Liabilities 2015

BA 219 Corporate Financial Reporting Valderrama

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Liabilities

Liability

• Present obligation

• As a result of past transactions or events

• Expected to result in an outflow of resources embodying economic benefits


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Initial Recognition: Criteria

(1) It is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation; and

(2) The amount at which the settlement will take place can be measured reliably.

Types of Liabilities

1. Liabilities of definite timing and amount

2. Liabilities of uncertain timing and amount (a.k.a. “provisions” – covered by PAS 37)

3. Contingent liabilities


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Liabilities of Definite Timing and

Amount • Accounts payable

• Accrued expenses

• Salaries payable

• Unearned revenues

• Loans

Screen clipping taken: 8/2/2012, 11:54 PM

Globe 2011 Annual Report


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Customer Loyalty Programs


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IFRIC 13 – Accounting for Customer

Loyalty Programmes

http://www.pwc.com/en_GX/gx/retail-consumer/pdf/ifric13_final_low.pdf

• Applies to entities that grant awards credits as part of a sales transaction, including awards that can be redeemed for goods and services not supplied by the entity

• Requires that the consideration received from the sale be allocated to the “award credit” using relative fair values; the portion allocated to the “award credit” shall be considered deferred revenue

IFRIC 13 – Accounting for Customer Loyalty Programmes





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Provisions and Contingencies

A provision is a liability of uncertain timing or amount

A contingent liability is either –

1. A possible obligation whose existence will be confirmed only by the occurrence or non-occurrence of one or more future events not wholly within the control of the entity; or

2. A present obligation that is not recognized because at least one of the criteria for recognition is not satisfied


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Provisions and Contingencies:

Examples Provision Contingent Liability

1. Provision for dismantling and restoration costs

1. Loan guarantee

2. Provision for future warranty claims

2. Meralco’s liability for real estate taxes on its electric poles, wires, etc. (see excerpt).

3. Provision for damages arising from a lawsuit that management believes will be decided against the entity

3. Possible liabilities arising from lawsuits & other 3rd party claims against the company whose outcomes are not determinable on balance sheet date

4. Provision for employee pension benefits


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Contingent Liability: Other Examples

Source: Meralco 2007 Annual Report


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Philex on Aug 1 decided to suspend operations after indications that water and sediment were being discharged from one of two underground tunnels that drain water from the penstock in the tailing pond

Rehabilitation expected to cost P220M per month

So far, core income dropped by 26% to P2.11B in the first half on the back of lower gold output

Philex took out $30M in business interruption insurance and $50M in environment insurance following the incident


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Classification of Liabilities

• Current liabilities ▫ Expected to be settled in the entity’s normal operating

cycle

▫ Held primarily for trading

▫ Due to be settled within 12 months after balance sheet date

▫ Entity does not have an unconditional right, as of balance sheet date, to defer settlement of he liability for at least 12 months after the balance sheet date

Non-Current Liabilities: Bonds Payable

Common types of bonds

• Term and serial

• Secured and unsecured

• Registered and bearer (coupon)

• Callable

• Convertible

• Zero-interest or deep-discount


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Accounting for Bonds

• Issuance

▫ At par, discount or premium

▫ Bond issue costs

▫ Convertible bonds

• Accounting for interest and principal payments

• Measurement on balance sheet date

• Troubled debt restructuring


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Review: Price of a Bond

Q: What is the price of a 3-year, 10% bond with face value of P5M when the prevailing market interest rate is 12%?

A: (500,000 x 0.893)+(500,000 x 0.797) + (5,500,000 x

0.712) = P4,759,817 Note: The bond sold at a discount (i.e., less than par

value) because its coupon rate is less than the market interest rate.

Amortizing Bond Discount

Date Interest paid Interest expense amortization

Amortized cost

1/1/2008

4,759,816.87

12/31/2008

500,000.00 571,178.02

71,178.02

4,830,994.90

12/31/2009

500,000.00 579,719.39

79,719.39

4,910,714.29

12/31/2010

500,000.00 589,285.71

89,285.71

5,000,000.00


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Bond Issued at a Premium

Q: What is the price of a 5-year, 10% P5M bond paying annual interest every December 31 when the annual market interest rate is 8%?

A: P5,399,271.00

Amortizing a Bond Premium

date interest

paid interest expense

Amortiza-tion

cv

1/1/2005 5,399,271.00

12/31/2005

500,000.00 431,941.68

(68,058.32)

5,331,212.68

12/31/2006

500,000.00 426,497.01

(73,502.99)

5,257,709.70

12/31/2007

500,000.00 420,616.78

(79,383.22)

5,178,326.47

12/31/2008

500,000.00 414,266.12

(85,733.88)

5,092,592.59

12/31/2009

500,000.00 407,407.41

(92,592.59)

5,000,000.00


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Amortizing Both Principal and Interest:

Mortgage Loan

On January 1, 2008, Picard Inc. purchased a new piece of equipment from LaForge Engineering to expand its production facilities. The equipment was purchased at a cost of P800,000. Picard financed the purchase with an P800,000 mortgage to be repaid in annual payments of P211,038** over 5 years at the rate of 10%. The first payment is to be made on December 31, 2008.

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** P800,000/3.7908 (PV factor of an ordinary annuity for 5 periods at 10%)

Picard Inc.: Mortgage Amortization Schedule

Payment

Interest

Payment

Principal

Payment

Cumulative

Principal

Paid

Cumulative

Interest

Paid

Loan

Balance

10%

800,000

2008

211,038

80,000

131,038

131,038

80,000

668,962

2009

211,038

66,896

144,142

275,180

146,896

524,820

2010

211,038

52,482

158,556

433,736

199,378

366,264

2011

211,038

36,626

174,412

608,147

236,005

191,853

2012

211,038

19,185

191,853

800,000

255,190

(0)


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Measurement on Balance Sheet Date

• Two alternatives:

▫ Fair value – for liabilities designated as such at the time of borrowing

▫ Amortized cost – most commonly used measurement basis for long-term debt; is the present value of the cash payments expected to be made for the liability based on the effective borrowing cost when the liability was incurred

Troubled Debt Restructuring

• Asset swap ▫ Difference between the carrying amount of the liability

and the consideration paid shall be recognized in profit or loss

• Equity swap ▫ Equity issued is measured at fair value or, if not

reliably measurable, at the fair value of the liability extinguished.

▫ Gain/loss recognized in profit and loss is allowed for debt-equity swaps in a troubled debt restructuring (IFRIC 19 )

• Modification of debt terms ▫ Gain or loss is recognized if there is substantial

modification of debt terms


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Asset Swap

• Manila Bank loaned P10M to ABC Realty. On the loan’s maturity on Dec. 31, 2012, Manila Bank agreed to accept land with fair value of P9M in full settlement of the P10M and 1-year accrued interest at 12% or P1.2M. The land has a carrying value of P10.5M in ABC Realty’s books. Determine the effect of the asset swap on ABC Realty’s financial condition and performance.


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Equity Swap

• Assume that, instead of land, ABC Realty offered, and Manila Bank accepted, 180,000 of the former’s common shares which have a par value of P40 and a fair market value of P50. Determine the effect of the debt-for-equity swap on ABC Realty’s financial condition and performance.

Modification of Debt Terms

Forms of modification

• Reduction of stated interest rate

• Reduction of face amount of the debt

• Reduction or condonation of accrued interest

• Extension of maturity date

• Moratorium on the payment of interest and/or principal


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• A gain or loss is recognized when the original liability is deemed extinguished and the modified debt is deemed a new financial liability.


• The original liability is deemed extinguished when the modified loan terms are substantially different from the original terms. The terms are substantially different if the discounted present value of the cash flows under the new terms is at least 10% different from the discounted present value of the remaining cash flows (or carrying value) of the original financial liability.


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Illustration

• Let’s say the loan of ABC Realty with Manila Bank was instead restructured and now has the ff terms:

▫ Revised principal of P7M from P10M

▫ Condonation of accrued interest of P1.2M

▫ Extension of maturity date to 12.31.2016

▫ Reduction of interest rate from 12% to 8%

Illustration

PV of principal

7,000,000 0.63552

4,448,640

PV of interest 560,000 3.03735 1,700,916

Total PV of revised loan

6,149,556

Carrying value of existing loan

11,200,000

Gain from debt restructuring

5,050,444

The present value of the revised loan is determined as follows:


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Exercises

1. On Jan. 1, 2006, Phoenix Corp. purchased a building for P15M. The firm made a 20% downpayment and took out a mortgage payable over 30 years at a rate of P88,051.70 monthly. The first payment is due Feb. 1, ‘06. The mortgage interest rate is 8%. How will the purchase of the building affect the accounting equation?

Exercises

2. The Rugless Corp. issued P1M of bonds at a price of 108.

(a) Determine the total cash the company received from the bond issue.

(b) Did the bonds sell at par, at a discount, or at a premium?

(c) For this bond, is the stated rate of interest higher or lower than the market rate of interest?


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Exercises:

3. On Jan. 1, ‘06, Cobweb Corp. issued P1.5M of 10-year term bonds with a stated rate of interest of 12%. The bonds pay interest semiannually on Jan 1 and July 1. At the time of this issue, the current market interest rate was also 12%.

(a) How much cash did Cobweb receive when the bond was issued?

(b) How much interest will be paid every 6 months?

(c) Assuming Cobweb has a Dec 31 year-end, what adjustment will need to be made at the end of each year?

Exercises:

4. On Jan. 1, 2006, the Old Spice Company issued P300k of 10-year, 12% bonds at a price of 86.668. The market interest rate on the bond issuance date was 14%. The bonds pay interest semiannually on Jan. 1 and July 1.

(a) How much cash did the company receive from the issuance of the bonds?

(b) How much cash did the firm expend for interest during 2006?

(c) How much interest expense did the company report for 2006?

(d) How much total interest expense will the firm incur over the 10-year life of these bonds?


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Exercises:

5. Determine the financial reporting implications of the ff situations affecting Animaniacs Ltd., a manufacturer of toys:

(a) A safety hazard related to one of its toy products was discovered. It is considered probable that liabilities have been incurred. On the basis of past experience, a reasonable estimate of the amount of loss can be made.

Exercises:

(b) This year, Animaniacs began promoting a new toy by including a coupon, redeemable for a movie ticket, in each toy’s carton. The movie ticket, which cost AnimaniacsP30, is purchased in advance and mailed to the customer when the coupon is received by Animaniacs. Animaniacs estimated, based on past experience, that 60% of the coupons will be redeemed – 45% of the coupons were actually redeemed this year, and the remaining 15% of the coupons are expected to be redeemed next year.


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Leases (PAS 17)

Definition of a lease - an agreement whereby the lessor conveys to the

lessee in return for a payment or series of payments the right to use an asset for an agreed period of time

“Right to use” (see IFRIC 4) Ability to operate the asset or direct others to

operate the asset

Ability to control physical access to the asset

Ability to obtain or control significant output of/benefits from the asset

Types of Lease

▫ Operating lease – “a lease other than a finance lease” periodic payment is recognized as lease expense by the lessee and lease income by the lessor; an off-balance sheet transaction for the lessee

▫ Finance (or capital) lease – “a lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred.” lessee recognizes an asset and a liability; lessor derecognizes the leased asset and recognizes a receivable


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Rewards of ownership Risks of ownership

Benefits obtained from using

the asset to provide benefit or

service to the entity

Unsatisfactory performance

Appreciation in residual value

or gains on the eventual sale of

the asset

Obsolescence

Idle capacity

Decline in residual value or

losses on eventual sale of the

asset

Uninsured damage and

condemnation of the asset

Conditions that usually accompany a

capital lease • Transfer of ownership at the end of the lease

term

• Bargain purchase option

• Lease term is ≥ 75% of asset’s economic life

• Present value of lease payments are substantially all (≥ 90%) of the fair value of the asset


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Impact on Financial Condition and

Performance Operating Lease - Annual lease payments are rent expense

Capital Lease - Asset and liability recognized in the balance

sheet at the lower amount of the asset’s fair value and the present value of minimum lease payments

- Interest expense and depreciation are recognized in the income statement of the lessee

Impact on Financial Condition and

Performance On January 1, 2008, a company leases a machinery for 4 years (its entire economic life) at an annual rental of P100,000 payable at the end of each year. The interest rate implicit in the lease is 12%. Determine the impact of this transaction on the company’s financial condition and performance.

Note: PV factor of an ordinary annuity for 4 years at 12% = 3.0373


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Amortization Schedule

Date Payment Interest Principal Cumulative

Principal Principal Balance

1/1/2008

303,730.00

12/31/2008

100,000.00 36,447.60 63,552.40

63,552.40

240,177.60

12/31/2009

100,000.00 28,821.31 71,178.69

134,731.09

168,998.91

12/31/2010

100,000.00 20,279.87 79,720.13

214,451.22

89,278.78

12/31/2011

100,000.00 10,713.45 89,286.55

303,737.76

(7.76)

Lease: Exercises

1. Myra Company purchased a tractor on Jan. 1, 08 at a cost of P1.6M for the purpose of leasing it. The tractor is estimated to have a useful life of 5 years with a residual value of P100,000. On April 1, ‘08, Myra entered into a lease contract for the lease of the tractor for a term of 2 years up to March 31, 2010. The lease is P50,000 a month and the lessee paid P600,000, the lease fee for one year. Determine the effects of these transactions on the lessee and lessor’s financial position and performance.


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Lease: Exercises

2. Overland Company closed a lease contract for newly constructed terminals and freight storage facilities on 1.1.08. Although the terminals have a composite life of 10 years, the lease runs for 5 years with a favorable bargain purchase option upon expiration of the lease. The annual rental is P1M payable at the end of each year starting 12.31.08. The contract was negotiated to assure the lessor a 10% rate of return. Determine the effects of this transaction on the financial position and performance of lessee and lessor.

Employee Benefits

• Short-term employee benefits (includes bonuses and compensated absences)

• Post-retirement (pension) benefits


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Employee Benefits

• Employee benefits are considered additional compensation expense in the period in which the service rendered resulted in the benefit earned

• Post-employment (pension) benefits may result in a significant liability to the company if periodic contributions to a pension fund are not made.

Types of Benefit Plans • Defined Contribution

▫ Liability of the employer is limited to amount prescribed to be contributed to a pension fund/plan

• Defined Benefits ▫ Liability of the employer is based on benefits promised to

be received upon employees’ retirement

▫ Requires an actuarial estimate of the pension obligation ▫ May be funded or unfunded

▫ Pension asset (liability) in the Balance Sheet is mainly the difference between the fair value of the pension fund (if any) and the present value of the pension obligation

▫ Factors affecting the pension liability include the contributions to and return on pension plan assets, employee salary levels and expected increases, the duration of pension payments to retired employees


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Accounting Note: PAS 19 (Employee Benefits) Amendments effective 1.1.2013

Actuarial gains and losses and actual return on plan assets are recognised in the balance sheet immediately with a charge or credit to OCI in the period in which they occur. No more “corridor”.

Interest expense or income will be calculated on the net defined benefit liability (asset) by applying the discount rate to the net defined benefit liability (asset). This replaces the interest cost on the defined benefit obligation and the expected return on plan assets.

Liabilities 2015

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