Is3350 Unit 1 Assignment
EXAMPLE 1
A company began trading on 1 January 2009, preparing its financial statements to 31
December each year.
As at 31 December 2011, the company adopted a new accounting policy with regard to the measurement of inventories. If the new policy had been applied in previous years, the company's inventory at 31 December 2009 would have been £150,000 higher than the amount originally calculated. Similarly, the inventory at 31 December 2010 would have been £400,000 higher than the amount originally calculated.
An extract from the draft statement of comprehensive income for the year to 31 December
2011 (before accounting retrospectively for the change in accounting policy) is as follows:
2011 2010
£000 £000
Profit before taxation …show more content…
2,600 1,900
Taxation 780 570
––––– –––––
Profit after taxation 1,820 1,330
––––– –––––
Retained earnings were originally reported to be £840,000 on 31 December 2009. No dividends were paid in 2009, 2010 or 2011. It may be assumed that the company's taxation expense is always equal to 30% of its profit before tax.
(a) Prepare an extract from the company's statement of comprehensive income for the year to 31 December 2011, showing restated comparative figures for 2010.
(b) Calculate the company's retained earnings at 31 December 2011 and the restated retained earnings at 31 December 2009 and 2010.
Solution
(a) If the new accounting policy had always been applied, opening inventory for the year to 31 December 2011 would have been £400,000 higher. This would have caused an increase of £400,000 in cost of sales for the year and a decrease of £400,000 in pretax profits. Similarly, pre-tax profits for the year to 31 December 2010 would have been increased by £400,000 but reduced by £150,000, giving an overall increase of
£250,000. Therefore the extract from the company's statement of comprehensive income for the year to 31 December 2011 is as follows:
(restated)
2011 2010
£000 £000
Profit before taxation 2,200 2,150
Taxation 660 645
––––– –––––
Profit after taxation 1,540 1,505
––––– –––––
Note that these figures show an increase in profit of approximately 2%, whereas the original figures (which were distorted by the change in accounting policy) suggested incorrectly that profit had risen by nearly 37%.
(b) In the year to 31 December 2009, the effect of increasing closing inventory by
£150,000 is to increase pre-tax profit for the year by £150,000. The tax liability increases by £45,000 (30% of £150,000) and so retained earnings at the end of the year increase by £105,000. Retained earnings figures are as follows:
£000
Balance at 31 December 2009, as previously reported 840
Change in accounting policy relating to inventories 105
–––––
Restated balance at 31 December 2009 945
Restated profit for the year to 31 December 2010 1,505
–––––
Restated balance at 31 December 2010 2,450
Profit for the year to 31 December 2011 1,540
–––––
Balance at 31 December 2011 3,990
–––––
If the change in accounting policy had not been accounted for retrospectively, the retained earnings figure at 31 December 2011 would still have been £3,990,000
(£840,000 + £1,330,000 + £1,820,000). However, the distribution of earnings over the three years concerned would have been different and misleading.
EXAMPLE 2
Whilst preparing its financial statements for the year to 31 December 2011, a company discovers that (because of an arithmetic error) its inventory at 31 December 2010 was overstated by £50,000. This is a material amount.
An extract from the company's draft statement of comprehensive income for the year to 31
December 2011 (before correcting the error) shows the following:
2011 2010
£000 £000
Sales 940 790
Cost of goods sold 750 540
–––– ––––
Gross profit 190 250
Other expenses 120 110
–––– ––––
Profit before taxation 70 140
Taxation 14 28
–––– ––––
Profit after taxation 56 112
–––– ––––
Retained earnings were reported to be £270,000 on 31 December 2009. No dividends were paid in either 2010 or 2011. It may be assumed that the company's taxation expense is always equal to 20% of its profit before tax.
(a) Prepare an extract from the company's statement of comprehensive income for the year to 31 December 2011, showing restated comparative figures for 2010.
(b) Calculate the company's retained earnings at 31 December 2011 and the restated retained earnings at 31 December 2010.
Solution
(a) The extract from the statement of comprehensive income for the year to 31 December
2011 is as follows:
(restated)
2011 2010
£000 £000
Sales 940 790
Cost of goods sold 700 590
–––– ––––
Gross profit 240 200
Other expenses 120 110
–––– ––––
Profit before taxation 120 90
Taxation 24 18
–––– ––––
Profit after taxation 96 72
–––– ––––
(b) Retained earnings are as follows:
£000
Balance at 31 December 2009 270
Restated profit for the year to 31 December 2010 72
––––
Restated balance at 31 December 2010 342
Profit for the year to 31 December 2011 96
––––
Balance at 31 December 2011 438
––––
Note:
Retrospective adjustment of the prior period error reveals that profits after tax have risen in
2011. If the comparatives for 2010 had not been restated, the financial statements would have given the incorrect impression that profits after tax had fallen during 2011.
Exercises
4.1 (a) Distinguish between accounting policies and accounting estimates.
(b) Explain how a change in an accounting policy should be accounted for.
(c) Explain how a change in an accounting estimate should be accounted for.
4.2 (a) Explain how an entity should select its accounting policy in relation to an item if there is no applicable international standard or interpretation.
(b) In what circumstances may an entity change one of its accounting policies?
4.3 List the disclosures which must be made if an accounting policy is changed.
4.4 (a) Explain what is meant by a "material prior period error" and explain how such an error should be corrected.
(b) List the disclosures which must be made when a material prior period error is corrected.4.5 Harris plc began trading on 1 January 2008, preparing financial statements to 31
December each year. During 2011, the company decided to change its accounting policy with regard to the depreciation of property, plant and equipment. Depreciation charges calculated using the previous accounting policy and shown in the company's financial statements for the first three years of trading were as follows:
£000
year to 31 December 2008 230 year to 31 December 2009 270 year to 31 December 2010 290
If the new accounting policy had been applied in previous years, depreciation charges would have been:
£000
year to 31 December 2008 390 year to 31 December 2009 310 year to 31 December 2010 230
An extract from the company's statement of comprehensive income for the year to 31
December 2011 (before adjusting comparative figures to reflect the change in accounting policy) shows the following:
2011 2010
£000 £000
Profit before depreciation 2,510 2,450
Depreciation of property, plant and equipment 190 290
––––– –––––
Profit before taxation 2,320 2,160
Taxation 696 648
––––– –––––
Profit after taxation 1,624 1,512
––––– –––––
Retained earnings were reported as £2,943,000 on 31 December 2009. No dividends have been paid in any year. It may be assumed that the company's tax expense is always equal to 30% of the profit before taxation.
Required:
(a) Rewrite the extract from the statement of comprehensive income so as to reflect the change in accounting policy, in accordance with the requirements of IAS8.
(b) Compute the company's retained earnings at 31 December 2011 and the restated retained earnings at 31 December 2009 and 2010.
4.6 Whilst preparing its financial statements for the year to 30 June 2012, Ibex plc discovers that (owing to an accounting error) the sales figure for the year to 30 June 2011 had been understated by £100,000. Liabilities had been overstated by the same amount. This error is regarded as material.
An extract from the company's draft statement of comprehensive income for the year to
30 June 2012, before correcting this error, is as follows:
2012 2011
£000 £000
Sales 1,660 1,740
Cost of goods sold 670 730
––––– –––––
Gross profit 990 1,010
Expenses 590 560
––––– –––––
Profit before taxation 400 450
Taxation 80 90
––––– –––––
Profit after taxation 320 360
––––– –––––
Retained earnings at 30 June 2010 were £860,000. No dividends were paid during the two years to 30 June 2012. It may be assumed that the company's tax expense is always equal to 20% of the profit before taxation.
Required:
(a) Revise the extract from the statement of comprehensive income for the year to 30
June 2012, showing restated comparative figures for the year to 30 June 2011.
(b) Compute the company's retained earnings at 30 June 2012 and the restated retained earnings at 30 June 2011.
Chapter 4
4.1
(a) Accounting policies are "the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements". For example, an entity can choose between the cost model and the revaluation model for measuring property, plant and equipment. The entity's choice is one of its accounting policies.
Accounting estimates are judgements applied when measuring items that cannot be measured with precision (e.g. the estimated useful life of a non-current asset).
(b) A change in accounting policy should be accounted for retrospectively. Comparative figures for the previous period(s) must be adjusted and presented as if the new accounting policy had always been applied. This approach maintains comparability between accounting periods.
(c) A change in an accounting estimate should be accounted for prospectively. The effect of the change should be dealt with in the financial statements for the period of the change and future periods, but comparative figures for prior periods are not restated.
4.2
(a) If there is no applicable international standard or interpretation, management should use its judgement in selecting an accounting policy that results in information which is relevant and reliable. Reference should be made to any standards which deal with similar issues and to the
IASB Conceptual Framework.
(b) An accounting policy may be changed if this is required by an international standard or if the change improves the reliability and relevance of the financial statements.
4.3
If a change in accounting policy is caused by the initial application of an international standard or interpretation, the entity should disclose the title of that standard or interpretation. If a change in accounting policy is voluntary, the entity should disclose its reasons for making the change. In all cases, the entity should disclose the nature of the change and the amount of the adjustment made to each affected item in the financial statements.
4.4
(a) A material prior period error is a material omission or mis-statement occurring in an entity's financial statements for a prior period. Material prior period errors should be corrected retrospectively. This generally involves restating the comparative figures for the prior period in which the error occurred.
(b) The entity should disclose the nature of the prior period error. For each prior period presented, the entity should disclose the amount of the correction to each affected line item in the financial statements. The amount of the correction at the beginning of the earliest prior period presented should also be disclosed.
4.5
(a) 2011 2010
£000 £000
Profit before depreciation 2,510
2,450
Depreciation of property, plant and equipment 190 230
––––– –––––
Profit before taxation 2,320 2,220
Taxation 696 666
––––– –––––
Profit after taxation 1,624 1,554
––––– –––––
(b) £000
Balance at 31 December 2009, as previously reported 2,943
Change in accounting policy relating to depreciation (see below) (140)
–––––
Restated balance at 31 December 2009 2,803
Restated profit for the year to 31 December 2010 1,554
–––––
Restated balance at 31 December 2010 4,357
Profit for the year to 31 December 2011 1,624
–––––
Balance at 31 December 2011 5,981
–––––
Note:
The change in accounting policy results in additional depreciation of £160,000 in 2008 and
£40,000 in 2009. The total is £200,000. Tax saved at 30% is £60,000. Therefore profit after tax for the two years falls by £140,000.
4.6
(a) 2012 2010
£000 £000
Sales 1,660 1,840
Cost of goods sold 670 730
––––– –––––
Gross profit 990 1,110
Expenses 590 560
––––– –––––
Profit before taxation 400 550
Taxation 80 110
––––– –––––
Profit after taxation 320 440
––––– –––––
(b) £000
Balance at 30 June 2010 860
Restated profit for the year to 30 June 2011 440
–––––
Restated balance at 30 June 2011 1,300
Profit for the year to 30 June 2012 320
–––––
Balance at 30 June 2012 1,620
–––––
A company began trading on 1 January 2009, preparing its financial statements to 31
December each year.
As at 31 December 2011, the company adopted a new accounting policy with regard to the measurement of inventories. If the new policy had been applied in previous years, the company's inventory at 31 December 2009 would have been £150,000 higher than the amount originally calculated. Similarly, the inventory at 31 December 2010 would have been £400,000 higher than the amount originally calculated.
An extract from the draft statement of comprehensive income for the year to 31 December
2011 (before accounting retrospectively for the change in accounting policy) is as follows:
2011 2010
£000 £000
Profit before taxation …show more content…
2,600 1,900
Taxation 780 570
––––– –––––
Profit after taxation 1,820 1,330
––––– –––––
Retained earnings were originally reported to be £840,000 on 31 December 2009. No dividends were paid in 2009, 2010 or 2011. It may be assumed that the company's taxation expense is always equal to 30% of its profit before tax.
(a) Prepare an extract from the company's statement of comprehensive income for the year to 31 December 2011, showing restated comparative figures for 2010.
(b) Calculate the company's retained earnings at 31 December 2011 and the restated retained earnings at 31 December 2009 and 2010.
Solution
(a) If the new accounting policy had always been applied, opening inventory for the year to 31 December 2011 would have been £400,000 higher. This would have caused an increase of £400,000 in cost of sales for the year and a decrease of £400,000 in pretax profits. Similarly, pre-tax profits for the year to 31 December 2010 would have been increased by £400,000 but reduced by £150,000, giving an overall increase of
£250,000. Therefore the extract from the company's statement of comprehensive income for the year to 31 December 2011 is as follows:
(restated)
2011 2010
£000 £000
Profit before taxation 2,200 2,150
Taxation 660 645
––––– –––––
Profit after taxation 1,540 1,505
––––– –––––
Note that these figures show an increase in profit of approximately 2%, whereas the original figures (which were distorted by the change in accounting policy) suggested incorrectly that profit had risen by nearly 37%.
(b) In the year to 31 December 2009, the effect of increasing closing inventory by
£150,000 is to increase pre-tax profit for the year by £150,000. The tax liability increases by £45,000 (30% of £150,000) and so retained earnings at the end of the year increase by £105,000. Retained earnings figures are as follows:
£000
Balance at 31 December 2009, as previously reported 840
Change in accounting policy relating to inventories 105
–––––
Restated balance at 31 December 2009 945
Restated profit for the year to 31 December 2010 1,505
–––––
Restated balance at 31 December 2010 2,450
Profit for the year to 31 December 2011 1,540
–––––
Balance at 31 December 2011 3,990
–––––
If the change in accounting policy had not been accounted for retrospectively, the retained earnings figure at 31 December 2011 would still have been £3,990,000
(£840,000 + £1,330,000 + £1,820,000). However, the distribution of earnings over the three years concerned would have been different and misleading.
EXAMPLE 2
Whilst preparing its financial statements for the year to 31 December 2011, a company discovers that (because of an arithmetic error) its inventory at 31 December 2010 was overstated by £50,000. This is a material amount.
An extract from the company's draft statement of comprehensive income for the year to 31
December 2011 (before correcting the error) shows the following:
2011 2010
£000 £000
Sales 940 790
Cost of goods sold 750 540
–––– ––––
Gross profit 190 250
Other expenses 120 110
–––– ––––
Profit before taxation 70 140
Taxation 14 28
–––– ––––
Profit after taxation 56 112
–––– ––––
Retained earnings were reported to be £270,000 on 31 December 2009. No dividends were paid in either 2010 or 2011. It may be assumed that the company's taxation expense is always equal to 20% of its profit before tax.
(a) Prepare an extract from the company's statement of comprehensive income for the year to 31 December 2011, showing restated comparative figures for 2010.
(b) Calculate the company's retained earnings at 31 December 2011 and the restated retained earnings at 31 December 2010.
Solution
(a) The extract from the statement of comprehensive income for the year to 31 December
2011 is as follows:
(restated)
2011 2010
£000 £000
Sales 940 790
Cost of goods sold 700 590
–––– ––––
Gross profit 240 200
Other expenses 120 110
–––– ––––
Profit before taxation 120 90
Taxation 24 18
–––– ––––
Profit after taxation 96 72
–––– ––––
(b) Retained earnings are as follows:
£000
Balance at 31 December 2009 270
Restated profit for the year to 31 December 2010 72
––––
Restated balance at 31 December 2010 342
Profit for the year to 31 December 2011 96
––––
Balance at 31 December 2011 438
––––
Note:
Retrospective adjustment of the prior period error reveals that profits after tax have risen in
2011. If the comparatives for 2010 had not been restated, the financial statements would have given the incorrect impression that profits after tax had fallen during 2011.
Exercises
4.1 (a) Distinguish between accounting policies and accounting estimates.
(b) Explain how a change in an accounting policy should be accounted for.
(c) Explain how a change in an accounting estimate should be accounted for.
4.2 (a) Explain how an entity should select its accounting policy in relation to an item if there is no applicable international standard or interpretation.
(b) In what circumstances may an entity change one of its accounting policies?
4.3 List the disclosures which must be made if an accounting policy is changed.
4.4 (a) Explain what is meant by a "material prior period error" and explain how such an error should be corrected.
(b) List the disclosures which must be made when a material prior period error is corrected.4.5 Harris plc began trading on 1 January 2008, preparing financial statements to 31
December each year. During 2011, the company decided to change its accounting policy with regard to the depreciation of property, plant and equipment. Depreciation charges calculated using the previous accounting policy and shown in the company's financial statements for the first three years of trading were as follows:
£000
year to 31 December 2008 230 year to 31 December 2009 270 year to 31 December 2010 290
If the new accounting policy had been applied in previous years, depreciation charges would have been:
£000
year to 31 December 2008 390 year to 31 December 2009 310 year to 31 December 2010 230
An extract from the company's statement of comprehensive income for the year to 31
December 2011 (before adjusting comparative figures to reflect the change in accounting policy) shows the following:
2011 2010
£000 £000
Profit before depreciation 2,510 2,450
Depreciation of property, plant and equipment 190 290
––––– –––––
Profit before taxation 2,320 2,160
Taxation 696 648
––––– –––––
Profit after taxation 1,624 1,512
––––– –––––
Retained earnings were reported as £2,943,000 on 31 December 2009. No dividends have been paid in any year. It may be assumed that the company's tax expense is always equal to 30% of the profit before taxation.
Required:
(a) Rewrite the extract from the statement of comprehensive income so as to reflect the change in accounting policy, in accordance with the requirements of IAS8.
(b) Compute the company's retained earnings at 31 December 2011 and the restated retained earnings at 31 December 2009 and 2010.
4.6 Whilst preparing its financial statements for the year to 30 June 2012, Ibex plc discovers that (owing to an accounting error) the sales figure for the year to 30 June 2011 had been understated by £100,000. Liabilities had been overstated by the same amount. This error is regarded as material.
An extract from the company's draft statement of comprehensive income for the year to
30 June 2012, before correcting this error, is as follows:
2012 2011
£000 £000
Sales 1,660 1,740
Cost of goods sold 670 730
––––– –––––
Gross profit 990 1,010
Expenses 590 560
––––– –––––
Profit before taxation 400 450
Taxation 80 90
––––– –––––
Profit after taxation 320 360
––––– –––––
Retained earnings at 30 June 2010 were £860,000. No dividends were paid during the two years to 30 June 2012. It may be assumed that the company's tax expense is always equal to 20% of the profit before taxation.
Required:
(a) Revise the extract from the statement of comprehensive income for the year to 30
June 2012, showing restated comparative figures for the year to 30 June 2011.
(b) Compute the company's retained earnings at 30 June 2012 and the restated retained earnings at 30 June 2011.
Chapter 4
4.1
(a) Accounting policies are "the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements". For example, an entity can choose between the cost model and the revaluation model for measuring property, plant and equipment. The entity's choice is one of its accounting policies.
Accounting estimates are judgements applied when measuring items that cannot be measured with precision (e.g. the estimated useful life of a non-current asset).
(b) A change in accounting policy should be accounted for retrospectively. Comparative figures for the previous period(s) must be adjusted and presented as if the new accounting policy had always been applied. This approach maintains comparability between accounting periods.
(c) A change in an accounting estimate should be accounted for prospectively. The effect of the change should be dealt with in the financial statements for the period of the change and future periods, but comparative figures for prior periods are not restated.
4.2
(a) If there is no applicable international standard or interpretation, management should use its judgement in selecting an accounting policy that results in information which is relevant and reliable. Reference should be made to any standards which deal with similar issues and to the
IASB Conceptual Framework.
(b) An accounting policy may be changed if this is required by an international standard or if the change improves the reliability and relevance of the financial statements.
4.3
If a change in accounting policy is caused by the initial application of an international standard or interpretation, the entity should disclose the title of that standard or interpretation. If a change in accounting policy is voluntary, the entity should disclose its reasons for making the change. In all cases, the entity should disclose the nature of the change and the amount of the adjustment made to each affected item in the financial statements.
4.4
(a) A material prior period error is a material omission or mis-statement occurring in an entity's financial statements for a prior period. Material prior period errors should be corrected retrospectively. This generally involves restating the comparative figures for the prior period in which the error occurred.
(b) The entity should disclose the nature of the prior period error. For each prior period presented, the entity should disclose the amount of the correction to each affected line item in the financial statements. The amount of the correction at the beginning of the earliest prior period presented should also be disclosed.
4.5
(a) 2011 2010
£000 £000
Profit before depreciation 2,510
2,450
Depreciation of property, plant and equipment 190 230
––––– –––––
Profit before taxation 2,320 2,220
Taxation 696 666
––––– –––––
Profit after taxation 1,624 1,554
––––– –––––
(b) £000
Balance at 31 December 2009, as previously reported 2,943
Change in accounting policy relating to depreciation (see below) (140)
–––––
Restated balance at 31 December 2009 2,803
Restated profit for the year to 31 December 2010 1,554
–––––
Restated balance at 31 December 2010 4,357
Profit for the year to 31 December 2011 1,624
–––––
Balance at 31 December 2011 5,981
–––––
Note:
The change in accounting policy results in additional depreciation of £160,000 in 2008 and
£40,000 in 2009. The total is £200,000. Tax saved at 30% is £60,000. Therefore profit after tax for the two years falls by £140,000.
4.6
(a) 2012 2010
£000 £000
Sales 1,660 1,840
Cost of goods sold 670 730
––––– –––––
Gross profit 990 1,110
Expenses 590 560
––––– –––––
Profit before taxation 400 550
Taxation 80 110
––––– –––––
Profit after taxation 320 440
––––– –––––
(b) £000
Balance at 30 June 2010 860
Restated profit for the year to 30 June 2011 440
–––––
Restated balance at 30 June 2011 1,300
Profit for the year to 30 June 2012 320
–––––
Balance at 30 June 2012 1,620
–––––