Chapter 1: Nature and regulation of companies

Review questions

1. Outline the advantages of incorporation over other forms of organisation such as part-
nerships. (LO1)

The corporate form of organisation permits individuals to have "limited liability". This confers
on shareholders a limit on their liability in the event of a winding up of the company to the
amount (if any) unpaid on their shares. (S516).

In the case of a partnership no such limitation applies (unless the partnership specifically adopts
limited liability) and the insolvency of one or more partners can result in other solvent partners
having to contribute any losses and debts out of their own private assets.

11. Explain the difference between accounting standards, interpretations and the account-
ing framework. (LO7)

Accounting conceptual framework:

 Provide broad/general principles that provide guidance in preparation of general purpose
financial reports. These are not mandatory.

For example:

The Framework (paraOB2) provides l information about the objective of general purpose
financial reporting.

OB2: The objective of general purpose financial reporting is to provide financial

information about the reporting entity that is useful to existing and potential 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.

The Framework (para. 49) provides definitions of basic elements to be included in measuring the
financial position such as:
(a) An asset is 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.

Accounting standards can be defined as:

‘a technical pronouncement that sets out the required accounting for particular types of
transactions and events’ (AASB, 2014).

Hence these provide specific requirements for a particular area of financial reporting. These are
required to be complied with via corporations’ law.
For example:

AASB 101 Presentation of Financial Statements specifies that line items for particular classes of
assets or liabilities must be included in the statement of financial position itself (such as
intangibles).

AASB 102 Inventories (para 9) specifies that inventories shall be measured at the lower of cost
and net realisable value.
Interpretations provide guidance on urgent financial reporting issues. These are required to be
complied with via AASB 1048. The AASB is responsible for developing both Australian
equivalents of IFRIC Interpretations and domestic Interpretations, thereby replacing the former
Urgent Issues Group (UIG).

As stated by AASB (2014):

AASB and UIG Interpretations are listed in Accounting Standard AASB 1048
Interpretation of Standards, giving them authority under the Corporations Act 2001
alongside the Standards. Interpretations are mandatory for members of CPA Australia,
The Institute of Chartered Accountants in Australia and the Institute of Public
Accountants, and as such must be consistently applied in the preparation and presentation
of general purpose financial statements. Interpretations may also be given authority by
other legislative or regulatory bodies.

For example:

Interpretation 132 specifies the treatment of costs incurred in building Internet web sites.

Interpretation 1031 relates to issues re GST and, for example, specifies that (in
general):“Revenues, expenses and assets shall be recognised net of the amount of goods
and services tax (GST)” (para 6)

12. Does a company have to comply with accounting standards in order to show a ‘true
and fair view’ of its financial affairs? Discuss. (LO7)

Before the early 1990s, the directors of a company could elect not to comply with an accounting
standard issued by the AASB if they believed the particular standards would cause the accounts
not to present a true and fair view. This 'true and fair override' no longer exists and directors
must now comply with applicable accounting standards and add any additional information in
the notes to the financial statements if they believe adherence to the standards does not present a
true and fair view. Compliance with standards therefore has become the norm, resulting in an
increased interest, both positive and negative, in the requirements of accounting standards by
different lobby groups, particularly among those required to prepare financial statements.

As noted above, in Australia due to Corporations law requirements for the companies we are
considering, the accounting standards must be complied with, even if the resulting financial
statements and notes do not provide a true and fair view. Additional information is required if
compliance does not result in a true and fair view. The requirements for this additional
information are in AASB 101.

You should note that the current international accounting standards (in limited circumstances and
with extensive disclosure provisions) do provide for a true and fair ‘override’ (i.e. a true and fair
override allows companies to depart from accounting standards where compliance with these
would not provide a true and fair view). Although the Australian equivalent, AASB 101,
includes this override provision (in para 19) this is in effect negated for Australian companies as
Aus19.1 states:

Aus19.1 In relation to paragraph 19, the following shall not depart from a requirement in
an Australian Accounting Standard:
a) entities required to prepare financial reports under Part 2M.3 of the Corporations Act;
b) private and public sector not-for-profit entities; and
c) entities applying Australian Accounting Standards – Reduced Disclosure Require-
ments.

Chapter 2: Disclosure: Legal requirements and accounting policies

Review questions

4. What should be included in the directors’ report and the auditor’s report? (LO2)

(i) Director's reports:

 Under the Corporations Act, the annual financial report for a company, registered scheme
or disclosing entity must be accompanied by a directors' report (s.298). Minimum
requirements for the annual directors' report are set down in ss.298-300A. The amount of
detail necessary in the report depends on the nature of the company or registered scheme.
The content of the report consists of two main parts – general information about
operations and activities (required by s.299), and specific information (required by
s.300).

(ii) Auditor's report:

 According to s.307, the auditor who conducts an audit of the financial report must form
an opinion about the following matters:
- whether the financial report is in accordance with the Corporations Act
- whether the financial report is in accordance with accounting standards
- whether the financial report gives a true and fair view
- if additional information was included to give a true and fair view, whether that
additional information was necessary
- whether the auditor has been given all information, explanation and assistance
necessary for the conduct of the audit
 - whether the company has kept financial records sufficient to enable the financial
report to be prepared and audited
- whether the company has kept other records and registers as required by the Act.

The auditor's report must express the opinion of the auditor as to whether the financial report is
in accord with the Act, specifically s.296 (compliance with accounting standards) and s.297 (true
and fair view). If the auditor is of the opinion that the financial report does not give a true and
fair view, and is not in accord with the Act or with accounting standards, the auditor must state
the reasons for that opinion in the report. Furthermore, if the financial report does not comply
with an accounting standard, the auditor’s report must quantify the effect that non-compliance
has on the financial report.

Question 2.6

Materiality and events occurring after the end of the reporting period

The following information has been made available to you to assist in the preparation of
the financial statements of Ant Ltd for the year ended 30 June 2021:
1. The company has been involved in a dispute with a government environment agency
relating to the release of noxious gases from its manufacturing plant in early June 2021.
An expert investigation was conducted to determine if the company was at fault. The
investigator’s report released on 1 August 2021 found Ant Ltd to be responsible for the
release and damages amounting to $1 500 000 were payable by the company.
2. On 9 July 2021, the sales manager raised credit notes worth $30 000 relating to sales of
faulty goods in the last 2 weeks of June 2021.
3. On 25 September 2021, the company received notification that a customer owing
$130 000 had gone into liquidation. The liquidator advised that unsecured creditors are
likely to receive a distribution of only 20c in the dollar. The liquidation was caused by a
flood in July 2021 which destroyed the customer’s operating plant and warehouse. The
damage was not covered by insurance.

Assume all events or transactions are material.

Required
In relation to the above events or transactions, prepare the necessary notes or general
journal entries to comply with applicable accounting standards.
(LO8 and LO9)

1. Release of investigator’s report on 1 August 2021:

The release of the report and the decision that damages were payable by Ant Ltd provide new
information about conditions existing at the end of the reporting period given that the release of
the noxious gases occurred in June 2021. Assuming a profit before tax of $720 000, at the
amount of $1 500 000 is clearly material and the following adjustment should be made:
June 30 Damages expense Dr 1 500 000
Damages payable Cr 1 500 000
(Recognition of damages liability)

2. Credit notes raised on 9 July 2021:

As these credit notes relate to sales which occurred prior to the end of the reporting period this
provides more information about conditions existing at 30 June 2021 and will (or may,
depending on materiality) require adjustment by journal entry. However, as the credit notes
represent only approximately 4% of profit before tax ($30 000/$720 000), it could be argued that
no adjustment is necessary on the grounds of immateriality. The journal entry (ignoring
materiality considerations) is shown below:

June 30 Sales returns and allowances Dr 30 000

Accounts receivable Cr 30 000
(Credit notes relating to June sales)

3. Liquidation of debtor:

As the liquidation was caused by an event after the end of the reporting period no adjustment
will be made as this information does not change the situation that existed at 30 June 2021.
However, the $104 000 loss (80 cents in the dollar x $130 000) will be material to next year’s
profits based on the current year’s profit before tax ($104 000/$720 000 = 14%), and must be
disclosed by note.

Ant Ltd
Notes to the financial statements year ended 30 June 2021

Note X: Events occurring after the end of the reporting period

In September 2021, a debtor owing $130 000 went into liquidation. The company expects to
recover only 20% of the amount owing.

Question 2.7

Events occurring after the end of the reporting period

Sable Ltd has provided the following information concerning events occurring after the
end of the reporting period. This information is to be used for the preparation of the
financial statements for the year ended 30 June 2020. On 17 July 2020, a firebomb
destroyed four of the company’s transport vehicles resulting in damages of $400 000.
Insurance will cover $300 000 of the damages but payment of the insurance claim has been
delayed by a police investigation. As a result of the loss of these vehicles, the company’s
delivery schedules have been severely disrupted. On 18 July 2020, the release of a far
superior and cheaper product by a competitor caused a major decline in demand for
product X made by Sable Ltd. In an effort to sell remaining stock of the product Sable Ltd
has reduced its selling price to 50% of cost. Inventory on hand at 30 June 2020 was
recorded at its cost of $153 000.

On 15 August 2020, the Department of Occupational Health and

Safety charged the company over unsafe storage practices that
resulted in the leakage of toxic materials into a local
creek. The leakage occurred on 3 July 2020. If found to be negligent
by the court, the company will have to pay a fine of $350 000 plus
legal and clean-up costs in excess of $250 000. On 21 August 2020,
the purchasing manager discovered that a batch of invoices relating
to June inventory purchases had not been processed. The invoices
totalled $37 650. On 30 August 2020, the company issued a
prospectus offering 3000 10% debentures of $100 each for public
subscription. The debentures are redeemable on 1 October 2023.
Interest is payable annually in arrears. The debentures are secured
by a floating charge over the company’s assets.

Assume all events and transactions are material.

Required
(a) Classify the above events as either adjusting or non-adjusting events after the end of the
reporting period. Justify your classification.
(b) Based on your answer to requirement A, prepare the necessary journal entries or note
disclosures to comply with the requirements of AASB 110/IAS 10.
(LO8 and LO9)

(a) Classification of events:

Date Event Condition at New Classification

30 June 2020 information
17 July Firebombing None as Future losses Non-adjusting
of vehicles vehicles
destroyed after
30 June 2020

18 July Selling price Inventory on Net realisable Adjusting

reduction for hand at cost of value of
product X $153 000 inventory only
$76 500 (50% x
$153 000)

15 August Charge of None as leak Future fines Non-Adjusting

environmental occurred after ($350 000) plus
damage lodged 30 June 2020 legal costs and
clean-up costs
 (> $250 000)

21 August Unrecorded Accounts Understatement Adjusting

purchase payable and of both items
invoices inventory by $37 650

30 August Debenture None as Future cash Non-Adjusting

offer debentures flow effects and
issued after 30 increase of
June 2020 liabilities

(b) Adjusting journal entries:

2020
30 June Inventory write-down expense Dr 76 500
Inventory – product X Cr 76 500
(Write-down to net realisable value)

30 June Inventory Dr 37 650

Accounts payable Cr 37 650
(Recognition of unrecorded invoices)

Note Disclosures

Note X: Events occurring after the end of the reporting period

On 17 July 2020, a firebomb destroyed a number of transport vehicles resulting in disruption of

delivery schedules and an uninsured loss of $100 000.

On 15 August 2020, the company was charged with environmental damages arising from a
leakage of toxic materials from the storage tanks on 3 July 2020. Possible losses from fines,
legal and clean-up costs could be in excess of $600 000. The directors will vigorously defend
the claim of negligence.

On 30 August 2020, the company offered 3000 10% $100 debentures for public subscription.
The debentures are secured by floating charge over the company’s assets and are redeemable on
1 October 2023.