MN3245 ACCOUNTING FOR CORPORATE

ACCOUNTABILITY
OUTLINE ANSWERS TO EXAMINATION QUESTIONS
2008-09
Note: The answers that follow provide a statement of the calculations
involved in the various examination questions and an outline of the answers to
discussion parts of questions. You should note that alternative approaches to
the calculations were accepted where they were appropriate. In some places,
additional details were provided as a guide to the markers you should not
assume that these answers set out either the minimum or the maximum
material that would be required for a full answer.
Examiners Comments: These have been added to the outline answers to
provide some indication of the main areas in which students could have gained
extra marks.
49 students took the examination, and the mean mark was 61% (all students
sitting the examination were given one bonus mark because the three
questions were marked out of 33 marks each, making a total of 99 marks
available for the three questions). Distribution of marks was as follows (note
that this distribution relates to the examination only, and does not reflect the
inclusion of assessed coursework marks in the final module marks):
70 or above
60-69
50-59
40-49
39 or below

10

20
11
6

Two students attempted only two questions instead of the required three
questions. It is a good idea to leave at least a few minutes for a third
question, because the examiners are likely to award some marks even for a
short answer, and these marks could lift the overall mark for the module into a
higher classification.
For those interested, the names of the companies in the questions (Essendon,
Hawthorn and Richmond) are all teams that play in the Australian Football
League.

-2-

1. Essendon plc (off balance sheet finance)

Part (a)
In this part of the question, students could discuss the incentives faced by
managers to provide accounting statements that lead to particular
consequences. The balance sheet is used as an indication of the companys
financial well-being. If the company is able to keep a financing transaction
off its balance sheet, it will (typically) understate assets and liabilities. This
means that ratios based on comparing liabilities with equity (such as the
gearing ratio) will be less than if the transaction were reflected on the
balance sheet. Sometimes, these ratios are used in financial contracts to
restrict the ability of a company to raise additional funds. Directors and
managers who do not want to be restricted may consider it desirable to try
to understate liabilities so that the contractual terms do not create
constraints. Even in the absence of such debt covenants, a higher reported
level of debt may lead to potential lenders and investors requiring a higher
rate of return to compensate for the greater perceived risk. On the assets
side, off balance sheet finance may lead to risky assets being concealed.
Students should, for higher marks, make reference to at least one relevant
theory, for example, Positive Accounting Theory, with its economic
explanation of the incentives for choosing certain accounting policies, or
Legitimacy Theory, which would explain off balance sheet financing in
terms of the desire of directors to present balance sheets in line with the
expectations of key stakeholders, who might dislike high levels of reported
debt. Very good answers could include some additional examples of off
balance sheet finance, possibly referring to some recent real cases such as
securitised mortgages.
Part (b)
Candidates should explain why is a finance lease. The general definition of
a finance lease in IAS17 is that it transfers substantially all the risks and
rewards incidental to ownership to the lessee. IAS17 mentions a range of
factors that could be relevant to determining whether or not a lease is a
finance lease, and candidates should note:
(a) The lease is effectively for the useful economic life of the machine.
(b)The lessee bears the main risks associated with the machine, and the
lessors interest is only a financial one.
(c)The present value of the minimum lease payments at the inception of
the lease amounts to substantially all of the fair value of the leased
machine.
Ideally, candidates should check the present value by discounting the
minimum lease payments using the 10% discount rate.

-3-

Year
0
1
2
3
4
5

Payment
376,000
376,000
376,000
376,000
376,000
376,000

Discount
Present
factor
value
1.0000
376,000
0.9091
341,818
0.8264
310,744
0.7513
282,494
0.6830
256,813
0.6209
233,466
Total

1,801,336

This is approximately equal to the fair value of 1,800,000 (taken as equal

to the equivalent purchase price of a new machine).
Part (c)
The total payments due under the lease (including the option to renew) are
376,000 x 6 = 2,256,000. Hence the total finance cost is 456,000.
On the basis that this is a finance lease, an asset would be recognised at
1,800,000 (fair value of the asset, as this is approximately equal to
present value of minimum lease payments) and a liability would also be
recognised at 1,800,000. Better candidates may note that IAS 17 specifies
that the lease should be recognised initially at the lower of the fair value
and the present value of the minimum lease payments, which would
confirm the use of 1,800,000.
The company uses straight line depreciation, so the depreciation each year
will be 1/6 x 1,800,000 = 300,000. The company would show this
amount each year in the income statement as part of depreciation expense.
On the balance sheet, the asset would be shown at 1,500,000 at the end
of year 1 and 1,200,000 at the end of year 2.
If the company uses sum of digits to allocate the finance cost, then the sum
of digits will be 1 + 2 + 3 + 4 + 5 = 15 (note that the payments are made
in advance, so there will be no finance charge for year 6, as all payments
have been paid by the beginning of that year). The finance charge for year
1 would be 5/15 x 456,000 = 152,000, and so on. The liability would
evolve as follows:
Year

1
2

Opening
Balance
(A)
1,800,0
00
1,576,0
00

Paid at
start of yr
(B)
376,000
376,000

Finance
charge
(C)
152,0
00
121,6
00

Closing
Balance
(A B + C)
1,576,00
0
1,321,60
0

If the company uses the actuarial method, then it would apply the interest
rate implicit in the lease of 10% as follows:

-4Year

1
2

Opening

Paid at

Balance
start of yr
(A)
(B)
1,800,000
376,000
1,566,400
376,000

Bal.
bearing
interest
(A B = C)
1,424,000
1,190,400

Finance
charge
(D)
142,400
119,040

Closing
Balance
(C + D)
1,566,400
1,309,440

The question states clearly that calculations are required for the first two
years, so no credit will be given for calculations covering more years.
Examiners comments:
This question was attempted by 39 students. The mean mark was 20/33.
In part (a), some students provided examples of off balance sheet finance,
but the question asked why companies would want to engage in this.
Better answers made use of theory (almost always positive accounting
theory) to provide a rationale for the use of off balance sheet finance. The
best answers provided a clear explanation, grounded in theory, for why
companies might wish to engage in off balance sheet finance, and also
provided one or two additional examples. In part (b), some students
asserted that the present value of the minimum lease payments was at
least 90% of the fair value of the leased item, but did not justify this
assertion with a calculation. In part (c), students paid attention to the
requirement to calculate two years numbers only, but some students
provided numbers using only one of the two required methods (actuarial
and sum of the digits). Students who gained the highest marks for this
question tended to be those who explained their calculations clearly in part
(c) rather than just setting down a series of workings with little explanation.
2. Richmond plc (revenue recognition)
Part (a)
Students could mention that revenue is the top line in the income
statement it is one of the main performance indicators for companies, and
is widely used as a measure of the volume of activity. Not only is revenue
used as a way of ranking companies, but it also indicates corporate growth.
It enters into the calculation of various key ratios. Managers are often
rewarded in part by reference to revenues or revenue growth, so they have
an incentive to try to maximise reported revenues. Also, at various times,
investors have used revenue information in valuing companies (particularly
new businesses that are not yet profitable), so maximising reported
revenues can lead to increased share value.
Although only a brief answer is required, students who refer to theoretical
concepts as well as more descriptive ideas will gain higher marks.

-5Part (b)
Students who provide well-reasoned answers referring to principles
underpinning IAS 18 will gain high marks for this part, even if their detailed
answers are not exactly what was expected. Some general reference to the
IAS 18 principles for recognising revenue from the sale of goods may be
helpful. Revenue should be recognised when:
1. The enterprise has transferred to the buyer the significant risks and
rewards of ownership of the goods.
2. The enterprise retains neither continuing managerial involvement nor
effective control over goods sold.
3. The amount of revenue can be measured reliably.
4. It is probable that economic benefits from the transaction will flow to the
enterprise.
5. Costs incurred or to be incurred can be measured reliably.
Taking the four situations in turn:
(i) Richmond may recognise the sale of furniture at its full sales value and
show the amount of any discount credited to the discount card as a selling
cost (sales incentive). The discount will be carried forward as a liability
until it is used. If any discount is not used by the time it expires, then it will
be credited to selling costs. If Richmond can estimate the likely proportion
of customers who will use their discounts before they expire, then it could
account for only the expected proportion, rather than the full amount, but if
this is the first year in which the scheme is introduced, there is probably no
past experience to use in making reasonable estimates, and it is more
prudent to make full provision. A possible alternative treatment would be
to recognise net revenue equal to the gross value of the sale less any
discount credited to the card this would be consistent with the treatment
of prompt payment discounts under IAS 18, but it could perhaps be argued
that the discount card scheme is an incentive to encourage future sales
rather than a reduction in the amount expected to be received from present
sales, and thus is not similar to a cash discount for prompt payment.
(ii) The no payment for two years scheme raises several issues. First,
can Richmond be confident that economic benefits will flow to the
enterprise, that is, that customers will pay at the end of two years? In
practice, Richmond may be able to transfer the customers obligation to a
third party, but is unlikely to be able to do this at the full value of the sales
transaction. If there is doubt about collectibility, it may not be reasonable
for Richmond to recognise revenue. However, even if Richmond does
recognise revenue, should it do so at the full value of the transaction? IAS
18 states that revenue should be measured at the fair value of the
consideration received and receivable, and a receipt in two years will have
a lower present value (and thus fair value) than a receipt today. Hence, the
revenue should be discounted to reflect the time value of money, and the
difference between the amount of revenue recognised now and the amount
received from the customer should be recognised as finance income.

-6(iii) Has Richmond transferred to the buyer the significant risks and
rewards of ownership, or does it still retain management involvement and
effective control over the goods covered by the rent to buy scheme? If
the renter effectively carries the risks, and Richmonds involvement is
simply a financial one, then it could recognise the sale at the current sales
price, and split the cash received from the customer between payment for
the furniture and interest (note that the customer pays 24/20ths of the
sales price). Students could note that this transaction could be a finance
lease (or a hire purchase contract). If Richmond is effectively still in control
over the furniture, and perhaps continues to bear risks, such as loss from
damage to the furniture, then it would not recognise a sale but rather would
treat the cash paid by the customer as rental income as it falls due for
payment.
(iv) Richmond cannot recognise a sale until it actually takes place. The
deposit would be accounted for as a liability until a sale transaction occurs,
and then treated as part payment for the furniture being purchased. The
fact that the deposit is not refundable does not affect this accounting
treatment, because at the balance sheet date Richmond is liable to sell
furniture on favourable terms to the customer. Richmond should ascertain
whether completing the sale will actually lead to a loss and make provision
for any loss now.
Examiners Comments:
The question was attempted by 23 students, and the mean mark obtained
was 18/33. In part (a), some students simply set out the definition of
revenue and the five criteria for recognising revenue, without writing much
about why the revenue number is considered to be important. A few
students went into detail about technical issues to do with revenue
determination without linking these clearly to the four policies. The
examiners gave relatively few marks to such answers, which did not
address the question actually set. In discussions of the four policies, marks
were based on the amount and quality of the analysis and well-argued
answers gained high marks even if they came up with different analyses
from those in the answer above. A few students could have gained more
marks if they had analysed all four policies rather than limiting their
answers to only two or three policies.
3. Hawthorn Holdings plc (pensions)
Part (a)
The amounts to be shown in the financial statements, together with
supporting workings, are set out on the next page:

-7-

Balance sheet:
Net pension liability (2007: 2,300 2,500; 2008:
2,000 2,520)
Income statement:
Current service cost
Financial income: expected return on plan assets
Financial expense: interest on plan obligations
Total cost
Statement of other recognised income and expense:
Actuarial losses

2007
m

2008
m

350

520

190
(250)
125

210
(115)
159

65

254

525

176

2007
m

2008
m

2,500
250
240
2,990
270
2,720
2,300

2,300
115
255
5
2,675
290
2,385
2,000

420

385

2,500
125
190
2,815
270
2,545
2,650

2,650
159
210
3,019
290
2,729
2,520

Workings:
Movements of fund assets:
Opening balance
Expected return on fund assets at 10%/5%
Contributions from employer at 15%
Additional contributions
Less: Benefits paid
Expected fund assets at year-end
Actual fund assets at year-end
Actuarial loss on fund assets
Movements of pension obligations
Opening balance
Interest on plan obligations at 5/6%
Current service cost
Less: Benefits paid
Expected plan obligations at year end
Actual plan obligations at year end
Actuarial loss (2008 gain) on pension obligations
Actuarial losses:
Actuarial loss on fund assets
Actuarial loss (2008 gain) on fund obligations
Total actuarial losses
Part (b)

105

(209)

420
105

385
(209)

525

176

-8Companies are permitted to use the so-called corridor method for

recognising actuarial gains and losses. Under this method, if the net
cumulative unrecognised actuarial gains and losses at the end of the
previous period are more than the greater of 10% of the present value of
the defined benefit obligation and 10% of the fair value of any plan assets
at that date, then the excess gains or losses should be recognised in the
income statement over the expected average remaining service lives of
employees. Companies may choose to recognise actuarial gains and losses
over a shorter period, even in the period in which they occur. In the last
situation, companies may recognise actuarial gains and losses in the
Statement of Recognised Income and Expense or in the income statement.
Companies may prefer to adopt the corridor treatment because it can
reduce volatility arising from actuarial gains and losses. These numbers
reflect small changes in assumptions and differences between assumptions
and outcomes, and in a funded pension scheme they can swing between
gains and losses from one period to the next. The corridor treatment allows
employers to ignore relatively small gains and losses and to spread larger
gains and losses over several years. However, it is argued that this
treatment leads to balance sheet numbers that are difficult to interpret (for
example, a pension asset may be reported even though the underlying
pension fund is in deficit). In current market conditions, with substantial
falls in both security prices and interest rates, some companies face a
double whammy of substantial falls in pension asset values and increases
in pension liabilities, and some companies will prefer to choose accounting
policies that enable these losses to be recognised over several years rather
than all at once. It has been claimed that imposing volatility on companies
could have adverse effects if investors believe that short-term pension
deficits must be funded immediately rather than dealt with over several
years, and that this could hurt employees in particular if employers curtail
pension benefits in order to control the level of liabilities. However, a
counter-argument is that, so long as sufficient information is disclosed
about the nature of pension gains and losses, investors and other users will
be able to form their own judgements about a companys financial position
it is better to tell it as it is rather than use accounting methods to
mislead and conceal the financial position.
Examiners comments:
This was the most popular question, with 44 students making an attempt.
The mean mark was 22/33. In part (a), most students achieved a high
mark, particularly if they set their workings out clearly and with good
explanations (students who did this normally avoided calculation errors or
the omission of key figures). The only error made by more than one or two
students was to start the calculations for 2008 with the expected pension
fund assets and obligations at the end of 2007 rather than the actual
figures. In part (b), students generally provided a clear explanation of the
corridor method, though some students suggested that this was a much
more common choice for UK listed companies than is in fact the case (only
around 5% of such companies use the method, though it is more common
in other countries). The better answers noted that the question asked
students to comment critically, and therefore discussed the likely impact
of the corridor method not just on the financial statements but also on key

-9stakeholders such as employees (the general view was that immediate

recognition of actuarial gains and losses, and the balance sheet volatility
that this implies, would be likely to encourage the remaining companies
with defined benefit schemes to close them).
4. Social and environmental disclosure
This question allows students to demonstrate their knowledge of various
theories relating to financial reporting, in particular theories devised
specifically to explain corporate social and environmental disclosures, such
as legitimacy, stakeholder and institutional theories. Given the wording of
the question, it is likely that many students will use stakeholder theory.
They could distinguish between stakeholders who have the power to
influence the company, such as the providers of finance, and stakeholders
affected by the company but with limited influence. Stakeholder theory
argues that the stakeholders with influence are more likely to have their
interests reflected in corporate disclosures, and legitimacy theory suggests
that managers will aim to protect the companys licence to operate by
disclosing information that reduces pressure on the company from outside
stakeholders, including government regulators, and suppressing or
downplaying information that could show the company in an unfavourable
light from the perspective of stakeholders who could put pressure on the
company.
If companies do not disclose on a voluntary basis information that society
considers is important in assessing the companies general activities, then
it may be necessary to require disclosure through legislation. Good answers
may discuss theoretical arguments supporting accounting regulation, and
very good answers are likely to provide some examples of social and
environmental disclosure provided voluntarily or required by regulation.
Examiners comments:
This question was attempted by 30 students, and the mean mark was
21/33. The form of the question is important students were asked to
comment critically on a given statement. In practice many students
regarded the question as an opportunity to write a general essay on
theories of voluntary reporting, and only indirectly commented on the
statement itself. Most students took for granted, rather than questioning,
the claim that most corporate social and environmental disclosure reflects
the interests of the company rather than the interests of a broad range of
stakeholders, and did not challenge what could be meant by the interests
of the company (interests of shareholders, managers, employees, other
stakeholders?) and whether the claim is actually true empirically. The
statement also assumes implicitly that social and environmental disclosure
is inadequate and this needs to be remedied by introducing some way of
requiring companies to disclose more (how would this be achieved
legislation?). The answers gaining the highest marks were those where the
student actually commented on the statement rather than simply
presenting a general essay on theories of disclosure that could have been
prepared in advance.

- 10 -

5. Decision-usefulness
Students had a workshop on this topic, and they should be able to
summarise the main components of a conceptual framework (objectives of
financial reporting, qualitative characteristics, elements with an emphasis
on assets and liabilities recognition and measurement, and possibly a
discussion of the reporting entity). Students should briefly explain the idea
of decision-usefulness, in particular the way that the conceptual
frameworks tend to emphasise investors as the main users and making
investment decisions as the most important use. Students could link the
use of fair value with the focus on assets and liabilities and transactionsbased accounting with a focus on the income statement and the recognition
and measurement of income and expenses. The qualitative characteristics
could be referred to in terms of objectivity and subjectivity, linked to
reliability and relevance the decision-usefulness approach stresses
relevance for forward-looking economic decision-making, while the
transactions-based approach is more concerned with the outcome of past
management decisions, and hence may provide a clearer indication of how
well management have utilised the companys resources. Better answers
may refer to wider stakeholder groups others may challenge the emphasis
on capital markets by questioning whether information in financial
statements actually has much relevance to investors. Finally, some
consideration of the role of general-purpose financial statements and
their usefulness to wider groups of stakeholders than sophisticated
investors would be desirable in a very good answer.
Examiners comments:
Only 9 students attempted this question, and for some students time
pressures may have meant that only a brief answer could be presented.
The average mark of 19/33 disguises the wide range of marks. There were
two excellent answers, which gave a clear explanation of decisionusefulness, put this into the context of the IASBs conceptual framework,
explained the main elements of the framework concisely, and discussed the
advantages and disadvantages of a forward-looking approach in
comparison with a transactions-based approach. At the other end of the
mark range, two answers made only passing references to the issues of the
question, which should have been considered at a general conceptual level,
but instead these answers tried to apply the conceptual framework to
specific accounting issues studied during the course. The examiners were
unable to give many marks to essays that did not address the question
actually set.