1. Slide 11.1 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Chapter 11 Provisions and non-current (long-term) liabilities

2. Slide 11.2 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Non-current (fixed) assets plus Current assets minus Current liabilities minus Liabilities due after one year equals Ownership Interest [Share capital plus Reserves of past profits]

3. Slide 11.3 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 NotesYear 7Year 6 £m Amounts payable (creditors) 9 (2.7) (2.6) Bank and other borrowings (0.2) (0.6) Provisions 11(20.2) (22.2) Statement of financial position of Safe and Sure plc Non-current liabilities Net assets 464.3370.4

4. Slide 11.4 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Definition 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.

5. Slide 11.5 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Definition (Continued) A current liability is a liability, which satisfies any of the following criteria: (a) it is expected to be settled in the entity’s normal operating cycle; (b) it is held primarily for the purpose of being traded; (c) it is due to be settled within 12 months after the balance sheet date.

6. Slide 11.6 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Definition (Continued) A non-current liability is any liability that does not meet the definition of a current liability. Non-current liabilities are also described as long-term liabilities.

7. Slide 11.7 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Examples Loan stock Debentures Bonds Bank borrowing and commercial paper

8. Slide 11.8 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Debentures Loan made to the company: Packaged in a legal form by which the claims against the company can be bought and sold. Usually a fixed rate of interest.

9. Slide 11.9 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Bonds (US term) normally indicates that the funds have been borrowed from sources beyond the UK. May be fixed or variable rates of interest.

10. Slide 11.10 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Bank borrowing and commercial paper Funds supplied by banks or other financial institution (insurance company). Usually variable rate of interest.

11. Slide 11.11 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Features of loans The amount borrowed (the capital sum)? How much is to be repaid? When is it to be repaid? What is the timing of interest payments? Does the lender require security for the loan?

12. Slide 11.12 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Provisions A provision is a liability of uncertain timing or amount. Examples are provisions for: losses on contracts. obsolescence of inventory (stock). costs related to closure of a division of the company. costs of decommissioning an oil rig. costs of landscaping to restore site. warranties given for repair of goods.

13. Slide 11.13 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Creating a provision The ownership interest is reduced by an expense in the profit and loss account and a liability is created under the name of the provision. Assets – Liabilities = Ownership interest (increase expense) 

14. Slide 11.14 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Reducing an provision When the provision is no longer required it is released to profit and loss account as an item of revenue which increases the ownership interest and the liability is reduced. Assets - Liabilities = Ownership interest (decrease expense)  

15. Slide 11.15 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Example During the year ending 31 December Year 5, a company's sales of manufactured goods amounted to £1m. All goods carry a manufacturer's warranty to rectify any faults arising during the first 12 months of ownership. Based on previous experience, a provision of 2.5% of sales was made. Provision for warranties = £1,000,000 x 2.5% = £25,000

16. Slide 11.16 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Example (Continued) During Year 5 repairs under warranty cost £14,000. Further repair costs incurred are expected in respect of those items sold part-way through Year 5 whose warranty extends into Year 6.

17. Slide 11.17 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 – £25,000 Ownership interest (expense) =Liabilities– Assets As the repairs under warranty are carried out, When the provision is established   – £14,000 =–Assets   Ownership interest Liabilities + £25,000

18. Slide 11.18 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 ASSETLIABILITYOWNERSHIP INTEREST DateTransaction or eventCashProvisionProfit and loss account Year 5£000’s Jan. 1Provision for repairs25(25) Jan.–Dec.Repairs under warranty(14) Totals(14)11(25) Spreadsheet for warranty repairs Table 11.1 Spreadsheet for analysis of provision for warranty repairs

19. Slide 11.19 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Deferred income An amount received in a lump sum but related to activities over a number of years: the entity has not fully completed its side of the bargain. Costs have still to be incurred by the reporting entity. The matching concept is applied. For example, a government grant to a company, intended to help with the cost of training employees over the next three years.

20. Slide 11.20 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Should the income be recognised at once? No, the benefit of the grant will extend over three years and it would therefore seem appropriate to spread the revenue over three years to match the cost it is subsidising. Deferred income (Continued) OI=L–A  Cash from Government Show as revenue in year received

21. Slide 11.21 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Matching concept Aim of matching revenues to the cost to which they relate in the profit and loss account. When grant received: OI=L–A  Show as an income yet to be earned. An obligation? Cash from Gov’t

22. Slide 11.22 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Each year covered by grant, reduce liability and report a portion as income Matching concept (Continued) OI=L– A   That part of the income earned in the period. To be matched against the cost incurred in the activity to which it relates.

23. Slide 11.23 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Example A company receives a grant of £30,000 towards the cost of employee retraining. The retraining programme will last for three years and the costs will be spread evenly over the three years. Aim is to spread the income over 3 years at a rate of £10,000 each year.

24. Slide 11.24 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Example (Continued) Record the liability of £30,000 at the start and then reduce by £10,000 each year with transfer to profit and loss account, either as revenue or usually as a reduction in employee costs.

25. Slide 11.25 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 ASSETLIABILITYOWNERSHIP INTEREST DateCashDeferred income Revenue £000’s Year 1 Jan 1Receiving the grant30 Dec 31Transfer to P&L(10)10 Year 2 Dec 31Transfer to P&L(10)10 Year 3 Dec 31Transfer to P&L(10)10 Recording deferred income and transfer to revenue Table 11.2 Recording deferred income and transfer to revenue

26. Slide 11.26 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Chapter 11 Bookkeeping supplement

27. Slide 11.27 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 DEBIT ENTRIESCREDIT ENTRIES Left-hand side of the equation AssetIncreaseDecrease Right-hand side of the equation LiabilityDecreaseIncrease Ownership interestExpenseRevenue Capital withdrawnCapital contributed

28. Slide 11.28 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 DATEPARTICULARSPAGEDEBITCREDITBALANCE Year 5£££ Jan. 1Provision in respect of Year 5 L225,000(25,000) Jan.– Dec. Repairs carried outL114,000(11,000) L3 Provision for warranty repairs

29. Slide 11.29 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 DATEPARTICULARSPAGEDEBITCREDITBALANCE Year 1£££ Jan. 1Grant receivedL130,000(30,000) Dec. 31Transfer to profit and loss account L210,000(20,000) Year 2 Dec. 31Transfer to profit and loss account L210,000(10,000) Year 3 Dec. 31Transfer to profit and loss account L210,000nil L3 Deferred income (balance sheet)