QUESTION 1
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Explain how the following five pairs of topics, covered by the International Accounting Standards Board’s (IASB’s) Conceptual Framework, are connected and why the linkages between them are important for financial reporting standard setting.
a) Objective-> Qualitative Characteristics
b) Qualitative Characteristics -> Recognition
c) Elements -> Recognition
d) Elements -> Capital Maintenance
e) Measurement -> Capital Maintenance (5 marks each) TOTAL 25 MARKS
QUESTION 2
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Explain how each of the following five ideas may be applied to financial reporting and hence why they are of significance to those interested in standard setting.
a) Market for lemons
b) Information asymmetry
c) Goal congruence
d) Regulatory capture
e) Principles-based vs. Rules-based standards (5 marks each) TOTAL 25 MARKS
QUESTION 3
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Frest plc (Frest) is a large company manufacturing lifts and providing services around their installation and maintenance. In its financial statements for the fiscal year ended on 31 December 2021, Frest recognised a provision for the following pending lawsuit:
At the beginning of 2021, Frest entered into a contract with an operator of several shopping centres. The contract specified that Frest would install lifts in the operator’s shopping centres and provide maintenance services for the subsequent three years. Shortly after installation, lifts in one of the shopping centres caused a fire on a busy holiday weekend. The operator of the shopping centres sued Frest for negligent conduct during installation and loss of trade on an especially busy weekend.
At the end of 2021, the lawsuit was still pending. Frest’s lawyers expected Frest to be found liable and to have to pay damages to the operator of the shopping centres with a probability of 65%. They further expected damages to amount to £250,000 with a probability of 30%, £450,000 with a probability of 30% or, in the worst scenario, £750,000 with a probability of 40%. Finally, the lawyers expected the court ruling to take place at the end of 2023. The lawyers’ estimates are based on outcomes of several prior lawsuits involving similar accusations as well as parties with similar financial resources. The relevant discount rate for Frest is 8%.
REQUIRED:
a) Explain why Frest was correct in recognising a provision for the lawsuit. Include in your explanation a short discussion of the recognition criteria for provisions under IAS 37. (9 marks)
b) Determine the amount of the provision at initial recognition and prepare the journal entry for the initial recognition of the provision in Frest’s financial statements for fiscal year 2021. Explain each of your steps. (5 marks)
c) Assume that you are supposed to rewrite the above description of the lawsuit so that it results in a contingent liability and not a provision. Propose at least two changes that you would make to the description. Include in your answer an explanation of what contingent liabilities are and how they differ from provisions. (7 marks)
d) The above description of the lawsuits suggests that the recognition and measurement of provisions involves discretion. Identify at least two examples of discretionary decisions from the description of the lawsuit and explain how they can be used to manage earnings. (4 marks) TOTAL 25 MARKS
QUESTION 4
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Efil is large company operating in the taxi industry with a fiscal year ending on 31 December. On 31 December 2021, Efil acquired a five-year taxi licence for a price of £15,000 with the intention to use it for three years, after which the licence will be sold in the market for taxi licences. In this market, the fair value of the taxi licence is £9,000 on 31 December 2022 and £7,000 on 31 December 2023. In the same market, taxi licences with a remaining useful life of two years traded at a price of £3,000 on 31 December 2021 and do not change significantly in price in subsequent years.
Efil applies the straight-line amortisation method to all its intangible assets and the revaluation model according to IAS 38 to the taxi licences that it owns. The market for taxi licences qualifies as active market according to IAS 38 and is expected to continue to exist for the next years. REQUIRED:
a) Calculate the relevant amounts and prepare the journal entries for the initial recognition and subsequent measurement of the taxi licence in Efil’s financial statements for fiscal years 2021, 2022 and 2023. Explain each of your steps. (15 marks)
b) Under the revaluation model according to IAS 38, revaluation increases and revaluation decreases are to be treated differently and affect measures of financial performance differently.
i) Explain the differences in the accounting treatment of revaluation increases and revaluation decreases.
ii) Explain which summary measures from the financial statements the IASB considers as measures of financial performance.
iii) Based on your answers to i) and ii), discuss which measure of financial performance reflects the value development of assets measured under the revaluation model most comprehensively. (10 marks) TOTAL 25 MARKS
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