ACC/ACF3100 Semester 2, 2016 Final Exam Solutions

Question 1
a)
Lobbying is the action by those affected by accounting standards to place pressure on the
standard setters to effect change in order to achieve a favourable outcome (1%).

In terms of the of standard setting process views can be expressed and considered, through
such mechanisms as providing feedback on exposure drafts (1%), writing submissions to
standard setters either directly (1%) or through related bodies such as accounting
professional bodies etc. (1%)

b) i)
Acquired patent is recognised as an asset at cost (0.5%) since it is externally
acquired identifiable/separable (0.5%)
No active market, revaluation not permitted (0.5%)
Amortized over 6 years (straight line) (0.5%) based on managements best
estimate (0.5%)
Subject to impairment testing (0.5%)
b) ii)
Goodwill acquired in the business combination (0.5%) is recognised as an asset
at cost (=Acquisition cost less FV of net asset of acquired entity) (0.5%) since
it is acquired through business combination identifiable/separable (0.5%)
No active market, revaluation not permitted (0.5%)
Not amortized (assumed to have an indefinite life) (0.5%)
Subject to impairment testing (0.5%)

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Question 2
a) The horizon problem exists because managers and owners have differing time horizons in
relation to the entity. Shareholders have an interest in the long-term growth and value of the
entity as the share value of the entity today reflects the present value of the expected future
cash flows over the long-term. Shareholders prefer managers to undertake long-term projects
to ensure future growth of the firm. (1.5%)

Managers, on the other hand, are interested in the cash flow potential only as long as they
expect to be employed by the entity. Managers tend to focus on maximizing short-term
profitability to show evidence as effective management. (1.5%)

Linking bonuses to share price movement (1%) or giving managers shares and options (1%)
can mitigate the horizon problem, as managers are motivated to take long-term projects.
b) i)
If students get the right answer, reward 3 marks directly. Otherwise, the breakdown
of marks:

Percentage of completion in 2016 (1%)

= costs incurred to date/estimated total costs
=(5+6)/15
= 73.33%

Revenue to date (0.5%)

=$18m*0.7333
=$13.2m

Billings to date (0.5%)

=$4m+$4.8m
=$8.8m

CIP (1%)
= Revenue to date Billings to date
=$13.2m-$8.8m
=$4.4m

b) ii)
$4.8m-$4.4m =$0.4m (2%)
[Total = 5 + (3 + 2) = 10 marks]

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Question 3
a)
Present value of principal discounted at 4 per cent:
$5 000 000 x 0.8890 = $4,445,000

Present value of interest stream discounted at 4 per cent:

$100 000 x 2.7751 = $277,510

Total present value $4,722,510

Equity component $277,490
Total face value of convertible bonds
$5,000,000
1 July 2016
Dr Cash at bank 5,000,000 (1%)
Cr Convertible bonds liability 4,722,510 (1%)
Cr Convertible bonds option 277,490 (1%)
(equity)
(To record the issue of the convertible bonds and the recognition of the liability
and equity components.)

b)
30 June 2017
Dr Interest expense 188,900 (1%)
Cr Cash 100,000 (1 %)
Cr Convertible bonds liability 88,900 (1%)
(To recognise the interest expense)

Date Payment Interest expense Bond liability

1 July 2016 4,722,510
30 June 2017 100 000 188,900 4,811,410
30 June 2018 100 000 192,456 4,903,866
30 June 2019 100 000 196,155 5,000,000*
*rounding error

c)
Dr Convertible bonds liability 5,000,000 (1%)
Cr Bank 5,000,000 (1%)

Dr Convertible bonds option (equity) 277,490 (1%)

Cr Retained earnings 277,490 (1%)
(To record the redemption of bonds due to non-conversion at maturity)
(Total = 3 + 3 + 4 = 10 marks)

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Question 4
a)
Derivative financial instrument - Instrument that creates rights and obligations with
effect of transferring one or more of the financial risks inherent in an underlying
primary financial instrument (1%)
Example: Share option, currency swap, currency option, forward contract (1% for
any one of these mentioned)
Key aspects of derivatives (1% each for any two of the following max 2%)
Derivatives are contracts between buyers and sellers.
A derivative financial instrument derives its value from the value of some
other financial asset or variable.
The price of a derivative rises and falls in accordance with the value of the
underlying asset.
Generally, payoff is determined or made at the expiration date, although this is
not true in all cases.
Sometimes no money is exchanged at the beginning of the contract.
Derivatives are designed to offer a return that mirrors the payoff offered by the
instruments on which they are based.

b)
Gains/losses on the hedged item are calculated as follows:

Date Spot rate Firm Foreign

commitment/forecast exchange
transaction in $A gain/(loss)
1 March 2016 A$1.00 = US$0.81 - -
1 April 2016 A$1.00 = US$0.80 1,250,000 -
30 June 2016 A$1.00 = US$0.76 1,315,789 (65,789)
15 July 2016 A$1.00 = US$0.81 1,234,568 81,221
Note: the purchase is not recognised until such time as the inventory was shipped on 1
April 2016 however the firm commitment is made on 1 March 2016.

Gains/losses on the hedging instrument (the forward rate contract) are calculated as
follows:

Date Forward Receivable Fixed Amount Gain/(loss) on

rate from bank on payable to bank in $A forward contract
forward on forward contract with bank
contract
1 March 2016 0.83 1,204,819 1,204,819
1 April 2016 0.82 1,219,512 1,204,819 14,693
30 June 2016 0.78 1,282,051 1,204,819 62,539
15 July 2016 0.81 1,234,568 1,204,819 (47,483)

1 March 2016
No entry is required here as the fair value of the forward rate agreement is assessed as
being zero (1%) given that the fair value of the foreign currency receivable is the same
as the fair value of the commitment, both being $1,204,819.

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1 April 2016
Dr Forward contract (asset) 14,693 (0.5%)
Cr Hedge reserve (other comprehensive income) 14,693 (0.5%)
(To recognise the gain on the forward contract temporarily in OCI)

Dr Inventory 1,250,000 (0.5%)

Cr Accounts payable 1,250,000 (0.5%)
(To recognise the acquisition of inventory using the relevant spot rate)

Dr Hedge reserve (in other comprehensive income) 14,693 (0.5%)

Cr Gain on forward contract (P&L) or Inventory 14,693 (0.5%)
(To reclassify the cumulative gain on the forward contract up to the date of
inventory acquisition in P&L/inventory)

30 June 2016
Test for hedge effectiveness
65,789/62,539 = 105% - hedge is effective therefore continue hedge accounting (1%)

Dr Forward contract 62,539 (0.5%)

Cr Gain on forward contract 62,539 (0.5%)
(To recognise the gain on forward contract)

Dr Foreign currency loss 65,789 (0.5%)

Cr Accounts payable 65,789 (0.5%)
(To recognise the foreign exchange loss on the account payable to supplier)

15 July 2016
Dr Loss on forward contract 47,483 (0.5%)
Cr Forward rate contract 47,483 (0.5%)
(To recognise the loss on forward contract)

Dr Accounts payable 81,221 (0.5%)

Cr Foreign currency gain 81,221 (0.5%)
(To recognise the foreign exchange gain on the account payable to supplier)

Dr Accounts payable 1,234,568 (0.5%)

Cr Forward rate contract 29,749 (1%)
Cr Cash at bank 1,204,819 (0.5%)
(To settle accounts payable.)

0.5% for dates and 0.5% for narrations

Note: if students approached from an opposite underlying position i.e., Account

Receivable as their hedged item, the maximum marks they can get for this
question is 7/12.

Note: Consequential marks need to be rewarded if students started calculating

Account Payable on 1 March 2016. Suggestion: Perhaps in this case, the
maximum marks they can get for this question is 9/12.
(Total = 4 + 12 = 16 marks)

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Question 5 Old Leases standard AASB117 applied
a)
This is a finance lease (0.5%) because ownership risks and rewards have been
substantially transferred from the lessor to the lessee (0.5%).

1% for any of the following (Max 3%)

The present value of minimum lease payments is (substantially) all of the fair
value of the asset i.e. $129,247/ $129,247= 100% (>90%).
*PV of MLP = (32500-2500)*(1-1/1.15)/0.1 (or factor=3.7908) + 25,000*1/1.15
(or factor=0.6209) =$129,247
The lease is non-cancellable.
High possibility of transfer of ownership to lessee at the end of lease term
Bargain purchase option.
Leased assets appear to be of a specialised nature making them only useful to
the lessee
The lease term of 5 years, being equal to 83% (=5/6) of the equipments
estimated economic life of 6 years, indicates that the lease term is fairly for the
major part of the economic life of the asset (> 75%).
b)
1 July 2015
Dr COGS (0.5%) $100,000 (0.5%)
Cr Inventory (0.5%) $100,000 (0.5%)
(To record cost of equipment (inventory) at cost)

Dr Lease Receivable (0.5%) $129,247 (0.5%)

Cr Sales (0.5%) $129,247 (0.5%)
(To record sale and lease receivable at FV)

30 June 2016
Dr Cash (0.5%) $32,500 (0.5%)
Cr Executory Cost Reimbursement* $2,500 (0.5%)
(*Revenue used to offset expense) (0.5%)

Cr Interest Revenue (0.5%) $129,247*0.1= $12,924 (0.5%)

Cr Lease Receivable (0.5%) $32,500-$2,500-$12,924 = $17,067
(0.5%, allows for consequential)
(To record lease receipt)

Complete date 0.5% and narration 0.5%

(Total = 4 + 9 = 13 marks)

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Question 6
a) i)
2% for any of the following (Max 2%):
Earnings quality affects shareholders ability to assess stewardship (managerial
accountability) and a firms future prospects.
Earnings quality reflects how current earnings map into future earnings. It
indicates the persistence of future cash flows and hence returns (dividends) to
shareholders.
Distorted earnings cause adverse selection and impair shareholders resource
allocation decision (pricing or trading).
a) ii)
1% for each of the following for accrual earnings management (Max 2%):
Allows entities to delay or accelerate recognition of income and expense and
enables entity to temporarily adjust profit figures
No direct cash flow consequences
E.g., recalculating impairment of accounts receivables (provisioning for bad
debts), delaying asset impairment, adjusting inventory valuations, amending
depreciation and amortization estimates, including expected useful life and
residual values.
Can be regulated auditor and regulators can challenge accrual assumptions.
1% for each of the following for real earnings management (Max 2%):
Change the timing or structuring of an operation, investment, and or financing
transaction in an effort to influence the output of the accounting system.
Direct cash flow consequences.
E.g., discretionary spending on research and development or advertising,
offering price discounts to maximize sales towards the end of an accounting
period.
Can reduce entity value because actions taken in the current period to increase
earnings can have negative effects on cash flows in later periods.
Cannot be regulated- auditors and regulators cannot question a firms real
business decisions.

b)
When choosing whether to expense or capitalise an item managers need to make
judgements in a number of circumstances. One example is whether research and
development expenditure is likely to lead to future economic benefits (1%).

When making expensing-capitalisation choices managers are likely to take into account
what the management team want the bottom line profit or net assets to be (1%).

It can affect executive bonus payments (0.5%) and likelihood of defaulting on loans
(0.5%). Students may also provide a number of other reasonable examples.

c) Not Applicable
[Total = (2 + 4) + 3 + 3 = 12 marks]

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Question 7
a) Accept any two of the following: 1% each point to a maximum of 2
Normative accounting theories (NATs) are prescriptive since they provide
recommendation and guidance in accounting practice and financial reporting which
may or may not be adopted by practitioners in the field.
NATs attempt to prescribe what information ought to be communicated and how it
ought to be presented. In other words, NATs attempt to explain what accounting
"should be" rather than what accounting "is".
NATs are not based on real world observations and are therefore more
subjective/value-laden.
NATs cannot be tested. One can only agree or disagree with normative accounting
theories.
1% for identifying the example + 1% for illustrating NAT with the example
An example to NATs is the Conceptual Framework. The Conceptual Framework
prescribes the objectives of financial reports and the qualitative characteristics of
accounting information. The Conceptual Framework suggests relevance and faithful
representation as two fundamental qualitative characteristics of information, this is
subjective and one can challenge that other notion such as comparability should take
precedence.

Alternatively students can discuss ethical branch of stakeholder theory. Financial

reporting should provide information to all stakeholders for decision making. All
stakeholders ought to be treated fairly and equally in financial reporting regardless of
their power.

b)
Rational economic person is the underlying assumption of positive accounting theory.
(1%)

This assumption views that all individuals (be it shareholders, debtholders or managers)
are self-interested and rational parties who aim to maximize their own wealth. (1%)

For instance, self-interested managers have the incentives to maximize a companys

profit through creative accounting or capitalising rather than expensing an item in order
to receive greater remuneration. (2% for linking to financial reporting decision]

c)
The market approach uses prices and other relevant information generated by market
transactions involving identical or comparable items, for example quoted market prices.
(1%)

It would be more preferred because if an active market exists, the prices are determined
in a more objective manner (level 1 input) (1%) than other approaches by reducing
opportunistic or erroneous managerial assumptions, so are more easily verifiable. This
would increase the reliability/faithful representation of information. (1%)

Any one of the following or similar examples: equity securities (Shares), futures, treasury
notes (1%)
(Total = 4 + 4 + 4 = 12 marks)

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Question 8
Part A Not applicable
Part B
Each point 2%, mark generally based on the overall quality of discussion (Max 8%):
Accounting standards determine the recognition and measurement of accounting elements,
which influences a firms reported financial performance and position thus there are
economic consequences and wealth transfer.

Lobbying and equity in standard setting: Therefore, it often attracts lobbying from
powerful vested interests who are influenced by accounting standards. E.g.,
G100 successfully removed the mandatory status of SAC4.
The ASX fully supported the adoption of IFRS to boost its IPO success.
In the IASC international board meeting in 1992, the majority of delegations voted
to retain LIFO for tax purposes at the expense of the comparability of accounting
information.
Regulatory capture: Standards are set in the context of the values held by people around a
board table at any given time. They can prescribe specific accounting treatments, eliminate
alternative treatments, impose additional disclosure requirements, or tighten the allowed
interpretations. Standard setters may be captured by self-interested, powerful groups that
influence the standard setting process. E.g., Walker (1987) found that the Accounting
Standards Review Board (ASRB) was captured by accounting professions who influenced
the priority, procedures and outcomes of standard setting. The ASRB lost its independence
and control over standard setting, and was subsequently abolished and replaced by the
Australian Accounting Standards Board (AASB).

Stakeholders: Various stakeholders participate in standard setting, and they have

conflicting interests. There may be political motivations of individuals or organizations
advocating change to a standard setters due process. E.g., the EU and the IASB; the IASB
vs the FASB; why the area of interest method for EE in Australia rather than costs written
off and reinstated the economic significance and financing needs of extractive industries
in Australia.
(Total = 8 marks)

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Question 9
PART A
a)
Economically recoverable reserves refers to the estimated quantity of product in an area
of interest that can be expected to be profitably extracted, processed and sold under
current and foreseeable economic conditions. (2%)
b)
The importance of ERR disclosures:
Reserve disclosures reflect revenue of mining firms, investors will rely on such
information to revise their expectations about those firms future profitability and
cash flows (1%).
Reserve estimations involve complex assumptions and estimates that affect the
quality of information useful for decision making (1%).
c)
Factors influencing the extent of the ERR disclosure 2% for each of the following
(Max 4%)
Effective corporate governance: Ensure reserve-related risks are identified, assessed,
addressed and monitored to achieve organizational goals.
Foreign listing: Disclose more information about ERR to comply with the regulation
and listing rules in different jurisdictions so they can raise additional capital and
increase investment/business profile internationally.
Reserves in foreign jurisdictions: Disclose more information about ERR to comply
with legal, financial and operational requirements of the jurisdiction in which it
operates.
Pledging of reserves in debt covenants: Disclose more information about ERR so
that lenders can evaluate ERR which is pledged as security against borrowings.
Leverage: Disclose more information about ERR to reduce monitoring costs and
assure stakeholders that cash used to exploit reserves will generate future economic
benefits to discharge debt obligation.
External (big 4) auditor: Auditors, particularly Big 4 auditors with reputational
capital, require managers to disclose more information of ERR to assess the
appropriateness of assumptions and estimations.

d)
2% for any of the following contribution:
The study contributes to a better understanding of the extent and rationale behind the
reserves disclosure practices of Australian resource firms.
The study highlights that monitoring and contracting mechanisms enhance
disclosures of forward looking information about reserves in the annual report.
(Total =2 + 2 + 4 + 2 = 10 marks)

PART B Not applicable

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