Case Studies in Accounting

(1)

ISSN 2362-020X

Case Studies in Accounting

“Bridging the Gap”

.

Department of Accountancy

Faculty of Commerce and Management Studies University of Kelaniya

(2)

Editorial Board

Dr. P.M.C. Thilakarathne

B.Com. (Kel’ya) , M.Com. (Panjab), Ph.D. (Aegean)

Senior Lecturer- DoA Mr. R.M. S Bandara

B.B. Mgt. (Acc) (Kel’ya), ACA, ASA(Aust.)MBA (C’bo)

Senior Lecturer – DoA

Ms. W.M.H.N Wijekoon

B.B. Mgt. (Acc) (Kel’ya) MBA (C’bo), Passed Finalist CA Sri Lanka

Lecturer – DoA Mr. G.M.M Sujeewa

B.B. Mgt. (Acc) (Kel’ya), MSc (j'pura) Passed Finalist CASL

Lecturer – DoA

Mr. Samira Wipul Anthony

B.B.Mgt. (Finance) (Kel’ya), Passed Finalist CA Sri Lanka

Lecturer (Prob.) – DoA Panel of Reviewers

Dr. M.W Madurapperuma BA.(Econ)(C’bo),M.A.

(Econ)(C’bo),M.Com(Kel’ya),Ph.D. (UK) Head - Department of Accountancy (DoA) Dr. J.M.D. Ariyarathne

B.Com.(Kel’ya), M.Com. (Kel’ya), Ph.D (USQ), FCA

Senior Lecturer – DoA Ms. U.L.T.P. Gunasekara

B.Sc. Bus. Ad. (Sri J’pura), MBA (C’bo) Senior Lecturer- DoA

Dr.K.K. Thilakasiri

B.Com., (S. J’pura), MSc (Mgt.) (S.J'pura), Ph.D (Melb)

Senior Lecturer - DoA Dr. W.V.A.D Karunaratne

B.B. Mg . (Acc) (Kel’ya), PGD in Bus. Stat (S. J’pura), M.Com (Kel’ya), MAAT, Ph.D (CCNU)

Senior Lecturer – DoA Dr.D.K.Y Abeywardana

B. Com (S. J’pura , M.Sc (Mgt) (S. J’pura), Ph.D (UK), MAAT

Senior Lecturer – DoA

Mr. A.M.I. Lakshan

B.B.Mgt. (Acc) (Kel'ya), MBA (S. J’pura) Senior Lecturer – DoA

Mr. C.R. Thilakarathne

B.Sc (Computer) (Peradeniya), MCS (C’bo) Senior Lecturer – DoA

Ms. K.N Wijesinghe

B.B. Mgt. (Acc) (Kel’ya), MBA (C’bo), CA Strategic II

Lecturer – DoA

Ms. U.A.H.A Rathnasiri

B.B.A. (Finance) (C’bo), CA Strategic II Lecturer (Prob.) – DoA

Ms. Amila Rajapaksha

B.B.A. (Finance) (C’bo), CA Strategic II Lecturer (Prob.) – DoA

Mr. Prabath Perera

B.B.Mgt. (Finance) (Kel’ya), AMA (CMA Australia)

Lecturer (Prob.) – DoA Ms. Dilini Aruppala

B.B.Mgt. (Finance) (Kel’ya), CA Strategic II Lecturer (Prob.) – DoA

(3)

DoA

Case Studies in Accounting -2014 3

Editorial Note

Dear readers, we are pleased to offer these case studies in Accounting as 1st volume in year 2014. The Case studies in accounting is published annually by the Department of Accountancy.

The Case Study Book provides a valuable forum for the publication of selected case studies that address the significant issues in financial reporting and accounting. The book aspires to promote contemporary issues pertaining to interdisciplinary understanding on financial reporting and accounting. It aims to publish case studies that bridge the gap between accounting theory and practice and encourages submissions of high quality manuscripts that have an impact upon academia, accounting practice and stakeholders.

It covers a broad scope of areas related to financial reporting and accounting by providing understanding of theory and practice in a variety of fields in Accounting. It also keeps abreast with the development and advancement of accounting knowledge in financial reporting and accounting, blending theoretical aspects in to practical scenarios.

Manuscripts in this publication are the output of the interns of the Department of Accountancy in year 2013. Further we appreciate the generous support given by the training partners providing opportunities to interns for applying their knowledge into the practical context.

(4)

DoA

Recognition of revenue on freight forwarding services M.A.G. Piyankara &C.S.W. Anthony

[email protected] &[email protected] Introduction

Global Lanka Limited is a Limited liability company which is providing international freight forwarding services and clearing services. Exporters handover their goods to the company and the company transport to destination with the assistance of suppliers in the company. Currently,revenue and cost of revenue of the company were recognized without concerning whether it qualifies for recognition under relevant accounting standard and stage of completion at the time of reporting date by the company. According to the SLFRS for SMEs, Revenue from rendering service need to be recognized when stage of completion can be reliably measurable at the reporting date.

Discussion of the Issue

The normal forwarding transaction is carried out in four stages. The company assesses cost of each stage before accepting the contract and determines the sale price by adding a profit margin to it and confirms it with an agreement with customers (Exporters). Level of completion of each stage is followed on exchanging documents and via mails with their suppliers. But the issue is company recognizes revenue and cost of revenue before completing each stage and company can’t measure stage of completion reliably due to the non-completion of each stage. (Example given below)

(5)

DoA

Case Studies in Accounting -2014 5 Invoice No Stage 01 Com: % Stage 02 Com: % Stage 03 Com: % Stage 04 Com: % 12 UKR 35,111. 100 325,600. 75 41,664. 0 136,710 0

(Com: - Completion %, Total Cost – Rs.539, 085.00)(Gross Profit Margin 8%, Total Revenue – Rs.582, 211.80)

In this case the company has recognized total cost and total revenue as company’s cost of revenue and revenue end of the period. Although second stage is completed 75%, it can’t be measured reliably. It is non-compliance with SLFRS for Small and Medium Enterprises. According to this scenario, the company has failed to recognize revenue & cost of revenue as at the reporting date accurately and it presents an incorrect gross profit in Statement of Comprehensive Income. On the other hand, computation of tax is not correct, and also management has failed to take a proper decision on revenue and profit for the period.

Conclusions and Recommendations

In this case, we can identify that only Rs.35, 111/- as cost of sale and 37,920/- (Cost +8%) as revenue at the reporting date. Balance cost of revenue (Rs.503, 974.00) & revenue (Rs.544, 292.00) should be reversed.

Revenue from rendering service need to be recognized when stage of completion can be reliably measurable at the reporting date as per the section 23.14-23.16 and 23.21-23.27 of SLFRS for Small and Medium Enterprises. Specially, the outcome of a transaction can be estimated

(6)

DoA

reliably when four conditions are satisfied according to the standard.

We suggest to the client; Revenue should be recognized based on the stage of completion as at the reporting date and it can be reliably measurable according to the SLFRS for Small and Medium Enterprises and further the system should be adjusted in a way to facilitate stage of completion method.

(7)

DoA

Identification of Non-Current Asset Held for Sales S.J.K.U.Chinthaka & M.A.T.K.Munasingha

[email protected] & [email protected] Introduction

Wisdom Logistics (PVT) Limited is a Board of Investment (BOI) approved company which aims to lead the industry by utilizing world-class technology to provide solutions for complex logistic needs. Wisdom Logistics (PVT) Limited own prime movers which is classified under property plant and equipment in financial statements. These prime movers are used to provide transport services. Company is currently using cost model for the measurement of property plant and equipment. During the current financial year the Board of Directors have approved the resolution for selling some of these prime movers, but no any adjustment has been made during the current financial year regarding this.

Sri Lanka Accounting Standard SLFRS 5 Non-Current Asset Held for Sales and Discontinued Operation was issued by the Institute of Charted Accounts of Sri Lanka. According to the standard a non-current asset should be classified as “held for sale” if it’s carrying amount will be recovered principally thorough a sale transaction rather than though continuing use.

Following requirement should be satisfied to classify a non-current asset as held for sales.

The asset must be available for immediate sale in its present condition

(8)

DoA

The appropriate level of management must be committed to a plan to sell the asset

An active programme to locate a buyer and completed the plan must have been initiated

The sales should be expected to qualify for recognition as completed sales within one year from the date of classification, events or circumstance may extend the period to complete the sale beyond one year

Wisdom Logistics (PVT) Limited satisfied above

requirement therefore, those prime movers should be classified as held for sales asset.

Non-current asset that qualify as held for sale should be measured at the lower of;

• Carrying amount and

• Fair value less costs to sell

Held for sale non-current asset should be;

• Presented separately in the Statement of Financial Position

• Not depreciated

According to this case the company has depreciated their prime movers. As a result of that the company profit has been decreased and also written down value of motor vehicle shown in financial statement has been understated.

According to the SLFRS 5 non Current Assets held for Sales Company should present separately present Non Current assets held for Sales from their Property, Plant and Equipments. And also that asset should not be depreciated from the date of classified as Held for Sales

(9)

DoA

Separation of dual purpose asset as investment property and property plant & equipment

T.M.B.P.Bandara&Mr.C.S.W.Anthony [email protected] &[email protected] Introduction

Nisansala Fresh Teas (Private) Limited is a limited liability company incorporated in and domiciled in Sri Lanka. The principal activity of the company which is carry on the business of manufacturers and exports of Bulk Tea, Tea packets, Tea Bags and other kinds of products and by products processed or made of tea. Company has a building with four floors which were used for dual purpose for rent and administration and these two portions can be sold separately. However, company has been unable to get fair value assessment of the investment property as at the reporting date in Statement of Financial Position. Therefore, whole property has been shown as property plant &equipment in the financial statement at cost as one unit. Company has incurred additional cost such as decoration part, air condition, attached bathroom, and entertainment facilities etc., to upgrade the part of the building that has been given for rent. However it is not practical for company to separate the cost additionally they incurred and fair value of the investment property.

According to the Section 17 SLFRS for SMEs mixed use property shall be separated between investment property and property plant & equipment. However, if the fair value of the

(10)

DoA

investment property component cannot be measured reliably without undue cost or effort, the entire property shall be accounted for as property, plant & equipment. However, The Company wishes to recognize two parts as property plant & equipment at cost and Investment Property at fair value.

The impact of this issue to the statement of comprehensive income and the statement of financial position are as follows.

 Depreciation may be over stated.

 A gain or loss arising from a change in the fair value of investment property not included in the profit & loss account.

 Investment property also included in the property, plant & equipment. Therefore, it not appropriate for proper presentation.

It is recommended that one of the following methods to be used to determine the fair value of the property In the absence of current prices in an active market an entity considers information from a variety of sources, including; a) The best evidence of fair value is given by current prices in an active market for similar property in the same location and condition.

b) Recent prices of similar properties on less active markets.

c) discounted cash flow projections based on reliable estimates of future cash flows, supported by the terms of any existing lease and other contracts and (when possible) by external evidence such as current market rents for similar properties in the same location and condition, and using

(11)

DoA

discount rates that reflect current market assessments of the uncertainty in the amount and timing of the cash flows.

(12)

DoA

Accounting for goods sold with a right to return

H.P.S.M.Jayarathna & W.V.A.D.Karunarathne

[email protected] & [email protected]

Introduction

NOVA (Pvt) limited engages in importing of pharmaceutical products, warehousing, and distributing (wholesale activities). The company uses MYOB accounting package for accounting purpose. The company faced an issue relating to revenue recognition, that is how to recognize revenue when return goods that goods sold with a right of return in previous year.

Since the pharmaceutical products have different range of expiry periods the company use different due dates for sales returns. In this process some sales transactions are occurring in one financial year and returns of that sales are occurring in following financial year. The issue is how to get these returns in to accounts. The company considers this as current year sales return and used following journal entries.

When selling goods When sales Return

1. Debtor Dr xxx 1. Sales Dr xxx Sales Cr xxx Vat output/Payable Cr xxx Vat Output/payable Cr xxx Debtor Cr xxx (being enter the sales) (being Reverse the sales)

2. Cost of sales Dr xxx 2. Inventory Dr xxx Inventory Cr xxx Cost of sales Cr xxx (being enter the sales cost) (being Reverse the sales cost)

(13)

DoA

The accountant expressed his views saying that the method carried up to now is usual and we cannot access and alter the previous data base and we have no authority to do changes to the retained earnings. Data entry operator entered the sales invoice and returns as they received. When the retunes on previous year sales are considered as current year sales return it affects the Sales, VAT payable and cost of sales accounts and are not reflect the correct values for current period. So in the statement of comprehensive income, sales were under stated. According to the framework for preparation and presentation of financial statements, it violates the matching concept. On the other hand there is no responsible person to record returns and alter the relevant accounts, due to poor internal control procedures.

Conclusion and recommendations

It is a common practice in the retail and consumer products industries to sell goods with a right of return. The company should not recognize revenue for sales that are expected to fail because the customer exercises its right to return the goods, therefore under LKAS 18, revenue is recognized when the shipment has been formally accepted by the buyer or the goods have been delivered and the time period for rejection has elapsed According to the current situation, if impacts on accounts are not material it is allowed to consider as current year sales return, but the impacts of the accounts are material it is recommended to do a prior year adjustment. i.e. make adjustment to retain earnings and should disclose the effects on EPS, tax and sales, nature of adjustment,

(14)

DoA

besides, from this year the company would record a liability on their balance sheets representing their obligation related to the expected returns, there after any changes in provision should be charged to the profit and loss account respectively. Accordingly, the company needs to estimate their expected returns and recognize revenue net of the expected returns. That is, the amount entity is reasonably assured to be entitled to at the end of the return period, taking into consideration the products expected to be returned. An estimate of its expected returns would be determined using either an expected value (probability-weighted) approach or the most likely amount to be received, Whichever better predicts the amount of revenue (net of returns) to which the entity will be entitled. If an entity is unable to estimate expected returns, revenue should not recognized until the end of the return period. Together, it would also record an asset for their right to recover the goods expected to be returned by the customer. Hence an amount equivalent to this asset is generally included in inventory, and need to be presentation the returned inventory separately from normal inventory, this returned inventory would be subject to impairment testing, by periodically evaluating the returned asset for impairment separately, as opposed to considering the asset as part of their overall evaluation of inventory for impairment. The company should implement proper internal control system to record sales and sales returns especially to approve the return and record them into relevant accounts.

(15)

DoA

Double counting assets when investment properties are measured at fair value

M.D.P Kawshalya & Mr. C.S.W. Anthony [email protected] & [email protected] Introduction

The XYZ Limited owns an island with a club house and a restaurant which is classified under investment property in the financial statements and it uses to rent out to the people for their personal parties, weddings and other functions. Currently, the company measures its investment property at cost model and therefore the cost of the land and the buildings of the island is recognized under the investment property and the other plants and equipment in the same location (i.e. furniture, air conditioners and generators) are categorized under the property plant and equipment.

Because the company is currently using the cost model for the measurement of investment property, there is no probability of double counting the value of the other assets (i.e. furniture, air conditioners and generators) located in the club house and restaurant. But from this year onward because the company is going to adopt the fair value model in the measurement of investment property, then there is a possibility of double counting those assets in financial statements.

In determining the fair value or market value of this kind of club house and restaurant, it is obvious that the fair value of such property cannot be obtained by putting apart the

(16)

DoA

properties like furniture, generators and air conditioners which are integral parts of that property. The company has obtained a valuation for this investment property from a qualified valuer and in his report also he has mentioned that in determining the market value of this investment property, he has taken in to the account all the assets located in the same premises.

Therefore when company is going to recognize its investment property at fair value, it must be considered the possibility of double counting those assets in the financial statements. Otherwise, the value of the assets (i.e. either the value of property, plant & equipment or investment property) will be overstated and as a result the financial position of the company will also be overstated than the actual financial position of the company. It will lead to lose the reliability and relevance of the financial statements and the decisions made based on such financial statements also can be misled.

In Sri Lanka Accounting Standard (LKAS) 40 – “Investment Property”, there is a separate paragraph regarding the possibility of double counting assets in applying the fair value model for the measurement of investment property which is extracted below.

“In determining the carrying amount of the investment property under the fair value model, an entity does not double-count assets or liabilities that are recognized as separate assets and liabilities. For example; Equipment such as lifts or air conditioners is often an integral part of a

(17)

DoA

building and is generally included in the fair value of the investment property, rather than recognized separately as property plant and equipment.”(Paragraph 50 – LKAS 40) But LKAS 40 does not prescribe exact method to avoid this possibility of double counting assets and therefore the company has freedom to select any method based on their judgment. One option which can be implemented by the company is, the company has separate records of the assets which are located in the island, company can deduct the carrying amount of those assets from the valuation obtained from the qualified valuer for this investment property in the presentation of financial statements.

If the company is implemented this method, then it will have to be separately disclosed it in the financial statements because it is required by LKAS 40 as follows.

“When a valuation obtained for investment property adjusted significantly for the purpose of financial statements, for example to avoid double counting of assets or liabilities that are recognized as separate assets and liabilities as describe in paragraph 50, an entity shall disclose a reconciliation between the valuation obtained and the adjusted valuation in the financial statements.”(Paragraph 77 – LKAS 40)

(18)

DoA

The importance of scrap identification Y.N.D.Karunarathna & W.D.N.Aruppala [email protected]& [email protected] Introduction

ABC (Pvt) Ltd is a joint venture between the XYZ Group and the LPC group of Belgium.ABC (Pvt) Ltd mainly manufactures tires, rim and tracks. Issue arises from ABC (Pvt) Ltd for the financial year 2012/2013. The selected issue is relating to the rim, raw materials and the related stocks. Client used steel pallets with various gage for prepare rim. Following has been performed during the stock count and physical verification of the stock.

 Select highest value of stock which was cover at least 50% of the total stock

 Randomly select stocks physically in the floor and cross checked with the client given stock sheet ( Floor to Sheet)

 Randomly select stock from stock sheet and cross checked that stocks physically located in stores/factory (Sheet to Floor)

There were steel that represent high value as well as in stock sheet represent high number of quantity. Actually there were no physically exist huge number of quantity as cross checked with the stock sheet.

There was an issue related to the updating stocks at the system. The identified procedure for preparing rim is as follows:

(19)

DoA

 For rim there was standard size

 When preparing rim client cut the standard size from the steel and rest of the steel identified as scrap.

When purchase steel client pick to the system whole of the steel and actually client used ¾ of that and that ¾ transfer to the Cost of Sales. But client do not identify the scrap steel throughout the system and client do not transfer the scrap material from stock account.

Result of high value of closing stock influence for over estimate of gross profit and net profit of the company. Accordingly the company was non compliance with LKAS 02 - Inventory.

The company must adhere to the LKAS 02 – Inventory by identifying stock and scrap items separately. And when stock is issued and used for production client should update the system on time, by separately identifying scrap material and cost of sales. And there should be a proper internal control to identify scrap items and when selling for outsiders there should be proper valuation policy and proper authorization. The bulk scrap material should write off from the financial year and to interpret correct value of gross profit as well as the correct value of the net profit.

Used to prepare rim Whole Steel Scrap Used to prepare rim Whole Steel

(20)

DoA

Loan outstanding Vs Impairment L. S. S. Munasinghe & C. R. Thillakarathne [email protected]& [email protected] Introduction

"Protection PLC" is providing five major categories of staff loans to their employees. But they do not have a process in place to provide for impairment of the staff loan. But According to the LKAS 39 Financial Instruments recognition and measurement, at each balance sheet date the entity have to assess whether there are objective evidences of impairment. Still they couldn’t do any impairment. But there are some impairment indications in staff loans.

Discussion of the issue

At each reporting date, Protection PLC should assess whether there are objective evidences of impairment of staff loans based on following indicators.

1. Obligator facing significant financial difficulties 2. Default or breach of the loan contract

3. Resigning of the employee without settling the outstanding loan balance

4. Non Availability of an active market for the asset secured against the loan

5. Measurable decrease in the estimated future cash flows of the security

The standard says that “A financial asset or group of financial assets is impaired and impairment losses are incurred if, only if, there is objective evidence of impairment as a result of one or more events that occurred after the

(21)

DoA

initial recognition of the asset (a loss event) and that loss event (or events) has an impact on the estimated future cash flows of the financial asset or group of financial assets that can be reliably estimated.”

Finally the issue affects to the profit attributable to the shareholders. Further it wouldn’t be a fair presentation of financial information and not comply with the financial framework.

Since the nature of each category is different from others, the entity has to propose provisioning for those loans with considering every category separately.

Eg: Motor Bike loans, Laptop Loans etc.

If there are any indications recognized under the impairment test, the entity has to provide necessary provision in line with the provisioning guidelines of LKAS 39 Financial Instruments recognition and measurement. Basically it should be based on the security of each loan category. Because of the loan categories are different from each other.

(22)

DoA

Incorrect revenue recognition policy of a contract R.P.C.S Rajapaksha & G.M Mudith Sujeewa

[email protected]& [email protected] Introduction

Company recognizes revenue under the categories of supply sale, Installation sale, and transport income. But company has been following incorrect revenue recognition policy for material value of the job. Company recognized total material value of the job as a revenue before commencement of the job. Due to the fact that materials are subject to further installation process, it is a violation of LKAS 18.There are some sub issues also attached with this issue. They are,

 Company does not concern the Materials which are already sent to the work place (customer) and still not utilized.

 Cut-off of the revenue shown in financial statements is incorrect.

Discussion of Issue

When the material (granite) sending to the site (work place) from factory company recognize supply sale revenue by adding profit margin to the cost of granite. After transporting material (granite) to site company recognize transport income. Installation revenue recognize after the job complete or after the completion of a stage of the job. Installation revenue represents around 40% of revenue from particular job.

Company recognize the supply sale revenue when material sending to the particular site. But the job they have undertaken is not yet fully completed or a stage completed

(23)

DoA

by at that time. Issue is company already recognize part of the revenue (supply Sale) before the job or a stage of job completed.

Conclusions& Recommendations

Before the fully finished or stage finished company recognize part of revenue. Risks and rewards attached with materials still retaining with the company due to that materials are subject to further installation process. Due to this issue Companies revenue overstated and financial position & financial performance of the company represent in wrong figures. So revenue recognition of company not complies with LKAS 18 Revenue.

According to LKAS 18 Revenue paragraph 16 (c),

“When the goods are shipped subject to the installation and installation is a significant part of the contract which has not yet been completed by the entity.”

This is a situation where company retains significant risks & Rewards of the contract. So then Recommendation is recognize supply sale after the risks and rewards transferred to the customer. When the job company have undertaken is going long period subject to installation recognize revenue according to the Stage of completion which is described in LKAS 18 Revenue ,LKAS 11 Construction Contracts

Issue creates another 2 sub issues

Sub Issue 01 - Company did not concern about Goods in Transit (inventory).

At the beginning of the job company decreased its inventory (increasing cost of sales) and increased its revenue. Issue is

(24)

DoA

Company not utilized all materials at once which were issued from the factory to the work place at the beginning of the job. But the company have taken that all material as cost of sales when recognizing the supply sale revenue. Implication is Underestimate the inventory value of the company, Recommendation is Company should recognize goods in transit (inventory) for the materials which are not yet utilized at the work place.

Sub Issue 02 - Company overstated its Revenue at the Cut-Off.

At the cut-off company by sending more material (granite) to several work places overstated its revenue at the cut-off significantly by Using Company’s present revenue Policy. Recommendation is revenue should be recognize by reference to the stage of completion of the contract accordance with LKAS 18 & LKAS 11 and Cut-off of the revenue should be presented by considering stage of completion of the job

(25)

DoA

Effect ofmisrecognitionof assets T.M.N.B.Abeyrathna & U.L.T.P.Gunasekara [email protected] & [email protected] Introduction

Agma Company is a construction company, undertaking constructions of Roads, Bridges & Buildings all over the country. This is concerned with their recognition and maintaining of accounting records of Property Plant & Equipment (PPE) at their Projects. Agma Company maintains their accounting records regarding PPE as per the LKAS 16 (Property Plant and Equipment).Further they handle centralize accounting system in the head office of Company.

Due to wide Spared of projects all over the country, it becomes difficult to monitor the transactions regarding PPE and capitalize them. As an example, the Project Managers sometimes purchases assets (Machineries & Furniture) using their site petty cash. Thus they may not record correctly in the Assets Register Maintained at the Head office. Likewise it affected to the Financial Position as well as the depreciation expense of the company’s books.

Because of this incorrect recognition of assets, the company accounts has been showed a lower value of depreciation expense. This situation over estimated the profit of the company. Also the PPE figure shown in the statement of financial position was under estimated. Accordingly, the cost of the site was also shown an incorrect figure. Finally, it

(26)

DoA

affected adversely on the working capital shown in the company’s accounts.

If we consider another side of this issue, the company facilitated the Regional Officer (RE) and other government representatives with some assets for their use at site offices. But those assets have not been returned as the project was over. This also affected a loss to the company.

 According to this analysis, company should consider more about the adjustments of fixed assets.

 Company should establish a policy in purchasing assets. It will be more appropriate to purchase assets through head office.

 Also the sites should maintain an assets register and that must be cross-checked with the head office assets register.

 The depreciation regarding the assets of the sites should also be identified in the accounts.

 After the end of the project, company should have a policy to return back the assets used and revalue them. Then these assets can be transferred to a new site.

(27)

DoA

Revenue recognition of SLFRS for SME (Rendering of services)

H.P.M.V. Amarasinghe&K.K.Thilakasiri [email protected] & [email protected] Introduction

Ayurveda Health Resort (Pvt) Ltd is a limited liability Company incorporated in Sri Lanka under the Company Act No 07 of 2007. The principal activity of the Company is operating of Hotel and Ayurveda Health Care Centre. The Company provides hotel facilities to foreigners and local customers. Usually company collects advances from the customers before they arrive to the hotel. Company revenue recognition method is as follows when company received an advance amount it is considered as service income of the company.

When customers (foreigners) arrive to Hotel they should deposit advance money to the company bank account. This money is considered as revenue of the company. Therefore, company has accounted these cash deposits as follows.

Bank Account Dr

Revenue Account Cr

According to this method of revenue recognition, company has failed to recognize revenue for the accounting period correctly. Hence their statement of comprehensive income shows inaccurate gross profit margin. As a result of this error their statement of financial position is shown an inaccurate

(28)

DoA

point on the reporting date. Because the advanced received from the customers do not show in their current liabilities as well as their gross profit margin is overstated. Not only that, computation of tax is not correct, and also management cannot take a correct decision to recognize revenue and profit for the period correctly. According to the SLFRS for SMEs (Section 23.14) it should be recognized as advance received.

We recommended this cash receipt should be recognized according to the section 23 of SLFRS for SMEs. According to the SLFRS for SMEs when the outcome of a transaction involving the rendering of services can be estimated reliably, an entity shall recognize revenue associated with the transaction by reference to the stage of completion of the transaction at the end of the reporting period. The outcome of a transaction can be estimated reliably when all the following conditions are satisfied.

• The amount of revenue can be measured reliably. • It is probable that the economic benefits associated

with the transaction will flow to the entity.

• The stage of completion of the transaction at the end of the reporting period can be measured reliably.

• The costs incurred for the transaction and the costs to complete the transaction can be measured reliably. When service are performed by an indeterminate number of acts over a specified period of time, an entity recognizes

(29)

DoA

revenue on a straight-line basis over the specified period unless there is evidence that some other method better represents the stage of completion. When a specific act is much more significant than any other act, the entity postpones recognition of revenue until the significant act is executed.

When the outcome of the transaction involving the rendering of services cannot be estimated reliably, an entity shall recognize revenue only to the extent of the expenses recognized that are recoverable.

When we analyze this case, we reviewed that requirements of recognition of revenue of rendering service have not been satisfied. Therefore recognizing this cash deposits as revenue of the company is incorrect. Therefore it is advised to consider this cash deposits as advanced received from customers until rendered the service.

(30)

DoA

Revenue recognition of real estate sales G.A.N.R. Chathuranga & M.A.T.K. Munasinghe

[email protected], [email protected] lk Introduction

This case study was produced as an outcome of internship program which is a partial fulfillment of the Bachelor of Business Management degree program of department of accountancy of University of Kelaniya. Study refers to ABC Residencies (Private) limited operating as a limited liability company incorporated in Sri Lanka whose principle activities are construction and development of Real Estate.

The company is selling individual apartments while construction is still in progress and buyers enter into a binding sale agreement that gives them the right to acquire a specified unit when it is ready for occupation. At the time of entering into sale agreement, buyers have to pay Rs.600, 000 as booking fee. After that buyers pay a deposit (25% of sale value) that is refundable only if the company fails to deliver the completed unit in accordance with the contracted terms. Buyers are also required to make progress payments between the time of the initial agreement and contraction completion. Further, buyers are able to specify only minor variations to the basic design but they cannot alter major structural elements of the design of their unit according to the agreement.

(31)

DoA

Conflict is arisen since the company recognizes upfront revenue at the time of receiving 25% of sale value before risk & rewards are transferred to buyer. On the other hand according to the agreement with the customer, this arrangement does not come under construction contracts since it is not an undertaking for a construction contract.

According to the evaluation, transferring risk and rewards to buyer is on a continuous basis and this is supported by rendering of service agreement (according to LKAS 18 Revenue) entered by company with their customers. Further according to IFRIC 15 Agreements for the Construction of Real Estate, this is not a construction since buyers cannot make major structural changes to apartments while building is in progress. They can only make minor changes.

Based on the analyzed information, it is suggested to record as sales of goods within the scope of LKAS 18, since buyer has only limited ability to influence the design the real state and entity may transfer to the buyer control and the risk and rewards of the ownership of the real state in its entirely at a single time.

(32)

DoA

Director‟s loan classification as equity instrument Ridmi dodangoda & R.M.S Bandera

[email protected]&[email protected] Introduction

SIGMA Private Ltd is recognized as top manufacturing giant for garment manufacturing and wet processing in Sri Lanka. Its network extends across Sri Lanka and oversees with more than 8,000 employees working under the company. The privately owned BOI company still stands as a one of the most & reliable name in the industry. With the expansion of business activities, the company required more capital than previous years.

A Director of SIGMA (Pvt) Ltd provides interest free loan to the company as remedy of capital requirement of the business. There is no any agreement between company and the director of SIGMA regarding re- payment of loan and loan interest. Also subsequently company has an idea to make share issue and they wish to convert that loan amount to shares.

Recommendations & Conclusions

Financial Statement of SIGMA shows that the loan amount recognized as a “long term liability” of the company. Although as a professional accountants this issue brings some accounting dilemma regarding followings,

 Some financial instruments that meet the basic definition of a liability are classified as equity if debt

(33)

DoA

instrument not satisfy the specific recognition criteria mention in Section 11, SLFRS for SME. Accordingly, a debt instrument that required satisfying the conditions given below ,

Returns to the holder are; - Fixed Amount

- Fixed rate of return Over the life of the instrument - A Variable return that throughout the life of the

instrument, is equal to a single referenced quoted or observable interest rate.

- Some combination of such fixed rate and variable rate. Provided that both the fixed and variable rates are positive. For fixed & variable rate interest returns, Interest is calculated by multiplying the rate for the applicable period by the principal amount outstanding during the period.

- Arise adjusting event after the reporting period Subsequent share issue of the company provides a strong evidence of condition that existed at the end of reporting period. Therefore according to the LKAS 10, that share issue classify as an adjusting event.

The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decision. Although financial statement Information of SIGMA (Pvt) Ltd not comply qualitative characteristics the t should be complied by entities, due to their error classification of director loans. Therefore, the interest free loan amounting Rs. 50 Million provided by the Director, is not satisfied conditions mentions

(34)

DoA

in section 11, SLFRS for SME. Therefore the Director’s loan should be classified as an Equity Instrument.

(35)

DoA

Deductions from total statutory income when arriving to assessable income

H.M.A.M. Gunarathna &K.K.Thilakasiri

[email protected]& [email protected]

Introduction

South Asia (PVT)Ltd is a family owned business and registered under the companies act No 07 of 2007 as a private limited company. This company also registered as a BOI company as well. The main business of this company is providing consultancy service for landscaping. Since this is a BOI approved company in terms of the BOI agreement a tax holiday period of 3 years has been granted to South Asia (PVT) Ltd commencing from the 2 years from the commencement of operation or from the year of assessment in which company makes profit whichever is earlier.

The company operations commenced in the year of assessment 2006/07. From the commencement of the operation the company profit and loss schedule is as follows.

2006/07 Loss 2007/08 Loss

2008/09 Profit 2009/10 Profit

2010/11 Profit 2011/12 Profit

2012/13 Profit

According to the Inland Revenue Act of 2006 South Asia (PVT) Ltd can enjoy a tax benefit for the year of assessment 2008/09 to 2010/11. The year of assessment 2006/07 and

(36)

DoA

2007/08 the company did not earn any profit (Pre Tax Holiday Period). However year of assessment 2008/09 to 2010/11 tax holiday could be enjoyed. No tax losses were incurred during the tax holiday period. When calculating taxable income in year of assessment 2011/12 for tax purpose they have deducted the tax losses incurred year of assessment 2006/07 and 2007/08 subject to 35% of Total Statutory Income. An assessment has been issued by Commissioner General of Inland Revenue against the income tax return filled by the company for the year of assessment 2011/12 mentioning that South Asia (PVT) Ltd has deducted brought forwarded tax losses which are not eligible for deducting as tax losses.

According to the paragraph (b) of subsection 5 for the Inland Revenue Act, the losses which are eligible to deduct as tax losses have been clearly mentioned.

As per above section, the loss is deductible from the total statutory income subject to the 35% of total Statutory Income , if it would have been a profit such profit would have been taxable under the act. Therefore according to this section only the losses which are liable to income tax if it had been a profit is entitle, to be deducted. However in this case had this company loss become profit such profit in not liable as company is enjoying a tax holiday under BOI agreement with Board of Investment Sri Lanka. The company's view was that recognized loss was not within the tax holiday period; it was happened before commencing the

(37)

DoA

tax holiday period. Therefore deduction of such losses is not accepted because company had made a profit in the very first year and that profit was exempted and tax holiday of the company should have commenced from that year. Therefore there was no logic whether the loss was incurred before commencing the tax holiday or during the tax holiday period. Not only that, another ruling has issued by Department of Inland Revenue in Sri Lanka relating to the tax losses which are eligible for tax losses. It is “Ruling issued by CGIR on 14.05.1996.

According to this rule the loss incurred prior to the commencement of tax holiday of any undertaking (other than an undertaking referred to in section 29(3A)) is not deductible from the total statutory income of that undertaking of any period after the termination of the tax holiday period. Not clear of this statement

Hence recommendation for this issue is the tax losses incurred prior to commencement of tax holiday period cannot be deducted as tax losses even after the tax holiday period. Therefore company should prepare correct income tax return and submit immediately to the Inland Revenue Department.

(38)

DoA

Does revenue create better picture among its stakeholders?

H.M.VirajiniHerath&G.M. MudithSujeewa [email protected]&[email protected] Introduction

SUPERBOND (Pvt) LTD is an adhesive manufacturing company. This company imports the raw materials and processes them in its factory to manufacture the products. It carries out both direct & indirect sales to achieve their annual sales targets. The company’s stores are located in close proximity to its head office. When the items are delivered from the stores, the security officer stamps the security seal on the invoice and the accounts copy of the invoice is sent to the Accounts Department. The goods are delivered two or three days after the invoice has been raised. However, the Accounts Department updates the sales ledger based on the invoice date. Therefore it is clear that there is a time gap between date sales actually occurred and the date of revenue recognition.

Not only that but also the company has been identified as having a control weakness in its ERP system. The system has not been designed to provide an automatic restriction on further sales to defaulting customers. Hence there is a high probability for these defaulting customers to make continuous purchases and default payments indefinitely.

According to the LKAS 18- Revenue, there are five conditions which should be satisfied to identify revenue from the sale of goods. But the company’s sales procedure does

(39)

DoA

not comply with the LKAS 18 because it does not recognize its revenue at the point in which the ownership of goods is transferred to the third party. This causes an overstatement of revenue as well as debtors’ balances. Therefore, the financial statements of the company do not reflect the correct picture where revenue is concerned.

Since the company has not designed its system properly, there is a possibility that it affects its entire business process. Since defaulting customers are not monitored by the system itself by restricting further sales to them, there is a risk that the company’s liquidity position being badly affected.

 The company should comply with the Accounting standard of revenue recognition prescribed by the CA Sri Lanka (LKAS 18).

 The system should be modified in a way that it restricts the defaulting customers automatically when the approved credit limit is exceeded. Approval of an officer at a higher level should be necessitated when an invoice is needed to be raised for a further sale to such a defaulting customer.

(40)

DoA

Classification of lease assets G.P.Madusanka &D.K.Yapa Abeywardhana [email protected]& [email protected] Introduction

In year 2013 VVIRA Dairy yoghurt expand their production capacity to double the current production capacity to 50,000 cups a day in addition to allowing the manufacture of other milk based products. For that they lease a milk processing plant from China through a local agent as operating lease According to LKAS 17.

VVIRA Dairy yoghurt farm install this new plant in Kandy. This plant market value was around Rs.50mn. But VVIRA got it through a local agent under operating lease for 15 years with major modification to that plant. That modification is done by the local agent to match with VVIRA requirements. But the ownership of the plant was not transferred to VVIRA. Also the local agent had given a technician with the plant to VVIRA. The expected life of the plant was 20 years.

Currently, the monthly lease payment recognize as expense. The major part of the economic life of the plant hopes to use by VVIRA even if the ownership is not transferred to VVIRA. Also VVIRA can use this plant without any major modification. Because that major modification already done by the local agent. At the end of 15 years, there is an ability to continue the operating lease for further few years.

(41)

DoA

According to LKAS 17, lease that transfers substantially all the risks and rewards incidental to ownership of an asset, when title may or may not eventually transferred, is recognize as Finance Lease. Also after 15 years, it cannot give to another party to manufacture yoghurt.

Therefore this lease can be recognized as a „Finance lease‟. As a result of this recognition as finance lease, VVIRA should recognize this asset as fixed asset in there fixed assets register and make necessary adjustments in financial statements.

(42)

DoA

Effect of foreign currency movement on financial statements

M.S.P.K.Mathalage & W.M.H.N. Wijekoon [email protected]&[email protected] Introduction

This report includes descriptively an accounting issue and the analysis of that issue. Relevant areas of issue were identified and recommendations were given according to the applicable accounting standard. Main consideration was LKAS applications when analyzing this issue. This analysis has considered also about the accounting treatments of the other countries regarding the particular issue and compared those accounting treatments with LKASs. Similarities and differences between LKASs with, US GAAP and Ind GAAP were also analyzed.

Madura (Pvt) Ltd had engaged in foreign currency transactions such as sales and purchases and transactions has been recorded initially by applying spot rate at the date of the transactions. But the company has not reported foreign currency items using closing rate at end of the accounting period.

Applicable accounting standard

Effects of changes in foreign exchange rates (LKAS 21) Subsequent Recognition

 Foreign currency monitory items should translate using the closing rate at the end of each reporting period.

(43)

DoA

 The Non-monitory items that are measured at fair value in a foreign currency should translate using the exchange rates at the date when the fair value was determined.

Exchange Differences

 Arising on the settlement or translating on monitory items should recognize in profit or loss in the period.

 Arising on a non-monitory item(Gain or loss is recognized in other comprehensive income)should recognized directly in other comprehensive income.

 Arising on a non-monitory itemshould recognize in profit or loss in the period.

Comparison with International GAAPs

US GAAP and IFRS require foreign currency transactions to be recalculated into an entity’s functional currency with amounts resulting from changes in exchange rates reported in income. When there is a change in functional currency of either the reporting currency or a significant foreign operation, IAS 21 requires disclosure of that fact and the reason for the change in functional currency. In Ind AS 21 requires an additional disclosure of the date of change in functional currency.

Implications of the issue

 The balance of the foreign currency of the company will not be the correct amount.

 They have not identified the profit or loss arising from exchange differences. That is affecting directly to the equity of the shareholders and to the tax portion of the company.

(44)

DoA

 According to the above standard the company should assess their monitory terms according to the spot rate at the balance sheet date same as recognition date.

 The exchange difference should transfer to the statement comprehensive of the period.

(45)

DoA

Whether the installation cost of stand-along computer software recognize as an expense?

D.N.A.D.S.M.Nissanka & A.M.I.Lakshan [email protected] & [email protected] Introduction:

Tele employee security fund is a not for profits organization, registered as a society in Sri Lanka.

Certain officers of the telegraph department of the government of Ceylon are required to keep security for the due performance of their duties performed. For this purpose to make an initial deposit on first appointment and thereafter to pay monthly contribution from their salaries until the required security been completely furnished.

The organization keep their records manually for this purpose and maintain lot of books and it takes considerable time to complete work manual. Due to limitation of manual process Board of Management of the security fund decided to install tailor made accounting software to maintain the accounts. Therefore, they call quotation from IT facility providers and select one provider. That company made stand - alone computer software call” TELE-FUND”.

Discussion of the Issue:

Cost of computer software recognized as an Expense and charged in to Income and Expenditure account - LKAS 38 – Intangible Asset)

The Society prepared annual account on 31stof December each year. The organization installed tailor made accounting

(46)

DoA

software to maintain the accounts and keep records on collection and payment call “TELE-FUND”. Cost of this software is Rs.1,500,000. After the financial year end 2012, when prepared financial statements the accountant of fund recorded the cost of Computer Software as an expense and charged it to Income & Expenditure account.

The issue caused to,

 Statement of Comprehensive Income - Surplus for the year.

This discrepancy make it look like reporting business make less money during given period leading to lower net income. As a result financial performance of the society undervalued.

 Statement of Financial position-Understated of the value of the asset.

 Cash Flow Statement- Classification of cash flow statement changed.

Conclusions and Recommendations:

According to LKAS 38 requires an enterprise to recognize an intangible asset according to the following recognition criteria:

 It is probable that the expected future economic benefits that are attributable to the asset will flow to the enterprise; and

 The cost of the asset can be measured reliably.

In this case installing this software the organization gets more benefits such as increase capacity, quality, save time as well as the cost of the software can measured reliably.

(47)

DoA

Therefore it is recommended that the installation cost of stand-alone computer software recognize as an intangible asset & amortized over the useful life, cost of Software do not recognize as an expense since expected future economic benefits are attributable to the asset will flow to the enterprise and cost of the asset can be measured reliably according to LKAS 38- Intangible Asset and also the organization should follow SL SoRP – NPOs Guidelines (Sri Lanka Statement of Recommended Practice For Not For Profit Organizations) since this is not for profit organization.

(48)

DoA

Identifying the revenue of an export company which sells goods under FOB terms

H. H. D. Perera & G.M. Mudith Sujeewa [email protected]&[email protected] Introduction

The case is relating to the company name XYZ (Pvt ) Ltd which exporting fruits and vegetables overseas. We have performed the external audit for the financial year ended 31/03/2013 for the company. During the audit we have identified the issue relating to the recognition of revenue from export sales.

We have noted that the company has recognized the revenue at the time they dispatch the goods from warehouse. But the company’s delivery terms of the goods is Free on Board (FOB), meaning that the buyer pays for transportation of the goods. However company should recognized the revenue according to the provisions given by LKAS 18 Revenue.

Implications of the issue can be justified as follows.

 Risk & rewards have not been passed at the date of invoice.

 Cut-off test was inaccurate.

 Revenue may be overstated or understated.

Revenue should be recognized based on the Bill of Lading date because company has exported goods under FOB terms. Therefore up to issuing bill of lading, seller has not

(49)

DoA

transferred significant risks and rewards of ownership of the goods to the buyer.

According to the LKAS 18 Revenue from the sale of goods shall be recognized when all the following conditions have been satisfied

(a) The entity has transferred to the buyer the

significant risks and rewards of ownership of the goods ;

(b) The entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; (c) The amount of revenue can be measured reliably; (d) It is probable that the economic benefits associated

with the transaction will flow to the entity ; and

(e) The costs incurred or to be incurred in respect of the transaction can be measured reliably.

(50)

DoA

Revenue recognition of date on which the export sales in CIF term

Mr. P.V.L Premarathna & H.A.P.L. Perera [email protected] & [email protected] Introduction

XYZ Super mattress PLC is a one of the biggest gained expertise through continuous research and development in natural foam rubber technology over many decades. Company first mattress produced in 1987; today they are the biggest fully backward integrated high quality natural Latex manufacturer in the local and export market. Company’s Operation Integration is as follows,

1. Company Latex is processed in their own centrifuge plant within the plantations

2. Manufacturing of natural Latex foam happens in their factory which is 60Kms away from the plantations and make sure that they use timely matured fresh Latex in to the production

3. Company own shipping company takes care of the

shipment to customer’s doorstep with excellent service in clearing and forwarding through their agents

around the world

Recently Company has recognized revenue in export sales, when the goods are delivered from their stores. But the LKAS 18 clearly says that revenue should be recognized on the date on which significant risks and rewards are

(51)

DoA

transferred to the customers. The company has identified the revenue immediately in the income statement after the transfer the goods to the customers. But it should not be recognized in the income statement. According to the LKAS 18 revenue should be recognized, when the goods are arrived at the customer’s port. Because of this case the company’s revenue has been overstated and as a result company’s profit has been increased. Those export sales are not yet delivered to the customers, because company normally export goods to Asian and European Countries, such as Canada, German, France, USA etc. Goods shipping days normally take 10 to 20 days to arrive at customer’s port.

According to LKAS 18 Company can’t recognize the export sales in CIF term, until arrival at customer’s port. In that point significant risk and rewards has been transferred to the customer’s. Then recently company revenue has been included the CIF term export sales in the year-end sales amount, but it relates to next year sales. It should be reversed against the revenue and write-off to the income statement. When the goods are arrived at customer’s port, revenue can be recognized in their income statement. Company can prepare separate schedules to identify the CIF term export sales, and then they can recognize the year-end sales amount related in next year.

(52)

DoA

Recognition of export income when risks and rewards transfer to buyer

R.P.C.S Ranasinghe & M.A.T.K.Munasinghe [email protected]& amila@kln.ac.lk Introduction

XYZ (Pvt) Ltd was established under the Sri Lankan law in 2009 and is settled in the Koggala Export Processing zone close to Galle on the Southern Coast of Sri Lanka. XYZ (Pvt) Ltd. applied and received the status of BOI Company (Board of Investment of Sri Lanka) in order to benefit exemption of import and export taxes.

The company produces different types of rope products and sales only to the foreign market and they had agreed to sell their products to the customers on FOB term. But the company had recognized their export income based on the invoice date. But the products were not loaded to vessels on the same date.

When determine the income from sale of goods, the company needs to satisfy several conditions. Especially risks and rewards associated with the goods should be transferred to buyer from seller. The risks and rewards are not transferred to buyer when the company recognizes their sales income at invoice date. As a result of that export income of the company is increased. As well as value of the debtors shown in the statement of financial position are overstated and inventory value is understated. That leads to mislead the