- 20 Marks
FR – L2 – Q8 – Financial Reporting Standards
Question
The following information has been extracted from the draft financial statements of Trust Plc for the year ended 31 December 20X8.
| Net assets | Profit for the year |
|---|---|
| GH¢000 | GH¢000 |
| 5,000 | 500 |
As the senior in charge of the audit, you identify the following:
(i) The company has preference shares in issue and these are included in equity at an amount of GH¢500,000. The annual dividend of 10% has been recognised in equity. The shares are to be redeemed in three years’ time.
(ii) One of Trust Plc’s customers went into liquidation shortly after the year-end owing Trust Plc GH¢25,000. The finance director has argued that the liquidation did not exist at the year-end and has retained the balance in the financial statements.
(iii) The company had recognised impairment of goodwill in the amount of GH¢400,000 in the financial statements for the year ended 31 December 20X8. The finance director has reversed the write-off in this year’s accounts due to an upturn in fortunes of the cash-generating unit to which the goodwill related. This has resulted in a credit of the full amount to the statement of profit or loss.
Required:
(a) Explain whether the above accounting treatments are correct and, if not, explain the correct
(b) Adjust the net assets and profit figures after making any necessary corrections in respect of the above accounting treatments.
(c) Identify and explain any ethical issues arising in the above. (Assume that Kofi is a full member of ICAG and that you are a student member).
Answer
(a). Preference shares
The accounting treatment is incorrect. The preference shares are redeemable and so should be presented as a liability. This would reduce net assets by GH¢500,000.
The preference dividend should be classified in accordance with the classification of the preference shares. Therefore, the preference dividend of GH¢50,000 (10% of GH¢500,000) should be recognised as a finance cost rather than a deduction from equity. This would reduce the reported profit for the year by the same amount.
Liquidation of a customer
The finance director’s assertion is incorrect. Whilst the liquidation did not occur until after the year-end, the company must have been in financial difficulties at the year-end. The amount should be written off, reducing both net assets and profit for the year by GH¢25,000.
Reversal of impairment of goodwill
Recognising a reversal of impairment on goodwill is not allowed.
The credit of GH¢400,000 in the statement of profit or loss must be reversed, and the newly reinstated goodwill removed from the statement of financial position.
(b). The adjusted figures from the draft financial statements are as follows:
| Net assets | Profit for the year | |
|---|---|---|
| GH¢000 | GH¢000 | |
| 5,000 | 500 | |
| Adjustment for: | ||
| (i) Preference shares and preference dividend | (500) | (50) |
| (ii) Liquidation of customer | (25) | (25) |
| (iii) Goodwill | (400) | (400) |
| 4,075 | 25 |
(c). Members and student members of ICAG must abide by the IFAC code of ethics.
This is based on the following five fundamental principles:
- Integrity;
- Objectivity;
- Professional competence and due care;
- Confidentiality; and
- Professional behaviour.
Furthermore, the code points out that compliance with the fundamental principles may potentially be threatened by a broad range of circumstances. Many threats fall into the following categories:
- Self-interest threat;
- Self-review threat;
- Advocacy threat;
- Familiarity threat; and
- Intimidation threat.
Kofi is refusing to make the necessary adjustments for a number of issues, all of which would have a negative effect on Trust Plc’s results for the year.
It could be that Kofi does not understand the accounting rules and the need to make these adjustments. This calls his professional competence into question. As a member of ICAG, Kofi has a duty to make sure that he has the knowledge and skills needed to fulfil his function, and if his action is due to lack of competence, he has failed in that duty.
As a finance director of a plc, Kofi’s technical accounting knowledge should be very strong. This suggests that his failure to make the adjustments could be due to the fact that he is trying to falsely improve the picture of financial position and performance given by the financial statements in order to get a better price for his shares. This suggests that his integrity has been compromised by a self-interest threat.
The audit senior is facing intimidation and self-interest threats from Kofi with the aim of compromising her objectivity and integrity.
The audit senior needs to remind Kofi of his professional responsibilities, and if he still refuses to make the necessary changes, she must report the matters to the partner in charge of the audit, who will presumably then take them up with the board of directors. She might choose to take further action and report Kofi’s lapses to ICAG.
The audit senior would be advised to document all exchanges with Kofi on these matters for future reference.
Note: Kofi’s behaviour in this case is completely inappropriate. The threat made to the more junior member of the profession and the offer of advancement for hiding the truth are serious ethical wrongdoings on Kofi’s part. Such behaviour must not be tolerated.
- Tags: Accounting Corrections, Financial Adjustments, Net Assets, Profit Adjustment
- Level: Level 2
- Uploader: Samuel Duah