Questions :
The definition of liabilities is comprehensive in its coverage: indeed, some would argue that it is too comprehensive in that it makes no attempt to distinguish between liabilities and commitments, as it includes obligations arising from firm contracts where neither the entity nor the counter party has honoured its promises. Australian Accounting Research Foundation (AARF), 1998, Measurement in Financial Accounting, Accounting Theory Monograph, AARF, Melbourne, p. 36.
(a). With reference to the above statement describe what you understand by the term liabilities and how they are measured.
(b). Discuss liabilities and the problems of measurement in the context of the present IASB framework.
(c). Select a company from the Australian Securities Exchange website and download the 2014 annual report.Evaluate the categorisation and treatment of liabilities in the annual report.
(d). Comment on the relationship between the measurement of liabilities and decision useful information with examples from your selected annual report
(a). Liability is obligation to pay something to any person or do some act for others, this obligation comes due to some past action or event. Normally these obligations arise during business operations and settled also during business operations. These obligations are such that the company has to pay whether within a shorter period of time or within a longer period. All liabilities are exhibited under the liability side in a balance sheet of an entity and separate heads are there for each liability.
So we can say following are Characteristics of liabilities:
1. An obligation arises from past events
2. A responsibility or duty of enterprise to settle the amount by transfer of assets or monetary consideration
3. Enterprise cannot ignore settlement
4. Occurred during business operations and settlement is also expected during business operations.
Liability is broader term than commitment, as commitment is something which is related with morality but liability is more than morality concept. It is legal and if an enterprise cannot settle a liability it can be sued in courts. It is not compulsory that all the liabilities can be litigated in court if dishonoured but most of liabilities can be sued in court if there is a contractual obligation to do so. A short term liability has to be settled within one year generally, and the settlement of a long term liability is more than that, as the name suggests. But exceptions are there, there are instances when a long term financial arrangement has been made (for example, investment) to pay the long term liability, that may be settled within one year from the date of balance sheet.
Example of Liabilities:-
1. Salary payable – Since employees has done work based upon previous contract with employer, so after the work employer has liability to pay employee.
2. Purchase consideration – If enterprise has purchased something then they have to pay also as after delivery of goods it is liability of buyer to pay for that otherwise seller can sue also.
3. Accrued Expense being the amount not due but which accrues with the time and falls due at the right time of payment.
4. Customer’s deposit – If an enterprise has taken any deposit amount from customer then it is liability for the enterprise to pay to customer
5. Bills payable which is being considered as the total amount paid in order off acceptance of bills.
6. Long term borrowings and obligations for the company which are payable for fixed terms.
(b). Measurement of liability is one of the important concepts that are to be understood as it is one of the issues in the world of accounting system that needs to be measured properly so that the accounting system stays in balance around the world. The principles and rules of various accounting standard boards are being framed all around the world to govern the issue of measurement of the liabilities of the assets which has to be followed by the countries around the world for the purpose of recognition. Measurement of liability is done to help the financers and the investors and support those parties with a better understanding of liabilities of a particular financial statement. It also examines the financial position, solvency, credit worthiness of the company under the purview.
While conducting the measurement of liabilities, following are some issues which normally arise at the time of recording the liabilities:-
1. Issues based on Contractual obligation
2. Issues based on performance (like warranty)
3. Issues based on time period when it should be paid (Long term or short) – Record as per fair value, If long term then on discounted value and if short term then current obligation, not discounted amount.
In International Financial Reporting Standard, the liability measurement convention suffers from incomprehensible expressions in some cases. In our interpretation, we would evaluate the same with the help of arguments made by eminent authors and take the help of particular accounting standards, approaches of Financial Accounting Standard Board (FASB) and International Accounting Standard Board (IASB).
In the financial statement of an enterprise, when an item satisfies the definition of the particular item, can be reliably measured, clarify the users of financial statement relevantly, and all information relating to the item are original and neutral, the item can be recognized in the financial statement. These attributes should be present. In case of measuring the item, it is to be decided whether only a particular unit of the item or whether an attribute of the item is to be measured. A paper of discussion was announced by the IASB and FASB, on how the framework of the accounting statement conceptually should be, it came out in the year 2006. An exposure draft was also introduced by the IASB in the year 2005, and they amended the International Accounting Standard 37. IASB issues documents, changes in accounting standards, exposure drafts to initiate particular judicial pronouncements and considers areas where difficulties are there and how it can be improved to benefit the shareholders or users of the financial statements. Such documents and exposure drafts only accommodate formal requirements and format expressions. The exposure draft evaluated that a business entity has to determine the liability or obligation, the duty to measure the same lies up on the entity. They would measure the amount that they are obliged to pay at the end of the financial year or balance sheet date. Any cost incurred in relation to that, suppose for cancelling the transaction or transferring the liability to another entity shall have to be considered, and the value of the liability shall be lower of fulfilment, cancellation and transfer value. Valuing the contingent liability has been under doubt in many enterprises as the nature of the contingent liability has not specifically evaluated under the standard. Another point is that the derivation of exit price has not been explained whereas there is a mention of the exit price for determining the owner’s equity, change in the exit price of assets in the beginning and in the end of the financial period.
In other cases, it can also be pointed out that the IASB fails to provide with the definition of each element for present value calculation for assuring that it provides with the market based computations. In this situation, in absence of proper market based solutions, fulfilment value cannot be properly computed or it will more or less be equal to “entity specific cost”. While making the definition of a liability, two recognitions come out from two different scenarios that the outflow of the resources is apparent, they are likely to happen; and the other scenario is that the measurement of the amount for settlement is dependable. But the conventions fail to create a practical situation as the concept of future cash flow would depend on an imperceptible future cash flow concept.
When the recoverable amount is less than the replacement cost amount, the deprival value of an asset is irrecoverable, and that value adds a value to the entity. The limitations of replacement cost are overcome by the behavioural implications of deprival value given out by the rational management. In some cases, the only cynosure is on the realization of an asset through sale of that particular asset; the net realizable value of the particular asset is the benefit value of the asset. The net realizable value of the asset is a measure of it when it is going to be sold, in that time only it is a rational measure of the recoverable amount. Likewise, the value in use is also relevant when the asset is going to be used for a continuous period of time. Other than taking the component measurement bases, deprival value is contemplated to be a reliable measure by them.
In crucial issues where serious reliability problems are there, the ways and procedures how the deprival value could be measured is a question of fact. The three measurement issues in relation to this, has to be taken under consideration.
In the initial recognition, at that time when the fair value of an asset is not relevantly or reliably measurable, it was suggested not to take the replacement cost in the measurement. Reproduction cost could be used by substituting for the fair value of the asset when it can be estimated reliably. Historical cost convention is used in most of the cases to determine and depict the reproduction cost of the asset. Transaction cost could be fixed and other adjustments could be made to if required while measuring the same.
In this case, a concept of ‘relief value’ could be contemplated with the liability equivalent to deprival value. The higher of the consideration amount and the settlement amount of a liability is the relief value of that particular liability. In this context, the consideration amount is the amount which is received when the liability is issued on the date of measuring the same; and settlement amount is considered to be the lower of current cost of performance and current cost of release.
The discussion relating to considering the expected value, while measuring the amount of obligation or liability comes under the expected loss technique. The loss is recognized after they have occurred. From the point of view of a presentation of a proper reflection of price and assumptions and all possible results expected from the same, the liability measurement in here lacks in some corners.
The exposure draft of year 2005 also suffered from not addressing the risk margin concept coherently, Risk is an inherent phenomenon which is an important part in managing liability, the probable changes could be occurred if not managed it in time. The liability measurement with the help of present value suffers as it does not consider risk margin in it, whereas the same could be measures alternatively in an explicit manner and taking it together in the discounted cash flow manner taking discount rates.
Similarly, profit margin is an important phenomenon; the same could be properly dealt with if the measurement of the obligation is done using relevant market prices of the same, and the estimation should be based on the future outflow of the same.
There was mentioned that the liability could not be cancelled in the middle as it was not in the scope of a certain standard. An entity therefore may be unable to do that. But there can be more cases in which an enterprise or individual can cancel the amount of obligation when it is comparatively small in amount. Those evidences were not considered or mentioned in anywhere in the draft.
With the discussion of risk margin and profit margin, and by incorporating those things the management and exposure of loss could also be mitigated. A loss incurred due to not managing the risk associated with an obligation is a very common problem suffered by entities, which can be addressed with better tools of management.
The documents and exposure draft produced by the respective authorities should be more comprehensive in incorporating the discount rates, and why they are taken. The nature of the liability or obligation and details of the same whether they are supported with the risk free rate or risk premium rate, is to be observed while measuring the obligation.
Measurement of liability considers the assumptions relating to extension and conjointness in particular cases but fails to address many other arenas also. It is said that the measurement is done with relevance and representational faithfulness but the practical areas, the economic uncertainties could be a debacle at times because they are not included in the measurement perspective. The measurement theory only considers the issues which are basic and general, when the economic realities are considered there may be deviations from the measurement which are presented by the board, or they can be different from what it should be. The measure for economic uncertainty, risk issues, physical realities, errors are not considered.
The disclosure pattern could be made more comprehensive, while measuring the liability and exhibiting the same assumptions taken and disclosures of details which are to be exhibited and which are not, is an important issue. For understanding the nature of liability and the measurement of the same need more comprehensive disclosures which could have included the methods which were applied in the initial recognition of the liability, the risk margin and issues involved regarding the same, the profit margin and issues regarding the same, if any greater amount of disaggregation is involved, the assumption of losses and the steps taken to mitigate the same, any issues for developing and improving the measurement in future if is proposed to be considered. The exposure draft delivers a list of disclosures which are to be incorporated, but they are not adequate from the point of view of many organization and financial accounting institutions or board of studies.
There was an exposure draft to be issued in the year 2009 which was delayed for some uncertain political and social pressures; the exposure draft was intending to amend the discussion paper issued by International Accounting Standard Board on the use of international financial reporting.
It is observed that both the board have given its significant time and effort in improving the measurement of liability phenomenon by issuing disclosure papers, exposure drafts time to time and addressing the changes in certain standards and practices which have been raised by eminent scholars or raised in the day to day affairs of an entity.
(c). The company which we have selected for presenting the categorization and treatment of liabilities report is related to the mining sector in Australia. The company name is NEWSCREST MINING LIMITED. The company is operating in various countries including Australia through joint ventures, subsidiaries and associates. The company operations are related to Mining of Gold and producing gold thereon. The corporation is an Australian corporation which is involved in the developing, exploring and producing the gold and the concentrate of gold and copper in Australia and other international countries also like Indonesia. The company is a leading Gold Mining and exploring corporation in Australia. The company, Newcrest Mining Limited is a listed company which is recognized by stock exchange of Australia.
Now we will discuss the financial parameters of the company in detail, and for this we have considered the financial report of the company for the financial years 2012-13 and 2013-14 , and make a comparison of the two years. While doing so we are going to analyse the growth of the corporation financially on various financial parameter like current assets, current liabilities, shareholder’s equity etc.
The liability of the companies can be evaluated as internal as well as external liabilities which can be divided on the basis of time into noncurrent liabilities as well as current liabilities. The company should understand the fact that the division is to be backed up by proper explanatory notes as presented alongside the liabilities in the solution. .
It can be seen that the company had divided payables into unsecured as well as secured which indicates the security of the liabilities to the debt owes. It could be seen that the lease liabilities of the company has been divided as a current due for repayment of the same, and it is considered as a non current liability when it is payable in foreign exchange. In this case, the transaction cost has been reduced from the face value of the facilities, these are was incurred for establishing the facilities during the financial year 2013-14, which has been shown as Other Assets in the year before the current financial year.
These disclosures in one part are the several of those that help the stakeholders to understand the concept of the measurement of the liabilities as a whole. The categorization of these liabilities is also moved to the borrowings which are further classified on the basis of the maturity dates that are being highlighted through annexure present in the final report. These are bank dates and hence being summarised as the bank reports in the long run to be paid to the banks
There is a further division of the liabilities in the form of financial liabilities which plays the role of the better disclosure of the liabilities that are concerned with other items such as other assets that are financial in nature and linked to the obligations derived from the other liabilities.
(d). Measurement of liabilities becomes very important for the reason that these help the proper decision making by the stakeholders as they can understand the useful and the non useful information and can differentiate it easily for the purpose of the decision making and thus helps the shareholders to judge the obligations of the company in a better way.
In the given annual report it can be seen that liabilities are being divided in such a manner that it can be understood easily for the stakeholders. The liabilities are being placed as commitments for New Crest Mining and the disclosure also contain note relating to contingent liabilities and the same is being disclosed in the notes attached and has been explained with the help of examples that might affect the decagon making of the stakeholders for sure.
It can be said that the IASB framework provides for the better measurement which would indirectly to better presentation of the accounts and the decisions making would be much easier based on the above information. The measurement of the liabilities is of a huge concern and needs to be understood as a positive sign in the long run for the company and the stakeholders and the investors too.
References
https://www.futurpreneur.ca/en/resources/operational-and-financial-planning/articles/cybf-article-financial-analysis-and-the-effective-operation-of-your-company/.
Street.https://www.streetofwalls.com/articles/investment-banking/recruiting-interviewing/comparative-company-analysis/. https://www.streetofwalls.com/articles/investment-banking/recruiting-interviewing/comparative-company-analysis/.
Financial Accounting Standards Board (United States). Statement of Financial Accounting Standards No. 89, Financial Reporting and Changing Prices. Stamford, 1986.
Foster, John M. (Neel) and Wayne Upton. “The Case for Initially Measuring Liabilities at Fair Value”, Understanding the Issues (volume 2, series 1). Financial Accounting Standards Board (United States), Norwalk, May 2001.
Foster, John M. (Neel) and Wayne S. Upton. “Measuring Fair Value”, Understanding the Issues (volume 3, series 1). Financial Accounting Standards Board (United States), Norwalk, June 2001.
Hanna, John R., Duane B. Kennedy, and Gordon D. Richardson. Reporting the Effects of Changing Prices: A Review of the Experience with Section 4510 (Research Report). Canadian Institute of Chartered Accountants, Toronto, 1990.
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