2108AFE Financial Accounting
Workshop Questions Solution
Topic 8 – Liabilities
FOR HOMEWORK SUBMISSION:
QUESTION 1
Moolie Ltd is a manufacturer of surfboards. Pursuant to the sales terms, it gives wa
anties at the time of sales to purchasers of the surfboards for manufacturing defects that become apparent within two years from the date of sale. Based on past experience, Moolie is predicted to have 5% of the sales returned on manufacturing defects.
Required
Using the decision tree (see lecture slides) helps management make judgements on classifying a liability. Using this decision tree, determine how the case should be recorded?
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PowerPoint Presentation
2108AFE
Financial Accounting
Topic 8 - Liabilities
Learning objectives
Describe the purpose of AASB 137
Outline the concept of a provision and how it is distinguished from other liabilities
Outline the concept of a contingent liability and how it is distinguished from other liabilities
Explain when a provision should be recognised
Explain how a provision should be measured
Apply the definition, recognition, and measurement criteria for provisions and contingent liabilities to practical situations
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A Scenario for you….(1)
You are the Chief Financial Officer of a company listed on the ASX.
Annual financial reports are in the final stages of preparation.
Profit for the year is expected to be around $60 million
You are informed by the company’s legal officer of a pending court case. A class action has been filed by former employees for compensation for sickness caused by working for the company 20 years earlier. They are suing for $30 million.
Medical evidence has been provided that links the sickness with working with contaminated materials.
As CFO, you must make a recommendation to the CEO about the treatment of this new information.
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A Scenario for you….(2)
Discuss with the person next to you:
What would you do?
How would you go about making your decision?
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james hardie (JHX)
an old case but a good case
it is still ongoing (1)
2001 Media release: http:
pandora.nla.gov.au/pan/45031/ XXXXXXXXXX/R.pdf
Asbestos liability shown on Balance Sheets.
Non-cu
ent liability for asbestos payments:
2002 report: $A94.4 million
2003 report: $A0!
2007 report: $A1,614.2 million
2008 report: $A1,718.7 million
2008: ASIC commenced civil action against former directors (failure to discharge duties with due care and diligence)
2009: 10 Directors found guilty and given disqualifications of 5 – 15 years and fines of $30,000 - $350,000
2009 report: $A1,755.4 million
2010 report: $A1,651.5 million
2011 report: $US1,587.0 million
……..but wait, there’s more..
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james hardie (JHX)
an old case but a good case
it is still ongoing (2)
2012 report: $US1,662.6 million
2013 report: $US1,558.7 million
2014 report: $US1,571.7 million
2015 report: $US1,290.0 million
2016 report: $US1,176.3 million
2017 report: $US1,043.3 million
Mesothelioma claims are still at peak levels of 400 per year and will remain there until XXXXXXXXXXwhen they will start to decline
Claims are rising, but payouts are falling – Why?
Claims relate to exposure during the period from 1986 onwards
Claimants are ageing – 60% are older than 70 years old
Contingent liabilities will continue to appear on James Hardie’s Balance Sheet for many more years to come!
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why are liabilities important?
The way that a company measures and discloses its liabilities is important to its continuing survival
Legal contracts and agreements can put conditions on the company’s debt
e.g. specify maximum levels of debt, minimum levels of performance
Influence on financial ratios and debt covenants
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Conceptual framework
Liabilities defined
A liability is defined as (Framework 2014, para 49):
“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 essential characteristics:
A present obligation
Duty or responsibility to act in a certain way
More than just a commitment/intention
Arising from a past event
e.g. purchase of supplies/services
Expected to result in an outflow of economic resources
Little discretion in avoiding this outflow
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LO2
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conceptual framework
liability recognition
A liability should be recognised in the Statement of Financial Position when (Framework 2014, para 91):
It is probable that an outflow of resources embodying economic benefits will result from settling the present obligation, and
The amount at which the settlement will take place can be measured reliably
An item MUST satisfy BOTH the definition and recognition criteria!
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test yourself
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Liability definition criteria: Pick the co
ect 3!
Future disposition of economic benefits
Future disposition of economic benefits to other entities
Lots of money is owed
Past transaction or event created the obligation
The amount of money owed can be determined
Past obligation
Past or anticipated transaction or event created the obligation
Money is owed
Present obligation
test yourself
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Liability recognition criteria: Pick the co
ect 2!
The amount of the liability can be measured reliably
The amount of the liability can be known exactly
The liability can be expressed in monetary terms
It’s highly likely that future economic benefits will flow from the entity
It’s certain that future economic benefits will flow from the entity
The liability can be expressed as a percentage of assets
It’s probable that future economic benefits will flow from the entity
wesfarmers ltd
liabilities on the balance sheet
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Statement of Financial Position as at 30 June 2016
AASB 137
definition of a provision
AASB 137 Provisions, Contingent Liabilities, and Contingent Assets (para 10) 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”
This definition is equivalent to the definition in the AASB Conceptual Framework
Provision (a subset of liabilities)
A liability of uncertain timing or amount (AASB 137, para 10)
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LO2
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Key characteristic
Present obligation
A present obligation may be:
Legal: Arising from a contract
Equitable: Arising from normal business practice or custom
Constructive: Arising from established pattern of past practice
Exists only where the entity has no realistic alternative but to make the sacrifice of economic benefits to settle the obligation
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LO2
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distinguishing provisions from other liabilities
Key distinguishing factor
The uncertainty relating to either the timing or the amount
Accruals vs. Provisions
Accruals: reported as part of trade and other payables
Provisions: reported separately (e.g. provision for wa
anties)
Employee benefits are not provisions under AASB 137
AASB 119 deals with employee benefits (internal)
Only obligations to parties external to entity may be recognised as a provision (AASB 137, para 20)
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LO2
Trade payables and accruals are liabilities (not provisions) because:
(a) trade payables are liabilities to pay for goods or services that have been received or supplied and have been invoiced or formally agreed with the supplier; and
(b) accruals are liabilities to pay for goods or services that have been received or supplied but have not been paid, invoiced or formally agreed with the supplier, including amounts due to employees (for example, amounts relating to accrued vacation pay). Although it is sometimes necessary to estimate the amount or timing of accruals, the uncertainty is generally much less than for provisions.
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ecognition of provisions
A provision is recognised on the Statement of Financial Position if (AASB 137, para 14):
Present obligation (legal or constructive) as a result of a past event
Probable outflow of resources to settle obligation
Amount of obligation can be reliably estimated
If these conditions are not met, no provision shall be recognised (AASB 137, para 14)
Consistent with the AASB Framework 2014
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Wa
anty expense (E↑) (for example) DR XXX
Wa
anty provision (L↑) CR XXX
To record the provision for wa
anties
LO4
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measurement of provisions
‘Best estimate’ of the consideration required to settle the present obligation at the end of the reporting period (AASB 137, para 36):
Requires professional judgements
Is calculated using ‘expected value’ estimation
Measured before tax
Due to judgement involved, auditors focus on provisions more than other normal liabilities (e.g. trade creditors)
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LO5
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wesfarmers ltd
notes to the accounts 30 june 2016
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definition of contingent liabilities
A Contingent Liability is defined as (AASB 137, para 10):
A possible obligation whose existence will be confirmed only by the occu
ence or non-occu
ence of one or more uncertain future events not wholly in control of the entity
OR
A present obligation that fails the recognition criteria because:
It is not probable an outflow of resources will be required to settle the obligation o
The amount cannot be measured reliably
Not recognised, but they are disclosed in the notes to the financial statements
Unless possibility of settlement is remote
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LO3
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eporting contingent liabilities
Examples:
Guarantees to cover another entity’s debts
Potential obligations from legal actions
Inappropriate to recognise them on the Statement of Financial Position
Disclosures in notes consist of:
Estimate of financial impact
Indication of uncertainties relating to timing of any outflow
Possibility of any reimbursement
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LO3
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wesfarmers ltd
notes to the accounts 30 june 2016
Note 23 Parent Disclosures (p. 126)
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decision tree
Provision, contingent liability, or nothing?
AASB 137 Part B – Guide on Implementing
LO4
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let’s review (1)
Some provisions traditionally recorded by entities, e. g. provisions for maintenance, may not be considered liabilities under the AASB Framework because:
Their amounts are not considered probable.
There is no entity other than the reporting entity involved in the present obligation as a result of past transactions or other past events.
They do not involve a future sacrifice of economic benefits.
The identity of the external party to whom the present obligation is owed is unknown.
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B
let’s review (2)
Dunk N’ Dive Limited is a manufacturer of swimming pools and provides its customers with wa
anties at the time of sale.
The wa
anty applies for three years from the date of sale. Past experience shows that there will be some claims under the wa
anties.
The appropriate treatment of this item under AASB 137 Provisions, Contingent Liabilities and Contingent Assets, is to:
Transfer the expected amount of the wa
anty from retained earnings to a special reserve account in equity.
Disclose by note, but do not recognise in the financial statements.
Charge the costs directly to profit or loss in the period in which the economic outflows occur.
Recognise the best estimate of costs as a provision.
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D
let’s revisit our scenario (1)
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You are the Chief Financial Officer of a company listed on the ASX.
Annual financial reports are in the final stages of preparation. Profit for the year is expected to be around $60 million
You are informed by the company’s legal officer of a pending court case. A class action has been filed by former employees for compensation for sickness caused by working for the company 20 years earlier. They are suing for $30 million.
Medical evidence has been provided that links the sickness with working with contaminated materials.
As CFO, you must make a recommendation to the CEO about the treatment of this new information.
26
decision tree
Provision, contingent liability, or nothing?
AASB 137 Part B – Guide on Implementing
LO4
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let’s revisit our scenario (2)
Choose the option