ACCA AK Financial Accounting (FA) Financial Statements 2 — Questions and Answers
Question 1: Under IAS 37 Provisions, Contingent Liabilities and Contingent Assets, a provision should be recognised when:
- A possible obligation exists but the probability of outflow is remote
- A present obligation exists, an outflow of resources is probable, and a reliable estimate can be made (Correct answer)
- Any future cost is anticipated regardless of probability
- The entity wishes to smooth its reported profits
Correct answer: A present obligation exists, an outflow of resources is probable, and a reliable estimate can be made
IAS 37 requires three conditions for provision recognition: (1) a present obligation from a past event, (2) it is probable that an outflow of economic benefits will be required, and (3) a reliable estimate of the obligation can be made. All three must be met.
Question 2: In a statement of cash flows prepared under IAS 7, where is 'interest paid' classified under the indirect method?
- It must always be classified as an operating activity
- It must always be classified as a financing activity
- It may be classified as either an operating or a financing activity (Correct answer)
- It is excluded from the statement of cash flows
Correct answer: It may be classified as either an operating or a financing activity
IAS 7 allows flexibility in classifying interest paid. It may be classified as an operating activity (as it enters into the determination of profit) or as a financing activity (as it is a cost of obtaining financial resources). The entity must apply its chosen classification consistently.
Question 3: A company has trade receivables of £60,000 and estimates that 5% will be irrecoverable. The existing allowance for receivables is £2,000. What adjustment is needed?
- Increase the allowance by £3,000
- Increase the allowance by £1,000 (Correct answer)
- Decrease the allowance by £1,000
- No adjustment is required
Correct answer: Increase the allowance by £1,000
Required allowance = £60,000 × 5% = £3,000. Existing allowance = £2,000. Increase needed = £3,000 − £2,000 = £1,000. The irrecoverable debts expense in the income statement increases by £1,000.
Question 4: Under IAS 10 Events After the Reporting Period, which of the following is an adjusting event?
- A major fire destroys a warehouse after the reporting date
- The settlement after the reporting date of a court case that confirms an obligation existed at the reporting date (Correct answer)
- A decline in market value of investments after the reporting date
- The announcement of a major acquisition after the reporting date
Correct answer: The settlement after the reporting date of a court case that confirms an obligation existed at the reporting date
An adjusting event provides evidence of conditions that existed at the reporting date. Settlement of a court case confirms a liability that existed at year end, so the financial statements should be adjusted. The other events are non-adjusting — they relate to conditions arising after the reporting date.
Question 5: The closing inventory of a business is overstated by £4,000. What effect does this have on the financial statements?
- Profit is understated by £4,000 and assets are understated by £4,000
- Profit is overstated by £4,000 and assets are overstated by £4,000 (Correct answer)
- Profit is overstated by £4,000 and liabilities are overstated by £4,000
- Profit is understated by £4,000 and assets are overstated by £4,000
Correct answer: Profit is overstated by £4,000 and assets are overstated by £4,000
Closing inventory appears in two places: as a current asset on the statement of financial position and as a deduction from cost of sales. If overstated, cost of sales is too low (increasing profit) and the asset is too high. Both profit and net assets are overstated by £4,000.
Question 6: Which of the following items would appear in Other Comprehensive Income (OCI) rather than profit or loss?
- Revenue from contracts with customers
- Finance costs on a bank loan
- A revaluation surplus on property under the revaluation model of IAS 16 (Correct answer)
- Depreciation of office equipment
Correct answer: A revaluation surplus on property under the revaluation model of IAS 16
Under IAS 16, when an asset is revalued upwards for the first time, the revaluation surplus is recognised in other comprehensive income and accumulated in equity under a revaluation surplus reserve. It does not pass through profit or loss.
ACCA AK Financial Accounting (FA) Financial Statements 2
Under IAS 37 Provisions, Contingent Liabilities and Contingent Assets, a provision should be recognised when: