Question 1

A necessary condition to recognise a present obligation in the financial statements is that the identity of the party to whom the present obligation is owed must be known.

Accepted Answer

A present obligation can be recognized in the financial statements even if the identity of the party to whom the obligation is owed is not known, as long as there is a present obligation that will likely result in an outflow of resources.

Question 2

A discount on debentures issued arises when the market required rate of return is less than the coupon rate.

Accepted Answer

A discount on debentures issued arises when the market required rate of return is greater than the coupon rate. When the market required rate of return is less than the coupon rate, a premium on debentures is issued.

Question 3

In accordance with AASB 137 Provisions,Contingent Liabilities and Contingent Assets,a contingent liability must be disclosed in the financial statement even when the likelihood of a present obligation occurring in future is remote.

Accepted Answer

According to AASB 137, a contingent liability is not recognized in the financial statements; it is disclosed unless the possibility of an outflow of resources embodying economic benefits is remote.

Question 4

In a constructive obligation where the entity retains discretion to avoid any future sacrifice of economic benefits,no liability should be recognised in the financial statements.

Accepted Answer

In accounting, a constructive obligation where the entity retains discretion to avoid future sacrifice of economic benefits does not meet the criteria for liability recognition, as there is no present obligation that requires an outflow of resources.

Question 5

Under AASB 101 something may be classified as a current liability even when it is not expected to be settled for a period in excess of 12 months.

Accepted Answer

AASB 101 allows for classification as a current liability if it is expected to be settled within the normal operating cycle, even if that cycle exceeds 12 months, or if settlement is due within 12 months of the reporting date.

Question 6

A guarantee provided to a financier for a loan taken out by another entity,where default on that loan is uncertain as at the reporting date,is an example of a contingent liability.

Accepted Answer

A contingent liability is a possible obligation that arises from past events but is not likely to be confirmed until the occurrence of one or more uncertain future events beyond the control of the entity. In this case, the guarantee provided may result in a liability if the borrower defaults on the loan, which makes it a contingent liability.

Question 7

Entities are only required to record a liability if there has been a past transaction that has created a present obligation to another entity that is expected to result in an outflow of future economic benefits.

Accepted Answer

This statement is a correct statement of the recognition criteria for liabilities as per the International Financial Reporting Standards (IFRS) and generally accepted accounting principles (GAAP). To recognize a liability, there must be an obligation arising from a past transaction or event, which entails the entity's transfer of economic resources or settlement of a present obligation. The obligation must also result in an outflow of economic benefits that is probable and can be reliably measured.

Question 8

The defining characteristic of a 'provision' as opposed to other liabilities is that the existence of an obligation is uncertain.

Accepted Answer

A provision is a liability of uncertain timing or amount, but the existence of the obligation itself is certain.

Question 9

The market will only pay a premium for debentures if the par value of those debentures is lower than the market interest rate.

Accepted Answer

The market may pay a premium for debentures if the coupon rate of those debentures is higher than the prevailing market interest rate, not because of their par value.

Question 10

Provisions are established to allow for future sacrifices such as repairs and maintenance of machinery and may be recognised as liabilities.

Accepted Answer

Provisions are recognized as liabilities for present obligations arising from past events, not for future expenses like repairs and maintenance.

Question 11

In AASB 137 Provisions,Contingent Liabilities and Contingent Assets,there is symmetry in the treatment of contingent liabilities and contingent assets where both are required to be disclosed when the contingent event is probable to occur.

Accepted Answer

In AASB 137, there is an asymmetry in the treatment of contingent liabilities and contingent assets. Contingent liabilities are required to be disclosed if the outflow of resources embodying economic benefits is more than remote, whereas contingent assets are not recognized in financial statements but are disclosed only when the inflow of economic benefits is probable.

Question 12

In terms of accounting treatment debentures and bonds are the same thing.

Accepted Answer

Both debentures and bonds are long-term debt instruments issued by companies to raise funds from the market. They have many similarities in terms of accounting treatment, such as being recorded as a liability on the balance sheet, and interest payments being recorded as expenses in the income statement. Therefore, in terms of accounting treatment, debentures and bonds are considered to be the same thing.

Question 13

Executory contracts are within the scope of AASB 137 Provisions,Contingent Liabilities and Contingent Assets.

Accepted Answer

Executory contracts are not within the scope of AASB 137 Provisions, Contingent Liabilities and Contingent Assets, as this standard specifically excludes executory contracts unless they are onerous.

Question 14

A provision shall be recognised when an entity may have a future obligation as a result of a past event.

Accepted Answer

A provision should be recognized when an entity has a present obligation (legal or constructive) as a result of a past event, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and a reliable estimate can be made of the amount of the obligation.

Question 15

A necessary condition for a provision to be recognised is that there is a legal obligation to make a future sacrifice of economic benefits

Accepted Answer

A provision can be recognized based on either a legal obligation or a constructive obligation, where a company has created a valid expectation that it will undertake certain responsibilities.

Question 16

Convertible notes may be best described as having characteristics of both liabilities and bonds.

Accepted Answer

Convertible notes are best described as having characteristics of both debt and equity, not liabilities and bonds. They are a form of short-term debt that can convert into equity, typically at the discretion of the holder or upon certain events.

Question 17

An entity shall classify a liability as current when it holds the liability primarily for the purpose of trading.

Accepted Answer

According to IAS 1 Presentation of Financial Statements, a liability shall be classified as current when the entity expects to settle the liability within its normal operating cycle or hold the liability primarily for the purpose of trading. Therefore, if an entity holds a liability primarily for the purpose of trading, it should be classified as current.

Question 18

In accordance with AASB 137 Provisions,Contingent Liabilities and Contingent Assets some present obligations are allowed to be disclosed in the notes to the financial statements.

Accepted Answer

According to AASB 137 Provisions, Contingent Liabilities and Contingent Assets, some present obligations may not meet the definition of a liability and are allowed to be disclosed in the notes to the financial statements as contingent liabilities. Therefore, option A is correct.

Question 19

When determining whether a liability exists,the intentions or actions of management need to be taken into account.

Accepted Answer

The intentions or actions of management can be important factors in determining whether a liability exists, as they may have implications for the likelihood and timing of future cash outflows. For example, if management has announced plans to settle a lawsuit or pay a penalty, this may indicate that a liability exists even if it has not yet been formally recognized in financial statements. Similarly, if management has taken steps to address a potential environmental cleanup or remediation obligation, this may suggest that a liability is probable and should be recognized.

Question 20

Some researchers have found that firms can benefit from being in financial distress.

Accepted Answer

Some researchers have found that firms can benefit from being in financial distress by prompting changes and actions that may have otherwise not been taken, such as restructuring or cost-cutting measures, leading to improved efficiency and profitability in the long run. However, it is important to note that this is not the case for all firms and financial distress can also have negative consequences.

Quiz 10: An Overview of Accounting for Liabilities