B301 Examination August 1997: Suggested Solutions and Marking Guide

Question 1 (6 marks)

(a)

Users of financial statements generally measure the success of an entity by the rate of return it earns on its assets. However, in an environment of non-stable prices. the value of the entity's assets will have changed over time. It would therefore be appropriate to measure an entity's assets at their current value rather than at historical cost. (1 mark)
Historical cost accounting fails to provide information to reflect the replacement value of goods or services consumed by an entity. The financial results measured by historical cost could therefore be distorting, as they may give a misleading impression of the entity's ability to continue to operate at the same level of operation (1 mark)
One of the major objectives of accounting is the provision of information that helps users in making decisions. At times of changing prices, the historical cost method fails to provide meaningful information for decision makers since financial information is not reflected in the statements at current value. This makes it difficult to make a proper assessment of the entity 's performance. (1 mark)

(b) UKSSAPI 6 "Current Cost Accounting" was issued in March, 1980 in an attempt to compel certain business enterprises to provide information that would reflect the current value of their financial positions. Its final withdraws signifies the difficulty and resentment with which the standard was received by prepares. To date, no other SSAP has been issued to replace HKSSAP16 and the question of providing current values remains unsolved. (1 mark)

(c) The deductive approach usually involves making assumptions which may turn out to be unacceptable. Deductive theorists would probably use inductive methods to arrive at the postulates from which they derive a set of principles. (1 mark)

The inductive approach presents a problem in deciding how many observations and measurements are required to give the complete picture. Inductive theorists would probably use deductive methods in relating their assumptions or rules to the postulates. (1 mark)

Question 2 (6 marks)

(a) As business entities grow into larger and more complicated organizations, there is an increasing demand for more detailed disclosure of financial information in the annual accounts. This in turn leads to demands that the financial statements be prepared in accordance with some identifiable rules. Accounting standards can be described as a set of rules for recording financial data to which other measures are expected to conform. With its establishment, the choice accounting bases is restricted and financial reporting can be done in a more objective manner, It also enables users of the data to make more effective comparisons of business entities of an similar nature. (2 marks)

(b) Accounting standards are a set of rules which arc considered to be the best accounting practice for the preparation of financial statements that will present a true and fair view of the company's financial position. On the other hand, accounting policies are the specific accounting bases (methods developed for applying fundamental accounting concepts to financial transactions and items) selected and consistently followed by a business enterprise as being in the epsilon of management1 appropriate to its circumstances and best suited to present Wily its results and financial position. (2 marks)

As the work of die accountant is of a professional nature, it can never be confined between the areas of rigid rules and directions.
The use of standards may affect the quality of the work of the accountancy profession. Businesses and Industries differ and they are in a constantly changing environment and as standards are based on means of judgment, they may lead to rigidity and may inhibit the exercise of professional discretion.
Official directives may reduce the accountant' power to withstand pressure from directors where the circumstances applicable to the appropriate standard way not ensure a true and fair view.
The public may assume that financial statements governed by accounting standards are infallible.
The standards may be produced in response to social or political pressure, due to particular circumstances which have arisen. This may reduce the freedom of the profession as well as leading to inappropriate results.
The publication of standards from time to time may discourage the exercise of critical thoughts on behalf of members.
As standards are regarded as recommendations and not legally enforceable, they can and have been ignored by sections of the profession.

(1/2 mark for each of the 4 valid points)

Question 3 (6 marks)

(a) Paragraph 52 of HKSSAP 27 indicates that during the life of an asset, it may be apparent that the estimate of the useful life is inappropriate. It could either be extended or reduced. In such cases, the useful life and therefore, the depreciation rate is adjusted for the current and future periods. (1 mark)

(b) According to paragraph 28 of HKSSAP 2, fundamental errors are those errors that have such a significant effect on the financial statements of one or more prior periods that those financial statements can no 1onger be considered to been reliable at the date their issue. (1 mark) Paragraph 30 indicates that amount of the correction that relates of prior periods should be reported by adjusting the opening balance of retained earnings. (1 mark) Comparative information should be restated, unless it is impracticable to do so and this fact is disclosed. (1 mark)

(c) The cost of such an item is measured at the fair value of the asset received which is equivalent so the fair value of the asset given up adjusted by the amount of any cash or cash equivalents transferred. Such an exchange of assets is regarded as a transaction which gain or loss. (2 marks)

Question 4 (6 marks)

Closing Rate / Net Investment Method

(a) Balance Sheet Items

The amounts in the balance sheet of the foreign enterprise should be translated into the reporting currency of the inveting company using the rate of exchange prevailing on the balance sheet date, that is the closing rate subject to the maintenance of the share capital at the rate of the date of its injection. (1 mark)

(b) Profit and Loss Account Items

The amounts should be translated at either the closing rate or at an average rate for the period. The latter should be calculated by the method considered most appropriate for the circumstances of the foreign enterprise, such as the weighted average method. The alternative method once selected, should be applied consistently from one year to another. (1 mark)

Exchange differences arising from the translation of the balance sheet of the foreign enterprise when the rate of exchange on the date of the closing balance sheet differs from that on the date of the previous year's balance sheet or the date of any subsequent change in capital structure should be dealt with as a movement on reserves. Exchange differences arising from translation to the profit and loss account only if the average rate is used should also be recorded as a movement on reserves.

Temporal Method

(a) Balance Sheet Items

Non-monetary assets should be translated at the rate of exchange prevailing on the date of acquisition. If non-monetary assets have been revalued, they should be translated at the rate existing at the closing balance sheet date. Non-monetary liabilities should be translated at histoirc rates. Monetary asets and liabilities should be translated at the rate of exchange existing at the closing balance sheet date. (1 mark)

(b) Profit and Loss Account Items

All revenues and expenses are translated at the rate of exchange ruling at the time the transactions are recorded in the books of the accounts of the foreign enterprise. If it is impractical to trace the relevant rates, the average rate is used except for depreciation and proposed dividends. (1 mark)

Translation differences should be taken to the profit and loss account as part of the porfits on ordinary activities before tax. (1 mark)

Question 5 (6 marks)

(a) Deferral Method

Under this method, the tax effects of the timing differences are calculated using the tax rates prevailing when the differences arise. If there are any subsequent changes in the tax rates no adjustments need to be made. It therefore produces a tax charge or credit which relates solely to the period, but results in a balance sheet provision which does not necessarily give an indication of the amount of tax payable or recoverable. (2 marks)

Liability Method

This is a method whereby deferred tax is calculated at the rate of tax estimated will be applicable when the timing differences reverse. Where there are changes in the rates, the deferred tax provision has to be revised to reflect these changes. The method ensures that the balance sheet provision has to be revised to reflect these changes. The method ensures that the balance sheet provision reflects the tax that will be actually payable or recoverable. In years when tax rates change, the tax charge or credit for the period will include adjustments of accounting estimates relating to prior periods. (2 marks)

(b) It is recommedned that deferred tax be computed under the liability method. (1 mark) This is consistent with the aim of partial provision whereby degerred tax is provided to the extent that it is probable that it will be payable or recoverable. (1 mark)

Question 6 (6 marks)

(a) Market Value

This approach is based on the price a company pays to acqie certain assets, or the price the company receives if it sells certain assets. Net realizable value and replacement cost use market value in the valuation process. (2 marks)

Economic Value

This based on the future cash flows that a company can be expected to get by owning certain asset. Forecasting of future cash flows is required with this approach and it is therefore important ot consider the time value of money. A discount rate must alos be determined in estimating the valuation of cash flows. (2 marks)

(b) It is recommended that individual assets on the balance sheet be presented with the current market value and liabilities are generally included at face values. (1 mark) There are practical problems in determining the appropriate discount rate over time. As such, it as difficult to present a current value balance sheet by showing future cash flows that will be generated by a company's net assets. (I mark)

Question 7 (23 marks)

(a)

Dr.Cash / Bank 1,320,000

Cr. Application and allotment account 1.320,000

(Cash received on application.)

(b)

Dr. Application and allotment account 340,000

Cr. Share premium account 200,000

Cr. Ordinary share capital account 140,000

(Amount due on allotment of 400,000 shares at $0.85.)

(c)

Dr. Application and allotment account 1,032,000

Cr. Cash / Bank 1,032,000

(Return of application money oversubscribed.)

(d)

Dr. Cash / Bank (l) 51,975

Cr. Application and allotment account 51,975

(Balance of money received on allotment.)

(e)

Dr. Call account 60,000

Cr. Ordinary share capital account 60,000

(Amount due on first and final call.)

(f)

Dr. Cash / Bank 59,910

Cr. Call account 59,910

(Amount received on first and final call.)

(g)

Dr. Investment - own shares 115

Cr. Application and allotment account 25

Cr. Call account 90

(Forfeiture of shares.)

(p)

Dr. Cash / Bank 475,000

Dr. Share premium account 25,000

Cr. 7% debentures account 500,000

(Issue of 7% debentures at a 5% discount.)

(1/2 mark for each of the above 40 entries, total of 20 marks)

Workings:

Amount received on allotment

Total due on application and allotment 340,000

Received on application 1,320,000

Less: Returned to applicants 1.032,000 288,000

Amount due on allotment 52,000

Less:

Unpaid amount (100 x $0.25) 25

51,975

(3 marks for the above workings; if the candidate did not show the workings, but got the $51,975 entries correct, then give him/her 3 additional marks)

Question 8 (23 marks)

1.Dec.31

Dr. Kao, Capital .38,000

Cr. Au, Capital 38,000

(To record transfer of Kao's equity in the partnership to Au.)

2. Dec.31

Dr. Kao, Capital 38,000

Cr. Bains, Capital 19,000

Cr. Johnson, Capital 19,000

(To record transfer of Kao's equity in the partnership to Bains and Johnson.)

3. Dec.31

Dr. Kao, Capital 38,000

Cr. Cash 5,000

Cr. Note payable to Kao 33,000

(To record withdrawal of Kao from the partnership.)

4. Dec. 31

Dr.

Dr. Ma, Capital ($2,000 x 3/7) 857

Cr. Cash 20,000

Cr. Note Payable to Kao 20,000

(To record withdrawal of Kao from the partnership)

5. Dec. 31

Dr. Equipment ($150,000 - $130,000) 20,000

Cr. Kao, Capital ($20,000 x 0.30) 6,000

Cr. Lam, Capital ($20,000 x 0.40) 8,000

Cr. Ma, Capital ($20,000 x 0.30) 6,000

(To revalue the equipment and allocate the gain in value to the partners.)

Dec. 31

Dr. Kao, Capital ($38,000 + $6,000) 44,000

Cr. Cash 10,000

Cr. Inventory 34,000

(To record withdrawal of Kao from the partnership)

(1 mark for each of the above 20 entries, 1/2 mark for each of the above 6 explanations, total 23 marks)

Question 9 (24 marks)

Overmeyer Corporation

Statement of Cash Flows

For 1991

Cash flows from operating activities

Sales $8,000,000 (2 marks)

Increase in accounts receivable (250,000) (2 marks)

Cash from customers $7,750,000

Cost of sales $4,800,000 (2 marks)

Increase in inventory 400,000 (2 marks)

Increase in accounts payable (300,000) (2 marks)

Cash payments for merchandise (4,900,000)

Other operating expenses (2 marks) (2,300,000)

Net cash flow from operating activities $550,000

Cash flows from financing activities

Proceeds from sale of capital stock $1,000,000 (2 marks)

Retirement of bonds (500,000) (2 marks)

Dividends paid (200,000) (2 marks)

Net cash flow from financing activities 300,000

Cash flows from investing activities

Purchase of land ($250,000) (2 marks)

Purchase of building and equipment (500,000) (2 marks)

Net cash flow from investing activities (750,000)

Net increase in cash $100,000

It is assumed that there were no sales of land, buildings and equipment or bonds (2 marks)