UNIVERSITI UTARA MALAYSIA COLLEGE OF BUSINESS SCHOOL OF ACCOUNTANCY

FIRST SEMESTER SEPT. SESSION 2013/2014 (A131) BKAF3083 ACCOUNTING THEORY AND PRACTICE GROUP G-4

TUTORIAL NO: 2 QUESTION 1 - 4 PREPARED BY YEAP THYE BENG MOHD AYUB BIN KARULUS MOHD FIRDAUS BIN HITMI 205407 207686 207744

SUBMITTED TO PROF MADYA DR. AZHAR ABDUL RAHMAN

SUBMISSION DATE 14 OCTOBER 2013

Answers 2(a) Two important and interrelated aspects of relevance are its confirmatory and predictive roles. The Framework specifically states that to have predictive value, information need not be in the form of an explicit forecast. The serious drawback of forecast information is that it does not have confirmatory value, essentially it will be an educated guess. For example to enhancing the predictive value of historical financial statements the disclosure of continuing and discontinued operations. This allows users to focus on those areas of an entitys operations that will generate its future results. Alternatively it could be thought of as identifying those operations which will not yield profits or, perhaps more importantly, losses in the future. Besides that, the separate disclosure of non-current assets held for sale. This informs users that these assets do not form part of an entitys long-term operating assets. In additional, the requirement to disclose diluted EPS is often described as a warning to shareholders of what EPS would have been if any potential equity shares such as convertibles and options had already been exercised. Answers 3(a) The accruals basis requires transactions to be recognised when they occur rather than on a cash flow basis. Revenue is recognised when it is earned and it is received and expenses are recognised when they are incurred. For example when the entity has received the benefit from them, rather than when they are paid. Recording the substance of transactions and other events is requires them to be treated in accordance with economic reality or their commercial intent rather than in accordance with the way they may be legally constructed. This is an important element of faithful representation. Prudence is used where there are elements of uncertainty surrounding transactions or events. Prudence requires the exercise of a degree of caution when making judgements or estimates under conditions of uncertainty. Thus when estimating the expected life of a newly acquired asset, if we have past experience of the use of similar assets and they had had lives of between five and eight years, it would be prudent to use an estimated life of five years for the new asset. Comparability is fundamental to assessing the performance of an entity by using its financial statements. Assessing the performance of an entity over time requires that the financial statements used have been prepared on a comparable consistent basis. Generally this can be interpreted as using consistent accounting policies unless a change is required to show a fairer presentation. A similar principle is relevant to comparing one entity with another; however it is more difficult to achieve consistent accounting policies across entities.

Information is material if its omission or misstatement could influence decisions of users based on the reported financial statements. Clearly an important aspect of materiality is the size of a transaction, but in addition the nature of the item can also determine that it is material. For example the monetary results of a new activity may be small, but reporting them could be material to any assessment of what it may achieve in the future. Materiality is considered to be a threshold quality, meaning that information should only be reported if it is considered material. Too much detailed reporting of small items may confuse or distract users. Answers 3(b) Accounting for inventory, by adjusting purchases for opening and closing inventories is a classic example of the application of the accruals principle whereby revenues earned are matched with costs incurred. Closing inventory is by definition an example of goods that have been purchased, but not yet consumed. In other words the entity has not yet had the benefit from the closing inventory; therefore the cost of the closing inventory should not be charged to the current years income statement. Consignment inventory is where goods are supplied to a retailer under terms which mean the legal title to the goods remains with the supplier until a specified. Once the goods have been transferred to the retailer, normally the risks and rewards relating to those goods then lie with the retailer. Where this is the case then the consignment inventory meets the definition of an asset and the goods should appear as such on the retailers statement of financial position rather than on the statement of financial position of the manufacturer. At the year end, the value of an entitys closing inventory is, by its nature, uncertain. In the next accounting period it may be sold at a profit or a loss. Accounting standards require inventory to be valued at the lower of cost and net realisable value. This is the application of prudence. If the inventory is expected to sell at a profit, the profit is deferred until it is actually sold. However, if the goods are expected to sell for a loss, then that loss must be recognised immediately by valuing the inventory at its net realisable value. There are many acceptable ways of valuing inventory example average cost or FIFO method. In order to meet the requirement of comparability, an entity should decide on the most appropriate valuation method for its inventory and then be consistent in the use of that method. Any change in the method of valuing inventory would break the principle of comparability. For most businesses inventories are a material item. An error in the value or treatment of inventory has the potential to affect decisions users may make in relation to financial statements. Therefore accounting for inventory is a material event. Conversely there are occasions where on the grounds of immateriality certain inventories are not accounted for correctly. For example, at the year end a company may have an unused supply of stationery. Technically this is inventory, but in most

cases companies would charge this inventory of stationery to the income statement of the year in which it was purchased rather than show it as an asset. Answers 4 The primary advantage of principles-based accounting rests in its broad guidelines that can be applied to numerous situations. Broad principles avoid the pitfalls associated with precise requirements that allow contracts to be written specifically to manipulate their intent. Principles-based accounting standards allow accountants to apply professional judgement in assessing the substance of a transaction. This approach is substantially different from the underlying box-ticking approach common in rules-based accounting standards. The disadvantage of principles-based accounting is lack of precise guidelines could create unreliable and inconsistent information in the application of standards across organizations and make it difficult to compare one entity to another. For example, companies are required to recognize both an expense and a liability for a contingent liability that is probable and estimable. In additional principles-based accounting system generally requires preparers and auditors to apply professional judgment to implement and interpret the standards in the absence of sufficient guidance to exercise that judgment. There is a danger because they can be used to manipulate financial results. Since they have often set low standards for themselves in this regard it is a big question if they will rise to the occasion.

For the rules-based accounting standard the advantages is generally considered easier to audit for compliance purposes, and may produce more consistent and comparable financial reports across entities. Besides that, the Requirements are set out in detail and compliance with the rules can be more easily monitored and enforced. The disadvantages of rule-based accounting standard are not worked in practice. Critics argue that the present U.S. system does not produce accurate reporting. It focuses on checking the boxes more than portraying an underlying economic reality. It filled with specific details in an attempt to address as many possible contingencies as possible. This has made standards longer and complicated, and has led to arbitrary criteria for accounting treatments that allows companies to structure transactions to circumvent unfavourable reporting.

Besides that, ease accounting contains hundreds of pages of rules and interpretations while almost no leased assets appear on corporate balance sheets. The system has

created an industry of financial engineering and structured transactions designed to circumvent the rules. Many believe that rules closing structuring loopholes will only result in more elaborate ways to evade them.