Question

Financial statement disclosures

You are the financial accountant for Superstore Ltd, and are in the process of preparing its financial statements for the year ended 30 June 2018.  Whilst preparing the financial statements, you become aware of the following situations:

On 1 July 2017, the directors made a decision, using information obtained over the last couple of years, to revise the useful life of an item of manufacturing equipment.  The equipment was acquired on 1 July 2015 for $800,000, and has been depreciated on a straight-line basis, based on an estimated useful life of 10 years and residual value of nil.  Superstore Ltd uses the cost model for manufacturing equipment.  The directors estimate that as at 1 July 2017, the equipment has a remaining useful life of 6 years and a residual value of nil.  No depreciation has been recorded as yet for the year ended 30 June 2018 as the directors were unsure how to account for the change in the 2018 financial statements, and unsure whether the 2016 and 2017 financial statements will need to be revised as a result of the change.

In June 2018, the accounts payable officer discovered that an invoice for repairs to equipment, with an amount due of $20,000, incurred in June 2017, had not been paid or provided for in the 2017 financial statements.  The invoice was paid on 12 July 2018.  The repairs are deductible for tax purposes.  The accountant responsible for preparing the company’s income tax returns will amend the 2017 tax return, and the company will receive a tax refund of $6,000 as a result (30% x $20,000).  No journal entries have been done as yet in the accounting records of Superstore Ltd, as the directors are unsure how to account for this situation, and what period adjustments need to be made in.

Superstore Ltd holds shares in a listed public company, ABC Ltd, which are valued in the draft financial statements on 30 June 2018 at their market value on that date - $600,000.  A major fall in the stock market occurred on 10 July 2018, and the value of Superstore’s shares in ABC Ltd declined to $250,000.

On 21 July 2018, you discovered a cheque dated 20 April 2018 of $32,000 authorised by the company’s previous accountant, Max. The payment was for the purchase of a swimming pool at Max’s house.  The payment had been recorded in the accounting system as an advertising expense.  You advise the directors of this fraudulent activity, and they will investigate.

Assume that each event is material.

Required:

i) State the appropriate accounting treatment for each situation. Provide explanations and references to relevant paragraphs in the accounting standards to support your answers.  Where adjustments to Superstore Ltd’s financial statements are required, explain which financial statements need to be adjusted (ie. 2016, 2017, 2018 or 2019).  

ii) Prepare any note disclosures and adjusting journal entries that are needed in the 2018 financial statements for each situation

Answer 1

i. 1. As per IAS 16, a revision in the useful life of an asset is to be treated as a change in accounting estimate, and not as a change in accounting policy. Therefore retrospective restatement of accounts is not called for. The change will affect the financial statements of prospective years only.

Book value as on July 1, 2017 = $ [ 800,000 - 2 x (800,000/ 10) ] = $ 640,000.

Depreciation expense for each of the remaining 6 years = $ 640,000 / 6 = $ 106,667.

Therefore, depreciation expense to be recognized for the year ended June 30, 2018 : $ 106,667.

Additionally, a disclosure regarding the change in accounting estimate needs to be made in the notes to accounts.

2. The amount of $ 20,000 will appear as accounts payable in the current liabilities section of the balance sheet as on June 30, 2018.

This repairs expense pertained to the year ended June 30, 2017. Therefore, it cannot be charged as an expense in the income statement for the year ended June 30, 2018. ( Accrual, Matching and Accounting Period principles)

As the repairs account for 2017 is already closed, the adjustment would be made through Retained Earnings account, which represents the accumulated profits till date.

The entry would be a debit of $ 14,000 to Retained Earnings, a debit to Income Tax Refundable $ 6,000, and a credit of $ 20,000 to accounts payable.

3. A fall in the value of investment after the reporting date is a non-adjusting event.

In respect of non-adjusting events, no adjustment is required in financial statements. Instead IAS 10

requires such events to be disclosed in the notes to accounts if these are considered to be material, otherwise these will be ignored.

In the given situation, the fall in the value of investments from $ 600,000 to $ 250,000 is very large and very significant to the users of the financial statements.Though the decrease in market value does not warrant an adjustment to the asset value to be reported in the balance sheet of June 30, 2018, it should definitely be disclosed in the notes to accounts.

4. As per IAS 10, the business entity is required to account for the adjusting events by adjusting their potential financial impacts in financial statements before these are finalized and issued.

The identification of a fraud or an error after the reporting date is an adjusting event.

The entry to be passed with a debit to Max's personal account and a credit to Advertising Expense account.

ii.

Date	Account Titles	Debit	Credit
June 30, 20018		$	$
1.	Depreciation Expense	106,667
	Accumulated Depreciation : Equipment		106,667
2.	Retained Earnings	14,000
	Income Tax Refundable	6,000
	Accounts Payable		20,000
3.	No journal entry required	0	0
4.	Max	32,000
	Advertising Expense		32,000