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Current liabilities and contingencies

Current liabilities and contingencies. Typical coverage of US GAAP. Definition of current liabilities Various specific current liabilities Short-term obligations expected to be refinanced Long-term debt violations Income taxes Contingencies: Definition Gain contingency Loss contingency.

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Current liabilities and contingencies

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  1. Current liabilities and contingencies

  2. Typical coverage of US GAAP • Definition of current liabilities • Various specific current liabilities • Short-term obligations expected to be refinanced • Long-term debt violations • Income taxes • Contingencies: • Definition • Gain contingency • Loss contingency

  3. Typical coverage of US GAAP • Restructuring costs • Onerous contracts • Presentation of current liabilities • Presentation of contingencies

  4. Executive summary • Both IFRS and US GAAP have similar recognition criteria for a liability. • Both require recognition of the best estimate of a probable loss; however, US GAAP defines probable as “likely” and IFRS defines probable as “more likely than not.” • When there is a range of possible provision requirements all with an equal probability of occurring, US GAAP requires the minimum amount in the range to be recorded, while IFRS requires the midpoint in the range to be recorded. • Generally, US GAAP only allows discounting when the liability and the timing of payments are fixed or reliably determinable. IFRS requires provisions to be discounted for the time value of money if the impact is material.

  5. Executive summary

  6. Progress on convergence Both the FASB and the IASB have current agenda items related to provisions and contingencies, the objectives of which are: Convergence between US GAAP and IFRS. Improvements in the current standard. An IFRS working draft proposing a new IAS 37 was issued in February 2010. A new standard is expected in the latter half of 2010.

  7. Various specific liabilities • Most liabilities, unless otherwise noted, are generally accounted for in the same manner for US GAAP and IFRS.

  8. Short-term obligations expected to be refinanced US GAAP • Requires refinancing to be in place before the audited financial statements are issued. IFRS • Requires the refinancing to be consummated by the balance sheet date.

  9. ContingenciesDefinition US GAAP IFRS ASC 450-10-20 defines a contingency as “an existing condition, situation, or set of circumstances involving uncertainty as to possible gain (gain contingency) or loss (loss contingency) to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur.” Similar, according to IAS 37.

  10. ContingenciesGain contingency US GAAP IFRS Gain contingencies are defined as possible assets 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 control of the entity. Similar, although the term “contingent assets” is used for “gain contingencies.” Requires that certainty exists regarding its realization before a gain contingency can be recorded. Similar

  11. ContingenciesLoss contingency US GAAP IFRS • Requires a provision (liability) be recognized if: • As a result of a past event, the entity has an obligation to others. • It is probable that an outflow of resources will be required to settle the obligation. • The amount of the obligation can be reliably estimated. • The amount recognized as a provision should be the best estimate of the expenditure required to settle the present obligation at the balance sheet date. When there is a large homogeneous population, the best estimate of the obligation is generally based on the expected value. Similar

  12. ContingenciesLoss contingency US GAAP IFRS Requires information about a contingent liability whose occurrence is more than remote but did not meet the recognition criteria to be disclosed in the notes to the financial statements. Similar

  13. ContingenciesLoss contingency – definition of probable US GAAP • Defines probable as “likely” (this has been generally interpreted as greater than a 70% chance of occurring). IFRS • Probable is defined as “more likely than not” (more than a 50% chance of occurring).

  14. Example 4: After a wedding in 2010, 10 people died as a result of food poisoning from products sold by Kiss Catering Inc. (KCI). Legal proceedings started, seeking damages from the company. Up to the date of authorization of the financial statements for the year ended December 31, 2010, the company’s lawyers advised that it was 40% probable that the company would not be found liable. However, when the company prepared its financial statements for the year ended December 31, 2011, its lawyers advised that, owing to developments in the case, it was 85% probable that the company would be found liable. Probable liability example • Assuming the attorneys can arrive at a reasonable estimate of the potential damages, should KCI recognize a provision using US GAAP in 2010 and in 2011? • Should KCI recognize a provision using IFRS in 2010 and in 2011?

  15. Example 4 solution: US GAAP: In 2010, you would not recognize a provision for this situation. The probability that KCI would be found liable at this point is 60%. The definition of probable is “likely to occur” (> 70%). Therefore, the 60% falls below the threshold. In 2011, you would recognize a provision for this situation. Due to new developments, the probability of a negative outcome rose to 85%, which is above the threshold. IFRS: In 2010 and 2011, you recognize a provision for this situation. Using IFRS, “probable” indicates that an outcome is more likely than not to occur (more than a 50% chance of occurring). Since this situation is above this threshold in both years, a provision would be required to be recognized. Probable liability example

  16. ContingenciesLoss contingency – range of possible outcomes US GAAP • Where there is a continuous range of possible outcomes and each point in the range is as likely as any other to occur, under ASC 450-20-30-1, the minimum amount in the range is used to measure the provision. IFRS • The midpoint of the range is used to measure the provision.

  17. Example 5: An entity sells webcams with a warranty under which customers are covered for the cost of repairs of any manufacturing defects that become apparent within the first six months after purchase. The company has only recently started operations and thus cannot estimate what percentage of webcams will likely be returned. They do know that if defects were detected in all products sold, repair costs would range from $2 million for minor repairs to $4 million for major repairs. Range of possible outcomes example • Assuming all other criteria are met, how much should the entity book related to warranty repairs using US GAAP and IFRS? • Show any required journal entries.

  18. Example 5 solution: US GAAP The minimum point of the range, $2.0 million, should be recorded. Warranty expense $2,000,000 Warranty liability $2,000,000 IFRS The midpoint of the range, $3.0 million, should be recorded. Warranty expense $3,000,000 Warranty liability $3,000,000 Since the entity only had a range to work with, the treatment using the two sets of standards is different. If no particular outcome within the range is better than another, then for US GAAP the entity would book the minimum of the range, whereas for IFRS the entity would book the midpoint range. Range of possible outcomes example

  19. Example 6: Use the same facts in example 5, except now assume the entity is able to perform an analysis on the historical data of returns and estimates (based on historical data), finding that 75% of the goods sold will have no defects, 20% of the goods sold will have minor defects and 5% of the goods sold will have major defects. Range of possible outcomes example • Assuming all other criteria are met, how much should the entity book related to warranty repairs using US GAAP and IFRS? • Show any required journal entries.

  20. Example 6 solution: For both US GAAP and IFRS, $600,000 should be recorded. The most likely outcome is $600,000 explained as follows: (20% of $2 million for minor repairs = $400,000) + (5% of $4 million for major repairs = $200,000) + (75% without defects and, therefore, no impact on the estimate). Warranty expense $600,000 Warranty liability $600,000 Probable liability example

  21. ContingenciesLoss contingency US GAAP • Provisions may be discounted only when the amount of the liability and the timing of the payments are fixed or reliably determinable. IFRS • Provisions should be recorded at the estimated amount to settle or transfer the obligation, taking into consideration the time value of money (utilizing a pretax discount rate).

  22. Contingencies convergence A new standard, Liabilities, is expected in the latter half of 2010. This project is not part of the Memorandum of Understanding. The proposed standard would remove the requirement under IAS 37 for recognizing a liability when “it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation” (IAS 37, paragraph 14(b)). The result is that a company would recognize a liability for the amount it would rationally pay to be relieved of an obligation that can be reliably measured. The intent is to focus management on judging whether the company has an obligation rather than predicting the likely outcome. This proposed change will create a bigger difference between IFRS and US GAAP.

  23. Restructuring costs US GAAP IFRS IAS 37 similarly limits restructuring programs to those that either change how business is conducted or change the scope of the business. ASC 420 limits restructuring programs to those that relate to exit or disposal activities.

  24. Restructuring costs US GAAP IFRS • Focus is on the exit plan as a whole and, as a result, costs are generally recognized earlier. • Focus is on the individual cost components and, as a result, costs are generally recognized later.

  25. DisclosuresCurrent liabilities • The disclosure requirements for current liabilities are generally similar using US GAAP and IFRS. • Different accounting treatment, in areas such as short-term obligations to be refinanced, long-term debt covenants and income taxes, as discussed earlier, would impact the classification and, accordingly, the disclosure requirements.

  26. DisclosuresContingencies US GAAP IFRS Disclose a “more than remote” contingent liability when either it is probable that an outflow of resources will be required to settle the obligation or the amount of the obligation can be reliably estimated, but not both. The disclosure should describe the nature of the contingency. Additionally, an estimate of the possible loss or a statement that an estimate of the possible loss cannot be made should be disclosed. Similar

  27. DisclosuresContingencies US GAAP • There is no provision for reduced disclosure requirements similar to the one allowed using IFRS. IFRS • In extremely rare cases, disclosure of some or all of the required information can be excluded if it is expected to severely sway the outcome of a lawsuit. In such cases, an entity does not need to disclose the information, but shall disclose the general nature of the dispute and the fact that and reason why the information has not been disclosed.

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