Chapter 12: Flashcards
what is the definition of a liability
A present obligation of entity, arising from past events, the settlement of which is expected to result in an outflow of economic benefits.
what are the characteristics of a liability
- is an expected future sacrifice of assets or services;
- constituting a present obligation;
3.and
is the result of a past transaction or event.
legal Obligations arise due to
contract or legislation
example of contract or legislation legal obligations
trade payables
borrows
constructive obligations arise due to
a pattern of past practices or established policy
example of constructive obligation
company makes a statement that will accept certain responsibilities and creating an expectation
What are the two types of liabilities
- financial liabilities
2. non-financial liabilities
what is a financial liability
a financial instrument
- a contract that gives rise to a financial asset of one party and a financial liability or equity instrument of another party
Includes: a/p and notes payable
what is a non-financial liability
any liability that is not a financial liability (ie it has no offsetting financial asset on the books of the other party)
Include: unearned revenue, warranty liabilities
provisions - liability with certain timing or amount
understand slide 12
understand slide 12
what is discounting
financial liabilities must be valued at present value of future cash flows
- discount value if liability is due beyond one year
- discounted at current market (effective) interest rate specific to risk level
- interest is recorded as time passes
when do you not discount
if it is under one year and
- if amount and timing is highly uncertain
what are trade accounts payable
obligations to suppliers arising from operations
what kind of adjustments may be necessary for trade accounts payable
adjust for
- purchase discounts
- allowances
- returns
what do you report separately with regards to trade payables
income taxes payable are reported separately
what are notes payable
written promise to pay a specified amount (or series of amounts) a t specified date (or series of dates)
Notes payable can be secured with
collateral
what are the sources of notes payable
- borrowing from lenders
- purchase agreements with suppliers
** stated interest rate may be different form market interest rate
what is stated interest rate
the interest rate STATED in the loan agreement
what is the market interest rate, or yield
the rate accepted by two parties for loans of equal amounts , identical credit risks and conditions
what is interest bearing
specify a stated rate applied to face value
what is non-interest bearing
non stated rate, but get interest thorough difference between cash lent and the higher amount of cash repaid
notes with stated rates less than market rates may be used by suppliers as sales incentives
how are notes payable initially recorded
at fair value
- stated value if short term
- stated value if stated rate = market rate
- discounted value if stated rate is different from market rate
(market rate is used for discounting)
Notes payable Example:
notes payable issued august 1, 20x4 and due July 31,x 20x6 for $700,000
- stated rate is 5% which is equal to market rate
- interest Is payable annually on July 31
company has dec 31 year end
Entries:
Aug 1, 20x4 initial entry
cash 700,000
notes payable 700,000
Dec 31, 20x4 -accrue interst
700,000 x5% x 5/12
interest exp 14,583
accrued int. payable 14583
July 31, payment of annual interest
int exp 20,417b
accrued int pay 14,583
cash 35,000
loan guarantee - what is it
- requires a guarantor to pay loan principal and interest if borrower defaults
how do you record a loan guarantee
at fair value using probabilities
example of loan guarantee of $600,000 has a 20% probability that it will have to be honoured
record:
provision for $120,000
extensive disclosure required
other financial liabilities: cash dividends payable
dividends declared but not yet paid
- undeclared for dividends
- disclosure required for dividends in arrears for cumulative preferred shares
other financial liabilities: monetary accrued liabilities - what are they
- accrued wages and benefits
- accrued interest payable
- accrued goods and services received but not yet invoiced
other financial liabilities; advances what are they
represent guarantees for:
- future obligations
- performance on contract or service
- in case of non-collection
- for possible damage to property
other financial liabilities: returnable deposits - what are they
received form customers or employees
- company property, club memberships
other financial liabilities; advances and returnable deposits
- current or long-term depending on when the deposit is likely to be returned or the obligation or performance is completed
- terms of contract dictates what happens if the sale is not completed
- recorded as a customer deposit liability when received
financial liabilities - taxes
business collect taxes from customers and employees that are remitted to government
what does sales tax include
GST, PST, HST
how are revenues and purchases recorded with regards to tax
- revenue recorded net of taxes collected
2. purchases recorded net of GST/HST recoverable (PST is part of costs)
tax example:
sales $350,000 are made and GST is 5% collected $17,500 and PST (8%) collected of $28,000
A/R 395,500
revenue 350,000
gst payable 17,500
pst payable 28,000
tax example continued
company also purchased inventory for $282,500 including gst (5%) AND pst (8%)
inventory 270,000
gst payable 12,500
a/p 282,500
company pays taxes collected
gst payable 12,500
pst payable 28,000
cash 40,500
payroll taxes
what are they
withheld form employees pay and remitted to government
what are the payroll taxes
- personal income tax (federal and provincial)
- cpp
- ei
- other : insurance premiums, group insurance, medical insurance , pension plans
what are property taxes based on
assed values
- estimate of property tax accruals monthly as tax rates are set during the year
what are conditional payments
may be legal or constructive liabilities
- estimated throughout the year for interim reports and adjusted at year end as required
how do you record foreign currency payables
must be restaed to cdn$ at the CURRENT EXCHANGE RATE at year end date
- when initially recognized is translated using spot rate on the date of purchase
- at report date - must translate based on exchange rate at date of report
- when settled, and exchange gain or loss will be recognized
example of foreign currency do slide 34 - 35
example do
what is provision
- non-financial liability
- a liability of uncertain timing or amount
- caused by legal and constructive obligations?
terminology of provisions
degree of certainty / classification
- certain
- probable
- not probable
- payables, accruals (recorded)
- provision (recorded)
- contingency (disclosed only)
how do you measure a provision
recorded at the best estimate or expected value
what if there is a range of outcome possible for a provision - Large population
and small population
determine the expected value
Large population
- the sum of the outcomes multiplied by their probability
(30%) ($0) + 70% ($500,000) = 350,000
small population
-use the most likely outcome (ie 30% chance of $100,000 payout, 55% chance of $250,000 payout and 15% $310,00 payout. therefore record the $250,000
how do you record provisions
- re-estimate annually
- discount when the liability is due beyond one year (if amount and timing of cash flows is HIGHLY UNCERTAIN, the record on undiscounted basis
- if an estimate cannot be made - then this is a contingency and disclosed only
when does a contingency exist
- obligation is possible but NOT PROBABLE
- there is a present obligation BUT NOT ECONOMIC RESOURCES ATTACHED OR
- there is a present obligation but rate circumstances dictate than ESTIAMTE CANNOT BE MADE
- disclose only
how are contingencies recognized
they are only disclosed in the notes
what are contingent assets
arise form past events, but existence is confirmed with a future event
- not recorded until virtually certain
How are lawsuits recorded
- probability assessed by lawyers
- certain - probable -record as a provision
- not probable - contingency and disclose only
- a constructive liability may still be present
what are executor contracts
contracts that become liabilities once they have been executed
- a future commitment that is not a liability until the other party has performed a service
what is an onerous contract
- unavoidable costs of meeting a contract exceed the economic benefits
- record a provision for the net loss
- example, purchase contract to buy 10,000 kg of ore at $1.00per kg. the selling price is now $0.80 per kg.
- record a provision for 10,000 kg x $0.20 = $2,000
Provision - restructuring plan
a plan of action controlled by management that will materially change the scope of the business
how do you record a restructuring provision
- estimate of payments required under a future restructuring program
- recorded when the company has a detailed formal plan and has implemented or announced the commencement of the plan
- announcement must include specific facts and details
provision - warranties
what are warranties
assurance that he product will operate as intended and meet speciation
- can be legal or constructive (constructive because of actions by the company)
how do you record warranties
- cost deferral method is used
- estimate of all expected future claims is recorded at time of sale
- record warranty expense and provision for warranty
- adjust annually as estimates change
- as cash is paid out, reduce the provision for warranty
provisions - restoration and environmental obligations
may be constructive or legal (legislated)
- if pending legislation - provision accrued only if virtually certain
provisions - sales returns and refunds
may be constructive or legal
- estimate and record at time of sale
- review for reasonableness
provisions - coupons, refunds and gift cards
- if coupon is redeemed in cash, or products are sold at a loss -record a provision for the estimated obligation
- estimate breakage (unused) rate of coupons or gift cards
- discounted if the time period is long
provisions - loyalty programs
allocate portion of original sale that gives rise to the points and record as a provision for rewards
provision - repairs and maintenance
may NOT ACCRUE major overhaul repairs since not arising form a past event
provision - self insurance
accrue a provision for estimated losses for loss events that have taken place during the year
provisions - compensating-absence liabilities
- used only when employees can carry unused time to future years
- accrue in the year it is earned
- adjust at year -end all of the vacation and medical leave that can be carried over
what is the impact of discounting
- discounting required when liabilities have terms greater than one year
- discounting not required when for liabilities with initial term less than one year or if timing and amounts are uncertain and discounting is not practical
what is nominal interest rate
interest rate stated for the liability
- may be 0%
effective interest rate
also called the yield
- market interest rate for debt of similar term, security and risk
present value
is the discounted amount of the future cash flows (both interest and maturity amounts) using the effective interest rate (market rate)
if nominal rate = effective rate
the PV is equal to maturity amount and there is no need to discount
what is decommissioning provision
?
impact of discounting: example of decommissioning obligation with changes in estimates
- changes in amount or timing or discount rate of obligation must be recognized
- record interest expense of the year and then recognize changes in estiamtes
- assume market rate changes at end of year 3 to 6%
what is a current liability
settled with the next operating cycle or the next 12 months
what is an operating cycle
time between purchase of materials for processing into inventory and collection of cash form sale
when operating cycle cannot be identified what do you do
use 12 months
notes payable that are classified as current include:
- loans due on demand
- loans due within the next year
- current portion of long-term notes payable
- long-term debt in violation of covenants and callable at any time
what are loans due on demand
demand loans payable on demand (or short delay)
what are loans due within the next year
if loan has a due date within the next 12 months
if refinancing long-term debt what do you do
the contractual arrangement must be in place at the year end date in order to classify debt as long term
provisions are classified as current or long term based on
timing or expected future cash flows
- classification based on legal terms
what do you disclose
- carrying amounts in each category
- fair values and description of method used
- components of each category
- legal terms - maturity, interest rate, collateral
- any defaults or breaches and any resolution; and carrying amount
- financial risk exposure - credit, liquidity, market and objectives for managing risk
- related accounting policies
Statement of cash flows
on statement of cash flows report:
- operating activities - changes in liabilities and provisions related to earnings
- financing activities - cash cahgnes in borrowing
- interest paid - either operating or financing
- operating activity - interest due to unwinding a discount is a non-cash expense and is added back
- non-cash transactions are excluded form SCF and disclosed
Accounting standards for Private enterprises
- does not use the term “provision”
- recognize non-financial liabilities when:
- meet the definition of a liability, are measureable and if future economic sacrifices are probable
- some differences in measuring these between IFRS and ASPE
- constructive
- meet the definition of a liability, are measureable and if future economic sacrifices are probable
- constructive liabilities are NOT recorded under ASPE
- no ASPE standard for recording customer loyalty points - may use the IFRS approach or not
ASPE - contingent liability
a liability that will result in the outflow of resources only is another event happens
- If likely – record and disclose if measureable; if not measureable, disclose only
- If undeterminable – disclose
- If unlikely – Do not record or disclose unless material
ASPE - classification and disclosure
- If long-term loan is coming due and refinancing agreement is in place by date of release of financial statements
- May classify as long-term
