Current Liabilities Chapter 1 Current Liabilities Related standards; PAS 1: Presentation of Financial Statements PAS 32: Financial Instruments: Presentation PERS 9: Financial Instruments Learning Objectives 1, State the recognition criteria for liabilities. 2. Identify the characteristics of a financial liability. | 3. Classify liabilities as current and noncurrent. 4, State the initial and subsequent measurements of financial and non-financial liabilities, Liability Liability is “a present obligation of the entity to transfer an economic resource as a result of past events.” (Conceptual Framework 425) The definition of liability has the following three aspects: a, Obligation b, Transfer of an economic resource c. Present obligation as a result of past events Obligation An obligation is “a duty or responsibility that an entity has no practical ability to avoid.” (Conceptual Framework 4.29) An obligation is either: a. Legal obligation - an obligation that results from a contract, legislation, or other operation of law; or b. Constructive obligation - an obligation that results from an entity’s actions (e.g., past practice or published policies) that Scanned with CamScannerBo hater create a valid expectation on others that the entity will accept and discharge certain responsibilities. ‘An obligation is always owed to another party. However, it is not necessary that the identity of that party is known, for example, an obligation for environmental damages may be owed to the society at large. ‘One party's obligation-normally-corresponds.to another ‘party's right. For example, a buyer's obligation to pay an accounts payable of #100 normally corresponds to the seller’s right to collect an accounts receivable of #100. However, this accounting symmetry.is not maintained at all times because the Standards sometimes contain different recognition and_ measurement requirements.for the liability of one party. and the corresponding asset of the. other-party..For example, direct origination costs result to different measurements of the lender's loan receivable and the borrower's loan payable. Similarly, a seller may be required to recognize a warranty obligation but the buyer would not recognize a corresponding asset for that warranty. ‘There can be instances where the existence of an obligation is uncertain. Until that uncertainty is resolved (for example, by a court ruling), itis uncertain whether a liability exists. Transfer of an economic resource ‘The liability is the obligation-that has the potential to require the transfer of an economic resource to another party and not the future economic: benefits that the obligation-may cause to be transferred. Thus, the obligation’s potential to cause a transfer of economic benefits need not be certain, or even likely, for example, the transfer may be required only if-a specified uncertain future ‘event occurs. What is important is that the obligation already exists and that, in at least one circumstance, it would require the entity to transfer an economic resource. Consequently, a liability can exist even if the probability of a transfer of an. economic resource is low, although that low probability. affects~decisions-on- whether the liability is-to be Gurrent Lables 3 recognized, how it is measured, what information is to be provided about the liability, and how that information is provided. (Conceptual Famewek 4376 43 ‘An obligation to transfer an economic resource may be an obligation to: a. pay cash, deliver goods, or render services; b._ exchange assets with another party on unfrvorable terms; ¢._ transfer assets if a specified uncertain future event occu 4d, issue financial instrument that obliges the entity to transfer an economic resource. Present obligation as a result of past events ‘The obligation must be a present obligation that exists as a result of past events. A present obligation exists as a result of past events if a. the entity has already obtained economic benefits or taken an action; and b. as.a.consequence, the entity will or may have to transfer.an economic resource that it-would not otherwise have had to transfer. (Conepua Framework 445) Examples: [ Entity A intends to acquire goods in the future ] Analysis: Entity A has no present obli li igation. A present obligation aor Present obligation arises a. has already purchased and received the goods; and b. as a consequence, Entity A will have to pay for the purchase price. Entity B operates a nuclear power plant. In the current year, anew law was enacted penalizing the improper disposal of toxic waste. | | No similar law existed in prior years. eo ‘Scanned with CamScannerChapter 1 Analysis: ‘The enactment of legislation is not in itself sufficient to result in an, centity’s present obligation, except when the entity: ‘a. has already taken an action contrary to the provisions of that aw; and b. asa consequence; the entity will have to pay for a penalty. Accordingly: - Entity B has no present obligation if its existing method of ‘waste disposal does not violate the new law. Similarly, Entity B has no present obligation if it can avoid penalty by changing its future method of waste disposal. ~ On the other hand, Entity B has a present obligation if its previous waste disposal has already caused damages, and as a consequence, Entity B its to pay for those damages. Entity C enters into an irrevocable commitment with another | party to acquire goods in the future, on credit. Analysis: A non-cancellable future commitment gives rise to a present obligation only when it becomes onerous (ie., burdensome), for example, if the goods become obsolete before the delivery but Entity C cannot cancel the contract without paying a substantial penalty. Unless it becomes burdensome, no present obligation normally arises from a future commitment. Although not stated in the sales contract, Entity D has a publicly- | known policy of providing free repair services for the goods it | sells. Entity D has consistently honored this implied policy in the | i. Analysis: Entity D has a present constructive obligation to provide free repair services for the goods it has already sold because: Current Liabilities a. Entity D has already taken an action by creating v. expectations on the customers that it will provide free services; and bb. a5 a consequence, Entity D will have to provide those free services. Analysis: Entity E has a present obligation because it has already received the Ioan proceeds, and as a consequence, has to make the repayment, even though the bank cannot enforce the repayment until a future date. { Entity F has caused environmental damages. Although, no law | exists penalizing such act, Entity F believes it has an obligation to | rectify the damages. However, the identity of the party to whom | L the obligation is owed cannot be specifically identified Analysis: Entity F has a present obligation because it has already caused the damages, and as a consequence, has to rectify the damages, even if the identity of the party to whom the obligation is owed is not specifically known. Analysis: ~ Entity G has no present obligation to pay salary until after Mr. Juan has rendered service. Before then, the contract is executory ~ Entity G has a combined right and obligation to exchange future salary for Mr. Juan's future service. ‘Scanned with CamScannerAn is a contract that is equally unperformed — neither party has fulfilled any of its obligations, or both parties have partially fulfilled: their-cbligations to. an_equal extent.” (Comer Frameworh 430) An executory contract establishes a combined right and obligation to exchange -economic..resources, which are interdependent and inseparable. Thus, the two constitute a single asset or liability, The entity has an asset if the terms of the contract are-ficoratle; a liability-if-the terms are unfavourable. However, whether such an asset or liability is included in the financial statements depends on the recognition criteria and the selected ‘measurement basis, incuding any assessment of whether the ‘contractis onerous. The contract ceases to be executory when one party Performs its obligation. If the entity-performs first, the entity’s ‘combined right and obligation changes to an assef. If the other party performs first, the entity's combined right and_obligation changes toa liability. Continuing the previous example: ~ Entity G neither recognizes an asset nor a liability upon entering the employment contract with Mr. Juan because, at that point, the contract is executory. ~ _IfMr. Juan renders service, the contract ceases to be executory, and Entity G's combined right and obligation changes to a liability — an obligation to pay Mr. Juan's salary (eg,, salaries, payable. - If Entity G pays Mr. Juan's salary in-advance;-Entity G's combined right and obligation changes to an asset ~ a right to receive the service or a right to be reimbursed if the service is not received (e.g., advances to employees). Current Liabilities z REQ ST ‘An item is recognized if: a. itmeets the definition of a liability; and b. recognizing it would provide useful information, ie. relevant and faithfully represented information. Both the criteria above must be met before an item is recognized. Accordingly, items that-meet the definition. of a Iiability but do not provide useful information are not recognized, and vice versa. However, even if a liability is not recognized, information about it may stil need to be disclosed in the notes. In such cases, the item is referred to as unrecognized liability. Recognition may not provide ee {information if, for example: a. itis uncertain whether a liability exists; or b. alliability exists, but the probability of an outflow of economic benefits is low. (Coneptn Fmewer 13) Existence uncertainty or low probability of an outflow of economic benefits may result in, but does not automatically lead to, the non-recognition of liability. Other factors should be considered. A liability must be measured for-it to be recognized. Often, measurement requires estimation. and thus subject to measurement uncertainty. The use of reasonable estimates is an ‘essential part of financial reporting and does not necessarily undermine the usefulness of information. Even a high level of measurement uncertainty does not necessarily preclude an estimate from providing useful information if the estimate is clearly and accurately described and explained. However, an exceptionally high measurement uncertainty can affect the faithful Tepresentation of a liability. ‘Scanned with CamScanner