Liabilities Part 1

Essential characteristicsMeasurement of liabilitiesCurrent versus Noncurrent liabilitiesEstimated liabilities, part 1

Essential characteristics

•Present obligation

•Particular entity

•Past transaction or event

•Outflow of economic resources as settlement

Present obligation, past event

• Obligating event

• Legal obligation

• Contract, legislation or operation of law

• Constructive obligation

• Past practice, published policy or a sufficiently specific current statement

• Acceptance of responsibilities = valid expectation

Settlement of obligation

•Payment of cash

•Transfer of other assets

•Provision of services

•Replacement of that obligation with another obligation

•Conversion of the obligation to equity

Liabilities?

•Dividends payable

•Stock dividends payable

•Convertible bonds payable

•Unearned service income

Liabilities?

•Accrued expenses

•Deposits from customers

•Advances from customers

Measurement of liabilities

•Initially, at fair value plus direct transaction costs

• Fair value = present value (discounted amount at prevailing market rate of interest) of all future cash payment required to settle the obligation

•Subsequently, at amortized cost

Measurement of liabilities

• Current liabilities = face amount

• Noncurrent liabilities

• If NIB: measure at present value

• If IB: measure at face amount (because FA = present value)

Current liabilities

•Expected to be settled within the entity’s operating cycle

•Primarily held for trading

•Due to be settled within 12 months after reporting period

Current liabilities

•No unconditional right to defer settlement for at least 12 months after the reporting period

•Long term debt falling due within 12 months after ERP

Noncurrent liabilities

•Residual definition

• If not current, then non-current

Long-term debt falling due within 1 year

•General rule: Current liabilities

•Exceptions: LTD remains noncurrent if

• Entity has an unconditional right to defer settlement for at least 12 months after ERP or

• Agreement to refinance is completed on/before ERP

Current or noncurrent?

•Debt was originally incurred on Jan. 1, 2006, maturing on Jan. 1, 2010

•ERP = Dec. 31, 2006

•ERP = Dec. 31, 2008

•ERP = Dec. 31, 2009

Breach of debt covenants

•Restrictions undertaken by the borrower

• If violated (breach), loan becomes immediately demandable.

Breach - current or non-current

•Rule: Debt is reclassified as current

•Non-current if

•Grace period on/before ERP

•At least 12 months after ERP

Estimated liabilities

•Obligations existing at ERP

•Amount not definite

•Payee may or may not be known

•When obligation is due may or may not be known

Estimated premium liability

•Premiums ... assets when acquired

•Premium expense recognized

•At distribution of premiums

•At ERP for outstanding premiums

Outstanding premiums

•Total number of premiums estimated to be distributed less

•# of Premiums actually distributed =

•# of Premiums outstanding x net premium cost

Formula for outstanding liability

•Estimated distribution less

•Actual distribution

•Outstanding liability

EOY Premium expense/Estimated liability

•Net premium cost = Cost of premium plus shipping/distribution cost minus customer’s remittance

•Actual distribution immediately expensed

•Outstanding liability: debited to expense at EOY; reversed at BOY