CHAPTER 22 Liabilities

PowerPoint Presentation by Matthew Tilling

©2012 John Wiley & Sons Australia Ltd

LIABILITIES DEFINED

• Three essential characteristics

– Present obligation to external party

– Obligation must have resulted from past events

– Must have future outflow of resources embodying economic benefits

2

RECOGNITION OF LIABILITIES

• Recognition avoids overstatement of equity

• Criteria for recognition – Probable that future economic benefit will flow

from the entity • On demand

• On a specified date

• On the happening of a specified event

– Cost or value can be reliably measured • May require estimates

3

PROVISIONS

• Nature of provisions

– Liabilities with uncertain timing or amount

– Examples include

• Provision for long-service leave

• Provision for warranties

• Items excluded from provisions – future costs

– Future expected outlays where no present obligation exists

– ‘Self-insurance’

4

CONTINGENT LIABILITIES

• Conditions existing at balance date where uncertainty exists as to:

– Outcome

– Valuation

• Future event is beyond entity’s control

• Can be either an asset or a liability

5

CONTINGENT LIABILITIES

6

CLASSIFICATION OF LIABILITIES

• Appropriate classification allows users to assess short and long term commitments

• Liabilities are classified according to their amount, nature and timing

• Categories on balance sheet

– Current liabilities

– Non-current liabilities

7

CURRENT LIABILITIES

• Accounts payable (trade creditors)

– Amounts owed for purchase of inventory, supplies and services as part of the business operating cycle

• Bills payable

– Evidenced by a bill of exchange of a promissory note

• Trade bills

• Commercial bills

8

EXAMPLE – BILLS PAYABLE

• BD Ltd previously purchased inventory from R Smith on credit for $4000. On 1 August, Smith agreed to accept a 90-day, 10% bill to cover account payable

9

General Journal

Aug. 1 Accounts Payable – R. Smith 4 000.00

Unexpired Interest 98.63

Bills Payable 4 098.63

(Receipt of bill for Account payable) [Interest = $4000 x 0.10 x 90/365]

EXAMPLE – BILLS PAYABLE

– Note that if end of financial year falls within the term of the bill an adjusting entry is necessary to recognise interest incurred to date

10

General Journal

Oct. 30 Bills Payable 4 098.63

Cash at Bank 4 098.63

(Payment of Bill)

Interest Expense 98.63

Unexpired Interest 98.63

(Interest expense on bill)

EMPLOYEE BENEFITS

• Refer to AASB 119 Employee Benefits

• Employee benefits are all forms of consideration given by an entity in exchange for services rendered by employees

• Two measurement methods

– Short Term Liabilities

• Recorded at their nominal (undiscounted) amount

– Long Term Liabilities

• Recorded at their present (discounted) amount

11

EMPLOYEE BENEFITS

• Include

– Wages and salaries

– Long-service leave, sick leave, annual leave, maternity leave

– Superannuation and post employment benefits

– Fringe benefits (monetary and non-monetary)

12

EMPLOYEE BENEFITS

• Amounts deducted from an employee’s gross pay are liabilities of the employer, who acts as a collection agent for various organisations

13

General Journal

Jun. 28 Wages and Salaries Expense 3 650

Taxation Office 748

AB Superannuation Fund 191

XY Insurance Ltd 90

FM Medical Fund 178

Wages and Salaries Payable 2 443

(Payroll for the week ending 28 June)

EMPLOYEE BENEFITS

• Payroll ancillary costs

– Includes: • Annual leave • Sick leave • Maternity leave • Workers compensation • Public holidays • Long service leave

14

General Journal

Jun. 28 Annual Leave Expense 2 350

Annual Leave Payable 2 350

(Annual leave liability for month)

WARRANTIES

• Estimate of future obligations for inventory sold

15

General Journal

Jun. 30 Warranty Expense 70 000

Provision for Warranties 70 000

(Provision for warranty expense related to sales made in the year ended 30 June)

Jul. 15 Provision for Warranties 350

Cash at Bank 350

(Warranty costs incurred on a faulty computer)

ONEROUS CONTRACTS

• Where the unavoidable costs of meeting an obligation under a contract exceed the economic benefits expected to be received

• A liability must recognised for the unavoidable cost

16

GST COLLECTIONS

17

General Journal

May 20 Accounts Receivable 2 860

Sales 2 600

GST Collections 260

(Sale of computer)

May 25 Purchases/Inventory 1 400

GST Outlays 140

Accounts Payable 1540

(Purchase of computer)

Jul. 28 GST Collections 130 000

GST Outlays 130 000

Cash at Bank 20 000

(June quarter payment of GST)

NON-CURRENT LIABILITIES

• Amounts due for payment more than 1 year from reporting date

• Types of non-current liabilities

– Term loans

– Mortgage payable

– Debentures or bonds

18

DEBENTURES

• A written promise to pay a principal amount at a specified time and interest on the principal at a specified rate per period

• Types of debentures

– Mortgage debentures

– Debentures

– Unsecured notes

19

EXAMPLE - ACCOUNTING FOR DEBENTURES

• On 15 May Jordan’s Ltd issued 1000, $100, 8% debentures for 5 years, payable in full on application. Allotted on 30 June. Interest payable half-yearly

20

General Journal

Jul. 1 Cash Trust 100 000

Application – Debentures 100 000

(Money received on application)

EXAMPLE - ACCOUNTING FOR DEBENTURES

21

General Journal

Jul. 1 Application – Debentures 100 000

Debentures 100 000

(Allotment of 1000 $100 debentures)

Cash at Bank 100 000

Cash Trust 100 000

(Transfer to cash at bank on allotment)

Dec. 31 Debenture Interest Expense 4 000

Cash at Bank 4 000

(Paid half-yearly interest on 8% debentures)

EXAMPLE - ACCOUNTING FOR DEBENTURES

• Redemption of Debentures

22

General Journal

Jun. 30 Debentures 100 000

Debenture Holders 100 000

(Redemption of 1000 $100 debentures)

Debenture Holders 100 000

Cash at Bank 100 000

(Payment of debenture holders)

OTHER NON-CURRENT LIABILITIES

• Unsecured notes

• Mortgage payable

• Term loans

• Lease obligations

23

WHY FINANCE THROUGH LONG-TERM DEBT?

• Debt vs. equity

• Interest vs. dividends

• Risks

• Obligations

• Impact on financial statements

24

ANALYSING LIABILITIES FOR DECISION MAKING

• Liquidity Ratios

– Current ratio

– Quick or acid test ratio

25

Current Ratio = Current Assets

Current Liabilities

Quick Ratio = Cash at Bank + Marketable Securities + Net Receivables

Current Liabilities

ANALYSING LIABILITIES FOR DECISION MAKING

• Financial Stability Ratios

– Debt ratio

– Equity ratio

26

Debt Ratio = Total Liabilities

Total Assets

Equity Ratio = Total Equity

Total Assets

Capitalisation Ratio = Total Assets

Total Equity

EMPLOYEE BENEFITS

• Payroll ancillary costs

– Includes: • Annual leave • Sick leave • Maternity leave • Workers compensation • Public holidays • Long service leave

27

General Journal

Jun. 28 Annual Leave Expense 2 350

Annual Leave Payable 2 350

(Annual leave liability for month)

28