Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes

Page 1 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 1 preview image

INTERMEDIATE ACCOUNTING – VOLUME IICICA HANDBOOKIntroduction and Overview:The CICA Accounting Handbook is comprised of the following:PART IACCOUNTING, PART IInternational Financial Reporting Standards (IFRS)PART IIACCOUNTING, PART IIAccounting Standards for Private Enterprises (ASPE)PART IIIACCOUNTING, PART IIIAccounting Standards for Not-for-profit organizationsPART IVACCOUNTING, PART IVAccounting Standards for PensionsPART VACCOUNTING, PART VPre-changeover accounting standardsNote that the focus of this text is on the first two parts. Part II is commonly referredto as Accounting Standards for Private Enterprises (ASPE) and includes manyof the provisions in the pre-changeover accounting standards, though manyhave been simplified.Both ASPE and IFRS are required for year-ends beginning on or after 2011. Aprivate enterprise is one that has not issued, and is not in the process of

Page 2 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 2 preview image

Page 3 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 3 preview image

issuing debt or equity instruments that are, or will be, outstanding and tradedon a public market. A private enterprise does not hold assets in a fiduciarycapacity for a broad group of outsiders as one of its primary businesses.

Page 4 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 4 preview image

CHAPTER 13NON-FINANCIAL AND CURRENT LIABILITIESCHAPTER TOPICS CROSS-REFERENCED WITH THECICA HANDBOOK, PART I (IFRS) AND PART II (ASPE)Cash and Cash EquivalentsIAS 7Section 1540Current Assets and Current LiabilitiesIAS 1Section 1510Non-financial liabilitiesIAS 37 andIFRIC 13—Asset Retirement ObligationsIAS 37Section 3110Contractual ObligationsIAS 37Section 3280ContingenciesIAS 37Section 3290Financial Instruments—Recognition andMeasurementIAS 39Section 3856Financial Instruments—PresentationIAS 32Section 1521Financial Instruments—DisclosureIFRS 7Section 3856Disclosure of guaranteesIAS 37AcG-14Proposed amendments to IAS 37IASBExposure DraftED/2010/1—

Page 5 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 5 preview image

Page 6 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 6 preview image

LEARNING OBJECTIVES1.Understand the importance of non-financial and current liabilities from a businessperspective.2.Define liabilities, distinguish financial liabilities from other liabilities, and identifyhow they are measured.3.Define current liabilities and identify and account for common types of currentliabilities.4.Identify and account for the major types of employee-related liabilities.5.Explaintherecognition,measurement,anddisclosurerequirementsfordecommissioning and restoration obligations.6.Explain the issues and account for unearned revenues.7.Explain the issues and account for product guarantees and other customerprogram obligations.8.Explain and apply two approaches to the recognition of contingencies anduncertain commitments, and identify the accounting and reporting requirementsfor guarantees and commitments.9.Indicate how non-financial and current liabilities are presented and analyzed.10.Identify differences in accounting between IFRS and ASPE and what changes areexpected in the near future.

Page 7 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 7 preview image

CHAPTER REVIEW1.Chapter 13 explains the basic principles regarding accounting and reporting forcommon current liabilities and a variety of non-financial liabilities. Contingencies,commitments, and guarantees are also addressed. Explanations regarding non-financial liabilities under international standards are based on current IAS 37Provisions, Contingent Liabilities and Contingent Assetsand materials underlyingexpected revisions to this standard. In 2010 the IASB released an exposure draftof amendments to IAS 37 and invited comments on the draft. As of April 2012, theproject has been paused pending other discussions.Current Liabilities2.Existing IFRS and ASPE state liabilities have three essential characteristics:1.They embody a duty or responsibility.2.The entity has little or no discretion to avoid the obligation.3.The transaction or other event creating the obligation has alreadyoccurred.This is similar to the current proposed definition in Conceptual Framework—Elements and Recognition Project that states liabilities have three essentialcharacteristics:1.They exist at the present time2.They represent economic burdens or obligations3.The obligations are enforceable on the obligor entity.However, the key difference between the two is in how they are applied – the newdefinition will result in recognizing a liability whenever an unconditional obligationexists at the reporting date. Any uncertainty about the amount to be given up inthe future is considered when measuring the liability.3.A distinction is made between financial liabilities and those that are not financial innature.Financial liabilities are contractual obligations to deliver cash or otherfinancial assets to another entity, or to exchange financial assets or financialliabilities with another entity under conditions that are potentially unfavourable tothe entity.For example, unearned revenue is not a financial liability because itdoes not require the delivery of cash or another financial asset. Legislatedliabilities such as income taxes payable are not created by a contract so they donot qualify as financial liabilities either.

Page 8 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 8 preview image

4.Financial liabilities are initially measured at fair value and subsequently atamortized cost. Short-term financial liabilities, such as account payable, areaccounted for at their maturity value if the amount is immaterial. Non-financialliabilities under ASPE are generally measured at the fair value of the goods orservices to be delivered in the future. Under IFRS, non-financial liabilities aremeasured initially and at each subsequent reporting date at the best estimate ofthe amount the entity would rationally pay at the statement of financial positiondate to settle the present obligation.5.Liabilities areclassifiedonthestatement offinancial position ascurrentobligations orlong-termobligations.Current liabilitiesare those obligationswhose liquidation is reasonably expected to require use of existing resourcesclassified as current assets, or the creation of other current liabilities.6.The relationship between current assets and current liabilities is an importantfactor in the analysis of a company's financial condition. A liability is classified ascurrent under IFRS when ONE of the following conditions are met:1.It is expected to be settled in the entity’s normal operatingcycle2.It is held primarily for trading3.It is due within 12 months from the end of the reporting period4.The entity does not have an unconditional right to defer itssettlement for at least 12 months after the statement offinancial position date.COMMON CURRENT LIABILITIESBank Indebtedness and Credit Facilities1.The cash position of a company is closely related to its bank indebtedness forcurrent operating purposes and itsassociated line-of-credit or revolving debtarrangements. Instead of having to negotiate a new loan every time the companyneeds funds, it generally enters into an agreement with its bank to make multipleborrowings up to a negotiated limit. The company draws on the fund as neededand is normally required to make pre-negotiated repayments.

Page 9 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 9 preview image

Accounts Payable1.Accounts payablerepresent obligations owed to others for goods, supplies, andservices purchased on open account. These obligations, commonly known astrade accounts payable, should be recorded to coincide with the receipt of thegoods or at the time title passes to the purchaser. Attention must be paid totransactions occurring near the end of one accounting period and at the beginningof the next to ascertain that the goods received (inventory) are in agreement withthe liability (accounts payable) and that both are recorded in the proper period.Notes Payable1.Notes payableare written promises to pay a certain sum of money on a specifiedfuture date and may arise from sales, financing, or other transactions. Notes maybe classified as short-term or long-term, depending on the payment due date.2.Short-term notes payable resulting from borrowing funds from a lending institutionmay beinterest-bearingornon-interest-bearing(i.e., zero-interest-bearing).Interest-bearing notes payable are reported as a liability at the face amount of thenote along with any accrued interest payable. A zero-interest-bearing note doesnot explicitly state an interest rate on the face of the note. Interest is thedifference between the present value of the note and the face value of the note atmaturity. For example, assume that Landscape Corp. issues a $100,000, four-month, zero-interest-bearing note payable to the Provincial Bank on March 1. Thenote’s present value is $96,154, based on the bank’s discount rate of 12%. Theentry to record this transaction for Landscape Corp. would be as follows:Cash96,154Notes Payable96,1543.The currently maturing portion of long-term debts may be classified as a currentliability. When a portion of long-term debt is so classified, it is assumed that theamount will be paid within the next 12 months out of funds classified as currentassets.

Page 10 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 10 preview image

4.A liability due on demand (callable debt) is classified as current even if the debtagreement has a payment schedule over several years. Liabilities that becomecallable by the creditor because of a violation of a debt covenant will be classifiedas current, even if previously classified as long-term debt. Under IFRS, thisclassification will hold even if the lender agrees between the balance sheet dateand the date the financial statements are released that it will not demandrepayment because of the violation. This is because the lender, not the entity,was the one holding the unconditional right to defer the payment beyond 12months from the reporting date. Under ASPE, the liability is reclassified as currentunless:a.the creditor waives the covenant (agreement) requirements,orb.the violation has been cured within the grace period that is usually givenin these agreements,andc.it is likely that the company will not violate the covenant requirements witha year from the statement of financial position date.Short-Term Debt Expected to be Refinanced on a Long-Term Basis1.UnderIFRS, if the debt is due within 12 months from the reporting date, it isclassified as a current liability even if a long-term financing has been completedbefore the financial statements are released. The only exception is if, at thestatement of financial position date, the entity expects to refinance it or roll it overunder an existing agreement for at least 12 months and the decision is solely atits discretion. Under ASPE, short-term obligations expected to be refinanced on along-term basis could beexcludedfrom current liabilities if the liability has beenrefinanced on a long-term basis or there is a non-cancellable agreement to do sobefore the financial statements are completed and nothing stands in the way ofcompleting the refinancing.Dividends Payable1.Cash dividends payableare classified as current liabilities during the periodsubsequent to declaration and prior to payment. Once declared, a cash dividendis a binding obligation of a corporate entity, payable to its shareholders.Stockdividends payableare reported in the shareholders' equity section whendeclared, and dividends payable in the form of additional shares are notrecognized as a liability.

Page 11 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 11 preview image

Rents and royalties payable1.Rents and royaltiesare contractual agreements covering rent or royalty paymentswhich are conditional on the amount of revenues earned or the quantity of productproduced or extracted. As each additional unit of product is produced orextracted, an additional obligation, usually a current liability, is created.Customer Advances and Deposits1.Whenreturnable deposits or customer advancesare received from customersor employees, a liability corresponding to the asset received is recorded. Theclassification of these items as current or non-current liabilities is dependent onthe time involved between the date of the deposit and the termination of therelationship that required the deposit.Taxes Payable1.Current tax laws require most business enterprises to collect sales taxes fromcustomers and income taxes from employees during the year and periodicallyremit these collections to the appropriate governmental unit. In such instances,the enterprise is acting as a collection agency for a third party. If tax amounts dueto governmental units are on hand at the financial statement date, they arereported as current liabilities.2.Sales Taxes Payable: To illustrate the collection and remittance of sales tax by acompany, assume that Bentham Company recorded sales for the period of$230,000. Further assume that Bentham is subject to a 7% sales tax collectionthat must be remitted to the provincial government. The entry to record the salestax liability is:Accounts Receivable246,100Sales230,000Sales Tax Payable16,100When payment is made, the sales tax payable would be debited and cash couldbe credited.

Page 12 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 12 preview image

3.Goods and Services Tax: Most businesses in Canada are subject to a goods andservices tax (GST). Because companies are permitted to offset the recoverableand payable amounts, only the net balance of the two accounts is reported on thestatement of financial position. Until net credit balances are remitted to theCanada Revenue Agency, they are reported as current liability. A net debitbalance is reported as a current asset.In the provinces with a Harmonized SalesTax (HST), the full HST amount is treated the same as shown for the GST.4.Income Taxes Payable: A corporation should estimate and record the amount ofincome tax liability as computed per its income tax return. Chapter 18 discusses indetail the complexities involved in accounting for the difference between taxableincome under the tax laws and accounting income under generally acceptedaccounting principles.Employee-Related Liabilities1.Amounts owed to employees for salaries or wages of an accounting period arereported as a current liability. The following items are related to employeecompensation and are often reported as current liabilities:a.Payroll deduction.b.Short-term compensated absences.c.Profit-sharing and bonuses.2.The following illustrates the concept of accrued liabilities related to payrolldeductions. Assume a weekly payroll of $10,000 that is entirely subject to CanadaPension (4.95%) and Employment Insurance (1.83%) deductions. Also, incometax withholding amounts to $1,320, and union dues to $88. Two entries arenecessary to record the payroll, the first for the wages paid to employees and thesecond for the employer’s payroll taxes. The two entries are as follows:Wages and Salaries10,000.00Employee Income Taxes Payable1,320.00CPP Contributions Payable495.00EI Premiums Payable183.00Union Dues Payable88.00Cash7,914.00Payroll Tax Expense751.20CPP Contributions Payable ($495 x 1.0)495.00EI Premiums Payable ($183 x 1.4)256.20

Page 13 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 13 preview image

3.Compensated absencesare absences from employment, such as vacation,illness, maternity, paternity, and holidays, for which it is expected that employeeswill be paid. In connection with compensated absences,vested rightsexist whenan employer has an obligation to make payment to an employee even if thatemployee terminates.Accumulated rightsare those rights that can be carriedforward to future periods if not used in the period in which earned.Accumulatedrightsthat are not vested, but can be carried forward to future periods, must alsobe recorded. However, the accrued amount can be adjusted for estimatedforfeitures duetoturnover.Non-accumulating rightsare those to whichemployees are entitled if a specific event occurs, such as parental leave or short-term disability. As a result, no accrual is recorded, and the company onlyrecognizes an expense when the obligating event occurs (theevent accrualmethod).4.Theexpenseandrelatedliabilityforcompensatedabsencesshouldberecognized in the year in which they are earned by the employees, whenever areasonable estimate can be made of the amounts expected to be paid out in thefuture. To determine the cost of compensated absences, companies are morelikely to use the current wage rate rather than a future rate, which is less certainand raises issues concerning the discounting of the future amount.5.The accounting and reporting standards for post-retirement benefit payments arecomplex and are discussed extensively in Chapter 19.6.An obligation under a profit-sharing or bonus plan must be accounted for as anexpense and not a distribution of profit, since it results from employee service andnot a transaction with owners.Bonusagreements and profit-sharing plansarecommon incentives established by companies for certain key executives oremployees, though they may be open to all employees. In many cases, thepayment is dependent upon the amount of income earned by the company.However,becausethepaymentisacompensationexpensedeductedindetermining net income, it must be deducted before net income can be computed.Thus, we end up with the need to solve an algebraic formula to compute thebonus. In addition, when the concept of income taxes is added to the formula,calculation of the bonus requires solving simultaneous equations.

Page 14 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 14 preview image

NON-FINANCIAL LIABILITIESDecommissioning and Restoration ObligationsAsset Retirement Obligations1.In industries such as mining or oil drilling, the construction and operation of long-lived assets often involves obligations at the time of retirement of those assets. Acompany must recognize anasset retirement obligation (ARO), an existinglegal obligation associated with the retirement of a tangible long-lived asset thatresults from its acquisition, construction, development, or normal operation in theperiod in which it is incurred, if its fair value can be reasonably estimated.Ifa fair value cannot be reasonably estimated, the details must be reported in thenotes.2.Obligating Event.Existing legal obligation that requires the recognition of aliability and asset cost such as the cost of restoring or reclaiming oil and gasproperties.3.Measurement. Under theCICA Handbook, Part II (ASPE), Section 3110.09, anARO is initially measured at the best estimate of the expenditure required to settlethe present obligation at the reporting date, which is similar to the proposedrevision.4.Recognition and Allocation.The estimated costs of the ARO are included in thecarrying amount of the related long-lived asset in the same amount as the liabilityrecognized. An asset retirement cost is recorded as part of the related assetbecause these costs are considered a cost of operating the asset. Therefore, thespecific asset, e.g., mine, drilling platform, nuclear power plant, should beincreased and should not be recorded as a separate account. The ARO isamortized to expense over the related asset’s useful life. Because the liability ismeasured on a discounted basis, interest on the liability is recognized each periodas an increase in the carrying amount of the liability and either an accretionexpense (ASPE, operating cost) or an interest expense (IFRS, interest orborrowing cost). Subsequent changes in the ARO due to production are added tothe asset’s capital cost under ASPE and inventoried under IFRS.5.Reporting and Disclosure Requirements.Most of the AROs are long-term innature and should be shown outside current liabilities, providing details of theAROs and associated long-lived assets.

Page 15 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 15 preview image

Unearned Revenues1.A company sometimes receives cash in advance of the performance of servicesor issuance of merchandise. Such transactions result in a credit to a deferred orunearned revenue account classified as a current liability on the statement offinancial position. As claims of this nature are redeemed, the liability is reducedand a revenue account is credited.Product Guarantees and Customer ProgramsWarranties1.Awarranty(product guarantee) represents a promise by a seller to a buyer tomake good on any deficiency in quantity, quality, or performance specifications ina product. Product warranty costs may be accounted for by using thecash basismethodor theaccrual method. The cash basis method must be used for incometax purposes and for financial accounting purposes when a reasonable estimateof warranty costs cannot be made at the time of sale. The accrual methodincludes two different accounting treatments:a) expense warranty approach,andb)revenue warranty approach.2.The expense warranty treatment should be used whenever the warranty is anintegral and inseparable part of the sale and is viewed as a loss contingency.Under the expense warranty approach the liability is measured at the estimatedcost of meeting the obligation and recorded in the period of the sale. There is noeffect on future income if the estimated and actual costs are close. Warrantyexpense is recorded in the year in which the item subject to the warranty is sold.When the warranty is honoured in a subsequent period the liability is reduced bythe amount of the expenditure to repair the item. For example, if 200 units aresold for $5,000 each and the estimated warranty cost is $300 per unit, thefollowing entry would be made for the sale and the warranty:Cash ($5,000 x 200)1,000,000Sales1,000,000Warranty Expense60,000Estimated Liability Under Warranty60,000Actual expenditures made to honour the warranty would debit the liability accountand credit cash.

Page 16 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 16 preview image

3.The revenue warranty treatment defers a certain amount of the original sales priceuntil some future time when actual costs are incurred or the warranty expires.Under the revenue approach, the liability is recognized as an unearned revenueamount and is measured at the value of the service to be provided, not at its cost.For instance, assume the same basics as above, but warranty agreements for atwo year period similar to this are available separately and have a separate valueof $350 each. In this case, the company would allocate $350 of each “bundled”sale to the warranty contract. The entry to record the sale would be as follows:Cash ($5,000 x 200)1,000,000Unearned Warranty Revenue ($350 x 200)70,000Sales930,000Over the two years, the unearned warranty revenue will be recognized as earnedwarranty revenue.Premiums, Coupons, Rebates, and Loyalty Programs4.If a company offers premiums to customers in return for coupons, a liabilityshould normally be recognized at year-end for outstanding premium offersexpected to be redeemed. The liability should be recorded along with a charge toa premium expense account. The premiums, coupon offers, air miles, rebates,and prizes are made to stimulate sales, and their costs should be charged toexpense in the period that benefits from the premium plan, i.e., the period of thesale. The cost of outstanding promotional offers that will be presented forredemption must be estimated in order to reflect the existing current liability and tomatch costs with revenues.5.Customer loyalty programs where customer loyalty credits are awarded areconsidered revenue arrangements with multiple deliverables. Under IFRS, IFRICInterpretation 13Customer Loyalty Programmesspecifically identifies that therevenue from the original transaction is to be allocated between the award creditsand the other components of the sale with the fair value of the award creditsrecognized as unearned revenue, a liability account. ASPE does not specificallyaddress this but its general principles of revenue recognition would result insimilar treatment.

Page 17 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 17 preview image

Contingencies and Uncertain Commitments1.A contingency is an existing or possible condition or situation involving uncertaintyas to possible gain (gain contingency) or loss (loss contingency) to an enterprisethat will ultimately be resolved when one or more future events occur or fail tooccur that will confirm their existence or amount payable.Contingent gains are not recognized under ASPE. Under IFRS, a potentialreimbursement is only recognized when recovery is certain, and under theproposed new standards the right to reimbursement is recognized only if it can bereliably measured.2.Under current standards, somecontingent liabilitiesmay not be recognized atall, some are recognized in the accounts, and some only as note disclosures.Whether a liability should be recognized depends on the likelihood that a futureevent or events will confirm the contingency exists. Under ASPE, the range usedto asses this islikely,unlikely, or not determinable.3.An estimated loss from a loss contingency should be accrued by a charge toexpense and a liability recorded only if both the following conditions are met:a.Information available prior to the issuance of the financial statementsindicates that it is likely that a future event will confirm that an asset hasbeenimpairedoraliabilityincurredasofthedateofthefinancialstatements, andb.The amount of the loss can be reasonably estimated.Neither the exact payee nor the exact date payable need be known to record aliability.What must be known is whether it is likely that a liability has beenincurred.4.Under current IFRS, the term “contingent liability” refers only to those existing orpossibleobligationsthatarenotrecognized.Anobligationconsideredacontingent liability under ASPE would be called just a liability under IFRS. Theapproach to recognizing the liability under IFRS is similar to ASPE. However, newstandards being proposed would require an entity to determine whether anunconditional obligation exists at the reporting date before recognizing the liability.If the unconditional obligation exists, it must be recorded and the uncertaintyrelative to future events is taken into consideration when measuring the liabilitybeing recorded.

Page 18 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 18 preview image

Litigation, Claims, and Assessments1.Companies generally only report one current and one non-current amount forprovisionsinthestatementoffinancialposition.IFRSrequiresextensivedisclosure related to provisions in the notes to the financial statements. When acompany is threatened by legal action (litigation, claims, and assessments),the recording of a liability will depend upon certain factors. Among the moreprevalent are (a) thetime periodin which the underlying cause for actionoccurred (i.e., the cause for litigation must have occurred on or before the date ofthe financial statements), (b) theprobabilityof an unfavourable outcome, and (c)the ability to make areasonable estimateof the amount of loss. However, evenif the evidence does not favour a company, it will not publish a dollar estimate ofthe probable negative outcome as it would weaken their position. So, companiesprovide a general provision for the costs expected to be incurred with relating thedisclosure to any specific lawsuit or set of lawsuits.Financial Guarantees1.Financial guarantees are commonly those where one entity (the guarantor)contracts that it will pay the holder of a debt if another entity (the debtor) fails tomeet its obligations. Financial guarantees meet the definition of a financialliability. ASPE requires treatment for financial guarantees that are similar to losscontingencies. Under IFRS, the guarantee is recognized initially at fair value andsubsequently at the higher of the best estimate of the payments that would beneeded to settle the obligation at the reporting date and any unamortizedpremium received as a fee for the guarantee (unearned revenue).Commitments1.Executory contracts are contracts where neither party has yet performed and arenot included in the definition of non-financial liability. Contractual obligations andcontractual commitments arise as a result of agreements with customers,suppliers, employees and other parties. Disclosure is only required of significantcommitments – i.e., those that involve significant future resources, are abnormalrelative to the company’s financial position and usual operations, or involvesignificant risk.

Page 19 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 19 preview image

Presentation, Disclosure, and Analysis1.Current liabilitiesare usually recorded and reported in the financial statementsat their full maturity value. Present value techniques are not normally used inmeasuring current liabilities, because of the short time periods involved and thematurity value is generally not large. Current liabilities are normally listed at thebeginning of the liabilities and shareholders' equity section of the statement offinancial position. Within the current liability section the accounts may be listed inorder of maturity, in descending order of amount, or in order of liquidationpreference.2.Contingencies, Guarantees, and Commitmentsare disclosed if:•it is likely that a future event will confirm the existence of a loss but the losscannot be reasonably estimated.•a loss has been recognized, but there is an exposure to loss that is higherthan the amount that was recorded.•it is not possible to determine the likelihood of there being a future event thatconfirms the liability.3.Companies reporting under ASPE are also required to reportcontractualcommitmentsthat are significant relative to their current financial position offuture operations. Guarantors must report information about any guarantees theyhave made even if it is not likely they will be required to make any payments.4.Disclosure information should be sufficient to meet the requirement of fulldisclosure. Companies should clearly identify secured liabilities, as well asindicate the related assets pledged as collateral. If the due date of any liability canbe extended, a company should disclose the details. Companies should not offsetcurrent liabilities against assets that it will apply to their liquidation. Finally, currentmaturities of long-term debt should be classified as current liabilities.Analysis1.Analysts are interested in theliquidity of a company.Part of this analysisrequires an assessment of the ability to pay current obligations as they come due.These obligations arise from both financing activities (such as notes payable) andoperations (such as accounts and salaries payable). Ratios that focus on currentliabilities in this analysis include thecurrent ratio,theacid-test ratio,and thedays payables outstandingratio.

Page 20 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 20 preview image

IFRS and ASPE1.Accounting for non-financial liabilities, including contingencies, is still in a state oftransition. TextIllustration 13-15identifies the current differences between IFRSand ASPE in addition to an indication of what is expected in the revised IFRS onLiabilitiesthatwillreplaceIAS37Provisions,ContingentLiabilities,andContingent Assets.

Page 21 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 21 preview image

LECTURE OUTLINEThis chapter can be covered in two or three class sessions. Students should befamiliar with trade and payroll liabilities. Short-term obligations expected to berefinanced, accounting for contingencies, and transitioning international financialstandards are the conceptually challenging areas for many students.Section 1: Current LiabilitiesA.The Concept of Liabilities1.The question ofwhat is a liabilityis not a simple issue to resolve. This canbe seen if the example of preferred shares is analyzed.2.IFRS and ASPE identify 3 essential characteristics for liabilities. Howeverthe key difference is that the new definition will result in recognizing a liabilitywhenever an unconditional obligation exists at the reporting date. Anyuncertainty about the amount to be given up in the future is consideredwhen measuring the liability.B.Current Liabilities1.Current liabilities can be either financial or non-financial. Financial liabilitiesare contractual obligations to deliver cash or other financial assets toanother entity, or to exchange financial instruments with another entity,under conditions that are potentially unfavourable.2.Financial liabilities are initially measured and recorded at their fair value andthen subsequently at their amortized cost using the effective interestmethod. Non-financial liabilities are measured depending on their naturesuch as the fair value of the goods or services to be given up in the future.Under international standards, non-financial liabilities are measured initiallyand at each subsequent reporting date at the best estimate of the amountthe entity would rationally pay at the balance sheet date to settle the presentobligationFinancial liabilities do not include obligations resulting from legislation. Forexample, the income tax payable on corporate income would be a non-financial liability.

Page 22 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 22 preview image

3.A liability is classified as current if it meets one of 4 conditions:1.It is expected to be settled in the entity’s normal operating cycle2.It is held primarily for trading3.It is due within 12 months from the end of the reporting period4.The entity does not have an unconditional right to defer itssettlement for at least 12 months after the balance sheet date.C.CommonCurrent Liabilities:1.Bank Indebtedness and Credit Facilities: a line-of-credit or revolving debtarrangement. The company draws on the fund as soon as needed when theprevious amount is repaid.2.Accounts Payable:Trade accounts payableshould be recorded when thegoods are received, or the legal title passes to the purchaser.3.Notes Payable:a.Trade notesb.Short-term loan notes: Interest bearingnotes are presented at theirface value,zero-interest bearingnotes are presented at amortizedcost.c.Currentmaturityoflongtermdebt.Thatportionoflong-termindebtedness that matures within the next fiscal year is reported as acurrent liability if it is to be paid out of current assets, and if it is notgoing to be refinanced by a new debt issue or by conversion intoshares.4.Callable Debt and Short-term Obligations Expected to Be Refinanced.a.Callable debtis classified as current even if the debt agreement has apayment schedule over several years. Liabilities that become callableby the creditor because of a violation of a debt covenant will beclassified as current, even if previously classified as long-term debt.b.Under IFRS, this classification will hold even if the lender agreesbetween the balance sheet date and the date the financial statementsare released that it will not demand repayment because of theviolation.

Page 23 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 23 preview image

c.Under ASPE, the liability is reclassified as current unless:1.thecreditorwaivesthecovenant(agreement)requirements,or2.the violation has been cured within the grace period that isusually given in these agreements,and3.it is likely that the company will not violate the covenantrequirements with a year from the balance sheet date.d.Short-Term Debt Expected to be Refinanced on a Long-TermBasisUnder IFRS: if the debt is due within 12 months from the reportingdate, it is classified as a current liability even if a long-term financinghas been completed before the financial statements are released. Theonly exception is if, at the balance sheet date, the entity expects torefinance it or roll it over under an existing agreement for at least 12months and the decision is solely at its discretion.Under ASPE: short-term obligations expected to be refinanced on along-term basis could be excluded from current liabilities if the liabilityhas been refinanced on a long-term basis or there is a non-cancellableagreement to do so before the financial statements are completedand nothing stands in the way of completing the refinancing.5.Dividends Payable: At the date of declaration of acash dividendpayablethe corporation assumes a liability.Preferred dividends in arrearsare nota legal obligation until a distribution is formally authorized.Stock dividendspayable are part of shareholders' equity (not a liability).6.Other liabilities includereturnable deposits and customer advancesandrents and royalties payable.7.Collections for Third Parties:a.Sales taxesb.Income tax and other payroll deductions, such as Canada PensionPlan premium, employment insurance, and union dues.

Page 24 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 24 preview image

8.Accrued Expenses or Liabilities:a.Accrued payroll taxes: These would include the employer's share ofCPP and employment insurance premiums.b.Accrued property taxes: The accounting questions involved here arewhen the property owner should record the liability, andto whichperiods the cost should be charged.9.Compensated Absences: These are absences such as vacations, illnesses,or holidays for which employees are normally paid. When benefits vest,accrual of the estimated liability is recommended. Accumulating rightsare those rights that can be carried forward to future periods if not used inthe period in which earned.Non-accumulating rightsare those to whichemployees are entitled if a specific event occurs, such as parental leave orshort-term disability.10.Conditional Payments: These are liabilities that depend on annual incomeand therefore cannot be known for certain until the end of the period.a.Profit-sharing plansb.Bonus agreementsNon-Financial LiabilitiesD.Decommissioning and Restoration Obligations1.Obligating Events: Examples include decommissioning nuclear facilities,dismantling, restoring, and reclamation of oil and gas properties, closureand post-closure cost of landfills, and others.2.Measurement: Under theCICA Handbook, Part II (ASPE), Section 3110.09,an ARO is initially measured at the best estimate of the expenditure requiredto settle the present obligation at the reporting date, which is similar to theproposed revision.

Page 25 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 25 preview image

3.Recognition and Allocation: The estimated costs of the ARO are included inthe carrying amount of the related long-lived asset in the same amount asthe liability recognized. The ARO is amortized to expense over the relatedasset’s useful life. Because the liability is measured on a discounted basis,interest on the liability is recognized each period as an increase in thecarrying amount of the liability and either an accretion expense (ASPE) oran interest expense (IFRS). Subsequent changes in the ARO due toproduction are added to the asset’s capital cost under ASPE and inventoriedunder IFRS.4.Reporting and Disclosure Requirements:As most of the AROs are long-term in nature, they should be shown outside current liabilities, providingdetails of the AROs and associated long-lived assets.E:Unearned Revenues: Non-financial liabilities that are measured at the fair valueof the goods or services to be given up in the future.F.Product Guarantees and Customer Programs1.Guarantee and Warranty Costs: The amount of the liability is an estimate ofall the costs that will be incurred after sale and delivery.(1)Expense warranty approach. This method should be usedwhenever the warranty is an integral and inseparable part of theproduct sale and requires warranty costs to be charged tooperating expense in the year of sale.(2)Revenue warranty approach. This method should be usedwhen the warranty is sold separately from the product or is abundled sale (value of product and warranty can be identifiedseparately) and requires that revenues from the sale of thewarranty be deferred and subsequently recognised as incomeover the life of the warranty contract.Premiums, coupons, loyalty programs, and other bonuses offered to customers:result in the likely existence of a liability at the date of the financial statements.Under IFRS, IFRIC Interpretation 13,Customer Loyalty Programmesspecificallyidentifies that the revenue from the original transaction is to be allocated betweenthe award credits and the other components of the sale with the fair value of theaward credits recognized as unearned revenue.

Page 26 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 26 preview image

G.Contingencies and CommitmentThese are liabilities that are dependent upon the occurrence or non-occurrence of oneor more future events to confirm either the amount payable or the payee or thedate payable or its existence.1.Under ASPE, probability that the future event or events will confirm theincurrence of a liability can be classified as:a.Unlikely.b.Likely. A liability is recorded if the information indicates that it islikelythat a liability had been incurredat the statement of financialpositiondate, and the amount of the resulting loss can bereasonablyestimated.c.Not determinable.2.If information is available prior to the issuance of the financial statementsindicates a loss contingency exists at the statement of financial position dateand that a future event will confirm this, the estimated loss from the losscontingency should be accrued as a liability and charged to expense if it canbe reasonably estimated.TEACHING TIPThe current accounting treatment of loss contingencies can besummarized with the aid of Illustration 13-1.

Page 27 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 27 preview image

3.Under IFRS, treatment is similar however IFRS does not use the term“contingent” liability. However, new standards being proposed would requirean entity to determine whether an unconditional obligation exists at thereporting date before recognizing the liability. If the unconditional obligationexists, it must be recorded and the uncertainty relative to future events takeninto consideration when measuring the liability being recorded.TEACHING TIPUnder theExposure Draft of Proposed Amendment to IAS 37 Provisions,Contingent Liabilities and Contingent Assetseliminates the term“contingent liability” based on the fact that a situation either results in aliability or it doesn’t. Liabilities can arise only from unconditional or non-contingent obligations. The only uncertainty that exists is the amountpayable, which is taken into consideration on measurement of the liability.Therefore, the focus is on whether the liability actually exists. Theapplication of this approach is presented in Illustration 13-2.4.Litigations, Claims, and Assessments. The following factors should beconsidered:a.The period in which the underlying cause for action occurred.b.The degree of probability of an unfavourable outcome.c.The ability to make a reasonable estimate of the amount of the loss.5.Commitments: Disclosure is only required of significant commitments – i.e.,those that involve significant future resources, are abnormal relative to thecompany’s financial position and usual operations, or involve significant risk.6.FinancialGuarantees:Privateentity standardsrequirestreatmentforfinancial guarantees similar to loss contingencies.requires expandeddisclosure by all guarantors about obligations and particularly about the risksthat are assumed as a result of issuing guarantees. Under IFRS theguarantee is recognized initially at fair value and subsequently at the higherof the best estimate of the payments that would be needed to settle theobligation ant the reporting date and any unamortized premium received asa fee for the guarantee (unearned revenue).

Page 28 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 28 preview image

H.Presentation, Disclosures, and Analysis1.The current liability accounts are generally the first classification in theequity section of the balance sheet.2.Current liabilities are frequently listed in order of maturity, according toamount, or in order of liquidation preference.3.Areas that warrant additional disclosure are:a.Assets pledged as collateral for secured liabilities.b.Purchase commitments.c.Short-term obligations expected to be refinanced.d.Loss contingencies for which a liability has not been recorded.4.Analysis:Ratios used to measure the liquidity of a company to determine its ability tomeet its current financing and operating obligations include:a.Current ratiob.Acid-test ratioc.Days payables outstandingI.IFRS and Private Entity Standards ComparisonAccounting for non-financial liabilities, including contingencies, is still in a state oftransition. TextIllustration 13-15identifies the current differences between IFRSand ASPE in addition to an indication of what is expected in the revised IFRS onLiabilitiesthat will replace IAS 37Provisions, Contingent Liabilities, and ContingentAssets.

Page 29 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 29 preview image

ILLUSTRATION 13-1ACCOUNTING TREATMENT OF LOSS CONTINGENCIESNotMay beLoss Related to:AccruedAccrued*1.Risk of loss or damage of enterpriseproperty by fire, explosion,or other hazardsX2. General or unspecified business risksX3. Risk of damage from catastrophesassumed by property and casualtyinsurance companies includingre-insurance companiesX4. Threat of expropriation of assetsX5. Pending or threatened litigationX6. Actual or possible claims andassessmentsX7.Guarantees of indebtedness of others**X8.Agreements to repurchase receivables(or the related property) that havebeen soldX*Should be accrued when both criteria are met (likely and reasonably estimable).**Estimated amounts of losses incurred prior to the balance sheet date but settledsubsequently should be accrued as of the balance sheet date.Source: Kieso, Weygandt,Intermediate Accounting, Tenth Edition.

Page 30 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 30 preview image

ILLUSTRATION 13-2Treatment of Obligations that exist at the reporting date underIFRS:Description of SituationLiability Recognition Decision at the ReportingDateThere is only an unconditionalobligationAlways recognize because there is a presentobligation and it is enforceableThere is only a conditionalobligationDo not recognize; it is not a present obligation andtherefore not enforceable.There is an unconditionalobligation and a relatedconditional obligation at thesame timeAlways recognize due to the existence of theunconditional obligationSource: Kieso, Weygandt,Intermediate Accounting, Tenth Edition.

Page 31 of 31

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 31 preview image

CHAPTER 14LONG-TERM FINANCIAL LIABILITIESCHAPTERTOPICSCROSSREFERENCEDWITHCICAHANDBOOK, PARTI (IFRS) AND PART II (ASPE)Long-term debt currently maturingIAS 32Section 1510Financial Instruments—recognition andmeasurementIFRS 9(previously IAS39)Section 3856Financial Instruments—presentationIFRS 9 andIAS 32Section 1521Financial Instruments—disclosureIFRS 7Section 3856

Preview Mode

This document has 269 pages. Sign in to access the full document!

Report

Learning Tools

Writing Tools

Browse Resources

Intermediate Accounting, Volume 2, 10th Canadian Edition Lecture Notes - Page 1

Study Now!

Document Details

Related Documents

Test Bank For Intermediate Accounting, 15th Edition

Intermediate Accounting, Volume 2, 10th Canadian Edition Solution Manual

Intermediate Accounting, Volume 2, 10th Canadian Edition Test Bank

Accounting Principles II – Traditional Cost Systems

Accounting Principles II – Statement of Cash Flows

Accounting Principles II – Partnerships

Accounting Principles II – Managerial and Cost Accounting Concepts

Accounting Principles II – Long-Term Liabilities

Accounting Principles II – Investments

Accounting Principles II – Incremental Analysis

Company

Explore

Study Tools