LESSON - Liabilities (General Concepts)

Current Liabilities

Elements

• Financial statements portray the financial effects of transactions and other events by grouping them into broad classes according to their economic characteristics.

• These broad classes are termed the elements of financial statements.

• The elements directly related to the measurement of financial position in the statement of financial position are assets, liabilities and equity. 

Elements

• The elements directly related to the measurement of performance in the statement of profit or loss and other comprehensive income are income and expenses (paragraph 4.2 of the Conceptual Framework, with ‘statement of financial position’ substituted by the authors for ‘balance sheet’ and ‘statement of profit or loss and other comprehensive income’ substituted for ‘income statement’).

Liability

• A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits (paragraph 4.4(b) of the Conceptual Framework).

• The revised conceptual framework for financial reporting provides the following definition of liabilities: Liabilities are present obligations of an entity to transfer an economic resource as a result of past events.

Essential Characteristics of Liability

• An essential characteristic of a liability is that the entity has a present obligation. An obligation is a duty or responsibility to act in a certain way (paragraph 4.15 of the Conceptual Framework).

• The obligation is to transfer an economic resource.

• The liability arises from a past event.

Definition of Financial Liability (per PFRS 9)

• A financial liability is any liability that is: (a) a contractual obligation to:

  (i) deliver cash or another financial asset

  to another entity...(glossary)

• Same definition in Section 11 & 21 of PFRS for SME

Definition of Provision (per PFRS)

• A provision is a liability of uncertain timing or amount. (paragraph 10 of PAS 37)

• Same definition in Section 11 & 21 of PFRS for SMEs

2 Definitions of Contingent Liability (per full PFRS)

• [1] a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity; or

• [2] a present obligation that arises from past events but is not recognized because:(i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or(ii) the amount of the obligation cannot be measured with sufficient reliability.

1 Definition of Contingent Liability (per PFRS for SMEs)

• A contingent liability is either a possible but uncertain obligation or a present obligation that is not recognised because it fails to meet one or both of the conditions (b) and (c) of the Recognition Principle in paragraph 21.4 (see below). (paragraph 21.12)

Initial Recognition of Provisions

• (a) an entity has a present obligation (legal or constructive) as a result of a past event;

• (b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and

• (c) a reliable estimate can be made of the amount of the obligation

• If these conditions are not met, no provision shall be recognized. (paragraph 14 of IAS 37)

Initial Recognition of Financial Liability

• An entity shall recognize ... a financial liability in its statement of financial position when, and only when, the entity becomes party to the contractual provisions of the instrument... (paragraph 3.1.1 of IFRS 9)

Measurement of Financial Liability

• At initial recognition, an entity shall measure a ... financial liability at its fair value ... minus ... transaction costs that are directly attributable to the ... issue of the ... financial liability. In many cases the transaction price will equal the fair value...(paragraph 5.1.1 of IFRS 9 and paragraph 58 of IFRS 13)

Classification of Financial Liability

• An entity shall classify all financial liabilities as subsequently measured at amortised cost using the effective interest method ...

  (paragraph 4.2.1 of PFRS 9)

Amortized Cost

• Amortised cost is the amount at which the ... financial liability is measured at initial recognition minus principal repayments, plus or minus the cumulative amortisation using the effective interest method of any difference between that initial amount and the maturity amount...

  (IFRS 9 Appendix A)

Effective Interest Method

• The effective interest method is used in the calculation of the amortized cost of...a financial liability and in the allocation and recognition of the interest revenue or interest expense in profit or loss over the relevant period.

  (IFRS 9 Appendix A )

Effective Interest Rate

• The effective interest rate is the rate that exactly discounts estimated future cash payments ... through the expected life of the ... financial liability to the ... amortised cost of a financial liability... (IFRS 9 Appendix A)

Measurement of Provision

• Provisions shall be reviewed at the end of each reporting period and adjusted to reflect the current best estimate. (paragraph 59 of IAS 37

Measurement of Provision

• Provisions shall be reviewed at the end of each reporting period and adjusted to reflect the current best estimate. (paragraph 59 of IAS 37

Q&A

PART 1 - Current Liabilities

Multiple Choice

A debtor firm’s 12/31/05 balance sheet is to be published 3/1/06. An obligation with a due date of 3/4/11 is also due on demand by the creditor. At 12/31/05, there is no indication that the creditor intends to call in the debt. The obligation is a current liability.

• TRUE

• FALSE

Multiple Choice

Deposits taken from customers by public utilities should always be reported as current liabilities by the utility.

• TRUE

• FALSE

Multiple Choice

Since a dividend is generally paid within a month or so, it usually is classified as current.

• TRUE

• FALSE

Multiple Choice

All liabilities must be due within 12 months of the current balance sheet to be classified as current liabilities.

• TRUE

• FALSE

Multiple Choice

A current liability may be classified as a long-term liability if the entity has the intention to refinance it after the balance sheet date.

• TRUE

• FALSE