Discuss the definition, recognition, and measurement of liabilities

Answer 1

Liability

The FASB's conceptual framework defines a liability as a probable future sacrifice
of economic resources arising from present obligations of a particular entity to transfer assets
or provide services to other entities in the future as a result of past transactions or events. The
IASB's framework defines a liability as a present obligation of an entity arising from past
events the settlement of which is expected to result in an outflow of resources embodying
economic benefits.

The criteria for recognition of a liability are as follows:

1 . The obligation represents a present obligation, not a potential future commitment or intent.
2 . The obligation exists as a result of a past transaction or exchange, called the obligating event.
3 . The obligation requires the probable future sacrifice of an economic resource that the firm has little or no discretion to avoid.
4 . The obligation has a relevant measurement attribute that the firm can quantify with sufficient reliability.

Firms report many financial liabilities as the present value of the amount payable, except that firms can ignore discounting for liabilities due within one year. Nonfinancial liabilities, those settled by providing goods and services instead of cash, appear at either the amount of cash received (for example, advances from customers) or the expected cost of providing goods and services (for example, warranty liability).

Obligations under executory contracts do not usually appear as liabilities because they do not represent a present obligation. An exception involves leases accounted for as capital, or finance, leases. Firms also do not recognize certain obligations that are uncertain as to amount or timing or both as liabilities, unless those items meet a probability threshold and have a reliable measurement attribute. U.S. GAAP refers to these unrecognized obligations, such as the possible obligation under an unsettled lawsuit, as unrecognized contingencies, and IFRS uses the term contingent liability.

The FASB and the IASB are reconsidering the definition of a liability. Their proposed definition focuses on a present obligation and de-emphasizes a past obligating event and a probable future sacrifice of resources. For example, the proposed definition might result in the accounting for all leases as capital leases, the recognition of many executory contracts as liabilities, and the recognition of more obligations with uncertain amount or timing as liabilities.

The FASB and the IASB are reconsidering the role of uncertainty, or probability, in the
definition, recognition, and measurement of liabilities. Existing recognition criteria include
a probable future sacrifice of resources; one issue involves the minimum probability level to
warrant recognition of an uncertain obligation as a liability. U.S. GAAP does not specify
a minimum probability level, although the rule-of-thumb in practice is approximately 80%.
IFRS specifies that probable means more likely than not, implying greater than 50%.

Sometimes the FASB and the IASB view probability of payment as relating to measurement
of a liability, not to its definition and recognition. One of the characteristics of a fair value measurement is that the measurement does not embody a minimum probability for recognition. For example, an entity that guarantees the debt of another entity has incurred an unconditional obligation to stand ready to repay the other entity's debt. The probability of having to make a payment does not affect that unconditional obligation. Under current guidance, the unconditional obligation is a liability, measured at fair value incorporating both the probability of payment and the possible amounts of payment. The conditional obligation, which depends on whether the guaranteed firm is able to repay the debt, does not appear as a liability until it becomes probable.