ACCA F3 (INT) Financial Accounting - 2010 - Study text - Emile Woolf Publishing
Подождите немного. Документ загружается.
Chapter 7: Accruals and prepayments. Receivables and payables
© EWP Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides 205
4 An inexperienced bookkeeper has drawn up the following payables ledger control
account, which contains errors:
Payablesledgercontrolaccount
$$
Openingbalance
(amountsowedtosuppliers) 212,500
Purchases 447,000
Cashpaidtosuppliers 491,000 Discountsreceived 2,700
Purchasesreturns 7,600 Contrasagainstreceivablesledger 12,800
Refundsreceivedfromsuppliers 3,200 Closingbalance 251,800
714,300 714,300
What should the closing balance be after correcting the errors made in preparing the
account?
A $148,600
B $276,400
C $171,000
D $154,000
(2 marks)
5 A company has occupied rented premises for a number of years, paying rent quarterly
in advance on 1 January, 1 April, 1 July and 1 October each year. Until 1 April 2010, the
annual rental was $240,000. It was then increased to $288,000 each year.
What figures should appear in the company’s financial statements for rent for the year
ended 30 November 2010?
Income
statement
Statement of financial position
$ $
A
272,000 24,000
prepayment (Dr)
B
272,000 48,000
prepayment (Dr)
C
276,000 Nil
D
272,000 24,000
accrual (Cr)
(2 marks)
6 At 1 January 2010 a company had an allowance for receivables of $44,000. At 31
December 2010 the company’s trade receivables were $749,000 and it was decided to
write off balances totalling $29,000 as irrecoverable. In addition it was decided to
adjust the allowance for receivables to 5% of the remaining receivables, based on past
experience.
What total figure should appear in profit or loss for bad debts and allowance for
receivables, for the year to 31 December 2010?
A $21,000
B $65,000
C $37,000
D $22,475
(2 marks)
Paper F3: Financial accounting (International)
206 Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides © EWP
7 The following control account has been prepared by a trainee accountant.
Receivablesledgercontrolaccount
$$
Openingbalance
268,900
Cashreceivedfromcredit
customers
106,400
Creditsales
115,800
Interestchargedonoverdue
accounts
1,600
Cashsales 15,700 Discountsallowed 2,400
Contrasagainstpayablesledger 5,300 Baddebtswrittenoff 5,900
Allowanceforreceivables 3,100
Closingbalance 286,300
405,700 405,700
What should the closing balance be after correcting the errors made in preparing the
account?
A $263,200
B $282,000
C $266,300
D $247,500
(2 marks)
© EWP Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides 207
Paper F3 (INT)
Financial Accounting
CHAPTER
8
Provisions and contingencies
Contents
1 Liabilitiesandprovisions
2 Contingentliabilitiesandassets
Paper F3: Financial accounting (International)
208 Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides © EWP
Liabilities and provisions
Definition of a liability
Accounting treatment of liabilities
Provisions
Accounting for provisions
Increasing provisions
Reducing a provision
Recognition and measurement of provisions
1 Liabilities and provisions
1.1 Definition of a liability
A liability is defined by the IASB Framework as a present obligation arising as a
result of a past transaction or event. The settlement of a liability will result in an
outflow of resources or economic benefit, such as the payment of cash.
The main elements in this definition are as follows.
Obligation. The entity has an obligation that has arisen from an event or
transaction in the past. This is often a legal obligation, such as the contractual
obligation to pay a supplier for the purchase of goods or services. An obligation
might be a constructive obligation where the obligation arises out of an
established past practice or a valid expectation or declared policy of the business
entity - such as a promise by the business entity to refund the price of goods to
customers if the customers are dissatisfied.
The obligation exists now. The obligation is a present obligation. It is not an
obligation that will or might occur in the future. The payment will occur in the
future, but the obligation to pay already exists.
Outflow of economic benefits. The obligation will result in an outflow of
economic benefits at some time in the future. This will normally take the form of
payments in cash, or the transfer of an asset other than cash.
Examples of liabilities are loans from a bank, bonds issued by a company, trade
payables, tax payable to the government, and accrued expenses.
1.2 Accounting treatment of liabilities
IAS 1 states that liabilities should normally be shown in the statement of financial
position as either:
current liabilities (payable within 12 months or within the normal trading cycle
of the entity)
non-current liabilities: these are all liabilities that are not current.
Chapter 8: Provisions and contingencies
© EWP Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides 209
1.3 Provisions
IAS 37 Provisions, contingent assets and contingent liabilities defines a provision as ‘a
liability of uncertain timing or amount’. A provision is therefore a type of liability,
and meets the definition of a liability.
IAS 37 explains how provisions differ from other liabilities.
With a provision, there is uncertainty about the timing or the amount of the
future payment that will be required to settle the obligation.
With a liability such as a trade payable or a bank loan, the liability is for a
certain amount and it is also certain (or fairly certain) when settlement (=
payment) will be required.
An accrual is a liability for goods or services payable in the future where the
actual amount of the payment is usually not yet known (because there has not
yet been an invoice from the supplier). For example, accrued electricity charges
are an accrued expense for electricity based on an estimate of the amount of the
next electricity bill. However, the uncertainty with an accrual is much less than
the uncertainty for a provision.
1.4 Accounting for provisions
When a provision is created:
the amount of the provision is recognised as an expense in the income statement
for the period
a liability is created in the statement of financial position for the amount of the
provision.
A provision should be shown in the statement of financial position. It is shown as a
liability, but separate from other liabilities. (Whereas accruals are often included
with trade payables as a single figure in the statement of financial position, a
provision must be shown on a line of its own.)
Provisions should also be shown in the statement of financial position as either a
current liability or a non-current liability, depending on when settlement of the
obligation is expected to occur.
Example
A company has recently lost a legal dispute, and will have to make a payment in the
future to settle the dispute. As at the end of its financial year, Year 1, the amount of
the payment is uncertain, but it has been estimated as $150,000.
The company should create a provision for the liability arising to settle the legal
dispute:
Debit: Legal costs (expense) $150,000
Credit: Provision for legal costs (liability) $150,000.
Paper F3: Financial accounting (International)
210 Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides © EWP
If settlement is expected in Year 2, the provision will be reported within current
liabilities as a short-term provision. By creating the provision, the company incurs
an expense, which will be included in profit and loss for the period.
Settlement of a provision
The liability for which a provision has been made will eventually be settled. When
this happens, the liability is reduced to zero. This can be accounted for as follows:
Debit: Provision (reduce the provision to zero)
Credit: Expense account (= the expense account where the provision was
charged as an expense).
Study the following example carefully.
Example
In the previous example, suppose that the legal dispute is eventually settled in Year
2 by a payment of $162,000.
The accounting entries in Year 2 will be:
Debit Credit
$ $
Debit:Legalexpenses 162,000
Credit:Bank 162,000
Torecordtheactualpayment
Debit:Provision 150,000
Credit:Legalexpenses150,000
Torecordthereductionintheprovision
Debit:Incomestatement 12,000
Credit:Legalexpenses12,000
Thechargeforlegalexpensesinthe
Year2incomestatement
The total cost of the liability is $162,000, but by creating a provision in Year 1 the
cost is divided between Year 1 ($150,000) and Year 2 ($12,000). The charge for legal
expenses in Year 2 is simply the difference between the actual cost of $162,000 and
the provision that had been made in the previous year.
If the cost of settling the legal dispute had been less than $150,000, there would be a
profit in Year 2 when the provision is reduced to $0. For example, if the cost of
settling the dispute in Year 2 was only $130,000, there would be a credit to the
income statement of $20,000, increasing profit for the year.
Chapter 8: Provisions and contingencies
© EWP Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides 211
1.5 Increasing a provision
In some cases, a long-term provision that was created in an earlier year might be
increased at the end of a subsequent year, when the amount of the obligation is re-
assessed. When a provision is increased:
the increase in the amount of the provision is recognised as an expense in the
income statement for the period, and
the provision in the statement of financial position is increased to its revised,
higher amount.
Example
A company is in a long-running legal dispute, and in Year 1 it was advised by its
lawyers that the company would probably be required to pay $600,000 to settle the
dispute. The company therefore made a provision for legal costs of $600,000 in Year
1.
The dispute was not settled by the end of Year 2, when the company was advised
that the likely cost of settlement would be $950,000. The company therefore
increased its provision for legal costs to $950,000 in Year 2.
The accounting entries will be:
Debit Credit
Year1
$ $
Debit:Legalexpenses 600,000
Credit:Provisionforlegalexpenses 600,000
Torecordtheprovision
Debit:Incomestatement 600,000
Credit:Legalexpenses600,000
Tochargetheamountprovidedtoprofitandloss
Year2
Debit:Legalexpenses 350,000
Credit:Provisionforlegalexpenses350,000
Toincreasetheprovision
Debit:Incomestatement 350,000
Credit:Legalexpenses350,000
ThechargeforlegalexpensesintheYear2incomestatement
1.6 Reducing a provision
Similarly, in some cases a long-term provision that was created in an earlier year
might be reduced at the end of a subsequent year. When a provision is reduced:
the reduction in the amount of the provision reduces expenses in the income
statement for the period, and
the provision in the statement of financial position is reduced to its revised,
lower amount.
Paper F3: Financial accounting (International)
212 Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides © EWP
Example
A company made a provision of $8 million for reorganisation costs at the end of
Year 1. In Year 2 the reorganisation began and actual costs of reorganisation during
Year 2 were $2 million. At the end of Year 2 it was estimated that the remaining
costs of reorganisation would be $3.5 million
The accounting entries will be:
Debit Credit
Year1
$ $
Debit:Reorganisationcosts 8,000,000
Credit:Provisionforreorganisationcosts8,000,000
Torecordtheprovision
Debit:Incomestatement 8,000,000
Credit:Legalexpenses8,000,000
Tochargetheamountprovidedtoprofitandloss
Year2
Debit:Reorganisationcosts 2,000,000
Credit:Bank2,000,000
Actualcostsincurred
Debit:Provisionforreorganisationcosts
4,500,000
Credit:Reorganisationcosts4,500,000
Toreducetheprovisionfrom$8millionto$3.5million
Debit:Reorganisationcosts 2,500,000
Credit:Incomestatement2,500,000
Toincreaseprofitbythereductionintheprovision
minusactualcostsincurred
1.7 Recognition and measurement of provisions
In the past, some companies were suspected of using provisions to manipulate their
reported annual profits (an example of ‘window dressing’ of financial statements).
A company might create a provision in one year, which would have the effect of
reducing profits in that year. The next year, the provision would then be used or
reduced, which would have the effect of reducing costs and increasing profits for
that year. Provisions could therefore be used to move profits and losses from one
year to another.
IAS 37 seeks to prevent the use of provisions to manipulate or ‘window dress’
financial statements.
Chapter 8: Provisions and contingencies
© EWP Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides 213
Recognising provisions
IAS 37 states that a provision should only be recognised if the following conditions
are met:
The entity has a present obligation arising out of a past event or transaction.
It is probable that an outflow of economic resources (such as cash payments) will
be required to settle the obligation. ‘Probable’ means more likely than not.
Although the amount of the obligation is uncertain, there is a reliable estimate of
what it will be. This estimate might be based on a range of probable outcomes.
Examples of events or transactions that might result in a provision are:
an obligation to settle a legal dispute, where the legal case has already been lost
but the amount of the settlement has not yet been decided
an obligation to pay clean-up costs for causing environmental damage
an obligation to pay decommissioning costs to take an asset out of service at the
end of its useful life (for example a provision for decommissioning a nuclear
reactor).
IAS 37 specifically deals with certain situations where provisions may or may not be
created.
A provision cannot be made for future operating losses. There is no present
obligation arising out of past events; therefore a provision cannot be made. If a
company expects to make an operating loss in the next financial year, it cannot
make a provision and take the loss in the current year instead.
A provision can be made for future restructuring costs, when an entity closes
down a part of its business operations, or re-organises its management structure,
or decides to relocate operations to another country or region. However, a
provision may only be made if there is a detailed formal plan for the
restructuring and there is an expectation that the restructuring will take place. If
the reorganisation plan has been agreed but has not been formally announced
and employees have not yet been told, a provision cannot be made.
Measurement of provisions
The amount of a provision should be the best estimate of the amount (before tax)
that will be required to settle the obligation.
If the obligation is for a single transaction or event, the most likely amount of the
obligation should be used.
If there are obligations for many similar transactions, an expected value should
be calculated for the obligations. An example is a provision for future costs that
will be incurred to honour warranty obligations.
Example
A company sells its products under warranty. It promises to bear the costs of
repairing any goods that it has sold, within a 12-month period after the time of sale.
The company has estimated that the average cost of a repair is $150, and that if all
Paper F3: Financial accounting (International)
214 Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides © EWP
the goods it sold in the past months needed repair under warranty, the total cost of
repairs would be $3,000,000. It has also estimated that the probability that goods will
be returned for repair under warranty is 4%.
A provision should be recognised. The amount of the provision will be measured as
$120,000 (= 4% × $3,000,000).
The provision will be reported as a short-term provision, but there will be a
provision each year in the balance sheet for obligations under warranty agreements.
This provision might increase or be reduced from one year to the next.