In: Accounting
A : Explain the differences between the definitions and accounting treatment for a liability, provision and contingent liability. Give 2 examples of each.
B: Give 3 examples of financial assets. Explain to a classmate the initial measurement and subsequent measurement of financial assets.
C: Give 3 examples of financial liabilities. Explain to a classmate the initial measurement and subsequent measurement of financial liabilities. (You may exclude financial guarantee contracts and commitments to provide loans at a below-market interest rate from your answer).
D: Explain to a classmate the difference in the risks for the employee and employer if the following post-employment plan is employed:
Defined contribution post-employment plan
Defined benefit post-employment plan
E: Explain to a classmate how an employer accounts for:
i) Defined contribution post-employment plans
ii) Defined benefit post-employment plans
F: Sandy Ltd is an Australian company with a 30 June year end. Sandy Ltd sells inventory to Americas Ltd for US$100 000 on 21 June 2017. The settlement date is 15 August 2017.
Explain to a friend how items related to this transaction will be recorded in Sandy Ltd’s books at 21 June 2017, 30 June 2017 and 15 August 2017.
Solution A:- Definitions and Accounting Treatment for Liability, Provision & Contingent liability
Liabilities: Liabilities are legal obligation that binds an individual or entity to transfer economic benefits including money, goods or services to another individual or entity over time.
There are basically two type of Liabilities:-
Current liabilities: Debts that are to be settled within one year viz. Account Payable, taxes and Short term loans etc For Example - Sundry Creditors (Purchase of Goods/Services on Credit from Creditor)
Long-term liabilities: Debts that are to be settled over a longer period viz. long term loans, long-term leases etc. For example - Long Term Borrowings/Loans
Accounting Treatment: There are two examples of Liabilities:-
Journal Entry for the Sundry Creditors (Shown on Liability Side of Balance Sheet ):-
Purchases A/C Debit XXX
To Sundry Creditor Credit XXX
(Being Goods purchased on Credit)
Journal Entry for the Long Term Borrowings/Loans (Shown on Liability Side of Balance Sheet):-
Bank A/C Debit XXX
To Loan A/C Credit XXX
(Being Amount borrowed for business purpose)
Provisions Liabilities: A provision is a reserve fund that a firm or a company makes out of its profits for unexpected losses. It is something that provides for decline in an asset's value. For example: provision for bad debts or provision for reduction in value of Asset (Depreciation).
Provision for Bad Debts is a provision against the unexpected losses of non-recovery of Sales Amounts from Debtors (Bad Debts)
Provision for Depreciation is the collected value of all depreciation charged to Assets. Depreciation is an expense for any company, so this amount is not credited to asset account, instead this amount is transferred to provision for depreciation account. At the end of the year this amount is calculated as whole.
Accounting Treatment: The provision is charged to profit and loss statement (Debit Side) and shown in the balance sheet (Liability Side).
Example: Journal Entry for the Provision of Bad Debts:-
Profit & Loss A/C Debit XXX
To Provision for doubtful debts Credit XXX
(Being Provision is made against the Bad Debts)
Journal Entry for the Provision for Depreciation:-
Depreciation A/C Debit XXX
To Asset A/C Credit XXX
(Being Depreciation charged to the Asset)
Provision for Depreciation A/C Debit XXX
To Depreciation A/C Credit XXX
(Being Depreciation transferred to Provision for Depreciation)
Profit & Loss A/C Debit XXX
To Provision for Depreciation Credit XXX
(Being Provision for Depreciation transferred to P&L A/C)
Contingent liability: A contingent liability is a probable future cash outflow from any activity. The amount of outflow can be estimated but the possibility of the outflow is very less. Like a civil suit, the damages payable can be somewhat estimated but you're not always sure that you will lose the case.
Accounting Treatment: It is not shown in the Balance Sheet. However, Contingent liability is shown in the footnotes at the end of balance sheet (Just of information).
Solution B:- Financial Asset and its Measurement
Financial Asset is categorized into two type:-
Initial Measurement : Initial Measurement of all financial assets, be it a debt instrument or an equity instrument, shall always be at the fair value of the investment, irrespective of the purchase price.
Subsequent Measurement:
Subsequent measurement of Debt instruments is as follows
Abbreviation:-
FVTOCI = Fair Value through Other Comprehensive Income
FVTPL = Fair Value through Profit and Loss
Amortized Cost = Opening Balance + Interest as per effective interest method - cash flows
Solution C:- Financial Liabilties and its Measurement
Financial Asset is categorized into two type:-
Solution F:- Sandy Ltd’s books at 21 June 2017, 30 June 2017 and 15 August 2017.
Journal Entry for the transactions:-
21/June/2017 Accounts receivable Debit $ 100,000
To Inventory Sales Credit $ 100,000
(Being Inventory Sold on Credit)
30/June/2017:
Closing balance of Accounting Receivable will become opening balance as on 01/July/2017. Hence, No Accounting entry required.
15/Aug/2017 Bank A/C Debit $ 100,000
To Accounts receivable Credit $ 100,000
(Being Due Amount settled)