1
Q
A conceptual framework should provide consensus on:
A
- 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.
2
Q
Benefits of a conceptual framework
A
- 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.
3
Q
Why are conceptual frameworks developed
A
Provide guidance on key issues, such as objectives, qualitative characteristics, definitions and recognition criteria.
4
Q
Difference between conceptual framework and accounting standards
A
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..
5
Q
Objective of General Purpose Financial Reports
A
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.
6
Q
What is the current conceptual framework called.
A
IASB Conceptual Framework for Financial Reporting
7
Q
Qualitative characteristics of financial information—good quality information—is made up of:
A
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.
8
Q
What are the primary qualitative characteristics, and the four enhancing qualitive characteristics
A
- Relevance and Faithfully Represented
- Timeliness, Understandibility, Comparability, Verifiability.
9
Q
What are two main aspects to relevance characteristic
A
Predictive Value and Confirmatory (Feedback) value
10
Q
What is the base generally set at for materiality in AASB 1031
(No longer a quantitative test)
A
- 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.
11
Q
What are the three characteristics of faithful representation
A
Complete
Neutral
Free from error
12
Q
Definition of an Asset
A
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.
13
Q
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:
A
(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.
14
Q
Five elements of financial statements
A
Assets, Liabilities, Income, Expenses, Equity
15
Q
Define Fair Value
A
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.
16
Q
What are the benefits of conceptual framework
A
- 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.
17
Q
Definition of Assets and Recognition Criteria
A
- 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.
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.
18
Q
Definition of Liabilities and Recognition Criteria
A
- There must be an expected future disposition of economic benefits to other entities.
- There must be a present obligation.
- 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.
19
Q
Definition of Income and Recognition Criteria
A
- Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or
- 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.
20
Q
Definition of Expenses and Recognition Criteria
A
- Expenses are decreases in economic benefits during the accounting period in the form of outflows
- 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.
21
Q
Definition of Expenses and Recognition Criteria
A
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.
22
Q
Topic 2: E6 - What role does ‘materiality’ have with respect to deciding whether particular financial information should be disclosed?
A
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.
23
Q
Topic 2: R1 - What is a conceptual framework of accounting?
A
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
24
Q
Topic 2: R2 What is a general purpose financial statement?
A
- 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
25
Topic 2: R3 (1) What is a reporting entity?
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.
26
Topic 2: R5 Topic Do we need a conceptual framework in Australia? Why?
- 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.
27
Topic 2: R7 Should the general purpose financial statements of a company be compiled in a manner that is understandable to all investors?
- 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.
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
- 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.
29
Topic 2: R9 What are the fundamental qualitative characteristics that financial accounting information should possess?
Fundamental: Relevant and Faithfully Represented (used to be reliable)
30
What are the two main aspects to relevance
Predictive value: Info to predict what will happen in future, forecasting events.
Confirmatory Value: To confirm the predicted events in the past
31
What are the three characteristics to faithful representation
- Complete: All info necessary is provided.
- Neutral: Without bias.
- Free from error: Not '100% accurate', but no omissions, and estimates made clear.
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?
Complementary to fundamental characteristics (Relevance, Faithfully represented).
Comparability, Reliability, Understandability, Timeliness. These enhance decision usefulness.
33
Economic benefits come from two sources
- 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’.
34
Topic 3 R1: Differentiate between the ‘definition of assets’ and the ‘criteria for recognition of assets’ provided in the Conceptual Framework
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
35
Topic 3 R2: Should all expenditure carried forward to future periods be amortised/depreciated? Why?
- 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.
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?
- 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.
37
Topic 3 R4: Why would advertising expenditure typically be expensed in the period incurred? What would be an exception to this general rule?
- 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
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?
- 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.
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’?
- 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.
40
Topic 3 R8: When should an ‘impairment loss’ be recognised?
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.
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)?
‘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’.
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.
- 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.
43
Topic 3 R12: How are current assets defined for the purpose of presentation in a statement of financial position (balance sheet)?
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.
44
What standard is AASB 116 and what are the two measurement models
Property, Plant and Equipment.
- Cost Method - cost less depreciation
- Revaluation Method - The asset is revalued to fair value
45
Topic 4 R1: What effect will an asset revaluation have on subsequent periods' profits? Explain your answer.
- 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.
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’?
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.
47
Topic 4 R3: When should a revaluation increment be credited to the statement of comprehensive income?
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'
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.
- 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.
49
Topic 4 R8: If a reporting entity decides to revalue its property, plant and equipment, what basis of valuation must be adopted?
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.
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?
Yes, however only if there are justifiable reasons and as long as adequate disclosures of the change in accounting policy are made.
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?
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.
52
Topic 4 R11: How could a revaluation of a non-current asset minimise or loosen the effects of a restrictive debt covenant?
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.
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.
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.
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?
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.
55
Topic 4 R15: How should the reversal of an impairment loss be accounted for?
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.
56
Topic 4 R16: Which of the equity accounts would be affected directly or indirectly by a revaluation?
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..
57
Topic 5A R1: What attributes should an item or transaction exhibit in order to be classified a liability?
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.
58
Topic 5A R2: What is a contingent liability and how should it be disclosed for financial reporting purposes?
(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.
59
Topic 7 R1: What is a ‘temporary difference’ and why does it arise?
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.
60
Topic 7 R2: How is the tax base of an asset determined?
Calculate what the value of the asset would be from a tax perspective.
61
Topic 7 R3: How is the tax base of a liability determined?
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.
62
Topic 7 R4: How do you determine the income tax expense of a company for accounting purposes?
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).
63
Topic 7 R5: What is the rationale for recognising a deferred tax asset or a deferred tax liability?
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.
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
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.
65
Topic 7 R11: Can deferred tax assets be offset against deferred tax liabilities?
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.
66
Topic 8 R1: What is the role of consolidated financial statements?
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.
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?
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.
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?
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.
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?
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
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?
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.
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?
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.
72
Topic 8 R5 a): Define a legal entity
The term legal entity refers to each individual entity that has its own legal status, such as a company or a trust.
73
Topic 8 R5 b): Define an economic entity
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.
74
Topic 8 R5 c): Define a parent entity
A parent entity controls another entity. A parent is defined in AASB 10 as ‘an entity that controls one or more entities’.
75
Topic 8 R5 d): A subsidiary
A subsidiary is defined in AASB 10 as an entity that is controlled by another entity
76
Topic 8 R6: On consolidation, how is the goodwill on acquisition or the bargain gain on purchase determined?
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.
77
What are the three main elements of control
Power
Exposure to Variable Returns
The investor's ability to use power to affect its amount of variable returns
78
Topic 8 R8: What is ‘fair value’ and why is it relevant to consolidation accounting?
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.
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?
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.
80
Topic 11 R3: Define ‘cash and cash equivalents’ for the purposes of a statement of cash flows.
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.
81
Topic 11 R5: Is cash-flow data more ‘reliable’ than profit-related data? Explain your answer.
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.
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
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..
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.
- 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.
84
Topic 11 R7b: Critically appraise its value of Statement of Cash flows to the statutory accounts.
- 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.
85
Topic 11 R9: Pursuant to AASB107, apart from the statement of cash flows, what other disclosures must be made?
- 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.
86
Topic 9 R1: What is an intra group transaction and why do we need to know about them.
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.
87
Topic 9 R2: When does an intragroup inventory transaction require us to perform a consolidation adjustment to tax expense?
- 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.
88
Topic 9 R3: In the consolidated financial statements, which dividends are to be shown as paid, declared, payable and receivable?
Only dividends that are paid to external entities outside the group.
Intragroup dividends require elimination.
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?
- 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.
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?
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.
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?
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.
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?
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.
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?
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..
Accounting
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