RA1.9 Limits on Disclosure (15 marks)
There are many situations in which management of a company may want to disclose more or less information about its operations. Consider a manufacturer that is preparing for the launch of a new product line. The information available to management may include the product’s projected release date, the associated costs, the price at which the product will be sold, and the results of any market research performed as to the expected sales.
Why might management want to share the information above with the public? Why might they try to keep this information private? Also consider the impact of management’s decision on those outside of the organization 9 (15 marks)
CHAPTER 2 Conceptual Framework Underlying Financial Reporting
Instructions (15 MARKS)
For each item, briefly discuss how the proposed constraint addresses concerns about the costs and benefits of financial reporting.
P2.8 Recently, your Uncle Warren, who knows that you always have your eye out for a profitable investment, has discussed the possibility of your purchasing some corporate bonds that he just learned of. He suggests that you may wish to get in on the ground floor of this deal. The bonds being issued by Jingle Corp. are 10-year debentures, which promise a 40% rate of return. Jingle manufactures novelty and party items.
You have told Uncle Warren that, unless you can take a look at Jingle’s financial statements, you would not feel comfortable about such an investment. Thinking that this is the chance of a lifetime, Uncle Warren has obtained a copy of Jingle’s most recent, unaudited financial statements, which are a year old. These statements were prepared by Mrs. Jingle. You look over these statements, and they are quite impressive.
The statement of financial position showed a debt to equity ratio of 1:10 and, for the year shown, the company reported net income of $2,424,240.
The financial statements are not shown in comparison with amounts from other years. In addition, there are no significant note disclosures about inventory valuation, depreciation methods, loan agreements, and so on.
Write a letter to Uncle Warren explaining why it would be unwise to base an investment decision on the financial statements that he has given you. Refer to the concepts discussed in this chapter (Mark 15)
CHAPTER 2 Conceptual Framework Underlying Financial Reporting
RA2.6 Faithful Representation (15 MARKS)
In the IASB standard-setting conceptual framework, the word “reliability” has been replaced with “faithful representation.” This has caused much discussion among preparers of financial information. The change has led to other implications related to substance over form, neutrality, conservatism, and the ability of entities to “override” a standard in very rare circumstances.
Discuss the following questions. (You may find the IASB’s Basis for Conclusions on the Exposure Draft Conceptual Framework for Financial Reporting, of May 2015 (https://www.ifrs.org/-/media/project/conceptual-framework/exposure-draft/published-documents/ed-conceptual-framework-basis-conclusions.pdf), and Summary of the Discussion Paper: A Review of the Conceptual Framework for Financial Reporting, of January 2015 (http://archive.ifrs.org/Current-Projects/IASB-Projects/Conceptual-Framework/Documents/Effect-of-Board-decisions-on-DP-January-2015.pdf), helpful in your discussion.)
a. “Faithful representation” has replaced the term “reliability” as a fundamental qualitative characteristic of financial information. What does faithful representation mean and how does this differ from reliability? Why was the term “reliability” replaced?
b. What does “substance over form” mean? Give examples of where this might be relevant.
PC.15 Tudor Services Ltd., a private company following ASPE, has an August 31 fiscal year end. The company’s trial balance prior to adjustments follows:
Tudor Services Ltd.
August 31, 2020
Cash $ 35,420
Accumulated depreciation—equipment $ 42,000
Accumulated depreciation—vehicles 48,125
Accounts payable 7,950
Notes payable 60,000
Common shares 20,000
Retained earnings 55,750
Service revenue 200,525
Supplies expense 28,038
Insurance expense 9,500
Interest expense 3,392
Rent expense 21,000
Salaries expense 45,000
• 1. The equipment has an expected useful life of 10 years. The vehicles’ expected useful life is eight years.
• 2. A physical count showed $2,000 of supplies on hand at August 31, 2020.
• 3. Accrued salaries payable at August 31, 2020, were $2,550.
• 4. Interest on the 5.5% note payable is payable at the end of each month and $10,000 of the principal must be paid on December 31 each year. Interest payments are up to date as at July 31, 2020.
• 5. During 2020, additional common shares were issued for $3,000 cash.
a. Enter the trial balance on a work sheet and complete the work sheet. (Hint: Consider writing out the adjusting journal entries at August 31, 2020.) Ignore income taxes.
b. Prepare an income statement and a statement of retained earnings for the year ended August 31, 2020, and a balance sheet as at August 31, 2020.
c. Prepare closing entries.
d. Explain how the financial statements in part (b) would change if Tudor operated as a sole proprietorship, rather than a corporation.
1 Most companies use accounting software systems instead of manual systems. The software allows the data to be entered into a database and various reports can then be generated, such as journals, trial balances, ledgers, and financial statements.
2 Accumulated Other Comprehensive Income (AOCI) would also be part of the expanded basic equation if the company had Fair Value-OCI Investments (or other items affecting Other Comprehensive Income and Accumulated Other Comprehensive Income). If the AOCI balance represented accumulated gains, it would be added in the equation, similar to retained earnings. If AOCI represented accumulated losses, it would be subtracted.
3 The transition to electronic bookkeeping systems and databases has dramatically changed the way bookkeeping is carried out. Much of the terminology and visual layout of the reports has been retained, however.
4 Other, less common adjustments, such as revaluation of property, plant, and equipment at the end of an accounting period (Chapter 10), are discussed on a chapter-by-chapter basis.
5 Fair value-OCI investments are not permitted under ASPE. All fair value investments would typically be treated as FV-NI investments under ASPE. See Chapter 9 for a full discussion of accounting for investments.
6 Accumulated Other Comprehensive Income is a statement of financial position (SFP) account that is the total of all past charges and credits to OCI to the SFP date. It is similar to the Retained Earnings account.
7 Corporations are incorporated under a government act such as the Canada Business Corporations Act. The main reason for incorporation is to limit the liability for the owners if the corporation gets sued or goes bankrupt. When companies are incorporated, shares are issued to owners and the company becomes a separate legal entity (that is, it is distinct from its owners).