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REVIWQUSTON
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1.
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3.
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Three essential characteristics can be derived from the definition of liabilities in the
Conceptual Framework, paragraphs (4.15-4.19/60-64).
(a)
present obligation to make an outflow of resources,
(b) future outflows of economic benefits,
(c)
past transactions or other past events.
See section 3.1.3 of the chapter.
Discussed further as below: Essential characteristics of liability are:
1. Future outflows of economic benefits
Note: Liabilities can be settled by transfer of assets of any type (cash not the only
assetsay deliver goods that have been pre-paid) or by provision of services and the
fact that the amount of the liability is not certain (for example, warranty obligations,
long service leave) does not preclude recognition as a liability. This actually falls
under the reliability of measurement rule.
2. Present obligation to make an outflow of resources
Essential notion is that the entity is presently obligated and cannot avoid settling the
obligationthere is no reasonable alternative other than to settle. The obligation may
be enforceable from legal sources such as contract or legislation administrative
regulation, or it may be constructive.
Also note: This must involve an external party as cannot be obligated to one-self.
Hence setting aside reserves (for example, for major overhauls, renewals of plant, etc)
does not constitute a liability. Further, decisions to acquire assets in the future do not
give rise to liabilities unless there is an irrevocable agreement.
3. Past event
This is required to ensure that only present obligations to make future outflows of
economic resources are included as liabilities.
The Conceptual Framework (4.38/91) specifies two criteria which must be satisfied
before an item that meets the definition (such as a liability) can be recognised
(a) it is probable that any future economic benefit associated with the item will flow
to or from the entity; and
(b) the item has a cost or value that can be measured with reliability.
Probable in this context means that the future outflow of economic benefits is more
likely than less likely, i.e. a greater than 50% probability.
It is expected that the notion of a reliable measure will be replaced by a faithfully
representative and verifiable measure in the conceptual framework.
Most liabilities are measured at nominal value, however for particular liabilities like
long service leave entitlements for employees and certain lease liabilities, the
discounted present value method is used. Other possible measurement suggestions are
value to the entity and discharge price. Note measurement may involve the use of
estimates. See section 3.3.2 of the chapter for further discussion of measurement
methods.
See also section 3.1.4 of the chapter which discusses possible changes to the
definition of a liability.
4. What are the essential characteristics of equity?
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5. Explain what is meant by the term recognition. Are all items that meet the
definition of an element of the financial statement always recognised? Discuss
how the proposed changes to the recognition criteria in the 2013 Discussion
Paper, A Review of the Conceptual Framework for Financial Reporting, could
impact on recognition of items.
Recognition is outlined in the Conceptual Framework (4.37/ 82):
For example, a company may have an item that meets the definition of a liability but
not the recognition criteria (for example, has been found liable in a court case but the
amount to be paid has not yet been determined and cannot be estimated). In such
cases the relevant standard (AASB 137) requires disclosure of the item. As this does
not meet both the definition and recognition criteria it cannot be included on the face
of the financial statements. However information about this item would be disclosed
separately in the notes
Section 3.2.1 discusses the recognition criteria proposed in the 2013 discussion paper.
The significant change proposed is to abolish probability as recognition criteria. The
existing recognition criteria of probability means that any elements where there is less
than 50% likelihood of outflows being required to be made/or economic benefits
being received are excluded from recognition (subject to the requirements of specific
standards). The abolition of the probability threshold could result in such items being
included and probability of inflows/outflows would be reflected in the measurement.
Recognition would be subject to the cost constraint and considerations of relevance
and faithful representation.
9.
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10.
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12.
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Where a company has a constitution that provides for directors to declare a dividend,
then a dividend becomes a debt of the company once the dividend is declared. Where
no such statement exists in a companys constitution, then the debt will only arise
when the time for payment of the dividend arrives.
If a dividend has been declared (or paid) by the time of completion of the financial
report but not on or before the reporting date it must not be recognised as a liability as
at the reporting date. Instead such a dividend must be disclosed in notes as an event
after reporting date. See sections 3.4.1 and 3.4.2 of the chapter.
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AASB 101 para 54 describes the equity of a company as consisting of share capital
and reserves (retained earnings and other reserves).The term reserve is not defined in
any accounting standard or the Corporations Act. Guidance on the nature of a reserve
can be found by looking at what companies include as reserves in their annual
reports and what accounting standards refer to as reserves.
In addition to retained earnings, the most common type of reserves are general,
revaluation and foreign currency translation reserves. Retained earnings is one
category of reserves, according to AASB 101. Retained earnings represent the
balances of the profit and losses (before items of other comprehensive income) which
the company has made since incorporation, which have not been paid as dividends or
bonus share issues to shareholders, transferred to reserves, or used to buy back shares
(Henderson and Pierson, 2000, p 534).
Some other reserves arise as the result of accounting standards requiring amounts of
other comprehensive income to be accumulated in equity (eg. revaluation surplus)
and others arise from transfers from retained earnings (often known as general
reserves) due to generally accepted accounting principles. Some have arisen from
dubious accounting practices, now banned.
Students should realise that reserves do not represent cash balances. Reserves are
book entries and no cash is physically transferred or created by these entries.
Students should recognise that for example, the creation of a general reserve is a
transfer from profit, and profit does not necessarily represent cash.
What reasons may there be for no definitions being given for a reserve in the
legislation, accounting standards, and the conceptual framework ?
I would say that the reason there is no definition given for a reserve in the legislation,
accounting standards and conceptual framework is because it is not possible to
categorise reserves according to a homogeneous definition. Reserves may be created
in a number of different ways (accounting standards, GAAP, other dubious accounting
practices). It therefore would appear to be a very difficult task to establish a general
definition to include all reserves. Any definition may be too restrictive.