Question 3

Flummoxed Limited has acted as a guarantor for a loan taken out by one of its subsidiaries. The loan amount is considered material to both companies and is due to be repaid next month. The subsidiary is facing some financial difficulties and there is a possibility that the subsidiary may not be able to pay the loan when it falls due. However, based on the net assets of the subsidiary, it is more likely than not that the subsidiary will be able to liquidate its assets to pay off the loan. All the directors believe that there is no action needed with regards to the financial statements in connection with the above.

Required

Please explain in detail whether or not the directors are right. Please also show the relevant journal entries if any or any other information that should be included. I would appreciate it if you could prepare a Statement of Advice to address the above issues at your earliest convenience. Please include any references to relevant accounting standards (including specific paragraph numbers) but please explain in a way the directors will understand.