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Chapter 7

PAYABLES

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Learning Objectives
1.Outline and apply the definition of liability
and financial liabilities.

2. Describe the nature, type of current


liabilities.

3. Explain and apply the recognition criteria,


measurement and de-recognition criteria of
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financial liabilities (of current liabilities).
Chapter outline

Definition of liabilities, financial liabilities,


current liabilities
Initial recognition
Initial measurement
Subsequent measurement
De-recognition
Presentation, disclosure, and analysis
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What is a liability?

A present obligation of an entity arising from


past events, the settlement of which is expected
to give rise to an outflow of economic resources
from the entity
(paragraph 4.4 (b), the Conceptual Framework).

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What is a liability?
Three essential characteristics:

1. Present obligation.

2. Arises from past events.

3. Results in an outflow of
resources (cash, goods,
services).

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Financial Liabilities
IFRS 9/MFRS 9
A financial liability is any liability that is:
(a) A contractual obligation:
(i) to deliver cash or another financial asset i.e.
trade account payables, notes payable

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Recognition of Liabilities

A liability is recognised when it is probable that


an outflow of resources embodying economic
benefits will result from the settlement of a
present obligation and the amount at which the
settlement will take place can be measured
reliably .
(paragraph 4.46, the Conceptual Framework).

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Initial recognition Financial Liability
IFRS 9/MFRS 9
An entity shall recognise..a financial liability in its statement of
financial position when and only when the entity becomes a
party to the contractual provisions of the instruments.

Example- Trade payables are recognised as liabilities when the


entity becomes a party to the purchase contract (with immediate
delivery of goods) and, as a consequence, has a legal obligation
to pay money.

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Example 1: Trade Payable
1 Dec 2014 A bookshop decides to place an order for
1,000 books from a supplier.
10 Dec 2014- The bookshop orders the books from the
supplier. The order is fully cancellable (the bookshop can
nullify the order at any time before it accepts delivery of the
books from the supplier).
20 Dec 2014- The bookshop takes delivery of 1,000 books
from a supplier, and have to make a payment within 14 days
after delivery (legal title and control of the books passes to
the bookshop when the bookshop takes delivery of the
books).
3 Jan 2015- The bookshop pays the supplier the full amount
owed.
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Question: When does the bookshop have to recognise the
liability (trade payable)?
Example 1: Trade Payables
The bookshop should recognise the trade payable as a
liability on 20 Dec 2015 as on this date the bookshop
becomes a party to the purchase contract (MFR 9) and, as a
consequence, has a legal obligation (present obligation) to
pay money to the supplier (result in an outflow of
resources embodying economic benefits- The Conceptual
Framework).

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Example 2: Employee Benefits
On 1 January 2015 ABC Bhd paid one of its employees RM5,000
for work performed under contract of employment in December
2014.

Q: Does ABC Bhd have a liability on 31 Dec 2014?

A: Yes ABC Bhd have a liability (i.e. salary payable ) on 31 Dec


2014 as the company has a contractual obligation (present
obligation) (as provided under the contract of employment
entered by the company; ABC Bhd becomes party to the purchase
contract (MFR 9)) to pay (result in an outflow of resources
embodying economic benefits-The Conceptual Framework) the 11
employee for the work performed in Dec 2014.
What is a current liability?
LIABILITIES

Current Liabilities Long-term Liabilities

Obligations payable within one year or


one operating cycle, whichever is longer.

Expected to be satisfied with current


assets or by the creation of other 12
current liabilities.
MFRS 101 Para 69 provides that a liability should be
classified as a current liability when:

(a) It is expected to be settled in the entitys normal operating


cycle;
(b) Held primarily for the purpose of being traded;
(c) It is due to be settled within 12 months of the balance
sheet date; or
(d) the entity does not have an unconditional right to defer the
settlement fro at least 12 months after the balance sheet
date.
All other liabilities should be classified as non-current assets.

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Typical examples of Current Liabilities:
Accounts payable. Customer advances and
deposits.
Notes payable.
Unearned revenues.
Current maturities of long-
term debt. Sales taxes payable/GST.
Short-term obligations Income taxes payable.
expected to be refinanced.
Employee-related liabilities.
Dividends payable.

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Initial Measurement

A liability shall be recorded at its fair value upon


initial recognition (MFRS 9) i.e. the present value
of the cash payments made to settle the
obligation.
However, in practice, current liabilities are
normally recorded at its maturity value. This is
because the difference between the fair value
and the maturity is not significant due to short-
term settlement.

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Accounts Payable (trade accounts payable)

Balances owed to others for goods, supplies, or services


purchased on open account.

Time lag between the receipt of services or acquisition


of title to assets and the payment for them.

Terms of the sale (e.g., 2/10, n/30 or 1/10, E.O.M.)


usually state period of extended credit, commonly 30 to
60 days.
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Example:
On 1 Jan 2014 Darby Bhd purchased 10 refrigerators (to be
resale) at RM650 per unit plus 6% GST on credit from Orion
Company. Darby uses a perpetual inventory system.

Journal entry:
Jan 1 Inventory 6,500
GST input credit/Outlays 390
Accounts payable 6,890

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Notes Payable

Written promises to pay a certain sum of money on a


specified future date.

Arise from purchases, financing, or other transactions.

Notes classified as short-term or long-term (depending on


the payment due date).

Notes may be interest-bearing or zero-interest-bearing.

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Notes Payable

Notes payable will have a stated maturity date,


interest rate and the amount to be paid.
Example: Assume that Eman Bhd reports on a
calendar year. On 1 November 2014, it acquires a
machine with a value of RM30,000 by issuing a
RM30,000 note bearing interest at 10%, due in 6
months, the following entries are necessary:

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Notes Payable: Example

1/11/2014 Machine 30,000


Notes payable 30,000
(To record the purchase of machine)

31/12/2014 Interest expense 500


Interest payable 500
(To accrue interest at year end)

1/5/2015 Notes payable 30,000


Interest payable 500
Interest expense 1,000
Cash 31,500 20

(To record payment)


Interest-Bearing Note Issued
Interest Bearing Loan: Interest rate is stated clearly.
Loan is normally recorded at its principal value.

Example: Castle National Bank agrees to lend $100,000 on 1


March 2011, to Landscape Co. if Landscape signs a $100,000, 6
percent, four-month note. Landscape records the cash received
on March 1 as follows:
Cash 100,000
Notes Payable 100,000 21

LO 1 Describe the nature, type, and valuation of current liabilities.


Interest-Bearing Note Issued
If Landscape prepares financial statements semiannually, it makes
the following adjusting entry to recognize interest expense and
interest payable at June 30:

Interest calculation = ($100,000 x 6% x 4/12) = $2,000

Interest expense 2,000


Interest payable 2,000
At maturity (July 1), Landscape records payment of the note and
accrued interest as follows.

Notes payable 100,000


Interest payable 2,000 22

Cash 102,000
Zero-Bearing Note Issued (Non-interest
bearing)
interest rate is not stated, but the amount to be settled is more
than amount borrowed

Illustration: On March 1, Landscape issues a $102,000, four-


month, zero-interest-bearing note to Castle National Bank. The
present value of the note is $100,000. Landscape records this
transaction as follows.

Cash 100,000
Notes payable 100,000 23
If Landscape prepares financial statements semiannually, it
makes the following adjusting entry to recognize interest expense
and the increase in the note payable of $2,000 at June 30.

Interest expense 2,000


Notes payable 2,000

At maturity (July 1), Landscape must pay the note, as follows.

Notes payable 102,000


Cash 102,000
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Current Maturities of Long-Term Debt

Part of a long term liability i.e. portion of bonds, mortgage


notes, that is due to be settled within 12 months of the
balance sheet date.

Exclude long-term debts maturing currently if they are to be:


1. Retired by assets accumulated that have not been shown
as current assets,
2. Refinanced, or retired from the proceeds of a new debt
issue, or
3. Converted into ordinary shares.
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Short-Term Obligations Expected to Be
Refinanced
are debts scheduled to mature within one year after the
balance sheet date or within an entitys normal operating
cycle/.

Exclude from current liabilities if both of the following


conditions are met:
1. Must intend to refinance the obligation on a long-term
basis.

2. Must have an unconditional right to defer settlement of


the liability for at least 12 months after the reporting date. 26
Example of Refinancing of Short-Term Debt:

The CFO for Hendricks Corporation is discussing with the


companys chief executive officer issues related to the companys
short-term obligations. Presently, both the current ratio and the
acid-test ratio for the company are quite low, and the chief
executive officer is wondering if any of these short-term
obligations could be reclassified as long-term. The financial
reporting date is December 31, 2010. Two short-term obligations
were discussed, and the following action was taken by the CFO.

Instructions: Indicate how these transactions should be reported


at Dec. 31, 2010, on Hendricks statement of financial position.
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LO 2
Short-term obligation A: Hendricks has a $50,000 short-term
obligation due on March 1, 2011. The CFO discussed with its
lender whether the payment could be extended to March 1, 2013,
provided Hendricks agrees to provide additional collateral. An
agreement is reached on February 1, 2011, to change the loan
terms to extend the obligations maturity to March 1, 2013. The
financial statements are authorized for issuance on April 1, 2011.

Liability of Refinance Liability due Statement


$50,000 completed for payment Issuance

Dec. 31, 2010 Feb. 1, 2011 Mar. 1, 2011 Apr. 1, 2011


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Short-term obligation A: Hendricks has a $50,000 short-term
obligation due on March 1, 2011. The CFO discussed with its
lender whether the payment could be extended to March 1, 2013,
provided Hendricks agrees to provide additional collateral. An
agreement is reached on February 1, 2011, to change the loan
terms to extend the obligations maturity to March 1, 2013. The
financial statements are authorized for issuance on April 1, 2011.

Current Liability
of $50,000 Since the agreement was not in place as of the reporting
date (December 31, 2010), the obligation should be
Dec. 31, 2010 reported as a current liability.
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Short-term obligation B: Hendricks also has another short-term
obligation of $120,000 due on February 15, 2011. In its discussion
with the lender, the lender agrees to extend the maturity date to
February 1, 2012. The agreement is signed on December 18,
2010. The financial statements are authorized for issuance on
March 31, 2011.

Refinance Liability of Liability due Statement


completed $120,000 for payment Issuance

Dec. 18, 2010 Dec. 31, 2010 Feb. 15, 2011 Mar. 31, 2011

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Short-term obligation B: Hendricks also has another short-term
obligation of $120,000 due on February 15, 2011. In its discussion
with the lender, the lender agrees to extend the maturity date to
February 1, 2012. The agreement is signed on December 18,
2010. The financial statements are authorized for issuance on
March 31, 2011.

Non-Current
Refinance Liability of Since the agreement was in place as of
completed $120,000
the reporting date (December 31, 2010),
the obligation is reported as a non-
Dec. 18, 2010 Dec. 31, 2010
current liability.
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Accrued Liability

An expense that has been incurred but not paid.


Examples: interest payable, salaries payable, rent
payable, tax payable and dividend payables.

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Dividends Payable
Amount owed by a corporation to its shareholders as a
result of board of directors authorization.

Generally paid within three months.

Undeclared dividends on cumulative preference shares


not recognized as a liability.

Dividends payable in the form of additional shares are


not recognized as a liability. Reported in equity.

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Dividends payable
Arises when the Board of Directors of a company
decides and announces to distribute cash
dividends to its shareholders.
On announcement date:
Retained earnings XX
Dividends payable XX
On payment date:
Dividends payable XX
Cash XX 34
Goods and Services Tax (GST)
Businesses (with annual sales of RM500K and above) must
collect Goods and Services Tax (GST) from customers on
transfers of tangible personal property and on certain
services and then remit to the proper governmental authority
(Malaysian Royal Custom).

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Example- Dillons Bhd made credit sales of RM30,000 which are
subject to 6% GST. The corporation also made cash sales which
totaled RM20,670 including the 6% GST. (a) prepare the entry to
record Dillons credit sales. (b) Prepare the entry to record Dillons
cash sales (assuming Dillons Bhd uses perpetual inventory system).

Accounts receivable 31,800


Sales 30,000
GST payable ($30,000 x 6% = $1,800) 1,800

Cash 20,670
Sales ($20,670 1.06 = $19,500) 19,500
GST payable 1,170
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LO 2
Unearned Revenues
Payment received before delivering goods or rendering
services.
Illustration 13-2
Unearned and Earned
Revenue Accounts

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Example: Sports Pro Magazine sold 12,000 annual subscriptions
on August 1, 2010, for $18 each (with 6% GST). Prepare Sports
Pros August 1, 2010, journal entry and the December 31, 2010,
annual adjusting entry.

Aug. 1 Cash 228,000


Unearned revenue 216,000
(12,000 x $18)
GST Payable 12,960

Dec. 31 Unearned revenue 90,000


Subscription revenue 90,000 38
($216,000 x 5/12 = $90,000)
Income Tax Payable

Businesses must prepare an income tax return and compute


the income tax payable.

Taxes payable are a current liability.

Corporations must make periodic tax payments.

Differences between taxable income and accounting


income sometimes occur (Chapter 19).

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LO 2 Explain the classification issues of short-term


debt expected to be refinanced.
Employee-Related Liabilities

Amounts owed to employees for salaries or wages are


reported as a current liability.

Current liabilities may include:

Payroll deductions.

Compensated absences.

Bonuses.

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LO 3 Identify types of employee-related liabilities.


Payroll Deductions
Taxes:
Social Security Taxes (e.g. SOCSO deduction)
Income Tax Withholding (e.g. PCB deduction)
Illustration 13-3
Summary of Payroll Liabilities

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LO 3 Identify types of employee-related liabilities.


Illustration: Assume a weekly payroll of $10,000 entirely subject to
Social Security taxes (8%), with income tax withholding of $1,320 and
union dues of $88 deducted. The company records the wages and
salaries paid and the employee payroll deductions as follows.

Wages and salaries expense 10,000


Withholding taxes payable 1,320
Social security taxes payable 800
Union dues payable 88
Cash 7,792

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LO 3 Identify types of employee-related liabilities.


Illustration: Assume a weekly payroll of $10,000 entirely subject to
Social Security taxes (8%), with income tax withholding of $1,320 and
union dues of $88 deducted. The company records the employer
payroll taxes as follows.

Payroll tax expense 800


Social security taxes payable 800

The employer must remit to the government its share of Social Security tax
along with the amount of Social Security tax deducted from each employees
gross compensation.
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LO 3 Identify types of employee-related liabilities.


Compensated Absences

Paid absences for vacation, illness and maternity, paternity,


and jury leaves.

Vested rights - employer has an obligation to make payment to


an employee even after terminating his or her employment.

Accumulated rights - employees can carry forward to future


periods if not used in the period in which earned.

Non-accumulating rights - do not carry forward; they lapse if


not used.
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LO 3 Identify types of employee-related liabilities.


Illustration: Amutron Inc. began operations on January 1, 2011. The
company employs 10 individuals and pays each 480 per week.
Employees earned 20 unused vacation weeks in 2011. In 2012, the
employees used the vacation weeks, but now they each earn 540
per week. Amutron accrues the accumulated vacation pay on
December 31, 2011, as follows.

Wages expense 9,600


Vacation wages payable 9,600

In 2012, it records the payment of vacation pay as follows.

Vacation wages payable 9,600


Wages expense 1,200 45

Cash 10,800
LO 3
Profit-Sharing and Bonus Plans

Payments to certain or all employees in addition to their


regular salaries or wages.

Bonuses paid are an operating expense.


Unpaid bonuses should be reported as a current liability.

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LO 3 Identify types of employee-related liabilities.


Subsequent Measurement

MFRS 9 provides that after initial recognition:


financial liabilities that are classifies as amortised
cost should be measured at amortised cost, using
the effective interest rate method.

However current liabilities are:


Usually reported at their full maturity value.
Difference between present value and the
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maturity value is considered immaterial.
De-recognition

MFRS 9 provides that a financial liability should


be derecognised when and only when it is
extinguished, that is, when the obligation
specified in the contract is discharged (fully
paid), cancelled, or expire (para.39).

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Example 1: De-recognition
10 Dec 2014- The bookshop orders the books from the supplier. The
order is fully cancellable (the bookshop can nullify the order at any time
before it accepts delivery of the books from the supplier).
20 Dec 2014- The bookshop takes delivery of 1,000 books from a
supplier, and have to make a payment within 14 days after delivery
(legal title and control of the books passes to the bookshop when the
bookshop takes delivery of the books).
1 Jan 2015- The bookshop pays the supplier 50% of the full amount
owed.
3 Jan 2015 The bookshop pays the remaining balance of the amount
owed to the supplier.

Question: When does the bookshop should derecognize the liability


(Trade payable)?
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Example 1- De-recognition

In this example the financial liability (the trade


payable account ) should be de-recognised when
and only when it is extinguished, that is, when the
obligation (amount to be paid) specified in the
(purchase) contract is discharged (fully paid) on 3
January 2015 (MFRS 9).

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Presentation, Disclosure, and Analysis
Presentation of Current Liabilities
Usually reported at their full maturity value.
Difference between present value and the maturity
value is considered immaterial.

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Presentation and Analysis
Presentation of Current Liabilities
Illustration 13-13

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Presentation of Current Liabilities
Illustration 13-15

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Presentation and Analysis
Disclosure of Current Liabilities
If a company excludes a short-term obligation from
current liabilities because of refinancing, it should include
the following in the note to the financial statements:

1. A general description of the financing agreement.

2. The terms of any new obligation incurred or to be


incurred.

3. The terms of any equity security issued or to be issued.

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Presentation and Analysis
Presentation & Disclosure of Current
Liabilities
Actual Refinancing of Short-Term Debt Illustration 13-14

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Presentation and Analysis
Analysis of Current Liabilities
Liquidity regarding a liability is the expected time to elapse
before its payment. Two ratios to help assess liquidity are:

Current Assets
Current Ratio =
Current Liabilities

Cash + Marketable Securities + Net


Receivables
Acid-Test Ratio =
Current Liabilities 56
Presentation and Analysis
E13-17: (Ratio Computations and Discussion) Costner Company has
been operating for several years, and on December 31, 2010,
presented the following balance sheet.
Balance Sheet (in thousands)
Compute the current ratio:
Assets
Cash $ 40,000
$210,000
Accounts recievables, net 75,000 = 3.0 to 1
Inventories 95,000 70,000
Plant assets, net 220,000
Total assets $ 430,000
Liabilities and Equity Compute the acid-test ratio:
Accounts payable $ 70,000
Mortgage payable 140,000 $115,000
Common stock, $1 par 160,000 = 1.64 to 1
Retained earnings 60,000 70,000 57
Total liabilities and equity $ 430,000
References
Picker, R. Leo, K.J, Loftus, J. Wise, V., Clark, K., and Alfredson,
K., (2012). Applying International Financial Reporting
Standards, 3rd Edition, John Wiley & Sons Inc., USA.
Kieso, D. E., Weygandt, J. J., and, Warfield (2014). Intermediate
Accounting, IFRS edition, John Wiley & Sons Inc., USA.
Ng E. J., (2012). A Practical Guide to Financial Reporting
Standards (Malaysia), 3rd ed., CCH, Malaysia.
Hoggett, Edwards, Medlin & Titling (2009) Financial
Accounting, Wiley, Australia.
MFRS 139, IFRS 9, MFRS 101, MFRS 9
Conceptual Framework of Financial Reporting
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