FINANCIAL ACCOUNTING & REPORTING 3

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Statement of financial position

Module 008 Week003- FinAcct3 Statement of

financial position
A liability is defined as a present obligation of an entity arising from past
event, the settlement of which is expected to result in an outflow from the
entity of resources embodying economic benefits. Similar to assets,
companies classify liability as current or noncurrent.
Current liabilities are the obligations that a company reasonably expects to
liquidate either through the use of current assets or the creation of other
current liabilities. At times, a liability that is payable within the next year is
not included in the current liabilities section. This occurs either when the
company expects to refinance the debt through another long-term issue or to
retire the debt out of noncurrent assets. This approach is used because
liquidation does not result from the use of current assets or the creation of
other current liabilities.
Noncurrent liabilities are obligations that a company does not reasonably
expect to liquidate within the normal operating cycle. Instead, it expects to
pay them at some date beyond that time. The most common examples are
bonds payable, notes payable, deferred income tax amounts, lease
obligations, and pension obligations. Companies classify noncurrent
liabilities that mature within the current operating cycle as current liabilities
if payment of the obligation requires the use of current assets.

At the end of this module, you will be able to:

1. Understand the definition and essential characteristics of liabilities
2. Distinguish current and noncurrent classification of liabilities
3. Determine the presentation of liabilities
4. Understand the nature of estimated liabilities

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Statement of financial position

Definition of liabilities

A liability is defined as “a present obligation of an entity arising from past event, the
settlement of which is expected to result in an outflow from the entity of resources
embodying economic benefits.”
The essential characteristics of a liability are:
a) The liability is the present obligation of a particular entity.
- The entity liable must be identified. It is not necessary that the payee or the
entity to whom the obligation is owed be identified.
b) The liability arises from past event.
- This means that the liability is not recognized until it is incurred.
c) The settlement of the liability requires an outflow of resources embodying economic
benefits.
- The obligation of the entity is to transfer cash and noncash resources or provide
services at some future time.
Similar to assets, companies classify liabilities as current or noncurrent.

Current liabilities

PAS 1, paragraph 69, provides that an entity shall classify a liability as current when:
a) The entity expects to settle the liability within the entity’s normal operating cycle.
b) The entity holds the liability primarily for the purpose of trading.
c) The liability is due to be settled within twelve months after the reporting period.
d) The entity does not have an unconditional right to defer settlement of the liability for
at least twelve months after the reporting period.
Current liabilities are the obligations that a company reasonably expects to liquidate either
through the use of current assets or the creation of other current liabilities.
At times, a liability that is payable within the next year is not included in the current liabilities
section. This occurs either when the company expects to refinance the debt through another
long-term issue or to retire the debt out of noncurrent assets. This approach is used because
liquidation does not result from the use of current assets or the creation of other current
liabilities.
Examples of current liabilities
Trade payables and accruals for employee and other operating costs are part of the working
capital used in the entity’s normal operating cycle.

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Statement of financial position

Such operating items are classified as current liabilities even if they are settled more than
twelve months after the end of reporting period.
The excess of total current assets over total current liabilities is referred to as working
capital. Working capital represents the net amount of a company’s relatively liquid
resources. That is, it is the liquidity buffer available to meet the financial demands of the
operating cycle.
Other current liabilities are not settled as part of the normal operating cycle but are due for
settlement within twelve months after the end of reporting period or held primarily for the
purpose of being traded.
Examples of such current liabilities are financial liabilities held for trading, bank overdraft,
dividends payable, income taxes, other nontrade payable and current portion of noncurrent
financial liabilities.
Financial liabilities held for trading are financial liabilities that are incurred with an intention
to repurchase them in the near term.
An example of a financial liability held for trading is a quoted debt instrument that the issuer
may buy back in the near term depending on changes in fair value.
Long-term debt currently maturing
PAS 1, paragraph 72, provides that a liability which is due to be settled within twelve months
after the end of reporting period is classified as current, even if:
a) The original term was for a period longer than twelve months
b) An agreement to refinance or to reschedule payment on a long-term basis is
completed after the end of reporting period and before the financial statements are
authorized for issue.
However, if the refinancing on a long-term basis is completed on or before the end of the
reporting period, the refinancing is an adjusting event and therefore the obligation is
classified as noncurrent.
Discretion to refinance
PAS 1, paragraph 73, provides that if the entity has the discretion to refinance or roll over
an obligation for at least twelve months after the reporting period under an existing loan
facility, the obligation is classified as noncurrent even if it would otherwise be due within a
shorter period.
Note that the refinancing or rolling over must be at the discretion of the entity otherwise,
the obligation is classified as a current liability.
Covenants
Covenants are often attached to borrowing agreements which represent undertakings by the
borrower. These are actually restrictions on the borrower as to undertaking further
borrowings, paying dividends maintaining specified level of working capital and so forth.
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Statement of financial position

Under these covenants, if certain conditions relating to the borrower’s financial situation are
breached, the liability becomes payable on demand.
In this case, PAS 1, paragraph 74, states that “such a liability is classified as current even if
the lender has agreed, after the end of reporting period and before the financial statements
are authorized for issue, not to demand payment as a consequence of the breach.”
However, Paragraph 75 states that the liability is classified as noncurrent if the lender has
agreed on or before the end of reporting period to provide a grace period ending at least
twelve months after the end of reporting period.
In this context, grace period is a period within which the borrower can rectify the breach and
during which the lender cannot demand immediate payment.
Presentation of current liabilities
PAS 1, paragraph 54, provides that as a minimum, the face of the statement of financial
position shall include the following line items for current liabilities:
a) Trade and other payables
b) Current provisions
c) Short-term borrowing
d) Current portion of long-term debt
e) Current tax liability
The term ”trade and other payables” is a line item for accounts payable, notes payable,
accrued interest on note payable, dividends payable and accrued expenses.

Noncurrent liabilities

The term “noncurrent liabilities” is also a residual definition.

PAS 1, paragraph 69, simply states that “all liabilities not classified as current liabilities are
classified as noncurrent liabilities.”
Examples of noncurrent liabilities
a) Noncurrent portion of long-term debt
b) Finance lease liability
c) Deferred tax liability
d) Long-term obligations to entity officers
e) Long-term deferred revenue
PAS 1, paragraph 56, provides that “when an entity presents current and noncurrent
liabilities as separate classifications on the face of the statement of financial position, it
shall not classify deferred tax liability as current liability.

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Statement of financial position

Estimated liabilities

Estimated liabilities are obligations which exist at the end of reporting period although their
amount is not definite. In many cases, the date when it is due or payable 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.

Common examples of estimated liabilities include estimated liability for premiums,

estimated liability for warranties and estimated liability under customer loyalty program.

It may be classified as either as current or noncurrent. Technically, it may be considered as

a “provision” which is both probable and measurable.

References and Supplementary Materials

Books and Journals

Valix, C., Peralta, J. & Valix, C.A; 2016; Financial Accounting Volume 3; Metro Manila,
Philippines; GIC Enterprises & Co., Inc.

Valix, C., Peralta, J. & Valix, C.A; 2016; Financial Accounting Volume 1; Metro Manila,
Philippines; GIC Enterprises & Co., Inc.

Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield; 2013; Intermediate Accounting;

United States; John Wiley & Sons, Inc.

Online Supplementary Reading Materials

IAS 1 Presentation of Financial Statements; http://www.ifrs.org/issued-standards/list-
of-standards/ias-1-presentation-of-financial-statements/; October 30, 2017

IAS 37 Provisions, Contingent Liabilities and Contingent Assets;

http://www.ifrs.org/issued-standards/list-of-standards/ias-37-provisions-contingent-
liabilities-and-contingent-assets/; October 30, 2017

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Statement of financial position

Online Instructional Videos

Balance Sheet and Income Statement Relationship;
https://www.khanacademy.org/economics-finance-domain/core-finance/accounting-and-
financial-stateme/financial-statements-tutorial/v/balance-sheet-and-income-statement-
relationship; January 10, 2018

Financial Statements- Lecture 7- The Statement of Financial Position- IFRS;

https://www.bing.com/videos/search?q=statement+of+financial+position&&view=detail
&mid=60F5FC3563CF3AF4537C60F5FC3563CF3AF4537C&FORM=VRDGAR; January 10,
2018

Statement of Financial Position;

https://www.bing.com/videos/search?q=statement+of+financial+position&&view=detail
&mid=9B6C89069BFCB356AA209B6C89069BFCB356AA20&FORM=VRDGAR; January 10,
2018

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