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NCEA LEVEL 3 ACCOUNTING

By Elizabeth Pitu

(2013)

BOOK 5

The

FRAMEWORK

Exercise Solutions

Level 3 Accounting The Conceptual Framework – Exercise Solutions page 1

PRACTICE EXERCISES

Exercise One – page 20

Short answer questions based on the notes and examples handout

1. Going concern is the underlying assumption that the business will continue to operate into the

foreseeable future. At each balance sheet date management is required to assess whether or not the

business is a going concern and provided there is nothing to suggest the business will be liquidated in the

next year, the financial statements are prepared on the going concern assumption.

2. The accrual basis reports the effects of transactions and other events in the periods to which they relate.

Both cash and credit transactions are reported in financial statements of the period to which they relate.

The accrual basis is used to report assets, liabilities, expenses and income so that users are informed of

both past transactions involving the payment and receipt of cash and of obligations to pay cash in the

future and of resources that represent cash to be received in the future. Financial statements prepared on

the accrual basis provide the type of information about past transactions and other events that is most

useful to users in making economic decisions.

3. (a) Information needs to be relevant to the economic decision making needs of users. Information

which is relevant helps users evaluate past, present or future events or is used to confirm or correct

their past evaluations. Users need information to help them make economic decisions about the

future so the information should be able to be used in this way. Information about past transactions

and present asset holding in financial statements can help users to predict the ability of the entity to

take advantage of opportunities as they arise. Information about past financial performance is often

used to predict future financial performance. To be relevant, information also needs to be material –

that is able to influence the decisions users will make based on the information. Users do not want

to have to wade through a whole range of immaterial information to find the key pieces they need to

make economic decisions. While not related to financial statements themselves, for example the

credit manager who wants to chase up slow payers does not need a list of all the debtors who

regularly pay on time. Information also needs to be timely or it will lose its relevance – information

which takes too long to arrive, will be of no use to users who have had to make decisions in the

mean time.

(b) Information needs to be faithfully represented meaning it is

(i) complete meaning all necessary details explaining the information is provided

(ii) neutral meaning there is no bias in selecting or presenting the information

(iii) free from error meaning there is no error or omission in the descriptions of the information

so it can be used for decision making with confidence

(c) The information in the general purpose financial statements needs to be readily understandable to

users so that they are able to use it to make economic decisions. On the other hand, users can be

expected to have a reasonable knowledge of business and economic activities and accounting and a

willingness to study the information with reasonable diligence. Complex information that is relevant

to making economic decisions should not be left out on the grounds that it would be difficult for

users to understand.

(d) Information needs to be able to be compared from one period to the next within an entity and

between entities to determine similarities and differences between the information and the same

information in other reports. To allow comparability of information it needs to be prepared and

treated consistently from one period to the next.

4. An items materiality is determined by its ability to influence the economic decisions of users. If the item

is likely to influence users decisions based on the financial statements, either because of its nature and/or

its size, the item should be disclosed separately either in the financial statements or in the notes to the

financial statements.


5. Internally generated goodwill cannot be faithfully represented. Neutrality is an important component of

faithful representation. The measure would not be neutral as it would not be free from bias – the business

may well want to place a higher value on this goodwill than it warrants. No market transaction occurs in

relation to internally generated goodwill so while not necessary, it is difficult to provided a fair value for

the goodwill.

6. (a) Historical cost refers to the cost of acquisition or transaction cost of assets, expenses, liabilities and

revenues – it will faithfully represent a market transaction as there will be a source document that

can be referred back to which is neutral when the market transaction has taken place between two

independent parties. It will mostly also be relevant if it relates to expenses, income, assets and

liabilities acquired in the current period. It only becomes out of date, and possibly not relevant if

you do not regularly revalue assets like land and buildings, and ensure that the depreciated historical

cost of other property, plant and equipment is a good reflection of their fair value.

(b) Accountants should make general purpose financial statements understandable to shareholders,

potential investors and others who may be interested in doing business with the entity, however

simplification should not allow any material item of information to be omitted and accountants can

assume users will have a basic knowledge of financial statements and a reasonable knowledge of

business and economic activities.

(c) Allowing for doubtful debts meets the recognition criteria for assets which states that assets should

be reported at their probable future economic benefit which can be reliably measured. The probable

future economic benefit to flow to the entity in the form of cash from accounts receivable is the

historical cost of accounts receivable less allowance for doubtful debts. This is called their estimated

realisable value which is using the realisable value measurement base to report the accounts

receivable asset. The allowance for doubtful debts has a reliable measure based on past experience

of bad debts, the age of accounts receivable and the current economic climate.

Exercise Two – page 20

Short answer questions based on the New Zealand Framework paragraphs 9 – 21

1. The resource providers for whom general purpose financial statements are prepared are current and

potential shareholders, investors, creditors and lenders of finance to the entity.

2. The objective of financial statements to provide information about the financial position, performance

and changes in financial position of an entity that is useful to resource providers in making economic

decisions. Financial statements assist resource providers in assessing the financial position,

performance and cash flows of the entity. Financial statements also allow resource providers to make

decisions regarding providing resources to or doing business with the entity.

3. All users of financial statements require those financial statements to assist them in making economic

decisions regarding the future.

Relevant

If the information is not relevant it will not assist in the making of the decision – relevant information

assists in evaluating the past, present or future and allows decision makers to confirm or correct their

past evaluations. Material information needs to be included as information which can influence the

decision must be given or a wrong decision could be made. Information needs to be timely or it will lose

its relevance. Managers cannot make valid decisions to move the business forward, if the information

they have is not relevant to the business, up-to-date, and able to assist with the decisions they are

required to make.

Faithfully represented

If the information is not faithfully represented then the decisions made could be invalid. Faithfully

represented information will be complete so users know they have been given all the explanations they

need to make decisions based on the information; neutral so that it is not biased towards some specified

outcome; and it will be free from error ensuring the information has been correctly described so

decisions can be made.


Understandable

If the information is not understandable by users who have a reasonable knowledge of the business and

economic activities they are not going to be able to use it at all as they will not know what it means.

Comparable

Decisions makers including management, need to be able to compare the information from one year to

the next for the same entity and with other entities so they need to know that the information has been

prepared in a consistent way. Managers in particular need to identify trends in income and expenses to

ensure that the business is continuing to remain profitable and the decisions they are making are allowing

the business to grow.

4. Accountability is the requirement of one party to account to another party for its actions. Management is

required to account to the shareholders as to how they have made the best use of the resources the

company has. Financial statements show the results of the stewardship of management, or the

accountability of management for the resources entrusted to it. Financial statements show whether

sales/income/revenue is increasing, whether profit and return on assets/equity is improving, the ability of

the business to generate positive cash flows, the stability of the business all of which reflect management

ability to make to best use of the resources of the business.

Those users who wish to assess the stewardship or accountability of management do so in order that they

may make economic decisions; these decisions may include, for example, whether to hold or sell their

investment in the entity or whether to reappoint or replace the management.

5. (a) a statement of financial position provides information about the financial position of the business,

including information about the assets, liabilities and equity of the business at balance sheet date.

(b) a statement of comprehensive income statement provides information about the financial

performance of the business, including its income, expenses and profit over the year/period ended on

balance sheet date and items of other comprehensive income such as increases in revaluation

surpluses of land and buildings so the assets are reported at fair value.

(c) a cash flow statement provides information about the various cash flows including cash flow

generated from operating activities, cash flow generated from investing activities and cash flow

generated from financing activities. It shows where the business has spent its cash and from where it

has received its cash. It provides users with information to determine the likely future ability of the

business to continue paying dividends, to continue operating and paying its suppliers and employees

and the ability to finance property, plant and equipment to allow the business to continue to grow.

6. Employees may be interested in the businesses future development, in what areas expansion is planned,

how the business contributes to the community the employees belong to. This information is often

included in the management commentary in the annual report and provides information for employees

regarding the business and its relationship to the community it operates in. Employees may also be

interested on how the business impacts on the environment particularly if those employees are keen to

work for a company which takes care of the environment and its waste

7. Customers are interested in whether or not the entity is a going concern, especially for example if they

have bought goods with a warranty or if they want to continue buying from the entity. Customers may

also be interested in the entity’s environmental and social responsibility goals and sponsorship

programmes

8. They would be interested in the company’s impact on the environment so would want to see

environmental and/or sustainability reports and other information regarding how the business has acted

as a responsible citizen in terms of managing scarce and/or endangered natural resources and contributed

to preserving the


Exercise Three – page 21

Short answer questions on components and limitations of financial statements

1. Bad and doubtful debts are classified as an administrative expense, because the manager responsible for

allowing credit will be in the administrative department of the business – the credit manager works in

administration and makes decisions about who is allowed to have credit and it is administration that

sends out accounts to debtors and chases them up and monitors slow payers, hence bad debts and

doubtful debts stem from the administrative department/activities of the business so are classified as an

administrative expense.

2. The use of property, plant and equipment is often shared between various functions in the income

statement. For example the building may house the factory, administrative office and the retail space so

the depreciation on buildings is split between all three functions – the factory component goes to cost of

sales, the retail space goes to distribution costs and the office space goes to administrative expenses.

Depreciation on manufacturing plant needs to be included in cost of sales as it is a production cost – in a

manufacturing business it will be included in the cost of sales as part of production costs which become

cost of sales when the goods are sold. Depreciation on shop fittings and fixtures on the other hand is

included in distribution costs, while depreciation on office equipment is included in administrative

expenses.

3. Explain why inventory of a jeweller is classified as a current asset even if it may take more than one year

to sell some items. A current asset is defined as an asset which will be realised within the normal

operating cycle of the business – for a jeweller the normal operating cycle – the time taken to convert all

its inventory into cash – may be longer than one year.

4. The current portion of term debt is due for repayment/settlement within the next twelve months and a

current liability includes all those amounts which will be settled in the next year.

5. Explain how the following question from a company manager to his accountant illustrates a limitation of

the balance sheet: “our latest range of products have been a huge success with large numbers of new

customers, why can’t we report this in our balance sheet?” This is internally generated goodwill and

there is no transaction which can be represented faithfully by this “huge success” so there is no reliable

measure of the goodwill – without a reliable measure the goodwill cannot be recognised as an asset in

the balance sheet.

6. Explain a limitation of the income statement related to the “latest range of products”. The income

statement only shows the dollar impact of the sales of the product, it does not show that they have been a

huge success with many new customers, although if income has increased substantially the reason

behind this will be the success of the new product. The explanation of the increase in sales is not shown

in the income statement, but the result of the increase in sales is. If the product were being sold at a

cheaper price than other products, thus attracting the many new customers, then the numbers in the

income statement may not have increased as much – the quantity may have increased without an equally

proportional increase in sales.

7. The main limitation of the statement of cash flow is that it is a historical statement showing what has

been received and what money has been spent on. It does not show the quality of that spending and it

does not show future cash commitments the business may have. A budget would be needed to see this

information.


Exercise Four – page 21

Conceptual Basis of Accounting

Knights Catering Ltd PART A

(a) Going concern

It is assumed Knights Catering will continue its present operations into the foreseeable future –

management has no intention of closing down or changing course and has not identified any reason to

believe Knights Catering Ltd is not a going concern. Hence the financial statements have been prepared

with going concern as an underlying assumption.

(b) Reporting period

The balance sheet date is 31 March 2006 – the balance sheet shows the financial position of Knights

Catering Ltd at that date and the income statement will have been prepared for the year ended on that

date. Preparation of annual financial statements is necessary to make comparisons of financial position

and financial performance and cash flows over time.

(c) Accrual basis

Under the accrual basis the effects of transactions and other events should be reported in the financial

statements of the periods to which they relate. Assets such as accounts receivable and liabilities such as

accounts payable and accrued expenses are reported in the balance sheet as they meet the recognition

criteria of assets/liabilities on balance sheet date – accounts receivable will provide future economic

benefit in the form of cash received when the debtors pay; accounts payable and accrued expenses will

require an outflow of cash in the future to settle the amounts owing. The related income and expenses

will have been included in the income statement for the current period as they were earned/incurred

during that period.

(d) Faithful representation

The information in the financial statements should faithfully represent the transactions and other events

which have occurred. The information should also be neutral, providing an unbiased representation of

transactions/events. Fathfully represented information has been included in the use of historical cost for

property, plant and equipment and investments as these costs are based on market transactions for which

a neutral source document will indicate the cost.

The balance sheet has not omitted any assets or liabilities so is a complete representation of the financial

position of Knights Catering Ltd as at balance sheet date.

(e) Materiality

All items likely to influence users decisions have been disclosed. Market value of investments and

current value of Land and Buildings are shown in the notes as they are significant and particularly with

land and buildings significantly larger than the cost, and will influence the decisions of users of the

financial statements

PART B

The Shares in KPR Ltd are reported as an asset because

(i) they were purchased in the past (past transaction exists)

(ii) only Knights Catering Ltd can benefit from the dividends received from the shares and from the

eventual sale of the shares so Knights Catering Ltd controls the benefits to be received from the shares

(iii) the shares provide future economic benefit as cash flows to the entity when dividends are received and

eventually if they are sold there will be a cash flow to Knights Catering Ltd for the sale price.

(iv) it is probable that KPR will pay dividends so the future economic benefit from the shares in the form of

dividends is likely. Eventually if the shares are sold it is probable they will be sold for at least their

cost so this represents the eventual future economic benefit to be received

(v) there is a reliable measure of the cost of the shares on the source document which records their

purchase by Knights Catering Ltd.


PART C

(a) the income in advance is classified as a current liability

(b) it is a current liability as it will be settled in the next month – which is easily within the operating

cycle/next year for Knights Catering

(c) the income in advance will be reported as $1,500 as this is the amount of the future outflow of

resources from Knights Catering Ltd

(d) Knights Catering Ltd will have a (current) liability of $1,500 representing the present obligation to

provide catering for the wedding as a result of a past transaction – receiving the $2,000 – which will

require a future outflow of resources costing $1,500 – the cost of catering for the wedding which is not

going to be cancelled. The reliable and probable amount of the future outflow of resources is $1,500

not $2,000, so the liability income in advance will be reported at $1,500.

PART D

(a) The historical cost measurement base is very reliable – for example assets are recorded at their cost of acquisition which is usually based on a transaction with an external party so there is a reliable measure which is neutral or free from bias by reference to the source document recording the purchase showing what the asset cost (not an opinion as to its value). The transaction will be reported to faithfully represent the substance of the transaction – if an asset has been purchased providing future economic benefit then it will be reported as an asset, if there is a decrease in economic benefit then an expense will be reported.

(b) Realisable value has been used to report accounts receivable and inventory

(c) The current values are relevant to the decision making needs of the users of the financial statements. The current value of land and buildings and investments is reported in the notes as the amounts (particularly for land and buildings) are significantly different to their historical cost reported in the balance sheet. These amounts are likely to influence users decisions based on the balance sheet, hence they are disclosed in the notes so users can make informed judgements and decisions particularly regarding the ability of the business to acquire debt finance in the future.

PART E

(a) Advantages include

ii. the owners have limited liability for the business debts to the extent of their investment and any

personal guarantees they have given over the company’s debt, beyond this they are not personally

liable for the company’s debts,

iii. the business can easily gain more capital by attracting additional shareholders,

iv. the business has a perpetual life – continues despite any change in ownership

v. the company can issue debentures to assist with additional finance

(b) Disadvantages include

must follow the legal requirements of the Companies Act 1993 and the Financial Reporting Act 1993,

must be registered, and file annual reports with the registrar of companies

legal and other formation costs involved in registration can add up

tax on profit is 33c in every $ compared to spitting profit among partners and each partner being taxed

individually where rates are lower on the first $38,000, the same on the next $22,000 then higher (but

average rates tend to be lower than the flat company rate),

partnership is simpler to form and useful for small business or business with a defined and limited life

(eg for the life of a contract)

(c) Knights Catering Ltd is small – total assets are less than $450,000 and turnover must have been less than

$1million. The shareholders are all directors.

(d) A Constitution


(e) In a partnership the entire profit must be shared between the partners and this is usually done based on

clauses in a Partnership Agreement – no profit is retained by the partnership as the partnership is not a

separate legal entity from the owners, when partners withdraw money for themselves it is treated as

drawings not a business expense – each partner may retain profit in the business via a credit balance in

their current account.

In a company profit may be either distributed to owners as a dividend, or shares may be repurchased, or

the profit can be retained in the company as retained earnings. The company can retain profit in its own

right as it is a separate legal entity. This also allows the company to employ its shareholders and pay

them a wage/salary for work they do in the company – this is a legitimate business expense deducted in

the Income Statement before profit is calculated and taxed. The amount of profit retained and the

amount distributed is up to the directors.

Exercise Five – Adapted from Bursary 1997 – page 23

(a) General purpose financial statements are used by external parties unable to contract for detailed

financial information, for making economic decisions. For sound decisions to be made there needs to be

an assurance that the statements are prepared on a consistent basis following accepted principles and

practice so comparisons can be made - requirement for information to be comparable. It is also

important that the information is relevant and reliable so that valid judgements can be made.

(b) (i) A financial element is recognised when there is a reliable measure of the amount of future

economic benefit likely to flow to or from the entity. The reliable measure of the amount of future

economic benefit in terms of cash likely to be received from accounts receivable is the historical

cost of accounts receivable less the allowance for doubtful debts which is based on past experience

with bad debts, the age of accounts receivable and the current economic climate providing a

measure of the amount of accounts receivable unlikely to be realised in cash therefore faithfully

representing the transaction and other events surrounding it.

(ii) Accounts receivable should be recognised in the balance sheet at its probable future economic

benefit. The recognition that accounts receivable will include a certain proportion of debts which

are likely to become bad debts reduces the probable future economic benefit likely to flow to the

entity in the form of cash from accounts receivable. It is this probable future economic benefit

which is reported, provided it can be reliably measured – see above.

(iii) Accrual basis means recognising transactions and other events when they occur and reporting them

in the financial reports of the periods to which they relate. Accrual basis requires that we account

for (recognise) doubtful debts as an expense of the current period as it relates to the current periods

sales and represents a decrease in economic benefit during the current period - the amount of

accounts receivable we are unlikely to receive.

(c) (i) Historical cost requires recording transactions and assets at their acquisition cost which in the case

of some assets, notably land and buildings, means that the value recorded is totally out of line with

the asset's current value. Businesses needing to make decisions about the future need relevant,

timely information which is up to date - not values from the past which will have little bearing on

these decisions. Judging the ability of the business to raise debt finance for example needs to be

based on the current value of land and buildings and not their historical cost.

(ii) When land and buildings are revalued the credit should go to the Land Revaluation Surplus for

land and Buildings Revaluation Surplus for buildings. The increase in fair value is reported in the

statement of comprehensive income as “Other Comprehensive Income” and added to the

Revaluation Surplus balances in the Statement of Changes in Equity.


(d) (i) Relevance and Materiality - this law suit cannot be recorded as a liability as we do not have the

recognition criteria met - it is not probable and there is no reliable measure - but it is likely to

influence decisions users will make based on the statements so it is required to be disclosed in the

financial report in the notes to the financial statements.

(ii) It is a contingent liability (dependent on the outcome of the court case) which should be disclosed

in the notes to the financial statements.

(e) (i) The accounting entity concept is applied when recording transactions by recording business

transactions separately to personal transactions of the owner. Personal expenses of the owner when

paid with business money, or personal use of business assets, is recorded as drawings and not in the

income statement as an expense as expenses do not include distributions to owners.

(ii) This is correct treatment of the vehicle expenses for an employee when these are part of the

employment contract as this is part of the running costs of the business which when the person acts

as an employee - regardless of whether they are a shareholder - they are treated as any other

employee, as the company is a separate legal entity.

Exercise Six – page 24

Concepts Question based on Taihape Adventure Tours Ltd

(a) Kay and Bob have limited liability for the company debts meaning they are not personally liable for

company debts, provided they have not given any personal guarantees or they are not negligent in their

directorship of the company and they have paid for their shares in full.

(b) (i) A constitution so they can get the best advantage from the clauses in the Companies Act like

limiting directors powers and who can own shares, allowing for share repurchase

(ii) In a partnership the entire profit is shared between the two partners based on their profit sharing

agreement whereas in a company the profit may be kept/retained for expansion or distributed to

shareholders by way of dividend based on the number of shares owned

(c) Taihape Tours is an exempt company because it has less than $450,000 in assets and less than $1 million

in revenue.

(i) The entity

• Is not an issuer or shares or debt securities to the public – Taihape Tours Ltd has two shareholders

who are also directors so it does not have public accountability (it would also not have issued any

debentures to the public to qualify as not an issuer)

• is not large – the company has less than $20m in revenue, less than $10m in assets and less than 50

employees

• owners are members of governing body – Kay and Bob are the only shareholders and directors

• owners have not requested full compliance with NZ GAAP – Kay and Bob will prefer to use

differential reporting as it costs less to prepare their general purpose financial statements

(ii) Full compliance with financial reporting standards in the preparation of financial statements would

add a cost greater than the benefit to be gained from the financial statements as the shareholders are

also directors and already have considerable knowledge of the company– differential reporting

allows for some exemptions from full compliance with financial reporting standards such as not

being required to prepare a statement of cash flows

(d) (i) Generally accepted accounting practice is the term used to describe the basis on which general

purpose financial reports are normally prepared.

The term encompasses:

(a) specific rules, practices and procedures relating to particular circumstances; and

(b) broad concepts and principles of general application.


New Zealand equivalents to IFRSs and FRSs are the primary indicators of NZ GAAP. Conformity

with generally accepted accounting practice means:

(a) compliance with all New Zealand equivalents to IFRSs and FRSs applicable to the entity; and

(b) in relation to matters for which no provision is made in New Zealand equivalents to IFRSs or

FRSs and that are not subject to any applicable rule of law, adopting accounting policies that:

(i) are appropriate to the circumstances of the entity; and

(ii) have authoritative support within the accounting profession in New Zealand.

(ii) The objectives of general purpose financial statements include

The objective of financial statements is to provide information about the financial position,

performance and changes in financial position of an entity that is useful to a wide range of users in

making economic decisions.

Information in financial statements should assist users to

(a) assess the performance, financial position and cash flows of the entity;

(b) assess the entity’s compliance with legislation, regulations, common law and contractual

arrangements, as they relate to the assessment of the entity’s performance, financial position

and cash flows; and

(c) make decisions about providing resources to, or doing business with, the entity.

(iii) The NZIFRS provide guidelines and rules for preparers of general purpose financial statements in

relation to the recognition, measurement and disclosure of transactions and other events in the

financial statements, and accompanying notes where applicable, so that those financial statements

comply with NZGAAP and will present a true and fair view or fair presentation of the financial

position, financial performance and cash flows of the entity. NZIFRS also assist in providing for

consistency of treatment of items by different entities, including entities from different countries, to

allow comparisons to be made.

(e) (iv) Investors, lenders, suppliers, government, employees, customers, general public

(v) Investors or shareholders want to ensure their investment is safe so they are interested in the long

term stability of the business and also the ability of the business to pay dividends in the mean

time/on an annual basis

Lenders want to ensure they will be paid back, including any interest owing

Suppliers are interested in a more short term ability to meet amounts owing – often in the next month

or two

Government wants to ensure correct taxes are paid and that the business is meeting its legal

obligations

Employees are interested in the ability of the business to pay their wage/salary and other

employment benefits and in the stability of the business in terms of their job security

Customers are interested in whether the business will continue to serve their needs and in particular

if they have goods under warranty, that the warranty will be honoured if need be

General public are interested in the contribution of the entity to the local community including

employment opportunities, donations and sponsorship programmes

(vi) Users may also be interested in interpretive comment and explanations as to some of the key changes

in the financial statements. They may also be interested in prospective information regarding the

direction the business is heading. A number of users are also interested in environmental and social

responsibility issues (eg environmental impact reports, “triple bottom line reports”) and the entity’s

contribution to the wider community and the “clean, green, image”. Non-financial information

might also focus on identifying and describing the key business, operational and strategic factors

facing an entity. Key value driver information can encompass a broad range of measures including

sales growth, profit, and client satisfaction, measures of the quality of goods and services, and

supplier relationships.


(f) The petrol on hand does not be recorded as an asset as it is immaterial – the amount is too small to be

treated as an asset even though the petrol will provide future economic benefit to the business when it is

used in the vans for tours. The $100 will not affect any decisions made on the financial statements –

therefore it can be recorded as an expense of the current period as there has been a decrease in economic

benefits when the petrol was paid for and it won’t last very long into the next year.

OR The petrol could be argued is an asset as it will provide future benefit when the petrol is used in the

vehicles taking clients on tours which is probable, it has been purchased, is in the control of the

entity and the amount can be measured reliably.

OR accrual basis would suggest the expense relates to the next period when the petrol will be used so

should be recorded as an expense in that period – hence an asset now.

(g) (i) Depreciation on vehicles and kayaks and equipment is a decrease in economic benefit via a depletion

of the assets vehicles and kayaks and equipment resulting in a decrease in the assets. There is also a

decrease equity by less profit and is clearly depreciation is not a distribution to the owners. It is

probable that the vehicles, kayaks and equipment have worn out somewhat over the year through

their use by the tour company and the amount has a reliable measure based on experience with the

expected economic life and pattern of use of the assets.

(ii) Diminishing value depreciation better reflects the consumption of future benefits of vehicles as they

provide most benefit with little maintenance in early periods, and usually more maintenance when

the vehicles are older and depreciation is less; thus spreading the total cost of the vehicles relatively

evenly over their useful lives. Straight line depreciation is appropriate for kayaks and equipment as

they provide equal benefit in each year they are used.

(h) (i) 0.6*8,000 = 4,800 therefore the amount of liability $4,800.

(ii) The amount of the liability is the future outflow of resources that can be reliably measured and is

probable. The future outflow for these tours which cannot be cancelled is the cost of providing the

tours – at most – and the company has a present obligation to provide these tours as they have

already been paid for. No refunds are available and it is probable the tours will proceed. Hence a

liability of $4,800 exists.

(i) “Inventories shall be measured at the lower of cost and net realisable value” (NZIAS2). Therefore the

clothing inventory should be measured at $25,700 which includes cost for most of the inventory and net

realisable value in relation to the $9,000 which is now only likely to net $5,000. $25,700 is a better

reflection of the probable future economic benefit to be derived from inventory and it means that the asset

is not overstated.

(j) (i) The faithfully represented piece of information is the $12,000 paid for the gear as this is based on an

actual (past) transaction where there would be an invoice confirming the amount. This is verifiable

as the initial cost of the gear from a market transaction.

(ii) Money in the bank to pay for it or working/liquid capital indicating ability to meet the payments.

(iii) The cost of the new equipment, the possible trade-in value of the old gear as this would influence

how much they can afford to purchase/what type of equipment they can afford to buy.

(iv) Health and safety regulations regarding the new gear; quality of the new gear; range of sizes needed

for lifejackets for example etc.


Exercise Seven – page 26

Conceptual Basis adapted from Bursary 1999

Part A

Matt has limited liability for the company debts provided, as director he does not act negligently or make

a distribution to shareholders when the company does not meet the solvency test

Matt can sell some of his shares in the company and gain some personal cash for himself.

As a small company, the directors are likely to want to restrict who can own shares, they may want to

modify other requirements of the Companies Act 1993, allow for repurchase of shares to retain family

ownership, restrict powers of the directs etc

Part B

Issue One

(a) the car is a personal asset which is separate from the business assets for accounting purposes according

to the notion of accounting entity; or the car is not under the control of the company and therefore does

not qualify as an asset of the company; or the car produces little future economic benefit to the firm and

therefore should not be included as a company asset

(b) as a dividend/loan to a director/as a profit distribution/as a reduction in retained earnings

Issue Two

(a) the revaluation makes the information in the financial statements relevant as better decisions can be

made based on the up-to-date (timely) value of the land and buildings, which is significantly greater than

their historical cost – revaluing the land and buildings adds to the equity of the business so it is seen to

offer better security for further debt finance should this be required. The amount of the revaluation is

material so therefore should be reported as it is relevant to the decision making needs of the users of the


(b) The revaluation can be said to faithfully represent the fair value of the land and buildings as an

independent valuation has been obtained, ensuring the amount is free from bias.

Issue Three

(a) accrual basis

(b) $100 is a small amount which will not make any difference to the decisions made based on the financial

statements so it does not need to be included in the assets even though it will be used by/will benefit the

business in the future

Issue Four

(a) Shareholders – to provide information of the financial performance, position and cash flows of the

company or to provide financial information for decision making purposes or to inform shareholders of

how their funds have been invested

(b) The asset should be recorded at the lower of depreciated historical cost and fair value. The amount of

future economic benefit embodied in the asset stems form its historical cost and expected useful life and

pattern of use/wearing out which has to be assumed has resulted in the 15% DV depreciation being

applied. This rate should not be changed unless the pattern of use of the asset has changed from being

diminishing value (higher loss of benefit in early years) to straight line – the same/equal use/benefit

gained in each year or the assets future economic benefit may be understated as the 30% rate would

result in a higher accumulated depreciation and a lower carrying amount for the asset thus understating

the asset’s probable future economic benefit.

(c) In the notes to the property, plant and equipment there should be reference to the change in the estimate

of depreciation from 15% diminishing value to 30% straight line so that comparisons can be made (note

this is NOT a change in accounting policy – it is just a change in an accounting estimate).


Issue Five

This inventory needs to be written off as an expense for the period of $7,500 and not carried forward as an

asset as there is no future economic benefit to be gained from it so it cannot be recorded as part of the

inventory asset in the Balance Sheet. The flea collars need to be valued at their estimated net realisable

value when this is below cost, so in this case zero for inventory. The inventory in the Balance Sheet would

be reduced by $75,00. The cost of sales or expenses will increase via the write down of inventory, thus

decreasing net profit by $7,500 – and hence equity.

Exercise Eight – Adapted from Bursary 2000 – page 27

Alex and Anita’s partnership

PART A

Q. No Evidence Code

(a)

Shareholder knows the financial statements

comply with NZ generally accepted accounting practice

comply with NZIFRS

meet legal requirements of the Financial Reporting Act 1993

show a true and fair view/fair presentation of the financial position, financial

performance and cash flows of the entity

Judgement

- any one D

(b)

Policies stating how assets, liabilities, income and expenses have been measured are

necessary for users to make sound decisions based on the financial statements, for example

users need to know that land and buildings are revalued annually in order to make sound

decisions based on the balance sheet; they also need to know the measurement bases

adopted so as to be able to compare the financial statements with previous years and other

(similar) entities

Judgement

answer just refers to understanding the financial statements for decision making

answer identifies measurement bases needing to be known for decision making and

gives an appropriate example

D

A

(c)

The accrual basis says transactions should be reported in the financial statements of the

periods to which they relate.

By expensing bad debts when they are recognised, you are reporting the expense in the

income statement in the period in which the bad debt actually occurred

Judgement

definition of accrual basis (NOT with only recording)

answer links bad debts to expenses being reported in the period incurred D

A

(d) (i)

Office furniture and equipment is an asset because

it has been purchased in the past (there is a past transaction)

only New Zealand Consultancy Company Limited can use the office furniture and

equipment to administer their business (they have present control of the office furniture

and can exclude others from using it)

in the future office furniture and equipment like computers will be used to write up

consultancy reports which earn income for the business – hence future economic

benefit as the cash will be received from the income earned

Judgement

Refers only to the characteristics or does not make a valid link to office equipment

Makes a valid link to each of the characteristics (note office equipment provides future

economic benefit is NOT a valid link)

D

A


(d) (ii)

It is probable that the office furniture and equipment will be used in the future for

consultancy work, thus it is probable that the future economic benefit exists

There is a reliable measure of the office furniture and equipment by reference to the

purchase invoice which is neutral/free from bias/and faithfully represents the fact an asset

was purchased

Judgement

Makes a valid link to both recognition criteria (repeating the criteria without a valid link

to office furniture and equipment is wrong) E

(e)

Depreciation on office furniture and equipment is an expense because it is a consumption

of the future economic benefit of the asset office furniture and equipment which reduces

the asset and reduces equity by less net profit and it is not a distribution to owners

Judgement

Refers to consumption of future economic benefit/service potential, reducing of the

asset and reducing of the equity A

(f)

Straight line depreciation is used because the (pattern of) consumption of future economic benefit of the assets is the same in each period/year they are used by the business

Judgement

Refers to consumption of future economic benefit/service potential being the same from one year to the next for the assets

A

(g) (i)

Historical cost is reliable because this is the transaction cost which is neutral by reference to the source document (eg invoice) recording the transaction and the transaction can be assumed to be represented faithfully as an asset when an asset is purchased providing future economic benefit or as income when income has been received increasing economic benefits and increasing equity etc

Judgement

Just defines reliability as neutral and faithful representation of the transaction

Links historical cost to transaction cost and source document being neutral/faithful representation of the transaction

D

E

(g) (ii)

Historical cost provides a consistent measurement of transactions and assets so it is easier to compare results from one period to the next/from one company to another

Judgement

Answer gives idea of historical cost giving a consistent measurement allowing for comparability to occur between periods/businesses

E

(h)

Land and buildings are more likely to have a current value which is materially/significantly different from their historical cost and current value gives a more relevant and timely measure of these assets in terms of their probable future economic benefit/predictive value as land and buildings are likely to be relatively significant in size/appreciate in value/have a much longer economic life compared to office equipment for which historical cost is relevant

Judgement

Answer explains current value of land and buildings as relevant with a valid reason for using current value compared to office equipment for which historical cost is relevant – must refer to both land and buildings and office equipment

E

(i)

The probable future economic benefit to be received from receivables is their estimated realisable value after allowing for doubtful debts and this should be shown as the amount for the asset as it is a reliable measure of the amount of cash likely to flow to the business from accounts receivable and also so as not to overstate the asset’s future economic benefit (prudence, a component of reliability requires that assets are not overstated)

Judgement

Answer must link estimated realisable value to probable future economic benefit and reliable measure of cash to flow to the business

E


Part B

(a)

James can withdraw some capital/share the workload now he is older/take more time

off/semi retire/work more flexible hours

Judgement

Any valid reason from James perspective D

(b)

Judy will benefit from being a partner in an established business/can learn from James

experience/will receive a share of the profits/shares the risk of being in business for herself

Judgement

Any valid reason from Judy’s perspective D

(c)

To recognise the different contributions each partner makes otherwise they are treated

equally/to allow for profit sharing clauses so profit can be shared other than equally)/to

formalise decision making in the partnership so that the partnership can operate effectively

Judgement

Any valid reason for having a Partnership Agreement

Any valid reason explained (ie so that… because… used to explain the reason given)

D

A

(d)

To gain access to limited liability – so he would not be personally liable for the business

debts once his shares were paid for/provided he didn’t give personal guarantees for the

company debts/did not act negligently as a director

Judgement

reference to limited liability or other valid reason

addition of not personally liable once shares paid for

addition of exceptions

D

A

E

(e) (i) Constitution D

(e) (ii)

To modify the requirements of the Companies Act such as restricting the powers of

directors/restricting share issue/allowing for repurchase of shares

Judgement

Answer just says modify companies act

Addition of valid example D

A

(f)

In a partnership all the profit is shared out between the partners based on clauses in the

partnership agreement (or equally if no agreement)

In a company profit may be distributed as a dividend or retained in the business – the

shareholders receive a dividend based on the number of shares owned – not all the profit

needs to be distributed as the company is a separate legal entity to its owners

Judgement

Answer just mentions dividends for company, drawings for partnership

Answer refers to both partnership and company

Answer clearly distinguishes the two (all profit shared in partnership,some can be

retained in a company)

D

A

E


Exercise Nine – page 29

Adapted from Bursary 2001 and updated to reflect NZIFRS

Part A

(a)

Objective of financial statements is to provide information about the financial position,

performance and changes in financial position of an entity that is useful to a wide range of

users in making economic decisions or

To assess the entity’s financial performance/financial position/cash flows or

To assist users to make decisions regarding doing business with the entity

Judgement

Answer must state “assess” or refer to users making economic decisions D

(b) (i)

Nordical Ltd is an issuer of shares to the public as it is listed on the NZX

Nordical Ltd issues debentures to the public

Judgement

Either or valid alternative but must be non-financial D

(b) (ii) Nordical Ltd has assets of approx. $23m which is considerably greater than $10m which

qualifies the company as large

(b) (iii)

Nordical Ltd must complete its general purpose financial statements within five months of

balance sheet date; Nordical Ltd must complete general purpose financial statements that

fully comply with NZGAAP meaning full compliance with NZIFRS; an valid disclosure

requirement (eg must include accounting policies, must show donations, directors fees etc

- Any one valid obligation D

(b) (iv) See NZ Framework paragraph 9 or Taihape Tours Ltd answer (e) (iv) and (v)

(c) (i)

Both the following two tests apply after the dividend is paid

Balance sheet test – assets are greater than liabilities after dividends are paid

Liquidity test – the company is able to pay its debts as they fall due in the ordinary

course of business after the dividend is paid

Judgment

States one test accurately or gives both without reference to after dividend paid

States both tests including after dividend paid D

A

(c) (ii)

The assets are greater than the liabilities in the Balance Sheet

There is a positive working capital indicating broadly that the business should be able to

meet its debts in the ordinary course of business

Judgement

Gives one piece of evidence

Explains both pieces of evidence D

A

(c) (iii)

The expense definition clearly states an expense is “not a distribution to owners”

A dividend is a distribution to the owners hence it is not an expense of Dynamic Physio

Ltd.

Judgement

Just defines expense/says dividends is a distribution to owners

Makes a clear link from the “not a distribution to owners” aspect of the expense definition

to the dividends being a distribution so not an expense

D

E


Part B

(a)

It has been assumed Nordical Limited will carry on into the foreseeable future.

Management do not see any reason why Nordical Ltd is not a going concern (having

assessed this) – ie Nordical Ltd has no reason or plans to liquidate – as they have not

reported assets at liquidation values or given any other indication that Nordical Ltd is not a

going concern so the balance sheet has been prepared based on the going concern

assumption

Assets and liabilities have been identified as current and non-current – non-current assets

and liabilities have an expected “life” of more than one year/operating cycle of the

business so the business must be planning to continue into the foreseeable future/clearly

Judgement

Definition of going concern only provided

Answer refers to Nordical Ltd’s management having assessed the business as a going

concern and prepared the financial statements accordingly D

A

(b)

Comparability – enables comparisons to be made between different periods

Judgement

Identifies qualitative characteristic

Explains the characteristic in relation to comparative figures – refers to comparing time

periods

D

A

(c)

Understandability – assists with the user’s understanding/comprehension of the financial

statements

Reliability – notes give more information about actual events to assist/ensure transactions

and other events are represented faithfully, are based on neutral information, represent

substance rather than legal form, and the financial statements are complete (nothing

material to a proper understanding has been omitted)

Judgement

Identifies qualitative characteristic

Explains the characteristic in relation to the notes D

A


Part C

(a)

1. recognition criteria for assets/probable future economic benefit/reliable measure/prudence

2. Inventory is measured at the lower of cost and net realisable value to ensure the probable future economic benefit of the inventory is reliably measured as to the amount of benefit likely to flow to the entity. This amount should not be overstated (prudence part of reliability)

Judgement

Identifies an appropriate concept

Refers to measurement of inventory in relation to the concept identified

Links the measurement of inventory to the amount of benefit likely to flow to the entity

D

A

E

(b)

1. Materiality –

2. assets of less than $200 could be added to assets but will not influence the user’s decisions bout the value of the firm’s assets where the firm’s assets total nearly $23m

Judgement

Identifies and/or simply defines materiality

Adds reference to a $200 asset not being likely to influence decisions

Adds a comparison to the total assets

D

A

E

(c)

1. Current value measurement base/relevance/materiality

2. Land and Buildings tend to appreciate over time so current value gives a more relevant/up-to-date/timely measure of the future economic benefit of the land and buildings enabling better decisions to be made regarding the stability of the business and its ability to raise finance in the future

Land and Buildings have a long useful life so differences between their acquisition/historical cost and current value can be significant and likely to influence users of the financial statements so materiality indicates the current value should be disclosed

Judgement

Identifies and/or simply defines a concept

Refers also to land and buildings and current value being relevant or material

Makes a link to some aspect of relevance or materiality

D

A

E

(d)

1. Historical cost

2. other items of property, plant and equipment are recorded at their acquisition/purchase cost as this is reliable being verifiable by reference to the source document/invoice detailing their purchase

Judgement

Identifies and/or simply defines historical cost

Refers to other items… and recording

Links historical cost to some aspect of reliability

D

A

E

(e)

1. Asset/reliability

2. there is no past transaction relating to when this “extra” goodwill was acquired / the goodwill does not faithfully represent a transaction or past event, and the amount of probable future economic benefit cannot be measured with reliability as it is not neutral/free from bias hence it fails to meet the recognition criteria for an asset so cannot be recognised in the balance sheet

Judgement

Identifies and or simply defines asset/reliability

Refers to goodwill and recognises no past transaction/does not faithfully represent a past transaction/event

Links measurement of amount to not being able to be measured reliably hence fails the criteria for recognition as an asset

D

A

E


(f)

1. Liability

2. the law suit may or may not involve a future outflow of resources/money and at present

the amount (of the future outflow of resources) cannot be measured with reliability – it

would not be free from bias so it cannot be recorded as a liability in the balance sheet

or

1. materiality

2. the law suit must be disclosed in the notes to the balance sheet as a contingent liability

as it is likely to influence the decisions of users of the financial statements because of its

nature (the firm may have acted illegally) or its potential amount $100,000 is significant

Judgement

Identifies and/or simply defines liability or materiality

Refers to the law suit

Links liability to not being able to be recorded because of no reliable measure or

materiality to influencing decisions because of either the nature or significant amount (if

the firm lost the case)

D

A

E

Part D

(a)

Limited liability does not apply if you have given personal guarantees over the debts of

the business and banks and suppliers have indicated they would require these

Judgement – answer must refer to context A

(b) Jim will have the majority voting rights or Jim will maintain control over the company D

(c)

Allows for modification of the Companies Act by allowing for shares to be repurchased –

helps keep control in the hands of a few shareholders – limits the powers of directors –

limits the sale of shares

Judgement

Just says can modify companies Act

Adds a valid example of a modification that would be relevant in the circumstances D

A

(d)

• Less expensive to set up

• Fewer compliance costs

Judgement – any valid reason D


Exercise Ten – NCEA 2004 Adapted – page 31

Evidence Statement

Part A

Q Evidence

Part A

(a) (i) Constitution D

(a) (ii)

so Dave and Rose can take full advantage of the Companies Act 1993

so they can limit who they sell shares to

so they can keep the company small

so they can limit their powers as directors etc.

Any one reason.

D

(a) (iii)

In the partnership the entire profit was shared between Dave and Rose based on the clauses

in their agreement.

In the company they will receive a dividend based on the number of shares they own as

their share of the profit while the remaining profit will be retained in the company.

– Answer just refers to drawings/dividends.

– Answer refers to clauses in a partnership agreement and/or dividend based on number of

shares and/or some profit retained.

D

A

(b) (i) Dave and Rose are not personally liable for the company debts. D

(b) (ii)

Once they have paid their shares in full (award A if included in (i) above and not also stated

here).

provided they have not given any personal guarantees

they do not act negligently as directors

they do not make a distribution to owners when the company fails the solvency test.

Any one of these three.

A

E

(c) (i)

Objectives are:

to provide information about the financial position, performance and changes in

financial position of an entity that is useful to resource providers – current and potential

investors, creditors and lenders in making economic decisions about providing resources

to the business

assessing the entity’s financial performance, financial position and cash flows

Any one D

(c) (ii)

Purposes are:

NZIFRS establish requirements for recognising, measuring and disclosing transactions

and other events in general purpose financial statements

Or

Financial reporting standards are the primary indicators of generally accepted

accounting practice (which reporting entities must follow in the preparation of general

purpose financial statements).

Either one at a basic level

– FRS are rules used in the preparation of financial statements.

Either one at the explained level

– refers to measuring transactions/assets/liabilities etc or refers to GAAP

D

A


(c) (iii)

it is not publicly accountable – it is not an issuer

it is not large (does not have more than $20m income, $10m assets, 50 employees)

Rose and Dave are the sole shareholders and directors

The annual turnover is $2.7m which is less than $20m (and greater than exempt total);

total assets are $1.2m which is less than $10m (and greater than exempt total) allowing

it to qualify under size criteria

First two with no reference to Northern Maintenance Ltd

Next two – links to some aspect of Northern Maintenance Ltd

D

A

(c) (iv)

The cost of producing full general purpose financial statements would outweigh the

benefits to shareholders who are also directors since they will already know a

considerable amount about the company and do not need as much information as

shareholders who do not have this position.

Discussion of the size criteria leading to it being more costly to fully comply with FRS

than benefits to be gained as smaller companies will have less people interested in their


– for costs of doing something should not outweigh benefits

– the cost of producing general purpose financial reports should not outweigh the benefits

to readers of those reports

– where discussion links costs and benefits to the director/ shareholder situation or the size

situation as per evidence.

D

A

E

Part B

(a)

Equipment is initially stated at cost of acquisition in the accounting records.

– Answer simply says historical cost is purchase/original or acquisition cost

– refers to equipment and cost of acquisition or purchase and recording/stating (in accounting

records/financial statements).

D

A

(b)

Faithful representation

Initial statement of PPE at acquisition is based on market transactions for which there is a

source document providing evidence of the cost – the source document is neutral, free from

bias and represents the transaction faithfully provided that a transaction resulting in an asset is

reported as an asset, not an expense and vice versa. Also land and buildings a revalued by

independent valuers who provide a fair value that is free from bias. The method of valuation is

disclosed so the information regarding the value of land and buildings is complete and free

from error in how fair value is determined and reported.

Relevance

Land in buildings tend to rise in value over time so reporting them at fair value, faithfully

represented provides relevant information as it is current value that users of the financial

statements need to make decisions on, not dated information. The relevant information is

enhanced by being timely. The fair value of land and buildings represents the future economic

benefit of the land and buildings so allows for better decisions to be made regarding the

stability of the business and its ability to access debt finance in the future – assists better with

making economic decisions regarding Northern Maintenance Ltd

– defines faithful representation or relevance

– clearly links faithful representation of PPE to neutrality/free from bias or complete or free

from error

or – clearly links relevance to information that users need to make decisions

– both the second and third bullet – must have a link to making decisions

D

A

E


(c)

Operating revenue includes amounts received and receivable for industrial machinery

maintenance services provided to customers – it reports these amounts in the current

period as revenue, as they have been earned in this period and recognises an asset –

accounts receivable/accrued revenue on balance sheet date.

Important note: use of the word recorded alone is wrong /“recorded in the financial

statements” is ok

– Answer only defines accrual basis (but must not use only recording) eg – accrual basis is

reporting revenue/transactions in the period to which it relates

– include reference to amounts received and receivable being reported as revenue in the

current period and/or amounts receivable being reported as an asset, (Accounts

Receivable) on balance day.

– includes both reported as revenue and reporting of asset

Note the term income may replace the term revenue.

D

A

E

(d)

(i)

Accounts Receivables have been stated at estimated realisable value (after allowing for

debts where collection is doubtful).

The probable future economic benefit to be received from accounts receivable is their

estimated realisable value and this should be shown as the amount for the asset. The amount

of cash likely to flow to the business is the estimated realisable value (not the historical cost)

because of the potential bad debts included in accounts receivable

Answer must link probable future economic benefit to estimated realisable value and/or

accounts receivable less allowance for doubtful debts. D

A

(d)

(ii)

Reporting the estimated realisable value for accounts receivable faithfully represents the

event that some accounts receivable will ultimately not be received

– Simply restates the policy

– provides a valid link to reliability/faithful representation E

Evidence Part C

(a)

When employees use the vehicle to go to jobs to provide maintenance of machinery in the

future this provides future income/revenue for Northern Maintenance Ltd from which cash

will be received either when the job is done (cash job) or later (credit job)

– provides a valid link from the vehicle to how the future economic benefit arises from its

use by employees to get to jobs which then earn income/revenue. A

(b)

The vehicles are only used for three years and each year will provide equal amounts of

benefit to the business or the consumption of the (future economic) benefit of the vehicles in

each of the three years will be the same so charging the same amount of depreciation is

appropriate.

– must refer to the vehicle and explain that its pattern of use/consumption of future

economic benefit is the same from year to year – hence straight-line depreciation. (note

not approximately the same) A

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