For IFRS financial reporting purposes financial liabilities exclude trade and other payables and provisions.
Financial liability: any liability that is:
- a contractual obligation:
- to deliver cash or another financial asset to another entity; or
- to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity; or
- a contract that will or may be settled in the entity’s own equity instruments and is
- a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity’s own equity instruments; or
- a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments. For this purpose the entity’s own equity instruments do not include: instruments that are themselves contracts for the future receipt or delivery of the entity’s own equity instruments; puttable instruments classified as equity or certain liabilities arising on liquidation classified by IAS 32 as equity instruments.
Examples of financial liability are trade payables, loans from other companies and debt instruments issued by the entity.
In order for a liability to be recognised in the financial statements, it must meet the following definition provided by the framework (Definition of a liability 4.26 – 4.27):
- A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.
As is clear from the above definition, the obligation must be a present one, arising from past events. In case of a bank loan for instance, the past event would be the receipt of loan principal. The obligation to pay off the loan would be present from the day the entity receives the loan principal (i.e. when an obligating event occurs). Conversely, a liability may not be recognised in anticipation of a future obligation such a bank loan expected to be taken in two year’s time.
The obligation to transfer economic benefits may not only be a legal one. Liability in respect of a constructive obligation may also be recognised where an entity, on the basis of its past practices, has a created a valid expectation in the minds of the concerned persons that it will fulfil such obligations in the future. For example, if an oil exploration company has a past practice of restoring oil rig sites after they are dismantled in spite of no legal obligation to do so, and it advertises itself as an environment friendly organisation, then this gives rise to a constructive liability and must therefore be recognised in the financial statements of the company. This is because a valid expectation has been created that the company will restore oil rig sites in the future.
Derecognition of financial liabilities
An entity shall remove a financial liability (or a part of a financial liability) from its statement of financial position when, and only when, it is extinguished—i.e. when the obligation specified in the contract is discharged or cancelled or expires.
An exchange between an existing borrower and lender of debt instruments with substantially different terms shall be accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability.
Similarly, a substantial modification of the terms of an existing financial liability or a part of it (whether or not attributable to the financial difficulty of the debtor) shall be accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability.
The difference between the carrying amount of a financial liability (or part of a financial liability) extinguished or transferred to another party and the consideration paid, including any non-cash assets transferred or liabilities assumed, shall be recognised in profit or loss.
Reclassification of financial liabilities
An entity shall not reclassify any financial liability.
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