auditing final exam
Accounting Theory III Revision Exercises Example 1 Identify the accounting issue(s) / problem(s) in each of the following scenarios? a) Corporate Ltd paid $5,000 for office equipment that will last for four years, with maintenance service to be provided for two years. b) Office Supplies sold office equipment to Corporate Ltd. Terms of the sale include two years maintenance to be provided by Office Supplies. c) X Ltd acquired office premises for $1,000,000 paid in cash. Example 2 Identify the four components of an accounting policy. Illustrate your answer with an example of an accounting policy for emission trading allowances that are received by the reporting entity from the government at no cost. The emission trading allowances will expire two years after they were received. · Define – what element(s) of the financial statements · Recognise – when should it be recognised · How it should be MEASURED · What is to be disclosed about the transaction/event/item Example 3 Critically evaluate this statement. “Regulators should not worry about what is reported because investors can’t be fooled if the market is efficient in the semi-strong form.” Strength: In an efficient market prices reflect all publicly available information; investors are not fooled by how an item is reported. Elaborate with example. Weakness: But this does not mean that what is reported does not matter · Prices respond to available information____________________________________ · Investors could still be misled by · ______________________________________________________________________________________________________________________________________________________________________________________________________ Example 4 The fair value of A Ltd’s financial assets declined by $2,500,000. However, A Ltd reclassified its financial assets because of a change in accounting standards. The effect of the reclassification was that changes in the fair value of the financial assets were not recognised in the 20X3 financial statements. Accordingly, A Ltd reported profit of $4,000,000 in 20X3, compared with $3,500,000 the year before. A Ltd disclosed the decline in the fair value of the financial assets in the notes to the financial statements. Required a) Calculate the amount of profit that would have been reported by A Ltd if the financial assets had not been reclassified. b) Describe the mechanistic hypothesis. How does the mechanistic hypothesis predict investors, and therefore, share prices, would respond to the information reported in A Ltd financial statements for 20X3? c) Describe the semi-strong form of market efficiency. What does it imply about how investors, and therefore, share prices, will respond to information reported in A Ltd’s financial statements for 20X3? 3 11/06/2021 1 Accounting Theory III Revision Podcast 1 Exam Revision Example 1 Course Map of Accounting Theory III 2 Exercising Judgement in the application of principles-based accounting standards Part III: Overarching ethical principles Part I: Accounting regulation and the need for judgement Part II: What is an accounting policy? Definition Recognition Measurement Disclosure And how to choose one Part IV: Gathering evidence Part V: Accounting policy decision model applied Accounting Policy Decision Model • Step 1 Describe the facts • Step 2 Identify the accounting issue • Step 3 Identify relevant principles that will guide the choice of accounting policy • Step 4 Identify alternatives policies • Step 5 Evaluate them • Step 6 Make a choice, based on step 5 Refer Lecture 1 Topic 4 What’s the big issue? • Refer to Exam Revision Example 1 a) Corporate Ltd acquired equipment plus service contract b) Office Supplies Ltd received $5,000 for office equipment and a 2 year maintenance service c) X paid $1M for office premises Step 2: scenario a) • How to define, recognise and measure …… the office equipment – Generic, catch all, not demonstrating ability to identify the problem Step 2: scenario a) • How to allocate the consideration between the office equipment and the maintenance service – And when to recognise the maintenance expense – Subsequent measurement and depreciation of the equipment. 11/06/2021 2 Step 2: scenario b) When to recognise revenue? • Can we improve on this? Step 2: scenario b) • How to allocate the proceeds between the sale of equipment and the maintenance services … • What else? Step 2: scenario b) • How to allocate the proceeds between the sale of equipment and the maintenance services … and when to recognise revenue for the maintenance services Step 2: scenario c) • How to account for the expenditure – Too vague • Whether to recognise the premises as an asset – Not the key decision point ✓How to measure the office premises subsequent to initial recognition Step 3: Identify relevant principles What is a principle? “AASB 116 permits cost or revaluation model” • This is the choice, not the principle. • The principles should guide the choice. Step 3: Identify relevant principles • Principles should guide the judgement/choice ✓ should be a basis of the evaluation of the choice in step 5 • Might be a rule that restricts choices, – Fair value can only be used for intangible assets if there is an active market 11/06/2021 3 How to select a principle? • Use a principle that is relevant to the issue • E.g., deciding whether to use cost or revaluation model for measurement of the equipment subsequent to initial recognition: – Relevance – Faithful representation What am I being asked to do? Issue: whether a liability should be recognised for a lawsuit Although step 3 is to identify relevant principles, you should take note of what you are being asked to do to demonstrate your ability to apply this step. Typically, questions assessing this step ask you to: Identify or describe principles The question might also ask you to explain why the principle is relevant. What am I being asked to do? Issue: whether a liability should be recognised for a lawsuit Identify two relevant principles • definition of a liability and this is relevant because … • recognition criteria of a liability in the Conceptual Framework What am I being asked to do? Issue: whether a liability should be recognised for a lawsuit Describe a relevant principle • A liability is a present obligation to transfer an economic resource as a result of past events. Explain why it is relevant The definition of a liability is relevant because we need to decide whether the lawsuit gives rise to a liability before considering whether to recognise it. Step 4: The accounting policies • You might be given one policy, and ask to suggest a different one • You might be asked to suggest two alternatives • The policy must be sufficiently clear so that we can assess the logic of your evaluation of it. • A good answer would describe the policy with sufficient clarity and detail that someone could apply it in preparing the financial statements. Step 4 Identify alternative policies Exam Revision Example Q1 scenario c) • Recognise the building as an asset at cost, when acquired, and depreciate over 20 years using the straight-line method • And disclose the depreciation method and useful life • Recognise building as an asset at cost, when acquired, and subsequently revalue based on fair value with gains recognised in OCI, and depreciate over 20 years using the straight- line method • And disclose the depreciation method and useful life 11/06/2021 4 • We will get some more practice with step 4 using Exam Revision Example 2 but for now we will continue on to step 5 using Exam Revision Example 1, scenario c). Step 5: evaluate alternatives • Identify strengths and weaknesses, if applicable, of each policy – Satisfies definition • explain how it does this – Recognition criteria satisfied because recognising the building as an asset • conveys relevant information about the building because omitting it (and instead recognising as an expense) would signal that it cannot provide future economic benefits which is not appropriate for a resource with a long useful life it and • Provides a faithful representation because there is little measurement uncertainty for this asset. – In this example this part would most likely be the same for both policies Step 5 (continued) • Cost is not particularly relevant because it is not up to date and property values can change a lot over the useful life of the asset. However, cost facilitates faithful representation because we can verify the amount. • The revaluation model provides more relevant information because it uses a current fair value instead of a historical transaction price that can become very out of date. Faithful representation can be achieved by using a valuation model based on observable inputs. Tips for a good evaluation • Evaluate as many components of the policy as you can. • Don’t just make assertions, substantiate your claims with facts from the case. • Make assumptions if necessary. • Evaluation should provide a justification of the policy you are using/choosing/recommending. • Use the principles that you identified in step 3.