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Solution manual test bank Chapter 5: Balance Sheet iStudy Questions Please refer to the iStudy for solutions to these questions. Apply Your Knowledge Australia’s largest book retailers, REDgroup Retail, collapsed on 17 February 2011. The REDgroup Retail owns 103 Angus & Robertson bookshops and 26 Borders stores in Australia.
Subsequent to the collapse, one Border’s outlet and 37 Angus & Robertson branches were closed, making 321 staff redundant. Subsequent to the announcement of financial difficulties of REDgroup Retail, Borders and Angus & Robertson book stores refused to honour the face value of gift vouchers. “Customers attempting to use gift vouchers are being told they have to spend double the value of each voucher” (ABC News, Friday 18 February 2011). Required:. Explain the initial recording that Borders should prepare when a customer purchases a book gift voucher for $100 cash. (3 marks) When a customer purchases a book gift voucher for $100 cash, Borders’ cash balance would increase by $100, which will be recorded on the debit side of the general journal. The credit entry will record an increase in a prepaid or unearned revenue account, which is a liability.
Hence, the initial recording in the general journal would be: Dr Cash 100 Cr Prepaid (or unearned ) Revenue 100 (to record sales of gift voucher for cash). Using the definition and recognition of financial report elements contained in the Conceptual Framework, discuss why you have suggested the particular recording.
(8 marks) From the journal entry above, it can be seen that an asset account (cash) has increased. The Conceptual Framework defines an asset as ‘a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity’.
The $100 cash that Borders receives from the sale of gift voucher is an asset because:. it is controlled by Borders as Borders can use the cash for whatever purposes or deny access to others from using the cash;. it arises as a result of a past event, which is the sale of gift voucher;. it gives Borders future economic benefits in the form of purchasing items or paying for expenses. The $100 cash also satisfies the recognition criteria of probable occurrence and reliable measurement. It is probable (i.e.
More likely than less likely) that Borders will receive the future economic benefits from the cash received, a transaction has occurred and the customer has given the cash to Border in exchange for the gift voucher. Further, the cash received has a value that can be measured with reliability, being $100. The credit side of the journal entry records an increase in a liability account (prepaid or unearned revenue). The Conceptual Framework defines a liability as ‘a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits’. The $100 revenue received in advance is a liability because:. there is a present obligation for Borders to give the customer goods upon redemption of the voucher;.
the present obligation arises as a result of a past event, which is sale of gift voucher;. Borders will have to make sacrifices of future economic benefits when the customer redeems the voucher (i.e. In the form of goods to be exchanged with the voucher). The prepaid revenue also satisfies the recognition criteria of probable occurrence and reliable measurement. It is probable (i.e.
More likely than less likely) that Borders will have to sacrifice future economic benefits as the recipient of the voucher is likely to redeem it. In addition, the liability can be faithfully measured as t has a face value of $100. Explain the recording that Borders would prepare when a customer redeems their $100 gift voucher by using it to purchase $100 of books. The cost price of the books that the customer purchased is $40. (6 marks) When a customer redeems their $100 gift voucher by using it to purchase $100 of books, there is a reduction in Borders’ liabilities as an outstanding book voucher has been redeemed with Borders making a sacrifice (i.e. As a result, the prepaid revenue account will be debited.
The redemption of the voucher also means that Borders can now recognise income from the sale of books as they have provided the goods to the customer. Assuming a perpetual inventory system is used in recording inventory, the journal entries that Borders would prepare to record the redemption of the gift voucher would be: Dr Prepaid or unearned Revenue 100 Cr Sales Revenue 100 (to record the redemption of gift voucher for books) Dr Cost of Sales 40 Cr Inventory – Books 40 (to record the cost of books sold). It was reported in the financial press that REDgroup Retail had a total of $6.4 million in cash, and inventory on hand of $119.9 million when it collapsed. Further, it had employee benefits (amounts owed to employees for annual leave) of $7.8 million and unsecured creditors of $44 million. Using the Conceptual Framework, explain the essential characteristics that categorise amounts owed to employees for annual leave as a liability.
(5 marks) The Australian National Employment Standards stipulates that full-time and part-time employees are entitled to receive certain amount of days of paid annual leave. This implies that REDgroup needs to recognise the annual leave entitlements of workers as they accrue. This amount owed to employees for annual leave is a liability for REDgroup because it satisfies the definition of liability in the Conceptual Framework, which is ‘a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits’.
There is a present obligation for REDgroup to pay annual leave to its employees as part of their entitlements. This obligation arises as a result of past events, in which the employees provide their service to REDgroup.
For every day that employees work for REDgroup, they will accumulate a portion of annual leave which they can take sometimes in the future when needed. When employees take their annual leave, there will be outflows of economic benefits from REDgroup in the form of payments made to employees for their usual salary even though they will not be working during the time of taking annual leave. Taking annual leave will reduce REDgroup’s provision for annual leave. For this liability to be recorded in REDgroup’s balance sheet, it must also satisfy the recognition criteria of probable occurrence and reliable measurement. In the case of REDgroup, it is probable that the outflows of economic benefits will be incurred as employees have provided their services and hence they have accumulated their annual leave. In the event that an employee resigned with annual leave entitlements owing, the company has an obligation to pay out these entitlements. In addition, the amount owed to employees for their annual leave can be measured with reliability using a rate calculated based on the employees’ salary.
Therefore, the annual leave owed to employees is recorded under liability section in REDgroup’s balance sheet as it satisfies both definition and recognition criteria of liability. Comprehension Questions 5.4 Discuss if the following statements are true or false. The terms ‘accounts receivable’ and ‘creditors’ mean the same thing. FALSE – these terms actually have opposite meaning.
The terms ‘accounts receivable’ or ‘debtors’ are used to describe entities/people who owe money to an entity. If the debtors owe money as a result of the entity selling goods or providing services, the debtors are referred to as trade debtors. On the contrary, the terms ‘creditors’ or ‘accounts payable’ are used to describe entities/individuals to whom an entity owes money, such as suppliers, or utility companies. The balance sheet is a financial statement that shows the financial position of an entity as at a point in time. TRUE – the balance sheet shows the assets, liabilities and equity of an entity at a point in time, hence it is titled ‘Balance Sheet as at’.
Ms Entrep invests her own cash to start a business. This transaction will increase the equity and assets of the business. TRUE – the owner’s contribution of cash increases the assets of the entity. The dual effect of this is to recognise that the owner has contributed equity to the business, and the equity in the balance sheet increases by the same amount as the assets have increased. All entities are legally obliged to prepare general purpose financial reports. FALSE – in Australia, only entities that are assessed as reporting entities are obliged to prepare general purpose financial statements. The Conceptual Framework defines reporting entities as entities in which it is reasonable to expect the existence of users who depend on general purpose financial statements for decision-making.
If an entity does not have users who are dependent upon its general purpose financial statements to make decisions, then it can prepare special purpose financial statements. The measurement system used in accounting is historical cost. FALSE – The Conceptual Framework discusses a number of measurement systems used in financial reporting in addition to historical cost. These include current cost, realisable value, and present value.
Although many items are initially recorded at historical cost, different measurement basis may be applied subsequently if permitted by accounting standards. Further, for some items (e.g.
Biological assets, certain financial instruments), the prescribed measurement is one based on a fair value concept. 5.5 The balance sheet for Promotion Pty Ltd reveals cash on hand of $8000, accounts receivable of $48 000, inventory measured at $50 000 and plant and equipment measured at $116 000.
The liabilities of the entity are: accounts payable $28 000, a bank overdraft of $32 000 and a loan of $180 000. Relate this information to the liquidity of the entity. Liquidity refers to the ability of the entity to pay their debts as they fall due. Liquidity can be assessed by comparing the entity’s current assets and current liabilities.
The current assets of Promotion total $106 000 being: cash $8000, accounts receivable $48 000, and inventory $50 000. The entity’s current liabilities are $60 000 being the accounts payable $28 000 and bank overdraft of $32 000. Although not explicitly stated, it is assumed that the loan is for a period exceeding one year and therefore is not a current asset. As Promotion’s current assets exceed their current liabilities, the entity would not appear to have a liquidity problem. This assumes that the inventory is saleable, the cash can be recovered from the debtors and the entity is generating sufficient cash flow to service its debt obligations.
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Given the entity’s stated liabilities exceed its stated assets, the entity’s equity is negative. This suggests that the entity has accumulated losses. 5.6 An entity has total assets measured at $170 000 on the balance sheet. The entity’s liabilities total $100 000, of which $40 000 is a bank loan. Calculate the entity’s net assets. Discuss the entity’s financing decision. Net assets refer to an entity’s total assets less total liabilities.
Given that the entity’s assets are $170 000 and the total liabilities are $100 000, the entity’s net assets are: Net Assets = Assets less Liabilities = $170 000 – $100 000 = $70 000 The entity is financing its assets with $100 000 of liabilities and $70 000 of equity. This means that the entity is using more debt than equity to finance its assets. For every $1 of assets, the entity has $0.59 of liabilities and $0.41 of equity. Relative to equity funding, interest-bearing debt has to be serviced via regular interest payments and the entity would have to have sufficient cash to meet these fixed interest payments. 5.7 List three essential characteristics necessary to consider an item either as an asset or a liability. The Conceptual Framework defines an asset as ‘a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity’ The Conceptual Framework defines a liability as ‘a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits’ 5.8 The Snags Software Company wants to increase its asset base by recognising its customer list as an assets.
Discuss whether this is permissible under accounting standards. Customer lists are regarded as intangible assets and accounting rules applicable from 1 January 2005 to reporting entities under AASB 138 Intangible Assets specify that certain intangible assets (such as brands, mastheads, publishing titles, or customer lists) that are internally generated (rather than being purchased) cannot be recorded as assets on the balance sheet (para. Prior to 1 January 2005, Australian entities had discretion to record such internally generated intangibles as assets. This means that The Snags Software Company would not be able to increase its asset base by recognising its customer list in the balance sheet. While it can be argued that such assets satisfy the asset definition criteria, regulators’ concerns are that being able to reliably measure such assets, when they do not trade in an active and liquid market, is problematic. If Snags had acquired the customer lists as part of a business acquisition, it could legitimately record them as intangible assets since they had been purchased.
Accounting for intangible assets is controversial and many Australian firms were opposed to being disallowed the opportunity to recognise internally generated intangible assets as assets on the balance sheet. (Note: Show students an extract of a company report with derecognised identifiable intangibles – Coca-Cola would be a good example given that it had to derecognise many millions of dollars of intangible assets). Note: it is interesting to explore students’ views as to the appropriateness of having different accounting treatments for internally generated versus acquired intangible assets.
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5.9 JB Hi-Fi Ltd has a legal obligation to prepare and lodge financial statements. Access the notes to JB Hi-Fi Ltd’s financial statements and identify the rules and regulations that govern the basis for the preparation of the financial statements. Compare this with the basis for the preparation of the financial statements used by a not-for-profit organisation of your choice.