Question

Mini-bus Rentals Ltd has a fleet of 36 mini-buses that customers can hire for self- drive tours and other transportation needs. The mini-buses cost between $120 000 and $160 000 each and have a useful life of 12 years. Tyres are replaced after 40 000 km, which is approximately every two years for most vehicles in the fleet. The cost of replacing tyres is $2 000 per vehicle.

The bookkeeper had been studying accrual accounting and though it would be a good idea to accrue maintenance expenses for the replacement of tyres. On 30 June 20X6 he observed that the tyres on 9 vehicles were due for replacement, which was expected to occur within six months after the reporting period.

Required

1. 1. Identify the main accounting policy issue(s) in relation to the replacement of tyres in preparing the financial statements for the year ended 30 June 20X6?
2. 2. escribe two principles or rules from Accounting Standards or the Conceptual Framework that are relevant to the accounting policy issue.
3. 3. The bookkeeper proposed to recognise a provision for maintenance and corresponding maintenance expense of $18 000 at 30 June 20X6, and disclose in the notes that the tyres are expected to be replaced within six months after the end of the reporting period.
   4. Describe a different policy (i.e., different from the bookkeeper’s suggestion) to account for the anticipated replacement of tyres in preparing the financial statements for the year ended 30 June 20X6. Please do NOT attempt to justify the policy.
4. 4. Evaluate the bookkeeper’s policy with reference to the principles identified in part b), if applicable. You may also draw on other principles in your evaluation.

Answer 1

a) Issue in the Accounting Policy:

Accrual Accounting is a system of accounting in which transaction are entered in the books of accounts, when they become due. The transactions are recognised as soon as a right to receive revenue and/or an obligation to pay a liability is created. The expenses are recognised when the resources are consumed. And in the given situation on 30 June 20X6 the accountant observed that the tyres on 9 vehicles were due for replacement, which was expected to occur within six months after the reporting period. On 30^th June, 20X6, we have not even replaced the tyres and therefore we have no obligation to pay for the maintenance expenses on 30^th June, 2016.

Describe two principles or rules from Accounting Standards or the Conceptual Framework that are relevant to the accounting policy issue

1. Materiality principle - An item is considered ‘material’ if it would affect or influence the decision of a reasonable individual reading the company's financial statements. This concept states that accountants must be sure to include and report all material items in the financial statement
2. The expense recognition principle (also referred to as the matching principle) states that we must match expenses with associated revenues in the period in which the revenues were earned. A mismatch in expenses and revenues could be an understated net income in one period with an overstated net income in another period. There would be no reliability in statements if expenses were recorded separately from the revenues generated.

b) Following is the policy which can be used to account for the anticipated replacement of tyres in preparing Financial Statement:

PROVISIONS AND CONTINGENCIES

A provision is recognized when the Company has a present obligation (legal/constructive) as a result of past events and it is probable that an outflow of resources will be required to settle the obligation, in respect of which a reliable estimate can be made.

The amount recognized as a provision is the best estimate of the consideration required to settle the present obligation at the end of the reporting period, taking into account the risks and uncertainties surrounding the obligation. When a provision is measured using the cash flows estimated to settle the present obligation, its carrying amount is the present value of those cash flows (when the effect of the time value of money is material).

Contingent liability is disclosed for (i) Possible obligation which will be confirmed only by future events not wholly within the control of the Company or (ii) Present obligations arising from past events where it is not probable that an outflow of resources will be required to settle the obligation or a reliable estimate of the amount of the obligation cannot be made. When some or all of the economic benefits required to settle a provision are expected to be recovered from a third party, a receivable is recognized as an asset if it is virtually certain that reimbursement will be received and the amount of the receivable can be measured reliably.