Chapter 2

Objective test 2 On 1 April ABC Ltd purchased and received equipment to be used in the production of items that will be sold. The equipment was purchased for cash for R REQUIRED Discuss whether the equipment will be recognised as an asset

Objective test 3 The equipment satisfies the definition of an asset as follows: An 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.

Recognition criteria 4 -Probability -Reliably measured

Recognition criteria: Asset 5 -Probable that future economic benefits associated with the item will flow to the entity, and -The item has a cost or value that can be measured reliably.

Recognition criteria Asset 6 Example Trade inventory was purchased at an invoice price of R The trade inventory meets the definition requirements of an asset and will be sold at a profit in the future.

Example 7 Probable that future economic benefits associated with the item will flow to the entity, and The inventory will be sold at a profit, which will result in an inflow of cash and future economic benefits The item has a cost or value that can be measured reliably. Measured reliably at historical cost price namely the invoice price.

Recognition criteria Liability 8 -Probable that future economic benefits associated with the item will flow from the entity, and -The item has a cost or value that can be measured reliably.

Recognition criteria Liability 9 Example The entity obtained a loan from ABC Bank for R1 million. The loan will be repaid in equal annual installments at the end of each year. The loan meets the definition of a liability.

Example 10 Probable that future economic benefits associated with the item will flow from the entity, and The loan will be repaid in equal annual installments, so it is probable that future economic benefits will flow out. The item has a cost or value that can be measured reliably. Measured reliably at the value of the loan received (R1 million). Refer to contract.

Example p The owner of a business contributes R cash as his capital contribution to the entity. Discuss with reference to the definition and recognition criteria whether the bank amount of R is an asset

Example p Definition 12 An 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.

Example p Definition 13 An asset is a resourceCash is a resource that can be utilised by AC Entity, for example to buy other assets. controlled by the entity as a result of past events, Cash is controlled because it has already been received in the bank account. and from which future economic benefits are expected to flow to the entity. Cash can be used to generate future economic benefits by funding the entity’s operations – for instance to purchase more assets or pay for salaries.

Example p. 37 – Recognition criteria 14 It is probable that future economic benefits associated with the item will flow to the entity, and the item has a cost or value that can be measured reliably.

Example p. 37 – Recognition criteria 15 It is probable that future economic benefits associated with the item will flow to the entity, and The cash has already been received, therefore it is probable that when it is used it will lead to an inflow of future economic benefits the item has a cost or value that can be measured reliably. The cash can be measured reliably at the amount of R

The accounting equation Example p ASSETS = EQUITY + LIABILITIES + 4,5m= +4,5m 0 Classification Capital

Example p On 4 January 20.7 AC Entity received a bank loan of R The contract was signed on 19 December 20.6 Discuss with reference to the definition and recognition criteria whether the bank loan amount of R is a liability.

Example p Definition 18 A liability is a present, legal obligation arising from past events, and of which the settlement is expected to result in an outflow of resources embodying economic benefits/cash.

Example p Definition 19 A liability is a present, legal obligation The loan agreement that was signed results in a legal obligation, arising from past events,The signing of the loan agreement together with the transfer of the funds from the bank, causes the bank to have an enforceable right to claim, and of which the settlement is expected to result in an outflow of resources embodying economic benefits/cash. The loan amount will be settled in cash in the future at the end of the loan term.

Example p. 38 – Recognition criteria 20 It is probable that future economic benefits associated with the item will flow from the entity, and the item has a cost or value that can be measured reliably.

Example p. 38 – Recognition criteria 21 It is probable that future economic benefits associated with the item will flow from the entity, and The existence of a legal obligation (due to the contract together with the loan received) leaves the entity with no alternative but to settle the loan. the item has a cost or value that can be measured reliably. The cost of the loan can be measured at the historical cost thereof, namely the amount received according to the contract of R

The accounting equation Example p ASSETS = EQUITY + LIABILITIES + 0,8m= 0 + 0,8m (Bank)(Bank loan)

Recognition criteria Income 23 An income item that satisfies the definition of income is recognised when an increase in economic benefits associated with an increase in an asset, can be measured reliably. I.e. simultaneously with the asset item at the same amount as the asset.

Recognition criteria Expense 24 An expense item that satisfies the definition of an expense is recognised when a decrease in an asset or increase in a liability, can be measured reliably. I.e. simultaneously with the decrease in the asset item or the increase in the liability item, at the same amount as the asset or liability.

Example p. 45 – Recognition criteria 25 AC Entity had its delivery vehicle repaired on credit by Payable M on 3 March 20.7 and payment would be deferred by 30 days. The expense item for Maintenance will be recognised together with the increase in the liability item Payable M.

Example p. 47 – Definition of expense 26 Expenses are decreases in economic benefits during the reporting period in the form of an outflow/decrease in assets or increase in liabilities, that result in a decrease in equity, excluding those decreases that relate to distributions to the owner.

Example p. 47 – Definition of expense 27 Expenses are decreases in economic benefits during the reporting period in the form of an outflow/decrease in assets or increase in liabilities, Maintenance is a decrease in economic benefits during the reporting period, in the form of an incurrence of a liability. that result in a decrease in equity, excluding those decreases that relate to distributions to the owner. The maintenance decreases the profit of the entity and results in a decrease in retained earnings.

Example p. 47 – Definition of expense 28 Subsequently the definition and recognition criteria for a liability are discussed because the maintenance is incurred on credit. The expense item is recognised on the same day as the liability item.

The accounting equation 29 ASSETS = EQUITY + LIABILITIES 0= Classification(Payable M) Retained earnings expense (maintenance)

Derecognition of assets and liabilities 30 If an element no longer meets definition and/or recognition criteria – derecognise. Examples: -Debtor settles his debt, derecognise the debtor. -Pay of a loan or creditor, derecognise the loan or creditor.

Accrual accounting 31 -Transactions are accounted for in the period to which it relates and not necessarily when cash flow takes place. -Elements of financial statements are recognised when they meet the definition and recognition criteria. Basis on which F/S are prepared

Accrual accounting 32 Example -Buy inventory on credit on 5 March for R from ABC Payable. -Pay the R to ABC Payable on 30 April to settle the debt. Indicate the above effect on the Accounting equation

Accrual accounting 33 ASSETS = EQUITY + LIABILITIES 5 March = (Inventory)(ABC Payable) 30 April = (Bank)(ABC Payable)

Going concern 34 -FS are prepared on the assumption that the entity will carry on operating in the foreseeable future. -For instance: entity will carry on buying and selling at “normal” prices/market related prices. -Entity is able to settle its debts and collect from its debtors “as usual”. What would the effect be on a factory if the factory can’t carry on manufacturing?

Measurement basis 35 -Initial measurement versus subsequent measurement. Initial = on the date of the transaction Subsequent = at the end of each reporting period -Historical cost model versus fair value model. Historical cost = invoice price/amount received Fair value model = amount at which an asset can be exchanged in an arm’s length

Explain – Sales vs COS 36 Purchase trade inventories cash R400 -Trade inventory (Asset) + -Bank (Asset) – Sell the trade inventory for cash R700 -Sales (Equity/Income) + -Bank (Asset) + -Trade inventory (Asset) – -Cost of sales (Equity/Expense) -

Self-study 37 p 17 – p 20 -Users of financial statements, -Qualitative characteristics, Example 2.1 & Example 2.2 (p 57 – p 66)