SOLUTIONS MANUAL
INTERMEDIATE ACCOUNTING VOL. 2
CHAPTER 12: FINANCIAL LIABILITIES AND PROVISIONS
CONCEPT REVIEW SOLUTIONS
Liability Definition and Categories
1. The three time periods inherent in the definition of a liability are:
a) an expected future delivery of assets or services;
b) constitutes a present obligation; and
c) Is the result of a past transaction or event.
2. A financial liability (payables) is a financial instrument that requires some form of
cash payment or asset transfer. It gives rise to a corresponding financial asset for
another individual or company. An example is a bond or a loan. A non-financial
liability is any liability that is not a financial liability, for example a warranty.
Financial liabilities are further classified by how they will be subsequently
measured. FVTPL/FVNI are initially recorded at fair value and subsequently
measured at fair value. Other financial liabilities are initially measured at fair value
and subsequently at cost.
3. Financial liabilities can either be classified and measured using the amortized cost
method or FVTPL/FVNI.
FVTPL – Initial recognition is at fair value. At each reporting date, the instrument is
measured at fair value with gains and losses recognized in earnings (changes to
credit risk is recognized in OCI).
Amortized cost – initial recognition at fair value. Subsequently, the liabilities are not
adjusted except for impairments (cost), or using the effective interest method
(amortized cost).
, 4. Liabilities of all categories must be valued at the present value of cash flows—
commonly called discounting—where the time value of money has material impact
on the value of the liability.
Common Financial Liabilities
1. A loan guarantee is measured at its fair value which is an expected value calculated
multiplying the probability that a payment will be required times the amount of the
guarantee. A 10% chance of having to be honoured is a positive fair value of 10% of
the debt and would have to be recorded as such. A loan guarantee would not be
recorded if there was a 0% probability.
2. The $8,000 of GST would not be included in the cost of inventory as this is a
recoverable tax. In most cases PST is not levied on goods for resale, but in the event
it was, it would be included in the cost of the inventory and the inventory cost would
be $105,000.
3. In the case of employee withholdings, the employer acts as the government’s agent
in collecting and remitting these payroll taxes.
Foreign Currency Payables
1. Inventory is recorded at the amount using the spot rate on the date of purchase.
2. The capital asset would be recorded at $210,000 (100,000 x $2.10).
3. There would be an exchange gain of $15,000. (100,000 x (2.10-1.95)).
On the date of purchase:
Dr. Capital Asset 210,000
Cr. Accounts payable 210,000
When the balance is paid:
Dr. Accounts payable 210,000
Cr. Cash 195,000
, Cr. Foreign exchange gain 15,000
Non-Financial Liabilities: Provisions
1. A provision is defined as a liability of uncertain timing or amount. If here is
sufficient certainty the liability is recorded for a provision. In the case of a
contingency the likelihood of a liability falls beneath the threshold to be recorded.
2. A provision is recorded at the best estimate of the expenditure required to settle the
present obligation – the expected value. In a large population this would be a
statistical product of the possible outcomes and their probabilities. In a small
population, judgment would be applied to obtain the best estimate.
3. These would not be discounted if the amount and timing of cash flows is highly
uncertain.
4. Virtually certain is a much higher degree of certainty compared to probable. It
means that the amount is going to be paid. Probable has a lower degree of certainty,
but given the balance of facts there is a strong chance that it will be paid.
Examples of Provisions
1. If the unavoidable costs of meeting a contract exceed the economic benefits under
the contract, then the contract is classified an onerous contract. An example is when
a company has vacated leased premises, but must continue to make payments on
the lease until it matures. This contract is now onerous since there are no benefits
to be received from these payments.
2. A warranty is either a legal or constructive obligation providing assurance that a
product will operate to meet specifications. While there is uncertainty concerning
the amount or timing of providing services under the warranty a provision can be
recorded.
3. A provision for coupons is recorded when the coupon results in either a payment of
cash (to the retailer or customer) or the product is sold at a loss, and the company
cannot cancel the coupon at any time.
, 4. A provision for losses arising from self-insurance is recorded when a loss event has
arisen prior to the reporting date even if the loss event is not yet known. A
provision cannot be made for self-insurance for future events. When comparing to
the definition of a liability, it makes sense that you cannot recognize a liability for
self-insurance relating to a future event as liabilities must be a present obligation for
a past event.
The Impact of Discounting And Remeasurements
1. When an asset is acquired and all or part of the consideration is debt at a low rate of
interest or no interest, then the cost of the asset will be reduced to reflect the fair
value of the low-cost debt. This would be discounted using an interest rate
equivalent to the current market rate.
2. Discounting is the practice of revaluing future cash flows to reflect time and interest.
The difference in the nominal value of cash flows and the discounted values of the cash
flows is referred to as the discount. Over time this discount is amortized to reflect the
effective interest cost of the transaction so to speak it is unwound.
3. The interest rate used to discount a low-interest note payable would be the equivalent
rate that the party would experience to finance a similar transaction in the market place
at arm’s length-the market rate.
4. When an estimate changes for an environmental provision, interest for the year is first
recorded using the estimates from the beginning of the period, i.e. before any changes.
Then any adjustments required due to changes in estimates are recorded to the asset
and decommissioning liability account. Interest expense is not impacted in the year of
change.
INTERMEDIATE ACCOUNTING VOL. 2
CHAPTER 12: FINANCIAL LIABILITIES AND PROVISIONS
CONCEPT REVIEW SOLUTIONS
Liability Definition and Categories
1. The three time periods inherent in the definition of a liability are:
a) an expected future delivery of assets or services;
b) constitutes a present obligation; and
c) Is the result of a past transaction or event.
2. A financial liability (payables) is a financial instrument that requires some form of
cash payment or asset transfer. It gives rise to a corresponding financial asset for
another individual or company. An example is a bond or a loan. A non-financial
liability is any liability that is not a financial liability, for example a warranty.
Financial liabilities are further classified by how they will be subsequently
measured. FVTPL/FVNI are initially recorded at fair value and subsequently
measured at fair value. Other financial liabilities are initially measured at fair value
and subsequently at cost.
3. Financial liabilities can either be classified and measured using the amortized cost
method or FVTPL/FVNI.
FVTPL – Initial recognition is at fair value. At each reporting date, the instrument is
measured at fair value with gains and losses recognized in earnings (changes to
credit risk is recognized in OCI).
Amortized cost – initial recognition at fair value. Subsequently, the liabilities are not
adjusted except for impairments (cost), or using the effective interest method
(amortized cost).
, 4. Liabilities of all categories must be valued at the present value of cash flows—
commonly called discounting—where the time value of money has material impact
on the value of the liability.
Common Financial Liabilities
1. A loan guarantee is measured at its fair value which is an expected value calculated
multiplying the probability that a payment will be required times the amount of the
guarantee. A 10% chance of having to be honoured is a positive fair value of 10% of
the debt and would have to be recorded as such. A loan guarantee would not be
recorded if there was a 0% probability.
2. The $8,000 of GST would not be included in the cost of inventory as this is a
recoverable tax. In most cases PST is not levied on goods for resale, but in the event
it was, it would be included in the cost of the inventory and the inventory cost would
be $105,000.
3. In the case of employee withholdings, the employer acts as the government’s agent
in collecting and remitting these payroll taxes.
Foreign Currency Payables
1. Inventory is recorded at the amount using the spot rate on the date of purchase.
2. The capital asset would be recorded at $210,000 (100,000 x $2.10).
3. There would be an exchange gain of $15,000. (100,000 x (2.10-1.95)).
On the date of purchase:
Dr. Capital Asset 210,000
Cr. Accounts payable 210,000
When the balance is paid:
Dr. Accounts payable 210,000
Cr. Cash 195,000
, Cr. Foreign exchange gain 15,000
Non-Financial Liabilities: Provisions
1. A provision is defined as a liability of uncertain timing or amount. If here is
sufficient certainty the liability is recorded for a provision. In the case of a
contingency the likelihood of a liability falls beneath the threshold to be recorded.
2. A provision is recorded at the best estimate of the expenditure required to settle the
present obligation – the expected value. In a large population this would be a
statistical product of the possible outcomes and their probabilities. In a small
population, judgment would be applied to obtain the best estimate.
3. These would not be discounted if the amount and timing of cash flows is highly
uncertain.
4. Virtually certain is a much higher degree of certainty compared to probable. It
means that the amount is going to be paid. Probable has a lower degree of certainty,
but given the balance of facts there is a strong chance that it will be paid.
Examples of Provisions
1. If the unavoidable costs of meeting a contract exceed the economic benefits under
the contract, then the contract is classified an onerous contract. An example is when
a company has vacated leased premises, but must continue to make payments on
the lease until it matures. This contract is now onerous since there are no benefits
to be received from these payments.
2. A warranty is either a legal or constructive obligation providing assurance that a
product will operate to meet specifications. While there is uncertainty concerning
the amount or timing of providing services under the warranty a provision can be
recorded.
3. A provision for coupons is recorded when the coupon results in either a payment of
cash (to the retailer or customer) or the product is sold at a loss, and the company
cannot cancel the coupon at any time.
, 4. A provision for losses arising from self-insurance is recorded when a loss event has
arisen prior to the reporting date even if the loss event is not yet known. A
provision cannot be made for self-insurance for future events. When comparing to
the definition of a liability, it makes sense that you cannot recognize a liability for
self-insurance relating to a future event as liabilities must be a present obligation for
a past event.
The Impact of Discounting And Remeasurements
1. When an asset is acquired and all or part of the consideration is debt at a low rate of
interest or no interest, then the cost of the asset will be reduced to reflect the fair
value of the low-cost debt. This would be discounted using an interest rate
equivalent to the current market rate.
2. Discounting is the practice of revaluing future cash flows to reflect time and interest.
The difference in the nominal value of cash flows and the discounted values of the cash
flows is referred to as the discount. Over time this discount is amortized to reflect the
effective interest cost of the transaction so to speak it is unwound.
3. The interest rate used to discount a low-interest note payable would be the equivalent
rate that the party would experience to finance a similar transaction in the market place
at arm’s length-the market rate.
4. When an estimate changes for an environmental provision, interest for the year is first
recorded using the estimates from the beginning of the period, i.e. before any changes.
Then any adjustments required due to changes in estimates are recorded to the asset
and decommissioning liability account. Interest expense is not impacted in the year of
change.
