Lec 9 Flashcards
(13 cards)
Liability definition
Iasb conceptual framework (ias36) defines a liability as a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits
Three components of a liability must be present
Three components of a liability:
Future disposition of economic benefits to other entities
There must be a present obligation
A past transaction or other event must have created the obligation
For a liability to be recognised the iasb conceptual framework requires that:
For a liability to be recognised the IASB conceptual framework requires that:
It must be probable that a sacrifice of economic benefits will be required
The amount must be able to be reliably measured
Provision definition under IAS 37
IAS37 provision is a liability of uncertain timing or amount
When is a provision recognised
A provision is recognised if
A firm has a present obligation as a result of past events
Outflow of resources is probable to settle the obligation
A reliable estimate can be made
Amount recognised = best estimate of the expenditure required to settle the obligation
Reviews at end of each accounting period
Note: provisions are required to be discounted to pv when the effect of discounting is material
Provision for warranties example:
Denson machine company sells 100 machines for 5000 unit since July 19 to dec 19. Each machine is under warranty for one year. Denson estimates based on past experiences, that the warranty will cost 200 a unit (20,000 with an estimate of 4000 in 2019 and 16000 in 2020).
A provision for warranties is a promise from the producer to cover product deficiencies.
July 19
Cash 500,000
Sr 500,000
31 dec 2019
Warrant liability (provision) 16000
Cash 4000
31 December 2020
Warranty liability (provision) 16000
Cash 16000
Provisions for environmental issues
On jan 1 2018, wildcat oil company erected an oil platform in the Gulf of Mexico. Wildcat is legally required to dismantle and remove the platform at the end of its useful life, estimated to be 5 years. Wildcat estimates that dismantling and removal will cost 1,000,000. Based on a 10% discount rate, the fair value of the environmental liability is estimated to be 620,920 (1,000,000 /1.1^5). Wildcat records this liability on jan 1 2019 as follows
Provision for environmental issues is estimates of clean up / waste costs > use best estimate again
Jan 2019 Drilling platform (+nca) 620920 Environmental liability (+ncl) 620920
31 dec 2019 - 2023
Dep expense 620,920/5. 124184
Acc depr. 124184
31 dec 2019
Interest expense 620,920/10. 62092
Environmental liability. 62092
Jan 2024 dismantling goods
Environmental liability 1,000,000
Cash. 995,000
Gain on settlement of environmental liability 5000
Provision for onerous contracts
A company contacts/rents an apartment for 2 years (12000 a year) to put their c level execs when they visit the factory. Operations are finally outsourced to other geographies but company still needs to meet the contractural obligations (ie onerous contract)
A provision for onerous contracts are unfavourable contracts signed (eg rents that are not enjoyed)
Loss on lease contact (-NI) 24000
Lease contact liability (+ncl) 24000
If there was a cancellation penalty for 15 k Then liability reduced to 15 k
Provisions for litigation costs
Company expects an unfavourable outcome say 500,000
Provisions for litigation costs need to take into account the probability of an unfavourable outcome and the ability to reasonably estimate the loss amount
If company expects an unfavourable outcome (500,000) Lawsuit loss (-ni) 500,000 Lawsuit liability (+ncl) 500,000
If company expects that the lawsuit is not probable > no provision
Provisions for restructuring process: decision to restructure operating activities eg closure or relocation of business locations
3 conditions need to be met:
A present (legal or implicit) obligation must exist (eg informing clients of relocation) Only direct (to the restructuring) costs allowed If restructuring involves the sale of operations > no provision until binding sale agreement exists
Contingent liability are:
Contingent liabilities are
Obligation dependent On a future event
Obligation for which settlement amount Cannot be measured reliably
Contingent liability cannot be recognised on the balance sheet, but must be disclosed in footnotes.
Examples: guarantees to cover other companies debts, customer claims
Contingent liabilities: company must disclose each class of contingent liabilities where nature of the liability and where predictable;
Estimate of its financial effect on sofp and net income
Uncertainty about amount or timing of outflow
Possibility of reimbursement
Contingent liabilities vs provisions
A suit has been filed against abc which disputes that liability. Up to dec 2015, it’s lawyers advise that it is probable that abc will not be found liable. A year later, lawyers consider that abc will have to settle an obligation and give a money estimate for that.
On dec 2015:
No provision but a contingent liability is disclosed in fs ( unless probability of obligation is too remote)
On dec 2016
A provision is recorded: a) probable cf outflow and b) estimate available
