ACC/291 Principles of Accounting II - Discussion Questions [This isn't an essay] Discussion on this Learning Activity: Week 2 Electronic Reserve Readings Wk2 DQ#6 - Liability Why is the definition of a liability being is discussed in the article "What are the essential features of a liability? Reference: Murray, D. (2010). What are the essential features of a liability? Accounting Horizons, 24(4), 623-633. Retrieved from http://search.proquest.com/docview/822244056?accountid=35812 Wk2 DQ#7 - Cash Flow Review the article titled "The importance of forecasting cash flow"- what are some of the challenges and issues associated with accurately forecasting cash flow? Reference: Hipshman, J., & Campbell, C. (2010). The importance of forecasting cash flow. Orange County Business Journal, 33(39), 2-B46,B50. Retrieved from http://search.proquest.com/docview/821699016?accountid=35812 [NOTE: Hi, I uploaded two separate documents of articles for reading or skimming through. I need substantive responses (answers) for each discussion question (Wk 2 DQ#6 & DQ#7), and there isn't a minimum word count. This is not an essay, but these are discussion questions that I need help with replying to. Please answer each question completely. Also, I will try to check in whenever I can to review the answer, so please bear with me. Can you please help me, and I will greatly appreciate it if you can. I look forward to working with you. Thank you very much, and have a wonderful day.]

_______________________________________________________________ _______________________________________________________________ Report Information from ProQuest July 02 2015 10:48 _______________________________________________________________ 02 July 2015 ProQuest Table of contents 1. The Importance of Forecasting Cash Flow................................................................................................... 1 Bibliography...................................................................................................................................................... 4 02 July 2015 ii ProQuest Document 1 of 1 The Importance of Forecasting Cash Flow Author: Hipshman, Jeff; Campbell, Curtis ProQuest document link Abstract: [...] in the current economic situation, it is often vital for companies to manage their business on a 13week cash flow forecast. Under the indirect method, the income statement must be adjusted for any non-cash items and any changes in the business's current assets and liabilities, such as accounts receivable and accounts payable. Links: Linking Service Full text: The combination of high operating costs, low profit margins, tight credit and a challenging economic environment can mean poor cash flow. In turn, effectively managing cash flow can mean the difference between a sustainable or collapsed business. However, it can be difficult to clearly assess cash flow. HMWC CPAs &Business Advisors prepares a "Statement of Cash Flows" for our clients, who find that it is a highly useful document that allows management to track key financial information and, more importantly, forecast financial trouble. In fact, in the current economic situation, it is often vital for companies to manage their business on a 13-week cash flow forecast. Key facts Your company's financial statement is composed of a balance sheet, an income statement and a cash flow statement. All three statements comprise the same accounting information, but each one serves a different function. The balance sheet provides a presentation of your company's assets, liabilities and net worth. The income statement indicates the business's profitability during a specified period. The cash flow statement, however, connects the two to provide a more comprehensive view of your finances. A cash flow statement is a financial accounting document that is essentially concerned with the flow of cash in and out of a business. It shows how changes in balance sheet accounts and income affect cash and cash equivalents. The statement captures both the current operating results and the accompanying changes in the balance sheet. As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills. How and when is a cash flow statement useful in analyzing a company's financial situation? When analyzing your company's liquidity, for example, cash flow information is more informative, while balance sheet data is more static, measuring a single point in time. The income statement is also not quite as useful in assessing liquidity because it contains many arbitrary non-cash allocations, such as pension contributions and depreciation and amortization. A cash flow statement reconciles both of these much in the same manner that a checkbook would reconcile a checking account. It records the changes in the other statements and nets out the bookkeeping, showing the amounts and sources of profits and losses for any given period. The cash flow statement also maintains records of your company's fiscal transactions. A snap-shot of activities If you're operating under the accrual method of accounting, sales and expenses often appear on financial statements before payment is received or made. A cash flow statement converts financial data recorded on an accrual basis in the income statement and balance sheet to a cash basis. The statement shows sources of cash receipts, where cash is spent, and the net change. To arrive at the net change, the statement focuses on three areas of activity: 1. Operations. Operating activities are a company's dally internal activities that generate cash or require its 02 July 2015 Page 1 of 4 ProQuest expenditure. These include cash collections, operating expenses (such as payroll, rent, supplies and inventory) and income taxes. 2. Investing. This varies depending on your industry. For example, with manufacturers, investing generally involves the purchase or sale of equipment. 3. Financing. Loans and leases that provide or require cash generally fall under financing. You can measure cash flow using the direct or indirect method. The direct method uses the cash activity recorded in the company's checkbook. Cash receipts and disbursements shown are totaled and classified in the three categories above. The more common, and more complicated, indirect method uses information gathered from the income statement and balance sheet. Cash for investing and financing is calculated in the same manner under both methods, but the calculation of operating receipts and disbursements differs. Under the indirect method, the income statement must be adjusted for any non-cash items and any changes in the business's current assets and liabilities, such as accounts receivable and accounts payable. Regular analyses Even if a company is turning a profit, it can still go out of business if it is experiencing negative cash flow and is unable to pay its bills. By regularly analyzing cash flow statements, you can pinpoint reasons for negative cash flow, such as poor collections or changes in fixed assets and debt. You can then begin to develop plans to remedy them by implementing ways to reduce your company's day-to-day operating expenses. You might, for example, find it more cost effective to outsource certain areas of the business, such as human resources, payroll and benefits management, or information technology support. Or you might choose to implement inventory management agreements with suppliers that allow you to house inventory at their sites for longer periods, allowing you to save on storage and interest costs. Cash flow ratios You can plug data found on your cash flow statement Into simple ratios to gain a better understanding of your company's financial cori dition. For example, if cash is criticai to servicing lohg-tefrfi debt, ten "cash flow to long-term debt" would be a useful ratio. Using the "operating cash flow" ratio helps gauge your short-term liquidity by comparing the amount of cash generated to outstanding debt. This can help you understand how your current liabilities are covered byih cash flow generated by your company's operations, giving you a quick appraisal on whether you'll be able to manage future loans, interest payments, payroll and other expenses. Seek our assistance A cash flow statement provides information mat is not easily extracted from an income statement or balance sheet, such as where your cash is and where its being generated. Only by analyzing the components together along with other critical data can you understand your company's financial outlook. HMWC CPAs &Business Advisors can help your company by not only preparing financial statements but also assisting you in analyzing them so that you can more effectively manage your business. AuthorAffiliation By Jeff Hipshman and Curtis Campbell, HMWC CPAs &Business Advisors AuthorAffiliation Jeff Hipshman and Curtis Campbell, are partners at HMWC CPAs &Business Advisors (www.hmwccpa.com) in Tustin. Contact them at (714) 505-9000 to discuss how your company or client could benefit from the firm's sen/ices. Subject: Cash flow statements; Profitability; Financial statements; Current liabilities; Corporate profits; Cash flow forecasting; 02 July 2015 Page 2 of 4 ProQuest Classification: 4120: Accounting policies & procedures; 3100: Capital & debt management Publication title: Orange County Business Journal Volume: 33 Issue: 39 Pages: B46,B50 Number of pages: 2 Publication year: 2010 Publication date: Sep 27-Oct 3, 2010 Section: CORPORATE FINANCE Publisher: CBJ, L. P. Place of publication: Newport Beach Country of publication: United States Publication subject: Business And Economics--Economic Situation And Conditions ISSN: 10517480 Source type: Trade Journals Language of publication: English Document type: General Information ProQuest document ID: 821699016 Document URL: http://search.proquest.com/docview/821699016?accountid=35812 Copyright: Copyright CBJ, L. P. Sep 27-Oct 3, 2010 Last updated: 2014-02-15 Database: ProQuest Central 02 July 2015 Page 3 of 4 ProQuest Bibliography Citation style: APA 6th - American Psychological Association, 6th Edition Hipshman, J., & Campbell, C. (2010). The importance of forecasting cash flow. Orange County Business Journal, 33(39), 2-B46,B50. Retrieved from http://search.proquest.com/docview/821699016?accountid=35812 _______________________________________________________________ Contact ProQuest Copyright 2015 ProQuest LLC. All rights reserved. - Terms and Conditions 02 July 2015 Page 4 of 4 ProQuest _______________________________________________________________ _______________________________________________________________ Report Information from ProQuest July 02 2015 10:28 _______________________________________________________________ 02 July 2015 ProQuest Table of contents 1. What Are the Essential Features of a Liability?............................................................................................ 1 Bibliography...................................................................................................................................................... 12 02 July 2015 ii ProQuest Document 1 of 1 What Are the Essential Features of a Liability? Author: Murray, Dennis ProQuest document link Abstract: The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are in the process of jointly re-examining their conceptual frameworks. The re-examination includes assessing the definition of a liability. The Boards' existing liability definitions include three criteria: (1) a present obligation; (2) a past transaction or event; and (3) a probable future sacrifice of economic benefits. The Boards have recently proposed that a liability be defined as "a present obligation for which the entity is the obligor" (FASB 2008c, 2). The proposed definition mentions only one time dimension (the present). References to the past and future are omitted. This paper argues that these omissions are undesirable. Omitting a reference to the past removes the link between the definition and the tradition of historically based financial statements. More importantly, however, the failure to reference future sacrifices of economic benefits divorces the definition from the primary objective of financial reporting: to provide information about the "amount, timing and uncertainty of an entity's future cash flows" (FASB 2008a, para. OB6). This paper offers an alternative definition that emphasizes the past and future rather than the present. [PUBLICATION ABSTRACT] Links: Linking Service Full text: Headnote SYNOPSIS: The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are in the process of jointly re-examining their conceptual frameworks. The re-examination includes assessing the definition of a liability. The Boards' existing liability definitions include three criteria: (1) a present obligation; (2) a past transaction or event; and (3) a probable future sacrifice of economic benefits. The Boards have recently proposed that a liability be defined as "a present obligation for which the entity is the obligor" (FASB 2008c, 2). The proposed definition mentions only one time dimension (the present). References to the past and future are omitted. This paper argues that these omissions are undesirable. Omitting a reference to the past removes the link between the definition and the tradition of historically based financial statements. More importantly, however, the failure to reference future sacrifices of economic benefits divorces the definition from the primary objective of financial reporting: to provide information about the "amount, timing and uncertainty of an entity's future cash flows" (FASB 2008a, para. OB6). This paper offers an alternative definition that emphasizes the past and future rather than the present. INTRODUCTION The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are in the process of re-examining their conceptual frameworks. The goal is for the Boards to jointly issue a common framework that would underlie the deliberations of both bodies. The framework will delineate the objectives of financial reporting, identify the qualitative characteristics of decision-useful information, define the elements of financial statements and address recognition and measurement issues (FASB 2006). The Boards are considering substantive changes to the definition of a liability. The changes, if implemented, could significantly affect the particular obligations included in financial statements and, ultimately, the usefulness of those statements. The purpose of this paper is to review and critically evaluate the newly proposed liability definition. While the definition itself is of primary interest, issues related to recognition and measurement will be addressed in a limited fashion. In order to conduct the analysis, one presumption will be made. The tentative conclusions about the objective of financial accounting reached by the Boards will be accepted. The Boards maintain that: 02 July 2015 Page 1 of 12 ProQuest The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in making decisions in their capacity as capital providers. (FASB 2008a, para. OB2) The Boards further maintain that both equity investors and lenders "are interested in the amount, timing, and uncertainty of an entity's future cash flows" (FASB 2008a, para. OB6). The Boards have taken a strong decision usefulness orientation. The envisioned decisions involve the allocation of resources (e.g., investing and lending) that are made by investors and creditors. In making these decisions, investors and creditors assess an entity's ability to generate net cash inflows. To assist in making this determination, financial reporting is to provide, among other things, information about claims to an entity's resources (FASB 2008a, para. OB6). Thus, the major criterion used in this paper to evaluate the desirability of a liability definition is the degree to which it can assist financial statement users in assessing the cash flows needed to satisfy the claims of creditors. EXISTING DEFINITIONS The FASB's existing liability definition is contained in Statement of Financial Accounting Concept (SFAC) No. 6, Elements of Financial Statements: Liabilities are probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of a past transaction or event. (FASB 1985a, para. 35) The existing IASB definition is contained in Framework for the Preparation and Presentation of Financial Statements: 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. (IASB 2001, para. 49) Each definition contains essentially the same components, although the sequencing and exact phraseology differ slightly. Both definitions reference (1) present obligations, (2) past events, and (3) a future conveyance of economic benefits. Present obligations refer to responsibilities or duties that exist on the balance sheet date. Present obligations are viewed as leaving the entity "little or no discretion" (FASB 1985a, para. 36). Both the FASB and IASB believe that constructive or equitable obligations meet their definitions. Constructive or equitable obligations arise from custom or potential social sanctions rather than from legal compulsion. Examples include product warranty costs arising from customary practice rather than formal warranties (IASB 2001, para. 60) and vacation pay obligations not supported by contract (FASB 1985a, para. 40). Both definitions refer to past events. This reference acknowledges that financial statements are historically based. The Boards have stated that financial reporting information is based on "the financial effects on an entity of transactions and other events and circumstances that have happened or that exist" (FASB 2008a, para. OB14). Accountants have become accustomed to searching for past transactions or events to trigger the recognition of financial statement items. Both definitions also look to the future. The FASB references "probable future sacrifices of economic benefits." The IASB definition includes the phrase "expected to result in an outflow from the entity of resources embodying economic benefits." Economic benefits are items that have the capacity to result in net cash inflows (FASB 1985a, para. 27). Both definitions anticipate the entity's conveyance of such benefits to an outside party at a date in the future. However, neither definition demands that the anticipated conveyance be certain. The FASB uses the term probable, which "refers to that which can reasonably be expected or believed on the basis of available evidence or logic" (FASB 1985a, para. 35). The IASB has indicated that its term expected has the same meaning as the term probable (IASB 2008a). Storey and Storey (1998) report that the FASB included the term probable in the liability definition because of concerns that its omission would require the anticipated outflow to be virtually certain, resulting in the recognition of many fewer liabilities than is presently the case. PROPOSED DEFINITION The Boards have proposed the following definition: 02 July 2015 Page 2 of 12 ProQuest A liability of an entity is a present economic obligation for which the entity is the obligor. (FASB 2008c, 2) The proposed definition contains two provisions: (1) that a present economic obligation exists and (2) that the entity is the obligor. An economic obligation is an unconditional promise or other requirement to provide economic resources (FASB 2008c). The term present indicates that the obligation exists on the balance sheet date. No mention is made of past transactions or future sacrifices; the focus is exclusively on the present. The necessity of identifying past triggering transactions or events is obviated. Additionally, future outcomes do not play a role. Forecasts or expectations are not a factor. An entity simply must identify the obligations it has on the reporting date. The Boards have also tentatively decided that liabilities should be unconditional. "An unconditional obligation requires performance to occur now or over a period of time, whereas a conditional obligation requires performance to occur only if an uncertain future event occurs" (FASB 2008b, 8). The second provision of the proposed definition requires that the entity be the obligor. This indicates that the "obligation is enforceable by legal or equivalent means" against the entity (FASB 2008c, 3). FASB staff has indicated that this phrase is intended to imply that constructive obligations should be viewed as liabilities (FASB 2008c). ANALYSIS OF PROPOSED DEFINITION The proposed definition is markedly different from the existing definitions. The proposed definition is shorter and simpler. It mentions only the present, instead of referencing three time dimensions (past, present, and future). The simplicity and the focus on the present are appealing attributes. However, does a singular focus on the present yield information that compromises the ability of financial statement users to assess the amounts, timing, and uncertainty of the entity's future cash flows? Is an emphasis on present obligations to the exclusion of probable future sacrifices desirable? Are constructive obligations really enforceable? Should probability thresholds for recognition be abandoned? The following subsections address these questions. Constructive Obligations The proposed definition and additional commentary provided by the FASB indicate that a liability must be an obligation that is enforceable by legal or equivalent means. A legal obligation arises (1) from a law, statute, or ordinance, (2) from a written or oral contract, or (3) via promissory estoppel (FASB 2001, para. 2). Promissory estoppel is the doctrine that a promise made without consideration may be legally enforceable if the promisor should have reasonably expected the promisee to rely on the promise and the promisee did in fact rely on the promise to his or her detriment (Garner and Black 2009). Note, in particular, that promissory estoppel is a method to achieve legal enforcement. Beyond legal compulsion, by what "equivalent means" can an obligation be enforced? Constructive obligations are presumably "binding primarily because of social or moral sanctions or custom" (FASB 1985a, para. 40). How can social or moral sanctions or custom be used to enforce a constructive obligation? Consider unvested pension benefits. Statement of Financial Accounting Standard (SFAS) No. 87, Employers' Accounting for Pensions (FASB 1985b), and International Accounting Standard (IAS) 19, Employee Benefits (IASB 2007), both require recognition of liabilities for pension benefits that have been earned but remain unvested as of the reporting date. The entity is not legally obligated to honor these benefits. Can employees enforce the obligation for unvested benefits by non-legal means? The Pension Benefit Guaranty Corporation (PBGC) provides important information on this question. PBGC (2008) reports that of the single-employer plans that it insured in 2003, 2004, and 2005, 9.5 percent, 12.1 percent and 14.1 percent, respectively, had a hardfreeze in place.1 By hard-freezing a plan, earned but unvested benefits will not be paid. Unvested benefits based on future salary progression will also not be paid. Thus, it appears that in some cases unvested benefit obligations may not be enforceable, thereby disqualifying them as liabilities under the proposed definition.2 The FASB's existing rationale for viewing unvested pension benefits as liabilities is revealing. The going concern assumption is invoked as implying that a pension plan will continue in operation (in the absence of evidence to the contrary) and that benefits will be paid. "Benefits that are expected to vest are probable future 02 July 2015 Page 3 of 12 ProQuest sacrifices, and the liability in an ongoing plan situation is not limited to vested benefits" (FASB 1985b, para. 149). Notice that the argument is not that the entity is presently obligated. The argument underlying the view that an unvested pension benefit is a liability is that the sacrifice is probable. However, the liability definition proposed by the FASB and IASB does not contain the criterion of probable future sacrifice. Thus, if the proposed definition is adopted, the Boards must develop an alternative rationale to justify treating unvested pension obligations as liabilities. However, unvested pension benefits are likely associated with future cash flows (if not on an individual employee basis, certainly on a workforce wide basis). Assuming that actuarial estimates are sufficiently reliable, financial statement recognition of this obligation may provide information helpful in assessing an entity's future cash flows to employees. Barth (1991) shows that the accumulated benefit obligation (ABO), which includes unvested benefits, is more consistent with security prices (i.e., assessments of future cash flows) than the vested pension obligation (VBO), which includes only vested benefits. Requiring a liability to be a presently enforceable obligation may not, therefore, be desirable if the goal is to provide information that assists in assessing the amount, timing and uncertainty of an entity's future cash flows. Unconditionality Another important issue is that of unconditionality. The Boards have tentatively concluded that obligations must be unconditional in order to qualify as liabilities. Recall that unconditional obligations are not contingent on the occurrence of future events. Consider how product warranties would be viewed in this context. Payments on product warranties are conditional on a future event: product failure. Without product failure, no economic resources will be conveyed. Therefore, according to the proposed definition, product warranties would not meet the definition of a liability until failure has occurred. At the time of sale, the proposed definition would not be met, and no liability would exist or be reflected on the balance sheet. Given that warranties on products that have been sold but have not yet failed are likely associated with future payments to correct defective products, excluding this obligation from the balance sheet would not assist financial statement users in assessing an entity's future cash flows. Now consider conditional asset retirement obligations (AROs). FASB Interpretation (FIN) No. 47, Accounting for Conditional Asset Retirement Obligations (FASB 2005), defines a conditional ARO as "a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity" (FASB 2005, para. 3). FIN No. 47 assumes a situation where "(t)he obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing (or) method of settlement" (FASB 2005, para.3). The term conditional is being used differently in the proposed definition and in FIN No. 47. In the proposed definition, conditional refers to the existence of the obligation. That is, the proposed definition requires that the obligation not be conditional on a future event. This is why product warranties do not meet the proposed definition: they are conditional on a future event (product failure). The issue is the existence of the obligation, not its measurement. FIN No. 47 deals with a situation where the existence of the obligation is unconditional, but the method of settlement and, therefore, the associated costs are conditional on future events. Consider the example of a nuclear power plant where the operating license includes a requirement for decommissioning. The decommissioning obligation arises as soon as the plant begins operations. However, the method used to decommission the plant will depend on the technology available at the time of decommissioning, as well as other factors. Uncertainty exists about the method of settlement and associated costs because they are conditional on future technology. The issue in FIN No. 47 is measurement of the obligation, not its existence. I believe that conditional AROs would be viewed as liabilities under the proposed definition. Conditional AROs are actually unconditional obligations, if one uses the meaning of unconditional in the proposed liability definition. If the measurement issues are such that a reasonable estimate of the obligation can be made, the obligation would be recognized. In contrast, the existence of a product warranty liability is conditional on an 02 July 2015 Page 4 of 12 ProQuest uncertain future event (product failure) even if the method of settlement is known with virtual certainty. The difference between product warranties and conditional AROs underscores the importance of clearly distinguishing definitional issues from measurement issues. The Boards apparently recognize the undesirability of the product warranty result and have created the notion of a stand-ready obligation.3 In the product warranty situation, the entity is viewed as having (1) an unconditional obligation to stand-ready to perform if product failure occurs and (2) a conditional obligation to correct a defect if product failure occurs. While the Boards acknowledge that a stand-ready obligation is passive, they believe that it is a genuine obligation that arises at the time of sale and should be recognized at that point. The responsibility to actually honor the warranty by repairing or replacing a defective product is viewed by the Boards as a conditional obligation prior to product failure, which would not meet the proposed liability definition at the time of sale. At the time of failure, the obligation to repair or replace then becomes unconditional and recognition of this liability would then be appropriate. IASB (2005) has addressed the measurement of stand-ready obligations. It recommends that a stand-ready (unconditional) obligation be measured at a settlement amount (i.e., an amount the entity would be required to pay a third party to relieve itself of the obligation). In the product warranty situation, because a third party would consider the likelihood that it would ultimately be called upon to remedy a product failure, the measurement of the stand-ready obligation would reflect the likelihood of product failure and the associated costs. That is, the measurement of the unconditional stand-ready obligation would reflect the third party's assessment of its obligation to honor the obligation for actual repairs, which is conditional on product failure. The passive nature of a stand-ready obligation is of paramount importance. What sacrifice is needed to honor a stand-ready obligation? That is, what sacrifice is needed to provide risk protection prior to product failure? None. I can stand-ready all day, every day and it will cost me nothing. With no conveyance of economic benefits, no economic obligation exists. Thus, a standready obligation is not really an economic obligation and is not a liability. The notion of a stand-ready obligation is simply a contrivance by the Boards. The contrivance is needed because the proposed liability definition does not yield sensible, useful results. The proposed definition demands that an unconditional enforceable obligation exists on the balance sheet date. Product warranty obligations do not meet this standard because they are conditional on a future event: product failure. Yet virtually all accountants view these obligations as liabilities, and with good cause. They are likely associated with future cash flows. To obtain a desirable result, the Boards have artificially bifurcated certain obligations into a conditional obligation and an unconditional stand-ready obligation that is associated with no flow of economic resources. Given that no sacrifices of economic benefits are associated with stand-ready obligations, their recognition would presumably result in no increase in measured liabilities. This perhaps is, at least in part, the motivation for the measurement rules suggested in IASB (2005), which propose the use of a third party settlement amount. A third party settlement amount would include an assessment of the expected future cash flows associated with the conditional obligation tied to product failure. Therefore, the proposed measurement rules for the unconditional stand-ready obligation result in the recognition of the expected cash flows associated with the unrecognized conditional obligation. That is, according to the FASB and IASB's proposed definition and measurement rules, the obligation for product repair that is contingent on product failure should not be recognized because it is conditional on a future event (i.e., product failure). Moreover, the Boards propose that the recognized unconditional stand-ready obligation be measured by a settlement amount that reflects the expected cash flows associated with the unrecognized conditional obligation, a seemingly incongruous outcome. Without the stand-ready contrivance and the associated measurement rules (which incorporate the expected cash flows from the conditional obligation), product warranties would not meet the proposed definition and no product warranty obligation would appear as a liability on balance sheets prior to product failure. Thresholds versus Expected Values 02 July 2015 Page 5 of 12 ProQuest SFAS No. 143, Accounting for Asset Retirement Obligations (FASB 2001), provides another instructive illustration about the FASB's approach to liability recognition and measurement. SFAS No. 143 provides an example of a governmental unit retaining the right to require a retirement activity. The FASB concludes that "Uncertainty about whether performance will be required does not defer the recognition of a retirement obligation; rather, that uncertainty is factored into the measurement of the fair value of the liability through assignment of probabilities to cash flows" (FASB 2001, para. A17). Thus, the FASB has moved from a threshold approach for liability recognition to an expected value approach. The FASB ignored the probability criterion in the existing liability definition. That is, a minimal level of likelihood is not required for recognition of asset retirement obligations. Rather, uncertainty is incorporated in the measurement of the liability, even if the likelihood of the sacrifice is extremely low.4 A recent survey by PricewaterhouseCoopers (PwC 2007) provides some evidence about financial statement users' views of this issue. Buy-side and sell-side investment professionals and investors across four countries (Canada, Germany, U.K., and U.S.) were interviewed (PwC 2007).5 Eighty-six percent of those surveyed support recognizing liabilities only when the outflow is likely. Curiously, 96 percent prefer a measurement model based on probability-adjusted discounted cash flows. Whereas the Boards appear to view thresholds and expected values as alternatives to dealing with uncertainty, the financial statement users interviewed in PwC (2007) prefer that these approaches be used jointly. However, more to the point of the present discussion, the PwC (2007) respondents clearly favor retaining a probability threshold for liability recognition. This preference is inconsistent with the Boards' reliance on expected values. Probable Future Sacrifice The previous subsections suggest that a weakness in the proposed definition may well be its focus on the present. Given that financial reporting is intended to help users assess an entity's future cash flows, the likelihood that an outflow of resources will ensue from an arrangement is critical. The existing FASB liability definition uses the phrase "probable future sacrifices," while the proposed definition makes no reference to the future. Instead, the proposed definition requires a presently enforceable economic obligation. This requirement is too exclusionary. That is, numerous probable future sacrifices (e.g., unvested pension benefits and product warranties) would fail to meet this requirement and be excluded from balance sheets. By ignoring the future, the proposed definition fails to meet the Boards' stated goal of providing information useful in assessing an entity's future cash flows. The proposed definition also does not reference the past. This fails to acknowledge that business transactions often unfold over time, rather than occur at discrete points in time. Both the unvested employee benefits illustration and the product warranty illustration are good examples of transactions that can easily take years to complete. A key question is: when during a possibly extended arrangement should the liability definition be considered fulfilled? To summarize, a liability definition that demands the existence of an unconditional, enforceable present obligation will omit from the balance sheet numerous probable future sacrifices of economic benefits. These omissions will compromise the ability of financial statement users to assess an entity's future cash flows. Moreover, a liability definition should also provide guidance regarding the many transactions that require an extended period of time to complete. AN ALTERNATIVE Consider a definition that emphasizes future sacrifices and the possibly prolonged nature of some relationships and transactions: A liability is a likely future sacrifice of economic benefits arising as the result of events and transactions that have largely been completed. The Boards' stated objective of financial statements is to help users assess an entity's future cash flows. Accordingly, the first component of the definition refers to a likely future sacrifice of economic benefits. If an item 02 July 2015 Page 6 of 12 ProQuest is not reasonably associated with a future cash outflow, its treatment as a liability would not be helpful to users in assessing those flows. Therefore, such an association is a necessary condition of a liability. Given that future events are referenced in the definition, the qualifier likely is used in recognition of the uncertainty surrounding the future. The existing FASB liability definition includes the term probable with the meaning of reasonably expected. The FASB also uses the term probable in SFAS No. 5, Accounting for Contingencies (FASB 1975). In that standard, probable is used with a different meaning; it is defined as likely to occur. At the very least, communication is hampered by having two definitions for one term. To distance my alternative definition from the resulting confusion, I have chosen the term likely rather than probable. What meaning should be attached to likely? In IAS 37, the IASB defines probable as "more likely than not to occur" (IASB 2008b, para. 23). That is, recognition as a liability would require a greater than 50 percent probability of occurring. I adopt this meaning for several reasons. First, the meaning is simple and easy to understand. It can be thought of as either a probability or odds (i.e., better than even odds). It is concrete (at least in terms of basic conceptualization), unlike the existing FASB definitions of probable. Additionally, a 50 percent threshold is not far from users' preferences, as documented by Aharony and Dotan (2004). The financial analysts participating in their study attached an average probability level of 65 percent to the term probable (as used in SFAS No. 5). Thus, a 50 percent threshold would be a bit more conservative than the average preference of these analysts. While a 50 percent threshold is quite specific in concept, both the Boards and practitioners would need to use judgment when applying this definition. Judgment would be needed by the Boards in developing specific financial accounting standards. For example, the Boards might conclude that unvested pension benefits meet the threshold, but guarantees of the indebtedness of others do not. Practitioners would also need to exercise judgment in applying the threshold to situations left unaddressed by the Boards (e.g., litigation). The second component of the definition requires that the future sacrifice be due to events and transactions that have largely been completed. This aspect of the definition is consistent with historically based financial statements. In particular, it recognizes that a probable future sacrifice is necessary but not sufficient for the existence of a liability. At a given point in time, an entity will have many plans and expectations that will likely result in future sacrifices of economic benefits. Examples include plans for the purchase of goods and services, future capital expenditures and the anticipated payment to employees for services that have not yet been rendered. Inclusion in the financial statements of the expected cash flows associated with these plans would mark a significant departure from traditional historically based financial statements. Accordingly, the second component of the definition reinforces the historical nature of accounting and excludes from liabilities cash flows associated with an entity's plans for future transactions. The second component also acknowledges that events, transactions, situations, and relationships can take time to complete. Ijiri (1980) examined the recognition issue with respect to contractual rights and obligations. Using the example of a non-cancellable commodity purchase contract, Ijiri (1980) identified five possible liability recognition points for the buyer: (1) contract point-when the contract is signed, (2) procurement point-when the seller procures the product, (3) production point-when the seller completes processing the product, (4) segregation point- when the seller segregates the product prior to shipment, and (5) delivery point-when the seller delivers the product to the buyer. Ijiri (1980) suggests that the delivery point might signal a sufficient increase in the likelihood that the obligation will be fulfilled to warrant recognition. Specification of delivery as the recognition point seems too detailed for the definitional level. However, Ijiri (1980) directs attention to a critical question: when has a relationship sufficiently progressed to warrant recognition? The definition that I offer requires that the future sacrifice be the result of events and transactions that have largely been completed. The existing definition references past transactions and events, to some degree implying a binary characterization: transactions and events are in the past or they are not. The phrase "largely been completed" explicitly recognizes that transactions and events might be partially complete on the reporting 02 July 2015 Page 7 of 12 ProQuest date. The term largely requires that the bulk of the obligating event(s) must have already occurred. Current generally accepted accounting principles take a similar approach, particularly with respect to revenue recognition. For example, SFAS No. 45, Accounting for Franchise Fee Revenue (FASB 1981a), provides that revenue shall be recognized when services have been substantially performed. Similarly, SFAS No. 48, Revenue Recognition When Right of Return Exists (FASB 1981b), establishes as a condition for revenue recognition that the seller does not have significant future performance obligations. These standards address specific situations where the relationship between the parties evolves over time. Judgment will be needed in applying fundamental concepts and definitions to specific settings. The definition I offer provides the Boards reasonable guidance and flexibility when setting standards addressing particular liabilities. Examples How would unvested pension benefits and product warranties be evaluated in terms of my suggested definition? On a workforce-wide basis, unvested pension benefits are likely associated with future cash flows, thereby meeting the first component of the definition (i.e., a likely future sacrifice). Are these benefits due to events and transactions that have largely been completed? Unvested (but earned) pension benefits result from services that have already been rendered, but the actual payment is contingent upon continued employment for a specified period. Judgment is clearly necessary to answer this question. My judgment would be in the affirmative. The services that underlie the determination of the benefits have been rendered. While additional services are needed in order for payment to be compulsory, the amount of the payment will be unaffected by the additional years of service. Although different people may render different judgments, the definition directs attention to the important questions. Product warranties, as a group, are also very likely associated with future cash flows, thereby meeting the first component of the definition. Are they due to events and transactions that have largely been completed? Assume that the sale of the underlying product has occurred, the revenue has been recognized, but product failure has not occurred. Although the product has not yet failed, the production process has been completed and the inherent quality of the product has been established. My conclusion would be that the product warranty transaction is largely completed at the time of sale, thereby justifying the view that product warranties are liabilities. Note that product warranties would not meet the Boards' proposed definition because they are conditional on a future event (product failure). Consider two final examples. The first example involves a lessee's obligation for a contingent rental. Assume that on July 1 a calendar year-end entity signs a one-year store lease for a fixed sum plus an additional fixed sum if a sales threshold is met. Also assume that as of December 31 the sales volume is 95 percent of the threshold and every expectation is that sales will continue to be strong. Does a liability exist on December 31? According to my proposed definition, a liability does exist. The future sacrifice is likely and the events and transactions underlying the liability are 95 percent complete. According to the Boards' proposed definition, a liability does not exist because the obligation is conditional on a future event (additional sales). Therefore, according to the Boards' proposal, this very likely cash outflow would be omitted from the balance sheet, whereas under my proposal, it would be reflected on the balance sheet. The above three examples have a common thread. They involve a likely future sacrifice that is due to events and transactions that have largely been completed. However, the future sacrifice is conditional on future events (i.e., a present obligation does not exist). Consequently, those situations meet my proposed liability definition, but not the definition proposed by the Boards. The next example is based on material in SFAS No. 143. Assume an entity leases a tract of land for the purpose of harvesting timber. The lease gives the lessor the option to require the lessee to reforest the land. Also assume that given the lessor's past history, the likelihood that reforestation will be required is 10 percent. Does a liability arise as harvesting takes place? According to my proposed definition, a liability does not exist because the cash outflow is not likely. According to the Boards' proposed definition, the entity has a liability 02 July 2015 Page 8 of 12 ProQuest because a present obligation exists. Therefore, according to the Boards' definition, this extremely unlikely cash outflow would be recorded as a liability on the balance sheet. The uncertainty is reflected in the measurement by using an expected cash flow figure, rather than using a probability threshold for recognition. Let's contrast the last two examples. The contingent rent in the store lease is a highly likely future cash outflow that is due to events that have largely taken place. My alternative definition would reflect this obligation on the balance sheet, whereas the Boards' proposal would not because the entity is not presently obligated. The ARO for reforestation is highly unlikely to materialize and, accordingly, does not meet my proposed definition. However, this ARO does meet the Boards' definition because a legal obligation exists, even though the likelihood of future cash outflows is small. In my view, a flaw in the Boards' definition is that some likely cash outflows would not be considered liabilities and some unlikely cash outflows would be considered liabilities. I do not believe that this would result in improved financial reporting. SUMMARY The existing liability definitions promulgated by the FASB and IASB reference three time dimensions: past, present and future. The Boards' proposed definition does not reference the past or future, instead focusing on present, enforceable obligations. Many obligations (e.g., bank loans and purchases on account) clearly are present, enforceable obligations. However, meeting the standard of a present, enforceable obligation can be challenging in some settings, such as unvested pension benefits and product warranties. In those situations, a present, enforceable obligation does not exist and no liability should be reported under the Boards' proposed definition. This result conflicts with the existing treatment of these items, and would compromise users' ability to assess an entity's future cash flows. While a liability definition that focuses on present obligations has appeal, an emphasis on the present drives a wedge between the definition and the use to which financial statement information will be put: assessing future cash flows. Consequently, I propose a definition that emphasizes a probable future sacrifice of economic benefits coupled with the requirement that the events and transactions underlying the future sacrifice have largely been completed. The latter requirement retains the historical nature of financial reporting, assures that the balance sheet is not cluttered with an entity's future plans, and accommodates the extended nature of some arrangements while the link to the future helps assure that the objectives of financial reporting will be met. I understand the Boards' motivation for focusing on the present, rather than the past and future. However, doing so destroys the link between the liability definition and the objective of financial reporting, thereby compromising the usefulness of financial statement information. Footnote 1 A hard-freeze suspends new benefit accruals with respect to both service and compensation levels. 2 An alternative interpretation is that employees elected not to enforce the unvested obligations. 3 The concept of a stand-ready obligation has been most extensively developed by the IASB in its reconsideration of IAS 37, Provisions, Contingent Liabilities and Contingent Assets (IASB 2005). 4 See Johnson et al. (1993) for a discussion of thresholds and expected values. 5 Given the sampling approach employed, PwC cautions that its results should not be viewed as statistically valid. References REFERENCES Aharony, J. and A. Dotan. 2004. A comparative analysis of auditor, manager, and financial analysts' interpretations of SFAS 5. Journal of Business Finance &Accounting 31 (3 and 4): 475-504. Barth, M. E. 1991. Relative measurement errors among alternative pension asset and liability measures. The Accounting Review 66 (3): 433-463. Financial Accounting Standards Board (FASB). 1975. Accounting for Contingencies. Statement of Financial Accounting Standards No. 5. Norwalk, CT: FASB. 02 July 2015 Page 9 of 12 ProQuest _____. 1981a. Accounting for Franchise Fee Revenue. Statement of Financial Accounting Standards No. 45. Norwalk, CT: FASB. _____. 1981b. Revenue Recognition When Right of Return Exists. Statement of Financial Accounting Standards No. 48. Norwalk, CT: FASB. _____. 1985a. Elements of Financial Statements. Statement of Financial Accounting Concepts No. 6. Norwalk, CT: FASB. _____. 1985b. Employers' Accounting for Pensions. Statement of Financial Accounting Standards No. 87. Norwalk, CT: FASB. _____. 2001. Accounting for Asset Retirement Obligations. Statement of Financial Accounting Standards No. 143. Norwalk, CT: FASB. _____. 2005. Accounting for Conditional Asset Retirement Obligations, an Interpretation of FASB Statement No. 143. Interpretation No. 47. Norwalk, CT: FASB. _____. 2006. Conceptual Framework for Financial Reporting: Objective of Financial Reporting and Qualitative Characteristics of Decision-Useful Financial Reporting Information. Preliminary Views. Norwalk, CT: FASB. _____. 2008a. Conceptual Framework for Financial Reporting: Objective of Financial Reporting and Qualitative Characteristics of Decision-Useful Information. Exposure Draft. Norwalk, CT: FASB. _____. 2008b. Board Meeting Handout. Conceptual Framework. Available at: http://www.fasb.org/jsp/FASB/ Document_C/DocumentPage&cid(1218220092264. _____. 2008c. Minutes of the October 20, 2008 Board Meeting. Available at: http://www.fasb.org/ board_meeting_minutes/10-20-08_cf.pdf. Garner, B. A., and H. C. Black. 2009. Black's Law Dictionary. St. Paul, MN: West. Ijiri, Y. 1980. Recognition of Contractual Rights and Obligations: An Exploratory Study of Conceptual Issues. Stamford, CT: FASB. International Accounting Standards Board (IASB). 2001. Framework for the Preparation and Presentation of Financial Statements. London, U.K.: IASB. _____. 2005. Amendments to IAS 37 Provisions, Contingent Liabilities and Contingent Assets and IAS 19 Employee Benefits. Exposure Draft. London, U.K.: IASB. _____. 2007. Employee Benefits. International Accounting Standard 19. London, U.K.: IASB. _____. 2008a. Project update for amendments to IAS 37, Provisions, Contingent Liabilities and Contingent Assets and IAS 19, Employee Benefits. Available at: http://www.iasb.org/NR/rdonlyres/B2EE99F3- C48E-40A18827-5137C92C0EF4/0/LiabIAS37projectJune08.pdf. _____. 2008b. Provisions, Contingent Liabilities and Contingent Assets. International Accounting Standard 37. London, U.K.: IASB. Johnson, L. T., B. P. Robbins, R. J. Swieringa, and R. L. Weil. 1993. Expected values in financial reporting. Accounting Horizons 7 (4): 77-90. Pension Benefit Guaranty Corporation. 2008. Hard-Frozen Defined Benefit Plans. Washington, D. C.: Pension Benefit Guaranty Corporation. PricewaterhouseCoopers (PwC). 2007. Measuring Assets and Liabilities: Investment Professionals' Views. New York, NY: PricewaterhouseCoopers. Storey, R. K., and S. Storey. 1998. The Framework of Financial Accounting Concepts and Standards. Norwalk, CT: FASB. AuthorAffiliation Dennis Murray is a Professor at the University of Colorado at Denver. I am grateful for the helpful comments of two anonymous reviewers. Submitted: February 2009 Accepted: June 2010 02 July 2015 Page 10 of 12 ProQuest Published Online: December 2010 Corresponding author: Dennis Murray Email: Dennis.Murray@ucdenver.edu Subject: Professional liability; Financial statements; Accounting standards; Errors & omissions; Boards of directors; Studies; Location: United States--US Classification: 2410: Social responsibility; 4120: Accounting policies & procedures; 2110: Board of directors; 9130: Experiment/theoretical treatment; 9190: United States Publication title: Accounting Horizons Volume: 24 Issue: 4 Pages: 623-633 Number of pages: 11 Publication year: 2010 Publication date: Dec 2010 Publisher: American Accounting Association Place of publication: Sarasota Country of publication: United States Publication subject: Business And Economics--Accounting ISSN: 08887993 Source type: Scholarly Journals Language of publication: English Document type: Feature Document feature: References ProQuest document ID: 822244056 Document URL: http://search.proquest.com/docview/822244056?accountid=35812 Copyright: Copyright American Accounting Association Dec 2010 Last updated: 2011-01-04 Database: ProQuest Central 02 July 2015 Page 11 of 12 ProQuest Bibliography Citation style: APA 6th - American Psychological Association, 6th Edition Murray, D. (2010). What are the essential features of a liability? Accounting Horizons, 24(4), 623-633. Retrieved from http://search.proquest.com/docview/822244056?accountid=35812 _______________________________________________________________ Contact ProQuest Copyright 2015 ProQuest LLC. All rights reserved. - Terms and Conditions 02 July 2015 Page 12 of 12 ProQuest