Issues in Financial Reporting Depends on the Applicability

Question: Discuss about the Issues in Financial Reporting for Depends on the Applicability. Answer: 1. A The Corporation Act 2001, Australian Accounting Standard Board and other relevant requirements of the statue, guides the preparation and presentation of financial statements. The reporting requirement of an entity depends on the applicability of the various provisions that are stated in various laws and standards. In the given case, the reporting requirement of Brixton is discussed in this section. In the Corporation Act 2001, it is provided under section 292 that all the registered schemes, proprietary companies and disclosing entities are required under this section to prepare a director report and financial report for each financial year. The financial reports and the director reports prepared by the companies are required under section 314 of the corporation Act 2001 to be produced to every member of the company for each financial year. The financial report produced to the members at each financial year should contain a financial statement for the year; notes to the financial statements and the directors declaration as required under section 295(1) of the Corporation Act 2001. The section 296(1) of the Corporation Act 2001 states that the financial reports prepared must comply with the requirement of the Accounting Standards (Chalmers et al. 2012). In conclusion, the reporting requirement of the corporation Act 2001 can be summarized by stating that a company is required un der this act to prepare a financial report in accordance with the requirement of the accounting standards. The company is also required under the act to prepare this report every year and present this report to the members of the company. The reporting requirement of the company is also affected by the application of SAC 1. The concept document issued by the Financial Accounting Standard Board is known as Statement of Accounting concepts. This document provides an overview of the accounting concepts, definitions and ideas and additionally it also covers the broad reporting concepts of the financial statements. In Australia, the Framework for presentation and preparation of financial statements was adopted on 2005 but the Statement of Accounting concept 1 continued to be applicable along with the new requirements (Rahman 2013). In 1990, the Statement of Accounting Concept (SAC) 1 was issued and it includes the definition of the reporting entity. The SAC1 defines an entity as reporting entity if the management is of the opinion that the user of the financial statements will use this statement to make economic decisions. The reporting requirement of a company is hugely affected by the requirements of the accounting standards. The Accounting Standards are developed, issued, maintained and interpreted by the Australian Accounting Standard Board. The entities that are required to prepare financial report as provided in the corporation Act 2001 is required to comply with the requirements of the Accounting Standard. The reporting requirement of the general-purpose financial statements is classified into Tier 1 and Tier 2. In Tier 1 it is the Australian Accounting Standard and in Tier 2 it is the reduced disclosure requirement of the Australian Accounting standards. In Para 5 of the AASB 1057 it is stated that a financial report prepared under Corporation Act 2001 should follow the requirements of the Australian Accounting Standards. Brixton Ltd is a public company and it is listed on Australian Security Exchange so the requirement of the corporation Act 2001 applies. Therefore, as section 314 of the Corporation Act 2001 applies so the Brixton Ltd is required to produce at each financial year the financial reports to the members of the company. The financial reports prepared by the Brixton Ltd should be in accordance with the section 295(1) of the corporation act 2001. As required by the section 296 of the corporation act 2001 the financial reports prepared by the Brixton Ltd should comply with the requirements of the accounting standards. The investors of the Brixton Ltd will make investment decision based on the analysis of the financial report so Brixton Ltd is a reporting entity as per SAC1. The Australian Accounting standards are required to be followed by Brixton Ltd in preparing and presenting financial report as required by the AASP 1057. Therefore based on the above discussion it can be said that the fin ancial report of Brixton Ltd should be in accordance with the requirement of the Corporation Act 2001, SAC 1 and Australian Accounting Standards (Henderson et al. 2015). The Brixton Company is required to present the revenue and expenses by preparing a statement of the profit or loss account and other comprehensive income as provided in AASB 101. The Para 6.3of the AASB 1042 provides that expenses related to discounting operations is required to be presented within the ordinary activities. The statement of Brixton Ltd profit or loss and other comprehensive income is shown below. B. Statement of Profit or Loss and other Comprehensive Income For the year ended 30 June 2016 Particulars Amount (in thousands) Revenue $ 360,000.00 Cost of Sales $ (204,000.00) Gross Profit $ 156,000.00 Other Income $ 24,000.00 Gain on sale of financial assets $ 2,000.00 Loss for the year from discounted operation $ (9,000.00) Sales and Marketing Expenses $ (37,500.00) Administrative Costs $ (33,000.00) Finance Costs $ (18,000.00) other operating expenses $ (16,500.00) Occupancy Expenses $ (30,000.00) Profit Before Tax $ 38,000.00 Income Tax Expenses $ (14,000.00) Profit For the Year $ 24,000.00 Other Comprehensive Income Items that will not be reclassified to profit and Loss Gain on remeasurement of defined benefit plan $ 9,000.00 Gain on Revaluation of property $ 13,500.00 Income tax relating to items that will not be reclassified $ (10,500.00) $ 12,000.00 Items that may be reclassified subsequently to profit and Loss Unrealized gain on Cash flow hedges $ 9,000.00 Exchange difference on translation of foreign operation $ (4,500.00) Income Tax relating to items that may be reclassified $ (1,500.00) $ 3,000.00 Other Comprehensive Income for the year, net of tax $ 15,000.00 TOTAL COMPREHENSIVE INCOME FOR THE YEAR $ 39,000.00 2. A In preparing the financial statement of the company all, the item of the expenditure cannot be measured accurately so in some cases estimation is necessary. Few of the examples of estimates that are made in preparing financial statements are useful life of assets, fair value of assets, residual value of assets, liabilities etc. The reliable and latest information available are used in making estimate and if a new circumstance originates then the estimates must be revised (Chua et al. 2012). The AASB 108 states that changes made in accounting estimated for preparing financial statement should be properly shown in the accounts. The profit and loss account of the year in which the change take place should appropriately reflect the change in accounting estimate as required by Para 36 of the AASB 108. The standard also provides if the change in accounting estimate affect the future period then the profit and loss account of the future period should also reflect that. The Para 37 of the AA SB 108 states that the value of the assets, liabilities and equity should be adjusted if the change in estimates affects the balance of the assets, liabilities or equity of the future and current period. In 2011, the Bostock estimated the useful life and the residual value of the equipment. Based on the evaluation and recommendation of the technical expert the residual value and the useful life of the equipment were revised in 2016 and in the same year, management accepted the suggestions given by the expert. The depreciation should therefore be calculated on the revised estimates provided by the experts from the year 2016 as required by the AASB 108 and the change will also affect the future periods (Tsunogaya et al. 2016). B Statement showing Calculation of Depreciation Particular Amount Cost of the Equipment $ 400,000.00 Original estimate Useful life (years) 10 Residual Value $ 40,000.00 Depreciation $ 36,000.00 Accumulated Depreciation as on 01.06.2015 144000 Carrying Amount as on 01.06.2015 $ 256,000.00 Revised Estimate Useful life (years) 11 Residual Value $ 46,000.00 Remaining useful life 7 Depreciation $ 30,000.00 The depreciation for 30 June 2015 is $36000.00 As on that date, the machine has been used for 4 years. So the remaining life of the assets is 6 years. The revised estimate provides the useful life as 11 years so the remaining useful life is 7 years. This re estimated remaining life is used for calculating the revised depreciation. The residual value is also revised. Based on the revised useful life and residual the depreciation is calculated by using the following formula Depreciation= (256000-46000)/7 = $30000.00. The Depreciation for 2016 and 2017 will be $30000.00 C. The Para 42 of the AASB 108 Accounting Policies, Change in Accounting estimates and error deals with the prior period errors and it provides that all the material errors that affects the financial statement should be corrected by revising the prior period financial statements. The standard requires that the nature and the amount of the error that is adjusted at the earliest period reported should be appropriately disclosed (Horngren et al. 2012). Bostock purchased the machinery on 1 July and the company paid purchase Tax of $60000.00. The company did not account for purchase tax as it believed that it would receive the refund. The refund was later canceled by the tax office in 2016 and the company had to pay the purchase tax. As a result of this the cost of machinery was understated by $60000.00 therefore the depreciation was also understated for the year, This understatement of depreciation will make the profit overstated and therefore an adjustment of this error is required to be made as per the requirement of the AASB 108. D. As on 30 June 2015 the depreciation was understated by (60000/15) =$4000.00. The journal entry that Bostock is required to pass on 30 June 2016 for rectifying the error is: Machinery A/C Dr $60000.00 Depreciation A/C.Dr $44000.00 Retained Earnings A/cDr $40000.00 Accumulated Depreciation $48000.00 Bank A/c $60000.00 The effect of the journal entries: The machinery account is debited by $60000.00 to include in the cost of the machinery the purchase tax paid. The revised depreciation of $440000.00 is calculated and it is recorded in the accounts. The understatement of depreciation has overstated the profit and now it is adjusted. The depreciation that was understated by $4000.00 is transferred to accumulated depreciation. The amount paid as purchase tax of $60000.00 to tax office was recorded as the expanses. Calculation of Depreciation of Machinery Particular Amount Cost of machinery $600,000.00 Useful live 15 Depreciation $40,000.00 Error Purchase Tax 60000 Depreciation understated 4000 Revised Depreciation $44,000.00 3. A It is provided in the AASB 137 Provisions, Contingent liability and Contingent Assets that contingent liabilities, contingent assets and provisions should be appropriately measured and recognized in the financial statements (Mala and Chand 2012). In Para 10 of the AASB 137 provisions is defined as the liability of which the amount and the timing of its settlement are not certain. The provision is required to be made either by way of constructive obligations or leagal obligations. The AASB 137 on Para 14 it is provided that entity is required to satisfy certain conditions before it could recognize provision in the financial statements. These conditions are: The company should have a present obligation. It may either be constructive or legal obligations. There should be an obligating event that is a past event that is responsible for present obligations. There is a probability that outflow of economic benefit will be required to settle the present obligations. The reliable estimate for amount of obligation is not possible. On fulfilling all of the above conditions an entity can provide for the provisions in the financial statements. The Orange limited provides 2 years warranty to the purchaser of mobile phone.. The obligating event in this case is the act of sale and as soon as a mobile is sold then the company has a present obligation. The company from its past experience is reasonably certain that there will be some claims from the customer. The company has estimated that it will require for minor repair $200 per mobile phones and for major repair it will require $800 per mobile phones. It is certain that the company will have to incur outflow of resources embodying economic benefit so it is satisfies that fourth condition of the requirement. The company cannot estimate the actual amount required because there is no certainty of the number of warranty claim that the company is going to receive. The company makes an estimate on the number of claim to be received based on the experience. Therefore, the fifth condition of recognizing the provision is also satisfied. The analysis above shows that the company should recognize provision as soon as the mobile phones are sold. C. It is provided in the Para 36 of the AASB 137 that provision should be recognized as the best estimated amount that is required to settle the obligation.. The calculation of provision can be done using different methods. The best estimate in case of an individual obligation is done by adjusting the liability amount with the risk and uncertainty involved and this method is called the most likely outcome. The provision for a large population of item is calculated by using the expected value calculation. In this method the probable outcomes are weighted against the probably and the calculation of provision is done. It is the most appropriate method for calculating provision in case of warranty. The provision can also be calculated using another method called range of possible outcomes. It is appropriate when there are range of possible outcomes (Botzem 2012). D. The AASB 137 Para 42 states that risk and uncertainty should be appropriately reflected in the calculation of the proviso. The Para 42 requires that the uncertainty and risk should be taken into account in calculating provisions. As the Para 45 require provision should include the present of the estimated obligation that is required to settle the obligations. (Chambers and Dean 2013). E. The amount of warranty provision on 30 June 2016 is $556456.29. It is required for getting the required warranty amount of $600000.00. The calculation is given below. Calculation of the amount of provision Particulars Probability Number of units Estimated expenses per unit Amount of provision No warranty repair 85% 8500 $ - $ - Minor repair 10% 1000 $ 200.00 $ 200,000.00 Major repair 5% 500 $ 800.00 $ 400,000.00 Total Provision required $ 600,000.00 Calculation of the amount of provision to be recognized Particular Future Value Present value Amount of warranty expected in 2017 $ 360,000.00 $342,857.14 Amount of warranty expected in 2018 $ 240,000.00 $213,599.15 Total Provision required at the end of 30 June 2016 $556,456.29 F. AASB provides the definition and accounting treatments for the contingent liabilities in the Para 10. As per the guideline, the contingent liability of a company is to be defined as the probable liability of a company, which is dependent on some special cases or incidents. For the purpose non occurrence, the contingent liabilities are not treated in the income statement and balance sheet. The AASB discloses that the contingent liabilities are to be mentioned as foot note in the financial statement. As per AASB 27, all the probable liabilities are required to be mentioned in the foot note after the balance sheet. The contingent liabilities of an entity are needed to be analyzed properly as the contingent liabilities plays vital role in the future income statements. In the case of Orange limited, the company is confidence for their win over lawsuit. The mobile company maintains a provision for the case of $5 million to $15 million as contingent liability, which is to be mentioned in the foot note after the income statement (Irwin 2012). In the given case, Orange limited is facing a patent litigation from a mobile phone company. If Orange limited is confident that it can defend the lawsuit then it should be recognized as contingent liability and a disclosure should be provided in the notes to financial statement. If the orange limited based on the evidence available finds that it is probable that the company will lose the lawsuit then the company should immediately recognize a provision of $5 million to $15 million. 4. A. Statement showing calculation of Cost of machinery Particular Amount ($) Cost of purchase 480000 Custom duties 17000 Consultation fees to engineers 10000 Transportation and delivery charges 15000 Insurance ncost 5000 Installation and assembly costs 8000 Modification charges of machinery 20000 Cost of testing 4165 Cost of Machinery at initial recognition 559165 B. The AASB provides guidance to the companies of Australia to charge depreciation over the useful life of a machine. AASB 116 discloses all the rules of charging depreciation of an asset, which is used by the domestic as well as the foreign companies in the country. Para 15 of the Audit and Accounting standard of Australia disclose that the machineries and other assets are needed to be depreciated systematically over the useful life of assets. Furthermore, the AASB defines the depreciation as the economic value of assets used for production purpose. Two methods of charging depreciation are also mentioned in the AASB, which are straight line method and diminishing balance method (Horngren 2012). In the AASB 116, the choosing of the depreciation method is also mentioned. As per Para 62 of the standard, the entities are given the responsibility to chose the method of depreciation. Recton electronics limited has planned to produce 10000 units for the first 8 years out of the total useful life of 10 years. If the company chooses the straight line method of depereciatring its assets, the total cost of asset is to be allocated as depreciation on equal basis. Moreover, the installation cost of the machinery is to be depreciated for the first four years as the economic benefit is to be utilised for the initial four years. C. The asset of the company was bought on March 1, 2016 and the same was put to use from 1 April, 2016. If the machinery is to be charged depreciation on straight line method, the cost of the machine was required to be divided by the estimated life of such machine (Berk et al. 2013). But in the present case, the company is required to charge depreciation on the basis of units produced. Therefore, the depreciation is to be charged from the date of commencement of production. Reference Berk, J., DeMarzo, P., Harford, J., Ford, G., Mollica, V. and Finch, N., 2013.Fundamentals of corporate finance. Pearson Higher Education AU. 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