1. 17.1PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. ACCOUNTING Financial and Organisational Decision Making Chapter 17 Liabilities Slides written by Sandra Porritt designed by Tony Van Eekelen

2. Chapter 17: Liabilities 17.2 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Learning 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

3. Chapter 17: Liabilities 17.3 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Learning Objectives –liability measurement techniques, particularly for the measurement of debentures and leases.

4. Chapter 17: Liabilities 17.4 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Introduction 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

5. Chapter 17: Liabilities 17.5 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. The 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)

6. Chapter 17: Liabilities 17.6 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Existance of present obligation result of past transaction or event legally enforceable ethical consideration - moral and social obligation outside warranty

7. Chapter 17: Liabilities 17.7 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Other 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

8. Chapter 17: Liabilities 17.8 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Constructive obligation proposed final dividend = current liability –dividend to be ratified by shareholders at AGM before it is a legal obligation

9. Chapter 17: Liabilities 17.9 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Obligations settled in the future by payment in cash transfer of other assets provision of services replacement of obligation with another or conversion of obligation to equity

10. Chapter 17: Liabilities 17.10 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. The 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

11. Chapter 17: Liabilities 17.11 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Executory 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

12. Chapter 17: Liabilities 17.12 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Contingent 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

13. Chapter 17: Liabilities 17.13 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. The 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?)

14. Chapter 17: Liabilities 17.14 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Future interest commitment –on debentures –on loans

15. Chapter 17: Liabilities 17.15 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. The irrelevance of possible future actions 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

16. Chapter 17: Liabilities 17.16 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. The discount rate fluctuation of interest rate –due to market forces in historical cost –changes ignored –assumes that debt held to maturity

17. Chapter 17: Liabilities 17.17 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. A 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)

18. Chapter 17: Liabilities 17.18 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Effect 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

19. Chapter 17: Liabilities 17.19 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Comparion 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

20. Chapter 17: Liabilities 17.20 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Ethical issues as the provision accounts are subject to judgement overstating provisions can be used in future years

21. Chapter 17: Liabilities 17.21 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Summary clearly specified definition of liabilities would lead to full and consistant reporting in practice judgement is involved