Intermediate Accounting 2

Module 1: Current Liabilities

II. How about a long-term debt
that falls due within one year?
What will be the classification
of the liability?

An obligation that will be

settled within twelve months
after reporting date is still
classified as current, even if:
Liability is something a person a. The original term was for a
or company owes, that are settled period longer than twelve months.
over time through the transfer of b. There is an agreement
economic benefits including to refinance or to reschedule
money, goods, or services, as a payment on a long-term basis is
result of past events. completed after the reporting the
period and before the financial
statements are authorized for
issue.

III. Covenants. Breach of

covenants, how will it affect the
liability classification?

Covenant is a promise in an
indenture, or any other formal
debt agreement, that certain
activities will or will not be
carried out or that certain
thresholds will be met.
If there are conditions relating
to the borrower’s financial
situation are breached, the
obligation becomes immediately
payable. This is considered as
current liability, because at the
Short-term obligations or Long end of the reporting period, the
term obligations. Which is which? entity does not have the
contractual right to defer the
I. How can we classify a debt to settlement for at least twelve
be a non-current liability even months after that date.
if it is originally classified as But if the lender has agreed on
a short term obligation? Here are or before the end of the
the two considerations: reporting period to provide
a grace period ending at least
a. The liability is contractually twelve months after the date, the
due to be settled more than one liability is classified as non-
year (or operating cycle, if current.
longer) after the balance sheet
date. Module 2: Estimated Liabilities
b. The entity has a contractual
right to defer settlement of the Gift Certificate Payable
liability for at least one year
(or operating cycle, if longer) One strategy of some entities
after the balance sheet date. such as supermarkets, department
stores and malls to attract more
customers are to sell gift
certificates that are redeemable
in merchandise. Because of this a
liability account should be
recognized with the following
accounting procedure:

Bonus Computation

Entities usually motivates their

employees to do well by offering
bonuses based on their
performances.

Bonus computation results in

liability that should be measured
and reported at year-end in the
financial statements. It have
four variations:

1. Bonus is expressed as a
certain percent of income before
bonus and before tax.

B=%I

2. Bonus is expressed as a
certain percent of income after
bonus but before tax

B=%(I-B)

3. Bonus is expressed as a
certain payment of income after
bonus and after tax

B=%(I-B-T)

4. Bonus is expressed as a
certain percent of income after
tax but before bonus.

B=%(I-T)

Premiums
 These are object of value
such as small toys, office
supplies, dishes and other
products given to customers as an
outcome of past sales
transactions or sales marketing
activities.
To boost the sale of the
entities products, premiums are
offered to customers in exchange
for product labels, box tops,
wrappers and coupons.
Once a merchandise is sold,
an accounting liability should be Cash rebate program and Cash
recognize for the future discount coupon
distribution of premiums. Here is
the accounting procedure for Cash Rebate is the money
premiums from acquisition to refunded to customers who buy
recognition of premium liability. merchandise from retailers within
a specified time, the rebate
allows dealers to clear
inventories without cutting list
price, for example, a new mobile
phone dealer might announce that
everyone who purchases a certain
mobile phone in the current month
at the regular price of P35,000
will receive a cash rebate of
P5,000. Another example is cash
rebate credit card which gives 1%
cash back on general purchases
and 5% on specific purchases.
It is one of the other
programs offered by the entities
to stimulate their sales. Just
like premiums, cash rebates
should be recognized as an
expense and an estimated
liability in the period of sale.
Cash Discount Coupon Stated on PAS 37, par. 14, a
provision shall be recognized as
Another program that are used by a liability in the financial
the entities to increase their statements if the following
sales is the cash discount criteria are met:
coupon. Just like premiums and
cash rebate program, an expense a. A present obligation, legal or
and estimated liability should be constructive, must be present as
recognized in the period of sale. a result of a past event.

Illustration: b. To settle the obligation, a

To boost the sale of the probable outflow resources
fantastic umbrella, RainyCo. embodying economic benefits would
Included in each unit sold a be required.
coupon that offers P50 discount
on the purchase price of Hot Cap c. The obligation amount can be
(new product of the company) when measured reliably.
the coupon is presented to
retailers. What are the approaches used in
RainyCo. Has an agreement to its accounting for warranty?
retailers that they will be
reimbursed for the face amount of
the coupon plus 5% for handling.
Based on last year’s data, 40% of
the coupons can be redeemed.
RainyCo issued coupons with face
amount of P4,500,000 and total
payments to retailers amounted to
P1,000,000.

Warranty

Gadgets like laptops, tablets and

mobile phones are sold with
guarantee or warranty that the
manufacturer of the product will
repair or replace the product for
a certain period of time.

Because of this policy,

Illustration:
significant cost can be incurred
Astig Technology sells 500 units
by the entity if the products
of laptop at P25,000 each for
sold are proved to be defective
cash. Each unit is under warranty
in the future.
for one year.
Based on the entity’s past
Recognition of Warranty provision
experience, an average of P1,000
per unit as warranty cost will be
the best estimate and that only
50% of the laptops sold will be sales and warranty repairs are
returned for repair. made.
At the end of the year, Astig
Tech incurs a total repair cost The entity projects an estimated
of P200,000. warranty cost as a percentage of
sales as follows:

Take note of the following:

A. As of year-end the statement

of financial position would
report an estimated warranty
liability of P50,000 as a current
liability.

B. A warranty expense of
P250,000.00 should reflect in the
profit or loss statement.

C. The warranty cost expected to

be incurred within one year is
classified as current and the
remaining balance as noncurrent.

Expense as incurred approach

Some entities assume that

warranty cost is not very
substantial or the warranty
period is relatively short. That
is when the expense as incurred
approach is the most appropriate
method to be used.

For a simple illustration, an

actual warranty cost of P200,000
is recorded by debiting warranty
expenses and crediting cash.
Sale of warranty
Another Illustration:
Some entities sold warranty
Sure Buy Co. sell TV sets that separately from the product. If
carries a 2-year warranty against products are sold, the customers
defects. Throughout the year, are entitled to the usual
manufacturer’s warranty during a
certain period.

“Extended warranty” on the

product sold with additional
cost, can be offered by some
sellers to give their customers
assurance that the product
purchased can be still repaired
for an additional period of time.

The accounting procedure to be

observed here is that the sale of
the product with the usual
warranty is recorded separately
from the sale of extended
warranty.

The amount received from the sale

of the extended warranty is
recognized initially as deferred
revenue and subsequently
amortized using straight-line
over the life of the warranty
contract.

But, if costs are expected to be

incurred in performing services
under the extended warranty
contract, revenue is recognized
in proportion to the costs to be
incurred annually.

Illustration:
Bili Kayo sold a product for
P2,000,000. The regular warranty
for this product is two years.
Bili Kayo sold an additional
warranty of two years at a cost
of P50,000.

The extended warranty

contract starts only after the
expiration of the regular two-
year warranty period.
If the costs are incurred evenly,
the unearned warranty revenue is
amortized at the end of the third
year as: