17.1PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

ACCOUNTINGACCOUNTINGFinancial and Organisational Financial and Organisational

Decision MakingDecision Making

Chapter 17

LiabilitiesSlides written by Sandra Porritt

designed by Tony Van Eekelen

17.2

Chapter 17: Liabilities

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Learning ObjectivesLearning Objectives

• In this chapter you will be introduced to: – the nature of liabilities– the criteria for the recognition of liabilities– executory contracts and contingent liabilities

17.3

Chapter 17: Liabilities

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Learning ObjectivesLearning Objectives

– liability measurement techniques, particularly for the measurement of debentures and leases.

17.4

Chapter 17: Liabilities

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

IntroductionIntroduction

• definition and recognition of liabilities raises problems in the reporting

• liabilities are often recognised because of a related asset and or expense and or revenue

• the release of accounting concepts statements has provided guidance

17.5

Chapter 17: Liabilities

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

The definition of liabilitiesThe definition of liabilities

• Nature of liabilities– legal debts or legal obligation

• The IASC framework defines a liability as:-– A liability is a present obligation of the

enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits…….para 49(b)

17.6

Chapter 17: Liabilities

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Existance of present obligationExistance of present obligation

• result of past transaction or event

• legally enforceable

• ethical consideration - moral and social obligation outside warranty

17.7

Chapter 17: Liabilities

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Other liabilitiesOther liabilities

• partly equitable partly legal

– certain minium requirements for environmental restoration on mining companies

– matching principle, each period takes a part of the restoration costs

17.8

Chapter 17: Liabilities

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Constructive obligationConstructive obligation

• proposed final dividend = current liability

– dividend to be ratified by shareholders at AGM before it is a legal obligation

17.9

Chapter 17: Liabilities

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Obligations settled in the future Obligations settled in the future by by

• payment in cash• transfer of other assets• provision of services• replacement of obligation with another or• conversion of obligation to equity

17.10

Chapter 17: Liabilities

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

The recognition of liabilitiesThe recognition of liabilities

• IASC framework provides the following tests:– it is probable that any future economic benefit

associated with the item will flow to or from the enterprise and

– the item has a cost or value that can be measured with reliability…….para 83

17.11

Chapter 17: Liabilities

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Executory contractsExecutory contracts

• (performance depends on some future action by both parties)

– accepted practice is that no obligation exists on the part of the purchaser of goods until the creditor has performed the service

17.12

Chapter 17: Liabilities

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Contingent liabilitiesContingent liabilities

• probable future committment

• not sufficiently defined at present

• amounts potentially material

• to remain faithful to the principles of the historical cost system, contingent liabilities must relate to a past event

17.13

Chapter 17: Liabilities

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

The measurement of liabilitiesThe measurement of liabilities

– made difficult• future

• uncertain

– timing of payment• present resources used

• paid in one year (resources used by the company and in that year can earn interest?)

17.14

Chapter 17: Liabilities

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Future interest commitmentFuture interest commitment

– on debentures

– on loans

17.15

Chapter 17: Liabilities

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

The irrelevance of possible future The irrelevance of possible future actionsactions

• the company might seek to repay the debentures early and perhaps incur a penalty...

• the company might repurchase the debentures on the open market ……

• the company may enter liquidation

17.16

Chapter 17: Liabilities

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

The discount rateThe discount rate

• fluctuation of interest rate– due to market forces

• in historical cost– changes ignored– assumes that debt held to maturity

17.17

Chapter 17: Liabilities

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

A specific application ofA specific application of

• the recognition and measurement principles: leases– finance leases

• used to buy assets - loan repaid in installments.

– Operating leases• short period for jobs or equipment for a project

(technology changing rapidly)

17.18

Chapter 17: Liabilities

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Effect on financial statementsEffect on financial statements Profit and Loss statement extract for year 1

Rental approach Purchase approach

Lease rental expense $3880 -

Interest expense - $ 800

Amortised expense - 2000

Balance sheet extract at end of year 1

Assets

Leased assets - $10000

less Accumulated amortisation - 2000

8000

Liabilities

Leases liabilities - 6920

17.19

Chapter 17: Liabilities

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Comparion of approachesComparion of approaches

• Rental/operating - keeps liabilities off the balance sheet

• Accounting standards require finance lease liabilities shown

• The variety of lease arrangements in practice make it difficult to distinguish

17.20

Chapter 17: Liabilities

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

Ethical issuesEthical issues

• as the provision accounts are subject to judgement

• overstating provisions can be used in future years

17.21

Chapter 17: Liabilities

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.

SummarySummary

• clearly specified definition of liabilities would lead to full and consistant reporting

• in practice judgement is involved