Financial Accounting: Classification, Share Capital, Income Tax, Revaluation, And Impairment Of Assets Essay.

Classification of Items

You are the financial accountant for Superstore Ltd, and are in the process of preparing its financial statements for the year ended 30 June 2018.  Whilst preparing the financial statements, you become aware of the following situations:

1. On 1 July 2017, the directors made a decision, using information obtained over the last couple of years, to revise the useful life of an item of manufacturing equipment.  The equipment was acquired on 1 July 2015 for $800,000, and has been depreciated on a straight-line basis, based on an estimated useful life of 10 years and residual value of nil.  Superstore Ltd uses the cost model for manufacturing equipment.  The directors estimate that as at 1 July 2017, the equipment has a remaining useful life of 6 years and a residual value of nil.  No depreciation has been recorded as yet for the year ended 30 June 2018 as the directors were unsure how to account for the change in the 2018 financial statements, and unsure whether the 2016 and 2017 financial statements will need to be revised as a result of the change.
2. In June 2018, the accounts payable officer discovered that an invoice for repairs to equipment, with an amount due of $20,000, incurred in June 2017, had not been paid or provided for in the 2017 financial statements.  The invoice was paid on 12 July 2018.  The repairs are deductible for tax purposes.  The accountant responsible for preparing the company’s income tax returns will amend the 2017 tax return, and the company will receive a tax refund of $6,000 as a result (30% x $20,000).  No journal entries have been done as yet in the accounting records of Superstore Ltd, as the directors are unsure how to account for this situation, and what period adjustments need to be made in.
3. Superstore Ltd holds shares in a listed public company, ABC Ltd, which are valued in the draft financial statements on 30 June 2018 at their market value on that date - $600,000.  A major fall in the stock market occurred on 10 July 2018, and the value of Superstore’s shares in ABC Ltd declined to $250,000.
4. On 21 July 2018, you discovered a cheque dated 20 April 2018 of $32,000 authorised by the company’s previous accountant, Max. The payment was for the purchase of a swimming pool at Max’s house.  The payment had been recorded in the accounting system as an advertising expense.  You advise the directors of this fraudulent activity, and they will investigate.

Assume that each event is material.

Required:

1. i) State the appropriate accounting treatment for each situation. Provide explanations and references to relevant paragraphs in the accounting standards to support your answers.  Where adjustments to Superstore Ltd’s financial statements are required, explain which financial statements need to be adjusted (ie. 2016, 2017, 2018 or 2019).  

1. ii) Prepare any note disclosures and adjusting journal entries that are needed in the 2018 financial statements for each situation.  

Marking Guide - Question 1	Max. marks awarded
Classification of each item	4
Discussion to support classification decision, including references	6
Note disclosures and journal entries where necessary	4

Question 2

Accounting for share capital

Rippa Ltd was incorporated on 1 July 2017.  The following transactions and events occurred during the year ended 30 June 2018:

1 Jul 2017:  Rippa Ltd makes an offer to the public for investors to subscribe for 5,000,000 shares, at an issue price of $4.00 per share, with $2.50 payable on application, $1.00 being payable within one month of allotment, and $0.50 payable on a call to be made at a later date.  The issue is underwritten at a commission of $12,000.

31 Jul 2017:  Applications close, with applications received for 6,000,000 shares.

10 Aug 2017:  5,000,000 shares are allotted in proportion to the number of shares for which applications had been made.  The surplus application money is offset against the amount payable on allotment.

12 Aug 2017:  The underwriter’s commission is paid.

10 Sep 2017:  All allotment money is received.

1 Feb 2018:  The call is made, with money due by 28 February 2018.  

28 Feb 2018:  All call money is received except for holders of 40,000 shares who fail to meet the call.  

20 Mar 2018:  The shares on which call money was not received are forfeited and sold as fully paid.  An amount of $3.20 is received for each share sold.  Costs of the forfeiture and reissue amount to $4,000, and are paid.  

25 Mar 2018:  The balance of the Forfeited Shares Account is returned to the former shareholders.

Required:

2018. i)  Prepare the journal entries to record the transactions of Rippa Ltd up to and including that which took place on 25 March 2018.  Show all relevant dates and narrations.
2019. ii)  After returning money to the former shareholders on 25 March 2018, one of the former shareholders has contacted you in relation to the amount of money that he received.  He tells you that he paid the application money and allotment money for the shares that he had, so he should get an amount back of $3.50 per share.  Explain why the amount returned to the former shareholders was not $3.50 per share, and prepare workings to show how the refund per share was calculated. 

Marking Guide - Question 2	Max. marks awarded
Journal entries with narrations	9
Dates	2
Explanation of amount returned to former shareholders	3

Question 3

Accounting for income tax

Jackson Storm Ltd commenced business on 1 July 2017, with share capital of $300,000.  On 30 June 2018, the company presents its first Statement of Profit or Loss and Other Comprehensive Income, and first Statement of Financial Position.  The statements are prepared before considering taxation.  The following information is available:

Statement of Profit or Loss and Other Comprehensive Income (Extract) for the year ended 30 June 2018
	$	$
Revenue		2 150 000
Government grant (exempt from income tax)		50 000
Expenses
Cost of sales	925 000
Advertising	59 000
Annual leave	25 000
Depreciation – equipment	70 000
Depreciation – motor vehicles	30 000
Doubtful debts expense	34 000
Entertainment (not tax deductible)	4 500
Insurance	18 000
Rent	78 000
Salaries	335 000
Warranty expenses	18 500
Other expenses	47 200	1 644 200
Accounting profit before tax		555 800

Statement of Financial Position (Extract) as at 30 June 2018
	$	$
Assets
Cash		40 000
Inventory		162 900
Accounts receivable	250 000
Less: allowance for doubtful debts	(32 000)	218 000
Prepaid insurance		7 000
Equipment – cost	700 000
Less: accumulated depreciation	(70 000)	630 000
Motor vehicles – cost	120 000
Less: accumulated depreciation	(30 000)	90 000
Total assets		1 147 900
Liabilities
Accounts payable		54 600
Loan		200 000
Provision for annual leave		21 000
Provision for warranties		16 500
Total liabilities		292 100
Net assets		855 800
Equity
Share capital		300 000
Retained earnings		555 800
		855 800

Additional information:

The company purchased equipment at a cost of $700,000 on 1 July 2017.  The equipment is depreciated over ten years for accounting purposes, and seven years for taxation purposes (using the straight-line basis of depreciation, and a residual value of nil).  

• The company purchased motor vehicles at a cost of $120,000 on 1 July 2017.  The motor vehicles are depreciated over four years for accounting purposes, and six years for taxation purposes (using the straight-line basis of depreciation, and a residual value of nil).  
• Tax deductions for annual leave, warranties, insurance are available when the amounts are paid, and not as amounts are accrued.
• Amounts received from sales, including those on credit terms, are taxed at the time the sale is made.
• Tax deductions are not available for doubtful debts. Tax deductions are only available when bad debts are written off.
• The tax rate is 30%.

Required:

112. i)  Determine the balance of any current tax liability and deferred tax assets and deferred tax liabilities for Jackson Storm Ltd as at 30 June 2018, in accordance with AASB 112.  Use appropriate worksheets and show all necessary workings.

1. ii)  Prepare the journal entries to record the current tax liability and deferred tax assets and deferred tax liabilities.

Marking Guide – Question 3	Max. marks awarded
Determination of taxable income and current tax liability	6
Determination of deferred tax assets and liabilities in deferred tax worksheet	7
Journal entries	2

Question 4

Revaluation of property, plant and equipment

You are the accountant for Superstar Ltd, and you are required to account for the company’s equipment for the years ended 30 June 2017 and 30 June 2018, which are measured using the revaluation model.  The directors elect to depreciate equipment on a straight-line basis.

Accounting for Share Capital

Equipment 1:

The first equipment has a carrying amount as follows, prior to any depreciation or revaluation being recognised for the year ended 30 June 2017:

Revalued amount (as at 30 June 2016):	$60,000
Less: accumulated depreciation	-
Carrying amount	$60,000

This equipment was revalued for the first time on 30 June 2016, from $70,000 to $60,000.  The directors determined that as at 30 June 2016, this equipment had an estimated remaining useful life of 4 years, and an estimated residual value of $10,000.  The directors have determined that the fair value of this equipment on 30 June 2017 is $55,000.  At 30 June 2017, this equipment had an estimated remaining useful life of 3 years, and the residual value remains unchanged at $10,000.  

The directors have determined that the fair value of this equipment on 30 June 2018 is $44,000.  

Equipment 2:

The second equipment at has a carrying amount as follows, prior to any depreciation or revaluation being recognised for the year ended 30 June 2017:

Revalued amount (as at 30 June 2016):	$20,000
Less: accumulated depreciation	-
Carrying amount	$20,000

This equipment has been revalued a number of times, with revaluation decrements amounting to $1,000 being previously recognised in profit or loss.  The directors determined that as at 30 June 2016, this equipment had an estimated remaining useful life of 4 years, and an estimated residual value of $4,000.  

The directors have determined that the fair value of this equipment on 30 June 2017 is $18,000.  At 30 June 2017, this equipment had an estimated remaining useful life of 3 years, and the residual value has been revised to $6,000.  

This equipment is sold on 31 December 2017 for $13,000.

Required:

Prepare the necessary journal entries to account for each of the above equipment for the years ended 30 June 2017 and 30 June 2018 (including entries for depreciation, revaluations, and any disposals).   Show all relevant workings. Note: you are not required to account for income tax associated with revaluations.

Marking Guide - Question 4	Max. marks awarded
Journal entries	12
Workings	4

Question 5 

Impairment of assets

Foodie Ltd has two separate cash generating units, ‘Fizzy Drinks’ and ‘Ice creamery’.  At 30 June 2018, the carrying amounts of the assets of the units, valued pursuant to the cost model, are as follows:

	Fizzy Drinks	Ice creamery
	$	$
Cash	18,000	14,000
Inventory	34,000	25,000
Fixtures and fittings	25,000	35,000
Accumulated depreciation – fixtures and fittings	(5,000)	(10,000)
Equipment	165,000	25,000
Accumulated depreciation – equipment	(55,000)	(15,000)
Land and buildings	650,000	185,000
Accumulated depreciation – buildings	(25,000)	(6,000)
Patent	25,000	-
Goodwill	40,000	15,000
Total	872,000	268,000

The inventory is recorded at the lower of cost and net realisable value. The patent has a fair value less costs to sell of $20,000.  The land and buildings of ‘Fizzy Drinks’  have a fair value less costs to sell of $620,000, and the land and buildings of ‘Ice creamery’ have a fair value less costs to sell of $175,000.

On 30 June 2018, the directors of Foodie Ltd estimate that the fair value less cost to sell for ‘Fizzy Drinks’ and ‘Ice creamery’ amount to $750,000 and $260,000 respectively. The value in use of ‘Fizzy Drinks’ and ‘Ice creamery’ are estimated at $810,000 and $240,000 respectively.

Required:

Determine the impairment loss (if any) to be recognised by Foodie Ltd for each of its cash generating units as at 30 June 2018, and determine how the impairment loss (if any) is to be allocated.  Prepare the journal entries to account for the impairment loss/losses (if any). Show all workings and provide references to the relevant accounting standard to support your answer.

Classification of Items

1. Accounting for share capital

Work note 1

Table for shares

Applied, Allocated, Cash received related to application & Excess cash received.

	Applied	Allocated
	6,000,000	5,000,000
No. Of shares	No. Of shares allocated (B)	Total cash received (C)	Cash received that related to application	Excess cash received from application
(A)	(B)	(A*2.5) = C	(B*2.5) = D	Related to allotment (C-D)
6,000,000	5,000,000	6,000,000*2.5 = 15,000,000	5,000,000*2.5 = 12,500,000	15,000,000-12,500,000 = 2,500,000

Journal entries in the books of Rippa Ltd.

DATE	Account title and explaination	Debit	Credit
10-Aug	Cash A/c	$  15,000,000.00
	To share Application A/c		$   15,000,000.00
	(being recording of application money received)
10-Aug	Share application (6,000,000*2.5)	$  15,000,000.00
	To share capital (5,000,000*2.5) A/c		$   12,500,000.00
	To share Allocation (15,000,000*12,500,000)A/c		$     2,500,000.00
12-Aug	Underwriting commission A/c	$         12,000.00
	To cash A/c		$          12,000.00
	(being recording underwriting commission paid)
10-Sep	share allotment (5,000,000*1) A/c	$    5,000,000.00
	To share capital A/c		$     5,000,000.00
	(being recording of share allotment money become due)
10-Sep	Cash (5,000,000-2,500,000) A/c	$    2,500,000.00
	share Application (15,000,000-12,500,000) A/c	$    2,500,000.00
	To share Allotment A/c		$     5,000,000.00
	(being recording receipt of allotment money)
1-Feb-18	share 1st call (5,000,000*0.50) A/c	$  25,000,000.00
	To share capital A/c		$   25,000,000.00
	(being recording 1st call money become due)
28-Feb	Cash (25,000,000-20,000) A/c	$  24,980,000.00
	Calls in arrears (40,000*0.5) A/c	$         20,000.00
	To share 1st call (50,000,000*0.50) A/c		$   25,000,000.00
	(being recording receipt of money from 990,000 shares)
20-Mar	Share capital (40,000*4) A/c	$       160,000.00
	To share Forfeiture(40,000*3.5)		$        140,000.00
	To calls in Arrears		$          20,000.00
	(being recording of forfeiture of shares)
25-Mar	Cash (40,000*3.2) A/c	$       128,000.00
	Share Forfeiture (40,000* (4-3.2)	$         32,000.00
	To share capital (40,000*4)		$        160,000.00
	(being recording reissue of shares)
25-Mar	Share reissue Cost A/c	$           4,000.00
	To cash A/c		$            4,000.00
	(being recording of reissue cost)
25-Mar	Share Forfeiture (140,000-32,000) A/c	$       108,000.00
	To share reissue cost A/c		$            4,000.00
	To shareholders A/c		$        104,000.00
	(being record of amount that is to be refunded to shareholders)
	Shareholders A/c
	To cash A/c		$        104,000.00
	(being record of amount refunded)

Explaining why the amount returned to the former shareholders was not $3.50 per share.

            The amount discounted was not equivalent to 3.50 as requested by one investor since when he neglected to pay the sum his offers are forfeited and the organization has likewise to bring about additional cost 4,000 for reissuing it.            At the point when the organization has reissued these offers it will get just 3.20 and not 4.

            Subsequently the organization needs to endure lost 0.80 = (4-3.20) and furthermore needs to acquire re-issue cost of 0.10 = (4,000/40,000).

            Subsequently, total misfortune end up 0.90 = (0.80+0.10) and this misfortune must be conceived by the investors.

            In this manner, investor will not get $3.50 per share rather they will get just $2.60 per share.

Question 4

Experiment 1:

For 30 June 2017

Carrying amount is 60,000

Calculating depreciation (Straight line method):

60,000-10,000 (Residual value) = 50,000

The equipment can be used for 4 more years, so 50,000/4 years = 12,500 per year

Journal entry:

Depreciation entry:

Depreciation A/c Dr. 12,500

            To Equipment 1 A/c Cr. 12,500

So the Depreciated value as on 30 June 2017 is 60,000 – 12,500 = 47,500

            The decrease of an asset’s carrying value is recognized in the P&L. Also the revaluation surplus of the same asset the decrease will be recognized in the other comprehensive income.

            Note: When the first revaluation was done, from 70,000 to 60,000, the question does not indicate that there was any difference between the depreciation value (Carrying value as on 30^th June 2015 depreciation for that year) and the revalued amount, or the difference was charged to the profit & loss A/c. So, we will directly credit the current year difference to revaluation surplus.

            Fair value (Revalued) as on 30^th June 2017 is 55,000. Difference = 55,000-47,500 (depreciated value) = 7500. This is for what we have to pass the entries:

Equipment 1 A/c Dr. 7,500

            To revaluation Cr. 7,500

(To record the increment in the asset value as per the prudence concept)

For June 2018:

Calculation of depreciation:

Carrying value on 30^th June 2017 = 55,000 – 10,000 (Residual value) = 45,000/3 years life = 15,000

Journal entries:

Depreciation A/c Dr. 15,000

Accounting for Share Capital

            To equipment 1 A/c Cr. 15,000

Depreciated value of the asset 55,000 – 15,000 = 45,000

Fair value (Revalued) as on 30^th June 2018 is 44,000

The difference to be adjusted: 45,000 – 44,000 = 1,000 to be debited to the revaluation surplus as we have earlier made an increasing revaluation and credited the revaluation surplus, so we will reverse it to the amount of difference.

Revaluation surplus Dr. 1,000

            To equipment 1 Cr. 1,000

(This way decreasing the value of the asset against the revaluation surplus).

Equipment 2

For 30^th June 2017

Calculating Depreciation:

20,000 (carrying value) – 4,000 (Residual amount) =16,000/4 years estimated life = 4,000

Journal entry:

Depreciation A/c Dr. 4,000

            To equipment 2 A/c Cr. 4,000

So the depreciated value as on 30^th June 2017 is 20,000 – 4,000 = 16,000

Fair value (Revalued) on 30^th June 2017 is 18,000

Difference: 18,000 – 16,000 = 2,000

(Increment) which is to be adjusted.

Note: Here the asset was revalued multiple times and decrements amounting to 1,000 being previously recognized in profit & loss A/c. We shall reverse it up to 1,000 and rest shall be credited to revaluation surplus.

Equipment 2 Dr. 2,000

To profit & loss A/c Cr. 1,000

To revaluation surplus Cr. 1,000

(Being increment in the value of asset adjusted)

            For 31 December 2017:

Calculating depreciation:

18,000 -6,000 (revised residual value) = 12,000/3 years life =4,000 x 6months/12 month as it has been sold on 31th December 2017 =2,000.

Depreciation A/c Dr. 2,000

            To equipment 2 A/c Cr. 2,000

So, the depreciated value on 30^th June 2018 is 18,000 – 2,000 = 16,000

Different: 16,000 – 13,000 = 3,000

Asset sold for 13,000, its entry shall be

Cash/Bank A/c Dr. 13,000

Revaluation surplus Dr. 1,000

Profit & loss A/c Dr. 2,000

            To Equipment 2 Cr. 16,000   

            Sales of the equipment recorded, and as there is loss the revaluation surplus shall be reversed to the extent of credit balance and rest be charged to P&L A/c.

            If there is gain on sale of revalued (increment) asset, the balance of revaluation surplus shall be credited to profit & loss A/c and rest if any shall be directly credited to the same.

Question 5      

When carrying value exceeds the recoverable amount that is when an asset is impaired and this is according to the IFRS. The recoverable amount is greater of its fair value less any selling expenses and its value in use.

Accounting for Income Tax

Impairment loss if any is allocated to first intangible asset with indefinite lives. Hence, Impairment loss will be first allocated to goodwill.

Remaining impairment loss will be allocated in ratio of fair value of assets.

Journal entry

            Impairment loss Dr. 70,000

                        To Goodwill ice creamery Cr. 8,000

                        To Goodwill Fizzy drinks Cr. 40,000

                        To Furniture & Fixture Fizzy drinks Cr. 571

                        To Equipment Fizzy drinks Cr.3,143

                        To Land and building fizzy drinks Cr. 17,714

                        To Patents fizzy drinks Cr. 572

                        (Being impairment loss recorded)

Question 3

I (a) Calculation of current Tax liability.

II (b) Calculation of deferred tax asset and deferred tax liability.

Balance as on 30^th June 2018

Current Tax liability (A) …………………………..156,240

Deferred Tax Asset (B) …………………………....12,450

Deferred Tax Liability (B)………………………… (9,600)

1. Journal entries
2. Tax Expenses Dr. 156,240

Current tax liability Cr. 156,240

            (To record current tax liability)

2. Deferred tax expenses Dr. 600

Deferred tax liability Cr 600

            (To record deferred tax liability on temporary difference between carrying value and tax base of accounts receivable)

3. Deferred tax expenses Dr. 9,000

Deferred tax liability Cr. 9,000

(To record deferred tax liability on temporary difference between carrying value and tax base of equipment)

4. Deferred tax asset Dr. 3,000

Deferred tax income Cr. 3,000

(To record deferred tax liability on temporary difference between carrying value and tax base of motor vehicle)

5. Deferred tax asset Dr. 5,100

Deferred tax income Cr. 5,100

            (To record deferred tax liability on temporary difference between carrying value and tax base of provision for leave.)

6. Deferred tax asset Dr. 4,350

Deferred tax income Cr. 4,350

            (To record deferred tax liability on temporary difference between carrying value and tax base of provision for warranties)

Question 1

            Calculating depreciation

            Depreciation for 8 years =160,000

            800,000-160,0000= 640,000

            640,000/6years = 106,667

            Adjusted depreciation as 30^th June2018 is 106,667

Journal entry

            Depreciation A/c Dr. 106,667

                        To accumulated depreciation A/c Cr. 106,667

1. ii) Repairs for 2017 should be charged in the same year and not in 2018 so the journal will be adjusted as follows:

            Repairs A/c Dr. 20,000

                        To accumulated repairs A/c Cr. 20,000

iii) Adjustment also must be done on the company’s shares where the different will be indicated in the P&L.

            Past shares 600,000 – 250,000 the current share = 350,000

            Journal entries

            Revenue/profit & Loss A/c Dr. 350,000

                        To investment A/c Cr. 350,000

Reference

Beaver, W. H. (1981). Financial reporting: an accounting revolution. Prentice Hall.

Deegan, C. (2013). Financial accounting theory. McGraw-Hill Education Australia.

Financial Accounting Standards Board. (2003). Statement of Financial Accounting Standards (No. 123). Financial Accounting Standards Board.

Scott, W. R. (1997). Financial accounting theory (Vol. 3, pp. 335-360). Upper Saddle River, NJ: Prentice Hall.

Scott, W. R. (2003). Financial accounting theory. Prentice Hall.