Question

Explain how Beachside Ltd should account for the following items/situations, justifying your answer by reference to the Conceptual Framework’s definitions and recognition criteria.

(i) Beachside Ltd is the guarantor for an employee’s bank loan:     

1. You have no reason to believe the employee will default on the loan.
2. As the employee is in serious financial difficulties, you think it likely that he will default on the loan.

(ii)  Beachside Ltd receives 5 000 shares in Monty Ltd, trading at $6 each, as a gift from a grateful client.

(iii) The panoramic view of the coast from Beachside Ltd.’s café windows, which you are convinced attracts customers to the café.

(iv) The court has ordered Beachside Ltd to repair the environmental damage it caused to the local river system. You have no idea how much this repair work will cost.

Answer 1

i. Guarantor for an employee’s loan:

(a) Employee will not default on loan

• It meet the definition of liability as per para 49(b):
  • Present obligation - There is a legal obligation via the guarantor contract
  • Past event - The signing the guarantor contract is the past event
  • Settlement involving outflow of economic benefits - Payment of the guarantee
• It however fails recognition criteria. It is not likely that Beachside Ltd will be required to pay the guarantee. Hence, no liability can be recognized. However disclosure of the guarantee by way of a note must be given

(b) Employee will default on loan

• It meet the definition of liability as per para 49(b):
  • Present obligation - There is a legal obligation via the guarantor contract
  • Past event - The signing the guarantor contract is the past event
  • Settlement involving outflow of economic benefits - Payment of the guarantee
• It also satisfies recognition criteria. The outflow of economic benefits is probable and amount can be reliably measured. Hence, liability should be recognized
• It also meets the definition of expense and recognition criteria
  • There is a decrease in economic benefits due to increase in liability as Beachside Ltd now owes the amount of the employee’s loan
  • During period - liability arose during period
  • Results in decrease of equity - when liabilities increase without increase in assets, equity decreases.
  • Recognition criteria - The outflow of economic benefits is probable and amount can be reliably measured

ii. Receipt of 5000 shares in Monty Ltd, trading at $6 each, as a gift from a grateful client:

• It meets the asset definition:
  • It represent future economic benefits
  • It is controlled by Beachside Ltd
  • It is a past event
• It also meet the asset recognition criteria:
  • Future economic benefits are probable
  • Shares have a value and can be reliably measured
• It also meet the income definition and recognition criteria:
  • There is an increase in economic benefits due to increase in asset as Beachside Ltd now owns the shares
  • During period - the shares were received during period
  • There is an increase in equity - when assets increase without an increase in liabilities, equity increases.
  • Recognition criteria - The increase in economic benefits is probable and amount can be reliably measured

iii. Café’s panoramic view:

• The view does not meet the definition of an asset as there is no control on the future economic benefits that are expected to flow from the view
• The access to the view by others cannot be denied or regulated
• Recognition criteria is irrelevant, as there is no asset to recognize

iv. Court order to repair environmental damage caused to the local river system:

• The court order meets the definition of a liability
  • There is a present legal obligation
  • The order has been made
  • There will be outflow of economic benefits by way of repairs for damage
• It fails recognition criterion as the amount required to repair the damage cannot be estimated. Hence, no liability can be recognized. However disclosure of the court order by way of a note must be given
• If a minimum amount that will have to be paid is known, then measurement criterion is met. The probability criterion is met as outflow is certain. Disclosure by way of a note stating that the cost may exceed should be given