12.10 Chapter Summary

LO 1: Define current liabilities and account for various types of current liabilities.

A liability is 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. A current liability is one that is expected to be settled within the normal operating cycle, or within 12 months, of the balance sheet date. A liability may also be current if it is held for trading, or if the company does not have the unconditional right to defer settlement beyond one year. Common current liabilities include accounts payable, lines of credit, notes payable, customer deposits, and sales tax payable.

LO 2: Differentiate between financial and non-financial current liabilities.

A financial liability is a contractual obligation to deliver cash or another financial asset to another entity, or to exchange financial assets or liabilities under conditions that are unfavourable to the entity. Non-financial liabilities are those that do not meet this definition.

LO 3: Explain the accounting treatment of different types of current, financial liabilities.

With accounts payable, an important accounting procedure is ensuring that the liability is reported in the correct period. Lines of credit usually require a formal agreement with a lender and, as such, certain disclosures will be required. Notes payable should be accounted for using the effective interest method. The conditions of individual contracts with customers need to be examined carefully to determine the correct classification of deposits received. Sales tax collected on behalf of a government agency represents a liability, but the liability may be offset for sales tax paid in certain cases. Employee-related liabilities can include salaries and wages payable, payroll deductions, paid absences, profit-sharing, and bonus plans. For paid absences, IAS 19 distinguishes between accumulating and non-accumulating absences, and only requires accrual of accumulating amounts.

LO4: Explain the accounting treatment of different types of current, non-financial liabilities.

Unearned revenues represent an obligation to provide goods or services in the future to customers. Unearned revenues are reported as liabilities until such time as they are recognized as revenues, that is, when the goods or services are provided. Unearned revenues should be reported at their fair values, and are normally not discounted. A product warranty is a promise to provide future repairs or replacement if a product has defects. The preferred accounting approach is to treat this as a bundled sale and recognize the warranty component as unearned revenue. The revenue will then be recognized over the term of the warranty, matched against the actual expenses incurred to service the warranty. If the warranty does not represent a separate performance obligation, then the liability for future repairs is treated as a provision. A customer loyalty program represents a separate component of revenue that should be reported at its fair value and deferred as appropriate. Estimation will likely be required to determine the fair value.

LO 5: Discuss the nature of provisions and contingencies and identify the appropriate accounting treatment for these.

A provision is a liability of uncertain timing or amount. A provision will be accrued when the future outflow of resources is probable and the amount can be reliably measured. If one of these conditions is not present, then no amount is accrued but disclosure is required (except when the probability is remote). When the revenue portion of a product warranty cannot be determined, a provision for future expected warranty expenditures is required. The provision will be based on the expected value of the obligation, and will be accrued at the time of sale of the product. As warranty costs are incurred, the provision will be reduced. A provision for decommissioning costs needs to be accrued based on the legal and constructive obligations of the company (only the legal obligation under ASPE). As the costs may be incurred far into the future, discounting of the obligation is appropriate. The value of the initial obligation will be added to the cost of the relevant asset. Every year, interest calculated will be added to the balance of the obligation. Each year the asset will be depreciated and the interest expense recorded. At the end of the asset’s life, the balance of the obligation will equal the amount estimated to complete the decommissioning.

LO 6: Discuss the nature of commitments and guarantees and identify the appropriate accounting disclosure for these items.

A commitment represents a future action to be taken by the company under an unexecuted contract. Commitments are not normally accrued, as no part of the contract has yet been executed. However, if they are material, commitments should be disclosed because they do represent a potential effect on future cash flows. If a contractual commitment becomes onerous, the least amount required to execute or withdraw from the contract should be accrued, as this future expenditure cannot be avoided.

Guarantees represent possible future outflows of resources on behalf of another party. Guarantees are initially measured and recorded at their fair value, and are subsequently recorded at the greater of the amount required to settle the obligation and the unamortized premium.

LO 7: Describe the presentation and disclosure requirements for various types of current liabilities.

As current liabilities have a direct impact on immediate cash flows, significant disclosure requirements are detailed in several sections of the IFRSes. The standards do not specify the precise format of current liability disclosure on the balance sheet, so companies have adopted a variety of practices regarding the order of presentation and terminology used.

LO 8: Use ratio analysis of current liabilities to supplement the overall evaluation of a company’s liquidity.

The days’ payables outstanding ratio can be used in conjunction with the current and quick ratios to draw some conclusions about a company’s liquidity. However, a broader understanding of the nature of the business, industry standards, historical trends, and other factors is required to draw proper conclusions.

LO 9: Identify differences in the accounting treatment of current liabilities between IFRS and ASPE.

There are some differences between IFRS and ASPE with respect to contingencies and provisions, customer loyalty programs, and decommissioning costs. ASPE disclosure requirements are less detailed than IFRS requirements.