• 20 Marks

IA – JULY 2020 – L1 – Q2 – Accounting Concepts Violations and Working Capital

Identify violated accounting concepts in scenarios and explain; define working capital and explain four factors determining its requirements.

Answer at least ONE question from this section

a. A number of accounting reporting situations are described below.

  1. In preparing its financial statements, GROUP NDOMIE omitted information about an ongoing lawsuit which its lawyers advised that the company could very well lose when it gets to court.
  2. RECEIVERSHIP COMPANY believes its people are its most significant asset. It estimates and records their value on its Balance Sheet.
  3. SME LIMITED is carrying stock at its current market value of GHS100,000. The stock had an original cost of GHS75,000.
  4. BREW CORPORATION is in its fifth year of operations and has yet to issue financial statements.
  5. Nana Appah, President of A1-GOLD COMPANY LIMITED bought a computer for his personal use. He paid for the computer with company funds and recorded it in the Computers’ account.

You are required: For each of the above situations, indicate the concept or convention that has been violated, and explain why the situation described violates this assumption or principle.

b.

  1. Define the term “working capital”.
  2. State and explain any four (4) factors which determine the Working Capital requirements of a business enterprise.

Total Marks – 20

a. Violated concepts:

  1. Full Disclosure Principle: Violated because omitting material information about the lawsuit prevents users from making informed decisions (IAS 1 requires disclosure of contingencies).

Explanation: Lawsuits can impact financial position; non-disclosure misleads stakeholders, as seen in Ghanaian bank collapses where undisclosed risks led to BoG interventions.

  1. Entity Concept: Violated by recording employee value as an asset, as humans are not owned by the business.

Explanation: The business entity is separate; valuing people as assets ignores that they can leave, contrary to IAS 38 for intangibles.

  1. Historical Cost Concept (and Prudence): Violated by carrying stock at market value > cost; stock should be at lower of cost or net realizable value (IAS 2).

Explanation: Overstating assets inflates profits, risky in volatile markets like Ghana’s commodity sector.

  1. Going Concern Concept: Violated if no statements issued, implying the business may not continue, but if operating, statements should be prepared annually.

Explanation: IAS 1 requires periodic reporting; delay could signal issues, similar to delayed audits in Ghana’s 2017 cleanup.

  1. Entity Concept: Violated by recording personal purchase as business asset.

Explanation: Personal and business transactions must be separate; this overstates assets, potentially breaching tax laws or BoG governance directives.

b. 1. Working capital is the excess of current assets over current liabilities, used for daily operations and liquidity (Current Assets – Current Liabilities).

  1. Factors:
  • Nature of Business: Manufacturing needs more for inventory (e.g., mining like Galamsey Ltd), services less.
  • Production Cycle: Longer cycles tie up capital in WIP (e.g., Ghanaian agriculture vs. retail).
  • Credit Policy: Generous terms increase debtors, needing more WC; strict policies reduce it.
  • Seasonality: Peak seasons require higher WC for stock buildup (e.g., post-DDEP recovery in banking increased WC needs for liquidity).
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