CHAPTER 4 EXERCISES

Mid-Chapter Summary Problem

Nora, the owner of a small business, came to you for help in reviewing the business’s financial
statements. She passed you a (rather disorganized) file containing many separate pieces of papers
collated by her assistant. The first thing you noticed when you open the file was this document:

Requirements
1. Explain to Nora how the above Balance Sheet does not follow the general
presentation requirement of financial statements.
Solution:
The general presentation requirements of financial statements include the following:
■ Identification: The Balance Sheet should be labeled appropriately. For example, the
name of the entity, the date of the end of the reporting period, the currency used, and any
rounding (if any).
■ Fair presentation, compliance to accounting standards, and accrual accounting:
Compliance with accounting standards is presumed to result in fair presentation of the
financial statements. Nora has selectively applied the accrual basis of accounting, unless
immaterial. This is not allowed under IAS 1.
■ Going concern: The notes to the account should contain a reference to the
appropriateness of the going concern assumption. From the Balance Sheet alone, it
appears the going concern may be an issue as Nora has outstanding loans within the next
two years, with very little resources to settle the obligations.
■Materiality and aggregation: There is not enough information to determine the level
of
materiality, but it appears that line items of the Balance Sheet are highly aggregated.
■ Offsetting: Nora deducted a receivable of $50 from a payable of $200 to Marcus Ltd.
This is not allowed under IAS 1.
■ Frequency, comparative information, and consistency of presentation: There was
no information on the financial statements that they are prepared at least annually.
Furthermore, there was no comparative information provided and thus consistency of
 presentation cannot be assured. The only comparative was a “total” of all numbers at the
bottom of the Balance Sheet, which does not convey any meaning.
2. What else do you expect to find in the file Nora passed to you?
IAS 1 specifies that a complete set of financial statements consists of the statement of
financial position, statement of comprehensive Income, Statement of changes in equity,
statement of cash flows, and notes to the account. The file should contain these items.

End of Chapter- Summary problem:

Requirements
1. Examine BASF’s statement of financial position in Exhibit 4-7. What are its current and
non-current assets, and current and non-current liabilities? Does it appear to meet the
presentation requirements of a statement of financial position?
Solution:
BASF uses a short-term versus long-term classification to denote current and non-current assets/
liabilities, respectively. Total currents assets are €24,566 million, total non-current assets are
€46,270 million, total current liabilities are €14,236 million, and total non-current liabilities are
€25,055 million.
BASF’s statement of financial position appears to meet the requirements in IAS 1, for example:
a. The financial statement title, date of end of reporting period, presentation currency, and
rounding, as well as comparative information, are all clearly displayed.
b. The Balance Sheet appears to display the minimum line items shown in Exhibit 4-6 (BASF
is unlikely to have assets such as biological assets). If BASF has any investment properties,
this should be presented separately on the Balance Sheet. BASF uses an older term for non-
controlling interest (labeled “minority interests”).
2. Examine BASF’s consolidated statement of income in Exhibit 4-9. Does it appear to meet
the presentation requirements of an Income Statement? Do you find sufficient details on
the face of the Income Statement to make a judgment about BASF’s financial performance
in 2015?
Solution:
BASF’s Income Statement appears to meet the requirements in IAS 1, for example:
a. The financial statement title, date of end of reporting period, presentation currency, and
rounding, as well as comparative information, are all clearly displayed.
b. The Income Statement contains all the required information. It shows total sales revenue of
€70,449 million (with additional information in Notes 4, not shown), finance costs of €638
million, equity method income of €251 million, and tax expenses of €1,247 million.
BASF also offered sufficient details on the Income Statement for readers to evaluate its financial
performance. For example:
a. The Income Statement shows additional headings and subtotals that BASF felt would make
the information more relevant to readers. For example, it displays subtotals such as gross
profit (€18,077 million), income from operations (€6,248 million), and income before taxes
(€5,548 million).
b. BASF provides additional explanation for a number of items on the Income Statement.
There is, however, a practical limit of how much you can expect a company to disclose. For
example, cost of sales is a total number without specific information on the actual cost of
every product that BASF sells. Notes 7 and 8, explaining breakdown of other operating
income and other operating expenses (not shown), provide additional details of disclosure as
well.

S4-1. (Learning Objective 1: Understanding annual reports as a communication tool) You

were discussing corporate annual reports with your friends. One of them said “Annual
reports are no different from a marketing brochure.” How would you react to this
statement?
Solution:
Annual Report:
  Purpose: To inform stakeholders about the company’s financial health, performance,
governance, and future prospects.
 Contents: Includes audited financial statements, management discussion and analysis
(MD&A), corporate governance reports, and notes to the accounts—all required by law
or accounting standards.
 Regulation: Must follow IFRS, GAAP, and stock exchange requirements; subject to
auditor verification.
 Audience: Mainly investors, analysts, regulators, and other formal users.

Marketing Brochure:
 Purpose: To promote products or services and enhance brand image.
 Contents: Focuses on benefits, visuals, and sales pitches.
 Regulation: Usually not regulated or audited.
 Audience: Customers or potential buyers.

S4-2. (Learning Objective 1: Understanding annual reports as a communication tool)

Bobby Young is one of the many investors in your company. He demands to see your
accounting records because he wants to have a “complete picture of the company’s
operations.” Write a short email in response to Bobby’s request.
Solution:
Subject: Your Request for Company Accounting Records

Dear Mr. Young,

Thank you for your investment in [Company Name] and your interest in understanding our
operations more deeply. We appreciate your engagement and commitment to transparency.

As a valued investor, you are entitled to access our audited financial statements, including the
Annual Report, Balance Sheet, Income Statement, and Cash Flow Statement. These documents
are prepared in compliance with accounting standards (e.g., GAAP/IFRS) and audited by an
independent third party to ensure accuracy. They provide a comprehensive overview of our
financial performance, position, and key operational metrics. You can access these reports on our
Investor Relations portal here: [Link].

While detailed accounting records (e.g., transactional ledgers) are confidential and reserved for
internal use to protect sensitive business information, we are happy to address any specific
questions or concerns you may have about the published financials. Please feel free to contact
our Investor Relations team at [Email/Phone] or schedule a call to discuss further.

Thank you again for your trust in [Company Name]. We remain committed to maintaining
transparency while safeguarding the interests of all stakeholders.

Best regards,
[Your Full Name]
[Your Position]
[Company Name]
[Contact Information]

S4-3. (Learning Objective 2: Identifying financial statements) What are the IAS 1
requirements in terms of the ordering of financial statements in an annual report? What
additional labels must each financial statement display?
Solution:
IAS 1 Requirements for Ordering Financial Statements and Additional Labels
Order of Financial Statements in an Annual Report (IAS 1.10): IAS 1 mandates the
following sequence for presenting financial statements in an annual report:
 Statement of Financial Position (Balance Sheet).
 Statement of Profit or Loss and Other Comprehensive Income (can be presented as one
combined statement or two separate statements).
 Statement of Changes in Equity.
 Statement of Cash Flows.
 Notes (including significant accounting policies and explanatory information).
 Comparative Information for the preceding period (e.g., prior year figures must be
disclosed alongside current period amounts).
Additional Labels Required for Each Financial Statement (IAS 1.51):
 Each financial statement must prominently display the following labels:
 Name of the Reporting Entity (e.g., "Robert’s Home Repair Services").
 Type of Statement (e.g., "Consolidated Statement of Financial Position" or "Individual
Statement of Profit or Loss").
 Date or Period Covered (e.g., "As of December 31, 20X5" for the balance sheet; "For the
Year Ended December 31, 20X5" for income statements).
 Presentation Currency (e.g., "All amounts in US dollars").
 Level of Rounding (e.g., "Amounts in thousands, unless otherwise stated").
Key Notes:
 IAS 1 emphasizes comparability: Prior-period data must be included for all numerical
information.
 Titles like "Balance Sheet" are replaced with "Statement of Financial Position" under IAS
1 terminology.
 The notes are an integral part of the financial statements and must follow the primary
statements.
 If financial statements are consolidated, this must be explicitly stated in the labels (e.g.,
"Consolidated Statement of Cash Flows").

S4-6. (Learning Objectives 2, 3: Aggregating information for presentation on the Balance

Sheet) Trivago has the following account balances:
What amount of total receivables and total payables should Trivago report on its Balance
Sheet? Is it allowed to net off the balances to and from Doha Markets?
Solution:
Trivago should report $13,500 in total receivables and $8,600 in total payables on its Balance
Sheet. Netting off the balances with Doha Markets is not permitted under the given
circumstances.
N.B. Netting off balances refers to the practice of offsetting amounts owed to a party (payables)
against amounts owed by that same party (receivables), resulting in a single net amount instead
of reporting both gross figures separately.

S4-7. (Learning Objective 3: Distinguishing current assets from non-current assets)

Wayne Enterprises has the following assets: Cash and cash equivalents $35,200, Inventory
$18,200, Receivables $32,900, Prepayments $12,000, Long-term interest-free loan to
employees $20,000, Equipment $40,000, Accumulated depreciation—equipment $4,200,
Motor vehicle $78,000, Accumulated depreciation—motor vehicle $22,800, Intangible
assets $21,000. What are Wayne’s total current assets and total non-current assets?
Solution:
Wayne Enterprises' Total Assets Breakdown:
Current Assets
Cash and Cash Equivalents: $35,200
Inventory: $18,200
Receivables: $32,900
Prepayments: $12,000
Total Current Assets = $35,200 + $18,200 + $32,900 + $12,000 = $98,300

Non-Current Assets
Long-Term Loan to Employees: $20,000
Equipment (Net): $40,000 - $4,200 = $35,800
Motor Vehicle (Net): $78,000 - $22,800 = $55,200
Intangible Assets: $21,000
Total Non-Current Assets = $20,000 + $35,800 + $55,200 + $21,000 = $132,000

S4-8. (Learning Objective 3: Distinguishing current assets from non-current assets) Wayne
Enterprises have the following liabilities: Accounts payable $24,000, Accrued staff wages
$3,100, Accrued interest $2,600, Commission payable $2,800, Tax payable $6,000, Loan
$110,000 (half of which is due in the coming financial period). What are Wayne’s total
current liabilities and total non-current liabilities?
Solution:
Wayne Enterprises' Total Liabilities Breakdown:
Current Liabilities
Accounts Payable: $24,000
Accrued Staff Wages: $3,100
Accrued Interest: $2,600
Commission Payable: $2,800
Tax Payable: $6,000
Current Portion of Loan: $110,000 × ½ = $55,000
Total Current Liabilities = $24,000 + $3,100 + $2,600 + $2,800 + $6,000 + $55,000 = $93,500
Non-Current Liabilities
Non-Current Portion of Loan: $110,000 × ½ = $55,000
Total Non-Current Liabilities = $55,000
S4-9. (Learning Objective 4: Assessing net income versus comprehensive income) Company
Nile reported a net profit of $2 million on its Income Statement and a $2 million loss in
other
comprehensive income. Company Thames reported a net loss of $2 million on its Income
Statement and $2 million other comprehensive income. Both Nile and Thames, thus, report
zero total comprehensive income. If you have to pick one company, which company would
you pick? Why?
Solution:
Recommendation: Choose Nile.
Reasoning:
Nile reports a net profit of $2 million from core operations, indicating its primary business
activities are profitable.
Thames reports a net loss of $2 million from operations, signaling challenges in its fundamental
business model.

E4-13A. (Learning Objective 1: Identifying key elements of an annual report) For each of
the following items, identify which section they would typically appear in on an annual
report. Use (1) for corporate information, (2) for analysis and commentaries, (3) for other
statements and disclosures, and (4) for financial statements.
a. Revenue recognition policy -3____
b. Company history - 1
c. Listing of company’s subsidiaries and associated entities - 3
d. Review of segment performance - 2
e. New upcoming product launches - 2
f. Breakdown of trade and other payables - 4
g. Chairman’s letter to shareholders - 2

E4-15A. (Learning Objective 2: Understanding materiality) Insignia is a company with

total
assets of $500,000, total revenue of $800,000, gross profit of $300,000, and net profit of
$100,000 in its last financial year, 20X5. Which of the following items are likely to be
material for Insignia?
A common benchmark is anything affecting 5% or more of net profit, total assets, or equity—but
qualitative factors (like legal risk or regulatory compliance) are equally important.
a. There was an error in the calculation of commission payable to employees amounting
to $2,200 in 20X4. The additional payments were made in 20X5, but the 20X4
comparatives on the financial statement were not adjusted for this error.
Quantitative assessment: $2,200 is only 2.2% of net profit and 0.44% of assets —
relatively small.
Qualitative assessment: It’s an error, but not a significant one, and it relates to a prior year.
Conclusion: Not material.
b. Insignia has erroneously recognized revenue for items that have not yet been shipped
to customers at the end of 20X5, amounting to $28,000.
Quantitative: $28,000 is 28% of net profit and 9.3% of gross profit — quite significant.
Qualitative: Recognizing revenue prematurely is a serious accounting error affecting
reported earnings.
Conclusion: Material.

c. Insignia suffered a major flood in one of its largest warehouses in September 20X5.
Insignia did not recognize or disclose the losses it suffered because it was in the
process of making claims to its insurance company. In early 20X6, before the
issuance of the annual report, the insurance company paid the claims in full.
Quantitative: We don’t have exact figures, but flood damage to a major warehouse could
involve significant assets or inventory.
Qualitative: This is a significant event that occurred before report issuance and should be
disclosed as a subsequent event under IAS 10.
Conclusion: Material.
d. Insignia sold an old factory to another company. The buyer was going to demolish
the factory and build a hostel on the site. However, the buyer failed to secure
permission to build the hostel because the grounds showed higher levels of toxicity
than allowed. The buyer claimed this is due to Insignia’s failure to meet
environmental regulations on disposal of industrial waste in the past. The buyer is
now suing Insignia for damages, expected to be in the millions. Insignia believes this
lawsuit is baseless and would vigorously defend the case in court. It did not mention
this lawsuit in its annual report.
Quantitative: A lawsuit for "millions" is vastly higher than Insignia’s $100,000 profit or
$500,000 assets.
Qualitative: A pending legal claim that could severely impact financial position should be
disclosed or provisioned under IAS 37.
Conclusion: Material.
E4-17A. (Learning Objective 3: Classifying assets based on liquidity) A thorough review
of GE Broadcasting assets at the end of December 31, 20X5, resulted in the following
information:
■ Cash on hand and cash at bank totaling $484,000
■ Fixed-term deposits with banks totaling $142,000 (matures July 1, 20X7)
 ■ Inventories totaling $324,000
■ Trade receivables totaling $245,000
■ Loans to employees of $120,000, 30% of which is due by the end of 20X6
■ PPE with a historical cost of $129,000 and accumulated depreciation of $12,000
■ Investment in associate companies using equity method at $35,000
■ Short-term investment in publicly traded shares of listed companies at $10,000
What is GE Broadcasting’s current and non-current assets?
Solution:
Current Assets:
Cash: $484,000
Inventories: $324,000
Trade receivables: $245,000
Loans (30% of $120,000): $36,000
Short-term investments: $10,000
Total Current Assets = $1,099,000

Non-Current Assets:
Fixed-term deposits: $142,000
Loans (remaining 70%): $84,000
PPE (net): $117,000
Investment in associates: $35,000
Total Non-Current Assets = $378,000

E4-18A. (Learning Objective 3: Classifying liabilities based on liquidity) The same review in
E4-17A resulted in the following information on GE Broadcasting’s liabilities at the end of
December 31, 20X5:
■ Trade payable of $317,000
■ Note payable of $245,000 due July 1, 20X7
■ Interest accrued for note payable $8,000 (payable every quarter, the next payment being
on April 1, 20X6)
■ Provisions for unbilled expenses of $40,000
■ Provision for employee benefit of $248,000 (first employee retirement expected in 20X9)
■ Interest-free loan from a shareholder, totaling $400,000, payable in eight equal quarterly
installments, first payment due on March 1, 20X6.
What are GE Broadcasting’s current and non-current liabilities?
Solution:
Current Liabilities:
Trade payables: $317,000
Interest accrued: $8,000
Unbilled expenses: $40,000
Shareholder loan (4 quarterly installments): $200,000
Total Current Liabilities = $565,000

Non-Current Liabilities:
Note payable (due 2027): $245,000
Provision for employee benefits: $248,000
Shareholder loan (remaining 4 installments): $200,000
Total Non-Current Liabilities = $693,000

E4-19A. (Learning Objective 4: Preparing Statement of Comprehensive Income) Logan

Enterprise reported the following balances.

Prepare Logan’s Statement of Comprehensive Income in a single statement format and a

two
separate statements format.
Solution:

Logan Enterprises
Comprehensive Income Statement
As of December 31, 20X5 and 20X4
2025($) 2024($)
Revenue
Sales revenue 37800 22900
Other income 5300 4700
Total revenue 43100 27600
Cost of goods sold 12200 9300
Gross Profit 30900 18300
Operating expenses
Distribution expenses 2300 2200
Marketing expenses 3700 3000
Administrative expenses 2800 2400
Total operating expense 8800 7600
Net operating income 22100 10700
Finance expense 600 500
Profit before tax 21500 10200
Tax expense 1500 1000
Net Income 20000 9200
Other comprehensive income 4400 3600
Total comprehensive income 24400 12800

P4-39A. (Learning Objective 1: Expressing an audit opinion) You have just completed the
audit of four companies: Summer, Autumn, Winter, and Spring. The conclusions of the audits
are summarized below for each company.
■ Summer: Its financial statements fairly represent the company’s financial position and
performance, but the audit team disagreed with management’s use of a particular estimate.
■ Autumn: Its financial statements are wrought with errors, as the accountant has completely
messed up the translation of various foreign currencies in numerous accounts. As a result, the
Balance Sheet, whilst still balanced, is not a faithful representation of the economic phenomenon
during the financial period.
■Winter: The accountant was not able to explain numerous discrepancies. One of the major
problems were that the receivable, inventory, and payable control accounts do not tally with their
respective sub-ledger, making it impossible to audit.
■ Spring: The audit highlighted a number of immaterial differences in the calculation of
depreciation for the year.
Requirements
Propose the most appropriate type of audit opinion for Summer, Autumn, Winter, and
Spring
based on the audit notes above.
Solution:
Company Type of Opinion Reason
Summer Qualified Material but not pervasive misstatement
Autumn Adverse Material and pervasive misstatement
Winter Disclaimer Material and pervasive limitation of scope
Spring Unqualified No material misstatement

P4-40A. (Learning Objective 3: Preparing a classified Balance Sheet) The accounts of Bay
View Services Ltd. as of June 30, 20X5, are listed below in alphabetical order.

Requirements
Prepare the Bay View Services’ classified Balance Sheet at June 30, 20X5. Show necessary
captions. Note that for this question, you do not need to show comparative amounts.
Solution:

Bay View Services Ltd.

Classified Balance Sheet
As of June 30, 20X5
 Liabilities and Shareholder's Amount(
Asset Amount($) Equity $)

Current assets Current liabilities

Cash 7900 Accounts payable 14400

Account receivable 16600 Salary payable 2700

Supplies 3900 Current portion of notes payable 1000

Prepaid expenses 6000 Unearned service revenue 2800

Total current assets 34400 Total current liabilities 20900

Non-current assets Long-term liabilities

Equipment* 44700 Note payable, long-term 6000

Other assets 14400 Total Liabilities 26900

Total non-current
assets 59100

Total assets 93500 Shareholder's equity

Share capital 6600

Retained earnings 21000

Net income 60200

Dividends -21200

Total shareholder's equity 66600

Total Liabilities and Shareholder's

Equity 93500

Revenue 95400

Expense 35200

Net income 60200

P4-41A. (Learning Objectives 2, 4: Aggregating information for presentation on the Income

Statement) Robert’s Home Repair Services had the following balances at the end of 20X4 and
20X5.
Requirements
1. Assuming that Robert would like to disclose no more than what is required by
accounting
standards, with the maximum level of aggregation possible, prepare an Income Statement
to such effect.
Solution:
Robert's Home Repair Services
Income Statement
As of December 31, 20X5
Category Amount 20X5($) Amount 20X4($)
Revenue
Sales Revenue 40800 32900
Service revenue 21300 17700
Total revenue 62100 50600
Cost of goods sold 17200 13400
Gross profit 44900 37200
Operating expenses
Wages and Salaries 12300 10200
Depreciation 2700 2700
Supplies expense 8800 7400
Motor vehicle expense 4500 3100
Fuel expense 2600 1400
Utilities expense 1100 2500
Advertising expense 3700 3100
Total expense 35700 30400
Net Operating Income 9200 6800
Other items
 Interest Income 3300 2900
Interest expense -600 -500
Profit before tax 11900 9200
Tax expense 2400 1000
Net Income 9500 8200

2. Why would it not be possible for Robert to simply show a three-line Income Statement,
one that simply lists total revenue, total expenses, and net profit?
Solution:
Accounting standards (e.g., IFRS, GAAP) require specific disclosures to ensure transparency.
Users need to evaluate critical components like gross profit, operating performance, and tax
impacts. Aggregating all revenues/expenses into single lines would obscure key details, such as
cost structure, profitability drivers, and financial risks, violating the principle of fair presentation
3. How should Robert decide which line items are important enough to be shown separately
on the Income Statement and which ones to aggregate?
Solution:
Robert should:
 Apply materiality: Items exceeding 5% of total revenue/expenses should be disclosed
separately (e.g., COGS, wages).
 Separate by nature/function: Distinct categories (e.g., Sales vs. Service Revenue, COGS
vs. Operating Expenses) must be split to reflect business operations.
 Follow standards: Mandatory line items (e.g., tax, interest) are always separate.
Immaterial items (e.g., fuel expense) may be aggregated.

P4-42A. (Learning Objectives 2, 4: Reporting comparative amounts on the Income Statement)

Refer to Robert’s Home Repair Services account balances for 20X4 and 20X5 in P4-41A.
Suppose Robert decided to show all the accounts on its Income Statement. In addition, Robert
discovered that:
■ Supplies expense in 20X4 and 20X5 contained an item amounting to $500 in each year
that is more appropriately classified as advertising expense.
■ Other expenses in 20X4 and 20X5 contained an item amounting to $400 in each year that
is more appropriately classified as motor vehicle expense.
Requirements
Prepare Robert’s Income Statement for 20X5 with the appropriate 20X4 comparative
amounts.
Solution:
Robert's Home Repair Services
Income Statement
As of December 31, 20X5
Amount Amount
Category 20X5($) 20X4($)
Revenue
Sales Revenue 40800 32900
Service revenue 21300 17700
 Total revenue 62100 50600
Cost of goods sold 17200 13400
Gross profit 44900 37200
Operating expenses
Wages and Salaries 12300 10200
Depreciation 2700 2700
Supplies expense* 8300 6900
Motor vehicle expense* 4500 3100
Fuel expense 2600 1400
Utilities expense 1100 2500
Advertising expense* 4200 3100
Total expense 35700 29900
Net Operating Income 9200 7300
Other item
Interest Income 3300 2900
Interest expense -600 -500
Profit before tax 11900 9700
Tax expense 2400 1000
Net Income 9500 8700

P4-43A. (Learning Objectives 3, 5: Preparing a note to the financial statement) Musashi

Ltd. commenced operations on January 1, 20X6. On that day, it bought:
■ Equipment costing ¥3.6 million, with a useful life of 3 years.
■ Furniture and fittings costing ¥2.4 million, with a useful life of 4 years.
■Motor vehicles costing ¥4.5 million, with a useful life of 10 years.
No other PPE was purchased or disposed of during the year.
Requirements
What would Musashi report as PPE on its Balance Sheet? Prepare the notes to the accounts
related to PPE. Note that you may need to look at how BASF provided a similar note on its
PPE.
Solution:
Musashi Ltd.
Property, Plant, and Equipment (PPE) Disclosure
As of December 31, 20X6
Balance Sheet Presentation
Category Amount (¥ million)
Non-Current Assets:
Property, Plant, and Equipment (Net) 8.25
Notes to the Accounts:
Category Cost as of January Accumulated Carrying Amount as of
1, 20X6(¥ million) Depreciation(¥ December 31, 20X6(¥
million) million)

Equipment 3.60 (1.20) 2.40

Furniture and 2.40 (0.60) 1.80

Fittings

Motor 4.50 (0.45) 4.05

Vehicles

Total PPE 10.50 (2.25) 8.25

Depreciation Policy
Method: Straight-line depreciation is applied to allocate the cost of PPE over their estimated
useful lives.
Useful Lives:
Equipment: 3 years
Furniture and Fittings: 4 years
Motor Vehicles: 10 years
Key Assumptions
No impairments, disposals, or transfers occurred during the year.
Residual values are assumed to be zero for all asset categories.
The company commenced operations on January 1, 20X6, and all PPE was acquired on this date.

P4-44A. (Learning Objectives 2, 5: Understanding materiality, correction of prior period profits)

In December 20X8, just before the financial statements were finalized, James & Jones
discovered that a programming error in the calculation of depreciation of specialized, expensive
machinery has caused the annual depreciation charge to be erroneously calculated. The error
started from the date the machinery was purchased on January 1, 20X2. The error resulted in a
lower depreciation of $120,000 per year. Due to a large dividend payment in the previous year,
J&J’s total equity balance stands at $1,200,000 at the end of 20X8.
Requirements
In your opinion, is this error material or not material? Why? How should this be rectified
in the 20X8 financial statements, if needed?
Solution:
The company understated depreciation by $120,000 per year.
This began from January 1, 20X2, and continued through 20X8 (7 years total).
The cumulative error amounts to:
120,000×7=$840,000
This qualifies as a material prior-period error under IAS 8, as it resulted from a programming
mistake and caused significant misstatement of net income and asset values.
It equals 70% of the total equity at year-end 20X8:
840,000
=70 %
1,200,000
A 70% impact on equity would influence financial decisions of users of the statements.
Therefore, under IAS 8, this material prior-period error must be retrospectively restated.
Rectification:
Restate prior financial statements as if the error never occurred:
 Adjust the opening balances of assets, liabilities, and retained earnings as of January
1, 20X8 (or the earliest period presented).
 Increase accumulated depreciation by $840,000.
 Decrease retained earnings by $840,000.
Disclose in the Notes:
 Description of the error and how it occurred (programming issue).
 The amount of the correction for each affected year.
 The total cumulative impact ($840,000).
No adjustment to the 20X8 income statement since this is a prior-period adjustment.

P4-45A. (Learning Objectives 2, 5: Understanding annual reports and financial statements

reporting requirements) Manuel Young, the new accountant of Raffles Place Ltd., was
preparing the company’s financial statements ending 20X6. During the year, the company:
■ Changed the useful life estimates of some assets from 3 to 5 years.
■ Had to account for its investment differently due to the publication of a new IFRS.
■ Changed its accounting policy on revenue recognition.
■ Discovered an error in the 20X5 financial statement.
Manuel is somewhat unsure of what to do next. He has emailed you, his former accounting
professor, for advice.
Requirement
Write a reply to Manuel and offer your guidance on the appropriate treatment of the items.
1. Change in Useful Life Estimates (from 3 to 5 years)
This is considered a change in accounting estimate.
Treatment:
 Do not restate prior-period financials.
 Apply the change prospectively, meaning use the new estimate (5 years) from 20X6
onward.
 Disclose the nature and reason for the change in the notes to the financial statements.
2. New IFRS Impacting Investment Accounting
This is a change due to a new IFRS standard.
Treatment:
 Follow the transition guidance provided in the new IFRS.
 Often this involves either retrospective application or prospective adoption, depending on
what the standard requires.
 Be sure to disclose the change, the reason (i.e., new standard), and the financial impact in
the notes.
3. Change in Accounting Policy on Revenue Recognition
This is a voluntary change in accounting policy, assuming it’s not due to a new IFRS.
Treatment:
 Apply the change retrospectively, as if the new policy had always been in use.
 Restate prior-period financial statements, unless impractical.
  Adjust the opening balances of assets, liabilities, and equity for the earliest period
presented.
 Disclose the nature of the change, the reason, and its effect on current and prior periods.
4. Error in the 20X5 Financial Statement
This is a prior-period error.
Treatment:
 Treat it as a material prior-period adjustment.
 Restate the 20X5 financial statements to correct the error.
 Adjust the opening retained earnings of the earliest period presented if full restatement is
not practical.
 Clearly disclose the nature of the error, the corrected amounts, and its impact.

Case 1. (Learning Objectives 3, 4, 5: Preparing financial statements) You are the accountant of
Majestic Limited, headquartered in Zurich, Switzerland, and have just completed the accounting
cycle for the period ended December 31, 20X5. You have performed all necessary adjustments
and closing entries to the accounts. The adjusted trial balance (after allocation to function
expense categories) is shown as follows, along with comparative figures from the last financial
year.
Requirement
Prepare the statement of financial position, statement of comprehensive income, and
statement of changes in equity in good form, with any relevant accompanying notes to the
financial statements. Before aggregating line items, you should consider the key principles
outlined in IAS 1.
Solution:

Majestic Limited
Statement of Comprehensive Income
As of December 31, 20X5 and 20X4
Amount Amount
Category 20X5(in CHF) 20X4(in CHF)
Revenue
Sales revenue 166700 151100
Commission revenue 32900 26500
Dividend income 49300 53800
Total revenue 248900 231400
Cost of Sales 41600 39800
Gross profit 207300 191600
Expenses
Logistics and distribution
expenses 26900 34200
Sales and marketing expenses 16300 35700
Other administrative expenses 29100 46300
Total expenses 72300 116200
Net operating income 135000 75400
 Finance expenses 21700 22200
Profit before tax 113300 53200
Tax expense 23700 20800
Net income 89600 32400
Other comprehensive income 0 0
Total comprehensive income 89600 32400

Majestic Limited
Statement of Changes in Equity
As of December 31, 20X4
Common Additional Retained
Stock Paid-in Capital Earnings Total
Balance January 1, 20X4 0 0 87400 87400
Stock issuance 150000 150000
Net income 32400 32400
Dividends 45000 45000
Balance December 31, 20X4 150000 0 74800 224800

Majestic Limited
Statement of Changes in Equity
As of December 31, 20X5
Common Additional Retained
Stock Paid-in Capital Earnings Total

Balance January 1, 20X4 150000 0 74800 224800

Stock issuance 19500 19500

Net income 89600 89600

Dividends 80000 80000

Balance December 31, 20X4 169500 0 84400 253900

Majestic Limited
Statement of Financial Position
As of December 31, 20X4 and 2025
Assets 2025(in 2024(in Liabilities and 2025(in 2024(in
 CHF) CHF) Shareholder's Equity CHF) CHF)
Current assets Current liabilities
Cash on hand 68900 51200 Trade payables 39900 34900
Bank account
balances 76000 55000 Dues to employees 27200 17700
Trade
receivables 80300 47000 Notes payable(due20X6) 40000 0
Interest
receivable 26100 25300 Unearned revenue 22900 29100
Other
receivables 46000 60300 Deferred income 25000 24000
Inventory 50300 47000 Accrued liabilities 8300 13600
Advances to
employees 43600 49400 Total current liabilities 163300 119300
Prepaid
Insurance 25800 24300 Long-term liabilities
Prepaid rent 10200 24300 Bank loan(due 20X8) 120000 120000
Prepaid
subscriptions 3500 2300 Notes payable(due20X6) 0 40000
Total current
assets 430700 386100 Total long-term liabilities 120000 160000
Non-current
assets Total liabilities 283300 279300
Vehicles and
trucks(Net) 25000 30000 Shareholder's Equity
Furniture and
fixtures(Net) 29500 31000 Common stock 169500 150000
Office
equipment(Net) 31000 33000 Retained earnings 84400 74800
Store
equipment(Net) 21000 24000 Total Shareholder's Equity 253900 224800
Total non-current Total Liabilities and
assets 106500 118000 Shareholder's Equity 537200 504100
Total Assets 537200 504100

Notes to Financial Statements

1. Accounting Policies: Financial statements comply with IAS 1. Depreciation is calculated
using the straight-line method.
2. Equity Changes: Share Capital increased by 19,500 CHF due to new issuances. Retained
Earnings include net income and dividends.
3. Tax Expense: Calculated at the applicable statutory rate.
4. Comparative Figures: Provided for 20X4 to enhance comparability.