Chapter One

Current Liabilities, Provisions, and Contingencies

1.1 Nature and types of current liabilities
The IASB defines a 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
future benefits.
The basic divisions of liabilities include (1) current liabilities and (2) non-current liabilities.
A 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.
The operating cycle is the period of time elapsing between the acquisition of goods and services
and the final cash realization resulting from sales and subsequent collections.
1.1.1 Types of current liabilities
Here are some typical current liabilities

1. Accounts payable. 6. Customer advances and deposits.

2. Notes payable. 7. Unearned revenues.
3. Current maturities of long-term debt. 8. Sales and value-added taxes payable.
4. Short-term obligations expected to be refinanced. 9. Income taxes payable.
5. Dividends payable. 10. Employee-related liabilities.

Accounts payable, or trade accounts payable:- is 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.
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. Companies classify notes as
short-term or long-term, depending on the payment due date. Notes may also be interest-bearing
or zero-interest-bearing.

Interest-Bearing Note Issued

Assume that Castle Bank agrees to lend $100,000 on March 1, 2022, 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, 2022
Cash 100,000
Notes Payable 100,000
(To record issuance of 6%, 4-month note to Castle Bank)

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At maturity (July 1, 2022), Landscape must pay the face value of the note ($100,000) plus
$2,000 interest ($100,000 × .06 × 4⁄12). Landscape records payment of the note and accrued
interest as follows.

July 1, 2022
Notes Payable 100,000
Interest Payable 2,000
Cash 102,000
(To record payment of Castle Bank interest-bearing note and accrued interest at
maturity)

Zero-Interest-Bearing Note Issued: It does not explicitly state an interest rate on the face of the
note. The note is recorded at its face value and the "prepaid" interest is recorded in a Discount on
Notes Payable account.
Current Maturities of Long-Term Debt:- That portion of long-term debt that matures within
the next fiscal year is reported as a current liability. However, if current maturities of LTD will
be retired from sinking funds, from the proceeds of new long-term indebtedness, or through
conversion into common stock, the debt is reported as noncurrent
Exclude currently maturing long-term debts from current liabilities if they are to be:
1. Refinanced, or retired from the proceeds of a new long-term debt issue or,
2.Converted into ordinary shares.
Short-Term Obligations Expected to Be Refinanced:- are debts scheduled to mature within
one year after the date of a company’s statement of financial position or within its normal
operating cycle. However it Exclude from current liabilities if both of the following conditions
are met:
 Must intend to refinance the obligation on a long-term basis.
 Must have unconditional right to defer settlement of the liability for at least 12 months
after the reporting date.
Dividends Payable:- A cash dividend payable is an amount owed by a company to its
shareholders as a result of the board of directors’ authorization (or in other cases, vote of
shareholders). At the date of declaration, the company 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.
Customer 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. For example, a company may receive deposits from customers as guarantees
for possible damage to property.

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Unearned Revenues: - Payment received before providing goods or performing services.
When a company receives an advance payment, it debits Cash and credits a current liability
account identifying the source of the unearned revenue.
Sales and Value-Added Taxes Payable:- Consumption taxes are generally either a sales tax or
a value- added tax (VAT). The purpose of these taxes is to generate revenue for the government
similar to the company or personal income tax. These two taxes accomplish the same objective
to tax the final consumer of the good or service.
To illustrate the accounting for sales taxes, assume that Halo Supermarket sells loaves of bread
to consumers on a given day for $2,400. Assuming a sales tax rate of 10 percent, Halo
Supermarket makes the following entry to record the sale.

Cash 2,640
Sales Revenue 2,400
Sales Taxes Payable 240

In this situation, Halo Supermarket records a liability to provide for taxes collected from
customers but not yet remitted to the appropriate tax authority. At the proper time, Halo
Supermarket remits the $240 to the tax authority.
Income Taxes Payable: - Using the best information and advice available, a business must
prepare an income tax return and compute the income taxes payable resulting from the
operations of the current period. Companies should classify as a current liability the taxes
payable on net income, as computed per the tax return.
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:- The most common types of payroll deductions are taxes, insurance
premiums, employee savings, and union dues.
2. Compensated absences:- are paid absences from employment—such as vacation, illness,
and maternity, paternity, and jury leaves.
3. Bonuses:- Many companies give a bonus to certain or all employees in addition to their
regular salaries or wages. Frequently, the bonus amount depends on the company’s yearly
profit. A company may consider bonus payments to employees as additional salaries and
wages and should include them as a deduction in determining the net income for the year.

Example:-
Assume a weekly payroll of $10,000 entirely subject to Social Security taxes (8 percent),
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.

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 Salaries and Wages Expense 10,000
Withholding Taxes Payable 1,320
Social Security Taxes Payable 800
Union Dues Payable 88
Cash 7,792

1.2. Recognition and measurement of provisions

A provision is a liability of uncertain timing or amount. Provisions are very common and may
be reported as either 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.
1.2.1 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.
Note: - 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 50 percent. If the probability is 50 percent or less, the provision is not recognized.
It is assumed for each of the following examples that a reliable estimate of the amount of the
obligation can be determined.
Illustration 13.5 Santos SA 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 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?
Analysis: (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 settlement—it is
probable that there will be some claims related to these warranties.
Conclusion: Santos 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
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 2.As a result, the company has created a valid expectation on the part of those other parties
that it will discharge those responsibilities.
Illustration 13.6 , 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?
Analysis: (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 will be returned for refund.
Conclusion: A provision is recognized for the best estimate of the costs of refunds.
1.2.2 Measurement of Provisions
How does a company determine the amount to report for its provision?
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.
The measurement of the liability should consider the time value of money, if material. In
addition, future events that may have an impact on the measurement of the costs should be
considered.

1.2.3 Common Types of Provisions

Here are some common areas for which provisions may be recognized in the financial
statements:
1. Lawsuits 4. Environmental
2. Warranties 5. Onerous contracts
3. Consideration payable 6. Restructuring
Although companies generally report only one current and one non-current amount for
provisions in the statement of financial position, IFRS also requires extensive disclosure related
to provisions in the notes to the financial statements.

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.
1.The time period in which the underlying cause of action occurred.

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 2.The probability of an unfavorable outcome.
3.The ability to make a reasonable estimate of the amount of loss.
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.
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, the company should accrue the liability.

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. Warranties and guarantees entail future costs. 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.

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.

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
Assurance-Type Warranty
Companies do not record a separate performance obligation for assurance-type warranties.
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 addition, the company should record
a warranty liability.
Service-Type Warranty
A warranty is sometimes sold separately from the product. For example, when you purchase a
television, you are entitled to an assurance-type warranty. You also will undoubtedly be offered
an extended warranty on the product at an additional cost, referred to as a service-type warranty.
In most cases, service-type warranties provide the customer a service beyond fixing defects that
existed at the time of sale.
Companies record a service-type warranty as a separate performance obligation. For example, in
the case of the television, the seller recognizes the sale of the television with the assurance-type
warranty separately from the sale of the service-type warranty. The sale of the service-type
warranty is usually recorded in an Unearned Warranty Revenue account.
Illustration 13.10 presents an example of both an assurance-type and service- type warranty.

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Warranties
Facts: You purchase an automobile from Hamlin Auto for $30,000 on January 2, 2022. Hamlin
estimates the assurance-type warranty costs on the automobile to be $700 (Hamlin will pay for
repairs for the first 36,000 kilometers or 3 years, whichever comes first). You also purchase for
$900 a service-type warranty for an additional 3 years or 36,000 kilometers. Hamlin incurs
warranty costs related to the assurance-type warranty of $500 in 2022 and $100 in 2023 and
2024. Hamlin records revenue on the service-type warranty on a straight-line basis.

Question: What entries should Hamlin make in 2022 and 2025?

Solution:

1.To record the sale of the automobile and related warranties:

January 2, 2022
Cash ($30,000 + $900) 30,900
Unearned Warranty Revenue 900
Sales Revenue 30,000
2.To record warranty expenditures incurred in 2022:

January 2—December 31, 2022

Warranty Expense 500
Cash, Inventory, Accrued Payroll 500

3.The adjusting entry to record estimated warranty expense and warranty liability for
expected assurance warranty claims in 2023:

December 31, 2022

Warranty Expense 200
Warranty Liability 200

As a consequence of this adjusting entry at December 31, 2022, the statement of financial
position reports a warranty liability of $200 ($700 – $500) for the assurance-type warranty.
The income statement for 2022 reports sales revenue of $30,000 and warranty expense of
$700.
4. To record revenue recognized in 2025 on the service-type warranty:

December 31, 2025

Unearned Warranty Revenue ($900 ÷ 3) 300
Warranty Revenue 300
Warranty expenditures under the service-type warranty will be expensed as incurred in 2025–

Consideration Payable

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Companies offer premiums, coupon offers, and rebates to stimulate sales. And to the extent that
the premiums reflect a material right promised to the customer, a performance obligation exists
and should be recorded as a liability. However, the period that benefits is not necessarily the
period in which the company pays the premium. At the end of the accounting period, many
premium offers may be outstanding and must be redeemed when presented in subsequent
periods. In order to reflect the existing current liability, the company estimates the number of
outstanding premium offers that customers will present for redemption. The company then
charges the cost of premium offers to Premium Expense. It credits the outstanding obligations to
an account titled Premium Liability.
Premiums and coupons are loss contingencies that satisfy the conditions necessary for a liability.
Regarding the income statement, the expense recognition principle requires that companies
report the related expense in the period in which the sale occurs
Environmental Provisions
Estimates to clean up existing toxic waste sites are substantial. In addition, cost estimates of
cleaning up our air and preventing future deterioration of the environment run even higher.
A company must recognize an asset retirement obligation (ARO) when it has an existing legal
obligation associated with the retirement of a long-lived asset and when it can reasonably
estimate the amount of the liability. Companies should record the ARO at fair value.
Examples of existing legal obligations, which require recognition of a liability include:
 Decommissioning nuclear facilities;
 Dismantling, restoring, and reclamation of oil and gas properties;
 Certain closure, reclamation, and removal costs of mining facilities; and
 Closure and post-closure costs of landfills.
In order to capture the benefits of these long-lived assets, the company is generally legally
obligated for the costs associated with retirement of the asset, whether the company hires another
party to perform the retirement activities or performs the activities with its own workforce and
equipment.
A company initially measures an environmental liability at the best estimate of its future costs.
The estimate should reflect the amount a company would pay in an active market to settle its
obligation (essentially fair value).
Illustration: assume that on January 1, 2022, Wildcat Oil Company erected an oil platform in
the Gulf of Mexico. Wildcat is legally required to dismantle and remove the platform at the end
of its useful life, estimated to be five years. Wildcat estimates that dismantling and removal will
cost $1,000,000. Based on a 10 percent discount rate, the fair value of the environmental liability
is estimated to be $620,920 ($1,000,000 × .62092). Wildcat records this liability as follows.

January 1, 2022

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 Drilling Platform 620,920
Environmental Liability 620,920

During the life of the asset, Wildcat allocates the asset cost to expense. Using the straight-line
method, Wildcat makes the following entries to record this expense.

December 31, 2022, 2023, 2024, 2025, 2026

Depreciation Expense ($620,920 ÷ 5) 124,184
Accumulated Depreciation—Plant Assets 124,184
In addition, Wildcat must accrue interest expense each period. Wildcat records interest
expense and the related increase in the environmental liability on December 31, 2022, as
follows.
December 31, 2022
Interest Expense ($620,920 × .10) 62,092
Environmental Liability 62,092
On January 10, 2027, Wildcat contracts with Rig Reclaimers, Inc. to dismantle the
platform at a contract price of $995,000. Wildcat makes the following journal entry to
record settlement of the liability.

January 10, 2027

Environmental Liability 1,000,000
Gain on Settlement of Environmental Liability 5,000
Cash 995,000

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.
1.3.1 Contingent Liabilities
IAS 37 defines a contingent liability as an obligation that is either a possible obligation arising
from past events, the outcome of which will be confirmed only on the occurrence or non-
occurrence of one or more uncertain future events which are not wholly within the control of the
reporting entity; or
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 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.

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Illustration 13.16 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 51–89% probable Report as liability (provision).
than not)
Possible but not probable 5–50% Disclosure required.
Remote Less than 5% No disclosure required.
*In practice, the percentages 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.

1.3.2 Contingent Assets

A contingent asset is a possible asset that arises from past events and whose existence will be
confirmed by the occurrence or non-occurrence of uncertain future events not wholly within the
control of the company. Typical contingent assets are:

1. Possible receipts of monies from gifts, donations, and bonuses.

2. Possible refunds from the government in tax disputes.
3. Pending court cases with a probable favorable outcome.

Contingent assets are not recognized on the statement of financial position. If realization of the
contingent asset is virtually certain, it is no longer considered a contingent asset and is
recognized as an asset. Virtually certain is generally interpreted to be at least a probability of 90
percent or more.

Contingent assets are disclosed when an inflow of economic benefits is considered more likely
than not to occur (greater than 50 percent). However, it is important that disclosures for
contingent assets avoid giving misleading indications of the likelihood of income arising. As a
result, it is not surprising that the thresholds for allowing recognition of contingent assets are
more stringent than those for liabilities.

What might be an example of a contingent asset that becomes an asset to be recorded? To

illustrate, assume that Marcus Realty leases a property to Marks and Spencer plc (M&S)
(GBR). The contract is non-cancelable for five years. On December 1, 2022, before the end of

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the contract, M&S withdraws from the contract and is required to pay £245,000 as a penalty. At
the time M&S cancels the contract, a receivable and related income should be reported by
Marcus. The disclosure includes the nature and, where practicable, the estimated financial effects
of the asset.

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.

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.

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