Financial Accounting and Reporting

Assessment 2
Case study

Background information
You are a financial controller at AccountantSea Limited (AccountantSea) – an international cruise line with
headquarters in Auckland, New Zealand. It offers year-round cruises in New Zealand, Australia, the Bahamas, the
Caribbean, Bermuda, Mexico and Hawaii. It also operates seasonal cruises in Canada, New England, Alaska and
Europe.

It is February 2023, and your team is preparing the financial statements for the 31 December 2022 year end. The
following are four independent tasks that still need to be completed.

Task 1: ‘Set Sales’ rewards program

On 1 January 2021, AccountantSea launched the ‘Set Sales’ rewards program to encourage employees to focus on
increasing sales revenue. Under this program, 32 sales managers were each granted 10,000 share options, with the
vesting period dependent on revenue growth as follows.

Vesting date Conditions

If revenue increases by at least 15% for the financial year ending on that date,
31 December 2021
compared with the 31 December 2020 financial year

OR

If revenue increases by an average of at least 13% across the two-year period from
31 December 2022
1 January 2021 to 31 December 2022

OR

If revenue increases by an average of at least 11% across the three-year period from
31 December 2023
1 January 2021 to 31 December 2023

The shares will not vest if:

• revenue does not increase in line with one of the three conditions in this table
• the employee does not remain employed as a sales manager at AccountantSea during the vesting period.

At grant date (1 January 2021), the share price was valued at $10.50 and the exercise price was determined at $6. The
fair value of each share option was $4.50.

During 2021:
• revenue increased by 14.5%
• three sales managers left.

At 31 December 2021, management expected that:

• revenue would increase by 12.5% in 2022 and 9.5% in 2023
• five more sales managers would leave during 2022
• another two sales managers would leave during 2023.

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 During 2022:

• revenue increased by 11%

• four more sales managers left.

At 31 December 2022, management expected that:

• revenue would increase by 9.5% in 2023

• another three sales managers would leave during 2023.

Required – Task 1
(a) Prepare the journal entries to account for the ‘Set Sales’ rewards program for the years ended
31 December 2021 and 31 December 2022. Ignore any tax implications. Show all workings.

(b) Explain the accounting implications if, by 31 December 2023, AccountantSea fails to achieve the 11%
revenue growth target across the three-year vesting period required for the rewards program. Structure
your answer to refer to the impact on:

i. the vesting of the share options

ii. the transactions recognised in 2021 and 2022

iii. the statement of profit or loss for the year ended 31 December 2023 and the statement of financial
position as at 31 December 2023.

Your response to Task 1 will form part of the 1,000-word limit for your written submission.

Task 2: Lawsuit
In August 2022, a group of 231 guests from several AccountantSea cruises joined a class action lawsuit claiming that
AccountantSea had not met the standard of care owed to its guests over the past year. The lawsuit alleges that these
guests all contracted serious illness while on board AccountantSea’s cruises because of inadequate health and safety
procedures.

The guests are seeking a combined total of $2,310,000 in damages. A hearing is scheduled for mid-March 2023.
AccountantSea’s main competitor has recently settled a similar class action lawsuit for $2,400,000 for 300 guests.

AccountantSea disputes the allegations and its lawyers have advised that, in their opinion, AccountantSea is likely to
win the case. AccountantSea has public indemnity insurance.

Required – Task 2
(a) Determine whether the lawsuit constitutes a provision or a contingent liability for AccountantSea in its
31 December 2022 financial statements. Explain your reasoning with a specific paragraph reference(s)
from the applicable accounting standard(s).

(b) Determine whether AccountantSea is required to record and/or disclose anything relating to this lawsuit in
the 31 December 2022 financial statements. Explain what needs to be recorded and/or disclosed, if
anything, and justify your reasoning with a specific paragraph reference(s) from the applicable accounting
standard(s).

Your response to Task 2 will form part of the 1,000-word limit for your written submission.

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 Task 3: Ethics
AccountantSea has recently increased its long-term borrowings to fund the acquisition of two new cruise ships. The
bank approved the increase subject to a debt covenant of maintaining a debt–equity ratio of 0.5 or less.

The board of directors is concerned because AccountantSea must also provide for upgrades on all existing cruise ships
to comply with the new Protocols of Operational Compliance in Cruise Liners. This may impact its debt–equity ratio for
the year ended 31 December 2022, taking it above the maximum allowed by the bank.

To avoid exceeding the maximum debt–equity ratio of 0.5, the board wants to delay recording a provision for the
upgrades to 2023. The Chief Financial Officer (CFO), keen to keep the board happy, has instructed you to prepare the
financial statements for the year ended 31 December 2022 without including a provision for the upgrades. You raised
with the CFO that excluding the provision would not be in accordance with IAS 37 Provisions, Contingent Liabilities and
Contingent Assets (IAS 37). However, he told you not to ask any more questions. You are now considering assigning
this work to a junior staff member who does not have experience working with IAS 37.

Required – Task 3
Identify and explain two (2) key ethical principles at risk for you.

Your response to Task 3 will form part of the 1,000-word limit for your written submission.

Task 4: Review of draft financial statements

Your team is finalising AccountantSea’s financial statements for the year ended 31 December 2022. You have
extracted certain information from the draft financial statements to review. The extract and related explanations are as
follows:

Draft financial statements for the year ended 31 December 2022

Statement of profit or loss and other comprehensive income for the 2022
year ended 31 December 2022 (extract) $ million
Revenue1 4,410
Employee benefits expense (2,500)
Depreciation and amortisation expense2 (600)
Profit on sale of property, plant and equipment2 40
Other expenses 3 (30)
Impairment loss4 (120)
Other comprehensive income (extract)
Items that may be subsequently reclassified to profit or loss
Investments in equity classified as fair value through other comprehensive 3
income – net change in fair value5
2022
Statement of financial position as at 31 December 2022 (extract) $ million
Non-current liabilities
Long-term borrowings6 1,400

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 Explanations provided to AccountantSea’s financial controller

1. Revenue includes fees charged to guests for cruise trips. To boost sales revenue in November and December
2022, the company offered an incentive, entitling each guest to a 20% discount on their next cruise to be taken
in January 2023. Revenue recognised in November and December 2022 totalled $1,256,000,000 for guests
embarking on cruises over these two months. This included $250,000,000 in revenue attributable to the
incentive program redeemed in January 2023.
2. A cruise ship, the Bottom Liner, was sold on 31 July 2022 for $400,000,000 when its carrying amount was
$440,000,000. Included in the depreciation and amortisation expense line item is this ship’s annual depreciation
charge of $100,000,000.
3. Included in other expenses is $10,000,000 of interest expense from AccountantSea’s new lease. The interest
expense on this lease is not disclosed anywhere else in the financial statements or the notes. The lease is for a
new cruise ship, the Fare Value, and commenced on 1 January 2022 for five years. Lease payments are made
in arrears on 31 December each year. The present value of all lease payments on 1 January 2022 was
$200,000,000. The interest rate implicit in the lease is 6% and AccountantSea’s incremental borrowing rate
is 5%.
4. On 31 December 2022, an impairment test was performed on AccountantSea’s luxury line of cruise ships. No
previous impairment had been recognised for these cruise ships. On 31 December 2022, the carrying amount of
the cruise ships was $1,000,000,000, the fair value less costs of disposal was $880,000,000, and the value in
use was $950,000,000.
5. On 1 July 2022, AccountantSea acquired 5,000 shares of CruiseSea Limited for $1,000,000. AccountantSea
elected to classify these shares at fair value through other comprehensive income at initial recognition. No
dividends were received from these shares for the year ended 31 December 2022. The fair value of these
shares was $4,000,000 at 31 December 2022.
6. $1,000,000,000 of these borrowings relate to the principal of a 10-year bank loan that will be repaid in full at
maturity on 30 June 2023.

Required – Task 4
Identify eight (8) errors in the draft financial statements and briefly explain why the accounting treatment is
incorrect. Assume that all information presented is material. You are not required to:

• consider the requirement for comparative financial information

• account for any income tax issues under IAS 12 Income Taxes
• provide references to accounting standards.

Your response to Task 4 will form part of the 1,000-word limit for your written submission.

Note: The word limit for your written submission for all tasks in Assessment 2 is 1,000 words.

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