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ACCOUNTING 311

Financial Accounting

Mid-Semester ONLINE Test

SEMESTER ONE, 2023

Question 1: Accounting information in capital markets and Theory of accounting choices

WRITE YOUR ANSWER TO QUESTION 1 in the indicated placeS ON PAGEs 3-4 of the answer booklet.

Below are extracted from two news clips.

(a) 16 March 2023. NZ Herald. “Shares in the globally connected Swiss bank Credit Suisse have plunged overnight, dragging down other major European lenders as fears about deeper problems in the world banking system spread in the wake of bank failures in the United States. At one point, Credit Suisse shares lost more than a quarter of their value, hitting a record low after the bank’s biggest shareholder - the Saudi National Bank - told news outlets that it would not inject more money into the bank, which was beset by problems long before the US failures.”

REQUIRED:

Referring to the research evidence discussed in Module 1, briefly explain why we observed a price drop of Credit Suisse. (Maximum words: 150) (4 marks)

(b) 10 March 2023. Forbes. “In the 25 years leading up to the financial crisis of 2007-2008, financial industry deregulation permitted—some might even say encouraged—U.S. financial services firms to take bigger and bigger gambles, such as holding large amounts of risky mortgage-backed securities and other complex financial instruments, than ever before. The result was an epic bubble in the U.S. housing sector that wrecked the banking industry and crashed stock markets at home and abroad, driving the worst global recession seen in generations.”

REQUIRED:

Referring to the research evidence discussed in Module 2, can you identify any indications of agency conflicts between a U.S. financial services firm and its lenders? Briefly explain. (Maximum words: 150) (4 marks)

(Total for Question 1: 8 marks)

Question 2: Accounting information in capital markets and Theory of accounting choices

WRITE YOUR ANSWER TO QUESTION 2 in the indicated places ON PAGES 5-8 of the answer booklet.

The following information is abstracted from Company X's DRAFT financial statements for the fiscal year ending December 31, 2022 (FY2022). Company X is preparing financial statements in accordance with International Financial Reporting Standards (IFRS).

After reviewing the information, chief executive officer (CEO) of the company instructed the financial controller to make the following two adjustments:

(1) Capitalize an amount of $150,000 related to the research expense (as part of the operating expenses) for an asset development project. The asset has not yet been proved to be a viable product.

(2) Adjust the estimate for the allowance for doubtful accounts to reflect the anticipated decrease in customers’ credit risk. As a result, the doubtful debt expense (as part of the operating expenses) will decrease by $105,000, and the net balance of accounts receivable will increase by $105,000.

Additional information

· Under IFRS, a company can capitalize its asset development costs as an intangible asset if it can prove that the asset it is developing is a viable product or technology for future revenue generation. Otherwise, the asset development costs need to be expensed.

· The company’s debt covenants specify a restriction of leverage ratio (Total liabilities/Total tangible assets) less than 60%.

· The CEO receives a bonus if ROA (Net income/Total assets, year-end) is larger than 0.25.

REQUIRED:

(a) Ignore tax, assess the combined effects of the two adjustments on the following line items/ratios based on the company’s FY2022 DRAFT financial statements. Show your workings.

· Net income

· Total tangible assets

· Leverage ratio

· ROA

(4 marks)

Question 2 continued:

(b) Referring to the efficient contracting view discussed in Module 2, do you think the two adjustments are in line with the efficient use of accounting? Briefly explain. (Maximum words: 150) (4 marks)

(c) Referring to the opportunistic view discussed in Module 2 and your answer in part (a), do you think the two adjustments are in line with the opportunistic use of accounting? Briefly explain. (Maximum words: 150) (4 marks)

(d) As an accountant, utilize the fundamental principles of the NZICA Codes of Ethics and relevant ethical theories to identify TWO ethical issues in this question. (Maximum words: 100) (2 marks)

(Total for Question 2: 14 marks)

Question 3: Accounting for financial instruments

WRITE YOUR ANSWERS TO QUESTION 3 in the indicated places ON PAGES 9-11 of the answer booklet, which includes a worksheet (worksheet 1).

Each of the statements below is either true (T) or false (F):

(a) Statement: Hedge accounting in NZ IFRS 9 is not the direct response from IASB to the global financial crisis in 2008.

(b) Statement: The asset account ‘Investment in listed company shares’ on Balance sheet is an equity instrument.

(c) Information: On 1 January 2023, The Mandalorian Ltd purchased 10,000 shares in Grugo Ltd at a price of $10 each in cash. The transaction costs for brokerage for the purchase are $4,000, paid in cash. On 31 December 2023 (Balance Date), the closing market price for a share in Grugo Ltd is $12. The Investment in Grugo Ltd is not held for trading and The Mandalorian Ltd has elected to account for “Investment in Grugo Ltd” at “Fair value through OCI”.  As required by NZ IAS 32 and NZ IFRS 9:

Statement: Therefore, the journal entry on 31 December 2023 to account for the investment in Grugo Ltd will be:

Dr Investment in Grugo Ltd $20,000

Cr Gain in Fair value – OCI $20,000

(d) Statement: The hedging relationship can have hedge ineffective portion to qualify for “hedge accounting”.

(e) Information: A NZ importer has bought a call option contract to fair value hedge its accounts payable A$100,000. The option has an exercise rate of 1$NZ = A$0.9 with a contract amount of A$100,000. On settlement date, the spot exchange rate is 0.85.

Statement: Therefore, the importer will not exercise the option as the option value is worth 0 on settlement date.

(f) Information: A company issued 1 million convertible notes on 1 January 2023. The arrangement of the notes is that the noteholder has the option to convert one note into one ordinary share on the expiry of the notes.  The face value of each note is $1.5. The issue price of each note is $2. No transaction costs associated with the issue.

Statement: Therefore, the company should recognise $2 million dollars as the total fair value of the convertible notes on 1 January 2023.

(g) Information: A company issued some convertible notes, which can be converted into a fixed dollar value of shares at the end of the contract period.

Statement: Therefore, the company should treat the convertible notes as a compound financial instrument, that is, present the liability component and the equity component separately.

Question 3 continued:

(h) Information: A NZ importer recognised an accounts payable US$200,000, to be settled one month later. The spot exchange rate was $NZ1 = US$0.63. At the same time, the importer entered into a one-month forward contract to hedge the exchange rate risk associated with the accounts payable. The forward contract has a contract amount of US$200,000 and an agreed forward rate of 0.6. On the settlement date, the spot exchange rate is 0.7.

Statement: Therefore, the fair value of the forward contract on settlement date will be net forward asset NZ$47,619.

REQUIRED:

Using WORKSHEET 1, according to NZ IFRS 7, NZ IFRS 9 and NZ IAS 32:

· Indicate for each of the statements above whether it is T or F;

· If the statement is False, rewrite the statement to MAKE IT TRUE;

· If the statement is True, you do NOT need to explain.

(Total for Question 3: 16 marks)

Question 4: Accounting for financial instruments

WRITE YOUR ANSWERS TO QUESTION 4 in the indicated places ON PAGES 12-15 of the answer booklet, which includes a worksheet (worksheet 2).

Beef and Lamb Ltd is a New Zealand exporter with Fiji as one of its sales markets. The exporter wants to limit the effect of currency fluctuations in the next year by hedging forecasted Fijian dollar denominated sales. It expects to sell FJ$500,000 of goods on 31 July 2023, and receive the payment on 31 October 2023. Therefore, on 31 July 2022, it enters into a fifteen-month forward contract with the bank to sell FJ$500,000 and receive the agreed number of NZ dollars on 31 October 2023 at a forward rate of NZ$1 = FJ$1.40.

You can assume that the goods of FJ$500,000 were sold on 31 July 2023 according to the plan. Also, assume that this is an effective cash flow hedge and the change in fair value of the forward contract before the forecast sales is 100% effective, under NZ IFRS 9. Relevant exchange rates (i.e., spot rates and forward rates for 31 October 2023 delivery of cash) for transaction dates and balance dates (30 September) are provided in the table below. PART of the forward contract calculation over the 15-month contract period is also provided below.

REQUIRED:

· In accordance with NZ IFRS 9, using WORKSHEET 2, disclose the forward contract and the sale, including related gains, losses and the effect on retained earnings, by completing the relevant parts of the Balance Sheet as at 30 September 2023, and the relevant parts of the Statement of Comprehensive Income for the year ended 30 September 2023.

· Show your working.

(Total for Question 4: 12 marks)