Liability Defined
Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events (page 702 of text)
Current Liability Defined
Current liabilities are obligations whose
liquidation is reasonably expected to require
use of existing resources properly classified as
current assets, or the creation of other current
liabilities (page 702 of text)
Examples of Current Liabilities
Accounts payableNotes payableCurrent maturities of long-term debtDividends payableCustomer advances and depositsUnearned revenuesSales taxes payableIncome taxes payableEmployee-related liabilities
• Theoretically, they should be measured at the present value of the amounts owed, taking into consideration the timing of the payment(s) and an appropriate interest rate
• For convenience, GAAP allows them to be measured at their face amount (i.e., not discounted)
Measurement of Current Liabilities
• General rule – should be included in current liabilities
• Exceptions
If the debt will be paid off with assets that appropriately have not been classified as current assets (e.g., a bond “sinking fund” that can be used for no purpose other than to pay off the bonds
If the debt is “refinanced on a long-term basis”
Current Maturities of Long-Term Debt
Short-Term Obligations Expectedto be Refinanced
Exclude from current liabilities (include in l.t. liab.) if
Management intends to refinance the obligation on a long-term basis.
Management, by the date the financial statements are issued, demonstrates the ability to refinance on a long-term basis by either:
Actually refinancing on a long-term basis or
Enter into a qualifying financing agreement
An existing condition, situation, or set of
circumstances involving uncertainty as to possible
gain (gain contingency) or loss (loss contingency)
to an enterprise that will ultimately be resolved when
one or more future events occur or fail to occur
Contingencies
Gain Contingencies
Typical Gain Contingencies are:
Possible receipts of monies from gifts, donations, and
bonuses.
Possible refunds from the government in tax disputes.
Pending court cases with a probable favorable
outcome.
Gain contingencies are not recognized (recorded) until
realized
May be necessary to disclose, however
Loss Contingencies
Likelihood of confirming event
FASB uses three classifications of likelihood:
Probable – likely to occur
Reasonably possible – chance is more than remote but less than probable
Remote – chance of occurring is slight
Loss Contingencies
Common loss contingencies:
• Litigation, claims, and assessments.
• Guarantee and warranty costs.
• Premiums and coupons.
• Environmental liabilities.
Determinable Liabilitiesvs. Contingent Liabilities
Determinable liabilities – the transaction or other event obligating the entity has already occurred
• Liability is known – amount may be known (e.g., salaries payable) or may have to be estimated (e.g., income taxes payable)
• “Confirming” critical event has already occurred
• Recognize liability at known or estimated amount
Contingent Liabilities
Contingent liabilities – “confirming” critical event has not yet occurred
• Example – lawsuit resulting from employee having accident in company’s delivery truck
• A first event has occurred (the accident) but the confirming event has not occurred – the judge or jury has not yet decided if the company is at fault
Recognize (Record) Contingent Liability
• Probable that liability has been incurred (or asset impaired) at the date of the balance sheet
• Amount of the loss can be reasonably estimated
May be necessary to disclose
Only Disclose Contingent Liability
• Reasonably possible that liability has been incurred (or asset impaired) at the date of the balance sheet
• Amount of the loss can be reasonably estimated
Generally No Disclosure Necessary
• Likelihood that liability has been incurred (or asset impaired) is remote
Nature of compensated absences:
Compensated Absences
Paid absences for vacations, illnesses, and holidays.
Accounting for Compensated Absences
Accrue (record) a liability if all the following conditions are met
The employer’s obligation is attributable to employees’ services already rendered
The obligation relates to rights that vest or accumulate
Payment of the compensation is probable
The amount can be reasonably estimated
Litigation, Claims and Assessments
Companies must consider the following factors, in
determining whether to record a liability with respect
to pending or threatened litigation and actual or
possible claims and assessments.
Time period in which the action occurred
Probability of an unfavorable outcome
Ability to make a reasonable estimate of the loss.
Asserted Litigations, Claims & Assessments
Recognize (record) in current year if
• Related critical event occurred by balance sheet date
• Probable that contingent loss will be incurred
• Can reasonable estimate loss amount
Unasserted Litigations, Claims & Assessments
Recognize (record) in current year only if
• Related critical event occurred by balance sheet date
• Probable that unasserted LCA will be asserted (filed)
• Probable that the “asserted” claim will result in a loss
• Amount of the loss can be reasonably estimated
Unasserted Litigations, Claims & Assessments
Disclose in current year (but do not record) if
• Related critical event occurred by balance sheet date
• Only reasonably possible that unasserted LCA will be asserted (filed)
• Probable that the “asserted” claim will result in a loss
• Amount of the loss can be reasonably estimated
Asset Retirement Obligations
A company must recognize an asset retirement
obligation (ARO) when it has an existing legal obligation
associated with the retirement of a long-lived asset and
when it can reasonably estimate the amount of the
liability.
Presentation
Presentation of Current Liabilities
Usually reported at their full maturity value.
Difference between present value and the maturity
value is considered immaterial.
Presentation of Contingencies
Disclosure should include:
Nature of the contingency.
An estimate of the possible loss or range of loss.