The Conceptual Framework Defines Liabilities And

Question

The Conceptual Framework defines liabilities and outlines a number of criteria for their recognition. a-Forden and a-Holden Custom Cars Ltd identifies the following items: (a) Purchased tyres, glass a…

The Conceptual Framework defines liabilities and outlines a
number of criteria for their recognition. a-Forden and a-Holden
Custom Cars Ltd identifies the following items:

(a) Purchased tyres, glass and steel on account.

(b) Received $100 000 in deposits for custom cars to be built in
the next financial period.

(c) Employed two new staff members and agreed to pay them $75
000 per annum. They begin work next week.

(d) One of a-Forden and a-Holden Custom Cars Ltd’s customers is
suing the company as he is not happy with the colour scheme the
company used to paint the custom car. The customer chose the colour
scheme at the time of signing the contract and has now changed his
mind. The lawsuit is for $15 000. a-Forden and a-Holden Custom Cars
believe they might lose the case.

(e) When constructing a car in the factory, one of a-Forden and
a-Holden Custom Cars Ltd’s employees dumped excess paint and other
waste products into the local river running behind the factory. The
company has been ordered by the court to pay damages; however, the
exact amount is yet to be determined.

Required:

For each of the items listed above, explain whether you would
recognise it as a liability in the statement of financial position.
Refer to the definition and recognition criteria outlined in the
Conceptual Framework to support your answer.

Solutions

Expert Solution

(a) Yes, Liability would be recognized as the tyres, glass and
steel are already purchased on account and therefore, Purchases
account being expense account is debited and Accounts Payable is
recorded as the liability and thus, credited.

(b) Yes, liability would be recorded as revenues are received in
advance from customers against the future deliveries of custom
cars. Since the amount is received, therefore, it will be recorded
as per the concept of Unearned Revenue and shown in the balance
sheet as liability. Cash or Bank account will be debited as the
amount has been received and Unearned revenue or Advance from
customers will be credited being the liability account.

(c) No, liability would not be recorded. Salaries to staff is
generally recorded on accrual basis and as given that staff will
start working next week, therefore, no salaries are accrued to
them. Therefore, no entry will be recorded.

(d) Yes, liability would be recorded. Generally court cases are
recorded as contingent liability. However, in this case company
assumes that they might lose therefore, as per the principle of
contingent liabilities, any potential liability which may occur due
to happening of any future uncertain event. However, in this case,
event is certain as the company has assumed that they might lose.
Therefore, it will be recorded as liability.

(e) No, liability would not be recorded as future event is
uncertain and amount is also not known, therefore, liability would
not be recorded until determination of amount.

I hope above answer will help you in your task.


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