QUESTION 2.
PART A:
A liability is defined as:
A liability is a present obligation of the entity to transfer an economic resource as
a result of past events.
Application:
A present obligation arose when the entity purchased/received (past event)
inventory without paying for it. Happy Foods is required to transfer cash (an
economic resource) to settle the R100 000 outstanding.
Recognition criteria:
Relevance of the item:
The payment of the amount outstanding has a high probability due to the
existing liability (the goods were already received), and it will therefore result
in a probable decrease in future economic benefits (cash).
Faithful representation:
The amount outstanding can be reliably measured at R100 000, thus no
material measurement uncertainty exists, and the item can be faithfully
presented.
Conclusion:
Since the amount owing meets the definition and recognition criteria of a liability, it
will be recognised as such on the date of the transaction.
PART B:
Income is:
an increase in assets,
or decrease in liabilities,
that results in an increase in equity,
other than those relating to contributions from holders of equity claims.
Application:
There has been an increase in assets,
(a present economic resource controlled by an entity as a result of past
events) in the form of cash interest received as result of a past investment
made which gives the entity the right to future economic benefits when it
utilises this cash in the future.
That will result in an automatic increase in equity as result of the accounting
equation, and
The cash received was not a contribution from an equity participant/owner
/shareholder.
Recognition criteria:
the recognition of income occurs at the same time as:
(i) the initial recognition of an asset, or an increase in the carrying amount of an
asset; or (ii) the derecognition of a liability, or a decrease in the carrying amount of a
liability.
Application:
The income will be recognised at the same time as the asset (bank/cash). The
recognition of the asset is determined by:
Relevance of the item:
The amount has already been received and is therefore 100% probable.
Faithful representation:
The amount received can be reliably measured as R1 000, thus no material
measurement uncertainty exists, and the item can be faithfully presented.
The asset meets the recognition criteria, and will therefore be recognised.
Conclusion:
Since the interest received meets the definition and recognition criteria of an income,
it must be recorded as such on the same date as the cash (asset) was received.
PART C:
An expense is a:
Decrease in assets,
or increase in liabilities,
that results in a decrease in equity,
other than those relating to distributions to holders of equity claims.
Application:
The cash payment of R1.2 million results in a decrease in an asset (bank/cash),
the decrease in asset therefore lead to a decrease in equity, and
the distribution was not made to equity participants.
Recognition criteria:
the recognition of expenses occurs at the same time as:
(i) the initial recognition of a liability, or an increase in the carrying amount of a
liability; or (ii) the derecognition of an asset, or a decrease in the carrying amount of
an asset.
Application:
The cash paid results in a decrease in bank (asset), and the wage expense should
therefore be recognised at the same time as this derecognition of the R1.2 million
cash.
Conclusion:
Since the wages paid meet the definition and recognition criteria of an expense, they
will be recorded as such.