Slide 11.1
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Chapter 11
Provisions and non-current(long-term) liabilities
Slide 11.2
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Non-current (fixed) assets
plus
Current assets
minus
Current liabilities
minus
Liabilities due after one year
equals
Ownership Interest[Share capitalplusReserves of past profits]
Slide 11.3
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Notes Year 7 Year 6
£m £m
Amounts payable (creditors)
9 (2.7) (2.6)
Bank and other borrowings
(0.2) (0.6)
Provisions
11 (20.2) (22.2)
Statement of financial position
of Safe and Sure plc
Non-current liabilities
Net assets 464.3 370.4
Slide 11.4
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Definition
A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.
Slide 11.5
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Definition (Continued)
A current liability is a liability, which satisfies any of the following criteria:
(a) it is expected to be settled in the entity’s normal operating cycle;
(b) it is held primarily for the purpose of being traded;
(c) it is due to be settled within 12 months after the balance sheet date.
Slide 11.6
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Definition (Continued)
A non-current liability is any liability that does not meet the definition of a current liability. Non-current liabilities are also described as long-term liabilities.
Slide 11.7
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Examples
• Loan stock
• Debentures
• Bonds
• Bank borrowing and commercial paper
Slide 11.8
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Debentures
Loan made to the company:
• Packaged in a legal form by which the claims against the company can be bought and sold.
• Usually a fixed rate of interest.
Slide 11.9
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Bonds
(US term) normally indicates that the funds have been borrowed from sources beyond the UK. May be fixed or variable rates of interest.
Slide 11.10
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Bank borrowing and commercial paper
• Funds supplied by banks or other financial institution (insurance company).
• Usually variable rate of interest.
Slide 11.11
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Features of loans
• The amount borrowed (the capital sum)?
• How much is to be repaid?
• When is it to be repaid?
• What is the timing of interest payments?
• Does the lender require security for the loan?
Slide 11.12
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Provisions
A provision is a liability of uncertain timing or amount.
Examples are provisions for:• losses on contracts.• obsolescence of inventory (stock).• costs related to closure of a division of the
company.• costs of decommissioning an oil rig.• costs of landscaping to restore site.• warranties given for repair of goods.
Slide 11.13
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Creating a provision
The ownership interest is reduced by an expense in the profit and loss account and a liability is created under the name of the provision.
Assets – Liabilities = Ownership interest
(increase expense)
Slide 11.14
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Reducing an provision
When the provision is no longer required it is released to profit and loss account as an item of revenue which increases the ownership interest and the liability is reduced.
Assets - Liabilities = Ownership interest
(decrease expense)
Slide 11.15
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Example
During the year ending 31 December Year 5, a company's sales of manufactured goods amounted to £1m. All goods carry a manufacturer's warranty to rectify any faults arising during the first 12 months of ownership. Based on previous experience, a provision of 2.5% of sales was made.
Provision for warranties =
£1,000,000 x 2.5% = £25,000
Slide 11.16
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Example (Continued)
During Year 5 repairs under warranty cost £14,000. Further repair costs incurred are expected in respect of those items sold part-way through Year 5 whose warranty extends into Year 6.
Slide 11.17
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
– £25,000
Ownershipinterest (expense)
=Liabilities – Assets
As the repairs under warranty are carried out,
When the provision is established
– £14,000– £14,000
=–Assets Ownership interestLiabilities
+ £25,000
Slide 11.18
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
ASSET LIABILITY OWNERSHIP INTEREST
Date Transaction or event Cash Provision Profit and loss account
Year 5 £000’s £000’s £000’s
Jan. 1 Provision for repairs 25 (25)
Jan.–Dec. Repairs under warranty (14) (14)
Totals (14) 11 (25)
Spreadsheet for warranty repairs
Table 11.1 Spreadsheet for analysis of provision for warranty repairs
Slide 11.19
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Deferred income
• An amount received in a lump sum but related to activities over a number of years: the entity has not fully completed its side of the bargain. Costs have still to be incurred by the reporting entity. The matching concept is applied.
• For example, a government grant to a company, intended to help with the cost of training employees over the next three years.
Slide 11.20
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Should the income be recognised at once?
No, the benefit of the grant will extend over three years and it would therefore seem appropriate to spread the revenue over three years to match the cost it is subsidising.
Deferred income (Continued)
OI =L–A
Cash fromGovernment
Show as revenuein year received
Slide 11.21
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Matching concept
Aim of matching revenues to the cost to which they relate in the profit and loss account.
When grant received:
OI=L –A
Show as an income yetto be earned.
An obligation?
Cash from Gov’t
Slide 11.22
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Each year covered by grant, reduce liability and report a portion as income
Matching concept (Continued)
OI =L –A
That part of theincome earnedin the period.
To be matched againstthe cost incurred in theactivity to which it relates.
Slide 11.23
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Example
• A company receives a grant of £30,000 towards the cost of employee retraining. The retraining programme will last for three years and the costs will be spread evenly over the three years.
• Aim is to spread the income over 3 years at a rate of £10,000 each year.
Slide 11.24
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Example (Continued)
• Record the liability of £30,000 at the start and then reduce by £10,000 each year with transfer to profit and loss account, either as revenue or usually as a reduction in employee costs.
Slide 11.25
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
ASSET LIABILITY OWNERSHIP INTEREST
Date Cash Deferred income
Revenue
£000’s £000’s £000’s
Year 1
Jan 1 Receiving the grant 30 30
Dec 31 Transfer to P&L (10) 10
Year 2
Dec 31 Transfer to P&L (10) 10
Year 3
Dec 31 Transfer to P&L (10) 10
Recording deferred income and transfer to revenue
Table 11.2 Recording deferred income and transfer to revenue
Slide 11.26
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Chapter 11
Bookkeeping supplement
Slide 11.27
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
DEBIT ENTRIES CREDIT ENTRIES
Left-hand side of the equation
Asset Increase Decrease
Right-hand side of the equation
Liability Decrease Increase
Ownership interest Expense Revenue
Capital withdrawn Capital contributed
Slide 11.28
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
DATE PARTICULARS PAGE DEBIT CREDIT BALANCE
Year 5 £ £ £
Jan. 1 Provision in respect of Year 5
L2 25,000 (25,000)
Jan.–Dec.
Repairs carried out L1 14,000 (11,000)
L3 Provision for warranty repairs
Slide 11.29
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
DATE PARTICULARS PAGE DEBIT CREDIT BALANCE
Year 1 £ £ £
Jan. 1 Grant received L1 30,000 (30,000)
Dec. 31 Transfer to profit and loss account
L2 10,000 (20,000)
Year 2
Dec. 31 Transfer to profit and loss account
L2 10,000 (10,000)
Year 3
Dec. 31 Transfer to profit and loss account
L2 10,000 nil
L3 Deferred income (balance sheet)