Corporate Accounting Assignment

This assignment explains the nature of reserves and their movement in corporate accounting, as well as the calculation for impairment in a case study. It covers topics such as revenue reserves, capital reserves, dividend, and disclosure of reserves in the balance sheet.

CORPORATE ACCOUNTING ASSIGNMENT
MAY 27, 2019
Student name
University Name

1
By student name
Professor
University
Date: 16 May 2019.
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Executive Summary
This report is a Corporate accounting based assignment whereby there are 2 parts. In the first
part, the nature of reserves and the movement in the reserves has been explained in detail
including the treatment of dividend. Various types of reserves and the reason for which they are
formed has been explained in detail. In the second part, a case study on impairment has been
given which has been solved using the rules of impairment as per the accounting standards. The
journal entries and the relevant workings with respect to impairment has also been shown.
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Table of Contents
Part A: Nature of Reserves and their movement.........................................................................................4
Introduction.................................................................................................................................................4
Description..................................................................................................................................................4
Reserves in Accounting................................................................................................................................7
Dividend......................................................................................................................................................8
Conclusion...................................................................................................................................................9
Disclosure of Reserves in Balance sheet..................................................................................................9
Part B: Calculation for Impairment for Gali Limited.....................................................................................9
References.................................................................................................................................................11
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Part A: Nature of Reserves and their movement
Introduction
Reserves are profits, which have been set aside for a particular purpose or to expand or
strengthen the financial position of the business. Sometimes reserves are also referred to as
retained earnings. Reserves as a component of financial statement is very important because
amount, which is set aside for reserves, reduces the net profit of the company. Thus, thorough
understanding of reserves, how they are created or made is very much important for the company
(Appelbaum, et al., 2018).
Reserves are kept aside for various purposes such as it can be used for purchase of any fixed
assets, repaying of debts, for payment of bonuses, fund expansions, dividend payments.
Sometimes provisions are misinterpreted as reserves but they are actually not same as a provision
is a liability which is yet to come and whose cost or date is not confirmed. AASB has prescribed
AASB 101 for presentation of financial statement under section 334 of Corporations Act, 2001.
AASB 101 sets out basis for presentation of general-purpose financial statement for making
comparison of company’s financial statement of previous period with that of other entity’s.
Description
Reserves has a credit balance in balance sheet and referred as a part of shareholders equity. A
reserve can be any part of shareholders’ equity except for basic share capital. There are various
types of reserves, which are used, in financial reporting but these reserves are broadly classified
under two types:
1. Revenue Reserves
2. Capital Reserves
Revenue Reserves: Revenue reserves are those reserves, which are retained or set aside
by the company for business expansion or investment in future growth of the company. Revenue
reserves are not distributed to the shareholders in the form of any dividend or bonus. These are
profits, which are earned by company through its normal operations. Revenue reserves are
further classified into two types (Alexander, 2016):
a.) General Reserves: General reserves are those reserves, which are not for any specific or
particular purpose but as the name specifies these are for general purpose including for
general financial strengthening of the entity (Arnott, et al., 2017).
b.) Specific Reserves: As the name specifies, specific reserves are those reserves, which are
kept aside for a specific purpose, which cannot be used for any other purpose except for
the purpose for which it is kept aside. Sometimes specific reserves are also referred to as
special reserves. Examples of various specific reserves are Dividend equalization
reserve, capital redemption reserves, Contingency reserves, Debenture redemption
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reserves etc. Bad debt reserve is the best example for specific reserve as this is an
amount, which is kept aside in case customer is unable to pay (Belton, 2017).
Creation of revenue reserve from profit: The thing, which should be kept in mind, is that
revenue reserve of a company is just not on the books of the company rather it is actual money,
which is earned, by company out of its real profits. Creation of revenue reserves can be better
explained through example:
Example showing creation of revenue reserves:
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 Here, in this example we can see the net profit of two years which is real money and
which is available in books as well as in cash.
 We can see that net profits of 2 years in year 2015 and 2016 are $47000 and $48000
 Let us assume 50% of the profits will be transferred to revenue reserves, the amount
would be 48000*50% i.e. $24000 for year 2015 and 47,000*50% i.e. $23500, so total
revenue reserve for the year 2016 will be $23,500+$24,000 = $47,500 (Choy, 2018).
 These amounts will be shown in balance sheet under reserves as retained earnings in
shareholders fund.
Uses of Revenue Reserves: Revenue reserves are used for following purposes:
1. Payment of dividend to its shareholders
2. To expand its business operations
3. For the purpose of stabilizing the rate of dividend
Capital Reserves: Capital reserves are those reserves, which are made or created out of
capital profits, and normally they are not available for distribution to shareholders of the
company as dividend. It is to be noted that capital reserves cannot be made or created from the
profits earned from normal trading activities or from its core operations of a company. Capital
reserves are usually set aside for meeting capital losses or helps company in case of
unpredictable events like inflation, business expansion or get into new project (Sithole, et al.,
2017). There are various examples of capital reserves like profit on sale of any fixed assets of the
company, profit on sale of shares of company etc. In case company sells or dispose its assets and
earn some profit out of it then in that case company can transfer that profit to capital reserve.
Suppose if company sells its assets and on sell if there is any capital loss to the company in that
case, company can use capital reserve to mitigate or reduce its loss or any other contingencies.
Capital reserves are not related to any operational activities of the company hence it is nothing to
do with operational efficiency (Lessambo, 2018).
Let us understand capital reserve by taking a practical example: Let us say company want to buy
a machine to increase its operational efficiency for which company needs capital. Moreover,
company do not want to take any loan from outside or financial institution, as the cost of raising
funds will be very high. In that case, company plans to create a capital reserve. Therefore,
company sell out its old machineries or any other assets and money received from sell of those
assets are directly transferred to the capital reserve. In addition, since it is not a free reserve so
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company to pay any dividend to its shareholders cannot use it. Hence, the amount transferred to
capital reserve can be used to buy machine (Heminway, 2017).
Capital Reserve Exceptions:
a. Company not always create capital reserve for specific project rather sometimes company
create capital reserve for meeting any inflation, recession or excessive competition.
Therefore, for that purpose company can transfer any money received from sell of any
assets and can create a reserve.
b. Profits on sell off assets are not always received in money value sometimes there can be
profit because of revaluation so in that case also profits are transferred to reserve
irrespective of actual receipt of money (Jefferson, 2017).
Reserves in Accounting
While doing the accounting what company do is debit the retained earning accounts and credit
the same amount to reserve account. In case the activity for which reserve was created gets
complete then the entry is reversed and if there is any balancing figure it is transferred to the
retained earnings account.
Apart from two major reserves there are other reserves also which are very important for any
company such as:
Fair value reserves: These reserves are important for businesses like property and Insurance
Company who holds huge amount of fixed income investments. Available for sale assets and
securities are generally included (Gooley, 2016).
Asset Revaluation Reserves: These reserves are created when the adjustment is made in the
value of asset in balance sheet and in need of offsetting the transaction.
Hedging Reserves: company to hedge itself from any volatility in certain costs creates these
reserves.
Foreign currency translation Reserves: These reserves are created by company when there is
change in value of currency in which balance is reported and in which currency assets are held in
balance sheet (Dichev, 2017).
Statutory Reserves: These reserves are those reserves which company creates doe to the
requirement of law or regulation and company cannot pay statutory reserves as dividends.
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Dividend
A dividend is not an expense for the company rather it is a distribution of its retained earnings. A
dividend is distributed to shareholders in the proportion of number of shares held by them.
Dividend cannot be paid out of any reserves other than the free reserves (Vieira, et al., 2017).
Below table shows how dividends appear or affect financial statement:
There is no impact on balance sheet before dividend is paid. When dividend is paid, it reduces
the amount of retained earnings in the balance sheet.
As per AASB 101, company shall disclose the following in the notes:
Conclusion
Disclosure of Reserves in Balance sheet
Reserves and surplus are disclosed in balance sheet on liabilities side under the head ‘Equity and
Liabilities’ under sub head ‘Shareholders’ funds.
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As per AASB 101, company shall disclose in either the Balance sheet or statement of changes in
the equity or in the notes to accounts a description or explanation of the nature and the need of
each reserve made or shown in the books (Kim, et al., 2017).
Part B: Calculation for Impairment for Gali Limited
Gali limited is the entity, which has been given in the question. It has identified fine china
division as one of its cash-generating unit for the purpose of the impairment. The carrying values
of the assets of the company as on 30th June 2015 has been given below along with the other
inputs as well:
Gali Ltd.
Impairment calculation as on 30th June, 2015
Account Carrying amount
Plant 190,700
Brand 44,000
Fittings 28,000
Inventory 12,000
Goodwill 10,000
Total carrying amount 284,700
Value in Use of division 254,700
Fair value less cost of disposal of Plant 183,441
Impairment is the amount of the difference between the carrying value of the asset and the fair
value less cost of disposal or the value in use, whichever is lower (Das, 2017). Here since the fair
value less cost of disposal of the entire division has not been given so the value of impairment to
be considered is (carrying value less value in use) = (284700-254700) = $ 30000. As per the
rules laid down in Accounting standard for impairment, the amount of impairment first needs to
be allocated towards goodwill and hence impairment of goodwill here is $ 10000. The remaining
$ 30000 -$ 10000 = $ 20000 will be allocated towards the rest of the assets in the ratio of
carrying values with the exception of inventory since the current assets which are held for the
purpose of selling are not eligible for impairment. The working a calculation for the same has
been shown below:
Account Carrying Amount Pro rata Impairment loss allocated Adjusted CA
Plant 190,700 0.73 14,518 176,182
Brand 44,000 0.17 3,350 40,650
Fittings 28,000 0.11 2,132 25,868
Total CA 262700 1.00 20,000 242700
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However, the fair value less cost of disposal has been given for the plant to be $ 183441 beyond
which the plant cannot be impaired so the maximum amount of impairment that can be allocated
to Plant is $190700 - $183441 which amounts to $ 7259. Therefore, the remaining amount of
impairment, which was earlier, allocated to Plant ($14518 - $7259) = $ 7259 needs to be
reallocated to the rest of the assets (Kew & Stredwick, 2017). The revised calculation for
appropriation of impairment amount is shown below:
Accoun
t
Adjusted
CA
Pro
rata
Impairment loss
allocated
Total impairment loss
allocated
Plant 7,259
Brand 40,650 0.61 4,436 7,786
Fittings 25,868 0.39 2,823 4,955
Total CA 66,518 1.00 7,259 20,000
Therefore, the final amount of impairment asset wise is Goodwill: $ 10000; Plant: $ 7259;
Brand: $ 7789 and Fittings: $ 4955.
The journal entries in the books of Gali Ltd. to account for the impairment loss has been shown
below:
Journal
Date Particulars Dr./Cr. Amt ($) Amt ($)
2015
30-Jun Impairment Loss Dr. 30000
To Goodwill Cr. 10,000
To Accu. Depn and Impairment loss on Plant Cr. 7,259
To Accu. Depn and Impairment loss on Brand Cr. 7,786
To Accu. Depn and Impairment loss on Fittings Cr. 4,955
(Being impairment loss recorded in the company’s books)
References
Alexander, F., 2016. The Changing Face of Accountability. The Journal of Higher Education, 71(4), pp.
411-431.
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Appelbaum, D., Kogan, A. & Vasarhelyi, M., 2018. Analytical procedures in external auditing: A
comprehensive literature survey and framework for external audit analytics.. Journal of Accounting
Literature, 40(1), pp. 83-101.
Arnott, D., Lizama, F. & Song, Y., 2017. Patterns of business intelligence systems use in organizations.
Decision Support Systems, Volume 97, pp. 58-68.
Belton, P., 2017. Competitive Strategy: Creating and Sustaining Superior Performance. London: Macat
International ltd.
Choy, Y. K., 2018. Cost-benefit Analysis, Values, Wellbeing and Ethics: An Indigenous Worldview Analysis.
Ecological Economics, 3(1), p. 145.
Das, P., 2017. Financing Pattern and Utilization of Fixed Assets - A Study. Asian Journal of Social Science
Studies, 2(2), pp. 10-17.
Dichev, I., 2017. On the conceptual foundations of financial reporting. Accounting and Business
Research, 47(6), pp. 617-632.
Gooley, J., 2016. Principles of Australian Contract Law. 2 ed. Australia: Lexis Nexis.
Heminway, J., 2017. Shareholder Wealth Maximization as a Function of Statutes, Decisional Law, and
Organic Documents. SSRN, pp. 1-35.
Jefferson, M., 2017. Energy, Complexity and Wealth Maximization, R. Ayres. Springer, Switzerland.
Technological Forecasting and Social Change, pp. 353-354.
Kew, J. & Stredwick, J., 2017. Business Environment: Managing in a Strategic Context. 2nd ed. London:
Chartered Institute of Personnel and Development.
Kim, M., Schmidgall, R. & Damitio, J., 2017. Key Managerial Accounting Skills for Lodging Industry
Managers: The Third Phase of a Repeated Cross-Sectional Study. International Journal of Hospitality &
Tourism Administration, , 18(1), pp. 23-40.
Lessambo, F., 2018. Audit Risks: Identification and Procedures. Auditing, Assurance Services, and
Forensics, 3(1), pp. 183-202.
Sithole, S., Chandler, P., Abeysekera, I. & Paas, F., 2017. Benefits of guided self-management of attention
on learning accounting. Journal of Educational Psychology, 109(2), p. 220.
Vieira, R., O’Dwyer, B. & Schneider, R., 2017. Aligning Strategy and Performance Management Systems.
SAGE Journals, 30(1), pp. 23-48.
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