Slide AKT 405 Teori Akuntansi 8 Godfrey
GODFREY
HODGSON
HOLMES
TARCA
CHAPTER 8
LIABILITIES AND OWNERS’
EQUITY
Proprietary and entity
theory
• Proprietary theory is based on the
idea that the owner is the centre of
attention
– accounting is done with the owners’
interests in mind
• Entity theory focuses on the firm as
the centre of attention
2
Proprietary theory
• Proprietorship = net worth of owners =
capital
• P=A–L
• The objective of accounting is to
determine the net worth of the owners
• Profit is the increase in net worth
– includes operating profit
– includes changes in the values of assets
3
Proprietary theory
• Present accounting is largely based on
this theory
– dividends
– salaries
– equity accounting
– consolidation accounting
• Has a financial view of capital
– emphasis on the financial investment of
the owners and changes in owners’ wealth
4
Proprietary theory
• With the advent of the company the
theory has proved 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
5
Entity theory
• Inadequacies in proprietary theory
led to the entity theory
• Formulated to address separate legal
status of company
6
Entity theory
• The company is viewed as 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
7
Entity theory
• 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
8
Entity theory
• Focuses on the assets
• Assets are resources controlled by
the entity
• Liabilities are obligations of the entity
• Profit increases net assets and
accrues to the entity
• The owners only have a residual
claim on the net assets of the entity
9
Entity theory
• Both proprietary and entity theories
are still influential in practice
– entity theory
• conventional accounting theory based on it
• financial reports reflect it
– proprietary theory
• interest charges are an expense
• dividends are a distribution of profit
10
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
11
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
12
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
13
Liability recognition
Recognition criteria:
• Reliance on the law
– legal enforceability
• Determination of the economic
substance of the event
– ‘real’ obligation
14
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
15
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
16
IASB Framework
• What does probable mean?
• What is meant by reliable
measurement?
17
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
• Fair value measurement is more commonly being
used
– leases
– financial instruments
– share based payments
– business combinations
18
Employee benefits –
pension (superannuation)
plans
• Unfunded commitments
– equitable obligations
19
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
criteria
– notes
20
What impact will the credit crisis
have on the provision for bad debts
and the financial position of an
entity?
21
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
22
Owners’ equity
Essential features
• Rights of the parties
• Economic substance of the
arrangement
23
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
24
Classifications within
owners’
equity
• The distinction between contributed
and earned capital is useful
– retained earnings
– not all transactions fit nicely into
categories
• share dividends
25
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)
26
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
27
Summary
• There two competing theories that help explain
accounting practice - proprietary and entity
theories
• There are definitions for both liabilities and
equity
• There are recognition criteria for both liabilities
and equity
• There are various measurement practices used
in relation to liabilities and equity
• There are challenging issues for standard setters
and auditors
28
Key terms and concepts
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Liabilities
Owners’ equity
Proprietary theory
Entity theory
Definitions
Recognition criteria – probable, reliable
Present obligation
Past transaction
Measurement and fair value
Provisions and contingencies
Rights of the parties
Economic substance
Concept of capital
Debt versus equity, extinguishing debt and employee shares
Issues for auditors
29
30
HODGSON
HOLMES
TARCA
CHAPTER 8
LIABILITIES AND OWNERS’
EQUITY
Proprietary and entity
theory
• Proprietary theory is based on the
idea that the owner is the centre of
attention
– accounting is done with the owners’
interests in mind
• Entity theory focuses on the firm as
the centre of attention
2
Proprietary theory
• Proprietorship = net worth of owners =
capital
• P=A–L
• The objective of accounting is to
determine the net worth of the owners
• Profit is the increase in net worth
– includes operating profit
– includes changes in the values of assets
3
Proprietary theory
• Present accounting is largely based on
this theory
– dividends
– salaries
– equity accounting
– consolidation accounting
• Has a financial view of capital
– emphasis on the financial investment of
the owners and changes in owners’ wealth
4
Proprietary theory
• With the advent of the company the
theory has proved 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
5
Entity theory
• Inadequacies in proprietary theory
led to the entity theory
• Formulated to address separate legal
status of company
6
Entity theory
• The company is viewed as 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
7
Entity theory
• 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
8
Entity theory
• Focuses on the assets
• Assets are resources controlled by
the entity
• Liabilities are obligations of the entity
• Profit increases net assets and
accrues to the entity
• The owners only have a residual
claim on the net assets of the entity
9
Entity theory
• Both proprietary and entity theories
are still influential in practice
– entity theory
• conventional accounting theory based on it
• financial reports reflect it
– proprietary theory
• interest charges are an expense
• dividends are a distribution of profit
10
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
11
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
12
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
13
Liability recognition
Recognition criteria:
• Reliance on the law
– legal enforceability
• Determination of the economic
substance of the event
– ‘real’ obligation
14
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
15
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
16
IASB Framework
• What does probable mean?
• What is meant by reliable
measurement?
17
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
• Fair value measurement is more commonly being
used
– leases
– financial instruments
– share based payments
– business combinations
18
Employee benefits –
pension (superannuation)
plans
• Unfunded commitments
– equitable obligations
19
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
criteria
– notes
20
What impact will the credit crisis
have on the provision for bad debts
and the financial position of an
entity?
21
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
22
Owners’ equity
Essential features
• Rights of the parties
• Economic substance of the
arrangement
23
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
24
Classifications within
owners’
equity
• The distinction between contributed
and earned capital is useful
– retained earnings
– not all transactions fit nicely into
categories
• share dividends
25
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)
26
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
27
Summary
• There two competing theories that help explain
accounting practice - proprietary and entity
theories
• There are definitions for both liabilities and
equity
• There are recognition criteria for both liabilities
and equity
• There are various measurement practices used
in relation to liabilities and equity
• There are challenging issues for standard setters
and auditors
28
Key terms and concepts
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Liabilities
Owners’ equity
Proprietary theory
Entity theory
Definitions
Recognition criteria – probable, reliable
Present obligation
Past transaction
Measurement and fair value
Provisions and contingencies
Rights of the parties
Economic substance
Concept of capital
Debt versus equity, extinguishing debt and employee shares
Issues for auditors
29
30