Week Four

Question 1

Identify the financial reporting obligations of an entity.

Answer 1

The reporting obligations of an entity vary depending on the nature of the entity. Entities with public accountability are required to prepare general purpose financial statements in accordance with approved accounting standards.

Question 2

What can a financial report include?

Answer 2

Four financial statements:

• a balance sheet
• an income statement (statement of profit and loss)
• statement in changes in equity
• statement of cash flows

Question 3

Sole traders/partnerships in financial reporting

Answer 3

there is no legal requirement to prepare financial statements as the business are not separate legal entities from their owners.

Question 4

General purpose financial statements (GPSF)

Answer 4

Financial statements prepared to meet the info needs common to external users who are unable to command the preparation of statements tailored to their needs. Follows generally accepted accounting principles (GAAP)

Question 5

GAAP

Answer 5

generally accepted accounting principles that are a set of rules and practices that guide financial reporting

Question 6

Public accountability

Answer 6

entities with securities debt or equity, traded in a public market or entities that hold assets in a fiduciary capacity as their main business activity.

Question 7

Explain the nature and purpose of the balance sheet.

Answer 7

The balance sheet lists the entity’s assets, the external claims on the assets (the liabilities) and the internal claim on the assets (the equity).

The balance sheet reports the entity’s financial position at a point in time. The financial position of the entity refers to the entity’s:
•economic resources (assets)
•economic obligations (liabilities)
•financial structure
•financial solvency.

Question 8

Investment decisions

Answer 8

Decisions involving the acquisition and sale of investments and productive non-current assets using cash, and lending money and collecting on those loans

Question 9

Financing decisions

Answer 9

Decisions involving the mix of debt and equity financing chosen by the entity

Question 10

Liquidity

Answer 10

Ability of an entity to meet its short-term financial commitments

Question 11

Outline the effect of accounting policy choices, estimates and judgements on financial statements

Answer 11

Even when preparing financial statements in compliance with accounting standards, preparers are given accounting choices and are required to use estimations and judgements. Users of financial statements need to appreciate that accounting flexibility, discretion and incentives exist that may affect preparer’s choices, estimations and judgements, and therefore they need to be aware of the impact of these choices, estimations and judgements on the financial information reported.

Question 12

Apply the asset definition and recognition criteria.

Answer 12

The essential characteristics for an asset are:
•the resource must be controlled by the entity
•the resource must be as a result of a past event
•future economic benefits are expected to flow to the entity from the resource.

The item does not have to be tangible or exchangeable to be regarded as an asset. To be recognised on the balance sheet, the economic benefits must be probable and capable of being measured reliably.

An entity can always disclose information about an asset that fails the definition or recognition criteria in the notes to the accounts.

Question 13

Asset recognition

Answer 13

Recording items in the financial statements with a monetary value assigned to them

Question 14

Monetary concept

Answer 14

Use of money as a the basis of quantifying items in financial statements.

Question 15

Apply the liability definition and recognition criteria.

Answer 15

The essential characteristics for a liability are:
•a present obligation to another entity
•the present obligation arises as a result of past events
•an outflow of resources embodying economic benefits is expected to flow from the entity as a result of settling the present obligation.

A legal obligation is a liability; however, a non-legal obligation may also be a liability.

To be recognised on the balance sheet, the outflow and resources embodying economic benefits must be probable and capable of being measured reliably.

An entity can always disclose information about a liability that fails the definition or recognition criteria in the notes to the accounts.

Question 16

Contingent

Answer 16

existence of an asset or liability arising from a past event that may be confirmed only by uncertain future events not controllable the entity

Question 17

Discuss the definition and nature of equity.

Answer 17

Equity is the residual interest in the assets of the entity after the liabilities have been deducted. The equity balance represents the owner’s or owners’ claims on the entity’s net assets. The equity on the balance sheet comprises capital that has been contributed by owners, and gains (or losses) accruing to the entity that are undistributed.

Question 18

Describe the format and presentation of the balance sheet.

Answer 18

The balance sheet is usually presented in a narrative format or a T-format. A balance sheet in narrative format lists the assets, liabilities and equity in a column format. The T-format lists the assets on one side, with the liabilities and equity on the other side. It is usual for the balance sheet to report the financial figures for the current period and the corresponding previous reporting period. If an entity has subsidiary entities, then the balance sheet reports the consolidated entity results.

Question 19

Describe the presentation and disclosure requirements for elements on the balance sheet.

Answer 19

Assets and liabilities are assigned either a current or non-current classification on the basis of when the economic benefits (sacrifices) are expected to occur.

If the benefits (sacrifices) are expected to occur within 12 months of the end of the reporting period or within the entity’s operating cycle, a current classification is appropriate.

For assets (liabilities) where the benefit (sacrifice) is expected to occur beyond the next 12 months or operating cycle, a non-current classification results.

Within the current and non-current sections, assets and liabilities are classified according to their nature or function.

Typical asset classifications include cash; receivables; inventories; investments; property, plant and equipment; intangibles; tax assets; and other assets.

Typical liability classifications include payables; interest-bearing liabilities; provisions; and tax liabilities.

The equity classifications on the balance sheet are capital (contributed equity), reserves, retained earnings, and non-controlling interests.

A breakdown of the items within the various classifications is usually included in the notes to the accounts. The terms given to various elements on the balance sheet, and the extent to which entities aggregate elements for the purposes of balance sheet disclosure, vary according to the entity structure.

Question 20

Operating cycle

Answer 20

length of time it takes for an entity to acquire and sell goods and collect the cash from the sale.

Question 21

Cash and cash equivalents

Answer 21

cash held at bank, on hand and in short term deposits

Question 22

Trade receivables or accounts receivable

Answer 22

Amounts due from customers for the sale of goods or services

Question 23

Derivative financial asset

Answer 23

Financial asset whose value depends on the value of an underlying security, reference rate or index

Question 24

Identifiable intangible assets

Answer 24

Intangible assets that can be identified (eg trademarks, brand names etc)

Question 25

Goodwill

Answer 25

An unidentifiable intangible asset (eg established client base)

Question 26

Trade payables (trade creditors)

Answer 26

Amounts owed to suppliers for the purchase of goods or services

Question 27

Provisions

Answer 27

Liability class involving more uncertainty regarding the monetary value to be assigned to the future sacrifice of economic benefits

Question 28

Financial liability

Answer 28

Liability that is a contractual obligation to deliver cash or another financial asset to another financial asset to another entity or a contractual obligation to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity

Question 29

Derivative financial liability

Answer 29

financial liability whose value depends on the value of an underlying security, reference rate or index

Question 30

Secured debt

Answer 30

debt with a priority claim on the entities assets in the event of the entity demise

Question 31

Reserves

Answer 31

equity accounts that organise in a variety of ways including asset revaluations (revaluation surplus), transfers of profits (general reserve) or movements in exchange rates (foreign currency translation reserve)

Question 32

Discuss the measurement of various assets and liabilities on the balance sheet.

Answer 32

Numerous measurement systems can be used to measure elements on the balance sheet. Items are initially recorded at their historical cost. At the time of acquisition, this reflects the items’ fair values.

Subsequent to acquisition, receivables are recorded at their expected cash equivalent and inventory is measured at the lower of cost and net realisable value.

Property, plant and equipment can either remain at their cost price or be revalued regularly to fair value. Regardless, the carrying amount of an asset must not exceed its recoverable amount. If it does, the asset is impaired and must be written down.

There are some asset classes (such as agricultural assets and derivative financial instruments) where accounting rules specify that the assets must be recognised at their fair value.

Non-current assets with limited lives must be depreciated. Goodwill cannot be revalued and identifiable intangible assets can only be revalued if an active and liquid market exists. Goodwill and intangible assets must be tested for impairment at least annually. The value assigned to such assets on the balance sheet is their cost or revalued amount, less the accumulated depreciation charges, less any impairment charges.

It is important for a user to identify the basis for measuring assets and liabilities on the balance sheet

Question 33

Discuss the limitations of the balance sheet.

Answer 33

When analysing the financial numbers on the balance sheet, it is necessary to consider issues associated with the preparation of the statement that potentially limit the inferences made.

The balance sheet is a historical snapshot of the entity’s economic resources and obligations at a point in time only, and this may not be representative of its resources and obligations throughout the reporting period.

Further, the balance sheet does not represent the value of the entity. This is due to the existence of assets and liabilities that are not reported on the balance sheet, and the measurement systems used to recognise assets and liabilities.

Finally, the definition and recognition of items on the balance sheet involve management choices, estimations and judgements.