Liability Measurement Approaches - Literature review Example

Name: Tutor: Subject: Date: ABSTRACT Liabilities are very important in calculating profits for any organization. They are often practiced under AASB/IFRS and have different approaches for measuring as found out by Barth, M. E. (2013). Approaches of measuring liabilities incurred are very essential in any organization since they enable the organization to establish accounting and financial reporting aspects. Measuring liabilities enables auditors in evaluation of financial statements of any institution (Matsushita, S., 2014). Auditors can ascertain clearly the reported profits from the liabilities incurred. Measurement approaches are key components in understanding the IFRS/AASB frameworks according to Matsushita, S. (2014). This research will seek to understand the various liability measurement approaches using a selected annual report. Two IASB/AASB accounting standards will be discussed. The research will suggest various liability measurement approaches that can be used in different organizations in Australia. The comments on the liability measurement approach adopted in the annual report will be given. INTRODUCTION Liability measurement concept is very important in ascertaining the reported profits for any entity. This research paper will determine the approaches of measuring liabilities. The standards of IFRS/AASB will be used to provide the concept of liability measurement. IFRS/AASB accounting standards provide multiple diverse methods of measuring liabilities for organizations (Matsushita, S., 2014). However, the methods tend to change regularly with no consistency. However, various methods project the value of liabilities to be incurred in the future. There are different implications of accounting standards while measuring and recognizing liabilities for companies. Different theories have been used to explain liability measurement approaches such as the conservatism theory (Barth, M. E., 2013). However it is important to understand that measurement approaches do not apply to all liabilities, and that is why it is important to apply the theory of conservatism in liability measurement approaches as claimed by Matsushita, S. (2014). The meaning of the statement The statement by (Deegan, C., 2009) on liability measurement meant that there are different ways liability measurements are used in the IFRS/AASB accounting standards. The statement clearly shows there are different types of liabilities that are measured using different measurement approaches. The different measurement approaches use different scales. Scales used may be either interval, ratio, ordinal or even nominal. The different scales are useful in ensuring recognition and measurement of liabilities for effective financial reporting (Ryan, R. J., 2015). According to the statement, the different ways of defining liability has a direct implication to the reported profits. The IFRS/AASB provides different definitions of liabilities that are very useful in financial reporting. For instance in the AASB framework a liability is defined as a current obligation of an organization from past events which has to be settled as also posited by Barth, M. E. (2013). The settlement leads to an outflow from the organization’s resources, therefore, implying benefits in terms of economic growth. From this definition, it is clear that an outflow of resources is probable. The second implication of this definition is that the measurement of liability is often reliable. However, the term “probable” outflow has a negative implication since it constrains the application of the definition in reported profits. This implies that it is possible for liability to have a present observable market price, therefore, making it be measurable yet the liability may have a possibility of not outflowing from an entity. Alternative liability measurement approaches used in the Annual Report Different measurement approaches are used to measure liability. The approach of indirect proxy measurement of liabilities provides a historical cost of the liabilities to be measured. This simply means the historically known value of the liability of the resources received is used in evaluating the cost of the liabilities (Horton et al. 2011). For example, from the annual report where fair values are assumed for liabilities depending on their historical costs. For instance in the year 2015 historical value. The other approach used is the discounting approach. The estimates of future liability flows are discounted as depicted in the annual report. From the annual report shares allotted are discounted up to 5%. The shares represent a liability to the AGL Company. Financial statement, other financial liabilities are estimated at a cost of $27M depending on their value in the preceding year. Two accounting standards of IASB/AASB There are various accounting standards in IASB/AASB that suggest various liability measurement approaches to be used in financial reporting. According to Ryan, R. J. (2015) the first accounting standard as per AASB is that all entities are expected to prepare their financial reports after their fiscal years as stipulated in the Corporations Act 2001 of the Australian law. The financial reports should clearly outline the assets and liabilities incurred by the entity according to Barth, M. E. (2013). This standard stipulates that liability is capable of reliable measurement in the financial reporting. It requires a liability to be recognized if it can constantly be estimated (Ryan, R. J., 2015). Estimation of the value of liability incurred is very essential in preparing financial statements since it does not assume the reliability of the estimated liability values. This standard expects liabilities to be true provisions in the statement of financial position even though uncertainty may occur as explained by Duffie, D., & Singleton, K. J. (2012). This standard assumes that an organization has many possible outcomes and, therefore, can have a wide range of liability values that can be reliable in financial reporting as found out by Nobes, C. (2011). This measurement approach has been applied in the annual report of AGL Company. The company has prepared financial reports for the financial year ending 2015 in accordance to the Corporations Act 2001 and as expected in the accounting standards of AASB 1039 of the Concise Financial Reports. The Concise Financial Reports has estimation values of the liabilities incurred by the AGL Energy Company in the various statements of financial positions. The second standard of both AASB/IASB is the fair value cost. Fair value is often an observable measure of the liability incurred by an organization for active markets (Duffie & Singleton, 2012). Fair values are given to assets and liabilities incurred in statements of financial positions. However, variations of this standard have occurred since IASB has included the fair value in situations where active markets do not exist as posited by (Wagner et al., 2011). At these points, fair values cease to be observable while giving values of assets and liabilities in statements of financial positions. Therefore historical and settlement amounts are then used to estimate the liability of any organization. Fair value approaches in liability measurement stipulates that it is only from the existence of an active market whereby subjective expectations are transformed into observable measures (Nobes, C., 2011). In the annual report provided, fair value has been widely used in liability measurement. Changes in the fair value of financial instruments between financial periods have been considered in the equity of the company so as to adjust the reserves. The changes of fair values of financial instruments have been widely considered between the reporting periods and have been considered in the balance sheets of the company. For instance, the change in fair value financial instruments which have been reported in the company in the balance sheet for the fiscal period ending 30 June 2015 has showed a gain of $237 million before taxation of the liabilities and $166 million after taxation. For that period, the initial fair values for the liability is $405 million for the year ending 30 June 2015. Comment on the liability measurement approaches in the report The company has adopted relatively wide approaches in measuring their liability. This is regarded as an important application as expected in the standards of AASB/IASB in order to address the complexities of the statements of financial position.it has adopted multiple different methods of recognising and measuring the liabilities incurred by the company as depicted in the annual report. The various approaches used in liability measurement as per the annual report include; the fair value, the indirect proxy, the initial and re-measured amount approaches. The initial amount approach has been used to ascertain the time a liability was incurred by the company. The initial approach method has enabled the company to determine the liabilities it incurs while providing their services to their customers. The re-measured amount approach has been used to measure the liability as of the date of every year’s statement of financial position. Re-measured amount approach has been used to measure the liabilities that have uncertainties when it comes to timing and payments as depicted in the annual report of the company. The approaches used have helped the preparers of the annual report and auditors of the various financial statements of the annual report as claimed by Ryan, R. J. (2015). Auditors from the measures of liabilities have been able to evaluate the various transactions. The liability measurement approaches have provided integral components of a complete IASB/AASB conceptual frameworks (Ryan, R. J., 2015). The stakeholders and top executives of AGL Energy Limited Company have adopted the use of IFRS accounting guidelines to give financial reports that are consistent. The various liability measurement approaches used have ensured consistency while addressing the financial transactions of the company. The conceptual frameworks used for IASB/AASB in liability measurement have established three measurement attributes used in the approaches of the liability that is to be measured. First, historical cost attribute has been evident from the annual report of the AGL company. Amounts received which are consistent to the incurrence of liability have been considered in the annual report. Consider an example whereby the audits and reviews of Historical Financial Information has been used while estimating the liabilities of the company. For instance when the earnings of the company fell by 4.4% attributed by low average demand and low average customers historical averages have been used to estimate the liabilities of the company in that financial period. Secondly, fair value attribute has been depicted in the approaches used by the company to measure their liability. The company has paid to settle obligations from an orderly transaction perspective among market participants in a measurable date. The company has used the fair value in measuring their liability. Consider an example where the trade and other receivables of the AGL Company are acquired at a relatively fair value of $80 million in the period ending 30 June 2015. The total liabilities for the period are valued at a fair value of $534. The company pays their liabilities at the so as to relieve their current obligation. Finally, the attribute of settlement has been evident while measuring the liabilities of the company. In the cases where there have been no active markets, fair value has ceased to be observed and, therefore, the settlement amount has been used to ascertain the liability for that period as depicted in the annual report. For instance in the consolidated statement of cash flow for the period ending 30 June 2015, payments have been done to settle the derivative financial instruments costing $10million which flow from the financial activities of the company. Conclusion In conclusion, liability measurement is very essential in financial reporting as expected in the accounting standards of AASB/IFRS (Wagner et al., 2011). Different approaches have been used to measure the liability as seen in the annual report of the AGL Company. Two theories have been evident in the annual report of the company that is; the conservatism and measurement theories (Nobes, C., 2011). Different attributes pertaining to liability measurement have come up from the approaches used which are the historical cost, fair value and the settlement amount. However limitations have arose since the approaches used in the annual report are not applicable to all liabilities (Horton, J. et al 2011). Inconsistencies have been apparent in the approaches employed in the annual report. The approaches used in liability measurement have not lead to comprehensive recognition and measurement as stipulated in the IFRS/ AASB accounting standards (Milburn, J. A., 2012). REFERENCES Barth, M. E. (2013). Measurement in financial reporting: the need for concepts. Accounting Horizons, 28(2), 331-352. Duffie, D., & Singleton, K. J. (2012). Credit Risk: Pricing, Measurement, and Management: Pricing, Measurement, and Management. Princeton University Press. Horton, J., Macve, R., & Serafeim, G. (2011). ‘Deprival value’vs.‘fair value’measurement for contract liabilities: how to resolve the ‘revenue recognition’conundrum?. Accounting and business research, 41(5), 491-514. Kulikova, L. I., Samitova, A. R., & Aletkin, P. A. (2015). Investment Property Measurement at Fair Value in the Financial Statements. Mediterranean Journal of Social Sciences, 6(1S3), 401. Matsushita, S. (2014). 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