Financial Accounting

Question 1

A conceptual framework should provide consensus on:

Answer 1

• the scope and objectives of financial reporting
• the qualitative characteristics of financial information.
• what the elements of financial reporting are, and what their characteristics and recognition criteria are.

Question 2

Benefits of a conceptual framework

Answer 2

• accounting standards are more consistent and logical
• international comparability
• the thinking behind specific requirements is clearer
• enhanced communication between standard setters and other parties
• development of standards is more economical because basic concepts don’t need to be revisited each time a standard is developed
• less need for specific standards where concepts are developed within a framework.

Question 3

Why are conceptual frameworks developed

Answer 3

Provide guidance on key issues, such as objectives, qualitative characteristics, definitions and recognition criteria.

Question 4

Difference between conceptual framework and accounting standards

Answer 4

Framework is about objective, scope, and characteristics of financial information.

Standards develop and implement standards in line with the framework’s objectives. These are the rules, the framework is the objective..

Question 5

Objective of General Purpose Financial Reports

Answer 5

The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential equity investors, lenders and other creditors in making decisions about providing resources to the entity. Those decisions involve buying, selling or holding equity and debt instruments, and providing or settling loans and other forms of credit.

Question 6

What is the current conceptual framework called.

Answer 6

IASB Conceptual Framework for Financial Reporting

Question 7

Qualitative characteristics of financial information—good quality information—is made up of:

Answer 7

o Understandability—for users with some business and accounting knowledge

o Relevance—influences users by evaluating past, present or future events or confirming or correcting past evaluations

o Reliability—free from material bias and error and can be depended on by users

o Comparability—methods of measurement and disclosure should be consistent but should be changed if no longer relevant

o One point to note is that some information can be very relevant but not reliable or vice versa so there is often a trade-off with accounting treatments.

Question 8

What are the primary qualitative characteristics, and the four enhancing qualitive characteristics

Answer 8

• Relevance and Faithfully Represented

- Timeliness, Understandibility, Comparability, Verifiability.

Question 9

What are two main aspects to relevance characteristic

Answer 9

Predictive Value and Confirmatory (Feedback) value

Question 10

What is the base generally set at for materiality in AASB 1031

(No longer a quantitative test)

Answer 10

• an amount equal to or greater than 10 per cent of the appropriate base amount is presumed to be material, and
• an item that is equal to or less than 5 per cent of the appropriate base amount is presumed not to be material.

Question 11

What are the three characteristics of faithful representation

Answer 11

Complete

Neutral

Free from error

Question 12

Definition of an Asset

Answer 12

There must be a future economic benefit.

The reporting entity must control the future economic benefits.

The transaction or other event giving rise to the reporting entity’s control over the future economic benefits must have occurred.

Question 13

In relation to the recognition criteria, the IASB Conceptual Framework provides general recognition criteria for all five elements of financial statements (assets, liabilities, income, expenses and equity), these being:

An item that meets the definition of an element should be recognised if:

Answer 13

(a) it is probable that any future economic benefit associated with the item will flow to or from the entity; and
(b) the item has a cost or value that can be measured with reliability.

Question 14

Five elements of financial statements

Answer 14

Assets, Liabilities, Income, Expenses, Equity

Question 15

Define Fair Value

Answer 15

The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

Question 16

What are the benefits of conceptual framework

Answer 16

• Accounting standards should be more consistent, as they come from an orderly framework of concepts. If the framework wasn’t there, accounting concepts would be all over the place and ad hoc.
• Increased comparability on an international level, because other countries have frameworks that adopt the international conceptual framework.
• The AASB and IASB should be more accountable, because the thinking behind decisions should be more explicit, and always have a strong foundation.
• Communication between the IASB and AASB should be greater, as they are drawing from the same framework when developing standards or handling enquiries. Will also alleviate political pressure. When a standard is made it can ‘fall back’ on the framework
• Development of accounting standards would be more economical, and focused, as they have pre-adhered list of concepts to build on. Basic concepts do no need to be revisited.
• There might be less need to develop specific accounting standards as the conceptual framework may already address certain issues.

Question 17

Definition of Assets and Recognition Criteria

Answer 17

1. There must be a future economic benefit.
2. The reporting entity must control the future economic benefits.
3. The transaction or other event giving rise to the reporting entity’s control over the future economic benefits must have occurred.
   a) It is probably that economic benefit will flow to the entity
   b) The item has a cost or value that can be measured with reliability.

Question 18

Definition of Liabilities and Recognition Criteria

Answer 18

1. There must be an expected future disposition of economic benefits to other entities.
2. There must be a present obligation.
3. A past transaction or other event must have created the obligation.
   a) It is probably that economic benefit will flow from the entity
   b) The item has a cost or value that can be measured with reliability.

Question 19

Definition of Income and Recognition Criteria

Answer 19

1. Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or
2. decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.
   __________________________

a) It is probable that the inflow or other enhancement or saving in outflows of future economic benefits has occurred; and
b) The inflow or other enhancement or saving in outflows of future economic benefits can be measured reliably.

Question 20

Definition of Expenses and Recognition Criteria

Answer 20

1. Expenses are decreases in economic benefits during the accounting period in the form of outflows
2. Depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.
   _______________________________

a) It is probable that the inflow or other enhancement or saving in outflows of future economic benefits has occurred; and
b) The inflow or other enhancement or saving in outflows of future economic benefits can be measured reliably.

Question 21

Definition of Expenses and Recognition Criteria

Answer 21

The residual interest in the assets of the entity after deducting all its liabilities’. The residual interest is a claim or right to the net assets of the reporting entity.
____________________________

The criteria for the recognition of assets and liabilities, in turn, directly govern the recognition of equity. There is no need for a separate recognition criteria for equity.

Question 22

Topic 2: E6 - What role does ‘materiality’ have with respect to deciding whether particular financial information should be disclosed?

Answer 22

Generally speaking, if an item of information is not deemed material (which is, of course, a matter of professional judgment), the mode of disclosure or even whether or not it is disclosed at all should not affect the decisions of financial statement readers.

If it will affect, it is therefore material.

Question 23

Topic 2: R1 - What is a conceptual framework of accounting?

Answer 23

The conceptual framework is put in place to provide a set of guidelines and objectives towards the purpose of financial reporting.

This framework is the basis for all accounting standards, and is what all developed standards are put in place. Unless there is an agreement on central issues, it would be hard to develop consistent accounting standards.

Once a framework is established, theoretically all financial statements and standards should be consistent, as they are developed from the same framework

Question 24

Topic 2: R2 What is a general purpose financial statement?

Answer 24

• The term general purpose financial statements refers to financial statements that comply with the conceptual framework, accounting standards and other generally accepted accounting principles
• Releases by reporting entities for decision makers such as investors, lenders or creditors
• Those financial statements intended to meet the needs of users who are not in a position to require an entity to prepare reports tailored to their particular information needs

Question 25

Topic 2: R3 (1) What is a reporting entity?

Answer 25

Definition

An entity in respect of which it is reasonable to expect the existence of users who rely on the entity’s general purpose financial statements for information that will be useful to them for making and evaluating decisions about the allocation of
resources. A reporting entity can be a single entity or a group comprising a parent and all of its subsidiaries.

Question 26

Topic 2: R5 Topic Do we need a conceptual framework in Australia? Why?

Answer 26

• Matter of opinion
• Ideally would have CF before standards created, so standards developed are consistent with objective.
• Avoid debate on topics already decided in CF each time a standard is developed.

Question 27

Topic 2: R7 Should the general purpose financial statements of a company be compiled in a manner that is understandable to all investors?

Answer 27

• Generally accepted that users have a reasonable knowledge of business and accounting methods and practises.
• If you don’t know, then you’re expected to gain assistance elsewhere.

Question 28

Topic 2: R8 What is the difference between revenues and gains and do you think it is useful to subdivide income into revenues and gains? Explain your answer

Answer 28

• Revenues arise in ordinary activities throughout a business (service revenue, interest revenue etc)
• Gains, not so such as asset revaluation or selling an asset for more than historical cost.

Question 29

Topic 2: R9 What are the fundamental qualitative characteristics that financial accounting information should possess?

Answer 29

Fundamental: Relevant and Faithfully Represented (used to be reliable)

Question 30

What are the two main aspects to relevance

Answer 30

Predictive value: Info to predict what will happen in future, forecasting events.

Confirmatory Value: To confirm the predicted events in the past

Question 31

What are the three characteristics to faithful representation

Answer 31

• Complete: All info necessary is provided.
• Neutral: Without bias.
• Free from error: Not ‘100% accurate’, but no omissions, and estimates made clear.

Question 32

Topic 2: R10 What is an enhancing qualitative characteristic, and what role do enhancing qualitative characteristics have relative to the role of fundamental qualitative characteristics?

Answer 32

Complementary to fundamental characteristics (Relevance, Faithfully represented).

Comparability, Reliability, Understandability, Timeliness. These enhance decision usefulness.

Question 33

Economic benefits come from two sources

Answer 33

• Value to an entity of using an asset in the business -‘value in use’
• Value if the asset is sold—‘fair value less cost to sell’.

Question 34

Topic 3 R1: Differentiate between the ‘definition of assets’ and the ‘criteria for recognition of assets’ provided in the Conceptual Framework

Answer 34

Definition is:

• the asset should be expected to provide future economic benefits;
• the asset must be controlled (as contrasted to legal ownership); and
• the event giving rise to the control must already have occurred.

Recognition is:

(a) it is probable that any future economic benefit associated with the item will flow
to or from the entity; and

(b) the item has a cost or value that can be measured with reliability.

The recognition criteria enable the application of the definition of assets

Question 35

Topic 3 R2: Should all expenditure carried forward to future periods be amortised/depreciated? Why?

Answer 35

• Most assets have a finite period, and therefore (with the possible exception of land) should be depreciated.
• However, some assets have an indefinite period (intangible, goodwill), then impairment testing is applied.
• Impairment is different to depreciation, a change would indicate revenue or loss, and not necessarily depreciation of the asset.
• Not to be confused with revaluation, where a change in fair value would lead to depreciation.

Question 36

Topic 3 R3: If an asset is expensed in one financial year because future economic benefits were not deemed to be ‘probable’, can the same asset be reinstated in future periods if the benefits are subsequently assessed as probable? In this respect, does the ability to reinstate assets apply to all assets?

Answer 36

• It is possible that the
  recoverable amount of an asset might subsequently increase towards former levels
• According to the Framework “An item that, at a particular point in time, fails to meet the recognition criteria in paragraph 4.38, may qualify for recognition at a later date as a result of subsequent circumstances or events.
• subsequent recognition of an asset will require a credit to the entity’s profit or loss, perhaps labelled something like ‘gain from asset previously derecognised’ or ‘gain from reinstatement of asset previously written off’
• However, some standards specifically exclude the abillity to reinstate from impairment.
• Intangible assets (AASB 138) cannot be re-recognised if already expensed, even if future benefits probably. Financial Statement may be understated.

Question 37

Topic 3 R4: Why would advertising expenditure typically be expensed in the period incurred? What would be an exception to this general rule?

Answer 37

• Advertising benefits are difficult to make a judgment to quantify when exactly they were produced, or reliably measure
• Therefore AASB 138 (Intangible Assets) requires that it needs to be recognised when incurred.
• An exception is prepaid advertising, where an entity pays for the service before it is performed. It would remain an asset, and you would then account for it once it is performed

Question 38

Topic 3 R5: Should borrowing costs associated with the construction of a building be treated as part of the cost of the building, or should the borrowing costs be expensed as incurred?

Answer 38

• AASB 123 Borrowing costs that are directly attributable to the acquisition or production of an asset that takes a substantial period of time (generally 12 months) to get ready for its intended use or sale must be capitalised as part of the cost of the asset.
• The capitalisation of the borrowing costs is to cease when substantially all the activities necessary to prepare the asset for its intended use or sale are complete.

Question 39

Topic 3 R6: In accounting for the acquisition of assets, the assets acquired are to be recorded at the ‘cost of acquisition’. How would you determine the ‘cost of acquisition’?

Answer 39

• What does cost mean? Cost is the amount of cash or cash equivalents paid or the fair value of other consideration given to acquire an asset at the time of its acquisition or construction, or, when applicable, the amount attributed to that asset when initially recognised in.
• So everything involved to get it up and running, but differs from asset to asset. Need to look into question more as to what differences there are.

Question 40

Topic 3 R8: When should an ‘impairment loss’ be recognised?

Answer 40

If, and only if, the recoverable amount of an asset is less than its carrying amount,
the carrying amount of the asset shall be reduced to its recoverable amount. That
reduction is an impairment loss.

Question 41

Topic 3 R9: What is the difference between value-in-use and value-in-exchange and of what relevance is either to the determination of the amount at which an asset is to be disclosed within the statement of financial position (balance sheet)?

Answer 41

‘Fair value less costs to sell’ (value-en-exchange) is defined in paragraph 6 as ‘the amount obtainable from the sale of an
asset or cash-generating unit in an arm’s length transaction between knowledgeable, willing
parties, less the costs of disposal’.

‘Value in use’ is defined as ‘the present value of the future
cash flows expected to be derived from an asset or cash-generating unit’.

Question 42

Topic 3 R10: Can an entity include an asset in its statement of financial position that it does not legally own? Justify your answer.

Answer 42

• Yes. The requirement is that the asset be controlled, not owned. That is, ‘control’ is one of
  the important attributes of the definition of assets.
• If an asset is controlled by an entity, then by definition that entity can use the asset to generate economic benefits in the same manner as if it owned the asset.
• Assets can therefore be shown on a balance sheet, yet have a liability owing to whomever it is borrowed from.

Question 43

Topic 3 R12: How are current assets defined for the purpose of presentation in a statement of financial position (balance sheet)?

Answer 43

An entity shall classify an asset as current when:

(a) it expects to realise the asset, or intends to sell or consume it, in its normal operating cycle;
(b) it holds the asset primarily for the purpose of trading;
(c) it expects to realise the asset within twelve months after the reporting period; or

(d) the asset is cash or a cash equivalent (as defined in AASB 107) unless the asset is
restricted from being exchanged or used to settle a liability for at least twelve months after the reporting period.

An entity shall classify all other assets as non-current.

Question 44

What standard is AASB 116 and what are the two measurement models

Answer 44

Property, Plant and Equipment.

• Cost Method - cost less depreciation
• Revaluation Method - The asset is revalued to fair value

Question 45

Topic 4 R1: What effect will an asset revaluation have on subsequent periods’ profits? Explain your answer.

Answer 45

• If an upward revaluation occurs for a depreciable asset, then depreciation in subsequent periods will increase.
• Profit on sale of asset will therefore be lower, as revalued amount goes to surplus, not profit.
• If revalued and sold, surplus goes straight to retained earnings, and doesn’t register as profit or loss.

Question 46

Topic 4 R2: Explain the difference in the accounting treatment for revaluation increments and revaluation decrements. Do you consider that this difference is ‘conceptually sound’?

Answer 46

AASB 116 States

Increment: Increase recognised in comprehensive income and accumulated in equity under ‘revaluation surplus’. If reversing a loss, it is recognised as profit.

Decrement: Recognised as loss, unless reversing a revaluation surplus.

A very conservative approach, and in line with the framework, questions have to be asked as to whether this is a conservatively biased approach.

Question 47

Topic 4 R3: When should a revaluation increment be credited to the statement of comprehensive income?

Answer 47

Always

• Should be credited to ‘other comprehensive income’ as profit or loss when it reverses a previous devaluation, to reverse an expense.
• If increment goes past carrying amount (cost - deprection), then any increase credits towards a ‘revalution surplus’

Question 48

Topic 4 R6: Prior to 2005, reporting entities within Australia could offset increments and decrements within a class of assets so that only the net amount would go to profit or loss, or the revaluation surplus. This practice is no longer permitted for for-profit entities (not-for-profit entities are still permitted to offset increments and decrements within a class of assets). You are required to identify whether you prefer the pre- or post-2005 requirements, and justify your preference.

Answer 48

• Is tough given the conservative view of these methods, if one building goes down, it is registered as a loss, while if another goes up it is not ‘profit’, even though the net value is increased.
• However, the old method does raise questions of relevance and faithful representation.

Question 49

Topic 4 R8: If a reporting entity decides to revalue its property, plant and equipment, what basis of valuation must be adopted?

Answer 49

Revaluation must be to fair value, in accordance with AASB 116. If carrying value differs to fair value, then it needs to be adjusted accordingly.

Fair Value is defined in AASB 116 as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

Question 50

Topic 4 R9: If a reporting entity elects to use either cost or fair value as the basis for measuring its property, plant and equipment, can it elect to switch to the other method at a later time?

Answer 50

Yes, however only if there are justifiable reasons and as long as adequate disclosures of the change in accounting policy are made.

Question 51

Topic 4 R10: For the purposes of AASB 116, how is a ‘class of assets’ defined? Would residential land and farming land be included in the same class of assets?

Answer 51

Class of assets are a group of assets of a similar nature, and need to be revalued all at the same time.

These two it could be argued that they are ‘not of similar nature and use’ and therefore should be separate classes.

Question 52

Topic 4 R11: How could a revaluation of a non-current asset minimise or loosen the effects of a restrictive debt covenant?

Answer 52

Increasing the book value of an asset will decrease the debt to asset ratio, thereby potentially loosening the effects of a debt restriction.

Some debt contracts restrict the ability of the firm to revaluations to be conducted by them only, to avoid false asset increments.

Question 53

Topic 4 R12: Ignoring reversals of previous revaluations, do you think that requiring revaluation decrements to be part of the period’s profit or loss but letting revaluation increments go to the revaluation surplus is consistent with the requirements of the AASB Conceptual Framework? Explain your answer.

Answer 53

It is probably inconsistent, especially with the framework wanting methods to be free from bias. It could be argued that this is too conservatively biased.

You’d expect if devaluations are expensed, why not revaluations incomed?

Either way, standards take precendence over the framework, so this is how it is at the moment.

Question 54

Topic 4 R14: What does the ‘impairment of an asset’ mean? How should an impairment of an item of property, plant and equipment be accounted for?

Answer 54

If, and only if, the recoverable amount of an asset is less than its carrying amount, the carrying amount of the asset shall be reduced to its recoverable amount. That reduction is an impairment loss.

Question 55

Topic 4 R15: How should the reversal of an impairment loss be accounted for?

Answer 55

If using the ‘cost’ model, then you would debit ‘acc. impairment loss’ and credit ‘income’ as a reversal.

If using revaluation, debit the asset account and credit and income as a gain on reversal.

Question 56

Topic 4 R16: Which of the equity accounts would be affected directly or indirectly by a revaluation?

Answer 56

Revaluation Surplus: obviously as a result of increase.

Retained Earnings: At whatever point the surplus is transferred.

Profits: As depreciation expense is now higher, this would affect future profits..

Question 57

Topic 5A R1: What attributes should an item or transaction exhibit in order to be classified a liability?

Answer 57

Definition:

1. There must be an expected future disposition of economic benefits to other entities.
2. There must be a present obligation.
3. A past transaction or other event must have created the obligation.

Recognition:

1. It is probable that any future economic benefit associated with the item will flow from the entity.
2. The item has a cost or value that can be measured with reliability.

Question 58

Topic 5A R2: What is a contingent liability and how should it be disclosed for financial reporting purposes?

Answer 58

(a) a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity
(b) a present obligation that arises from past events but is not recognised because:
(i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or
(ii) the amount of the obligation cannot be measured with sufficient reliability.

Question 59

Topic 7 R1: What is a ‘temporary difference’ and why does it arise?

Answer 59

When carrying amount of asset/liability is different to tax base then ‘temporary difference’ can arise.

Temp differences can be either deductible or taxable.

Something that will lead to increase in taxable income is deferred tax liability. A decrease is a deferred tax asset.

Question 60

Topic 7 R2: How is the tax base of an asset determined?

Answer 60

Calculate what the value of the asset would be from a tax perspective.

Question 61

Topic 7 R3: How is the tax base of a liability determined?

Answer 61

The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods. In the case of revenue which is received in advance, the tax base of the resulting liability is its carrying amount, less any amount of the revenue that will not be taxable in future periods.

Question 62

Topic 7 R4: How do you determine the income tax expense of a company for accounting purposes?

Answer 62

Income tax expense represents the sum of the tax attributable to the taxable profit (where taxable profit is calculated by applying tax rules) plus or minus any adjustments relating to temporary differences.

• Tax expense (tax income) is the aggregate amount included in the determination of profit or loss for the period in respect of current tax and deferred tax.
• Tax expense (tax income) comprises current tax expense (current tax income) and deferred tax expense (deferred tax income).

Question 63

Topic 7 R5: What is the rationale for recognising a deferred tax asset or a deferred tax liability?

Answer 63

The rationale for recognising a deferred tax asset or a deferred tax liability is that failure to do so will misstate the assets and liabilities of an entity. The argument is that the entity’s current activities will create some future taxation obligations (deferred tax liabilities) or taxation benefits (deferred tax assets) which would otherwise be ignored.

Question 64

Topic 7 R8: Explain why a temporary difference relating to an ‘employee benefits in relation to long-service leave’ account creates a deferred tax asset

Answer 64

When a provision is created in relation to long-service leave, or is increased, there is no actual cash flow. There is a debit to employee benefits expense and a credit to provision for long-service leave.

When cash flows associated with the long-service leave obligation occur in a subsequent period, the ATO will allow a deduction. In a sense the company will be receiving a tax deduction for an expense that was incurred in a previous period.

Where a provision for long-service leave is created, a liability will be created for accounting purposes. However, for taxation purposes the liability is not recognised (a tax base of $0). Where the carrying amount of a liability is greater than the tax base of a liability, this will give rise to a deductible temporary difference, which will in turn give rise to a deferred tax asset.

Question 65

Topic 7 R11: Can deferred tax assets be offset against deferred tax liabilities?

Answer 65

To avoid the need for detailed scheduling of the timing of the reversal of each temporary difference, this Standard requires an entity to set-off a deferred tax asset against a deferred tax liability of the same taxable entity if, and only if, they relate to income taxes levied by the same taxation authority and the entity has a legally enforceable right to set-off current tax assets against current tax liabilities.

Question 66

Topic 8 R1: What is the role of consolidated financial statements?

Answer 66

The purpose of providing consolidated financial statements is to show the results and financial position of a group of organisations as if they are operating as a single economic entity. The ‘group’ will comprise the parent entity and all of its subsidiaries.

Question 67

Topic 8 R2a: When we are preparing consolidated financial statements, Do we make consolidation adjustments and eliminations directly to the parent entity’s and/or the subsidiaries’ accounts? Why?

Answer 67

No. Consolidation adjustments are made outside of their individual ledgers.

Entries written into a consolidation journal and are posted to a consolidation worksheet. A new worksheet required each time required.

We don’t do adjust invidually because as they are separate legal entities and we do not want to disrupt the information there, as other interested stakeholders will need this info separately.

Question 68

Topic 8 R2b: When we are preparing consolidated financial statements, Will the financial statements of the parent entity, or the subsidiary companies, as at the beginning of the financial period reflect prior period consolidation adjustments? Why?

Answer 68

No they will not. At no stage were adjustments made within, or posted to accounts of the parent or subsidiary.

These are made outside the individual ledgers, and done on a consolidation worksheet.

The affects of past consolidation adjustments are not incorporated in any opening balances and need to be replicated across successive years.

Question 69

Topic 8 R2c: When we are preparing consolidated financial statements, will we have to eliminate the parent entity’s investment in the subsidiaries each year as part of our consolidation entries, or will we only have to do the elimination in the first year following acquisition but not thereafter? Why?

Answer 69

We will have to eliminate the parent entity’s investment in the subsidiaries each year as part of our consolidation. As we are performing the consolidation in a worksheet and as we do not adjust the ledger accounts of the individual legal entities making up the economic entity, the effects of past consolidation adjustments and eliminations are not incorporated in any opening balances and need to be replicated across successive years. This is an important point that students often forget

Question 70

Topic 8 R3: The consolidated statement of financial position will show the total assets controlled by the economic entity (group) and the total liabilities owed to parties outside the economic entity. As such, will liabilities owing to, and amounts receivable from, organisations within the group (that is, within the economic entity) be eliminated in the consolidation process, and not be shown in the consolidated statement of financial position? Why?

Answer 70

All amounts owing to, and receivable from will be eliminated in the consolidation process, and not shown in the consolidated statements.

This is because consolidated statements want to show the relative group as a single economic entity. It doesn’t make sense to ‘owe your self’ funds.

Question 71

Topic 8 R4: There is one asset that appears in the consolidated statement of financial position, but probably does not appear in the parent entity’s or subsidiaries’ separate accounts, and there is also one asset that will appear in the statement of financial position of the parent entity, but will not appear in the consolidated financial statements. Which accounts would these be?

Answer 71

Goodwill is typically recognised as part of the consolidation process, and is generally on the CFS, but won’t appear in the FS of parent or subsidiary.

Gain on bargain sale.

Question 72

Topic 8 R5 a): Define a legal entity

Answer 72

The term legal entity refers to each individual entity that has its own legal status, such as a company or a trust.

Question 73

Topic 8 R5 b): Define an economic entity

Answer 73

An economic entity is a group of entities comprising the parent entity and each of its subsidiaries. An economic entity may comprise many legal entities.

Question 74

Topic 8 R5 c): Define a parent entity

Answer 74

A parent entity controls another entity. A parent is defined in AASB 10 as ‘an entity that controls one or more entities’.

Question 75

Topic 8 R5 d): A subsidiary

Answer 75

A subsidiary is defined in AASB 10 as an entity that is controlled by another entity

Question 76

Topic 8 R6: On consolidation, how is the goodwill on acquisition or the bargain gain on purchase determined?

Answer 76

Goodwill is the excess of the cost of an acquisition incurred by an entity, measured at fair value, over the net fair value of the identifiable assets, liabilities and contingent liabilities acquired.

Question 77

What are the three main elements of control

Answer 77

Power

Exposure to Variable Returns

The investor’s ability to use power to affect its amount of variable returns

Question 78

Topic 8 R8: What is ‘fair value’ and why is it relevant to consolidation accounting?

Answer 78

Fair Value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

Relevant because when consolidating, you need to eliminate the investment against the pre-acquisition share capital. This needs to be fair value, which helps in calculating what goodwill, if any is found.

Question 79

Topic 11 R1: Identify and describe the three types of activities that are reported in the statement of cash flows. Why do you think that AASB107 would require such a breakdown?

Answer 79

Operating Activities
Investing
Financing

Important to distinguish between the three, in the long run you would prefer to have most of your cash coming through by way of operating activities. While all cash flows important, the way cash is flowing gives a good idea of the risk or vitality of an entity.

Question 80

Topic 11 R3: Define ‘cash and cash equivalents’ for the purposes of a statement of cash flows.

Answer 80

Cash comprises cash on hand and demand deposits.

Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.

Question 81

Topic 11 R5: Is cash-flow data more ‘reliable’ than profit-related data? Explain your answer.

Answer 81

The argument that it is is based on the fact that accrual profit is based primarily on professional (and therefore maybe arbitrary) judgments, and the data could be skewed. They could arguably be manipulated.

Cash can be more objectively determined and therefore less susceptible to manipluation. However, jury is out as to whether or not it is more relevant data.

Question 82

Topic 11 R6: Which form of information is more useful for evaluating the financial performance and position of a reporting entity: cash-flow data or information about accounting profits? Explain your answer

Answer 82

Arguably accounting profit data. Cash flows assess only cash and equivalents, while accounting profit measures all economic benefits/losses. Not all economic benefits come in the form of cash, however this is not to discount the importance of cash flow..

Also, if you received cash for a building, it would not affect net profit, although it does show cash..

Question 83

Topic 11 R7a: Discuss the practical difficulties in preparing a statement of cash flows pursuant to AASB107 Critically appraise its value to the statutory accounts.

Answer 83

• Obtaining the information
• Working out whether transactions relate to operating, investing or financing.
• Definition of cash equivalents.
• Reconciling the cash flows from operations with the net profit.

Question 84

Topic 11 R7b: Critically appraise its value of Statement of Cash flows to the statutory accounts.

Answer 84

• Provides other information not available in other sections.
• Difference between cash flow and profits, which is useful in assessing the solvency of the business.
• Past cash flows may be useful in forming predictions about the future.
• Summarise management’s investment and financing policies.

Question 85

Topic 11 R9: Pursuant to AASB107, apart from the statement of cash flows, what other disclosures must be made?

Answer 85

• Information about transactions and other events that do not result in any cash flows during the financial year but affect assets and liabilities that are recognised
• The policy for determining what items are ‘cash’ or ‘cash equivalents’
• Reconciliation of the amount of cash at the end of the period related to the items in Balance Sheet.
• Summary of used and unused loan facilities
• Amount of cash not available for use, and why they are restricted.
• Reconciliation of cash flows from operating activities compared to profit and loss.

Question 86

Topic 9 R1: What is an intra group transaction and why do we need to know about them.

Answer 86

Intragroup transactions are transactions undertaken between the separate legal entities (subsidiaries and the parent entity) comprising an economic entity (the group). We need to know about them because there is a requirement that on consolidation the effects of all intragroup transactions must be eliminated in full—and this applies even if the subsidiary is not 100 per cent owned.

Question 87

Topic 9 R2: When does an intragroup inventory transaction require us to perform a consolidation adjustment to tax expense?

Answer 87

• When the related profits are unrealised from the perspective of the economic entity.
• Where an unrealised profit has been eliminated in a group, the single legal entity still reports the profit, therefore a tax difference has occurred.

Question 88

Topic 9 R3: In the consolidated financial statements, which dividends are to be shown as paid, declared, payable and receivable?

Answer 88

Only dividends that are paid to external entities outside the group.

Intragroup dividends require elimination.

Question 89

Topic 9 R4: How would dividends that have been paid out of pre-acquisition earnings of a subsidiary be treated in the accounts of the parent entity?

Answer 89

• Used to be a return part of the asset.
• Now it is treated as income, and a dividend revenue is recorded in the parent entity, this is for both pre-and post-acquisition.
• An impairment loss is recognised if shares fair value exceed below the original cost of the investment.

Question 90

Topic 9 R5: What effect, if any, would the payment of dividends by a controlled entity, out of its pre-acquisition earnings, have on the amount of goodwill that would be recognised on consolidation?

Answer 90

No effect. If a dividend payment is subsequently paid from pre-acquisition earnings, then there is not retrospective change. If there was an impairment loss, that loss would be reversed in the consolidation.

Question 91

Topic 9 R6: If one entity sells inventory to another entity, which is 80 per cent owned, what percentage of the sales revenue needs to be eliminated in the consolidation process?

Answer 91

100% The effects of all transactions between entities within the economic entity shall be eliminated in full. This is the case if a subsidiary is 100 per cent owned or, for example, 80 per cent owned.

Question 92

Topic 5A R3: If a reporting entity has an obligation to clean up a contaminated site, but does not believe it can measure the liability with any reliability, then should the obligation be disclosed at all within the financial statements and accompanying notes? If so, how would it be disclosed?

Answer 92

No as it doesn’t meet criteria. If there is possibility they will be obliged to pay, and it is not deemed to be ‘remote’, then disclosure is appropriate.

They would be disclosed in the notes if it is material information, providing a brief explanation.

Question 93

Topic 5A R7: Some researchers argue that it would be harder to renegotiate a public debt agreement than a private debt agreement. Why do you think this might be the case?

Answer 93

Higher the debt, the higher the perceived level of risk, and more obligations for the entity regardless of profit or cash flows.

Orgs often enter into contracts which say they cannot go over a certain amount of debt..