ACCY201 Financial Accounting IIB Spring Session 2015 Tutorial Solutions Week 3 Leo et al (2015) Chapter 2 Review questions: 6, 10, 13 and 15 Case Study: 1 Practice questions: 2.10, 2.17 and 2.19 In-class question: 2.18 Review Questions 6. How should a company account for the legal costs of formation? Should the accounting treatment be the same as that for underwriting and other share issue costs? Legal costs of formation were traditionally treated as an asset and then systematically amortised over an arbitrary period. However there are no future economic benefits to be gained from these costs and they should be written off to expense, as per AASB 138 Intangible Assets . Underwriting and other share issue costs are discussed in AASB 132 Financial Instruments: Presentation, paras. 35 and 37, and the appropriate treatment is to regard these costs as a reduction of the share capital being raised (if the share issue occurs). The rationale for the different treatment is that share issue costs and the raising of capital is viewed as a single transaction and as such, the increase in equity is the net amount the company receives from the issue of shares (after considering any tax effect on the share issue costs). However, if no capital is issued (i.e. the share issue is not successful) then such costs are expensed. 10. Detail the characteristics of redeemable preference shares recognised as liabilities rather than equity. Redeemable preference shares recognised as liabilities rather than equity normally would be redeemable in cash on a specified date or at the option of the holder, be cumulative in regard to the payment of dividends, non-participating in further dividends and have priority rights to return of capital over ordinary shares. The accounting treatments of such preference shares when they are redeemed are shown the text in illustrative examples 2.9 and 2.10. 13.Why would a company wish to buy back its own shares? What conditions must be fulfilled before the company can do so? What types of share buy-backs are permissible under the Corp Act 2001 ? A company may wish to buy back its own shares in order to change its financial leverage. Alternatively it may be cashed up with no suitable profitable investments, so rather than keep the cash idle it may be beneficial to buy back its shares. Share buy-backs can also help in cleaning up small lots of shares that are held. A company can only buy back its own shares if the buy back does not materially prejudice the company’s ability to pay its creditors. The five types of share buy backs permissible under the Corporations Act are discussed in section 2.9 of the chapter. See especially Table 2.1, page 55. 1
ACCY201 Financial Accounting IIB Spring Session 2015 Tutorial Solutions Week 3 15. What is a debenture? Briefly outline the different types of debentures permitted under the Corporations Act 2001 and outline the procedures which must be followed to issue debentures.
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