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Liabilites

Define Liabilities.
Liabilities are present obligations from past transactions or events, the settlement of
which is expected to result in an outflow from the entity of resources
embodying economic benefits.

Essential Characteristics of an Accounting Liability.


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The liability is the present obligation is owed to be identified.


The liability arises from past transaction or event.
The settlement of the liability requires an outflow of resources embodying economic
benefits.

Examples of liabilities

Accounts payable to suppliers for the purchase of goods and services.


Amounts withheld from employees for taxes and for contributions to the social
security system or the pension funds.
Accruals for wages, interest, royalties, taxes, product warranties and profit sharing
plans
Dividends payable in cash or noncash asset
Deposits and advances from customers, officers and shareholders
Debt obligations for borrowed fund notes, mortgages and bonds payable
Income tax payable
Unearned revenue
Initial measurement of liabilities
An entity shall measure initially a financial liability at fair value minus, in the case of
financial liability not designated at fair value through profit or loss, transaction
costs that are directly attributable to the issue of the financial liability. The
transaction costs are included in the initial measurement of a financial liability
measured at amortized cost. However, the transaction costs are expensed
immediately if the financial liability is designated initially as at fair value
through profit of loss.

Transaction costs
Transaction costs are incremental costs that are directly attributable to the issue of a
financial liability. An incremental cost is one that would have been incurred if
the entity had not issued the financial liability.
Transaction costs include:

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


Levies by regulatory agencies and securities exchanges
Transfer taxes and duties

Transaction costs do not include

Debt premiums or discounts


Financing costs
Internal administrative or holding costs

Fair value
Fair value is the price that would be paid to transfer a liability in an orderly
transaction between market participants at the measurement date. Conceptually,
the fair value of the liability is equal to the present value of the future cash payment
to settle the obligation. The term present value is the discounted amount of the
future cash outflow in settling an obligation using the market rate of interest.

Subsequent measurement
After initial recognition, an entity shall measure a financial liability (a) at amortized
cost using the effective interest method or (b) at fair value through profit or loss.

Amortized cost
Amortized cost of a financial liability is the amount at which the financial liability is
measured at initial recognition minus principal repayment, plus or minus the
cumulative amortization using the effective interest method of any difference
between the initial amount and the maturity amount.
Simply stated, the difference between the face amount and the present value of the
financial liability is amortized using the effective interest method. The difference
between the face amount and the present value is either discount or premium on
the issue of financial liability.

Noncurrent liabilities
Noncurrent liabilities are initially measured at present value and subsequently
measured at amortized cost. Long term note payable that are interest bearing is
initially and she subsequently measured at face amount. In this case, the face
amount is equal to the present value of the note payable.

Current liabilities

Conceptually, all liabilities are initially measured at fair value and subsequently
measured at amortized cost. However, in practice, current liabilities or short term
obligations are not discounted anymore but measured and reported at their face
amount. The reason is that the discount or the difference between the face amount
and the present value is usually not material and therefore ignored.

Fair Value Option


At initial recognition, an entity may irrevocably designate a financial liability at fair
value through profit or loss when doing so results in more relevant information. In
other words, under the fair value option the financial liability, for example, bonds
payable, is measured at fair value t every year-end and any change in fair value is
recognized in profit or loss.
The amortization rules for discount or premium no longer apply. The interest
expense is recognized using the nominal or stated interest rate and not the
effective interest rate.

Estimated Liabilities
Estimated liabilities are obligations which exist at the end of reporting period
although the amount is not definite. In many cases, the date when the obligation is
due is not also definite and in some instances, the exact payee cannot be identified
or determined. But in spite of these circumstances, the existence of the estimated
liabilities is valid and unquestioned.
Estimated liabilities are either current or noncurrent by nature. Examples include
estimated liability for premium, award points, warranties, gift certificates and
bonus.
An estimated liability is considered as a provision which is both probable and
measurable.