solution

How has Benson Ltd taken risk into account to estimate the amount to be recognised as a provision?

Distinguish between ‘retrospective application’ and retrospective restatement’

 

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SKU: Em0049

Objectives

This assessment item relates to the following course learning outcomes:

  • Interpret the technical requirements and conceptual aspects of selected accounting standards that address key issues in financial reporting.
  • Apply relevant accounting pronouncements and professional judgement to solve routine accounting problems.

 

Question 1

Bradfield Ltd is registered as a public company and is required by the Corporations Act 2001 to prepare a financial report for each financial year (s. 292) that complies with Australian accounting standards (s. 296). The financial statements prepared by Bradfield Ltd are general purpose financial statements because Bradfield Ltd is a reporting entity as defined in SAC 1 Definition of the Reporting Entity. The following is an extract from the trial balance prepared by Bradfield Ltd’s accounting staff for the year ended 30 June 2016.

 

Notes

1. The following items of other comprehensive income will not be reclassified subsequently to profit or loss: gain on revaluation of property; and gain on remeasurement of defined benefit plan. All other items of other comprehensive income may be reclassified subsequently to profit or loss.

2. Comparative figures for the preceding year (ending 30 June 2015) have been omitted.

3. All figures in the trial balance are in thousands ($’000).

 

Required

Prepare the Statement of profit or loss and other comprehensive income for Bradfield Ltd for the year ended 30 June 2016 in accordance with the requirements of AASB 101 Presentation of Financial Statements.
In addition to referring to AASB 101 Presentation of Financial Statements, you may find it useful to refer to IAS 1 Presentation of Financial Statements Implementation Guidance (in Moodle) which provides examples of financial statements prepared in accordance with IAS 1 Presentation of Financial Statements which is the international equivalent of AASB 101 Presentation of Financial Statements.

 

Question 2

Bendigo Ltd sells consumer whitegoods through 100 retail outlets throughout Victoria, New South Wales and Queensland. Bendigo Ltd leases the retail outlets and their accounting policy (in accordance with AASB 117 Leases) is to classify leases as finance leases when the terms of the lease transfer substantially all the risks and rewards of ownership to the lessee (Bendigo Ltd); all other leases are classified as operating leases. In applying this policy, Bendigo Ltd has classified all of its leases for the retail outlets as operating leases. In February 2016, the AASB issued a new accounting standard (AASB 116 Leases which is based on the new IFRS 16 Leases) that introduces a new accounting policy for the classification of leases. Although AASB 116 Leases does not become effective for some years, early adoption is permitted and Bendigo Ltd has decided to adopt it for the reporting period ending 30 June 2016.

In July 2015, at the beginning of the current reporting period, Bendigo Ltd decided to change its accounting policy for the valuation of inventories from a weighted-average cost (WAC) method to a first-in, first-out (FIFO) method. Bendigo Ltd believes that the FIFO method more accurately reflects the usage and flow of inventories in the economic cycle.

 

Required

(a) Explain the term ‘accounting policy’. What is the policy of the Wesfarmers Group (in their 2015 Annual Report) about the recognition of operating lease payments?

(b) Distinguish between ‘retrospective application’ and retrospective restatement’.

(c) According to AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors, how would Bendigo Ltd account for the change in accounting policy for lease classification as a consequence of adopting the new accounting standard, AASB 116 Leases?

(d) According to AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors, under what circumstances is Bendigo Ltd permitted to change its accounting policy for the valuation of inventories? How, according to AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors, should the change be accounted for?

(e) Bendigo Ltd has determined that the cumulative effect of the change in accounting policy for the valuation of inventories is a decrease in profit of $80,000 as at 1 July 2015 (the beginning of the current reporting period) but that it is impracticable to determine the individual period-specific effects of the change in accounting policy on the prior periods presented. What should Bendigo Ltd do in this situation?

 

Question 3

Benson Ltd is a manufacturing company that operates a production facility in the Sydney suburb of Alexandria. In January 2016, residents living adjacent to the production facility complained that groundwater was being contaminated from waste discharged from Benson Ltd’s production facility. In May 2016, environmental officers from the City of Sydney Council confirmed the existence of groundwater contamination although they did not regard the contamination as particularly serious. Benson Ltd immediately responded by implementing new procedures for the storage and disposal of waste material to prevent any further contamination from occurring. Although Benson Ltd is not required by law to restore the contaminated environment, the company made a series of public announcements that it would undertake to restore the contaminated environment in two years’ time.

As at 30 June 2016, the individual most likely outcome (with an 80% probability) is that it will cost Benson Ltd $400,000 to restore the contaminated environment. Also on this date the risk-free discount rate, based on two-year government bonds, is 6%. However, Benson Ltd believes that a discount rate of 4% is appropriate to adjust for the risks specific to this liability.

 

Required

(a) How is a provision defined in AASB 137 Provisions, Contingent Liabilities and Contingent Assets? Why would Benson Ltd’s obligation to restore the contaminated environment be classified as a provision?

(b) Briefly explain the three methods that, according to AASB 137 Provisions, Contingent Liabilities and Contingent Assets, can be used by an entity to estimate the amount to be recognised as a provision.

(c) How has Benson Ltd taken risk into account to estimate the amount to be recognised as a provision? What is an alternative approach to taking risk into account?

(d) From the information in the question, calculate the amount that Benson Ltd should recognise as a provision as at 30 June 2016.

(e) By how much will the provision have increased as at the end of the following year on 30 June 2017? How should Benson Ltd account for the increase?

 

Question 4

GDK Electronics Ltd manufactures a range of household electronic appliances. Based on expectations that the demand for their products would increase over the next ten years, GDK Electronics Ltd decided, in late 2015, to increase their manufacturing capacity through the purchase of an item of machinery that would be used to manufacture a new product line. The following costs associated with the purchase and installation of the item of machinery were incurred during February 2016:

 

Notes:

1. The physical life of the item of machinery is estimated to be 25 years. However, GDK Electronics Ltd expects that, due to future technological changes, demand for the product line that the item of machinery will be used to manufacture will only last 10 years at which time GDK Electronics Ltd will dismantle the item of machinery and dispose of it.

2. A small number of sample products were produced during the testing of the item of machinery. The sample products cost $443 to manufacture and were sold for $1,000.

3. The costs of dismantling the item of machinery after 10 years are estimated to be $40,000. To discount liabilities associated with future dismantling costs, management of GDK Electronics Ltd believe a discount rate of 5% best reflects current market assessments of the time value of money and the risks specific to the liability.

4. The modifications, which involved the installation of safety guards, were necessary for the item of machinery to comply with Occupational Safety and Health (OSH) Regulations. The cost of the modifications comprised $30,000 in materials and $10,000 in labour.

5. It is also a legal requirement that the item of machinery be inspected and certified by WorkCover NSW every four years. The first inspection was carried out on 23 February 2016 and a Certificate of Compliance (valid for 4 years from the date of issue) was issued by WorkCover NSW on 27 February 2016. The cost of the inspection and certification was $12,000. The next inspection is scheduled for June 2020.

6. On 1 March 2016, the item of machinery was ready for use as intended by management of GDK Electronics Ltd and production commenced.

7. According to GDK Electronics Ltd’s long-term plan, the item of machinery is expected to be used to manufacture 375,000 units over the next 10 years. Although 60,000 units are expected to be manufactured during the first year, the rate of production is expected to decline by 5,000 units per year (that is, 55,000 for year two and 50,000 for year three) to 15,000 units in year ten.

 

Required

(a) In accordance with AASB 116 Property, Plant and Equipment, what is the cost of the item of machinery on initial recognition?

(b) What, in your judgement, is the appropriate depreciation method for the item of machinery?

(c) How should the inspection and certification costs be depreciated? How, in accordance with AASB 116 Property, Plant and Equipment, should the subsequent inspection and certification costs be accounted for?

 

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