Question

1. What is a reporting entity and what factors would you consider in determining whether an entity is a reporting entity? 5 marks 2. What do ‘probable’ and ‘measured reliability” mean with respect to the recognition of the elements of financial accounting? 5 marks 3. Explain the difference in the accounting treatment for revaluation increments and revaluation decrements. Do you consider that this difference is ‘conceptually sound’? 5 marks 4. An asset having a cost of $100 000 and accumulated depreciation of $20 000 is revalued to $120 000 at the beginning of the year. Depreciation for the year is based on the revalued amount and the remaining useful life of eight years. Shareholders’ equity, before adjusting for the above revaluation and subsequent depreciation, is as follows: Items In $ Share capital 300 000 Revaluation surplus 45 000 Capital profits reserve 85 000 Retained earnings 70 000 500 000 Required Prepare journal entries to reflect the revaluation of the asset and the subsequent depreciation of the revalued asset. Which of the equity accounts would be affected directly or indirectly by the revaluation?

Answer 1

Question 1 What is a reporting entity and what factors would you consider in determining whether an entity is a reporting entity:

Answer Reporting Entity Means an entity in which the users are dependent on the general purpose financial report (GPFR) to get the understanding of the financial position and performance of the entity so that they can make their decisions based on the financial information contained in such reports.

Generally these users are called as stakeholders which include the shareholders, employees, lenders, suppliers, etc.

Factors which determine whether an entity is a reporting entity or not are as follows:

1. Separation of management from economic interest: As the gap between the owner and the management increases more reliability is laid on the financial reports of the company, as the decisions can be taken only after considering the financial position of the company.

2. Economic or political importance/influence: entities which enjoy the dominant position in market and entities which balance the interest of the significant groups, like employee associations, public sector entities, etc. have economic or political importance and influence. Therefore stakeholders make use of the financial reports for making the balanced and evaluated decisions.

3. Financial characteristics: as the enterprise grow, its financial resources also increases in terms of assets, liabilities, indebtedness etc. therefore stakeholders like creditors, government entities, banks etc. require the financial statements/reports of the entity so that they can evaluate the worth of entity and make their decisions accordingly.

Question2 What do ‘probable’ and ‘measured reliability” mean with respect to the recognition of the elements of financial accounting.

Answer In Financial Accounting, Recognition is a process through which an item which satisfies the below criteria, is incorporated in the balance sheet or income statement:

1. It is probable that any future economic benefit associated with the item will flow to or from the entity; and

2. The item's cost or value can be measured with reliability.

Based on these general criteria:

An asset is recognised in the balance sheet when it is probable that the future economic benefits will flow to the entity and the asset has a cost or value that can be measured reliably.

A liability is recognised in the balance sheet when it is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation and the amount at which the settlement will take place can be measured reliably.

Income is recognised in the income statement when an increase in future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably.

Expenses are recognised when a decrease in future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably.

Question 3 Explain the difference in the accounting treatment for revaluation increments and revaluation decrements. Do you consider that this difference is ‘conceptually sound’

Answer Where the value of an asset is increased as per the as a result of revaluation then the amount is directly credited to the revaluation reserve. But where the same asset was previously devaluated then the amount upto the extent of the amount of devaluation previously done shall be recognized in the Profit and loss account and the balance if any shall be credited to the revaluation reserve.

Similarly, if the Where the value of an asset is decreased as per the as a result of revaluation then the amount is directly recognized in the profit and loss account. But where the same asset was previously revaluated upwards then the amount upto the extent of the amount of revaluation made upward shall be reduced(debited) from revaluation reserve and the balance if any shall be Charged to Profit and Loss account.

Since the accounting is done based on the concept of prudence or we can say with conservative approach, therefore it is done that the revaluation upward is not treated as profit rather a revaluation reserve is created, and in case of revaluation downwards, it is directly charged to the profit and loss account. Therefore we can say that it is somewhere a bit biased. But the financial statements shall not be biased, all the things shall proceed in the same manner and not biasedly. Also the general purpose financial reports shall be free from biased and shall represent the true picture of the business. Therefore we can say that this concept of difference in accounting treatment for revaluation increments and revaluation decrements is a bit biased one and do not go on the same concept as of the other.

Answer to Question 4

Since there is a accumulated depreciation in the books therefore the written down value shall be firstly be decreased in the books for which the journal entry shall be as follows

Particulars	Debit ( Amount In $)	Credit ( Amount In $)
Accumulated depreciation	20000
Asset		20000

Thereafter the entry for the revaluation upward for the asset shall be done

Revaluaton upward amount = revalued amount - written down

Revaluaton upward amount = 120000 – 80000 = 40000

Particulars	Debit ( Amount In $)	Credit ( Amount In $)
Asset	40000
Revaluation Surplus		40000

And now the revalued asset will be used for the 8 years and since the scrap value is not given therefore we can take it as nil.

Therefore the amount of depreciation every year = Revalued amount/estimated useful life

amount of depreciation every year = 120000/8

amount of depreciation every year = 15000

Particulars	Debit ( Amount In $)	Credit ( Amount In $)
Depreciation Expense	15000
Accumulated depreciation		15000

Following accounts will be directly or indirectly affected:

1. Revaluation surplus: it will be directly affected as the amount of $ 40000 will be added to it and its closing balance will be $85000
2. Retained earnings: it will be indirectly affected as the amount of depreciation will be changed and the profit will be affected consequently.