Bao3309 Advanced Financial Accounting : Assessment Answers

1.Explain, with reference to the research literature, how accounting policy choices can affect financial results?
2.Why did ASIC choose to focus its investigation on material disclosures of decision useful information such as assumptions supporting accounting estimates, significant accounting policy choices? Explain your answer with reference to the research literature. 
3.Explain, with reference to the research literature, why CPA Australia, with reference to ASIC, believes that ‘a suitable revenue recognition policy’ requires the ‘appropriate application’ of ‘the timing of recognition’ therefore ‘reflecting the substance of underlying transactions’?
4.Explain and analyze the extent to which the revenue recognition criteria in AASB 118 / IAS 18 Revenue and AASB 15 / IFRS 15 Revenue from Contracts with Customers meets the ASIC and CPA requirements of an ‘appropriate application’ of ‘the timing of recognition ‘of revenue and therefore represents the substance of underlying transaction.
5.Review the annual financial reports of a company of your choice for the reporting years 2014, 2015 and 2016. Analyze how revenue was recognized in each of the reporting years, and explain any variations in the firm’s reported revenueover this period by examining the accounting policies section in the notes to the accounts with regards to AASB 118 / IAS 18 Revenueand AASB 15 / IFRS 15 Revenue from Contracts with Customers.
6.Explain the choices of accounting policies with regards toAASB 118 / IAS 18 RevenueandAASB 15 / IFRS 15 Revenue from Contracts with Customers by reference to the relevant accounting research literature on factors influencing firms’ accounting policy choice (e.g. Positive Accounting Theory). 

Question 1

The application and selection of accounting policies, specifically the alternate methods as per the international financial reporting standards (IFRS) may have a considerable impact on valuation of capital, assets and liabilities and therefore, on the organization’s financial position that is based on the information of the financial statements, specifically the balance sheet. The users of the financial reports can presume that they receive the information from the financial reports are reliable and will fulfil their purpose. However, in reality, who prepares the financial reports get an incentive for misrepresenting the data as their performance are analysed through the financial performance stated in the financial reports. Various kinds of manipulations are done with the financial statements at the level of the management. The accounting policies, International accounting standards and the changes in the accounting errors and estimates specifically deals with the changes in accounting policies. There are various sources of inequalities and sources of changes in the accounting policies among various countries and enterprises (Ifrs.org 2017).

Accounting policies are the specific practices, rules, conventions, bases and principles that are applied by the organization for presenting and preparing the financial statements. The choices of accounting policies are the required extension for the accounting regulation in the form of standards, by-laws and laws. The accounting policies are required for delivering more relevant and reliable information in the financial statements for the impacts of the transactions, conditions or the events related to the financial position of the organization (Haller and Wehrfritz 2013). These data must be presented in the consistent and undistorted manner. Legal misrepresentation for the presentation of the financial information are presented in the changes of accounting policies that favour the managerial compensation and guide the users of the financial reports to make the wrong choices for the investment. The below presented table reveals how the choices of accounting policies influence the financial position with regard to the most crucial agents that is the shareholders, management and the government and the vice-versa (Jackson, Lipe and Waddoups 2016).

Therefore, the chosen accounting policy is the part requirement for reducing the contract costs. Thus, various accounting policies that are employed by the reporting organization have considerable effect on interpretation of the financial reports through the analysis of ratios. Various accounting policies have great impact on the financial position as well as the income statement of the organization (Ahmed, Neel and Wang 2013). However, this has both indirect and direct impact on the major ratios of the organization like capital gearing ratio and the return on the capital employed. From the preceding aspects, the users of the financial statement must analyse all the information involved in the financial reports of the organization. The selected accounting policies must be recognized to explain how one company is compared with another within the industry (Christensen and Nikolaev 2013).

Question 2

ASIC announced their focus areas for the year ended 31^st December 2016 financial statements for the listed companies and other companies for the public interests with the stakeholders. As on June 2016, ASIC highlighted that the organizations shall adopt the realistic valuations for the values of assets and shall use the suitable accounting policies. ASIC will continue focussing on the material disclosures like assumptions that support the accounting estimates, choice of significant accounting policies, and the effect of the newly applied reporting requirements (Asic.gov.au 2017). They influence the organizations for communicating the information in more clear way in their financial statements. The focus areas that are required to be widely consistent with the prior periods are as follows:

• Impact of the new financial instrument and revenue standards
• Accounting for tax
• Recognition of revenue
• Arrangements for off-balance sheet items
• Judgements for accounting and estimates policies
• Assets valuation and impairment testing
• Deferral of expenses

Careful consideration is required while determining the cash-generate unit identification, assumptions on cash flows, calculation of fair values, disclosures of the key assumptions and sensitivity with regard to the alteration sin the assumptions (EY. com 2017).

Further the auditors and the directors must review the policies regarding the revenue recognition of the organization and assure that the revenue is recognized as per the substance of the underlying assets. This also involves assuring that:

• Control on the relevant goods are passed on to the purchaser
• Services with which the revenues are related are performed
• Revenues are recognized in the financial statements based on the appropriate method of instrument class
• Assets are appropriately segregated as non-financial and financial assets
• When the revenue is related to both sales of the goods as well as the provision of the related services then the revenue is suitably assigned to the elements and are recognised accordingly.   

Question 3

The latest wish of the ASIC regarding the improvements in the financial reporting cover the focus areas that are remained as the areas of concern for last few years. The list includes the revenue recognition policy and CPA Australia believes that there must be a proper timing and application for recognition of the revenue with a view to reflect the substances for the underlying transactions. ASIC is and will continue to behave sensitively with regard to the selection of the policies while recognising the revenues as the proper application of requirements that takes into consideration the timing of revenue recognition and reflects the substances for the underlying transactions, are crucial for the appropriate policy related to the recognition of revenue. The companies those prepare their financial statement in compliance with IFRS, their auditors must focus on the expected impact of the new application of the IFRS 15 that is revenue from contracts with the customers and shall make suitable disclosures as per the requirements. IFRS 15 on revenue from contracts was issued in May 2014 by the International Accounting Standard Board (IASB) and the application date for the standards was set for the accounting period that will begin on or after 1^st January 2017 and a copy of the IFRS 15 can be availed from the CPA library. The AASB 118 on Revenue is applicable for the reporting of the financial statements from the period of 1^st January 2005 (apesb.org.au 2017)

With regard to the above factors, the CPA Australia believes that the suitable policy for the revenue recognition requires appropriate application for the timing of the negotiation to reflect the substance for the underlying transactions.

Question 4

The main objective of IFRS 15/AASB 15 on Revenue from contracts with customers stated that the organizations shall apply the useful information while preparing the financial statements regarding the timing, amount, nature and uncertainty regarding the cash flows and revenues that are expected to arise from the customers. Costs that are incurred for fulfilling the contracts are recognised as the asset only if all the below mentioned criteria are fulfilled:

• The costs are directly related to the contract or the particular anticipated contract
• Cost are expected to be recovered
• The cost enhances or generates the resources of the organization that will be utilised for satisfying the performance obligations for the future.

The costs include the costs of direct labour, direct material and the assignment of overheads that are directly related to the contracts (Dakis 2016).

Revenue shall be recognized at the fair value with regard to the consideration receivable or received by taking into consideration the amount of volume rebates and trade discounts that are allowed by the organisation, if any.  Revenue generated from selling of the goods is recognized only after the below mentioned conditions are fulfilled:

• The cost that is to be incurred or that has been incurred with regard to the transaction can be measured reliably
• There is potentiality that economic benefits that are associated with the relevant transaction will flow to the organization.
• The amount of revenue can be reliably measured
• The organization does not retain the continuing managerial involvement to the extent it is linked with the ownership and not having the controls over the sale of goods.
• The organization transferred the significance rewards and risks associated with the ownership of goods (Capalbo and Sorrentino 2013).

Therefore, with regard to the above discussion, it can be said that the revenue recognition criteria under the IAS 18/AASB 118 on Revenue and IFRS 15/AASB 15 on revenue from contracts with customers are complied with the CPA and ASIC requirements for ‘appropriate application’ for the ‘timing of recognition’ for the revenue and are therefore represents the substance for the underlying transactions (Holland 2016).    

Question 5

Selected company is Wesfarmers

The financial report of the company is prepared based on the requirement of Corporation Act 2001, International Financial Reporting Standards (IFRS) and authoritative pronouncement of Australian Accounting Standards Board (AASB) as are issued by the International Accounting standards Board (IASB) (Wesfarmers.com.au 2017). From the annual reports of the company for the year 2014, 2015 and 2016, it is identified that the revenue has been recognized by the company in the following ways:

For the year 2016 - from the annual report of the company for the year 2016, it has been identified that the amount of revenue was for $ 65,981 million. The revenue of the company has been measured based on the fair value of the consideration receivable or received. The recognition of revenue after it met the following criteria:

Sale of goods: the company earned a considerable amount of revenue from the sale of the below mentioned goods:

• LNG and LPG
• Coal, both internationally as well as nationally
• Specialty gases and fertilisers
• Direct merchandise to the customers through the retail operation of the company
• Sales to the other product business for which the company has the right for distribution those are primarily related to the industrial safety and industrial maintenance.

Revenue is recognised only after the rewards and risks related to the ownership of goods are passed to the purchaser and it can be reliably measured. Rewards and risks are considered as passed on to the purchaser when the goods are delivered to the customers. Revenue generated from lay-by transactions are recognised on the same date when the customer makes the payment and takes the possession for the merchandise (IASB 2015).

Rendering of the services: with regard to services that has been rendered, the revenues are recognised based on the completion stage of those services

Interest: Amount of interest is computed through the effective interest method that is applicable to the exact rate of interest and the discount rate are also taken into consideration for the projection of future receipts of cash over the financial instrument’s expected life.

Dividends: revenue arising from dividends is recognized only after the company’s right of receiving the payment is established

Rental revenue from operating lease: this revenue includes the rental from sub-lease and from the investment properties. Rentals from the initial direct cost and operating leases are recognised based on the straight-line over the lease term

For the year 2015 - from the annual report of the company for the year 2015, it has been identified that the amount of revenue was for $ 62,447 million. The revenue of the company has been measured based on the fair value of the consideration receivable or received. The recognition of revenue after it met the following criteria:

Sale of goods: the company earned a considerable amount of revenue from the sale of the below mentioned goods:

• LNG and LPG
• Coal, both internationally as well as nationally
• Specialty gases and fertilisers
• Direct merchandise to the customers through the retail operation of the company
• Sales to the other product business for which the company has the right for distribution those are primarily related to the industrial safety and industrial maintenance.

Revenue is recognised only after the rewards and risks related to the ownership of goods are passed to the purchaser and it can be reliably measured. Rewards and risks are considered as passed on to the purchaser when the goods are delivered to the customers. Revenue generated from lay-by transactions are recognised on the same date when the customer makes the payment and takes the possession for the merchandise.

Rendering of the services: with regard to services that has been rendered, the revenues are recognised based on the completion stage of those services

Interest: Amount of interest is computed through the effective interest method that is applicable to the exact rate of interest and the discount rate are also taken into consideration for the projection of future receipts of cash over the financial instrument’s expected life.

Dividends: revenue arising from dividends is recognized only after the company’s right of receiving the payment is established

Rental revenue from operating lease: this revenue includes the rental from sub-lease and from the investment properties. Rentals from the initial direct cost and operating leases are recognised based on the straight-line over the lease term (AASB 2014)

For the year 2014 - from the annual report of the company for the year 2015, it has been identified that the amount of revenue was for $ 60,181 million. The revenue of the company has been measured based on the fair value of the consideration receivable or received. The recognition of revenue after it met the following criteria:

Sale of goods: the company earned a considerable amount of revenue from the sale of the below mentioned goods:

• LNG and LPG
• Coal, both internationally as well as nationally
• Specialty gases and fertilisers
• Direct merchandise to the customers through the retail operation of the company
• Sales to the other product business for which the company has the right for distribution those are primarily related to the industrial safety and industrial maintenance.

Revenue is recognised only after the rewards and risks related to the ownership of goods are passed to the purchaser and it can be reliably measured. Rewards and risks are considered as passed on to the purchaser when the goods are delivered to the customers. Revenue generated from lay-by transactions are recognised on the same date when the customer makes the payment and takes the possession for the merchandise.

Rendering of the services: with regard to services that has been rendered, the revenues are recognised based on the completion stage of those services

Interest: Amount of interest is computed through the effective interest method that is applicable to the exact rate of interest and the discount rate are also taken into consideration for the projection of future receipts of cash over the financial instrument’s expected life.

Dividends: revenue arising from dividends is recognized only after the company’s right of receiving the payment is established

Rental revenue from operating lease: this revenue includes the rental from sub-lease and from the investment properties. Rentals from the initial direct cost and operating leases are recognised based on the straight-line over the lease term

From the above analysis of the annual report for recognition of revenue for the year ended 2016, 2015 and 2014, it is identified that for all the three years company followed the same basis for recognition of revenue and there is no change in the method of recognition.

Question 6

With regard to the IFRS 15 / AASB 15 on revenue from contracts with customers and IAS 18 / AASB 118 the choices of accounting policies can be as follows:

Positive accounting theory – It tries for good predictions regarding the real world happening and transform them to the accounting transactions. It intends to predict and explain

• How the organization will react with regard to the newly required accounting standards
• Actions that are required to be taken with regard to the choices of the accounting policies

The overall aim is to get the better idea and forecast the choice for the accounting policies for various organizations. It identifies that the consequences of economies do exist. Under the positive accounting theory, the organization wishes to maximise the prospects for existence, so that they can efficiently organize themselves. Further, under this theory the organizations are considered as the accumulation of contracts they have entered into (Baboukardos and Rimmel 2016).    

Normative accounting theories – instead of focussing on what is going on within the organization at present scenario, it suggest the policy makers for accounting what shall be done on the basis if the theoretical approaches. It is more in the nature of deductive procedure as compared to the positive accounting theory. It starts with theory and ends up with particular policies (Roberts 2014).  Therefore, this theory does not analyse the performance through the projection and mainly focus on the logical consistency. Thus, it can be said that the normative theory only gives importance to the ways in which the data shall be collected and analysed but not takes into consideration the fact that in which areas improvements can be done.

Statement of accounting policy – accounting policies play an important role in getting a clear idea regarding the information involved in the financial statements. The company shall clearly mention in their disclosure notes about the policies they have used to prepare their financial reports. Disclosures of policies will assist the users like creditors, stakeholders, customers and potential investors to get the exact idea regarding the performance of the organization if they want to compare the performance with other companies in the same industry. It will assist in better proper analyzation as the different accounting policies for same transaction can lead to different outcomes.

Taken into consideration both the above explained theories, it is concluded that the firms shall go for adopting the positive accounting theory with regards to the IAS 18/AASB 118 on Revenue and IFRS 15/AASB 15 on revenue from contracts with customers as it starts with a particular policy but ends up with generalising to higher-level principles. Further this assist in recognition of changing circumstances that need the managers do deal with flexibility while choosing the accounting policies.

References 

AASB, C.A.S., 2014. Financial Instruments. Project Summary.

Ahmed, A.S., Neel, M. and Wang, D., 2013. Does mandatory adoption of IFRS improve accounting quality? Preliminary evidence. Contemporary Accounting Research, 30(4), pp.1344-1372.

Asic.gov.au. (2017). ASIC Home | ASIC - Australian Securities and Investments Commission. [online] Available at: https://www.asic.gov.au/ [Accessed 23 May 2017].

Baboukardos, D. and Rimmel, G., 2016. Positive Accounting Theory.

Capalbo, F. and Sorrentino, M., 2013. Cash to Accrual accounting: Does it mean more control for the public sector? The case of revenue from non-exchange transactions. Risk Governance & Control: Financial Markets & Institutions, 3(4), pp.28-35.

Christensen, H.B. and Nikolaev, V.V., 2013. Does fair value accounting for non-financial assets pass the market test?. Review of Accounting Studies, 18(3), pp.734-775.

Dakis, G.S., 2016. Upcoming changes to contributions and leasing standards. Governance Directions, 68(2), p.99.

Haller, A. and Wehrfritz, M., 2013. The impact of national GAAP and accounting traditions on IFRS policy selection: evidence from Germany and the UK. Journal of International Accounting, Auditing and Taxation, 22(1), pp.39-56.

Holland, D., 2016. Simplifying income recognition for not-for-profit entities. Governance Directions, 68(11), p.666.

https://www.apesb.org.au. (2017). APES 110 Code of Ethics for Professional Accountants. [online] Available at: https://www.apesb.org.au/uploads/standards/apesb_standards/standard1.pdf [Accessed 23 May 2017].

https://www.ey.com. (2017). The new revenue standard affects more than just revenue. [online] Available at: https://www.ey.com/Publication/vwLUAssets/EY-applying-ifrs-the-new-revenue-standard-affects-more-than-just-revenue/$FILE/EY-applying-ifrs-the-new-revenue-standard-affects-more-than-just-revenue.pdf [Accessed 23 May 2017].

IASB, F., 2015. Revenue from Contracts with Customers. Exposure Draft.

Ifrs.org. (2017). IFRS - Home. [online] Available at: https://www.ifrs.org/Pages/default.aspx [Accessed 23 May 2017].

Jackson, S.B., Lipe, M.G. and Waddoups, N., 2016. Are Discretionary Accounting and Finance Choices Made to Address Management Control Concerns by Influencing Organizational Actions?.

Roberts, J., 2014. Testing the limits of structuration theory in accounting research. Critical Perspectives on Accounting, 25(2), pp.135-141.

Savage, A., Douglas, C., and Barra, R. (2013). Accounting for the Public Interest: A Revenue Recognition Dilemma. Issues in Accounting Education, Vol. 28, No. 3, pp. 691-703.

Wesfarmers.com.au. (2017). Home. [online] Available at: https://www.wesfarmers.com.au/ [Accessed 23 May 2017].