David and Leona are discussing four types of long-term liability: deferred tax, warranties, deferred consideration, and provisions
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David and Leona are discussing four types of long-term liability: deferred tax, warranties, deferred consideration, and provisions for restructuring. From their conversation, why is an investor interested in seeing these long-term liabilities in the balance sheet? What problems might an auditor face in giving an opinion on these long-term liabilities in the balance sheet?
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DAVID: Where do I start in explaining how I look at liabilities? Well, I always read the accounting policy notes before I look at any financial statements. This company provides three accounting policy notes relating to matters of liabilities. The policy on warranties is interesting because it confirms that the company does not record any expected liability on warranties. The first time I saw this in the annual report I was quite concerned about lack of prudence, but on my first visit to the company I was shown the warranty settlement file. There are very few claims under warranty because the company has lots of procedures which have to be followed by employees who carry out service work. Warranty claims are relatively unusual and unpredict- able for this company so there is no previous pattern to justify setting up a liability in the form of a provision for future claims. The deferred consideration arises because this company has acquired another business and wants to look into all aspects of the newly acquired investment before making full payment. Deferred tax provisions are common to many companies. They are an attempt to line up the accounting profit with the tax charge based on taxable profits, which are usually different. I don't understand the technical details but my test of importance is to look at the amount charged to the income statement (profit and loss account) for the year. It is less than 1% of the profit after tax, so I shan't be giving it much attention on this occasion. Provisions for restructuring are my real headache. These are a measure of the costs expected when the company plans a restructuring such as changing the manage- ment structure with redefinition of the role of some employees and redundancy for others. It sounds reasonable to give warning of what all this will cost but the stand- ard-setters have to be strict about the details because in the past the use of provisions has been linked to some creative accounting in the income statement (profit and loss account). Do you know anything about that?
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