BKAR1013 FINANCIAL ACCOUNTING AND REPORTING I (A171)

MINI CASE 1
CONCEPTUAL FRAMEWORK

QUESTION 1

Choose the best answer for the following questions:

(a) Which of the following statements about the Conceptual Framework is incorrect?
(i) The Conceptual Framework considers timeliness and materiality to be constraints
on relevant and faithfully represented information.
(ii) The Conceptual Framework states that the elements directly related to the
measurement of financial position are assets, liabilities and equity.
(iii) The Conceptual Framework applies to the financial statements of all commercial,
industrial and business reporting entities.
(iv) In accordance with the Conceptual Framework, income is recognized when an
increase in future economic benefits related to an increase in an asset or a
decrease in a liability has arisen that can be measured reliably.

(b) The Conceptual Framework enhancing qualitative characteristics include:

(i) Understandability, timeliness, verifiability and comparability.
(ii) Faithful representation, relevance, understandability and verifiability.
(iii) Comparability and reliability.
(iv) Substance over form and relevance.

(c) Which of the following statements about the Conceptual Framework’s definition of
expense is correct?
(i) Expenses include distribution to owners
(ii) Expenses are always in the form of outflows or depletions of assets.
(iii) Expenses exclude losses.
 (iv) Expenses are always decreases in economic benefits.

(d) In accordance with the Conceptual Framework, a lender should recognize the
forgiveness of its RM20,000 interest free-loan as:
(i) An increase in income and a decrease in a liability.
(ii) An increase in an expense and a decrease in an asset.
(iii) An increase in an asset and an increase in income.
(iv) An increase in an expense and a decrease in a liability.

Answers:
(a) (i) is incorrect. Materiality is not a constraint
(b) Only (i) is correct
(c) Only (iv) is correct
(d) (ii) is correct.

QUESTION 2

a. Jusa Bhd purchases a rental property for RM10,000,000 as an investment. The building
is fully rented and is in a prosperous area. At the end of the current year, the entity hires
an appraiser who reports that the fair value of the building is RM15,000,000 plus or
minus 10%. Depreciating the building over 50 years would reduce the carrying amount to
RM9,800,000.
(i) What are the relevance and faithful representation considerations in deciding how
to measure the building in the entity’s financial statements?

Suggested answer
a. Is the fair value relevant to stakeholders’ decisions? Whether the stakeholders care about
the fair value of the building should be considered.
Relevance
 Information in financial statements is relevant when it influences the economic decisions
of users. It can do that both by (a) helping them evaluate past, present, or future events
relating to an enterprise and by (b) confirming or correcting past evaluations they have
made.
 Materiality is a component of relevance. Information is material if its omission or
misstatement could influence the economic decisions of users.
 Timeliness is another component of relevance. To be useful, information must be
provided to users within the time period in which it is most likely to bear on their
decisions.

Reliability
 Information in financial statements is reliable if it is free from material error and bias
and can be depended upon by users to represent events and transactions faithfully.
Information is not reliable when it is purposely designed to influence users' decisions in a
particular direction.
 There is sometimes a tradeoff between relevance and reliability - and judgement is
required to provide the appropriate balance.
 Reliability is affected by the use of estimates and by uncertainties associated with items
recognised and measured in financial statements. These uncertainties are dealt with, in
part, by disclosure and, in part, by exercising prudence in preparing financial statements.
Prudence is the inclusion of a degree of caution in the exercise of the judgements needed
in making the estimates required under conditions of uncertainty, such that assets or
income are not overstated and liabilities or expenses are not understated. However,
prudence can only be exercised within the context of the other qualitative characteristics
in the Conceptual Framework, particularly relevance and the faithful representation of
transactions in financial statements. Prudence does not justify deliberate overstatement
of liabilities or expenses or deliberate understatement of assets or income, because the
financial statements would not be neutral and, therefore, not have the quality of
reliability.
b. Explain how you would account for the following items, justifying your answer by
reference to the definitions and recognition criteria in the Conceptual Framework. Also
state, where appropriate, which ledger accounts should be debited and credited.
(i) a. Your firm has been sued for negligence – likely you will lose the case.
b. Your firm has been sued for negligence – likely you will win the case.
(ii) Obsolete plant now retired from use.
(ii) Receipt of donation of RM10,000.

Suggested answer
(a)(i) Your firm has been sued for negligence – likely you will lose the case.
 The liability definition (para 49(b)) is met as all 3 characteristics are present.
o Past event: The act of negligence or the act of being sued.
o Present obligation: Para 60 states that an obligation is a duty or responsibility to
act or perform in a certain way. The key question here is whether there is a
present obligation. Does the lawsuit create a present obligation? Or will the
obligation only arise when a court decision against you is handed down? The
definition requires the existence of a present, not a future, obligation (para 61). I
believe that the lawsuit (arising from being sued) gives rise to a present
obligation.
o Settlement involves the outflow of economic benefits: If a present obligation is
accepted as existing, its settlement will involve the outflow of economic benefits,
namely cash.
 The liability recognition criteria (para 91) are met, as it is probable that an outflow of
economic benefits (cash) will result from settling the liability.
 The expense definition (para 70(b)) is met as all 3 characteristics are present.
o Decrease in economic benefits during the period: The loss represents a decrease
in economic benefits and you were sued during the period.
o In the form of a liability increase:
o Results in a decrease in equity: If liabilities increase and assets remain
unchanged, equity decreases.
(a)(ii) Your firm has been sued for negligence – likely you will win the case.
 The liability definition (para 49(b)) is met as all 3 characteristics are present. See
discussion in (b) (i) above.
 However, the liability probability recognition criterion (para 91) is failed, as it is not
probable that an outflow of economic benefits will result from settling the liability.
As you are likely to win the case, it is unlikely that you will have to pay damages.
 Therefore, the liability cannot be recognised. However, if material, the lawsuit should be
disclosed in the notes.

(b) Obsolete plant now retired from use.

 The asset definition is failed as the plant no longer represents future economic benefits
(para 49(a)).
 The plant must now be written off from the accounts.
 Recognition criteria are thus irrelevant, as there is no asset to recognise.

(c) Donation of RM10,000 cheque.

 The asset definition (para 49(a)) is met as all 3 characteristics are present.
o Past event: The receipt or clearance of the cheque.
o Flow of future economic benefits: The cheque represents an inflow of $10,000
cash into your firm.
o Control over the future economic benefits: Your firm will benefit from this
RM10,000 cash inflow and can deny or regulate the access of others to this cash
inflow.
 The asset recognition criteria (para 89) are met, as it is probable (actually, it is certain)
that an inflow of economic benefits (cash) will flow to the entity, and the amount
(RM10,000) can be reliably measured as it is known.
 Therefore, an asset of RM10,000 must be recognised.
 The income definition (para 70(a)) is met as all 3 characteristics are present.
o Increase in economic benefits during the period: The inflow of $10,000 cash
represents an increase in economic benefits, and you received and cleared the
cheque during this period.
 o In the form of an asset increase: See above asset discussion – you now have
additional cash of RM10,000.
o Results in an increase in equity: If assets increase and liabilities remain
unchanged, equity increases.
 The income recognition criteria (para 92) are met, as the increase in economic benefits
has arisen (as you now have additional cash), and the amount (RM10,000) is known.
 Therefore, income of RM10,000 must also be recognised.
 Note that in this case the recognition of an asset has resulted in the simultaneous
recognition of income (paras 84 and 92).
QUESTION 3

a. Hasnah Bhd operates a catering service specializing in business luncheons for large
corporations. Hasnah Bhd requires customers to place their orders 2 weeks in advance of
the scheduled events. Hasnah bills its customers on the tenth day of the month following
the date of service and requires that payment be made within 30 days of the billing date.
Conceptually, when should Hasnah Bhd recognised revenue related to its catering
service?

Suggested answer:
Revenues are recognized when a performance obligation is met. / The most common time
at which these two conditions are met is when the product or merchandise is delivered or
services are rendered to customers. / Therefore, revenue for Hasnah Bhd should be
recognized at the time the luncheon is served. /
(3/ x 0.1 =0.3)

b. Master Bhd paid RM135,000 for a machine. The accumulated depreciation account has a
balance of RM46,500 at the present time. The company could sell the machine today for
RM150,000. The company’s CEO believes that the company has a “right to this gain”.
What does the CEO mean by this statement? What do you think?

Suggested answer:
The president means that the “gain” should be recorded in the books./ This item should
not be entered in the accounts, however, because a reliable measurement of the revenue
is questionable. /
(2/ x 0.1 =0.2)

c. The financial director in the company for which you are an accountant has told you that
he has little use for accounting figures based on historical cost. He believes that fair
values are of far more significance to the board of directors than “out of dates”. Give
some arguments to convince him that accounting data should still be based on historical
costs.
 Suggested answer:
Some of the arguments which might be used are outlined below:
(1) Cost is definite and reliable; other values would have to be determined somewhat
arbitrarily and there would be considerable disagreement as to the amounts to be
used.
(2) Amounts determined by other bases would have to be revised frequently.
(3) Comparison with other companies is aided if cost is employed.
(4) The costs of obtaining fair values could outweigh the benefits derived.

QUESTION 4

A. Write an accounting equation.

B. What is the main rule relating to the total for this equation?
C. Show how the following transactions effect the equation?
1. Invest RM20,000 in cash
2. Pay rental RM500 in cash
3. Receive RM1500 cash for completing a job
4. Receive RM800 cash for a job that is yet to be carry out
5. Purchase inventory of RM600 on credit
D.. Journalise all the above transactions in (C).

Suggested answer:
A. Asset = Liability + Equity
B. Total on the left and total on the right has to be equal at all time
C. Asset = Liability + Equity
(1) 20,000 20,000
(2) (500) (500)
(3) 1,500 1,500
(4) 800 800
(5) 600 600 .
22,400 1,400 21,000

D. Cash 20,000
Capital 20,000

Rental Expenses 500

Cash 500
 Cash 1,500
Revenue 1,500

Cash 800
Unearned Revenue 800

Inventory 600
Account Payable 600

QUESTION 5

A partial adjusted trial balance of Satin Bhd at January 31, 2015, shows the following:

SATIN BHD
ADJUSTED TRIAL BALANCE
31-Jan-15
RM
Debit Credit
Supplies 900
Prepaid Insurance 2,400
Salaries and Wages Payable 800
Unearned Service Revenue 750
Supplies Expense 950
Insurance Expense 400
Salaries and Wages Expense 1,800
Service Revenue 2,000

Answer the following question:

(a) If the amount in Supplies Expense is the January 31 adjusting entries and RM850 of
supplies was purchased in January, what was the balance in Supplies on January 1?
(b) If the amount in Insurance Expense is the January 31 adjusting entry and the original
insurance premium was for one year, what was the total premium and when was the
policy purchased?
(c) If RM2700 of salaries and wages were paid in January, what was the balance in Salaries
and Wages Payable at December 31, 2014?
(d) If RM1,600 was received in January for services performed in January, what was the
balance in Unearned Service Revenue at December 31, 2014?
 Suggested answer:

(a) Ending balance of supplies............................................................. RM 900

Add: Adjusting entry ..................................................................... 950
Deduct: Purchases ......................................................................... 850
Beginning balance of supplies ....................................................... RM1,000

(b) Total prepaid insurance .................................................................. RM4,800 (RM400 X 12)

Amount used (6 X RM400) ............................................................ 2,400
Present balance ............................................................................... RM2,400

The policy was purchased six months ago (August 1, 2014)

(c) The entry in January to record salaries paid was

Salaries and Wages Expense ............................................................. 1,800

Salaries and Wages Payable .............................................................. 900
Cash ........................................................................................... 2,700

The “T” account for salaries and Wages payable is

Salaries and Wages Payable

Paid 900 Beg. Bal. ?
January
End Bal. 800

The beginning balance is therefore:

Ending balance of Salaries
and Wages Payable ..................................................................................
RM 800
Plus: Reduction of Salaries
 and Wages Payable .................................................................................. 900
Beginning balance of Salaries
and Wages Payable ..................................................................................
RM1,700

(d) Service revenue ................................................................... RM2,000

Cash received ...................................................................... 1,600
Unearned service revenue reduced...................................... RM 400

Ending Unearned revenue January 31, 2015................................................ RM 750

Plus: Unearned service revenue reduced...................................................... 400
Beginning unearned revenue December 31, 2014 ....................................... RM1,150