Summary: Accounting
200101 Accounting Information for Managers
Tutorial Solutions - Week 7
School of Business│
Spring 2012
STAFF
Unit Coordinator
Graeme Mitchell
Building ED.G.212, Parramatta campus
Please contact via e-mail (if required)
Email: g.mitchell@uws.edu.au
vUWS
Coordinator,
and External
Studies
Coordinator
Simon Lenthen
Building ED.G.11, Parramatta campus
Unit administration School of Business Undergraduate Student Services Team
Building EQ, Parramatta campus (Manu Cherian)
Phone: 9685 9473
Phone: 9685 9200
Teaching team lecturers
Email: s.lenthen@uws.edu.au
Email: business.courses@uws.edu.au
Graeme Mitchell and Stanley James (Parramatta), Brian Voysey (Bankstown) ,
Michelle Cull and Stanley James …show more content…
(Campbelltown), Chris Endicott (Penrith)
[Refer to the vUWS site for a detailed list of all tutors]
Edition: Spring 2012
© Copyright: University of Western Sydney, 2012. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without the prior written permission from the Dean of the School of Business. Copyright for acknowledged materials reproduced herein is retained by the copyright holder. All readings in this publication are copied under licence in accordance with Part VB of the Copyright Act 1968 .
200101
ACCOUNTING
INFORMATION
FOR
MANAGERS
SPRING
2012
|
Teaching activities
Schedule of activities
Spring semester teaching begins on Monday, 30 July 2012. The intra session break runs from
Monday, 24 September 2012 to Friday, 28 September 2012 (Week 9).
There is one public holiday this semester which may affect classes. Labour Day falls o n Monday, 1
October 2012 (Week 10). Alternative teaching arrangements for any classes affected by this public holiday will be posted on the vUWS website.
WEEK
TOPICS AND TEXTBOOK READINGS
STUDENT ACTIVITIES
1
Introduction to accounting (Chapter 1).
Read learning guide and unit outline.
30 July-3 August
Business sustainability (Chapter 2).
Complete handout in class for Week 1.
2
Business structures (Chapter 3).
6-10 August
Business transactions (Chapter 4).
Textbook: Chapter 1 (1.12) and Chapter 2 (2.10,
2.12, 2.18, 2.38, 2.41).
3
Business transactions (Chapter 4).
Textbook: Chapter 3 (3.29, 3.38, 3.45) and
Chapter 4 (4.2, 4.16, 4.17).
Balance sheet (Chapter 5, pp. 142-172 up to LO
9).
Textbook: Chapter 4 (4.27, 4.29, 4.35(a)).
5
Note: No lectures or tutorials this week.
27-31 August
Staff will be available for additional consultation
– see vUWS for details.
Due: Mid-semester examination on Saturday, 1
September 2012.
6
Balance sheet cont. (Chapter 5, pp. 172 [from
LO9] -185).
Textbook: Chapter 5 (5.11, 5.17, 5.18, 5.21,
5.24).
Income statement and statement of changes in equity (Chapter 6).
Textbook: Chapter 5 (5.9, 5.16, 5.30, 5.33, 5.50).
Statement of cash flows (Chapter 7).
Textbook: Chapter 6 (6.4, 6.5, 6.8, 6.16, 6.17,
6.20, 6.22, 6.26, 6.41).
24-28
September
INTRA SESSION BREAK
INTRA SESSION BREAK
10
Analysis and interpretation of financial statements (Chapter 8, pp. 312-331).
Textbook: Chapter 7 (7.2, 7.6, 7.10, 7.16, 7.17,
7.35, 7.38).
13-17 August
4
20-24 August
3-7 September
7
10-14
September
8
17-21
September
Note: Check vUWS site closer to the date for further details.
9
1-5 October
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200101
ACCOUNTING
INFORMATION
FOR
MANAGERS
SPRING
2012
WEEK
TOPICS AND TEXTBOOK READINGS
STUDENT ACTIVITIES
11
Analysis and interpretation of financial statements (Chapter 8, pp. 332-353).
|
Textbook: Chapter 8 (8.3, 8.9, 8.18, 8.21, 8.25).
8-12 October
12
Due: Individual assignment
Budgeting (Chapter 9).
Textbook: Chapter 8 (8.2, 8.20, 8.22, 8.27,
8.46(a)).
Cost-volume-profit analysis (Chapter 10).
Textbook: Chapter 9 (9.7, 9.8, 9.14, 9.22, 9.32).
Review lecture.
Textbook: Chapter 10 (10.2, 10.18, 10.20, 10.38,
10.41).
STUVAC
STUVAC
15-19 October
13
22-26 October
14
29 October-2
November
15
5-9 November
Note: In Weeks 4 and 6, LO means ‘Learning Objective’ in the textbook.
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200101
ACCOUNTING
INFORMATION
FOR
MANAGERS
SPRING
2012
|
In Class ‘Seen’ Solutions
Week 7
5.9
Chapter 5: 5.9, 5.30, 5.33, 5.50
Frazier Ltd is always running short of cash, despite growing sales volumes and its current assets exceeding its current liabilities. A review of its operations by a consultant finds that a considerable portion of the company’s inventory is obsolete stock for which there is limited demand. Further, many of the accounts receivable are overdue by more than 60 days. The accounts receivable and inventory are carried at their gross amount and cost value respectively on the balance sheet. Explain how the accounts receivable and inventory should be valued on the balance sheet. If Frazier Ltd was to apply the correct measurement basis, determine the effect on: 1.) profit and 2.) assets.
Accounts receivable should be measured at their cash equivalent. This is the cash that the entity expects to recover. The carrying amount assigned to accounts receivable should reflect the monies owed to the entity less an allowance for doubtful debts. The allowance for doubtful debts represents the entity’s estimate of the monies not expected to be received.
When estimating the amount to record as the allowance for doubtful debts, entities consider the time for which the debt has been outstanding (e.g. the collectability of debts related to invoices from 6 months ago may be remote if the monies were due one month from the invoice date). Alternatively, based on past experience, the entity may provide for a certain percentage of the current period’s sales to be treated as doubtful.
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200101
ACCOUNTING
INFORMATION
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SPRING
2012
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Inventory must be measured on the balance sheet at the lower of cost and net realisable value. Net realisable value is the amount that the inventory could be sold for in an orderly fashion less estimated selling costs. Thus it is necessary to compare the cost price of inventory with the net realisable value with the lower valuation assigned to the inventory for balance sheet purposes. For example, if inventory has a cost price of $20 000 and it has a net realisable value of $30 000 the value assigned to the inventory in the balance sheet would be
$20 000 as the cost is lower than the net realisable value. Conversely, if inventory has a cost price of $20 000 and it has a net realisable value of $15 000 the value assigned to the inventory in the balance sheet has to be $15 000 as the net realisable value is the lower value. In the latter case, this would mean that the inventory, currently recorded at its cost price of $20 000, would have to be written down by $5000 to $15 000. Given that an asset has been reduced, to keep the balance sheet equation in balance, an expense of $5000 is recorded in the income statement being the inventory write-down. Students will explore the concept of income and expenses in Chapter 6.
If Frazier was to apply the correct measurement basis for its accounts receivable, the entity firstly would need to estimate how much of its accounts receivable would be uncollectable, since many of its accounts receivable are already overdue.
The estimated uncollectable accounts receivable is then debited as a bad debt expense and is recognised in the income statement, which subsequently would reduce the entity’s profit in the current accounting period. At the same time, the estimated uncollectable accounts receivable is also credited to an allowance for doubtful debts account, which is a contra asset account that reduces the amount of accounts receivable. As a result, applying the correct measurement basis for accounts receivable will reduce Frazier’s profit for the current period and its assets.
Similarly, if Frazier was to apply the correct measurement basis for its inventory, the inventory must be valued at the lower of cost and net realisable value. As a considerable portion of Frazier’s inventory is already obsolete, the inventory must be writt en down to net realisable value. The inventory write-down will reduce the inventory value recognised in the balance sheet, and will be treated as an expense in the income statement. As a result,
Frazier’s profit in the current period and its assets will also decrease.
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200101
ACCOUNTING
INFORMATION
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SPRING
5.30
2012
|
You have a friend who is considering purchasing some shares in LookFool
Ltd. The shares are currently trading on the stock exchange at $3.58 each. The entity’s financial statements suggest that the entity’s net assets are $250 000 and there are 150 000 shares on issue, giving a book value per share of $1.67.
Your friend is confused as to why the financial statements do not reflect the measure of the entity’s value. Explain this to your friend.
LookFool’s shares are currently trading at $3.58. Given that there are 150 000 shares on issue, the market capitalisation of LookFool is $3.58 × 150 000 = $537 000. The financial statements show the carrying value of net assets to be $250 000. So, the issue is why doesn’t the balance sheet reflect economic reality (i.e. show the net assets to be what the company is measured at in the market place)? There are a number of reasons why the market value and book value differ including: assets in LookFool’s balance sheet may be measured at cost (or depreciated cost) and this may not resemble the current value of the assets; the market may be valuing assets that LookFool is not recognising on its balance sheet because the definition and recognition criteria are not satisfied (e.g. internally generated intangibles, strength of management team); the market may be valuing LookFool on its growth potential rather than on
its asset base.
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200101
ACCOUNTING
INFORMATION
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SPRING
5.33
2012
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Preparing a balance sheet
Required
a.
What is the equity as at the end of the two financial years?
Equity = Total Assets – Total Liabilities
Equity as at 30 June 2012
= ($6000 + $15 000 + $2500 + $6000 + $20 000 + $40 000) – ($17 500 + $8000 +
$10 000 + $37 500)
= $16 500
Equity as at 30 June 2013
= ($15 000 + $14 000 + $5000 + $7000 + $20 000 + $40 000) – ($26 000 + $5000 +
$10 000 + $35 000)
= $25 000
b. If Briony contributed an extra $15 000 capital during the financial year ending 30
June 2013 and made no drawings, determine her profit (or loss) for the year, assuming the above balances remain the same.
To calculate profit or loss for the 2013 financial year, it would be helpful to prepare an extract of the statement of changes in equity for the period ending 30 June 2013 as follows:
Beginning Capital, as at 1 July 2012
Add:
Additional Capital Contribution
Profit
Less:
Drawings
Ending Capital, as at 30 June 2013
$16 500 (from part
(a))
15 000
???
0
$25 000 (from part
(a))
Profit (loss) gained during the financial year ending 30 June 2013 is calculated as owner’s equity as at 30 June 2013 less owner’s equity as at 30 June 2012 less additional capital contribution, that is:
$25 000 - $16 500 - $15 000 = -$6500
This means that Briony incurred a loss of $6500 for the year ended 30 June 2013.
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200101
ACCOUNTING
INFORMATION
FOR
MANAGERS
SPRING
c.
2012
|
If Briony had contributed an extra $20 000 and withdrew $15 000 during the year ending 30 June 2013, determine her profit for the year, assuming the above balances remain the same.
Again, it would be helpful to prepare an extract of statement of changes in equity in order to calculate profit (loss) for the year 2013:
Beginning Capital, as at 1 July 2012
Add:
Additional Capital Contribution
Profit
Less:
Drawings
Ending Capital, as at 30 June 2013
$16 500 (from
(a))
20 000
???
(15 000)
$25 000 (from
(a))
part
part
If Briony contributed an extra $20 000 capital during the financial year ending 30 June 2013 and withdrew $15 000, her profit result for 2013 would be:
$25 000 - $20 000 (additional capital) - $16 500 + $15 000 (drawings) = $3500
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200101
ACCOUNTING
INFORMATION
FOR
MANAGERS
SPRING
2012
5.50
The ‘Apply your knowledge’ question in this chapter referred to Australian
Securities and Investments Commission (ASIC) taking the directors of Centro to court over the misclassification of liabilities. On 27 June, the Federal Court found the directors had breached their duty of care. The judge found that each director knew of the interest-bearing securities and should have been aware of the relevant accounting principles that would have alerted them to the error in signing off accounts that classified billions of dollars as long-term rather than short-term debt. Each month the directors received a 450-page board package.
The financial report presented to the board contained 65 documents with 93 sets of complex financials. The directors’ defence was that the board papers were voluminous and they could not be expected to absorb that amount of information. a.
|
Discuss when a liability should be classified as a current liability.
The classification of liabilities into current and non-current is based on the timing of the expected future economic sacrifices. A liability should be classified as a current liability if the future economic sacrifices are expected to occur within the next reporting period
(usually 12 month) or one operating cycle, whichever is longer.
b.
Explain why Centro’s debt should have been classified as a current liability.
As explained above, a liability is classified as current if the outflow of resources that represents future economic sacrifice is expected to occur within one year or one operating cycle. Centro’s debt should have been classified as a current liability because it is expected to mature within one year. A current classification should also apply if the debt is repayable on demand.
c.
Outline the duties of directors in relation to the financial statements.
Duties of directors are regulated by the Corporations Act 2001. In general, directors must exercise their duties with care and diligence (s.180), in good faith and in the best interest of the company (s.181). They are also prohibited from using their position and information available to them to gain an advantage for themselves or someone else, or to cause detriment to the company (s.182-183).
In relation to the financial statements, company directors have the following duties:
Directors are obliged, under the Corporations Act 2001, to review the company’s financial statements and to form an opinion of whether the financial statements comply with relevant accounting standards and represent a ‘true and fair view’ of the company’s position.
Before they form an opinion about the company’s financial statements, directors must carefully read and understand the financial statements.
Directors should acquire basic understanding of the company’s operations and keep informed with the activities of the companies.
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200101
ACCOUNTING
INFORMATION
FOR
MANAGERS
SPRING
2012
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Directors should be familiar with the company’s financial status, which indicates that it is necessary for directors to be financially literate.
While it is reasonable for directors to rely on external advisers for issues in the financial statements, directors are expected to make further enquiries if, in their judgement, the contents of the financial statements are not consistent with their knowledge about the company’s financial position.
d.
Critique accounting for goodwill and appraise its usefulness for decision making. Goodwill is an intangible asset that represents the excess of the consideration paid over the fair value of net assets acquired in a business combination. Goodwill can only be recognised as an asset when it is acquired, as International Financial Reporting Standards prohibit internally-generated goodwill to be recognised. Goodwill is initially measured at cost as at the acquisition date. Goodwill cannot be revalued upward and must be tested for impairment at least on an annual basis. If the value of goodwill is deemed to be impaired, then goodwill must be written-down and the impairment loss is charged as an expense in the income statement. Amortisation of goodwill, that was permitted under pre-IFRS accounting standards, is now prohibited.
There have been debates over the years about reporting assets in the financial statements based on cost versus fair value. Whilst fair value-based accounting figures are deemed to be more relevant in representing how much assets are worth at present time, the reliability of fair value is only maximised if markets, where the assets are being actively traded, exist.
This is exactly the main issue with goodwill. There is no active market for goodwill, which makes it difficult to determine the current value of goodwill, and this is the reason why accounting standards prohibit the upward revaluation of post-acquisition goodwill.
Although increasing the value of goodwill post-acquisition is not permitted, goodwill is required to be tested for impairment on annual basis. The AASB 136 Impairment of Assets provides some indicators to assess whether goodwill is impaired. However, the consideration of those indicators significantly depends on management’s judgement, thereby providing management with discretion to determine whether and by how much goodwill has been impaired. This could create incentives for management to arrange the timing for reporting goodwill impairment or even to postpone goodwill impairment, as the impairment loss is directly charged against profit for the current period.
A number of empirical studies conducted over the years have found that managerial incentives have played an important role in shaping management’s decisions for goodwill write-downs. For example, new management may decide to write-off certain value of goodwill in a particular financial year, causing the company’s profit to decline as a result of impairment loss. The new management can attribute the write down to their review of previous invetsment decisions and take credit when profitability improves in the next years.
Management’s decisions related to goodwill write-downs may also depend on economic conditions and the capacity of the company to absorb losses. If management considers that the company is not in the position of being capable to absorb more losses this year, they may postpone goodwill impairment charge for next reporting year.
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200101
ACCOUNTING
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SPRING
2012
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Apart from issues with management discretions as discussed above, the requirement that goodwill impairment loss be charged as an expense in the income statement has been criticised for creating earnings volatility. Although there is no cash flow involved in impairment losses, a decline in profit may adversely affect the company’s value in the market given the importance investors place on earnings growth. In addition, when goodwill is written-down from the balance sheet, the company’s total assets and equity will also decrease. This will increase company’s debt ratios, which also creates unfavourable signal in the market.
In order to achive the objective of financial statements, that being to assist users in decision making, financial information contained in the financial statements must be both relevant
(i.e. useful for users in decision making) and reliable (i.e. being a faithful representation of the company’s financial performance and position). Since goodwill is required to be recognised at cost, its value is reliable. However, the value of goodwill post-acquisition may not be relevant to users in their decision making as it does not reflect its current value.
Furthermore, management discretion in determining goodwill impairment may lead to unrealiablity and value irrelevance of accounting information as their judgements are biased towards their own incentives. Despite the potential issues affecting the usefulness of accounting of goodwill for decision making, it is important to note that no single accounting rule is perfect and therefore, in many cases such as goodwill, there will be trade-offs between relevance and reliability. A good corporate governance will help minimising the trade-offs and enhance the financial reporting.
e.
Each year ASIC conducts a surveillance program of companies’ financial reporting. Identify the areas that ASIC focused on in its most recent surveillance program.
At the time of writing, ASIC has released the results of its surveillance program for the year ended 31 December 2010 and identified the following focus areas for 30 June 2011 financial reports: segment reporting;
consolidation of controlled entities;
use of the going concern assumption;
asset impairment;
fair value of financial assets;
financial instrument disclosures;
disclosures of estimates and accounting policy judgements;
accounting for business combinations;
related party disclosures;
operating and financial review; and
alternative profits.
The full media release can be found on ASIC’s website through the following link:
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200101
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MANAGERS
SPRING
2012
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‘Other’ Textbook Homework Solutions
Week 6
Chapter 5:
5.16
5.16 Solve for the missing financial numbers as they would appear on the balance sheet. Non
Non
Current Current
Total
Current Current
Total
Share Retained
Total
Assets assets assets liabilities liabilities liabilities capital Earnings Reserves Equity
64 000 456 000 520 000
68 000 170 000
82 000
238 000 130 000
70 000 282 000
170 000 820 000 990 000 150 000 180 000
0 660 000
330 000 486 000 174 000
12 000
99 000
23 000
37 000 40 000
7 000
15 000
62 000
87 000
14 000
1 000
4 800
220
1 000
1 840
0
3 800
3 800
780
1 960
1 175 200 1 232 600 2 407 800 686 000 382 000 1 068 000 400 500 421 500 517 800 1 339 800
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
m.
n.
o.
456 000
238 000
70 000
820 000
330 000
660 000
87 000
14 000
40 000
3 800
780
1 960
2 407 800
1 068 000
421 500
(520 000 – 64 000)
(68 000 + 170 000)
(282 000 – 130 000 – 82 000)
(990 000 – 170 000)
(150 000 + 180 000)
(486 000 + 174 000)
(99 000 – 12 000)
(37 000 – 23 000)
(62 000 – 7 000 – 15 000)
(4 800 – 1 000)
(1 000 – 220)
(3 800 – 1 840)
(1 175 200 + 1 232 600)
(686 000 + 382 000)
(1 339 800 – 400 500 – 517 800)
Page | 13
Tutorial Solutions - Week 7
School of Business│
Spring 2012
STAFF
Unit Coordinator
Graeme Mitchell
Building ED.G.212, Parramatta campus
Please contact via e-mail (if required)
Email: g.mitchell@uws.edu.au
vUWS
Coordinator,
and External
Studies
Coordinator
Simon Lenthen
Building ED.G.11, Parramatta campus
Unit administration School of Business Undergraduate Student Services Team
Building EQ, Parramatta campus (Manu Cherian)
Phone: 9685 9473
Phone: 9685 9200
Teaching team lecturers
Email: s.lenthen@uws.edu.au
Email: business.courses@uws.edu.au
Graeme Mitchell and Stanley James (Parramatta), Brian Voysey (Bankstown) ,
Michelle Cull and Stanley James …show more content…
(Campbelltown), Chris Endicott (Penrith)
[Refer to the vUWS site for a detailed list of all tutors]
Edition: Spring 2012
© Copyright: University of Western Sydney, 2012. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without the prior written permission from the Dean of the School of Business. Copyright for acknowledged materials reproduced herein is retained by the copyright holder. All readings in this publication are copied under licence in accordance with Part VB of the Copyright Act 1968 .
200101
ACCOUNTING
INFORMATION
FOR
MANAGERS
SPRING
2012
|
Teaching activities
Schedule of activities
Spring semester teaching begins on Monday, 30 July 2012. The intra session break runs from
Monday, 24 September 2012 to Friday, 28 September 2012 (Week 9).
There is one public holiday this semester which may affect classes. Labour Day falls o n Monday, 1
October 2012 (Week 10). Alternative teaching arrangements for any classes affected by this public holiday will be posted on the vUWS website.
WEEK
TOPICS AND TEXTBOOK READINGS
STUDENT ACTIVITIES
1
Introduction to accounting (Chapter 1).
Read learning guide and unit outline.
30 July-3 August
Business sustainability (Chapter 2).
Complete handout in class for Week 1.
2
Business structures (Chapter 3).
6-10 August
Business transactions (Chapter 4).
Textbook: Chapter 1 (1.12) and Chapter 2 (2.10,
2.12, 2.18, 2.38, 2.41).
3
Business transactions (Chapter 4).
Textbook: Chapter 3 (3.29, 3.38, 3.45) and
Chapter 4 (4.2, 4.16, 4.17).
Balance sheet (Chapter 5, pp. 142-172 up to LO
9).
Textbook: Chapter 4 (4.27, 4.29, 4.35(a)).
5
Note: No lectures or tutorials this week.
27-31 August
Staff will be available for additional consultation
– see vUWS for details.
Due: Mid-semester examination on Saturday, 1
September 2012.
6
Balance sheet cont. (Chapter 5, pp. 172 [from
LO9] -185).
Textbook: Chapter 5 (5.11, 5.17, 5.18, 5.21,
5.24).
Income statement and statement of changes in equity (Chapter 6).
Textbook: Chapter 5 (5.9, 5.16, 5.30, 5.33, 5.50).
Statement of cash flows (Chapter 7).
Textbook: Chapter 6 (6.4, 6.5, 6.8, 6.16, 6.17,
6.20, 6.22, 6.26, 6.41).
24-28
September
INTRA SESSION BREAK
INTRA SESSION BREAK
10
Analysis and interpretation of financial statements (Chapter 8, pp. 312-331).
Textbook: Chapter 7 (7.2, 7.6, 7.10, 7.16, 7.17,
7.35, 7.38).
13-17 August
4
20-24 August
3-7 September
7
10-14
September
8
17-21
September
Note: Check vUWS site closer to the date for further details.
9
1-5 October
Page | 3
200101
ACCOUNTING
INFORMATION
FOR
MANAGERS
SPRING
2012
WEEK
TOPICS AND TEXTBOOK READINGS
STUDENT ACTIVITIES
11
Analysis and interpretation of financial statements (Chapter 8, pp. 332-353).
|
Textbook: Chapter 8 (8.3, 8.9, 8.18, 8.21, 8.25).
8-12 October
12
Due: Individual assignment
Budgeting (Chapter 9).
Textbook: Chapter 8 (8.2, 8.20, 8.22, 8.27,
8.46(a)).
Cost-volume-profit analysis (Chapter 10).
Textbook: Chapter 9 (9.7, 9.8, 9.14, 9.22, 9.32).
Review lecture.
Textbook: Chapter 10 (10.2, 10.18, 10.20, 10.38,
10.41).
STUVAC
STUVAC
15-19 October
13
22-26 October
14
29 October-2
November
15
5-9 November
Note: In Weeks 4 and 6, LO means ‘Learning Objective’ in the textbook.
Page | 4
200101
ACCOUNTING
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2012
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In Class ‘Seen’ Solutions
Week 7
5.9
Chapter 5: 5.9, 5.30, 5.33, 5.50
Frazier Ltd is always running short of cash, despite growing sales volumes and its current assets exceeding its current liabilities. A review of its operations by a consultant finds that a considerable portion of the company’s inventory is obsolete stock for which there is limited demand. Further, many of the accounts receivable are overdue by more than 60 days. The accounts receivable and inventory are carried at their gross amount and cost value respectively on the balance sheet. Explain how the accounts receivable and inventory should be valued on the balance sheet. If Frazier Ltd was to apply the correct measurement basis, determine the effect on: 1.) profit and 2.) assets.
Accounts receivable should be measured at their cash equivalent. This is the cash that the entity expects to recover. The carrying amount assigned to accounts receivable should reflect the monies owed to the entity less an allowance for doubtful debts. The allowance for doubtful debts represents the entity’s estimate of the monies not expected to be received.
When estimating the amount to record as the allowance for doubtful debts, entities consider the time for which the debt has been outstanding (e.g. the collectability of debts related to invoices from 6 months ago may be remote if the monies were due one month from the invoice date). Alternatively, based on past experience, the entity may provide for a certain percentage of the current period’s sales to be treated as doubtful.
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2012
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Inventory must be measured on the balance sheet at the lower of cost and net realisable value. Net realisable value is the amount that the inventory could be sold for in an orderly fashion less estimated selling costs. Thus it is necessary to compare the cost price of inventory with the net realisable value with the lower valuation assigned to the inventory for balance sheet purposes. For example, if inventory has a cost price of $20 000 and it has a net realisable value of $30 000 the value assigned to the inventory in the balance sheet would be
$20 000 as the cost is lower than the net realisable value. Conversely, if inventory has a cost price of $20 000 and it has a net realisable value of $15 000 the value assigned to the inventory in the balance sheet has to be $15 000 as the net realisable value is the lower value. In the latter case, this would mean that the inventory, currently recorded at its cost price of $20 000, would have to be written down by $5000 to $15 000. Given that an asset has been reduced, to keep the balance sheet equation in balance, an expense of $5000 is recorded in the income statement being the inventory write-down. Students will explore the concept of income and expenses in Chapter 6.
If Frazier was to apply the correct measurement basis for its accounts receivable, the entity firstly would need to estimate how much of its accounts receivable would be uncollectable, since many of its accounts receivable are already overdue.
The estimated uncollectable accounts receivable is then debited as a bad debt expense and is recognised in the income statement, which subsequently would reduce the entity’s profit in the current accounting period. At the same time, the estimated uncollectable accounts receivable is also credited to an allowance for doubtful debts account, which is a contra asset account that reduces the amount of accounts receivable. As a result, applying the correct measurement basis for accounts receivable will reduce Frazier’s profit for the current period and its assets.
Similarly, if Frazier was to apply the correct measurement basis for its inventory, the inventory must be valued at the lower of cost and net realisable value. As a considerable portion of Frazier’s inventory is already obsolete, the inventory must be writt en down to net realisable value. The inventory write-down will reduce the inventory value recognised in the balance sheet, and will be treated as an expense in the income statement. As a result,
Frazier’s profit in the current period and its assets will also decrease.
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You have a friend who is considering purchasing some shares in LookFool
Ltd. The shares are currently trading on the stock exchange at $3.58 each. The entity’s financial statements suggest that the entity’s net assets are $250 000 and there are 150 000 shares on issue, giving a book value per share of $1.67.
Your friend is confused as to why the financial statements do not reflect the measure of the entity’s value. Explain this to your friend.
LookFool’s shares are currently trading at $3.58. Given that there are 150 000 shares on issue, the market capitalisation of LookFool is $3.58 × 150 000 = $537 000. The financial statements show the carrying value of net assets to be $250 000. So, the issue is why doesn’t the balance sheet reflect economic reality (i.e. show the net assets to be what the company is measured at in the market place)? There are a number of reasons why the market value and book value differ including: assets in LookFool’s balance sheet may be measured at cost (or depreciated cost) and this may not resemble the current value of the assets; the market may be valuing assets that LookFool is not recognising on its balance sheet because the definition and recognition criteria are not satisfied (e.g. internally generated intangibles, strength of management team); the market may be valuing LookFool on its growth potential rather than on
its asset base.
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Preparing a balance sheet
Required
a.
What is the equity as at the end of the two financial years?
Equity = Total Assets – Total Liabilities
Equity as at 30 June 2012
= ($6000 + $15 000 + $2500 + $6000 + $20 000 + $40 000) – ($17 500 + $8000 +
$10 000 + $37 500)
= $16 500
Equity as at 30 June 2013
= ($15 000 + $14 000 + $5000 + $7000 + $20 000 + $40 000) – ($26 000 + $5000 +
$10 000 + $35 000)
= $25 000
b. If Briony contributed an extra $15 000 capital during the financial year ending 30
June 2013 and made no drawings, determine her profit (or loss) for the year, assuming the above balances remain the same.
To calculate profit or loss for the 2013 financial year, it would be helpful to prepare an extract of the statement of changes in equity for the period ending 30 June 2013 as follows:
Beginning Capital, as at 1 July 2012
Add:
Additional Capital Contribution
Profit
Less:
Drawings
Ending Capital, as at 30 June 2013
$16 500 (from part
(a))
15 000
???
0
$25 000 (from part
(a))
Profit (loss) gained during the financial year ending 30 June 2013 is calculated as owner’s equity as at 30 June 2013 less owner’s equity as at 30 June 2012 less additional capital contribution, that is:
$25 000 - $16 500 - $15 000 = -$6500
This means that Briony incurred a loss of $6500 for the year ended 30 June 2013.
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If Briony had contributed an extra $20 000 and withdrew $15 000 during the year ending 30 June 2013, determine her profit for the year, assuming the above balances remain the same.
Again, it would be helpful to prepare an extract of statement of changes in equity in order to calculate profit (loss) for the year 2013:
Beginning Capital, as at 1 July 2012
Add:
Additional Capital Contribution
Profit
Less:
Drawings
Ending Capital, as at 30 June 2013
$16 500 (from
(a))
20 000
???
(15 000)
$25 000 (from
(a))
part
part
If Briony contributed an extra $20 000 capital during the financial year ending 30 June 2013 and withdrew $15 000, her profit result for 2013 would be:
$25 000 - $20 000 (additional capital) - $16 500 + $15 000 (drawings) = $3500
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5.50
The ‘Apply your knowledge’ question in this chapter referred to Australian
Securities and Investments Commission (ASIC) taking the directors of Centro to court over the misclassification of liabilities. On 27 June, the Federal Court found the directors had breached their duty of care. The judge found that each director knew of the interest-bearing securities and should have been aware of the relevant accounting principles that would have alerted them to the error in signing off accounts that classified billions of dollars as long-term rather than short-term debt. Each month the directors received a 450-page board package.
The financial report presented to the board contained 65 documents with 93 sets of complex financials. The directors’ defence was that the board papers were voluminous and they could not be expected to absorb that amount of information. a.
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Discuss when a liability should be classified as a current liability.
The classification of liabilities into current and non-current is based on the timing of the expected future economic sacrifices. A liability should be classified as a current liability if the future economic sacrifices are expected to occur within the next reporting period
(usually 12 month) or one operating cycle, whichever is longer.
b.
Explain why Centro’s debt should have been classified as a current liability.
As explained above, a liability is classified as current if the outflow of resources that represents future economic sacrifice is expected to occur within one year or one operating cycle. Centro’s debt should have been classified as a current liability because it is expected to mature within one year. A current classification should also apply if the debt is repayable on demand.
c.
Outline the duties of directors in relation to the financial statements.
Duties of directors are regulated by the Corporations Act 2001. In general, directors must exercise their duties with care and diligence (s.180), in good faith and in the best interest of the company (s.181). They are also prohibited from using their position and information available to them to gain an advantage for themselves or someone else, or to cause detriment to the company (s.182-183).
In relation to the financial statements, company directors have the following duties:
Directors are obliged, under the Corporations Act 2001, to review the company’s financial statements and to form an opinion of whether the financial statements comply with relevant accounting standards and represent a ‘true and fair view’ of the company’s position.
Before they form an opinion about the company’s financial statements, directors must carefully read and understand the financial statements.
Directors should acquire basic understanding of the company’s operations and keep informed with the activities of the companies.
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Directors should be familiar with the company’s financial status, which indicates that it is necessary for directors to be financially literate.
While it is reasonable for directors to rely on external advisers for issues in the financial statements, directors are expected to make further enquiries if, in their judgement, the contents of the financial statements are not consistent with their knowledge about the company’s financial position.
d.
Critique accounting for goodwill and appraise its usefulness for decision making. Goodwill is an intangible asset that represents the excess of the consideration paid over the fair value of net assets acquired in a business combination. Goodwill can only be recognised as an asset when it is acquired, as International Financial Reporting Standards prohibit internally-generated goodwill to be recognised. Goodwill is initially measured at cost as at the acquisition date. Goodwill cannot be revalued upward and must be tested for impairment at least on an annual basis. If the value of goodwill is deemed to be impaired, then goodwill must be written-down and the impairment loss is charged as an expense in the income statement. Amortisation of goodwill, that was permitted under pre-IFRS accounting standards, is now prohibited.
There have been debates over the years about reporting assets in the financial statements based on cost versus fair value. Whilst fair value-based accounting figures are deemed to be more relevant in representing how much assets are worth at present time, the reliability of fair value is only maximised if markets, where the assets are being actively traded, exist.
This is exactly the main issue with goodwill. There is no active market for goodwill, which makes it difficult to determine the current value of goodwill, and this is the reason why accounting standards prohibit the upward revaluation of post-acquisition goodwill.
Although increasing the value of goodwill post-acquisition is not permitted, goodwill is required to be tested for impairment on annual basis. The AASB 136 Impairment of Assets provides some indicators to assess whether goodwill is impaired. However, the consideration of those indicators significantly depends on management’s judgement, thereby providing management with discretion to determine whether and by how much goodwill has been impaired. This could create incentives for management to arrange the timing for reporting goodwill impairment or even to postpone goodwill impairment, as the impairment loss is directly charged against profit for the current period.
A number of empirical studies conducted over the years have found that managerial incentives have played an important role in shaping management’s decisions for goodwill write-downs. For example, new management may decide to write-off certain value of goodwill in a particular financial year, causing the company’s profit to decline as a result of impairment loss. The new management can attribute the write down to their review of previous invetsment decisions and take credit when profitability improves in the next years.
Management’s decisions related to goodwill write-downs may also depend on economic conditions and the capacity of the company to absorb losses. If management considers that the company is not in the position of being capable to absorb more losses this year, they may postpone goodwill impairment charge for next reporting year.
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Apart from issues with management discretions as discussed above, the requirement that goodwill impairment loss be charged as an expense in the income statement has been criticised for creating earnings volatility. Although there is no cash flow involved in impairment losses, a decline in profit may adversely affect the company’s value in the market given the importance investors place on earnings growth. In addition, when goodwill is written-down from the balance sheet, the company’s total assets and equity will also decrease. This will increase company’s debt ratios, which also creates unfavourable signal in the market.
In order to achive the objective of financial statements, that being to assist users in decision making, financial information contained in the financial statements must be both relevant
(i.e. useful for users in decision making) and reliable (i.e. being a faithful representation of the company’s financial performance and position). Since goodwill is required to be recognised at cost, its value is reliable. However, the value of goodwill post-acquisition may not be relevant to users in their decision making as it does not reflect its current value.
Furthermore, management discretion in determining goodwill impairment may lead to unrealiablity and value irrelevance of accounting information as their judgements are biased towards their own incentives. Despite the potential issues affecting the usefulness of accounting of goodwill for decision making, it is important to note that no single accounting rule is perfect and therefore, in many cases such as goodwill, there will be trade-offs between relevance and reliability. A good corporate governance will help minimising the trade-offs and enhance the financial reporting.
e.
Each year ASIC conducts a surveillance program of companies’ financial reporting. Identify the areas that ASIC focused on in its most recent surveillance program.
At the time of writing, ASIC has released the results of its surveillance program for the year ended 31 December 2010 and identified the following focus areas for 30 June 2011 financial reports: segment reporting;
consolidation of controlled entities;
use of the going concern assumption;
asset impairment;
fair value of financial assets;
financial instrument disclosures;
disclosures of estimates and accounting policy judgements;
accounting for business combinations;
related party disclosures;
operating and financial review; and
alternative profits.
The full media release can be found on ASIC’s website through the following link:
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‘Other’ Textbook Homework Solutions
Week 6
Chapter 5:
5.16
5.16 Solve for the missing financial numbers as they would appear on the balance sheet. Non
Non
Current Current
Total
Current Current
Total
Share Retained
Total
Assets assets assets liabilities liabilities liabilities capital Earnings Reserves Equity
64 000 456 000 520 000
68 000 170 000
82 000
238 000 130 000
70 000 282 000
170 000 820 000 990 000 150 000 180 000
0 660 000
330 000 486 000 174 000
12 000
99 000
23 000
37 000 40 000
7 000
15 000
62 000
87 000
14 000
1 000
4 800
220
1 000
1 840
0
3 800
3 800
780
1 960
1 175 200 1 232 600 2 407 800 686 000 382 000 1 068 000 400 500 421 500 517 800 1 339 800
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
m.
n.
o.
456 000
238 000
70 000
820 000
330 000
660 000
87 000
14 000
40 000
3 800
780
1 960
2 407 800
1 068 000
421 500
(520 000 – 64 000)
(68 000 + 170 000)
(282 000 – 130 000 – 82 000)
(990 000 – 170 000)
(150 000 + 180 000)
(486 000 + 174 000)
(99 000 – 12 000)
(37 000 – 23 000)
(62 000 – 7 000 – 15 000)
(4 800 – 1 000)
(1 000 – 220)
(3 800 – 1 840)
(1 175 200 + 1 232 600)
(686 000 + 382 000)
(1 339 800 – 400 500 – 517 800)
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