Company Accounting: Australia-New Zealand, 5th Edition Solution Manual

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Company Accounting 5eSolutions ManualPeter Jubb Stephen Haswell Ian Langfield-SmtihVersion 5.0Chapter 1General introduction1.1Givesomeexamplesofthewaysinwhichcompaniesaffectthefollowing groups, favourably or adversely: shareholders, consumers,governments, employees, creditors, the ‘general public’.The answer to this question is found from the prior experience of students, not in the text. Thequestion is designed to concentrate attention on the benefits and detriments to different groupswithin society of the corporate form. The following table lists some of the aspects that could bementioned.FavourablyAdverselyshareholdersincreased wealth•dividends•share pricerisk of loss due to:•commercial factors•dishonest managementconsumers•an efficient and effectivemechanism for meeting demandsof consumers•effective way of ‘mobilisingcapital’loss of control and bargaining powergovernmentsassist in:•economic development•expanding taxation basemoral hazards:•major company crashes•need for regulatory interventionemployees•opportunities for employment•greater remuneration•scope for advancement•loss of bargaining power•risks of limited liability ofemployer (employee benefits)•loss of self-esteem (small cog inlarge enterprise)creditors•increase potential market•risks of limited liability‘general public’•economic growth•increased standard of living•impact on share values•increased gap between haves andhave nots1.2Towhatextentshouldcompaniesbecompelledtoprovideinformation to the above-mentioned groups?This question builds on question 1.1. As noted on page 4 these questions derive from social andeconomic policy considerations. Ultimately it comes down to personal preferences. However, as wewill see in chapter 3, arguments can be developed in support of such disclosures, for example, onesbased on protection of company members or the general public.

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2Company Accounting 5e Solutions ManualVersion 5.01.3With which functions of the companyshould a company accountantbefamiliar?This question is not directly answered in chapter 1; however, the following aspects can be distilledfrom the discussion:•the life-cycle of the companyformationissue of securities (equity and debt)how operations are reflected in financial reports (elements of financial reporting)preparation of reports for external usersexternal administration•the financial reporting of consequences of events and transactions of the company and otherregulatoryrequirements(legislation,accountingstandardsandstockexchangerequirements).1.4What are the sources of authority for company regulation, record-keeping and reporting?See page 4, where the following are listed:•legislation (primarily theCorporations Act);•accounting standards; and•stock exchange requirements.Other sources (not mentioned in chapter 1) include the Australian Securities and InvestmentsCommission (ASIC) and the Urgent Issues Group.

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Company Accounting 5eSolutions ManualPeter Jubb Stephen Haswell Ian Langfield-SmtihVersion 5.0Chapter 2Companies and corporate regulation2.1Discuss the characteristics of a company and the aspectsthatmakethe company an attractive structure for business enterprises.These characteristics are discussed on pages 8 and 9 of the textbook:•legal personality•limited liability•perpetual succession•share based ownership interests•ability to mobilise individual capital•scope for professional managementThese factors allow for an efficient and effective way for ‘jointly’ engaging in commercial activity.Legal personality and perpetual succession makes the company independent of individual owners,thereby facilitating transfer of ownership interest and not subjecting the business to other risksundertaken by individual owners (as is the case in partnerships). While for smaller enterpriseslimited liability may be defeated by lenders (and others) insisting on guarantees from owners, forlarger companies the risk limitation makes the investment more attractive to potential investors,while the use of share capital as the basis of ownership and interest in profits creates potential forinvestments with higher marketability than is otherwise available. It allows undertakings that cannotbe financed by individuals or small groups of individuals (via a partnership) to be establishedthrough mobilising relatively small investments by a large number of investors. Professionalmanagement provides the opportunity for more efficient and effective operation, thereby increasingreturns to investors. (Of course, the risks arising from the separation of ownership and managementmust be remembered.)2.2Outline the factors that give rise to the different types of companyallowable under the Corporations Act. By which permutations may thefactors be combined?Three general factors dictate the classes of companies that are available under theCorporations Act:•Factor 1:maximum size of the ownership pool and scope for fund raisingproprietary companiesmaximum membership 50 (excluding employees and former employees)cannot raise funds from the general public (in chapter 4 we see that they can onlymake unregulated offers of securities)

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2Company Accounting 5e Solutions ManualVersion 5.0public companiesno limit on number of membersable to offer securities to general public (as we see in chapter 4 this requires aregulated offer of securities through a prospectus complying with theCorporationsAct)•Factors 2 and 3:limited liability and how it is implementedcompanies without share capitallimited by guarantee (pubic companies only)companies with share capitallimited by sharesno liability companies (public companies only)unlimited companiesThese factors affect the forms in which a company can be registered. The distinction between smallproprietaryandlarge(ornotsmall)proprietarycompaniesdoesnotdependonformalcharacteristics; rather it depends on the indicators of economic significance. The implications of thisdistinction are limited to financial reporting requirements.The possible combinations are depicted in figure 2.1 (page 12).2.3What is meant by the following terms:limited liability,no liabilityandunlimited liability?•Limited liabilityowner or member’s (investor’s) liability for the debts of the company is limited to theamount not yet paid on shares ownedorthe amount agreed by way of guaranteeif there is share capitalthe owner must pay amounts not yet paid when called on to do so (if they do not theshares can be forfeited)on liquidation owner can be called on to pay amounts not yet paid (but no more)if there is no share capitalusually an obligation to make an annual payment (can be varied from time to time)on liquidation, maximum amount member can be called on to pay is the amount ofthe guarantee•No liabilitya member or owner has no liability for amounts unpaid on shares owned, both arrears anduncalled amounts (only available if company engages in mining activities)–if a memberfails to pay an amount when called on to do so, the company must forfeit the shares andsell them by public auctionthere is no liability in event of liquidation•Unlimited liabilitythe owner must pay amounts not yet paid when called on to do so (if they do not the sharescan be forfeited)on liquidation, the amount that members can be called on to contribute to meet thecompany’s debts is unlimited

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Chapter 2: Companies and corporate regulation3Version 5.02.4Howmayasharecompanybedistinguishedfromaguaranteecompany?•A share company can:have limited liability; orhave unlimited liability; orbe a no liability company.A guarantee company must have limited liability.•A share company has share capital that is (notionally) divided into individual shares, and theinterest of an owner of shares in the capital and profits of the company depends on the number ofshares held, and the rights attaching to those shares.For a guarantee company, the members have no interest in the underlying assets of the companyand cannot receive dividends or other distributions from the company.•A share company can beeithera public company or a proprietary company.A guarantee company must be a public company.(For some long-formed guarantee companies members can have an interest in the underlying assets,however, such companies are rare. Before theFirst Corporate Law Simplification Act 1995it waspossible to create public or proprietary companies with both share capital and liability limited byguarantee. Again, such companies are rare.)

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4Company Accounting 5e Solutions ManualVersion 5.02.5Draw two separate tree diagrams, similar to the diagram in figure 2.1,showing the permutations of corporate structure possibilities. Startthe left-hand side of the first diagram with ‘Mode of participation’ andthe second diagram with ‘Extent of liability’.SharesGuaranteeMode of ParticipationPublicPublicProprietaryType of companyLimited liabilityLimited liabilityUnlimitedliabilityLimited liabilityUnlimitedliabilitySmallLargeNo liability

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Chapter 2: Companies and corporate regulation5Version 5.02.6What is the applicability of the termsmemberandshareholder?See page 10, paragraph under heading ‘Mode of participation’ where the distinction is explained asfollows: ‘A generic name for owners ismembers.Shareholdersare described alternatively asmembers, but for companies with no shares, only the title ‘members’,is appropriate.’Limited liabilityNo liabilityUnlimitedlaibilityExtent of liabilityPublicProprietarySmallLargePublicPublicProprietaryType of companySmallLargeSharesSharesGuaranteeSharesSharesShares

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6Company Accounting 5e Solutions ManualVersion 5.02.7Briefly outline the test applied in classifying an entity as a disclosingentityanddescribetheconsequencesofbeingclassifiedasadisclosing entity.The test for determining if an entity is a disclosing entity is quite complex, however, in summary anentity is a disclosing entity if:•its securities are listed on a stock exchange (such as the one operated by the ASX);•it has issued debentures for which theCorporations Actrequires the appointment of a trusteefor debenture holders; and•for securities (other than debentures), the entity has issued securities–either under adisclosure document or under a takeover–for which there are at least 100 persons or entitiesholding those securities.Securities that satisfy any of the above are called enhanced disclosure securities in the Act.The main consequences of an entity being classified as a disclosing entity are:•having to prepare both half year and full year financial reports;•the ability to use abbreviated disclosure documents in fund-raising; and•the obligation to keep both the ASX and ASIC informed of information that may affect theprice of its securities (the continuous disclosure requirement).2.8Giveabriefsummaryofthehistoricalevolutionofthecompanyuntil 1961.The answer to this question is found on pages 14–16 of the textbook.2.9Outline and briefly discuss the method of operation of the nationalcompany schemes that operated in Australia between 1961 and 2000.Before 1991 regulation of companies was cooperative. In 1961 and 1962 uniform legislation wasadopted in the States and Territories (although there were some differences between the states).These were known as theUniform Companies Acts 1961–1962.There was no formal cooperationin the administration of the law. Starting in 1965 some states amended their legislation (often morethan once); by 1980 there were substantial differences in legislation–there was little uniformityleft.However,signatoryjurisdictionstotheInter-StateCorporateAffairsAgreementhadsubstantially similar legislation and had developed limited administrative cooperation. In 1980 theNational Co-operative Scheme was implemented under an agreement between the Commonwealth,the States and Territories. The scheme was based on the Commonwealth Act, which applied to theACT, and was adopted as ‘codes’ in the States and Northern Territory (the codes were substantiallythe same as the Commonwealth legislation). Collectively, the legislation was known as theCompanies Act and Codes. Amendments to the Act and Codes required Commonwealth legislationand legislation in each State and the Northern Territory. Administration was split between thenationalregulator(TheNationalCompaniesandSecuritiesCommission–NCSC)andtheCorporate Affairs Commissions and Departments of the States and Territories. While the NCSCwas responsible for coordination of policy, administration was primarily the responsibility of theStates and Territories. This splitting of responsibility caused many problems.

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Chapter 2: Companies and corporate regulation7Version 5.0The Commonwealth’sCorporations Act 1989was intended to address these problems. Thislegislation was originally intended to displace the States’ involvement in company administrationand to establish the Commonwealth as the only authority. However, the original legislation wassubstantially rejected by the High Courtas being unconstitutional.The Commonwealth redraftedthe legislation so that, rather than overriding the power of the States to legislate on company law,the Corporations Act would be used as a model that the States could adopt voluntarily.Anamendedversion passed through the Federal Parliament in 1990, and all of the States and Territoriessubsequently adopted the scheme, which became operational on 1 January 1991.The first part of the amended Act contained a lot of enabling legislation that provided theframework for the Commonwealth–States arrangements. The actual companies’ legislation itself(the contents of the original Act) was relegated to a large schedule, which became known as the‘Corporations Law’ to distinguish it from the rest of the Act. At first glance, the resulting schemeseems to be the same in concept as the 1981 National Cooperative Scheme. However, although theStates still technically retained a ‘reserve’ power over their own companies’ legislation,the schemewas much closer to being a truly national arrangement, especially because its administration wasrun by a single Commonwealth created and controlled body, the Australian Securities Commission.Despite all this remedial legislation there was still doubt that the changes would survive aconstitutional challenge. This resulted in a new act in 2001, which forms the basis of the presentscheme.2.10Give an overview of the present company law scheme that operatesin Australia.The current company law is found in theCorporations Act 2001, which re-enacted the priorCorporations Law (a schedule to section 82 of theCompanies Act 1989). The Act applies to allstatesandterritories–theStateshavingreferredthenecessarylegislativepowerstotheCommonwealth (thereby avoiding constitutional problems that had plagued the Corporations Law).Administration of theCorporations Actis the responsibility of the Australian Securities andInvestments Commission (formed under theAustralian Securities and Investments Commission Act1989).ASIC’s powers in relation to companies arise from theCorporations Act 2001and theAustralian Securities and Investments Commission Act 2001.2.11Outline the structure of theCorporations Act 2001.This structure of theCorporations Act 2001is depicted in Table 2.1 (page 17 of the textbook). Themost important chapters, for our purposes, are 2A–2C, 2F–2J, 2L–2N, 2M (deals with financialreports and audit), 5, 5A and 6D.2.12Briefly outline the powers and functions of the AASB.Under theCorporations Act 2001, the AASB has the power to make accounting standards which,under Chapter 2M of theCorporations Act, must be applied by entities that are required to preparefinancial reports under Part 2M.3 of the Act. The AASB has the power, under the ASIC Act 2001 tomake accounting standards for the purposes of theCorporations Actand for other purposes. Otherlegislative and administrative schemes can require entities to apply AASB accounting standards.The AASB is formed under theAustralian Securities and Investments Commission Act 1989,andunder section 227 of theAustralian Securities and Investments Commission Act 2001its powersinclude the power to:

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8Company Accounting 5e Solutions ManualVersion 5.0•develop a conceptual framework not having force of law for the purposes of evaluatingaccounting standards;•make accounting standards under s 334 of theCorporations Act for the purposes of theCorporations Act and formulate accounting standards for other purposes; and•participate in, and contribute to, the development of a single set of accounting standards forworldwide use.2.13Describe the role of ASIC in the regulation of financial reporting inAustralia.ASIC’s role in the regulation of financial reporting in Australia is primarily in enforcement of theCorporations Act’sfinancial reporting requirements. In doing so it can assist enforcement throughPractice Notes (outlining the ASIC’s interpretation of particular requirements of the Act–includingaccounting standards) and policy statements (outlining how the ASIC will exercise its powers underthe Act relating to accounting requirements–primarily the power to modify the application ofaccounting standards).[From July 2007 these were included in a new category ‘Regulatory guides’,together with policy statements, guides and frequently asked questions.] From time to time theASIC establishes enforcement programs, which include the review of financial reports lodged withit. If a report is deficient in any way, the ASIC can require lodging of reports amended to overcomethat deficiency or take other enforcement action. It can also refer matters to other administrativeorganisations such as the Company Auditors and Liquidators Disciplinary Board.2.14Describetheobjectivesoftheinternationalharmonisationofaccounting standards.Reductions in international differences of standards or the adoption of one set of accountingstandards world-wide could improve efficiency and comparability in world capital markets, andreduce costs. There are a number of ways in which this could occur. Three distinct approaches,globalisation, international harmonisation and internationalisation, are summarised by Godfrey andLangfield-Smith (2005) as follows:(a)globalisation,which involves adopting a single set of accounting standards throughoutthe world;(b)international harmonisation,which involves Australia using all, or a subset, ofaccounting standards developed in another jurisdiction to develop its standards; underthis approach compliance with Australian standards would ensure compliance with thestandards of that other jurisdiction but not, necessarily, vice versa; and(c)internationalisation,which involves Australia developing local accounting standardson the basis of a detailed examination of accounting standards and practices in otherjurisdictions.Globalisation is the ultimate goal of the IASB (International Accounting Standards Board) butinternational harmonisation is a means of helping to attain this goal, while at the same time offeringsome of its ultimate benefits. Harmonisation needs to occur with the agreement of governmentswho can adopt, in part or full, the accounting standards made by the IASB. Other interested partiesinclude domestic standard setters and stock exchanges.The IASB(originally called the International Accounting Standards Committee (IASC)), wasformed in 1973 through the cooperation of the professional accounting bodies in numerouscountries. Its purpose was to‘formulate and publish … accounting standards to be observed in thepreparation of financial statements and to promote their world wide acceptance and observance.’

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Chapter 2: Companies and corporate regulation9Version 5.0The standards issued by the IASC were called International Accounting Standards (IAS) and thoseissued by the new Board are called International Financial Reporting Standards (IFRS), which isnow also the generic name for IAS. These standards have been adopted by many countries forspecific purposes, for example, for reporting to stock exchanges by listed companies. Countriessuch as Pakistan, without a history of their own standard making, have adopted IFRS in the 1980sor 90s for general purposes. In 2005 Australia became the first country with a history of its ownstandard setting to adopt IFRS for general financial reporting purposes. The European Union hasalso adopted IFRS from this date but in a more limited way, for group reporting of listedcompanies.While many countries have, or have annouced an intention to adopt IFRSs for listedentities, other Western countries are yet to adopt IFRS as compulsory for general purposes so thelong term prospects for harmonisation by this means are still unclear.Reference:Godfrey, J.M. and I. A. Langfield-Smith, I.A., 2005,‘Regulatory Capture in theGlobalization of Accounting Standards’,Environment and Planning, 37, 11: 1975–1993.2.15Describe the process by whichAASBinterpretations are producedand their authority in the regulation of financial reporting.The role of interpretations is to provide timely guidance on urgent financial reporting issues, and toavoid the development of ‘divergent or unsatisfactory’ financial reporting practices in areas notdealt with in the accounting standards.The timeframe for production of an interpretation is very short. It does not involve the lengthy dueprocess used in the development of accounting standards; this process is needed to consult widelywith interest groups. Members of CPA Australia and ICAA must comply with them under APES205:Conformity with Accounting Standards, a standard developed by the Accounting Professional& Ethical Standards Board Limited, which was established in 2005 as an independent body todevelop ethical standards for the profession. Members of CPA Australia, The Institute of CharteredAccountants in Australia, and the National Institute of Accountants are required to apply itsstandards.The content of an interpretation must be consistent with existing accounting standards.2.16‘The type of entity used to conduct economic activity affects thenature of the financial information presented in an entity’s financialreports.’ Do you agree with this statement? Give reasons to supportyour view.The critical question (as we see in Chapter 3 when discussing the reporting entity concept) is: whatinformation would it be reasonable to expect that users will need? The answer may depend onlypartially on the form in which the entity’s operations are carried out, for example, whether the entityis a company and if so whether a proprietary company, large or small. Other important factorsincludethe degree of separation of management and owners, the number of owners, the size ofthe entity and amount of resources deployed.2.17ProvideabriefhistoryoftheroleoftheAustralianprofessionalaccounting bodies in the development of accounting standards.Compliance with the profession’sowntechnical statements became mandatory for members ofICAA and ASA in 1973.Primary responsibility for enforcement rested with the professional bodies,although neither ASA nor ICAA had a formal monitoring process. Auditors could issue qualifiedaudit opinions for non-compliance but could do little else. A qualified audit report signals that all

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10Company Accounting 5e Solutions ManualVersion 5.0might not be well within the company and can have a powerful communicative effect on investors.In1984 the Accounting Standards Review Board (ASRB) was founded under the legislation oftheNational Cooperative Scheme. The ASRB was the first quasi-government body to have thepower to approve standards that had force of law. The ASRB was the forerunner of the AASB.Initially the ASRB’s role was primarily one of reviewing accounting standards submitted toitbyothers,generallytheaccountingprofessionrepresentedthroughTheAustralianAccountingResearchFoundation(AARF)abodyjointlyfundedbytheprofessionalassociations.In 1988 an expanded ASRB took over the standard setting functions of theAccounting Standards Board of AARF. This included AARF taking over the role of ASRBtechnical support. Responsibility for public sector standard setting remained with the PublicSectorAccountingStandardsBoard(PSASB)ofAARF,establishedin1983.Accountingstandards, other than public sector specific ones, were developed jointly by the ASRB andPSASB. The ASRB was replaced bytheAASB, with similar powers, to coincide with the newscheme under the 1989 Corporations Act. These arrangements prevailed until January 2000when the FRC was created, with the revamped AASB assuming all accounting standard settingresponsibilities, including those formerly the responsibility of the PSASB. This left AARF andthe professional bodies with no formal accounting standard making responsibilities, and acorrespondingreductioninpowerandinfluence.Itwasdisbandedin2005followingtheestablishment, under the ASIC Act, of a statutory body, similar to the AASB, to set auditingstandards.2.18How are professional accounting standards enforced?ICAA, CPA Australia and NIA enforce financial reporting-related requirements through theirrules of professional conduct. These standards are determined by an independent standard setterestablished by the profession–theAccounting Professional and Ethical Standards Board, and areformalised in the rules within APES 205 Conformity with Accounting Standards. Compliance isrequired of individual professional practitioners rather than reporting entities; for the lattercompliance is enforced by ASIC. Penalties for practitioner’s non-compliance with the standardsmay include censure, fines or temporary or permanent exclusion from membership.Memberswho are in breach of AASB standards may also be prosecuted by ASIC.2.19Describe the relationship between the AASB, theformer UIGand theFRC.The FRC is responsible for the oversight and funding of the AASB. It also appoints all members ofthe AASB, other than the chair who is appointed by the Minister (currently the Treasurer). TheAASB is responsible for the making of accounting standards both for the purposes of theCorporations Act and otherwise.The FRC has no power of veto over AASB standards; howeverthose standards may be disallowed by either House of the Commonwealth Parliament. The UIG wasa subcommittee of the AASB. Following the change to IFRS protocol in 2005 the UIG committeehas been disbanded and its functions have been returned to the AASB.2.20Are AASB standards exactly the same as IASB standards? Explain.No. All of the IAS/IFRS standards issued at 1 January 2005 have an Australian equivalent, but thenew standards are not exactly the same as their IFRS counterparts due to slight modifications forAustralian use. Additional requirements were also necessary for not-for-profit and governmententities, since Australia has sector neutral accounting standards. The new set of AASB standards in2005 comprised 35 of the 36 IFRS-based standards plus some additional standards. The remaining

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Chapter 2: Companies and corporate regulation11Version 5.0IFRS (IAS 26) is replacedby AAS 25: Financial Reporting by Superannuation Plans. Five other ofthe previouslyexisting Australian AAS standardswereretained–most in a revised form–becausethere is noIFRS equivalent. There is also a new AASB standard with no IFRS equivalent, this isAASB 1048: Interpretation and Application of Standards. All the new standards have a re-numbered and re-titled AASB-prefix that distinguishes them from the IFRS equivalent. Thisresulted inthree groups of AASB standards,thosewith three digit numbers (corresponding to IAS-series),thosewith one digit numbers (corresponding to IFRS-series), andthosewith four digitnumbers (existing Australian standards for which there is no corresponding IFRS).Except for AAS 25, all of the AAS series standards were subsequently replaced with AASBstandards (with four digit numbers). TheAASB has continued the use of four-digit Australiaspecific standards, with new standards primarily dealing with public sector reporting issues. Thereis also a series of standards that amend existing AASB standards, mainly to reflect changes made toIFRSs, they are identified by the year and a sequence number, for example AASB 2007-8.2.21Describe the role of the ASX in the development of financial reportingrequirements in Australia.The ASX (and its predecessors) has played an important role in the development of Australianfinancial reporting requirements. Although today the ASX’s financial reporting requirementssubstantially mirror those intheCorporations Actand AASB accounting standards, in the pastmany financial reporting requirements started as requirements of the ASX Listing Rules, forexample the provision of consolidated financial statements, the provision of funds statements (andlater, the statement of cash flows), and the preparation of half-year financial reports. The ASX alsoplayed a key role in the AASB’s international harmonisation program, by promoting the use of IASaccounting standards and provided substantial financial support for the AASB’s harmonisationactivities.2.22What was the purpose of professional (AAS) accounting standardsand what now is their relevance?AAS standards are remnants of the professional bodies’ standard making, designated ‘AustralianAccounting Standards’ (AAS), all but one of which have now been replaced following theassumption of full standard-setting responsibility by the AASB in 2000. Several of the AASstandards remained in force in 2005 to cover topics outside the scope of IFRSs or where the IFRSwas not considered acceptable for Australian use; AAS 25: Financial Reporting by SuperannuationPlans is an example of the latter and is also the only one left. This standard applies mainly withinthe superannuation industry, although AAS 25 may affect the accounting obligations of a company,for example, if it is the trustee of a superannuation plan. The other AAS series standards, primarilyconcerned with public sector reporting issues, were subsequently replaced by Australia specificAASB standards. Enforcement of AAS standards is primarily made by the professional bodies. Theorigins and role of AASs are explained in the section on enforcement of financial reportingrequirements.2.23Describethemeansbywhichcompliance withfinancialreportingrequirements can be achieved.Essentially, achieving compliance is predicated by some form of enforcement mechanism. Suchmechanisms can be formal or informal. Formal mechanisms include the professional obligations

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12Company Accounting 5e Solutions ManualVersion 5.0(under APES 205 Conformity with Accounting Standards) of members of the accountancy bodies tocomply with (a) AASB/AAS accounting standards and with (b) AASB/UIG Interpretations. Indoing so, members must use their best endeavours to ensure that if an entity is a reporting entity thatthe entity prepares a financial report that is a general-purpose financial report that complies withaccounting standards. Another formal mechanism arises when compliance is required by law. Forexample, AASB accounting standards must be complied with when reporting under Part 2M of theCorporations Act. Further requirements and obligations to comply can be imposed by the listingrules of a stock market on which a company’s securities are traded (for example by the ASX). Theaccountancy bodies, the ASX and ASIC,have compliance programs designed to pick up instancesof non-compliance.2.24Describe the reasons for,and the political process that led to,theintroduction of IFRS for Australian use in 2005.The Australian economy, with its high degree of share ownership, has an investor-informationorientation like the US and UK. The EU decisionto adopt IFRS in 2005has been used by theGovernment and FRC to justifyitsmove to IFRSs; even the same date was chosen. The keydifference is that in Australia, IFRSs have been adopted for all types of entities rather than partialadoption. The decision process is shrouded in mystery. The announcement took the accountingcommunity in Australia and elsewhere by surprise. There was no pubic consultation, which for astatutory authority is extremely unusual.The FRC may have seen it as an opportunity to steal amarch on other regulators; however being the first one to do so is not without risk. The decisionmay have increased the AASB’s political visibility and its influence on the IASB, in the short-term at any rate. The incentives to move from harmonisation–the process previously adopted inAustralia–to adoption were significant.Doing so may be in the interests of big business,especially the stock exchange. Smaller companies that are not listed and do not raise financeoffshore, the overwhelming majority of companies, will not benefit directly, but they have themassive changeover costs, nevertheless.

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Chapter 2: Companies and corporate regulation13Version 5.02.25Which of the following broad regulatory reporting requirements•statutory provisions;•ASX listing rules;•AASB/UIG interpretations;•AASB accounting standards;•AAS accounting standards;applytoeach of the following:•public companies limited by shares;•listed public companies limited by shares;•proprietary companies;•small proprietary companies;•companies with unlimited liability?Explain your answer.Publiccompanieslimited bysharesListed publiccompanieslimited bysharesProprietarycompaniesSmallproprietarycompaniesCompanieswith unlimitedliabilityStatutory provisions(Corporations Act)YesYesYesYesYesASX listing rulesOnly if listedYesNoNoOnly if listedAASB/UIGInterpretationsYesYesYesOnly if reportingentityYesAASB accountingstandardsYes(provided it is areporting entity;if not, onlyAASB 101, 107,108, 1031 and1048 apply)YesOnly if a largeproprietarycompany(provided it is areporting entity;if not, onlyAASB 101, 107,108, 1031 and1048)No (limitedexceptionsexplained inchapter 11)Yes(provided it is areporting entity;if not, onlyAASB 101, 107,108, 1031 and1048 apply)AAS accountingstandardsNo(AAS 25 mayapply)NoNo(AAS 25 mayapply)No(AAS 25 mayapply)No(AAS 25 mayapply)

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Company Accounting 5eSolutions ManualPeter Jubb Stephen Haswell Ian Langfield-SmtihVersion 5.0Chapter 3Objectives of company reporting,conceptual elements and terminology3.1What reasons can be provided to justify the compulsory presentationof company reports to shareholders?Compulsory presentations of company reports (financial and other) can be supported in variousways, some of which are discussed in the text(see pages 33–35 generally; see also SAC1,paragraphs19–22.)TraditionallyAnglo-Australiancompanylawhasbeenpremisedontheexistence of separation of economic interest from management (control) and, therefore, the need forpublicly available information for the protection of creditors and members. It is directed to dealingwith the problems of information asymmetry.Disclosure is seen as one way of reducing the risk of fraud and mismanagement. To a significantextent the imposition and extension of compulsory financial reporting requirements can be relatedto market failure (as evidenced by major corporate collapses) and the need for politicians to be seento be doing something about them.3.2Do you believe that company reports should be made available to thegeneral public? Justify your answer. What is the extent of companyfinancial data that should be included in those reports?This is a more wide-ranging question than 3.1, since the provision of information extends beyondowners. Arguments similar to those in the answer to 3.1 can be put in support of such requirements.Here we are concerned with a far more potent problem since now the interest is not simplyeconomic nor is it based on ownership, and there is no direct means by those with that interest toexercise control over management.The extent to which financial data should be included can be deduced from the SACs. It shouldinclude such information that results in the financial report being a general purpose financial report.That is, it must ‘meet the information needs common to users who are unable to command thepreparation ofreportstailored tosatisfy,specifically, alltheir informationneeds’(SAC2,paragraph5). Such information must allow them to ‘make informed judgements about performance,financial position, financing and investing, and compliance’ (SAC 2, paragraph5).3.3Discuss the political forces that may give rise to compulsory financialreporting.See pages 33–35. Frequently it has been a perceived need by regulators (the Parliament, standardsetters etc) that has resulted in the extension of compulsory financial reporting requirements. Thisstems from a belief that financial reporting can minimise the risks of future corporate failures.Alternatively, there is a desire to be doing something whether or not it will actually minimise the

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2Company Accounting 5e Solutions ManualVersion 5.0possibility of future failures. Not only may political forces give rise to the imposition of financialreporting requirements, they can explain the lobbying activities by the various interested parties(those with a vested interest in the outcome). The accounting profession itself has a vested interestin maintaining or increasing compulsory reporting because it generates fee-for-service workloads.Corporations too, while they sometimes resist regulation altogether, more generally recognise thatsome regulation is inevitable. That being the case, they have an interest in reporting requirementsthat can allow them to present their results in the most favourable light or which will enhance theirlegitimacy as corporate citizens. Corporations will lobby regulators and government to have therequirements designed in a way that suits them best. These interests are, however, not the samefrom one corporation to another: for example, some may want financial reporting rules that showhigher profit, other companies who are politically visible may want to show lower profits. Thelobbying efforts of companies are therefore not consistent. To the extent that some of the lobbyingis successful, the result tends to be inconsistent accounting standards.Political forces and influences can also have the effect of reducing regulation. In Australia in recentyears the general thrust of politically driven reform has been to deregulate rather than increase thecontrols over the corporate sector (see pages 28–29 of the textbook for a brief discussion).3.4Doyoubelievecompulsorycompanyreportsareusefultotheirusers?Usefulness will be affected by:(i)The relevance of the information contained in the financial report. Is there informationoverload? Would concise financial statements better satisfy the relevance requirement?(ii)The timeliness of distribution of information. The information included in annual reports isalready several months out of date when received by the shareholder. The frequency ofreporting financial information will also have an impact (note the greater frequency fordisclosing entities).This can then be related back to the objectives underlying general purpose financial reports. That is,it must ‘meet the information needs common to users who are unable to command the preparationof reports tailored to satisfy, specifically, all their information needs’ (SAC 2, paragraph 5). Suchinformation must allow users to ‘make informed judgements about the performance, financialposition, financing and investing, and compliance’ (SAC 2, paragraph 5).3.5Which do you believe to be the more relevant to external report users:(a)information necessary to determine future share prices(b)information on the stewardship of company assets?Does your answer depend on the type of user?The folklore of financial reporting is that originally it was concerned with providing information onthestewardshipovercompanyassets(accountabilityandcompliancefunctions).Thiswasconsistent with the giving of account by a steward to the lord of the manor. This involved afiduciary relationship that was mirrored in early commercial ventures. However, as the scale ofcommercial operations became larger, particularly through the use of joint stock companies havingtransferableownershipinterests,ownerswerenotsolelyconcernedwithaccountabilityandcompliance; they were also concerned with making investment decisions. To a significant extent,this can be related to current and expected future share prices (which presumably reflect evaluationsabout an entity’s investing, financing and operating activities).

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Chapter 3: Objectives of company reporting, conceptual elements and terminology3Version 5.0The answer will be influenced by the type of user being considered. Owners will be interested infuture share prices as well as stewardship. However, creditors, employees and suppliers would bemore interested in the ability of the company to continue in operation and to meet its obligations.Therefore these latter are more interested in accountability related information which includesinformation on stewardship.3.6Explain how a reporting entity differs from a non-reporting entity.The key difference between a reporting entity and a non-reporting entity is the existence (forreporting entities) of ‘users who are unable to command the preparation of reports tailored tosatisfy, specifically, all their information needs’ (SAC 2, paragraph 5).3.7What is a general purpose financial report?A general purpose financial report is designed to ‘meet the information needs common to users whoare unable tocommand the preparation of reports tailored tosatisfy, specifically, alltheirinformation needs’ (SAC 2, paragraph 5). Such information must allow them to ‘make informedjudgements about the performance, financial position, financing and investing, and compliance’(SAC 2, paragraph 5). Such financial reports must comply with accounting standards and thequalitative characteristics discussed in The Framework.3.8Explain the relationship between being a reporting entity, the need toprepare and distribute general purpose financialstatements, and theneed to follow accounting standards.The term ‘general purpose financial statements’ is used in IFRSs, and has subsequently adopted inAASB standards rather than the more accurate term, ‘general purpose financial reports’ used inSAC 1 and SAC 2. While the two terms are slightly different they are concerned with the sameconcept.If we have an entity that is a reporting entity, then we have ‘users who are unable to command thepreparation of reports tailored to satisfy, specifically, all their information needs’ (SAC 2, paragraph5). We are told that such users need information that allows them to ‘make informed judgementsabout the performance, financial position, financing and investing, and compliance’ (SAC 2,paragraph 5). A financial report that does so is described as a general purpose financial statement.Such reports must be prepared in accordance with SAC 1 and 2, the Framework and accountingstandardsand will include such financial statements as necessary under those requirements. Theymust produce financial information that satisfies the qualitative characteristics dealt with in theFramework and also apply the definitions and recognition criteria for the elements of financialreporting.3.9‘In enhancing the quality of financial reports,relevance,reliabilityandmaterialityare inextricably linked.’ Explain the meaning of each term.Doyouagreethattheyareinextricablylinked?Givereasonstosupport your answer.Information ismaterialif:its omission or misstatement could influence the economic decisions of users taken on the basisof the financial report. Materiality depends on the size of the item or error judged in theparticular circumstances of its omission or misstatement. Thus, materiality provides a threshold

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4Company Accounting 5e Solutions ManualVersion 5.0or cut-off point rather than being a primary qualitative characteristic which information musthave if it is to be useful. (Framework paragraph 30.)According to the Framework (paragraph 26)information will berelevantwhen it:influences the economic decisions of users by helping them evaluate past, present or futureevents or confirming, or correcting, their past evaluations.Information isreliableif:it isfree from material error and bias and can be depended upon by users to represent faithfullythat which it either purports to represent or could reasonably be expected to represent.(Framework paragraph 31).These three characteristics of financial information are discussed on pages 39–40 of the text.The linkage between them can be explained as follows. Often there is a trade-off between reliabilityand relevance (the more relevant information is the less likely it is to be reliable and the morereliable the less likely it is to be relevant). The materiality test is designed to filter (potentially)reliable information by only including that relevant information that is likely to affect decisions andevaluations made by users.3.10Describeandillustratethetensionbetweenthetwodominantqualitative characteristics of financial information, namelyrelevanceandreliability.According to the Framework(paragraph 26) information will berelevantwhen it:influences the economic decisions of users by helping them evaluate past, present or futureevents or confirming, or correcting, their past evaluations.Information isreliableif:it is free from material error and bias and can be depended upon by users to represent faithfullythat which it either purports to represent or could reasonably be expected to represent.(Framework paragraph 31).The tension is explained by the fact that:•the more reliable an item of information is, the less likely it is to be relevant to decisionmakers needs; and•the more relevant an item of information is to users needs, the less likely it is to have a highlevel of reliability.For example, information about an entity’s future cash flows is likely to be very relevant to decisionmakers needs, however, the inherent uncertainties in predicting those future cash flows means thatthe reliability of the information is likely to be relatively low. Similarly the measure of the cost ofacquisition of an asset may be highly reliable, but its relevance to decisions that are likely to bemade by users may be quite limited; particularly those that are concerned with the prediction offurther cash flows. Therefore, we need to make a trade-off between the relevance and reliabilitywhen deciding to include such information in a financial report. In some cases relevance will be thedeciding consideration and in other cases reliability will be the deciding consideration. Thereforethe information contained in financial statements is a composite of measures that which has beenchosen mainly because of its relevance and that which has been chosen mainly because of its

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Chapter 3: Objectives of company reporting, conceptual elements and terminology5Version 5.0reliability. In some cases relevant but unreliable measures may be relegated to the notes to thefinancial statements while reliable, but less relevant measures are included in the financialstatements themselves.3.11Explain the difference betweencomparabilityandunderstandability.Understandability is concerned with the ability of users of a financial report to understand theinformation in fact provided in the report, whereas comparability is concerned with their ability torelate that information to information contained in other financial reports, either of the same entityor of other entities. The latter is important if users are to be able to assess the relative performance,financial position, investing and financing activities of an entity over time or against a benchmarkor other entities.3.12Howcantheneedtosatisfythequalitativecharacteristicofcomparability be used to argue in support of mandatory financialreporting requirements, such as those under theCorporations Act?In the Framework,theneedfor comparabilityisdescribed in the following way:users must also be able to compare the financial reports of different entities in order to evaluatetheir relative financial position, financial performance and cash flows. Hence, the measurementand display of the financial effect of like transactions and other events must be carried out in aconsistent way throughout an entity and over time for that entity and in a consistent way fordifferent entities. (paragraph40)To achieve comparability efficiently it is desirable that information be collected, processed anddisclosed in the same way by an entity over time and by all entities for the same reporting period. Ifthe methods of collecting, processing and reporting financial information are regulated (forexample, through accounting standards), then the resulting information is more likely to becomparable.3.13Brieflyoutlinethekeyaspectsoftherecognitioncriteriafortheelements of financial statement under the Framework.Under the Framework, ‘recognition’ involves depicting an item ‘in words and by a monetaryamount and the inclusion of that amount…’ (paragraph82). Amounts in the financial statementsrepresent recognised items of asset, liability, equity, income or expense;these are theelements.Anitem that meets the definition of an element of the financial statements should be recognised if:(a)it is probable that any future economic benefit associated with the item will flow to orfrom the entity; and(b)the item has a cost or value that can be measured with reliability. (Framework,paragraph83).3.14Explain the requirement to present a ‘true and fair view’ contained inthe Corporations Act.The Act itself gives little guidance about how to give a true and fair view, except that merecompliance with accounting standards may be insufficient (s. 295(3)(c))—in which case additionalinformation must be included. ‘True and fair’ is not defined by the Act. However, the ‘true and fairview’ test conjures up the following notions: true and fair accounting is based on reasonedjudgement and ethical fair play. Flexibility and interpretation, applied from a moral and honest

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6Company Accounting 5e Solutions ManualVersion 5.0viewpoint, are integral to the relevance and reliability of financial information. A literal observanceof rulebooks isnotsufficient. Where the accounting standards allow choice, the method chosenmust be one that gives a true and fair view. Even when the standards insist on a particulartechnique, the true and fair application might result in additional information being supplied.3.15Which documents constitute the conceptual framework of accountingand what are their main contents?The conceptual framework is a set of guidance documents for the development and interpretation ofaccounting standards.The present conceptual framework in Australia consists of the Framework (adocument adapted from IASB origins as part of IFRS adoption) and Statements of AccountingConcepts (SAC) 1 and 2 (these two documents were developed in Australia in the 1990s). Thispiecemeal approach to a conceptual framework has come about because the Framework is notconsidered by Australian authorities to contain sufficient coverage of material.In the 1990s the Australian Accounting Research Foundation (AARF, described in Chapter 2),began to produce a set of Statements of Accounting Concepts (SACs), the foundation documents ofa proposed conceptual framework. Four SACs had been issued and more were proposed, but theincomplete project was interrupted by plans to adopt IASB standards in 2005. The four issued SACsare:•SAC 1: Definition of the Reporting Entity (1990)•SAC 2: Objectives of General Purpose Financial Reporting (1990)•SAC 3: Qualitative Characteristics of Financial Information (1990)•SAC 4: Definition and Recognition of the Elements of Financial Statements. (1992, reissued1995)These four made up a reasonably comprehensive conceptual framework by themselves but they didnot have the force of law. Their purpose was guidance, to assist in standard setting and assist userswhenno accounting standard applied.The IASB Framework predates the SACs; it was published in 1989. Much of the development workwas carried out by AARF. To adopt IASB standards the AASB decided it was necessary to adoptthe Framework. Unfortunately, the Framework is not as detailed or comprehensive as the fourAustralian SACs.The Framework has the following main contents:(a)objective of financial reports;(b)assumptions underlying financial reports;(c)qualitative characteristics of financial reports;(d)elements of financial reports; and(e)recognition criteria for the elements of financial statements.Some of these points overlap slightly, but not sufficiently,with SAC1 and SAC2. The maincoverage approximately corresponds to material in SAC3 and SAC4, but the latter have moredepth of analysis. Fortunately,concepts in the Framework are similar to the SACs, but there aredifferencesthatare causing problems with the drafting of Australian standards.There are no IASBdocuments that correspond closely to SAC1 and SAC2. Therefore AASB found it necessary toretain SAC1 and SAC2 to fill in the gaps in the Framework. SAC3 and SAC4 are withdrawn;however,to the extent they take the same position, the more comprehensive discussion in them maybe useful in applying the Framework. SACs 1 and 2 remain guidelines only, although thedefinitions of entity, general purpose financial report and special purpose financial report in SACs 1and 2 are adopted in AASB 101.

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Chapter 3: Objectives of company reporting, conceptual elements and terminology7Version 5.03.16To what extent does the conceptual framework of accounting assist inthe understanding of financial reporting requirements?•Definition of reporting entity contained in SAC 1 helps us to decide the circumstances whena general purpose financial report is required. These guidelines work in conjunction with thescope and application paragraphs of the accounting standards. Objectives of financialreporting in SAC 2 help us to decide the type of information that must be provided, thoughonly in general terms. Specific requirements are contained in the accounting standards.•The definitions of the elements of financial reporting used in the Framework are replicated inmany AASB accounting standards, as are the recognition criteria for those elements. Instandards where specific mention is not made of these criteria, the Framework can provideassistance for interpreting a standard’s requirements.•The qualitative characteristics of accounting information provided by the Framework can beused to interpret the requirements of information under the accounting standards.•The conceptual framework is used by the AASB in developing new accounting standardsand in revising existing accounting standards.•The conceptual framework is limited in providing assistance where certain of its featureshave not been fully developed or seem to be defective in their drafting. For example, thedefinition of elements of revenue and expense in the Framework appears to be too loose toresult in competently categorised elements. This problem is explained in chapters 3 and 5 ofthe text on pages 43–44 and 90–93.3.17What is capital maintenance and why is it important to accounting?A company has maintained capital if it has as much capital at the end of the period as it had at thebeginning. Net increases in assets held above the amount of maintained capital are ‘profits.’Managers who act prudently do not erode the capital of their company.For a discussion ofdifferent conceptual approaches to understanding capital maintenance, see pages 44–45 of thetext.3.18What is meant bythe termssubstance over formandprudence?In principlesubstance over formmeans that thesubstance—the real impact of a transaction or eventon financial performance or position—should be shown rather than merely its superficialform.Thesubstanceof a transaction or event is not always consistent with its legalform. For example,some kinds of share might have more of the characteristics of debt than equity—there might be afixed dividend rate that more resembles interest payments, and no voting entitlements (see Chapter4of the text). Legally it is a share but in substance it is debt and may have to be reported in theliabilities part of the balance sheet.Prudenceis ‘the inclusion of a degree of caution in the exercise of the judgements needed inmaking the estimates required under conditions of uncertainty, such that assets or income are notoverstated and liabilities or expenses are not understated’ (Frameworkparagraph37). This exerciseof caution should extend to all matters of business judgement. However, it cannot be used as anexcuse to misrepresent financial position or financial performance; it is not prudent to mislead ordeceive users.

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8Company Accounting 5e Solutions ManualVersion 5.03.19What is the difference between a financial instrument and financialassets and liabilities?Afinancial instrumentis any contract that gives rise to a financial asset of one entity and a financialliability or equity instrument of another entity (AASB 132.11). Afinancial assetis any asset that is:(a)cash;(b)an equity instrument of another entity;(c)a contractual right:(i)to receive cash or another financial asset from another entity; or(ii)to exchange financial assets or financial liabilities with another entity underconditions that are potentially favourable to the entity; or(d)a contract that will or may be settled in the entity’s own equity instruments. (AASB132.11)Afinancial liabilityis any liability that is:(a)a contractual obligation:(i)to deliver cash or another financial asset to another entity; or(ii)to exchange financial assets or financial liabilities with another entity underconditions that are potentially unfavourable to the entity; or(b)a contract that will or may be settled in the entity’s own equity instruments. (AASB132.11)And anequity instrumentis any contract that evidences a residual interest in the assets of an entityafter deducting all of its liabilities. A share is the obvious example.Note: The IASB amendment the definition of financial liabilityin October 2009 (Classification ofRights Issues (Amendment to IAS 32)).Financial instruments must be constituted by a contract:•One contracting party (entity) has a financial asset and the other contracting party (entity)has a financial liability or an owners’ equity instrument.•There must be either (a) a financial asset and a financial liability or (b) a financial asset andan owners’ equity instrument, created by the contract.•With more complex financial instruments there may be a combination of financial liabilitiesand owners’ equity instruments. It is also possible for more than one type of financial assetto be created by the one contract.•The existence of a financial asset, or financial liability or owners’ equity instrument on itsown does not give rise to a financial instrument.3.20Whatproblemsareassociatedwiththedefinitionofincomeandexpense in the accounting standards?The new AASB standards are based on conceptual definitions adapted from theIASB’s Frameworkand standards. The IASBemployed three different terms to denote equity increments.Incomeis a‘headline’ or summary term but is not distinguished clearly fromrevenuesorgains. Revenue isassociated with ordinary period activity items while gains need not be; but there is no test todistinguish the two. No test is provided to assist us in distinguishing ordinary activities from other

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Chapter 3: Objectives of company reporting, conceptual elements and terminology9Version 5.0activities. In other accounting standards, and in practice, there are many exceptions to the examples.A similar problem exists for expenses. There are two types:expensesandlosses. Expense istherefore both a generic label and a specific one that denotes items arising in ordinary operatingactivities. Losses may or may not relate to ordinary operating activities; again there is no test todistinguish them from expenses.The Framework provides a summary term for the net of these increments and decrements,which isincome and expense, meaning, the sum of income (revenues plus gains) and expenses (expensesplus losses). AASB 101.88 requires that all items of income and expense be recognised in periodprofit or loss unless excluded by another accounting standard. No criteria are provided in theFramework by which we can decide which ones are excluded from the period profit or loss; otheraccounting standards require these exclusions arbitrarily. These categorising problems and theconfusing profit terminology that accompanies them are discussed in more detail in chapter 5 (pages90–93).3.21Brieflyexplainthemeaningandpurposeofreplacementcostaccounting.Like historical cost, replacement cost systems are an input-based approach to measurement.Atacquisition, the replacement cost of an asset will normally be the same as its historical cost. Afteracquisition, the recorded amounts may differ if the cost of an equivalent replacement asset haschanged. The purpose of changing the recorded amount is to take account of the effect of changingprices of assets in a way that is specific to the firm. This could be called a method of ‘inflationaccounting’ although the measurements are more sophisticated than mere adjustments for consumerprice indices, which only give a non-specific indicatorof price changes in the whole economy.Replacement cost can be measured in several ways; it can be the cost of acquiring an identical assetin new condition (the Edwards and Bell approach), the cost of replacing in current condition, or thecost of replacing the operating capability–the number of units of output–of the asset in its originalcondition. All of these systems provide a measure of physical capital maintenance.One technique for example is based on the cost of replacing assets with identical assets. Under thismethod, we substitute the replacement cost of an identical asset in new condition for the historicalcost (or a previous replacement cost), and adjust accumulated depreciation so that its amount is thesame proportion of the carrying amount under replacement cost as it is for historical cost. Theadjustment is done typically at the end of each financial reporting period.3.22Explainthedifferencebetweenthefollowingmeasurementtechniques: fair value, net fair value and net market value.Fair value is concerned with the amounts for which an asset would be exchanged, or a liabilitysettled, between knowledgeable willing parties in an arms-length transaction. This doesnot requirethe existence of an active and liquid market. (Various means of estimating fair value are discussedin chapter 9.)Net fair value is fair value less the expected cost of sale (asset) plus the expected costs of discharge(liabilities).Net market value is the amount found using a price taken from an active and liquid market afterdeducting expected costs of sale.

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10Company Accounting 5e Solutions ManualVersion 5.03.23Explain the difference between current cash equivalent and fair value.Current cash equivalent is the market or realisable price of an asset. In an active and liquid marketCCE and FV will differ by the amount of transaction cost for the sale. Also, if there is no activeorderly market the CCE will be zero, whereas if other estimators of FV are permitted, the FV maybe non-zero. This depends on how we limit the way in which we measure FV.3.24Explain the meaning of net realisable value(in the context of inventoryvaluation).The net realisable value (NRV) of an asset is the amount that it could be sold for less the cost ofgetting it to a saleable condition and the costs of selling it. It differs from the current cashequivalent in that the current cash equivalent is concerned with sale in current condition,whereasNRVispremisedonsaleincompletedcondition.NRVwasdevelopedforthemeasurement of inventory.3.25‘The diverse measurement techniques developed for different types ofassets suggests that standard setters are confused about the natureoftheattributethatistobemeasured.’Doyouagreewiththisstatement? Provide reasons to support your position.This is, of course, a matter of opinion. To an extent the differences merely reflect the point of timeat which the particular standard was first made. It may also reflect differences in the nature of theproblem (or perceived problem) to which the standard is addressed. This can result in differentattributes being measured, or apparently similar terms being used for distinctly different measures,orquitedifferenttermsbeingusedforalmostidenticalmeasures.Itreflectsthefactthatmeasurement has, in the past, been addressed on an ad hoc basis without first considering the capitalmaintenance concept to be adopted and the attribute that must be measured if capital is to bemaintained under that capital maintenance concept. It also can reflect changing attitudes to theobjective of financial reporting–for example, the balance taken at a particular point of timebetween the concerns of management in portraying financial performance and position in the mostfavourable way (preparer perspective) and the need to provide relevant and reliable information tousers (user perspective).

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Company Accounting 5eSolutions ManualPeter Jubb Stephen Haswell Ian Langfield-SmtihVersion 5.0Chapter 4Forming a company and issuingshares4.1Describe the sequence of events that usually takes place when agroup of people wish to form a public company.The first step is to register the company. Before doing so, it must be decided if the company isgoing to have a constitution that is comprised of the Corporations Act’s replaceable rules or by acombination of those rules and specially drafted rules, or wholly by specially drafted rules. If thecompany is to have a specially drafted constitution, it must be finalised before applying forregistration (since it must accompany the application). The information required in the applicationfor registration is listed on page 56 of the textbook.The subscribers must appoint the company’s directors, its secretary and take steps to appoint anauditor.The subscribers must then pay the amounts they have agreed to pay on the shares they agreed topurchase.Sometimes further money will be raised by a regulated offer of shares through a disclosuredocument,which must comply with the requirements of the Act and be lodged with ASIC.4.2What is the role and function of:(a)replaceable rules(b)a company’s constitution?The role of replaceable rules and a company’s constitution is basically the same (section 134).Under the Corporations Act the replaceable rules regulate the internal operation of the company, thepowers and duties of the directors, the relationship between members and the company and betweenthe members of the company. A company’s constitution (in substance) comprises the replaceablerules (to the extent that they have not been replaced by a specially drafted constitution) and theprovisions of any specially drafted constitution.4.3How may a company’s constitution be amended?A company’s constitution may be amended by a special resolution of members (one requiring a 75per cent majority) or by a more stringent procedure contained in the company’s constitution.

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2Company Accounting 5e Solutions ManualVersion 5.04.4Of what relevance is an ‘objects’ clause in a company’s constitution?An objects clause specifies the objectives for which the company was formed. The replaceable rulesdo not contain an objectives clause.However, the no liability company’s specially draftedconstitution does specify its objectives, since such companies must not engage in activitiesoutside their mining purposes. Other types of companies can elect to include an objects clause intheir specially drafted constitution, but doing so may have little or noeffect. Atone time, thedoctrine of ultra vires made it impossible to enforce contracts to do things outside a company’sspecified objects or beyond its specified powers. The ultra vires rules have been replaced bystatutory provisions dealing with the ability of companies to contract freely (Act, s. 125).4.5What rules govern a company if it does not have a constitution?The replaceable rules listed in section 141, together with other provisions of theCorporations Actgovern the company’s operations.4.6What is meant by ‘registering’ a company? Explain the registrationprocess.The process of registration is discussed on page 56 of the textbook. Registration is the process bywhich a company is formally recognised for the purposes of theCorporations Actand involves themaking of a formal application for and registration by ASIC and the assignment of an ACN(Australian Company Number) or more recently an ABN (Australian Business Number).In the text we have used the term registration rather than the narrower term incorporation.Registration can be by incorporation of a new entity under theCorporations Actand the issue of acertificate of incorporation. Registration also applies to entities formed under earlier company’s acts(they are deemed to be registered) and by entities formed under other legislative schemes that applyfor registration.4.7Detail the administrative matters that must be attended to shortly afterregistration.These matters are discussed on page 57 and 58 of the textbook. This includes the appointment of thefirst directors and company secretary, and for companies other than those qualifying as a smallproprietary company, the appointment of an auditor.The company must put in place procedures to ensure that it complies with the record keepingrequirementsoftheCorporationsAct,includingvariousregister-keepingrequirements(forexample, members, debenture holders, directors, charges, option holders), minute books for meetingof directors and members, and to ensure that accounting records necessary to meet the requirementsof the Act are maintained–this allows a double-entry bookkeeping system from which thenecessary financial reports can been drawn up.

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Chapter 4: Forming a company and issuing shares3Version 5.04.8What advantages are gained by listing on a stock exchange?See page 59 of the textbook. The main advantage is that it encourages shareholders to acquire newshares of the company since they can be more easily traded through the formal market establishedby a stock exchange such as the ASX. This is described as providing a greater degree of liquidity tothe investment. In turn this means that it is easier for the company to sell new shares, particularlywhen a substantial number of shares are to be issued.4.9Explain the distinction between a regulated offer of securities and anunregulated offer of securities. Why is this distinction important?An unregulated offer is generally onethatis made on a small scale, to less than 20 investors.Unregulated offers can also be made on a large scale if made to ‘sophisticated’ investors, forexample,to professional portfolio managers(Acts. 708). These offers are unregulated because itis assumed that those investors are capable of making decisions with less assistance; often theyhave the bargaining power to compel the company to provide the information they need.Regulated offers are necessary for other primary share issues for two reasons.First, to ensurethat information is provided to investors before they make a decision to invest, and second toprotect them from potentially misleading information. The main function of the regulated offer istherefore to mandate the nature and quality of information that must be given to any potentialinvestor. With a public company share issue this can be particularly important because thecompany and shares can be advertised widely and are therefore offered to people who may knowvery little about that company or about investing.4.10Under what circumstance must a disclosure document be lodged withASIC? What information is contained in such a disclosure document?A disclosure document must be lodged with the ASIC whenever a regulated offer of securities ismade. The disclosure document is usually aprospectus, though in some cases a shorter documentcalled a brief profile can be used, or a document called an offer information statement. The differingcontent depends on the amount being raised, the information previously lodged by the companywith ASIC, the type of securities, the circumstances of the issue, and whether securities of the classbeing offered are already listed on a securities exchange such as the ASX.The prospectus sets out information relevant to the potential investor’s understanding of theprospects of the company.There is no express requirement to include reports by experts; however,their inclusion will reduce potential third-party liability of the directors.Generally, the prospectusis required to include all the information that investors and their professional advisers wouldreasonably require to make an informed assessment of:•the assets and liabilities, financial position and performance, profits or losses andprospects of the body that is to issue the shares;•the rights and liabilities attaching to the shares, including the terms and conditions ofthe offer, the issue price, number of shares to be issued, how to deal with anoversubscription of the issue;•the interests of directors and other persons named in the disclosure document, in assetsto be acquired by or previously acquired by the company (Act,s.710).

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4Company Accounting 5e Solutions ManualVersion 5.04.11Under which circumstances may a company issue more than one typeof share?There are various types of shares, such as ordinary, preference and redeemable preference shares. Acompany generally has the power to issue different types of shares according to its requirements.Normally this power is exercised by the directors. In some cases there may be restrictions, forexample, where a debt agreement prohibits the directors from issuing redeemable preference sharesthat are in-substance debt.4.12What characteristics distinguish the main types of shares?The basic type of share is the ordinary share. If there is only one class of share, then those sharesare, by definition, ordinary. The rights, duties and other terms on which ordinary shares are issuedare determined by the company. In some circumstances, the rights and obligations are affected bylegislation and common law. Ordinary shares typically confer full voting rights and the right toreceive dividends.The most common other type of share is the preference share, which gives holders preferentialrights,the most common of which is preference to dividends. Frequently this means that theshareholder receives a dividend based on a fixed percentageof the issue price–provided thereare enough profits–whereas ordinary shareholders receive a variable dividend which dependson the level of profit and the willingness of directors to recommend that a dividend be paid. Thename is slightly misleading, however, because preference shares often confer reduced votingrights, and might be non-preferential as to return of capital in the event of liquidation. When acompany issues preference shares, it must set out the rights of those shares with respect to thefollowing matters, either in a special resolution of the company or in its constitution:•repayment of capital;•participation in surplus assets and profits;•cumulative and non-cumulative dividends;•voting; and•priority of payment of capital and dividends in relation to other shares or classes ofpreference shares.Some preference shares are redeemable; in which case the Corporations Act imposes furtherrestrictions (see chapter 6). Less commonly, a company might create other classes of shares withidiosyncratic conditions attached, of which the most important is the founder or deferred share.With this type of share, usually issued to the initial subscribers or founders of the company,dividends are received only after they have been paid to other classes of shareholders. Companiesmay also issue targeted or tracking shares, which participate in profits of only some aspects of thecompany’s undertakings. Targeted shares are considered in chapter 5.

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Chapter 4: Forming a company and issuing shares5Version 5.04.13Explain the following terms:issue price,called-up amount,call, andpaid-up amount.Theissue priceis the amount that the person to whom a share is issued agrees to pay for the share.That is, the total consideration payable in respect of the issue of the share.Thecalled-up amount (or value)is equal to the issue price less the amount uncalled. That is, it isthe sum of the amount of the issue price that has been paid (or deemed to have been paid) and anyamount that is currently payable (called-up but not paid) by the person to whom the shares havebeen issued.Acallis made where not all of the issued price of a share has been calledup. The directors have thepower, subject to the terms of issue, to call up all or part of theamount that has not been calledup.When they do so, they are said to make a call.Paid-up amountis the amount that has actually be paid in respect of a share. It is usually equal tothe called-up amount less the amount of any call or calls that have not yet been paid.4.14Briefly outline the requirements of accounting standards dealing withtransaction costs incurred when issuing new shares.In making a share issue, the company will incur costs such as stamp duties and taxes, fees ofprofessional advisors and brokerage fees that are directly related to the issue. Under the Framework,they would appear to meet the definition of an expense, and should be included in the profit or loss.However, under AASB 132.35, they must instead be ‘accounted for as a deduction from equity’, therationale being that they are then accounted for as part of the transaction to which they relate–theissue of the shares. This seems to be an application of substance over form; however here it isquestionable if the substance is any different from the form; the potential shareholder is not a partyto that transaction involving the transaction cost and in all likelihood is completely unaware that ithas taken place.It is unclear what is meant by the words ‘as a deduction from equity’; this issue is discussed inchapter 12 (page 334).4.15Describe the sequence of events that usually takes place when acompany whose shares are listed on a stock exchange decides tomake an issue of shares to the general public.The procedures for the issue are summarised in thesix points on pages 62–64of the textbook.4.16In what ways can share issues for established companies differ fromthose of newly formed companies?The distinguishing feature is that an established company always has the opportunity of offeringnew shares to existing members (a rights issue). Indeed, in many instances a failure to allowexisting members the opportunity of participating in the issue may result in a breach of the ASXlisting rules (if the company is listed)–the so-called 15 per cent rule (Listing Rules 7.1 and 7.2)–or may amount to oppressive conduct. For both initial issues and subsequent issues it is possiblethat the issue is either a regulated issue or an unregulated issue.

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