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Intermediate Accounting 13th Canadian Edition, Volume 2 Kieso Weygandt Warfield Wiecek McConomy Chapter 13 Non-Financial and Current Liabilities This slide...

Intermediate Accounting 13th Canadian Edition, Volume 2 Kieso Weygandt Warfield Wiecek McConomy Chapter 13 Non-Financial and Current Liabilities This slide deck contains animations. Please disable animations if they cause issues with your device.  CHAPTER 13 NON-FINANCIAL AND CURRENT LIABILITIES CHAPTER TOPICS CROSS-REFERENCED WITH THE CPA CANADA HANDBOOK, PART I (IFRS) AND PART II (ASPE) Cash and Cash Equivalents Section 1540 IAS 7 Current Assets and Current Liabilities Section 1510 IAS 1 Non-financial liabilities — IAS 37 and IFRS 15 Asset Retirement Obligations Section 3110 IAS 37 Contractual Obligations Section 3280 IAS 37 Contingencies Section 3290 IAS 37 Financial Instruments—Recognition and Section 3856 IAS 39 Measurement Financial Instruments—Presentation Section 1521 IAS 32 Financial Instruments—Disclosure Section 3856 IFRS 7 Disclosure of guarantees AcG-14 IAS 37  Video- Conceptual Framework https://www.youtube.com/watch?v=LGJqmIikrXg&list=PL6c0ylpV_Baf2LhxuajA7MYn-G8P4IHWZ Chapter 13: Non-Financial and Current Liabilities (LO 1 to LO 5) studying this chapter, you should be able After to: 1. Understand the importance of non-financial and current liabilities from a business perspective. 2. Define liabilities, distinguish financial liabilities from other liabilities, and identify how they are measured. 3. Define current liabilities and identify and account for common types of current liabilities. 4. Identify and account for the major types of employee-related liabilities. 5. Explain the recognition, measurement, and disclosure requirements for Copyright ©2022 John decommissioning Wiley Canada, Ltd. & Sons, 4 Chapter 13: Non-Financial and Current Liabilities (LO 6 to LO 9) 6. Explain the issues and account for product guarantees, other customer program obligations, and unearned revenues. 7. Explain and account for contingencies and uncertain commitments, and identify the accounting and reporting requirements for guarantees and commitments. 8. Indicate how non-financial and current liabilities are presented and analyzed. 9. Identify differences in accounting between IFRS and ASPE, and what changes are expected in the near future. Copyright ©2022 John Wiley & Sons, 5 Canada, Ltd. LO 1-Understanding Non- Financial and Current Liabilities It is important for businesses to properly account for liabilities because it is useful for cash flow management Cash flow management is a key control factor for most companies Control of expenses and accounts payable can improve the efficiency of a business and can be particularly important during economic downturns LO 1 Copyright ©2022 John Wiley & Sons, 6 Canada, Ltd. LO 2-Definition of Liabilities, IFRS vs. ASPE Part A: Definition in IFRS Conceptual Framework (summary) A liability is a present obligation of the entity to transfer an economic resource as a result of past events. For a liability to exist, the following criteria must all be satisfied: 1. The entity has an obligation (that is, a present duty or responsibility to others that it has no practical ability to avoid). 2. The obligation is to transfer an economic resource to another party or parties. 3. The obligation exists as a result of past events. Part B: ASPE Definition in CPA Canada Handbook, Part II (summary) A liability is an obligation that arises from past transactions or events, which may result in a transfer of assets or provision of services. Liabilities have three essential characteristics: 4. They embody a duty or responsibility to others. LO 2 Copyright ©2022 John Wiley & Sons, 7 5. They entity has little or no discretion Canada, Ltd. to avoid the duty. Liability Definition and Characteristics A liability requires a duty or responsibility to perform in a specific way, therefore o It suggests there might be an economic burden o The requirement can be enforced by legal means A constructive obligation arises o From past or present practice o Indicates acknowledgement of a potential economic burden Entities must comply with statutes, laws, and regulations o A liability arises only if the provisions are violated LO 2 Under ASPE recognition requirements, Copyright ©2022 John Wiley & Sons, Canada, Ltd. 8 Financial Liabilities A financial liability (under ASPE and IFRS) is any liability that is a contractual obligation to either: o deliver cash or other financial assets to another party, or o exchange financial assets or financial liabilities with another party under conditions that are potentially unfavourable to the entity Liabilities that are created by legislation do not qualify as financial liabilities, they must be created by a contract LO 2 Copyright ©2022 John Wiley & Sons, 9 Canada, Ltd. Classification Classification of liabilities into financial and non-financial liabilities o Defines the accounting standard that is applied o Conceptual framework provides a basis for settling classification issues LO 2 Copyright ©2022 John Wiley & Sons, 10 Canada, Ltd. Measurement of Financial Liabilities Financial liabilities o Initially measured at fair value o Subsequent measurement generally at amortized cost (except those held for trading where fair value is used) o Include transaction costs at acquisition o Transaction costs after acquisition are expensed o Short-term liabilities are accounted for at maturity value—little difference between fair value and maturity value LO 2 Copyright ©2022 John Wiley & Sons, 11 Canada, Ltd. Measurement of Non- Financial Liabilities Non-financial liabilities—not payable in cash ASPE: no specific measurement standards (measurement varies based on nature of liability) IFRS: measured at best estimate of payment that would be required to settle the obligation at the date of the statement of financial position o Timing and amount are usually not fixed o Expected value or probability-weighted LO 2 average of possible outcomes Copyright ©2022 John Wiley & Sons, Canada, Ltd. 12 LO 3-What is a Current Liability? An important feature of liabilities is the timing of when they are due o Short-term maturity places a demand on current assets o Distant due dates do not result in a claim on current assets o Difference in timing and the effect on current assets distinguish current from non-current liabilities Separate current assets from non-current assets to show how working capital is used in the normal operating cycle LO 3 Copyright ©2022 John Wiley & Sons, 13 Canada, Ltd. Current Liability Under IFRS, liabilities are classified as current when they meet any one of the following conditions: o Expected to be settled within normal operating cycle o Held primarily for trading o Due within 12 months from the end of the reporting period o No unconditional right to defer settlement for at least 12 months after the date of the statement of financial position LO 3 ASPE has a less specific Copyright definition, ©2022 John Wiley & Sons, similar 14 Canada, Ltd. 1) Bank Indebtedness Line-of-credit or revolving debt Revolving debt arrangements: an agreement entered with the bank that allows multiple borrowings up to a negotiated limit Repayments made whenever there are sufficient funds available Usually collateral required; some restrictions set Amount borrowed reported on the SFP; availability of funds and restrictions imposed by the financial institution are typically disclosed in the notes LO 3 Copyright ©2022 John Wiley & Sons, 15 Canada, Ltd. 2) Accounts Payable Also called trade accounts payable Amounts owed for goods, supplies or services related to the entity’s ordinary business activities purchased on open account Arise because of the time lag between receipt of goods and services and the payment for them Usually record liabilities when the goods are received Generally recorded when title has passed LO 3 Copyright ©2022 John Wiley & Sons, 16 Canada, Ltd. 3)Notes Payable Notes payable are written promises to pay a sum of money on a specified future date Arises from purchases, financing or other transactions Notes payable may be classified as either current or long-term depending on the payment due date Notes payable may be interest-bearing or zero-interest-bearing (non-interest- bearing) o In both cases, interest expense must be LO 3 accrued regardless Copyright ©2022of Johnwhen cash payment is Wiley & Sons, Canada, Ltd. 17 Notes Payable: Zero- Interest-Bearing For zero-interest-bearing notes, the difference between the amount of cash received at issuance and the higher face value at maturity represents the interest o The borrower receives the note’s present value and pays back the face value The interest expense is recorded over the life of the note LO 3 Copyright ©2022 John Wiley & Sons, 18 Canada, Ltd. 4)Current Maturities of Long- Term Debt The portion of long-term debt maturing within 12 months from the date of the statement of financial position is reported as a current liability Portions of long-term debts should not be reported as current liabilities if, by contract, they are retired by assets not classified as current assets Any liability due on demand, or due on demand within a year or operating cycle, even if it has payments due over a number of years, is reported as a current liability If a long-term debt is violated and becomes payable on demand, the debt is reclassified as LO 3 current Copyright ©2022 John Wiley & Sons, 19 Canada, Ltd. 5)Short-Term Debt Expected to be Refinanced Short-term debt obligations are classified as current except if they are expected to be refinanced on a long-term basis, and no current assets will be required to settle Under IFRS, debt due within 12 months is classified as current, unless it is expected to be refinanced under an existing agreement for at least 12 months Under ASPE, currently maturing debt can be classified as long-term if there is irrefutable evidence when the financial statements are completed that the debt has been or will be converted to a long-term obligation LO 3 Copyright ©2022 John Wiley & Sons, 20 o The short-term debt reclassified cannot be more Canada, Ltd. Refinancing of Short-Term Debt PiP 13.3 Assume a company has $3 million of short- term debt at the reporting date. Company then issues $2 million of long-term debt after the balance sheet date but before the financial statements are issued. Under ASPE, only Under IFRS, $3 million of $2 million can be maturing debt would still be reclassified as classified as current; IFRS long-term requirements are more stringent: the agreement must be in place at the date of the SFP LO 3 Copyright ©2022 John Wiley & Sons, 21 Canada, Ltd. Repayment of Short-Term Debt PiP 13.4 A company pays off short-term debt of $40,000 on Jan 17 and issues long-term debt of $100,000 on Feb 3. The company’s financial statements are date Dec 31 (prior year) and are issued on Mar 1. Refinancing does not appear to be linked to the short-term debt—both ASPE and IFRS require the debt to be classified as current Because repayment occurred before funds were obtained through long-term financing, the repayment used existing current assets LO 3 Copyright ©2022 John Wiley & Sons, 22 Canada, Ltd. 6) Cash Dividends Payable An amount a corporation owes to its shareholders because the board authorized a dividend Liability recognized at the dividend declaration date Generally paid within three months Classified as current liability LO 3 Copyright ©2022 John Wiley & Sons, 23 Canada, Ltd. 7) Preferred Dividends in Arrears Undeclared dividends on cumulative preferred shares are not a liability Not an obligation until distribution is authorized Disclose undeclared cumulative dividends in arrears in the notes LO 3 Copyright ©2022 John Wiley & Sons, 24 Canada, Ltd. 8) Share or Stock Dividends Payable Dividends payable in the form of additional shares Not recognized as a liability Do not meet the definition of a liability— do not require future outlays of economic resources Represents a transfer of equity from retained earnings to contributed capital LO 3 Copyright ©2022 John Wiley & Sons, 25 Canada, Ltd. 9) Rents and Royalties Payable This type of liability may be created by a “contractual agreement in which payments are conditional on the amount of revenue that is earned or the quantity of product that is produced or extracted.” Examples o Franchisees often pay the franchisor franchise fees calculated as a percentage of sales o Tenants in shopping centres may be required to pay additional rents based on sales o Manufacturers pay the holder of a patent a royalty for each unit produced LO 3 Copyright ©2022 John Wiley & Sons, 26 Canada, Ltd. 10) Customer Advances and Deposits Customers may pay deposits that guarantee the payment of expected future obligations, the performance of a future service or to cover possible future damage to property They are classified as either current or non- current liabilities depending on the specific conditions attached to the deposit If settlement of the deposit cannot be deferred for a period of more than 12 months from the SFP date, it is reported as a current liability LO 3 Copyright ©2022 John Wiley & Sons, 27 Canada, Ltd. 11)Taxes Payable: Sales Tax In some provinces, sales tax is applied to transfers of tangible property and to certain services The liability represents sales taxes that have been collected from customers but have not been remitted to the appropriate government Usually applied to the sale amount LO 3 Copyright ©2022 John Wiley & Sons, 28 Canada, Ltd. 12)Taxes Payable: Goods and Services Tax The GST is a value-added tax of 5% based on the value added to goods and services by each taxable entity The net amount is payable to Canada Revenue Agency (CRA)—deduct the GST paid on goods and services purchased from the GST collected by customers Some provinces charge Harmonized Sales Tax (provincial retail sales tax plus GST) which is accounted for in the same way as GST LO 3 GST collected is©2022 Copyright notJohnincluded Wiley & Sons, in 29 Canada, Ltd. Accounting for Goods and Services Tax Accounting for GST involves two accounts: o GST Payable: liability; credited with GST charged to customers on sales o GST Receivable: asset; debited with GST paid to suppliers The net amount of the GST Payable and GST Receivable accounts is remitted to (due from) Canada Revenue Agency (CRA) This net amount is reported on the statement of financial position as a current liability (credit balance) or a current asset (debit balance) LO 3 HST is treatedCopyright similarly to GST ©2022 John Wiley & Sons, Canada, Ltd. 30 13) Taxes Payable: Income Tax Corporations are charged federal and provincial income tax based on taxable income Since income tax returns are generally finalized after the financial statements have been issued, companies generally estimate the total amount of income tax payable Income taxes payable are reported as a current liability CRA reassessment amounts are charged to current operations; obvious arithmetic errors LO 3 from prior periods are Canada,corrected Copyright ©2022 John Wiley & Sons, Ltd. through R/E 31 LO 4-Employee-Related Liabilities Employee-related liabilities include the following: o 1) Salaries or wages owed to employees at end of the accounting period o 2) Payroll deductions owed to CRA and others o 3) Short-term compensated absences o 4) Profit-sharing and bonuses Usually reported as current liabilities LO 4 Copyright ©2022 John Wiley & Sons, 32 Canada, Ltd. 2) Payroll Deductions Payroll deductions include statutory and discretionary deductions 1) Statutory (mandatory) deductions include: o Canada (Quebec) Pension Plan [CPP/QPP] o Employment Insurance (EI) o Income Tax Withholding (Federal and Provincial) 2) Discretionary deductions might include: o Insurance premiums, union dues, employee savings Until these deductions, along with matching amounts from the employer, are remitted LO 4 to the government or other entity, they are 33 Copyright ©2022 John Wiley & Sons, Canada, Ltd. 3) Short-Term Compensated Absences Compensated absences are periods of time taken off from active employment for which employees are paid—statutory holidays; vacations The entitlement to such benefits is one of two types: o Accumulated rights are rights that accrue with employee service o Non-accumulating compensated absences are benefits employees are entitled to by virtue of their employment and the occurrence of an obligating event: paternity leave LO 4 Copyright ©2022 John Wiley & Sons, 34 Canada, Ltd. 1) Accumulating Rights to Benefits Rights that accrue with employee service (vacation pay, sick leave) For some benefits, such as vacation, employers have an unconditional obligation to pay for benefits that accrue as the employee works Some rights are vested—the rights do not depend on an employee’s continued service (e.g., minimum level of vacation pay as prescribed by law) Costs are accrued as expense and liability in the period in which the benefit is earned o Future obligation (liability) must be estimated o Use current rate of pay or future amounts that are LO 4 likely to be paid Copyright ©2022 John Wiley & Sons, 35 Canada, Ltd. 2)Non-Accumulating Rights to Benefits Benefits earned through employment and a specific situation: additional compensation and time off for parental leave beyond government benefits, or short-term disability Rights to the benefits are not vested No basis for accrual of the costs and the associated liability, not recorded until the event occurs When benefit is used, the total estimated expense and liability must be recognized at the time LO 4 Copyright ©2022 John Wiley & Sons, 36 Canada, Ltd. 4)Profit-Sharing and Bonus Agreements Payments are in addition to regular salary or wage, and are considered compensation Can be based on regular rates of pay, productivity, or company profits Obligations arising are reported as current liabilities at the reporting date o Usually relate to the period just ended o Usually based on results of the period just ended o Usually payable in the near term May involve complex calculations LO 4 determining the taxCanada, consequences Copyright ©2022 John Wiley & Sons, Ltd. 37 LO 5-Decommissioning and Restoration Obligations Construction and operation of long-lived assets: obligations associated with retirement o Decommissioning nuclear facilities o Dismantling, restoring, reclaiming oil and gas properties o Closure, reclamation, removal of mining facilities o Closure and post-closure remediation of landfills Liability is known as an asset retirement LO 5 obligation (ARO) or©2022 Copyright siteJohn restoration Wiley & Sons, obligation38 Canada, Ltd. Asset Retirement Costs: IFRS versus ASPE Category of obligations—IFRS recognizes a broader group of non-financial obligations as liabilities: both legal and constructive obligations; ASPE recognizes legal obligation only Category of activities—costs related to production of the goods and services: ASPE capitalizes; IFRS recognizes as product costs LO 5 Copyright ©2022 John Wiley & Sons, 39 Canada, Ltd. Decommissioning and Restoration Obligations: Measurement Initially measured at “best estimate of the expenditure required to settle the present obligation” Because obligation will be met in the future; future costs must be discounted ARO cost is recorded as part of the cost of the related asset because it is necessary to acquire the asset Because no future economic benefit is associated with the ARO as a stand-alone asset, it is included in the asset account LO 5 Copyright ©2022 John Wiley & Sons, 40 Canada, Ltd. Decommissioning and Restoration Obligations: Recognition Expected ARO and cost increases arising from production activities Recognized differently by IFRS and ASPE IFRS ASPE Added to the obligation Added to the obligation amount; incremental amount (liability) and to costs caused by the capital asset production are added account, increasing to inventory as product future depreciation cost amount LO 5 Copyright ©2022 John Wiley & Sons, 41 Canada, Ltd. Decommissioning and Restoration Obligations: Allocation ARO cost is amortized to expense over the related asset’s useful life--depreciation Because ARO is measured on a discounted basis, interest must be accrued each period o Interest Expense under IFRS o Accretion Expense under ASPE Costs arising from catastrophic events do not result in an asset retirement obligation, and are not added to the cost base of the underlying asset LO 5 Copyright ©2022 John Wiley & Sons, 42 Canada, Ltd. Accounting for Asset Retirement Obligations PiP 13-13 Facts Oil platform erected January 1, 2023 Platform must be dismantled at the end of the useful life of 5 years Estimated cost of dismantling: $1,000,000 Discount rate: 10% PV of the asset retirement obligation: $620,920 ($1,000,000 × 0.62092) LO 5 Copyright ©2022 John Wiley & Sons, 43 Canada, Ltd. Accounting for ARO: Initial Recognition PiP 13.13 (a) Prepare the journal entry to initially recognize the ARO. Date Account Debit Credit Same entry under Jan 1 Drilling Platform 620,920 IFRS & ASFE Asset Retirement Obligation 620,920 PiP 13.13 (b) Prepare the journal entry to initially recognize the ARO assuming 80% of the $1,000,000 ARO is related to the acquisition; 20% caused by production. Date Account Debit Credit Same entry under Jan 1 Drilling Platform 496,736 IFRS & ASFE Asset Retirement Obligation 496,736 80% x PV of $1,000,000 discounted at 10% LO Copyright ©2022 John Wiley & Sons, 44 5 Canada, Ltd. Accounting for ARO: Allocation PiP 13.13 (c) Prepare the journal entry to be recorded at year-end assuming straight-line depreciation. Straight-line Date Account Debit Credit depreciation: 31-Dec Depreciation Expense 99,347 $496,736 for this Accumulated Depreciation-- year—same journal Drilling Platform 99,347 entry for all 5 years (unless the amount of the ARO changes) LO Copyright ©2022 John Wiley & Sons, 45 5 Canada, Ltd. Accounting for ARO: Accrued Interest PiP 13.13 (d) Prepare the journal entries to recorded interest relating to the ARO liability under IFRS and ASPE. Under IFRS, the Under ASPE, the interest is interest adjustment recognized as an operating due to the passage of expense on the income time is a borrowing statement cost LO 5 Copyright ©2022 John Wiley & Sons, 46 Canada, Ltd. Accounting for ARO: Increases Related to Production PiP 13.14 (a) & (b) Prepare the journal entries to be recorded assuming the increase in the ARO due to production in 2023 was $136,602. Under ASPE, the increase in Under IFRS, the increase cost would be added to the in cost would be charged cost of the asset: drilling to production (through platform inventory and then COGS) Under ASPE, the Under IFRS, the cost of goods sold depreciation expense would would increase as the inventory is sold increase in the following years LO Copyright ©2022 John Wiley & Sons, 47 5 Canada, Ltd. Accounting for ARO: Settlement of the Liability PiP 13.14 (c) Prepare the journal entry to be recorded when the platform is dismantled at a cost of $995,000. Date Account Debit Credit 10-Jan Asset Retirement Obligation 1,000,000 Gain on Settlement of ARO 5,000 Cash 995,000 With the annual accrued interest, the ARO liability will increase to $1,000,000 by Dec 31, 2027 The interest component would be adjusted annually with any increases in the liability estimate LO 5 Copyright ©2022 John Wiley & Sons, 48 Canada, Ltd. LO 6-Product Guarantees, Customer Programs, and Unearned Revenue A continuing obligation results when an entity provides customer programs requiring that goods or services be provided after the initial product or service is delivered There are two approaches to accounting for the outstanding liability: o Expense approach—used to account for liabilities relating to services provided after good delivery; assurance-type warranties; consistent with matching principle o Revenue approach—used to account for LO 6 service-type warranties Copyright ©2022 John Wileynot & Sons,included in 49 Canada, Ltd. Product Guarantees and Warranty Obligations A warranty (product guarantee) is a promise made by a seller to a buyer to correct problems experienced with a product’s quantity, quality, or performance Warranties and product guarantees are stand-ready obligations at the reporting date that result in future costs that are often significant LO 6 Copyright ©2022 John Wiley & Sons, 50 Canada, Ltd. Comparison: Assurance-Type and Service-Type Warranties Assurance-type Warranty Service-type Warranty Expense-based approach Revenue-based approach Associated expense is measured Proceeds are unearned revenue at and matched to actual revenue the point of sale Liability is measured at the Liability is measured at the value estimated cost of meeting the of the obligation, that is, the obligation service to be provided As actual costs are incurred, the The revenue is earned as the liability is reduced warranty service is provided; and the liability is reduced No effect on future income Some unearned revenue is recognized as a liability, recognized as revenue when the obligation is satisfied LO 6 Copyright ©2022 John Wiley & Sons, 51 Canada, Ltd. Assurance-Type Warranty Illustrated PiP 13.15 Facts Sales of 100 units at $5,000 each during 2023 Provides one-year assurance-type warranty Estimate of $200 per unit warranty cost Incurs $4,000 in actual warranty costs in 2023 on machines sold before year-end Estimates further costs of $16,000 in 2024 Actual costs in 2024: $16,800 LO 6 Copyright ©2022 John Wiley & Sons, 52 Canada, Ltd. Assurance-Type Warranty: Initial Sale and Warranty Expense PiP 13.15 (a) Prepare the journal entries to account for the sale of the machines using the expense approach. July to December 2023 Account Debit Credit Cost estimate could Accounts Receivable 500,000 also be accrued at time Sales Revenue 500,000 of sale PiP 13.15 (a) Prepare the journal entry to record the related warranty costs using the expense approach. July to December 2023 Account Debit Credit Warranty costs Warranty Expense 4,000 incurred are charged Materials, Cash, Payables 4,000 to expense LO 6 Copyright ©2022 John Wiley & Sons, 53 Canada, Ltd. Assurance-Type Warranty: Year End 2023 & 2024 PiP 13.15 (a) Prepare the year-end adjusting entry at the end of 2023 to accrue outstanding warranty obligations. Account Debit Credit Remaining expense Warranty Expense 16,000 associated with the sale is Warranty Liability 16,000 recognized and the liability account is adjusted for the Recognizes warranty expense in the same amount same period as the sales PiP 13.15 (b) Prepare the journal entry to record the actual warranty costs at the end of 2024 and to adjust the liability to zero. Account Debit Credit Warranty Liability is adjusted Warranty Expense 16,800 to zero because the Materials, Cash, Payables 16,800 warranty period has expired for machines sold in 2023. Warranty Liability 16,000 Warranty Expense 16,000 LO 6 Copyright ©2022 John Wiley & Sons, 54 Canada, Ltd. Product Guarantee and Warranty Obligations-Use of Cash Basis Cash basis of accounting for warranties is sometimes used o When warranty costs are immaterial o When the warranty period is short Warranty costs are charged to expense as incurred in the period when the warranty is honoured No liability is recognized for future costs Expense may not be recognized in the period of the sale Used for income tax; not for financial reporting LO 6 Copyright ©2022 John Wiley & Sons, 55 Canada, Ltd. Service-Type Warranty Illustrated PiP 13.16 Facts Date of sale of equipment: January 2, 2023 Total sale price of equipment including two-year warranty: $20,000 Estimated stand-alone value of the two-year warranty (if purchased separately): $1,200 Assume costs of $423 were incurred in 2023 to service the warranty Under the revenue approach for service-type warranties, the warranty service is considered sold as a separate service or as part of a bundle of associated goods. The proceeds from the sale of the warranty are unearned at the point of sale. LO 6 Copyright ©2022 John Wiley & Sons, 56 Canada, Ltd. Service-Type Warranty and Warranty Liability: The Sale PiP 13.16 (a) Prepare the journal entry to record the sale. Estimated warranty revenue is separated from Account Debit Credit the proceeds of Cash 20,000 the “bundled” Sales Revenue 18,800 Recorde sale Unearned Revenue 1,200 d at fair value LO 6 Copyright ©2022 John Wiley & Sons, 57 Canada, Ltd. Service-Type Warranty and Warranty Liability: Recording PiP 13.16 Prepare theRevenue/Expense journal entry to remeasure the warranty at the end of 2023. Account Debit Credit Recognize the revenue Unearned Revenue 600 from one year of the two- Warranty Revenue 600 year warranty PiP 13.16 Prepare the journal entry to record actual costs incurred in 2023. Account Debit Credit If costs are expected to Warranty Expense 423 exceed the remaining Materials, Cash, Payables 423 unearned revenue (onerous contract), a loss and related liability should be recognized immediately LO 6 Copyright ©2022 John Wiley & Sons, 58 Canada, Ltd. Customer Loyalty Programs Promise future benefits in exchange for current sales IFRS ASPE Recognizes the promise to Does not specifically provide goods as a address loyalty performance obligation programs Fair value of the General principle that ”rewards” is recognized revenue recognition as a liability criteria is applicable Recognized as revenue May record rewards as when rewards are unearned revenue redeemed LO 6 Copyright ©2022 John Wiley & Sons, 59 Canada, Ltd. Premiums and Rebates Offers to customers with evidence of having purchased a particular product Printed and online coupons; cash rebates; contests To increase current sales—costs incurred in the future Total estimated cost is expensed in current period IFRS ASPE Liability is for aat Obligations separate Liability: period end are Estimated recognized as a performance liability obligation: Liability for Premiums Unearned Revenue LO 6 Copyright ©2022 John Wiley & Sons, 60 Canada, Ltd. Unearned Revenue Cash received in advance for specific goods or services to be delivered or performed in the future Recognized as a liability: unearned revenue Liability is measured at the fair value of the outstanding obligation Revenue is recognized as the goods are delivered or the services are provided LO 6 Copyright ©2022 John Wiley & Sons, 61 Canada, Ltd. LO 7-Contingencies and Uncertain Commitments Issue: Does an obligation exist at the SFP date and what is the amount required to settle the obligation? Under ASPE a contingency is: “An existing condition or situation involving uncertainty as to possible gain or loss to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur” (CPA Handbook-Accounting, Part II, Section 3290.05) Gain contingencies and contingent assets are not recorded in the accounts LO 7 Copyright ©2022 John Wiley & Sons, 62 Canada, Ltd. Recognition of Contingent Liabilities IFRS ASPE Contingent liability: used Contingent liability: whole only for those existing or population of existing or possible obligations that possible obligations that are not recognized depend on the occurrence of a future event The approach taken by current standards is– determine the probability of a future event occurring (or not occurring) that would establish whether the outcome is a loss. LO 7 Copyright ©2022 John Wiley & Sons, 63 Canada, Ltd. Recognizing Contingent Losses (ASPE) Under ASPE, a contingent loss is recognized in income and as a liability if two conditions are met: o It is probable a future event will confirm the impairment or the liability and it relates to events occurring on or before the SFP date o The loss can be reasonably estimated—that is, it is possible to make a reasonable and reliable estimate Based on experience or expert guesses Often consists of a range of possible outcomes LO 7 Copyright ©2022 John Wiley & Sons, 64 Canada, Ltd. Disclosing Contingent Losses (ASPE) Contingencies with a higher degree of uncertainty require disclosure in addition to the accrual if o Occurrence is likely but a reasonable estimate cannot be determined o The likelihood of a confirming future event cannot be determined o The entity is exposed to loss above the amount accrued Information to be disclosed o Nature of the contingency o Estimated amount of the loss or a statement that an estimate cannot be made o The extent of loss exposure in excess of the LO 7 amount thatCopyright has ©2022 been recognized John Wiley & Sons, Canada, Ltd. 65 Recognizing Provisions under IFRS Under IFRS, provisions are required for situations where it is more likely than not that a present obligation exists A provision is recognized based on whether it is “probable” there will be an outflow of resources o Probable involves considerable judgement and subjectivity o So, recognition of losses and liabilities varies considerably o War, strikes, uninsurable catastrophes, economic recession are not accounting contingencies Provisions are liabilities; not contingent liabilities LO 7 If recognized, the best Copyright ©2022estimate and an expected 66 John Wiley & Sons, Canada, Ltd. Contingent Liabilities under IFRS Under IFRS, contingent liabilities refer only to those existing or possible obligations that are not recognized Contingent liabilities are not recognized because their existence and amount are very uncertain Disclosure is required about their nature and, if practicable o An estimate of the financial effect o Information about the uncertainties related to the amount and timing of outflows o Whether any reimbursement is possible LO 7 Copyright ©2022 John Wiley & Sons, 67 Canada, Ltd. Contingencies and Uncertain Commitments: Summary IFRS ASPE Recognize if occurrence of a Recognize if occurrence of a future confirming event is future confirming event is “probable,” meaning more “likely,” meaning a high likely than not and measurable probability and measurable. —a lower threshold than under Measure the amount of the ASPE. liability at the best estimate Measure the amount at the in the range of possible probability-weighted expected outcomes; if none, use value of the loss. lowest point in the range and IAS 37 identifies specific disclose the remaining disclosures for “provisions” exposure to loss. including descriptions and a Disclosures are less reconciliation of balances extensive between beginning and LO 7 ending than required under Copyright ©2022 John Wiley & Sons, 68 balances. international standards. Canada, Ltd. Litigation, Claims by Others, Assessments To recognize a loss and liability, the litigation cause must have occurred on or before the statement date—even if the company was not aware To evaluate the likelihood of an unfavourable outcome, consider: nature of the litigation, progress of the case, opinion of legal counsel, experience of the company, other similar cases, and the company’s response Estimating the amount of loss can rarely be done with certainty, and generally is not LO 7 disclosed (could produce Copyright a &negative ©2022 John Wiley Canada, Ltd. Sons, 69 Financial Guarantees One party (the guarantor) contracts to reimburse a second party for a loss incurred if a third party (the debtor) does not make required payments when due Qualifies as a financial liability because the guarantor has unconditional obligation to transfer cash Disclosure objective is to give readers information about the company’s obligations and the risks associated with the guarantees LO 7 Copyright ©2022 John Wiley & Sons, 70 Canada, Ltd. Financial Guarantees (ASPE) Falls under the loss contingency standards and disclosure provisions for guarantees o Specific disclosures even if the probability of making payments is slight o Information presented— What types of guarantees have been made Maximum exposure How much has been recognized as a liability Prospects for recovery Details of guarantees issued to benefit related parties LO 7 Copyright ©2022 John Wiley & Sons, 71 Canada, Ltd. Financial Guarantees (IFRS) Guarantee initially recognized at fair value (usually equal to the premium charged by the guarantor) After this, the higher of the loss allowance required and the amount recognized initially The best estimate would be the most likely amount Time value of money considered is effects are significant Disclosure requirements similar to ASPE except o Must provide a reconciliation of the opening to LO 7 Copyright ©2022 John Wiley & Sons, the closing balance forLtd.this type of obligation 72 Canada, Commitments Executory contracts—contracts where neither party has yet performed Not recognized as liabilities These types of contracts should be disclosed if o The company is committed to expenditures that are unusual for their typical operations o They involve significant risk o Costs to complete the contract exceed the benefits to be received (an onerous contract) o A penalty is charged for failing to fulfill a contract Examples: commitments for major PP&E purchases, intangible asset expenditure commitments, lease payments LO 7 Copyright ©2022 John Wiley & Sons, 73 Canada, Ltd. LO 8-Presentation and Disclosure of Current Liabilities First classification in the liability section of the SFP IFRS allows presentation of the current liabilities at the bottom of the statement Within the section, accounts may be listed in order of maturity, or liquidation preference IFRS requires provisions to be reported separately along with a reconciliation of the opening to closing balances Amounts owing to associated persons and companies are reported separately LO 8 Secured liabilities and any assets used as Copyright ©2022 John Wiley & Sons, 74 collateral should be identified Canada, Ltd. Presentation and Disclosure —Contingencies, Guarantees, and Commitments (ASPE) Any contractual obligations that are significant relative to their financial position or future Disclose contingent liabilities if one of the following is true o If the future event is likely to confirm a loss but the amount cannot be estimated o The expected loss is more than the amount recognized o The likelihood of the confirming event happening cannot be determined Guarantees—nature, maximum potential LO 8 payments, potential recoveries, existence of any Copyright ©2022 John Wiley & Sons, 75 collateral Canada, Ltd. Presentation and Disclosure —Contingencies, Guarantees, and Commitments (IFRS) Similar to ASPE requirements except for contingent liabilities Companies are required to disclose o A brief description for each class of contingent liability unless the probability of outflow is remote o An estimate of the financial effect of the contingency LO 8 Copyright ©2022 John Wiley & Sons, 76 Canada, Ltd. Analytics—Liquidity Ratios Identifying current liabilities separately from long-term obligations is important because it provides information about the company’s liquidity Liquidity is a company’s ability to convert assets into cash to pay off its current liabilities in the ordinary course of business Current ratio: shows how many dollars of current assets are available for each dollar of current liabilities LO 8 Copyright ©2022 John Wiley & Sons, 77 Canada, Ltd. Analytics—More Liquidity Ratios Acid-test or quick ratio: relates quick assets (cash, investments for trading, receivables-- which are all readily convertible to cash) to total current liabilities Days payables outstanding: how long it takes a company to pay its trade payables LO 8 Copyright ©2022 John Wiley & Sons, 78 Canada, Ltd. LO 9 -Comparison of IFRS and ASPE There are many differences between ASPE and IFRS with respect to non-financial and current liabilities. The majority of these have been addressed in the body of this presentation. For more specific information refer to Illustration 13.14 in the text. LO 9 Copyright ©2022 John Wiley & Sons, 79 Canada, Ltd. Looking Ahead Accounting for a variety of liabilities, including contingencies, continues to be under review by the IASB Review of IAS 37 continues anchored by the updates to the new Conceptual Framework (2020) including o aligning the liability definition and requirement for identifying liabilities with the updates in the Conceptual Framework o Clarifying the costs to include in the measure of a provision o Specifying whether rates used by entities to discount provisions should reflect their own LO 9 credit risk Copyright ©2022 John Wiley & Sons, Canada, Ltd. 80 Copyright Copyright © 2022 John Wiley & Sons, Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein. Copyright ©2022 John Wiley & Sons, 81 Canada, Ltd.