Solutions Manual for Contemporary Accounting 8th Edition By Mike Bazley, Phil Hancock by digitaldownload87

Solutions Manual for Contemporary Accounting 8th Edition By Mike Bazley, Phil Hancock

Contemporary Accounting 8e Mike Bazley, Phil Hancock (Solutions Manual All Chapters, 100% Original Verified, A+ Grade)

Chapter 1 Introduction to accounting Review questions 1 a

To help control the level of expenditure, to assist in planning future levels of expenditure, to help raise additional finance (e.g. mortgages, hire-purchase and so on) and to help decide the best way to spend their money. b To control the activities of the organisation, to plan future activities, to assist in raising finance and to report upon the activities and performance of the entity to interested parties. 2 Numerous examples are acceptable. Ideas such as exclusion of certain items (e.g. good reputation, brand names, technical know-how) and how accounting reflects the past can be used to provoke discussion.

Problems for discussion and analysis 1 a The name of the auditing firm is Deloitte. b From note 1P (iv) it is reported that Woolworths does provide share based payments to employees. It operates an ESP where employees receive an interest-free loan that can be used to buy shares in Woolworths. c Yes, the same note states that the cost of equity settled share based payment plans are recognised as an expense over the vesting period. 2 In general, students will need to be aware of the contents of the AASB Framework and the more recent IASB Conceptual Framework. Accordingly, responses should include at least the following points: a Employees are interested in the generation of cash flows and whether the entity is achieving its objectives. This information is available from general purpose financial reports (GPFRs) which also contain non-financial information on the future direction of the entity. b Investors are interested in the amount and timing of profitability, the generation of cash flows, whether the company is achieving its objectives and its future direction. This information is available from GPFRs, ASX extracts and media releases. c Regulators are interested in whether the reporting entity is operating in the interests of its members, whether the entity is achieving its objectives, and if it is operating economically and efficiently. They are also interested in ensuring that reporting entities are complying with various rules and regulations, i.e. AAS, AASB, Corporations Act 2001, ASX. Additionally, regulators are concerned with the efficiency of the law and will therefore monitor reports to ensure that regulation complies with public expectation. This information is available from GPFRs and other reports to meet specific regulatory requirements, i.e., Corporations Act 2001, ASX. d Suppliers of goods and services are primarily interested in whether the entity is solvent. In addition, they are concerned with profitability and cash flows, and whether the entity is achieving its objectives. This information is available from the statement of comprehensive income and the balance sheet. e Customers are interested in the ability of the entity to continue a future supply of goods and services, the level at which they will be provided and the likely cost of provision. Ongoing supply depends on profitability and cash flows. In addition, they may be Contemporary Accounting (8th edition) – Solutions Manual © 2013 Cengage Learning Australia Pty Limited.

Chapter 1: Introduction to accounting

concerned with non-financial issues, such as externalities (pollution, land degradation and so on). 3 This question should promote lively debate about the advantages and disadvantages of mandating the publication of social and environmental information. Costs versus benefits need to be considered. What requirements are to be mandated? Are these to be audited? The UK now requires companies to report on environmental and social matters in the Operating and Financial Review but this need not be audited. 4 The G100 definition is very descriptive and gives details of what triple bottom line (TBL) reporting should contain in very broad terms. The ICANZ definition indicated what the report should cover but also contained some potential benefits from the production of a TBL. The benefits range from micro for the firm and users of its stakeholders through to macro benefits for human welfare. This question will provoke lively debate about the relationship between publishing a TBL report and influencing behaviour. 5 Changing the law for directors will have the following possible implications: a Which stakeholders should be considered most important? b Potential increased risks for directors would act as a disincentive and therefore make attracting directors more difficult. A legal requirement for disclosure provides a clear signal as to the importance of this information. Of course if disclosure is to be mandated, then the next issue is what disclosures should be required? The second alternative is to rely on companies voluntarily disclosing such information and many companies now do this. However, not all companies will disclose and when they do it may be difficult to compare companies. There is argument that where competitors are providing information, non-disclosers are also likely to start providing such information. 6 You are employed by the client, but there are certain obligations to regulatory bodies, such as ASIC and the ASX, which cannot be deliberately disobeyed. 7 • Information on costs, including goods purchased, wages, rents, electricity and other overheads, so prices can be set to cover all costs and return a profit to the owner. • Information on cash flows – weekly or even daily. • Information on inventory levels so goods can be ordered in time to be available before all items are sold. Daily and weekly, depending on items. • Competitor pricing policy. • Opportunity costs. What could you earn with your money invested elsewhere and what is the cost of wages you could earn by working as an employee? This is an issue that should be considered at some stage, preferably before making the decision to buy the supermarket. 8 What is the amount per band member? What are the opportunity costs of taking the job, i.e. what does the band give up? Any costs to incur, such as hiring equipment, transport to the venue? Tax implications should also be considered. 9 a Some examples are: selling price, costs of manufacture, set up costs, marketing costs, patent costs, expected life for the product. b Some examples are: size of market, competitors, technical specifications. Potential costs which may arise given the risk of hang gliders, does the company need to consider special insurance protection – is it available? This is not the company’s core business. What skills does it have in this industry? Costs of relocating to Sydney. 10 • Information about competitors. • Any proposed changes to zoning in the area which may affect the business. • If a lease, when is the lease due for renewal? • Information about suppliers. Contemporary Accounting (8th edition) – Solutions Manual © 2013 Cengage Learning Australia Pty Limited.

Chapter 1: Introduction to accounting

• •

Any new competitors likely to enter the area? Market research may be necessary but this depends on how long the business has been established and how successful it has been. • Any new developments or road construction in the area. 11 There is no ‘right’ answer to this problem as until the yacht charter business was purchased there was no separate business entity. However, there is clearly a need for Tom to prepare a statement of expenditure as an individual. Some additional questions to promote discussion are: If there had been no problem with the purchase of the boat building business, what would you have done with the $1000 paid to the accountant? Would you have a different answer if Tom was already in an established business looking for areas to expand or to diversify into? Should Tom even consider investing in a business of which he has no knowledge? 12 • Financial issues – cost of building, machinery, training costs, purchase of components, personnel (wages, annual leave, superannuation and so on), provision for any tax on externalities, projected revenue, life of the project. • Health and safety issues – location of plant, emissions of toxic substances. • Social and legal issues – location of plant, disposal of waste products, procurement of necessary licences for construction. • Market research – demand, price, competition. Note: if nuclear-powered Frisbees are made and/or tested on site then the above issues will need to be expanded (e.g. community reaction, strict health and safety regulations, adequate containment of nuclear materials, as well as the impact these may have on future legislation, adherence to Consumers Protection Act and so on). 13 The solution to this problem should focus on the tentativeness which attaches to all economic measurements. Students should appreciate the difference between intrinsic values of an item (such as the official exchange price of a bar of gold) versus the extrinsic effects on economic value produced by conditions or events in the environment (as demonstrated in this problem). a Discussion of the economic worth of the project to be measured might take into account (1) estimated future rental income offset by estimated expenses to maintain and operate the hotel, (2) the expected exchange price if the hotel building were to be sold to an outside party, or (3) an accumulation of the costs incurred. It is not clear that the costsincurred measure is the best from an economic point of view – even though admittedly it is the simplest and most easily quantifiable. Before the decision of the lower court any of the above measures could be justified depending on expectations about the outcome of the court decision. However, following the decision of the lower court the use of measure (3) may seem more prudent. b Students should have some indication of the difficulty of making qualitative versus quantitative measurements. Quantitative measurements in business affairs are typically subject to several assumptions which must be made before such measurements become substantive or reliable. No one economic measurement is perfect. The question, in other words, is the degree of reliability which can be placed upon any one individual measure. c The loss in the case described falls to the owners of the Coastal Development Company. Discussion should bring out that a company is nothing more than a creation of the law and in reality cannot sustain an economic loss. The owners of the company are the real economic party at interest. But those who might have stayed in the hotel also lost, although those who retained their views and the character of the neighbourhood gained, as did the general public through the protection of the sand dunes. The local shire council may ultimately lose as it is likely the Coastal Development Company will sue the shire for the losses incurred. If successful, then the ratepayers in the shire area must ultimately pay. Contemporary Accounting (8th edition) – Solutions Manual © 2013 Cengage Learning Australia Pty Limited.

Chapter 1: Introduction to accounting

14 a Thug Possessions 6 large brown furs 2 small brown furs 5 small black furs 34 morsels of meat Rock fridge

Exchange rates 50 morsels of meat each 30 morsels of meat each 15 small brown furs at 30 morsels of meat per fur 3 small brown furs at 30 morsels each Taxed at 1 rock for every 10 morsels

Equivalent morsels of meat 300 60 450 34 90 934 93 rocks

Exchange rates 50 morsels of meat each 20 large brown furs at 50 morsels of meat each 27 small brown furs at 30 morsels of meat per fur 2 large brown furs at 50 morsels each (equivalent to 1 large black fur) Taxed at 1 rock for every 10 morsels

Equivalent morsels of meat 100 1000 810 22 100 2032 203 rocks

Olga Possessions 2 large brown furs 10 large black furs 9 small black furs 22 morsels of meat Rock fridge

b Thug should pay taxes equivalent to 93 rocks and Olga should pay the equivalent of 203 rocks. They could either collect the rocks themselves or pay Ugg by means of furs and morsels of meat equivalent to the amounts of tax they owe. (Tutors should discuss other possible solutions and alternative measurements, e.g. the rock fridge is shown at two different amounts. Discuss the concept of decline in value through use.)

Chapter 2 Types of organisations and the financial reporting framework Review questions 1 A sole trader has one owner whereas a partner has at least two. Partners are jointly and severally liable for the debts of partnership, there needs to be separate accounts kept of the transactions relating to each partner, agreements need to be reached regarding profit shares and so on. All partners are bound by the requirements of the Partnership Act. 2 The liability of the owners (shareholders) is limited to the amount paid on their shares. 3 Legal status, membership of company, dividends vs. drawings, limited liability, audit, filing of accounts and so on. 4 As the terms imply, the principal difference between limited, unlimited and no-liability companies is in the amount of the shareholders’ obligation to contribute towards the debts of the company when the company is unable to meet those debts itself. • For a limited liability company, shareholders’ liability is restricted to the amount paid for the shares. • Members of an unlimited liability company are liable for all debts of the company. • No-liability companies are restricted to mining companies. Shareholders of these companies are not required to contribute the unpaid value of the issued shares if the company is liquidated 5 Presumably it is to encourage people to invest in this industry which is very high risk but offers enormous benefits to the country if successful. 6 Students should raise and discuss the following points dealt with in the text: Advantages: • ease of formation • limited rules and regulations • provision of capital and expertise • taxation advantages. Disadvantages: • limited life • unlimited liability • mutual agency. 7 Two-dollar companies, as the name suggests, are companies that have a nominal ($2) share capital. They are generally small private companies with the minimum number of members permitted (i.e. one or two members). 8 The term ‘due process’ refers to procedures which are designed to allow all interested parties the opportunity to comment on a proposed accounting standard prior to its adoption. The steps in this process are: • identify technical issues • add issues to the AASB agenda • research and consider issues • consult with stakeholders and issue an exposure draft or discussion paper • issue an accounting standard or other pronouncement such as an Interpretation. Contemporary Accounting (8th edition) – Solutions Manual © 2013 Cengage Learning Australia Pty Limited.

Chapter 2: Types of organisations and the financial reporting framework

9 Points raised by students on the various influences on external reporting for companies in Australia should include: • international financial reporting standards as issued by the IASB are now issued as Accounting Standards by the AASB and must be complied with by all reporting entities • Corporations Act 2001 • ASX listing requirements, where applicable. 10 It is a set of interrelated concepts that define the nature, subject, purpose and broad content of general-purpose financial reporting. It is an attempt to establish the foundations from which general-purpose financial statements can be prepared. 11 It is an entity which has users who require general-purpose financial reports (GPFRs) to assist them in making decisions about the allocation of scarce resources. Such users are unable to demand information and receive it from the entity as would normally be the case if they were a banker or large creditor. 12 The users of general-purpose financial reports are those users who cannot demand and receive information from an entity. For example, the Reserve Bank would be able to demand and receive any information from a bank in Australia; therefore the Reserve Bank does not rely on general-purpose financial reports to assist in its supervision of the banks. However, most users, whether they are shareholders, employees, customers or analysts, are unable to demand and receive financial information from an entity. (Tutors may ask students how successful they would be if they approached BHP for financial information.) Users require general-purpose financial reports to assist them with a range of decisions, for example, to buy or sell shares in the entity, to provide goods to the entity, to buy goods from the entity and so on. 13 Students need to understand that while legal ownership will normally provide control, it is not always the case, e.g. a leased asset. Tutors should discuss the rights and obligations of lessors and lessees in a finance lease. The lease allows you to demonstrate that the accountant is concerned with the economic substance of transactions, rather than the legal form. 14 This is a point of view expressed by some authors. A conceptual framework provides definitions of key elements, establishes objectives for financial reporting and is an attempt by the profession to improve its image to outsiders. In doing so, the profession hopes to reduce threats of government intervention into the regulation of the accounting profession. If the conceptual framework simply maintains the status quo then the above argument has some merit. SAC 4 in Australia had the potential to alter current practice and therefore not maintain the status quo. It was strongly opposed by business in Australia. 15 Conservatism is often used to describe an approach to accounting whereby assets, income and revenues should not be overstated and expenses and liabilities should not be understated. It is sometimes associated with prudence and is acceptable provided there is no deliberate overstatement of expenses and liabilities or understatement of assets and income and revenues. 16 Reliable and irrelevant financial information – e.g. amounts to the exact dollars and cents for any items in the financial statements. Unreliable and relevant information – estimates of probability of success from research and development expenditure, extent of reserves underground for mining companies, value of internally-generated goodwill. 17 The purpose of an external audit is to add credibility to general-purpose financial reports so that users can be assured that the reports are a true and fair representation of the economic activities of the reporting entity.

Chapter 2: Types of organisations and the financial reporting framework

18 The expectation gap refers to the difference between what an auditor is legally required to do in auditing general-purpose financial reports and what is expected by users of financial statements. Example: an auditor is required under the Corporations Act to report an incident of fraud or illegal acts discovered during the course of an audit. This requirement may raise the expectation among individual shareholders that, if an auditor reports no such acts, then no fraud or illegal act has been perpetrated. The law, on the other hand, requires the auditor to exercise due care when forming his or her opinion but does not require the auditor to detect fraud. 19 An audit adds credibility to general-purpose financial reports, however, the preparation and presentation of the reports remains the responsibility of the directors of public companies. It would therefore be incorrect to conclude that public financial statements would not be true and fair merely because they were not audited. 20 The unqualified audit report should provide a greater level of confidence with respect to that company. If all other things are equal then the one with the audit report would be preferred.

Problems for discussion and analysis 1 a

Note 1B states that the accounts are prepared on the basis of historical cost basis except for derivative financial instruments, financial instruments held for trading and availablefor-sale, which are valued at fair value. b The auditors are Deloitte. c The auditors were paid $2.153 million for the audit and $660 000 for other non-audit services. As the amount for non-audit services is significantly less than the audit fee it therefore does not present a problem for audit independence. 2 a Asset – something of value that belongs to you. b Liability – an amount you owe someone. c Equity – your interest in a business. d Expense – cost of running a business. e Income – amount received for selling assets and goods and services. 3 a Mike and Phil Income statement for year ending 30 June 20X9 $

Sales Less: cost of goods sold Less: Selling expenses Depreciation expenses Financial expenses General expenses Net profit

b Profit share Mike Phil

36 320 90 800 54 480 90 800

7 316 4 322 1 827 12 035

210 000 163 000 47 000

25 500 21 500

× 21 500 = $8600 × 21 500 = $12 900

Chapter 2: Types of organisations and the financial reporting framework

4 a With no agreement, share profit equally. Steve and Lee each receive $75 000. b Share according to capital investment: Steve 55.6% × 150 000 = $83 400 Lee = $66 600 c $150 000 – 45 000 = $105 000 Steve = 105 000 × 0.4 = $42 000 Lee = $63 000 d $150 000 – 135 000 = 15 000 Steve = $7500 Lee = $7500 e 150 000 – (45 000 + 135 000) = loss $30 000 Steve and Lee each have a loss of ($15 000) 5 $276 000 Plan a b

50/50

Andrew Glen $138 000

40.54%/59.46% $111 892 66.7%/33.3% $184 092 c less $37 000 and $149 375 d 62.5%/37.5% less $37 000 + $44 500 e $150 000 and 50/50 as above + 20% 276 000 – 150 000 *bonus to Glen if – 37 000 – 25 200 f net profit < $187 × 0.5 000 = $31 900 * Bonus to Glen based on NP – salary payments only.

$162 000 Norman Dale $138 000

Andrew Glen $81 000

Norman Dale $81 000

$164 108 $91 908

$65676 $108 054

$96 324 $53 946

$89 625

$78 125

$46 875

$44 500

–$12 500

$31 900

162 000 – 150 000 – 37 000 – 2 400 × 0.5 = –$13 700

–$13 700

6 Students should understand the meaning of a present obligation, sacrifice of future economic benefits and that it must be as a result of a past event. 7 Make sure students understand the meaning of future economic benefits, control and that it must be as a result of a past event. 8 No. As the probability of having to sacrifice $100 000 is only 35 per cent, this fails the recognition criterion of probable and should not be recognised in the balance sheet. If the amount is material then disclosure of this possible liability in the notes is recommended. 9 a The article raises an interesting issue about whether a football player is an asset. Consider whether in this case the definition of an asset is satisfied. Manchester United controls the services of a player because of the contract it would have in place. The future economic benefits relate to the value of the player’s services and his resale value by way of the transfer payment, which is paid when a player moves from one club to another. The future economic benefits are the value of the playing services and the merchandise based on the player. The past event would be the signing of the contract. Before being recorded on the balance sheet, an item that meets the definition of an asset must also satisfy the recognition criteria. It must be probable that the future economic benefits will flow to the entity and there must be a cost or other value which can be reliably measured. The present value of the player salary payments over the contract period could be an amount which could be used to report the value of the player. The probability of the

Chapter 2: Types of organisations and the financial reporting framework

economic benefits flowing to the club depends on a number of issues, including player age, risk of injury and performance on the field. Students should understand that it is the player’s services which the club controls during the contract period and not the player himself. Clearly the player who plays for the local club does not provide the same economic benefits to the club in terms of drawing large crowds to the game. The player may be important for the local team to win but huge sums of money are not involved. The local club probably does not produce a set of financial statements. b No set answer. 10 We begin by examining the transaction in the context of the definition and recognition criteria for liabilities: Present obligation Yes, there is a present obligation that arises when a frequent flyer takes a flight with an appropriate airline. Sacrifice of future economic benefits Yes there is a sacrifice of FEBs which would include the incremental costs incurred when someone flies free, including meals, baggage handling and so on. It could be argued that when a passenger purchases an airline ticket that he or she is in effect buying a portion of a future ‘free’ trip. Past event The past event is the flight that provides frequent flyer points to a member. Probable that there will be a sacrifice of future economic benefits Yes, in fact it is highly likely that frequent flyer members will use points at some stage and so it is certainly probable. Reliable measurement The liability for free tickets would need to be calculated based on an estimation of the portion of free tickets that are likely to be redeemed. If this argument is pursued, a portion of the revenue of each ticket sold to a ‘frequent traveller’ would need to be deferred. Airlines can use past experience to estimate the amount of points that are likely to be redeemed. Airlines would argue that there is little or no cost in free tickets as otherwise empty seats are filled. The liability for free tickets would need to be calculated based on an estimation of the portion of free tickets that are likely to be redeemed and an estimation of the additional cost. The most significant cost would result if the award booking resulted in a fare-paying passenger choosing to fly with a competitor. Most airlines now use the deferred revenue approach following the release of IFRIC 12 on customer loyalty programs which require a portion of the cost of a ticket to be deferred and recognised as unearned revenue. This obligation is then settled when the frequent flyer uses points to take a free flight. 11 The management of companies are interested in the standard-setting process because it may affect the way they have to report the performance and financial position of the company. Tutors should discuss the economic consequences of standard-setting and why management may have a vested interest in the outcome of standard-setting. 12 The due process allows for any interested parties to make comment on proposed accounting standards. However, experience shows that managers and accountants are most active in making submissions to the AASB. User groups such as the Securities Institute and the Australian Shareholders Association do also comment on proposed standards.

Chapter 2: Types of organisations and the financial reporting framework

13 There are far more onerous reporting requirements for public companies and in particular listed public companies. All companies have to submit financial statements to their shareholders. For reporting entities they must prepare: • a statement of comprehensive income • a statement of financial position or balance sheet • a statement of changes in equity • a statement of cash flows. Notes to the financial statements: • a director’s report • an auditor’s report. Public companies have the ability to raise funds from the public, therefore their level of reporting requirements are stringent. The ASX imposes additional reporting requirements on listed companies due to the depth of their shareholding. Proprietary companies are smaller and their members are considered to be better informed. Small proprietary companies have less stringent regulation imposed as they have a very limited number of shareholders who have no requirement for extensive financial reports and verification. They are frequently family businesses. If they are not a reporting entity then they are not required to produce a GPFR but can produce a special purpose financial report which does not include all the details in a GPFR and need not comply with all accounting standards. 14 This question refers to the ‘expectation gap’ of what the actual role of an audit is and what users believe an audit should be. Students should therefore discuss the role of the audit and the way the auditor goes about gathering information to help form an opinion about the financial statements. The discussion should also address the issue of the cost of an audit versus the need to gather enough evidence and to do enough testing to be able to arrive at a reasonable assurance. The cost of checking everything would be prohibitive and so sampling is used. Discuss the issue of tendering for an audit and the implications of this on audit quality. 15 The amount of fees a practice derives from one client is one potential measure of audit independence. If Dorro accepts the engagement then the new client will represent one third of the fees for his practice. If Dorro employs more staff based on the new work and incurs other costs then his practice becomes more reliant on the fees from the new client. The argument is that the client may then be able to exert pressure on Dorro and such pressure can impede his independence. Of course a counter argument is that the professionalism of Dorro will mean that he will not succumb to any undue pressure from the new client, even if this means losing the client. 16 a Yes. The company should recognise a liability as it is probable that there will be a sacrifice of future economic benefits and the amount can be reliably estimated. b No. While it is probable that the company will have to pay money from the claim, we are not told about the amount and if this cannot be reliably estimated then a liability would not be recognised. A note in the financial statements should be included if the amount is likely to be material. c This would not be a liability as there is no present obligation to sacrifice future economic benefits to an external party. You might ask students would the answer be different if they had a contact with a provider to carry out the overhaul? When a company incurs the costs of maintenance the amount involved may be added to the asset cost and subsequently depreciated.

Chapter 2: Types of organisations and the financial reporting framework

17 Solutions to the case study should cover the following points: a Organisation Partnership: – easily formed by simple agreement with a minimal cost – not subject to requirements of corporations law – no requirement for preparation of financial statements – not taxed as an entity thereby providing tax planning opportunities – withdrawal or death of either partner will result in dissolution Company: – a company has a continuous life – the company offers limited liability whereas both partners would be jointly or severally liable for the debts of the partnership – no mutual agency – ease of transfer of ownership of shares of the company – the company is a taxpayer in its own right and would pay franked dividends – separate legal entity Bev and Daniel would probably find the limitation of liability of a company attractive in view of their large debt and the business’s lack of past success. The major disadvantage in choosing a company would be its additional regulation and costs. b Generally companies are better placed to raise finance compared to partnership or sole traders, however, in the case of a small company with a limited capital base, this would probably not be a significant advantage. In these circumstances, financiers frequently request personal guarantees from directors and shareholders of small companies. c A whole range of ideas should be raised, such as knowledge of the particular business sector, tax planning, inventory and cash management and marketing and financial planning. d There are a number of possibilities, however, given the large debt Bev and Daniel will incur, a loan from a large bank or financial institution would be the most likely source of funds. Security in the form of a mortgage over the assets of the business and possibly the personal assets of Bev and Daniel (or a personal guarantee) would be required. 18 Option a Borrow $3m at 10 per cent Interest $300 000 per annum As this is tax deductible the after tax cost is (1 – 0.36) × 300 000 or $192 000 each year. The $3m must be repaid in five years. Option b Converting to a public company and issuing shares will raise the required cash if the market considers the price of $5 appropriate. If the family is to retain control then they will need to purchase at least 50 per cent of the shares for an outlay of $1.5m. As a public company there will be increased regulations and shareholder expectations concerning dividends. Therefore it is wrong to assume this is a costless option. Option c Issuing preference shares will raise the $3m and will impose a dividend cost of $180 000 each year on the company. This is not tax deductible as the preference shares are considered as equity and not debt. This is because the company has complete discretion as to whether the shares are to be redeemed.

Chapter 2: Types of organisations and the financial reporting framework

Recommendation: Options (a) and (b) impose cash flow obligations on the company and cash flows have been a problem. I recommend the company investigate the reasons for the cash flow problems. Option (c) is preferred to Option (a) as it is less costly and does not require the company to repay the principal at any specified time. The choice then is Option (b) or (c). While Option (b) appears less costly it will create greater scrutiny of the company by shareholders and create demands for dividend payments. Therefore Option (c) is perhaps the best option for the company, provided it can remedy the cash flow problems in order to service the dividend. 19 a Optimistic estimate: Net profit Less salaries Share Bob Phil

Year 1 75 000 35 000 40 000

Year 2 85 000 35 000 50 000

Year 3 95 000 35 000 60 000

24 000 16 000

30 000 20 000

36 000 24 000

Year 1 55 000 35 000 20 000

Year 2 65 000 35 000 30 000

Year 3 75 000 35 000 40 000

12 000 8 000

18 000 12 000

24 000 16 000

Year 1 45 000 35 000 10 000

Year 2 50 000 35 000 20 000

Year 3 65 000 35 000 30 000

6 000 4 000

12 000 8 000

18 000 12 000

Total 90 000 60 000

b Most probable estimate: Net profit Less salaries Share Bob Phil

Total 54 000 36 000

Pessimistic estimate: Net profit Less salaries Share Bob Phil

Total 36 000 24 000

d Bob’s share of profit Optimistic Probable Pessimistic

Amount 90 000 54 000 36 000

Probability 0.2 0.6 0.2

EV 18 000 32 400 7 200 57 000

Based on the analysis in (d), if Bob can receive $80 000 then this appears like a good price. The expected profits over the next three years are well below the $100 000 set by Bob. The expected value of $57 600 has not been discounted to a present value which makes the offer of $80 000 today even more attractive. The share of profits is after deduction of the $20 000 per annum salary to Bob. If he added the three years’ salary to the profit then the amount exceeds $100 000. Therefore, it is important that Bob realises he is giving up both his share of profits and the salary.

Chapter 2: Types of organisations and the financial reporting framework

a Cash received for next year’s services The cash flows received from customers cannot yet be recognised as revenues because the definition of revenues (para. 7 of AASB 118) has not been satisfied. Although the cash flows received have increased assets, this increase in assets has not resulted in an increase in equity. Rather, it is the liabilities which have increased. The definition of liabilities (para. 4.4b of the Conceptual Framework) indicates that, in this case, New Incentives Ltd has a present obligation, as a result of the payment received, to sacrifice future economic benefits to supply services to the customers. In the absence of any information to the contrary, this liability meets the recognition criteria in paragraph .4.4b of the Conceptual Framework. Advertising expenditures: These expenditures must meet the definition of assets (para. 4.4a of the Conceptual Framework) and the recognition criteria (para. 4.38 of the Conceptual Framework) before the proposed accounting treatment is acceptable. In principle, advertising expenditures can satisfy the definition of assets because the expectation is that they will give rise to future benefits (e.g. increase or maintenance of sales levels), are controlled by the entity (it is New Incentives Ltd that is the only subject of the advertising), and result from a past event (the screening of television). However, it is much less likely that the expenditures will satisfy the recognition criteria because the ability to identify the specific benefits of any advertising program are notoriously difficult (although this will very much depend on the discernible facts of any given case).

b Facts – Tom has a new job after looking for six months – Tom has been asked to adopt two ‘favourable’ accounting treatments of certain cash receipts and expenditures – Management bonuses are tied to reported profits Four possible courses of action – Action one: comply with boss’s instruction – Action two: record transactions in accordance with the Conceptual Framework – Action three: try to convince boss that the Conceptual Framework should be complied with – Action four: resign from the position of accountant (There may be many other courses of action raised, including reporting the proposal (or eventual action) to the Board of Directors or the ASIC.) Evaluation Action one: – breaches all the ethical principles noted above but will gain approval from boss – managers more likely to achieve bonuses – may encourage boss to impose further manipulation of accounts – could harm the interests of shareholders and creditors Action two: – compliance with ethical principles – disapproval by managers/boss may lead to Tom being overruled anyway, or fired – shareholders’ and creditors’ interests protected

Chapter 2: Types of organisations and the financial reporting framework

Action three: – may succeed and problem resolved – may not be able to convince boss and so could be overruled or fired – gives boss an opportunity to change her mind Action four: – lose job and income – integrity intact – problem remains for someone else Choose a plan of action – take a poll of the class but emphasise the requirement that class members present a plan of action and that they properly justify that plan by reference to principles and consequences. It is often helpful to ask students if they would be comfortable having their actions publicly disclosed on television or before the courts.

Chapter 3 Ethics and corporate governance Review questions 1 The challenge is how to achieve ethical behaviour in business. How do we develop ethical behaviour – through education and training? How do we change certain attitudes, which can result in employees stealing from their employer and justifying their action on the basis that the company is making huge profits? The challenge facing the accounting profession is the same – perhaps the difference is that members of the accounting profession have to show a certain understanding of the profession’s code of ethics before being admitted as a full member. Furthermore, they are then bound by the code of ethics as they go about their work. Is it possible to develop a code of ethics for business people? How would it be enforced? 2 Discussion should focus on the total costs of unethical behaviour. Take McKinley Tabor as an example. His initial unethical actions brought about increases in his personal wealth and could be argued was in his self-interest. However, in the end the costs of his actions outweighed his gains and his self-interest would have been best served by remaining ethical. 3 The role of the board of directors is to represent the shareholders of the company, make decisions and endeavour to add value for the shareholders. The board is one way in which the management of the company is held accountable for its actions. 4 The issues concerning a board of directors and its role in corporate governance include the size of the board and the number of independent directors. Should the CEO also chair the board? What qualifications should directors have? Should there be restrictions on the number of boards on which directors can sit? Should there be a time limit on the length of service on a board?

Problems for discussion and analysis 1 The corporate governance report for Woolworths is available at www.woolworthslimited.com.au (click on ‘annual report’). The notes below are based on the 2011 annual report and are meant as a guide only. It is important for students to discuss whether making statements about ethical decision making, for example, provides sufficient assurances to shareholders. Strengths: • Very detailed and transparent. Meets and exceeds most of the best practice guidelines. • There are nine on the board of directors (BOD) and all except for the CEO and CFO are claimed to be non-executive and independent, which conforms with best practice recommendations. The board size is also not too large and is within the range of what some researchers have found is desirable. • BOD members are able to seek independent advice at the company’s expense. • The roles of chairman and CEO are held by different people. • Has a corporate governance committee that is responsible for the appointment of members to the BOD. • Has an active audit committee (AC) comprised of non-executive directors with financial skills. The AC has wide ranging responsibilities. The AC requires the lead audit partner to be rotated every five years and has a policy of not appointing the firm’s auditors to the

Chapter 3 Ethics and corporate governance 16

BOD at any time. The AC can also seek independent advice at the company’s expense. The AC also reviews all on-audit services provided by the external auditor. • Has a people policy committee made up of non-executive directors which is responsible for the establishment and review of the remuneration of the company’s senior executives. Improvements: • There are few areas where the company needs to improve, but one area not mentioned is whether the non-executive members of the BOD meet independently at any time. Another area could be in terms of directors’ access to information. 2 Students should use their own words, such as honesty, morally right, fairness, integrity, accountability and so on. 3 The government can regulate against fraud and it is a criminal offence with a gaol term for offenders. The issue relates more to the capacity of law enforcement agencies to apprehend the perpetrators of fraud. As a white collar crime it was once viewed as much less serious than other forms of crime, but attitudes have since changed as evidenced by the public opinion towards individuals associated with companies, such as ABC Learning, Enron and Worldcom, and individuals like Bernie Madoff in the USA. 4 Facts – You (the accountant) are preparing the tax return for Jim’s Towing Service. – Jim is the sole owner of the business. – Jim does not appear to be declaring his cash-based income for tax purposes. Stakeholders – Jim – Australian Taxation Office (ATO) – Other taxpayers Problem – What action should you (the accountant) take with respect to the undeclared income? Values and principles – Professional principles at issue here include the public interest (APES 110–100.1), integrity (APES 110–110), objectivity (APES 110–120), independence (APES 110–290), and technical and professional standards (APES 110–130). There is also the principle of fairness to all taxpayers. These principles would all seem to suggest that, from the accountant’s perspective, Jim’s behaviour is unacceptable. – However, the principles above are in some conflict with the principle of confidentiality (APES 110–140 – or is there a legal or professional duty to disclose Jim’s actions?) and the accountant’s need to maintain a client and make an income. – Also consider the legal requirements. Tax penalties apply when there is a ‘tax shortfall’, which is the difference between tax payable determined in accordance with the law (‘proper tax’) and the amount that would be payable as determined by the taxpayer (‘statement tax’). Relevant provisions are ITAA36 s222A – 226ZB. Penalty tax may be applied under s.227 and the Commissioner has power to remit the penalty in whole or part. Where the ‘tax shortfall’ is caused by intentional disregard of the law (i.e. tax evasion), a penalty of 75 per cent applies; s.226J, compounding for repeat offences and where the taxpayer hinders the Commissioner. Alternatively, taxpayers may be prosecuted under the Tax Administration Act, ss.8A–8ZN, and face heavy penalties or imprisonment; or under s.29B of the Crimes Act, which also carries a penalty of imprisonment.

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Four possible courses of action – Action one: ignore the non-disclosure – Action two: try to convince Jim to disclose the cash income in his return – Action three: inform the ATO that Jim has not declared all his income – Action four: resign from the position of accountant to Jim’s business Evaluation Action one: – Not in keeping with most of the professional principles (including APS 6) or with fairness to other tax payers. – May encourage Jim to make even more unacceptable demands upon you in the future. – Jim may be audited by the ATO and the non-disclosure of the cash revenues would be discovered. There may be fines or other penalties imposed upon Jim and you (and the profession) would be brought into disrepute. Action two: – You may be able to convince Jim to disclose his cash revenues (by, for instance, pointing out the costs of his behaviour should it be discovered) and the problem then goes away. – Consistent with paragraph 7.4 and 7.5 of APES 220: 7.4 Where a Member finds that a Client or Employer has filed returns or submissions in previous years (with which the Member may or may not have been associated) that contain materially false or misleading information or omit material information, the Member should discuss the matter with the Client or Employer and advise them of their responsibilities. 7.5 In the event of a Member subsequently becoming aware that information previously provided to a Revenue Authority by the Member, which the Member had no reason to believe at the time to be incorrect, is false or misleading, the Member should recommend that the Client or Employer make an appropriate disclosure or, alternatively, the Member should obtain authority from them to make the disclosure on their behalf. [Source: Accounting Professional and Ethical Standards Board, APES 220 Taxation Services, March 2011, p. 8, http://www.apesb.org.au/attachments/Revised%20APES%20220%20Taxation%20Services%20%28March%202011 %29%20-%20Final.pdf]

– Jim may refuse to make the disclosures and the problem remains – Jim may sack you (the accountant) – loss of income and problem remains Action three: – potentially breaking principle of confidentiality to client – not giving Jim the opportunity to change his behaviour – likely to lose Jim as a client Action four: – you lose client but the problem has not been resolved – see paragraph 7.6 of APES 220: 7.6 A Member in Public Practice who (a) knows that a Client or the Member on behalf of the Client has filed a return or submission materially understating a tax liability to a Revenue Authority, and (b) finds the Client unwilling to correct such understatement, Contemporary Accounting (8th edition) – Solutions Manual © 2013 Cengage Learning Australia Pty Limited.

Chapter 3 Ethics and corporate governance 18

shall consider the Firm’s policies and procedures established in accordance with paragraphs 28-35 Acceptance and Continuance of Client Relationships and Specific Engagements of APES 320 Quality Control for Firms in determining whether to continue acting for the Client in a professional capacity. [Source: Accounting Professional and Ethical Standards Board, APES 220 Taxation Services, March 2011, p. 8, http://www.apesb.org.au/attachments/Revised%20APES%20220%20Taxation%20Services%20%28March%202011 %29%20-%20Final.pdf]

Choose a plan of action – Take a poll of the class but emphasise the requirement that class members present a plan of action and that they properly justify that plan by reference to principles and consequences. It is often helpful to ask students if they would be comfortable having their actions publicly disclosed on television or before the courts. 5 a Michael should advise his client that the ATO should be notified. Note: some students would expect nothing to be done, as a monetary error by a government department in their favour seems acceptable conduct. The discussion could centre on why it would be ethically correct to obtain a monetary advantage from a government department and not from a friend. b The captain knows the error has been made. He knows he is not legally entitled to the money. It can be assumed that this is akin to stealing as he is taking money that rightfully does not belong to him. c Michael’s responsibility is to act professionally. His first course of action is to inform his client that the error should be reported. If the captain is unwilling to do this then Michael should state quite clearly that he cannot act on his client’s behalf. Further, Michael should let the captain be aware that he believes it is his duty to report the matter. 6 a Were the transactions unethical? – Legal considerations: Jan Skully’s actions have most likely breached several sections of corporations law. For instance, s232 which requires directors not to abuse their special position for self-gain; also Part VII 11 of the Act, on conduct in relation to securities, particularly ss995–998 which outlaw misleading or deceptive conduct of the type given in the case facts. There are also common law considerations, such as Skully breaching her fiduciary duties as a director. – Ethical considerations: Skully’s actions are inconsistent with a number of ethical principles, such as honesty, a duty of care to protect the uninformed and not to abuse her position of trust. As a member of a professional accounting body, Skully would not have complied with the principles of integrity (APES 110–110), objectivity (APES 110–120), independence (APES 110–290) and ethical behaviour (APES 110–150) – that is, bringing the profession into disrepute. Her actions will have benefited her (and her family?) in the short-term but the transfer of funds from other companies and the ramping of the share price of Extraordinary Products Ltd has eventually led to losses to the other shareholders (assuming they exist) of Skully’s related companies and the shareholders in Extraordinary. Her actions would also result in a general decline in public confidence in the share market. b How could the scheme have been prevented? – As the founder and chairperson of Extraordinary Products Ltd, Skully may well have had a very dominant position on the Board and may have seen the company as ‘her’ company. This would have made it difficult to control her actions. – Some possible preventative measures might include: Contemporary Accounting (8th edition) – Solutions Manual © 2013 Cengage Learning Australia Pty Limited.

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• A strong board of directors made up of a substantial proportion of non-executive directors • Policies in which all director share transactions must be declared to, and approved by, the board of directors • Policies prohibiting insider trading • Internal auditing which reviews changes in the share register and the internal auditor reports to the whole Board (or audit committee) • A policy of disclosure in the financial report of all related party transactions along the lines of AASB 124 Many of these suggestions have been incorporated in the Corporate Governance Best Practice Guidelines issued by the ASX. Details are provided in Chapter 12. 7 Any increase in regulation comes at a cost and we should therefore consider whether the cost of regulating corporate governance structures would provide greater benefits. To some extent the legislative reaction, such as Sarbanes-Oxley in the US, was to be seen to be doing something in the light of the spectacular company collapses, because the research on corporate governance does not provide any conclusive evidence about ideal size of boards, number of independent directors and so on. By using the best practice approach, the market can then penalise companies if it feels the corporate governance practices of the company are inadequate. 8 The arguments in favour of a majority of independent directors relate to the ability of external directors to more effectively monitor the performance of the company and its management than internal directors, who will be less objective in the assessment of the company’s performance. External directors will be less susceptible to manipulation from the CEO than internal directors. There is also the argument that firms with better corporate governance will be more attractive to investors and thus enjoy a share price premium. Those who argue against this view believe that external directors do not add to the economic discipline already imposed on managers by product and factor markets, the managerial labour market and the market for corporate control. Some argue that given the large number of directorships held by many directors they do little more than provide outside contacts and advice for senior management. Internal directors have intimate knowledge about the company and are able to make more informed decisions for the benefit of the company. Research results on this issue are mixed but the majority of papers tend to report no association between independent directors and firm performance. Presumably the need for independent directors to hold separate meetings is to enable them to debate issues openly which may be difficult with internal directors present, particularly the CEO. This is particularly true if they wish to discuss the performance of the CEO. 9 It is important for audit committees to have the ability to seek independent advice on issues to enable them to properly discharge their duties. Such advice may be on legal or accounting matters if the members of the audit committee do not have the required expertise. If the committee has to seek funding permission from the CEO, then this is a limiting factor. Members of the management team should only attend meetings when invited. This may be appropriate from time to time so the committee can ask relevant questions about the company, such as about issues to do with internal control procedures. They would attend meetings to provide information but would certainly not hold any voting rights.

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Ethics case study a

There are clearly important social issues involved in this case and students will have strong views. Many have argued that it was unacceptable behaviour by the company in moving its registered office to Holland and then cancelling the $1.9b scheme. Should the company be liable for the illnesses suffered by previous employees? The definition of a liability includes constructive and moral obligations. Does James Hardie have a moral obligation to assist previous employees? The case raises interesting issues about the recognition and disclosure of liabilities of this type. It may be useful to have students think about current company activities that may at some future date create obligations on a company as community norms change, research reveals dangers of products and so on. A triple bottom line (TBL) report should at the very least disclose details about the situation and indicate possible costs to the company. How far should such disclosures go in admitting responsibility of the company is also worthy of discussion. Some companies are reluctant to report activities or events which may be construed as an admission of guilt and used against the company in court. However, if TBL reports only report positive information, then their value is likely to be undermined. b The controversy surrounding James Hardie and asbestos-related diseases continues in 2012. The courts issued penalties for 10 former executives and directors. In May 2012, the High Court ruled that seven former directors misled investors about a compensation fund for asbestos victims. The company has now moved its head office from the Netherlands to Ireland at a time when news was surfacing that the next wave of asbestos-related diseases are hitting home handymen (it has been discovered that asbestos found its way into underfelt laid beneath carpet back in the 1970s). Here is a link to the James Hardie website devoted to asbestos compensation: http://www.ir.jameshardie.com.au/jh/asbestos_compensation.jsp

Chapter 4 Wealth and the measurement of profit Review questions 1 Answers should encapsulate the idea of the static nature of a stock measure, and the way in which that differs from the dynamic nature of measures covering periods of time. 2 The alternatives and the drawbacks identified were: – original cost: identification of original cost as cost to whom – historic cost: reductions in value, increases in prices – replacement cost: specialist items, changes in technology leading to non-replacement – economic value: problems of forecasting the future, the choice of appropriate discount rates – net realisable value: do we want to sell, whether it is a forced sale or at open market value – fair value: what is the fair value when the market for an asset is illiquid? 3 Answers should show an understanding that assets are used up over time and that this fact is not reflected merely by stating an asset at cost. The example used in the chapter is the car. We have found that students can understand the idea of written-down cost if they are directed towards examples with which they are familiar. 4 Historic cost: normally technology will lower prices as better alternatives become available. In this situation unadjusted historic cost will overstate the asset worth. Replacement cost: changes in technology will lead to two effects. The asset is likely to be replaced with a technologically superior asset and so the replacement cost of the asset held will be difficult to establish even if it is still appropriate. Economic value: as this is based on future cash flows from the asset, the economic value is likely to be reduced. Net realisable value and fair value: once again these are likely to reduce with a change in technology.

Problems for discussion and analysis 1 a

Note 1K states that for short life retail stocks the average cost method is used. For long life retails stocks the retail inventory method is used. This method involves using the mark up from cost to estimate the cost of inventory on the shelves at the end of the period. b The cost method used for other plant and equipment is as per note 1G. c An asset is impaired when its recoverable amount is below its carrying value. Recoverable amount is described as the higher of the fair value less costs to sell and value in use. 2 This exercise is designed to have students consider their own position and how they approach the measurement of their wealth. Tutors should see if students have considered all relevant items, e.g. insurance or superannuation policies, amounts owing for telephone, electricity and so on. What measurement base did they use? Why? 3 The figure should be based on the benefits the player will earn for the club. This will include consideration of the player’s ability to help the club win more games, which in turn will increase attendances at games, membership of the club, sponsorship for the club and so on. Now that there is a market for players, clubs are obviously influenced by what other clubs are prepared to pay, which represents a form of market value for a player. Contemporary Accounting (8th edition) – Solutions Manual © 2013 Cengage Learning Australia Pty Limited.

Chapter 4: Wealth and the measurement of profit

4 a b c 5 a

$12 000 $13 000 $1000 with no repairs, $3000 if repairs are made. The calculation of the opening wealth here is straightforward as the historic cost, replacement cost, and net realisable value can be judged to be effectively the same. However, the question is designed to raise problems in terms of the wealth at the end of the period as here the historic cost of the beds is $200 per bed, the replacement cost is $240 and the net realisable value is $260, assuming that there is a market at the price of $280 less $20 costs. The answers using historic cost, replacement cost and net realisable value are as follows:

Beds Cash

Bed Cash

Historic cost Start $ 80 000 0 80 000

End $ 20 000 84 000 104 000

Beds Cash

Replacement cost Start End $ $ 80 000 24 000 0 84 000 80 000 108 000

Net realisable value Start End $ $ 80 000 26 000 0 84 000 80 000 110 000

Profit calculations: These are done using the formula Wealth 1 – Wealth 0 as illustrated in the chapter, as this is the only way of calculating profit the students have been exposed to up to this point. Historic cost $104 000 – $80 000 = $24 000 Replacement cost $108 000 – $80 000 = $28 000 Net realisable value $110 000 – $80 000 = $30 000 b The point that needs to be illustrated is that, depending on the valuation basis used, the profit changes. Students should be encouraged to identify what the profit per bed is likely to be next year, i.e., based on the conditions at the end of the year, it is likely to be only $20 per bed. This is arrived at by taking the selling price prevailing at the end of the year of $280, less the costs per bed of advertising, delivery and so on of $20, making a net selling price of $260, and then taking off the cost of beds at the end of the period, i.e. $240. Therefore, if they sold the same number of beds next year they would only make $6000 (assuming they bought all those beds at the current price). You may wish to illustrate the effect on that profit of having 100 beds in stock which were bought at $200. The point being made is that, in this situation, none of the profit figures is a guide to the future. As far as their usefulness as a measure of performance goes, the conclusion that should be reached is that none is superior, as we can only measure performance by comparison.