4.16     Classify each of the following according to whether it is an asset, liability or equity account. Apply your learning from the definitions in the introduction to accounting and business decision making chapter to provide a justification for each classification.

4.17     Using your knowledge of the accounting equation, solve the missing values in the following table:

4.18     Determine the missing entries:

Please note: March 4 could alternatively be recorded as an asset (office stationery). So instead of – 1600 profit or loss it would be + 1600 office stationery (asset). The decision to expense or capitalise office stationery as an asset depends on the size of the business and the frequency of stationery purchases. For example, if the stationery purchase is for a month then it’s more likely to be an expense. If it is purchased in large amounts for the year, then the purchase should be treated as an asset. It is not a credit transaction as, unlike March 10, it does not state ‘on credit’ .

4.27     Preparing a worksheet

The closing statement of financial position items are given below for Jason Rosco in in accounting equation form as at 30 June 2024. Transactions for the following month of July are also given.

Transactions for July 2024 were as follows:

Required

a.    Prepare worksheet entries for the business transactions for the month ended 31 July 2024.

b. At the end of July, Jason realised that the customer invoice sent on 5 July was recorded incorrectly. The correct amount should be $6500. Explain what type of error Jason made and explain the impact of this error on the statement of financial position and the statement of profit or loss.

a.

b.

5.6      An entity has total assets measured at $330 000 on the statement of financial position. The entity’s liabilities total $150 000, of which $90 000 is a bank loan. Calculate  the   entity’s net assets.  Discuss  the   entity’s   financing decision.

Net assets refer to an entity’s total assets less total liabilities. Given that the entity’s assets are $330 000 and the total liabilities are $150 000, the entity’s net assets are:

Net assets = Assets – Liabilities

= $330 000 – $150 000

= $180 000

The entity is financing its assets with $150 000 of liabilities and $180 000 of equity. This means that the entity is using more equity than debt to finance its assets. For every $1 of assets, the entity has $0.45 of liabilities and $0.55 of equity. Relative to equity funding, interest-bearing debt has to be serviced via regular interest payments and the entity would have to have sufficient cash to meet these fixed interest payments.

5.8       The  Digital  Marketing Company  wants to increase its asset base by recognising its customer list as an asset. Discuss whether this is permissible under accounting standards.

Customer lists are regarded as intangible assets and accounting rules applicable from 1 January 2018 to reporting entities under AASB  138 Intangible Assets specify that certain intangible assets (such as brands, mastheads, publishing titles or customer lists) that are internally generated (rather than being purchased) cannot be recorded as assets on the statement of financial position (para. 48). Prior to 1 January 2005, Australian entities had discretion to record such internally generated intangibles as assets. This means that the company would not be able to increase its asset base by recognising its customer list in the statement of financial position.

While it can be argued that such assets satisfy the asset definition criteria, regulators’ concerns are that being able to reliably measure such assets, when they do not trade in an active and liquid market, is problematic. If the company had acquired the customer lists as part of a business acquisition, it could legitimately record them as intangible  assets since they had been purchased.

Accounting  for  intangible  assets  is  controversial  and  many Australian  firms  were opposed  to  being  disallowed  the  opportunity  to  recognise  internally  generated intangible assets as assets on the statement of financial position.

Suggestion:  show  students  an  extract  of  a   company  report  with  derecognised identifiable intangibles — Coca-Cola would be a good example given that it had to derecognise many millions of dollars of intangible assets. It is interesting to explore students’ views as to the appropriateness of having different accounting treatments for internally generated versus acquired intangible assets.

5.10     Knowing that you have some accounting experience, a friend has sought

your advice regarding a business that she intends purchasing. The statement  of  financial  position for the business shows total assets of $240 000 and liabilities of $120 000. The selling business has provided no notes to accompany the statement of financial position. On the basis of the information provided, your friend believes the business is worth $120 000. Advise your friend as to the accuracy of her assessment and what questions regarding the statement of financial position she should ask the seller of the business.

The carrying amount of the net assets of the entity is $120 000 (i.e. the $240 000 assets less the $120 000 liabilities). However, this does not mean that this is what the net assets of the entity are worth. Considering the variety of measurement bases that can be applied to an entity’s assets and liabilities and the possibility that a business may have valuable resources that are not captured on the statement of financial position (i.e. strong management), a statement of financial position does not portray the worth of the entity. To illustrate, consider an entity that acquired some land at a cost of $200 000 five years ago. The entity can legitimately report the land on the statement of financial position  at  its  historical  cost  (i.e.  $200 000).  This  will  not  necessarily  bear  any resemblance to the current value of the land. Assuming that real estate prices have increased, the land may currently be valued at $500 000.  Therefore, carrying it at $200 000 on the statement of financial position is not reflecting its current value. As the statement of financial position does not reflect the current value for all assets and liabilities, valuing an entity based on the carrying amount of the net assets may be inappropriate. Usually, it would be expected that the entity is worth more than the net assets reported on the statement of financial position.

This question highlights the importance of ascertaining things such as:

.    the measurement bases applied to the various asset and liability classes

.    the depreciation method and assumptions used to calculate depreciation

.    the amount of inventory on hand

.    the age of the debtors

.    the underlying profitability of the business

.    the cash generating capability of the business

.    an independent valuation of assets such as property, plant and equipment.

5.11    As  an investor in equities, you use the financial  statements to assess the

financial condition of  entities and inform your investment   decisions. Discuss if you would find it more useful to have items of PPE valued at historical cost or fair value.

An investor requires information that is both relevant and reliable for their decision making. Often it is necessary to trade-off the desirable characteristics of relevance and reliability. This is evident when considering historical cost and fair value. Generally, the fair value of property, plant and equipment (PPE) is more relevant to assess the financial position of the entity relative to historical cost. Fair value is the price at which a willing, knowledgeable seller and buyer would exchange an asset in an arms’ length transaction. Knowing the fair value of the PPE gives the investor a better indication as to what the assets are worth in the market. However, without a sale transaction to verify the fair value, subjectivity is introduced into the measurement process. Thus, compared to historical cost that is more objective, fair value may not be as reliable.

To extend this question, other issues that could be raised include:

.    the importance of recognition relative to disclosure

.    if items of PPE are measured at historical cost, would investors find it useful to have the fair values disclosed?

.    how could the investors assess the reliability of the fair value?

5.13    Kookaburra  Ltd  is  always  running short of cash, despite growing sales

volumes and its current assets exceeding its current liabilities. A review of its  operations by  a  consultant  finds  that  a  considerable  portion  of the company’s inventory is obsolete stock for which there is limited demand. Further, many of the accounts receivable are overdue by more than 60 days. The accounts receivable and inventory are carried at their gross amount and cost value, respectively, on the statement of financial position. Explain how the accounts receivable and inventory should be valued on the statement of financial position. If Kookaburra Ltd was to apply the correct measurement basis, determine the effect on: (1) profit; and (2) assets.

Accounts receivable should be measured at their cash equivalent. This is the cash that the entity expects to recover. The carrying amount assigned to accounts receivable should reflect the monies owed to the entity less an allowance for doubtful debts. The allowance for doubtful debts represents the entity’s estimate of the monies not expected to be received. When estimating the amount to record as the allowance for doubtful debts, entities consider the time for which the debt has been outstanding (e.g. the collectability of debts related to invoices from 6 months ago may be remote if the monies were  due  one month  from the  invoice  date). Alternatively, based  on past experience, the entity may provide for a certain percentage of the current period’s sales to be treated as doubtful.

Inventory must be measured on the statement of financial position at the lower of cost and net realisable value. Net realisable value is the amount that the inventory could be sold for in an orderly fashion less estimated selling costs. Thus it is necessary to compare the  cost price  of inventory with  the net realisable value with the  lower valuation assigned to the inventory for statement of financial position purposes. For example, if inventory has a cost price of $20 000 and it has a net realisable value of $30 000 the value assigned to the inventory in the statement of financial position would be $20 000 as the cost is lower than the net realisable value. Conversely, if inventory has a cost price of $20 000 and it has a net realisable value of $15 000 the value assigned to the inventory in the statement of financial position has to be $15 000 as the net realisable value is the lower value. In the latter case, this would mean that the inventory, currently recorded at its cost price of $20 000, would have to be written down by $5000 to $15 000. Given that an asset has been reduced, to keep the statement of financial position equation in balance, an expense of $5000 is recorded in the statement of profit or loss being the inventory write-down. Students will explore the concept of income and expenses in chapter 6.

If Kookaburra  Ltd  was  to  apply  the  correct  measurement  basis  for  its  accounts receivable, the entity firstly would need to estimate how much of its accounts receivable would be uncollectable, since many of its accounts receivable are already overdue. The estimated uncollectable accounts receivable is then debited as a bad debt expense and is recognised in the statement of profit or loss, which subsequently would reduce the entity’s  profit  in  the  current  accounting  period.  At  the  same  time,  the  estimated uncollectable accounts receivable is also credited to an allowance for doubtful debts account, which is a contra asset account that reduces the amount of accounts receivable. As a result, applying the correct measurement basis for accounts receivable will reduce Kookaburra Ltd’s profit for the current period and its assets.

Similarly,  if Kookaburra  Ltd  was  to  apply  the  correct  measurement  basis  for  its inventory, the inventory must be valued at the lower of cost and net realisable value. As  a  considerable portion  of Kookaburra  Ltd’s  inventory  is  already  obsolete,  the inventory must be written down to net realisable value. The inventory write-down will reduce the inventory value recognised in the statement of financial position, and will be treated as an expense in the statement of profit or loss. As a result, Kookaburra Ltd’s profit in the current period and its assets will also decrease.

5.20     Solve for the missing financial numbers as they would appear on the statement of financial position.

5.21     Identify whether the following assets would be classified as current or non-

current as at the end of the reporting period and justify your classification decision.

a. Right-to-use assets

b. Intangible assets

c. Property

d. Accounts receivable

e. Deferred tax assets

f. Inventory

The distinction between current and non-current assets is normally based on when the future economic benefit is expected to occur. If within 12 months (i.e. the next reporting period), the item is classified as current; if beyond 12 months, the item is classified as non-current.

a.      Right-to-use assets arise through contracts that give the entity  (the lessee) the right to use the asset for a certain period of time in exchange for consideration (such as leases). The classification as current or non-current will depend on the term of the right to use the asset.

b.      Intangible assets are non-current assets as it is expected to generate economic benefits over a period greater than 12 months.

c.      Non-current asset, as the benefits of using property are expected to occur beyond 12-month period.

d.      Current asset, as the amount owing by the debtors are expected to be received within 12 months.

e.      Deferred tax assets are a non-current assets as the benefit from the temporary tax difference is likely to be greater than 12 months.

f.       Inventory would be classified as current assets as they are available for sale and would be expected to be sold within the next 12 months.

5.22    Identify whether the following liabilities would be classified as current or

non-current as at  the   end of  the reporting  period   and  justify your classification decision.

a. Provision for employee long service leave

b. Long-term bank loan

c. Lease liabilities