Question

Q-02 (MARKS: 15 )

After reviewing the financial statements section of Annual report dated Dec-31, 201 the following points regarding Statement of financial Position against which doubts are presented to you.

Inventory: The following items are included in Inventory

1. Goods held on consignment from another company
2. Short term investments in shares and bonds that will be resold in near future
3. Goods sold f.o.b destination that are in transit at Dec-31
4. Office supplies
5. Goods sent on consignment to another company

Investments:

1. Bonds that will mature in 5 years are purchased; the company has a strategy to hold them to collect the contractual cash flow on bonds for 5 years. (These bonds are reported at fair value).
2. Ordinary shares of a distributor are purchased to meet regulatory requirement for doing business in the distributor’s region, the investment will be held indefinitely. (Classified as trading).

Property Plant and Equipment

1. Interest cost during the construction of a building is not included in the cost of the building.
2. There is a recovery of impairment loss regarding equipment resulting in an amount in excess of the carrying value that would result had impairment would not occurred.
3. Gain on Revaluation of Land is disclosed in Income statement.

Receivables

The company has treated a tax refund as receivable the outcome of which is probable

Liabilities

Including in liabilities is a contingency regarding a litigation the outcome of which is possible but not probable.

        

           Required: You being Financial Analyst asked to Comment on each Note stated above, also give your suggestions for a right treatment if there is a wrong treatment.

Answer 1

Inventory:

a. Goods held on consignment from another company should not be included in inventory, as the legal title to the goods is not with the consignee. They should also not be included in the cost of goods sold.

b. Short term investments in shares and bonds that will be resold in the near future should not be included in inventory, rather they should be carried in the balance sheet as trading investments, and disclosed under current assets.

c. Goods sold f.o.b. destination are correctly included in inventory as on Dec 31. Legal title to the goods will pass to the buyer only when the goods reach their destination.

d. Office supplies are held for use, not for resale. Hence they should not be included in inventory as on December 31. Rather, they should be recorded as office supplies and the amount of office supplies on hand should be carried in the balance sheet under current assets.

e. Goods sent on consignment to another company are correctly included in inventory as on Dec 31, as the legal title to the goods is with the consignor company.

Investments:

a. Held to maturity investments are to be reported at amortized cost, not at fair value. The amortized cost apprach should be followed, and interest revenue should be reported on the income statement.

b. This investment is incorrectly classified as trading. These should be classified as non-trading, the dividends should be recognized as revenue in the income statement, unrealized gains or losses should be reported in the statement of other comprehensive income.

Property Plant and Equipment:

a. Interest cost during the construction of the building should be capitalized. Therefore, it should be included in the cost of the building by debiting building account or capital WIP account by the amount of interest cost.

b. Gain on revaluation of land is unrealized profit, and therefore should not be reported on the income statement. The amount of gain should should be credited to the equity account Revaluation Surplus.