Liabilities Flashcards
definition of liabilities
the entity must have a present obligation to an external party
the obligation must have resulted from past events
the entity must have a future outflow of resources embodying economic benefits, which represents a sacrifice of economic resources
when liabilities are recognised
if they aren’t recognised the liabilities of the entity will be understated, and the entity’s equity will be overstated
must be recognised when…
- it is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation
- the amount at which the settlement will take place can be measured reliably
- the outflow of resources from the entity can be paid on demand, a specified date or the occurrence of a specified event
nature of provisions
liabilities of uncertain timing or amount
exists when an entity is presently obliged to make a future outflow of economic benefits as a result of past events
future costs are excluded from provisions
nature of contingent liabilities
a possible obligation arising from a past event that will be confirmed only by the occurrence or non‐occurrence of one or more uncertain future events that are not wholly within the control of the entity
a liability or provision that does not meet the recognition criteria
how liabilities are classified
liabilities be classified according to their amount, nature and timing
current liabilities
liabilities that are expected to be settled during the entity’s normal operating cycle or within 12 months of the end of the reporting period
non-current liabilities
long‐term borrowings payable beyond the 12 months or operating cycle,
categories of non-current liabilities
term loans
mortgage payable
debentures or bonds
liability analysis for decision making
external users are interested in how well the entity’s short‐term liquidity and its long‐term financial stability are managed
ratios can highlight areas of concern
advantages of financing through long-term debt
creditors do not have voting rights
- this avoids diluting the control of the existing owners
creditors do not share in any excess profits
owners can receive a greater return than if more shares are issued
disadvantages of financing through long-term debt
interest payments to creditors must be made each period as specified in the debt instrument regardless of whether the entity is profitable
default on the interest commitment could result in a forced winding‐up of the entity
if the entity is wound up, creditors must be paid in full before any asset distribution is made to owners
Relevant Ratios
current ratio
quick ratio
debt ratio
equity ratio
debt to equity ratio
