Substance over form

This is the principle that transaction and other events are accounted for and presented in accordance with their substance and economic reality and not merely their legal form. This is important in considering whether or not a sale has taken place

Prudence

Prudence requires accountants to exercise a degree of caution in making estimates under conditions of uncertainty, in order to ensure that assets are not overstated, not liabilities understated

Comparability

This requires consistent application of accounting policies and adequate disclosure

Materiality

The Frameworks describes this as a “threshold” quality and it requires the application of judgement. An item of information is material if it is omission or misstatement could influence the economic decision of users taken on the basis of the financial statements. An item can be material on account of its size or on account of its nature

B) Application to inventory

Matching/accuruals

Inventory is charged to profit or loss in the period in which it is used, not the period in which it is recived of paid for

Substance over form

Goods may be purchased for resale on a consignment basis, which means that they can be returned if unsold.

Prudence

If the net realisable value of an item of inventory falls below original cost, then the item is valued at NRV. This is important because if closing inventory is overvalued prifet will be overstated.

Comparability.

Inventory should be valued in financial statement using FIFO or weighted avarege and this should be consistently applied form one period to the next. If a change is made to the method of valuation, it must be discloused, so that the current and prior periods canstill be compared.

Materiality

Inventory is counted at the end of each reporting period and the valuation is based on this physical count, because inventory is generally regarded as a material item. However, it could be decided that a small discrepancy in the count would not be investigated because the amounts involved were too small to affect the decision of users and so were not material.

15) A) IAS 10 relates to events talking about between the last day of the reporting period ( the year end date) and the date on which the financial statements are approved and sighed by the directors. This period is usually several months.

Adjusting events are events taking place after the reporting period which provide further evidence of condition existing at the end of the reporting period or wich call into question the going concern status of the entity. For this reason, adjusting events required adjustment to be made to the financial statements must be prepared on ta brake-up basis.

Non-adjusting events provide evidence of conditions arising after the end of the reporting period. If material, these should be disclosed by note, but they do not require that the financial statements be adjusted.

B) (I) This is a non-adjusting event as it does not affect the valuation of property or inventory at the year end. However, it would be treated as adjusting if the scale of losses were judged to threaten the going concern status of Waxwork. It will certainly need to be disclosed in the notes of the financial statements, disclosing separately the $16m loss and the expected insurance recovery of $9m.

(II) The sale in April 2009 gives further evidence regarding the realisable value of inventory at the year end and so an adjustment will be required. If 70% of the inventory was sold for $280.000 less commission of $42.000, it had a net realisable value of $238.000. on this basis, the total cost of $460.000 should be restated at NRV of $ 340.000. So inventory at the end of the reporting period should be written down by $120.000.

(III) This change has occurred outside the period specified by IAS 10, so it is not treated as an event after the reporting period. Had it occurred period to 6 May 2009, it would have been treated as a non-adjusting event requiring disclosure in the notes. The increase in the deferred tax liability will be accounted for the 2010 financial statements.

16)-

17)(i) This is adjusting event after the reporting period within the terms of IAS 10. 23000$ should be written off to inrreoverable debts at the year end and the trade receivables balance correspondingly reduced.

(ii) In this case sales after the reporting period have demonstrated that the NRV on inventory item W32 is below cost. In accordance with IAS”, Inventory of w32 should now bewritten down to NRV as follows:

$

Cost (12,000x6) 72,000

NRV (12,000x (5.4x85%)) (55,080)

Write off to income statement 16,920

(iii) As it is not yet known whether the employees legal action will be successful, Tentacle is corret to show it as a contingent liability. However, on the basis of the settlement in the other case, the contingent liability should be increased to 750,000$. If the case is settled before the financial statements are authorised for issue, this will be an adjusting event requiring a provision for damages if Tentacle is found liable.

18)1-

2) A) Provisions and IAS37

Provisions are liabilities of uncertain timing or amount. Because the are liabilities they must meet the recognition criteria for liabilities – that is there must be:

· A present obligation arising from past transactions or event.

· The transfer of economic benefit to settle the obligation must be probable

· A reliable estimate can be made of the amount of the obligation

The obligation giving rise to a provision can be legal or constructive. A constrictive obligation can arise when the actions or statement made by an entity create an expectations that they will meet certain obligations, even if there is no legal requirement for them to do so; for example they may have a well – known policy of replacing goods beyond the normal warranty period.

Provisions are recognised in full as soon as an entity is aware of them, but long term provisions are recognised at present value. AS time goes by the discount unwinds, increasing the provisions. The increase in the provisions is charged to the income statement as a financial cost.

If an obligation depends upon a future event, then it is a contingent liability , not a provision. Also, if the amount of an obligation cannot be measured reliably, then it is a contingent liability. Contingent liabilities are not recognised in the financial statements, although they need to be disclosed unless the possibility of an outflow of economic benefits in remote.

(In the past the term provision has been used to describe the reduction in the carrying value of an asset for example the provision for depreciation. This use of the word provision does not meet the criteria of IAS 37, and so the term allowance is used instead; for example the allowance for receivables.)

B) The need for a standard

Although provisions have been a key area of financial reporting for many years, IAS 37 was the first standard to address the issue. Before IAS 37 there were no rules governing the

· Definition

· Recognition

· Measurement

· Use, and

· Presentation

of provisions.

IAS 37 definition of a provision as a liability of uncertain timing or amount means that provisions must meet the recognition for liabilities. This means that provisions cannot be created to suit management needs. In the pas provisions were often created and released in order to smooth profits, rather than provide for a specific liability. These were sometimes called ’big bath provisions’ because they could be used for any and every purpose.

A specific example of this was the creation of provisions for reorganisation or restructuring. The charge to set these provisions up could be explained away by management to their investors as one-off exceptional items, but the release of the provision in the future would boost profits. Under IAS 37 provisions for restricting can only be recognised if the restricting has begun or if the restricting has been announced public.

The measurement rules have standardised practice in an area where there were genuine difference of opinion. For example there are at least three ways in which the cost of cleaning up an industrial site after it is closed down (restoration cost) can be accounted for:

· Ignore the costs until the site is abandoned,

· Accrue the costs evenly over the productive life of the site, or

· Provide for the costs in full immediately

IAS 37 states that these costs should be provided for in full immediately, but at their present value.

Under IAS 37 provisions can only be used for the purpose that they were created for; if provision is no longer needed it must be released. In the past provisions were sometimes created for one purpose and then used to cover the costs of another.

IAS 37 includes detailed disclosure requirements, including the movement on provisions during the year and an explanation of what each provision has been created for. This ensures that the rules set out above have been complied with.

3 )Rockbuster

No obligation exists to replace the engine and so it is wrong to create a provision for its replacements. Rockbuster may decide to trade in the earthmover rather than replace the engine. Also, the $2.4m depreciation charge includes an element in respect of the engine, so to make a provision as well is double-counting.

Instead IAS 16 states that the earth-mover should be treated as an asset with two separate components (the engine and the rest) with different useful lives. The engine (cost $7.5m) will be depreciated on a machine hours basis over 5000 hours, while the rest of the machine (cost $16.5m) will be depreciated over tem years.

Depreciation charge

Engine $7.500.000 Depreciated on a machine hours basis over 5.000 Hours. The charge is $1500 per hour

The rest $16.500.000 Depreciated on a straight line basis over its ten year useful life. The charge is $16.5000.000 per annum

Total $24.000.000

When the engine is replaced the cost and accumulated depreciation on the existing engine will be retired and the cost of the new engine will be capitalised and depreciated over its working life.

4) a) The Framework defines a liability as a present obligation of an entity arising from past events, the settlement of which is expected to result in an outflow form the entity of resources embodying economic benefits. The obligation can be legal or constructive.

A provision is a liability of uncertain timing or amount. It can be recognised when the outflow of resources is probable and when the amount concerned can be reliably estimated. Because it is regarded as a liability, a provision must meet the definition of a liability, this regulates when a provision should, or should not, be made. For instance, entities are not allowed to provide for future operating losses which use to be a means of ‘profit smoothing’, because the losses are in the future, rather than arising from past events. At the same time, an entity which has a future environmental liability because of past polluting activities, is required to make a provision as soon as the liability becomes apparent.

B) I) promoil must provide from dismantling and restoration cost at 30 September 2008, as the liability come into existence with the granting of the licence and the cost has been reliably estimated.

The provision at 30 September 2008 will be for the future cost discounted over 10 years. This will be added to the carrying amount of the oil platform and depreciated over 10 years. The discount will be ‘unwound’ each year and charged to finance costs. The credit entry will increase the provision until at the end of 10 years it will stand at $15m.

At 30 September 2008:

INCOME STATEMENT:

Depreciation (see SFP) $3690000

Finance costs (6,900(see SFP)x 8%) $552000

STATEMENT OF FINANCIAL POSITION

Non-current assets:

Oil platform 30.000.000

Dismantling (15m x .46) 6.900.000

36.900.000

Depreciation (36.900/10) (3.690.000)

Carrying value 33.210.000

Bib-current liabilities:

Environmental provision at 1 October 2007 6.900.000

Discount unwound (6.900x8%) 552.000

7.452.000

II) If the government licence did not require an environmental clean-up, Promoil would have no legal obligation. It would then be necessary to determine whether or not Promoil had a constructive obligation. This would apply if on past performance it had established a practice of carrying out an environmental clean-up where required, which would give rise to the expectation that it would do so in this case. If a constructive obligation existed, the accounting would be as pre the above,

If no obligation were established, there would be no liability. No provision would be made for the clean-up. The platform would be capitalised at $30m and depreciated over 10 years. There would be no finance costs.

12) £

Direct materials (20x 5,000) 100,000

Direct labour (10x 5,000) 50,000

Direct expenses (6x 5,000) 30,000

Production overheads

([2,000,000 / 50,000] x 5,000) 200,000

380,000

i.e. £76 per unit.

NB If actual production had been used as a basis for apportioning overhead, an extra £50,000

would have been added to inventory values (£86 per unit) and reported profits.

Q 19) same as 18)4.(AB) and 8(a) and 14

Date: 2015-12-11; view: 889