Financial Accounting: In an Economic Context

CHAPTER 10

Introduction to Liabilities: Economic Consequences, Current Liabilities, and Contingencies

KEY POINTS

The following key points are emphasized in this chapter:

• Definition of a liability.
• Economic consequences associated with reporting liabilities on the financial statements.
• Determinable and contingent liabilities.
• Current liabilities.
• Bonus systems and profit-sharing arrangements and the reporting incentives they create.
• Methods used to account for contingencies.

Waste companies have great latitude in setting reserves (liabilities) for future environmental costs at their dumps. The process involves estimating how high the costs will be thirty years or more in the future and calculating how big a fund is needed in today's dollars to satisfy the future obligation. For example, Waste Management Inc., previously accused of using aggressive accounting methods, once recorded a $173.3 million cost that lowered its third-quarter profit by 63 percent. The cost included $45 million to boost cleanup reserves for some dumps, $26 million to increase reserves for litigation, and $72.3 million to boost reserves for future claims. Does anybody really know how large the liability should be? This example illustrates the difficulties involved in measuring liabilities, the topic of Chapters 10 and 11.

Liabilities, defined as obligations of a company to disburse assets or provide services in the future, are divided on the balance sheet into two categories: current liabilities and long-term ...