Company accounting ch1 tut working Essay
Company accounting ch1 tut working
The board of directors has resolved to change the accounting policy for treatment of advertising expenditure. Previously, advertising expenditure has been expensed as incurred. Following extensive market research, the board has taken the view that benefits from advertising expenditure in the form of product awareness and increased sales will be received by the company over a 3-year period following the expenditure. Due to a recent fire and water damage to the company’s accounting records, details of advertising expenditure in prior years have been destroyed. Required:
The board of directors has approached you for advice regarding the disclosures, if any, which are required for this change in accounting policy.
As the change in accounting policy was voluntary, the provisions of paragraph 29 of AASB 108 are applicable as follows: the nature of the change the reasons that applying the new accounting policy provides reliable and more relevant information to the extent practicable, the amount of the adjustment for the current and previous periods to each financial statement line item affected and, if applicable, the basic and diluted earnings per share the amount of the adjustment relating to periods prior to those presented to the extent practicable if retrospective application is impracticable, the circumstances that led to the existence of that condition and a description of how and from when the change in accounting policy was applied.
To comply with paragraph 29, the change in accounting policy note may be worded as follows (other variations are possible):
The board of directors has resolved to change the accounting policy for treatment of advertising expenditure. Previously, advertising expenditure had been expensed as incurred. However, following extensive market research, the board has taken the view that benefits from advertising expenditure in the form of product awareness and increased sales and will be received by the company over a 3 year period following the expenditure. Accordingly, the board believes the new accounting policy will provide reliable and more relevant information.
Retrospective application of this change in accounting policy is impractical following a recent fire and water damage which has destroyed the company’s accounting records.
Note, insufficient information was provided in the case study to determine: the amount of the adjustments for the current period to each financial statement line item affected; calculation of basic and diluted earnings per share; and how and from when the change in accounting policy was applied.
Case Study 3 – Materiality
Antelope Ltd is a catering company specialising in providing catering services to remote area mine sites. The company has operations in Australia but during the current year it acquired significant long-term contracts in Pakistan and Nigeria. AASB 8 Operating Segments requires entities to disclose material segment information but Antelope Ltd has failed to comply with this requirement Required:
Discuss whether the non-disclosure of information about operations in Pakistan and Nigeria would be material.
Information is material if its omission or misstatement would influence the economic decisions of users taken on the basis of the financial report (the Conceptual Framework, paragraph QC11). The non-disclosure of information relating the existence of long-term contracts in both Pakistan and Nigeria would be material to the users of Antelope’s financial statement. Both countries are politically and economically unstable so there is a significant risk that these operations could be disrupted exposing Antelope Ltd to potential losses on the contracts and other losses if corporate employees are harmed or property is destroyed. Disclosing the information allows users to factor in such risks into their predictions about the company’s future performance and position and ensures an informed decision is made.
Furthermore, paragraph 12 of AASB 1031 notes:
In deciding whether an item or an aggregate of items is material, the size and nature of the omission or misstatement of the items usually need to be evaluated together. In particular circumstances, either the nature or the amount of an item or an aggregate of items could be the determining factor. For example: an entity expands its operations into a new segment which affects the assessment of the risks and opportunities facing the entity (paragraph 12(b)(iii)).
NOTE: This solution is only one possibility. Students may use alternative or average base amounts.
1.Unrecorded creditor’s invoices
These invoices understate Expenses (purchases and service related expenses) and Accounts Payable by $62 150.
Error as % of base
Profit before tax
17.7% (62 150/352 000)
19.7% (62 150/316 000)
As the error is greater than 10% of both base amounts it is material and must be adjusted.
If the invoices all relate to purchases within a perpetual inventory system the accounts affected are Inventories (current asset) and Accounts Payable (current liability) and there will be nil profit effect.
2.Sales invoices not processed
These invoices understate both Sales Revenue and Accounts Receivable by $50 000. Additionally, Cost of goods sold (expense) is understated and Inventory (current asset) is overstated by $36 000. The profit effect is $14 000 ($50 000 – $36 000).
Error as % of base
Profit before tax
3 600 000
1.4% (50/3 600)
The omitted invoices are material in relation to inventories and should be adjusted.
3.Bankruptcy of Debtor after reporting date
The adjustment will increase Bad Debts expense by $89 120 and decrease
Accounts Receivable by $89 120.
Error as % of base
Profit before tax
25.3% (89 120/352 000)
14.4% (89 120/621 000)
The overstatement is material in relation to both base amounts and must be adjusted as it relates to conditions existing at reporting date. QUESTION 12.3
The significant variances between the provision for warranty and the actual repairs in the two years indicate that either the policy of using a percentage of net credit sales as a means of estimating warranty costs is not appropriate, or the percentage used is not adequate. The company needs to look at changing either its policy or perhaps simply increasing the percentage used. Past claims as a percentage of past net credit sales should provide a reliable measure. If a new percentage is adopted it will be applied prospectively (from 2015-16 on) according to AASB 108 paragraph 36.
If the variance for 2014-15 was due to an error in calculation then, providing it is material, the figures for 2014-15 should be retrospectively corrected (according to AASB 108 paragraph 42) by the following entry:
Retained earnings (1 July 2015)Dr 8 000
Provision for WarrantyCr8 000
Additionally, this would indicate that the variance in 2013-14 may be a one-off aberration.
Release of investigator’s report on 1 August 2015
The release of the report and the decision that damages were payable by Antelope Ltd provide new information about conditions existing at the end of the reporting period given that the release of the noxious gases occurred in June 2015. At $750 000 the amount is clearly material (in relation to profit before tax of $360 000) and the following adjustment should be made:
June 30Damages expenseDr750 000
Damages payableCr750 000
(Recognition of damages liability)
Credit notes raised on 9 July 2015
As these credit notes relate to sales which occurred prior to the end of the reporting period this provides more information about conditions existing at 30 June 2015 and will (or may, depending on materiality) require adjustment by journal entry. However, as the credit notes represent only approximately 4% of profit before tax ($15 000/$360 000), it could be argued that no adjustment is necessary on the grounds of immateriality. The journal entry (ignoring materiality considerations) is shown below:
June 30Sales returns and allowancesDr15 000
Accounts receivableCr15 000
(Credit notes relating to June sales)
Liquidation of debtor
As the liquidation was caused by an event after the end of the reporting period no adjustment will be made as this information does not change the situation that existed at 30 June 2015. However, the $52 000 loss (80 cents in the dollar x $65 000) will be material to next year’s profits based on the current year’s profit before tax ($52 000/$360 000 = 14%), and must be disclosed by note.
Notes to the financial statements year ended 30 June 2015
Note X:Events occurring after the end of the reporting period In September 2015, a debtor owing $65 000 went into liquidation. The company expects to recover only 20% of the amount owing.QUESTION
AASB 108, paragraph 36 requires that the effect of a change in an accounting estimate shall be recognised prospectively by including it in profit or loss in the period of the change. New information in the form of debts which actually went bad during the year ended 30 June 2015 proved that the estimate of doubtful debts as at 30 June 2014 (last year) was inadequate and should have been $17 600 rather than $12 000. The amount of $5 600 ($17 600 – $12 000) in bad debts written off that was more than allowed for last year has been added to bad debts expense for the current year (i.e. prospectively) in accordance with paragraph 36. The balance of the bad debts expense for the current year, $23 400, is comprised of $17 800 (allowance for doubtful debts as at 30 June 2015 based on an analysis of outstanding account receivable balances) plus $5 600 (adjustment for underestimation of allowance for doubtful debts as at 30 June 2014).
The key issue here is whether or not the change in the way Mousedeer Ltd estimates its doubtful debts is a change in an accounting policy. AASB 108, paragraph 35 states ‘A change in the measurement basis applied is a change in an accounting policy, and is not a change in an accounting estimate. When it is difficult to distinguish a change in an accounting policy from a change in an accounting estimate, the change is treated as a change in an accounting estimate.’ The asset here is Accounts Receivable, a financial asset which is measured at the lower of nominal value and recoverable amount.
Where a debt is not expected to be collected in full it is disclosed in the financial statements at its expected amount via the allowance for doubtful debt adjustment. The change in the way this ‘recoverable amount’ is estimated does not change the measurement basis and is therefore not a change in accounting policy. Mousedeer Ltd should disclose the nature and amount of any change in an accounting estimate (according to AASB 108 paragraph 39), usually in its accounting policy note.