slide 11.1 pauline weetman, financial and management accounting, 5 th edition © pearson education...

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Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011

Chapter 11

Provisions and non-current(long-term) liabilities

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Non-current (fixed) assets

plus

Current assets

minus

Current liabilities

minus

Liabilities due after one year

equals

Ownership Interest[Share capitalplusReserves of past profits]

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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

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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.

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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.

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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.

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Examples

• Loan stock

• Debentures

• Bonds

• Bank borrowing and commercial paper

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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.

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Bonds

(US term) normally indicates that the funds have been borrowed from sources beyond the UK. May be fixed or variable rates of interest.

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Bank borrowing and commercial paper

• Funds supplied by banks or other financial institution (insurance company).

• Usually variable rate of interest.

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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?

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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.

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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)

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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)

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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

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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.

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– £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

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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

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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.

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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

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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

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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.

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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.

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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.

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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


Year 3


Recording deferred income and transfer to revenue

Table 11.2 Recording deferred income and transfer to revenue

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Chapter 11

Bookkeeping supplement

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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

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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

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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


L2 10,000 (10,000)

Year 3


L2 10,000 nil

L3 Deferred income (balance sheet)

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