Accounting For Liabilities

CHAPTER 11
ACCOUNTING FOR LIABILITIES
Department of Accounting
Faculty of Management Studies and Commerce
University of Sri Jayewardenepura
1
ACC1370: Financial Accounting and Reporting Department of Accounting
Learning Outcomes
At the end of this chapter, you should be able to:
1. Define liabilities, provision, contingent liabilities and financial liabilities;
2. Identify how the provisions and financial liabilities should be recognized,
measured and disclosed; and
3. Identify information to be disclosed about the contingent liabilities in the
financial statements.
2
Lesson Outline
Liabilities
 Provisions
 Contingent Liabilities
 Financial Liabilities
 Other Liabilities
3
Liabilities
• A liability is a present obligation of the entity to transfer an economic
resource as a result of past events.
(IASB Conceptual Framework 2018)
• Three key characteristics are available in liability.

– There is an obligation.
– The obligation is to transfer an economic resource.
– It is a present obligation that exists as a result of past events.
4
Recognition of Liabilities
• An item which meets the definition of a liability should only be
recognized in the financial statements if such recognition provides
users of financial statements with information that is useful, i.e., with:
(a) relevant information about the liability and about any resulting income,
expenses, or changes in equity.
(b) a faithful representation of the liability and of any resulting income,
expenses, or changes in equity.
(IASB Conceptual Framework 2018)
5
Provisions
• A liability of uncertain timing or amount.
• A provision should be recognized when:

– an entity has a present obligation (legal or constructive) as a result of a past
event;
– it is probable that an outflow of resources embodying economic benefits will
be required to settle the obligation; and
– a reliable estimate can be made of the amount of the obligation.
6
Provisions (Contd.)
1. Present Obligation
• The present obligation could be either a legal obligation or a
constructive obligation.
a) Legal obligation
May arise due to operations of;
• Contractual law (E.g. Provision for product warranty);
• Provisions in Parliament Acts (E.g. Provision for income tax); or
• Other laws (E.g. Provision for compensation for a case filed
against a company by a customer).
7
Provisions (Contd.)
Present Obligation (Contd.)
b) Constructive obligation
May arise due;
• Established pattern of past practice, published policies or a
sufficiently specific current statement, the enterprise has
indicated to other parties that it will accept certain
responsibilities; and
• Valid expectations created by enterprise on the part of those
other parties that it will discharge those responsibilities.
E.g. Provision for environmental conservation in the absence
of legal obligation to do so.
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Provisions (Contd.)
Probable Outflow of Economic Benefits
• Outflow of resources is regarded as probable if the event is more
likely to occur than not to occur.
Probability that the Probability that the

event will occur event will not
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Provisions (Contd.)
2) Probable Outflow of Economic Benefits (Contd.)
Number of similar Single obligation:

obligations: Probability is determined
Probability is determined by considering the
by considering the class individual most likely
of obligations as a whole outcome
10
Activity 11.1
Quicksilver PLC sells toasters. Toasters are sold with a six-month warranty that covers the
costs of repairing any manufacturing defects that become apparent within six-months of
purchase. If minor defects are detected in all products sold, repair costs of Rs.1,050,000
would be incurred. If major defects are detected in all products sold, repair costs of
Rs.6,500,000 would result.
Based on past experience and future expectations, Quicksilver PLC is able to estimate that
80% of all toasters sold will have no defects, 12% of goods sold will have minor defects, and
8% will have major defects.
Required:
Identify the expected cost of repairs and prepare the journal entry to record it.
11
Activity 11.1 (Answer)
Expected cost of Repair
(1,050,000*.12) +(6,500,000*0.08) = 646,000
Warranty expense Dr 646,000

Provision for warranty expense Cr 646,000
(Provision for warranty expense on toasters)
12
Activity 11.2
The following issues have arisen during the preparation of Silver PLC’s draft financial statements for the year ended 31 March
2023:
Silver PLC has two potential liabilities to assess. The first is an outstanding court case concerning a customer claiming damages
for losses due to faulty components supplied by the company. The second is the provision required for product warranty claims
against 100,000 units of retail goods supplied with a one-year warranty. The estimated outcomes of the two liabilities at the
reporting date are as follows:
Court case Product warranty claims
10% chance of no damages awarded 70% of sales will have no claim
70% chance of damages of Rs.6 million 20% of sales will require a repair of Rs.250 per each unit
20% chance of damages of Rs.4 million 10% of sales will require a repair of Rs.1,200 per each unit
Required:
Briefly explain how each of the above transactions should be treated and provide journal entries to record them in the financial statements of
Silver PLC for the year ended 31 March 2023.
13
Activity 11.2 (Answer)
The two provisions must be calculated on different bases because LKAS 37 Provisions, Contingent Liabilities and Contingent
Assets distinguishes between a single obligation (the court case) and a large population of items (the product warranty
claims).
For the court case, the most probable single likely outcome is normally considered to be the best estimate of the liability, i.e.,
Rs.6 million. The Rs.6 million will be an expense for the year ended 31 March 2023 and recognized as a provision.
Legal expenses Dr 6,000,000

Provision for court case Cr 6,000,000
(Recognition of provision for court case)
The provision for the product warranty claims should be calculated on an expected value basis at Rs.17 million (70% x100,000
x nil) + (20% x100,000 x Rs.250) + (10% x 100,000 x Rs.1200). This will also be an expense for the year ended 31 March 2021
and recognized as a current liability (it is a one-year warranty scheme) in the statement of financial position as at 31 March
2023.
Warranty expenses Dr 17,000,000

Provision for Product warranty Cr 17,000,000
(Recognition of provision for product warranty)
14
Provisions (Contd.)
3) Reliable Estimate of the Obligation
• In most cases reliable estimate can be made for an event when:
– Present Obligation and
– Probable Outflow of Economic Benefits exists.
15
Measurement
• The amount recognized as a provision should be the best estimate
of the expenditure required to settle the obligation that existed at
the reporting date.
• If the time value of money is material, the amount of a provision
should be the present value of the expenditure required to settle
the obligation.
• Provisions should be reviewed at the end of each reporting date and
adjusted to reflect the best estimate.
16
Activity 11.3
Baxter PLC is a manufacturing company specializing in making Rubber products.
The company started its operations on 1 April 2022. The manufacturing process
produces toxic chemicals which pollute the nearby environment. In order to be
eligible for the renewal of the operating license in five years, legislation requires
that a clean-up operation must be undertaken by Silver PLC on 31 March 2027. This
has an estimated cost of Rs.5 million. Silver PLC’s cost of capital is 12% per annum.
Discounting factor at 12% in five years time has a present value of 0.567.
Required:
Provide the extracts of Statement of Financial position as at 31 March 2023 and
Statement of Profit or Loss and Other Comprehensive Income for the year ended
31 March 2023 with respect to the above provision.
17
Activity 11.3 - Answer
Extracts from Statement of Financial Position as at 31 March 2023(Rs)
Non-Current Liabilities
Provision for Clean-up 3,175,200
(5,000,000*0.567+340,200)
Extracts of Statement of Profit or Loss and Other Comprehensive Income

For the year ended 31 March 2023 (Rs)
Finance Expenses
Finance cost of cleanup (5,000,000*.567*.12) 340,200
18
Provisions (Contd.)
Disclosures
• The carrying amount at the beginning and end of the period;
• Additional provisions made in the period, including increases to
existing provisions;
• Amounts used (i.e., incurred and charged against the provision)
during the period;
• Unused amounts reversed during the period; and
• The increase during the period in the discounted amount arising from
the passage of time and the effect of any change in the discount rate.
19
Contingent Liabilities
• A Possible Obligation that arises from past events and whose
existence will be confirmed only by the occurrence or non-
occurrence of one or more uncertain future events not wholly within
the control of the enterprise; or
e.g. legal case filed by one of the employees against the company claiming
that the dismissal is unfair. At the reporting date the case is being heard by the
court and the professional advice indicates the outcome of the case is
unpredictable at the moment.
20
Contingent Liabilities (Contd.)
• A Present Obligation, but is not recognized because:
– it is not probable that an outflow of resources embodying economic benefits
will be required to settle the obligation; or
e.g. a guarantee provided to a finance provider for a loan taken out by another entity
where default on that loan is uncertain as at the reporting date.
– the amount of the obligation cannot be measured with sufficient reliability.

e.g. a claim for damages against the entity, where the entity is defending the claim even
though professional advice indicates the defense is unlikely to succeed, and the amount
of the claim cannot be measured reliably as at the reporting date.
21
Contingent Liabilities (Contd.)
Disclosures
A brief description of the nature of the contingent liability and, where
practicable:
– an estimate of its financial effect;
– an indication of the uncertainties relating to the amount or timing of any
outflow; and
– the possibility of any reimbursement.
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Activity 11.4
During the year ending 31.03.2022, Mark PLC whose reporting period
ends on 31 March each year guarantees the bank overdraft of Thomson
PLC. At the time of providing the guarantee, Thomson PLC was in a sound
financial position. During the year ending, 31.03.2023, trading conditions
changed to the extent that Thomson PLC incurred substantial losses.
Required:
How would Mark PLC report the guarantee provided to Thomson PLC in
its financial statements ending 31.03.2022 and 31.03 2023?
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At 31st March 2022 it is unlikely that an outflow of resources
embodying economic benefits will occur. Hence no provision is
recognized. However, the guarantee is disclosed as a contingent
liability.
At 31 March 2023, it is probable that an outflow of resources

embodying economic benefits will occur. A provision for the best
estimate of the obligation must be recognized.
24
Figure 9.1: Decision Tree
Start
Present obligation as an Possible obligation? No

No
obligating event?
Yes Yes
Probable outflow? No Remote? Yes
Yes
No
Reliable estimate? No
Yes
Disclose as a
Provision Do nothing
contingent liability
25
Financial Instruments
Any contract that gives rise to both a financial asset of

one entity and financial liability or equity instrument of
another entity.
(Source: LKAS 32: Financial Instruments: Presentation)
26
Financial Instruments (Contd.)
Holder
Issuer
Financial
Financial
Asset Financial Liability
(E.g. Instruments
or Equity (E.g.
Investment in Issue of Shares,
Shares, Debentures)
Debentures)
27
Financial Liability Definition – (32.11)
Is any liability that is:
a) a contractual obligation:
i. to deliver cash or another financial asset to another entity; or
ii. to exchange financial assets or financial liabilities with another
entity under conditions that are potentially unfavourable to the
entity; or
b) a contract that will or may be settled in the entity’s own equity
instruments and is:
i. a non-derivative for which the entity is or may be obliged to deliver a
variable number of the entity’s own equity instruments; or
ii. a derivative that will or may be settled other than by the exchange of a
fixed amount of cash or another financial asset for a fixed number of the
entity’s own equity instruments. For this purpose the entity’s own equity
instruments do not include instruments that are themselves contracts for the
future receipt or delivery of the entity’s own equity instruments.
28
Financial Liabilities Definition
Financial liability is a contractual obligation to deliver cash or another
financial asset to another entity.
E.g. Bank overdrafts, Trade payables, Loans, Debentures issued,
Redeemable preference shares issued.
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Measurement
Financial Liabilities Initial Measurement Subsequent
Measurement
Financial Liabilities at amortized cost Fair value minus Amortized Cost
E.g. Debentures Issued, Loans, Trade transactions costs that are
Payables directly attributable to the
issue of the financial
liability.
Financial liabilities at fair value through Fair value. Transaction Fair Value
profit or loss costs are charged as an
E.g. Options expense of the period.
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Activity 11.5
On 1 April 2022, Amaya PLC issued Rs.5,000,000 of debentures to Asitha PLC. The
debentures have a life of five years, and they offer interest, payable at the end of
each financial year, at a rate of 12% p.a. The debentures were issued at Rs.5,389,079
after incurring issue cost of Rs.10,000. The debentures will be redeemed at par (face
value) at its maturity. The market requires a rate of return of 10 percent per annum
on such securities.
Required:
• Calculate the amount at which the financial liability is recognized as at 1 April
2022.
• Calculate the interest expense (finance cost) for the year ending 31 March 2023.
• Calculate the carrying amount of the financial liability as at 31 March 2027 (prior
to the redemption).
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Financial Liability
B/B/F Int. Expense Interest Paid B/C/F
5,379,079 537,908 600,000 5,316,987
5,316,987 531,699 600,000 5,248,686
5,248,686 524,869 600,000 5,173,554
5,173,554 517,355 600,000 5,090,909
5,090,909 509,091 600,000 5,000,000
5,389,079-10,000
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Other Liabilities
• Statutory Obligations
E.g. EPF Payables, ETF Payables, VAT Payables
• Deferred Obligations
E.g. Deferred Tax Liability
33
Thank
you!

Accounting For Liabilities

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Accounting For Liabilities

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CHAPTER 11

ACCOUNTING FOR LIABILITIES

• Three key characteristics are available in liability.

• A provision should be recognized when:

Probability that the Probability that the

Number of similar Single obligation:

Warranty expense Dr 646,000

Legal expenses Dr 6,000,000

Warranty expenses Dr 17,000,000

Extracts of Statement of Profit or Loss and Other Comprehensive Income

– the amount of the obligation cannot be measured with sufficient reliability.

At 31 March 2023, it is probable that an outflow of resources

Present obligation as an Possible obligation? No

Probable outflow? No Remote? Yes

Any contract that gives rise to both a financial asset of

ACC1370: Financial Accounting and Reporting Department of Accounting

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