Question

TOPIC 3 DQ: Defining Liabilities for Financial Reporting Purposes

As the background paper Financial Statement Concepts and Financial Reporting explains, businesses should record as liabilities items representing “probable future sacrifices of economic benefits arising from present obligations . . . to transfer assets or provide services . . . as a result of past transactions or events.” This definition of liabilities for accounting purposes is not identical to the legal definition of a liability.

Objective of Financial Reporting:
The U.S. Congress passed the Securities Act of 1933 (the 1933 Act) and the 1934 Act in response to the market abuses that contributed to the stock market “crash” of 1929. Recall that the 1929 “crash” was a material contributing factor in the Great Depression of the early 1930s. One of Congress’ objectives in adopting these statutes was to improve the quality and transparency of financial reporting as a means to protect the integrity and enhance the efficiency of the securities markets. The securities markets include principally the national securities exchanges. Consistent with this legislative objective, the FASB determined that the objective of general-purpose financial statements is to provide financial information about a business that is useful for making capital allocation decisions by Equity investors and Creditors, such as — Banks — Insurance and finance companies, and — Investors in bonds and other debt securities. In addition to current and potential investors and creditors (collectively, the capital markets), financial statement user groups include (among others) — Managers of public companies (financial statement issuers) — Employees and unions — Customers and suppliers — Government agencies with oversight responsibility (such as the SEC, FCC, FRB, and Environmental and social interest groups.

a.       Taking into consideration the objective of financial reporting (as set forth in the background paper), should a business’ balance sheet report as liabilities all obligations representing legal (statutory or contractual) obligations?

b.      Should a business’ balance sheet report as liabilities moral or social obligations not constituting legal obligations (assume these are subject to reasonable measurement)?

Answer 1