FINANCIAL ACCOUNTING 101

DEPARTMENT OF
Class Test 2 ** Date: 7 February 2014
Marks: 30 ** Time: 45 minutes ACCOUNTING
Proposed solution
UP
L van Eck/ L Venter

PROPOSED SOLUTION TO PART 1 (a):

Definition of an expense:

 Decreases in economic benefits during the accounting period ^

 in the form of a outflows or depletions of assets or increases of liabilities ^
 that result in decreases in equity ^
 other than those relating to distributions to equity participants ^ (2)

Recognition criteria:

 It must be probable that the economic benefits associated with the item will flow from^
the entity
 The item has a cost price or value that can be measured reliably^ (1)

Application of definition criteria:

 A decrease in economic benefits during the accounting period:

The settlement of the fine of R55 000 000 resulted in an outflow/decrease^ of economic
benefits during the financial year ended 31 December 2013. (½)

 In the form of a decrease in assets or an increase in liabilities:

The fine was settled in cash on 31 March 2013. This resulted in a decrease in assets^
(bank account balance reduced). (½)

 Resulting in a decrease in equity:

The fine will result in a decrease in equity as it is an expense^ (½)

 Other than those relating to distributions to equity participants:

The decrease in equity is not related to distributions to equity participants^ (½)

Application of recognition criteria:

 It must be probable that the economic benefits associated with the item will flow
from the entity: It is probable that economic benefits will flow from the entity. The
R55 000 000 was paid during the current financial year. This will result in an outflow of
economic benefits ^ (½)

 The item has a cost price or value that can be measured reliably:
The value/cost of the fine can be measured reliably as R55 000 000 ^ (½)
Conclusion:

 The R55 000 000 related to fine can be recognised as an expense ^ in the financial
statements of Davines.
 It meets all the requirements of the definition^ and recognition^ criteria of an expense. (1½)
TOTAL PART (a): 7½ MARKS

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PROPOSED SOLUTION TO PART 1 (b):

Definition of an asset:

 A resource ^
 controlled by the entity^
 as a result of past events^
 from which future economic benefits are expected to flow to the entity ^ (2)

Recognition criteria

 It is probable that any future economic benefit associated with the item will flow to the
entity ^
 The item has a cost or value that can be measured reliably^ (1)

Application of definition criteria:

 Resource:
The new environmentally friendly machinery is a resource of the entity as it can be used
to produce goods that can be sold to generate economic benefits ^ (½)

 Controlled by the entity:

The ownership was transferred to the entity when they purchased the new machinery on
30 June 2013 ^ (½)

 As a result of past events:

The past event is the purchase transaction that took place on 30 June 2013 ^ (½)

 From which future economics are expected to flow to the entity:

The new machinery will be used to generate an income as the products produced will be
sold to generate revenue^

Due to the technologically advanced nature of the new machinery it would also enable
Davines to increase their output by at least 20% per year. This would, in turn, allow them
to accept more orders to generate more revenue ^ (1)

Application of the recognition criteria:

 It must be probable that the economic benefits associated with the item will flow
to the entity:
The new machinery will increase their output by at least 20% per year. This would, in
turn, allow them to accept more orders to generate more revenue ^ (½)

 The item has a cost price or value that can be measured reliably:
Cost price of the new machinery is R110 250 000 (€1 050 000^ x R10.50^ x 10^)

The cost can be measured reliably ^ (2)

Conclusion:

 The new machinery must be recognised as an asset^ in the financial statements of

Davines.
 It meets all the requirements of the definition^ and recognition^ criteria of an expense. (1½)

TOTAL PART (b): 9½ MARKS

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PROPOSED SOLUTION TO PART 1 (c):

Definition of liability:

 A present obligation of the entity^

 Arising from past events ^
 the settlement of which is expected to result in an outflow from the entity of resources
embodying economic benefits ^ (1½)

Recognition criteria:

 It is probable that any future economic benefit associated with the item will flow from^
the entity
 The item has a cost or value that can be measured reliably^ (1)

Application of definition criteria:

 A present obligation:
Davines has a present obligation to repay the loan. This agreement is legally
enforceable. The binding nature of the agreement commits the entity to an outflow
(repayment of the loan in equal annual instalments) of resources to another party (ABBA
Bank) ^ (½)

 Arising from past events: The past event took place on the date that the loan was
granted (30 June 2013) ^. The receipt of a bank loan resulted in an obligation to repay
the loan and a liability is thus created. (½)

 Where settlement is expected to result on an outflow of resources: The entity has

an obligation to repay the loan in ten equal annual instalments of R6 063 750 each
(R110 250 000^ x 55% ^= R60 637 500/10 instalments^). The repayment will result in
an outflow of economic benefits^ (2)

Application of recognition criteria:

 It must be probable that the economic benefits associated with the item will flow
from the entity: The entity has a contractual obligation to repay the loan in ten equal
annual instalments of R6 063 750 each. The repayment will result in an outflow of
economic benefits^ (½)

 The item has a cost price or value that can be measured with reliably: The loan has
a value of R60 637 500 (R110 250 000 x 55%) and the equal annual instalments have a
value of R6 063 750 ^. The value of these items can be measured reliably ^ (1)

Conclusion:

 The loan must be recognised as a liability^ in the financial statements of Daviness.

 It meets all the requirements of the definition^ and recognition^ criteria of a liability. (1½)

TOTAL PART (b): 8½ MARKS

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PROPOSED SOLUTION TO PART 2

a) Definition of income:

 Increases in economic benefits during the accounting period^

 in the form of inflows or enhancements of assets or decreases of liabilities^
 that result in an increases in equity^
 other than those relating to contributions from equity participants^ (2)

b) Sales price per bottle: R50^

Cost per bottle: R10 + R5 = R15^^
Profit per bottle = R50 – R15 = R35^
Total profit = R35 per bottle x 150 000 000 bottles^ = R525 000 000 (2½)

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