Week 3 Tutorial Questions

Chapter 2: Financial statements for decision making

Discussion questions
5. Discuss why the payment for an entity's telephone bill is an expense, yet the cash
paid to the owner is not an expense.

The Conceptual Framework defines expenses as ‘decreases in assets, or increases in liabilities,

that result in decreases in equity, other than those relating to distributions to holders of equity
claims’ (CF, par4.69). In other words, for an item to be classified as an expense, there must be
decreases in assets which result in decreases in equity, but the decrease must not be related to a
distribution to an owner. The cash payment for the telephone bill is a decrease in asset (reduced
cash at bank) that reduces equity. Since this payment is not a payment to the owner, it thus
meets the definition of an expense. Cash paid to an owner is also a decrease in an asset (reduced
cash at bank) that thus reduces equity, however it does not meet the definition of an expense as it
is a distribution to an owner (often referred to as a distribution or drawings).

6. Discuss whether an asset needs to be legally owned to be recorded as an asset on the

statement of financial position.

Assets are defined in the Conceptual Framework as ‘a present economic resource controlled by the
entity as a result of past events’ (para. 4.3). That is, to be recorded as assets, the entity must have
the ability to benefit from the use of the assets and deny access of others to the benefits (i.e.
control).

Although, in most cases, legal ownership will give the entity control over an asset, certain types of
lease arrangements can result in the entity controlling the asset. For example, finance leases
transfer the risks and benefits of ownership to the lessee, which means the leased asset is now
controlled by the lessee. Subsequently, the leased asset should be recorded as an asset on the
lessee’s Statement of financial position, even though the lessee does not legally own the asset
just yet.

Furthermore, following the qualitative characteristics of faithful representation in the Conceptual

Framework, it is important that the economic substance rather than the legal form of the
transaction is reported. In a finance lease, legal title to the leased asset still remains with the
lessor until the end of the relevant lease term when the lessee has made all lease payments.
However, the lessee has use of and earns economic benefits from the leased asset for this time
period (i.e. economic substance), and hence the leased asset should be recorded as an asset in the
lessee’s Statement of financial position during the period of the lease term.

In summary, an asset does not need to be legally owned by the entity to be recorded as an asset on
the Statement of financial position. As long as the entity controls the asset, then the asset must be
reported on the entity’s Statement of financial position.
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11. List and define the fundamental and enhancing characteristics of financial
information.

The two fundamental characteristics of financial information are:

 Relevance: relevance means that the information contained in financial statements is able to
influence the economic decisions made by users. For example, the information may help
users to predict future events, such as future cash flows, from alternative courses of action
under consideration. Also, information is relevant if it is able to help decision makers
evaluate past decisions. The information may confirm that a previous decision was correct, or
it could show that the results of a previous decision were undesirable and that a new decision
is necessary. Thus, relevant information is said to play a predictive role and a confirmatory or
feedback role.
 Faithful representation: faithful representation is attained when the depiction of an
economic event is complete (i.e. all information necessary to represent the event are
included), neutral (i.e. free from bias), and accurate (i.e. free from material error). In
addition, financial information that faithfully represents an economic phenomenon should
depict the economic substance of the underlying transaction, event or circumstances, rather
than its legal form.

The four enhancing characteristics of financial information are:

 Comparability: comparability is the quality of information that enables users to identify
similarities in and differences between two sets of economic data. For financial information
to be comparable, users need to be able to compare information of an entity over time, and
between entities at one time and over time.
 Verifiability: if financial information is verifiable, it means that different independent
observers would reach general agreement that the information represents economic event it
purports to represent without material error or bias.
 Timeliness: to be relevant for decision-making, financial information must be available in a
timely manner. If there is undue delay in reporting the information to users, then the
information will lose its capacity to influence decisions (i.e. no longer relevant).
 Understandability: the Conceptual Framework defines understandability as the quality of
information that enables users who have a reasonable knowledge of business and economic
activities and financial accounting, and who study the information with reasonable diligence,
to comprehend its meaning.

Exercise 2.7

Assumptions and characteristics of information LO3

Identify by letter, the assumption or characteristic of information which best represents the
situations given.

A. Accounting entity assumption

B. Accrual basis assumption
C. Going concern assumption
D. Period assumption
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E. Relevance
F. Faithful representation
G. Materiality
H. Comparability

F. 1. The reporting of accounting information should be free from personal bias.

A. 2. In a single proprietorship, the owner’s house and car are not recorded in the records of
the business.
G. 3. The cost of stationery is not shown separately in the statement of financial
performance.
B. 4. Services provided by a business entity are recorded before the receipt of cash.
E. 5. Machinery held by the business under a long-term lease arrangement is recorded by the
business as its own asset.
D. 6. The period of time covered by the financial statements.
C. 7. Assets are not recorded at liquidation prices.
H. 8. Consistent accounting policies and methods are used in the preparation of financial
statements from one year to another.

Exercise 2.10

Explaining accounting transactions LO5

The following schedule shows the effect of several transactions on the accounting equation
of Photomania, a photography business, and the balance of each item in the equation after
each transaction. Write a sentence to explain the nature of each transaction. (LO5)
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(1) $20 000 was invested into the business by the owner.
(2) Purchased office equipment for cash $7000.
(3) A further $2000 was invested into the business, or sold services for cash.
(4) Performed services and billed clients for $6000.
(5) Office supplies of $3000 were bought on credit.
(6) $4000 was received from clients for amounts owed (accounts receivable).
(7) $8000 was withdrawn from the business, or expense paid in cash.
(8) $2000 worth of office supplies were used.
(9) Paid accounts payable $3000 owed to them.
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Chapter 3: Recording transactions

Exercise 3.9

Recording transactions in general journal

The following information relates to the business of Man Ting’s Travel Agency for the
month of June 2022:

Required
a. Prepare general journal entries to record the above events, as appropriate, in the
accounting records of Man Ting’s Travel Agency. Ignore GST.
b. (a)
c.
MAN TING’S TRAVEL AGENCY (ignore GST)
2022
June 1 Cash at Bank 120 000
Man Ting Lau, Capital 120 000
Cash contributed by owner.
2 Office Equipment 36 000
Cash at Bank 36 000
Office equipment purchased for cash
3 No entry required
6 No entry required at this point (the booking may be
cancelled!?)
15 Cash at Bank 10 000
Accounts Payable 9 000
Commission Income 1 000
Cash received as part payment for airlines and hotel.
22 Accounts Payable 4 200
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Cash at Bank 4 200

Cash paid to airline.
25 Accounts Payable 4 800
Cash at Bank 4 800
Cash paid to hotel chain as part payment.
30 Wages Expense 3 500
Cash at Bank 3 500
Cash paid for one month’s wages to employee
d.
e. Note: Commission income is recognised above as cash is received even though, under the
contract, the agency is not ‘entitled’ to the income until the client pays in full. An
argument could also be put with students that the total commission income of $1600
could be recorded on 6 June, when the trip is booked for the client. Questions to consider:
f. Has the income been ‘earned’?
g. Is it probable that it will be received?
h. [Use AASB 118 paragraph 20 (revenue from services) as a guide].
i.
j. (b)
k.
June 1 This transaction is an investment of cash assets into the business by the owner. A
credit is made to the Capital account (equity) to reflect the increase in the owner’s
investment in the business, and the increase in the Cash at Bank account (asset) is
recorded by a debit.

2 The Office Equipment account is increased to record the purchase by debiting the
account. At the same time, Cash at Bank is decreased by crediting the account for
the amount of the cash paid.

3 No entry is made at this time as the hiring of staff does not represent a transaction.
The assistant is owed nothing as he/she has not yet performed any services for the
business.

6 No entry is made at this date as there is no clear evidence that the entity has
performed services, and it is possible that the booking may be cancelled without
any penalty. [However, an argument could be mounted that part of the income
could be recognised if para. 20 if AASB 118 Revenue is considered to apply and
the percentage of completion of the services can be determined in a faithful,
verifiable manner.]

18 This is an income transaction reflecting the amount of commission earned on the

cash received to date from the client. Hence, an income account, called
Commission Income, is credited for 10% of the cash received, and Cash at Bank is
debited for the amount received from the customer. A liability, Accounts Payable,
is credited to record the amount owing by the business to the airline and to the
hotel chain.
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22 The Accounts Payable liability account was credited at that time the amount of
cash was received from the customer. Now, the payment of the Accounts Payable
to the airline is recorded by reducing the liability account (debit) and reducing the
Cash at Bank account (credit) for the amount of $4800.

25 The Accounts Payable liability account was credited at that time the amount of
cash was received from the customer. Now, the payment of the Accounts Payable
to the hotel chain is recorded by reducing the liability account (debit) and reducing
the Cash at Bank account (credit) for the amount of $4200, namely $9000 – $4200.

30 Wages are an expense of the business to reflect the cost of services received by the
business from its employees. The business pays the assistant for the services
he/she has rendered to the business for the month by crediting the Cash at Bank
account and debiting the Wages Expense account.

Problem 3.18

Preparing the general journal

Non-GST version

The Arid Sands Golf Club was opened for business on 1 July by Todd Simpson. The
following selected events and transactions occurred during the first month of operations.

Required
Prepare general journal entries for the month of July, using appropriate account titles.
Ignore GST. (LO4)

July 1 Cash at Bank 2 500 000

Todd Simpson, Capital 2 500 000
Cash contributed by owner.
3 Land 1 000 000
Building 650 000
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Equipment 150 000

Cash at Bank 1800000
Jeffrey’s Golf World acquired for
cash.
6 Advertising Expense 36 000
Cash at Bank 36 000
Cash paid for advertising.
10 Prepaid Insurance 36 000
Cash at Bank 36 000
Cash paid for 1 year insurance
policy.
18 Golfing Equipment 60 000
Accounts Payable 60 000
Purchase of golfing equipment
from Rory Golfing.
19 Cash at Bank 22 000
Golf Fees Income 22 000
Cash received for golf fees.
25 Cash at Bank 80 000
Unearned Golf Services 80 000
Cash received on sale of 200
coupon books for $90 each.
27 Todd Simpson, Drawings 10 000
Cash at Bank 10 000
Cash withdrawn by owner.
29 Wages Expense 12 600
Cash at Bank 12 600
Cash paid for wages
30 Accounts Payable 60 000
Cash at Bank 60 000
Cash to Rory Golfing.
31 Cash at Bank 12 000
Golf Fees 12 000
Income
Cash received for
golf fees.