Topic 4 - Accounting for Liabilities

Question 1

Differentiate between the three types of liability items.

Answer 1

Liabilities

• fulfil all liability definition and recognition criteria

Provisions

• fulfil all liability definition and recognition criteria, but some uncertainty regarding their timing or amount of the required expenditure

Contingent Liabilities

• fulfil all liability definition criteria but one or more of the liability recognition criteria is/are not fulfilled

Question 2

What is the definition of a liability?

Answer 2

• present obligations of the entity arising from past events, the settlement of which is expected to result in an outflow of economic benefits:

· obligation must exist today

· a past event must have created the obligation

· future outflow of economic benefits is expected

Question 3

What is the recognition criteria for a liability?

Answer 3

• outflow of economic benefits in the future must be probable
• must be able to measure the cost/value of an item reliably

Question 4

What recognition criterion is not required for a liability?

Answer 4

• legal basis for obligation

Question 5

How are liabilities classified?

What is an important consideration?

Answer 5

• similar to the classification of assets:

· current/non-current liabilities

· order of liquidity (if reliable and more relevant)

Important consideration:

Is there a clearly identifiable operating cycle?

Question 6

Current liabilities are liabilities that are?

-

-

-

Answer 6

• expected to be settled within one operating cycle/12 months of the reporting date
• primarily held for trading purposes
• not subject to an unconditional right that allows the deferral of the liability for more than 12 months

Question 7

Provisions are liabilities with some uncertainty in the timing and amount of the required expenditure.

Recognition is only possible if these liabilities:

1.

2.

3.

4.

Answer 7

Question 8

What are the valuations of provisions based on?

Answer 8

• based on the best estimate of the expenditure required to settle the obligation at the reporting date:

· discounting of amounts is necessary if time-value-of-money has a material effect

Question 9

For contingent liabilities, a liability exists, but one or both recognition criteria are not satisfied:

What is required in the financial report?

Give an example of a contingent liability.

Answer 9

• it is unclear whether or not the existence of outflow is probable
• outflow cannot be measured or valued reliably

Required: Note disclosure of contingent liability, but no recognition in the statement of financial position

Example: A lawsuit filed against an entity, but the probability of winning or losing is unclear, and/or the amount of any payments that may be required is unclear.

Question 10

Draw the diagram of liability versus a contingent liability.

Answer 10

Question 11

What needs to be included in the disclosure of a contingent liability?

Answer 11

• an estimate of the financial effects
• description of why the timing or amount of outflow is uncertain
• description of any possibility for reimbursement by a third party (e.g. insurance)

Question 12

What is the very rare exception that applies to the disclosure of a contingent liability?

Answer 12

• entities that are part of an ongoing lawsuit are not required to provide full disclosure of a contingent liability if this would have a serious negative effect on their legal position:

Alternative disclosure requirements:

• general nature of the lawsuit
• the reason why no detailed disclosure is made