Liabilities are future obligations to others that have three essential characteristics. Firstly, a liability can be settled in the future by transferring or using cash or other assets, by providing services, or giving up other economic benefits. A future obligation that doesn't require giving up some economic benefit is not considered a liability. Secondly, the date that the obligation must be settled must be previously determined, or must be based on some specific event occuring, or can be on demand. However, the entity itself should have little discretion in avoiding the obligation. Thirdly, the transaction or other even that creates the liability must have already occured for the liability to be recognized.
Distinguishing Between Financial and Non-Financial Liabilities
In addition to our definition for liabilities, we also recognize a distinction between financial liabilities and those that are not financial in nature. According to the FASB master glossary, a financial liability is a contract that imposes on one entity an obligation to do either of the following: (a) deliver cash or another financial instrument to another entity or (b) exchange other financial instruments on potential unfavourable terms with another entity. It is important to recognize that this definition requires the liability to be based on a contract. Therefore, obligations that arise as a result of legislation, such as income taxes payable, are not considered financial liabilities. The distinction is important because financial liabilities may be required to be measured at fair value as opposed to historical cost.
Most current liabilities are financial in nature expect for those where the obligation will be met by the delivery of goods or services. For example, deferred revenue, commitments, gaurantees and warranties are often non-financial in nature. Long-term liabilities that are non-financial in nature may include asset retirement obligations, environmental obligations, exit or disposal cost obligations and loss contingencies.
Distinguishing Between Liabilities and Equity
One of the more complicated aspects of accounting for liabilities is the ability to determine whether an obligation is a liability or an ownership claim. For example, while perferred shares are reported as part of shareholders' equity we know that preferred shares, in fact, have many characteristics of debt. GAAP looks at distinguishing freestanding financial instruments which have characteristics of both debt and equity in.1
1. FASB ASC 480-10
Current liabilities mean liabilities that will become payable within a year or within the normal operating cycle (if this is longer than a year). As a result, we normal expect current liabilities to be settled using existing current assets.
Long-term liabilities mean liabilities that will become payable beyond one year or beyond the normal operating cycle (if this is longer than a year).
Future obligations such as warranties, guarantees, and customer loyalty programs are probably and can be estimated. As a result, an expense and correlated liability should be recognized today.
A contingency is an existing condition, situation, or set of circumstances involving uncertainty as to possible gain (gain contingency) or loss (loss contingency) to an entity that will ultimately be resolved when one or more future events occur or fail to occur.
Raffie's Kids, a nonprofit organization that provides aid to victims of domestic violence, low-income families, and special-needs children, has a 30-year, 5% mortgage on the existing building. The mortgage requires monthly payments of $3,000. Raffie's bookkeeper is preparing financial statements for the board and, in doing so, l
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Accounts Receivable Turnover, Credit Card Sales, Cash Collections, Current Liabilities and Ratios, Statement of Cash Flows
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Define Liability of Foreignness and Regionalism. Discuss how it relates to and how it impacts international strategies.
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Current legislation limits the amount of economic-related liabilities to be paid by a company on account of an oil spill to $75 million. A move to amend that legislation and raise the liability cap to $10 billion was blocked in the Senate because Big Petroleum, who is responsible for a recent spill, has given its word that it wo
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The accounting for liabilities, both current and long-term, and equity has changed significantly since the inception of the FASB. Discuss some of the primary changes in the accounting (measurement and reporting) for liabilities and equity that the FASB has implemented.
(Classification of Liabilities) Presented below are various account balances. (a) Bank loans payable of a winery due Mar 10, 2016 (the product requires aging for 5 years before sale) (b) Unamortized premium on bonds payable, of which 3,000 will be amortized during the next year (c) Serial bonds payable, 1,000,000 of whi
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Effect of a land sale on the accounting equation in terms of increases and decreases to assets, liabilities and equity
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Why are current and long-term liabilities important to internal users such as management and external users such as investors and creditors?
A transaction that is likely to cause an increase in a current liability is: a. payment of accrued wages. b. accrual of interest expense. c. depreciation of equipment. d. accrual of bad debts expense. Which of the following is a true statement regarding interest calculation methods? a. Interest is calculated on eith
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Would you be able to describe the two types of current liabilities that must be estimated and why this is so? How are the financial statements affected if they are not estimated?
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How should the following types of current liabilities be accounted for? Known amounts, estimated, contingent
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Describe where you see personal responsibility and accountability fitting into this chapter's materials on product liability. An owner of a manufacturing firm is being sued for potential product liability of a particular product. Identify at least two things the owner should consider in the decision to fight in court or settle.