Financial reporting

Case study 1 – 10.03.2021

You will be working as an accounting manager in the accounting department at World Clothing Corporation.

The parent company –

World Clothing Corporation is an European company working on integrating technology into clothes for sports and medical applications. It is the pioneer and worldwide leader for wearable technologies well known for its high-quality “Smart Clothes”, from biometric shirts to contactless payments jackets. They procure and produce fabric mainly in Asia. Since 2009, they’ve grown so much that they expanded their operations into several countries, including USA.

Subsidiary in Vietnam

Whitefabric Inc. is one of the largest fabric production bases of the World Clothing group. They have five domestic subsidiaries and prepare the related consolidated financial statements in accordance with its local GAAP. They are planning to adopt IFRS Standards for the first time with a date of transition of 1 September 2020.

Meet the people

In your role you will have various meetings with the following characters to help solve issues they encounter in preparing financial statements under IFRSs.

Hung Nguyen – Senior Accountant of Whitefabric

Hung is a 28-years-old from Vietnam and has obtained his accounting degree from one of the most esteemed local universities. He landed his first job at Whitefabric. He had been working in the accounting department in the main factory for two years and then moved to the accounting department in the head office. Whitefabric has five domestic subsidiaries and he is responsible for providing support and advice to oversee accounting staff across the group.

He knows all the accounting and financial reporting requirements of Vietnamese companies, but he is not proficient in IFRS standards.

He is a world traveler.

Emma Bernard – Accounting Manager of Whitefabric

Emma is a 34 -years-old from France, who has lived in Vietnam for 12 years. She fell in love with the country and decided to move her family there at the end of a two-year overseas assignment. She had worked at a Big Four accounting firm before she joined Whitefabric. She has worked in the accounting department for five years and is responsible for the preparation of the reporting package for World Clothing Group.

She is very involved in the transition to IFRS Standards and takes her job seriously.

She’s happily married with two children and is an active volunteer for animals and wildlife.

An unexpected overseas travel

It is Monday morning, you are busy preparing for a meeting with the CEO, and your mobile rings. It’s your boss, the head of the finance department.

“Hi. One of our subsidiaries, Whitefabric, in Vietnam, previously prepared their financial statements in accordance with its local GAAP. However they need our help to prepare the financial statements in accordance with IFRS Standards because Whitefabric is adopting IFRS Standards for the first time with a date of transition of ” September 2020. Can you plan a visit to support them in preparing the financial statements under IFRS, please?”

Consider if an entity is a going concern

One month later you arrived at Whitefabric and have just finished the kickoff meeting with key members of the accounting team. During the kickoff meeting, Hung, the senior accountant of Whitefabric, approaches you and say that he’d like to seek your advice on some issues after the meeting.

Hi. Thank you so much for coming to help us. We are pressed for time at the moment. I have completed a number of IFRS training units and reviewed the financial statements of our subsidiaries again before you came. I found that there are some important issues to consider as we prepare to adopt IFRS Standards.

For example, earlier in February 2020, following a significant market event, the board of Whitefabric announced its intention to reduce its exposure to the pre-cut plain fabric business by placing Color Design Inc., one of our subsidiaries which manufactures pre-cut plain fabric for sale to industry, into voluntary liquidation. The expected completion date of the voluntary liquidation is toward the end of September 2020.

Would you consider Color Design Inc. a going concern at the end of the reporting period ending 31 August 2020?

Hung: Here are some of the actions that were considered. If Color Design Inc is not considered a going concern, than what would be required to do in terms of the Conceptual Framework?

a) Obtain a subordination agreement from its holding company, Whitefabric

b) Apply a liquidator for exemption from the requirements of the Conceptual Framework;

c) Financial statements may still be prepared on a going concern basis but with appropriate disclosures;

d) The financial statements may have to be prepared on a basis other than going concern and, if so, the basis used needs to be disclosed.

A complex finance transaction

Hung: - Thanks for that! It’s good to confirm that the financial statements may have to be prepared on a basis, other than going concern, and the basis used needs to be disclosed

· Next I would like to discuss the financial statements of another subsidiary, Yellow-knit Inc. I’ve received an email from the accounting staff which describes a complex finance transaction involving derivatives and bonds during the year.

· The accounting staff at Yellow-knit is of the opinion that, because the majority of financial statement users won’t understand the transaction, they should leave it off the financial statements. Does this sound correct? It seems that excluding this information might make the information easier to understand.

Should they leave the complex finance transaction off the financial statements because this information cannot be made easy to understand?

a) Yes, they should leave it off because the information is not relevant if it cannot be understood by most users;

b) Yes, they should leave it off because such complex information might mislead the users;

c) No, they should not leave it off because financial statements users are assumed to have a reasonable knowledge of business, economic activities and accounting;

d) No, they should not leave it off as this information may require an adviser to be understood.

Next day, Hung sends you an email:

I have another question. Please can you help?

I am not certain about the amount by which the carrying value of inventory in Yellowknit should be reduced due to obsolescence. In the past., the reduction due to obsolescence has been approximately € 1000 per annum.

The accounting staff is of the opinion that this year the reduction should range between € 150 and € 1500. However, in order to avoid taking more losses in the profit or loss (the company is already generating severe losses), they propose to set the reduction at € 150, the lowest possible…

Can we do that? I’m not comfortable with their proposal, but it’s still within the ranhe of possible outcomes they have provided.

Best regards,

Hung

Response

Hung is violating the faithful representation qualitative characteristics of:

a. Completeness

b. Free from error

c. Neutrality

d. Verifiability

e. Understandability.

Morning cup of ca phe soon

On Tuesday morning, Hung brought you a cup of the strong and flavorful Vietnamese coffee – the morning cup of ca phe soon. You are amazed at the taste of the coffee and agree with Hung that Vietnamese coffee certainly has developed a style of its own. When you are enjoying your well-earned morning coffee break with Hung, your phone rings. It is Emma, the accounting manager of Whitefabric.

· Good morning! As you may have heard, we have succeeded in the manufacturing of a new fabric which can be used to interact with a variety of services including music and map apps, etc. We’re also making good progress in ways to integrate sensors into the garment along with the data recording clip-on box, which can be used to measure heart rate variability as well as stress levels.

The whole company is very excited about these top tech application products that are coming in the foreseeable future. I am thrilled about the breakthrough, but it’s also giving me a headache. Do you know anything about similar and related issues? I can’t seem to find any Standard that specifically applies to an event or transaction like this…..

(You decided to end your coffee break with Hung to go on the call with Emma)

Emma: My understanding is: in the absence of a Standard or an Interpretation that specifically applies to a transaction or event that deals with similar and related issues, we should use our judgement in developing and applying an accounting policy that results in information that is relevant and faithfully representing. In making that judgement, we need to consider the definitions, recognition criteria and measurement concepts in the Conceptual Framework.

The recent manufacturing materials and design innovations no doubt has a potential to bring us huge economic benefits. However, as the application products are still not finalized or not commercialized yet, I’m not sure whether the ultimate inflow of economic benefits will be produced.

Emma wants to know whether their recent innovations meet the Conceptual Framework’s definition of an asset. What would you tell her?

a) No, because it is not certain whether the potential to produce economic benefits exist;

b) No, because it is not certain whether the ultimate inflow of economic benefits will be produce;

c) Yes, because of the potential that economic benefits will arise;

d) Yes, unless the probability of their producing economic benefits is low.

Later that day, Emma comes to thank you in person and raises another question.

· We face a claim for an alleged infringement of intellectual property rights. On 31 December 2019, in settlement of the claim, we agreed to pay the claimant a fixed sum plus a variable amount calculated as 1 percent of any revenue generated over the next five years from sales of our Product X. different views have emerged about whether we should recognize a liability. A present obligation to make payments, arising from past events, does exist, and we have no practical ability to avoid those payments, so the definition of a liability is certainly met. The question is: whether the liability meets recognition criteria?

A liability should be recognized:

a) If it results in relevant information;

b) Unless its monetary amount cannot be observed directly and must be estimated;

c) Unless the outflow of economic benefits is associated with uncertainty;

d) If the recognition results in useful information

On Wednesday afternoon, you have been out to the canteen to get some late lunch. You reflect on a morning meeting that has lasted way longer than expected. However, you are happy with the fruitful discussion. The key members of Whitefabric seem very keen to learn the practical implementation of IFRS Standards. The objective of the meeting was to work on changes that are needed under IFRS Standards for the software system to function, to create new categories in the software system as needed, and set up the software system services to smaller divisions. When you return to the meeting room with another Vietnamese coffee, Emma walks into the room. It seems that she is desperately looking for you.

Emma:

- Hey, there you are! I was looking for you. I am so sorry for the last minute request. I know you’re busy, but you are the only qualified person I can think of.

As you know, we are having a training workshop for all the accounting staff, including those of subsidiaries, tomorrow. We have a session on concepts and guidance in the Conceptual Framework. We want them to learn those concepts and understand the guidance so that they will be able to decide how to account for transactions or other events when no Standard applies or a Standard allows a choice of accounting policies. Hung is responsible for preparing the training materials. I have specifically asked him to ensure that the materials are updated to reflect the recent amendments to the Conceptual Framework.

Anyway, I am supposed to meet Hung later this afternoon to go through the workshop materials he has prepared. But I have to leave the office now because of a family emergency. Could you please help to do the final check for me? I’ve emailed you the materials.

While you have some time before your next meeting, you decided to take a quick look at the materials that Emma forwarded you. All of the materials look good except for the content regarding measurement. You then start to complete the following to describe what information various measurement bases provide.

Current cost	Provides information about the cost of an asset consumed or about income from the fulfillment of liabilities
Current value	Provides information updated to reflect conditions at the measurement date
Fair value	Provides information about the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date
Historical cost	Provides information derived from the price of the past transaction or other event that gave rise to the item being measured
Value in use/fulfillment value	Provide information about the present value of future cash flows from the continuing use of the asset and from its disposal

A successful workshop

A week has almost passed. Tomorrow is the last day of your visit. When you are preparing for the wrap-up meeting, Hung has come to you again for more help as Emma is still off work.

Hung: - Hi. Thank you so much for your review. The workshop held this morning was a great success! I received a query during the workshop for which I do not have an immediate answer. I would like to seek your thoughts before I get back to them.

“The Conceptual Framework describes two measurement bases: historical cost and current value. It seems that both bases can provide predictive and confirmatory value to users…”

Hung wants to know what determines an appropriate measurement.

a) A high level of uncertainty will make a particular measurement basis irrelevant.

b) The characteristics of the asset or liability is the determinative factor that can affect whether a particular measurement basis provides relevant information.

c) How the asset or liability contributes to future cash flows is the determinative factor that can affect whether a particular measurement basis provides relevant information.

d) No single factor is determinative when selecting an appropriate measurement basis

Final assessment

1. When there is a conflict between the Conceptual Framework and a specific IFRS Standard, which of the following statements is true:

a) The requirements of the specific IFRS Standard prevail over the Conceptual Framework;

b) The requirements of the Conceptual Framework prevail over the specific IFRS Standard;

c) Entities may make an accounting policy choice when doing so results in providing more relevant information or a more faithful representation;

d) Both the Conceptual Framework and IFRS Standards have equal standing, and management who prepare the financial statements have the discretion to decide which prevails.

2. When judging the relative importance of the qualitative characteristics in the context of information to be presented, which of the following should be applied?

a) Understandability is of primary importance.

b) Relevance is of primary importance.

c) Faithful representation is of primary importance.

d) The relative importance of each characteristic is a matter of professional judgement.

3. Gilte Corporation has been trading at severe losses for the past three years. During the year, it has implemented a number of measures to improve the performance and financial position of the company. These measures include the following: Gilte has laid off 30percet of its staff during the year as part of its cost reduction program; Gilze has sold various fixed assets to improve working capital; Gilte is negotiating with its principal bankers to extend the payment terms of loans that fall due within the next year; and Gilte has discontinued those loss-making operations so that it can focus its business development on more profitable operations. Which of the following statements is correct when Gilte prepares its annual financial statements?

a) Gilte cannot prepare its financial statements on a going on concern basis, as Gilte has been trading at severe loses for the past three years.

b) Gilte cannot prepare its financial statements on a going on concern basis, unless it is expected that Gilte become profitable in the next fiscal year.

c) Gilte can prepare its financial statements on a going on concern basis, as it has implemented measures to improve the performance and financial position of the company.

d) Gilte can prepare its financial statements on a going on concern basis, unless it has the intention or the need to liquidate or cease trading in the foreseeable future.

4. Which of the following statements regarding the cost constraint is correct? Select two best responses.

a) Cost is a pervasive constraint on the information that can be provided by financial reporting.

b) Assessments of costs and benefits justifies the same reporting requirements for all entities.

c) The benefit of providing information needs to justify only the cost of providing that information.

d) The benefit of providing information needs to justify the cost of providing and using information.

5. Kidstoy Co. and one of their customers are in court disputing whether Kidstoy Co. has a right to receive a payment for a transaction that occurred on 1 September 2019. The customer claims that the transaction has been invalidated. Until a court rulling, it is uncertain whether Kidstoy Co. has a right to receive a payment. The recognition of an account receivable by Kidstoy Co. is appropriate:

a) Unless the probability of un inflow of economic benefits is low;

b) Unless it is associated with high level of measurement uncertainty;

c) Only if they win the case and the existence of the right becomes virtually certain;

d) If it results in both relevant information and a faithful representation of the asset.

6. Taylor Co. owns a building with a carrying amount of 1.000 Euro and a fair value of 1.000 Euro. On 1 January, it sells the building to Smith Inc for 1.000 Euro. Concurrently, Taylor Co. enters into a contract with Smith Inc to buy back the building for 1.045 Euro after 12 months. The difference of 45 Euro approximates market interest rates for a loan secured by a similar building during the same period. Taylor Co. determines that it still has the control of the building even though the title has been transferred to Smith Inc. Should the building be derecognized in the statement of financial position by Taylor Co.?

a) Yes. The title has been transferred to Smith Inc.

b) Yes. Taylor however should depict the transaction with appropriate disclosure.

c) No. The building will be bought back in 12 months.

d) No. the building still meets the definition of an asset.

7. The Conceptual Framework set out concepts and guidance on presentation and disclosure of financial information. Which of the following statements is true? (Select two best responses)

a) Information about assets, liabilities, equity. Income and expenses is communicated through presentation and disclosure in the financial statements.

b) Effective communication enhances the comparability and verifiability of information in financial statements.

c) Effective communication of information in financial statements makes that information more timely and contributes to its understandability.

d) Effective communication of information in financial statements makes that information more relevant and contributes to a faithful representation.

8. The Conceptual Framework describes what information measurement bases provide. Which of the following applications of the measurement bases is correct?

a) One way to apply historical to financial assets and financial liabilities is to measure them at the amortized cost.

b) Current cost is the consideration that would be received to sell an equivalent asset at measurement date plus transaction costs.

c) Fair value is the price that would be paid to acquire an asset, or received to incur a liability, in an orderly transaction between market participants at the measurement date.

d) Value in use/fulfillment value is reduced if the assets become impaired and the cost of liabilities is increased if they become onerous.

9. Which of the following fall within the scope of the Conceptual Framework?

a) Prospectus for a share issuance

b) General purpose financial statements

c) Management accounts

d) Tax filings

10. The objective of financial reporting is to provide information about the financial position, financial performance and changes in the financial position of a reporting entity. Complete the following sentences:

To obtain information about an entity’s financial position I would look at the……………………………..

To obtain information about an entity’s financial performance I would look at the……………………………..

11. A complex hedging transaction occurred during the year for Learning Solutions group. Management of the Learning Solutions group is of the opinion that as the majority of financial statements users won’t understand the transaction, it should be excluded in the financial statements. Is this correct?

a) Yes. Complex information misleads users.

b) Yes. Complex information is not useful if it cannot be understood by most users.

c) No. The financial statements would be incomplete and potentially misleading.

d) No. unless there is a management consensus of excluding such complex information across the group.

12. Which of the following measurement bases is not defined in the Conceptual Framework?

a) Historical cost

b) Current cost

c) Fair value

d) Realizable (settlement) cost

e) Value in use

13. Which of the following is correct about the financial performance elements?

a) Information about income and expenses are less important than information about assets or liabilities.

b) Income is changes in assets or liabilities, which result in increase in equity, including those relating to contributions from holders of equity claims.

c) Income is changes in assets or liabilities, which result in decrease in equity, other than those relating to contributions from holders of equity claims.

d) Expenses are decreases in assets or increases in liabilities, which result in decreases in equity, other than those relating to distributions from holders of equity claims.

14. New legislation requiring operating factories to install specific exhaust gas pipes will be enacted and is effective from 1 January 2021. If any factories operate without the specific gas pipe, it may incur severe penalties. At the end of December 2020, Motor Co. has not installed the specific pipes required to be in compliance with the legislation. Motor Co. has a financial year ending 31 December. Should Motor Co. recognize a liability for the penalty regarding this legislation for its financial statements ending 31 December 2020?

a) Yes. The enactment of the new legislation will result in sever penalties if the factory operates without the specific gas pipe.

b) Yes. Motor Co. has no practical ability to avoid the penalty.

c) No. Motor Co. does not have an obligation to pay the penalty until the legislation is enacted on 1 January 2021.

d) No. Motor Co. does not have a present obligation to pay the penalty until the legislation is enacted and the factory operates without the specific pipes.

15. The Conceptual Framework sets out guidance on including income and expenses in the statement of profit or loss. Which of following statements regarding the guidance on the statement of profit or loss is correct?

a) All income and expenses are classified and included in the statement of profit and loss without exception.

b) The statement of profit and loss is the sole source of information about an entity’s financial performance for the reporting period.

c) The statement of profit and loss includes a total (subtotal) for income and expenses included in other comprehensive income.

d) The statement of profit and loss could be a separate section within a single statement of financial performance or a separate statement.

16. Which of the following are the fundamental qualitative characteristics of financial statements? Select two best responses.

a) Comparability

b) Faithful representation

c) Relevance

d) Timeliness

e) Understandability

f) Verifiability.