Summary: Accounting

200101 Accounting Information for Managers
Tutorial Solutions - Week 7

School of Business│

Spring 2012

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Graeme Mitchell and Stanley James (Parramatta), Brian Voysey (Bankstown) ,
Michelle Cull and Stanley James
The estimated uncollectable accounts receivable is then debited as a bad debt expense and is recognised in the income statement, which subsequently would reduce the entity’s profit in the current accounting period. At the same time, the estimated uncollectable accounts receivable is also credited to an allowance for doubtful debts account, which is a contra asset account that reduces the amount of accounts receivable. As a result, applying the correct measurement basis for accounts receivable will reduce Frazier’s profit for the current period and its assets.
Similarly, if Frazier was to apply the correct measurement basis for its inventory, the inventory must be valued at the lower of cost and net realisable value. As a considerable portion of Frazier’s inventory is already obsolete, the inventory must be writt en down to net realisable value. The inventory write-down will reduce the inventory value recognised in the balance sheet, and will be treated as an expense in the income statement. As a result,
Frazier’s profit in the current period and its assets will also decrease.

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Your friend is confused as to why the financial statements do not reflect the measure of the entity’s value. Explain this to your friend.

LookFool’s shares are currently trading at $3.58. Given that there are 150 000 shares on issue, the market capitalisation of LookFool is $3.58 × 150 000 = $537 000. The financial statements show the carrying value of net assets to be $250 000. So, the issue is why doesn’t the balance sheet reflect economic reality (i.e. show the net assets to be what the company is measured at in the market place)? There are a number of reasons why the market value and book value differ including: assets in LookFool’s balance sheet may be measured at cost (or depreciated cost) and this may not resemble the current value of the assets; the market may be valuing assets that LookFool is not recognising on its balance sheet because the definition and recognition criteria are not satisfied (e.g. internally generated intangibles, strength of management team); the market may be valuing LookFool on its growth potential rather than on