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American Accounting Association DOI: 10.2308/acch.2010.24.4.623

What Are the Essential Features of a Liability?

Dennis Murray
SYNOPSIS: The Financial Accounting Standards Board FASB and the International Accounting Standards Board IASB are in the process of jointly re-examining their conceptual frameworks. The re-examination includes assessing the denition of a liability. The Boards existing liability denitions include three criteria: 1 a present obligation; 2 a past transaction or event; and 3 a probable future sacrice of economic benets. The Boards have recently proposed that a liability be dened as a present obligation for which the entity is the obligor FASB 2008c, 2 . The proposed denition mentions only one time dimension the present . References to the past and future are omitted. This paper argues that these omissions are undesirable. Omitting a reference to the past removes the link between the denition and the tradition of historically based nancial statements. More importantly, however, the failure to reference future sacrices of economic benets divorces the denition from the primary objective of nancial reporting: to provide information about the amount, timing and uncertainty of an entitys future cash ows FASB 2008a, para. OB6 . This paper offers an alternative denition that emphasizes the past and future rather than the present.

INTRODUCTION he Financial Accounting Standards Board FASB and the International Accounting Standards Board IASB are in the process of re-examining their conceptual frameworks. The goal is for the Boards to jointly issue a common framework that would underlie the deliberations of both bodies. The framework will delineate the objectives of nancial reporting, identify the qualitative characteristics of decision-useful information, dene the elements of nancial statements and address recognition and measurement issues FASB 2006 . The Boards are considering substantive changes to the denition of a liability. The changes, if implemented, could signicantly affect the particular obligations included in nancial statements and, ultimately, the usefulness of those statements. The purpose of this paper is to review and critically evaluate the newly proposed liability denition. While the denition itself is of primary interest, issues related to recognition and measurement will be addressed in a limited fashion. In order to conduct the analysis, one presumption will be made. The tentative conclusions about the objective of nancial accounting reached by the Boards will be accepted. The Boards maintain that:
The objective of general purpose nancial reporting is to provide nancial information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in making decisions in their capacity as capital providers. FASB 2008a, para. OB2

Dennis Murray is a Professor at the University of Colorado at Denver.

I am grateful for the helpful comments of two anonymous reviewers.

Submitted: February 2009 Accepted: June 2010 Published Online: December 2010
Corresponding author: Dennis Murray Email: Dennis.Murray@ucdenver.edu

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The Boards further maintain that both equity investors and lenders are interested in the amount, timing, and uncertainty of an entitys future cash ows FASB 2008a, para. OB6 . The Boards have taken a strong decision usefulness orientation. The envisioned decisions involve the allocation of resources e.g., investing and lending that are made by investors and creditors. In making these decisions, investors and creditors assess an entitys ability to generate net cash inows. To assist in making this determination, nancial reporting is to provide, among other things, information about claims to an entitys resources FASB 2008a, para. OB6 . Thus, the major criterion used in this paper to evaluate the desirability of a liability denition is the degree to which it can assist nancial statement users in assessing the cash ows needed to satisfy the claims of creditors. EXISTING DEFINITIONS The FASBs existing liability denition is contained in Statement of Financial Accounting Concept SFAC No. 6, Elements of Financial Statements:
Liabilities are probable future sacrices of economic benets arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of a past transaction or event. FASB 1985a, para. 35

The existing IASB denition is contained in Framework for the Preparation and Presentation of Financial Statements:
A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outow from the entity of resources embodying economic benets. IASB 2001, para. 49

Each denition contains essentially the same components, although the sequencing and exact phraseology differ slightly. Both denitions reference 1 present obligations, 2 past events, and 3 a future conveyance of economic benets. Present obligations refer to responsibilities or duties that exist on the balance sheet date. Present obligations are viewed as leaving the entity little or no discretion FASB 1985a, para. 36 . Both the FASB and IASB believe that constructive or equitable obligations meet their denitions. Constructive or equitable obligations arise from custom or potential social sanctions rather than from legal compulsion. Examples include product warranty costs arising from customary practice rather than formal warranties IASB 2001, para. 60 and vacation pay obligations not supported by contract FASB 1985a, para. 40 . Both denitions refer to past events. This reference acknowledges that nancial statements are historically based. The Boards have stated that nancial reporting information is based on the nancial effects on an entity of transactions and other events and circumstances that have happened or that exist FASB 2008a, para. OB14 . Accountants have become accustomed to searching for past transactions or events to trigger the recognition of nancial statement items. Both denitions also look to the future. The FASB references probable future sacrices of economic benets. The IASB denition includes the phrase expected to result in an outow from the entity of resources embodying economic benets. Economic benets are items that have the capacity to result in net cash inows FASB 1985a, para. 27 . Both denitions anticipate the entitys conveyance of such benets to an outside party at a date in the future. However, neither denition demands that the anticipated conveyance be certain. The FASB uses the term probable, which refers to that which can reasonably be expected or believed on the basis of available evidence or logic FASB 1985a, para. 35 . The IASB has indicated that its term expected has the same meaning as the term probable IASB 2008a . Storey and Storey 1998 report that the FASB included the term probable in the liability denition because of concerns that its omission would require the anticipated outow to be virtually certain, resulting in the recognition of many fewer liabilities than is presently the case.

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PROPOSED DEFINITION The Boards have proposed the following denition:

A liability of an entity is a present economic obligation for which the entity is the obligor. FASB 2008c, 2

The proposed denition contains two provisions: 1 that a present economic obligation exists and 2 that the entity is the obligor. An economic obligation is an unconditional promise or other requirement to provide economic resources FASB 2008c . The term present indicates that the obligation exists on the balance sheet date. No mention is made of past transactions or future sacrices; the focus is exclusively on the present. The necessity of identifying past triggering transactions or events is obviated. Additionally, future outcomes do not play a role. Forecasts or expectations are not a factor. An entity simply must identify the obligations it has on the reporting date. The Boards have also tentatively decided that liabilities should be unconditional. An unconditional obligation requires performance to occur now or over a period of time, whereas a conditional obligation requires performance to occur only if an uncertain future event occurs FASB 2008b, 8 . The second provision of the proposed denition requires that the entity be the obligor. This indicates that the obligation is enforceable by legal or equivalent means against the entity FASB 2008c, 3 . FASB staff has indicated that this phrase is intended to imply that constructive obligations should be viewed as liabilities FASB 2008c . ANALYSIS OF PROPOSED DEFINITION The proposed denition is markedly different from the existing denitions. The proposed denition is shorter and simpler. It mentions only the present, instead of referencing three time dimensions past, present, and future . The simplicity and the focus on the present are appealing attributes. However, does a singular focus on the present yield information that compromises the ability of nancial statement users to assess the amounts, timing, and uncertainty of the entitys future cash ows? Is an emphasis on present obligations to the exclusion of probable future sacrices desirable? Are constructive obligations really enforceable? Should probability thresholds for recognition be abandoned? The following subsections address these questions. Constructive Obligations The proposed denition and additional commentary provided by the FASB indicate that a liability must be an obligation that is enforceable by legal or equivalent means. A legal obligation arises 1 from a law, statute, or ordinance, 2 from a written or oral contract, or 3 via promissory estoppel FASB 2001, para. 2 . Promissory estoppel is the doctrine that a promise made without consideration may be legally enforceable if the promisor should have reasonably expected the promisee to rely on the promise and the promisee did in fact rely on the promise to his or her detriment Garner and Black 2009 . Note, in particular, that promissory estoppel is a method to achieve legal enforcement. Beyond legal compulsion, by what equivalent means can an obligation be enforced? Constructive obligations are presumably binding primarily because of social or moral sanctions or custom FASB 1985a, para. 40 . How can social or moral sanctions or custom be used to enforce a constructive obligation? Consider unvested pension benets. Statement of Financial Accounting Standard SFAS No. 87, Employers Accounting for Pensions FASB 1985b , and International Accounting Standard IAS 19, Employee Benets IASB 2007 , both require recognition of liabilities for pension benets that have been earned but remain unvested as of the reporting date. The entity is not legally obligated to honor these benets. Can employees enforce the obligation for unvested benets by non-legal means? The Pension Benet Guaranty Corporation PBGC provides important information on this question. PBGC 2008 reports that of the single-employer plans that it

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insured in 2003, 2004, and 2005, 9.5 percent, 12.1 percent and 14.1 percent, respectively, had a hard-freeze in place.1 By hard-freezing a plan, earned but unvested benets will not be paid. Unvested benets based on future salary progression will also not be paid. Thus, it appears that in some cases unvested benet obligations may not be enforceable, thereby disqualifying them as liabilities under the proposed denition.2 The FASBs existing rationale for viewing unvested pension benets as liabilities is revealing. The going concern assumption is invoked as implying that a pension plan will continue in operation in the absence of evidence to the contrary and that benets will be paid. Benets that are expected to vest are probable future sacrices, and the liability in an ongoing plan situation is not limited to vested benets FASB 1985b, para. 149 . Notice that the argument is not that the entity is presently obligated. The argument underlying the view that an unvested pension benet is a liability is that the sacrice is probable. However, the liability denition proposed by the FASB and IASB does not contain the criterion of probable future sacrice. Thus, if the proposed denition is adopted, the Boards must develop an alternative rationale to justify treating unvested pension obligations as liabilities. However, unvested pension benets are likely associated with future cash ows if not on an individual employee basis, certainly on a workforce wide basis . Assuming that actuarial estimates are sufciently reliable, nancial statement recognition of this obligation may provide information helpful in assessing an entitys future cash ows to employees. Barth 1991 shows that the accumulated benet obligation ABO , which includes unvested benets, is more consistent with security prices i.e., assessments of future cash ows than the vested pension obligation VBO , which includes only vested benets. Requiring a liability to be a presently enforceable obligation may not, therefore, be desirable if the goal is to provide information that assists in assessing the amount, timing and uncertainty of an entitys future cash ows. Unconditionality Another important issue is that of unconditionality. The Boards have tentatively concluded that obligations must be unconditional in order to qualify as liabilities. Recall that unconditional obligations are not contingent on the occurrence of future events. Consider how product warranties would be viewed in this context. Payments on product warranties are conditional on a future event: product failure. Without product failure, no economic resources will be conveyed. Therefore, according to the proposed denition, product warranties would not meet the denition of a liability until failure has occurred. At the time of sale, the proposed denition would not be met, and no liability would exist or be reected on the balance sheet. Given that warranties on products that have been sold but have not yet failed are likely associated with future payments to correct defective products, excluding this obligation from the balance sheet would not assist nancial statement users in assessing an entitys future cash ows. Now consider conditional asset retirement obligations AROs . FASB Interpretation FIN No. 47, Accounting for Conditional Asset Retirement Obligations FASB 2005 , denes a conditional ARO as a legal obligation to perform an asset retirement activity in which the timing and or method of settlement are conditional on a future event that may or may not be within the control of the entity FASB 2005, para. 3 . FIN No. 47 assumes a situation where t he obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing or method of settlement FASB 2005, para.3 . The term conditional is being used differently in the proposed denition and in FIN No. 47. In the proposed denition, conditional

1 2

A hard-freeze suspends new benet accruals with respect to both service and compensation levels. An alternative interpretation is that employees elected not to enforce the unvested obligations.

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refers to the existence of the obligation. That is, the proposed denition requires that the obligation not be conditional on a future event. This is why product warranties do not meet the proposed denition: they are conditional on a future event product failure . The issue is the existence of the obligation, not its measurement. FIN No. 47 deals with a situation where the existence of the obligation is unconditional, but the method of settlement and, therefore, the associated costs are conditional on future events. Consider the example of a nuclear power plant where the operating license includes a requirement for decommissioning. The decommissioning obligation arises as soon as the plant begins operations. However, the method used to decommission the plant will depend on the technology available at the time of decommissioning, as well as other factors. Uncertainty exists about the method of settlement and associated costs because they are conditional on future technology. The issue in FIN No. 47 is measurement of the obligation, not its existence. I believe that conditional AROs would be viewed as liabilities under the proposed denition. Conditional AROs are actually unconditional obligations, if one uses the meaning of unconditional in the proposed liability denition. If the measurement issues are such that a reasonable estimate of the obligation can be made, the obligation would be recognized. In contrast, the existence of a product warranty liability is conditional on an uncertain future event product failure even if the method of settlement is known with virtual certainty. The difference between product warranties and conditional AROs underscores the importance of clearly distinguishing denitional issues from measurement issues. The Boards apparently recognize the undesirability of the product warranty result and have created the notion of a stand-ready obligation.3 In the product warranty situation, the entity is viewed as having 1 an unconditional obligation to stand-ready to perform if product failure occurs and 2 a conditional obligation to correct a defect if product failure occurs. While the Boards acknowledge that a stand-ready obligation is passive, they believe that it is a genuine obligation that arises at the time of sale and should be recognized at that point. The responsibility to actually honor the warranty by repairing or replacing a defective product is viewed by the Boards as a conditional obligation prior to product failure, which would not meet the proposed liability denition at the time of sale. At the time of failure, the obligation to repair or replace then becomes unconditional and recognition of this liability would then be appropriate. IASB 2005 has addressed the measurement of stand-ready obligations. It recommends that a stand-ready unconditional obligation be measured at a settlement amount i.e., an amount the entity would be required to pay a third party to relieve itself of the obligation . In the product warranty situation, because a third party would consider the likelihood that it would ultimately be called upon to remedy a product failure, the measurement of the stand-ready obligation would reect the likelihood of product failure and the associated costs. That is, the measurement of the unconditional stand-ready obligation would reect the third partys assessment of its obligation to honor the obligation for actual repairs, which is conditional on product failure. The passive nature of a stand-ready obligation is of paramount importance. What sacrice is needed to honor a stand-ready obligation? That is, what sacrice is needed to provide risk protection prior to product failure? None. I can stand-ready all day, every day and it will cost me nothing. With no conveyance of economic benets, no economic obligation exists. Thus, a standready obligation is not really an economic obligation and is not a liability. The notion of a stand-ready obligation is simply a contrivance by the Boards. The contrivance is needed because the proposed liability denition does not yield sensible, useful results. The proposed denition

The concept of a stand-ready obligation has been most extensively developed by the IASB in its reconsideration of IAS 37, Provisions, Contingent Liabilities and Contingent Assets IASB 2005 .

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demands that an unconditional enforceable obligation exists on the balance sheet date. Product warranty obligations do not meet this standard because they are conditional on a future event: product failure. Yet virtually all accountants view these obligations as liabilities, and with good cause. They are likely associated with future cash ows. To obtain a desirable result, the Boards have articially bifurcated certain obligations into a conditional obligation and an unconditional stand-ready obligation that is associated with no ow of economic resources. Given that no sacrices of economic benets are associated with stand-ready obligations, their recognition would presumably result in no increase in measured liabilities. This perhaps is, at least in part, the motivation for the measurement rules suggested in IASB 2005 , which propose the use of a third party settlement amount. A third party settlement amount would include an assessment of the expected future cash ows associated with the conditional obligation tied to product failure. Therefore, the proposed measurement rules for the unconditional stand-ready obligation result in the recognition of the expected cash ows associated with the unrecognized conditional obligation. That is, according to the FASB and IASBs proposed denition and measurement rules, the obligation for product repair that is contingent on product failure should not be recognized because it is conditional on a future event i.e., product failure . Moreover, the Boards propose that the recognized unconditional stand-ready obligation be measured by a settlement amount that reects the expected cash ows associated with the unrecognized conditional obligation, a seemingly incongruous outcome. Without the stand-ready contrivance and the associated measurement rules which incorporate the expected cash ows from the conditional obligation , product warranties would not meet the proposed denition and no product warranty obligation would appear as a liability on balance sheets prior to product failure. Thresholds versus Expected Values SFAS No. 143, Accounting for Asset Retirement Obligations FASB 2001 , provides another instructive illustration about the FASBs approach to liability recognition and measurement. SFAS No. 143 provides an example of a governmental unit retaining the right to require a retirement activity. The FASB concludes that Uncertainty about whether performance will be required does not defer the recognition of a retirement obligation; rather, that uncertainty is factored into the measurement of the fair value of the liability through assignment of probabilities to cash ows FASB 2001, para. A17 . Thus, the FASB has moved from a threshold approach for liability recognition to an expected value approach. The FASB ignored the probability criterion in the existing liability denition. That is, a minimal level of likelihood is not required for recognition of asset retirement obligations. Rather, uncertainty is incorporated in the measurement of the liability, even if the likelihood of the sacrice is extremely low.4 A recent survey by PricewaterhouseCoopers PwC 2007 provides some evidence about nancial statement users views of this issue. Buy-side and sell-side investment professionals and investors across four countries Canada, Germany, U.K., and U.S. were interviewed PwC 2007 .5 Eighty-six percent of those surveyed support recognizing liabilities only when the outow is likely. Curiously, 96 percent prefer a measurement model based on probability-adjusted discounted cash ows. Whereas the Boards appear to view thresholds and expected values as alternatives to dealing with uncertainty, the nancial statement users interviewed in PwC 2007 prefer that these approaches be used jointly. However, more to the point of the present discussion, the PwC 2007 respondents clearly favor retaining a probability threshold for liability recognition. This preference is inconsistent with the Boards reliance on expected values.

4 5

See Johnson et al. 1993 for a discussion of thresholds and expected values. Given the sampling approach employed, PwC cautions that its results should not be viewed as statistically valid.

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Probable Future Sacrice The previous subsections suggest that a weakness in the proposed denition may well be its focus on the present. Given that nancial reporting is intended to help users assess an entitys future cash ows, the likelihood that an outow of resources will ensue from an arrangement is critical. The existing FASB liability denition uses the phrase probable future sacrices, while the proposed denition makes no reference to the future. Instead, the proposed denition requires a presently enforceable economic obligation. This requirement is too exclusionary. That is, numerous probable future sacrices e.g., unvested pension benets and product warranties would fail to meet this requirement and be excluded from balance sheets. By ignoring the future, the proposed denition fails to meet the Boards stated goal of providing information useful in assessing an entitys future cash ows. The proposed denition also does not reference the past. This fails to acknowledge that business transactions often unfold over time, rather than occur at discrete points in time. Both the unvested employee benets illustration and the product warranty illustration are good examples of transactions that can easily take years to complete. A key question is: when during a possibly extended arrangement should the liability denition be considered fullled? To summarize, a liability denition that demands the existence of an unconditional, enforceable present obligation will omit from the balance sheet numerous probable future sacrices of economic benets. These omissions will compromise the ability of nancial statement users to assess an entitys future cash ows. Moreover, a liability denition should also provide guidance regarding the many transactions that require an extended period of time to complete. AN ALTERNATIVE Consider a denition that emphasizes future sacrices and the possibly prolonged nature of some relationships and transactions:
A liability is a likely future sacrice of economic benets arising as the result of events and transactions that have largely been completed.

The Boards stated objective of nancial statements is to help users assess an entitys future cash ows. Accordingly, the rst component of the denition refers to a likely future sacrice of economic benets. If an item is not reasonably associated with a future cash outow, its treatment as a liability would not be helpful to users in assessing those ows. Therefore, such an association is a necessary condition of a liability. Given that future events are referenced in the denition, the qualier likely is used in recognition of the uncertainty surrounding the future. The existing FASB liability denition includes the term probable with the meaning of reasonably expected. The FASB also uses the term probable in SFAS No. 5, Accounting for Contingencies FASB 1975 . In that standard, probable is used with a different meaning; it is dened as likely to occur. At the very least, communication is hampered by having two denitions for one term. To distance my alternative denition from the resulting confusion, I have chosen the term likely rather than probable. What meaning should be attached to likely? In IAS 37, the IASB denes probable as more likely than not to occur IASB 2008b, para. 23 . That is, recognition as a liability would require a greater than 50 percent probability of occurring. I adopt this meaning for several reasons. First, the meaning is simple and easy to understand. It can be thought of as either a probability or odds i.e., better than even odds . It is concrete at least in terms of basic conceptualization , unlike the existing FASB denitions of probable. Additionally, a 50 percent threshold is not far from users preferences, as documented by Aharony and Dotan 2004 . The nancial analysts participating in their study attached an average probability level of 65 percent to the term probable as used in SFAS No. 5 . Thus, a 50 percent threshold would be a bit more conservative than the average preference of these analysts.

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While a 50 percent threshold is quite specic in concept, both the Boards and practitioners would need to use judgment when applying this denition. Judgment would be needed by the Boards in developing specic nancial accounting standards. For example, the Boards might conclude that unvested pension benets meet the threshold, but guarantees of the indebtedness of others do not. Practitioners would also need to exercise judgment in applying the threshold to situations left unaddressed by the Boards e.g., litigation . The second component of the denition requires that the future sacrice be due to events and transactions that have largely been completed. This aspect of the denition is consistent with historically based nancial statements. In particular, it recognizes that a probable future sacrice is necessary but not sufcient for the existence of a liability. At a given point in time, an entity will have many plans and expectations that will likely result in future sacrices of economic benets. Examples include plans for the purchase of goods and services, future capital expenditures and the anticipated payment to employees for services that have not yet been rendered. Inclusion in the nancial statements of the expected cash ows associated with these plans would mark a signicant departure from traditional historically based nancial statements. Accordingly, the second component of the denition reinforces the historical nature of accounting and excludes from liabilities cash ows associated with an entitys plans for future transactions. The second component also acknowledges that events, transactions, situations, and relationships can take time to complete. Ijiri 1980 examined the recognition issue with respect to contractual rights and obligations. Using the example of a non-cancellable commodity purchase contract, Ijiri 1980 identied ve possible liability recognition points for the buyer: 1 contract pointwhen the contract is signed, 2 procurement pointwhen the seller procures the product, 3 production pointwhen the seller completes processing the product, 4 segregation point when the seller segregates the product prior to shipment, and 5 delivery pointwhen the seller delivers the product to the buyer. Ijiri 1980 suggests that the delivery point might signal a sufcient increase in the likelihood that the obligation will be fullled to warrant recognition. Specication of delivery as the recognition point seems too detailed for the denitional level. However, Ijiri 1980 directs attention to a critical question: when has a relationship sufciently progressed to warrant recognition? The denition that I offer requires that the future sacrice be the result of events and transactions that have largely been completed. The existing denition references past transactions and events, to some degree implying a binary characterization: transactions and events are in the past or they are not. The phrase largely been completed explicitly recognizes that transactions and events might be partially complete on the reporting date. The term largely requires that the bulk of the obligating event s must have already occurred. Current generally accepted accounting principles take a similar approach, particularly with respect to revenue recognition. For example, SFAS No. 45, Accounting for Franchise Fee Revenue FASB 1981a , provides that revenue shall be recognized when services have been substantially performed. Similarly, SFAS No. 48, Revenue Recognition When Right of Return Exists FASB 1981b , establishes as a condition for revenue recognition that the seller does not have signicant future performance obligations. These standards address specic situations where the relationship between the parties evolves over time. Judgment will be needed in applying fundamental concepts and denitions to specic settings. The denition I offer provides the Boards reasonable guidance and exibility when setting standards addressing particular liabilities. Examples How would unvested pension benets and product warranties be evaluated in terms of my suggested denition? On a workforce-wide basis, unvested pension benets are likely associated with future cash ows, thereby meeting the rst component of the denition i.e., a likely future

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sacrice . Are these benets due to events and transactions that have largely been completed? Unvested but earned pension benets result from services that have already been rendered, but the actual payment is contingent upon continued employment for a specied period. Judgment is clearly necessary to answer this question. My judgment would be in the afrmative. The services that underlie the determination of the benets have been rendered. While additional services are needed in order for payment to be compulsory, the amount of the payment will be unaffected by the additional years of service. Although different people may render different judgments, the denition directs attention to the important questions. Product warranties, as a group, are also very likely associated with future cash ows, thereby meeting the rst component of the denition. Are they due to events and transactions that have largely been completed? Assume that the sale of the underlying product has occurred, the revenue has been recognized, but product failure has not occurred. Although the product has not yet failed, the production process has been completed and the inherent quality of the product has been established. My conclusion would be that the product warranty transaction is largely completed at the time of sale, thereby justifying the view that product warranties are liabilities. Note that product warranties would not meet the Boards proposed denition because they are conditional on a future event product failure . Consider two nal examples. The rst example involves a lessees obligation for a contingent rental. Assume that on July 1 a calendar year-end entity signs a one-year store lease for a xed sum plus an additional xed sum if a sales threshold is met. Also assume that as of December 31 the sales volume is 95 percent of the threshold and every expectation is that sales will continue to be strong. Does a liability exist on December 31? According to my proposed denition, a liability does exist. The future sacrice is likely and the events and transactions underlying the liability are 95 percent complete. According to the Boards proposed denition, a liability does not exist because the obligation is conditional on a future event additional sales . Therefore, according to the Boards proposal, this very likely cash outow would be omitted from the balance sheet, whereas under my proposal, it would be reected on the balance sheet. The above three examples have a common thread. They involve a likely future sacrice that is due to events and transactions that have largely been completed. However, the future sacrice is conditional on future events i.e., a present obligation does not exist . Consequently, those situations meet my proposed liability denition, but not the denition proposed by the Boards. The next example is based on material in SFAS No. 143. Assume an entity leases a tract of land for the purpose of harvesting timber. The lease gives the lessor the option to require the lessee to reforest the land. Also assume that given the lessors past history, the likelihood that reforestation will be required is 10 percent. Does a liability arise as harvesting takes place? According to my proposed denition, a liability does not exist because the cash outow is not likely. According to the Boards proposed denition, the entity has a liability because a present obligation exists. Therefore, according to the Boards denition, this extremely unlikely cash outow would be recorded as a liability on the balance sheet. The uncertainty is reected in the measurement by using an expected cash ow gure, rather than using a probability threshold for recognition. Lets contrast the last two examples. The contingent rent in the store lease is a highly likely future cash outow that is due to events that have largely taken place. My alternative denition would reect this obligation on the balance sheet, whereas the Boards proposal would not because the entity is not presently obligated. The ARO for reforestation is highly unlikely to materialize and, accordingly, does not meet my proposed denition. However, this ARO does meet the Boards denition because a legal obligation exists, even though the likelihood of future cash outows is small. In my view, a aw in the Boards denition is that some likely cash outows would not be considered liabilities and some unlikely cash outows would be considered liabilities. I do not believe that this would result in improved nancial reporting.

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SUMMARY The existing liability denitions promulgated by the FASB and IASB reference three time dimensions: past, present and future. The Boards proposed denition does not reference the past or future, instead focusing on present, enforceable obligations. Many obligations e.g., bank loans and purchases on account clearly are present, enforceable obligations. However, meeting the standard of a present, enforceable obligation can be challenging in some settings, such as unvested pension benets and product warranties. In those situations, a present, enforceable obligation does not exist and no liability should be reported under the Boards proposed denition. This result conicts with the existing treatment of these items, and would compromise users ability to assess an entitys future cash ows. While a liability denition that focuses on present obligations has appeal, an emphasis on the present drives a wedge between the denition and the use to which nancial statement information will be put: assessing future cash ows. Consequently, I propose a denition that emphasizes a probable future sacrice of economic benets coupled with the requirement that the events and transactions underlying the future sacrice have largely been completed. The latter requirement retains the historical nature of nancial reporting, assures that the balance sheet is not cluttered with an entitys future plans, and accommodates the extended nature of some arrangements while the link to the future helps assure that the objectives of nancial reporting will be met. I understand the Boards motivation for focusing on the present, rather than the past and future. However, doing so destroys the link between the liability denition and the objective of nancial reporting, thereby compromising the usefulness of nancial statement information.

REFERENCES
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