement of Financial
Position
2021
Current Liabilities
Notes Payable 1,000,000
Interest Payable 120,000
Non-Current Liabilities
Notes Payable 2,000,000
 MNO Corporation
2022 Debit Credit
31 Aug Notes Payable 1,000,000
Interest Expense 240,000
Interest Payable 120,000
Cash 1,360,000
(Int. Exp. P3 Million*12% = P360,000 * 8/12 = P240,000)

31 Dec Interest Expense 80,000

Interest Payable 80,000
(P2 Million*12% = P240,000 * 4/12 = P80,000)
 Presentation in the Statement of Financial
Position
2021 2022
Current Liabilities
Notes Payable 1,000,000 1,000,000
Interest Payable 120,000 80,000
Non-Current Liabilities
Notes Payable 2,000,000 1,000,000
 MNO Corporation
2023 Debit Credit
31 Aug Notes Payable 1,000,000
Interest Expense 160,000
Interest Payable 80,000
Cash 1,240,000
(Int. Exp. P2 Million*12% = P240,000 * 8/12 = P160,000)

31 Dec Interest Expense 40,000

Interest Payable 40,000
(P1 Million*12% = P120,000 * 4/12 = P40,000)
 Presentation in the Statement of Financial
Position
2021 2022 2023
Current Liabilities
Notes Payable 1,000,000 1,000,000 1,000,000
Interest Payable 120,000 80,000 40,000
Non-Current Liabilities
Notes Payable 2,000,000 1,000,000 -
 MNO Corporation
2024 Debit Credit
31 Aug Notes Payable 1,000,000
Interest Expense 80,000
Interest Payable 40,000
Cash 1,120,000
(Int. Exp. P1 Million*12% = P120,000 * 8/12 = P80,000)
Note-Bearing Unrealistic Interest Rate
a) The interest rate appearing on the face of the note is significantly
different from the market rate of similar notes; and
b) The consideration received on account of the note issued has a
fair value that is significantly different from the face value of the
note.
 Unrealistic Interest Rate
If STATED rate > MARKET rate = Premium on Notes Payable
If STATED rate < MARKET rate = Discount on Notes Payable

Present Value Factor (PVF) Formula:

PVF Single Payment = 1
(1 + r)n
1 – (1+r)-n
PVF Ordinary Annuity =
r
Short-term Note – Stated Rate>Market Rate

Illustration:
On May 1, 2021, Tokyo Company purchased from Rio Corporation a
piece of special equipment by issuing a 14%, one-year note for
P320,000. There is no equivalent cash price for this equipment, but
the market rate of interest on similar notes is 8%
 Tokyo Company

Principal P320,000
Stated interest (320,000 * 14% * 1 year) 44,800
Total future Cash Outflow P364,800
PV factor at 8% for 1 period 0.925926
Present Value of the Note P337,778
 Tokyo Company
2021 Debit Credit
1 May Equipment 337,778
Notes Payable 320,000
Premium on Notes Payable 17,778

31 Dec Interest Expense (337,778 * 8% * 8/12) 18,015

Premium on Notes Payable 11,852
Interest Payable (320,000*14%*8/12) 29,867
At Dec 31, 2021, the amortized cost of the
Notes Payable is computed as:
Notes Payable (at Face Value) P320,000
Premium on Notes Payable 5,926
Interest Payable 29,867
Total P355,793
 Tokyo Company
2022 Debit Credit
1 May Notes Payable 320,000
Interest Payable 29,867
Interest Expense 9,007
Premium on Notes Payable 5,926
Cash 364,800
Short-term Note – Stated Rate<Market Rate

Illustration:
On May 1, 2021, Tokyo Company purchased from Rio Corporation a
piece of special equipment by issuing a 5%, one-year note for
P320,000. There is no equivalent cash price for this equipment, but
the market rate of interest on similar notes is 10%
 Tokyo Company

Principal (Face value of Note) P320,000

Stated interest (320,000 * 5% * 1 year) 16,000
Total future Cash Outflow P336,000
PV factor at 10% for 1 period 0.909091
Present Value of the Note P305,454
 Tokyo Company
2021 Debit Credit
1 May Equipment 305,458
Discount on Notes Payable 14,542
Notes Payable 320,000

31 Dec Interest Expense 20,364

Interest Payable 10,667
Discount on Notes Payable 9,697
At Dec 31, 2021, the amortized cost of the
Notes Payable is computed as:
Notes Payable (at Face Value) P320,000
Discount on Notes Payable (4,845)
Interest Payable 10,667
Total P325,822
 Tokyo Company
2022 Debit Credit
1 May Interest Expense 4,845
Discount on Notes Payable 4,845

Notes Payable 320,000

Interest Payable 10,667
Interest Expense 5,333
Cash 336,000
Non-Interest Bearing Note
- Does not explicitly state an interest rate on the face of the note. It is
simply written in a form where the interest is imputed on the face
value of the note. The face value represents the present value of the
obligation plus the imputed interest for the term of the note.
 Transaction Price of the Non-Interest Bearing
Note
a) Amount of Cash received; or
b) Fair Value of goods and services received; or
c) Prevailing market rate of interest if Fair Value cannot be reliably
determined
Illustration:
On October 1, 2021, RST Enterprise purchased an equipment paying
P100,000 down and issuing a one-year, non-interest bearing note for
P200,000. There is no known market value for the equipment. The
prevailing market rate of interest for similar transactions at that time
is 12%
 RST Enterprise
The cost of the equipment is computed as follows:
Down payment P100,000
Present Value of Note 178,571
Total Cost of Equipment P278,571

The initial discount on Notes Payable is:

Face Value of the Note P200,000
Present Value at date of issuance 178,571
Discount on Notes Payable P21,429
 RST Enterprise
2021 Debit Credit
1 Oct Equipment 278,571
Discount on Notes Payable 21,429
Notes Payable 200,000
Cash 100,000

31 Dec Interest Expense 5,357

Discount on Notes Payable 5,357
At Dec 31, 2021, the amortized cost of the
Notes Payable is computed as:
Notes Payable (at Face Value) P200,000
Discount on Notes Payable (16,072)
Total P183,928
 RST Enterprise
2022 Debit Credit
1 Oct Interest Expense 16,072
Discount on Notes Payable 16,072

Notes Payable 200,000

Cash 200,000
 Transaction Price of the Non-Interest Bearing
Note
a) Amount of Cash received; or
b) Fair Value of goods and services received; or
c) Prevailing market rate of interest if Fair Value cannot be reliably
determined
Illustration:

XYZ Company discounted its own one-year P120,000, non-

interest bearing not on May 1, 2020 with Amihan Bank at a
discount rate of 12%. The proceeds received from this loan
is P105,600, which is equal to P120,000 less the discount of
P14,400 (P120,000 X 12%).
On May 1, 2020, XYZ Company records the
transactions as follows:

Debit Credit
Cash 105,600
Discount on Notes Payable 14,400
Notes Payable 120,000
Computation of effective interest rate:

Face 100% P120,000

Discount rate 12% OR 14,400
Net proceeds 88% P105,600

Effective Interest Rate 13.64%

 If XYZ Company uses the calendar year as its reporting
period, an adjustment on December 31 is made as follows:

Debit Credit
Interest Expense 9,600
Discount on Notes Payable 9,600
(14,400 * 8/12 or 105,600 * 13.64% * 8/12)
At Dec 31, 2021, the amortized cost of the
Notes Payable is computed as:
Notes Payable (at Face Value) P120,000
Discount on Notes Payable (4,800)
Total P115,200
On May 1, 2021, XYZ Company records the
transactions as follows:

Debit Credit
Interest Expense 4,800
Discount on Notes Payable 4,800

Notes Payable 120,000

Cash 120,000