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The other side of the equation.

At year end, we spend a great deal of time carefully accounting for cash, receivables and equipment, so that our presentation of these items on the financial statements will be as accurate as possible. Sometimes in the process we give less attention to the liability side of the equation than we should. We know that without accurate reporting of liabilities the balance sheet can be misstated. We must remember also that the income statement can be affected, when unrecorded expenses or unearned income is overlooked.

Liabilities can be defined as future claims against the resources of an entity arising from a past transaction. This "claim" can be the payment of money, the performance of a service, the forgiveness of a debt or other transfers of value. So long as we know the entity to whom the payment will be made, the amount of the payment and the date the claim will be due, the liability should be recorded.

When this obligation is planned for payment within the year, it is classified as a current liability. In order to correctly value the liability, we need to know if it is:

1. A definitely determinable liability;

2. An estimated liability; or 3) a contingent liability.

Since these obligations involve a future payment, there is always some level of uncertainty about them. However, a definitely determinable liability is one whose value is set by contract and can be measured precisely. Liabilities of this nature include notes payable, trade accounts payable, accrued wages payable and associated payroll liabilities, interest and rent payable and unearned revenues.

Estimated liabilities are those obligations that a firm knows it will have, but which it cannot yet measure. FASB Statement #5 requires that when there is no doubt that the liability exists, the amount should be estimated from available information and the liability recorded on the books. Warranties, vacation pay, property taxes and income tax payable are a few examples of this type of liability.

Contingent liabilities represent possible claims against the firm. They depend on a future event happening as a result of some past transaction. Unless the claim can meet both of the FASB #5 requirements of probability of occurrence and capability of estimation, it should not be recorded on the books of the firm. This potential obligation may be important information to readers of the financial statements, however, and thus we are required to disclose the details of contingent liabilities within the footnotes to the financial statements. Law suits and IRS disputes are good examples of contingent liabilities!

Try the following current liabilities problem just for fun. See if your answer matches the one given in next month's column!
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Title Annotation:Accounting Scene; includes quiz; liability
Author:Winicur, Barbara
Publication:The National Public Accountant
Date:Dec 1, 1992
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