Essay: Accounting And Revenue Recognition Compliance Guide With AASB.

In calculating the allowance for doubtful debts last year (year ended 30 June 2016) the accounts clerk who did the calculation made a big error in his excel spreadsheet and understated the amount significantly. Instead of allowing for 2% sales revenue ($2.5 million last year and $2.9 million estimated for the current year) which is the company’s accounting policy, the amount allowed was just 0.02%. How should we treat this in the current year’s financial statements? I have said that the board could decide on how we deal with this but unfortunately, we are equally divided and Charade said that as the problem is less than 5% of sales revenue it is not material. The sales director is concerned that his sales figures will be impacted by this. How should we treat this? Can the board just decide? 

Recognition of Revenues under AASB 118

The issue was raised by the board of directors on the aspect of revenue recognition. The newly appointed director observed that currently the company recognizes revenues on cash basis, which is not in compliance with the generally accepted accounting principles as prescribed by AASB. The company sales products to three types of customers namely retailers, wholesalers, and cafes and motels. The company delivers products to its customers (retailer/wholesaler/cafes/motels) on credit and then the products are finally sold to the consumers. The billing process of the company is different from the usual one. The company bills its customers on a monthly on the basis of report of representative who visits the customer’s site. The representative visits the customer’s site on month to month basis and prepares the report of items sold by them. Further, the customers return the products remained unsold to the representative and company issues new stock replacing the returned items. The customers make payment to the company after one month from the billing date and then on receipt of payment company recognizes revenues.    

It has been observed that the revenue recognition process of the company is not in line with the generally accepted accounting principles. The AASB 118 contains provisions for revenue recognition (AASB 118, 2009). As per the provisions, the revenues from sale of goods are to be recognized when all the following conditions are satisfied:

• The goods have been delivered to the customer along with the right of possession (AASB 118, 2009).
• All the risks and rewards related to the goods so delivered have also been transferred to the customer (AASB 118, 2009).
• There is reasonable expectancy that the company will receive benefits from the goods sold (AASB 118, 2009).

When the above conditions are satisfied, the entity should recognize revenues in the statement of profit and loss. Further, the companies act 2001requires the corporations to prepare the financial statements on accrual basis (Choi, 2007). This implies that the recognition of revenues can not be deferred till the time of actual receipt of the consideration.

In the current case, the company and customers (retailer/wholesaler/cafes/motels) are acting on principal to principal basis. Thus, the risks and rewards related to the goods delivered to the customers are deemed to be transferred at the point when the goods are received by the customer. Therefore, the sale is concluded at the time of receipt of goods by the customer and hence the revenues are to be recognized at this point only. However, there is goods return policy. The customer returns unsold goods to the company at the month end. Therefore, the company should also make provision for return of goods (Alexander, Britton, and Jorissen, 2007). It could be concluded that the objections raised by the new director in regards to current recognition of revenues policy of the company are genuine. Adopting cash basis for recognition of revenues would be in violation of the provisions of companies act as well as AASB 118 (AASB 118, 2009).

In the current case the issue raised was related to recognition of an item of plant. The company manufactured in-house a piece of plant to dry the fresh produces. The only out of pocket cost incurred in manufacturing this piece of plant was $80,000. Further, the management estimated fair value of the piece of plant as $225,000. The issue was raised that whether the item of plant should be recognized on the basis of cost or fair value. Further, what the cost of item of plant manufactured in house should comprise and if the recognition is made on fair value basis then how should the gain on revaluation be treated in the books. In regards to these issues, the guidance can be taken from the AASB 116 which contains provisions on the recognition, measurement, and de-recognition of property, plant, and equipment (AASB 116, 2014).     

Recognition of Property, Plant and Equipment under AASB 116

The standard states that an item of property, plant, and equipment should be recognized in the books only when there seems a possibility of getting economic benefits from its use and there is no ambiguity regarding estimation of the cost. In the current case, the item of plant has been manufactured in-house thus; it could be inferred that the cost can be measured reliably without any ambiguity (AASB 116, 2014). Further, it has been observed that this item of plant would reduce the manufacturing time by 2 hours, which means that the economic benefits will accrue to the company by the use of item of plant. The recognition criteria as specified in the standard is mate and therefore, the item of plant can be recognized as property, plant and equipment in the books of the company for the year ended on 30 June 2017.    

For the purpose of measurement of value of an item of property, plant, and equipment, the standard provides two models such as cost model and revaluation model (AASB 116, 2014). The cost model provides that an item of property, plant, and equipment should be recognized at the cost incurred in bringing that item to the condition at which it becomes capable to perform as intended by the management. As per revaluation model, the item of property, plant, and equipment could be revalued subsequently after initial recognition having regard to fair value. However, at the time of initial recognition, the item of property, plant, and equipment must be recognized at cost. In case, the cost is not measurable then the fair value is taken as cost (AASB 116, 2014).

Further, the cost of an item of property, plant, and equipment manufactured in-house comprises material, labor, and other expenses which can be considered to be directly attributable (AASB 116, 2014). Therefore, in the current case, the company should determine the total cost incurred in manufacturing the item of plant. However, if the total cost can not be measured, the item of plant should be recognized at fair value. At the time of initial recognition there does not arise any gain or loss even if the item is taken at fair value in the books. However, the gain or loss arises when the item is revalued on further occasions. Further, it is to be noted that the gain or loss on the revaluation of the item of property, plant and equipment are to be taken to the revaluation surplus account (AASB 116, 2014).

Therefore, it could be concluded that the company can recognize the item of plant at fair value of $225,000 if the total cost is not measurable, but there does not arise any gain or loss at the time of initial recognition and even if it arises, it can not be accounted for as revenues. 

In the current case, the accountant made a mistake in calculating the amount of provision for doubtful debts last year and this error is revealed in the current year. Last year which ended on 30 June 2016, the accountant made provision for doubtful debts at the rate of 0.02% instead of 2%. Thus, the accountant understated the amount of provision for doubtful debts in the last year by a significant margin. Now, the issue has arisen in front of the board of directors in regards to treatment of this error related to past year in the books of current year. One of the directors asserted that since the amount involved in the transaction is less than 5% thus, it could be ignored considering as immaterial. Further, director of sales department is concerned the sales figures of would require adjustment for this error.

The resolution to the issues and concerns of the directors can be found in the provisions contained in AASB 108 (AASB 108, 2015). The AASB 108 provides for the accounting treatment of changes in accounting policies and estimates and prior period errors. The error in the prior period accounts found in the current period could be due to mathematical mistake, misapplication of wrong accounting policy, or it may be due to fraud. As per the provisions of the standard, the prior period errors are adjusted by restating the amount of comparative period presented in the current year financial statements. However, if the error relates to the prior period which is not presented in the current period financial statements as comparative, the error is to be adjusted by restating the asset, equity, and liabilities (AASB 108, 2015).  

Further, standard states that if the financial statements contain errors whether material or immaterial, it will not be construed that the financial statements are complying with the generally accepted accounting principles as prescribed under the AASB framework. Thus, all type of errors disregarding the fact that they are material or not need to be given adequate accounting treatment in accordance with the provisions of AASB 108 (AASB 108, 2015). Considering these provisions, the statement of Charade that the error amount is less than 5% hence it can be ignored deeming it immaterial is not correct. The accounting treatment for error in the provision for doubtful debts is required to be given as per AASB 108 (AASB 108, 2015).

In the current case, the error discovered in the financial year 2017 relates to the accounting period 2016. The financial figures of 2016 would be given as comparative in the financial statements of 2017.

References

AASB 108. 2015. Accounting Policies, Changes in Accounting Estimates and Errors. [Online]. Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB108_07-04_COMPjan15_07-15.pdf [Accessed at: 20 May 2017].

AASB 116. 2014. Property, plant and equipment. [Online]. Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB116_07-04_COMPjun14_07-14.pdf [Accessed at: 20 May 2017].

AASB 118. 2009. Revenue. [Online]. Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB118_07-04_COMPmay09_01-10.pdf [Accessed at: 20 May 2017].

Alexander, D., Britton, A., and Jorissen, A. 2007. International Financial Reporting and Analysis. Cengage Learning EMEA.

Choi. 2007. International Accounting, 5/E. Pearson Education India.