Further Sub Classifications of The Line Items Shall Be Disclosed Either Directly in The Statement of

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PART 1 - ESSAY

1. Explain the presentation of assets and liabilities in the statement of financial position.

IAS 1 requires presentation of classified statement of financial position where current


assets or liabilities are separated from non-current assets or liabilities. Basically, the asset or
liability is current when it is expected to be recovered or settled within 12 months after the
reporting period1.

With regard to a minimum content, the following line items shall be presented:

ASSETS EQUITY AND LIABILITIES


Property, plant and equipment Issued capital and reserves attributable to
Investment property owners of the parent
Intangible assets Non-controlling interests
Financial assets Financial Liabilities
Investments accounted for using equity Provisions
method
Biological assets
Inventories
Trade and other receivables Trade and other payables
Cash and cash equivalents
Totals of assets in accordance with IFRS 5 Totals of liabilities in accordance with IFRS 5
Non-current assets Held for Sale and Non-current assets Held for Sale and
Discontinued Operations Discontinued Operations
Current tax assets Current tax liabilities
Deferred tax assets Deferred tax liabilities
Further sub classifications of the line items shall be disclosed either directly in the statement of
financial position or in the notes, such as disaggregation of property, plant and equipment into
classes, and similar. Also, certain information related to the share capital, reserves and a few
others shall be included in the statement of financial position, the statement of changes in
equity or in the notes.

IAS 1 does NOT prescribe the precise format of the statement of financial position. Instead,
several formats are acceptable if they fulfill all requirements outlined above.

2. What are the essential characteristics of assets?

Financial accounting has basic elements like assets, liabilities, owners’ equity, revenue,
expenses and net income (or net loss) which are related to the economic resources, economic

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obligations, residual interest and changes in them. Similarly, balance sheet which displays
financial position of a business enterprise has basic elements like assets, liabilities, and owners’
equity.

Assets have the following main characteristics2

(1) Future Economic Benefits:


‘Future economic benefit’ or ‘service potential’ is the essence of an asset. This means
that the asset has capacity to provide services or benefits to the enterprises that use them. In a
business enterprise, that service potential or future economic benefit eventually results in net
cash inflows to the enterprise.

Money (cash, including deposits in banks) is valuable because of what it can buy. It can
be exchanged for virtually any goods or services that are available or it can be saved and
exchanged for them in the future. Money’s command over resources—its purchasing power—is
the basis of its value and future economic benefits.

Assets other than cash provide benefits to a business enterprise by being exchanged for
cash or other goods or services, by being used to produce or otherwise increase the value of
other assets, or by being used to settle liabilities. Services provided by other entities including
personal services cannot be stored and are received and used simultaneously.

They can be assets of a business enterprise only momentarily—as the enterprise


receives and uses them—although their use may create or add value to other assets of the
enterprise. Rights to receive services of other entities for specified or determinable future
periods can be assets of particular business enterprises.

(2) Control by a Particular Enterprise:


To have an asset, a business enterprise must control future economic benefit to the
extent that it can benefit from the asset and generally can deny or regulate access to that
benefit by others, for example, by permitting access only at a price.

Thus, an asset of a business enterprise is future economic benefit that the enterprise
can control and thus, within limits set by the nature of the benefit or the enterprise’s right to it,
use as it desires.

Although the ability of an enterprise to obtain the future economic benefit of an asset
and to deny or control access to it by others rests generally on foundation of legal rights, legal

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enforceability of a right is not an indispensable prerequisite for an enterprise to have an asset if


the enterprise otherwise will probably obtain the future economic benefit involved. For
example, exclusive access to future economic benefit may be maintained by keeping secret a
formula or process..

(3) Occurrence of a Past Transaction or Event:


Assets imply the future economic benefits of present assets only and not the future
assets of an enterprise. Only present abilities to obtain future economic benefits are assets and
these assets are the result of transactions or other events or circumstances affecting the
enterprise.

For example, the future economic benefits of a particular building can be an asset of a
particular entity only after a transaction or other event—such as a purchase or a lease
agreement—has occurred that gives it access to and control of those benefits.

Similarly, although an oil deposit may have existed in a certain place for millions of
years, it can be an asset of a particular enterprise only after the enterprise has discovered it in
circumstances that permit the enterprise to exploit it or has acquired the rights to exploit it
from whoever had them.

This characteristic of assets excludes from assets items that may in the future become
an enterprise’s assets but have not yet become its assets. An enterprise has no asset for a
particular future economic benefit if the transactions or events that give it access to and control
of the benefit are yet in the future.

3. Explain briefly an operating cycle.

The operating cycle is the average period of time required for a business to make an
initial outlay of cash to produce goods, sell the goods, and receive cash from customers in
exchange for the goods. This is useful for estimating the amount of working capital that a
company will need in order to maintain or grow its business.

4. What are the essential characteristics of liabilities?

A liability has three essential characteristics: (a) it embodies a present duty or


responsibility to one or more other entities that entails settlement by probable future transfer
or use of assets at a specified or determinable date, on occurrence of a specified event, or on
demand, (b) the duty or responsibility obligates a particular entity, leaving it little or no
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discretion to avoid the future sacrifice, and (c) the transaction or other event obligating the
entity has already happened.

Characteristic (a) requires the liability to "embody a present duty or responsibility... That
entails settlement". In legal terms this would be an obligation to pay a specific party or parties.
By strict definition, accrual-in-advance may not meet this definition. When considering the
financial substance of the transaction and its effect on current financial position, the liability
created under the accrue-in-advance method may be a far more accurate measurement.
Accrue-in-advance allows for true matching of expenses (and liabilities) to the periods in which
they occurred.

Characteristic (b) requires "the duty or responsibility obligates a particular entity, leaving it
little or no discretion to avoid the future sacrifice". From a practical standpoint, major overhaul
costs cannot be avoided, and in some cases they are strictly regulated. Weather accrue-in-
advance meets this portion of the definition would depend on the intent of the applying party.

Characteristic (c) requires "the transaction or other event obligating the entity has already
happened". The accrue-in-advance method provides a measurable result in the period in which
it occurs, and the resulting expense and liability are matched to that period. In conclusion, aside
from the definition of liability issue, we believe that the accrue-in advance method of
accounting for major maintenance activities is a financially sound method of accounting.

5. Explain fully the treatment of currently maturing long-term debt.

The current maturity of a company’s long-term debt refers to the portion of liabilities


that are due within the next 12 months. As this portion of outstanding debt comes due for
payment within the year, it is removed from the long-term liabilities account and recognized as
a current liability on a company’s balance sheet. Any amount to be repaid after 12 months is
kept as a long-term liability3.

For example, assume Michael A. Company has a P120, 000 outstanding debts to be paid
off in P20, 000 installments over the next six years. P20, 000 will be recognized as the current
portion of long-term debt to be repaid this year. P100, 000 will be recorded as a long-term
liability. It is possible for all of a company's long-term debt to suddenly be classified as debt
with a current maturity if the firm is in default on a loan covenant. In this case, the loan terms
usually state that the entire loan is payable at once in the event of a covenant default, which
makes it a short-term loan.

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6. Explain the classification of a liability if the related covenants are breached.

Almost every loan agreement will be carrying some of the terms and conditions that are
required to be fulfilled by a borrower to keep that loan continue as per the agreed terms OR an
immediate re-payment might be initiated which can end the relationship related to the debt.
Presentation of Financial Statements4
Where there is a breach of a material provision of a long-term loan arrangement on or
before the end of the reporting period with the effect that the liability becomes payable on
demand on the reporting date, the entity does not classify the liability as current, if the lender
agreed, after the reporting period and before the approval of the financial statements for issue,
not to demand payment as a consequence of the breach,
However, an entity classifies the liability as non-current if the lender agreed by the end
of the reporting period to provide a period of grace ending at least twelve months after the
reporting period, within which the entity can rectify the breach and during which the lender
cannot demand immediate repayment.
7. Explain the treatment of a contingent liability
A subjective assessment of the probability of an unfavorable outcome is required to
properly account for most contingences. Rules specify that contingent liabilities should be
recorded in the accounts when it is probable that the future event will occur and the amount of
the liability can be reasonably estimated. This means that a loss would be recorded (debit) and
a liability established (credit) in advance of the settlement.
On the other hand, if it is only reasonably possible that the contingent liability will
become a real liability, then a note to the financial statements is required. Likewise, a note is
required when it is probable a loss has occurred but the amount simply cannot be estimated.
Normally, accounting tends to be very conservative (when in doubt, book the liability), but this
is not the case for contingent liabilities. Therefore, one should carefully read the notes to the
financial statements before investing or loaning money to a company5.
Four Potential Treatments for Contingent Liabilities
1. If the contingency is probable and estimable, it is likely to occur and can be
reasonably estimated. In this case, the liability and associated expense must be
journalized and included in the current period’s financial statements (balance sheet
and income statement) along with note disclosures explaining the reason for
recognition.

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2. If the contingent liability is probable and inestimable, it is likely to occur but cannot
be reasonably estimated. In this case, a note disclosure is required in financial
statements, but a journal entry and financial recognition should not occur until a
reasonable estimate is possible.
3. If the contingency is reasonably possible, it could occur but is not probable. The
amount may or may not be estimable. Since this condition does not meet the
requirement of likelihood, it should not be journalized or financially represented
within the financial statements. Rather, it is disclosed in the notes only with any
available details, financial or otherwise.
4. If the contingent liability is considered remote, it is unlikely to occur and may or may
not be estimable. This does not meet the likelihood requirement, and the possibility
of actualization is minimal. In this situation, no journal entry or note disclosure in
financial statements is necessary.

8. Explain the treatment of a contingent asset.

A contingent asset is a potential asset or economic benefit for a company. It does not
currently exist but may arise in the near future. The occurrence of such a contingent asset depends
on the occurrence or the non-occurrence of a particular set of events over which the company
itself does not have full control. Such an asset or economic interest arises from an uncertain and
unpredictable event.
Due to their uncertainty and in accordance with some accounting concepts, contingent
assets do not find themselves on the balance sheet of a company. Let us enumerate the reasons a
contingent asset is not recognized as an asset,

 Uncertain Event: The occurrence of such a benefit is not a given. Since the outcome of
the event is not fully in control of the company we cannot guarantee its occurrence. There
may be a case where we might recognize a contingent asset that never realizes. Hence they
are kept off the balance sheet of the company.
 Conservatism: The conservatism principle clearly states that any uncertain future
expense must be recognized immediately. But any future uncertain income must not be
recognized. A contingent asset will come under the latter. The idea behind the principle was
to record the lowest possible profit in the spirit of trueness and fairness of the financial
statements.

Disclosure of Contingent Asset


A contingent asset should not be disclosed in the financial statements following the
accounting concept of prudence. However, the approving authorities can make a mention of the
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asset in their report. In the case of a company, this will be the report by the Board of Directors. But
such a disclosure can be made in the report only if,

1. The economic benefit is probable, i.e. more than likely to happen


2. The amount of such an asset/benefit can be estimated reliably
Contingent assets are to be monitored very closely. Once it becomes certain that
the economic benefit will arise, only then can they be included in the financial statements of the
company. Then the asset is not a contingent asset anymore6.

9. Explain share capital, subscribed share capital and share premium.

Share Capital
Share capital is the money a company raises by issuing common or preferred stock. The
amount of share capital or equity financing a company has can change over time with
additional public offerings.

The term share capital can mean slightly different things depending on the context.
Accountants have a much narrower definition and their definition rules on the balance sheets
of public companies. It means the total amount raised by the company in sales of shares.

Subscribed Share Capital


Subscribed shares are shares that investors have promised to buy. These shares are
usually subscribed as part of an initial public offering (IPO). When a company prepares to "go
public" by issuing stock for the first time, investors can submit an application expressing their
desire to participate.3
Underwriters often promise to deliver a certain number of subscribed shares prior to
the IPO. The subscribers are usually large institutional investors and banks. Subscribed share
capital refers to the monetary value of all the shares for which investors have expressed an
interest.
Share Premium
A share premium account is typically listed on a company’s balance sheet. This account
is credited for money paid, or promised to be paid, by a shareholder for a share, but only when
the shareholder pays more than the cost of a share. This account can be used to write off
equity-related expenses, such as underwriting costs, and may also be used to issue bonus
shares7.

10. Discuss the meaning of the term reserves.


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In financial accounting, "reserve" always has a credit balance and can refer to a part
of shareholders' equity, a liability for estimated claims, or contra-asset for uncollectible
accounts.
A reserve can appear in any part of shareholders' equity except for contributed or basic
share capital. In nonprofit accounting, an "operating reserve" is the unrestricted cash on hand
available to sustain an organization, and nonprofit boards usually specify a target of
maintaining several months of operating cash or a percentage of their annual income, called an
Operating Reserve Ratio. 
Reserves help in safeguarding the financial position of a company and can be used for
various purposes such as expansion, stable dividend repayments, and legal requirements,
meeting contingencies, improving the financial situation, investments and more. It is also
sometimes referred to as retained earnings. It is shown on the liability side of a balance sheet
under the head. “Reserves and Surplus” along with capital. If a company incurs losses then it is
not created.

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