CH.

LIABILITIES &
OWNERS
EQUITY
Anbiya R D

Felicia

Ariel Liauw

Katherine Ferry

Davita Kusuma

Proprietary Theory
Based on the idea that the owner is the
center of attention
Represents the net worth of the business
P=AL
Objective accounting: to determine the
net worth of the owner

Change in net worth

Net income: increase the wealth of the
owner
Income is the increase in proprietorship; expense is
the decrease in proprietorship

Changes in value of asset

Present accounting practice is based on proprietary
theory.

Dividends;
Salaries;
Equity method for long-term investment;
Consolidation Financial Statements

Financial capital view

 The theory is inadequate as a basis for

explaining company accounting.

developed when businesses were smaller

a company is separate from its owners
a company is a legal entity in its own right
shareholders rely on managers for
information
no longer so relevant

Entity Theory
Proposed that the business is a separate entity and
accounting records the transaction of the entity; the
company is a separate entity with its own identity
separation of owners and managers
accounting views the entity as an operating unit
accounting principles and procedures not formulated in
terms of an ownership interest
can also be applied in proprietorships, partnerships and
not-for-profit organisations

 The objective of accounting may be

either stewardship or accountability

entity seen as being in business for itself

interested in its own survival
sees owners as outsiders
reports to owners to meet legal requirements
and maintain good relationships with them

Assets = Equities
Assets belongs to the firm
Liabilities are obligations
Profit increases net assets and accrues to the
entity
The owners only have a residual claim on the net
assets of the entity

 Proprietary and entity theories are still

influential in practice
Conventional accounting theory base of
Entity Concept
Financial reports reflect an entity view
Interest charges are an expense and
dividends are a distribution of profit, based
on proprietary concept.

Liabilities defined
IASB Framework definition of
liabilities:
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
9

Present obligation
The actual sacrifices are yet to be made
Obligation is already present
Planned obligation included if to an
external party
Legal enforceability
Settlement of liability in various ways
Equitable and constructive obligations
10

Past transaction
A past transaction (or event) ensures that
only present liabilities are recorded and
not future ones
What kind of past transaction or event is
acceptable?
wholly executory contracts

11

Liability recognition
Recognition criteria:
Reliance on the law
legal enforceability

Determination of the economic substance

of the event
real obligation
12

Liability recognition
Recognition criteria:
Ability to measure the value of the
liability
normally the nominal amount
if period longer than 12-months, based on
the present value of expected future cash
flows

Use of the conservatism principle

at what point is the entity too conservative
13

IASB Framework
A liability should be recognised if
it is probable that any future economic
benefit associated with the items will flow to
or from the entity; and
the item has a cost or value that can be
measured with reliability

14

Liability measurement
The Framework provides little guidance about how to measure
liabilities
A number of different measurement bases may be used
Under IFRS, historical cost is the most common
The amount for which an asset could be exchanged or a
liability settled between knowledgeable, willing parties in an
arms length transactions
Thus, the liability arising under a finance lease is recognized at
inception based on the fair value of the lease (which according
to the above definition could be a market price for the leased)
15

Non-current liabilities
Long-term borrowings
Finance lease
obligations
Defined benefit post
employment
obligations
Deferred tax
Long-term provisions
Current Liabilities
Trade payables
Derivatives
Short-term borrowings
Current portion of
long-term borrowings
Other financial
liabilities
Current tax payable
Short-term provisions

Usual measurement
basis allowed by IFRS
and adopted in
practice

Amortised cost
Amortised cost

Fair value option*

Present value of expected

payments less fair value
of plan assets
Expected payments
Present value of expected
payments

Amortised cost
Fair value
Amortised cost
Amortised cost

No

Amortised cost

Yes

Expected payments
Expected payments

No
No

No
No

No
No

No
No
No

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Employee benefits pension

(superannuation) plans
Fully funded, partially funded or unfunded
Fully funded plans have sufficient cash or investments to
meet the funds obligation to members.
Since pension funds are separate legal entities, it might be
presumed that unfunded commitments of the plans are not
liabilities of an employer firm that pays into a fund.
However, it can be argued that the firm has an equitable
obligation to meet unfunded commitments and, therefore,
has a liability

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 Another issue relates to when to recognize

liabilities for pension (superannuation) payouts. Is
it:
As the employee renders services? The notion is that
the payout is a form of compensation earned by the
employee as services are rendered. However, it is paid
in the future, after requirement.
When the employee retires?
When the fund is required to make payments under the
pension plan?
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Provisions and
contingencies

Provisions and contingencies occur where

there is a blurring between present and
future obligations
Liabilities and provisions are recognised
only when there is a present obligation, it
is probable and it can be reliably
measured
Contingent liabilities do not meet these 19

Owners equity
Framework defines equity as
the residual interest in the assets of the entity after
deduction of its liabilities

Owners equity is a residual claim

There are 2 essential features which can help us to
distinguish between liabilities and owners equity.
They are:
The rights of the parties
The economic substance of the agreement
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Owners equity
Essential features
Rights of the parties
Economic substance of the arrangement

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Concept of capital
Influenced by legal prescriptions
capital maintenance

Financial capital
invested money or invested purchasing power

Physical capital
the productive capacity of the entity

Capital can be measured on either a nominal

dollar or purchasing power (real) scale
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Classifications within owners equity

The distinction between contributed and
earned capital is useful
retained earnings
not all transactions fit nicely into categories
share dividends

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Challenges for standard

setters

IASB has several projects which

will affect the definition,
recognition and measurement
of liabilities
debt versus equity distinction
extinguishing debt
employee shares (share-based
payment)

Issues for auditors

The completeness of liabilities
recognised on the balance sheet and the
note disclosures about contingencies
and other obligations are major issues
for auditors

evidence, timing, cut off

concealment and understatement
going concern
overstatement - provisions
reasonableness of fair values

Thank you