Intermediate Financial Accounting II Chapter One
CHAPTER ONE
CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
1.1. The Nature and Types of Current Liabilities
Recall that the definition of liability is “a present obligation of the entity arising from past
events, the settlement of which is expected to result in an outflow from the entity of resources
embodying economic benefits”
First, the liability needs to be a present obligation. This means that at the financial reporting
date the entity must have some legal or constructive force that will compel it to settle the
obligation. This suggests that the company has no effective way to avoid the obligation.
Second, the obligation must be the result of a past event. Two common examples of events
that would give rise to a liability include the purchase of goods on credit or the receipt of loan
proceeds from a bank. The events, which result in economic benefits being delivered to the
company, clearly create an obligation.
The third criterion requires a future outflow of economic benefits. Although we can easily
understand the repayment of an outstanding account payable as a use of economic resources,
there are other ways that liabilities can be settled that don’t involve the payment of cash.
These can include the future delivery of goods or services to customers or other parties.
Current liabilities are “obligations whose liquidation is reasonably expected to require use of
existing resources properly classified as current assets, or the creation of other current
liabilities. When a company or a bank advances credit, it is making a loan. The company or
bank is called a creditor (or lender). The individuals or companies receiving the loan are
called debtors (or borrowers). Debt is recorded as a liability by the debtor.
Current liability is reported if one of two conditions exists:
1. The liability is expected to be settled within its normal operating cycle; or
2. The liability is expected to be settled within 12 months after the reporting date.
This definition has gained wide acceptance because it recognizes operating cycles of varying
lengths in different industries.
The operating cycle is the period of time elapsing between the acquisition of goods and
services involved in the manufacturing process and the final cash realization resulting from
sales and subsequent collections.
Types of current liabilities
The following are the types of current liabilities
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Account Payable: or trade accounts payable, are balances owed to others for goods,
supplies, or services purchased on open account. Accounts payable arise because of the time
lag between the receipt of services or acquisition of title to assets and the payment for them.
The terms of the sale (e.g., 2/10, n/30 or 1/10, E.O.M.) usually state this period of extended
credit, commonly 30 to 60 days.
Most companies record liabilities for purchases of goods upon receipt of the goods. If title
has passed to the purchaser before receipt of the goods, the company should record the
transaction at the time of title passage.
Measuring the amount of an account payable poses no particular difficulty. The invoice
received from the creditor specifies the due date and the exact outlay in money that is
necessary to settle the account. The only calculation that may be necessary concerns the
amount of cash discount.
Notes Payable: Notes payable are written promises to pay a certain sum of money on a
specified future date. They may arise from purchases, financing, or other transactions. Some
industries require notes (often referred to as trade notes payable) as part of the
sales/purchases transaction in lieu of the normal extension of open account credit. Notes
payable to banks or loan companies generally arise from cash loans.
Interest-Bearing Notes Issued
Assume that Castle National Bank agrees to lend €100,000 on March 1, 2015, to Landscape
Co. if Landscape signs a €100,000, 6 percent, four-month note. Landscape records the cash
received on March 1 as follows.
March 1, 2015
Cash 100,000
Notes Payable 100,000
(To record issuance of 6%, 4-month note to Castle National Bank)
If Landscape prepares financial statements semi-annually, it makes the following adjusting
entry to recognize interest expense and interest payable of €2,000 (€100,000 x 6% x 4/12) at
June 30, 2015.
June 30, 2015
Interest expense 2,000
Interest Payable 2,000
(To record interest for 4 months on Castle National Bank)
If Landscape prepares financial statements monthly, its interest expense at the end of each
month is €500 (€100,000 x 6% x 1/12).
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At maturity (July 1, 2015), Landscape must pay the face value of the note (€100,000) plus
€2,000 interest (€100,000 x 6% x 4/12). Landscape records payment of the note and accrued
interest as follows.
July 1, 2015
Notes payable 100,000
Interest Payable 2,000
Cash 102,000
(To record payment of Castle National Bank interest-bearing note and accrued interest at
maturity)
Interest expense 2,000
Interest Payable 2,000
(To record interest for 4 months on Castle National Bank)
Zero-Interest-Bearing Note Issued
A company may issue a zero-interest-bearing note instead of an interest-bearing note. A zero-
interest-bearing note does not explicitly state an interest rate on the face of the note. Interest
is still charged, however. At maturity, the borrower must pay back an amount greater than the
cash received at the issuance date. In other words, the borrower receives in cash the present
value of the note. The present value equals the face value of the note at maturity minus the
interest or discount charged by the lender for the term of the note.
To illustrate, assume that Landscape issues a €102,000, four-month, zero-interest-bearing
note to Castle National Bank on March 1, 2015. The present value of the note is €100,000.
Landscape records this transaction as follows.
March 1, 2015 Cash 100,000
Note Payable 100,000
(To record issuance of 4-month, zero-interest-bearing note to Castle
National Bank)
Landscape credits the Notes Payable account for the present value of the note, which is
€100,000. If Landscape prepares financial statements semi-annually, it makes the following
adjusting entry to recognize the interest expense and the increase in the note payable of
€2,000 at June 30, 2015.
June 30, 2015 Interest expense 2,000
Note Payable 2,000
(To record interest for 4-month on Castle National Bank)
At maturity (July 1, 2015), Landscape must pay the face value of the note, as follows.
July 1, 2015 Note payable 102,000
Cash 102,000
(To record payment of Castle National Bank zero-interest-bearing at
maturity)
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In this case, the amount of interest expense recorded and the total cash outlay are exactly the
same whether Landscape signed a loan agreement with a stated interest rate or used the zero-
interest-rate approach.
Current Maturities of Long-Term Debt
Companies report as part of its current liabilities the portion of bonds, mortgage notes, and
other long-term indebtedness that matures within the next fiscal year. It categorizes this
amount as current maturities of long-term debt.
A company should classify as current any liability that is due on demand (callable by the
creditor) or will be due on demand within one year (or operating cycle, if longer). Liabilities
often become callable by the creditor when there is a violation of the debt agreement. For
example, most debt agreements specify a given level of equity to debt be maintained, or
specify that working capital be of a minimum amount. If the company violates an agreement,
it must classify the debt as current because it is a reasonable expectation that existing
working capital will be used to satisfy the debt.
Dividends Payable
A cash dividend payable is an amount owed by a corporation to its shareholders as a result of
board of directors’ authorization (or in other cases, vote of shareholders). At the date of
declaration, the corporation assumes a liability that places the shareholders in the position of
creditors in the amount of dividends declared. Because companies always pay cash dividends
within one year of declaration (generally within three months), they classify them as current
liabilities.
Dividends payable in the form of additional shares are not recognized as a liability. Such
share dividends do not require future outlays of assets or services.
Customers Advances and Deposits
Current liabilities may include returnable cash deposits received from customers and
employees. Companies may receive deposits from customers to guarantee performance of a
contract or service or as guarantees to cover payment of expected future obligations.
The classification of these items as current or non-current liabilities depends on the time
between the date of the deposit and the termination of the relationship that required the
deposit.
Unearned Revenues
When a company receives cash or other assets in advance for specific goods or services to be
delivered or performed in the future, the entity recognizes the obligation as a liability.
For example, a magazine publisher receives payments from customers when subscriptions to
magazines are ordered, and an airline usually sells tickets in advance for flights.
How do these companies account for unearned revenues that they receive before providing
goods or performing services?
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To illustrate, assume that the Rambeau Football Club sells 5,000 season tickets at $50 each
for its five-game home schedule. The entry for the sale of the season tickets is:
August 6 Cash 250,000
Unearned Sales Revenue 250,000
(To record sales of 5,000 season tickets)
As each game is completed, the following entry is made to recognize the revenue earned:
Sept. 7 Unearned Sales Revenue 50,000
Sales Revenue 50,000
The account Unearned Sales Revenue represents unearned revenue. Logo University reports
it as a current liability in the statement of financial position because the school has a
performance obligation. As ticket holders attend games, Logo recognizes revenue and
reclassifies the amount from Unearned Sales Revenue to Sales Revenue.
Sales and Value-Added Taxes Payable
Most countries have a consumption tax. Consumption taxes are generally either a sales tax or
a value-added tax (VAT).
Sales Taxes Payable
Nearly all states and many cities levy taxes on retail sales. Sales taxes are stated as a percent
of selling prices. The seller collects sales taxes from customers when sales occur and sends
these collections to the government. Since sellers currently owe these collections to the
government, this amount is a current liability.
To illustrate, if Home Depot sells materials on August 31 for $6,000 cash that are subject to a
5% sales tax, the revenue portion of this transaction is recorded as follows. (The entry for
cost of sales is omitted for simplicity.)
Cash 6,300
Sales Revenue 6,000
Sales Taxes Payable 300
Value-Added Taxes Payable
This tax is placed on a product or service whenever value is added at a stage of production
and at final sale. A VAT is a cost to the end user, normally a private individual, similar to a
sales tax.
Assume the following examples
1. Hill Farms Wheat Company grows wheat and sells it to Sunshine Baking for $1,000.
Hill Farms Wheat makes the following entry to record the sale, assuming the VAT is
15 percent.
Cash 1,150
Hill Sales Revenue 1,000
Farms Value-Added Taxes Payable 150
Wheat
then remits the $150 to the tax authority.
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2. Sunshine Baking makes loaves of bread from this wheat and sells it to Halo
Supermarket for $2,000. Sunshine Baking makes the following entry to record the
sale, assuming the VAT is 15 percent.
Cash 2,300
Sales Revenue 2,000
Value-Added Taxes Payable 300
Sunshine Baking then remits $150 to the government, not $300. The reason: Sunshine Baking
has already paid $150 to Hill Farms Wheat. At this point, the tax authority is only entitled to
150. Sunshine Baking receives a credit for the VAT paid to Hill Farms Wheat, which reduces
the VAT payable.
3. Halo Supermarket sells the loaves of bread to consumers for $2,400. Halo
Supermarket makes the following entry to record the sale, assuming the VAT is 15
percent.
Cash 2,760
Sales Revenue 2,400
Value-Added Taxes Payable 360
Halo Supermarket then sends only $60 to the tax authority as it deducts the $300 VAT
already paid to Sunshine Baking.
Income Taxes Payable
Corporations should classify as a current liability the taxes payable on net income, as
computed per the tax return. Unlike a corporation, proprietorships and partnerships are not
taxable entities. Because the individual proprietor and the members of a partnership are
subject to personal income taxes on their share of the business’s taxable income, income tax
liabilities do not appear on the financial statements of proprietorships and partnerships.
Employee-Related Liabilities
Companies also report as a current liability amounts owed to employees for salaries or wages
at the end of an accounting period. In addition, they often also report as current liabilities the
following items related to employee compensation.
1. Payroll deductions.
2. Compensated absences.
3. Bonuses.
Payroll Deductions
The most common types of payroll deductions are taxes, insurance premiums, employee
savings, and union dues. To the extent that a company has not remitted the amounts deducted
to the proper authority at the end of the accounting period, it should recognize them as
current liabilities.
Social Security Taxes: Most governments provide a level of social benefits (for retirement,
unemployment, income, disability, and medical benefits) to individuals and families. The
benefits are generally funded from taxes assessed on both the employer and the employees.
These taxes are often referred to as Social Security taxes or Social Welfare taxes. Funds for
these payments generally come from taxes levied on both the employer and the employee.
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Employers collect the employee’s share of this tax by deducting it from the employee’s gross
pay, and remit it to the government along with their share.
Income Tax Withholding: Income tax laws generally require employers to withhold from
each employee’s pay the applicable income tax due on those wages. The employer computes
the amount of income tax to withhold according to a government-prescribed formula or
withholding tax table.
Payroll Deduction Example: Assume a weekly payroll of $10,000 entirely subject to Social
Security taxes (8%), with income tax withholding of $1,320 and union dues of $88 deducted.
The company records the wages and salaries paid and the employee payroll deductions as
follows.
Salaries and Wages Expense 10,000
Withholding Tax Payable 1,320
Social Security Taxes Payable 800
Union Dues Payable 88
Cash 7,792
It records the employer payroll taxes as follows.
Payroll Tax Expense 800
Social Security Taxes Payable 800
The employer must remit to the government its share of Social Security tax along with the
amount of Social Security tax deducted from each employee’s gross compensation. It should
record all unremitted employer Social Security taxes as payroll tax expense and payroll tax
payable.
Short-Term Notes Payable
Companies record obligations in the form of written notes as notes payable. Notes payable
are often used instead of accounts payable because they give the lender formal proof of the
obligation in case legal remedies are needed to collect the debt.
Companies frequently issue notes payable to meet short-term financing needs. Notes payable
usually require the borrower to pay interest. Notes are issued for varying periods. Those due
for payment within one year of the balance sheet date are usually classified as current
liabilities.
Illustration: Hong Kong National Bank agrees to lend HK$100,000 on September 1, 2017, if
C.W. Co. signs a HK$100,000, 12%, four-month note maturing on January 1.
Instructions
a) Prepare the journal entry on September 1.
b) Prepare the adjusting journal entry on December 31, assuming monthly
adjusting entries have not been made.
c) Prepare the journal entry at maturity (January 1, 2018).
Solution
A.
Cash 100,000
Sep, 1 Notes Payable 100,000
B. Adjusting entry
Interest expense 4,000
Dec, 31 Interest Payable 4,000
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Accrued Interest 100,000 x 12% x 4/12 = $4,000
C. Prepare the journal entry at maturity (January 1, 2018
Note payable 100,000
Jan. 1, 2018 Interest Payable 4,000
Cash 104,000
1.2. Recognition and Measurement of Provisions
A provision is a liability of uncertain timing or amount (sometimes referred to as an
estimated liability). Provisions are very common and may be reported either as current or
non-current depending on the date of expected payment.
Common types of provisions are obligations related to litigation, warrantees or product
guarantees, business restructurings, and environmental damage.
The difference between a provision and other liabilities (such as accounts or notes payable,
salaries payable, and dividends payable) is that a provision has greater uncertainty about the
timing or amount of the future expenditure required to settle the obligation.
Recognition of a Provision
Companies accrue an expense and related liability for a provision only if the following three
conditions are met.
1. A company has a present obligation (legal or constructive) as a result of a past event;
2. It is probable that an outflow of resources embodying economic benefits will be required to
settle the obligation; and
3. A reliable estimate can be made of the amount of the obligation.
If these three conditions are not met, no provision is recognized.
In applying the first condition, the past event (often referred to as the past obligatory event)
must have occurred. In applying the second condition, the term probable is defined as “more
likely than not to occur.” This phrase is interpreted to mean the probability of occurrence is
greater than 50percent. If the probability is 50percent or less, the provision is not recognized.
Recognition Examples
We provide three examples to illustrate when a provision should be recognized. It is assumed
for each of these examples that a reliable estimate of the amount of the obligation can be
determined. The following illustration presents the first example in which a company has
a legal obligation to honor its warranties. A legal obligation generally results from a contract
or legislation.
Recognition of Provision – Warranty
Example: Santos Company gives warranties to its customers related to the sale of its
electrical products. The warranties are for three years from the date of sale. Based on past
experience, it is probable (more likely than not) that there will be some claims under the
warranties.
Question: Should Santos recognize at the statement of financial position date a provision for
the warranty costs yet to be settled?
Solution: (1) The warranty is a present obligation as a result of a past obligating event – the
past obligating event is the sale of the product with a warranty, which gives rise to a legal
obligation. (2) The warranty results in the outflow of resources embodying benefits in
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settlement – it is probable that there will be some claims related to these warranties. Santos
Company should recognize the provision based on past experience.
A constructive obligation is an obligation that derives from a company’s actions where:
1. By an established pattern of past practice, published policies, or a sufficiently specific
current statement, the company has indicated to other parties that it will accept certain
responsibilities; and
2. As a result, the company has created a valid expectation on the part of those other parties
that it will discharge those responsibilities.
The second example, presented in Illustration below demonstrates how a constructive
obligation is reported.
Refund
Example: Christian Dior (FRA) has a policy of refunding purchases to dissatisfied customers
even though it is under no legal obligation to do so. Its policy of making refunds is generally
known.
Question: Should Christian Dior record a provision for these refunds?
Solution: (1) The refunds are a present obligation as a result of a past obligating event—the
sale of the product. This sale gives rise to a constructive obligation because the conduct of the
company has created a valid expectation on the part of its customers that it will refund
purchases. (2) The refunds result in the outflow of resources in settlement—it is probable that
a proportion of goods are returned for refund. A provision is recognized for the best estimate
of the costs of refunds.
The third example, the case of Wm Morrison Supermarkets (GBR) in Illustration below,
presents a situation in which the recognition of the provision depends on the probability of
future payment.
Lawsuit
Example: Assume that an employee filed a £1,000,000 lawsuit on November 30, 2015,
against Wm Morrison Supermarkets for damages suffered when the employee slipped and
suffered a serious injury at one of the company’s facilities. Morrison’s lawyers believe that
Morrison will not lose the lawsuit, putting the probability at less than 50 percent.
Question: Should Morrison recognize a provision for legal claims at December 31, 2015?
Solution: Although a past obligating event has occurred (the injury leading to the filing of the
lawsuit), it is not probable (more likely than not) that Morrison will have to pay any damages.
Morrison therefore does not need to record a provision. If, on the other hand, Morrison’s
lawyer determined that it is probable that the company will lose the lawsuit, then Morrison
should recognize a provision at December 31, 2015.
Measurement of Provision
How does a company determine the amount to report for its warranty cost on its products?
How does a company determine its liability for customer refunds? Or, how does determine
the amount to report for a lawsuit that it probably will lose? And, how does a company
determine the amount to report as a provision for its remediation costs related to
environmental clean-up?
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IFRS provides an answer: The amount recognized should be the best estimate of the
expenditure required to settle the present obligation. Best estimate represents the amount that
a company would pay to settle the obligation at the statement of financial position date.
In determining the best estimate, the management of a company must use judgment, based on
past or similar transactions, discussions with experts, and any other pertinent information.
Warranty Provisions
A warranty (product guarantee) is a promise made by a seller to a buyer to make good on a
deficiency of quantity, quality, or performance in a product. Manufacturers commonly use it
as a sales promotion technique. Automakers, for instance, “hyped” their sales by extending
their new-car warranty to seven years or 100,000 miles. For a specified period of time
following the date of sale to the consumer, the manufacturer may promise to bear all or part
of the cost of replacing defective parts, to perform any necessary repairs or servicing without
charge, to refund the purchase price, or even to “double your money back.”
Warranties and guarantees entail future costs. These additional costs, sometimes called “after
costs” or “post-sale costs,” frequently are significant. Although the future cost is indefinite as
to amount, due date, and even customer, a liability is probable in most cases. Companies
should recognize this liability in the accounts if they can reasonably estimate it. The
estimated amount of the liability includes all the costs that the company will incur after sale
and delivery and that are incident to the correction of defects or deficiencies required under
the warranty provisions. Thus, warranty costs are a classic example of a provision.
Companies often provide one of two types of warranties to customers:
1. Warranty that the product meets agreed-upon specifications in the contract at the time the
product is sold. This type of warranty is included in the sales price of a company’s
product and is often referred to as an assurance-type warranty.
This type of warranty is nothing more than a quality guarantee that the good or service is free
from defects at the point of sale. These types of obligations should be expensed in the period
the goods are provided or services performed (in other words, at the point of sale). In
addition, the company should record a warranty liability. The estimated amount of the
liability includes all the costs that the company will incur after sale due to the correction of
defects or deficiencies required under the warranty provisions.
Assurance-Type Warranty
ILLUSTRATION: Accounting for an Assurance-Type Warranty
Denson Machinery Company begins production of a new machine in July 2015 and sells 100
of these machines for $5,000 cash by year-end. Each machine is under warranty for one year.
Denson estimates, based on past experience with similar machines, that the warranty cost will
average $200 per unit. Further, as a result of parts replacements and services performed in
compliance with machinery warranties, it incurs $4,000 in warranty costs in 2015 and
$16,000 in 2016.
For the sale of the machines and related warranty costs in 2015 the entry is as follows.
1. To recognize sales of machine & accrual of warranty liability:
July- Cash 500,000
December Warranty Expense 20,000
2016 Warranty Liability 20,000
Sales Revenue 500,000
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2. To record payment for warranties incurred:
July-Dec. Warranty Liability 4,000
2015 Cash, Inventory, Accrued Payroll 4,000
The December 31, 2015, statement of financial position reports Warranty Liability as a current
liability of $16,000. The income statement for 2015 reports Warranty Expense of $20,000.
3. To record payment for warranty costs incurred in 2016 related to 2015 machinery sales:
Jan.1-Dec.31 Warranty Liability 16,000
2016 Cash, Inventory, Accrued Payroll 16,000
At the end of 2016, no warranty liability is reported for the machinery sold in 2015.
2. Warranty that provides an additional service beyond the assurance-type warranty. This
warranty is not included in the sales price of the product and is referred to as a service-
type warranty. As a result, it is recorded as a separate performance obligation.
The sale of the service-type warranty is usually recorded in an Unearned Warranty Revenue
account. Companies then recognize revenue on a straight-line basis over the period the
service-type warranty is in effect. Companies only defer and amortize costs that vary with
and are directly related to the sale of the contracts (mainly commissions). Companies expense
employees’ salaries and wages, advertising, and general and administrative expenses because
these costs occur even if the company did not sell the service-type warranty.
Warranties
Example: You purchase an automobile from Hamlin Auto for €30,000 on January 2, 2014.
Hamlin estimates the assurance-type warranty costs on the automobile to be €700 (Hamlin
will pay for repairs for the first 36,000 miles or three years, whichever comes first). You also
purchase for €900 a service-type warranty for an additional three years or 36,000 miles.
Hamlin incurs warranty costs related to the assurance-type warranty of €500 in 2014 and
€200 in 2015. Hamlin records revenue on the service-type warranty on a straight-line basis.
Required: What entries should Hamline make in 2014 and 2017?
1. To record the sales of automobile & related warranties:
Jan. 2, 2014 Cash (€30,000 + €900) 30,900
Warranty Expense 700
Warranty Liability 700
Unearned Warranty Revenue 900
Sales Revenue 30,000
2. To record warranty cost incurred in 2014:
Jan. 2 – Dec. Warranty Liability 500
31, 2014 Cash, Inventory, Accrued Payroll 500
3. To record revenue recognized inn 2017 on the service-type warranty:
Jan.1-Dec.31 Unearned Warranty Revenue (€900 ÷ 3) 300
2017 Warranty Revenue 300
Litigation Provisions
Companies must consider the following factors, among others, in determining whether to
record a liability with respect to pending or threatened litigation and actual or possible claims
and assessments.
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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 the amount of loss.
To report a loss and a liability in the financial statements, the cause for litigation must have
occurred on or before the date of the financial statements. It does not matter that the company
became aware of the existence or possibility of the lawsuit or claims after the date of the
financial statements but before issuing them. To evaluate the probability of an unfavorable
outcome, a company considers the following: the nature of the litigation, the progress of the
case, the opinion of legal counsel, its own and others’ experience in similar cases, and any
management response to the lawsuit.
With respect to unfiled suits and unasserted claims and assessments, a company must
determine (1) the degree of probability that a suit may be filed or a claim or assessment may
be asserted, and (2) the probability of an unfavorable outcome. For example, assume that a
regulatory body investigates the Nawtee Company for restraint of trade and institutes
enforcement proceedings. Private claims of triple damages for redress often follow such
proceedings. In this case, Nawtee must determine the probability of the claims being asserted
and the probability of triple damages being awarded. If both are probable, if the loss is
reasonably estimable, and if the cause for action is dated on or before the date of the financial
statements, then Nawtee should accrue the liability.
Companies can seldom predict the outcome of pending litigation, however, with any
assurance. And, even if evidence available at the statement of financial position date does not
favor the company, it is hardly reasonable to expect the company to publish in its financial
statements a dollar estimate of the probable negative outcome. Such specific disclosures
might weaken the company’s position in the dispute and encourage the plaintiff to intensify
its efforts. As a result, many companies provide a general provision for the costs expected to
be incurred without relating the disclosure to any specific lawsuit or set of lawsuits.
Example: Litigation Disclosure
Nestle Group
Notes to the financial statements (partial)
Litigation
Litigation provisions have been set up to cover tax, legal and administrative proceedings that arise in
the ordinary course of business. These provisions concern numerous cases whose detailed disclosure
could seriously prejudice the interests of the Group. Reversal of such provisions refer to cases
resolved in favour of the Group. The timing of cash outflows of litigation provisions is uncertain as it
depends upon the outcome of the proceedings. These provisions are therefore not discounted because
their present value would not represent meaningful information. Group Management does not believe
it is possible to make assumptions on the evolution of the cases beyond the balance sheet date.
1.3. Contingencies
In a general sense, all provisions are contingent because they are uncertain in timing or
amount. However, IFRS uses the term “contingent” for liabilities and assets that are not
recognized in the financial statements.
Contingent liabilities are not recognized in the financial statements because they are (1) a
possible obligation (not yet confirmed as a present obligation), (2) a present obligation for
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which it is not probable that payment will be made, or (3) a present obligation for which a
reliable estimate of the obligation cannot be made. Examples of contingent liabilities are:
• A lawsuit in which it is only possible that the company might lose.
• A guarantee related to collectibility of a receivable.
Illustration below presents the general guidelines for the accounting and reporting of
contingent liabilities.
Outcome Probability* Accounting treatment
Virtually certain At least 90% Report as liability (provision)
Probable (more likely than not) 51 – 89% probable Report as liability (provision)
Possible but not probable 5 – 50% Disclosure required
Remote Less than 5 % No disclosure required
*In practice, the percentage for virtually certain and remote
may deviate from those presented here
Unless the possibility of any outflow in settlement is remote, companies should disclose the
contingent liability at the end of the reporting period, providing a brief description of the
nature of the contingent liability and, where practicable:
1. An estimate of its financial effect;
2. An indication of the uncertainties relating to the amount or timing of any outflow; and
3. The possibility of any reimbursement.
Illustration below provides a disclosure by Barloworld Limited (ZAF) related to its
contingent liabilities.
Barloworld Limited
2012 2011
Contingent liabilities (in part)
Bills, lease and hire-purchase agreement discounted with recourse, other
guarantees and claims 1,440 1,316
Buy-back and repurchase commitment not reflected on the balance sheet
131 161
The related assets are estimated to have a value at least equal to the repurchase commitment.
The group has given guarantees to the purchaser of the coatings Australian business relating to
environmental claims. The guarantees are for a maximum period of eight years and are limited to the
sales price received for the business. Freeworld Coatings Limited is responsible for the first AUD5
million of any claim in terms of the unbundling arrangement.
Warranties and guarantees have been given as a consequence of the various disposals completed
during the year and prior years. None are expected to have a material impact on the financial results of
the group.
There are no material contingent liabilities in joint venture companies. Litigation, current or pending,
is not considered likely to have a material adverse effect on the group.
1.4. Presentation of Current Liabilities
In practice, current liabilities are usually recorded and reported in financial statements at their
full maturity value. Because of the short time periods involved, frequently less than one year,
the difference between the present value of a current liability and the maturity value is
usually not large. The profession accepts as immaterial any slight overstatement of liabilities
that results from carrying current liabilities at maturity value.
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Intermediate Financial Accounting II Chapter One
The current liabilities accounts are commonly presented after non-current liabilities in the
statement of financial position. Within the current liabilities section, companies may list the
accounts in order of maturity, in descending order of amount, or in order of liquidation
preference.
Detail and supplemental information concerning current liabilities should be sufficient to
meet the requirement of full disclosure. Companies should clearly identify secured liabilities,
as well as indicate the related assets pledged as collateral. If the due date of any liability can
be extended, a company should disclose the details.
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