Financial Reporting Standard 5 Reporting the Substance of Transactions requires an entity’s financial statements to report the substance of transactions into which it has entered. The FRS sets out how to determine the substance of a transaction and whether any resulting assets and liabilities should be included in the balance sheet. The FRS came about partly as a result of concern over arrangements made by companies whereby assets and liabilities were omitted from the balance sheet.

Required

(a) Explain the reasons why companies may wish to omit assets and liabilities from their balance sheets. (5 marks)

(b) Explain the reasons why the Accounting Standards Board felt it necessary to introduce FRS 5 Reporting the Substance of Transactions. (5 marks)

(c) Discuss the proposed treatment of the following items in the financial statements:

(i) Beak plc sells land to a property investment company, Wings plc. The sale price is

£20 million and the current market value is £30 million. Beak plc can buy the land back at any time in the next five years for the original selling price plus an annual commission of 1% above the current bank base rate. Wings plc cannot require Beak plc to buy the land back at any time.

The accountant of Beak plc proposes to treat this transaction as a sale in the financial statements. (7 marks)
(ii) A car manufacturer, Gocar plc, supplies cars to a car dealer, Sparks Ltd, on the following terms. Sparks Ltd has to pay a monthly fee of £100 per car for the privilege of displaying it in its showroom and also is responsible for insuring the cars.
When a car is sold to a customer, Sparks Ltd has to pay Gocar plc the factory price of the car when it was first supplied. Sparks Ltd can only return the cars to Gocar plc on the payment of a fixed penalty charge of 10% of the cost of the car. Sparks Ltd has to pay the factory price for the cars if they remain unsold within a four month period. Gocar plc cannot demand the return of the cars from Sparks Ltd.
The accountant of Sparks Ltd proposes to treat the cars unsold for less than four months as the property of Gocar plc and not show them as stock in the financial statements. (8 marks)
ACCA, Accounting and Audit Practice, December 1994 (25 marks)