Faculty of commerce and public management
Advanced accounting 2
In financial accounting, a liability is defined as an obligation of an entity arising from past transactions or events, the settlement of which may result in the transfer or use of assets, provision of services or other yielding of economic benefits in the future. A liability is defined by the following characteristics: * Any type of borrowing from persons or banks for improving a business or personal income that is payable during short or long time; * A duty or responsibility to others that entails settlement by future transfer or use of assets, provision of services, or other transaction yielding an economic benefit, at a specified or determinable date, on occurrence of a specified event, or on demand; * A duty or responsibility that obligates the entity to another, leaving it little or no discretion to avoid settlement; and, * A transaction or event obligating the entity that has already occurred. Liabilities in financial accounting need not be legally enforceable; but can be based on equitable obligations or constructive obligations. An equitable obligation is a duty based on ethical or moral considerations. A constructive obligation is an obligation that is implied by a set of circumstances in a particular situation, as opposed to a contractually based obligation. The accounting equation relates assets, liabilities, and owner's equity:
The accounting equation is the mathematical structure of the balance sheet.
Liabilities are reported on a balance sheet and are usually divided into two categories: * Current liabilities — these liabilities are reasonably expected to be liquidated within a year. They usually include payables such as wages, accounts, taxes, and accounts payables, unearned revenue when adjusting entries, portions of long-term bonds to be paid this year, short-term obligations * Long-term liabilities — these liabilities are reasonably expected not to be liquidated within a year. They usually include issued long-term bonds, notes payables, long-term leases, pension obligations, and long-term product warranties. -------------------------------------------------
The Valuation of Liabilities
* Liabilities may be defined as currently existing obligations which the firm intends to meet at some time in the future. Such obligations arise from legal or managerial considerations and impose restrictions on the use of assets by the firm for its own purposes.
To be recognized as a liability in accounting, the following tests must be satisfied:
(a) the liability must exist at the present time;
(b) it must involve expenditure in the future;
(c) it must be ascertained with reasonable accuracy;
(d) it must be quantifiable;
(e) its maturity date must be known at least approximately
The capital invested by the owner or shareholders in an enterprise is not regarded as a liability in accounting. Shareholders have a right at law to the payment of a dividend once it has been declared. As a result, unpaid or unclaimed dividends are shown as current liabilities. It is the practice to show proposed dividends as current liabilities also, since such proposed dividends are usually final dividends for the year which must be approved at the annual general meeting before which the accounts for the year must be laid.
The valuation problem
The valuation of liabilities is part of the process of measuring both capital and income, and is important to such problems as capital maintenance and the ascertainment of a firm's financial position. Hence, 'the requirements for an accurate measure of the financial position and financial structure should determine the basis for liability valuation. Their valuation should be consistent with the valuation of assets and expenses’ The need for consistency arises from the objectives of liability valuation, which are...
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