ACC204 Advanced Financial Accounting Assignment

ACC204 Advanced Financial Accounting Assignment

ACC204 Advanced Financial Accounting Assignment

Introduction

This assignment relates to the application of accounting policies and accounting framework for the various accounting issues in relation to Australian companies. The accounting framework applied to solve the issues is the accounting standard framework developed by Australian Accounting Standard Board (AASB) which is required to be followed by the companies under the Corporation Act 2001. The issues included relate to revaluation of fixed assets, issue of debentures at fair value and revenue recognition on construction contracts.

ACC204 Advanced Financial Accounting Assignment

Question 1

John Pty Ltd is a manufacturing company which belongs to the diversified manufacturing industry of Australia. It produces the floatation devices for small children. The operations of company are very profitable but the directors of company use the excess profits for investment in diversification of operations rather than distributing as dividends. The fixed assets categorised as property plan and equipment comprise of land at building of NSW Factory and building of QLD Factory. The directors of the company wish to make revaluation of its assets for the year but the company has not made any revaluation in the past. Thus the accounting for revaluation and journal entries in the books of John Pty Ltd are presented in the question.

Accounting for revaluation of Fixed Assets

The accounting for revaluation of fixed assets of a company incorporated in Australia is done in accordance with the provisions of Accounting Standard AASB 1041 which specifically relates to revaluation of Non-current Assets. Since the company John Pty Ltd is a reporting entity as per the guidelines given in the corporation Act 2001, therefore the revaluation of its property plant and equipment will be required to be done according to the requirements of this accounting standard. The measurement of fixed assets can be either on cost basis or fair value basis but it shall be same for all the assets of same class. The accounting of the revaluation of the assets of a company where the revaluation is done on the basis of fair value of assets shall be done as follows:

When there is an increment in the value of asset after revaluation which means that when the fair value of the asset is higher than its carrying amount, then in such case there will be a profit to the company and such profit shall be as soon as possible be directly credited to the revaluation reserve created for that class of asset. However if this is subsequent recognition which means that previous revaluation on same class of asset has been done before and there was net decrement, then in such case the increased amount shall be recognised as income in the profit and loss account. This can only be done if the value of asset was valued downward in the previous year (Lewis, 2012).

Similarly in case of decrement in the value of asset as a result of revaluation, the amount shall be debited to the revaluation reserve account of the asset. If the same class of asset was increased to a higher value in the previous year which means at the time of revaluation in previous period an income was recognised in the profit and loss account and currently there is a credit balance in the revaluation reserve account then in such case the decreased amount on revaluation in the current year shall be transferred to profit and loss account as an expense. This accounting treatment will be also being applied if the decrement relates to the grossing up of current tax or deferred tax.

Journal Entries

For passing the journal entries for the revaluation of assets of John Pty Ltd, the revaluation amount can be calculated as follows:

Assets

Carrying Amount ($)

Fair value ($)

Revaluation Amount ($)

Property, plant and equipment

 

NSW Factory

 

Land

100000.00

150000.00

50000.00

Building (At cost less depreciation)

(70000-20000) = 50000.00

80000.00

30000.00

Qld Factory

 

Land

150000.00

120000.00

-30000.00

Building (At cost less depreciation)

(125000-45000) = 80000.00

70000.00

-10000.00

 Total

380000.00 

 420000.00

40000.00 

Assuming that the revaluation of assets is being done for the first time, the journal entries to be made are as follows:

Journal of John Pty Ltd

 

 

 

Amount in $

 

Dr/ Cr

 

Debit

Credit

1

Dr

Cr

NSW Factory Land

Profit on revaluation of asset

(Being profit on revaluation of land recognised)

50,000.00

 

50,000.000

2.

Dr

Cr

NSW Factory Building a/c    Dr

Profit on revaluation of asset

(Being profit on revaluation of building recognised)

30,000.00

 

30,000.00

3.

Dr

Cr

Loss on revaluation of asset

Qld Factory land

(Being loss on downward revaluation of old factory recognised)

30,000.00

 

30,000.00

4.

Dr

Cr

Loss on revaluation of asset

 Qld Factory Building a/c

(Being loss on downward revaluation of old factory building recognised)

10,000.00

 

10,000.00

 

5.

Dr

Cr

Profit on Revaluation

Loss on revaluation

Revaluation surplus

(Being profit and loss on revaluation of assets transferred to revaluation surplus reserve)

80,000.00

 

 

40,000.00

40,000.00

Question 2

Determination of  Fair Value of Debentures

Debentures issued by Kruger Ltd on 1 July 2015 are the financial instruments which need to be recognised at the fair value in the books of accounts of company. The company uses effective interest method to determine the fair value of its debentures at the time of issue. The fair value at the time of issue of debentures is considered as the issue price of the debentures (Blankespoor et al, 2013). The fair value of debentures is the present value of interest payments and redeemable value of such debentures on maturity. Kruger ltd has issued debentures amounting to $900,000 million maturing in six years. These debentures pay interest @6% whereas the market rate of return required for issue of securities is 4%. The effective interest method as per AASB 9 requires the estimation of fair value using discounted method using market rate of return. The fair value of debentures can be calculated as follows:

Fair value of debentures = Present value of interest payments + Present value of redeemable value

(Hu. Et al, 2015)

Here, interest payments = ($900,000 million * 6%)*1/2= $27,000 million

Present value of interest payments = $27,000 million*Present Value factor for 12 years at the rate of 2%

                                                            = $27000million *10.58

= $285,660 million

Present Value of redeemable amount = Redeemable value*Present Value Factor at 12th year on 2%

                                                            = $900,000 million *0.788

                                                            = $709,200 million

Thus fair value of debentures as on 1 July 2015 = $285,660 million + $709,200 million

                                                                        = $994,860 million

The debentures have the value of $900,000 million whereas the fair value of debentures to be considered as issue price is $994,860 which means that the debentures have been issued by Kruger Ltd at a premium of $94,860.

Journal entries

For making the journal entries on issue of debentures as well as for next two half years, the amortization of premium is required to be made which can be presented in the following table:

Journal entries

I July 2015 (Amount in million)

For issue of debentures

Dr        Bank                                                    $994,860.00

Cr        Debenture payable                              $900,000.00

Cr        Premium on issue of debentures         $94,860

(Being debentures issued on premium)

31 December 2015 (Amount in million)

Dr        Interest on debentures                                    $19,897

Dr        Premium on issue of debentures         $7,103

Cr        Bank                                                    $27,000

(Being interest on debentures paid)

30 June 2016 (Amount in million)

Dr        Interest on debentures                                    $19,755

Dr        Premium on issue of debentures         $7,245

Cr        Bank                                                    $27,000

(Being interest on debentures paid)

Question 3

Calculation of gross profit to be recognised for three years

The contract of Sun City Ltd is a fixed price contract for the period of three years to be started on 1 July 2014 and expected to be completed in the year 2017. The estimated revenue of the contract is $40 million whereas the estimated cost is $38 million. The estimated cost of project changes during the life of the project and therefore the estimated gross profit also differs. The calculation of gross profit from the construction project for Sun City Ltd for each of the three years is as follows:

Year

Total estimated revenue

Total estimated cost

Cost incurred to date

Percentage of completion

(Cost incurred to date/Total estimated cost*100)

Revenue to be recognised

(Total estimated revenue*Percentage of completion)

Gross profit

(Revenue to be recognised – Cost recognised during the year)

2014-15

$40 million

$38 million

$10 million

10/38*100 = 26%

40*26%= $10.4 million

$10.4 million - $10 million = $400,000

2015-16

$40 million

$38 million + $2million = $40 million

$28 million

28/40*100= 70%

 

40*70%= $28 million

 

=$28 million +$0.4million -  $28 million = $400,000

2016-17

$40 million

$40 million

$40 million

100%

$40 million

(40-40) +.4 - .4= 0

Journal entries using percentage of completion method

Percentage of completion method requires the revenue and profit to be recognised on the basis of level of completion of the project as against the estimated level in terms of cost incurred (Hathorn, 2011). The journal entries for the year ending 30 June 2015 for Sun City Ltd are as follows:

Journal of Sun City Ltd for the year ending 30 June 2015

S. No.

Dr/ Cr

Particulars

Amount

1

Dr

Cr

Contract revenue

Contract work in progress

 (Being revenue recognised)

$10.4 million

$10.4 million

2

Dr

Cr

Contract work in progress

Construction expense

(Being expense recognised)

$10 million

$10 million

3

Dr

Cr

Contract work in progress

Gross profit

(Being profit recognised)

$400,000

$400,000

4

Dr

Cr

Accounts receivable

Billing on contract work in progress

(Being debtors recognised)

$12 million

$12 million

5

Dr

Cr

Bank

Accounts receivable

(Being amount received)

$11 million

$11 million

Journal entries assuming the stage of completion cannot be assessed reliably

In case where the stage of completion of the construction project cannot be determined, the percentage of completion method cannot be applied by a company for its project. In this case the profit is recognised on the completion of the whole project rather than profit recognition at each stage of completion (Egan, 2015). The cost incurred on the construction project is recognised as expense from profit and loss account as and when such cost is incurred by the company.

Journal of Sun City Ltd for the year ending 30 June 2015

S. No.

Dr/ Cr

Particulars

Amount

1

Dr

Cr

Profit and loss account

Construction expense account

(Being expenses on construction project recognised)

$10 million

$10 million

2

Dr

Cr

Accounts receivable

Billing on contract work in progress

(Being debtors recognised)

$12 million

$12 million

3

Dr

Cr

Bank

Accounts receivable

(Being amount received)

$11 million

$11 million

Conclusion

From the discussion of accounting issues in relation to Australian companies, it can be concluded that the accounting standards serve as an important tool in resolving the accounting issues and fairly presenting the accounting information to the users. These provide the guidelines to be followed for dealing with the accounting problems. Thus, the companies shall comply with the provisions of AASB for reporting and presentation of financial and accounting information to its users.

References

AASB 116  (2010)“Property, Plant and Equipment” Compiled AASB Standard – RDR Early Application Only, pp-1-34

AASB 9 (2012) “Financial Instruments” Australian Accounting Standard Board, pp-1-8

Blankespoor, E., Linsmeier, T. J., Petroni, K. R., & Shakespeare, C. (2013). Fair value accounting for financial instruments: Does it improve the association between bank leverage and credit risk? The Accounting Review, 88(4), 1143. doi:10.2308/accr-50419

Egan, T. (2015). Contract - accounting - limitation of liability, Rhode Island Lawyers Weekly

Hathorn, J. (2011). Accounting for unprofitable construction contracts: a teaching note. Journal of Finance and Accountancy, 7, 1.

Hu, F., Percy, M. & Yao, D., (2015).Asset revaluations and earnings management: Evidence from Australian companies. Corporate Ownership and Control, 13(1), 930-939.

Lewis B.(2012), “Asset Revaluation or Impairment: Understanding the Accounting for Fixed Assets” COLLABORATE, pp-1-7

Strouhal, J. (2015). Historical Costs or Fair Value in Accounting: Impact on Selected Financial Ratios. Journal of Economics, Business, and Management, 3(5), 560-564.