Question 2
Felix decided to review Fresh & Fragrant Pte Ltd’s accounts since its incorporation. He discovered the following points stated under additional information below. Felix roughly re-constructed the company's financial statements including the additional information. Instead of a net profit, the adjusted accounts showed a net loss.
After spending some time with Fresh & Fragrant Pte Ltd, Felix noticed that Mrs Fu allows her daughter to take cash from the company to spend on her daughter’s household groceries of about $1,000 per month. Mrs Fu just includes the cash used as miscellaneous expenses. Felix is not able to find the actual amount of cash involved.
Finally Mrs Fu instructed Felix that he is not allowed to pay for anything in December as December was reporting month and to hold back suppliers’ invoices. In addition Mrs Fu always request suppliers to delay delivery of December orders till January.

Additional information:
• Mr Fu sent a production machine for a major overhaul to extend its life and improve efficiency. On 1 October 2012, the machine was returned and Mr Fu paid $40,000 for new equipment parts, $3,500 for transportation charges, $1,500 for insurance cost during transportation. Mr Fu also signed a quarterly maintenance contract of $1,000 per maintenance starting 1 January 2013. Mrs Fu capitalised the cost of new equipment parts and recorded all the other payments as expenses. The machine has a useful life of 5 years with no residual value. No depreciation expense was recorded. Felix wants to use the straight line depreciation method.
• On 1 June 2012, Mr Fu purchased a new van for delivery. The van cost $120,000 and has a useful life of 10 years. Mrs Fu does not think that depreciation of the van is necessary as it is not production equipment. No depreciation expense was recorded. Felix wants to use the straight line depreciation method.
• The company’s premises were leased for three years from 1 January 2009 at $10,000 per month and renewed for another three years at the same rent. A deposit of three months’ rent was paid and recorded as rent expenses. Mrs Fu pays the rent promptly every month but records rent for premises as expenses only at the end of the three year lease period.
• Expenses including salaries and bonuses are paid in cash and recorded when paid. Mr & Mrs Fu traditionally give staff a 13th month bonus paid on 15 January the following year. Staff bonus for the year is estimated at $9,000. In addition, Directors’ fees of $24,000 approved for the year were not provided in the accounts as payment is made on 15 January the following year.
• On 1 April, the company bought and paid $48,000 for a two year fire insurance policy. This was recorded as prepaid insurance. There were no subsequent entries.

At the beginning of the year, Mr Fu bought an advertising package costing $30,000 to have promotions throughout the year starting January 2012. This was recorded as prepaid advertising. There were no subsequent entries.
• On 20 December 2012, the company bought on credit $10,000 worth of inventory. Entry was recorded as Debit Inventory $10,000 and Credit Cash $10,000. Supplies are paid in cash and recorded when paid.
• Mrs Fu does not believe in taking a provision for uncollectible accounts. Mrs Fu is confident of fully collecting all her outstanding sales proceeds as her customers are regulars. She told Felix that her customers have always paid up given enough time. Even with new customers, Mrs Fu believes in building up a good relationship and will give them credit for as long as customers need to pay up. However the general industry practice is to provide for uncollectible accounts at 1% of sales. Sales for 2012 were $900,000.
• General expenses including printing costs of $1,000 were billed for December 2012 but paid in January next year.
Required:
(a) Name users of financial reports and describe what users use the financial reports for.
(3 marks)
(b) Felix wants to use his knowledge as a trained accountant to apply accrual accounting concepts and principles to Fresh & Fragrant Pte Ltd’s accounts. Analyse, explain and show the following accounting concepts and principles and use them to discuss the points and issues above with regard to what should be the appropriate treatment.
(i) Capital expenditure versus expenses.
(ii) Depreciation.
(iii) Conservatism.
(iv) Business entity concept.
(v) Accrual accounting and matching principle.
(30 marks)
(c) Felix is trying to explain to Mr & Mrs Fu his thoughts on the information in the three paragraphs above the additional information in Question 2, namely on financial reporting standards and accrual accounting adjustments; personal expenses and separate business entity; and holding back suppliers’ invoices and matching of revenue and expenses. Help Felix with his explanations.
(6 marks)