Company Accounting: Australia-New Zealand, 5th Edition Solution Manual
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Company Accounting 5e Solutions Manual Peter Jubb Stephen Haswell Ian Langfield - Smtih Version 5.0 Chapter 1 General introduction 1.1 Give some examples of the ways in which companies affect the following groups, favourably or adversely: shareholders, consumers, governments, employees, creditors, the ‘general public’. The answer to this question is found from the prior experience of students, not in the text. The question is designed to concentrate attention on the benefits and detriments to different groups within society of the corporate form. The following table lists some of the aspects that could be mentioned. Favourably Adversely shareholders increased wealth • dividends • share price risk of loss due to: • commercial factors • dishonest management consumers • an efficient and effective mechanism for meeting demands of consumers • effective way of ‘mobilising capital’ loss of control and bargaining power governments assist in: • economic development • expanding taxation base moral hazards: • major company crashes • need for regulatory intervention employees • opportunities for employment • greater remuneration • scope for advancement • loss of bargaining power • risks of limited liability of employer (employee benefits) • loss of self - esteem (small cog in large enterprise) creditors • increase potential market • risks of limited liability ‘general public’ • economic growth • increased standard of living • impact on share values • increased gap between haves and have nots 1 .2 To what extent should companies be compelled to provide information to the above - mentioned groups? This question builds on question 1.1. As noted on page 4 these questions derive from social and economic policy considerations. Ultimately it comes down to personal preferences. However, as we will see in chapter 3, arguments can be developed in support of such disclosures, for example, ones based on protection of company members or the general public.
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2 Company Accounting 5e Solutions Manual Version 5.0 1.3 With which functions of the company should a company accountant be familiar? This question is not directly answered in chapter 1; however, the following aspects can be distilled from the discussion: • the life - cycle of the company formation issue of securities (equity and debt) how operations are reflected in financial reports (elements of financial reporting) preparation of reports for external users external administration • the financial reporting of consequences of events and transactions of the company and other regulatory requirements (legislation, accounting standards and stock exchange requirements). 1.4 What are the sources of authority for company regulation, record - keeping and reporting? See page 4, where the following are listed: • legislation (primarily the Corporations Act ); • accounting standards; and • stock exchange requirements. Other sources (not mentioned in chapter 1) include the Australian Securities and Investments Commission (ASIC) and the Urgent Issues Group.
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Company Accounting 5e Solutions Manual Peter Jubb Stephen Haswell Ian Langfield - Smtih Version 5.0 Chapter 2 Companies and corporate regulation 2.1 Discuss the characteristics of a company and the aspects that make the company an attractive structure for business enterprises. These characteristics are discussed on pages 8 and 9 of the textbook: • legal personality • limited liability • perpetual succession • share based ownership interests • ability to mobilise individual capital • scope for professional management These factors allow for an efficient and effective way for ‘jointly’ engaging in commercial activity. Legal personality and perpetual succession makes the company independent of individual owners, thereby facilitating transfer of ownership interest and not subjecting the business to other risks undertaken by individual owners (as is the case in partnerships). While for smaller enterprises limited liability may be defeated by lenders (and others) insisting on guarantees from owners, for larger companies the risk limitation makes the investment more attractive to potential investors, while the use of share capital as the basis of ownership and interest in profits creates potential for investments with higher marketability than is otherwise available. It allows undertakings that cannot be financed by individuals or small groups of individuals (via a partnership) to be established through mobilising relatively small investments by a large number of investors. Professional management provides the opportunity for more efficient and effective operation, thereby increasing returns to investors. (Of course, the risks arising from the separation of ownership and management must be remembered.) 2.2 Outline the factors that give rise to the different types of company allowable under the Corporations Act. By which permutations may the factors be combined? Three general factors dictate the classes of companies that are available under the Corporations Act: • Factor 1: maximum size of the ownership pool and scope for fund raising proprietary companies maximum membership 50 (excluding employees and former employees) cannot raise funds from the general public (in chapter 4 we see that they can only make unregulated offers of securities)
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2 Company Accounting 5e Solutions Manual Version 5.0 public companies no limit on number of members able to offer securities to general public (as we see in chapter 4 this requires a regulated offer of securities through a prospectus complying with the Corporations Act ) • Factors 2 and 3: limited liability and how it is implemented companies without share capital limited by guarantee (pubic companies only) companies with share capital limited by shares no liability companies (public companies only) unlimited companies These factors affect the forms in which a company can be registered. The distinction between small proprietary and large (or not small) proprietary companies does not depend on formal characteristics; rather it depends on the indicators of economic significance. The implications of this distinction are limited to financial reporting requirements. The possible combinations are depicted in figure 2.1 (page 12). 2.3 What is meant by the following terms: limited liability , no liability and unlimited liability ? • Limited liability owner or member’s (investor’s) liability for the debts of the company is limited to the amount not yet paid on shares owned or the amount agreed by way of guarantee if there is share capital the owner must pay amounts not yet paid when called on to do so (if they do not the shares can be forfeited) on liquidation owner can be called on to pay amounts not yet paid (but no more) if there is no share capital usually an obligation to make an annual payment (can be varied from time to time) on liquidation, maximum amount member can be called on to pay is the amount of the guarantee • No liability a member or owner has no liability for amounts unpaid on shares owned, both arrears and uncalled amounts (only available if company engages in mining activities) – if a member fails to pay an amount when called on to do so, the company must forfeit the shares and sell them by public auction there is no liability in event of liquidation • Unlimited liability the owner must pay amounts not yet paid when called on to do so (if they do not the shares can be forfeited) on liquidation, the amount that members can be called on to contribute to meet the company’s debts is unlimited
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Chapter 2: Companies and corporate regulation 3 Version 5.0 2.4 How may a share company be distinguished from a guarantee company? • A share company can: have limited liability; or have unlimited liability; or be a no liability company. A guarantee company must have limited liability. • A share company has share capital that is (notionally) divided into individual shares, and the interest of an owner of shares in the capital and profits of the company depends on the number of shares held, and the rights attaching to those shares. For a guarantee company, the members have no interest in the underlying assets of the company and cannot receive dividends or other distributions from the company. • A share company can be either a public company or a proprietary company. A guarantee company must be a public company. (For some long - formed guarantee companies members can have an interest in the underlying assets, however, such companies are rare. Before the First Corporate Law Simplification Act 1995 it was possible to create public or proprietary companies with both share capital and liability limited by guarantee. Again, such companies are rare.)
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4 Company Accounting 5e Solutions Manual Version 5.0 2.5 Draw two separate tree diagrams, similar to the diagram in figure 2.1, showing the permutations of corporate structure possibilities. Start the left - hand side of the first diagram with ‘Mode of participation’ and the second diagram with ‘Extent of liability’. Shares Guarantee Mode of Participation Public Public Proprietary Type of company Limited liability Limited liability Unlimited liability Limited liability Unlimited liability Small Large No liability
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Chapter 2: Companies and corporate regulation 5 Version 5.0 2.6 What is the applicability of the terms member and shareholder ? See page 10, paragraph under heading ‘Mode of participation’ where the distinction is explained as follows: ‘A generic name for owners is members . Shareholders are described alternatively as members , but for companies with no shares, only the title ‘ members’, is appropriate.’ Limited liability No liability Unlimited laibility Extent of liability Public Proprietary Small Large Public Public Proprietary Type of company Small Large Shares Shares Guarantee Shares Shares Shares
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6 Company Accounting 5e Solutions Manual Version 5.0 2.7 Briefly outline the test applied in classifying an entity as a disclosing entity and describe the consequences of being classified as a disclosing entity. The test for determining if an entity is a disclosing entity is quite complex, however, in summary an entity is a disclosing entity if: • its securities are listed on a stock exchange (such as the one operated by the ASX); • it has issued debentures for which the Corporations Act requires the appointment of a trustee for debenture holders; and • for securities (other than debentures), the entity has issued securities – either under a disclosure document or under a takeover – for which there are at least 100 persons or entities holding those securities. Securities that satisfy any of the above are called enhanced disclosure securities in the Act. The main consequences of an entity being classified as a disclosing entity are: • having to prepare both half year and full year financial reports; • the ability to use abbreviated disclosure documents in fund - raising; and • the obligation to keep both the ASX and ASIC informed of information that may affect the price of its securities (the continuous disclosure requirement). 2.8 Give a brief summary of the historical evolution of the company until 1961. The answer to this question is found on pages 14 – 16 of the textbook. 2.9 Outline and briefly discuss the method of operation of the national company schemes that operated in Australia between 1961 and 2000. Before 1991 regulation of companies was cooperative. In 1961 and 1962 uniform legislation was adopted in the States and Territories (although there were some differences between the states). These were known as the Uniform Companies Acts 1961 – 1962. There was no formal cooperation in the administration of the law. Starting in 1965 some states amended their legislation (often more than once); by 1980 there were substantial differences in legislation – there was little uniformity left. However, signatory jurisdictions to the Inter - State Corporate Affairs Agreement had substantially similar legislation and had developed limited administrative cooperation. In 1980 the National Co - operative Scheme was implemented under an agreement between the Commonwealth, the States and Territories. The scheme was based on the Commonwealth Act, which applied to the ACT, and was adopted as ‘codes’ in the States and Northern Territory (the codes were substantially the same as the Commonwealth legislation). Collectively, the legislation was known as the Companies Act and Codes . Amendments to the Act and Codes required Commonwealth legislation and legislation in each State and the Northern Territory. Administration was split between the national regulator (The National Companies and Securities Commission – NCSC) and the Corporate Affairs Commissions and Departments of the States and Territories. While the NCSC was responsible for coordination of policy, administration was primarily the responsibility of the States and Territories. This splitting of responsibility caused many problems.
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Chapter 2: Companies and corporate regulation 7 Version 5.0 The Commonwealth’s Corporations Act 1989 was intended to address these problems. This legislation was originally intended to displace the States’ involvement in company administration and to establish the Commonwealth as the only authority. However, the original legislation was substantially rejected by the High Court as being unconstitutional. The Commonwealth redrafted the legislation so that, rather than overriding the power of the States to legislate on company law, the Corporations Act would be used as a model that the States could adopt voluntarily. An amended version passed through the Federal Parliament in 1990, and all of the States and Territories subsequently adopted the scheme, which became operational on 1 January 1991. The first part of the amended Act contained a lot of enabling legislation that provided the framework for the Commonwealth – States arrangements. The actual companies’ legislation itself (the contents of the original Act) was relegated to a large schedule, which became known as the ‘Corporations Law’ to distinguish it from the rest of the Act. At first glance, the resulting scheme seems to be the same in concept as the 1981 National Cooperative Scheme. However, although the States still technically retained a ‘reserve’ power over their own companies’ legislation, the scheme was much closer to being a truly national arrangement, especially because its administration was run by a single Commonwealth created and controlled body, the Australian Securities Commission. Despite all this remedial legislation there was still doubt that the changes would survive a constitutional challenge. This resulted in a new act in 2001 , which forms the basis of the present scheme . 2.10 Give an overview of the present company law scheme that operates in Australia. The current company law is found in the Corporations Act 2001 , which re - enacted the prior Corporations Law (a schedule to section 82 of the Companies Act 1989 ) . The Act applies to all states and territories – the States having referred the necessary legislative powers to the Commonwealth (thereby avoiding constitutional problems that had plagued the Corporations Law). Administration of the Corporations Act is the responsibility of the Australian Securities and Investments Commission (formed under the Australian Securities and Investments Commission Act 1989). ASIC’s powers in relation to companies arise from the Corporations Act 2001 and the Australian Securities and Investments Commission Act 2001 . 2.11 Outline the structure of the Corporations Act 2001. This structure of the Corporations Act 2001 is depicted in Table 2.1 (page 17 of the textbook). The most important chapters, for our purposes, are 2A – 2C, 2F – 2J, 2L – 2N, 2M (deals with financial reports and audit), 5, 5A and 6D. 2.12 Briefly outline the powers and functions of the AASB. Under the Corporations Act 2001 , the AASB has the power to make accounting standards which, under Chapter 2M of the Corporations Act , must be applied by entities that are required to prepare financial reports under Part 2M.3 of the Act. The AASB has the power, under the ASIC Act 2001 to make accounting standards for the purposes of the Corporations Act and for other purposes. Other legislative and administrative schemes can require entities to apply AASB accounting standards. The AASB is formed under the Australian Securities and Investments Commission Act 1989, and under section 227 of the Australian Securities and Investments Commission Act 2001 its powers include the power to:
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8 Company Accounting 5e Solutions Manual Version 5.0 • develop a conceptual framework not having force of law for the purposes of evaluating accounting standards; • make accounting standards under s 334 of the Corporations Act for the purposes of the Corporations Act and formulate accounting standards for other purposes; and • participate in, and contribute to, the development of a single set of accounting standards for worldwide use. 2.13 Describe the role of ASIC in the regulation of financial reporting in Australia. ASIC’s role in the regulation of financial reporting in Australia is primarily in enforcement of the Corporations Act’s financial reporting requirements. In doing so it can assist enforcement through Practice Notes (outlining the ASIC’s interpretation of particular requirements of the Act – including accounting standards) and policy statements (outlining how the ASIC will exercise its powers under the Act relating to accounting requirements – primarily the power to modify the application of accounting standards). [From July 2007 these w ere included in a new category ‘Regulatory guides’, together with policy statements, guides and frequently asked questions.] F rom time to time the ASIC establishes enforcement programs, which include the review of financial reports lodged with it. If a report is deficient in any way, the ASIC can require lodging of reports amended to overcome that deficiency or take other enforcement action. It can also refer matters to other administrative organisations such as the Company Auditors and Liquidators Disciplinary Board. 2.14 Describe the objectives of the international harmonisation of accounting standards. Reductions in international differences of standards or the adoption of one set of accounting standards world - wide could improve efficiency and comparability in world capital markets, and reduce costs. There are a number of ways in which this could occur. Thr ee distinct approaches, globalis ation, internationa l harmonisation and internationalisation, are summaris ed by Godfrey and Langfield - Smith (2005) as follows: (a) globalisation, which involves adopting a single set of accounting standards throughout the world; (b) international harmonisation, which involves Australia using all, or a subset, of accounting standards developed in another jurisdiction to develop its standards; under this approach compliance with Australian standards would ensure compliance with the standards of that other jurisdiction but not, necessarily, vice versa; and (c) internationalisation, which involves Australia developing local accounting standards on the basis of a detailed examination of accounting standards and practices in other jurisdictions. Globalisation is the ultimate goal of the IASB (International Accounting Standards Board) but international harmonisation is a means of helping to attain this goal, while at the same time offering some of its ultimate benefits. Harmonisation needs to occur with the agreement of governments who can adopt, in part or full, the accounting standards made by the IASB. Other interested parties include domestic standard setters and stock exchanges. The IASB ( originally called the International Accounting Standards Committee (IASC) ) , was formed in 1973 through the cooperation of the professional accounting bodies in numerous countries. Its purpose was to ‘formulate and publish … accounting standards to be observed in the preparation of financial statements and to promote their world wide acceptance and observance . ’
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Chapter 2: Companies and corporate regulation 9 Version 5.0 The standards issued by the IASC were called International Accounting Standards (IAS) and those issued by the new Board are called International Financial Reporting Standards (IFRS), which is now also the generic name for IAS. These standards have been adopted by many countries for specific purposes, for example, for reporting to stock exchanges by listed companies. Countries such as Pakistan, without a history of their own standard making, have adopted IFRS in the 1980s or 90s for general purposes. In 2005 Australia became the first country with a history of its own standard setting to adopt IFRS for general financial reporting purposes. The European Union has also adopted IFRS from this date but in a more limited way, for group reporting of listed companies. While many countries have, or have annouced an intention to a dopt IFRSs for listed entities, other Western countries are yet to adopt IFRS as compulsory for general purposes so the long term prospects for harmonisation by this means are still unclear. Reference: Godfrey, J.M. and I. A. Langfield - Smith, I.A., 2005, ‘ Regulatory Capture in the Globalization of Accounting Standards ’ , Environment and Planning , 37, 11: 1975 – 1993. 2.15 Describe the process by which AASB i nterpretations are produced and their authority in the regulation of financial reporting. The role of interpretations is to provide timely guidance on urgent financial reporting issues, and to avoid the development of ‘divergent or unsatisfactory’ financial reporting practices in areas not dealt with in the accounting standards. The time frame for production of an interpretation is very short. It does not involve the lengthy due process used in the development of accounting standards; this process is needed to consult widely with interest groups. Members of CPA Australia and ICAA must comply with them under APES 205: Conformity with Accounting Standards, a standard developed by the Accounting Professional & Ethical Standards Board Limited, which was established in 2005 as an independent body to develop ethical standards for the profession. Members of CPA Australia, The Institute of Chartered Accountants in Australia, and the National Institute of Accountants are required to apply its standards. The content of an interpretation must be consistent with existing accounting standards. 2.16 ‘The type of entity used to conduct economic activity affects the nature of the financial information presented i n an entity’s financial reports. ’ Do you agree with this statement? Give reasons to support your view. The critical question (as we see in Chapter 3 when discussing the reporting entity concept) is: what information would it be reasonable to expect that users will need? The answer may depend only partially on the form in which the entity’s operations are carried out, for example, whether the entity is a company and if so whether a proprietary company, large or small. Other important factors include the degree of separation of management and owners, the number of owners, the size of the entity and amount of resources deployed. 2.17 Provide a brief history of the role of the Australian professional accounting bodies in the development of accounting standards. Compliance with the profession’s own technical statements became mandatory for members of ICAA and ASA in 1973. P rimary responsibility for enforcement rested with the professional bodies, although neither ASA nor ICAA had a formal monitoring process. Auditors could issue qualified audit opinions for non - compliance but could do little else. A qualified audit report signals that all
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10 Company Accounting 5e Solutions Manual Version 5.0 might not be well within the company and can have a powerful communicative effect on investors. In 1984 the Accounting Standards Review Board (ASRB) was founded under the legislation of the National Cooperative Scheme . The ASRB was the first quasi - government body to have the power to approve standards that had force of law. The ASRB was the forerunner of the AASB. Initially the ASRB’s role was primarily one of reviewing accounting standards submitted to it by others, generally the accounting profession represented through The Australian Accounting Research Foundation ( AARF ) a body jointly funded by the professional associations . In 1988 an expanded ASRB took over the standard setting functions of the Accounting Standards Board of AARF. This included AARF taking over the role of ASRB technical support. Responsibility for public sector standard setting remained with the Public Sector Accounting Standards Board (PSASB) of AARF, established in 1983. Accounting standards, other than public sector specific one s , were developed jointly by the ASRB and PSASB. The ASRB was replaced by the AASB, with similar powers, to coincide with the new scheme under the 1989 Corporations Act. These arrangements prevailed until January 2000 when the FRC was created, with the revamped AASB assuming all accounting standard setting responsibilities, including those formerly the responsibility of the PSASB. This left AARF and the professional bodies with no forma l accounting standard making responsibilities, and a corresponding reduction in power and influence . It was disbanded in 2005 following the establishment, under the ASIC Act, of a statutory body, similar to the AASB, to set auditing standards. 2.18 How are professional accounting standards enforced? ICAA, CPA Australia and NIA enforce financial reporting - related requirements through their rules of professional conduct. These standards are determined by an independent standard setter established by the profession – the Accounting Professional and Ethical Standards Board , and are formalised in the rules within APES 205 Conformity with Accounting Standards. Compliance is required of individual professional practitioners rather than reporting entities; for the latter compliance is enforced by ASIC. Penalties for practitioner’s non - compliance with the standards may include censure, fines or temporary or permanent exclusion from membership. Members who are in breach of AASB standards may also be prosecuted by ASIC. 2.19 Describe the relationship between the AASB, the former UIG and the FRC. The FRC is responsible for the oversight and funding of the AASB. It also appoints all members of the AASB, other than the chair who is appointed by the Minister (currently the Treasurer). The AASB is responsible for the making of accounting standards both for the purposes of the Corporations Act and otherwise. The FRC has no power of veto over AASB standards; however those standards may be disallowed by either House of the Commonwealth Parliament. The UIG was a subcommittee of the AASB. Following the change to IFRS protocol in 2005 the UIG committee has been disbanded and its functions have been returned to the AASB. 2.20 Are AASB standards exactly the same as IASB standards? Explain. No. All of the IAS/IFRS standards issued at 1 January 2005 have an Australian equivalent, but the new standards are not exactly the same as their IFRS counterparts due to slight modifications for Australian use. Additional requirements were also necessary for not - for - profit and government entities, since Australia has sector neutral accounting standards. The new set of AASB standards in 2005 comprised 35 of the 36 IFRS - based standards plus some additional standards. The remaining
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Chapter 2: Companies and corporate regulation 11 Version 5.0 IFRS (IAS 26) is replaced by AAS 25: Financial Reporting by Superannuatio n Plans. Five other of the previously existing Australian AAS standards were retained – most in a revised form – because there is no IFRS equivalent. There is also a new AASB standard with no IFRS equivalent, this is AASB 1048: Interpretation and Application of Standards. All the new standards have a re - numbered and re - titled AASB - prefix that distinguishes them from the IFRS equivale nt. This resulted i n three groups of AASB standards, those with three digit numbers (corresponding to IAS - series), those with one digit numbers (corresponding to IFRS - series), and those with four digit numbers (existing Australian standards for which there is no corresponding IFRS). Except for AAS 25, all of the AAS series standards were subsequently replaced with AASB standards (with four digit numbers). The AASB has continued the use of four - digit Australia specific standards, with new standards primarily dealing with public sector reporting issues. There is also a series of standards that amend existing AASB standards, mainly to reflect changes made to IFRSs, they are identified by the year and a sequence number, for example AASB 2007 - 8. 2.21 Describe the role of the ASX in the development of financial reporting requirements in Australia. The ASX (and its predecessors) has played an important role in the development of Australian financial reporting requirements. Although today the ASX’s financial reporting requirements substantially mirror those in the Corporations Act and AASB accounting standards, in the past many financial reporting requirements started as requirements of the ASX Listing Rules, for example the provision of consolidated financial statements, the provision of funds statements (and later, the statement of cash flows), and the preparation of half - year financial reports. The ASX also played a key role in the AASB’s international harmonisation program, by promoting the use of IAS accounting standards and provided substantial financial support for the AASB’s harmonisation activities. 2.22 What was the purpose of professional (AAS) accounting standards and what now is their relevance? AAS standards are remnants of the professional bodies’ standard making, designated ‘Australian Accounting Standards’ (AAS), all but one of which have now been replaced following the assumption of full standard - setting responsibility by the AASB in 2000. Several of the AAS standards remained in force in 2005 to cover topics outside the scope of IFRSs or where the IFRS was not considered acceptable for Australian use; AAS 25: Financial Reporting by Superannuation Plans is an example of the latter and is also the only one left. This standard applies mainly within the superannuation industry, although AAS 25 may affect the acco unting obligations of a company, for example, if it is the trustee of a superannuation plan. The other AAS series standards, primarily concerned with public sector reporting issues, were subsequently replaced by Australia specific AASB standards. Enforcement of AAS standards is primarily made by the professional bodies. The origins and role of AASs are explained in the section on enforcement of financial reporting requirements. 2.23 Describe the means by which compliance with financial reporting requirements can be achieved. Essentially, achieving compliance is predicated by some form of enforcement mechanism. Such mechanisms can be formal or informal. Formal mechanisms include the professional obligations
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12 Company Accounting 5e Solutions Manual Version 5.0 (under APES 205 Conformity with Accounting Standards) of members of the accountancy bodies to comply with (a) AASB/AAS accounting standards and with (b) AASB/UIG Interpretations. In doing so, members must use their best endeavours to ensure that if an entity is a reporting entity that the entity prepares a fin ancial report that is a general - purpose financial report that complies with accounting standards. Another formal mechanism arises when compliance is required by law. For example, AASB accounting standards must be complied with when reporting under Part 2M of the Corporations Act. Further requirements and obligations to comply can be imposed by the listing rules of a stock market on which a company’s securities are traded (for example by the ASX). The accountancy bodies, the ASX and ASIC , have compliance programs designed to pick up instances of non - compliance. 2.24 Describe the reasons for , and the political process that led to , the introduction of IFRS for Australian use in 2005. The Australian economy, with its high degree of share ownership, has an investor - information orientation like the US and UK. The EU decision to adopt IFRS in 2005 has been used by the Government and FRC to justify its move to IFRSs; even the same date was chosen. The key difference is that in Australia, IFRSs have been adopted for all types of entities rather than partial adoption. The decision process is shrouded in mystery. The announcement took the accounting community in Australia and elsewhere by surprise. There was no pubic consultation, which for a statutory authority is extremely unusual. The FRC may have seen it as an opportunity to steal a march on other regulators; however being the first one to do so is not without risk. The decision may have increased the AASB’s political visibility and its influence on the IASB, in the short - term at any rate. The incentives to move from harmonisation – the process previously adopted in Australia – to adoption were significant. Doing so may be in the interests of big business, especially the stock exchange. Smaller companies that are not list ed and do not raise finance off shore, the overwhelming majority of companies, will not benefit directly, but they have the massive changeover costs , nevertheless .
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Chapter 2: Companies and corporate regulation 13 Version 5.0 2.25 Which of the following broad regulatory reporting requirements • statutory provisions; • ASX listing rules; • AASB/UIG i nterpretations; • AASB accounting standards; • AAS accounting standards; apply to each of the following: • public companies limited by shares; • listed public companies limited by shares; • proprietary companies; • small proprietary companies; • companies with unlimited liability? Explain your answer. Public companies limited by shares Listed public companies limited by shares Proprietary companies Small proprietary companies Companies with unlimited liability Statutory provisions ( Corporations Act ) Yes Yes Yes Yes Yes ASX listing rules Only if listed Yes No No Only if listed AASB/UIG Interpretations Yes Yes Yes Only if reporting entity Yes AASB accounting standards Yes (provided it is a reporting entity; if not, only AASB 101, 107, 108, 1031 and 1048 apply) Yes Only if a large proprietary company (provided it is a reporting entity; if not, only AASB 101, 107, 108, 1031 and 1048) No (limited exceptions explained in chapter 11) Yes (provided it is a reporting entity; if not, only AASB 101, 107, 108, 1031 and 1048 apply) AAS accounting standards No (AAS 25 may apply) No No (AAS 25 may apply) No (AAS 25 may apply) No (AAS 25 may apply)
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Company Accounting 5e Solutions Manual Peter Jubb Stephen Haswell Ian Langfield - Smtih Version 5.0 Chapter 3 Objectives of company reporting, conceptual elements and terminology 3.1 What reasons can be provided to justify the compulsory presentation of company reports to shareholders? Compulsory presentations of company reports (financial and other) can be supported in various ways, some of which are discussed in the text (s ee pages 33 – 35 generally; see also SAC 1, paragraphs 19 – 22.) Traditionally Anglo - Australian company law has been premised on the existence of separation of economic interest from management (control) and, therefore, the need for publicly available information for the protection of creditors and members. It is directed to dealing with the problems of information asymmetry. Disclosure is seen as one way of reducing the risk of fraud and mismanagement. To a significant extent the imposition and extension of compulsory financial reporting requirements can be related to market failure (as evidenced by major corporate collapses) and the need for politicians to be seen to be doing something about them. 3.2 Do you believe that company reports should be made available to the general public? Justify your answer. What is the extent of company financial data that should be included in those reports? This is a more wide - ranging question than 3.1, since the provision of information extends beyond owners. Arguments similar to those in the answer to 3.1 can be put in support of such requirements. Here we are concerned with a far more potent problem since now the interest is not simply economic nor is it based on ownership, and there is no direct means by those with that interest to exercise control over management. The extent to which financial data should be included can be deduced from the SACs. It should include such information that results in the financial report being a general purpose financial report. That is, it must ‘meet the information needs common to users who are unable to command the preparation of reports tailored to satisfy, specifically, all their information needs’ (SAC 2, paragraph 5). Such information must allow them to ‘make informed judgements about performance, financial position, financing and investing, and compliance’ (SAC 2, paragraph 5). 3.3 Discuss the political forces that may give rise to compulsory financial reporting. See pages 33 – 35. Frequently it has been a perceived need by regulators (the Parliament, standard setters etc) that has resulted in the extension of compulsory financial reporting requirements. This stems from a belief that financial reporting can minimise the risks of future corporate failures. Alternatively, there is a desire to be doing something whether or not it will actually minimise the
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2 Company Accounting 5e Solutions Manual Version 5.0 possibility of future failures. Not only may political forces give rise to the imposition of financial reporting requirements, they can explain the lobbying activities by the various interested parties (those with a vested interest in the outcome). The accounting profession itself has a vested interest in maintaining or increasing compulsory reporting because it generates fee - for - service workloads. Corporations too, while they sometimes resist regulation altogether, more generally recognise that some regulation is inevitable. That being the case, they have an interest in reporting requirements that can allow them to present their results in the most favourable light or which will enhance their legitimacy as corporate citizens. Corporations will lobby regulators and government to have the requirements designed in a way that suits them best. These interests are, however, not the same from one corporation to another: for example, some may want financial reporting rules that show higher profit, other companies who are politically visible may want to show lower profits. The lobbying efforts of companies are therefore not consistent. To the extent that some of the lobbying is successful, the result tends to be inconsistent accounting standards. Political forces and influences can also have the effect of reducing regulation. In Australia in recent years the general thrust of politically driven reform has been to deregulate rather than increase the controls over the corporate sector (see pages 28 – 29 of the textbook for a brief discussion). 3.4 Do you believe compulsory company reports are useful to their users? Usefulness will be affected by: (i) The relevance of the information contained in the financial report. Is there information overload? Would concise financial statements better satisfy the relevance requirement? (ii) The timeliness of distribution of information. The information included in annual reports is already several months out of date when received by the shareholder. The frequency of reporting financial information will also have an impact (note the greater frequency for disclosing entities). This can then be related back to the objectives underlying general purpose financial reports. That is, it must ‘meet the information needs common to users who are unable to command the preparation of reports tailored to satisfy, specifically, all their information needs’ (SAC 2, paragraph 5). Such information must allow users to ‘make informed judgements about the performance, financial position, financing and investing, and compliance’ (SAC 2, paragraph 5). 3.5 Which do you believe to be the more relevant to external report users: (a) information necessary to determine future share prices (b) information on the stewardship of company assets? Does your answer depend on the type of user? The folklore of financial reporting is that originally it was concerned with providing information on the stewardship over company assets (accountability and compliance functions). This was consistent with the giving of account by a steward to the lord of the manor. This involved a fiduciary relationship that was mirrored in early commercial ventures. However, as the scale of commercial operations became larger, particularly through the use of joint stock companies having transferable ownership interests, owners were not solely concerned with accountability and compliance; they were also concerned with making investment decisions. To a significant extent, this can be related to current and expected future share prices (which presumably reflect evaluations about an entity’s investing, financing and operating activities).
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Chapter 3: Objectives of company reporting, conceptual elements and terminology 3 Version 5.0 The answer will be influenced by the type of user being considered. Owners will be interested in future share prices as well as stewardship. However, creditors, employees and suppliers would be more interested in the ability of the company to continue in operation and to meet its obligations. Therefore these latter are more interested in accountability related information which includes information on stewardship. 3.6 Explain how a reporting entity differs from a non - reporting entity. The key difference between a reporting entity and a non - reporting entity is the existence (for reporting entities) of ‘users who are unable to command the preparation of reports tailored to satisfy, specifically, all their information needs’ (SAC 2, paragraph 5). 3.7 What is a general purpose financial report? A general purpose financial report is designed to ‘meet the information needs common to users who are unable to command the preparation of reports tailored to satisfy, specifically, all their information needs’ (SAC 2, paragraph 5). Such information must allow them to ‘make informed judgements about the performance, financial position, financing and investing, and compliance’ (SAC 2, paragraph 5). Such financial reports must comply with accounting standards and the qualitative characteristics discussed in The Framework. 3.8 Explain the relationship between being a reporting entity, the need to prepare and distribute general purpose financial statements , and the need to follow accounting standards. The term ‘general purpose financial statements’ is used in IFRSs, and has subsequently adopted in AASB standards rather than the more accurate term, ‘general purpose financial reports’ used in SAC 1 and SAC 2. While the two terms are slightly different they are concerned with the same concept. If we have an entity that is a reporting entity, then we have ‘users who are unable to command the preparation of reports tailored to satisfy, specifically, all their information needs’ (SAC 2, paragraph 5). We are told that such users need information that allows them to ‘make informed judgements about the performance, financial position, financing and investing, and compliance’ (SAC 2, paragraph 5). A financial report that does so is described as a general purpose financial statement. Such reports must be prepared in accordance with SAC 1 and 2, the Framework and accounting standards and will include such financial statements as necessary under those requirements. They m ust produce financial information that satisfies the qualitative characteristics dealt with in the Framework and also apply the definitions and recognition criteria for the elements of financial reporting. 3.9 ‘In enhancing the quality of financial reports, relevance , reliability and materiality are inextricably linked.’ Explain the meaning of each term. Do you agree that they are inextricably linked? Give reasons to support your answer. Information is material if: its omission or misstatement could influence the economic decisions of users taken on the basis of the financial report. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement. Thus, materiality provides a threshold
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4 Company Accounting 5e Solutions Manual Version 5.0 or cut - off point rather than being a primary qualitative characteristic which information must have if it is to be useful. (Framework para graph 30.) According to the Framework (paragraph 26) information will be relevant when it: influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluations. Information is reliable if: it is free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent. (Framework paragraph 31). T hese three characteristics of financial information are discuss ed on pages 39 – 40 of the text. The linkage between them can be explained as follows. Often there is a trade - off between reliability and relevance (the more relevant information is the less likely it is to be reliable and the more reliable the less likely it is to be relevant). The materiality test is designed to filter (potentially) reliable information by only including that relevant information that is likely to affect decisions and evaluations made by users. 3.10 Describe and illustrate the tension between the two dominant qualitative characteristics of financial information, namely relevance and reliability . According to the Framework (paragraph 26) information will be relevant when it: influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluations. Information is reliable if: it is free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent. (Framework paragraph 31). The tension is explained by the fact that: • the more reliable an item of information is, the less likely it is to be relevant to decision makers needs; and • the more relevant an item of information is to users needs, the less likely it is to have a high level of reliability. For example, information about an entity’s future cash flows is likely to be very relevant to decision makers needs, however, the inherent uncertainties in predicting those future cash flows means that the reliability of the information is likely to be relatively low. Similarly the measure of the cost of acquisition of an asset may be highly reliable, but its relevance to decisions that are likely to be made by users may be quite limited; particularly those that are concerned with the prediction of further cash flows. Therefore, we need to make a trade - off between the relevance and reliability when deciding to include such information in a financial report. In some cases relevance will be the deciding consideration and in other cases reliability will be the deciding consideration. Therefore the information contained in financial statements is a composite of measures that which has been chosen mainly because of its relevance and that which has been chosen mainly because of its
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Chapter 3: Objectives of company reporting, conceptual elements and terminology 5 Version 5.0 reliability. In some cases relevant but unreliable measures may be relegated to the notes to the financial statements while reliable, but less relevant measures are included in the financial statements themselves. 3.11 Explain the difference between comparability and understandability . Understandability is concerned with the ability of users of a financial report to understand the information in fact provided in the report, whereas comparability is concerned with their ability to relate that information to information contained in other financial reports, either of the same entity or of other entities. The latter is important if users are to be able to assess the relative performance, financial position, investing and financing activities of an entity over time or against a benchmark or other entities. 3.12 How can the need to satisfy the qualitative characteristic of comparability be used to argue in support of mandatory financial reporting requirements, such as those under the Corporations Act ? In the Framework, the need for comparability is described in the following way: users must also be able to compare the financial reports of different entities in order to evaluate their relative financial position, financial performance and cash flows. Hence, the measurement and display of the financial effect of like transactions and other events must be carried out in a consistent way throughout an entity and over time for that entity and in a consistent way for different entities. ( paragraph 40) To achieve comparability efficiently it is desirable that information be collected, processed and disclosed in the same way by an entity over time and by all entities for the same reporting period. If the methods of collecting, processing and reporting financial information are regulated (for example, through accounting standards), then the resulting information is more likely to be comparable. 3.13 Briefly outline the key aspects of the recognition criteria for the elements of financial statement under the Framework. Under the Framework, ‘recognition’ involves depicting an item ‘in words and by a monetary amount and the inclusion of that amount…’ ( paragraph 82). Amounts in the financial statements represent recognised items of asset, liability, equity, income or expense; these are the elements . An item that meets the definition of an element of the financial statements should be recognised if: (a) it is probable that any future economic benefit associated with the item will flow to or from the entity; and (b) the item has a cost or value that can be measured with reliability. (Framework, paragraph 83). 3.14 Explain the requirement to present a ‘true and fair view’ contained in the Corporations Act . The Act itself gives little guidance about how to give a true and fair view, except that mere compliance with accounting standards may be insufficient (s. 295(3)(c)) — in which case additional information must be included. ‘True and fair’ is not defined by the Act. However, the ‘true and fair view’ test conjures up the following notions: true and fair accounting is based on reasoned judgement and ethical fair play. Flexibility and interpretation, applied from a moral and honest
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6 Company Accounting 5e Solutions Manual Version 5.0 viewpoint, are integral to the relevance and reliability of financial informatio n. A literal observance of rule books is not sufficient. Where the accounting standards allow choice, the method chosen must be one that gives a true and fair view. Even when the standards insist on a particular technique, the true and fair application might result in additional information being supplied. 3.15 Which documents constitute the conceptual framework of accounting and what are their main contents ? The conceptual framework is a set of guidance documents for the development and interpretation of accounting standards. The present conceptual framework in Australia consists of the Framework (a document adapted from IASB origins as part of IFRS adoption) and Statements of Accounting Concepts (SAC) 1 and 2 (these two documents were developed in Australia in the 1990s). This piecemeal approach to a conceptual framework has come about because the Framework is not considered by Australian authorities to contain sufficient coverage of material. In the 1990s the Australian Accounting Research Foundation (AARF, described in Chapter 2), began to produce a set of Statements of Accounting Concepts (SACs), the foundation documents of a proposed conceptual framework. Four SACs had been issued and more were proposed, but the incomplete project was interrupted by plans to adopt IASB standards in 2005. The four issued SACs are: • SAC 1: Definition of the Reporting Entity (1990) • SAC 2: Objectives of General Purpose Financial Reporting (1990) • SAC 3: Qualitative Characteristics of Financial Information (1990) • SAC 4: Definition and Recognition of the Elements of Financial Statements. (1992, reissued 1995) These four made up a reasonably comprehensive conceptual framework by themselves but they did not have the force of law. Their purpose was guidance, to assist in standard setting and assist users when no accounting standard applied. The IASB Framework predates the SACs; it was published in 1989. Much of the development work was carried out by AARF. To adopt IASB standards the AASB decided it was necessary to adopt the Framework. Unfortunately, the Framework is not as detailed or comprehensive as the four Australian SACs. The Framework has the following main contents: (a) objective of financial reports; (b) assumptions underlying financial reports; (c) qualitative characteristics of financial reports; (d) elements of financial reports; and (e) recognition criteria for the elements of financial statements. Some of these points overlap slightly, but not sufficient ly, with SAC 1 and SAC 2. The main coverage approximately corresponds to material in SAC 3 and SAC 4, but the latter have more depth of analysis. Fortunately , concepts in the Framework are similar to the SACs, but there are differences that are causing problems with the drafting of Australian standards. There are no IASB documents that correspond closely to SAC 1 and SAC 2. Therefore AASB found it necessary to retain SAC 1 and SAC 2 to fill in the gaps in the Framework. SAC3 and SAC4 are withdrawn; however , to the extent they take the same position, the more comprehensive discussion in them may be useful in applying the Framework. SACs 1 and 2 remain guidelines only, although the definitions of entity, general purpose financial report and special purpose financial report in SACs 1 and 2 are adopted in AASB 101.
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Chapter 3: Objectives of company reporting, conceptual elements and terminology 7 Version 5.0 3.16 To what extent does the conceptual framework of accounting assist in the understanding of financial reporting requirements? • Definition of reporting entity contained in SAC 1 helps us to decide the circumstances when a general purpose financial report is required. These guidelines work in conjunction with the scope and application paragraphs of the accounting standards. Objectives of financial reporting in SAC 2 help us to decide the type of information that must be provided, though only in general terms. Specific requirements are contained in the accounting standards. • The definitions of the elements of financial reporting used in the Framework are replicated in many AASB accounting standards, as are the recognition criteria for those elements. In standards where specific mention is not made of these criteria, the Framework can provide assistance for interpreting a standard’s requirements. • The qualitative characteristics of accounting information provided by the Framework can be used to interpret the requirements of information under the accounting standards. • The conceptual framework is used by the AASB in developing new accounting standards and in revising existing accounting standards. • The conceptual framework is limited in providing assistance where certain of its features have not been fully developed or seem to be defective in their drafting. For example, the definition of elements of revenue and expense in the Framework appears to be too loose to result in competently categorised elements. This problem is explained in chapters 3 and 5 of the text on pages 43 – 44 and 90 – 93. 3.17 What is capital maintenance and why is it important to accounting? A company has maintained capital if it has as much capital at the end of the period as it had at the beginning. Net increases in assets held above the amount of maintained capital are ‘profits.’ Managers who act prudently do not erode the capital of their company. For a discussion of different conceptual approaches to understanding capital maintenance, see pages 44 – 45 of the text. 3.18 What is meant by the terms substance over form and prudence ? In principle substance over form means that the substance — the real impact of a transaction or event on financial performance or position — should be shown rather than merely its superficial form . The substance of a transaction or event is not always consistent with its legal form . For example, some kinds of share might have more of the characteristics of debt than equity — there might be a fixed dividend rate that more resembles interest payments, and no voting entitlements (see Chapter 4 of the text ). Legally it is a share but in substance it is debt and may have to be reported in the liabili ties part of the balance sheet. Prudence is ‘the inclusion of a degree of caution in the exercise of the judgements needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated’ (Framework paragraph 37). This exercise of caution should extend to all matters of business judgement. However, it cannot be used as an excuse to misrepresent financial position or financial performance; it is not prude nt to mislead or deceive users.
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8 Company Accounting 5e Solutions Manual Version 5.0 3.19 What is the difference between a financial instrument and financial assets and liabilities? A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity (AASB 132.11). A financial asset is any asset that is: (a) cash; (b) an equity instrument of another entity; (c) a contractual right: (i) to receive cash or another financial asset from another entity; or (ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity; or (d) a contract that will or may be settled in the entity’s own equity instruments. (AASB 132.11) A financial liability is any liability that is: (a) a contractual obligation: (i) to deliver cash or another financial asset to another entity; or (ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity; or (b) a contract that will or may be settled in the entity’s own equity instruments. (AASB 132.11) And a n equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. A share is the obvious example. Note: The IASB amendment the definition of financial liability in October 2009 (Classification of Rights Issues (Amendment to IAS 32)). F inancial instruments mus t be constituted by a contract: • O ne contracting party (entity) has a financial asset and the other contracting party (entity) has a financial liability or an owners’ equity instrument. • T here must be either (a) a financial asset and a financial liability or (b) a financial asset and an owners’ equity instrument, created by the contract. • With more complex financial instruments there may be a combination of financial liabilities and owners’ equity instruments. It is also possible for more than one type of financial asset to be created by the one contract. • T he existence of a financial asset, or financial liability or owners’ equity instrument on its own does not give rise to a financial instrument. 3.20 What problems are associated with the definitio n of income and expense in the accounting standards? The new AASB standards are based on conceptual definitions adapted from the IASB ’s Framework and standards. The IASB employed three different terms to denote equity increments. Income is a ‘headline’ or summary term but is not distinguished clearly from revenues or gains . Revenue is associated with ordinary period activity items while gains need not be; but there is no test to distinguish the two. No test is provided to assist us in distinguishing ordinary activities from other
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Chapter 3: Objectives of company reporting, conceptual elements and terminology 9 Version 5.0 activities. In other accounting standards, and in practice, there are many exceptions to the examples. A similar problem exists for expenses. There are two types: expenses and losses . Expense is therefore both a generic label and a specific one that denotes items arising in ordinary operating activities. Losses may or may not relate to ordinary operating activities; again there is no test to distinguish them from expenses. The Framework provides a summary term for the net of these increments and decrements , which is income and expense , meaning, the sum of income (revenues plus gains) and expenses (expenses plus losses). AASB 101.88 requires that all items of income and expense be recognised in period profit or loss unless excluded by another accounting standard. No criteria are provided in the Framework by which we can decide which ones are excluded from the period profit or loss; other accounting standards require these exclusions arbitrarily. These categorising problems and the confusing profit terminology that accompanies them a re discussed in more detail in chapter 5 (pages 90 – 93). 3.21 Briefly explain the meaning and purpose of replacement cost accounting . Like historical cost, replacement cost systems are an input - based approach to measurement. At acquisition, the replacement co st of an asset will normally be the same as its historical cost. After acquisition, the recorded amounts may differ if the cost of an equivalent replacement asset has changed. The purpose of changing the recorded amount is to take account of the effect of changing prices of assets in a way that is specific to the firm. This could be called a method of ‘inflation accounting’ although the measurements are more sophisticated than mere adjustments for consumer price indices, which only give a non - specific indicator of price changes in the whole economy. Replacement cost can be measured in several ways; it can be the cost of acquiring an identical asset in new condition (the Edwards and Bell approach), the cost of replacing in current condition, or the cost of replacing the operating capability – the number of units of output – of the asset in its original condition. All of these systems provide a measure of physical capital maintenance. One technique for example is based on the cost of replacing assets with identical assets. Under this method, we substitute the replacement cost of an identical asset in new condition for the historical cost (or a previous replacement cost), and adjust accumulated depreciation so that its amount is the same proportion of the carrying amount under replacement cost as it is for historical cost. The adjustment is done typically at the end of each financial reporting period. 3.22 Explain the difference between the following measurement techniques: fair value, net fair value and net market value. Fair value is concerned with the amounts for which an asset would be exchanged, or a liability settled, between knowledgeable willing parties in an arms - length transaction. This does not require the existence of an active and liquid market. (Various means of estimating fair value are discussed in chapter 9.) Net fair value is fair value less the expected cost of sale (asset) plus the expected costs of discharge (liabilities). Net market value is the amount found using a price taken from an active and liquid market after deducting expected costs of sale.
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10 Company Accounting 5e Solutions Manual Version 5.0 3.23 Explain the difference between current cash equivalent and fair value. Current cash equivalent is the market or realisable price of an asset. In an active and liquid market CCE and FV will differ by the amount of transaction cost for the sale. Also, if there is no active orderly market the CCE will be zero, whereas if other estimators of FV are permitted, the FV may be non - zero. This depends on how we limit the way in which we measure FV. 3.24 Explain the meaning of net realisable value ( in the context of inventory valuation ) . The net realisable value (NRV) of an asset is the amount that it could be sold for less the cost of getting it to a saleable condition and the costs of selling it. It differs from the current cash equivalent in that the current cash equivalent is concerned with sale in current condition, whereas NRV is premised on sale in completed condition. NRV was developed for the measurement of inventory. 3.25 ‘The diverse measurement techniques developed for different types of assets suggests that standard setters are confused about the nature of the attribute that is to be measured.’ Do you agree with this statement? Provide reasons to support your position. This is, of course, a matter of opinion. To an extent the differences merely reflect the point of time at which the particular standard was first made. It may also reflect differences in the nature of the problem (or perceived problem) to which the standard is addressed. This can result in different attributes being measured, or apparently similar terms being used for distinctly different measures, or quite different terms being used for almost identical measures. It reflects the fact that measurement has, in the past, been addressed on an ad hoc basis without first considering the capital maintenance concept to be adopted and the attribute that must be measured if capital is to be maintained under that capital maintenance concept. It also can reflect changing attitudes to the objective of financial reporting – for example, the balance taken at a particular point of time between the concerns of management in portraying financial performance and position in the most favourable way (preparer perspective) and the need to provide relevant and reliable information to users (user perspective).
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Company Accounting 5e Solutions Manual Peter Jubb Stephen Haswell Ian Langfield - Smtih Version 5.0 Chapter 4 Forming a company and issuing shares 4.1 Describe the sequence of events that usually takes place when a group of people wish to form a public company. The fi r st step is to register the company. Before doing so, it must be decided if the company is going to have a constitution that is comprised of the Corporations Act’s replaceable rules or by a combination of those rules and specially drafted rules, or wholly by specially drafted rules. If the company is to have a specially drafted constitution, it must be finalised before applying for registration (since it must accompany the application). The information required in the application for registration is listed on page 56 of the textbook. The subscribers must appoint the company’s directors, its secretary and take steps to appoint an auditor. The subscribers must then pay the amounts they have agreed to pay on the shares they agreed to purchase . Sometimes further money will be raised by a regulated offer of shares through a disclosure document , which must comply with the requirements of the Act and be lodged with ASIC. 4.2 What is the role and function of: (a) replaceable rules (b) a company’s constitution? The role of replaceable rules and a company’s constitution is basically the same (section 134). Under the Corporations Act the replaceable rules regulate the internal operation of the company, the powers and duties of the directors, the relationship between members and the company and between the members of the company. A company’s constitution (in substance) comprises the replaceable rules (to the extent that they have not been replaced by a specially drafted constitution) and the provisions of any specially drafted constitution. 4.3 How may a company’s constitution be amended? A company’s constitution may be amended by a special resolution of members (one requiring a 75 per cent majority) or by a more stringent procedure contained in the company’s constitution.
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2 Company Accounting 5e Solutions Manual Version 5.0 4.4 Of what relevance is an ‘objects’ clause in a company’s constitution? An objects clause specifies the objectives for which the company was formed. The replaceable rules do not contain an objectives clause. However, the no liability company’s specially drafted constitution does specify its objectives, since such companies must not engage in activities outside their mining purposes. Other types of companies can elect to include an objects clause in their specially drafted constitution, but doing so may have little or no effect. At one time, the doctrine of ultra vires made it impossible to enforce contracts to do things outside a company’s specified objects or beyond its specified powers. The ultra vires rules have been replaced by statutory provisions dealing with the ability of companies to contract freely (Act, s. 125). 4.5 What rules govern a company if it does not have a constitution? The replaceable rules listed in section 141, together with other provisions of the Corporations Act govern the company’s operations. 4.6 What is meant by ‘registering’ a company? Explain the registration process. The process of registration is discussed on page 56 of the textbook. Registration is the process by which a company is formally recognised for the purposes of the Corporations Act and involves the making of a formal application for and registration by ASIC and the assignment of an ACN (Australian Company Number) or more recently an ABN (Australian Business Number). In the text we have used the term registration rather than the narrower term incorporation. Registration can be by incorporation of a new entity under the Corporations Act and the issue of a certificate of incorporation. Registration also applies to entities formed under earlier company’s acts (they are deemed to be registered) and by entities formed under other legislative schemes that apply for registration. 4.7 Detail the administrative matters that must be attended to shortly after registration. These matters are discussed on page 57 and 58 of the textbook. This includes the appointment of the first directors and company secretary, and for companies other than those qualifying as a small proprietary company, the appointment of an auditor. The company must put in place procedures to ensure that it complies with the record keeping requirements of the Corporations Act , including various register - keeping requirements (for example, members, debenture holders, directors, charges , option holders ), minute books for meeting of directors and members, and to ensure that accounting records necessary to meet the requirements of the Act are maintained – this allows a double - entry bookkeeping system from which the necessary financial reports can been drawn up.
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Chapter 4: Forming a company and issuing shares 3 Version 5.0 4.8 What advantages are gained by listing on a stock exchange? See page 59 of the textbook. The main advantage is that it encourages shareholders to acquire new shares of the company since they can be more easily traded through the formal market established by a stock exchange such as the ASX. This is described as providing a greater degree of liquidity to the investment. In turn this means that it is easier for the company to sell new shares, particularly when a substantial number of shares are to be issued. 4.9 Explain the distinction between a regulated offer of securities and an unregulated offer of securities. Why is this distinction important? An unregulated offer is generally one that is made on a small scale, to less than 20 investors. Unregulated offers can also be made on a large scale if made to ‘sophisticated’ investors, for example , to professional portfolio managers ( Act s. 708). These offers are unregulated because it is assumed that those investors are capable of making decisions with less assistance; often they have the bargaining power to compel the company to provide the information they need. Regulated offers are necessary for other primary share issues for two reasons. First, to ensure that information is provided to investors before they make a decision to invest, and second to protect them from potentially misleading information. The main function of the regulated offer is therefore to mandate the nature and quality of information that must be given to any potential investor. With a public company share issue this can be particularly important because the company and shares can be advertised widely and are therefore offered to people who may know very little about that company or about investing. 4.10 Under what circumstance must a disclosure document be lodged with ASIC? What information is contained in such a disclosure document? A disclosure document must be lodged with the ASIC whenever a regulated offer of securities is made. The disclosure document is usually a prospectus , though in some cases a shorter document called a brief profile can be used, or a document called an offer information statement. The differing content depends on the amount being raised, the information previously lodged by the company with ASIC, the type of securities, the circumstances of the issue, and whether securities of the class being offered are already listed on a securities exchange such as the ASX. The prospectus sets out information relevant to the potential investor’s understanding of the prospects of the company. There is no express requirement to include reports by experts; however, their inclusion will reduce potential third - party liability of the directors. Generally, the prospectus is required to include all the information that investors and their professional advisers would reasonably require to make an informed assessment of: • the assets and liabilities, financial position and performance, profits or losses and prospects of the body that is to issue the shares; • the rights and liabilities attaching to the shares, including the terms and conditions of the offer, the issue price, number of shares to be issued, how to deal with an oversubscription of the issue; • the interests of directors and other persons named in the disclosure document, in assets to be acquired by or previously acquired by the company ( Act, s. 710).
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4 Company Accounting 5e Solutions Manual Version 5.0 4.11 Under which circumstances may a company issue more than one type of share? There are various types of shares, such as ordinary, preference and redeemable preference shares. A company generally has the power to issue different types of shares according to its requirements. Normally this power is exercised by the directors. In some cases there may be restrictions, for example, where a debt agreement prohibits the directors from issuing redeemable preference shares that are in - substance debt. 4.12 What characteristics distinguish the main types of shares? The basic type of share is the ordinary share. If there is only one class of share, then those shares are, by definition, ordinary. The rights, duties and other terms on which ordinary shares are issued are determined by the company. In some circumstances, the rights and obligations are affected by legislation and common law. Ordinary shares typically confer full voting rights and the right to receive dividends. The most common other type of share is the preference share, which gives holders preferential rights, the most common of which is preference to dividends. Frequently this means that the shareholder receives a dividend based on a fixed percentage of the issue price – provided there are enough profits – whereas ordinary shareholders receive a variable dividend which depends on the level of profit and the willingness of directors to recommend that a dividend be paid. The name is slightly misleading, however, because preference shares often confer reduced voting rights, and might be non - preferential as to return of capital in the event of liquidation. When a company issues preference shares, it must set out the rights of those shares with respect to the following matters, either in a special resolution of the company or in its constitution: • repayment of capital; • participation in surplus assets and profits; • cumulative and non - cumulative dividends; • voting; and • priority of payment of capital and dividends in relation to other shares or classes of preference shares. Some preference shares are redeemable; in which case the Corporations Act imp oses further restrictions (see c hapter 6). Less commonly, a company might create other classes of shares with idiosyncratic conditions attached, of which the most important is the founder or deferred share. With this type of share, usually issued to the initial subscribers or founders of the company, dividends are received only after they have been paid to other classes of shareholders. Companies may also issue targeted or tracking shares, which participate in profits of only some aspects of the company’s undertakings. Targeted share s are considered in chapter 5.
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Chapter 4: Forming a company and issuing shares 5 Version 5.0 4.13 Explain the following terms: issue price , called - up amount , call , and paid - up amount . The issue price is the amount that the person to whom a share is issued agrees to pay for the share. That is, the total consideration payable in respect of the issue of the share. The called - up amount (or value) is equal to the issue price less the amount uncalled. That is, it is the sum of the amount of the issue price that has been paid (or deemed to have been paid) and any amount that is currently payable (called - up but not paid) by the person to whom the shares have been issued. A call is made where not all of the issued p rice of a share has been called up. The directors have the power, subject to the terms of issue, to call up all or part of the amount that has not been called up. When they do so, they are said to make a call. Paid - up amount is the amount that has actually be paid in respect of a share. It is usually equal to the called - up amount less the amount of any call or calls that have not yet been paid. 4.14 Briefly outline the requirements of accounting standards dealing with transaction costs incurred when issuing new shares. In making a share issue, the company will incur costs such as stamp duties and taxes, fees of professional advisors and brokerage fees that are directly related to the issue. Under the Framework, they would appear to meet the definition of an expense, and should be included in the profit or loss. However, under AASB 132.35, they must instead be ‘accounted for as a deduction from equity’, the rationale being that they are then accounted for as part of the transaction to which they relate – the issue of the shares. This seems to be an application of substance over form; however here it is questionable if the substance is any different from the form; the potential shareholder is not a party to that transaction involving the transaction cost and in all likelihood is completely unaware that it has taken place. It is unclear what is meant by the words ‘as a deduction from equity’; this issue is discussed in chapter 12 (page 334). 4.15 Describe the sequence of events that usually takes place when a company whose shares are listed on a stock exchange decides to make an issue of shares to the general public. The procedures for the issue are summarised in the six points on pages 62 – 64 of the textbook. 4.16 In what ways can share issues for established companies differ from those of newly formed companies? The distinguishing feature is that an established company always has the opportunity of offering new shares to existing members (a rights issue). Indeed, in many instances a failure to allow existing members the opportunity of participating in the issue may result in a breach of the ASX listing rules (if the company is listed) – the so - called 15 per cent rule (Listing Rules 7.1 and 7.2) – or may amount to oppressive conduct. For both initial issues and subsequent issues it is possible that the issue is either a regulated issue or an unregulated issue.
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