Unit 1 – CF, IAS 1 and IAS 8 2024

Accounting 3
2024

Study guide

THE REPORTING ENVIRONMENT

And
THE CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

Unit 1
(Updated by S Qakaza – February 2024)

1. Learning outcomes:
When you have completed this unit, you should be able to formulate a technically accurate
solution to a practical case study based on the principals in the framework:

B1.1 Fundamental reporting concepts

Level Learning Outcomes Minimum content
2 a) Identify users’ needs and develop a reporting
approach by selecting suitable reporting and
regulatory framework(s) which satisfies most
users’ needs in general purpose reporting by:
(i) Applying the fundamental theories related Agency theory, stakeholder theory, legitimacy
to reporting theory
(ii) Applying the objective, usefulness and IFRS, IFRS for SMEs, GRAP, <IR> Framework,
limitations of the available reporting Task Force on Climate-related Financial
frameworks Disclosures, The Global Reporting Initiative, The
UN’s Sustainable Development Goals
(iii) Applying the objective, nature and Companies Act, JSE Listings Requirements, King
characteristics of regulatory frameworks IV Report, Public Finance Management Act,
and requirements Municipal Management Act
3 b) Apply the qualitative characteristics and IFRS
principles of useful information
2 c) Identify, define and evaluate appropriate IFRS
reporting boundaries
3 d) Identify, define and evaluate the different IFRS
elements in reporting frameworks
e) Apply the recognition and de-recognition IFRS
criteria to an element
f) Select and apply a measurement basis to an IFRS
Unit 1 – IAS 1 and IAS 8 2024

B1.1 Fundamental reporting concepts

Level Learning Outcomes Minimum content
element
g) Critically analyse and prepare presentation IFRS
and disclosures for a selected framework and
reporting boundary
1 h) Explain the concepts of capital and capital IFRS
maintenance
2 i) Critically analyse and prepare non-GAAP IFRS
disclosures in an ethical manner
1 j) Explain and contrast the various formats of XBRL
reporting
k) Identify and explain emerging trends and IFRS
forthcoming changes in financial and non-
financial reporting

2. Prescribed reading material:

The prescribed literature for this unit is as follows:
a) International Financial Reporting Standards (IFRSs):
Conceptual framework for financial reporting, IAS 1 and IAS 8
b) Gripping GAAP:
• Chapter 1 – The reporting environment
• Chapter 2 – The conceptual framework for financial reporting

3. Introduction

This topic lays the foundation for what is done in accounting and financial reporting and is
considered very important. You need to understand the concepts in the Conceptual Framework
and begin to develop your professional judgment in making decisions about how to account for
economic phenomenon.

This topic is reinforcement of knowledge learnt from accounting 3. Students should pay special
attention to the use of the Conceptual Framework in an open-book assessment.
Unit 1 – IAS 1 and IAS 8 2024

Accounting 3
2024

Study guide

IAS 1 Presentation of financial statements

IAS 8 Accounting policies, estimates and
errors.

Unit 1
(Updated by S Qakaza– February 2024)

Table of contents

1. Learning outcomes
2. Prescribed reading material
3. Introduction
4. Lecture notes and class examples – IAS 1
5. Lecture notes and class examples – IAS 8
6. Tutorial questions
Unit 1 – IAS 1 and IAS 8 2024
4. Learning outcomes:
When you have completed this unit you should be able to:

Learning outcome
a) Develops or evaluates accounting policies in accordance with IFRS: *
• Identifies and evaluates alternative accounting methods for the entity’s routine financial transactions, e.g. revenue recognition,
short-term investments.
• Selects accounting policies, within IFRS, that most fairly present the financial situation.
• Understands and incorporates the requirements of new standards into the entity’s accounting policies.
b) Prepares general purpose financial statements using the identified basis of accounting to achieve fair presentation of the entity’s
financial position and performance. *
c) Prepares or evaluates financial statement note disclosure: *
• Prepares information to be included in the notes to the financial statements.
• Ensures note disclosure enhances the fair presentation of the entity’s financial performance.
• Ensures note disclosure is in accordance with the identified basis of accounting, is complete and provides useful and
understandable info to users.
d) Explains the financial statement results and balances to stakeholders *
• Explains the financial information in the context of the entity’s operations and activities during the period using financial statement
tools such as ratio and trend analysis.
• Provides a tailored description of the entity’s balances as at the reporting date to the different stakeholder groups.
• Ensures that the explanation accurately reflects the entity’s results and takes into account the degree of sophistication of the
stakeholder group.
e) Maintains awareness of key ideas and principles of proposed financial reporting standards changes: *
• Understand the purpose and process of issuing exposure drafts, and is aware of any major proposed changes.
IAS 1
• Prepare and correctly present the following general purpose financial statements and related notes
• Statement of financial position;
• Statement of profit or loss and other comprehensive income (alternatively, income statement and statement of
comprehensive income);
• Statement of changes in equity;
• Understand the current versus non-current distinction;
• Understand, and be able to apply, the overall considerations of financial statements; and
• Know when departures from Stds are allowed.
IAS 8
• Understand all issues relating to a change in accounting policy (including all disclosure requirements);
• Understand all issues relating to a change in accounting estimate (including all disclosure requirements);
• Understand all issues relating to a material prior period errors (including all disclosure requirements).
* These outcomes are introduced in this unit and then applied throughout the remaining units to specific
topics

5. Prescribed reading material:

The prescribed literature for this unit is as follows:
a) International Financial Reporting Standards (IFRSs):
• IAS 1 (excluding para 8A and 136A)
• IAS 8

b) Gripping GAAP:
Chapter 3 (excluding section 11.8)
Chapter 26

6. Introduction:
IAS 1 – that part of the unit that relates to IAS 1 will seldom be tested on its own. It forms the
foundation for the preparation and presentation of financial statements. This implies that it
will usually be tested in an indirect manner when you answer a question relating to
presentation and disclosure. Discussion points from IAS 1 may be included in general
discussion questions.
Unit 1 – IAS 1 and IAS 8 2024

This unit will also allow you to revise what you learnt in Accounting 2 and in the Units on PPE
and Deferred tax, especially the calculation and presentation of taxation and deferred taxation
in profit/loss and other comprehensive income.

Items of OCI that may be reclassified to P/L will only be covered later in the course.
At that stage you should revise example 14 in Chapter 3.

IAS 8 – you have already dealt with changes in accounting estimates and correction of
prior period errors in Accounting 2. In Accounting 3 we also deal with changes in
accounting policies. This is then integrated into future topics where changes in
accounting policy are possible.

PRESENTATION IN TESTS AND EXAMS:

In tests and exams marks are awarded for presentation when the student is required to
prepare financial statements or note disclosure. By allocating marks to presentation the
student is effectively given time (1 mark = 1.5 minutes) to present the answer correctly in
accordance with IAS 1 and the applicable IFRS.

These marks are awarded on the following basis:

E.G. Presentation marks (all students start with the max) say, 3

½ mark is subtracted for every presentation or disclosure error e.g:

- ½ for not putting R or R’000 or Rm above the numbers
- ½ for not using the company’s name in the headings
- ½ for not identifying the report correctly (e.g. Statement of profit or
loss and other comprehensive income)
- ½ for not totaling the rows and columns
Unit 1 – IAS 1 and IAS 8 2024
Make sure you know what is required in an assessment question (as per the options
available to preparers in IAS 1 para 10A):

• A single Statement of Profit or Loss and Other Comprehensive Income

• or under the two statement approach:
o A separate Statement of Profit or Loss (or called an Income Statement)
o A Statement of Comprehensive Income (which starts with profit or loss for the
year)

HOW DO YOU KNOW WHAT TO PREPARE?

1. We will tell you whether the company has chosen to prepare a single statement or two
statements in terms of IAS 1.81A.

2. A single statement *
a. Starts with Revenue and ends with Total comprehensive income for the year.
b. Can be called
• A Statement of Profit or Loss and Other Comprehensive Income or
• A Statement of Comprehensive Income

3. The two statement approach

a. From Revenue to Profit for the year is called
• a Statement of Profit or loss or
• an Income Statement
b. From Profit for the year to Total Comprehensive Income is called
• A Statement of Profit or Loss and Other Comprehensive Income or
• A Statement of Comprehensive Income

Please read the question carefully.

* We will most often require you to prepare a single statement (2a above) and call it a Statement
of Comprehensive Income.

Items that appear in other comprehensive income (covered in Accounting 3)

Items that will not be reclassified to profit or loss

• Revaluation of property, plant and equipment (IAS 16)
• Gains/losses on remeasuring investments in equity instruments designated at FV
through OCI (IFRS 9)

Items that may be reclassified subsequently to profit or loss

• Gains/losses on financial assets (debt instruments) measured at FV through OCI
• Other gains/losses arising from financial instruments (IFRS 9)
Unit 1 – IAS 1 and IAS 8 2024

7. Lecture notes and class examples

Lecture example – IAS 1: (also refer to Ex 14 in Chapter 3 of Gripping GAAP)

Items of OCI that may be reclassified to P/L will only be covered later in the course. At
that stage you should revise example 15 in Chapter 3.

The following information was extracted from the records of Apple Limited which was
incorporated on 1 January 20X0:

for the year ended 31 December 20x1

Trial balance (summarised extracts) Debit Credit
Revenue 1 000 000
Cost of sales 450 000
Cost of distribution 120 000
Cost of administration 80 000
Interest expense 100 000
Income tax expense: profit or loss 70 000

Retained earnings - 31/12/20x0 275 000

Revaluation surplus - 31/12/20x0 38 800
Ordinary dividends declared - 31/12/20x1 36 000
Land, at fair value (cost at 1/1/x0 was R70 000) 120 000

Land:
Apple Ltd owns land that it revalues annually to fair value. The fair value of the land had
increased to R140 000 at 31 December 20X1. The revaluation entries in 20X1 have not yet
been done. Normal tax rate of 28% and capital gains inclusion tax rate of 80% is applicable.

Required:
1) Prepare the journal entries relating to the land in 20X1.
2) Present the Statement of Profit or Loss and Other Comprehensive Income as a single
statement with the tax effect of OCI on the face of the statement (not in the notes)
(comparative figures are required where available).

3) Prepare closing journal entries.

4) Present the statement of changes in equity for the year ended 31 December 20X1
(comparative figures are required where available).
Only the retained earnings and revaluation surplus columns are required.

5) Prepare an extract from the statement of financial position at 31 December 20X1 with only
those line items that are provided in the question.
Unit 1 – IAS 1 and IAS 8 2024

Lecture example - IAS 1

20X0 entries:
Fair value gain on financial assets
Dr Land (SOFP) 50 000
Cr Gain on revaluation (OCI) 50 000

Dr Tax on revaluation (OCI) 11 200

Cr Deferred tax (SOFP) 11 200

Closing entry:
Dr Revaluation surplus (OCI) 38 800
Cr Revaluation surplus (SCE) 38 800

20X1 entries:
Dr Land (SOFP) (140 000 - 120 000)
Cr Gain on revaluation (OCI)

Dr Tax on revaluation (OCI)

Cr Deferred tax (SOFP)

Closing journal entries:

Dr Revaluation surplus (OCI)
Cr Revaluation surplus (SCE)

Dr Revenue
Cr Cost of sales
Cr Cost of distribution
Cr Cost of administration
Cr Interest expense
Cr Income tax expense
Cr Retained earnings (SCE)
Unit 1 – IAS 1 and IAS 8 2024
Unit 1 – IAS 1 and IAS 8 2024

Apple Limited
Statement of Profit or Loss and Other Comprehensive Income 20X1 20X0
for the year ended 31 December 20X1 (extracts) R R
Revenue comparative
Cost of sales
Gross profit info
Distribution costs
Administration costs not
Finance costs
Profit before tax available
Tax expense
Profit for the year

Other comprehensive income:

Items that will not be reclassified to profit or loss:
Revaluation surplus
Gains arising during the year
Income tax relating to items that will not be reclassified

Items that may be reclassified subsequently to profit or loss:

Other comprehensive income for the year, net of tax

Total comprehensive income for the year not avail

Earnings per share - basic (cents per share) (Assume 100 000 shares in XX
issue)
Retained
Revaluation earnings
Statement of changes in equity (extract) surplus R R
for the year ended 31 December 20X1
Balance: 1/1/20X0 info not
Total comprehensive income for the year avail
Balance: 1/1/20X1
Total comprehensive income for the year
Dividend declared (XX per share)
Balance: 31/12/20X1

Statement of financial position 20X1 20X0

as at 31 December 20X1 (extracts) R R
ASSETS
Land (at revaluation)

EQUITY AND LIABILITIES

Retained earnings
Revaluation surplus
Unit 1 – IAS 1 and IAS 8 2024

Current liabilities versus non-current liabilities

Work through IAS 1 para 60-76 and Gripping GAAP pages 71-76

Q2.6 Current / non-current distinction (Source: Stainbank, Razak and Oakes)

The reporting entity borrowed R100 million from a reputable financial institution. The loan bears
interest at the fixed rate of 10% per annum. Interest is payable annually in arrears on 31
December of each year. The capital amount is repayable on 31 December 20.9. The loan
agreement provides that if the reporting entity’s debt: equity ratio declines below 1:2 the full
amount (capital and interest) becomes payable on demand.

At 31 December 20.5 the reporting entity’s debt:equity ratio was 1:1.8.

During January 20.6, before the 31 December 20.5 annual financial statements were authorized
for issue, the reporting entity restored its debt:equity ratio to acceptable levels and successfully
negotiated with the financial institution so as to prevent foreclosure of the loan for at least the
next two financial years.

REQUIRED:
Discuss whether the reporting entity should present the loan as a current or non-current liability
in its 31 December 20.5 statement of financial position.

Glossary:

Reputable = __________________________________________________________

Debt:equity ratio = ____________________________________________________

Foreclosure = ________________________________________________________

Changes in accounting policy

• Required as a result of the initial application of an IFRS in which

o Transitional provisions are given or
o No transitional provisions are given
• A voluntary change in accounting policy (voluntary changes that are most relevant for
Accounting 3):
o Change in the cost formula used to measure the cost of inventory –
retrospectively (IAS 2)
o Change from cost model to revaluation model for measuring PPE – prospectively
(IAS 16)
o Change from cost model to revaluation model for measuring intangible assets –
prospectively (IAS 38)
o Change from the cost model to the fair value model for investment properties –
retrospectively (IAS 40)

Changes in accounting policy will be covered in the respective units (on PPE, intangible assets
and investment properties).

As IAS 2 Inventory is not covered specifically in Accounting 3 but is required prior knowledge, -
this unit will cover an example of a change in cost formula for inventory.
Unit 1 – CF, IAS 1 and IAS 8 2024

Now we turn to IAS 8 – remember this picture from Acc 2?

THEBIGPICTURE: IAS8(AC103)

IA S8(A C103)
Accountingpolicies, changesinestimatesanderrors

Introduction Definitions Accounting C hangein Errors Im practicability

policies accounting i.r.o.
estimates retrospective
applicationand
retrospective
restatem ent
T histopicis
Objective Selectionand onlydiscussed
A ccountingpolicies inA ccounting
C hangeinaccountingestim ate applicationof
Scope accounting III
InternationalF inancial
R eportingS tandards(IF RS s) policies
M aterial C onsistencyof
P riorperioderrors policies
R etrospectiveapplication
R etrospectiverestatem ent Changein
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III
Unit 1 – CF, IAS 1 and IAS 8
2024

Lecture example – IAS 8 (change in estimate)

Source: Stainbank, Razak and Oakes (13.2)

Lotus Limited is a manufacturing company listed on the JSE Securities Exchange.

The following partial statement of comprehensive income were prepared in respect of the
financial years ended
31 December 20.5 and 20.4.
20.5 20.4
Rand Rand
Revenue 500 000 400 000
Cost of sales (100 000) (100 000)
Gross profit 400 000 300 000
Administration expenses (130 000) (150 000)
Profit before tax 270 000 150 000
Taxation (130 000) (50 000)
Profit for the year 140 000 100 000

An extract from the statement of changes in equity revealed:

20.5 20.4
Rand Rand
Opening retained earnings 150 000 50 000
Profit for the year 140 000 100 000
Closing retained earnings 290 000 150 000

Additional information:
1. Lotus Limited owns one major asset, a machine which was purchased on 1 January 20.3 for
R500 000. Lotus Limited, in the financial year ended 31 December 20.5, decided to change its
depreciation policy from the reducing balance method to the straight-line method. In both
cases, a rate of 20% is applied. Revenue Services grants 20% per annum straight- line.
2. In arriving at cost of sales, the following items were deducted:
20.5 20.4
Rand Rand
Depreciation - owned plant 64 000 80 000
Loss as a result of uninsured earthquake damage 40 000 -
3. The taxation rate was 50% from 20.3 to 20.5. In both 20.4 and 20.5 permanent differences
prevented perfect matching from being attained. The only temporary differences giving rise to
deferred taxation are those applicable to the machine. It is expected that the deferred tax
balance can be recovered. The loss as a result of flood damage is fully deductible for tax
purposes. The company determines deferred taxation in accordance with IAS 12.

REQUIRED: (class examples)

For the year ended 31 December 20.5, prepare only the note to the financial statements
regarding the change in estimate.

REQUIRED: (tutorial homework)

Prepare the statement of comprehensive income and statement of changes in equity for the
year ended 31 December 20.5 in compliance with IFRS.
Use only the information in the question. Lotus Ltd prepares a single statement of
comprehensive income and analyses expenses by function.

Notes and comparatives are required. Accounting policy notes are not required.
Unit 1 Conceptual framework 2024
Unit 1 Conceptual framework 2024
Lecture example – IAS 8: Correction of error

Batis (Pty) Ltd has a financial year end of 31 December 20.3.

The cost of goods sold for 20.3 was calculated using opening inventory of R950 000.

However, closing inventory used in the 20.2 financial year was R700 000.

The difference of R250 000 relates to inventory sheets that were not taken into account
when the total inventory value was calculated at the end of December 20.2.

Assume that SARS will not reopen the 20.2 assessment and that the normal tax rate is
45%.

REQUIRED:
1) Prepare the journal entry to correct the error
a. Assume that you can post to the 20.2 general ledger.
b. Assume that you cannot post to the 20.2 general ledger (already been
closed off).

2) Prepare the note to the financial statements relating to the correction of error.

Journal entries if the correction had been done in 20.2

Journal entry to correct the error in 20.3

Unit 1 Conceptual framework 2024
Batis (Pty) Limited
Notes to the financial statements for the year ended 31 December 20.3

Note 4. Correction of error

Batis Limited incorrectly understated inventory at 31 December 20.2 by R250 000. The
financial statements at 31 December 20.2 have been restated to correct this error. The
effect of the restatement on those financial statements is summarized below. There is
no effect in 20.3.

Effect on
20.2
R
Decrease in cost of goods sold 250 000
Increase income tax expense (112 500)
Increase in profit 137 500

Increase in inventory 250 000

Increase in deferred tax liability (112 500)
Increase in equity 137 500
Unit 1 Conceptual framework 2024

Accounting 3
2024

Tutorial pack

The reporting environment, Conceptual Framework, IAS 1 and

IAS 8

Unit 1

Tutorial
Included in this handout:
Framework question 1 – Moonlight Cruisers Hand-in
Framework question 2 Please attempt
Framework question 3 Solution attached
Q26.9 Correction of error but using a tax rate of 28% Hand-in
2024 Graded Question 3.2, 3.3, 3.4 and 3.4 Solution attached
Unit 1 Conceptual framework 2024
FRAMEWORK QUESTION 1 16 MARKS

IN THIS QUESTION WE ILLUSTRATE A 5-STEP APPROACH TO A DISCUSSION

QUESTION

“Moonlight Cruisers Limited started business on 1 January 20X1. Moonlight Cruisers

builds sailboats on customer orders to customer specifications. It takes an average of
two years to build a sailboat. Costs of R850 000 were incurred on the building of
sailboats during the financial year ended 31 December 20X1 and none of these
sailboats were completed or sold before 31 December 20X1”.

The following journal has been processed by the accountant regarding the costs
incurred:
Dr Cost of sales 850 000
Cr Bank 850 000
Recording of costs incurred on sailboats

YOU ARE REQUIRED TO:

Indicate, with reasons, whether you agree with the above accounting treatment in the
financial records of Moonlight Cruisers Limited for the year ended 31 December 20X1.

You should apply the principles of the “Conceptual Framework for Financial Reporting
(2018)” in your answer.

PLAN YOUR ANSWER

Unit 1 Conceptual framework 2024

FRAMEWORK QUESTION 2 15 marks

As a post graduate student, you are offering tutoring to some of the second-year
students. One of the students has emailed you to assist them with some
questions on The Conceptual Framework for Financial
Reporting.

From: A. Nxious <[email protected]>

Sent: Thursday, 22 February 2023
To: Tutor <[email protected]>
Subject: Help needed with Conceptual Framework

Dear Tutor,

We covered The Conceptual Framework this week in class but I am feeling very confused
and overwhelmed :( Please can you help me.

1. My lecturer keeps talking about the fundamental qualitative characteristics of useful

financial information. Do
you know what she means by this?

2. We were asked to identify the elements for some transactions by using the definitions
of the Conceptual Framework. My friend and I have attempted the example below,
but do not agree with one another. My friend says that the grapevines should be
classified as an asset but I feel that it is an expense.

3. Please can you help. Mr Merlot is a wine farmer in the Stellenbosch area. He has
bought grapevines to the value of R50 000. Vines are considered bearer plants (A
bearer plant is a living plant that is used in the production or supply of agricultural
produce, is expected to bear produce for more than one period and has a remote
likelihood of being sold as agricultural produce, except for incidental scrap sales).

Looking forward to hearing from you.

Thank you,

A. Nxious
Unit 1 Conceptual framework 2024

Marks
FRAMEWORK QUESTION 2 – REQUIRED Sub-
Total
total
a Write an email response to A. Nxious in which you address both his issues by
referring to the Conceptual Framework for Financial Reporting:
i) List and explain the fundamental qualitative characteristics of useful 6
financial information
ii) ii) Explain how the vines meet the definition of one of the elements of 7
financial statements. (Ignore the recognition criteria)

Presentation marks (presentation, layout and neatness) 2

Total 15
Unit 1 Conceptual framework 2024

FRAMEWORK QUESTION 3 23 MARKS

THIS IS AN EXAMPLE OF AN APPROPRIATE ASSESSMENT LEVEL QUESTION ON

THE CONCEPTUAL FRAMEWORK

Pletbay Limited (“Pletbay”) operates an integrated fishing and aquaculture business in

an environmentally sensitive area on the east coast of South Africa. The financial year
end of the company is 28 February.

On 1 November 2016 Pletbay acquired the assets and liabilities of an aquaculture

business. During January 2018, Groundwatch, an environmental watchdog group,
lodged a complaint against Pletbay with the Department of Environmental Affairs on
behalf of the KwaMbonambi community. Groundwatch alleged that Pletbay has been
releasing effluent (i.e. waste water) from its aquaculture business into the water supply
of the nearby KwaMbonambi rural residential area over a number of years. In February
2018, the Green Scorpions of the Department of Environmental Affair’s started
investigating this matter under the National Environmental Management Act. Due to the
adverse publicity surrounding this matter, Pletbay made a statement in the local
newspaper on 25 February 2018, that it would clean up the KwaMbonambi water supply.
At this stage Pletbay estimated that it would cost R500 000 to clean up the local
community’s water supply.

Pletbay modified its effluent management system and cleaned up the local community’s
water supply over the period March to September 2018. During June 2018 the directors
of Pletbay instructed their lawyers to peruse the original agreement for the purchase of
the business of Fishfarm and to institute a counterclaim against the previous owners of
Fishfarm if it was reasonable to expect that this matter was known to the previous
owners of Fishfarm and should have been disclosed by them to Pletbay when Pletbay
acquired the business of Fishfarm. At 28 February 2019 the lawyers of Pletbay
believed that it was probable that Pletbay would succeed in claiming at least R450 000
of the cost of cleaning up the local community’s water supply from the previous owners
of Fishfarm.

Pletbay raised a provision of R500 000 at 28 February 2018 to clean up the water supply
of the local community. Pletbay incurred costs of R450 000 in this clean-up operation
which was finalised before 28 February 2019. At 28 February 2019 Pletbay did not
recognised an asset for the counterclaim against the former owners of Fishfarm.

REQUIRED:
You are the nephew/niece of the new financial director of Pletbay Limited. He has heard
that there is a new conceptual framework and since you are enrolled for a post-graduate
qualification in accounting he has asked you to:

Explain how Pletbay Limited would have accounted for the matters arising from point 2
above if the Conceptual Framework for Financial Reporting (2018) had been applied at
28 February 2018 and 28 February 2019. 21

Communication - logical reasoning, language, grammar 2

Unit 1 Conceptual framework 2024

QUESTION 3 SUGGESTED SOLUTION

The promise to clean up the local community's water supply should be

considered as to whether it meets the definition of an liability at 28
1.0
February 2018.
In terms of the Conceptual Framework for Financial Reporting (2018) a liability
is a present obligation of the entity to transfer an economic resource as a result
1.0
of past events.
Firstly, we consider whether Pletbay had an obligation at 28 February 2018,
that is, a duty or responsibility that it has no practical ability to avoid. 1.0
This obligation is to the KwaMbonambi rural community to clean up their water
supply.
It is a constructive obligation as Pletbay has made a public statement that they
will clean up the water supply and they have no practical ability to act in a
1.0
manner inconsistent with that statement.
Secondly, that obligation is to transfer an economic resource as Pletbay will
have to incur costs to clean up the water supply. 1.0
The probability of needing to incur these costs and therefore transfer an
economic resource is high as Pletbay are likely to follow through on their
1.0
promise so as to maintain good relationships with the local community.
However, the probability of transferring the economic resource does not need
to be certain for an obligation to meet the definition of a liability. 1.0
Thirdly, this is a present obligation at 28 February 2018, as the past event of
damaging the water supply had already occurred prior to 28 February 2018, and
1.0
Pletbay had made a statement committing itself to cleaning up the water supply.
As a consequence Pletbay will have to incur costs that it would not
otherwise have had to transfer. 1.0
This obligation therefore meets the new definition of a liability in the new
conceptual framework (2018). 1.0
This liability will be recognised if it provides users of financial statements with
information that is useful, that is with relevant information that is a faithful
1.0
representation of the liability and related expense.
The liability is relevant to the users of the financial statements as it is capable of
making a difference to the decisions made by the users e.g. had they known,
Pletbay would have taken it into account when negotiating about the price of the 1.0
purchase of the business (assets and liabilities) of Fishfarm.
The existence of the liability is not uncertain and the probability of the outflow
is high therefore there is no reason to believe that recognition of the liability
1.0
would not be relevant.
The liability is a faithful representation of the financial position of the entity at
28 February 2018 as it represents an obligation to transfer economic resources
1.0
in the future.
It results in the recognition of an expense in the financial year ended 28
February 2018 which is the period in which the event occurred. 1.0
The alternative treatment which is to recognise the expense when the costs are
actually incurred is not a faithful representation of the financial performance of
1.0
2019 as the events occurred in earlier periods.

1
The measurement of the liability is fairly certain as it is based on Pletbay's best 1.0 7
estimate of the amount they expect to incur to settle the obligation.
1 ltd to
Unit 1 Conceptual framework 2024
4
(students may discuss how the R450 000 that was spent in FY2019 should be
accounted for - it was not required as the question referred to "at 28 February
2018 and 2019" not for the year ended. However, for clarity purposes, the R450
000 would have be accounted for as a reduction in the provision and not as an
expense in 2019. The remaining balance of R50 000 would have been reversed
to profit/loss and recognised as an income in FY2019)
The countersuit against the former owners of Fishbay should be
considered as to whether it meets the definition of an asset at 28 February
1.0
2019.
An asset is a present economic resource controlled by the entity as a result of
past events. An economic resource is a right that has the potential to produce
1.0
economic benefits.
Pletbay has a possible right to receive compensation from the former owners of
Fishfarm for the cost of cleaning up the water supply of the local community. 1.0
This would be a legal right if Pletbay are successful in their legal claim against
the former owners of Fishfarm. 1.0
However, the existence of this right is uncertain as it will only be resolved by a
court ruling, and consequently is uncertain as to whether an asset exists. 1.0
The right does have the potential to produce economic benefits if Pletbay
win their case against the former owners of Fishfarm. 1.0
The lawyers of Pletbay have indicated that is it probable that Pletbay will
succeed in claiming the compensation from the former owners of Fishfarm. This
would affect the decision as to whether to recognise this as an asset, if the other 1.0
elements of the definition of an asset were met.
It is uncertain as to whether Pletbay controls the potential economic benefits
from the counterclaim. The decision about whether the former owners should
compensate Pletbay is a matter for the court to decide. However, if the court
1.0
does decide in Pletbay's favour then Pletbay would be the entity which would
obtain the economic benefits.
As the existence of this right is uncertain, recognition of it as an asset and
recognition of the related income is probably not relevant to the users of the
1.0
financial statements.

The existence uncertainty related to this right means that recognition of an asset 1
and the related income is also probably not a faithful representation of the 1.0 0 asse
financial position and financial performance of Pletbay. t
7 ltd to
In conclusion, the Conceptual Framework for Financial Reporting (2018) would
have resulted in Pletbay recognising the provision at 28 February 2018 and not conc
1.0
recognising an asset at 28 February 2019. 1 l

Maximum: 28.0

Limited to: 21.0

Communication: 2.0

Total: 23.0