FINANCIAL REPORTING ASSIGNMENT FOR WEEK 3
Date of Submission: 27th September, 2022
1. The IASB's Framework for the Preparation and Presentation of Financial Statements
requires financial statements to be prepared on the basis that they comply with certain
accounting concepts, underlying assumptions and (qualitative) characteristics. Four of these are:
• Matching/accruals
• Prudence
• Comparability
• Materiality
For most entities, applying the appropriate concepts/assumptions/qualitative characteristics in
accounting for inventories is an important element in preparing their financial statements.
Required:
Illustrate with examples how each of the concepts/assumptions/qualitative
characteristics above may be applied to accounting for inventory.
2. On 1 January 2009, Emma Oil Company acquired a newly constructed oil platform at a cost of
GH30 million together with the right to extract oil from Cape Four Points offshore oilfield under
a Government of Ghana license. The terms of the license are that Emma Oil will have to remove
the platform (which will then have no value) and restore the sea bed to an environmentally
satisfactory condition in 10 years* time when the oil reserves have been exhausted. The
estimated cost of this on l December 2018 will be GHS1 million. The present value of GHS1
receivable in 10 years at the appropriate discount rate for Emma Oil of 8% is GHS 0.46.
Required:
Explain and quantify how the oil platform should be treated in the financial statements
of Emma Oil for the year ended 30 September 2009.
3. A director of Enca, a public listed company, has expressed concerns about the accounting treatment
of some of the company’s items of property, plant and equipment which have increased in value. His
main concern is that the statement of financial position does not show the true value of assets which
have increased in value and that this ‘undervaluation’ is compounded by having to charge
depreciation on these assets, which also reduces reported profit. He argues that this does not make
economic sense.
Required:
Respond to the director’s concerns by summarising the principal requirements of IAS 16
Property, Plant and Equipment in relation to the revaluation of property, plant and equipment,
including its subsequent treatment.
In a question like this you can easily see that there will be marks available for the description of each
concept and further marks for the application of each to inventory. Therefore you must write something
on each point and you must not waste time writing too much on any of them-half a page on any of these
points would still only get you the same marks. Part (c ) requires you to apply what you know.
(a) Matching/accruals This dictates that the effects of transactions and other events are recognised
in the financial statements in the period in which they occur, rather than in the period when cash
is received or paid.
(b) Going Concern This is the assumption that the entity has neither the intention nor the
necessity to liquidate or curtail major operations. If this assumption did not apply, the financial
statements would be prepared on a different basis.
(c) Verifiability This means that different, knowledgeable and independent observers could agree
that a particular depiction of a transaction in the financial statements is a faithful representation.
(d) Comparability This requires consistent application of accounting policies and adequate
disclosure in order that (a) the financial statements of an entity can be compared with its
financial statements for previous accounting periods and (b) the financial statements of an
entity can be compared with the financial statements of other entities.
(e) Materiality An item of information is material if omitting it or misstating it could influence the
decisions that users make on the basis of the financial statements. An item can be material on
account of its nature or account of its magnitude.
(b) Application to inventory
a. Matching/accruals: Inventory is charged to profit or loss in the period in which it is used, not
the period in which it is received or paid for. This is done by adjusting cost of sales for opening
and closing inventory.
b. Going concern: As long as the going concern assumption applies, inventory valued at lower
of cost and NRV will in most cases be valued at cost. If the business is subject to a forced sale,
the NRV of inventory is likely to be below cost.
c. Verifiability The cost element of inventory is easy to verify as it will be recorded in invoices.
The calculation of NRV must be based on verified information. The annual inventory
count provides verifiability on quantities.
d. Comparability: Inventory should be valued in financial statements using FIFO or weighted
average must and this should be consistently applied from one period to the next. If a change
is made to the method of valuation, it must be disclosed, so that the current and prior periods
can still be compared.
e. Materiality: Inventory is counted at the end of each reporting period and the valuation is
based on this physical count, because inventory is generally regarded as a material
item. However, it could be decided that a small discrepancy in the count would not be
investigated because the amounts involved were too small to affect the decisions of users and
so were not material.
2. Answer according to IAS 37, Oil Platform and right to extract oil platform are recognized as
asset in statement of financial position. A provision is created because present obligation as a
result of past events and settlement is expected to result in an outflow of resources (payment).
Hence An entity must recognise a provision if, and only if a present obligation (legal or constru
3. The requirements of IAS 16 Property, Plant and Equipment may, in part, offer a solution
to the director’s concerns.
IAS 16 allows (but does not require) entities to revalue their property, plant and equipment to
fair value; however, it imposes conditions where an entity chooses to do this.
First, where an item of property, plant and equipment is revalued under the revaluation model
of IAS 16, the whole class of assets to which it belongs must also be revalued. This is to
prevent what is known as ‘cherry picking’ where an entity might only wish to revalue items
which have increased in value and leave other items at their (depreciated) cost.
Second, where an item of property, plant and equipment has been revalued, its valuation (fair
value) must be kept up-to-date. In practice, this means that, where the carrying amount of the
asset differs significantly from its fair value, a (new) revaluation should be carried out. Even
if there are no significant changes, assets should still be subject to a revaluation every three to
five years. A revaluation surplus (gain) should be credited to a revaluation surplus
(reserve), via other comprehensive income, whereas a revaluation deficit (loss) should be
expensed immediately (assuming, in both cases, no previous revaluation of the asset has
taken place). A surplus on one asset cannot be used to offset a deficit on a different asset
(even in the same class of asset). Subsequent to a revaluation, the asset should be
depreciated based on its revalued amount (less any estimated residual value) over its
estimated remaining useful life, which should be reviewed annually irrespective of
whether it has been revalued.
An entity may choose to transfer annually an amount of the revaluation surplus relating to a
revalued asset to retained earnings corresponding to the ‘excess’ depreciation caused by an
upwards revaluation. Alternatively, it may transfer all of the relevant surplus at the time of the
asset’s disposal.
The effect of this, on Enca’s financial statements, is that its statement of financial position will
be strengthened by reflecting the fair value of its property, plant and equipment. However, the
downside (from the director’s perspective) is that the depreciation charge will actually increase
(as it will be based on the higher fair value) and profits will be lower than using the cost model.
Although the director may not be happy with the higher depreciation, it is conceptually correct.
The director has misunderstood the purpose of depreciation; it is not meant to reflect the
change (increase in this case) in the value of an asset, but rather the cost of using up part of
the asset’s remaining life.