FINANCIAL ACCOUNTING

Question 1: (Approximately 400 words)

Queenslander Ltd operates a café and gift shop at Montville in the Sunshine Coast hinterland. You are the accountant for the company and the following items relate to the year ended 30 June 2016:   (a) Queenslander Ltd is the guarantor for an employee’s bank loan. As the employee is in serious financial difficulties, you think it is likely that he will default on the loan.

(b) As a gift from a very grateful and generous customer, Queenslander Ltd receives 500 shares in Walters Ltd which are currently trading at $2 per share.

(c) The company’s directors believe that the panoramic views of the Sunshine Coast hinterland from the windows of the café attracts a large number of customers.

Required: Explain how Queenslander Ltd should account for each of the above items. You should justify your answer by reference to the AASB conceptual framework’s definitions and recognition criteria for assets, liabilities, income and/or expenses.

Question 2: (Approximately 350 words)

One of the directors on the board of directors of Manly Ltd has proposed that the company adopt the revaluation model for the measurement of its machinery. Some of this machinery is difficult to replace because of its unique nature and certain items of machinery have increased in value in the current period. The director is arguing that, as there has been no decline in the machinery’s fair value, no depreciation expense should be recognised on these items of machinery.

Required: Explain whether the director’s proposal (about not recognising depreciation) should be adopted by the board.

 

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Question 3: (Approximately 400 words)

Sharks Ltd is an Australian mail-order company that sells a variety of homeware products. Although the online homeware products industry in Australia is growing slowly, Sharks Ltd has reported significant increases in sales and net profits in recent years. While sales increased from $50 million in 2009 to $120 million in 2015, net profit increased from $3 million to $12 million over the same period. The stock market and analysts believe that the company’s future is very promising. In early 2016, the company had a market capitalisation of $350 million, which was approximately three times the 2015 sales and around 26 times estimated 2016 profit. The company’s management and many investors attribute the company’s success to its marketing flair and expertise. Instead of competing on price, Sharks Ltd prefers to focus on service and innovation, including:

• free delivery across Australia; and
• a free gift with orders over $200.

As a result of such innovations, the company’s customers are willing to pay prices that are 60% above those of competitors, and Sharks Ltd maintains a gross profit margin of around 40%.

Nevertheless, some investors have doubts about the company as they are uneasy about certain accounting policies the company has adopted. For example, Sharks Ltd capitalises as a non-current asset the costs of its direct mailings to prospective customers of catalogues advertising the company’s products ($4.2 million at 30 June 2015) and amortises them on a straight-line basis over 3 years. The mailing lists have been developed by the company’s in-house marketing staff. This accounting practice is considered by some investors to be questionable as there is no guarantee that customers will be obtained and retained from direct mailings.

In addition to the company’s in-house developed direct mailing lists, Sharks Ltd purchased a customer list from a competitor for $800,000 on 4 July 2016. This list is also recognised as a non-current asset. Sharks Ltd estimates that this list will generate sales for at least another 2 years. The company also plans to add names, obtained from a phone survey conducted in August 2016, to the list. These extra names are expected to extend the list’s useful life by 1 more year.

Sharks Ltd’s 2015 statement of financial position also reported $7.5 million of marketing costs as non-current assets. If the company had expensed marketing costs as incurred, 2015 net profit would have been $10 million instead of the reported $12 million as $2 million was spent on marketing activities in the 2015 financial year. The concerned investors are uneasy about this capitalisation of marketing costs, as they believe that Sharks Ltd’s marketing practices are relatively easy to replicate. However, Sharks Ltd argues that its accounting is appropriate. Marketing costs are amortised at an accelerated rate (55% in year 1, 29% in year 2, and 16% in year 3), based on the company’s 25 years’ knowledge and experience of customer purchasing behaviour.

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Required:

Explain how Sharks Ltd’s costs (costs of direct mailings, purchased customer list and marketing costs) should be accounted for under AASB 138/IAS 38 Intangible Assets, giving reasons for your answers.

Question 4: (Approximately 350 words)

Bird Ltd, a listed company, provides food to function centres that host events such as weddings and engagement parties. After an engagement party held by one of Bird Ltd’s customers in June 2017, 100 people became seriously ill, possibly as a result of food poisoning from products sold by Bird Ltd. Legal proceedings were commenced by legal representatives of the people seeking damages from Bird Ltd, which disputed liability by claiming that the function centre was at fault for handling the food incorrectly. Up to the date of authorisation for issue of the financial statements for the year to 30 June 2017, Bird Ltd’s lawyers advised that it was probable that Bird Ltd would not be found liable. However, two weeks after the financial statements were published and released to shareholders, Bird Ltd’s lawyers advised that, owing to developments in the case, it was probable that Bird Ltd would be found liable and the estimated damages would be material to the company’s reported profits.

Required:

Explain whether Bird Ltd should recognise a liability for legal damages in its financial statements as at 30 June 2017? How should it deal with the information it receives two weeks after the financial statements are published? You should refer to relevant parts of the AASB conceptual framework and AASB accounting standards in your answer.