According to the conceptual framework, an expense consists of losses and expenses that occur in the ordinary course of business activities in the enterprise(Tent, 2015). Losses on the other hand characterises items that meet the definition of the expenses and may or may not arise in the ordinary course of business activities( Dichev, 2017). Losses represents decrease in economic benefits and hence are similar to that of other expenses. Losses comprise of those items that result from natural disaster like fire and flood as well as those arising on the disposal of non current assets(Tent, 2015). When losses are recognised in the income statement, they are usually displayed separately because they having knowledge of this aspect is useful for the purpose of making financial decisions( Dichev, 2017).
In this case GDX retail has done its due diligence in estimating the degree of certainty of probable loss and measuring the amount of flood loss reliably . Since flood is a common phenomenon in the area of business, it is very reasonable to assume that the cost of flood insurance forms a part of normal activities of the business .It is therefore construed to be an expense in the ordinary course of business activities. So it is appropriate for GDX retail to recognise the flood insurance as an expense and a liability.
According to the conceptual framework, an asset is recognised in the financial statement as soon as it is possible that the upcoming monetary benefits will flow to the entity and that it has a cost that can be measured dependably(Lo et al., 2017). It is not recognised in the statement of financial position when the expenditure has been incurred for which the economic benefits will flow beyond the present accounting year(Khamis, 2016).
In this case Able Ltd can recognise the goods sold on consignment basis as an asset when he transfers control of his goods to Baker ltd. A product that has been brought to another party may be tied up in a consignment procedure if that other party has not attained control of the mentioned product(Khamis, 2016). Since the title of ownership has been legally transferred to Baker Ltd, the company. In a few of these contracts control is reassigned when the product is carried to the location of the customer or at the moment when that product is shipped. This depends upon the terms of the contract(Lo et al., 2017). In this case the goods have been safely transported to the warehouse of Baker Ltd. Hence Able ltd is well within its rights to recognise the goods sold on consignment basis as an asset in his books.
According to the conceptual framework, an asset is a resource measured by the entity due to which the economic benefits are ecpected to flow to the entity in the future(Basnan et al., 2017). This definition identifies its crucial features but however do not certify the standards that are required to be met previously recognised in the statement of financial position. In particular, the most important criteria that needs to be met is the probability that upcoming economic benefits must flow to the entity before recognising it is an asset(Basnan et al., 2017).
The above painting is a collector’s item and a historical treasure. Rickson Ltd plans to use this artwork to donate to a reputable art gallery. Collection items are mostly held for long periods of time and are rarely sold .They are categorized as assets and continue providing economic benefit through their usage.( Ellwood & Greenwood, 2016). If the collection item is properly capitalized , it can be recognized as an asset. Hence in this case Rickson Ltd can recognize the painting as an asset, as long as it properly capitalizes the gallery collections on a retrospective basis or a prospective basis.
A property , plant and equipment item that has been recognised as an asset shall be measured at its cost. The cost compromises of its purchase price, plus import duties and non-refundable purchase taxes , minus discounts and rebates(Petrovic, Manson & Coakley, 2016). The non-refundable deposit of $ 150,000 forms a part of the cost of the equipment and is hence incorporated in the total cost of the asset. The cost of this asset is the cash price, $ 500,000 which is inclusive of the security deposit paid earlier.
Since the cost of the asset is recognised as soon as the item is shipped, therefore a journal entry is required as soon as the cost of the asset is recognised(Swink & Schoenherr,2015). In the corresponding journal entry, plant and equipment will be debited by $500, 000 while the corresponding cash at bank would be credited by the same amount. The asset is created in the book sand is hence debited, while cash is used to acquire the asset which implies there is an outflow of cash, Hence cash is credited.
The operating cycle of an organization is the average lenghth of time period that is needed by a business to make a preliminary amount of cash for production processes, then selling it and receiving cash in exchange for the goods that are being provided. This is suitable for assessing the extent of working capital that is useful in the preparation of financial statements. It focuses on the purchase and sell of assets(Michalski, 2016). It also helps the users of financial statements in seeing what assets will be used and what liabilities will become due in the current year.
Operating cycle can also be determined by summing up raw material conversion period, finished goods conversion period and debtors collection period . In the case of Celeste Company, the operating cycle is
Operating cycle- RMCP +FGCP +DCP
|
Statement of Financial position of Celeste Ltd as on 30th June,2018 |
|
|
ASSETS |
$ |
|
Financial assets |
|
|
Cash and cash equivalents |
9000 |
|
Trade and other receivables |
8500 |
|
Total Financial assets |
17500 |
|
Non-financial assets |
|
|
Property, plant and equipment |
58000 |
|
Inventory |
15000 |
|
Investment properties |
4000 |
|
Intangible assets |
13,000 |
|
Accrued lease income |
5000 |
|
Accrued income for available for sale financial assets |
5500 |
|
Accrued income for other financial assets |
2000 |
|
Total non-financial assets |
102500 |
|
Total assets |
1,20,000 |
|
Liabilities |
|
|
Payables |
|
|
Suppliers |
7000 |
|
Total payables |
7000 |
|
Interest Bearing Liabilities |
|
|
Outstanding Borrowings |
36000 |
|
Outstanding Current tax liabilities |
2,500 |
|
Outstanding deferred income |
2000 |
|
Outstanding Retirement benefit obligation |
7,000 |
|
Outstanding other financial liabilities |
6500 |
|
Outstanding Other non-current liabilities |
4000 |
|
Total interest bearing liabilities |
58000 |
|
Provisions |
|
|
Other |
5000 |
|
Total provisions |
5000 |
|
Total liabilities |
70000 |
|
Net assets |
50,000 |
|
Equity |
|
|
Share capital |
30,000 |
|
Other components of equity |
5,000 |
|
Retained earnings |
15000 |
|
Total equity |
50,000 |
Accounting estimates are approximate values that is assigned by the management of a company to various accounting variables, whose measurement cannot be reliably measured, for example, determining useful life of an asset or measuring bad debts provision (Bauman & Shaw, 2014). A change in accounting estimate makes changes in current and future periods only and not in past periods. The changes are either definite or variable in nature. The nature of accounting information is reliable when it is definite(Bauman & Shaw, 2014). However only passage of time can prove whether the changes in accounting estimates are definite or not. More often than not a balance is needed to be maintained between relevance and reliability.
In the following scenario, the accountant wants to change the percentage of accounting estimate of estimating bad debts from five per cent to six per cent of net credit sales and also wants to make this understatement from the previous year as a prior period error and correct this by adjusting the opening balance of retained earnings. He can change the accounting estimate from five per cent to six per cent , if he feels it better warrants a more reliable and relevant data. However he cannot adjust the item as a prior period error because the change in estimate only incorporates that changes can be made to present and future periods, and not in past periods.
A change in accounting policy makes the financial statements reliable and relevant. The entity shall incorporate such a change in accounting policy that results from the preliminary application of an Australian Accounting Standard in agreement with the precise transitional provisions, if any (Christensen et al.,2015).
In this case the accountant decides to change the calculation of bad and doubtful debts estimate from a more traditional percentage of credit sales method to a less followed ageing of accounts receivable method. This involves a change in accounting policy(Christensen et al.,2015). The percentage of credit sales method estimates the amount of uncollectible amounts from the credit sales of a given period where the amount of bad debts expense is equal to net credit sales multiplied by the percentage estimated as uncollectable. The ageing off accounts receivable method involves classifying accounts receivable based on age , which actually gives a better basis for estimating the total amount of uncollected accounts. It considers experience as h basis by which they estimate how much of the accounts receivable would be uncollectible. This is a better basis of calculating total amount of bad and doubtful debts as it provides a better and more reliable display of financial information.
Errors can take place in reverence of recognising or measurement of elements of financial statements. Material errors, that is errors of significant amounts need to be corrected before the financial statements make its way to the public(Chan & Vasarhelyi, 2018). However material errors are not found out until the following period . These prior period errors need to be adjusted. An entity needs to retrospectively adjust the material errors in the financial statements(Chan & Vasarhelyi, 2018).
In this case the accountant made a material error in calculating the provision of bad debts. Instead of calculating the provision of bad debts on the amount of $ 600,000 , it is calculating the amount on $ 300,000.It has understated the amount of provision of bad and doubtful debts. It needs to retrospectively correct this error in the end of the financial year 2018 to account for the material difference by restating the balance of credit sales for the earliest prior period presented.
References:
Basnan, N., Salleh, M. F. M., Ahmad, A., Harun, A. M., & Upawi, I. (2017). Challenges in accounting for heritage assets and the way forward: Towards implementing accrual accounting in Malaysia. Geografia-Malaysian Journal of Society and Space, 11(11).
Bauman, M. P., & Shaw, K. W. (2014). An analysis of critical accounting estimate disclosures of pension assumptions. Accounting Horizons, 28(4), 819-845.
Chan, D. Y., & Vasarhelyi, M. A. (2018). Innovation and practice of continuous auditing. In Continuous Auditing: Theory and Application (pp. 271-283). Emerald Publishing Limited.
Christensen, H. B., Lee, E., Walker, M., & Zeng, C. (2015). Incentives or standards: What determines accounting quality changes around IFRS adoption?. European Accounting Review, 24(1), 31-61.
Dichev, I. D. (2017). On the conceptual foundations of financial reporting. Accounting and Business Research, 47(6), 617-632.
Ellwood, S., & Greenwood, M. (2016). Accounting for heritage assets: Does measuring economic value ‘kill the cat’?. Critical Perspectives on Accounting, 38, 1-13.
Khamis, A. M. (2016). Perception of Preparers and Auditors on New Revenue Recognition Standard (IFRS 15): Evidence From Egypt. Jurnal Dinamika Akuntansi dan Bisnis, 3(2), 1-18.
Lo, K., Fisher, G., Tsang, D., & Trottier, K. (2017). Intermediate Accounting. Pearson Canada Incorporated.
Michalski, G. (2016). Full operating cycle influence on the food and beverages processing firms characteristics. Agricultural Economics/Zemedelska Ekonomika, 62(2).
Petrovic, N., Manson, S., & Coakley, J. (2016). Changes in Non?current Assets and in Property, Plant and Equipment and Future Stock Returns: The UK Evidence. Journal of Business Finance & Accounting, 43(9-10), 1142-1196.
Swink, M., & Schoenherr, T. (2015). The effects of cross?functional integration on profitability, process efficiency, and asset productivity. Journal of Business Logistics, 36(1), 69-87.
Tent, S. I. (2015). Revenue Recognition–Milestone Method (Topic 605) 2010 Amendment: From the R&D Industry Perspective.
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