Chapter 13

Non-Financial and Current Liabilities

Prepared by: Dragan Stojanovic, CA Rotman School of Management, University of Toronto

Non-Financial and Current Liabilities

Recognition Common Current and Liabilities Measurement What is a current liability?
Liability definition and characteristics
Financial liabilities and non-financial liabilities Measurement

Non-Financial Liabilities
Decommissioning and restoration obligations Unearned revenues

Bank indebtedness and credit facilities

Accounts payable Notes payable Current maturities of longterm debt Short-term debt expected to be refinanced Dividends payable Rents and royalties payable Customer advances and deposits Taxes payable Employee-related liabilities

Presentation, IFRS / Disclosure, and Private Analysis Enterprise GAAP Presentation and disclosure of Comparison
current liabilities Comparison chart Looking ahead

Presentation and disclosure of Product contingencies, guarantees and customer programs guarantees, and Contingencies and commitments Analysis uncertain commitments Financial guarantees Commitments

Non-Financial and Current Liabilities

Recognition Common Current and Liabilities Measurement What is a current liability?
Liability definition and characteristics
Financial liabilities and non-financial liabilities Measurement

Non-Financial Liabilities
Decommissioning and restoration obligations Unearned revenues

Bank indebtedness and credit facilities

Accounts payable Notes payable Current maturities of longterm debt Short-term debt expected to be refinanced Dividends payable Rents and royalties payable Customer advances and deposits Taxes payable Employee-related liabilities

Presentation, IFRS / Disclosure, and Private Analysis Enterprise GAAP Presentation and disclosure of Comparison
current liabilities Comparison chart Looking ahead

Presentation and disclosure of Product contingencies, guarantees and customer programs guarantees, and Contingencies and commitments Analysis uncertain commitments Financial guarantees Commitments

Current Definition and Characteristics

IFRS and Accounting Standards for Private Enterprises currently define a liability as
Obligation of an enterprise Arising from past transactions or events The settlement of which may result in the

transfer or use of assets, provision of services, or other yielding of economic benefits in the future

Current Definition and Characteristics

Current definition therefore describes three essential characteristics of a liability as:
1. Obligation requiring the transfer or use of an asset or provision of a service or giving up other economic benefits, to be settled on a determinable date or on the occurrence of an event or on demand 2. There is little or no discretion to avoid the obligation 3. Obligation arises from a transaction or event which has already occurred
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Proposed Definition and Characteristics

Proposed definition of a liability is
Present economic obligation For which the entity is the obligor

Proposed Definition and Characteristics

Based on this definition, liability would have three essential characteristics: Exists at present time (i.e. at balance sheet date) Represents economic burdens or obligations
Always includes unconditional obligations

(including stand-ready obligations)

These burdens / obligations are enforceable
Includes constructive obligations (obligations

based on entitys present/past practices)

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Financial Liabilities
Financial liability is any liability that is a contractual obligation to either: 1. deliver cash or other financial asset to another party, or 2. to exchange financial instruments with another party under conditions that are potentially unfavourable Measurement rules are significantly different based on whether the liability is considered financial or non-financial

Measurement of Financial vs. Non-Financial Liabilities

Financial liabilities
Initially measured at fair value Subsequent measurement generally at amortized cost (except those held for trading, such as derivatives, where fair value is used)

Non-financial liabilities

PE GAAP: no specific measurement standards (measurement varies based on nature of liability) IFRS: measured at best estimate of payment that would be required to settle the obligation at balance sheet date
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Non-Financial and Current Liabilities

Recognition Common Current and Liabilities Measurement What is a current liability?
Liability definition and characteristics
Financial liabilities and non-financial liabilities Measurement

Non-Financial Liabilities
Decommissioning and restoration obligations Unearned revenues

Bank indebtedness and credit facilities

Accounts payable Notes payable Current maturities of longterm debt Short-term debt expected to be refinanced Dividends payable Rents and royalties payable Customer advances and deposits Taxes payable Employee-related liabilities

Presentation, IFRS / Disclosure, and Private Analysis Enterprise GAAP Presentation and disclosure of Comparison
current liabilities Comparison chart Looking ahead

Presentation and disclosure of Product contingencies, guarantees and customer programs guarantees, and Contingencies and commitments Analysis uncertain commitments Financial guarantees Commitments

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Current Liabilities
Under IFRS, liabilities are classified as current when

they meet any one of the following conditions:

1.
2. 3.

Expected to be settled within normal operating cycle

Held primarily for trading Due within 12 months from balance sheet date

4.

No unconditional right to defer settlement for at least 12 months after balance sheet date

PE GAAP has no specific definition, but has same intent

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Bank Indebtedness
Line-of-credit (revolving debt) Generally, an agreement entered with the bank that allows multiple borrowings up to a negotiated limit Repayments made whenever there are sufficient funds available Amount borrowed reported on the balance sheet; availability of funds and restrictions imposed by the financial institution requires note disclosure
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Accounts Payable
Amounts owed for goods, supplies or services purchased on open account Generally recorded when title has passed Recorded at amount payable

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Notes Payable
Notes payable are written promises to pay a sum of money on a specified future date Arises from purchases, financing or other transactions Notes payable may be classified as either short-term or long-term Notes payable may be interest-bearing or zero-interest-bearing (non-interest-bearing) In both cases, interest expense is determined whenever financial statements are prepared
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Interest-Bearing Notes Payable

Given: Landscape Corp. borrows $100,000 Signs a 4-month, 12% note on March 1
Journal Entries to record Signing of note Interest accrual at June 30 year end and Note repayment

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Interest-Bearing Notes Payable

March 1: Cash 100,000 Notes Payable 100,000 June 30: Interest Expense 4,000 Interest Payable 4,000 (100,000 x 12% x 4/12) July 1: Notes Payable Interest Payable Cash 100,000 4,000 104,000

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Zero-Interest-Bearing Notes Payable

For zero-interest-bearing notes, the difference between the present value of the note and the face value of the note represents the discount on the note payable and the related interest The discount is the interest expense recorded over the life of the note

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Zero-Interest-Bearing Notes Payable

Given:
Landscape Corp. issues a $104,000, 4-month, zero-interest-bearing note on March 1 Present value (PV) of note and cash received is $100,000 Journal entries to record the signing and repayment of the note

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Zero-Interest-Bearing Notes Payable

March 1: Cash Discount on Note Payable Notes Payable 100,000 4,000

104,000

In effect: $100,000 borrowed for four months and $4,000 interest = $104,000 maturity value

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Zero-Interest-Bearing Notes Payable

June 30: Interest Expense Discount on Note Payable July 1: Note Payable Cash

4,000 4,000

104,000 104,000

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Current Maturities of Long-Term Debt

The portion of long-term debt maturing within 12 months from the balance sheet date is reported as a current liability Portions of long-term debts should not be reported as current liabilities if, by contract, they are retired by assets not classified as current assets Any liability due on demand, or due on demand within a year or operating cycle, is reported as a current liability
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Short-Term Debt Expected to be Refinanced

IFRS has more stringent rules than PE GAAP Under IFRS, debt due within 12 months is classified as current, unless at balance sheet date the company has the intent and a right (under existing contract, and solely in its discretion) to refinance with long-term debt

Under PE GAAP, currently maturing debt can be classified as long-term if there is irrefutable evidence at time of issuing financial statements that debt has been or will be converted to long-term debt
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Dividends Payable
Cash Dividend Becomes legal obligation on declaration date Classified as current liability Preferred Dividends in Arrears Cumulative preferred dividends that have not been declared require note disclosure Not recognized as a liability Stock Dividends Not a liability; does not meet the definition of a liability as no future outlays of assets/services Recorded only through equity accounts i.e. represents a transfer of equity from retained earnings to contributed capital 23

Rents and Royalties Payable

This type of liability may be created by a contractual agreement in which payments are conditional on the amount of revenue that is earned or the quantity of product that is produced or extracted. Examples include the following: Franchisees often pay the franchisor franchise fees calculated as a % of sales Tenants in shopping centers may be required to pay additional rents based on sales
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Customer Advances and Deposits

Customers may pay deposits that guarantee the payment of expected future obligations or the performance of a future service They are classified as either current or noncurrent liabilities depending on specific conditions

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Taxes Payable
Most businesses in Canada pay Goods and Services Tax (GST) As of July 1, 2008 GST is calculated at a rate of 5% GST Payable Represents amount collected on eligible sales GST Recoverable GST paid on eligible purchases Net amount of GST Payable and GST Recoverable remitted to (due from) Canada Revenue Agency (CRA)
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Employee-Related Liabilities
Employee-related liabilities include the following: Salaries or wages owed to employees at end of the accounting period Payroll deductions owed to CRA and others Short-term compensated absences Profit-sharing and bonuses Usually reported as current liabilities
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Payroll Deductions
Payroll deductions include statutory and discretionary deductions Statutory (mandatory) deductions include: Canada (Quebec) Pension Plan [CPP/QPP] Employment Insurance (EI) Income Tax Withholding (Federal and Provincial) Discretionary deductions might include: Insurance premiums Union dues Until these deductions are remitted to the government, they are reported as current liabilities
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Short-Term Compensated Absences

Compensated absences are absences from employment for which employees are paid There are two main types: Accumulating

Employee rights accruing with employee service (e.g. vacation and statutory holidays) Expense and liability recognized as earned by employees
Employee rights based on occurrence of obligating event (e.g. disability, parental leave, etc) Expense and liability recognized at time of obligating event
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Non-accumulating

Use best estimate of future pay-rates to estimate future liability (often, current rates of pay are used)

Non-Financial and Current Liabilities

Recognition Common Current and Liabilities Measurement What is a current liability?
Liability definition and characteristics
Financial liabilities and non-financial liabilities Measurement

Non-Financial Liabilities
Decommissioning and restoration obligations Unearned revenues

Bank indebtedness and credit facilities

Accounts payable Notes payable Current maturities of longterm debt Short-term debt expected to be refinanced Dividends payable Rents and royalties payable Customer advances and deposits Taxes payable Employee-related liabilities

Presentation, IFRS / Disclosure, and Private Analysis Enterprise GAAP Presentation and disclosure of Comparison
current liabilities Comparison chart Looking ahead

Presentation and disclosure of Product contingencies, guarantees and customer programs guarantees, and Contingencies and commitments Analysis uncertain commitments Financial guarantees Commitments

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Decommissioning and Restoration Obligations

Obligation associated with retirement of a longlived asset must be recognized when incurred Existing legal obligations include those related to:
1. Decommissioning nuclear facilities 2. Dismantling, restoring, and reclamation of oil and gas properties, 3. Certain closure, reclamation, and removal costs of mining facilities, and 4. Closure and post-closure costs of landfills

Liability also known as asset retirement obligation (ARO) or site restoration obligation
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Decommissioning and Restoration Obligations

PE GAAP recognizes cost of legal obligations only, while IFRS also includes constructive obligations Initial measurement at best estimate of the expenditure required to settle the present obligation at balance sheet date Need to discount future costs (i.e. present value) Recognition and allocation Capitalized costs are not recorded in separate account Added to the carrying amount of the underlying asset Amortized over underlying assets useful life 32

ARO An Example
Oil Platform erected January 1, 2011
Platform must be dismantled at the end of the useful life: 5 years

Estimated cost of dismantling: $1,000,000

Discount rate: 10% PV of the dismantling cost (ARO): $620,920
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ARO An Example
Journal entry to recognize ARO, Jan 1, 2011: Drilling Platform 620,920 Asset Retirement Obligation 620,920
(Drilling Platform is the underlying asset account)

Year-end Adjustment journal entries (2011 2015): Amortization Expense 124,184 Accumulated Amortization 124,184
($620,920 5 years = $124,184 assuming straight-line method)
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Decommissioning and Restoration Obligations: Interest

Interest must also be recorded because the obligation is initially recorded and reported at PV Interest cost classified as Accretion expense (under PE GAAP) Interest Expense (IFRS) Amount calculated using the same rate used to calculate the PV (the discount rate)

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ARO An Example
Year-end (December 31, 2011): Accretion Expense (PE GAAP) 62,092 or Interest Expense (IFRS) 62,092 Asset Retirement Obligation
($620,920 x 10% = $62,092)

62,092

Record Settlement, January 2016: Asset Retirement Obligation 1,000,000 Gain on Settlement of ARO 5,000 Cash 995,000
Assuming that the actual cost of the dismantling and removal was $995,000
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Unearned Revenues
When cash is received before the product is delivered or service is rendered Examples include gift certificates, prepayment for subscription A current liability is created by the transaction When cash is received: Dr. Cash Cr. Unearned Revenue When revenue is earned (service or good is provided) Dr. Unearned Revenue Cr. Revenue
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Product Guarantees and Customer Programs

Continuing obligation results when an entity provides customer programs requiring that goods or services be provided after the initial product or service is delivered There are two approaches to accounting for the outstanding liability

Expense approach
Liability is measured at cost of meeting the obligation, and expense is matched against period revenues (current)

Revenue approach
Liability is measured at value of the service to be provided (not cost) and recognized in revenue as earned (future)
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Product Guarantees and Warranty Obligations

Warranty (product guarantee) is a promise made by a seller to correct problems experienced with a products quantity, quality, or performance These are stand-ready obligations at reporting date that result in future post-sale costs

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Expense Approach: Example

Given: Warranty provided at no additional charge and all revenues considered earned at time of sale Units sold in 2011: 100 units at $5,000 Expected average repair cost (under 1-year warranty) per unit: $200 Actual repair costs incurred in 2011: $4,000 The entity has the calendar year as its fiscal year
Record the warranty expense for 2011
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Expense Approach: Example

Warranty Expense Recognition (Time of Sale): No entry made
Actual Warranty Costs in 2011: Warranty Expense 4,000 Cash/Inventory/Payroll 4,000 Year-end adjusting entry, Dec. 31, 2011: Warranty Expense 16,000 Estimated Warranty Liability 16,000
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Product Guarantee and Warranty Obligations-Use of Cash Basis

Warranty costs charged to the period in which the costs are paid No estimated liability recorded or reported Acceptable for accounting purposes when: Warranty costs are immaterial, or Warranty period is relatively short Required for income tax purposes

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Warranty Sold Separately

Applies to extended product warranties; or warranties sold as separate product (or having stand-alone value) Accounted for using revenue approach Revenue from warranty sale deferred Recognized over life of the warranty generally using straight-line method

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Revenue Approach: Example

Sold equipment as follows: Date of sale: January 2, 2011 Total sale price of equipment: $20,000 Equipment includes two-year warranty Estimated stand-alone value of two-year warranty (if purchased separately) : $1,200 Assume costs of $423 were incurred in 2011 to service the warranty Entries to record this transaction for 2011:
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Revenue Approach: Example

Record the initial sale on January 2, 2011: Cash 20,000 Sales-Equipment 20,000 Unearned Warranty Revenue 1,200 Recognize warranty revenue in 2011: Unearned Warranty Revenue 600 Warranty Revenue 600 ($1,200 2 years = $600, assuming straight-line)

Recognize warranty costs as incurred in 2011: Unearned Contract Expense 423 Accounts Payable / Payroll 423 Represents actual costs incurred
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Customer Loyalty Programs

Many companies offer customer loyalty programs (such as frequent flyer miles, discounts, etc) Under IFRS, revenues from original sales that give rise to loyalty points (or other award credits) should be allocated Fair value of award credits should be deferred as unearned revenue and recognized when exchanged for promised rewards While PE GAAP does not have a specific standard on loyalty programs, it has similar intent
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Premiums and Rebates

Premiums, coupons, contests, and other benefits have generally been accounted for under the expense approach In the future, standards may focus on measuring such obligations at their value (not estimated cost)

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Contingency: Definition
A contingency is: an existing condition or situation involving uncertainty as to possible gain or loss that will ultimately be resolved when one or more future events occur or fail to occur
(CICA Handbook, Part II, Section 3290)

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Loss Contingencies: General

Loss contingencies involve situations of

possible loss at the balance sheet date PE GAAP and IFRS have different terminology and accounting rules for contingent losses

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Loss Contingencies: Accrual

PE GAAP: A liability incurred as a result of a loss contingency is a contingent liability The likelihood of occurrence of the future event may be:
Likely (high chance) Unlikely (slight chance) Not determinable (the chance of the event

occurrence cannot be determined)

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Loss Contingencies: Accrual

PE GAAP: Under PE GAAP, estimated losses are accrued as contingent liabilities if both of the following conditions are met: 1. it is likely that a future event will confirm that a liability has been incurred, at the balance sheet date and 2. the amount of loss can be reasonably estimated

Disclosure in notes is still required even if Likelihood is not determinable, or Cannot establish reasonable estimate

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Loss Contingencies: Accrual

IFRS: Under IFRS, estimated losses from loss contingencies are accrued as liabilities (called provisions) if:

the occurrence of the confirming future event is probable (less strict than likely), and amounts are reliably measurable

Measurement of liability is made using the expected value method (takes into account probabilities of possible outcomes) Term contingent liabilities is used only for possible obligations that are not recognized Disclosure required unless likelihood is remote

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Litigation, Claims, and Assessments

To determine whether a liability should be recorded, evaluate: 1. the time period in which the underlying cause of action occurred 2. the probability of an unfavorable outcome 3. the ability to make a reasonable estimate of loss

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Litigation, Claims, and Assessments

To evaluate the likelihood of an unfavourable

outcome, consider:
nature of litigation and progress of case opinion of legal counsel
experience in similar cases company response to the lawsuit

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Future Approach to Contingencies

Under proposed IFRS changes, term contingent liabilities is removed Situation is either a liability (unconditional obligation at balance sheet date) or not Uncertainty about amounts payable in future are considered questions of measurement, and not existence of the liability There is no probability threshold to provide guidance for difficult situations

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Financial Guarantees
Example: standby letter of credit guaranteeing anothers payment of a loan PE GAAP follows rules for loss contingencies, with additional disclosure requirements Under IFRS, recognize guarantee at fair value Key focus is to give users information about risks assumed by being a guarantor

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Commitments

Executory contracts are agreements where neither party has yet performed These commitments are not considered liabilities as at balance sheet date, but they do represent a contractual obligation of future funds Disclosure is required for abnormal commitments or ones that carry significant risks

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Non-Financial and Current Liabilities

Recognition Common Current and Liabilities Measurement What is a current liability?
Liability definition and characteristics
Financial liabilities and non-financial liabilities Measurement

Non-Financial Liabilities
Decommissioning and restoration obligations Unearned revenues

Bank indebtedness and credit facilities

Accounts payable Notes payable Current maturities of longterm debt Short-term debt expected to be refinanced Dividends payable Rents and royalties payable Customer advances and deposits Taxes payable Employee-related liabilities

Presentation, IFRS / Disclosure, and Private Analysis Enterprise GAAP Presentation and disclosure of Comparison
current liabilities Comparison chart Looking ahead

Presentation and disclosure of Product contingencies, guarantees and customer programs guarantees, and Contingencies and commitments Analysis uncertain commitments Financial guarantees Commitments

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Presentation and Disclosure of Current Liabilities

Disclose separately: bank loans, trade creditors and accrued liabilities, taxes, dividends, deferred revenue, future income taxes, amounts owing to related parties Identify secured liabilities and related assets pledged

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Analysis of Current Liabilities

Current Ratio: Current Assets Current Liabilities Acid-Test Ratio: Cash + Marketable Securities + Net Receivables Current Liabilities Days Payables Outstanding: Average Trade Accounts Payable Average Daily Cost of Goods Sold

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Non-Financial and Current Liabilities

Recognition Common Current and Liabilities Measurement What is a current liability?
Liability definition and characteristics
Financial liabilities and non-financial liabilities Measurement

Non-Financial Liabilities
Decommissioning and restoration obligations Unearned revenues

Bank indebtedness and credit facilities

Accounts payable Notes payable Current maturities of longterm debt Short-term debt expected to be refinanced Dividends payable Rents and royalties payable Customer advances and deposits Taxes payable Employee-related liabilities

Presentation, IFRS / Disclosure, and Private Analysis Enterprise GAAP Presentation and disclosure of Comparison
current liabilities Comparison chart Looking ahead

Presentation and disclosure of Product contingencies, guarantees and customer programs guarantees, and Contingencies and commitments Analysis uncertain commitments Financial guarantees Commitments

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Looking Ahead
Changes are expected as a result of the work on the conceptual framework by IASB and FASB As a result, definition of liability and application of recognition criteria are expected to change

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Copyright 2010 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein.

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