5. Accounting for liabilities

Question 1

Liability definition

Answer 1

A present obligation of the entity to transfer an economic resource as a result of past events.
An obligation is a duty or responsibility that an entity has no practical ability to avoid.

Question 2

Reliable measurement of liabilities

Answer 2

In order to be recognised in the SFP, liabilities must be capable of being measured with a reasonable level of certainty, if not, often will be disclosed in the notes to the accounts.

Question 3

IAS 12 Income taxes

Answer 3

Sets out the accounting treatment for taxes on income (such as corporation tax) which is paid by UK companies and is based on their profits.

Question 4

Current tax

Answer 4

Amount of income taxes payable in respect of the taxable profit of the year.

Question 5

Estimates of tax

Answer 5

A business often has to estimate the amount of tax due in its profits and record this amount in the financial statements.
This estimate may differ from the actual liability and consequentially an adjustment will need to be made in the financial statements of the next accounting period.

Question 6

IFRS 16 Leases

Answer 6

On the lessee’s statement of financial position, the initial measurement of the lease liability is at present value of the lease payments over the lease term. This is calculated using the discount rate implicit in the lease.

Question 7

IAS 37 Provisions, Contingent Liabilities and Contingent Assets

Answer 7

“To ensure that appropriate recognition criteria and measurement bases are applied to provisions, contingent liabilities and contingent assets and that sufficient information is disclosed in the notes to enable users to understand their nature, timing and amount”.

Question 8

Obligating event

Answer 8

Event that creates a legal or constructive obligation that results in an entity having no realistic alternative to settling that obligation.

• Legal obligation: derives from a contract, legislation or other operation of law.
• Constructive: derives from an entity’s actions such as an established pattern of past practice or created valid expectation.

Question 9

Provisions, Contingent Liabilities and Contingent Assets

Answer 9

Represent uncertainties that may have an effect on future financial statements. Need to be accounted for consistently so that users have a better understanding of their effect on financial statements.

Question 10

Provision

Answer 10

Liability of uncertain timing or
amount. A provision is made when it is probable, or more likely than not, that the liability will occur.

Question 11

Provision recognised as liability in Financial statements when

Answer 11

• An entity has a present obligation as a result of past event.
• It is probable that an outflow of economic benefits will be required to settle the obligation.
• A reliable estimate can be made of the amount of the obligation.

Otherwise, the liability may be contingent.

Question 12

Contingent liability

Answer 12

• 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
• It may be a present obligation that arises from past events but is not recognised because [either]:
• it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation
  or
• the amount of the obligation cannot be measured with sufficient reliability

Question 13

Contingent Assets

Answer 13

A possible asset 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.

Question 14

Contingent Assets treatment

Answer 14

A business should not recognise a contingent asset (it could result in the recognition of income that may never be realised). Only when the realisation is certain should be recognised.
If considered possible or remote, no disclosure is required in the notes either.

Question 15

Summary of IAS37

Answer 15

• Provisions (probable):
  Recognised in financial statements and disclosure in notes.
• Contingent liabilities
  (Possible) No liability recognised but disclosure in notes.
  (Remote) No liability recognised no disclosure in notes.
• Contingent assets:
  (Probable) No liability recognised but disclosure in notes.
  (Possible) No liability recognised no disclosure in notes.
  (Remote) No liability recognised no disclosure in notes.

Question 16

IAS 10. Events after the Reporting Period

Answer 16

Favourable or unfavourable events that take place after the financial statements have been prepared at the year-end and before being authorised for issue to interested parties.

Question 17

Adjusting events after the reporting period

Answer 17

Provide evidence of conditions that existed at the end of the reporting period.
An entity shall adjust the amounts recognised in its financial statements to reflect these.

Question 18

Examples of adjusting events

Answer 18

• The settlement after the reporting
  period of a court case that confirms that the entity had a present obligation at the end of the reporting period.
• Assets, where a valuation shows impairment.
• Inventories, where the net realisable value falls below cost price.
• Trade receivables, where a customer becomes insolvent.
• Determination after the reporting period of the amount of profit sharing or bonus payments.
• Discovery of fraud or errors in the financial statements.

Question 19

Non-adjusting events

Answer 19

Are indicative of conditions that arose after the end of the reporting period.
Generally, if they are material, then the notes to the accounts must disclose the nature of the event and an estimate of its financial effect, or a statement to say that an estimate cannot be made.

Question 20

Examples of non-adjusting events

Answer 20

• Dividens declared or proposed after reporting period (disclosed in notes).
• Business combinations.
• Discontinue part of the busines.
• Major purchases of assets.
• Losses of produciton capacity.
• Announcing or starting a major restructuring.
• Major share transactions, not including bonus issues.
• Large changes in asset prices or foreign exchange rates.
• Changes in tax rates
• Entering into significant commitments or contingent liabilities.
• Commencing major litigation arising solely out of events that
  occurred after the reporting period.

Question 21

Authorisation of accounts

Answer 21

The standard requires that the date of authorisation and the identity of the person that gave authorisation be published with the accounts.
If anyone has the power to amend the financial statements after issue, then that too must be disclosed.

Question 22

IFRS 15 Revenue from contracts with customers

Answer 22

An entity should recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

Question 23

Customer (definition)

Answer 23

A party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration

Question 24

Income (definition)

Answer 24

Increases in economic benefits during the accounting period in the form of inflows of assets or decreases of liabilities that result in an increase in equity, other than those relating to contributions from equity participants.

Question 25

Revenue (definition)

Answer 25

Income arising in the course of an entity’s ordinary activities.

Question 26

5-step process to revenue recognition

Answer 26

1. Identify the contract with a customer
2. Identify the performance obligations in the contract
3. Determine the transaction price
4. Allocate the transaction price to the performance obligations in the contract
5. Recognise revenue when a performance obligation is satisfied.

Question 27

Contract (criteria)

Answer 27

• The parties to the contract have approved the contract
• The entity can identify each party’s rights regarding the goods or services to be transferred
• The entity can identify the payment terms
• The contract has commercial substance.
• It is probable that the entity will collect the consideration to which it will be entitled for the goods and services that will be transferred to the customer.

Question 28

Revenue recognised when

Answer 28

The entity satisfies a performance obligation by transferring a promised good or service (i.e. an asset) to a customer. An asset is transferred when the customer obtains control of that asset.

Question 29

Revenue recognition over time

Answer 29

We may do this through output or input methods.
- Output methods use the basis of how much of the total work has been completed in each time period.
- The input method recognises revenue on the basis of the entity’s efforts or inputs (for example, resources consumed).

Question 30

Standards for Liabilities (summary)

Answer 30

• IAS 12 Income taxes
• IFRS 16 Leases
• IAS 37 Provisions, Contingent Liabilities and Assets
• IAS 10 Events after the reporting period
• IFRS 15 Revenue from contracts with customers