Week 1

Accounting is a language of business (communicate something about the business)

Accounting measures the activities of the business and communicates the financial info to the stakeholders

Accounting is a process of recognizing/ identifying, measuring, recording business/accounting transactions,

analysing, summarising, and reporting/ communicating financial information to business stakeholders.

Business
- Exchange of goods, services, and money on an arm’s length basis
- Result in mutual benefits for both buyer and seller
- Aim to create value
- Owner’s face:
a. Risks: possible future sacrifices e.g. increasing cost of raw materials
b. Rewards: profits distributed to owners

Objective of business: Value creation

Business adds value via it’s value chain

Types of businesses: 1. Manufacturing, 2. Merchandising, 3.Service (difficult to classify)

Nature of business decides which legal form

Legal forms of business
- Profit Organisations
a. Sole-proprietorship (does not have a separate legal entity) (no limited liability)
b. General partnership (does not have a separate legal entity) (no limited liability, max 20
partners)
c. Limited Liability Partnership (each partner has limited liabilities)
d. Limited Partnership (Min 2 partners- 1 general partner (he has no limited liability), 1 limited
partner)
e. Company
 private Company (max 50 owners) (exempt Pvt max 20 owners)
 Public Company (listed on share exchange)(more than 50 owners)
Only companies required to prepare financial statements

Stakeholders of public and private sector companies

Public sector:
- Public sector organisations are owned, controlled and managed by the government or other state-
run bodies. E.g. ministries, statutory boards etc.
- Gov (to decide on the allocation of resources, policy-making, and governance)
- Public/residents (to get info on how tax revenue is utilized)
- Research institutions/uni (to get info for research on resource utilisation, social, economic, and
political impact, and policymaking)
- International bodies (to get info on collaboration and negotiation)

Private sector:
- Private sectors organisations are owned, controlled and managed by individuals, groups or business
entities. This includes both private companies and public listed companies. A public company is a
company listed on a stock exchange, a private company is one that is not listed on a stock
exchange.
- Investors (to decide whether to invest in shares)
- Creditors (to decide whether to lend money)
- Customers (to decide whether to purchase products)
- Suppliers (to decide the customer’s ability to pay for suppliers)
- Managers (to decide production& expansion)
- Employees (to decide employment opportunities)
- Competitors (to decide market share and profitability)
- Regulators (to decide on social welfare)
- Tax authorities (to decide on taxation policies)
- Local communities (to decide on environment issues)

Separate legal entity and owner’s liabilities

- Have a separate legal entity when the business is separated from its owners for accountability
- An owner is having a limited liability when he is not personally liable for the debts and obligations
of the business.

Factors to consider when selecting a legal form of business

- Ease in formation/cessation
- Ease in funds raising
- Lifespan of business
- Transferability of ownership (how easy it is to transfer)
- Degree of privacy (whether they need to disclose financial info)
- Risk: Is your liability limited? (limited vs unlimited liability; separate legal entity)
- Tax advantage
 - Compliance cost (cost incurred to comply with regulations)
- Control

Reporting requirement of business entities in Singapore

- Companies Act – provides rules and regulations governing companies in Singapore e.g.
incorporation, issue of shares, management & administration, financial statement requirements
etc.
- Companies listed on a stock exchange need to also follow that exchange’s rules & regulations e.g.,
Singapore Exchange (SGX) rules require disclosures on corporate governance, sustainability
reporting etc.
a. Corporate governance – system of rules, practices, and processes by which firm is directed
and controlled
b. Sustainability reporting (June 2016) including climate change reporting (Dec 2021)

The business can be viewed as having a series of contracts with its stakeholders
Stakeholders are parties that are affected by the business
Stakeholders are different from shareholders, shareholders are only one type of stakeholders

Type of contracts
- Written and verbal
- Explicit and implicit

Cause of contracting issues

- Information asymmetry
a. Condition in which at least some relevant information is known to some but not all parties
involved.
b. Information asymmetry causes markets to become inefficient since all the market
participants do not have access to the information they need for their decision-making
processes
c. One party has more knowledge than the other party

Pre-contractual information problem

- Bargaining failure
a. Failure to reach an agreement even when a contract could be constructed that would be
mutually advantageous.
b. Solution: Signalling (to show, to tell)

- Adverse selection
a. The tendency of an individual with private information about something that affects a
potential trading partner’s costs or benefits to extend an offer that would be detrimental to
the trading partner.
b. Solution: screening & self-selection, bonding
 - Agency problem
a. This is a principal-agent conflict of interests problem whereby the agent is supposed to act
in the principal's best interests but is motivated by self-interest when his interests are
different from those of the principal.
b. Solution: monitoring, incentives

Stakeholders and their information needs

Role of accounting in business

To provide (financial & non-financial) for decision-making by stakeholders

Role of accountants

Information risk is a risk that the information prepared and used for decision making has material
misstatements.

Factors affecting the quality of info

- Quality of information is affected by:
a. Judgement
b. Uncertainty (sometimes info not available)
c. Management incentives

Reduce information risk

- Compliance to laws:
a. SFRS(I) (standards setters: ASC, FASB, IASB)
b. Companies Act
 c. SGX regulations
d. Corporate Governance Practices
- Code of Professional Conduct and Ethics
- Assurance / External audit
- Internal controls and procedures

Reporting requirement of business entities in SG

- Companies Act: provides rules and regulations governing companies in SG e.g. incorporation, issue
of shares, management& admin
- Companies listed on a stock exchange need to follow that exchange’s rules & regulations
a. Corporate governance  system of rules, practices and processes by which firm is directed
and controlled
b. Sustainability reporting  including climate change reporting

Main Accounting Standards Setting Bodies

- IASB – International Accounting Standards Board
a. Issues exposure drafts to get feedback
b. Finalises and issues the International Financial Reporting Standards (IFRS)
- FASB – Financial Accounting Standards Board – USA accounting standards setting body
- ASC – Accounting Standards Council – Singapore accounting standards setting body
a. Issues Financial Reporting Standards (FRS) in SG
b. Board policy obj is to adopt IFRS taking into consideration local economic and business
circumstances and context and entities
c. SG Financial Reporting Standards (International) (SFRSI)
d. Financial Reporting Standards (FRS)
e. SFRS for small companies
f. Charity accounting standards

The conceptual framework (very general) look at slides

Elements of financial statements

Preparation of these financial statements to report to the entity stakeholders is known as financial
reporting
Objective of financial reporting
- The objective of general purpose financial reporting is to provide financial information about the
reporting entity that is useful to existing and potential investors, lenders and other creditors in
making decisions relating to providing resources (funds) to the entity. Those decisions involve
decisions about:
- (a) buying, selling or holding equity (shares) and debt instruments (bonds);
- (b) providing or settling loans and other forms of credit; or
- (c) exercising rights to vote on, or otherwise influence, management’s actions that affect the use of
the entity’s economic resources.

Reporting entity
- A reporting entity is an entity that is required, or chooses, to prepare financial statements. A
reporting entity can be a single entity or a portion of an entity or can comprise more than one
entity. A reporting entity is not necessarily a legal entity.
- If reporting entity comprises both the parent company and its subsidiaries the reporting entity’s
financial statements are referred to as consolidated financial statements
- If the reporting entity is the parent company alone then the financial statements are referred to as
unconsolidated financial statements
- If reporting entity comprises 2 or more entities that are not linked by a parent-subsidiary
relationship the reporting entity’s financial statements are referred to as combined financial
statements

Business entity concept  a business separated from its owner

Elements of financial statements

- Assets
a. An asset is a present economic resource controlled (does not mean legal ownbership) by
the entity as a result of past events. Total resources of a company
b. An economic resource is a right that has the potential to produce economic benefits.
 Rights
  Rights that have the potential to produce economic benefits take many forms,
including:
 (a) rights that correspond to an obligation of another party, for example: rights to
receive cash and goods or services.
 (b) rights that do not correspond to an obligation of another party, for example:
rights over physical objects, such as property, plant and equipment or inventories;
and rights to use intellectual property.
 Potential to produce economic benefits
 An economic resource is a right that has the potential to produce economic benefits.
For that potential to exist, it does not need to be certain, or even likely, that the
right will produce economic benefits. It is only necessary that the right already exists
and that, in at least one circumstance, it would produce for the entity economic
benefits beyond those available to all other parties.
 Control
 An entity controls an economic resource if it has the present ability to direct the use
of the economic resource and obtain the economic benefits that may flow from it.
 Control includes the present ability to prevent other parties from directing the use of
the economic resource and from obtaining the economic benefits that may flow
from it.
 It follows that, if one party controls an economic resource, no other party controls
that resource.
c. Examples of assets: cash, property, plant and equipment buildings/equipment/motor
vehicles, intangible assets trademarks/copyrights, inventory, accounts receivable
d. Intangible assets  Must be able to give a reliable
dollar value to be considered an asset

- Liabilities
a. A liability is a present obligation of the entity to transfer an economic resource as a result of
past events. Amounts owed to creditors.
b. For a liability to exist, three criteria must all be satisfied:
(a) the entity has an obligation;
An obligation is a duty or responsibility that an entity has no practical ability to avoid. An
obligation is always owed to another party (or parties).
If one party has an obligation to transfer an economic resource, it follows that another
party (or parties) has a right to receive that economic resource.
The obligations can be contractual or constructive

(b) the obligation is to transfer an economic resource; and

The obligation must have the potential to require the entity to transfer an economic
resource to another party (or parties). For that potential to exist, it does not need to be
certain, or even likely, that the entity will be required to transfer an economic resource
—the transfer may, for example, be required only if a specified uncertain future event
occurs. It is only necessary that the obligation already exists and that, in at least one
circumstance, it would require the entity to transfer an economic resource.

(c) the obligation is a present obligation that exists as a result of past events.
A present obligation exists as a result of past events only if:
(a) the entity has already obtained economic benefits or taken an action; and
(b) as a consequence, the entity will or may have to transfer an economic resource that
it would not otherwise have had to transfer.
o Examples of liabilities: accounts payable, borrowings (loans)
 - Equity (owner equity) (claims that do not meet the definition of a liability)
a. Equity is the residual interest in the assets of the entity after deducting all its liabilities.
Represents the owner’s claims to resources
b. Two sources:
 External: Capital contributions from business owners
 Internal: Retained earnings (retained profits)
c. Companies: Shareholder’s equity
- Revenue
a. Amounts recognized when the company sells products or provides services to customers

- Income
a. Income is increases in assets, or decreases in liabilities, that result in increases in equity,
other than those relating to contributions from holders of equity claims.
b. Revenue from sale of goods and services in the ordinary activity of an entity.
c. Other income and gains represent other items that meet the definition of income and may,
or may not, arise in the course of the ordinary activities of an entity.
d. Net income is the difference between revenues and expenses

- Expenses
a. Expenses are decreases in assets, or increases in liabilities, that result in decreases in equity,
other than those relating to distributions to holders of equity claims.
- Dividends
a. ARE not an expense

Objectives of financial statements

- Is to provide financial information about the reporting entity’s assets, liabilities, equity, income
and expenses that is useful to users of financial statements in assessing the prospects for future net
cash inflows to the reporting entity and in assessing management’s stewardship of the entity’s
economic resources.

Types of Financial statements (format)

- In the statement of financial position, by recognising assets, liabilities and equity; (Balance sheet)
- In the statement(s) of financial performance, by recognising income and expenses; (Statement of
Profit or Loss and other Comprehensive Income (Income Statement) )
- In other statements and notes, by presenting and disclosing information about:
(iii) cash flows; (Statement of cash flows)
(iv) contributions from holders of equity claims and distributions to them; and (Statement of
changes in shareholder’s equity)
(v) the methods, assumptions and judgements used in estimating the amounts presented or
disclosed, and changes in those methods, assumptions and judgements. (notes to the financial
statements)

Statement of financial position (balance sheet)

 - The “what do we have” statement
- Shows the resources that a business controls and the liabilities a business owes at a specific date.
(end of the month)
- Assets – liabilities = net assets

Statement of profit and loss (income statement)

- Reports the company’s revenues and expenses over an interval of time

- The “what did we do” statement
- Shows the business’ financial performance (profitability) for a period of time.
- Entity performance usually measured in terms of profit
- Income- expenses = net income
- Expenses > income = net loss
- Heading: company name, income statement, time period (for the period ended…)
-

Statement of changes in equity

- Shows changes in owners’ equity for a period.

 - Common stock External source of stockholder’s equity
- Retained earnings internal source of stockholder's equity

Statement of cash flows

- Shows cash receipts and cash payments during a period.

- Operating cash flows cash receipts and cash payments for transactions involving revenue and
expense activities during the period. In other words, operating activities include the cash effects of
the same activities that are reported in the income statement to calculate net income.
- Investing cash flows: generally include cash transactions for the purchase and sale of investments
and long-term assets. Long-term assets are resources owned by a company that are thought to
provide benefits for more than one year.
- Financing cash flows: include cash transactions with lenders, such as borrowing money and
repaying debt, and with stockholders, such as issuing stock and paying dividends.

Notes to financial statements

- Additional notes and information to supplement the financial statements
- Provides details of accounting policies adopted, detailed computations and breakdown of the
numbers reflected in the financial statements.

Monetary unit concept Business transactions must be measurable in monetary unit

Going concern concept Financial statements are normally prepared on the assumption that the
reporting entity is a going concern and will continue in operation for the foreseeable future. (the entity
has neither the intention nor a need to enter liquidation or to cease trading)

Time period concept Requires that accounting information be reported at regular intervals

Relationships among financial statements

The first 4 financial statements are interrelated
To find revenue net income add total expenses
Net income (income statement  see from statement of changes in equity
Issuance of Shares ending share capital less beginning share capital balance
Less: Dividends  Ending retained earnings balance less beginning retained earnings balance less net
income
Total Assets Total equity + Total liabilities
Types of business activities
- Financing activities

- Investing activities
a. The purchase of long-term resources or assets (benefit for more than a year)

- Operating activities
a. Occur on a daily basis, day to day ordinary activities
b. Buying of G&S for suppliers, employees and landlords and the selling of G&S to customers

Types of business activities

Source documents are the evidence used to record the business transactions in the accounting system

The accounting equation

“owes” the company does not owe the owners for the capital that the owners have injected and for the
profits generated by the company
A (assets)= L (liabilities) + O E (owner’s equity) (equation of the balance sheet)
OE comprises of share capital and retained earnings (profits) and other reserves
Retained earnings  opening balance + net income – dividend = closing balance (whatever undistributed
profits)

Income – Expenses = net income ( eqn of the income statement)

Liabilities + equity is source of funds
Assets is use of funds

Effect on the accounting equation

- Each business transaction will have at least two effects on the accounting equation.
- The accounting equation must be maintained after each business transaction.

Objectivity concept  Objective information are verifiable by Independent observers

Historical cost concept  Transactions are recorded at purchase cost

Accounts receivable: amounts owed by customers

Table that shows Figures in red affecting the cash account statement of cash flows
Table that shows Figures in red which are revenue and expenses  statement of profit or loss
Table that shows Figures in red which are assets, liabilities and equity values  statement of financial
position
Week 2
Accounting Assumptions
- A set of rules that ensures the business operations of an organization are conducted efficiently and
as per the accounting standards
- Economic entity assumption: Business (The Entity) separate from owners
- Going concern assumption: no intention or need to liquidate/ curtail operations
- Time period assumption: economic life is divided into artificial periods
- Monetary unit assumption: only record transactions capable of being expressed in money in
accounts
- Cost principle: Assets are recorded at cost
- Full disclosure principle: disclose info that makes a diff to the decisions of the 3 users(investors,
lenders and creditors) of financial statements

The accounting cycle (4 phases)

- Recording phase
a. The Daily recording of business transactions during the financial period (a month, a quarter,
a year)
b. Daily business transactions: sale of G&S to customer, purchase of G&S for suppliers,
employees and landlords, collections from customers and payments to suppliers, employees
and landlords
c. Steps:
1. Identify/recognize and measure the daily business transactions (determine the value
monetary concept)
2. Journalise (record) transactions
3. Post each journal entry to appropriate ledger accounts
4. Prepare an unadjusted trial balance
- Adjusting phase
a. Takes place at the end of the financial period after the recording phase
b. Steps:
1. Identify/recognize and measure the end of period/adjusting entries (some can be
accounting transactions)
2. Journalise (record) the end of period/adjusting entries
3. Post each adjusting entry to appropriate ledger accounts
4. Prepare an adjusted trial balance
- Reporting phase
a. Takes place at the end of the financial period after the adjusting phase
b. Steps: Prepare financial statements
- Closing phase (once a year)
a. At the end of the financial year
b. Steps:
1. Journalise (record) the closing entries
 2. Post each closing entry to appropriate ledger accounts
3. Prepare an after-closing trial balance

An account
- Cash and share capital are known as accounts
- It is the basic unit for recording business transactions
- It contains a detailed record of increases and decreases in specific assets, liabilities or shareholder’s
equity accounts during a period
- Examples of accounts names: Borrowings / Loans Payable / Notes Payable, Salary Expense(expense
account), Salary Payable (liability), Loans Payable (amt owing to banks) vs Accounts Payable (amt
owing to suppliers) vs Salary Payable (amt owing to employees) (all liabilities), Accounts Receivable
(asset, amt owing by the customers to the business) vs Accounts Payable
- Staff loan is an asset as it is a loan receivable resulting from loans given to staff.

3-digit account code The company has not more than 999 account codes (grossly understated in reality)
For all journal entries: at least two entries, at least one debit, and one credit
Debit=credit
Journal (business transactions are first recorded here)
- Chronological record of transactions
- Organised by date
- “journalised business transactions”

Types of journals
- Special journal- sales, purchase
- General journals

Ledger
- Book holding all the accounts
- Organized by account
 Debit left side, credit right side

Rules of double entry (Dr and Cr)

- A=L+OE
- A business transaction always has at least two effects on the accounting equation
- A business transaction always has at least one debit and one credit entry
- Total debits must equal total credits in the accounts for each business transaction
Want to increase asset account we record transaction on the debit side of the asset account
Want to decrease asset account we record transaction on the credit side of the asset account
Want to increase liabilities or OE account we record transaction on the credit side
Want to decrease liabilities or OE account we record transaction on the debit side
SC and RE will have the same debit and credit rules as equity
Income has the same debit and credit rules as RE and OE
Expenses and dividends will have the opposite rules as RE and OE

Debit balance of the cash account  Normal balance

Assets accounts will have a debit balance as their normal balance, asset increases debit
Credit balance of a cash account  means abnormal balance, it means the company has spent more cash
than what it actually has
Liability and equity accounts have credit balances as normal balances, liability/equity increases credit
Share capital and retained earnings will have credit balances as normal balances, share capital/retained
earnings credit

Income will have credit balance as normal balance, increase in income credit
Expenses and dividends will have debit balances as normal balance, increase expense/dividend debit
Normal balance is the side we increase the account

Trial balance
- TRIAL BALANCE IS A LIST OF ACCOUNT BALANCES AND SHOWS TOTAL DEBITS = TOTAL CREDITS
- Listing of all accounts and their balances as at a specific date
- An internal document. Not part of financial statements
- Shows total debits= total credits
 - Just because total debits =total credits does not mean financial statements are accurate
- Examples of errors not detected: error of omissions:
a. Transactions not recorded in journal or ledgers
b. Posting errors: journal recorded but not posted to ledger, posting of journals

- Purposes:
a. To facilitate the preparation of financial statements
b. To check for errors

Trial balance errors

- When the total debit value is not equal to the total credit value in a trial balance, there are errors
- Types of errors:
a. Single sided entry
b. Two debit or credit entries posted
c. Debit value not equal to credit value
d. Error in posting of journals to ledgers
e. Calculation errors of ledger balances
f. Opening balance not brought forward in the ledgers
g. Extraction errors from ledgers to trial balance
h. ERRORS OF OMMISSIONS: TRANSACTION NOT RECORDED IN JOURNAL OR LEDGERS
i. POSTING ERRORS: JOURNAL RECORED BUT NOT POSTED TO LEDGER, POSTING OF
JOURNALS TO LEDGER TWICE
j. COMPENSATION ERRORS: INCORRECT AMOUNT RECORDED FOR BOTH DEBIT AND CREDIT
k. PREMATURE RECOGNITION OF REVENUE: RECOGNISING REVENUE BEFORE IT IS EARNED
l. CAPITALISATION OF EXPENSES: RECORDING AN EXPENSE AS AN ASSET
- However, when the total debit value equals the total credit value in a trial balance, there is no
guarantee that there are no errors

Subsidiary ledger (only for customers)

- Each customer who buys on credit from the company has a specific Accounts Receivable (AR)
account (sales Subsidiary ledger)
- Each supplier, whom the company buys on credit from has a specific Accounts Payable (AP) account
(Purchases Subsidiary ledger)

Control account in the general ledger (control)

- In the general ledger there is a AR control account and a AP control account
- The control account will consolidate all the transactions and balances of the subsidiary ledgers

Use control accounts only

we will record our credit transactions to the AR and AP control account, and there is no need to prepare
the subsidiary ledgers.
GST= Goods and Services Tax
Value-added Tax (VAT) or consumption tax collected at each stage of production or consumption of a good

When a business purchases from another business  GST input tax (can be claimed back GST
receivable)
When customer buys from business GST output tax (GST payable)
When a deposit forms partial payment for goods or services supplied, GST must be charged on the amount
of deposit and accounted for in the accounting period in which the deposit is received.

Recording GST
- Output tax (GST payable) (liability)
a. Charge customers
b. Received from customers
c. Payable to IRAS
- Input tax (GST Receivable) (asset)
a. Charge by suppliers
b. Paid to suppliers
c. Claimable from IRAS

Cash-basis accounting: Income are recorded when cash is received from customers and expenses are
recorded when cash is paid to suppliers
Both Related to timing of recognising income and expenses
Accrual-basis accounting: Income are recorded when earned and expenses are recorded when incurred
Earned business has provided the G&S to the customers

Concepts that apply to accrual accounting

- Time period
- Revenue recognition principle
Adopt Accrual basis of accounting

Relates to the timing of recognising income and expenses

Adjusting entries

Matching principle: Recognise all the expenses used to generate the income in the same period that the
income are recognised

Assets (economic resources that are expected to benefit the business in the future
Recognition criteria:
- Controlled (Vs Owned)
- Measurable (Monetary unit concept)
- Resulting from past transactions
- Future economic benefits
Pre-paid rent = asset
Rent= expense

Week 3
Adjusting entry depends on the entry made during the recording phase
An increase in expense will lead to a decrease in retained earnings (owner equity).

Four main types of adjusting entries

- Converting asset to expense
Cash is paid in advance and recorded as an asset before the benefits are consumed
When asset is used: Asset must be converted to an expense

a. Prepaid Rent / Insurance Expense (assets at payment) Rent / Insurance Expense (when
benefits are consumed)

b. Office / Cleaning / Pet Grooming Supplies (assets at purchase)Office / Cleaning / Pet

Grooming Supplies Expense (when used up)
 c. Property, Plant and Equipment “PPE” (assets at purchase)Depreciation (expense when
assets are used to generate revenue)
The concept of depreciation
 Depreciation is the systematic allocation of the cost of a depreciable asset to
expense (have to recognise the cost of using the supplies)
 Accumulated depreciation  contra asset account
 Depreciation is an expense.

- Converting liability to revenue

 Cash is received in advance and recorded as liability as the revenue is not earned
 If revenue has been earned: liability must be converted to revenue
 Unearned income/ revenue  Liability
 Depending on where it was entered:
 Transfer from OE to liability Or liability to OE
  Unearned income examples

- Accruing unpaid and unrecorded expenses

 Expenses incurred (utilised) but not yet paid and an invoice has not been received. No
record has been made
 An economic benefit has been received, no record has been made and no payment made.
New entry to record the expense and a liability must be made.
 Common expenses are utilities and telecommunication expenses
a. Accrued utility expense

b. Interest payable
 - Accruing uncollected and unrecorded income

 Income earned but collection has not been received and an invoice has not been issued. No
record has been made.
 Income has been earned, no record was made and no collection received. New entry to
record the income and an asset must be made
Accrued income/revenue or accounts receivable (accrued interest income)

Materiality concept  Comply with SFRS(I) and GAAP unless the transaction is not material
By material we mean that the transactions if not recorded correctly will have an impact on the decisions
made by the user of the financial statements
 - When the concept is applied
a. Office / Cleaning / Pet Grooming Supplies are recognised as expense at point of acquisition,
instead when supplies are used up to generate revenue.
b. Some low value Property, Plant and Equipment are not recognised as asset at point of
acquisition and then charge depreciation during assets usage, they are recognised as
expense at point of acquisition.

Closing of accounts
- Done once at the end of the financial year
- Zeroise all the temporary accounts to the Retained Earnings Account and get ready for the new
financial year

Steps in closing the accounts

1. Close all Income Accounts to the Retained Earnings Account
2. Close all Expenses Accounts to the Retained Earnings Account
3. Close Dividends Accounts to the Retained Earnings Account ( Dividends is closed directly to the
Retained Earnings Account)

Temporary accounts
- Closed at the end of the financial year
- Set the balance to zero and transfer to retained earnings
- Start the new financial year with zero balances
a. Income
b. Expenses
c. Dividends

Permanent accounts (balance sheet accounts)

- Not closed at the end of the financial year (carry forward balance to next year)
- Ending balances of year 1 are carried forward as beginning balances of year 2, will become opening
balances
a. Assets
b. Liabilities
c. Shareholder’s equity

Complete set of financial statements

- A statement of financial position as at the end of the period
- A statement of profit or loss and other comprehensive income for the period
- A statement of changes in equity for the period
- A statement of cash flows for the period
- Notes comprising a summary of significant accounting policies and other explanatory information
Statement of financial position (Balance sheet)
- As a minimum, the statement of financial position shall include line items that present the following
amounts:
(a) property, plant and equipment;
(b) investment property;
(c) intangible assets;
(d) financial assets (excluding amounts shown under (e), (h) and (i));
(e) investments accounted for using the equity method;
(f) biological assets;
(g) inventories;
(h) trade and other receivables;
(i) cash and cash equivalents;
(j) the total of assets classified as held for sale and assets included in disposal groups classified
as held for sale in accordance with SFRS(I) 5 Non-current Assets Held for Sale and
Discontinued Operations;
(k) trade and other payables;
(l) provisions;
(m)financial liabilities (excluding amounts shown under (k) and (l));
(n) liabilities and assets for current tax, as defined in SFRS(I) 1- 12 Income Taxes;
(o) deferred tax liabilities and deferred tax assets, as defined in SFRS(I) 1-12;
(p) liabilities included in disposal groups classified as held for sale in accordance with SFRS(I)5
(q) non-controlling interests, presented within equity; and
(r) issued capital and reserves attributable to owners of the parent.

- Classified balance sheet

o Non-Current Assets
o Current Assets
o Non-Current Liabilities
o Current Liabilities
o Shareholders’ Equity

Classification of assets
An entity shall classify an asset as current (short term) when:
a. It expects to realise the asset, or intends to sell or consume it, in its normal operating cycle;
b. It holds the asset primarily for the purpose of trading;
c. It expects to realise the asset within twelve months after the reporting period; or
d. The asset is cash or a cash equivalent (as defined in SFRS(I) 1-7) unless the asset is restricted from
being exchanged or used to settle a liability for at least twelve months after the reporting period.
An entity shall classify all other assets as non-current.

The operating cycle

- is the average period of time required for a business to make an initial outlay of cash to buy or to
produce and sell G&S to its customers and to receive cash from Its customers in exchange for G&S
Classification of liabilities
An entity shall classify a liability as current when:
a. It expects to settle the liability in its normal operating cycle;
b. It holds the liability primarily for the purpose of trading;
c. The liability is due to be settled within twelve months after the reporting period; or
d. The entity does not have an unconditional right to defer settlement of the liability for at least
twelve months after the reporting period.
An entity shall classify all other liabilities as non-current.

Liquidity
- Measure of how quickly an item cab be converted into cash
- A classified balance sheet usually lists assets in order of their liquidity (a practice)
o An example (in order of least liquidity): Inventory, Office Supplies, Prepaid Expense,
Accounts Receivables, Cash

- Classified balance sheet order from most liquidity

- Classified balance sheet  order from least liquidity

Other comprehensive income
-
Income statement presentation methods
- By nature of expense

- By function of expense

- Both start with revenue

Statement of cash flows
- Cash flows from operations
- Cash flows from investing
- Cash flows from financing

Notes to accounts
- General (place of domicile, registered office, principle activities)
- Significant accounting policy
- Explanatory notes

How to evaluate quality of financial information?

- Financial accounting amounts = f(Economics +Measurement error+ bisas)

Qualitative Characteristics of Useful Financial Information

- Identify info that will be the most useful
- To users of financial reporting i.e. investors (existing and potential) and lenders (and other
creditors)
- For making decisions about the entity based on the financial reports prepared by the entity
- Info must be relevant (primary) and faithfully represents (secondary) what it purports to
represent. The usefulness of financial info is enhanced if it is comparable, verifiable, timely and
understandable

Fundamental Qualitative Characteristics

- Relevance
o Info is relevant when it makes a difference in the decisions made by the users
o Information will have a difference in decision-making if it has (Makes a difference in user’s
decisions) :
 Predictive value or
 If the information can be used as an input for users making predictions
 Confirmatory value or
 Provides feedback about previous evaluations
 Both
- Relevance (materiality entity specific)
o Information is material if its omission or misstatement could influence decisions
 Entity specific
 Based on magnitude or nature, or both
 Non-quantitative threshold – professional judgement
- Faithful representation
o Financial information must faithfully represent the economic phenomena that it purports to
represent
 o Three characteristics for perfect faithful representation:
 1. Complete
 2. Neutral
 3. Free from error
o Impossible to be perfectly accurate in all respects, try to maximise these three
characteristics
- How to apply relevance and faithful rep
o 1. Identify the economic phenomenon that is useful for decision making
o 2. Identify the type of information (quantitative and qualitative information) about the
economic phenomenon that would be most relevant
o 3. Determine if information is available and can be faithfully represented in the financial
statements

Enhancing qualitative characteristics

- Comparability
o Able to see differences and similarities across entities and time
o Information is more useful when it can be:
 Compare with other entities
 Compare across time
o Not the same as consistency
 Not uniformity
- Verifiability
o Verifiability helps assure users that information faithfully represents the economic
phenomena it purports to represent
o Different independent observers could reach consensus (does not mean exact figure)
o Verification can be direct or indirect (Able to confirm directly or indirectly)
- Timeliness
o Timeliness means having information available to decision-makers in time to be capable of
influencing their decisions
o The older the information, the less useful it is (the newer the better)
o SGX listing requirement
o Companies Act requirement
- Understandability
o Classifying, characterizing and presenting information clearly and concisely makes it
understandable (clear and concise)

Cost constrain
- There is no perfect financial statements.
- Reporting financial information incurs costs.
- Costs must be justified by the benefits of reporting.
- Expensive to hire accountants (direct costs and indirect costs)

Week 4
Expenses
- Expenses encompasses losses as well as those expenses that arise in the course of the ordinary
activity of the entity.
- Example of lo
- Usually take the form of an outflow or depletion of assets
- Losses may or may not arise in the course of the ordinary activities of the entity (losses occur for
reasons outside of business
- Examples of losses: loss from sales of property, play &equipment, Loss from sale of investments
Recognition of expenses
- Recognised in income statement when a decrease in future economic benefits related to a decrease
in an asset or an increase of a liability has arisen that can be measured reliably. (reduction in
equity, + decrease in asset or increase in liability)
- When the expense has no direct relationship with the revenue generated, then the expenses are
recognized on the basis of systematic and rational allocation
- When an asset no longer produces future economic benefits then the asset should be transferred
to expense
- When a liability is incurred

Matching principle: Recognise all the expenses used to generate the income in the same period that the
income are recognised
- Expenses are recognized in the income statement on the basis of a direct association between the
costs incurred and the earning of income  matching of costs with revenue, involves the
simultaneous or combined recognition of revenues and expenses (in the same period)
- The matching concept does not allow the recognition items in the balance sheet which do not meet
the definition of assets and liabilities.

Merchandise inventories
- Are goods purchased by merchandising firms for resale to their customers
- Purchase can be made as cash or credit

- Merchandising firm plays two roles

o Plays the role of buyer/customer when it purchases good from its supplier
o Plays the role of seller/supplier when it sells good to its customers

Discount given by the supplier

- Trade discount is a discount off the list price and given by supplier (i.e. the seller) to the entity (i.e.
the buyer) to encourage purchase. Trade discount is not recorded by the entity. Not recorded by
both the seller and the buyer.

- Cash discount (purchase discount) is a discount off the buying price and given by the supplier (i.e.
the seller) to the entity (i.e. the buyer) for credit transactions only. The discount is given to
encourage early payment. Cash discount, is recorded by the entity when the purchase discount is
taken up. Examples are 2/10, n/30 or 2/eom.

Goods in transit
- When to recognise purchase of inventory depends on the shipping terms FOB Shipping Point and
FOB Destination
- Physical goods are transported from the supplier to the entity
 - The transportation cost to bring in the inventory from the supplier is known as freight inwards
(carriage inwards) and is added to the cost of inventory. This amount is inventorised as asset at the
point of inventory purchase

FOB (Freight on Board) shipping point

- The title of the goods is deemed to have transferred from seller to buyer when the goods departed
from the seller’s country.
- The seller will recognize sale of inventory and the buyer will recognise purchase of inventory (when
it departs)
- Buyer usually pays freight charges
- Buyer will bear all risks and rewards when they are in transit

FOB destination
- The title of the goods is deemed to have transferred from seller to buyer when the goods arrive at
the destination country.
- The seller will recognize sale of inventory and the buyer will recognise purchase of inventory
(When it arrives)
- Seller usually pays freight charges
- Seller will bear all risks and rewards when they are in transit

Return of goods back to the supplier

- Purchase return is the return of physical goods back to the supplier (i.e. the seller) as the entity (i.e.
the buyer) is not happy with the quality of the good. The supplier will issue a credit note for full
refund of the returned good

- Purchase allowance is a refund or “discount” given by the supplier (i.e. the seller) to the entity (i.e.
the buyer) as an incentive for the entity to keep the substandard good. The physical good is not
returned to the supplier.

Company also provides trade and cash discounts to customers when it sells goods to its customer. Sale of
inventory by cash or by credit
- Trade discount is a discount off the list price and given to the customer (i.e. the buyer) by the entity
(i.e. the seller) to encourage purchase. Trade discount is not recorded by the entity.

- Cash discount is a discount off the selling price and given by the entity (i.e. the seller) to the
customer (i.e. the buyer) for credit transactions only. The discount is given to encourage early
payment. Cash discount, also known as sales discount, is recorded by the entity when the sales
discount is taken up. Examples are 2/10, n/30 or 2/eom.

Goods sold to customer

- When to recognise sale of inventory depends on the shipping terms FOB Shipping Point and FOB
Destination
- Physical goods are transported from the entity to the customer
The transportation cost to bring the inventory out to the customer is known as freight outwards
(carriage outwards) and is a selling expense.

Return of goods back to entity

- Sales return is the return of physical goods back to the entity (i.e. the seller) as the customer (i.e.
the buyer) is not happy with the quality of the good. The entity will issue a credit note for full
refund of the returned good.
 - Sales allowance is a refund or “discount” given by the entity (i.e. the seller) to the customer (i.e.
the buyer) as an incentive for the customer to keep the substandard good. The physical good is not
returned to the entity

Goods consignment arrangement (common between manufacturer and retailer, common for perishable
and new products)
- Sometimes, an entity (i.e. the consignor) arranges for another entity (i.e. consignee) to sell its
products under consignment.
o The goods are physically transferred to the consignee but the consignor retains legal title.
o If the consignee cannot find a buyer, the goods will be returned to consignor.
o If the consignee finds a buyer, the consignee will return the selling price less commission to
the consignor.
o The consignor recognises selling price as revenue and the consignee recognises commission.
o The consignor recognises the selling price as sales revenue when the consignee sells the
goods.
o Consigner has control of inventory and transfers physical possession, consignee has the
physical possession of inventory
o Title passes from entity to customer when consignee sells inventory to customers i.e.
control passes to buyer

Inventories
- Are assets
o Held for sale in the ordinary course of business (the goods held for sale by merchandising
and manufacturing companies)
o In the process of production for such sale (The work in progress inventory that
manufacturing companies have) or
o In the form of material (raw materials used) or supplies to be consumed in the production or
in the rendering of services

Inventory strategy, Risks and controls

- Keep inventories  to avoid stock out situation (must balance stock out cost and inventory holding
costs)
- Inventory holding costs vs stock out costs Just-in- time inventory system (to minimise inventory
holding costs) (JIT requires extensive collaboration with suppliers to ensure that inventory arrives
just before customer wants to buy)
- Risk of inventory obsolescence, inventory damage, theft, fire, change in customers’ preference and
market conditions, etc.
- Timely and reliable detailed inventory records to reflect sales pattern and seasonal changes. Aim in
forecasting demands and inventory purchases in future (when to buy, what to buy, how much to
buy).
- Inventory controls :
o Physical controls over inventories, limit the storage locations
o Buy insurance to cover inventories
o Proper authorisation for inventory movements
o Separation of duties

Objective of SFRS(I) 1-2 on inventories

Primary issue in accounting for inventory:
- Amount of cost to be recognised as asset and carried forward until the related revenues are
recognised, then asset is transferred to expenses.
 - SFRS(I) 1-2 provides guidance on the determination of cost and its subsequent recognition as an
expense.

Scope of SFRS(I) 1-2 on inventories

SFRS (I) 1-2 applies to all inventories except for:
- Work in progress under construction contracts
- Financial instruments- inventories for commodity brokers/traders
- Biological assets related to agricultural activity

Recognition of inventories
- Inventory is initially recognized as an asset
- When inventories are sold, the carrying amount shall be recognized as expense (i.e. cost of goods
sold) in the period which the related revenue is recognized.

Initial measurement of inventories

- The cost inventories comprises:
o All costs of purchase
o Costs of conversion (for manufacturing firms)
o Other costs incurred in bringing the inventories to their present location and condition (for
sale)
o Cost of inventories of a service provider

Value of inventory depends on whether you are buying or selling

Measurement of inventories
- Inventories has be measured at the lower of cost and net realisable value
- Net realisable value is the estimated selling price in the ordinary course of business less the
estimated costs of completion and the estimated costs necessary to make the sale
- When the value of inventory falls below its cost, companies must record its inventory at the lower
net realisable value.

Inventory systems
These inventory systems relates to how the inventory
transactions are recorded not how the inventories are
being measured and valued at

Inventory transactions  Refer to purchase and sales of

inventory

Periodic inventory system Do not know inventory balance since not all transactions are recorded so need
to count goods periodically.

Perpetual inventory system Physical count at the end of reporting period to check physical inventory is
present. Updated inventory numbers and costs of goods sold.

To record purchase of inventory by credit debit inventory and credit accounts payable (for perpetual
inventory system)

To record purchase of inventory by credit debit purchases and credit accounts payable (for periodic
inventory system)
To record return of goods back to the supplier Debit accounts payable and credit inventory (for
perpetual inventory system)

To record return of goods back to the supplier Debit accounts payable and credit purchase returns and
allowances (for periodic inventory system)

Purchase discount is taken up recorded when the company pays the suppliers early  Debit accounts
payable and credit inventory and cash (for perpetual inventory system)
Purchase discount is taken up recorded when the company pays the suppliers early  Debit accounts
payable and credit purchase discounts and cash (for periodic inventory system)

To record transportation cost (supplier to entity) Debit inventory and credit accounts payable (for
perpetual inventory system)

To record transportation cost (supplier to entity) Debit freight-in charges and credit accounts payable
(for periodic inventory system)

To record sale of inventory by credit  Debit accounts receivable and cost of goods sold and credit sales
revenue and inventory (for perpetual inventory system)

To record sale of inventory by credit  Debit accounts receivable and credit sales revenue (for periodic
inventory system)

To record return of goods back to the entity Debit sales returns and allowances and inventory and credit
accounts receivable and cost of goods sold (for perpetual inventory system)

To record return of goods back to the entity Debit sales returns and allowances and credit accounts
receivable (for periodic inventory system)

To record sales discount is taken up  Debit cash and sales discounts and credit accounts receivable (for
perpetual inventory system)

To record sales discount is taken up  Debit cash and sales discounts and credit accounts receivable (for
periodic inventory system)

To record transportation cost (entity to customer) Debit freight-out charges and credit accounts
payable (for perpetual inventory system)

To record transportation cost (entity to customer) Debit freight-out charges and credit accounts
payable (for periodic inventory system)

Sales returns allowances is an indication of product quality, customer satisfaction and future profitability

Unadjusted trial balance at period end

- Perpetual inventory system – inventory figure is ending inventory
- Periodic inventory system – inventory figure is beginning inventory (since no transactions have
been recorded to inventory account) until the period-end adjustment is done
Inventory cost flow formula
Beginning inventory
+ Net purchases of inventory (purchases + freight-in charges – purchases returns and allowances –
purchase discounts)
– Ending inventory (per physical inventory count)
= Costs of goods sold (COGS)  derived

Cost formula’s/ Inventory valuation methods

- Specific Identification method
 o Used for items that are not interchangeable and G&S produced and segregated for specific
projects (expensive, unique items)
- First-in, first-out (FIFO) method
- Weighted average cost method

Other than the specific identification method, the physical inventory flow may not be the same as the
inventory cost flow method.

FIFO is with respect to cost of goods sold. Inventory that’s first to come in will be sold first. Oldest cost first.

FOR 3A> Under the periodic inventory system, only one average cost will be calculated for each financial
period. Financial period can be a moth, a quarter or a year.

3b. Weighted Average Cost Method under Perpetual Inventory System

- The weighted average unit cost in a perpetual inventory system becomes a moving average unit
cost.
- A new weighted average unit cost is calculated each time additional units are purchased.
Asset impairment
- Asset impairment occurs when the future cash flows (future benefits) generated for an asset is less
than carrying amount. Refer to SFRS(I) 1-36 – Impairment of Assets.
- Inventory impairment occurs when net realisable value of inventory is lower than the cost or
carrying amount of inventory.

Conservatism principle/Prudence concept

- Most likely to overst ate losses and expenses and
less likely to overstate income and assets

Recognition of inventories
- The amount of write-down of inventory to net realisable value and all losses of inventories shall be
recognised as expense in the period the write-down or loss occurs.

Measurement of inventories
- Inventories shall be measured at the lower of cost and net realisable value. SFRS(I) 1-2:9
- Net realisable value is the estimated selling price in the ordinary course of business less the
estimated costs of completion and the estimated costs necessary to make the sale. SFRS(I) 1-2:6
- Inventories are written down to NRV when inventories are damaged, wholly or partially obsolete or
if their selling prices have declined... SFRS(I) 1-2:28
Accounting for inventory impairement

A separate expense account is preferred as separate disclosure for inventory write down is required. But
the separate expense account will still be classified as COGS in the income statement

Reversal of write-down of inventories

- A new assessment is made of NRV in each subsequent period.
- When the circumstances that previously caused inventories to be written down below cost no
longer exist... the amount of the write-down is reversed (i.e. the reversal is limited to the amount of
the original write- down) so that the new carrying amount is the lower of cost and the revised
NRV....
- The amount of any reversal of any write-down of inventories, arising from an increase in NRV, shall
be recognised as a reduction in the amount of inventories recognised as an expense in the period in
which the reversal occurs (i.e. a reduction in Cost of goods sold).

Physical Inventory count

- Required for both periodic and perpetual inventory systems.
- For periodic, the physical inventory will determine the ending inventory.
- For perpetual, the physical inventory will be used to check against the inventory balance, and to
adjust the perpetual inventory records for unrecorded shrinkage losses, such as theft, spoilage, or
breakage

Net sales revenue: sales revenue- sales returns and allowances – sales discounts
Gross profit= Sales revenue - Sales returns– Sales discounts - Cost of goods sold
Presentation and disclosure
- Total carrying amount of inventories to be presented on the face of statement of financial position.
(SFRS(I) 1-1:54)
- Accounting policies, including cost formula used.
- The breakdown of carrying amount of inventories in classifications appropriate to the entity.
(SFRS(I) 1-2:37)
- The carrying amount of inventories carried at fair value less costs to sell.
- The amount of inventories recognised as an expense during the period (in the Statement of Profit
or Loss). SFRS(I) 1-2:38 and 2:39
- The amount of any write-down of inventories recognised as an expense in the period.
- The amount of any reversal of any write-down that is recognised as a reduction in expense.
- The circumstances or events that led to the reversal of a write-down of inventories.
- The carrying amount of inventories pledged as security for liabilities.

Disclosure principle
- Entities should report enough information for users of financial statements to make decisions
about the entities.

Consistency principle
- The same accounting method should be used from period to period to provide meaningful trend
comparability.

Accounting for missing inventory

- Record missing goods as cost of goods sold

Inventory error
- The physical inventory counts at year end may contain errors leading to over or understatement of
the ending inventory.
- This error may not be found out immediately but usually found out in the following financial year.
- The erroneous ending inventory of year of the error will become the beginning inventory of the
following year.
- Inventory in display not counted,

Ending inventory understated

Overstated will be offset by understatement in the next year hence the error in retained earnings
will self-correct
Ending inventory overstated

Week 5
Ethics
- Ethics is a set of core values and moral principles that govern a person’s behaviours
- Ethics is influenced by:
o Religion
o Philosophical thoughts
o Upbringing and life experiences
o Social values and culture
- Types of ethics
o Personal ethics
o Social responsibilities
o Business ethics
 A set of core values and standards to guide business decision making
 To consider the interest of the stakeholders in making business decisions:
 Ownership theory (of firm)
o Traditional view
o Firm is the property of its owners
o Purpose is to maximise returns to owned
o Owner’s interests are paramount and take precedence over all other
stakeholders
 Stakeholder theory (of firm)
o Contrasting view
o Argues firm is to create values for the society
o Must make profit for owners to survive, however, creates other kinds
of values too
o Corporations have multiple obligations, all “stakeholder” groups must
be taken into account
o Professional ethics and responsibilities
 Code of professional conduct and ethics
 AICPA and IMA's code of ethics
 IESBA - set ethics standards
 ISCA Code of Professional Conduct and Ethics - Parts A and C

Ethical dilemma
- A situation in which there is no obvious right or wrong decision, but rather a right or right decision

Ethical decision making process

1. Identify the ethical and professional issues (ethical sensitivity)
2. Identify and evaluate alternative courses of action (ethical judgment)
3. Reflect on the moral intensity of the situation and virtues that enable ethical action to occur
(ethical intent)
4. Take action(ethical behaviour)
Ethical sensitivity
- Ability to sieve out, recognize and identify ethical issues and risks
- Josephson’s six pillars of character
1. Trustworthiness
i. Be honest in communications and actions
ii. Don’t deceive, cheat or steal
iii. Be reliable- do what you say you’ll do
iv. Have the courage to do the right thing
v. Build a good reputation
vi. Be loyal- stand by your family, friends and country
vii. Keep your promises
2. Respect
i. Treat with respect and follow the golden rule
ii. Be tolerant and accepting of differences
iii. Use good manners and accepting of differences
iv.
3. Responsibility
i. Do what you are supposed to do
ii. Plan ahead
iii. Be diligent
iv. Persevere
v. Do your best
vi. Use self-control
vii.
4. Fairness
5. Caring
i. Be kind
ii. Be compassionate
6. Citizenship
- Code of professional conduct and ethics part (A)
o Fundamental principles:
 Integrity – A member should be straightforward and honest in all professional and
business relationships.
 Objectivity – A member should not allow bias, conflict of interest or undue influence
of others to override professional or business judgments.
 Professional Competence and Due Care–A member has a continuing duty to
maintain professional knowledge and skill at the level required to ensure that a
client or employer receives competent professional service based on current
developments in practice, legislation and techniques.
 Confidentiality – A member should respect the confidentiality of information as a
result of professional and business relationships and should not disclose any such
 information to third parties without proper and specific authority unless there is a
legal or professional right or duty to disclose.
 Professional behaviour – A member should comply with relevant laws and
regulations and should avoid any action that discredits the profession.

- Code of professional conduct and ethics part (C)

o Common threats faced
 Potential conflicts
 Preparation and reporting of information
 Acting with sufficient expertise
 Financial interests
 Inducements

Ethical judgement and intent

- Modern moral philosophies
o Teleology – look at the ends / results / consequences
 Egoism – only considers self interests
 Enlightened Egoism – considers interests of others as well
 Utilitarianism – select the action that results in the greatest net benefits
o Deontology – look at the rights of individuals
o Justice – base on rights, fairness and equality
o Virtues Ethics – base on virtuous trait of character
- Code of professional conduct and ethics
o Safeguards created by the profession, legislation or regulation – 100.12 and Part C
o Safeguards in the work environment– 300.16 and Part C
o Ethical Conflict Resolution – 100.16 to 100.21 of Part A
 Identify relevant facts and ethical issues
 Identify and evaluate alternative course of actions
 Seek advice from higher authority within the organisation
 Seek professional or legal advice – note confidentiality
 Withdraw / Resign
Ethical issues
- Moral values – honesty, integrity
- Professional code of ethics – integrity
- Conflict of interests – self-interest (job and relationship with supervisor) vs professional
responsibility as an accountant

Possible actions to take

- Teleology
o Egoism – process the claim without question to keep your job?
o Enlightened Egoism – to consider other stakeholders’ interests, e.g. shareholders’ interest?
Week 6
Accounts receivable is the amount collectable from customers, classified as current asset
Receivable is a right to receive cash in the future arising from a current transaction (an asset)
Trade Receivable Arising from sale on credit (credit sales) (AR)
Non-trade Receivable Arising from other transactions (loans) (other receivables)

Credit is granted by businesses to encourage more sales.

Credit risk is a risk of customers defaulting on payment, after a credit sale of goods and services is given.
When the customer defaults on payment, a credit loss results.
Controls include:
- Credit policy and procedures.
- Monitor credit customers’ payments.
- Send monthly Statement of Accounts to customers.
- Reward both sales and collections personnel for speedy collections so that they work as a team.

Objective SFRS(I) 9
- To establish principles for the financial reporting of financial assets and financial liabilities that will
present relevant and useful information to users of financial statements for their assessment of the
amounts, timing and uncertainty of an entity’s future cash flows.
- Examples of financial assets: Receivables, investments
- Examples of financial liabilities: Payables, bonds

Recognition
- An entity shall recognise a financial asset ... in its statement of financial position when, and only
when, the entity becomes party to the contractual provisions of the instrument (see paragraphs
B3.1.1 and B3.1.2).
- When an entity first recognises a financial asset, it shall classify it in accordance with paragraphs
4.1.1 – 4.1.5 and measure it in accordance with paragraphs 5.1.1 – 5.1.3.
- Receivable is recognized as an asset when there is a contractual requirement to collect cash flow in
the future

A financial asset shall be measured at amortised cost if both of the following conditions are met:
a) the financial asset is held within a business model whose objective is to hold financial assets in
order to collect contractual cash flows and
b) the contractual terms of the financial asset give rise on specified dates to cash flows that are solely
payments of principal and interest on the principal amount outstanding.

Measurement
- Except for trade receivables within the scope of para 5.1.3, at initial recognition, an entity shall
measure a financial asset or financial liability at its fair value plus or minus... transaction costs that
are directly attributable to the acquisition of the financial asset or financial liability...

- Despite the requirement in paragraph 5.1.1, at initial recognition, an entity shall measure trade
receivables that do not have a significant financing component (determined in accordance with
SFRS(I) 15) at their transaction price (as defined in SFRS(I) 15).

- Initial measurement – at fair value

- Subsequent measurement – at amortised cost, Subsequent measurement is affected by credit

losses and sales returns.

Amortised cost
- The amount at which the financial asset or financial liability is measured at initial recognition:
o minus the principal repayments (loans)
o plus or minus the cumulative amortisation using the effective interest method of any
difference between the initial amount and the maturity amount (bonds)
o and for financial assets, adjusted for any loss allowance (receivables)
- The loss allowance is the allowance for expected credit losses.

Recognition of expected credit losses

 - An entity shall recognise a loss allowance for expected credit losses on a financial asset that is
measured in accordance with paragraphs 4.1.2... SFRS(I) 9:5.5.1
- ... an entity shall always measure the loss allowance at an amount equal to lifetime expected credit
losses for:
o (a) trade receivables or contract assets that result from transactions that are within the
scope of SFRS(I) 15... SFRS(I) 9:5.5.15
Measurement of credit losses
- An entity shall measure expected credit losses of a financial instrument in a way that reflects:
o (a) An unbiased and probability-weighted amount that is determined by evaluating a range
of possible outcomes; ... SFRS(I) 9:5.5.17
 Expected loss model
o No need not necessarily identify every possible scenario for credit losses, just consider the
probability that a credit loss would or would not occur.
 Such credit loss is known as Impairment Loss on Trade/Accounts Receivable

Accounting for impairment loss on accounts receivable

- Direct write-off method

Matching principle is violated

- Allowance method (loss allowance method)

Estimate at the end

Fisrt period: This allowance account is a contra asset account against the AR account in the balance
sheet
Second period: Just write off the AR against the contra asset account. The write off of Ar does not
affect the expense account
Allowance method complies with matching principle

Estimating the impairment loss on AR

The longer the AR past due, the higher the probability it will be uncollectible
The percentages are estimates based on past experiences
These percentages are the unbiased and probability-weighted amount
Use the percentage of Aging of AR method
Multiply the percentages by the AR amount to get the estimated uncollectible AR amount

Adjusting entry made at the end of the financial period

The write-off of AR has no impact to the accounting equation

Presentation and disclosure
1. Significant accounting policies
2. Separate trade and non-trade receivables
3. Net AR (show allowance balances separately), usually in the notes
4. Movements in allowance of impairment of receivables account
5. Receivables denominated in other currencies.

Fixed deposits that are pledged as collateral for borrowings with a bank are not freely available for use in
operations. Fixed deposits  not cash or cash equivalent

Bank borrowings  financing activity

Bank overdraft if it is repayable on demand and forms an integral part of an entity’s cash management, it
is included in cash and cash equivalents

Sufficient Cash holdings

- Grab business opportunities
o Acquire other companies
o Acquire new techniques

Holding too much cash

- Lose out investment return

Proper cash management will:

 - Protect cash from theft, fraud or loss
- Include controls to ensure that there are enough cash holdings
- Prevent accumulation of excess amounts of idle cash

Effective internal control of cash

- Separation of duties
o Separate duties of
 Receiving and distributing cash,
 Procedures of accounting for cash receipts and cash disbursements
 Physical handling of cash and all phases of the accounting function
- Prescribing clear and proper policies and procedures
o Allows easy detection of errors or manipulations
o Depositing all cash receipts daily
o Separate approval of purchases and actual cash payments, use of pre-numberee cheques
and special care with electronic funds transfer
o Assign above-mentioned responsibilities to diff indiv
o Require monthly reconciliation of bank and cash accounts on the company’s books

Bank reconciliation
- Ensure that financial records tally
o Record include:
 Cheque register
 General ledger account
 Balance sheet (Statement of financial position)
 All other applicable records
o Differences are common
 Account for these in the bank reconciliation statement
 Reconciliation explanation of the differences
o Causes of differences
 Timing difference

 Deposits in transit: Deposits which have been sent by the company to the
bank but have not been received by the bank before issuance of bank
statement
 Cheques outstanding: Cheques which have been issued by the company but
were not presented or cleared before issuance of bank statement
 Service Charges: May have been deducted by the bank. Charges are usually
not known before issuance of the bank statement
 Interest income: Earned by the company on its bank account. Usually not
known before the issuance of the bank statement
 NSF cheques: Cheques deposited by the company into their bank account,
but cannot be processed by the bank due to “not sufficient funds” in the
payer’s account
 Electronic transfers or GIRO payments: Customers make or receive payments
directly through the bank
 Errors
  Good business practice:
o Prepare a bank reconciliation statement each time a bank statement
is received
o Prepare the reconciliation statement as quick as possible so that
queries can be resolved

Bank reconciliation process

- Adjusting the balance per bank
- Adjusting the balance per books
- Compare the adjusted balances
- Prepare the journal entries
- (The adjusted balances should be equal, The balances should be the correct balance of cash as at
the date of bank reconciliation)
- Asset accounts: (Debit cash, Credit Interest revenue), (debit Bank fees expense, credit cash)
Week 7
Income is increases in economic benefits during the accounting period in the form of inflows or
enhancements of assets or decreases of liabilities that result in increases in equity, other than those
relating to contributions from equity participants.

Income  A decrease in equity other than those relating to contributions from equity participants.

Revenue and gains

1. Income encompasses both revenue and gains.
2. Revenue arises in the course of the ordinary activities of an entity. (refers to sales of. G&S to
customers)
3. Gains are other items that meet the definition of income and may, or may not, arise in the course
of the ordinary activities of an entity. (foreign exchange gains)

Gains may or may not arise in the course of the ordinary activities of an entity

The importance of revenue

1. Revenue is the top line of the statement of profit or loss. An important figure stakeholders use to
measure performance and make comparison across businesses.
2. Revenue affects profits and loss reported.
3. Revenue affects management compensation, tax liability and insurance coverage.

Revenue sale of goods

a. The entity has transferred to the buyer the significant risks and rewards of ownership of the goods;
b. the entity retains neither continuing managerial involvement to the degree usually associated with
ownership nor effective control over the goods sold;
 c. the amount of revenue can be measured reliably;
d. it is probable that the economic benefits associated with the transaction will flow to the entity;
e. the costs incurred or to be incurred in respect of the transaction can be measured reliably. (ensure
matching principle is complied with)

Revenue rendering of service

a. the amount of revenue can be measured reliably;
b. it is probable that the economic benefits associated with the transaction will flow to the entity;
c. the stage of completion of the transaction at the balance sheet date can be measured reliably; and
d. the costs incurred for the transaction and the costs to complete the transaction can be measured
reliably.

Revenue from contracts with customers (SFRS(I) 15)

a. Both IASB and FASB issued a converged standard on revenue in May 2014.
b. IFRS 15 – Revenue from Contracts with Customers.
c. ASC issued SFRS(I) 15 in November 2014.
d. Effective for financial periods beginning on or after 1 January 2017. Earlier application is permitted.
e. In Nov 2015, ASC extended the effective date to 1 January 2018.

SFRS (I) 15 Supersedes

a. FRS 11 – Construction Contracts
b. FRS 18 – Revenue
c. INT FRS 113 – Customer Loyalty Programmes
d. INT SFRS(I) 15 – Agreements for the Construction of Real Estate
e. INT FRS 118 - Transfer of Assets from Customers
f. INT FRS 31 – Revenue – Barter Transactions Involving Advertising Services

Objective of SFRS(I) 115

To establish the principles that an entity shall apply to report useful information to users of
financial statements about:
 nature
 amount
 timing
 uncertainty of
revenue and cash flows arising from a contract with a customer.

Core principle of FRS 115

- An entity shall recognise revenue to depict the transfer of promised goods or services to customers
in an amount that reflects the consideration to which the entity expects to be entitled in exchange
for those goods or services.

Scope of FRS 115

- An entity shall apply FRS 115 to all contracts with customers, except for:
o Lease contracts – FRS 17 – Leases
o Insurance contracts – FRS 104 - Insurance Contracts
o Financial instruments – FRS 39 (FRS 109)
o Other contractual rights and obligations under FRS 110, 111, 27 and 28 (group of
companies, subsidiaries, joint ventures and associates)
o Non-monetary exchanges between entities in same line of business

- An entity shall apply this standard to a contract only if:

o The counterparty to the contract is a customer;
 o A customer has contracted with an entity to obtain goods and services that are an output of
the entity’s ordinary activities in exchange for consideration. (Usually cash consideration)

FRS 115 does not apply to non-monetary exchanges between entities in same line of business.

Five steps to recognise revenue from contracts with customers

- Step 1: Identify the contract(s) with a customer
- Step 2: Identify the performance obligations in the contract
- Step 3: Determine the transaction price
- Step 4: Allocate the transaction price to the performance obligations in the contract
- Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation

Under FRS 115

STEP 1
- Definition of a contract:
o A contract is an agreement between two or more parties that creates enforceable rights and
obligations. (SFRS(I) 15: IN7a)
o A contract includes promises to transfer goods or services to a customer. (SFRS(I) 15: IN7b)
- Definition of a customer:
o A customer is a party that has contracted with an entity to obtain goods and services that
are an output of the entity’s ordinary activities in exchange for consideration. (SFRS(I) 15: 6)

- An entity shall account for a contract with a customer that is within the scope of this Standard only
when all the following criteria are met:
1. Contract is approved (written, verbal or in other customary business practices).
2. Each party’s rights to the goods and services to be transferred can be identified.
3. Payment terms can be identified.
4. Has commercial substance. (Means that the entity has a future cash inflow or is making a
profit from this transaction)
5. Probable to collect from customer (customer’s ability and intention to pay). (ability and
intention to pay are different)

- SFRS(I) 15: 13If SFRS(I) 15:9 fulfilled, no need to reassess.

- SFRS(I) 15: 14 and 115: 15If SFRS(I) 15:9 not fulfilled, continue to assess. (if they are met at the
point of contract inception but subsequently the customer become incapable of paying due to
subsequent changes in his financial situation account for it under impairment loss on AR,
subsequent change in financial situation will not render contract invalid)

STEP 2
- At contract inception, an entity shall identify the performance obligation each promise to transfer
to the customer either:
a. a good or service (or a bundle of goods or services) that is distinct; or
b. a series of distinct goods or services that are substantially the same and that have the same
pattern of transfer to the customers.
 - A good or service that is promised to a customer is distinct if both of the following criteria are met:
a. the customer can benefit from the good or service either on its own or together with
other resources that are readily available to the customer (i.e. the good or service is
capable of being distinct); and
- For some goods and services, a customer may be able to benefit from a good or service on its own.
- For other goods and services, a customer may be able to benefit from the good or service only in
conjunction with other readily available resources.
- For example, the fact that the entity regularly sells a good or service separately would indicate that
a customer can benefit from the good or service on its own or with other readily available
resources.

- A readily available resource refers to a good or service that is sold separately by the entity or others
or a resource that a customer has already obtained from the entity
- A good or service that is promised to a customer is distinct if both of the following criteria are met:
b. the entity’s promise to transfer the good or service to the customer is separately
identifiable from other promises in the contract (i.e. the promise to transfer the good or
service is distinct within the context of the contract).

- Factors that indicate that two or more promises to transfer goods or services to a customer are not
separately identifiable include, but are not limited to, the following:
a. the entity provides a significant service of integrating the goods or services with other
goods or services....
b. one or more of the goods or services significantly modifies or customises, or are
significantly modified or customised by, one or more of the other goods or services
promised in the contract.
c. the goods or services are highly interdependent , or highly interrelated.

- If a promised good or service is not distinct, an entity shall combine that good or service with other
promised goods or services until it identifies a bundle of goods or service that is distinct.
- In some cases, that would result in the entity accounting for all the goods or services promised in a
contract as a single performance obligation.

- SFRS(I) 15: 6 – goods and services that are an output of the entity’s ordinary activities
- SFRS(I) 15: 25 – admin tasks to set up contracts and setup activities are not a performance
obligations.

- when a customer contracts with an entity for a bundle of goods or services, it can be difficult and
subjective for the entity to identify the main goods or services for which the customer has
contracted. In addition, the outcome of that assessment could vary significantly depending on
whether the entity performs the assessment from the perspective of its business model or from the
perspective of the customer. Consequently, the boards decided that all goods or services promised
to a customer as a result of a contract give rise to performance obligations (even when if it
something given for free) because those promises were made as part of the negotiated exchange
between the entity and its customer

- Criterion 1: capable of being Distinct

 A. Customer can

Material right: option for additional goods or services

- Para 40: If in a contract an entity grants a customer the option to acquire
STEP 3 (relating to measurement issue)
- An entity shall consider the terms of the contract and its customary business practices to determine
the transaction price.
- The transaction price is the amount of consideration to which an entity expects to be entitled in
exchange for transferring promised goods or services to a customer, excluding amounts collected
on behalf of third parties (e.g. GST).

STEP 4
- The objective when allocating the transaction price is for an entity to allocate the transaction price
to each performance obligation (or distinct good or service) in an amount that depicts the amount
of consideration to which the entity expects to be entitled in exchange for transferring the
promised goods or services to the customer.

- To allocate the transaction price to each performance obligation on a relative stand-alone selling
price basis. (SFRS(I) 15: 76)

- The stand-alone selling price is the price at which an entity would sell a promised good or service
separately to a customer. (SFRS(I) 15: 77)

- If a stand-alone selling price is not directly observable, an entity shall estimate the stand-alone
selling price... (SFRS(I) 15: 78)

- Methods to estimate stand-alone selling price (SFRS(I) 15: 79-80) – for reading only.

STEP 5 (recognition issue)

- An entity shall recognise revenue when (or as) the entity satisfies a performance obligation by
transferring a promised good or service (i.e. an asset) to a customer. An asset is transferred when
(or as) the customer obtains control of that asset.
- Satisfies the performance obligation over time or at a point in time.

Control of asset
- Control of an asset refers to the ability to direct the use of, and obtain substantially all of the
remaining benefits from, the asset. Control includes the ability to prevent other entities from
directing the use of, and obtaining the benefits from, an asset. The benefits of an asset are the
potential cash flows (inflows or savings in outflows) that can be obtained directly or indirectly

Performance obligations satisfied over time (usually for sale of service)

- When one of the following criteria is met:
 1. The customer simultaneously receives and consumes the benefits provided by the entity’s
performance as the entity performs (e.g. cleaning services).
2. The entity’s performance creates or enhances an asset that the customer controls as the
asset is created or enhanced (e.g. renovation and repairs and maintenance services).
3. The entity’s performance does not create an asset with an alternative use to the entity and
the entity has an enforceable right for payment for performance completed to date. (e.g.
contractual restriction, substantial modifications).

Performance obligations satisfied at a point in time

- If a performance obligation is not satisfied over time... an entity satisfies the performance
obligation at a point in time.
- An entity satisfies a performance obligation when the customer obtains control of a promised asset.

Indicators of transfer of control

a. The entity has a present right to payment for the asset.
b. The customer has legal title to the asset.
c. The entity has transferred physical possession of the asset.
d. The customer has the significant risks and rewards of ownership of the asset.
e. The customer has accepted the asset.

Customer acceptance clauses

- Customer acceptance clauses allow a customer to cancel a contract or require an entity to take
remedial action if a good or service does not meet agreed-upon specifications.

Principal vs agent considerations

- An entity is a principal if it controls the specified good or service before that good or service is
transferred to a customer.
- An entity that is a principal may satisfy its performance obligation to provide the specified good or
service itself or it may engage another party (e.g. a subcontractor) to satisfy some or all of the
performance obligation on its behalf.
- An entity is an agent if the entity’s performance obligation is to arrange for the provision of the
specified good or service by another party.
- Indicators that an entity controls the specified good or service before it is transferred to the
customer and is therefore a principal include, but are not limited to:
a. the entity is primarily responsible for fulfilling the promise to provide the specified good or
service
b. the entity has inventory risk
c. the entity has discretion in establishing the price for the specified good or service
 - When (or as) an entity that is a principal satisfies a performance obligation, the entity recognises
revenue in the gross amount of consideration to which it expects to be entitled in exchange for the
specified goods or service transferred. (SFRS(I) 15:B35B)
- When (or as) an entity that is an agent satisfies a performance obligation, the entity recognises
revenue in the amount of any fee or commission to which it expects to be entitled in exchange for
arranging for the specified goods or services to be provided by the other party. (SFRS(I) 15:B36)

Presentation
- When either party to a contract has performed, an entity shall present the contract in the
statement of financial position as a contract asset or contract liability, depending on the
relationship between the entity’s performance and the customer’s payment.
- An entity shall present any unconditional rights to consideration as a receivable.

- If a customer pays consideration, or an entity has a right to an amount of consideration that is

unconditional (i.e. a receivable), before the entity transfers a good or service to the customer, the
entity shall present the contract as a contract liability.
- Dr Cash Cr Unearned Revenue (Contract liability)
- Dr Accounts Receivable Cr Unearned Revenue (Contract liability)

- If an entity performs by transferring goods or services to a customer before the customer pays
consideration or before payment is due, the entity shall present the contract as a contract asset.
- A contract asset is an entity’s right to consideration in exchange for goods or services that the
entity has transferred to a customer.
- Dr Accounts Receivable (Contract asset) Cr Revenue
- Dr Accounts Receivable (Not a contract asset) Cr Unearned Revenue (Contract liability)

Contract assets as the entity’s rights to consideration in exchange for goods or services that the entity has
transferred to a customer

Consideration received from customers

- An entity shall recognise the consideration received from a customer as a liability until
1. the entity has no remaining obligations; or
2. the contract has been terminated and the consideration received from the customer is non-
refundable.
- The liability recognised represents the entity’s obligation to either transfer goods or services in the
future or refund the consideration received.

Disclosure
- To disclose sufficient information to enable users of financial statements to understand the nature,
amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.
- Disclose qualitative and quantitative information about:
Contracts with Customers
 1. Separate revenue recognised from contracts with customers from other revenue sources.
2. Any impairment losses recognised on receivables.
Disaggregation of revenue
3. Disaggregate revenue recognised into categories that depict how the nature, amount,
timing and uncertainty of revenue and cash flows are affected by economic factors
Contract balances
4. Opening and closing balances of receivables, contract assets and contract liabilities.
5. Revenue recognised in the reporting period from opening contract liabilities and from
performance obligations satisfied or partially satisfied in the previous period.
6. Explain how the timing of satisfaction of its performance obligation relates to timing of
payment.
7. Explain significant changes in the contract asset and the contract liability.
Performance obligations
8. When the entity typically satisfies its performance obligations.
9. Its significant payment terms.
10. Nature of goods and services that the entity promised to transfer.
11. Obligations for returns, refunds, and other similar obligations.
12. Types of warranties and related obligations.
Transaction price allocated to remaining performance obligations
13. Aggregated amount of transaction price allocation to unsatisfied performance obligations.
14. Explanation when the entity expects to recognise revenue of the unsatisfied performance
obligations.

Disclosure principle: Entities should report enough information for users of financial statements to make
decisions about the entities.

Week 8
The need for estimating sales returns
- Most companies do not have material sales returns, thus it is alright to record sales returns as and
when it occurs.
- However, some retailers with returns policy may have material sales returns.
- Sales can be reported in one period while sales returns may occur in the following period, thus
resulting in an overstatement of sales in the period of sales but understatement of sales in the
period of sales return.
- Thus, there is a need to estimate and record the sales returns and refund liability during the period
of sales.

Refund liability
- It is a liability account
- It is a refund to be made to the customers for the expected sales returns
Week 9
Income statement (statement of profit or loss and other comprehensive income)
- Classification of expense
o By Nature of expense
 An entity aggregates expenses within profit or loss according to their nature, and
does not reallocate them among functions within the entity
 Depreciation
 Purchases of materials
 Transport costs
 Employee benefits
 Advertising costs etc

o By function of expense
 Classifies expenses according to their function as part of cost of sales, or costs of
distribution or administrative activities
 At a minimum an entity discloses its cost of sales under this method separately from
other expenses
 Can provide more relevant info to users as compared to nature method
 Allocating costs to functions may require arbitrary allocations and involve
considerable judgment
 Need to disclose additional info on the nature of expenses, including depreciation
and amortisation expense an employee benefits expense because info on the nature
of expenses is useful in predicting future cash flows
The choice between the function or nature method depends on historical and industry factors and the
nature of the entity. Both methods provide an indication of those costs that might vary directly or
indirectly with the level of sales
Choose a method that is reliable and more relevant

Statement of changes in equity

Total comprehensive income for the year showing separately total amounts attributable to owners of
parent , non-controlling interests

Notes to the financial statements

Order of presentation:
- General information:
o Place of domicile
o Registered office
o Principal activities
- Summary of significant accounting policies applied:
o Measurement basis used
 Fair value model
 Cost model
 FIFO basis
o Sources of estimation uncertainty
 - Explanatory notes and supporting info for items presented in the financial statements:
o Movement of number of shares
o Movement or breakdown of:
 Provisions
 Trade receivables
 PPE
 Investment property
o Other disclosures
 Contingent liabilities and contractual commitments
o Non-financial disclosures
 Risk management policies

Concept of capital and capital maintenance

- Concept of capital
o Under financial concept of capital such as invested money or invested purchasing power,
capital is synonymous with the net assets or equity of the entity (adopted by most)
 Capital = net assets/ equity of entity
o Under a physical concept of capital such as operating capability, capital is regarded as the
productive capacity of the entity based on e.g. unit of output per day
- Concept of capital maintenance
o Financial capital maintenance
 Profit is earned only if the financial amt of the bet assets at the end of the period
exceeds the beginning of the period
 Exclude any distributions to and contributions from the owners during the
period
 Measured in either nominal monetary units/units of constant purchasing
power
o Physical capital maintenance
 Profit is earned only if the operating capability of the entity at the end of the period
exceeds that at the beginning of the period
 Exclude any distributions to and contributions from owners during that
period

Week 10
Firms engage in three main types of investing activities
- Invest in PPE
- Invest in tangible assets
- Invest in other companies
Investing activities potentially create value for the company. A firm had to consider risks and returns
before deciding to invest

Property plant and equipment (PPE) (how does the entity use that asset)
- They are tangible items that are held for use in the production or supply of goods or services, for
rental to others or for administrative purposes and are expected to be used during more than one
period
- Long-term
o Non-current or long lived
o to be used during more than one period
- Used in the business
- Land/building held to rental or for capital appreciation  investment property
- Non-property PPE (machines) are classified as PPE when held for rental
 - Recognise PPE as an asset if and only if it is probable that future economic benefits associated with
the item will flow to the entity and the cost of the item can be measured reliably

Examples of PPE:
- Land
- Land improvements
- Motor vehicles
- Buildings
- Machinery
- Factory

Freehold land is not depreciable as its useful life is infinite

Leasehold land is depreciable because it has a finite lease term
Land improvements are separately recorded from land because it is not part of land. These are depreciable
because they have finite useful life

Concept of capitalisation
- Which is the process of identifying an expenditure as an asset
- Need to distinguish the expenditures that produce future benefits (assets) from those that produce
benefits only in the current period (expenses)

An item of PPE that qualifies for recognition as an asset shall be initially measured at its cost at acquisition

The modes of acquisition are:

- Purchase
- Self-constructed assets
- Exchange

The measurement issues to consider when purchasing an asset are:

- It's purchase price including import duties non-refundable purchase taxes and foreign exchange
gains or losses after deducting trade discounts and rebates. Refundable taxes should not be
included in the cost of PPE
- Directly attributable cost: any cost directly attributable to bringing the asset to the location and
condition necessary for it to be capable of operating in the manner intended by management.
These include delivery, assembling as well as testing costs.
- Estimate of dismantling of removal costs and restoration costs.
o Example of dismantling course all costs of preparing the land to build the warehouse such as
cost of clearing grading and removal should be capitalized as part of the cost of land
o The cost of restoration has to be estimated and capitalized upon acquisition due to contract
or agreement
- All initial expenditures that are necessary to bring the PP to its usable condition should be
capitalized

Self-constructed asset
- The cost of a self-constructed asset is determined using the same principles As for a purchased
asset.
- Cost includes identifiable materials labor and a portion of the companies manufacturing overhead
costs such as utility bills. They're not profit and cost of abnormal amounts of wasted material, labor,
other resources in court is not included when arriving at the cost of a self-constructed asset.
- Some measurement issues related to self-constructed assets are:
o do we capitalize borrowing costs incurred?
 o Do we recognize gains or losses if construction costs are lower or higher than purchase
prices?
- If construction cost is less than the purchase price of a similar asset no gain is recognized. If
construction cost is more than the purchase price, a loss is recognized.

Exchange
- One or more items of PPE may be acquired in exchange for a non-monetary asset or assets or a
combination of monetary and non-monetary assets
- To determine the cost of the acquired asset:
o SFRS(I) provides that an item of PPE acquired in exchange for a non-monetary asset should
be measured at fair value, unless the exchange lacks commercial substance or the fair value
of neither the asset received nor the asset given up is really measurable. The standard
further provides that the fair value of the asset given up should be used unless the fair value
of the asset received is more clearly evident.

o A transaction is deemed to have commercial substance if the company expects a change in

future cash flows as a result of the exchange and this expected change is significant relative
to the fair value of the assets exchange. The greater the fair value of the exchange asset, the
greater the future cash inflows.

o Gain or loss in disposal of the old asset: 2 scenarios

 1. Assume that the fair value of the new asset can be reliably measured and is more
clearly evident than the fair value of the old asset
 2. Assume that the fair value of the new asset cannot be reliably measured
 If neither the fair value of the new asset nor the fair value of the old asset can be
measured reliably we use the book value of the old asset to calculate the initial cost
of the new asset. In this Case No gain or loss will be recognized for the exchange

Initial measurement issues

Lump sum acquisition
- In some cases multiple PPE are acquired at the same time. We should capitalize the expenses
according to the intended use of each expenditure.

What do we do with subsequent expenditure?

- Expenditure that simply maintain a given level of benefit, such as day-to-day maintenance are
expensed as profit/loss. In order to be capitalized as an asset expenditures have to create future
economic benefits.
- These benefits include an extension in the assets estimate the useful life, increasing capacity,
substantial improvement in the quality of output and substantial reductions in previously assessed
operating costs.
 - The outcome of the statement of profit or loss and statement of financial position are dependent
on classification of expenditures.

- If subsequent costs are expensed off and included as profit/ loss, the statement of profit or loss will
reflect higher expense and lower net income in the future in the current period while the statement
of financial position will reflect lower asset values in the current maybe. In this scenario subsequent
depreciation expense will be lower. If subsequent costs are capitalized and recognized in the
carrying amount of an item of the statement of profit or loss will reflect lower expense and higher
net income in the current period while the statement of financial position will reflect higher asset
values in the current period. Subsequent depreciation expense will be higher.

- During the whole life of the asset, the total expense will be the same no matter whether
subsequent expenditures are expensed off or capitalized.
- Whether the subsequent course are expensed or capitalized also depends on management
activities. An entity aiming for IPO in the current period will look to increase their asset values
through capitalization.

Measurement models for PPE (can use to account for the subsequent measurement of PPE)
- Accounting treatments for initial acquisition and subsequent costs incurred are the same for both
the cost model and the revaluation model
o Cost Model
 PPE carried that cost is valued at (initial cost at acquisition + subsequent costs
incurred) - accumulated depreciation - subsequent impairment
 Firms are encouraged to disclose fair value of PPE in notes if it is materially different
from the carrying amount
o Revaluation model
 PPE carried at a revalued amount is the fair value at their valuation - subsequent
accumulated depreciation - subsequent impairment

Cost model Depreciation

- Depreciation is a systematic cost allocation process will be part of the acquisition cost of a PPE will
be expensed in each accounting over its useful life.

- Assets by definition are expected future economic benefits and the initial recognition of an item of,
PPE requires that it is probable that the future economic benefits will flow to the entity. On
acquiring these benefits, and entity will have expectations as to the period over which these
benefits are to be received or consumed, and the pattern of these benefits. The economic benefits
could be received or consumed evenly over the useful life of the asset.

- The purpose of determining the depreciation charge for the period is to measure the consumption
of benefits allocable to the current period ensuring that over the useful life of the asset each. Will
be allocated its fair share of the cost of the asset acquired.

- Useful life is the period over which an asset is expected to be available for use by an entity or the
number of production or similar units expected to be obtained from the asset by an entity.

- Residual value is the estimated amount of an asset that an entity will currently obtain from the
disposal of the asset after deducting the estimated cost of disposal if the asset was already of the
age and in the condition expected at the end of its useful life

- The depreciation should begin when the asset is available for use. Accumulated depreciation is the
cumulative amount of depreciation charged since initial recognition and measurement of an asset.
- This is a Contra asset: a Contra asset is always paired with an asset and reduces the assets balance.
the Contra asset account has a credit balance. a Contra asset is reported in the statement of
financial position.

- When we record the depreciation of a specific period, we would debit the depreciation which is the
profit or loss account and credit accumulated this depreciation to record the increase in
accumulated depreciation which will decrease the asset value on the statement of financial position

- The depreciation method used shall reflect the pattern in which the asset's future economic
benefits are expected to be consumed by the entity. Different depreciation methods will have
different effects on the financial statements but the total depreciation if expands over the whole
useful life of our PPE will be the same no matter what matter is used

- Straight-line depreciation method

o Assign an equal amount of depreciation to each year of the asset service life.
o Depreciation expense equals to acquisition cost minus residual value divided by the
estimated useful life in years of the asset. This method is generally applied to assets that are
expected to provide a level amount of economic benefits throughout its useful life.

- The declining-balance method

o Is an accelerated depreciation method that writes off a larger amount of the assets cost
near the start of its useful life.
o The depreciation expanse equals to the beginning book value multiplied by an acceleration
factor divided by the useful life in years. The beginning book value is equal to the acquisition
 cost minus the beginning accumulated depreciation. Deceleration factor should be greater
than one.

- Sum of the years digits is another accelerated depreciation method

o The depreciation expense equals to acquisition cost minus residual value multiplied by the
remaining years of useful life divided by the sum of the years digits
o The sum of tthe year some of the digits can be calculated based on the formula n *( n + 1) /
2 by n stands for the useful life in years
o the sum of the years digits and declining balance above accelerated depreciation methods
generally applied to assets that provide greater economic benefits at a more rapid rate at
the start of the useful life.
o Accelerated methods result in more depreciation in the early years and less depreciation in
the later years of an asset useful life. In the early years the statement of financial position
will reflect lower asset values and the statement of profit or loss will reflect lower net
income due to higher expenses therefore if we compare the accelerated method to the
straight line method we will get lower asset values and lower net income in the early years
under the accelerated method.

o
- Units-of-production depreciation method
o Assigns a fixed amount of depreciation to each unit of output or service produced by the
asset
o The depreciation per unit equals to acquisition cost – residual value, divided by useful life in
units of production. Depreciation expense is then derived by taking the depreciation per
unit multiply by the number of units produced by for a given time period
o Usually applied to asset which provide economic benefits that vary in direct proportion to
the amount of asset usage

- Changes in depreciation estimates

o If there is a change in the estimated useful life or the residual value, these changes will be
accounted for prospectively; The book value less any residual value at the date of change is
depreciated over the remaining useful life and a disclosure note should describe the nature
and the effects of the change.
- Impairment
o Impairment tests
 SFSR(I) requires entities to conduct impairment tests for its assets to see if it has
incurred any impairment losses. The purpose of the impairment test is to ensure that
assets are not carried at amounts that exceed their recoverable amounts or more
simply that assets are not overstated
 Not necessary at the end of each reporting period to test each asset in order to
determine if it is impaired. The only assets that need to be tested at the end of the
reporting period are those where there is any indication that an asset may be
impaired
 To see if asset is impaired: entity need to consider both external and internal sources
of information:
 Physical damage to an asset
 Significant decline in the market value of an asset
 Lower-than-expected economic performance of a segment
 Significant changes in the technological, economic or legal environment
 Significant increase in the interest rates used in discounting asset’s value in
use
o Cost-model impairment
 An asset is impaired when carrying amount exceeds recoverable amount
 Impairment loss = Carrying amount – recoverable amount


 When an assets carrying amount exceeds its recoverable amount and impairment
loss of carrying amount minus recoverable amount should be recognized and
expensed as profit or loss.
 The cumulative amount of impairment loss is known as accumulated impairment
loss. This is also a Contra asset.
 When we record the impairment of a specific period debit the impairment which is
the profit or loss account and credit accumulated impairment to record the increase
in accumulated impairment which would decrease the asset value on the statement
of financial position.
 Recoverable amount
  Carrying amount

- Effect of impairment on subsequent depreciation

o New carrying amount = cost- accumulated impairment -accumulated depreciation
o Subsequent depreciation will be based on the new carrying amount as shown in the
formula.

- Disposal of PPE under the cost model

o When PPE is disposed under the cost model, the entity needs to:
o Remove all records related to PPE, including cost, which is the gross amount of PPE
accumulated depreciation, accumulated impairment
o Record the net proceeds from the disposal derived from sale price minus cost paid for
disposal
o Account for gain or loss which is the difference between net proceeds and carrying amount
of PPE. There is a disposal gain if net proceeds is more than carrying amount, and the
disposal loss if net proceeds is less than carrying amount.
 o

Revaluation model
- Use it only if fair value of the PPE item can be measured reliably. If an entity has chosen the
revaluation model for subsequent measurement of the PPE, an item of PPE shall be carried at a
revalued amount, being its fair value at the date of revaluation less any subsequent accumulated
depreciation and subsequent impairment losses
- Measurement issues:
o PPE should be valued with sufficient regularity so that the carrying amount does not differ
significantly from its fair value
- Reevaluation for PPE can either increase or decrease the carrying amount of PPE
- The transaction used to determine the fair value measurement should be the one where market
participants are able to use the asset to generate economic benefits in its highest and best use or to
sell the asset to another market participant who use the asset in its highest and best use.
- The highest and best use of a non-financial asset takes into account the use of the asset that is
physically possible, legally permissible, and financially feasible.
- Physically possible: physical characteristics of the acid such as size and location will be taken into
consideration when the asset is price
- Legally possible: legal restrictions on the use of the assets such as zoning regulations will be taken
into consideration when the asset is priced
- Financially feasible: the extent to which the use of an asset can produce future economic benefits
will also be taken into consideration when the asset is priced

- Initial revaluation
o Upon initial revaluation the assets carrying amount can increase or decrease
o If an asset carrying amount is increased as a result of reevaluation the increase shall be
recognized in other comprehensive income and accumulated in equity under the heading of
revaluation surplus
o As this is an upward revaluation we debit the PE to record the increased amount of the
asset and credit the revaluation reserve to record the increase in equity
o If an asset carrying amount is decreased as a result of revaluation the decrease shall be
recognized in profit or loss
o As this is a downward revaluation we credit the PPE to record the decreased amount of the
asset and debit a profit or loss account which is the loss on reevaluation to record the
increase in expense

- Subsequent revaluation
o When current revaluation increases carrying amount of PPE and the previous revaluation
had increased carrying amount it would recognize the current increase in other
comprehensive income or if the previous revaluation had the decreased carrying amount we
need to reverse this previous loss by recognizing an increase in the profit or loss to the same
extent. When previous losses are fully reversed, the remaining increase in carrying amount
if any will be recognized in other comprehensive income under revaluation reserve
o When current revaluation decreases carrying amount of PPE and the previous revaluation
had decreased carrying amount we will recognize the current decrease in profit or loss or if
the previous revaluation had increased carrying amount we need to consume the
revaluation reserve in other comprehensive income. When valuation reserve is fully
consumed the remaining decrease in carrying amount if any will be recognized in profit or
loss
- After revaluation
o The benchmark for revaluation is the carrying amount because we compare the revalue
amount with the carrying amount determined the revaluation effect. After the revaluation,
the carrying amount is equal to the revalued amount.
o For non-depreciable PPE we don't need to determine the new cost and the new
accumulated depreciation after the revaluation because accumulated depreciation is not
considered for non-depreciable PPE. the asset is carried at revalued amount after
revaluation with no accumulated depreciation.
o For depreciable PE the assets are carried at cost minus accumulated depreciation.
Therefore, after the revaluation, we need to determine the new cost and the new
accumulated depreciation for the carrying amount of the PPE. this new cost minus the new
accumulated depreciation should be equal to the revalued amount.

- Revaluation for depreciable assets

o Method 1: is to restate the new cost and accumulated depreciation proportionately
according to old values by multiplying the old cost and old accumulated depreciation
respectively by the revalued amount divided by the old carrying amount
o Method 2: it's to treat their asset and revaluation as a new asset and assume zero
accumulated depreciation. Therefore the new cost is equal to the revalued amount.
- Disposal
o The entity needs to:
 Remove all records related to PPE including cost ,which is the gross amount of PPE,
accumulated depreciation
 Record the net proceeds from the disposal, derived from sales price minus cost paid
for disposal
 Account for gain or loss which is the difference between net proceeds and carrying
amount of PPE
  Eliminate revaluation reserve associated with the disposed PPE by transferring the
amount directly to retained earnings when the asset is derecognized.
 Debit revaluation reserve to remove the revaluation reserve associated with the
disposed PPE and credit retained earnings to reflect the transfer

- When there is a gain on revaluation, this will be recognized in the statement of profit or loss and
other comprehensive income under the section on other comprehensive income. The same amount
 will be reflected in the statement of changes in equity under the heading of revaluation surplus,
total comprehensive income for the year.

- On disposal the revaluation surplus from the PPE is transferred to retained earnings in statement of
changes in equity. The transfer leads to an increase in retained earnings by 40 million and a
decrease in the revaluation surplus due to the removal of the revaluation reserve associated with
the PPE
Week 11
Intangible assets
- Identifiable, non-monetary assets without physical substance
- Item is not touchable or visible, does not have a fixed exchange value to cash, but the value is very
much dependent on economic conditions
- This item must be separable from an entity
- 3 criteria to meet the definition of an intangible asset
o 1. Identifiability
 Meets the criteria if it can be separated from an entity or if it arises form contractual
or other legal rights regardless of whether those rights are transferable or separable
from the entity or from other rights and obligations
o 2. Control over a resource
 An entity needs to have sufficient power to obtain the future economic benefits
flowing from the underlying resource and also to restrict others from accessing tgose
benefits
 An entity’s capacity to control an asset’s future economic benefits will normally
depend on its legal rights
 As in a normal situation, in the absence of legal rights to protect, an entity has
insufficient control over the expected future economic benefits arising from the
training cost to meet the definition of an intangible asset. However, legal right is not
a necessary condition for control, as an entity may be able to control the future
economic benefits through other means
o 3. Future economic benefits must exist
 There are a number of ways to demonstrate the existence of future economic
benefits. These include: revenue from the sale of a product or service; cost savings;
or other benefits such as an increase in the productive capacity of an asset, resulting
from the use of the item by the entity. The use of intellectual property in the
production process to reduce future production cost can demonstrate that future
economic benefits can exist

Recognition of an intangible asset

 - The SFSR(I) requires an item to be recognised as an intangible asset in the statement of financial
position if it meets all the three recognition criteria as follows the definition of an intangible asset;
there are probable future economic benefits; and the cost can be measured reliably
- Probable More likely than not
- If the item meets the definition of an intangible asset but fails to meet the other one or two
recognition criteria in this case the item can be considered as an asset but this asset may not be
recognized in the statement of financial position.
- If an item fails to meet any one of these recognition criteria of intangible assets expenditure on this
item is to be recognized as an expense in the statement of profit or loss when it is incurred

Mode of acquisition: Purchase

- Intangible assets can be purchased or generated internally by a company for its own use or for sale
e.g. trademark, copyright, franchise, goodwill, and others.
- Entities can trademark their brand name. A trademark is an exclusive right to display a word, a
slogan or a symbol that distinctly identifies a company, a product or a service
- Copyright is an exclusive right of protection given to a creator of a published work to reproduce and
sell his work
- Franchise is a contractual agreement under which the franchisor grants the franchisee the exclusive
right to use the franchisor’s trademark, within a specific area/location and usually for a specific
period of time only
- Goodwill can emerge from a company’s reputation, favourable business location, good
management skills, etc (represents a unique value of the company as a whole, over and above all
identifiable tangible and intangible assets)
- Purchased goodwill can be separated from a company and while it is possible to acquire a company
without also acquiring its goodwill, it is not possible to acquire this goodwill without also acquiring
the whole company. Purchased goodwill appears as an asset in the statement of financial position
when it was paid for in connection with the acquisition of another company

Mode of acquisition: Internally generated

- Include: Goodwill, brand masthead and R&D
- Internally generated goodwill forms part of the business and cannot be separated from the
company or sold without selling the whole business = NOT an intangible asset
- Brand name NOT an intangible asset, brand developed through advertising, training 
measurement issues Difficulty splitting entire cost incurred into brand name marketing and
advertisement
- Research costs include expenditure incurred from searching for new ideas, application, application
of research findings, sourcing for alternatives for materials, devices, products = NOT an intangible
asset and costs are expensed because further outcome of the research is uncertain and
unpredictable, not possible to demonstrate that research expenditures will generate probable
future economic benefits
- Development costs refer to expenditure costs incurred to turn the knowledge into a product. The
costs involved are construction and testing, porotypes and models, design of tools and moulds =
CAN be recognised as an intangible asset if and only If it meets all 6 specific recognition criteria
 o
- If it did not meet any criteria any development cost should be written off as an expense in the
statement of profit or Loss
- If the company is not able to split the entire cost into research cost and development cost and
maintain the two accounts separately the entire cost incurred has to be expensed off immediately \

Recognition of expense
- Expenditures that are expensed off when incurred:
o Expenditure on research phase , start-up activities, training activities, expenditure on
advertising and promotional activities and expenditure on relocating or reorganising part or
all of an entity
o Expenditure initially recognised as an expense in the previous accounting period cannot be
recognised as part if the cost of an intangible asset at a later date.

Initial measurement of intangible assets

- Should be measured initially at cost
- For purchased intangible assets the initial cost of the intangible asset should be the purchase
consideration plus any necessary costs incurred so as to get the asset ready for intended use
- Internally generated intangible assets the cost is the sum of directly attributable costs incurred in
relation to the asset as from the date it first meets the recognition criteria

Purchased intangible assets

Internally generated intangible assets

Cost and revaluation model

(for the measurement of intangible assets subsequent to initial recognition)
Cost model Revaluation model

The allocation of the depreciable amount of an intangible asset over its useful life is normally referred to as
amortisation rather than depreciation
Revaluation model after the initial recognition, the intangible asset is carried at a revalued amount . The
revalued amount of an intangible asset consist of its fair value at the time of revaluation less any
subsequent accumulated amortisation and subsequent accumulated impairment losses
Revaluation model cannot be applied to an intangible asset unless its fair value can be measured reliably

Upward revaluation on assets not subject to amortisation

Downward revaluation on assets not subject to amortisation

Effects of revaluation on amortisation
- According to the financial reporting standards if an intangible asset is subject to amortization and
carried out a revalued amount any accumulated amortization at the date of revaluation is either
o Restated proportionately with the change in the gross carrying amount of the asset so that
the carrying amount of the asset after revaluation equals its revalued amount or
o The accumulator amortization is to be eliminated against the gross carrying amount of the
asset and the net amount restated to the revalued amount of the asset
- The accounting treatment for accumulated amortization for intangible assets under the revaluation
model is very similar to that of accumulated depreciation for PPE under the revaluation model
Useful life of an intangible asset
- The accounting treatment of an intangible asset is dependent upon the length of its useful life
o Factors to take into account when determining useful life
 The expected usage of the asset by the entity concerned
 Public information on the estimates of useful life of similar assets used in similar
ways
 Technological commercial or other types of obsolescence
 Expected actions by competitors and others
- If the intangible asset arises from contractual or other legal rights the useful life of the asset cannot
exceed the period of those rights but may be shorter if the entity intends to use the asset for a
shorter.

Amortisation of an intangible asset

- For an intangible asset with limited useful life is depreciable amount which is the cost or revalue
amount less any residual value should be amortized on a systematic basis over its useful life. The
amortization chart should begin when the asset is available for use and this amortization charge
should be recognized as an expense in the statement of profit or loss
- An intangible asset should be regarded as having an unlimited useful life only if there is no
foreseeable limit to the period over which the asset is expected to generate net cash inflows for the
entity. Intangible assets with unlimited useful life should not be amortized

Amortisation methods
- Straight-line method

- Diminishing balance method

- Unit of production method

A company is required to ensure that the amortization method used reflects the pattern in which future
economic benefits provided by the intangible asset are expected to be consumed by the company. If the
pattern cannot be determined reliably the straight-line method should be adopted

Changes in accounting estimates

- The amortization period and the method should be reviewed every financial year and any change in
the period or method should be accounted for as a change in the accounting estimates in
accordance with the provisions in the financial reporting standards on accounting policies. The
change in account thing is diminished has to be accounted for prospectively and the nature and the
effect of the change should be disclosed in the notes to the financial statements

Impairment of intangible assets

- Impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable
amount
- 2 general principles
o Whenever there is an indication that asset may be impaired the recoverable amount of the
asset should be estimated. The indication here refers to any loss, damages, significant
decline in market value, discontinuance or restructuring of operations, significant change in
the technological, economic or legal environment and other circumstances
o If the recoverable amount is less than the carrying amount and impairment loss should be
recognized. The recoverable amount is to be measured as the higher of the ‘net selling
price’ and ‘value in use’. The ‘net selling price’ can be referred to as ‘net realizable value’ or
fair value less any cost to sell whereas ‘value in use’ can be referred to as ‘net present
value’. And lastly the carrying amount is the net book value of an asset

The impairment test

Disposal of intangible asset

- Intangible asset should be derecognized on disposal
 -

If intangible assets are expected to be recovered in more than 12 months it should be classified as non
current asset

Tangibles are classified under fixed assets which is the same as non current asset and they are separately
presented from other assets. Additional information on the accounting policies adopted by the company
for its intangible assets is disclosed in the notes to financial statements. In notes to financial statement
about intangible assets be a description of the intangible assets the useful life of the intangible assets
and the amortization methods use. contains a reconciliation of the carrying amount at the beginning and at
the end of the period showing additions, amortization, impairment losses and any other movements

Issues on intangible assets (human resource accounting)

- Difference between the book value and market value is due to the following 5 factors
o Difference in value of recognized assets or liability. (Land at cost). If a company chooses to
carry its PPE at cost any changes in the market price will not be effected and recognized in
the book

o Market value of any unrecognized assets or liabilities those that are not recognized in the
statement of financial position. (Internally generated brand name)

o Market value of value drivers or impairs that do not meet the definition of asset or liability
and thus excluded from the statement of financial position. (Excellent knowledge)

o Market value of risk and opportunities. (Changes in legislation)

o Market sentiment (War time)

- Intangible items are the major factors

Week 12
Liabilities
- Present obligations of the entity to transfer an economic resource as a result of past events
o Involves the present, the future and the past. It is a present responsibility to sacrifice assets
in the future because of a transaction or event that has already happened.

Debt financing
- A subset of the total liabilities of an entity. When an entity obtains funds in exchange for an
obligation to repay – with interest – the borrowed amount in the future,
- Main sources: issuance of bonds and bank loans
- Advantages:
o You retain control of the entity. When you agree to debt financing the lender has no say in
how you run the business
o there is a tax advantage the amount you pay in interest is tax deductible which reduces your
net obligation
o creditor reputation making timely payments to your lenders will help improve your
reputation as a creditor
- Increases in entities risk of bankruptcy or solvency. Solvency risk is the risk that an entity is unable
to meet its debt obligations when they become due

Classification of liabilities
Recognition of liabilities
- Types of liabilities

o
Provision (dollar amt of a liability must be estimated)
- Are a subset of an entity’s total liability. Defined as a liability of uncertain timing or amount.
- A provision is a liability as it has all the three characteristics of a liability:
o A past obliging event has occurred
o the entity is presently obligated.
o there is a future outflow of benefits.
- The only uncertainties are in the timing and amount of the future outflow of benefits.
- Provisions are not the same as contingent liabilities.
- For provisions there is no uncertainty in the existence of the obligation and the likelihood of an
outflow even though the amount may be uncertain

Present obligation is an essential characteristic of a liability

An obligation is a duty or responsibility that an entity has no practical ability to avoid. And obligation is
always owed to another party. Obligations can be legal or constructive.
- Legal obligation
o Stems from contractual terms whether explicit or implied
o Legislation: existing or those certain to be enacted
o Other operations of law
o Legal and possibility is not a necessary requirement
- Constructive Obligation
o Normal business practice or custom
o Circumstances
o Often more difficult to identify
o Is derived from an entity’s actions either from:
 Established pattern of past practice
 Published policies.
 Sufficiently specific current statement, the entity has indicated to other parties that
it will accept certain responsibilities.
 As a result the entity has created a valid expectation on the part of those other
parties that it will discharge those responsibilities
o Is a strong case based not based on law but on past behavior by an entity towards
employees, suppliers, customers or other third parties
- The present obligation exists only when the entity has no realistic alternative but to make the
sacrifice of economic benefits to settle the obligation. A decision by the entities management or
governing body does not by itself create a constructive obligation. This is because the management
of government body retains the ability to reverse the decision.
- A present obligation would come into existence when the decision was communicated publicly to
those affected by it. This would create this will result in a valid expectation that the entity will fulfill
the obligation thus leaving the entity with little or no discretion to avoid the sacrifice of economic
benefits.
Recognition of a provision
- Provision is to be recognized only if:
o an entity has a present obligation, legal or constructive, as a result of a past event
o it is probable that an outflow of resources embodying economic benefits will be required to
settle the obligation
o a reliable estimate can be made of the amount of the legal obligation

- The concept of probability deals essentially with the likelihood of something eventuating.
Probability is assessed for each obligation separately unless the obligations form a group of similar
obligations such as warranties in which case the probability that can outflow will be required in
settlement is determined by assessing the class of obligations as a whole

- probable is when an event will more likely than not occur  likelihood of something happening is
greater than 50%
- possible can be interpreted when the probability of an event is less than more likely than not and
more than remote
- remote essentially means unlikely

- A past event that leads to a present obligation is called an obligating event. For an event to be an
obligating event the entity must have no realistic alternative to settling the obligation created by
the event.

- Reliable estimation is the final criteria for recognition of a provision. Although the use of estimates
it's a necessary part of the preparation of financial estimates the uncertainty associated with the
reliable measurement in the case of provisions is greater than for other liabilities.

- However it is expected that an entity will be able to determine a reliable estimate of the obligation
except in very rare cases..

Measurement of a provision
- The amount recognized should be the best estimate of the consideration required to settle the
present obligation at the end of the reporting.
- This amount is often expressed as the amount which represents as closely as possible what the
entity would rationally pay to settle the present obligation
- Expected value of future cash outflow is used to measure the best estimate the obligation is
estimated by weighing all the possible outcomes by their associated probabilities
- If time is a major factor in determining a provision and the effects of discounting are material then
we are required to discount the provision to present value
o Info needed: Interest rate, time period
 - Provisions should be reviewed at the end of each reporting period and adjusted to reflect the
current best estimate

Accounting for provisions: Warranties

- A warranty is a promise by the manufacturer or seller to ensure the quality of performance of the
product for a specific period of time.
- Product warranties inevitably entail cost. Since the amounts of those future costs can be reasonably
estimated usually based on past experience we should occur our liability for the estimated cost of
the warranty obligation
- accounting for warranties is dependent on how the warranty is sold there are two types of
warranties
o original product warranty is when warranty is provided part of the product price.
Accounting for provisions: Reimbursement of provisions
In some situations, reimbursements are expected

Accounting for provisions: Special cases

- Provisions must not be recognized for future operating losses. Even if a sacrifice of future economic
benefits is expected a provision for future operating losses is not recognized because the past event
creating a present obligation has not occurred. Entities management generally has ability to avoid
future operating losses by either disposing of or restructuring the operation in question

- provision for restructuring is allowed only if there is constructive obligation. Usually a restructuring
is initiated by management and thus it is rare that a legal obligation will exist for restructuring. A
constructive obligation to restructure arises only when an entity has:
o a detailed formal plan for the restructuring
o raised a valid expectation in those affected that it will carry out the restructuring by starting
to implement that plan or announcing its main features to those affected by it
- Provision is not allowed for those resulting from executory contracts except where the contract is
onerous
- an executory contract is a contract which has not yet been fully performed that is to say fully
executed it is a country under which both sides still have important performance remaining

Accounting for provisions: Onerous contract

- And onerous contract is defined in the SF RSI as a contract in which the unavoidable costs of
meeting the obligations under the contract exceed the economic benefits are expected to be
received under it
- the unavoidable cost of meeting the obligations under a contract will reflect the least net cost of
exiting from the contract which is the lower of the cost fulfilling it and any compensations or
penalty arising from failure to fulfill it
 - If the entity is party to an onerous contract a provision for the present obligation under the
contract must be recognized. The reason these losses should be provided for is that the entity is
contracted to fulfill the contract. Therefore entry into an onerous contract gives rise to a present
obligation.

Contingent liabilities
- A possible obligation that arises from past events and whose existence will be confirmed only by
the occurrence or non occurrence of one or more uncertain future events not wholly within the
control of the entity or
- a present obligation that arises from past events but is not recognized because:
o it is not probable that an outflow of resources embodying economic benefits will be
required to settle the obligation or
o the amount of the obligation cannot be measured with sufficient reliability
- Example: Pending Lawsuit
- An entity does not recognize a contingent liability. Instead and entity discloses a contingent liability
in the notes to financial statements unless the possibility of an outflow of resources embodying
economic benefits is remote

Contingent asset
 - Is a possible asset which will be known only upon the outcome of uncertain future events not
within the company's control
- not recognized in financial statements since this may result in the recognition of income that may
never be realized. However a disclosure in the notes to the financial statements is required where
an inflow of economic benefits is probable
- assessed continually to ensure that developments are appropriately reflected in the financial
statements. If it has become virtually certain that an inflow of economic benefits will arise the asset
and the related income are recognized in the financial statements of the period in which the change
occurs

Week 13
The capital structure describes how a firm gets money to finance its overall operations and growth using
different sources of financing.

Sources of finances
- Equity financing
o Through which a firm gets money in two ways. The first one is to bring in investors or
partners who provide capital in exchange for a share of ownership of the business owners
contribution.
o Second one is to fund the operating and investing activities by using the retained earnings
generated by the business
o From the share capital and undistributed retained earnings
o Shareholder’s equity
o Financial instruments are presented as equity or liability depending on substance
o SFRS(I) 1-32 classified as equity only if
 There is no contractual obligation to repay AND
 If it is to be settled in the issuer’s own shares then a fixed number of shares
o Class of share
 Ordinary shares
 Owner’s of the corporation
 Right to vote
 Right to dividends
 On liquidation right to receive proportionate share of net assets remaining
 Also called shares, stock
 Preference shares
 Have certain advantages over ordinary shares like receiving dividends first
 May have a right to vote
 May have a right to dividends (this can be cumulative)
 On liquidation may have right to receive proportionate share of net assets
remaining before ordinary shareholders
  No fixed kind of preference shares
 With or without par value

o
o Advantage
 company has no legal obligation to distribute the profits
 Profits can be reinvested
o Disadvantage
 you give up partial ownership and intern some level of decision making authority
over your business most up since the investors will acquire shares in the business
and be entitled to a percentage of the profits where dividends are declared decisions
may have to be discussed with and approved by the investors. This limits the control
you have over your business

- Debt financing
o Through which a firm borrows funds in exchange for obligation to repay borrowed funds in
the future sometimes plus interest
o Advantages
 Allows the entrepreneur to retain the profit earned by their business without sharing
it with the credit of. Therefore the company benefits if the returns earned by their
business are greater than the interest costs of using the borrowed funds
 the interest payments on a business loan are classified as business expenses and
they can therefore be deducted from the businesses income at tax time. This means
exemption from paying tax for the power of the business income used to pay
interest lowering the tax liability of the business
 can affect your overall tax rate Can lower your tax rate
o Disadvantages
 your sole obligation to the lender is to make your payments but you will still have to
make those payments even if your business fails. If you are forced into bankruptcy
your lenders will have a claim to repayment before any equity investors. (solvency
risk)

% in 8% preference share  is the rate of dividend payable to the preference share holder

Two key ratios to assess solvency

- Debt-to-equity ratio
 o Provide early warning that a company may soon be unable to meet its payment obligation.
o Each loan will be noted on your credit report and will negatively affect your credit rating.
The more you borrow the higher the risk becomes to the lender so you pay a higher interest
rate on each subsequent loan therefore a high debt to equity ratio will lead to a lower credit
rating.
- Times interest earned ratio

Return on assets ratio: Assessing profitability

Return on equity ratio: Assessing profitability (evaluate a company’s ability to generate profits from overall
resources)

Capital structure and firm value

- A firm’s capital structure is the proportion of equity and debt
- Optimum capital structure
o Determined by the tradeoff between the tax advantage associated with debt and the
increased bankruptcy risk associated with higher leverage. The proportion of the equity and
debt will determine the weighted average cost of capital

o Regarding the effect of financing on the firm's value it depends on the purpose of the
financing. The financing is to meet the company's growth needs the expected growth is very
 likely to increase the firm value. However, if the financing is to meet the operational cash
flow needs the firm value is less likely to increase because there is no expectation on the
growth of the firm

Other factors determining capital structure

- “Pecking order theory” argues that equity is a less preferred way to raise capital because investors
believe their managers who are assumed to know better about the true condition of the firm only
issue new equity when the firm is overvalued so that they can take advantage of the overvaluation.
This belief will lead to investors placing a lower value to the new equity issuance as a result
companies may prioritize their sources of financing first preferring internal financing and then debt
lastly raising equity as the last resort.

- Transparent institutional environment can reduce the information asymmetry between investors
and managers this will reduce the cost of issuing new equity which might influence the forms
choice of capital structure

- managers style can also play a role. Risk taking managers might prefer using debt financing to a
larger extent after considering the risk return tradeoff when choosing sources of financing

- Traditional view: Optimal capital structure theory

Bankruptcy

Preemptive rights

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To determine the fair value we should use whichever evidence of the fair value that seems more clearly
evident to record the value of the shares. This fair value amount should be credited to the issued capital or
share capital account and debited to the non-cash asset.

Share dividends (issuance of shares)

- distributions of additional shares to current shareholders of the company. Is a dividend payment
made in the form of additional shares rather than a cash payment
- for example a 5% share dividend gives existing investors in additional share of company share for
every 20 shares they already own which is 5% of those shares. By issuing share dividends, thumbs
can reinvest internally generated profits to increase each shares value
- a shared dividend has the added benefit that no taxes have to be paid when investors receive the
dividends
- issuing shared dividends can be better for both the company and the shareholders
- when a firm issues share dividends each shareholder receives the same proportion of the shares
they already own. The shareholders proportional interest remains unchanged. The issuance of
share dividends has no effect on assets or liabilities of the firm.
- There is nothing changed but the number of shares outstanding when a pure share dividend is
issued
- no journal entry is needed for the issuance of share dividends in Singapore. In the US however firms
will transfer some retained earnings to share capital at the share distribution date

Share split (increasing the number of outstanding shares)

- Dividing each share, which diminishes its price
- A share split is a corporate action that increases the number of the corporation's outstanding
shares by dividing each share which in turn diminishes price. With stocks market capitalization
however remains the same just like the value of the $100 bill if it is extreme for two 50s.
- When the share price becomes too expensive to investors may details more investors from buying
the shares especially if there is a minimum trading parcel
- A share split can help to reduce the share price allowing small investors to buy the shares. Buying
doing so the firm can keep the liquidity of the shares.
- Share split only changes the number of shares outstanding without affecting any accounts in the
balance sheet.
 - As there is no impact on the dollar amounts of the accounts no journal entries needed for a shares
list. Hence the accounting treatment for share splits is the same as that for pure share dividends.

Share buybacks
- Refer to the repurchasing of the company's own shares from the open market
- of course when the issuing company based shareholders the market value per share and reabsorbs
their portion of its ownership that was previously distributed amongst investors. Hence the share
buyback to reduce the number of outstanding shares
- Reasons to reacquire shares:
o Sometimes companies may find that some of their retained earnings cannot be reinvested
to produce acceptable returns so they will repurchase their own shares by distributing cash
to existing shareholders in exchange for a fraction of the companies outstanding equity. In
this case share repurchases are an alternative to cash dividends
o some firms might buy back their own shares to increase earnings per share which is an
important accounting performance measure that affects manager's compensation. When a
company repurchases its own shares it reduces the number of shares held by the public. The
reduction of the float or publicly traded shares means that even if profits remain the same
the earnings per share increase
o Share repurchases can also avoid the accumulation of excessive amounts of cash in the
company reducing the investors expectation of future dividends
o Shared by banks can help to reduce the chance of a hostile takeover because the buybacks
can make their business less valuable to a potential bidder. When a bidder acquires the
target from any assets of the target company I used to pay off the bills debt after
acquisition. By using any cash on hand to repurchase shares the company effectively
reduces its total assets and equity for stop this means a bidder would need to use other
assets to meet the targets financial obligations. Besides the solvency risk of the increases
because the decrease in equity will lead to an increase in the D/E ratio
o Do use the repurchase shares to report its employees of stock option
o share buybacks may also be used to signal the manager's belief that the firm's shares are
currently undervalued. If a firms manager believes their firm shares are currently trading
below its intrinsic value they may consider repurchases

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