Additional Tutorial Questions and Solutions

Chapter 10
Problem 10.18
Assets and income

A legal wrangle developed between the Australian Taxation Office (ATO) and Box Hill Ltd con-
cerning the treatment of certain disputed income tax payments. This prompted ASIC to seek a
formal ruling on the dispute and call for full disclosure of the effects of tax disputes in the com -
pany’s financial statements.

Box Hill Ltd and several other leading companies operated an in-house, tax-minimisation scheme which was
unacceptable to the ATO. As a result, the ATO assessed Box Hill Ltd as owing $15 million in tax stemming from
the use of the scheme. The company paid the tax to the ATO but then challenged the ATO in court and won its
challenge to the assessment in the state Supreme Court. Since then, the ATO has appealed against the decision
to the Federal Court, but no decision has yet been made.

In its financial statements at the end of the financial year, Box Hill Ltd included the amount of $15 million as an
asset, refundable from the ATO. On reviewing the financial statements, ASIC expressed concern about the
treatment of the money expected to be recovered from the ATO as an ‘asset’, as the amount appeared to
affect materially the reported profits of the company. ASIC suggested that disputed taxation assessments do
not qualify as items resulting from past transactions or to which a company has a definite legal right.

Required

(a) Discuss whether the disputed amount should be recognised as an asset and as income in the financial
statements of Box Hill Ltd.
(LO6 and LO7)

(a)SOLUTIONS

It would appear from the case that Box Hill Ltd has made the following entry:

Receivable from Australian Taxation Office Dr 15 000 000

Income from Recovery of Tax Cr 15 000 000

The question to be asked here is whether the entry made by Box Hill Ltd is legitimate under the Conceptual
Framework’s definitions of assets and income.
 Does Box Hill Ltd have an asset?

Are there future economic benefits? Yes, it has been decided so by the court.

Does the entity control those benefits? According to the definition of control, there
is a legal debt owed exclusively to Box Hill
Ltd, so control follows.

Is there a past event? Yes, there is a legal decision by the court, in

spite of the ASIC’s protestations.

So there is an asset, and it can be recognised as the recognition criteria, if you accept that the probability of
receipt from the Australian Taxation Office is greater than 50%, and that the amount is reliably measured at $15
000 000, are also satisfied.

Does Box Hill Ltd have income?

Has there been an increase in future Yes. Income exists and can be recognised.
economic benefits in the form of an asset,
and an increase in equity?

Some may object to the above reasoning and argue that the decision is yet to come before the Federal court of
appeal for a final verdict. Hence, there may be an asset and income, but if the probability of receipt is assessed as
being less than 50%, no asset or income can be recognised.

Alternatively, for those who are prepared to recognise the asset and income, if the decision is reversed, then Box
Hill Ltd can pass the following entry:

Expense from Loss of Court Case Dr 15 000

000
Receivable from Australian Taxation Office Cr 15 000 000
Problem 10.19

Assets, expenses and liabilities

Land and Water Waste Disposal Ltd (LAWWD) is a public company providing waste disposal
services to private homeowners and to customers in the commercial, industrial and public sectors.
Because of its active research program, the company has built a fine reputation as the leading han-
dler of waste products in Adelaide.

During the year ended 30 June 2023, LAWWD undertook an investigation on the feasibility of
establishing a waste processing plant in one of Melbourne’s eastern suburbs. Financial advisers,
engineers, architects and lawyers were consulted to determine the economic and legal feasibility of
establishing such a plant. As at 30 June 2023, the company had incurred costs of $800 000 but was
still unable to determine clearly the feasibility of the project; these costs were deferred as assets in
the company’s financial statements.

LAWWD has several long-term contracts which specify that predetermined quantities of waste
must be delivered to certain locations each year. The contracts specify that, if LAWWD is unable
to deliver the predetermined quantities, shortfalls must be made up in equivalent cash payments.
Unfortunately, LAWWD has not developed a system to keep track of exact quantities delivered to
each location. It has become an acceptable practice for delivery requirements to be renegotiated
during the life of any contract.

Shortly after the end of the financial year ending 30 June 2023, LAWWD was advised by one of its clients,
Dorset Ltd, that there was a shortfall in the tonnage of land waste delivered. The cash penalty for this
deficiency was approximately $300 000. Because of the long-standing business relationship between the two
parties, the management of Dorset Ltd agreed to a future meeting with LAWWD to be held on 30 September
2023 to discuss waiving the penalty and reducing next year’s delivery requirements. In the finalisation of its
general purpose financial reports at the end of August 2023, LAWWD has not recognised any liability for
penalties under this contract.

Required

(a) In the light of the Conceptual Framework, discuss LAWWD’s treatment in the general purpose financial
reports of the costs incurred for the feasibility study, and the penalty under the contract with Dorset Ltd.
(LO6 and LO7)
(a)SOLUTIONS

Issues to be considered:

 Costs of feasibility study.

 Penalty under contract with Dorset Ltd.

i. Cost of feasibility study:

 $800 000 incurred during year ended 30 June 2023.

 Feasibility of project uncertain.
 Costs deferred in statement of financial position, i.e. capitalised as asset.
 issue is one of assessment of the existence and probability of future economic benefits
 From the feasibility study, i.e. the definition and recognition of an asset.

Definition Future economic benefits (= means by which entities achieve

objectives) — yes, if plant goes ahead, company will generate future
cash flows.
Control — yes, no one else can benefit from results of study (unless the
company decides to sell its results) and the company can deny/regulate
access.
Past event — yes, study has been at least partly completed, i.e. past
event could be commencement of study.

Recognition Reliable (faithfully representative) measurement — yes — costs known.

Only has to be ‘a cost or other value’.
Probability of future economic benefits eventuating — This is a
problem. — What is the likelihood?
if > 50% — can be recognised as asset.
if < 50% — cannot be recognised as asset; hence the costs must be
recorded as an expense.

The question states that the company is ‘unable to determine clearly the
feasibility of project’ — need to evaluate this uncertainty in terms of
probability. If probability < 50%, company has incorrectly treated the
costs and now should write them off to expenses.

If next year probability > 50%, the Conceptual Framework would require
reinstatement as asset.
ii.
Penalty:

 Shortfall in waste delivered (predetermined quantities required).

 Cash penalty = $300 000.
 Possibility of waiver of penalty and reducing future delivery receipts under the
contract.
 No liability recognised by LAWWD.
 History — delivery receipts renegotiated despite penalty provisions.
 Should evaluate penalty in terms of liability definition and recognition criteria.

Definition Present obligation — yes, legal (under contract).

Default on the terms has occurred, therefore a penalty incurred.
Future settlement/sacrifice of future economic benefits
Involves notion of discretion to avoid settlement — adverse
financial concepts.
Penalty is legally enforceable, so condition satisfied.
Past event — default on terms of delivery receipts — yes.

Recognition Reliable (faithfully representative) measurement — yes.

Probability — problem.
History shows penalty provisions not enforced in past; instead
delivery receipts renegotiated — this is accepted practice.
Meeting to be held soon re possibility of waiver of this penalty.
Unlikely that future sacrifice will be required, i.e. probably the
recognition criteria are not met.
So, should not recognise as liability — company’s treatment thus
correct.

You should also address other ‘side’ of potential entry, i.e. expense.

Again, no expense recognised as no liability recognised.

Probability < 50% that consumption of economic benefits has occurred.