ch03 SM Leo 10e

Solutions Manual
to accompany
Company Accounting 10e

prepared by
Ken Leo
John Hoggett
John Sweeting
Jeffrey Knapp
Sue McGowan
© John Wiley & Sons Australia, Ltd 2015

Chapter 3: Company operations
REVIEW QUESTIONS
EW QUESTIONS
1. Discuss the definition and essential characteristics of an asset. When should an asset
be recognised? How should assets be measured?
Three essential characteristics can be derived from the definition of assets in paragraphs 4.8-
4.14 (53-59) of the Conceptual Framework.
(i) A resource controlled by the entity,
(ii) future economic benefits,
(iii) past events.
Refer section 3.1.1 of the chapter and these are discussed further below:
Future economic benefit. (refer paragraphs 4.8- 4.11/53- 56)
Possession of a right, or of a physical object, does not constitute an asset in the absence of
future economic benefits (business entities—generation of cash flow, non-business—
providing goods or services which satisfy the organisation's objectives). A machine that
produces unwanted output and has no resale value is not an asset.
Control (refer paragraphs 4.12- 4.13/57-58)
Ownership or title to a physical item is not necessary for that item to qualify as an asset (for
example, a leased asset). The issue is whether the entity can secure the benefits and deny
access to others.
Past transaction or event (refer paragraphs 4.13- 4.14/58- 59)
A past transaction or event ensures that we count as assets only present capacity to obtain
future benefits. Therefore, we exclude items that may provide future benefits because we
have budgeted their acquisition but which are not presently controlled because acquisition has
not yet occurred.
Also note the fact in paragraph 59 of the Framework that incurring a cost is not a requirement
for an asset.
To be recognised (included in the financial statements) an item must meet the definition and
recognition criteria. Paragraph 4.44/83 of the Conceptual Framework states that an asset
should only be recognised when it is probable that any future economic benefit associated
with the item will eventuate and that the asset possesses a cost or other value that can be
reliably measured. It is expected that the notion of “a reliable measure” will be replaced by a
“faithfully representative and verifiable measure” in the conceptual framework.
Section 3.3.1 notes various measurement bases for assets. It is important to understand that
the criteria requires a ‘cost or other value’, so do not need to be able to measure the value of
the actual benefits to be received.
Initially many assets are measured at cost, however subsequent to this different rules may
apply depending on the nature of the asset. For example, inventory must be measured at
lower of cost or net realisable value; certain non-current assets may remain measured at cost
(subject to depreciation) or measured at fair value. Accounting standards may specify the
measurement required for particular assets. If a choice of measurement is allowed this would
© John Wiley and Sons Australia, Ltd 2015 3.1

Solution Manual to accompany Company Accounting 10e
be an accounting policy choice and hence the measurement chosen should be one that
provides relevant and reliable (representationally faithful) information (refer section 3.6).
Section 3.1.2 of the chapter, discusses a proposed asset definition as outlined in the
discussion paper, A Review of the Conceptual Framework for Financial Reporting. A new
definition has been developed because of perceived shortcomings of the existing definition.
The definition proposed is:
a present economic resource controlled by the entity as a result of past events (para 2.11)
2. Ottowa Ltd was going through some difficult trading times and was barely breaking
even. In attempting to improve sales, the company spent $500 000 on an advertising
campaign during the current year in the hope that sales would improve in the new
year. Management decided that the cost of this campaign should be recorded as an
asset in order that the small current profit for the firm would not become a loss.
Discuss whether management’s decision is justified.
Advertising costs may be treated as an asset only if they satisfy the definition of an asset. Do
they have the essential characteristics of an asset? Do they provide controlled future
economic benefits flowing to the entity from a past event or events? Do they satisfy the
proposed definition of an asset put forward by the IASB and as discussed in section 3.1.2 of
the chapter?
It is not sufficient to treat them as an asset merely to show a better profit figure. If advertising
costs are not assets, then management’s decision is not justified. If they are assets, then the
decision to treat them as an asset in the records will only be justified if the advertising costs
satisfy the recognition criteria, i.e. is it probable that the advertising expenditure will lead to
future economic benefits flowing to the entity, and can the costs be measured reliably?
Discuss the meaning of “probable”. Note that in this case, there is a cost which can be
reliably measured (i.e. a faithfully representative and verifiable cost).
3. What are the essential characteristics of a liability? When should liabilities be

recognised in the accounting records, and what techniques should be used to
measure them?
The Conceptual Framework (4.4.b/49.b) defines a liability as:
a present obligation of the entity arising from past events, the settlement of which is expected to
result in an outflow from the entity of resources embodying economic benefits.
Three essential characteristics can be derived from the definition of liabilities in the
Conceptual Framework, paragraphs (4.15-4.19/60-64).
(a) present obligation to make an outflow of resources,
(b) future outflows of economic benefits,
(c) past transactions or other past events.
See section 3.1.3 of the chapter.
Discussed further as below: Essential characteristics of liability are:

1. Future outflows of economic benefits

Note: Liabilities can be settled by transfer of assets of any type (cash not the only asset—say
deliver goods that have been pre-paid) or by provision of services and the fact that the
amount of the liability is not certain (for example, warranty obligations, long service leave)
does not preclude recognition as a liability. This actually falls under the reliability of
measurement rule.
2. Present obligation to make an outflow of resources
Essential notion is that the entity is presently obligated and cannot avoid settling the
obligation—there is no reasonable alternative other than to settle. The obligation may be
enforceable from legal sources such as contract or legislation administrative regulation, or it
may be constructive.
Also note: This must involve an external party as cannot be ‘obligated’ to one-self. Hence
setting aside reserves (for example, for major overhauls, renewals of plant, etc) does not
constitute a liability. Further, decisions to acquire assets in the future do not give rise to
liabilities unless there is an irrevocable agreement.
3. Past event
This is required to ensure that only present obligations to make future outflows of economic
resources are included as liabilities.
The Conceptual Framework (4.38/91) specifies two criteria which must be satisfied before an
item that meets the definition (such as a liability) can be recognised –
(a) it is probable that any future economic benefit associated with the item will flow to or
from the entity; and
(b) the item has a cost or value that can be measured with reliability.
“Probable” in this context means that the future outflow of economic benefits is more likely
than less likely, i.e. a greater than 50% probability.
It is expected that the notion of “a reliable measure” will be replaced by a “faithfully
representative and verifiable measure” in the conceptual framework.
Most liabilities are measured at nominal value, however for particular liabilities like long
service leave entitlements for employees and certain lease liabilities, the discounted present
value method is used. Other possible measurement suggestions are “value to the entity” and
“discharge price”. Note measurement may involve the use of estimates. See section 3.3.2 of
the chapter for further discussion of measurement methods.
See also section 3.1.4 of the chapter which discusses possible changes to the definition of a
liability.
4. What are the essential characteristics of equity?
Equity is defined in the Conceptual Framework (paragraph 4.4/49(c)), as ‘the residual

interest in the assets of the entity after deducting all its liabilities’. Equity as such is not a
stand-alone concept but a ‘residual’, determined by subtracting recognised liabilities from
recognised assets.

5. Explain what is meant by the term recognition. Are all items that meet the definition
of an element of the financial statement always recognised? Discuss how the
proposed changes to the recognition criteria in the 2013 Discussion Paper, A Review
of the Conceptual Framework for Financial Reporting, could impact on recognition of
items.
Recognition is outlined in the Conceptual Framework (4.37/ 82):

Recognition is the process of incorporating in the balance sheet or income statement an item that
meets the definition of an element and satisfies the criteria for recognition set out in paragraph 83.
It involves the depiction of the item in words and by a monetary amount and the inclusion of that
amount in the balance sheet or income statement totals. Items that satisfy the recognition criteria
should be recognised in the balance sheet or income statement. The failure to recognise such items
is not rectified by disclosure of the accounting policies used nor by notes or explanatory material.
Hence recognition is inclusion of an item in a financial statement. This can be contrasted with
disclosure which normally means that information is included (disclosed) either in the
statements or in the notes to the accounts.
Not all items that meet the definition will be recognised as the Conceptual Framework (4.38/
83) requires that the following criteria be met before an element can be recognised:
An item that meets the definition of an element should be recognised if:

(a) it is probable that any future economic benefit associated with the item will flow to or
from the entity; and
(b) the item has a cost or value that can be measured with reliability.
For example, a company may have an item that meets the definition of a liability but not the
recognition criteria (for example, has been found liable in a court case but the amount to be
paid has not yet been determined and cannot be estimated). In such cases the relevant
standard (AASB 137) requires disclosure of the item. As this does not meet both the
definition and recognition criteria it cannot be included on the face of the financial
statements. However information about this item would be disclosed separately in the notes
Section 3.2.1 discusses the recognition criteria proposed in the 2013 discussion paper. The
significant change proposed is to abolish probability as recognition criteria. The existing
recognition criteria of probability means that any elements where there is less than 50%
likelihood of outflows being required to be made/or economic benefits being received are
excluded from recognition (subject to the requirements of specific standards). The abolition
of the probability threshold could result in such items being included and probability of
inflows/outflows would be reflected in the measurement. Recognition would be subject to the
cost constraint and considerations of relevance and faithful representation.
6. As maintenance costs on equipment have been steadily rising every year, Brasilia
Ltd has been setting aside regularly a provision for plant maintenance at an
increasing amount. The provision has been recorded as a liability, and as an
expense. Discuss whether Brasilia Ltd’s treatment is correct.
The Conceptual Framework definition of a liability requires that there must be a present
obligation. Furthermore, a provision must firstly be a liability for it to exist. See Section 3.1.3
of the chapter.

The recording of future maintenance costs is merely a book entry involving a future sacrifice
by Brasilia Ltd itself to any external party. There is no present obligation that exists separate
from the company’s own actions and so no liability for maintenance costs exists under the
Framework’s definition of liabilities. Nor can there be an expense as there has been no
outflow or depletion of assets or incurrence of a liability in Brasilia Ltd. It may be more
appropriate for Brasilia Ltd to ensure that the depreciation charged takes into account
accurately the consummation of economic benefits over time.
7. Distinguish between current and non-current assets. Can property, plant and
equipment be reported as a current asset? If so, when?
The distinction between a current and a non-current asset can be found in paragraph 66 of
AASB 101. Here a current asset is defined as an asset that (a) is expected to be realised in, or
is intended to be sold or consumed in the entity’s normal operating cycle (usually twelve
months); or (b) is held primarily for trading purposes, or (c) is expected to be realised within
twelve months after the reporting period; or (d) the asset is cash or a cash equivalent which is
not restricted in its use beyond twelve months. If an asset doesn’t satisfy this definition, then
it will be classified as a non-current asset. See section 3.3.1 of the chapter.
An example of an item of property, plant and equipment being reported as a current asset
may be where a particular machine or group of such assets is no longer being used by the
entity in its factory and is being held for sale, which is expected to take place in the next
twelve months. For such non-current assets to be reclassified as current, it must satisfy the
requirements of paragraph 3 of AASB5, Non-current Assets Held for Sale and Discontinued
Operations, which states:
Assets classified as non-current in accordance with AASB 101 Presentation of Financial

Statements shall not be reclassified as current assets until they meet the criteria to be
classified as held for sale in accordance with this Standard. Assets of a class that an entity
would normally regard as non-current that are acquired exclusively with a view to resale shall
not be classified as current unless they meet the criteria to be classified as held for sale in
accordance with this Standard.
8. Distinguish between current and non-current liabilities. Can a liability, which

satisfies the definition of a current liability, be reported, internally and/or externally,
as a non-current liability? Explain.
The distinction between a current and a non-current liability can be found in paragraph 69 of
AASB 101. Here a current liability is defined as a liability that is (a) expected to be settled in
the entity’s normal operating cycle or (b) is held primarily for trading purposes, or (c) it is
due to be settled within twelve months after the reporting period, or (d) the entity does not
have an unconditional right to defer the settlement of the liability for at least twelve months
after the reporting period. If a liability doesn’t satisfy this definition, then it will be classified
as a non-current liability. See section 3.3.2 of the chapter.
A long-term interest bearing liability that is due to be settled within twelve months would
satisfy the definition of a current liability. However paragraph 73 of AASB 101 states that
such liabilities must continue to be reported as a non-current liability where the entity has

discretion to refinance or roll over its obligations for at least twelve months after the
reporting date.
In many cases an entity may report both non-current and current liabilities for an item. For
example, a loan for $100 000 for 5 years with $20 000 of the principal to be paid annually,
would, at inception, be presented as a $20 000 current liability and $80 000 as a non-current
liability.
9. Discuss the nature of income and revenue. When can revenue be recognised?
Income is defined at paragraph 4.25/70 of the Conceptual Framework as meaning increases

in economic benefits during the accounting period in the form of inflows or enhancements of
assets or decreases of liabilities that result in increases in equity, other than those relating to
contributions from equity participants.
Income is sub-classified into revenue and gains. The Conceptual Framework (paragraph
4.29/74) states that ‘revenue arises in the course of the ordinary activities of an entity and is
referred to by a variety of different names including sales, fees, interest, dividends, royalties
and rent.’ It notes (paragraph 4.30/75) that gains can arise either from ordinary activities or
from other activities/sources and are no different in nature, although presentation may vary.
Gains are usually reported on a net basis, unlike revenue.
Revenue is defined in AASB 118 Revenue as the gross inflow of economic benefits during
the period arising in the course of ordinary activities of an entity when those inflows result in
increases in equity, other than increases relating to contributions from equity participants.
Paragraph 4.38/83 of the Conceptual Framework states that income should only be
recognised when it is probable these inflows or savings in outflows will occur and the amount
can be reliably measured (to be replaced by a faithfully representative and verifiable
measure).
Specific standards provide guidance or place restrictions on the recognition of revenues.

For example, AASB 118 Revenue places further restrictions on the recognition of the types of
revenue within its scope in that it requires a control test and a cost test to be applied. The
control test requires the entity to transfer the significant risks and rewards of ownership of the
goods, and not to retain continuing management involvement associated with effective
control over the goods. The cost test requires that all costs incurred or to be incurred in
respect of the sale to be measured reliably.
For revenue from services, a stage of completion test is also required. Principles have been
established for an entity to apply in order to report useful information about the revenue and
cash flows arising from its contracts to provide goods or services to customers, especially
contracts which require performance over time. See section 3.2.2 of the chapter for further
details.
The standard also provides requirements for the recognition of revenue from dividends and
interest. See section 3.2.2 for further discussion, and AASB 118 paragraphs 14-34.
Section 3.2.2 of the text also discusses the revised AASB 118 Revenue from Contracts with
Customers expected to apply from 2017.

10. What is the nature of an expense, and when are expenses to be recognised? How can
expenses be classified in the preparation of financial statements for internal
reporting purposes?
Expenses are defined at paragraph 4.25/70(b) of the Conceptual Framework as decreases in

economic benefits during the accounting period in the form of outflows or depletions of
assets or incurrences of liabilities that result in decreases in equity, other than those relating
to distributions to equity participants. Paragraph 4.38/83 states that expenses should only be
recognised when it is probable that the future economic benefits will flow from the entity and
the amount can be reliably measured (to be replaced by a faithfully representative, verifiable
measure). See section 3.2.3 of the chapter for a brief discussion of the recognition of different
types of expenses.
Expenses are usually classified in general-purpose financial statements by their nature such
as employee expenses or depreciation, or their function such as distribution and
administrative expenses. However, for internal reporting purposes, expenses can be classified
in a way that best suits the user of the financial statement e.g. variable v fixed, controllable v
non-controllable. See also Section 3.3.5 of the chapter.
11. How are income and expenses classified in the preparation of a statement of profit
or loss and other comprehensive income? Can income and expenses appear directly
in the Retained Earnings account, without appearing in the current period’s profit?
Explain.
As discussed in question 10, expenses are classified according to their nature or their
function. For income items, AASB 118 classifies revenue into different categories.
Paragraph 88 of AASB 101 states that all income and expense items must be included in the
current period’s profit and loss, unless an Australian standard requires or permits otherwise.
The most common occurrence of this would be when an initial adjustment is made due to a
new or revised standard requiring an alternative application, or a change in accounting policy
or adjustment for a prior period error, usually requiring an adjustment to retained earnings
opening balance. Chapter 14 discusses accounting for changes in accounting policies and
prior period errors.
Note therefore that, apart from specified exceptions, income and expenses are to be included
in the profit or loss for the reporting period, and not as part of “other comprehensive income”
or adjusted from retained earnings directly.
12. When do dividends become a legal debt of the company? When are they to be
recognised as liabilities?
Where a company has a constitution that provides for directors to declare a dividend, then a
dividend becomes a debt of the company once the dividend is declared. Where no such
statement exists in a company’s constitution, then the debt will only arise when the time for
payment of the dividend arrives.
If a dividend has been declared (or paid) by the time of completion of the financial report but
not on or before the reporting date it must not be recognised as a liability as at the reporting

date. Instead such a dividend must be disclosed in notes as an event after reporting date. See
sections 3.4.1 and 3.4.2 of the chapter.
13. What factors determine the selection of accounting policies?
The overriding factor in the selection of an accounting policy is to determine whether the
policy provides users with information useful for making economic decisions.
In selecting accounting policies, AASB 108 Accounting Policies, Changes in Accounting
Estimates and Errors establishes a hierarchy for entities to follow in preparing general-
purpose financial statements.
Firstly, paragraph 7 of AASB 108 states that, when an Australian accounting standard
specifically applies to a transaction, other event or condition, the accounting policy or
policies applied to that item shall be determined by applying the Standard.
Secondly, in the absence of an Australian accounting standard that specifically applies to a
transaction, other event or condition, paragraph 10 requires management to use its judgement
in developing and applying an accounting policy that results in information that is:
(a) relevant to the economic decision-making needs of users; and
(b) reliable, in that the financial statements:
(i) represent faithfully the financial position, financial performance and cash flows
of the entity;
(ii) reflect the economic substance of transactions, other events and conditions, and
not merely the legal form;
(iii) are neutral, that is, free from bias;
(iv) are prudent; and
(v) are complete in all material respects.
(For further discussion of relevance, faithful representation, neutrality and completeness, see
section 3.6.1 of the text.)
Thirdly, in making the judgement described in paragraph 10, paragraph 11 requires
management to refer to the following sources in descending order:
(a) the requirements in Australian Accounting Standards dealing with similar and related
issues; and
(b) the definitions, recognition criteria and measurement concepts for assets, liabilities,
income and expenses in the Framework.
Fourthly, in making the judgement described in paragraph 10, paragraph 12 then suggests
that management may also consider the most recent pronouncements of other standard setting
bodies that use a similar conceptual framework to develop accounting standards, other
accounting literature and accepted industry practices, to the extent that these do not conflict
with the sources mentioned in paragraph 11.
Finally, AASB 108 paragraph 13 requires that the accounting policies selected are applied
consistently for similar transactions, other events and conditions, unless an Australian
accounting standard specifically requires or permits categorisation of items for which
different policies may be appropriate. If an accounting standard permits such categorisation,
then the accounting policy selected shall be applied consistently to each category.

14. Under what circumstances can an accounting policy be changed? How is the change
to be accounted for?
See section 3.6.2 of the text. AASB 108 paragraph 14 states that changes in accounting
policies can be made only in the following circumstances:
 the change is required by an accounting standard

 the change results in the financial statements providing reliable and more relevant
information about the effect of transactions , other events and conditions on the
entity’s financial position, financial performance or cash flows.
Thus, unless a change is prescribed or will result in improved financial reporting, the same
accounting policies should be adopted each year.
Where a new accounting policy is adopted other than as a result of the issue of a new
standard, AASB 108 paragraph 19(b) prescribes that the change arising on adoption is to be
applied retrospectively. Retrospective application is described in paragraph 22 thus:
the entity shall adjust the opening balance of each affected component of equity for the
earliest prior period and the other comparative amounts disclosed for each prior period
presented as if the new accounting policy had always been applied.
Thus, the company will need to consider the impact of the change of accounting policy not
only on current and future financial periods but also on past financial periods. Asset or
liability accounts may need to be amended. For example, assets raised under a previous
policy of capitalisation must be written off as if the costs included in those assets had been
expensed when incurred.
15. Discuss the nature of a reserve. What reasons may there be for no definitions being
given for a reserve in the legislation, accounting standards and the Conceptual
Framework?
AASB 101 para 54 describes the equity of a company as consisting of share capital and
reserves (retained earnings and other reserves).The term reserve is not defined in any
accounting standard or the Corporations Act. Guidance on the nature of a reserve can be
found by looking at what companies include as ‘reserves’ in their annual reports and what
accounting standards refer to as reserves.
In addition to retained earnings, the most common type of reserves are general, revaluation
and foreign currency translation reserves. ‘Retained earnings’ is one category of reserves,
according to AASB 101. Retained earnings represent the balances of the profit and losses
(before items of other comprehensive income) which the company has made since
incorporation, which have not been paid as dividends or bonus share issues to shareholders,
transferred to reserves, or used to buy back shares (Henderson and Pierson, 2000, p 534).
Some ‘other’ reserves arise as the result of accounting standards requiring amounts of other
comprehensive income to be accumulated in equity (eg. revaluation surplus) and others arise
from transfers from retained earnings (often known as general reserves) due to generally
accepted accounting principles. Some have arisen from dubious accounting practices, now
banned.

Students should realise that reserves do not represent ‘cash’ balances. Reserves are ‘book’
entries and no cash is physically transferred or created by these entries. Students should
recognise that for example, the creation of a general reserve is a transfer from profit, and
profit does not necessarily represent cash.
What reasons may there be for no definitions being given for a reserve in the legislation,
accounting standards, and the conceptual framework ?
I would say that the reason there is no definition given for a reserve in the legislation,
accounting standards and conceptual framework is because it is not possible to categorise
reserves according to a homogeneous definition. Reserves may be created in a number of
different ways (accounting standards, GAAP, other dubious accounting practices). It
therefore would appear to be a very difficult task to establish a general definition to include
all ‘reserves’. Any definition may be too restrictive.
16. In preparing financial statements for internal management purposes, discuss the
benefits and disadvantages of complying with the requirements of accounting
standards.
The benefit of complying with the requirements of accounting standards when preparing
financial statements for internal management is the cost savings. This is especially the case
for reporting entities required to prepare general-purpose financial statements for external
users. Rather than having an accounting system that is set up to prepare financial statements
for internal users and another set of financial statements for external users, costs would be
minimised if only the one set of financial statements was prepared. The disadvantage is that
management may feel that a certain number of accounting standards do not depict the
company’s overall profit performance and financial position from which key performance
indicators are being used to assess management. Furthermore, different expense
classifications would be more helpful for management control purposes than are the
classifications by nature or function.

CASE STUDIES
Case Study 1 Footballers as assets
One of the well-known soccer clubs in Britain, Liverchester, has made a decision to
include its players on the club’s statement of financial position as assets. These players
are signed to the club every 3 years and are paid large amounts of money by the club
each year under various contracts. The club also insists on a transfer fee being paid if a
player wishes to go to another club while under contract.
Required
Discuss whether the Liverchester club is justified in its action of treating players as
assets, by reference to appropriate accounting regulations.
Assets are defined in the Conceptual Framework, (para. 4.4/49(a)) as ‘a resource

controlled by the entity as a result of past events and from which future economic
benefits are expected to flow to the entity’. According to paras 4.8-4.14/53-59 of the
Framework, an asset has three essential characteristics:
1. An asset contains future economic benefits in the form of a potential to contribute,
directly or indirectly, to the flow of cash and cash equivalents to the entity.
2. The future benefits must be controlled by the entity. This means that an asset does
not have to be legally owned. Control is not defined in the Framework;
nevertheless, in para. 4.12/57, an ability of the entity to deny or regulate access to
those benefits is implied.
3. Assets must have come into existence as a result of past events. Future economic
benefits which are not currently controlled by the entity are not assets. A past
event must have occurred. Hence, inventories expected to be acquired by the
company next month are not assets to the entity at present.
Once these three essential characteristics are satisfied, an asset exists. Under the Conceptual
Framework the existence of an asset is not dependent on factors such as whether it has been
purchased at a cost, is ‘tangible’ or has a physical existence, has a legally enforceable claim
over it, or is exchangeable in the marketplace for cash or other assets.
Does the Liverchester club have future economic benefits? Yes. In the form of ticket sales,
promotional and sponsorship benefits.
Does Liverchester control the future economic benefits? As control means the capacity to
deny or regulate the access of others to those benefits, Liverchester would appear to have
control. Substantial transfer fees are required if a player wants to go to another club.
Has there been a past event? Yes, there is a contract signed with each player.
Can the players be recognised as assets? Recognition criteria could be discussed if it is
agreed that the players are assets. But how do you obtain a reliable measure of your asset?
And what about other officials e.g. coaching staff, management? Are they not assets as well?

Case Study 2 Liabilities and recognition

SuperBags Ltd is being sued for breach of patent. The company suing is claiming that a
range of handbags that SuperBags Ltd has manufactured and subsequently sold are
copies of their own designs. SuperBags Ltd has admitted that there are some similarities
between the designs and that their designs were based on the other company’s
handbags. However, SuperBags Ltd lawyers are arguing that the differences between
the handbag designs may be sufficient to avoid a finding of breach of patent. Legal
advice has suggested that there is a 40% probability that SuperBags Ltd will be found
guilty for breach of patent and has estimated that, if found guilty, Superbags Ltd will be
required to pay $980 000 to the other company.
Required
Discuss fully how SuperBags Ltd should account for this event by:
A. applying the requirements of AASB 137;
B. applying the definitions and recognition criteria as proposed in the July 2013
Discussion Paper, A Review of the Conceptual Framework for Financial Reporting.
A. AASB 137 defines a provision as:

a liability of uncertain timing or amount (para. 10)
To be recognised as a provision the item must:
 meet the definition of a provision, and
 meet the recognition criteria (i.e. can be measured reliably and it is probable the
outflow will be required. These recognition criteria are consistent with the Conceptual
Framework and are also specified in AASB 137 for provisions).
It would be argued that the item meets the definition of a provision. The past event is the
manufacture and sale of the handbags which are based on designs of the other company and
so have similarities to those of the other company. This has led to the SuperBags Ltd having a
present obligation (would be considered constructive due to sale of handbags which
potentially breach copyright of the other company and not a legal obligation as this time) to
make an outflow (this is potential payment of cash via damages). There is clearly uncertainty
about the timing and (possibly) the amount of any potential payment.
However at this time the recognition criteria are not met as the potential outflow (i.e.
payment of cash damages) is not probable (ie is less than 50%). Hence this would be a
contingent liability. As the possibility of an outflow is 40% this is not remote and hence
would need to be disclosed in the notes in accordance with AASB 137, para 86.
B. In the 2013 IASB discussion paper, A Review of the Conceptual Framework for Financial
Reporting, the proposed definition of a liability is:
a present obligation of the entity to transfer an economic resource as a result of past events
(2.11).
For the same reasons as outlined above in this case the item would meet the proposed
definition of a liability as there is a present obligation to transfer economic resources as a
result of past events (in this case actions of copying bags has given rise to an obligation to
potentially pay damages).

This discussion paper proposes that the only recognition criteria be that there be a faithful
representation. The discussion paper argues that probability would be reflected in
measurement (see section 3.2.1 of the text). Given this it would appear under the proposed
definition and recognition criteria this item would be recognised as a liability (presumably,
ignoring the time value of money, at $392 000 being 40% of $980 000). The uncertainly
associated with the item would also need to be disclosed if this was to be a faithful
representation.
Case Study 3 Reserves
Obtain the annual reports of a number of companies (these are usually available from
the company website).
Required
From the statement of changes in equity (and associated notes):
A. Identify the number and different types of reserves.
B. Check if the company explains the nature of these reserves (this will be in the notes if
these are explained).
C. Report to the class on the reserves common across the companies you have
considered and why there may be differences between the type and number of
reserves reported across these companies.
The discussion will vary depending on the companies that students consider.
For example,
 Woolworths’ 2013, annual report includes hedging reserve, foreign currency
translation reserve, remuneration reserve, asset revaluation reserve, equity instrument
reserve and retained earnings, and the nature of these is explained in note 18 of the
financial report.
 Telstra’s 2013 annual report includes reserves titled foreign currency translation, cash
flow hedging, consolidation fair value, general reserve and retained profits.
 Qantas’s 2013, annual report includes employee compensation reserve, hedging
reserve, foreign currency translation reserve and retained earnings, and the nature of
these is explained in note 23 of the financial report.
Many of these reserves (e.g. revaluation, hedging) are due to requirements of accounting
standards. Hence differences will occur due to different transactions/events that relate to the
entity and also through management choices/decisions (e.g. Telstra has a general reserve).

Case Study 4 Reserves and cash

Havana Ltd Has the following balances at 1 August 2017:
$
ASSETS
Cash 4 000
Accounts receivable 14 000
Inventory 11 000
Property, plant and equipment 37 000
Total assets 66 000
LIABILITIES
Accounts payable 4 000
Loan 19 000
Total liabilities 23 000
Net assets 43 000
EQUITY
Share capital 25 000
Retained earnings 18 000
Total equity 43 000
During the month ending 31 August 2017 the following occurred:

(a) Inventory that had cost $7000 was sold for $13 000 ($9000 on credit and $4000 cash
sales).
(b) $8000 in cash was received from customers for credit sales (i.e. accounts receivables).
(c) Inventory was purchased for $10 000 ($2000 on credit and $8000 for cash).
(d) A payment of $1100 was made on the loan: being $1000 principle and $100 interest
for August.
(e) $4000 was paid to creditors (accounts payable)
(f) Depreciation of $350 was charged on the property, plant and equipment.
(g) On 31 August 2017, the directors decided to transfer $11 000 from retained earnings
to a general reserve. They did this as they wished to ensure enough cash was
available to purchase more property, plant and equipment and this reserve is
intended to indicate cash available for such purchases.
Required
A. Calculate the profit for the month of August 2017 (ignore taxation).
B. Calculate the balances in the retained earnings and general reserve accounts at the
end of the period.
C. Calculate the amount of cash at the end of the period.
D. Use this case to illustrate/explain why a general reserve created does not represent
cash available for future purchases.
A. Profit for the month is:

Sales Revenue 13 000
Less Expenses of:
Cost of sales (7 000)
Interest (100)

Depreciation (350)
Profit 5 550
B. The balances are:

Retained earnings
Beginning balance 18 000
Plus profit 5 550
Less transfer to reserve (11 000)
End balance 12 550
General reserve
Beginning balance 0
Plus transfer from RE 11 000
End balance 11 000
C. The balance of cash is:

Beginning balance 4 000
Plus cash sales 4 000
Plus payments from customers 8 000
Less cash for inventory (8 000)
Less payment on loan (1 100)
Less payment to creditors (4 000)
End balance 2 900
D. This case shows:

 Although profit of $5,550 this is not represented by cash increases. Cash in fact has
decreased. The profit is reflected in the increase in net assets overall (for example,
increase in inventory and accounts receivable, and decrease in accounts payable and
loan).
 The general reserve of $11 000 represents an appropriation of profit – not cash. In
fact, despite the balance of $11 000 in this reserve, the company has only $2 900 in
cash. Hence a reserve does not ‘create’ or represent a pool of cash available for any
purpose.

Case Study 5 Accounting policies

Toyko Ltd has incurred advertising expenditure, the treatment of which is not
prescribed by any existing accounting standard. The board of directors has requested
the financial accountant record the expenditure as an asset so as not to impact the
current year’s profit. The accountant is concerned with the request and requires your
assistance in determining an accounting policy for this expenditure.
Required
A. Provide the accountant with two accounting policies or treatments that the company
could adopt to account for this expenditure.
B. What assistance does AASB 108 provide to help the accountant choose between the
policies provided in requirement A?
C. Which of your policies would best meet the requirements of AASB 108? Why?
A. Currently, there is no Australian accounting standard to provide accounting policies or

guidance specifically to deal with accounting for advertising expenditure of this kind.
Two potential accounting policies are:
(a) expense all advertising expenditure as incurred, or
(b) capitalise all advertising expenditure (i.e. treat the costs as an asset).
B. AASB 108, paragraph 10 states that, in the absence of an Australian accounting

standard, management shall use its judgement in developing and applying an
accounting policy that results in information that is both relevant to the economic
decision making needs of users and is reliable, i.e. provides a faithful representation of
the entity’s financial position and performance, as well as being free from bias and
complete. Paragraph 11 requires management to refer to the accounting standards of
other bodies dealing with similar and related issues and the definitions, recognition
criteria and measurement concepts contained in the conceptual framework when
choosing between competing accounting policies.
C. Students could select either policy – the key issue is whether or not such expenditure
results in the creation of an asset as per the Conceptual Framework’s definition. If so,
the expenditure should be capitalised. If not, the expenditure should be expensed.
Students should provide valid arguments to support their choice of accounting policy. In
this case, we would argue against capitalisation as the main purpose of the board is to
show a higher profit in the current year, i.e. this is not a faithful representation of the
entity’s financial position or performance.

Case Study 6 Accounting policies

Nassau Boats Ltd builds luxury ocean-going yachts which generally take up to 3 years
to construct and are worth $50 million each. The company normally takes out a loan to
finance the initial construction phase for each yacht. Interest on these loans has been
treated as an expense with $750 000 written off over the last 5 years. In the current year
ended 30 June 2017, the company changed its accounting policy with respect to interest
and now capitalises the interest against the cost of each yacht as allowed by AASB 123
Borrowing Costs. Amounts of $40 000 and $22 000 were capitalised against two yachts
on which construction started this year but no adjustments have been made for yachts
under construction at the beginning of the year. The new accounting policy and its
impact have been disclosed in the notes to the financial statements for the year ended 30
June 2017.
Required
Critically evaluate the company’s adoption of the new accounting policy with respect to
the requirements of AASB 108.
AASB 108 requires that when a company voluntarily changes an accounting policy it shall
apply the change retrospectively (p19(b)). Retrospective application means that, where
practicable, the entity shall adjust the opening balance of each affected component of equity
for the earliest period presented, and the other comparative amounts disclosed for each prior
period presented as if the new policy had always been applied.
Nassau Boats changed its accounting policy with respect to the capitalisation of interest
during the year but no retrospective adjustment was made to the value of yachts constructed
or commenced in prior periods. Retrospective adjustment requires adjustments to show
opening balances and comparative figures as if interest had always been capitalised rather
than expensed therefore prior year expenses amounting to $750 000 need to be reclassified.
To do this the company will need to go back and calculate the amount of interest for each
yacht constructed or commenced over the last five years. Cost of goods sold figures would
need to be restated for yachts completed and sold, and inventory costs would need to be
amended for yachts on hand or in progress that beginning of the current year. Prior year
adjustments to interest and cost of goods sold expenses would be made against the opening
balance of retained earnings.

PRACTICE QUESTIONS
RACTICE QUEST
IONS
Question 3.1 Dividends and reserve transfers
Prepare general journal entries to record the following unrelated transactions of a

limited company:
1. Payment of an interim dividend of $200 000 (in cash).

2. Declaration of a final dividend of $420 000.
3. Transfer of $65 000 from the revaluation surplus to a general reserve.
4. Transfer of $120 000 to the general reserve from retained earnings.
5. Payment of 300 000 bonus shares, fully paid at $1 per share from a general reserve.
1. Retained Earnings/Interim Dividend Dr 200 000

Cash Cr 200 000
(Payment of interim dividend)
2. Retained Earnings/ Dividend Declared Dr 420 000

Dividend Payable Cr 420 000
(Declaration of final dividend)
3. Revaluation Surplus Dr 65 000

General Reserve Cr 65 000
(Transfer from revaluation surplus
to general reserve)
4. Retained Earnings/ T’fer to Reserve Dr 120 000

(Transfer to general reserve)
5. General Reserve Dr 300 000

Share Capital Cr 300 000
(Being bonus dividend out of general
reserve)

Question 3.2 Dividends

The constitution of Beijing Ltd requires approval of final dividends by shareholders at
the Annual General Meeting (AGM) before these can be declared or paid.
1. On 27 September 2014, following approval and declaration at the AGM a final

dividend of $142 000 was paid. This dividend had been recommended on 29 June
2013 from retained earnings.
2. On 6 January 2015, the directors declared and paid an interim dividend of $98 000
from retained earnings.
3. On 2 July 2015, the directors recommended a final dividend of $180 000 from
retained earnings.
4. On 24 September 2015, the final dividend of $180 000 was approved and declared at
the AGM. This was paid later on 24 September after the AGM.
Required
A. Prepare general journal entries to account for the above events/transactions.
B. What is the total amount of dividends recognised for the year ending 30 June 2015?
C. Would your answers to A and B change if in relation to 3 above the directors had
recommended this dividend on the 28 June 2015 instead of the 2 July 2015?
A.
2014
27 Sept. Retained Earnings/Final Dividend Dr 142 000
Cash Cr 142 000
(Recognition and payment of final dividend)
2015
6 Jan. Retained Earnings/ Interim Dividend Dr 98 000
Cash Cr 98 000
(Recognition and payment of interim dividend)
2 July There is no entry as the dividend has not been declared (only recommended).
24 Sept Retained Earnings/Final Dividend Dr 180 000

Cash Cr 180 000
B.
The total amount of dividends recognised for the year ending 30 June 2015 is $240 000
being:
 Final dividend from 2014 of $142 000, and
 Interim dividend of $98 000.
C.
There would be no changes as the dividend has not been declared, and so is not recognised at
the date of recommendation.


The constitution of Hanoi Ltd allows directors to declare a final dividend at any time
and this is not subject to any further approval, authorisation or discretion.
1. On 27 September 2015, following the AGM a final dividend of $42 000 was paid. This
dividend had been declared on 29 June 2015 from retained earnings.
2. On 1 February 2016, the directors declared and paid an interim dividend of $24 000
from the general reserve.
3 On 2 July 2016, the directors declared a final dividend of $41 000 from retained
earnings.
4. On 24 September 2016, following the AGM the final dividend of $41 000 was paid.
Required
A. Prepare general journal entries to account for the above events/transactions. You
need to include a date for each entry.
declared this dividend on the 28 June 2016 instead of the 2 July 2016?
A.
2015
27 Sept. Dividend Payable Dr 42 000
Cash Cr 42 000
(Payment of final dividend recognised on 29 June 2015)
2016
1 Feb. General Reserve Dr 24 000
Cash Cr 24 000
2 July Retained Earnings/Final Dividend Declared Dr 41 000

(Recognition of declaration final dividend)
24 Sept Dividend Payable Dr 41 000

Cash Cr 41 000
(Payment of final dividend)
B.
The total amount of dividends recognised for the year ending 30 June 2016 is $24 000 being
the interim dividend.
C.
If the dividend had been declared on 28 June 2016 then it would be recognised at that date
and the total amount of dividends recognised for the year ending 30 June 2016 would be $65
000 being:
 Interim dividend of $24 000 and.
 Final dividend from 2016 of $41 000.


The constitution of Oslo Ltd states that directors can only determine a final dividend
and that any dividends determined can be revoked prior to time of payment.
1. On 5 August 2015, following the AGM a final dividend of $306 000 was paid from
retained earnings. This dividend had been determined on 29 June 2015.
2. On 11 January 2016, the directors declared and paid an interim dividend of $224 000
from the general reserve.
3. On 28 June 2016, the directors determined that a final dividend of $320 000 from
retained earnings would be paid following the AGM.
4. On 12 September 2016, following the AGM the final dividend of $320 000 was paid.
Required
A. Prepare general journal entries to account for the above events/transactions. You
need to include a date for each entry.
determined this dividend on the 1 July 2016 instead of the 28 June 2016?
A.
2015
5 Aug. Retained Earnings/Final Dividend Dr 306 000
Cash Cr 306 000
2016
11 Jan. General Reserve Dr 224 000
Cash Cr 224 000
28 June There is no entry as the dividend has not been declared (only determined).
12 Sept Retained Earnings/Final Dividend Dr 320 000

Cash Cr 320 000
B.
The total amount of dividends recognised for the year ending 30 June 2016 is $530 000
being:
 Final dividend from 2015 of $306 000, and
 Interim dividend of $224000.
C.
There would be no changes as the dividend has not been declared, and so is not recognised at
the date it is determined. Further the 1 July 2016 is not within the current reporting period.

Question 3.5 Retained earnings
At 1 July 2016, the balance in the Retained Earnings account of Canberra Ltd was
$3 500 000. The company’s share capital at the 1 July 2016 comprises 400 000 6%
preference shares issued for $2.00 per share and 1 400 000 ordinary shares fully paid at
$1 per share.
During the year ended 30 June 2017, the following events occurred:
1. On 1 February 2017, the directors declared and paid an interim ordinary dividend of
$224 000 from retained earnings.
2. On 14 March 2017, the directors issued 40 000 ordinary bonus shares fully paid at
$1.40 per share from retained earnings.
3. Profit for the year was $4 300 000.
4. On 30 June 2017, the directors declared a final ordinary dividend of $680 000. A
dividend was also declared on the preference shares.
5. On 30 June 2017, the directors resolved to transfer $1 500 000 to a general reserve
from retained earnings, and to transfer $4 000 000 from a previously created plant
maintenance reserve back to retained earnings.
Required
Prepare journal entries for the above transactions, and the Retained Earnings account
at 30 June 2017.
CANBERRA LTD
General Journal
2017
1 Feb Retained Earnings/Interim Dividend Dr 224 000
Cash Cr 224 000
(Payment of interim dividend)
14 Mar Retained Earnings Dr 56 000

Share Capital (ordinary) Cr 56 000
(Issue of bonus Shares)
June 30 Profit or Loss Summary Dr 4 300 000

Retained Earnings Cr 4 300 000
(Transfer of profit closing entry)
Retained Earnings/Dividend Declared Dr 728 000

Dividend Payable - Ord Cr 680 000
Dividend Payable - Pref Cr 48 000
(Declaration of final ordinary dividend
and 6% dividend on preference shares)
Retained Earnings/Transfer to Gen. Res. Dr 1 500 000

General Reserve Cr 1 500 000

Plant Maintenance Reserve Dr 4 000 000

Ret. Earnings/T’fer from P M Res. Cr 4 000 000
(Transfer from plant maintenance reserve)
Other closing entries will be required if the solution uses Interim Dividend, Dividend
Declared, and transfers to/from reserve accounts to close these accounts to Retained
Earnings.
Retained Earnings
1 /2/17 Ord Div. – interim 224 000 1/07/16 Open bal. 3 500 000
14/3/17 Share Capital 56 000 30/06/17 P or L Summary 4 300 000
30/6/17 Ord Div. Payable 680 000
Pref. Dividend 48 000
Payable
Transfer to general
reserve 1 500 000
30/06/17 Transfer from Plant
30/06/17 Balance c/d 9 292 000 Maint. Reserve 4 000 000
11 800 11 800
000 000
30/06/17 Balance b/d 9 292 000

Question 3.6 Dividends and share issues

The share capital of Kathmandu Ltd as at 1 July 2016 comprised 1 400 000 ordinary
shares issued and paid to $3.00 less share issue costs of $41 000.
Information about some events/transactions relating to Kathmandu Ltd is below:
1. On 21 August 2016, a dividend of $440 000 was paid in cash. This dividend had been
determined (proposed) on 29 June 2016 from retained earnings.
2. On 1 October 2016, Kathmandu Ltd issued a prospectus calling for applications for
1 600 000 ordinary shares from the public at an issue price of $4.20, payable $2.50 on
application and $1.70 on allotment. By 25 November 2016, it had received 1 800 000
applications with $2.50 paid. On 1 December 2016 the company issued the shares and
made refunds to 200 000 applicants. Costs incurred in the share issue totalled
$52 000. All allotment monies were received by 24 December 2016.
3. On 28 June 2017, the directors determined a final dividend of $0.18 per share from
retained earnings. This is to be paid on 20 August 2017 following the annual general
meeting.
At 30 June 2017, the directors transferred $350 000 to retained earnings from the
general reserve.
Required
A. Prepare the general journal entries required in the year ended 30 June 2017 to
reflect the events/transactions above.
B. How would your entries above change if the final dividends had not been determined
(at 29 June 2016 and 28 June 2017), but had been declared at these dates?
A.
2016
21 Aug Retained Earnings/Dividend paid Dr 440 000
Cash/Bank Cr 440 000
(Recognition and payment of dividend)
To 25 Nov Cash Trust Dr 4 500 000

Application Cr 4 500 000
(Receipt of monies with applications)
1 Dec Application Dr 500 000

Cash Trust Cr 500 000
(Refund to unsuccessful applicants)
Application Dr 4 000 000

Allotment Dr 2 720 000
Share Capital Cr 6 720 000
(Recognition of issues of shares and share capital due on allotment and
application)
Cash/Bank Dr 4 000 000

Cash Trust Cr 4 000 000
(T/f of monies received on application)
Share Issue Costs/Share Capital Dr 52 000

Cash/Creditors/Payables Cr 52 000
(Costs of share issue)
24 Dec Cash Dr 2 720 000

Allotment Cr 2 720 000
(Receipt of allotment money)
2017
28 June There is no entry as the dividend has only been determined, not declared.
30 June General reserve Dr 350 000

Retained earnings (or T’fer from Gen.Res.) Cr 350 000
(Transfer from general reserve)
B. If the final dividends had been declared then the following entries would be processed:
2016
21 Aug Dividend Payable Dr 440 000
Cash/Bank Cr 440 000
(Payment of dividend recognised on 29 June 2016)
2017
28 June Retained earnings/Dividend Declared Dr 540 000
(Recognition of final dividend declared: 3 million shares @18c)

Question 3.7 Equity movements and statement of changes in equity
The following is the equity of Paris Ltd on 30 June 2016:
Share capital (fully paid ordinary shares at $3.50) $ 2 100 000

General reserve 640 000
Revaluation surplus 160 000
$ 3 210 000
The following transactions occurred during the year ended 30 June 2017:
1. At the annual general meeting on 1 September 2016, the directors confirmed a final
dividend of 20c per share for the year ended 30 June 2016. The dividend had been
proposed (determined) on the 28 June 2016 and had not been provided for in the
annual financial statements. Dividends were paid by direct debit at the close of the
meeting.
2. On 31 December 2016, the directors, who were keen to keep cash resources in the
business for further expansion of plant facilities, made a bonus share issue of 1 share
for every 12 shares held valued at $3.80 per share from the general reserve.
3. On 30 June 2017, the directors decided to transfer $50 000 from the revaluation
surplus to the general reserve. This portion of the surplus related to an asset that had
been sold in May 2016.
4. The profit for the year after charging income tax expense of $140 000 was $690 000.
5. On 30 June 2017, the directors recommended a final dividend of 10c per share out of
retained earnings. This was expected to be ratified and paid at the annual general
meeting on 28 August 2017.
Required
A. Prepare journal entries to record the transactions.
B. Prepare a statement of changes in equity for the year ended 30 June 2017.
A.
2016
Sept 1 Retained Earnings/Dividend Paid Dr 120 000
Cash Cr 120 000
(Payment of dividend confirmed
at the AGM)
Dec 31 General Reserve Dr 190 000

(Payment of 1 for 12 bonus issue
@$3.80 out of general reserve)
2017
June 30 Revaluation Surplus Dr 50 000
(Transfer from revaluation surplus to general reserve)

Profit or Loss Summary Dr 690 000

Retained Earnings Cr 690 000
(Profit for the year closing entry)
No entry for dividends on 30 June 2017 as these have not been declared.
B.
PARIS LTD
Statement of Changes in Equity
for the year ended 30 June 2017
Total comprehensive income for the year* $690 000
Retained earnings:
Balance at 1 July 2016 $310 000
Profit for the period 690 000
Dividend paid during year (120 000)
Balance at 30 June 2017 $880 000
Share capital:
Balance at 1 July 2016 $ 2 100 000
Bonus share issue during the period 190 000
Balance at 30 June 2017 $ 2 290 000
Other reserves:
General
Bonus share issue during the period (190 000)
Transfer from revaluation surplus 50 000
Revaluation surplus
Transfer to general reserve (50 000)
* Comprehensive income = $690 000 profit. There were no items of other comprehensive
income

Question 3.8 Adjustments and preparation of financial

statements
The following details are taken from the accounting records of Aster Ltd at 30 June
2017:
Debit Credit
Sales revenue $ $ 882 680
Cost of sales 694 000
Selling expenses 82 000
Administrative and general expenses 51 000
Financial expenses (including borrowing costs 17 000
of $7000) 10 000
Dividend revenue 1 320
Interest revenue
Plant and machinery (cost) 150 000
Accumulated depreciation – plant and 70 000
machinery 40 000
Freehold land 80 000
Buildings (cost) 30 000
Accumulated depreciation – buildings 22 000
6% government bonds (face value $20 000) 75 000
Shares in other companies 24 000
Bank loan (due 2020) 54 000
Allowance for doubtful debts 46 000
Inventories (at lower of cost and market) 16 000
Mortgage payable (secured over land and 30 000
buildings) 30 000
Goodwill 16 000
Share capital (120 000 ordinary shares issued 13 000
for $2)
General reserve
Retained earnings 1/7/16
$ 1 341 000 $ 1 341 000
The following items, not yet recorded, must be adjusted before completion of the
company’s financial statements:
1. Depreciation to be recorded as follows: plant and machinery at 20% of cost;
buildings at 5% of cost. Goodwill has not been impaired.
2. Income tax to be provided at 30% of profit before tax.
3. Dividends of 8c per share were declared on 30 June 2017.
4. Transfer $10 000 of the general reserve back to retained earnings.
Required
A. Prepare general journal entries to record the adjustments necessary.
B. Prepare the statement of profit or loss and other comprehensive income for Aster
Ltd for the year ended 30 June 2017.
C. Prepare the statement of changes in equity for Aster Ltd for the year ended 30 June

2017.
D. Prepare the statement of financial position for Aster Ltd as at 30 June 2017.
A.
2017
June 30 Depreciation - Plant & Machinery Dr 30 000
Accum. Depn - Plant & Mach Cr 30 000
(Depreciation at 20% per annum)
Depreciation - Buildings Dr 4 000

Accum. Depn - Bldgs Cr 4 000
Income Tax Expense Dr 4 800

Current Lax Liability Cr 4 800
(Tax of 30% on profit of $16 000
as calculated below)
Retained Earnings/Dividend Declared Dr 9 600

(Final dividend of 8c per share
on 120 000 shares declared)
General Reserve Dr 10 000

Retained Earnings/Transfer
from reserve Cr 10 000
(Being transfer from this reserve)
B. ASTER LTD
Statement of Profit or Loss and Other Comprehensive Income
Income:
Sales $882 680
Dividend revenue 10 000
Interest revenue 1 320
Total revenues 894 000
Expenses:
Selling expenses
Cost of sales $694 000
Other selling expenses 82 000
Total selling expenses 776 000
Administrative expenses
Administrative expenses 51 000
Depreciation of plant & machinery 30 000
Depreciation of buildings 4 000
Total administrative expenses 85 000
Financial expenses
Financial expenses 17 000

Total financial expenses 17 000

Total expenses 878 000
Profit before income tax 16 000
Income tax expense (30%) 4 800
Profit for the year $11 200
Other comprehensive income 0
Total comprehensive income for the year $11 200
C. ASTER LTD

Retained earnings:
Dividend declared (9 600)
Transfer from general reserve 10 000
Share capital:
Other reserves:
General
Transfer to retained earnings (10 000)
D.
ASTER LTD
Statement of Financial Position
as at 30 June 2017
Current assets
Accounts receivable $54 000
Allowance for doubtful debts 8 000 $46 000
Inventories 46 000
Total current assets 92 000
Non-current assets
Government bonds 22 000
Shares in other companies 75 000
Freehold land 40 000
Buildings 80 000
Accumulated depreciation (34 000) 46 000
Plant and machinery 150 000
Goodwill 30 000
Total non-current assets 263 000

Total assets 355 000

Current liabilities
Current tax liability 4 800
Dividend payable 9 600
Total current liabilities 44 400
Non-current liabilities
Bank loan payable 24 000
Mortgage payable 16 000
Total non-current liabilities 40 000
Net assets $270 600
Equity
Share capital
120 000 ordinary shares issued and paid to $2 240 000
Total equity $270 600

Question 3.9 Ledger accounts for equity adjustments

The equity of Oslo Ltd at 30 June 2016 consisted of:
Share capital:
200 000 10% cumulative pref. shares issued at $2, fully paid $400 000
100 000 ordinary shares issued at $1, paid to 50c 50 000
2016
June 30 Already deducted from the retained earnings balance of $860 000
were final ordinary dividends of $7000 and preference dividends of
$40 000 that had been declared at 30 June 2016. These dividends
were expected to be paid later in 2016.
July 9 Final call made on 100 000 partly paid ordinary shares.
Sept. 19 Call money received.
Oct. 5 Final dividends paid.
21 Revaluation of an item of land upwards by $50 000. (This is the initial
revaluation of land. Ignore taxation.)
22 With the surplus created from the revaluation of land, the directors
made a bonus issue of ordinary shares to existing ordinary
shareholders, on the basis of 3 shares for every 10 shares, valued at
$1.08 per share.
2017
Jan. 10 Interim dividend of 6c per ordinary share paid out of retained
June 30 earnings.
Preference dividend for the year and final ordinary dividend of 6c
per share were declared.. Transfer of $3000 to the general reserve
from retained earnings.
Required
Prepare ledger accounts to reflect the above transactions.
OSLO LTD
General Ledger
Share Capital - Ordinary

30/6/17 Balance 132 400 30/6/16 Balance 50 000
9/9/16 Final call 50 000
22/10/16 Reval surplus 32 400
132 400 132 400
30/6/17 Balance 132 400

Share Capital – Preference

30/6/16 Balance 400 000
General Reserve
30/6/17 Balance 43 000 30/6/16 Balance 40 000
30/6/17 Retained earnings 3 000
43 000 43 000
30/6/17 Balance 43 000
Retained Earnings (extract)

10/1/17 Int ord div 7 800 30/6/16 Balance 860 000
30/6/17 Pref div payable 40 000
30/6/17 Ord div payable 7 800
30/6/17 General reserve 3 000
Final Call
9/7/16 Ord share capital 50 000 19/9/16 Cash 50 000
Cash (extract)
19/9/16 Final call 50 000 5/10/16 Ord div payable 7 000
5/10/16 Pref div payable 40 000
10/1/17 Retained earnings (int 7 800
ord div)

Ordinary Dividend Payable

5/10/16 Cash 7 000 30/6/16 Balance 7 000
Preference Dividend Payable

5/10/16 Cash 40 000 30/6/16 Balance 40 000
Revaluation Surplus
22/10/16 Share capital 32 400 21/10/16 Gain on Revaluation 50 000
(OCI)
30/6/17 Balance 17 600
50 000 50 000
30/6/17 Balance 17 600
Land (extract)
21/10/16 Gain on Revaluation 50 000
(OCI)
Other Comprehensive Income *

21/10/16 Revaluation Surplus 50 000 21/10/16 Land 50 000
*Entries for revaluations in this chapter are simplified and do not consider taxation.
Revaluations of such items are considered in Chapter 9.

Question 3.10 Adjustments and financial statements

The trial balance of Madrid Ltd as at 30 June 2016 is given below:
MADRID LTD
Trial Balance
as at 30 June 2016
Debit Credit
Share capital $ 101 250 000
Second call (3 000 000 shares at 25c each) $ 750 000
Calls in advance 3 000 000
Retained earnings (1/7/15) 3 900 000
Mortgage payable on land and buildings 30 000 000
Bank overdraft 11 250 000
Accounts payable 3 000 000
Land 15 300 000
Buildings 60 000 000
Vehicles 3 750 000
Accumulated depreciation — buildings 6 000 000
Accumulated depreciation — vehicles 750 000
Financial investments 52 500 000
Goodwill 8 250 000
Accounts receivable 8 240 000
Inventory 24 000 000
Sales revenue 36 000 000
Interest on financial investments 2 625 000
Cost of sales 16 500 000
Commission expense 150 000
Delivery expense 300 000
Salaries — administrative 3 000 000
Salaries — travellers 1 035 000
Directors’ fees 300 000
Interest on mortgage 1 500 000
General expenses 2 200 000
$ 197 775 000 $ 197 775 000
Additional information
A.The share capital at 1 July 2015 consisted of 45 000 000 shares fully paid at $1 and
75 000 000 shares issued for $1 and called to 75c per share.
B. The following adjustments have to be made to the trial balance prior to the
preparation of the financial statements:
(i) doubtful debts at 30 June 2016 are estimated to be $230 000
(ii) unrecorded and unpaid travellers’ salaries amount to $170 000
(iii) prepaid general expenses amount to $23 000
(iv) income tax expense to be recognised of $3 758 000
(v) a final dividend is to be recommended for $2 250 000. The company’s constitution
requires shareholders to ratify final dividends.
(vi) $1 300 000 is to be transferred to a general reserve
(vii) depreciation on vehicles at the rate of 20% p.a. and on buildings at the rate of 5%
p.a. for the whole year

Required
A. Prepare a statement of profit or loss and other comprehensive income for Madrid
Ltd for the year ended 30 June 2016 for internal purposes.
B. Prepare a statement of financial position for Madrid Ltd as at 30 June 2016 for
internal purposes.
Workings
2016
June 30 $’000 $’000
(i) Bad Debts Expense Dr 230
Allowance for Doubtful Debts* Cr 230
*or Allowance for Impairment of receivables
(ii) Salaries: Travellers Dr 170

Salaries Payable Cr 170
(iii) Prepaid Expenses Dr 23

General Expenses Cr 23
(v) Income Tax Expense Dr 3 758

Current Lax Liability Cr 3 758
(vi) No entry
(vi) Transfer to General Reserve Dr 1 300

(vii) Depreciation – Vehicles Dr 750

Depreciation - Buildings Dr 3 000
Accum. Depn – Vehicles Cr 750
Accum. Depn - Bldgs Cr 3 000
(Depreciation at 20% per annum on vehicles and 5% per annum on buildings)

The trial balance of Madrid Ltd as at 30 June 2016 after the above adjustments is therefore:
MADRID LTD
TRIAL BALANCE
(as at 30 June 2016)
Debit Credit
$’000 $’000
Share Capital 101 250
Second Call (3 000 000 shares at 25c each) 750
Calls in Advance 3 000
Retained Earnings (1/7/15) 3 900
Transfer to General Reserve 1 300
General Reserve 1 300
Mortgage Payable on Land and Buildings 30 000
Bank Overdraft 11 250
Accounts Payable 3 000
Salaries Payable 170
Current Tax Liability 3 758
Land 15 300
Buildings 60 000
Vehicles 3 750
Accumulated Depreciation - Buildings 9 000
Accumulated Depreciation - Vehicles 1 500
Financial Investments 52 500
Goodwill 8 250
Accounts Receivable 8 240
Allowance for Doubtul Debts 230
Inventory 24 000
Prepaid Expenses 23
Sales Revenue 36 000
Interest on Financial Investments 2 625
Cost of Sales 16 500
Commission Expense 150
Delivery Expense 300
Salaries: Administrative 3 000
Salaries: Travellers 1 205
Directors’ Fees 300
Interest on Mortgage 1 500
Bad Debt Expense 230
Income Tax Expense 3 758
Depreciation – Vehicles 750
Depreciation – Buildings 3 000
General Expenses 2 177 ______
206 983 206 983

MADRID LTD

For year ended 30 June 2016
Income: ($’000) ($’000)

Sales 36 000
Interest on financial investments 2 625
Total income 38 625
Expenses:
Selling expenses
Commission expense 150
Delivery expense 300
Depreciation – vehicles 750
Salaries: travellers 1 205
Salaries: administrative 3 000
Depreciation – buildings 3 000
Directors’ fees 300
General expenses 2 177
Financial expenses
Bad debt expense 230
Interest on mortgage 1 500
Income tax expense 3 758
Profit for the year 5 755

2.
MADRID LTD
as at 30 June 2016
Current assets ($’000) (4’000)
Inventory 24 000
Less Allowance for doubtful debts 230 8 010
Prepaid expenses 23
Non-current assets
Land 15 300
Buildings 60 000
Less Accumulated depreciation (9 000) 51 000
Vehicles 3 750
Less Accumulated depreciation (1 500) 2 250
Financial investments 52 500
Goodwill 8 250
Current liabilities
Bank overdraft 11 250
Salaries payable 170
Non-current Liabilities
Mortgage payable on land and buildings 30 000
Net assets $113 155
Equity
Less second call (750) 100 500
Calls in advance 3 000
Retained earnings* 8 355
*Retained earnings = 3 900 + 5 755 – 1 300

Question 3.11 Equity transactions and retained earnings

account
The equity of Washington Ltd at 1 July 2017 consisted of:
Share capital
500 000 ‘A’ ordinary shares — fully paid $1 500 000
400 000 ‘B’ ordinary shares issued for $2 and paid to $1.50 600 000
Retained earnings 1 780 200
The following events occurred during the financial year 1 July 2017 to 30 June 2018:
2017
Aug. 10 The final dividend of $96 000 was paid. This had been declared on
29 June 2017 from retained earnings.
Oct. 15 The first and final call was made on the ‘B’ ordinary shares.
20 All call money was received.
Dec. 21 The directors allotted a 1-for-10 bonus issue on all ‘A’ ordinary
shares, valued at $3, to be paid out of the general reserve.
2018
March 1 An interim dividend of 9c per fully paid share was paid on all
ordinary shares out of retained earnings.
June 30 The directors declared a final dividend of 11c per fully paid share
on all ordinary shares out of retained earnings. Half of the
remaining balance in the general reserve was transferred back to
retained earnings.
Required
A. Prepare journal entries to record the above transactions.
B. Assuming that the company made an after-tax profit of $1 400 000 for the year,
prepare the retained earnings ledger account for the year ended 30 June 2018.
A.
2017
Aug 10 Dividend Payable Dr 96 000
Cash Cr 96 000
(Payment of final dividend)
Oct 15 Final Call – B Ordinary Dr 200 000

Share Capital – B Ordinary Cr 200 000
(Call of 50c on 400 000 shares)
Oct 20 Cash Dr 200 000

Final Call – B Ordinary Cr 200 000
Dec 21 General Reserve Dr 150 000

Share Capital – A Ordinary Cr 150 000
(Bonus issue out of general reserve)

2018
Mar 1 Retained Earnings/Interim Dividend Paid Dr 81 000
Cash Cr 81 000
(Interim dividend of 9c per ord. share paid)
June 30 Retained Earnings/Dividend Declared Dr 99 000

(Declaration of final dividend: 11c * 900 000 shares)
Jun 30 General Reserve Dr 390 000

Retained Earnings/T’fer from Gen. Res. Cr 390 000
(General reserve transferred to retained earnings)
Workings: Calculation of general reserve

Balance 1/7/2017 930 000
Less bonus issue (150 000)
Less transfer to retained earnings (390 000)
Balance 30 June 2018 $390 000
B.
Retained Earnings
1/3/18 Interim dividend paid 81 000 1/7/17 Balance 1 780 200
30/6/18 Final Dividend 99 000 30/6/18 P or L Summary 1 400 000
Declared
30/6/18 Balance c/d 3 390 200 30/6/18 General Reserve t’fer 390 000
3 570 200 3 570 200
1/7/18 Balance b/d 3 390 200

Question 3.12 Equity adjustments, and statement of changes in equity
Equity of Santiago Ltd at 1 July 2016 consisted of:
Share capital $ 1 764 000

Plant replacement reserve 550 000
(a) Santiago Ltd had made two previous share issues. In 2012, it issued 400 000 ordinary
shares issued and paid to $2.00. Costs incurred in this share issue totalled $12 000. In
December 2015, it issued 500 000 ordinary shares at an issue price of $2.40. At 30
June 2016, these were paid to $2.00. Costs incurred in this share issue totalled
$24 000.
The following events occurred during the year ending 30 June 2017:
2016
July 5 Final dividend of $81 000 was declared.
Aug. 10 Final dividend declared on 5 July was paid
Sept. 2 First and final call made on the 500 000 partly paid shares.
Sept. 30 All call money received.
2017
Jan. 30 Interim dividend of 10c per share declared and paid out of
retained earnings.
March 10 The directors made a 1-for-8 bonus issue of shares from the
general reserve. Shares are issued at $2.20 each.
June 30 Profit before tax for the year was $760 000 out of which the
following appropriations were made:
(a) Income tax expense $220 000
(b) Transfers to reserves from retained earnings
July 2 The final dividend of 10c per share on all issued shares was
declared.
Required
A. Prepare the journal entries (in general journal format) required in the year ending
30 June 2017.
B. Prepare the statement of changes in equity up to 30 June 2017.
A.
2016
July 5 Retained Earnings/Final Div Declared Dr 81 000
(Final dividend declared)

Aug 10 Dividend Payable Dr 81 000

Cash Cr 81 000
(Final dividend paid)
Sept 2 Final Call Dr 200 000

(Final call on 500 000 shares at 40c)
Sept 30 Cash Dr 200 000

Final Call Cr 200 000
(Cash received on call)
2017
Jan 30 Retained Earnings/Interim Div Paid Dr 90 000
Cash Cr 90 000
(Interim dividend paid; 900 000*10c)
Mar 10 General Reserve Dr 247 500

(Bonus share issue; 900 000/8*$2.20)
Jun 30 Income Tax Expense Dr 220 000

Current Tax Liability Cr 220 000
(Income tax expense for the year)
Retained Earnings/T’fers to Reserves Dr 130 000

Plant Replacement Reserve Cr 30 000
(Transfers to reserves)
Revenues Dr x
Expenses (excl. tax) Cr x
Profit or Loss Summary Cr 760 000
(Closing entry)

Income Tax Expense Cr 220 000
(Tax expense closing entry)

(Closing entry to transfer profit)
The entry for the final dividend declared on the 2 July is not included as only required to
prepare entries for the year ending 30 June 2017.

B.
SANTIAGO LTD
Total comprehensive income for the period* $540 000
Retained earnings:
Dividend declared – final 2016 (81 000)
Interim dividend paid (90 000)
Transfer to plant replacement reserve (30 000)
Transfer to general reserve (100 000)
Balance at 30 June 2017 $1 219 000
Share capital:
Balance at 1 July 2016 $1 764 000
Call on shares 200 000
Issue of bonus shares 247 500
Balance at 30 June 2017 $2 211 500
Other reserves:
General reserve
Transfer from retained earnings 100 000
Issue of bonus shares (247 500)
Plant replacement reserve

Transfer from retained earnings 30 000
* Comprehensive income = Profit $540 000 (there are no items of other comprehensive
income)

Question 3.13 Equity adjustments and statement of changes in

equity
The equity of London Ltd at 30 June 2016 was:
Share capital
50 000 10% cumulative preference shares —
fully paid $ 50 000
100 000 ordinary shares — fully paid 200 000
250 000
Development reserve 20 000
Retained earnings (30 000 )
Total equity $ 290 000
During the year ended 30 June 2017, the following transactions occurred:
2016
Sept. 1 In 2015, the directors had authorised the development reserve as
they were considering developing a new product. In anticipation
of this, the directors had authorised the appropriation for
developments last year. The board now directs that the reserve be
discontinued and transferred back to retained earnings.
2017
March 1 The profits for the half-year were such that the directors declared
dividends of 10% on the preference shares. The directors also
declared an interim dividend of 10c per share on ordinary shares.
Preference dividends have not been paid for 2015 or 2016.
Dividends declared on 1 March were paid.
12
April 1 The directors authorised the issue to ordinary shareholders of a
bonus share issue of 1 share for every 5 held, valued at $2.20. The
shares do not rank for dividend until 2018. The issue is out of the
revaluation surplus.
June 30 The profit before tax for the year was $300 000. The directors
recommended a final dividend of 18c per share on ordinary shares
out of retained earnings. The company’s constitution requires
approval of final dividends on ordinary shares by shareholders at
the annual general meeting. Assume the taxation rate is 30%.
Required
A. Prepare general journal entries to record all transactions for the year.
B. Prepare a statement of changes in equity for the year ended 30 June 2017.

A.
2016
Sept 1 Damages Expense Dr 15 000
Cash Cr 15 000
(Payment of damages from lawsuit)
Development Reserve Dr 20 000

Retained Earnings/Transfer
from Reserve Cr 20 000
(Reserve transfer to retained earnings)
2017
Mar 1 Retained Earnings/Dividends Declared Dr 25 000
Dividend Payable – Pref Cr 15 000
Interim Dividend Payable-Ord Cr 10 000
(Declaration of 10% preference dividend for
three years on cumulative shares, and
ordinary interim dividend of 10c per share)
Mar 12 Dividend Payable - Preference Dr 15 000

Interim Dividend Payable – Ord Dr 10 000
Cash Cr 25 000
(Payment of dividends)
April 1 Revaluation Surplus Dr 44 000

Share Capital - Ordinary Cr 44 000
(Issue of 1 for 5 bonus shares
valued at $2.20 out of revaluation surplus)
June 30 Revenue and Expenses Dr 300 000

Profit or Loss Summary Cr 300 000
(Profit before tax for the year)
Income Tax Expense Dr 90 000

(Tax expense)
June 30 Profit or Loss Summary Dr 90 000

Income Tax Expense Cr 90 000
(Being closing entry)

(Transfer of profit)
No entry for dividends as not yet approved.

B.
LONDON LTD
Retained earnings:
Balance at 1 July 2016 $(30 000)
Profit 210 000
Preference dividend paid (15 000)
Ordinary interim dividend paid (10 000)
Transfer from development reserve 20 000
Share capital:
Other reserves:
Revaluation surplus
Balance at 1 July 2016 50 000
Issue of bonus shares (44 000)
Balance at 30 June 2017 (6 000)
Development reserve
Balance at 30 June 2017 $ 0

Question 3.14 Share issues, options, dividends and reserves

The equity of Cairo Ltd at 30 June 2016 consisted of:
400 000 ordinary ‘A’ shares, issued at $2, fully paid $800 000
300 000 ordinary ‘B’ shares, issued at $2, called to $1.20 360 000
50 000 6% redeemable preference shares, issued at $1.50, fully paid 75 000
Share issue costs
Calls in advance (at 80c) (2 670)
Share options (issued at 60c, fully paid) 16 000
318 000
The options were exercisable by 28 February 2017. Each option entitled the holder to
acquire two ordinary ‘C’ shares at a price of $1.80 per share, payable by 28 February
2017.
2016
Sept. 15 The preference dividend and the final ordinary dividend of 16c per
share were paid. These dividends had both been determined (i.e.
proposed but not declared) on 30 June 2016 from retained earnings.
Oct. 20 The preference shares were redeemed out of retained earnings at a
5% premium.
25 Cheques were issued to the preference shareholders.
Nov. 1 A 1-for-5 renounceable rights offer was made to ordinary ‘A’
shareholders at an issue price of $1.90 per share. The offer’s expiry
date was 30 November 2016. The issue was underwritten at a
commission of $3000.
30 Holders of 320 000 shares accepted the rights offer, with other rights
being renounced to the underwriter. Ordinary ‘A’ shares were issued
and money received.
Dec. 20 The underwriting commission was paid.
2017
Jan. 10 The directors transferred $35 000 from retained earnings to a general
reserve.
Feb. 28 As a result of options being exercised, 70 000 ordinary ‘C’ shares
were issued.
April 30 Unexercised options lapsed.
May 31 The final call, due by 31 May 2017, was made on the partly paid
shares.
June 18 All call money was received by this date, except for that due on
15 000 shares.
26 The shares on which the final call was unpaid were forfeited.
27 The forfeited shares were reissued, credited as paid to $2, for $1.80
cash per share. The balance of the Forfeited Shares account will be
refunded to the former shareholders on 27 June. Paid refund to
former holders of forfeited shares.
28 The directors determined a 20c per share final dividend out of

retained earnings to be payable on 15 September 2017.

Sept. 15 Final dividend paid.
Required
Prepare general journal entries to record the above transactions.
2016
Sept 15 Retained Earnings/Dividend Paid– Ordinary Dr 92 800
Retained Earnings/Dividend Paid– Preference Dr 4 500
Cash 97 300
(Recognition and payment of ordinary
dividend [400 000 x 16c +300 000 x 16c x 3/5
= $92 800] and preference dividend [$75 000
x 6%])
Oct 20 Share Capital – Preference Dr 75 000

Retained Earnings/Redemption Premium Dr 3 750
(75 000 x 5%)
Shareholders’ Redemption Cr 78 750
(Redemption of preference shares out of
profits)
Note: dividends do not accrue on the
preference shares
Retained Earnings/Transfer to Share Capital Dr 75 000

Share Capital – Ordinary Cr 75 000
(Retained earnings transferred to capital.
NOTE: no dividends will be paid on this
share capital)
Oct 25 Shareholders’ Redemption Dr 78 750

Cash Cr 78,750
(Payment of cash to redeem preference
shares)
Nov 30 Cash Dr 152 000

Share Capital – Ordinary ‘A’ Cr 152 000
(Renounceable rights issue)
[400 000/5 = 80 000 x 1.90]

Dec 20 Share Issue Costs (Share Capital) Dr 3 000

Cash Cr 3 000
(Payment of share issue costs)
2017
Jan 10 Retained Earnings/Transfer to reserve Dr 35 000
Feb 28 Cash Dr 126 000

Share Capital – Ordinary ‘C’ Cr 126 000
(Issue of shares to options holders)
[70 000 x $1.80]
Share Options Dr 24 000

Share Capital – Ord ‘C’ Cr 21 000
Lapsed Options Reserve Cr 3 000
(Transfer of options account, 35 000
exercised and 5 000 lapsed)
[70 000/2 = 35 000 x 60c = 21 000]
April 30 Call – Ordinary ‘B’ Dr 240 000

Share Capital – Ordinary ‘B’ Cr 240 000
Call of 80c per share on Ordinary B shares)
Calls in Advance (20 000 x 80c) Dr 16 000

Call – Ord ‘B’ Cr 16 000
(Transfer of calls in advance)
May 31 Cash Dr 212 000

Call – Ord ‘B’ Cr 212 000
(Cash received on call)
[(300 000 – 20 000 – 15 000) x 80c]
June 18 Share Capital – Ordinary ‘B’ Dr 30 000

Call – Ordinary ‘B’ Cr 12 000
Forfeited Shares Liability Cr 18 000
(Forfeiture of 15 000 Ordinary B shares)

26 Cash Dr 27 000
Forfeited Shares Liability Dr 3 000
Share Capital – Ordinary ‘B’ Cr 30 000
(Reissue of 15 000 shares paid to $2 for
payment of $1.80)
27 Forfeited Shares Liability Dr 15 000

Cash Cr 15 000
(Refund to former shareholders)
Sept 15 Retained Earnings/Dividend Paid Dr 170 000

Cash Cr 170 000
(Dividend recognised and paid)
[Workings from the entries above:
400 000 + 300 000 + 80 000 + 70 000
– 15 000 + 15 000= 850 000 x 20c]
Note: No entry for dividend on 28 June as not
declared (only determined).

Question 3.15 Financial statements

At 30 June 2017, the trial balance of Budapest Ltd was:
BUDAPEST LTD
Trial Balance
as at 30 June 2017
Debit $ Credit $
Bank loan 180 000
Consulting revenue 20 000
Cash 52 100
Inventory 300 000
Buildings 915 000
Equipment 425 000
Accumulated depreciation – equipment 48 100
Advertising expenses 57 050
Interest expense 16 400
Salaries and wages 255 000
Sales returns 79 000
Sales revenue 3 080 000
Doubtful debts expense 9 000
$4 222 150 $4 222 150
(a) The bank loan is to be repaid in three equal instalments payable on 1 July each year
commencing 1 July 2017. There is no intention of refinancing the loan.
(b) An interim dividend of $165 000 was paid during the year out of retained earnings.
(c) $75 000 was transferred from the revaluation surplus to retained earnings.
(d) A bonus share issue of 10 000 shares issued and paid to $4.00 was made in October
2017 from the general reserve.
(e) A final dividend of $195 000 has been declared at the end of the year (30 June 2017)

out of retained earnings.

Note (b) to (e) are already adjusted in the trial balance.
Required
A. Prepare the statement of profit or loss and other comprehensive income for Budapest
Ltd for the year ended 30 June 2017, with expenses classified by function.
B. Prepare the statement of changes in equity for the year ended 30 June 2017.
C. Prepare the statement of financial position for Budapest Ltd at 30 June 2017,
classifying assets and liabilities clearly into current and non-current categories.
A.
BUDAPEST LTD

For year ended 30 June 2017
Income:
Sales $3 080 000
Less sales returns 79 000 $3 001 000
Consulting revenue 20 000
Total revenues 3 027 000
Expenses:
Selling expenses
Advertising expenses 57 050
Salaries and wages 255 000
Total selling expenses 1 759 050
Financial expenses
Doubtful debts 9 000
Interest expense 16 400
25 400
Total expenses 2 125 050

B.
BUDAPEST LTD
Retained earnings:
Transfer from revaluation surplus 75 000
Interim dividend paid (165 000)
Final dividend declared (195 000)
Share capital:
Bonus share issue 40 000
Other reserves:
Revaluation surplus
Balance at 1 July 2016 121 000
General reserve
Balance at 1 July 2017 $ 85 000
Bonus share issue (40 000)

C.
BUDAPEST LTD
as at 30 June 2017
Current assets
Cash $52 100
Inventory 300 000
Less allowance doubtful debts (7 500) 234 000
Non-current assets
Buildings 915 000
Equipment 425 000
Total non-current assets 1 236 900
Total assets 1 823 000
Current liabilities
Bank loan 60 000
Non-current Liabilities
Bank loan 120 000
Net assets $1 298 500
Equity
Share capital $240 000
Total equity $1 298 500

Question 3.16 Equity transactions and adjustments,

statement of changes in equity
On 30 June 2016, the equity of Vienna Ltd consisted of:
25 000 ordinary shares, issued at $3, called to $2.50 $ 62 500

1500 ordinary shares, issued at $1.50, fully paid 2 250
Calls in arrears (1000 shares at 50c) (500 )
Total equity $ 116 250
The company has recognised a liability of $10 000 in relation to 5000 8% redeemable
preference shares, issued at $2 each and fully paid. These preference shares must be
redeemed at a 5% premium by 31 March 2017.
During the year ended 30 June 2017, the following events occurred:
1. By 31 July 2016, $300 of outstanding call money had been received.

2. On 7 August 2016 the directors forfeited those ordinary shares with calls still
outstanding. The company’s constitution provides that no refund is made to the
former shareholders.
3. On 17 September 2016, the final dividends (40c per share on ordinary shares and 8%
on preference shares) declared on 30 June 2016 were paid.
4. On 31 December 2016, an ordinary interim cash dividend of 30c per share was
declared and paid.
5. To fund the redemption of preference shares, on 16 January 2017 the directors issued
a prospectus offering 12 000 ordinary shares at an issue price of $2.80, payable 70c on
application, $1.40 on allotment, and 70c on a future call. The closing date for
applications was 15 February 2017. The issue was underwritten by UBeaut Ltd for a
fee of $1600, payable on 23 February 2017.
6. By 15 February 2017, applications had been received for 15 000 shares, with
applicants for 3000 shares having paid the full issue price.
7. On 25 February 2017, the directors allotted 3000 shares to those applicants who had
paid the full issue price per share, and 9000 shares to other applicants on a first-come
first-served basis. The company’s constitution allows excess application money to be
retained and used to offset other money payable. By 15 March 2017, all allotment
money had been received.
8. On 31 March 2017, the preference shares were redeemed, and cheques were sent to
preference shareholders on 4 April 2017.
9. Profit for the year was $3625. On 30 June 2017, the directors decided to:
• transfer the general reserve balance to retained earnings
• make a 1-for-6 bonus issue in lieu of a final cash dividend; the bonus shares were
issued on 30 June 2017, valued at $2.70 each.
Required
A. Prepare general journal entries (including any closing entries) to record the above
events.
B. Prepare a statement of changes in equity as at 30 June 2017.

A.
VIENNA LTD
General journal
2016
July 31 Cash Dr 300
Call Cr 300
(Receipt of call monies)
Aug 7 Share Capital Dr 1 000

Call Cr 200
Forfeited Shares Reserve Cr 800
(Forfeiture of 400 shares)
Sept 17 Preference Dividend Payable Dr 800

Ordinary Dividend Payable Dr 10 600
Cash Cr 11 400
(Payment of final ordinary and
preference dividend)
Dec 31 Retained Earnings /Dividend Paid Dr 7 830

Cash Cr 7 830
(Ordinary interim dividend paid
[26 500 – 400 = 26 100] x 30c)
2017
Feb 15 Cash Trust Dr 16 800
Application Cr 16 800
(Application monies received)
[3 000 x $2.80] + [12 000 x 70c]
Feb 23 Share Issue Costs (Share Capital) Dr 1 600

Cash Cr 1 600
(Payment of underwriting commission)
Feb 25 Application Dr 8 400

Allotment Dr 16 800
(Issue of 12 000 ordinary shares with
$1.40 due on allotment)
Application Dr 2 100
Cash Dr 14 700
Cash Trust Cr 16 800

(Refund to unsuccessful applicants

[3000 x 70c] and transfer of
balance of cash)
Application Dr 6 300
Allotment Cr 4 200
Calls in Advance Cr 2 100
(Transfer of excess application monies)
Mar 15 Cash Dr 12 600

Allotment Cr 12 600
(Receipt of balance of allotment monies)
Mar 31 Preference Share Liability Dr 10 000

Redemption Premium Exp. (10 000 x 5%) Dr 500
Shareholders’ Redemption Cr 10 500
(Redemption of preference shares liability
at a 5% premium out of profits)
Note: Interest up to 31 March has not been recognised on these preference shares. It could be
assumed that the premium on redemption is effectively interest expense. Alternatively,
interest of 8% for 9 months (= $600) could be recognised separately from the redemption
expense.
Mar 31 Retained Earnings/T’fer to Share Capital Dr 10 000

(Transfer to share capital as required
by ASIC Regulatory Guide 68)
April 4 Shareholders’ Redemption Dr 10 500

Cash Cr 10 500
(Payment to preference shareholders)
June 30 Profit or Loss Summary Dr 3 625

General Reserve Dr 12 500
(Transfer of profit and
transfer from general reserve)
Retained Earnings/Bonus Issue Dr 17 145

(Issue of 6 350 ordinary shares
under a 1-for-6 bonus issue)
[38 100 shares/6 x $2.70]

B.
VIENNA LTD

Retained earnings:
Ordinary dividend paid (7 830)
Bonus share issue (17 145)
Transfer to share capital (10 000)
Share capital:
Receipt of calls in arrears 300
Forfeiture of shares [1000 – 200] (800)
Share issue costs (1 600)
Issue of ordinary shares 25 200
Calls in advance 2 100
Transfer from retained earnings (redemption of
pref. share liability) 10 000
Other reserves:
Forfeited shares
Balance at 1 July 2016 0
Forfeiture of shares 800
Balance at 30 June 2017 800
General
Balance at 30 June 2017 $ 0


The unadjusted trial balance of Pretoria Ltd at 30 June 2016 contained the following
information:
PRETORIA LTD
Unadjusted Trial Balance
as at 30 June 2016
Debit Credit
Sales $ 624 000
Sales returns $ 1 080
Advertising expense 18 000
Sales salaries 72 000
Administrative salaries 75 000
Office expenses 15 900
Rent expense 19 600
Vehicle running expenses 2 000
Debenture interest expense 1 170
Bad debt expense 2 340
Motor vehicles 70 000
Accumulated depreciation – motor vehicles 20 000
Fixtures and fittings (cost) 26 000
Accumulated depreciation – fixtures and fittings 12 000
Allowance for doubtful debts
Debenture interest received 1 650
Retained earnings 360
Share capital (80 000 shares issued at $2 each) 18 600
160 000
7% debentures 18 000
Trade creditors 22 000
Loan payable to bank 14 000
Patents 30 000
8% debentures in Prague Ltd 9 000
Trade debtors 71 000
Bills receivable 5 400
Cash at bank 203 200
Share issue costs 3 600
$ 890 610 $ 890 610
(Unless otherwise indicated you will need to make adjustments for the following
events/transactions).
(a) The 8% debentures in Prague Ltd were held throughout the year, and the full
interest entitlement for the year has not been received. Likewise, there is interest to
be accrued on the debenture liability for the year.
(b) An interim dividend of $16 000 has been paid during the year out of retained
earnings. (Hint: This is already adjusted in the trial balance).
(c) Depreciation of motor vehicles and fixtures and fittings is to be provided at the rates

of 20% and 15% straight-line respectively for the year. Patents were not amortised
by the company.
(d) The allowance for doubtful debts is to be increased to $3600.
(e) ON 30 June 2016, a final dividend of 10c per share has been declared from retained
earnings.
(f) Income tax expense for the year is estimated to be $72 000.
(g) On 30 June 2016, the directors decided to set aside (i) $10 000 to provide for the
enhanced cost of replacing fixtures and fittings and (ii) $5000 for the redemption of
debentures.
(h) The debentures are due for redemption in 3 years.
Required
A. Prepare a statement of profit or loss and other comprehensive income for the year
ended 30 June 2016.
B. Prepare the Retained Earnings account for the year ended 30 June 2016.
C. Prepare a statement of financial position for the company as at 30 June 2016.
A.
Income:
Sales $624 000
Less sales returns 1 080 $622 920
Debenture interest revenue* 720
Total revenues 623 640
Expenses:
Selling expenses
Advertising 18 000
Sales salaries 72 000
Administrative salaries 75 000
Office expenses 15 900
Vehicle running expenses 2 000
Depreciation of furniture & fittings* 3 900
Depreciation of motor vehicles* 14 000
Financial expenses
Interest expense on debentures* 1 260
Rent expense 19 600
Bad debts* 4 290
Net profit before income tax 132 370
Profit for the year 60 370

*Workings for parts A and B (in general journal format)

(a) Interest Receivable Dr 360
Debenture Interest Received (revenue) Cr 360
(8% of $9 000 = $720 – 360)
Debenture Interest Expense Dr 90

Interest Payable Cr 90
(7% of $18 000 = $1 260 – 1 170 = 90)
(b) Interim dividend paid has already been debited to retained earnings as there is no separate
account in the trial balance; hence, the beginning balance of retained earnings = $18 600 +
$16 000 = $34 600
(c) Depreciation Expense – Motor Vehicles Dr 14 000

Depreciation Expense – Furniture & Fitts. Dr 3 900
Accumulated Depreciation – Vehicles Cr 14 000
Accumulated Depreciation – F & E Cr 3 900
(20% of $70 000 and 15% of $26 000)
(d) Bad Debts Expense Dr 1 950

Allowance for Doubtful Debts Cr 1 950
($3 600 - $1 650)
(e) Retained Earnings/Dividend Declared Dr 8 000

(f) Income Tax Expense Dr 72 000

(g) Retained Earnings/Transfer to reserves Dr 15 000

Plant Replacement Reserve Cr 10 000
Debenture Redemption Reserve Cr 5 000

B.
Retained Earnings
-/-/16 Dividend – interim 16 000 1/07/15 Opening balance 34 600
30/6/16
Dividend payable– 8 000 30/06/16 P or L Summary 60 370
final
Transfer to plant 10 000
replacement reserve
Transfer to deb.
redemption reserve 5 000
30/06/16 Balance c/d 55 970
94 970 94 970
1/7/16 Balance b/d 55 970

C.
PRETORIA LTD
as at 30 June 2016
Current assets
Cash $203 200
Trade debtors $71 000
Allowance for doubtful debts 3 600 67 400
Interest receivable 360
Bills receivable 5 400
Non-current assets
8% debentures in Prague Ltd 9 000
Motor vehicles 70 000
Furniture and fittings 26 000
Patents 30 000
Current liabilities
Trade creditors 22 000
Debenture interest payable 90
7% debentures 18 000
Loan payable to bank 14 000
Net assets $227 370
Equity
Share capital
80 000 ordinary shares issued at $2 160 000
Less, Share issue costs 3 600 156 400
Other reserves:
Debenture redemption reserve 5 000 15 000


The following unadjusted trial balance is for the year ended 30 June 2017:
SINGAPORE LTD
Unadjusted Trial Balance
as at 30 June 2017
Debit Credit
Bank overdraft $ 178 050
Vehicle rental expenses $ 72 000
Cash at bank 7 500
Investment in government bonds 150 000
Goodwill 24 000
Insurance expense 3 000
Land 230 000
Buildings 1 000 000
Office furniture and equipment 127 000
Retained earnings (1/7/16) 83 000
Accumulated depreciation – office furniture and 23 000
equipment
Sales returns and allowances 8 700
Sales 478 120
Inventory 106 000
Share capital (called to $1 per share) 1 140 000
Interest expense on overdraft 11 300
Discount received 11 250
Discount allowed 12 000
Fees revenue 17 900
Proceeds on sale of furniture 13 000
Carrying amount of furniture sold 5 000
Salaries of sales staff 60 000
Administrative wages 68 620
Calls in arrears (25c per share) 2 000
Calls in advance (25c per share) 6 000
Interest expense on mortgage 4 500
$ 2 326 720 $ 2 326 720
(a) Singapore Ltd is involved in the computer services industry. Leased vehicles are
used mainly for delivery and service of computers. The company’s head office, which

houses its administrative staff, is located on a prime piece of real estate in the local
township.
(b) The following adjustments are required before preparation of Singapore Ltd’s
financial statements for the year:
(i) Depreciation to be provided on a straight-line basis on buildings at 5% p.a. and
on office furniture and equipment at 10% p.a. The sale of office furniture
occurred at the beginning of the current financial year.
(ii) Goodwill is considered not to be impaired.
(iii) Management was informed that a particular debtor had become bankrupt and
the full account of $12 000 needs to be written off.
(iv) The Allowance for Doubtful Debts account needs to be adjusted to 8% of
accounts receivable, after considering the adjustment in item iii above.
(v) Current income tax expense (and tax liability) for the year is estimated to be
$8000.
(vi) Accrued wages to staff: sales $1500, administrative $2000.
(vii) Vehicle rental paid in advance at 30 June 2017 amounted to $30 000.
(viii) Shares with calls in arrears are to be forfeited, any reserve being retained by
the company.
(ix) A dividend of 3c per share is declared on shares remaining after considering
item viii.
(x) Land is to be revalued upwards to its fair value of $250 000.
(xi) Transfer $10 000 from the general reserve to retained earnings.
Required
A. Prepare the journal entries (in general journal form) required by items i to xi above.
B. Prepare the adjusted trial balance as at 30 June 2017.
C. Prepare the statement of profit or loss and other comprehensive income with
expenses classified by function for Singapore Ltd for the year ended 30 June 2017.
D. Prepare the statement of changes in equity for the year.
E. Prepare the company’s statement of financial position as at 30 June 2017.
A.
General Journal
2017
June 30 Depreciation Expense – Buildings Dr 50 000
Accumulated Depreciation – Buildings Cr 50 000
30 Depreciation Expense – Furniture & Equip. Dr 12 700

Accumulated Depreciation – F & E Cr 12 700
30 Allowance for Doubtful Debts Dr 12 000

Accounts Receivable Cr 12 000
(Bad debts written off)
30 Bad Debts Expense Dr 14 372

Allowance for Doubtful Debts Cr 14 372

(Recognition of allowance at 8%
of receivables)
8% x (225 400 – 12 000) – (14 700 – 12 000)
30 Income Tax Expense Dr 8 000

(Income tax expense)
30 Salaries Expense – Sales Staff Dr 1 500

Wages & Salaries Payable Cr 1 500
(Accrued salaries of sales staff)
30 Administrative Wages Expense Dr 2 000

Wages & Salaries Payable Cr 2 000
(Accrued wages of admin. staff)
30 Prepaid Rent Dr 30 000

Vehicle Rental Expense Cr 30 000
(Rent prepaid)
30 Share Capital Dr 8 000

Call Cr 2 000
Forfeited Shares Reserve Cr 6 000
(Forfeiture of 8 000 shares)
30 Retained Earnings/Dividend Declared Dr 33 960

(Dividend of 3c on 1 132 000 shares)
June 30 Land Dr 20 000

Gain on revaluation of land (OCI) Cr 20 000
(Recognition of other comprehensive income on revaluation of land)
30 Gain on revaluation of land (OCI) Dr 20 000

Revaluation Surplus Cr 20 000
(Transfer to revaluation surplus)
30 General Reserve Dr 10 000

Retained Earnings/Transfer from Reserve Cr 10 000
(Transfer from general reserve)

B.
SINGAPORE LTD
Adjusted Trial Balance
as at 30 June 2017
DEBIT CREDIT
$ $
Vehicle rental expenses 42 000
Cash at bank 7 500
Investment in government bonds 150 000
Goodwill 24 000
Land 250 000
Buildings 1 000 000
Office furniture & equipment 127 000
Accumulated depreciation – office furn & equip 35 700
Accumulated depreciation- buildings 150 000
Sales returns and allowances 8 700
Sales 478 120
Inventory 106 000
Share capital (called to $1 per share) 1 132 000
Fees revenue 17 900
Salaries of sales staff 61 500
Calls in advance (25 cents per share) 6 000
Depreciation expense – buildings 50 000
Depreciation expense - furniture & equipment 12 700
Bad debts expense 14 372
Wages & salaries payable 3 500
Prepaid rent 30 000
Forfeited shares reserve 6 000
2 421 292 2 421 292

C.
SINGAPORE LTD
Income:
Sales $478 120
Less sales returns 8 700 $469 420
Fees revenue 17 900
Total income 516 370
Expenses:
Selling expenses
Advertising 12 300
Vehicle rent 42 000
Sales staff salaries 61 500
Depreciation of furniture & equipment 12 700
Depreciation of buildings 50 000
Financial expenses
Bad debts 14 372
Net profit before income tax 19 678
Other comprehensive income 20 000

D.
SINGAPORE LTD
Retained earnings:
Profit 11 678
Dividend declared - final (33 960)
Share capital:
Balance at 1 July 2016 $1 144 000
Shares forfeited (6 000)
Balance at 30 June 2017 $1 138 000
Other reserves:
General reserve
Revaluation surplus
Balance at 1 July 2016 $ 15 000
Revaluation of land 20 000
Forfeited shares reserve
Balance at 1 July 2016 $ 0
Forfeiture of shares 6 000

E.
SINGAPORE LTD
as at 30 June 2017
Current assets
Cash at bank $7 500
Accounts receivable $213 400
Allowance for doubtful debts (17 072) 196 328
Inventory 106 000
Prepaid rent 30 000
Non-current assets
Government bonds 150 000
Land 250 000
Buildings 1 000 000
Office furniture and equipment 127 000
Goodwill 24 000
Total non-current assets 1 365 300
Total assets 1 705 128
Current liabilities
Wages and salaries payable 3 500
Net assets $1 257 718
Equity
Share capital
1 132 000 ordinary shares issued and paid to $1 1 132 000
Plus, calls in advance 6 000
1 138 000
Forfeited shares reserve 6 000
Total equity $1 257 718

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Solutions Manual

Company Accounting 10e

© John Wiley & Sons Australia, Ltd 2015

Chapter 3: Company operations

© John Wiley and Sons Australia, Ltd 2015 3.1

3. What are the essential characteristics of a liability? When should liabilities be

The Conceptual Framework (4.4.b/49.b) defines a liability as:

Discussed further as below: Essential characteristics of liability are:

© John Wiley and Sons Australia, Ltd 2015 3.2

4. What are the essential characteristics of equity?

Equity is defined in the Conceptual Framework (paragraph 4.4/49(c)), as ‘the residual

© John Wiley and Sons Australia, Ltd 2015 3.3

Recognition is outlined in the Conceptual Framework (4.37/ 82):

An item that meets the definition of an element should be recognised if:

© John Wiley and Sons Australia, Ltd 2015 3.4

Assets classified as non-current in accordance with AASB 101 Presentation of Financial

8. Distinguish between current and non-current liabilities. Can a liability, which

© John Wiley and Sons Australia, Ltd 2015 3.5

Income is defined at paragraph 4.25/70 of the Conceptual Framework as meaning increases

Specific standards provide guidance or place restrictions on the recognition of revenues.

© John Wiley and Sons Australia, Ltd 2015 3.6

Expenses are defined at paragraph 4.25/70(b) of the Conceptual Framework as decreases in

© John Wiley and Sons Australia, Ltd 2015 3.7

13. What factors determine the selection of accounting policies?

© John Wiley and Sons Australia, Ltd 2015 3.8

 the change is required by an accounting standard

© John Wiley and Sons Australia, Ltd 2015 3.9

© John Wiley and Sons Australia, Ltd 2015 3.10

Assets are defined in the Conceptual Framework, (para. 4.4/49(a)) as ‘a resource

© John Wiley and Sons Australia, Ltd 2015 3.11

Case Study 2 Liabilities and recognition

A. AASB 137 defines a provision as:

© John Wiley and Sons Australia, Ltd 2015 3.12

Case Study 3 Reserves

© John Wiley and Sons Australia, Ltd 2015 3.13

Case Study 4 Reserves and cash

During the month ending 31 August 2017 the following occurred:

A. Profit for the month is:

© John Wiley and Sons Australia, Ltd 2015 3.14

B. The balances are:

C. The balance of cash is:

D. This case shows:

© John Wiley and Sons Australia, Ltd 2015 3.15

Case Study 5 Accounting policies

A. Currently, there is no Australian accounting standard to provide accounting policies or

B. AASB 108, paragraph 10 states that, in the absence of an Australian accounting

© John Wiley and Sons Australia, Ltd 2015 3.16

Case Study 6 Accounting policies

© John Wiley and Sons Australia, Ltd 2015 3.17

Prepare general journal entries to record the following unrelated transactions of a

1. Payment of an interim dividend of $200 000 (in cash).

1. Retained Earnings/Interim Dividend Dr 200 000

2. Retained Earnings/ Dividend Declared Dr 420 000

3. Revaluation Surplus Dr 65 000

4. Retained Earnings/ T’fer to Reserve Dr 120 000

5. General Reserve Dr 300 000

© John Wiley and Sons Australia, Ltd 2015 3.18

Question 3.2 Dividends

1. On 27 September 2014, following approval and declaration at the AGM a final

24 Sept Retained Earnings/Final Dividend Dr 180 000

© John Wiley and Sons Australia, Ltd 2015 3.19

Question 3.3 Dividends

2 July Retained Earnings/Final Dividend Declared Dr 41 000