SOLUTIONS MANUAL

CHAPTER The Conceptual

2 Framework for
Financial Reporting

Review Questions
Question 1
The conceptual framework for financial reporting sets out the concepts that underlie the preparation
and presentation of a general purpose financial statements. It explains in general sense how financial
statements should be prepared.

Question 2
The objective of financial reporting to provide financial information about the reporting entity that is
useful for economic decision-making.

Question 3
(a) Investors
Existing investors and potential investors provide capital to the entity. They invest in equity
instruments such as ordinary or preferences shares or debt instruments such as bonds. They are
interested in minimizing their risks and maximizing their returns.
(b) Lenders
Lenders include financial institutions and all parties who lend money to the entity. Decisions by
lenders about providing or settling loans depend on the company’s ability to service the principal
and interest payments.
(c) Creditors
Creditors supply goods and services to the entity on credit terms. Decisions by creditors to extend
credit to a company depends on the company’s ability to settle the credit on time.

Question 4
Going concern: Financial statements are prepared on the assumption that an entity is a going concern.
This means that the entity will continue to operate for the foreseeable future, long enough to fulfil its
objectives and commitments and has no intention nor the need to liquidate or reduce significantly
the size of its operations. This enable the historical cost basis to be used as a basis of measurement. If
the entity is not a going concern, the historical cost basis cannot be used.

Question 5
Relevance: Information that is relevant is capable of changing the decision made by users.

Faithful representation: Information should represent what it is supposed to represent, meaning

information should be complete, neutral and free from error.
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Question 6
The main constraint in reporting information that is relevant and faithfully representative is cost.
Costs to providers include costs in collecting, processing, verifying and disseminating financial
information. Costs to users include costs of analysing and interpreting the information and to obtain
information elsewhere or to estimate the information in cases where the information needed was not
provided by the reporting entity. In determining what information to provide, the guiding principle
is the benefit to users should outweigh the costs incurred to prepare the information.

Question 7
Financial reporting standards provide guidance on very specific issue related to financial reporting
and applies concepts set out in the conceptual framework. Therefore a general guidelines is needed
in the form of a conceptual framework. The conceptual framework provides a general guide on how
financial statements should be prepared. It sets up principals which are general concepts which is
applicable to wide range of issues.

Question 8
The enhancing qualitative characteristics should be maximize to the extent possible.

Question 9
Materiality is an important consideration in determining what relevant information is. It refers to
the impact of an omission or misstatement of information in a company›s financial statements on
its users. If the omission or misstatement affects the users’ decision, then the item is considered
to be material. On the other hand, if users would not change their decision, then the omission or
misstatement is considered to be immaterial.

Question 10
The concept of capital maintenance is important as it allows us to differentiate between the return on
capital or earnings (profits) and the return of capital or cost recovery. Therefore the concept provides
a point of reference by which profit is measured.

Question 11
The use of reasonable estimate is an essential part of the preparation of financial statement and does
not reduce the reliability of the financial statements. This is because in many cases cost or value cannot
be determine with precision and thus requires estimation. However in cases where a reasonable
estimate cannot be made, then the item is not recognized.

Question 12
(a) Syarikat Permata has decided to issue the first quarter financial report only after the second
quarter report has been prepared, in an effort to ensure that there are no long intervals in between
the issuance of the reports.
Timeliness requires that information be made available in time for it to be capable of
influencing decisions. In general the older the information, the less useful it is.
(b) Guna Industries switched from weighted average method to FIFO in 2013 and switched back
from FIFO to weighted average method in 2014 for inventories.
Comparability—the method for inventories was not used in a consistent manner, thus
comparability is compromised.
(c) Normad Construction entered into several transactions for the purpose of hedging in the current
period. However no disclosure were made with regards to these transactions to avoid confusion
amongst users of financial statements as the transactions involved were complex.
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Understandability—users of financial information are assumed to be knowledgeable users.

This means that the users have reasonable knowledge of business and economic activities
that would enable them to review and analyse the information well. Therefore complex
information should still be included and disclosed even though such information may be
more difficult to understand.
(d) Mewah Industries has decided to report its head office building at fair value as at the end of the
current reporting period. Three different appraisers have arrive at substantially different amounts
for its fair value. The board has decided to use the middle range value for financial reporting
purposes so as to not overstate or understate the fair value of the building.
Verifiability means that different knowledgeable and independent observers could reach
consensus, although not complete agreement. This means that disclosure made by companies
of the methods, estimates and assumptions made in valuing its assets and liabilities would
enable knowledgeable users to reach an agreement that the value of a company’s assets and
liabilities falls within a certain range of values.

Application Exercises
Question 1
(a) Fair value reporting—relevance
(b) Use of specific formats for presenting financial statements—understandability
(c) Providing more detail information about financial statement items in the notes to the accounts:
faithful representation
(d) Issuing quarterly financial reports not later than two months after the end of each quarter of a
financial year—timeliness
(e) Ensuring no error was made in calculating impairment loss—faithful representation
(f) Providing current period and previous period information for all financial statement items—
comparability
(g) Disclose significant accounting policies in the note to the account—verifiability

Question 2
(a) Loss on sale of machinery—losses
(b) Retained earnings—equity
(c) Rental revenue—revenue
(d) Prepaid insurance—assets
(e) Advanced payment by customers—liabilities
(f) Share premium—equity
(g) Depreciation—expenses
(h) Patent—assets
(i) Trade payable—liabilities
(j) Gain on sale of marketable securities—gains

Question 3
(a) The concept of probability refers to the degree of uncertainty that the future economic benefit
associated to the item will flow to or from the entity. The assessments of the degree of uncertainty
is made based on the evidence available when the financial statements are prepared, taking into
consideration the environment in which the entity operates. However if there are uncertainty
with regards to the collectability of the amount owned, then Syarikat Idaman must wait until
payment is received before revenue can be recognized. Therefore the step taken is appropriate.
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(b) Gains on inventories cannot be recognized as it does not fulfil the definition of element (gains).
(c) Sales revenue cannot be recognized as revenue have not been earned since the goods have not
been transferred to the customer, therefore the definition of revenue has not been met.
(d) Rental expense cannot be recognized as it involves a prepayment, therefore the definition of
expenses has not been met.

Question 4
Direct association: Cost of sales and sales commission expense
Systematic allocation: Depreciation expense and insurance expense

Question 5
Estimation of depreciation expense and estimation of doubtful debts

Question 6
Historical cost: Initial recognition of assets
Current cost: Revaluation of PPE
Realizable value: Valuation of ending inventories as at the end of the accounting period
Present value: In determining value in use of asset (assets impairment)

Question 7
Kayangan Industries has total assets of RM1,200,000 and total liabilities of RM700,000 at the
beginning of the period and total assets of RM1,460,000 and total liabilities of RM810,000 at the
end of the period. Assume that there were no contribution from or distribution to owners during
the period.
Net assets = Total assets – Total liabilities
Net assets at the beginning of the period = RM1,200,000 – RM700,000
= RM500,000

Net assets at the end of the period = RM1,460,000 – RM810,000

= RM650,000

Profit for the period = RM650,000 – RM500,000

= RM150,000

A profit for the period of RM150,000 can be recognized as capital has been maintained since net
assets at the end of the period (RM650,000) exceeds net assets at the beginning of the period
(RM500,000).

Under the financial capital maintenance concept, a profit is earned only if the financial or money
amount of the net assets at the end of the period exceeds the financial or money amount of net assets
at the beginning of the period, after excluding any distributions to, and contributions from owners,
during the period. Based on this concept, all price changes affecting the assets and liabilities of the
entity are viewed as profits.

Question 8
(a) Assuming the balance payment is made in 5 equal annual instalments and the discount rate is
10% (any rate considered reasonable can be used).
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Cost of the machinery

= RM10,000 + (RM10,000 × PVA 10%, 5)
= RM10,000 + (RM10,000 × 3.79079)
= RM47,908
(b) The machinery should be recognized as assets when Hijau Industries took delivery of the
machinery on 30 September 2015.

(c) 15 Sep 2015

Dr Prepayment 10,000
Cr Bank 10,000

30 Jun 2015
Dr Vehicle 47,908
Cr Prepayment 10,000
Cr Accounts payable 37,908

Question 9
Type of revenue Revenue recognition
1 Rental revenue When guests check-in
2 Sales of food and beverage When goods exchange
3 Fee for guided tour When service is rendered
4 Fee for river rafting When service is rendered

Question 10
(a) Revenue should be recognized after 48 hours before the scheduled delivery’ time line is surpassed
as cancellations made in less than 48 hours of scheduled delivery time are still considered delivery.
(b) The deposits cannot be recognized as revenue as the deposits are returned to the customers upon
termination of services.
(c) Cancellation fees should be recognized as revenue but refunds made should not be recognized as
losses since they are repayment of advances from customers.
(d) Payments made to purchase tiffins should be recognized as assets as they can be used for 3 years
which is more than 12 months (one accounting period).