(Test Bank) About Financial Accounting Volume 2

Doussy,Rensburg,Ngcobo,Rehwinkel,Scheepers,Scott, 5

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Author(s): Doussy, Rensburg, Ngcobo, Rehwinkel, Scheepers, Scott

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About Financial Accounting Volume 2 Fifth Edition About Financial Accounting Volume 2 Fifth Edition Contributing authors JS Jansen van Rensburg RN Ngcobo A Rehwinkel D Scheepers (editor) Volume 1 Fifth Edition Contributing authors F Doussy (editor) D Scott Members of the LexisNexis Group worldwide Members of the LexisNexis Group worldwide Members of the LexisNexis Group worldwide Members of the LexisNexis Group worldwide SS SSouth Africaouth Africaouth Africaouth Africa LexisNexis (Pty) Ltd DD DDURBANURBAN URBANURBAN 215 Peter Mokaba Road (North Ridge Road), Morningside, Durban, 4001 JJ JJOHANNESBURGOHANNESBURGOHANNESBURGOHANNESBURG Building No. 9, Harrowdene Office Park, 124 Western Service Road, Woodmead, 2191 CC CCAPE APE APE APE TT TTOWNOWN OWNOWN Office Floor 2, North Lobby, Boulevard Place, Heron Close, Century City, 7441 www.lexisnexis.co.za www.lexisnexis.co.zawww.lexisnexis.co.zawww.lexisnexis.co.za AustraliaAustralia AustraliaAustralia LexisNexis, CHATSWOOD , New South Wales AustriaAustria AustriaAustria LexisNexis Verlag ARD Orac, V IENNA BeneluxBenelux BeneluxBenelux LexisNexis Benelux, A MSTERDAM CanadaCanada CanadaCanada LexisNexis Canada, M ARKHAM , Ontario ChinaChina ChinaChina LexisNexis, B EIJING FranceFrance FranceFrance LexisNexis, P ARIS GermanyGermany GermanyGermany LexisNexis Germany, M ÜNSTER Hong KongHong KongHong KongHong Kong LexisNexis, H ONG KONG IndiaIndia IndiaIndia LexisNexis, N EW DELHI ItalyItaly ItalyItaly Giuffrè Editore, M ILAN JapanJapan JapanJapan LexisNexis, T OKYO KoreaKorea KoreaKorea LexisNexis, S EOUL MalaysiaMalaysia MalaysiaMalaysia LexisNexis, K UALA LUMPUR New ZealandNew ZealandNew ZealandNew Zealand LexisNexis, W ELLINGTON PolandPoland PolandPoland LexisNexis Poland, W ARSAW SingaporeSingapore SingaporeSingapore LexisNexis, S INGAPORE United KingdomUnited KingdomUnited KingdomUnited Kingdom LexisNexis, L ONDON USAUSA USAUSA LexisNexis, D AYTON , Ohio © 2014 ISBN 978 0 409 05712 6 E-Book ISBN 978 0 409 11991 6 First edition 2005 Reprinted 2006 Second edition 2007 Third edition 2008 Fourth edition 2011 Copyright subsists in this work. No part of this work may be reproduced in any form or by any means without the publisher’s written permission. Any unauthorised reproduction of this work will constitute a copyright infringement and render the doer liable under both civil and criminal law. Whilst every effort has been made to ensure that the information published in this work is accurate, the editors, authors, writers, contributors, publishers and printers take no responsibility for any loss or damage suffered by any person as a result of the reliance upon the information contained therein. Editor: Mandy Jonck Technical Editor: Liz Bisschoff Printed in South Africa by Interpak Books Pietermaritzburg v Contents Page 1. Introduction to the preparation of financial statements ................................. 1 2. Establishment and financial statements of a partnership ............................. 49 3. Changes in the ownership structure of partnerships .................................... 83 4. The liquidation of a partnership .................................................................... 145 5. Close corporations ........................................................................................ 201 6. Introduction to companies ............................................................................ 243 7. Statement of cash flows ................................................................................ 287 8. Analysis and interpretation of financial statements ....................................... 345 9. Branches ....................................................................................................... 365 10. Manufacturing entities ................................................................................... 403 11. Budgets......................................................................................................... 427 Index ....................................................................................................................... 453 1 CHAPTER 1 Introduction to the preparation and presentation of financial statements Contents Page Overview of the introduction to the preparation and presentation of financial statements ............................................................................................................... 3 1.1 Introduction ................................................................................................... 3 1.2 Conceptual framework for financial reporting ............................................... 6 1.2.1 Introduction ...................................................................................... 7 1.2.2 Financial statements as part of financial reporting .......................... 8 1.2.3 The objective of general purpose financial reporting ...................... 9 1.2.4 Underlying assumption when preparing financial statements ......... 9 1.2.5 Qualitative characteristics of useful financial information ................ 9 1.2.5.1 Fundamental qualitative characteristics .......................... 10 1.2.5.2 Enhancing qualitative characteristics .............................. 10 1.2.5.3 The cost constraint on useful financial reporting ............. 11 1.2.6 Elements of financial statements ..................................................... 11 1.2.6.1 Introduction ..................................................................... 11 1.2.6.2 Financial position (balance sheet)(statement of financial position) ............................................................ 11 1.2.6.3 Financial performance (income statement)(statement of profit or loss and other comprehensive income) ......... 13 1.2.7 Recognition of the elements of financial statements ....................... 14 1.2.8 Measurement of the elements of financial statements ..................... 16 1.2.9 The concepts of capital and capital maintenance ........................... 17 1.2.9.1 The concepts of capital ................................................... 17 1.2.9.2 The concepts of capital maintenance and the determination of profit ...................................................... 17 1.3 The South African regulatory reporting framework ....................................... 18 1.3.1 Introduction ...................................................................................... 18 1.3.2 The current South African financial reporting framework .................. 19 1.4 Presentation of financial statements (IAS 1) ................................................. 20 1.4.1 Introduction ...................................................................................... 21 1.4.2 Definitions ........................................................................................ 22 1.4.3 The purpose of financial statements ................................................ 23 1.4.4 Overall considerations when preparing financial statements .......... 23 1.4.4.1 Fair presentation .............................................................. 23 1.4.4.2 Going concern ................................................................. 24 2 About Financial Accounting: Volume 2 Page 1.4.4.3 Accrual basis ................................................................... 24 1.4.4.4 Materiality and aggregation ............................................. 24 1.4.4.5 Offsetting ......................................................................... 25 1.4.4.6 Frequency of reporting .................................................... 25 1.4.4.7 Comparative information ................................................. 25 1.4.4.8 Consistency of presentation ............................................ 25 1.4.5 Structure and contents of financial statements ................................ 25 1.4.5.1 Introduction ..................................................................... 25 1.4.5.2 Identification of financial statements ............................... 26 1.4.5.3 Statement of financial position ......................................... 26 1.4.5.4 Statement of profit or loss and other comprehensive income ............................................................................. 28 1.4.5.5 Statement of changes in equity ....................................... 29 1.4.5.6 Statement of cash flows ................................................... 29 1.4.5.7 Notes ............................................................................... 30 1.5 Financial instruments .................................................................................... 31 1.5.1 Introduction ...................................................................................... 32 1.5.2 Definitions ........................................................................................ 32 1.5.2.1 Financial instrument ........................................................ 32 1.5.2.2 Financial asset (IAS 32.11) .............................................. 33 1.5.2.3 Financial liability (IAS 32.11) ........................................... 33 1.5.2.4 Equity instrument (IAS 32.11) .......................................... 33 1.5.2.5 Fair value (IAS 32.11) ...................................................... 33 1.5.2.6 Contract ........................................................................... 34 1.5.3 Identification of financial assets and financial liabilities .................. 34 1.5.4 Classification, recognition and measurement of financial instruments ...................................................................................... 35 1.5.4.1 Classification of financial instruments ............................. 35 1.5.4.2 Classification of financial liabilities .................................. 36 1.5.4.3 Recognition ..................................................................... 36 1.5.4.4 Classification and measurement ..................................... 37 1.6 Practical applications of IAS 1 and financial instruments ............................. 39 1.7 Special notes to the reader of Volume 2 ....................................................... 44 1.7.1 Cash transactions ............................................................................ 44 1.7.2 Calculations ..................................................................................... 44 1.7.3 References to gender ...................................................................... 45 1.7.4 Taxation rates .................................................................................. 45 1.7.5 The use of account names in comparison with financial statement terminology ..................................................................... 45 1.7.6 Interest calculations ......................................................................... 45 1.7.6.1 Simple interest rates ........................................................ 45 1.7.6.2 Compound interest rates ................................................. 45 1.7.6.3 Effective interest rates ..................................................... 46 1.8 Summary ....................................................................................................... 46 Chapter 1: Introduction to the preparation and presentation of financial statement s 3 Overview of the introduction to the preparation and presentation of financial statements Introduction to the preparation and presentation of financial statements In this chapter three aspects that form the basis for the preparation and presentation of financial statements are discussed 1 Conceptual framework for financial reporting Par 1.2 2 Presentation of financial statements (IAS1) Par 1.4 3. Financial instruments (IAS32,IAS39, IFRS7, IFRS9) Par 1.5 1.1 Introduction STUDY OBJECTIVES After studying this chapter, you should be able to: l describe what the concept the Conceptual Framework entails; l list the specific purposes of the Conceptual Framework regarding the prepa- ration and pres entation of financial statements; l explain the main objective of financial reporting according to the Conceptual Framework; l explain the underlying assumption when preparing financial statements as discussed in the Conceptual Framework; l discuss the qualitative characteristics of financial reporting according to the Conceptual Framework; l explain what is implied by the Conceptual Framework when it refers to the constraints in preparing financial statements; l discuss the elements of financial statements as explained in the Conceptual Framework and indicate which elements are balance sheet (Statement of fi- nancial position) elements and which are income statement (Statement of profit or loss and other comprehensive income) elements; l discuss the concepts of recognition of the elements incorporated in the finan- cial statements as explained in the Conceptual Framework; continued 4 About Financial Accounting: Volume 2 l explain what is meant by the measurement of the elements of financial state- ments by referring to the measurement methods discussed in the Conceptual Framework; l explain the acronyms GAAP, IFRSs, APB and SAICA; l explain what type of business ownership must comply with the IFRSs; l define each of the following terms by referring to IAS1: • fair presentation, • reporting period, • consistency of presentation, • materiality and aggregation, • offsetting, and • comparative information; l list the individual statements that, according to IAS 1, together form the finan- cial statements of a reporting entity; l explain what is meant by the identification of financial statements; l explain what is meant by the reporting period; l explain what is meant by the operating cycle; l explain which items comprise current assets and which comprise current lia- bilities, according to IAS 1; l list the items that must be presented on the face of the statement of financial position and statement of profit or loss and other comprehensive income re- spectively by referring to IAS 1; l list the items that can, according to IAS 1, be presented on either the face of the statement of financial position and statement of profit or loss and other comprehensive income or in the notes for the financial period; l discuss the purpose of notes by referring to IAS 1; l discuss the order in which items, that make up the notes, are normally pre- sented as indicated by IAS 1; l explain what is meant by the term “financial instrument”; l identify the instances when an asset will be classified as a financial asset; l identity the instances when a liability will be classified as a financial liability; l explain what is meant by the term “equity instrument”; l explain what the term “fair value” means; l explain when an entity must recognise a financial asset and a financial liability; l explain what is meant by the term “transaction costs”; and l briefly explain the initial and subsequent measurement of a financial instru- ment with an indication of the accounting treatment of any resulting gain and/or loss on re-measurement. Chapter 1: Introduction to the preparation and presentation of financial statement s 5 In About Financial Accounting Volume 1 the reader was introduced to the subject “Financial Accounting”. The Conceptual Framework for Financial Reporting (issued in December 2010 and hereafter referred to as the “Conceptual Framework”) was the starting point of study. Various concepts and procedures were introduced and dis-cussed that enabled the reader to record business transactions in journals, post to ledger accounts and prepare trial balances. The collecting, classifying and recording of accounting data enabled the reader to correctly prepare the financial statements of a sole trader. It is thus at this point necessary to emphasise that a thorough knowledge of all the learning content of Volume 1 is essential to continue with the learning content of Volume 2 of this textbook. In Volume 2, the Conceptual Framework is again the starting point. However, the angle of the discussion differs largely from that of Volume 1 as an in-depth knowledge of the Conceptual Framework (December 2010) and IAS 1 Presentation of Financial State- ments (June 2011) forms an important part of the learning content of this volume. Volume 2 focuses on the preparation and presentation of the financial statements of partnerships and close corporations, the purpose of which is to enable the reader to correctly prepare a full set of financial statements for these two types of business ownership. Other related and important issues regarding partnerships and close corporations, for example changes in ownership, dissolutions and conversions, are dealt with in detail as these events are reported on in the financial statements. Other topics discussed in Volume 2 are: l Statements of cash flows : Although a statement of cash flow forms part of the financial statements of an entity, it is dealt with separately from the other financial statements due to its complexity. l Introduction to companies : The reader is introduced to the company as a form of business ownership. It is compared to partnerships and close corporations, specif-ically relating to its capital structure. l Analysis and interpretation of financial statements: The purpose of and the methods used to analyse and interpret the information contained in financial statements are discussed. l Branches : The concept of an entity with branches is discussed, focusing on the recording of the transactions between the head office and its branches. l Manufacturing entities : The concept of manufacturing and all related issues are discussed, with special reference to the recording of transactions that are unique to manufacturing entities. l Budgets : The preparation of various types of budgets used by an entity, mainly to predict future cash flows, are discussed. The objective of this chapter is to serve as a general introduction for the preparation and presentation of financial statements. In order to achieve its objective, this chapter utilises a thorough discussion of the Conceptual Framework and IAS 1 to equip the reader with the necessary knowledge to prepare the financial statements of partner- ships and close corporations. 6 About Financial Accounting: Volume 2 1.2 Conceptual framework for financial reporting Overview of the conceptual framework for financial reporting Defining the Conceptual Framework Group of interrelated objectives and fundamental theoretical principles that serve as a frame of reference for Financial Accounting and more specifically for general purpose financial reporting Its objective Provide information that is useful to potential and existing investors, lenders and other creditors Underlying assumption: Going concern General purpose financial reporting Concept of accrual accounting Provides useful financial information which is enhanced by: Fundamental Qualitative Characteristics Enhancing Qualitative Characteristics Relevance Comparability Materiality Verifiability Faithfull representation Timeliness Understandability Elements of Financial Statements Financial Position Financial Performance Assets Income Liabilities Expenses Equity Chapter 1: Introduction to the preparation and presentation of financial statement s 7 Note: The Conceptual Framework (December 2010) has not been fully updated with the new terminology used in the revised IAS 1, issued in June 2011 (see below). Where applicable, the new IAS 1 terminology is indicated in brackets and in bold next to the current Conceptual Framework terminology. 1.2.1 Introduction The Conceptual Framework can be described as a group of interrelated objectives and fundamental theoretical principles that serve as a frame of reference for Financial Accounting and more specifically financial reporting. The Conceptual Framework is both normative (prescriptive) and descriptive (explanatory) in nature, with an overrid- ing requirement for information that is useful in making economic decisions. The Con- ceptual Framework is not an IFRS (International Financial Reporting Standard) and hence does not define standards for any particular measurement or disclosure issue. The Conceptual Framework does not override any specific IFRS. According to the International Accounting Standards Board (IASB) the purpose and status of the Conceptual Framework is to: (a) assist the Board in the development of future IFRSs and in its review of existing IFRSs; (b) Assist the Board 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 treatments permitted by IFRSs; (c) assist national standard setting bodies in developing national standards; (d) assist preparers of financial statements in applying IFRSs and in dealing with topics that have yet to form the subject of an IFRS; (e) assist auditors in performing an opinion on whether financial statements comply with IFRSs; (f) assist users of financial statements in interpreting the information contained in financial statements compared in compliance with IFRSs; and (g) provide those who are interested in the work of the IASB with information about its approach to the formulation of IFRSs The IASB states the scope of the Conceptual Framework as follows: The Conceptual Framework deals with: (a) the objective of financial reporting; (b) the qualitative characteristics of useful financial information; (c) the definition, recognition and measurement of the elements from which financial statements are constructed; and (d) concepts of capital and capital maintenance. The Conceptual Framework, as it is currently presented, was issued by the Interna- tional Accounting Standards Board (IASB) and adopted by the Accounting Practices Board (APB) in South Africa and applies to the financial statements of all commercial, industrial and business reporting entities, whether in the public or private sector 8 About Financial Accounting: Volume 2 1.2.2 Financial statements as part of financial reporting The communication of financial information is referred to as financial reporting. Finan- cial statements form part of the process of financial reporting and the purpose of their preparation is to summarise and present all the transactions recorded in the journals and ledgers of an entity in a useful, logical and understandable way to the users of those financial statements. A complete set of financial statements normally includes a statement of financial position, a statement of profit or loss and other comprehensive income , a state- ment of changes in the financial position (which may be presented in a variety of ways, for example as a statement of cash flows), and those notes and other statements and explanatory material that are an integral part of the financial statements. Excluded from financial statements are such items as reports by directors, statements by the chair- person of a company or similar items that may be included as part of the overall finan-cial report. The management of an entity has the primary responsibility for the preparation and presentation of the financial statements of the entity. Each component of the financial statements provides the following information about the entity: l Statement of financial position (information about the financial position of the entity): • the economic resources available to generate future cash flows; • the financial structure with emphasis on own and borrowed capital and may be used to predict future borrowing needs; • the liquidity position and may be used to predict the availability of cash after settling financial commitments for the same period; and • the solvency position and may be used to predict the availability of cash over longer periods to meet financial commitments as they fall due. l Statement of profit or loss and other comprehensive income (information about the financial performance of the entity): • allows assessment of potential changes in economic resources in the future; • permits assessment of potential effective use of additional resources; and • is useful in predicting the capacity of the entity to generate cash flows from existing resources. l Statement of changes in equity (information about changes in the capital struc- ture of an entity): • allows assessment of changes in equity and transactions affecting equity. (Note that the statement of changes in equity is not specifically mentioned by name in the Conceptual Framework (refer to Framework .7).) l Statement of cash flows (information about changes in the financial position of entity): • allows an assessment of the operating, investing and financing activities of an entity and its ability to generate cash and cash equivalents in order to meet its cash flow needs.