ACCT20002 Lecture 1: External Reporting Obligations & Conceptual Framework
5 Jun 2018
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IN-CLASS TUTORIAL SOLUTIONS: EXTERNAL REPORTING OBLIGATIONS
AND CONCEPTUAL FRAMEWORK
Q.1
Explain how Q Ltd should account for the following items/situations, justifying your
answer by reference to the conceptual framework’s definitions and recognition criteria:
1. Receipt of artwork of sentimental value only.
2. Q Ltd is the guarantor for an employee’s bank loan:
(a) You have no reason to believe the employee will default on the loan.
(b) As the employee is in serious financial difficulties, you think it likely that he will
default on the loan.
3. Q Ltd receives 1000 shares in X Ltd, trading at $4 each, as a gift from a grateful client.
4. The panoramic view of the coast from Q Ltd’s café windows, which you are convinced
attracts customers to the café.
5. The court has ordered Q Ltd to repair the environmental damage it caused to the
local river system. You have no idea how much this repair work will cost.
1. Trinket of sentimental value:
• Fails the para. 49(a) asset definition as it does not constitute future economic
benefits, defined in para. 53 as the potential to contribute, directly or indirectly,
to the flow of cash and cash equivalents to the entity.
• Recognition criteria are irrelevant, as there is no asset to recognise.
2. Guarantor for an employee’s loan.
(i) Employee unlikely to default on his/her loan
• Meets the para. 49(b) liability definition: (1) present obligation — legal
obligation via the guarantor contract; (2) past event — signing the guarantor
contract; (3) settlement involving outflow of economic benefits — payment of
the guarantee.
• Fails probability recognition criterion, as it is not likely that Q Ltd will be
required to pay on the guarantee. Hence, no liability can be recognised.
However, note disclosure of the guarantee may be warranted (para. 88).
(ii) Employee likely to default on his loan.
• Again, meets the liability definition as per (i) above.
• Meets both recognition criteria — probable that outflow of economic benefits
will be required, and settlement amount can be reliably measured (amount
owing). Hence, a liability should be recognised.
• Also meets the expense definition and recognition criteria. Definition: (1)
decrease in economic benefits in the form of a liability increase — Q Ltd now
owes the amount of the employee’s loan; (2) during period — the liability
increase arose during period; (3) results in equity decrease — if liabilities
increase and assets do not change, equity decreases. Recognition criteria: The
decrease in future economic benefits has arisen, as Q Ltd now owes the amount
of the employee’s loan. The bank can advise exactly how much the employee
owes and so it can be reliably measured.
3. Receipt of 1000 shares in X Ltd, trading at $4 each, as a gift from a grateful client.
• The receipt of the shares meets the asset definition: (1) represent future
economic benefits (via future sales or dividend stream); (2) controlled by Q Ltd
(only Q Ltd can benefit from either selling them or receiving dividends); (3)
past event (their receipt).
• They also meet the asset recognition criteria: probable that future economic
benefits will eventuate (via sale or dividend stream); and the shares have a value
(they are trading at $4 each) that can be reliably measured (this value can be
verified via securities exchange and so on).
• The shares also meet the income definition and recognition criteria. Definition:
(1) increase in economic benefits in the form of an asset increase — Q Ltd now
owns the shares; (2) during period — the shares were received during period;
(3) results in equity increase — if assets increase and liabilities do not change,
equity increases. Recognition criteria: The increase in future economic benefits
has arisen, as Q Ltd now owns the shares (asset). The shares’ value is known
and so can be reliably measured.
4. Café’s panoramic view.
• The view fails the definition as the entity does not control the future economic
benefits that are expected to flow from the view — the entity cannot deny or
regulate access by others to the view.
• Recognition criteria are irrelevant, as there is no asset to recognise.
5. Court order to repair environmental damage caused to the local river system. You have
no idea how much this repair work will cost.
• The court order meets the liability definition: (1) present obligation — legal
obligation; (2) past event — order has been made; (3) settlement will involve
outflow of economic benefits — future payment for repair of damage.
• Fails reliable measurement recognition criterion, as you have no idea as yet how
much the repair work will cost. Hence, no liability can be recognised. However,
note disclosure of the court order may be warranted (para. 88).
• However, if you know a minimum amount that Q Ltd will have to pay, then the
reliable measurement criterion is met for this amount. The probability criterion
is met as it is certain (given that Q Ltd has been ordered by the court) that Q Ltd
will have to pay the repair cost. Again, note disclosure may still be warranted
advising that the cost may be well in excess of this amount.
Document Summary
You have no idea how much this repair work will cost. Trinket of sentimental value: fails the para. 49(a) asset definition as it does not constitute future economic benefits, defined in para. However, note disclosure of the guarantee may be warranted (para. Hence, a liability should be recognised: also meets the expense definition and recognition criteria. Recognition criteria: the decrease in future economic benefits has arisen, as q ltd now owes the amount of the employee"s loan. Recognition criteria: the increase in future economic benefits has arisen, as q ltd now owns the shares (asset). The shares" value is known and so can be reliably measured. Court order to repair environmental damage caused to the local river system. However, note disclosure of the court order may be warranted (para. 88): however, if you know a minimum amount that q ltd will have to pay, then the reliable measurement criterion is met for this amount.
