Liabilities

• What are liabilities?
• Initial recognition
• Initial measurement
• Measurement subsequent to initial recognition
• Derecognition
• Contingent liabilities
• Presentation and disclosure

What are liabilities?


Liabilities are one of the five elements of financial statements [F.47] [IAS1R.7]. They directly relate to the measurement of financial position, together with assets and equity . A liability is an entity's present obligation arising from a past event, the settlement of which will result in an outflow of economic benefits from the entity [F.49] [IAS37R.10].

IFRS distinguishes financial liabilities as a separate component of liabilities [IAS32R.11] [IAS39R.9]. This distinction
is based on the principle that a financial liability is a contractual obligation to deliver cash or another financial asset or to
exchange financial assets or financial liabilities with another entity on terms that are potentially unfavourable, and certain
financial liabilities should be measured at fair value [IAS39R.9] [IAS39R.43, 47]. Financial liabilities also include certain
contracts that will or may be settled using an entity's own equity instruments. For example, an entity may be obliged to
deliver a variable number of its own equity instruments under a contract that is not a derivative to satisfy a fixed obligation.
Alternatively, an entity may enter into a derivative contract to exchange a variable amount of cash or another financial asset
for a variable number of the entity's own equity instruments. Liabilities that are not contractual in nature - such as income taxes
- but arise from statutory requirements are not financial liabilities . Other liabilities, such as an entity's obligations under a
defined benefit scheme, are excluded from the scope of financial liabilities [IAS39R.2]. These are liabilities generally covered
by the recognition and measurement rules within other standards.

Most obligations are legally enforceable and arise under contractual arrangements for amounts borrowed, amounts owed for assets purchased or services obtained (trade payables), and obligations to provide goods and services where an external party has paid in advance . Obligations can also be imposed, such as obligations to pay tax, retirement benefit obligations, the obligation to restore environmentally damaged sites and the obligation to pay damages under a lawsuit, or licence fees [IAS37R.10] .

Obligations can also be constructive or equitable. A constructive obligation is created or inferred from an entity's actions. For example, an entity may have a policy of refunding purchases to dissatisfied customers indicating that it will accept responsibility for faulty goods. The entity's customers will have a valid expectation of a refund on anything faulty [IAS37R.10].

An equitable obligation may arise from normal business practice, custom or the desire to behave as a good corporate citizen .

Past event
A present obligation arises from a past event known as an obligating event [F.63]. An obligating event arises when an entity has no realistic alternative to settling the obligation the event has created. This is the case where the obligation can be enforced by law, and in the case of a constructive obligation where the entity creates an expectation (with a third party) that it will discharge the obligation [IAS37R.17-22] .

To distinguish between present obligations and future commitments is important. The intention to give up economic benefits is not an obligating event. For example, certain entities regularly carry out overhauls, repairs and renewals to major items of property. This event does not give rise to a liability, as the entity has the choice to not use the equipment and avoid the expenditure. The obligation for the cost of the repair work will only arise when it is performed [F.61] .

An event that does not give rise to a liability immediately may give rise to a liability at a later date. For example, employees may satisfy the conditions for payment of bonuses; however, the Board must approve bonuses before they are paid. The present obligation arises following Board approval [IAS19R.17] [IAS37R.21] .

Outflows of economic benefits
A third characteristic of a liability is the entity's obligation to sacrifice future economic benefits. A liability exists when the entity has little or no discretion to avoid an outflow of economic benefits [F.61-62] [IAS37R.23-24]. For example, a liability does not usually arise when an entity places an order for goods or services and has the discretion to cancel the order and avoid the outflow. Consequently, liability recognition usually occurs only when the goods or service have been received. However, a liability will exist when an entity places an order for a specifically manufactured item, and the entity is obliged to take delivery .

Obligations may be due immediately and hence highly probable. They may also be due with the passage of time yet not conditional on any other event, such as restoration costs, and hence less probable. Conditional obligations require the occurrence of an event not certain to occur before they become unconditional, and do not satisfy the recognition criteria as liabilities (refer below contingent liabilities) [IAS37R.27-30].

The second recognition criterion is reliable measurement [F.64,91] [IAS37R.25-26]. The measurement of a liability can relate to an amount due, which is easily verified. However, the use of estimates is often required for liabilities recognised as provisions . An entity will usually be in a position to make an estimate of an obligation from a range of possible outcomes, without compromising its reliability.

Initial measurement


Liabilities are initially measured at the present discounted amount of the cash outflows due to an external party. Otherwise, where liabilities are based on best estimates, the present discounted value of the amount expected to settle an obligation is recorded [F.100(d)] [IAS37R.45-47].

Entities whose functional currency is the currency of a hyperinflationary economy must restate non-monetary liabilities in terms of the measuring unit current at the balance sheet date [IAS29R.8]. Monetary liabilities denominated in a foreign currency are recognised at an amount based on the exchange rate current at the balance sheet date [IAS21R.23(a)].

Contingent liabilities are:

a)	possible obligations that arise from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the entity's control;
b)	or a present obligation that arises from past events but is not recognised because: it is not probable that an outflow of economic benefits will be required to settle the obligation; or the amount of the obligation cannot be measured reliably [IAS37R.10,13(b),27-30].

The accounting treatment of contingent liabilities will depend on the probability of future benefits, for example, where:

a)	there is a possible obligation or a present obligation that may, but probably will not, require an outflow of resources, no provision is recognised but disclosures are required for a contingent liability; and
b)	there is a possible obligation or a present obligation where the likelihood of an outflow of resource is remote, no provision is recognised and no disclosure is required [IAS37R.28,86, Appendix A].

Note that a present obligation that probably requires an outflow of economic resources. is not a contingent liability. A provision should be recognised and disclosures given in respect of the obligation .