Commitments are items that are not reported as liabilities as of the balance sheet date. Some of these items are reported in the notes to the financial statements. Examples include non-cancelable (as at balance sheet date) binding contracts to rent space in the future or to purchase items at specified prices. Commitments in financial statements
A financial commitment is a commitment to an expense at a future date. Commitments in financial statements
A capital commitment is the projected capital expenditure a company commits to spend on non-current assets over a period of time. Commitments in financial statements
Financial or capital commitment revolves around the designation of funds for a particular purpose including any future liability. Most commonly, this includes regular operating expenses such as property-related costs, equipment, and production materials. Regardless of the circumstances in which the term is used, it relates to funds being held or directed in a particular manner.
Capital commitments may also include future business ventures such as the beginning of an expansion project. Capital commitments are generally higher for companies in capital-intensive industries such as power generation.
Capital commitments are not contingencies, which represent conditions or situations that cannot be predicted with any degree of certainty by the company.
Risks with financial and capital commitments Commitments in financial statements
A company has to exercise care to structure its financial and capital commitments since an inordinately high amount puts undue strain on the company’s finances.
Proper planning requires the company to ensure operating cash flow is sufficient to meet financial and capital expenditures, and if it is not, to make arrangements to ensure it can raise the additional funds on the capital markets. If a company overcommits and experiences a sudden unexpected decline in capital, it may have to direct a higher portion of the profits toward these commitments than originally intended. If it doesn’t, it may be unable to meet all of its obligations in their entirety. Commitments in financial statements
Due to these risks, these forms of commitments are disclosed within the released financial statements, often listed as a footnote in regards to the balance sheet (‘Off balance sheet disclosures’).