Chapter 2 – Types of organisations and the financial reporting framework
TRUE/FALSE
1 Mutual agency refers to the fact that each member of the partnership form of business entity can
bind the other(s) in contract within the scope of normal operations.
2. There are several advantages to forming a partnership, including the ease with which it can be
formed and the limited rules and regulations that apply to it. However, as for a company, one of
the regulations is that a partnership must prepare financial statements in accordance with
Accounting Standards if it is deemed to be a reporting entity.
3. Although partnerships may have a tax advantage over companies in that it is the partners that are
taxed and not the partnership, a disadvantage of partnerships is that they have unlimited liability.
4. All companies can raise funds through the general public but not all companies have limited
liability.
5. If a company has sales of $8 million, assets of $4 million and 60 employees, then it may be
classified as a small proprietary company.
6. All limited-by-shares companies must have ‘Ltd’ in their names, but a private company is
distinguishable from a public company because it has ‘Pty’ as well as ‘Ltd’ in its name.
7. Two companies were formed on 1 January 20X3, with the names Pluto Pty Ltd and Neptune NL.
From the names of the companies, it is clear that the former is a proprietary company and the latter
is a mining company.
8. There are several differences between the financial statements of a company and those of a
partnership, not least of which is the disclosure of taxation on the balance sheet as a liability. For a
company, the disclosure is a single amount as it is the company that is liable and not the owners.
For a partnership, the amount of taxation is split and reported separately in accordance with each
partner’s liability.
9. The reason why company shareholders may have the advantage of limited liability rests with the
entity principle in accounting, not the legal status of the company.
10. The partnership form of business organisation exists where two or more carry on a business in
common with a view to profit.
11. Accounting Standards set by the Australian Accounting Standards Board (AASB) apply to both the
private and public sectors in Australia.
12. Due process is primarily concerned with producing Accounting Standards that meet managers’
objectives.
13. The Corporations Act 2001 requires that financial statements include a directors’ report, a
directors’ statement and an auditor’s report.
14. The directors’ report included with a company’s financial statements contains an opinion on
whether the balance sheet and income statement present a ‘true and fair’ view.
15. Half-yearly reports contain more detailed information than annual reports.
16. A conceptual framework can be defined as a set of interrelated objectives and fundamentals that is
expected to lead to consistent standards, and that prescribes the nature, function and limits of
financial accounting and reporting.
17. One of the objectives of a conceptual framework is that it is considered to be a defence against
politicisation.
18. A general-purpose financial report is primarily directed toward the common information needs of a
wide range of users.
19. Users of general-purpose financial reports include investors, financial advisors, employees,
lenders, suppliers and customers.
20. A reporting entity is an entity for which there are users who rely on financial statements as their
major source of information about the entity.
21. General-purpose financial reports provide the information that is required for both internal and
external user group needs.
22. Accrual accounting refers to the method of measuring profit on the basis of cash flow, rather than
when revenues and expenses occur.
23. The going concern assumption assumes that an entity will continue to operate successfully into the
foreseeable future.
24. An asset must have physical qualities that can be measured reliably.
25. A liability must always be a legal obligation that arises from past events.
26. Equity is the residual interest in the assets of the entity after deduction of all its liabilities.
27. Revenue means the gross inflows arising from normal operations plus all gains during the
accounting period.
28. The elements of financial statements are always measured using the historical cost method.
29. The Australian Financial Reporting Council is not able to directly influence the content of the
AASB’s accounting standards, but has the capacity to do so given its control of the budget and
priorities of the AASB.
30. The political nature of standard setting refers to the fact that, for example, preparers may lobby the
standard setters to promote their own self-interest rather than the decision-making usefulness of
general purpose reports.
31. The fundamental element equity does not require recognition criteria, because it represents the
residual interest in assets, after deducting liabilities.
32. In accordance with the IASB Conceptual Framework, income includes both revenue and gains.
33. The external auditor is responsible for preparing the general-purpose financial reports of a
company.
34. The responsibilities of the Australian Financial Reporting Council include advising the
government on the process of setting accounting standards.
35. In Australia the overriding responsibility for the preparation and presentation of general-purpose
reports resides with the directors of a company.
36. An external auditor seeks to provide reasonable assurance that the financial statements of a
company are true and fair, not a guarantee that every error in the financial statements of the entity
has been detected.
MULTIPLE CHOICE
1. Which of the following is not true of sole traders?
A.
They are one-owner businesses.
B.
They are not normally reporting entities.
C.
They are separate legal entities.
D.
They usually have limited funds at their disposal.
2. Which of the following is not true for a partnership?
A.
Creditors can supply goods on credit to a partnership.
B.
Debtors can purchase goods on credit from a partnership.
C.
Partnerships have to pay their tax yearly.
D.
Partnerships can enter contracts on behalf of the partnership.
3. Which of the following statements regarding partnerships is incorrect?
A.
There are no legal formalities required to form a partnership and it can be an oral
agreement.
B.
Partnerships have unlimited liability not subject to the amount contributed by each partner.
C.
The partnership is subject to income tax, not the individual partners.
D.
Each partner has the authority to enter contracts on behalf of the partnership, provided the
contracts relate to normal operations.
4. Which of the following would not be considered a disadvantage of forming a partnership?
A.
Limited life
B.
Unlimited liability
C.
Ease of formation
D.
Mutual agency
5. Jack and Jill Repairers is founded by partners Jack, Jill and Jolly. Jack, Jill and Jolly contributed
$3000, $5000 and $8000 respectively. For the year ending 20X2, Jack and Jill Repairers produced
a profit of $12,000. If the profits are distributed in accordance with the initial investment which of
the following is true?
A.
Jack gets $2250 and Jill gets $6000.
B.
Jack gets $3750 and Jolly gets $6000.
C.
Jack gets $2250 and Jill gets $3750.
D.
Jack gets $2250 and Jolly gets $8000.
6. Which of the following items of information would not be found in the balance sheet of a
partnership?
A.
Assets
B.
Liabilities
C.
Dividends payable
D.
Distribution of profits to partners
7. Which of the following is true of companies? All companies:
A.
are limited liability companies.
B.
are separate legal entities.
C.
have a limited life.
D.
are bound by the contracts signed by shareholders.
8. A large proprietary company must have its financial statements audited and lodged with the:
A.
Australian Securities Exchange.
B.
Australian Securities and Investments Commission.
C.
Financial Reporting Council.
D.
Australian Accounting Standards Board.
9. Which of the following types of business organisation has a legal identity separate from those of
the owners?
A.
Sole proprietorships
B.
Companies
C.
Partnerships
D.
All of the above.
10. Limited liability is a feature of what form(s) of business organisation?
A.
Company
B.
Sole proprietorship
C.
Partnership
D.
Both a company and a partnership
11. It can be determined that Alpha Pty Ltd is a proprietary company as its records show that:
A.
no approach has been made to the public for funds.
B.
it has fewer than 50 employees.
C.
it is a family company.
D.
it has ‘Pty Ltd’ in its name.
12. Gamma Pty Ltd would be a small proprietary company as its records show:
A.
assets of $15m, sales of $26m and 40 employees.
B.
assets of $6m, sales of $26m and 60 employees.
C.
assets of $15m, sales of $9m and 55 employees.
D.
assets of $4.5m, sales of $12m and 45 employees.
13. An advantage that a company typically has over a partnership is:
A.
mutual agency.
B.
access to greater amounts of capital.
C.
avoidance of moral hazard.
D.
smaller size.
14. The advantages of the corporate form of business organisation do not include:
A.
ready transferability of shares.
B.
limited liability.
C.
mutual agency.
D.
continuity of existence.
15. Which one of the following is not an advantage of a company?
A.
Separate legal entity
B.
Access to capital
C.
Continuous existence
D.
No regulation
16. In which section of a balance sheet would a general reserve be found?
A.
Current Assets
B.
Current Liabilities
C.
Non-current Assets
D.
Shareholders’ Equity
17. Equity on the balance sheet of a sole proprietorship is normally referred to as:
A.
owner’s equity.
B.
shareholders’ equity.
C.
reserves.
D.
ordinary shares.
18. A small proprietary company is one that has:
A.
less than $25 million sales and fewer than 50 employees.
B.
less than $5 million liabilities and fewer than 50 employees.
C.
less than $5 million expenses and less than $12.5 million assets.
D.
less than $10 million equity and less than $12.5 million assets.
19. Which of the following items does not appear on the balance sheet of a partnership?
A.
Debtors
B.
Equipment
C.
Creditors
D.
Income tax payable
20. The ability of a partner to enter into a contract on behalf of all partners is called:
A.
voluntary association.
B.
mutual agency.
C.
the partnership agreement.
D.
unlimited liability.
21. The separation of ownership and control is normally a characteristic of:
A.
companies.
B.
partnerships.
C.
sole traders.
D.
partnerships and companies.
22. The factors that should be considered before forming the partnership and company forms of entity
would include:
A.
income taxation implications.
B.
the liability of the equity participants for the debts of the business.
C.
the scale/magnitude of the operations involved and the access to finance.
D.
all of the above.
23 Due process involves:
A.
the maximum opportunity to comment on proposed accounting standards.
B.
the selection and discussion of emerging issues of accounting.
C.
a process of fast-tracking the implementation of accounting standards.
D.
adequate consultation between the FRC and the AASB before an accounting standard is
issued.
24. The principle purpose of an audit is to:
A.
assure investors of the wealth of the entity.
B.
assure investors of the future profitability of the entity.
C.
express an opinion on the truth and fairness of the entity’s financial statements.
D.
detect fraud by the entity’s employees.
25. If the conceptual framework sets out the concepts that underlie the preparation and presentation of
financial statements for external users, which of the following questions is the conceptual
framework not attempting to answer?
A.
Who are the users of general-purpose financial reports?
B.
Which entities should prepare special-purpose financial reports?
C.
How should the elements of the financial statements be measured and displayed?
D.
What are assets, liabilities, income, expenses and equity?
26. Objectives of a conceptual framework include:
A.
providing a defence against lobby groups.
B.
fewer and more consistent Accounting Standards.
C.
improved communication.
D.
all of the above.
27. Which of the following statements is incorrect?
A.
Compliance with the conceptual framework is non-mandatory in general purpose financial
statements.
B.
Compliance with Accounting Standards is mandatory in general purpose financial
statements.
C.
Compliance with the conceptual framework is mandatory in general purpose financial
statements.
D.
Accounting Standards are more specific than the conceptual framework.
28. Which of the following sets of entities are not likely to meet the definition of a reporting entity?
A.
Small proprietary companies, large proprietary companies and partnerships
B.
Small proprietary companies and sole traders
C.
Large proprietary companies, sole traders and partnerships
D.
Small proprietary companies and large professional accounting practices
29. An example of a reporting entity is likely to be a:
A.
public company.
B.
partnership.
C.
family trust.
D.
small proprietary company.
30. Which of the following are likely to be reporting entities?
I.
BHP Billiton
II.
The corner store
III.
An unincorporated business with 10 employees
IV.
A large proprietary company with over 500 employees and 200 creditors
A.
I only
B.
I and IV only
C.
II, III and IV only
D.
I, III and IV only
31. Which one of the following groups is not generally regarded as an external user of the accounting
information of an enterprise?
A.
Employees
B.
Customers
C.
Management
D.
Lenders
32. FeelGood Limited has been set up specifically for the building of an inner-city women’s refuge.
When the building has been erected and becomes operational (estimated time four months), the
company will be liquidated. Which basic assumption underlying the preparation of general-
purpose financial reports will not apply in preparing the reports for FeelGood Limited?
A.
The business entity principle.
B.
The principle of duality.
C.
The going-concern principle.
D.
The period assumption.
33. Assets are best defined as a:
A.
resource owned by the entity as a result of current event, from which future economic
benefits are expected to flow.
B.
resource owned by the entity as a result of past event, from which future economic
benefits are expected to flow.
C.
resource controlled by the entity as a result of past event, from which future economic
benefits are expected to flow.
D.
resource controlled by the entity as a result of a future event, from which future economic
benefits are expected to flow.
34. Which of the following is not a primary characteristic of the accounting definition of an asset?
A.
The capacity to provide benefits to the entity
B.
Control but not necessarily ownership
C.
Representing past events
D.
The ability to be reliably measured
35. Which of the following is not an asset?
A.
Equipment
B.
Accounts receivable
C.
Accounts payable
D.
Inventory
36. Which of the following elements does not require recognition criteria in order to decide whether it
should be recognised in the financial statements?
A.
Assets
B.
Revenues
C.
Equity
D.
Expenses
37. In terms of the conceptual framework, an asset is recognised on a balance sheet if it:
A.
is capable of reliable measurement and it is probable that the asset will be realised.
B.
is owned by the entity and is capable of reliable measurement.
C.
results from a past event and is owned by the entity.
D.
provides future economic benefits.
38. Which one of the following is not an asset?
A.
Inventory
B.
Accounts receivable
C.
Revenue
D.
Cash
39. Which of the following is not a liability?
A.
Accounts payable
B.
Loan payable
C.
Investment by owner
D.
Unearned revenue
40. Which of the following is not an attribute of a liability?
A.
Present obligation to transfer resources to another entity.
B.
The transfer is unavoidable by the entity.
C.
The transfer results in reduced economic benefits to the entity making the transfer.
D.
The event creating the responsibility has not yet occurred.
41. Which of the following accounts is a liability?
A.
Interest Expense
B.
Interest Payable
C.
Interest Revenue
D.
Interest Receivable
42. Liabilities are:
A.
resources under an organisation’s legal control.
B.
obligations owed by an organisation to its creditors.
C.
the amount of investment made by owners in a business.
D.
the profits earned by a corporation.
43. Which of the following accounts is not a liability?
A.
Wages Payable
B.
Prepaid Rent
C.
Accounts Payable
D.
Notes Payable
44. Revenues result when a business:
A.
creates resources by selling goods or services.
B.
borrows money.
C.
receives money from owners of the business.
D.
pays its employees.
45. Expenses result when a business:
A.
pays a supplier for goods purchased last month.
B.
consumes resources during the production and sale of goods or services.
C.
distributes money to owners.
D.
hires employees.
46. Torger Associates sold business services to another organisation for cash. As a result, Torger’s
assets increased. Which accounting term best describes the concept involved in the other part of
this transaction?
A.
Liability
B.
Revenue
C.
Financing activity
D.
Dividends
47. Which of the following types of entities would not fit the category of a profit-making entity?
A.
Sole proprietorship
B.
Partnership
C.
Charitable institution
D.
Company
48 The present obligation to make a future sacrifice that is an essential criteria of the definition of a
liability under the IASB Conceptual Framework:
A.
can only arise from legal obligations.
B.
may arise out of moral or constructive obligations.
C.
meets the definition of an expense.
D.
may vary in different countries.
49 According to the Corporations Act, an external auditor must:
A.
have appropriate tertiary qualifications.
B.
satisfy ASIC that he/she is capable of performing the duties of an auditor.
C.
satisfy ASIC that he/she is a fit and proper person to be registered as an auditor.
D.
all of the above.
50. The role of an auditor is to:
A.
review accounting systems and internal controls.
B.
detect fraud.
C.
ensure that every transaction is correct.
D.
ensure that there is no fraud and that all transactions are correct.
51. The auditor’s report:
A.
expresses an opinion as to the truth and fairness of the financial statements.
B.
states that the reporting entity is in a sound financial position.
C.
is prepared by internal auditors.
D.
includes forecasts of future profits.
52. The relationship between the task undertaken by auditors and the understanding of the users is called:
A.
the experience gap.
B.
the auditor’s report.
C.
the expectations gap.
D.
the information gap.
53. What is the audit expectation gap?
A.
The auditors’ ensuring that financial statements are prepared in accordance with
accounting standards.
B.
The difference between what an auditor is required to do and what is expected by users.
C.
The auditors’ ensuring that they meet the requirements of an audit.
D.
The auditors’ providing a true and fair view of the financial statements.
SHORT ANSWER
1. What is a conceptual framework from the perspective of financial reporting?
2. Describe four objectives of a conceptual framework.
3. Outline the nature and purpose of general-purpose financial reports.
4. Under what circumstances does an entity represent a ‘reporting entity’ for the purposes of the
Australian conceptual framework?
5. Describe the purpose of the external auditor in financial reporting.
6. What is the expectation gap associated with the external audit?
PROBLEMS
1. Explain what is meant by the term limited liability as it relates to the shareholders of a corporation;
and explain why shareholders are able to gain the benefit of limited liability whereas sole traders
cannot.
2. Describe three advantages of a company over a partnership and a sole trader.
3. R2 and E2 have been working as employees in the fashion industry. They are considering forming
a partnership designing fashion clothing, trading under the RE2 label. Advise the individuals on
the advantages and the disadvantages of forming a partnership.
Limited life – a partnership can be brought to an end at any time through, for
Unlimited liability – each partner is jointly and severally liable for the debts of
efficient functioning of the business, but also has serious implications vis-a-vis
4. Required:
(a)
(b)
legal right to mine vis-a-vis regulating/denying the access of others); and the past event
(discovery).
placed on the asset, but the case details are not definitive vis-a-vis the reliability of the
method.
5. Vanessa raised a $15,000,000 loan to fund the exploration that led to the discovery of the deposit
of silver. Discuss whether the loan meets the definition and recognition criteria of a liability to
Vanessa during the term of the loan, according to provisions of the IASB Conceptual; Framework.
ESSAY
1. The opportunity for interested parties to participate in the development of accounting standards lies
in the ‘due process’. Discuss.
2. Describe the role that the following organisations play in relation to Australian accounting
standards:
(i)
the Financial Reporting Council; and
(ii)
the Australian Accounting Standards Board
technical deliberations.