Question

In accordance with the current Conceptual Framework, define liability as one of the five elements of the statutory financial statements and outline its recognition criteria.

Further, explain whether or not you would recognise each of the following independent items as a liability, by reference to the abovementioned liability definition and recognition criteria:

1. Your company has a 30-year history of donating $5 000 each year to The Salvation Army. So far, no amount has been paid in the current year and nothing has been recorded in the accounts.
2. Your rich uncle has lent $30 000 to your small business of delivery service (a single proprietorship) to buy a van, and told you to repay him whenever you like.

3. Yesterday a court of law ordered you and all your business partners to repair significant environmental damage that your partnership firm had caused to a park next to your firm’s premises. However, you do not yet have any idea as to how much this repair work will cost for your partnership business for which negotiations are being planned for two additional loans, each worth $3 million, from City Bank and ZNA Bank respectively.

Answer 1

The official definition of liabilities define by IASB’s Framework for preparation and presentation of financial statements are the present obligations arising from past events, the settlement of which is expected to result in an outflow from entity resources embodying economic benefit.

Liabilities are classified into two different types: Current liabilities and Non-current Liabilities. Current Liabilities refer to the kind of liabilities that expected to settle within 12 months after the reporting date.

i. Normally liability arises from present obligation. But future obligations may also create liability if they are irrevocable. A forward contract to buy goods is irrevocable; therefore, gain or loss on such a contract is evaluated and recognized as an asset or a liability.

ii. Liabilities result from past transactions or other past events. Even future obligation which is irrevocable arises from past transactions or commit­ment (events) only.

iii. Normally liabilities are measurable in money terms. Sometimes liabilities are estimated which are termed as provisions. IFRS Framework defines the term liability broadly that includes provisions.

iv. Settlement of liability means giving up resources embodying economic benefits.

(A)Though the company has been paying every year to The Salvation Army it does not bind a contractual obligation on the company to pay this year also. Hence no provision needs to be made or no amount of liability is to be created for the future payment of such amount.

(B)No this also need not be considered as a liability as Uncle gave such amount out of his goodwill and no contractual obligation arises for such payment of money. The fact that he can repay whenever he likes changes the recognition criteria. Hence I should consider it as a long-term liability in my books as there is an obligation to repay the money.

(C) There is a court order for damages caused by the firm is enough to recognize a liability in their books. The amount is uncertain hence the firm has to make a reasonable estimate basing on the facts and create a long term or short term liability as per time in which the amount might be spent.