Document

te mtauranga mahi kaute

accounting

2013/1

AC3004CONCEPTS FOR REPORTING ENTITIES

NCEA LEVEL 3

te aho o te kura pounamu

accountingncea level 3

Expected time to complete workThis work will take you about 15 hours to complete.

You will work towards the following standard: Achievement Standard 91404 (Version 1) Accounting 3.1 Demonstrate understanding of accounting concepts for a reporting entity Level 3, External 4 credits

In this booklet you will focus on these learning outcomes: describing the features of reporting entities and apply the statutory reporting requirements describing New Zealand Generally Accepted Accounting Practice (NZ GAAP) describing general purpose financial reports describing and applying the New Zealand Framework for general purpose financial

statements.

All the work for this standard is in this booklet.

Copyright 2013 Board of Trustees of Te Aho o Te Kura Pounamu, Private Bag 39992, Wellington Mail Centre, Lower Hutt 5045, New Zealand. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means without the written permission of Te Aho o Te Kura Pounamu.

1AC3004 te aho o te kura pounamu

contents

1 Features of reporting entities

2 New Zealands Financial Reporting Framework

3 General purpose financial reports

4 Qualitative characteristics

5 Financial elements

6 Teacher-marked activities

7 Answer guide

2 AC3004 te aho o te kura pounamu

how to do the work

When you see:

1A Complete the activity.

Check your answers.

Your teacher will assess this work.

Note this key point.

You will need:

a pen and paper a calculator.

Resource overview Complete your practice activities on your own paper (or one of the templates provided) and return them with your completed teacher-marked activities in this booklet.

Ensure that you have attempted all activities on your own before referring to the Answer guide.

At the end of each lesson, mark your practice work (P/X) from the Answer guide.

Take particular note of the key points as they will help you in your assessments.

Refer to the glossary in the Reference guide for an explanation of any new words you are not familiar with.

Each lesson begins with:

Learning intentions: what you are learning in this lesson Success criteria: what you should be able to do by the end of the lesson.

AssessmentIn this booklet you will work towards meeting the following criteria. Refer to your Reference guide for a full copy of achievement standard Accounting 91404 (Version 1) Accounting 3.1.

Achievement criteria 3.1

Achievement Achievement with Merit Achievement with Excellence

Demonstrate understanding of accounting concepts for a reporting entity.

Demonstrate in-depth understanding of accounting concepts for a reporting entity.

Demonstrate comprehensive understanding of accounting concepts for a reporting entity.


features of reporting entities1

learning intentionTo describe the features of reporting entities.

success criteriaYou will be able to:

describe accountability recognise stakeholders of reporting entities describe the contents of an annual report.

introductionYou will remember reading in booklet AC3001 that the Level 3 Accounting course (AC3000) extends the context of entities beyond the sole proprietor to include partnerships and reporting entities. In this booklet we take a closer look at reporting entities.

what is a reporting entity? The Financial Reporting Act 1993 gives the following examples of reporting entities:

issuers, which are companies that issue securities such as shares and debentures to the public, registered banks and insurance companies

overseas companies subsidiary companies companies that have one or more subsidiaries companies with assets valued at more than $450,000 companies with a turnover in excess of $1,000,000.

Important noteIssuers and companies are mainly private sector entities, although certain public sector entities such as state owned enterprises (SOEs), some Crown entities and some local authority trading enterprises (LATEs) are companies and therefore subject to the requirements of both the Financial Reporting Act 1993 and Companies Act 1993.

Key point Put very simply, a reporting entity is a limited area of economic activity whose financial information has the potential to be useful to existing and potential equity investors, lenders and other creditors.

4 te aho o te kura pounamuAC3004

features of reporting entities

For example, Air New Zealand sells/issues shares to the public and therefore it is a reporting entity. The principal activity of Air New Zealand is the operation of domestic and international passenger transport and cargo. Air New Zealands guiding principles are:

We will be the customers airline of choice when travelling to, from and within New Zealand. We will build competitive advantage in all of our businesses through the creativity and

innovation of our people.

We will champion and promote New Zealand and its people, culture and business at home and overseas.

We will work together as a great team committed to the growth and vitality of our company and New Zealand.

Our workplaces will be fun, energising and where everyone can make a difference.www.airnewzealand.co.nz/corporate-profile

When you read these guiding principles it is easy to see how potential investors could be persuaded to invest in a company such as Air New Zealand.

It would be very tempting to invest with an entity that is committed to their growth and vitality, because surely this must mean that if you invest in this company then they will be committed to the growth of your investment? However, apart from this impressive non-financial information, before you part with your money you would also be very interested in Air New Zealands financial information so that you can make a more informed decision as to whether to be that investor, lender or creditor to Air New Zealand. Below are extracts from Air New Zealands 2011 annual report.

2011

Company operating revenue

$3,949m

2011

Company net profit for the year

$223m

2011

Company total assets

$4,089m

isto

ck

5 te aho o te kura pounamu AC3004


Imagine that you have just inherited a substantial amount of money and you are thinking of purchasing shares in Air New Zealand. Apart from the extracts on the previous page, describe two pieces of financial information that could influence your decision whether or not to purchase shares.

If you have time, look at Air New Zealands 2011 annual financial report, which is available as a PDF from: www.airnewzealand.com/previous-reports

Browse through this, as it will help put your learning into a real scenario. There is a lot of interesting financial information in this document.

Check your answers.


accountabilityReporting entities are required by the Financial Reporting Act 1993 to provide general purpose financial reports (GPFR) for users and providers of resources (equity investors, lenders and other creditors) to the entity.

There are some entities that are excused from the strict provisions of the Act. These are covered under the statutory framework later in this booklet.

A reporting entity is considered accountable to their stakeholders, who include shareholders, creditors, employees, local communities and society (including the environment).

1A

Creditors

Local communities,

society

Stakeholders in an entity

Employees Shareholders



These stakeholders make economic decisions about the entity, such as:

deciding when to buy, hold or sell an equity investment in the entity assessing the stewardship or accountability of the management of the entity assessing the ability of the entity to pay and provide other benefits to its employees assessing the security for amounts lent to the entity determining taxation policies for the entity determining distributable profits and dividends preparing and using national income statistics regulating the activities of entities.

The diagram on the previous page and the economic decisions above show it takes a wide range of information to satisfy the range of stakeholders needs. The financial statements provide this they are general purpose financial reports (GPFR), which provide stakeholders with financial information that enables them to make informed decisions.

Stakeholders who are not members of the board are unable to contract for special purpose financial reports (SPFR). This means they have to rely on the financial statements for making decisions about providing further resources to the entity, and assessing whether management and the governing body of an entity have made efficient and effective use of the resources that have been provided.

Because the entity is accountable to the stakeholders, how the financial statements are prepared and what the financial statements should include are very important; not only to the entity but also to the stakeholders.

DefinitionsGeneral purpose financial reports are financial reports that provide information to meet the needs of those external users who are not able to pay for special reports to be prepared specifically for them.

Special purpose financial reports are financial reports tailored to meet the specific information needs of a particular user.

isto

ck



Objective of general purpose financial reportingThe objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity. Those decisions involve buying, selling or holding equity and debt instruments, and providing or settling loans and other forms of credit.

The New Zealand Framework 2011Debt instrument = mortgage/loan

(from the financial sector the business)

Equity instrument = shares (a share in the ownership

or equity of a business)

isto

ck

DIRECTORS FEAR JAIL FOR TAKING RIS

KS

www.stuff.co.nz/business/ind

ustries/7081715/Directors-fea

r-jail-for-taking-risks

ADAM FEELEY: EXPOSING NZS FINANCIAL CRIMEPeople will be surprised both

as to the scale

of fraud but probably also the breadth of

fraud. It happens everywhere, it happens in

the public and private sector... it happens in

charities, in banks, in sports clubs, in racing

clubs. It happens everywhere, Feeley said.

www.stuff.co.nz/national/politics/public-law-with-

mai-chen/6793984/Adam-Feeley-Exposing-NZs-

financial-crime

Recent cases in Australia and New Zealand involving directors obligations sound a warning for any directors who think: the difference between governance and management means that directors dont do detail directors dont need a basic level of financial literacy, or

directors dont need a good understanding of the companys business. www.chapmantripp.com/publications/Pages/Backsides-exposed-if-noses-in-fingers-out-means-hands-off-eyes-shut.aspx

LOMBARD DIRECTORS SAY VERDICT WRONG Lombard chairman Sir Douglas Graham, along with fellow former justice minister Bill Jeffries, Lawrence Bryant and Michael Reeves, were found guilty of making misleading statements in documents seeking money from the public between December 2007 and April 2008, when Lombard was put into receivership, owing $111 million to about 3600 unsecured investors.www.stuff.co.nz/business/6913494/Lombard-directors-say-verdict-wrong



contents of annual reportsAs can be seen from the newspaper headlines on the previous page, as well the reporting entity being accountable, the director or directors of the reporting entity are also accountable.

It is important that the financial reports of a reporting entity show a true and fair view. It is very important that the stakeholders can understand and trust what is being said (or advertised) about a reporting entity.

Key pointAn annual report is a comprehensive report on a reporting entitys activities throughout the preceding year. Annual reports are intended to give stakeholders information about the companys activities and financial performance.

True and fair viewWhether financial statements are external annual reports or internally-focused management statements, a clear objective has to be that the accounts fairly reflect the true substance of the entity and the results of its activities.

The application of the principal qualitative characteristics and of appropriate accounting standards normally result in financial statements that convey what is generally understood as a true and fair view of, or presenting fairly, such information.

Full compliance with New Zealand International Financial Reporting Standards (NZIFRS) would normally result in financial statements that show a true and fair view.

The following information must be included in an annual report:

description of the entitys affairs Financial Statements Auditors Report Accounting Policies charitable and political donations made since last annual report name of each director, and the amount of their remuneration amount of fees paid to the auditor disclosure of interest made during the period covered by the annual report (see Note) all directors notices covering use of company information during the period covered by the

annual report

all notices of directors share dealings made during the period covered by the annual report the number of employees who were paid more than $100,000 in bands of $10,000 (for

example $100,000$109,999).



NoteDisclosure of interest is a list of transactions and events that the directors have with the business. This includes:

dealings in company shares use of company information for personal use remuneration from the company loans or guarantees made to them by the company.

Although we have not yet covered all the accounting terminology below, this is a good chance for you to take some time to research these accounting terms. Use your local library or the Internet.

When preparing general purpose financial reports, entities must fully comply with NZ GAAP. This includes full compliance with New Zealand International Financial Reporting Standards (NZIFRS).State the objective of general purpose financial reports.

1. State the objective of general purpose financial reports.

2. State two examples of users/stakeholders who may be dependent on a reporting entitys general purpose financial reports.

3. Explain a reason for each users/stakeholders interest in the general purpose financial reports.

4. Explain why users may also be interested in non-financial and supplementary information included in an entitys annual report.

5. Explain NZ GAAP.

6. Explain the purpose of NZIFRS in the preparation of general purpose financial reports.

Check your answers.

rnzf

b

rich

mon

d

nzt

ba, p

hoto

: tri

sh d

unel

l

nzm

sc

1B


new zealands financial reporting framework

2

learning intentionTo describe statutory reporting requirements for reporting entities.


describe the purpose and objectives of financial reporting explain the financial reporting framework in New Zealand apply the statutory reporting requirements.

introductionIn the previous lesson, you learnt the features of reporting entities. In this lesson, you will learn about the current financial reporting framework. This reporting framework sets out what reporting entities are legally obliged to report.

the purpose and objectives of financial reporting

Key point The purpose of financial reporting for reporting entities is to assist stakeholders shareholders, creditors, employees, local communities and society (including the environment) in making decisions about where to invest their resources.

The current financial reporting framework sets out which entities have a legal obligation to:

prepare annual financial statements in accordance with generally accepted accounting principles (GAAP)

file annual financial statements with the New Zealand Companies Office and make them publicly available

obtain an independent audit opinion on the truth and fairness of the financial statements.

We started this course by defining accounting in booklet 1, AC3001, as:

... a subject that measures, records, reports and interprets both financial and non-financial information about an entity enabling communication to take place between the preparer and user of such information so that informed decisions can be made.

You might ask: Why are there legal obligations on reporting entities to report financially?

The reason for this is that, unlike sole traders and partnerships, the resource providers for reporting entities are often quite separate from the management of the reporting entity. As they are not on the management board, they cannot ask for financial reports to be prepared for their special purpose. Resource providers also have constrained influence on the management of the reporting entity.



For example, Harry is a shareholder who holds 1,000 shares in Air New Zealand. Although the number of shares held by Harry may be a significant investment for him, it is certainly not a significant figure given the total number of Air New Zealand shares on issue. Since Harry is not a major shareholder, he has very little influence on what the management of the company does.

Look at the table below.

major shareholders air new zealand 2011Shareholders Ordinary Shares Percentage

New Zealand Government* 804,191,058 73.36%

Other Investors 291,984,013 26.64%

Total Ordinary Shares on Issue 1,096,175,071 100.00%

As the owner of 1,000 shares, Harry, as an individual shareholder, has very little influence on how Air New Zealand, the reporting entity, should be managed. In other words, he has a very constrained influence. Harry is, however, one of the stakeholders that rely on Air New Zealands financial statements for all decisions he makes about his 1,000 shares.

On the other hand, Air New Zealand as a reporting entity is accountable to all its shareholders the Government and all other individual holders of the total 1,096,175,071 shares on issue.

Key point It is important that financial information provided to stakeholders shows a true and fair view of the reporting entity so informed and accurate decisions can be made. In order for a true and fair view to be shown, it is important that the reporting entity comply with the New Zealand International Financial Reporting Standards (NZIFRSs).

Harry owns 1,000 of the total 1,096,071 Air New

Zealand shares on issue.

ww

w.a

irn

ewze

alan

d.co

.nz/

shar

es-o

n-i

ssue

bi

gsto

ck



the failure of a large privately held company can have a significantly adverse impact on society. A key principle of Government policy is to require economically significant entities to both prepare General Purpose Financial Reports (GPFR) and have these reports audited www.grantthornton.co.nz/assets/documents/pubseminars/fra-april-2012.pdf

Read this quote from an article about changes to the New Zealands financial reporting framework, and in your own words, describe:

1. What is meant by significantly adverse impact on society?

2. What this new policy might mean for the wide range of stakeholders.

3. What this new policy might mean for reporting entities.

Check your answers.

financial reporting framework: standard setting arrangements

2A

NZIFRSs?

What are these?

Who makes the rules on these?

isto

ck

NZASBNew Zealand Accounting

Standards Board

NZAuASBNew Zealand Auditing and

Assurance Standards

Government

XRBExternal Reporting Board

Profession

NZICANZ Institute of Chartered

Accountants

Technical committees Sector interest groups



The framework for financial reporting in New Zealand is the structure that establishes and oversees requirements for external financial reporting by entities.

It covers:

types of entities that must comply with the financial reporting requirements financial statements that must be prepared principles that must be adopted in preparing financial statements requirements for disclosure, presentation and information regarded relevant to users.

The diagram on the previous page depicts the standard setting arrangements for financial reporting.

Let us look closer at the role that each organisation plays in the standard setting process.

external reporting board (xrb)The XRB is an independent Crown Entity responsible for developing and issuing New Zealands financial reporting standards.

Its statutory functions are:

financial reporting strategy accounting standards auditing and assurance standards liaising with international counterparts.

How does the XRB carry out these functions?

The XRB: governs the organisation establishes the financial reporting strategy appoints and oversees both the standard boards (NZASB and NZAuASB) oversees due process.

The XRB does all of the above with an underlying philosophy of:

user-needs focus (the XRB has a clear mandate to focus on the needs of all stakeholders, for instance shareholders, creditors, employees, local communities and society, including the environment).

user tiers to match costs and benefit (the XRB intends that the costs of producing financial reports should not outweigh the benefits to the various users of the reports).



new zealand accounting standards board (nzasb)The NZASBs strategic objective is:

To establish accounting standards for general purpose financial reporting which will encourage the preparation of financial reports that engenders confidence in New Zealand financial reporting, assists entities to compete internationally, and enhances entities accountability to stakeholders.www.xrb.govt.nz/site/about_us/nzasb_board/default.aspx

Therefore the NZASB is responsible for:

developing and issuing accounting standards for entities preparing General Purpose Financial Reports.

new zealand auditing and assurance standards board (NZAuASB)The NZAuASB is a sub-board of the XRB. Its strategic objective is:

To establish auditing and assurance standards which will encourage assurance providers to behave and provide assurance in a manner that engenders confidence in New Zealand financial reporting, assists entities to compete internationally, and enhances entities accountability to stakeholders.www.xrb.govt.nz/site/about_us/nzauasb_board/default.aspx

Therefore the NZAuASB is responsible for:

developing and issuing auditing and assurance standards for assurance providers required to use those standards.

isto

ck



the new zealand institute of chartered accountants (NZICA)NZICA encompass everything from quality assurance, advocacy and regulation, to leadership training, skills workshops, a comprehensive library and ongoing professional support.

NZICA strives to:

ensure that the quality, expertise and integrity of their members meet the highest standards, so businesses and individuals can be assured that they are working with the best and brightest accounting professionals

deliver the professional education and training people need to achieve a NZ Institute of Chartered Accountants designation, and provide the continuing professional development required to maintain the high standards of those designations

work on behalf of New Zealanders to advocate for sound public policy in the financial, regulatory and taxation areas. Internationally, we advocate for New Zealands interests through our membership of international accountancy bodies. www.nzica.com/about-us/who-we-are-and-what-we-do/our-mission.aspx

isto

ck

Oh my ... what does all this

mean?

isto

ck



summary of the financial reporting frameworkThis is certainly a lot of new learning. How can all this information be put into simple terms?

You have been made aware that there is a wide range of stakeholders for reporting entities; and when reporting entities fail, especially the economically significant entities, this affects society as a whole.

To minimise the chance of reporting entities failing, and to have full accountability, it is necessary to have a set of standards to make sure that financial reports are:

cost effective for the entity preparing the financial reports clear for users interpreting the financial reports consistent across time frames, entities and countries preparing financial reports coherent understood by the users of the financial reports.

The NZIFRS are a set of standards/guidelines developed to ensure financial reports contain these four key qualities.

The NZIFRS are standards and interpretations approved by the XRB.

Cost effective

Consistent

Financial Reporting

FrameworkCoherent Clear



1. One of the underlying philosophies of the XRB is ensuring that costs and benefits are matched when entities financially report. Describe in your own words what this means.

2. Why would the New Zealand Accounting Standards Board want to encourage confidence in New Zealand financial reporting?

3. What would be the consequence for New Zealand if this confidence was lost?

4. How does the auditing of financial reports enhance accountability to stakeholders?

5. Describe the role of NZICA in the development of the New Zealand International Financial Reporting Standards.

Check your answers.

the new statutory framework for financial reportingOn 14 September 2011, the Government announced its proposed reforms to the statutory financial reporting framework. At the same time, the External Reporting Board (XRB) released its proposed accounting standards framework that will apply to reporting entities under the new stator reporting framework. The new statutory framework for profit entities is shown on the next page.

To set out generally accepted accounting practices or the rules for general purpose financial reporting

in New Zealand.

What is the purpose of all the NZIFRSs?

Its so that reporting entities can prepare financial statements that comply

with the Financial Reporting Act and fairly reflect an entitys performance, financial

position and cash flows.

ww

w.b

nz.

co.n

z/ib

/app

/log

out,

isto

ck

2B



the (new) statutory framework

Publicly accountable entities are defined by the International Accounting Standards Board (IASB) definition. An entity is publicly accountable if:

1. its debt or equity is traded in a public market or is in the process of issuing such instruments

2. it holds assets in a fiduciary capacity for a broad group of outsiders as one of its primary businesses.

In all instances the following for-profit entities (as defined by legislation) are deemed to be publicly accountable and therefore in tier 1:

issuers registered banks deposit takers registered superannuation schemes.

For-profit entity

GPFR reporting requirement

Tier 1:Publicly accountable

entities/issuersGPFR prepared must:

Apply full NZIFRS Be audited Be publicly

available

Tier 2:Large for profit

companiesGPFR prepared must:

Apply NZIFRS but with RDR

Be audited Be publicly

available

Tier 2:Non-large for profit

companies with 10 or more shareholders

GPFR prepared must:

Apply NZIFRS but with RDR (but can opt out)

Be audited (but can opt out)

Distribute (to owners/members)

Special Purpose Financial Reporting

(SPFR)

usually prepared for Inland Revenue and

banks

No GPFR requirement

Fiduciary capacity means there is a duty of care.



A for-profit entity will be classified as large if it exceeds $30 million revenue per year or $60 million assets per year. The large criteria will be used to determine the statutory financial reporting requirements of privately held companies at the entity and group level.

Reduced disclosure regime (RDR)RDR provides for a significant reduction in required GPFR disclosure requirements.

Opt-out rulesA shareholder motion is required for non-publicly accountable for profit entities, which are not large, to opt-out of GPFR preparation and audit requirements. The opt-out would succeed if 95% of the voting shares cast on the motion supported the proposal (required on an annual basis).

statutory requirementsTier 1From the (new) Statutory Framework 2011 diagram, tier 1 reporting entities that are publicly accountable (i.e. owned or funded directly by the public) have a statutory requirement to prepare GPFR with full application of NZIFRS. These GPFR are required to be audited and made publically available.

An example of a reporting entity in tier 1 would be Westpac Bank, a registered bank.

isto

ckis

tock



Tier 2Large for-profit companies are considered to be economically significant as they have annual revenue of greater than $30 million or total assets of greater than $60 million. These large for-profit companies have a statutory requirement to prepare GPFR but not complete full application of NZIFRS. They are able to have a reduced disclosure regime, especially if the benefit is not outweighing the compliance cost of applying full NZ IFRS to their GPFR. These entities are required to have their GPFR audited and made publically available.

An example of a reporting entity in tier 2 would be Air New Zealand.

Tier 3Non-large for-profit companies with 10 or more shareholders are considered to have a significant degree of separation between management and owners or members of the entity. Because of this, these entities have a statutory requirement to prepare GPFR but can opt-out of the full application of NZIFRS.

You can see from the definitions above that an opt-out would require 95% of shareholders to cast a vote for such a motion (annually). These tier 3 entities can also opt out of an audit, but are required to distribute their GPFR to owners or members.

An example of a reporting entity in this tier would be a small company such as Burger Fuel.

Key point In New Zealand, most of the for-profit entities are small, and therefore do not fit into tier 1, 2 or 3. You only have to look around your neighbourhood to see all the small businesses that operate. Although they are not required to prepare general purpose financial reports, it is important that they do prepare special purpose financial reports so they are able to make informed financial decisions. It would be very costly for the local dairy if they continued to order a supply of good they could not sell.

Special purpose financial reports are financial reports tailored to meet the specific information needs of a particular user. For example, if an entity needs to apply to a bank for a loan so they can expand the business, they could prepare special purpose financial reports, so the bank could assess whether the business would be able to repay a loan.

isto

ck



1. Explain the reporting obligations of the following entities under the (new) Statutory Framework 2011.

a. Supertyres Limited has equity of $2m. The shares are held by Gary and Merv Robinson who manage the company. Average annual income is approximately $18m.

b. Footwear Distributors Limited has issued shares of $150m to the public. The business has assets of $160m and annual income of $180m.

2. Explain how the (new) Statutory Framework 2011 helps small for-profit companies that do not issue shares to the public, save money.

Check your answers.

isto

ck

2C


general purpose financial reports3

learning intentionTo describe general purpose financial statements and accounting policies.


identify general purpose financial reports describe the (new) New Zealand Framework 2011 and the Conceptual Framework explain generally accepted accounting practice (GAAP) explain the underlying assumption and the measurement bases used in the preparation of

financial reports.

introductionFrom the previous lesson, you now know that the financial reporting framework is the structure that establishes and oversees the requirements for external financial reporting by entities in New Zealand. In this lesson, you will learn about the general purpose financial reports that these reporting entities are obliged to prepare.

general purpose financial reportsReporting entities are required by the Financial Reporting Act 1993 to provide general purpose financial reports for users and providers of resources to the entity.

Some entities can opt out of the general purpose financial reporting requirements. These entities were identified under the (new) Statutory Framework 2011 in lesson 2.

The Financial Reporting Act 1993The Financial Reporting 1993 requires New Zealand reporting entities to produce general purpose financial reports prepared in accordance with generally accepted accounting practices (GAAPs).

Reporting entities are companies, government departments, Crown entities, local governments and other not-for-profit entities including trusts and charities.

General purpose financial reports include statements such as the Statement of Comprehensive Income, Statement of Financial Position, Statement of Cash Flows and notes to the financial statements.

Generally accepted accounting practices indicate the rules for recognising, measuring and disclosing transactions in general purpose financial reporting.

In later booklets you will be preparing general purpose financial reports for entities. Meanwhile, here is a brief summary of what each financial statement includes.


general purpose financial reports

statement of comprehensive income

Key point The purpose of a Statement of Comprehensive Income is to disclose the profit (loss) for a given period and the components of the profit, that is, revenue less expenses.

The Statement of Comprehensive Income must disclose:

revenue finance costs inventory write downs loss or gain on disposal of property, plant

and equipment

loss or gain on disposal of investments auditors fees broken into fees/advice etc total directors fees donations depreciation bad debts/doubtful debts tax expense profit or loss for the period.

statement of financial position

Key point The purpose of a Statement of Financial Position is to disclose the entitys asset, liabilities and equity, and the relationship of these elements to each other at a point in time.

The Statement of Financial Position must disclose:

current assets non-current assets current liabilities non-current liabilities equity appropriate notes.

isto

ckis

tock



statement of cash flows

Key point The purpose of a Statement of Cash Flows is to provide information about the historical changes in cash, that is, the entitys bank account. The Statement of Cash Flows reflects an entitys cash receipts and its cash payments during a period. This provides useful information about an entitys activities in generating cash through operations to repay debt, distribute dividends or reinvest to maintain or expand operating capacity.

The Statement of Cash Flows separately discloses the cash flows classified by major sources and uses from:

operating activities investing activities financing activities.

notes to the financial statements (accounting policies)

Key point The purpose of the Statement of Accounting Policies is to inform the users of the general purpose financial reports the accounting policies adopted in the preparation of those financial reports. This allows users to understand the significance of the information contained in the general purpose financial reports.

The Statement of Accounting Policies must disclose:

identification of the entity reporting by name and nature (including the statutory base, registered under the Companies Act 1993)

the measurement basis (or bases) used in preparing the financial statements the other significant accounting policies used that are relevant to an understanding of the

financial statements

myc

hill

ybin



a statement of changes in accounting policy only if the change is required by a standard or results in the financial statements providing reliable and more relevant information about the effects of transactions on the entitys financial statements. A change in depreciation per cent or doubtful debts per cent is a change in estimate, not a change in accounting policy.

The (new) New Zealand Framework 2011 states that the overall objective of general purpose financial reports is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.

This objective is achieved by publishing reports which assist users to assess an entitys:

financial position financial performance cash flows.

Changes happening in the New Zealand FrameworkThe International Accounting Standards Board (IASB) is currently in the process of updating its conceptual framework. This conceptual framework project is conducted in phases.

As a chapter is finalised by the IASB, the relevant paragraphs in the NZ Framework will be replaced. When the IASBs conceptual framework project is completed, the IASB will have a complete, comprehensive and single document called the Conceptual Framework for Financial Reporting.

This version of the NZ Framework includes the first two chapters the IASB published as a result of its first phase of the conceptual framework project.

new

zea

lan

d fr

amew

ork

2011

, for

ewor

d, p

age

5

The (new) New Zealand Framework 2011 replaces the Conceptual Framework.

Once finalised, the (new) New Zealand Framework 2011 is likely to be called

the Conceptual Framework for Financial Reporting.



purpose of the international accounting standards boards (iasb) framework The IASBs Conceptual Framework sets out the concepts that underlie the preparation and presentation of financial statements for external users. The purpose of the IASBs Conceptual Framework is to:

assist the IASB in the development of future IFRSs and in its review of existing IFRSs assist the IASB in promoting harmonisation of regulations, accounting standards and

procedures relating to the presentation of financial statements by providing a basis for reducing the number of alternative accounting treatments permitted by IFRSs

assist national standard-setting bodies in developing national standards assist preparers of financial statements in applying IFRSs and in dealing with topics that have

yet to form the subject of an IFRS

assist auditors in forming an opinion on whether financial statements comply with IFRSs assist users of financial statements in interpreting the information contained in financial

statements prepared in compliance with IFRSs

provide those who are interested in the work of the IASB with information about its approach to the formulation of IFRSs.

status of the new zealands conceptual frameworkThe IASBs Conceptual Framework is not an IFRS and therefore does not define standards for any particular measurement or disclosure issue. Nothing in the IASBs Conceptual Framework overrides any specific IFRS.

The IASB recognises that in a limited number of cases there may be a conflict between the IASBs Conceptual Framework and an IFRS. In those cases where there is a conflict, the requirements of the IFRS prevail over those of the Conceptual Framework.

scope of the iasbs conceptual frameworkThe IASBs Conceptual Framework covers:

the reporting entity the object of general purpose financial reporting the underlying assumption in the preparation of financial statements qualitative characteristics of useful financial information the definition, recognition and measurement of the elements which make up the financial

statements.

IASBFRAMEWORK

isto

ck



1. Describe briefly the requirements of the Financial Reporting Act 1993.

2. What is the purpose of the New Zealands Conceptual Framework?

3. In your own words, briefly describe why a complete, comprehensive and single document called the Conceptual Framework for Financial Reporting would be considered better than a separate conceptual framework for New Zealand.

4. What is the status of the IASBs Conceptual Framework in relation to financial reporting standards?

5. Explain how New Zealand equivalents to International Reporting Standards help to ensure that the general purpose financial statements fairly reflect the businesss performance, financial position and cash flows.

Check your answers.

importance of a reporting entitys accountability By now you will be aware that a reporting entity is accountable to a wide range of users. Unlike partnerships and sole traders, there is often a separation of ownership and management. Reporting entities are often economically significant, that is large in size, and therefore if they fail there is a considerable impact to society. You only have to search the newspapers to read the horrific impacts that the failures of the large finance companies have had on New Zealanders over the last few years. Investors, shareholders, general public, members, donors, taxpayers and ratepayers are all affected when an economically significant reporting entity fails.

To ensure that users needs are met, the financial reporting framework ensures that reporting entities prepare annual financial statements in accordance with Generally Accepted Accounting Principles (GAAP).

3A

isto

ck

PROVOST JUMPS INTO POLITICAL SHARKS TANKAuditor-General Lyn Provo

st and Prime Minister

John Key may find themselves at loggerheads over

just who is really to blame for the $1.78 billion the

taxpayer stumped up to bail out depositors in the

failed South Canterbury Finance.

www.nzherald.co.nz/business/news/article.cfm?c_

id=3&objectid=10749902



generally accepted accounting practiceGenerally accepted accounting practice (GAAP) is the term used to describe the basis on which general purpose financial statements are normally prepared. The term encompasses:

specific rules, practices and procedures relating to particular circumstances; and broad concepts and principles of general application.

Key point Reporting entities that comply with New Zealand generally accepted accounting practices (NZ GAAP) prepare their financial statements based on New Zealand International Financial Reporting Standards (NZIFRS), which outline rules and procedures for reporting the effects of transactions and other events in the financial statements. If all companies follow the same standards when reporting financial elements in their financial statements, the financial statements are able to be compared from one entity to another they have the enhancing qualitative characteristic of comparability.

independent audit report

Opinion on the financial statementsIn our opinion the financial statements of the Company and Group on pages 2 to 52:

comply with generally accepted accounting practice in New Zealand; comply with International Financial Reporting Standards; and give a true and fair view of the Company and Groups:

financial position as at 30 June 2011; and

financial performance and cash flows for the year ended on that date.

www.airnewzealand.co.nz/assets/pdfs/2011-airnz-annual-financial-report.pdf

Read this extract from the independent audit report for Air New Zealands financial results for the year 2011.

1. Describe what is meant by true and fair view.

2. Explain how Air New Zealand ensures its financial statements give a true and fair view.

Check your answers.

3B

bigs

tock



underlying assumption and concepts of financial statementsBefore we start to look at the qualitative characteristics and financial elements in the financial statements, let us look at the underlying assumption and other concepts that the financial statements are prepared upon.

underlying assumption: the entity is a going concern

Going concernThe financial statements are normally prepared on the assumption that an entity is a going concern and will continue in operation for the foreseeable future. Hence it is assumed that the entity has neither the intention nor the need to liquidate or curtail materially the scale of its operations; if such an intention or need exists, the financial statements may have to be prepared on a different basis and, if so, the basis used is disclosed.

New Zealand Framework 2011, Chapter 4, paragraph 1

From your previous study of accounting you will recognise some other important accounting concepts that are discussed in the NZ Framework with regards to the preparation of the financial statements.

accrual accounting

Accrual accounting depicts the effects of transactions and other events and circumstances on a reporting entitys economic resources and claims in the periods in which those effects occur, even if the resulting cash receipts and payments occur in a different period. This is important because information about a reporting entitys economic resources and claims and changes in its economic resources and claims during a period provides a better basis for assessing the entitys past and future performance than information solely about cash receipts and payments during that period.

New Zealand Framework 2011, Chapter 1, aob17

Financial statements based on accrual accounting report past transactions as well as inform users of the entitys obligation to pay cash in the future. For example, accounts payable and accrued expenses; and resources that represent cash to be received in the future, such as accounts receivable and accrued income.



reporting periodThe NZ Framework does not include the reporting period as an assumption, but NZ IAS 1 requires reporting entities to present financial statements annually.

The entitys continuing life is divided into nominated time periods in order to measure financial performance and position on a regular basis and to allow for comparisons from one period to the next.

NZ IAS 1 requires:

general purpose financial statements to be prepared annually the period covered by the financial statements must be disclosed on each statement.

1. Name the financial statements that make up general purpose financial reports.

2. State two objectives of general purpose financial statements.

3. Explain how the going concern concept is applied when preparing financial statements.

4. Give two examples of accrual accounting in financial statements.

Check your answers.

measurement bases

Measurement basesMeasurement is the process of determining the monetary amounts at which the elements of the financial statements are to be recognised and carried in the balance sheet and income statement. This involves the selection of the particular basis of measurement.

NZ Framework, Chapter 4, paragraph 54

3C



Different measurement A number of different measurement bases are employed to different degrees and in varying combinations in financial statements. They include the following:

Historical cost: Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances (for example, income taxes), at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business.

Current cost: Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset was acquired currently be obtained by selling the asset in an orderly disposal. Liabilities are carried at their settlement values; that is the undiscounted amounts of cash or cash equivalents expected to be paid to satisfy the liabilities in the normal course of business.

Reliable (settlement) value: Assets are carried at the amount of cash or cash equivalents that could currently be obtained by selling the asset in an orderly disposal. Liabilities are carried at their settlement values; that is the undiscounted amounts of cash or cash equivalents expected to be paid to satisfy the liabilities in the normal course of business.

Present value: Assets are carried at the present discounted value of the future net cash inflows that the item is expected to generate in the normal course of business. Liabilities are carried at the present discounted value of the future net cash outflows that are expected to be required to settle the liabilities in the normal course of business.

The measurement basis most commonly adopted by entities in preparing their financial statements is historical cost. This is usually combined with other measurement bases. For example, inventories are usually carried at the lower of cost and net realisable value, marketable securities may be carried at market value and pension liabilities are carried at their present value. Furthermore, some entities are the concurrent cost basis as a response to the inability of the historical cost accounting model to deal with the effects of changing prices of non-monetary assets.

New Zealand Framework 2011, Chapter 4, paragraph 56



Key pointIt is really important that you are able to explain the underlying assumption and other concepts that the financial statements are prepared upon in the context given. A definition alone is unlikely to receive a grading.

Example

Explain, in terms of accrual accounting, why an expense recognised for an insurance amount in a comprehensive income statement would include an amount already paid for insurance and an amount payable for insurance.

A possible answer would read:

Amounts paid and payable are for insurance used in the current accounting period, so the two make up the insurance expense for this current period. Even though the entire insurance amount has not been paid in cash, the entire insurance amount has been used by the entity in the current period so is reported as an expense in that period.

An answer such as this does more than just state the definition of accrual accounting it demonstrates to the marker your understanding of accrual accounting.

High Tech industries use the cost model to value plant and equipment and current cost to value its land and buildings each accounting period. At 30 March 2014, the carrying value of land was $250,000 and buildings $200,000.

A current valuation from a qualified valuer shows the market value of land is $350,000 and buildings $260,000.

1. What value will be shown in the Statement of Financial Position for both land and buildings?

2. High Tech Industries is planning to expand its operations. This will entail borrowing. Explain the benefit to High Tech Industries of using current cost as a measurement base for its assets when it attempts to raise a loan.

Check your answers.

3Dis

tock


qualitative characteristics4

learning intentionTo describe the qualitative characteristics and the constraints on them.


describe fundamental and enhancing qualitative characteristics explain the conflict between fundamental and enhancing qualitative characteristics describe the balance between benefit and cost.

introductionIn this lesson you will start to identify the types of information that are likely to be most useful to users for making decisions about the reporting entity on the basis of information in their financial statements.

qualitative characteristics of useful financial informationThe NZ Framework recognises qualitative characteristics which measure the quality of the information presented in financial statements.

As can be seen from the diagram on the following page, if the financial information in the general purpose financial reports is to be useful for decision-making then it must be relevant and faithfully represent what it purports to represent. The usefulness of financial information is enhanced if it is comparable, verifiable, timely and understandable.

isto

ck


qualitative characteristics

Pred

ictiv

e va

lue

Mat

eria

lity

Neu

tral

Conf

irm

ator

y va

lue

Veri

fiabi

lity

Com

para

bilit

y

Com

plet

eUn

ders

tand

abili

ty

Tim

elin

ess

Free

from

mat

eria

l err

or

Qua

litat

ive

char

acte

rist

ics

Fund

amen

tal

Enha

ncin

g

Faith

ful

repr

esen

tatio

nRe

leva

nce



Before financial information can be enhanced there are two characteristics that financial information must have. They are:

relevance faithful representation.

Relevance and faithful representation are known as the fundamental qualitative characteristics. They are like the foundation of financial information. If financial information is not relevant and faithfully represented then this information is not enhanced. Fundamental and enhancing qualitative characteristics complement each other but they do not stand alone.

Let us begin by defining the fundamental qualitative characteristics according to the New Zealand Framework.

fundamental qualitative characteristics

RelevanceRelevant financial information is capable of making a difference in the decisions made by users. Information may be capable of making a difference in a decision even if some users choose not to take advantage of it or are already aware of it from other sources.

Financial information is capable of making a difference in decisions if it has predictive value, confirmatory value or both.

Financial information has predictive value if it can be used as an input to processes employed by users to predict future outcomes. Financial information need not be a prediction or forecast to have predictive value. Financial information with predictive value is employed by users in making their own predictions.

Financial information has confirmatory value if it provides feedback about (confirms or changes) previous evaluations.

The predictive value and confirmatory value of financial information are interrelated. Information that has predictive value often also has confirmatory value. For example, revenue information for the current year, which can be used as the basis for predicting revenues in future years, can also be compared with revenue predictions for the current year that were made in past years. The results of those comparisons can help a user to correct and improve the processes that were used to make those previous predictions.

MaterialityInformation is material if omitting it or misstating it could influence decisions that users make on the basis of financial information about a specific reporting entity. In other words, materiality is an entity-specific aspect of relevance based on the nature or magnitude, or both, of the items to which the information relates in the context of an individual entitys financial report.

New Zealand Framework 2011, Chapter 3, AQC6 AQC11



How are these qualitative characteristics applied to general purpose financial reporting? Look at the example below.

ExampleIn 2011, New Zealand hosted the Rugby World Cup. This was a major event for New Zealand. Prior to hosting this event, a number of construction firms signed contracts to upgrade sports stadiums.

Mammoth Construction Ltd was one of these firms that in 2009 signed a two-year contract to upgrade Mt Eden Stadium, in Auckland. In 2009, Mammoth Construction Ltd included a note in their general purpose financial reports explaining the future capital expenditure commitments involved in completing this construction contract, as well as any penalty clauses for late completion.

Stop! Think, and then try to answer the question below.

With reference to relevance and materiality above why do you think that the note was included in Mammoth Construction Ltds financial reports in 2009?

The note was included in Mammoth Construction Ltds financial reports in 2009 because the future capital expenditure commitments outline Mammoth Construction Ltds intended purchasing of new assets, such as more construction vehicles, with their accompanying costs in order to complete the upgrade of the sports stadium in time for that Rugby World Cup in 2011.

The disclosure of Mammoth Construction Ltds future capital expenditure commitments in 2009 was relevant to the decision-making of the companys users because this would have assisted the users in 2009 to predict:

whether Mammoth Construction Ltd was able to finance the purchase of the additional assets within budget

whether Mammoth Construction Ltd was likely to meet the future contractual obligation of upgrading the stadium on time and not incur any penalty costs for late completion.

isto

ck



As you have read above materiality is also a component of relevance. This disclosure note in the financial reports was material because:

the significantly large amount of capital outlay required by Mammoth Construction Ltd in upgrading Mt Eden stadium would have influenced users decisions on the future financial stability of Mammoth Construction Ltd

the nature of signing a construction contract with penalty clauses for late completion would have influenced users decisions by causing them to consider whether Mammoth Construction Limited was likely to complete the contract in time and what the predicted penalty cost would be if the company finished the upgrade of the sports stadium outside the two-year period.

faithful representation

Financial reports represent economic phenomena in words and numbers. To be useful, financial information must not only represent relevant phenomena, but is must also faithfully represent the phenomena that it purports to represent. To be a perfectly faithful representation, a depiction would have three characteristics. It would be:

complete neutral free from error.

A complete depiction includes all information necessary for a user to understand the phenomenon being depicted, including all necessary description and explanations. For example, a complete depiction of a group of assets would include, at a minimum, a description of the nature of the assets in the group, a numerical depiction of all of the assets in the group, and a description of what the numerical depiction represents (for example, original cost, adjusted cost or fair value).

A neutral depiction is without bias in the selection or presentation of financial information. A neutral depiction is not slanted, weighted, emphasised, de-emphasised or otherwise manipulated to increase the probability that financial information will be received favourably or unfavourable by users. Neutral information does not mean information with no purpose or no influences on behaviour. On the contrary, relevant financial information is, by definition, capable of making a difference in users decisions.


An independent survey has rated Ring-a-ding Ltd as the best performing mobile phone company in New Zealand. Because of this acknowledgement, the directors wanted to include an amount for goodwill in their financial reports. 1. Explain fully why the directors wanted to include an amount for goodwill in their

financial reports, in terms of relevance.2. Using the qualitative characteristic of faithful representation, explain fully why

the amount of goodwill may or may not be complete, neutral and free from error.

Check your answers.

4A

isto

ck



enhancing qualitative characteristicsComparability, verifiability, timeliness and understandability are qualitative characteristics that enhance the usefulness of information that is relevant and faithfully represented. The enhancing qualitative characteristics may also help determine which of two ways should be used to depict a phenomenon if both are considered equally relevant and faithfully represented.

comparability

Users decisions involve choosing between alternatives, for example, selling or holding an investment, or investing in one reporting entity or another. Consequently, information about a reporting entity is more useful if it can be compared with similar information about other entities and with similar information about the same entity for another period or another date.

Comparability is the qualitative characteristic that enables users to identify and understand similarities in, and differences among, items. Unlike the other qualitative characteristics, comparability does not relate to a single item. A comparison requires at least two items.


Ring-a-ding Ltd, the best performing mobile phone company in New Zealand according to a recent independent published survey, wants to expand their company and offer other types of technology to their customers. This will require them to extend their factory. As part of a loan application to finance this project, Ring-a-ding Ltd included the 2014 and 2015 comprehensive income statement.

1. State the qualitative characteristic that Ring-a-ding Ltd is following by including both the 2014 and 2015 comprehensive income statement in their loan application.

2. Explain why the bank manager would be interested in viewing both the 2014 and 2015 comprehensive income statement figures.

Check your answers.

verifiability

Verifiability helps assure users that information faithfully represent the economic phenomena it purports to represent. Verifiability means that different knowledgeable and independent observers could reach consensus, although not necessarily complete agreement, that a particular depiction is a faithful representation.

New Zealand Framework 2011, Chapter 3, AQC26

A good example of verifying financial information is annual stock takes carried out by trading firms. Usually once or twice a year a trading firm, such as a supermarket, physically counts their stock and verify this figure with the computer-generated end inventory figure. Re-calculations are made where necessary.

4B



timeliness

Timeliness means having information available to decision-makers in time to be capable of influencing their decisions. Generally, the older the information is the less useful it is. However, some information may continue to be timely long after the end of a reporting period because, for example, some users may need to identify and assess trends.

New Zealand Framework 2011, Chapter 3, AQC29

understandability

Classifying, characterising and presenting information clearly and concisely makes it understandable.

Some phenomena are inherently complex and cannot be made easy to understand. Excluding information about those phenomena from financial reports might make the information in those financial reports easier to understand. However, those reports would be incomplete and therefore potentially misleading.

Financial reports are prepared for users who have a reasonable knowledge of business and economic activities and who review and analyse the information diligently. At times, even well-informed and diligent users may need to seek the aid of an adviser to understand information about complex economic phenomena.


applying the enhancing qualitative characteristicsThe enhancing qualitative characteristics do not stand alone. They complement the fundamental qualitative characteristics of relevance and faithful representation.

At times this may mean that one or other enhancing qualitative characteristics may have to be diminished in order to maximise another qualitative characteristic.

For example, it is expected that from 1 July 2013 for-profit reporting entities will have to comply with the new for-profit reporting framework. This will see some changes in financial reporting for these entities. There may be a temporary reduction in comparability as a result of these entities applying the new reporting framework to their financial statements. However, this will be worthwhile to improve the relevance or faithful representation in the longer term.



balance between benefit and costAccording to the NZ Framework, the benefits gained from information should be greater than the costs of providing it. It is difficult to measure benefits and costs, especially when the costs do not always fall on the users who enjoy the benefits.

Financial analysis, for example, use financial reports but pay nothing towards their preparation or publishing. On the other hand, the shareholders/owners of small companies may also be managers who, having worked closely with sales, budgets and other management reports all year, do not gain much further benefit from the financial statements.

Despite these difficulties, the NZ Framework insists that those who set financial reporting standards, as well as preparers and users of financial information, should be aware of this principle.

1. State and explain which qualitative characteristic of good accounting information is satisfied when:

a. Financial results from previous accounting periods are shown in the financial statements.

b. Notes to the financial statements are provided in the annual report.

2. An entity has taken two years to gather precise information on developing a new product line. Discuss how the fundamental and enhancing qualitative characteristics are in conflict.

3. Smile with Style Limited has furniture and equipment with a total cost of $60,000. When the entity buys new chairs costing $200 for their waiting room they treat this as an expense rather than an asset in the accounting records. Explain why the entity is able to do this in terms of materiality and relevance.

Check your answers.

4C

isto

ck


financial elements5

learning intentionTo explain the financial elements.


define assets, liabilities, equity, income and expenses apply these definitions in context define and apply the recognition criteria to each of the financial elements.

introductionThe New Zealand Framework identifies the financial elements that group the effects of transactions and other financial events in the general purpose financial reports. In the Statement of Financial Position the financial elements are assets, liabilities and equity. In the Income Statement the financial elements are income and expenses.

assets

definitionAn asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.

Key pointAssets have three essential characteristics:

a result of past events must be presently controlled by the entity must represent future economic benefits.

Note the words in bold will help trigger your memory when you are trying to remember the characteristics past, present, future.

These future economic benefits may flow to the entity in a number of ways. For example, an asset may be:

used singly or in combination with other assets in the production of goods or services exchanged for other goods used to settle a liability, or distributed to the owners of the entity.


financial elements

For example, a delivery truck is owned by an entity and its use is presently controlled by the entity. It was purchased prior to reporting date and the entity expects a flow of future economic benefits as the truck is used to deliver its products and generate revenue (cash) for the entity.

Key pointsAn asset is only recognised in the Statement of Financial Position when:

it is probable that the future economic benefit will eventuate it possesses a value or cost that can be reliably measured.

current assetsAn asset is classified as current when it satisfies any of the following criteria:

it is expected to be realised in, or is intended for sale or consumption in, the entitys normal operating cycle (this may exceed 12 months)

it is held primarily for the purpose of resale it is expected to be realised within 12 months after the reporting date, or it is cash or a cash equivalent.

non-current assetsAll other assets shall be classified as non-current. They include tangible, intangible and financial assets of a long-term nature.

liabilities

definitionA liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

isto

ck


financial elements

Key pointLiabilities have three essential characteristics:

A result of past events The entity presently has a financial obligation The settlement of which will require a future outflow of cash from the business.

A liability is only recognised in the Statement of Financial Position when it meets the definition of a liability and:

it is probable that the future economic sacrifice will eventuate the amount of the liability can be measured with reliability (a source document).

The settlement of a present obligation usually involves the entity giving up resources embodying economic benefits in order to satisfy the claim of the other party. Settlement of a present obligation may occur in a number of ways:

payment of cash transfer of other assets provision of services replacement of obligation with another obligation; or conversion of the obligation to equity.

For example, a loan is a liability because:

it is the result of a loan agreement with the bank made some time in the past the business presently has an obligation to repay the loan to the bank settlement of the loan involves an outflow of cash from the business bank account in the

future cash that could have been used to earn income for the business.

Recognition criteria for the loan:

It must be more than likely that there will be an outflow of cash from the business (repayment is a condition of the loan agreement).

The amount required to settle the loan can be measured with reliability (it is stated in the loan agreement).

current liabilitiesA liability shall be classified as current when it satisfies any of the following criteria:

it is expected to be settled in the entitys normal operating cycle (this may exceed 12 months) it is held primarily for the purpose of being traded it is expected to be settled within 12 months after the reporting date, or the entity does not have an unconditional right to defer settlement of the liability for at least

12 months after the reporting date.


financial elements

non-current liabilitiesAll other liabilities shall be classified as non-current.

fair valueThe New Zealand Framework emphasises that applying the definition and recognition criteria to assets and liabilities will result in fair value.

Fair value is the overriding consideration.

equity

Key point Equity is the residual interest in the assets of the entity after deduction of the liabilities.

In a partnership, for example, the partners equity is what is left of the assets after all liabilities have been deducted.

recognition criteriaThe recognition of assets and liabilities provides the criteria for the recognition of equity.

In other words, the amount at which equity is shown on the Statement of Financial Position is dependent on the measurement of assets and liabilities.

The NZ Framework identifies income and expenses as the financial elements that group the effects of transactions and other financial events in the Statement of Comprehensive Income.

income

definitionIncome is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.

isto

ck


financial elements

Key point Income has three essential characteristics:

increases in economic benefits from an inflow of assets (or decreases in liabilities) increases in equity (since profit increases) not contributed by equity participants.

Income includes both revenue and gains. Revenue arises in the course of the ordinary activities of the entity. It may be referred to by a variety of different names including sales, fees, interest, dividends, royalties and rent.

Gains represent other items that meet the definition of income but may, or may not, arise from the ordinary activities of the entity. The entity may for example make a gain when selling office furniture. Gains also include unrealised gains such as those arising from the revaluation of marketable securities or from increases in the carrying amount of non-current assets.

For decision-making purposes, gains are usually displayed separately in the Statement of Comprehensive Income. Gains are often reported net of related expenses.

In an architectural partnership, fees are revenue. They are an increase in economic benefits during the accounting period in the form of inflows of cash which result in increases in profit and therefore in equity. They have not been contributed by any of the partners in the practice.

Key pointsIncome is recognised in the Statement of Comprehensive Income when an increase in future economic benefit related to an increase in an asset (or a decrease of a liability) has arisen that can be measured reliably.

Income is recognised at the time there is an increase of assets from the sale of goods or services, or a net decrease in liabilities arising from the waiver of a debt payable.

expenses

definitionExpenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.


financial elements

Key pointExpenses have three essential characteristics. They are:

decreases in economic benefits from an outflow of assets (or increase in liabilities) decreases in equity (since profit decreases) not distributed to equity participants.

Expenses include those costs that arise in the course of the ordinary activities of the entity, for example cost of sales, cost of services provided, wages, advertising or depreciation. These usually take the form of an outflow or depletion of assets such as cash and cash equivalents, inventory, property, plant and equipment.

Expenses also include losses that meet the definition of expenses and may, or may not, arise in the course of the ordinary activity of the entity (for example, disasters like fire or flood) and losses from the sale of non-current assets.

Unrealised losses are also included; for example those arising from the effects of increases in the rate of exchange. For decision-making purposes, losses are displayed separately in the Statement of Comprehensive Income. Losses are often reported net of related income.

Auditors fees are an expense for a company because they cause decreases in economic benefits during the accounting period when cash is paid out (or when the bank overdraft is increased in settlement), causing a decrease in profit which decreases equity. The auditors fees were not paid to any shareholders.

Key pointsExpenses are recognised in the Statement of Comprehensive Income when a decrease in future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably.

Expenses are recognised when there is an increase in liabilities (for example, accrual of employee entitlements) or a decrease in assets (when equipment is depreciated).

In March 2014, High Tech Industries received a large order for computers. The value of the order was $2 million. Delivery is not until 10 April. The managing director wants some of the revenue recognised in the financial period ended 31 March 2014. The accountant disagrees.

isto

ck

5A


financial elements

Explain the correct treatment for the revenue earned from the sale of the computers in accordance with the NZ Framework.

Check your answers.

1. Classify each of the following as assets, liabilities, equity, income or expenses:

a. accrued expenses

b. wages and salaries

c. inventory held on layby at balance day

d. possible future refunds that may be necessary on faulty goods being returned after the Christmas sales. The financial period ends on 31 December.

e. net assets.

2. Give a reason for each answer in 1. above.

Check your answers.

For each of the following items, explain fully in terms of its definition whether an asset, liability, income or expense exists and the reason it should be recognised if it does exist at balance day.

1. Plant and equipment

2. Inventory ordered but not yet received

3. An account owing for vehicle expenses

4. Well-trained staff

5. Bad debts written off

6. Credit sale.

Check your answers.

Comment fully whether each of the following situations involves an asset or not.

1. A district health board has a number of old computers that cannot run modern software.

2. A start-up technology company keeps secret the know-how gained from a development project.

3. A large department store intends to purchase a container-load of linen from a new supplier.

4. The Government gifts a 30-acre property to the regional council to encourage economic growth and mineral discovery in the local area.

Check your answers.

5B

5C

5D


teacher-marked activities6

This is the time to revise the main topics in this booklet before you attempt the teacher-marked activities. You can:

make notes, highlight key points, have another go at the practice activities contact your teacher if you would like to discuss your work check the success criteria for each lesson to make sure you can do these.

When you have revised the topics, you are ready to attempt the teacher-marked activities.

achievement criteria Please refer to the Reference guide (AC3000R) for the achievement criteria for AS91406 Accounting 3.3.

The extract below is from the notes to the financial statements of Mighty River Power Limited (MRP*). The extract describes Mighty River Powers economic activities.

Note 1. Accounting Policies (extract):(1) Reporting entity (extract)The Groups principal activities are to invest in, develop and produce electricity from renewable and other energy sources and to sell energy and energy related services and products to retail and wholesale customers.

This indicates that:

Mighty River Power is a reporting entity. Mighty River Power generates electricity from hydro dams and geothermal plants

constructed by the company.

Mighty River Power sells the electricity it has generated to wholesale and retail customers. Customers pay for electricity used based on meter readings.

*You may use the abbreviation MRP to refer to Mighty River Power Limited in your answers.

1. Explain why, as a reporting entity, Mighty River Power Limited is required to prepare general purpose financial statements.

2. Explain the importance of the following statement included in Mighty River Power Limiteds accounting policies:

The accounting policies set out below have been applied consistently to both periods presented in these consolidated financial statements.

3. The Audit Report accompanying Mighty River Power Limiteds financial statements states that the financial statements comply with generally accepted accounting practice in New Zealand (NZ GAAP); and give a true and fair view.

6A


teacher-marked activities

a. Explain, in terms of comparability with other entities, why the financial statements are required to comply with NZ GAAP. In your answer, you should state what complying with NZ GAAP means.

b. Explain how Mighty River Power Limited ensures its financial statements give a true and fair view.

Mighty River Power Limiteds significant accounting policies include the following:

Revenue (extract) Revenue recognised in the income statement includes the amounts received and

receivable for energy and related energy services supplied to customers in the ordinary course of business.

Revenue includes the value of units assessed as being recorded on meters as at balance date, but for which invoices have not yet been sent.

1. Use the definition of income to explain why units assessed as being recorded on meters as at balance date are reported as income.

2. To be recognised as income, the income must have a value that can be measured reliably. Explain how units assessed as being recorded on meters as at balance date can be measured reliably.

3. Explain, in terms of accrual accounting, why revenue recognised in the income statement includes amounts received and receivable for energy and related energy services.

4. Explain why receivables for energy are a current asset in the balance sheet. You are not required to explain why receivables are an asset.

Mighty River Power Limited has constructed a number of new geothermal power generation plants in recent years.

Mighty River Power Limiteds significant accounting policies include the following:

Owned assets

Generation assets, which include freehold land and buildings and generation plant and equipment, are measured at fair value based on periodical valuations by third party valuation experts

Explain how a geothermal generation plant constructed by Mighty River Power Limited and measured at fair value meets the definition and recognition criteria of an asset.

6B

6C


teacher-marked activities

Base your answer on Mighty River Power Limiteds policy for owned assets. In your answer, you should:

link the characteristics of an asset to reporting of generation assets constructed by Mighty River Power Limited

explain why the amount reported for generation assets can be relied on by a bank manager asked to provide loan finance secured over the generation assets.

What to do nowCheck that you have:3/5

marked and corrected the self-marked practice activities

filled in the self-assessment rubric on the back page

filled in the cover sheet from the back of the booklet and attached your self-marked activities and teacher-marked activities.

Send your teacher-marked and self-marked work to your teacher.


answer guide7

how to use the answer guide

You will check your own answers, except in teacher-marked activities.

The answers give you essential feedback. Use them well.

Always:

check your answers carefully after you finish each activity try to work out where you have made errors study any

Document

Documents

Transcript of Document