ACCM4200 Financial Accounting And Reporting 1

Email

Re: Accounting Issues: Year Ending 30 June 2018

From: Peter Pepper ([email protected])

Sent: 5 July 2018

To: Margaret Montana ([email protected])

Dear Margaret

Thank you for your phone call this morning, as agreed I am emailing you regarding the accounting issues we briefly discussed. By the way to assist the accounting team in our decision-making process could you please make sure you reference any relevant sources relating to your advice, for example, AASBs, Corporations Act, and other relevant articles or websites.

As you know, a new management accountant has been appointed to Pepper Ltd and he has implemented major changes in the calculation of depreciation. As a result, some parts of the factory have much larger depreciation charges. The change in reporting has angered some operations managers who believe that, as they take particular care with the maintenance of their machines, their machines should not attract large depreciation charges that reduce the profitability of their operations and reflect badly on their management skills.

He has also indicated that more of our assets should be tested for impairment. The operations managers are also concerned about the impact of more charges against their divisions’ assets. Previously, impairment has only been carried out against assets carried under the cost model. For assets carried under the revaluation model, adjustments have been made using changes in fair value, resulting in revaluation gains or losses.

The operations managers plan to meet with myself and the accountant and ask for change.

Can you please explain the following before I meet with the operations managers:

• The difference between depreciation, impairment and revaluation losses?
• What impact these charges will have on profitability?
• Why the changes are required for depreciation, impairment and revaluation?
• What disclosures are necessary for these changes?

• How we could otherwise report on performance without upsetting the managers?

Please respond by letter (not email) as I would like to present this to the Board. I look forward to hearing from you shortly.

Regards

Peter Pepper

Managing Director, Pepper Limited

Level 5, 49 William Street,

Brisbane QLD 4000

Cover Letter

To Date: 02/09/2018

Executive Board

Level 5, 49 William Street,

Brisbane QLD 4000

Dear,

I would like to thank you for your letter dated 5^th July, 2018 requesting a written response to various questions relating to accounting issues that is to be presented before the board. After reading your mail, I have been able to deduce that the main accounting issues pertaining to your firm concerns the depreciation that is being charged on assets which is the consequence of changing method of charging depreciation by new management accountant.

Facts

For your convenience, I would be using several websites such as Corporation Act and AASB for references. In addition to this, questions would also be addressed using my accounting knowledge that would be easier to explain the accounting issues that are currently faced by your organization. Below is the requested response addressing your accounting queries and explaining the questions you have asked for

• The difference between depreciation, impairment and revaluation losses?
• What impact these charges will have on profitability?
• Why the changes are required for depreciation, impairment and revaluation?
• What disclosures are necessary for these changes?
• How we could otherwise report on performance without upsetting the managers?

Conclusions and Recommendation

All the questions that have been addressed would help in clarifying all your accounting relating queries faced in current situation. For any additional comments or questions, please free to contact us. We would be happy to serve you in future.

Best regards,

Graduate Accountant

Annexure A

Issue 1: The difference between depreciation, impairment and revaluation losses?

Depreciation: Depreciation is the allocation of depreciable amount of particular assets over their useful life in a systematic manner (Klychova et al. 2015). There are varieties of depreciation methods that can be used by organization depending upon their suitability. It is bring to your knowledge that the noncurrent assets regarding depreciation as per the International accounting standard. It is required by entity to make disclosure of the specific information relating to the depreciable assets and their amount.

Impairment: Your concern about impairment of assets requires me to give the explanation of the same. Impairment of assets is done when there is fall in assets fair value below the cost that is recorded. Hence, there arises the need to compute the difference between recorded cost and fair value. At the end of reporting period, it is required by your organization to make the assessment of any impairment indication (Gaynor et al. 2016). In addition to this, it is also required to conduct the impairment test for intangible assets and those acquired in business combination. 

Revaluation Loss: Revaluation of assets is another important concept seeking explanation that concentrates on revaluation model. Such model provides entity with the option of carrying the assets at revalued amount. I would like to acquaint that there should be continuous revaluation of fixed assets for ensuring that there do not exist any material difference between carrying value and fair value of assets. Surplus or loss resulting from revaluation has different accounting treatment. If value of assets decrease after revaluation, then such reduced value is treated in the profit and loss statement (Camilleri and Camilleri 2017).  On other hand, an increase in value is treated as surplus. 

Issue 2: What impact these charges will have on profitability?

Depreciation: Secondly, I would like to give an explanation about the impact of deprecation charge on business profitability. Change in accounting estimate results from any alteration in depreciation method. Impact of depreciation charge is required to be recognized in that particular period if the effect of such change is in the same period. However, any operating segments adjustments by way of retained profits and accumulated loss should not make any alteration in depreciation charge of the prior period. Under accounting standard, depreciation expense or depreciation charge is the amount that has been estimated regarding the future economic benefits (Macve 2015). It is to bring to your knowledge that expenses concerning depreciation incorporates element of approximation. Due to this, the current method and existing rate regarding depreciation organization is required to be evaluated by organization by reviewing their related factors. Depreciation charge amount directly influences the profit level that is reported on the income statement. An increase in amount of depreciation expense would result in generating lower profit due to lower net income (Abernathy et al. 2014). Nevertheless, the impact would reverse if depreciation expense decreases.

Impairment: Now, for addressing the question relating to the reasons why the changes for impairment, depreciation and revaluation are required. I would like to keep the explanation simple so that it facilitates understanding of the same. Various different accounting policies are adopted by different organization and the disclosure of accounting policies helps in appreciating the view that the financial statement presents. There are various factors forming the basis of adoption of depreciation methods such as the current situation faced by business, nature and types of assets. If there is not any material value relating to depreciable assets, there is full allocation of depreciation in the accounting period (Martínez et al. 2015). Entities are sometimes required to implement the combination of methods of depreciation.

Revaluation Loss: In addition to this, an organization is required to change in valuation method when the additional disclosures are sought for identification of items required by internal financial reporting. Reporting entities are required to treat assets impairment by practicing methods that is consistent with the accounting standard IAS 136 (Martin and Roychowdhury 2015). The prior period impairment loss should be reversed when there is any alteration is estimated amount when it is required to determine the assets recoverable amount.

Issue 3: Why the changes are required for depreciation, impairment and revaluation?

I would like to inform you that the internal and external factors impacting the business operations sought to conduct assets revaluation. Presentation of fair and true market value of assets requires balancing of any values that overstate or understate the assets. There are different circumstances that lead to revaluation of assets which leads to facilitation of strategic decisions by negotiating on the fair value (Tassadaq and Malik 2015).

Issue 4: What disclosures are necessary for these changes?

I have relied on relevant sources for addressing your accounting disclosure concerns. For depreciation treatment of plant, equipment and properties, entity is required to comply with the standard AASB 116. After the assets are realized, they should be carried at revalued amount when such values are measured reliably. The measurement basis that is required for determining depreciation method should be disclosed in the financial statement and notes of financial statement of the reporting entity. Furthermore, the carrying amount of reconciliation is required to be disclosed by entity at the beginning and end of the period. Reconciliation of such amount is done concerning acquisition or recognition of amount of impairment loss according to AASB 136 (Aasb.gov.au 2018). Therefore, Pepper limited should make disclosure about deprecation method with the applicable rate of depreciation that is followed which would assist users in providing relevant financial information.

The accounting standard IAS 136 intends to deal with the conducting impairment testing of tangible and intangible assets (Aasb.gov.au 2018). Such test is conducted to make the assessment that recoverable amount should not be less than the carrying value of assets. Impairment testing is conducted when there is any indication of impairment that exists within the scope. In addition to this, entity should determine cash generating unit recoverable amount. Impairment loss is recognized according to the standard when the carrying amount of such assets is less than their recoverable amount. Extensive disclosure should be made by entity relating to impairment loss treatment and impairment testing (Leuz and Wysocki 2016).

There should be adequate disclosure about the class of intangible and tangible assets when the entity applies the revaluation model. Any loss or surplus resulting from revaluation should be disclosed at the beginning of period along with the accumulated depreciation amount. Amount of any loss generated from impairment should be disclosed as per the concerned accounting standard (Leuz and Wysocki 2016).

Issue 5: How to report on performance without upsetting the managers?

The report addressing the several facts regarding the accounting disclosures would help in endeavouring the inspectors and administration that are prone to accounting complexities. The direction would be adjusted in promoting the impairment of assets that is consistent with the accounting standard.

References

Abernathy, J.L., Beyer, B., Masli, A. and Stefaniak, C., 2014. The association between characteristics of audit committee accounting experts, audit committee chairs, and financial reporting timeliness. Advances in Accounting, 30(2), pp.283-297.

Camilleri, E. and Camilleri, R., 2017. Accounting for Financial Instruments: A Guide to Valuation and Risk Management. Routledge.

Gaynor, L.M., Kelton, A.S., Mercer, M. and Yohn, T.L., 2016. Understanding the relation between financial reporting quality and audit quality. Auditing: A Journal of Practice & Theory, 35(4), pp.1-22.

Klychova, G.S., Fakhretdinova, E.N., Klychova, A.S. and Antonova, N.V., 2015. Development of accounting and financial reporting for small and medium-sized businesses in accordance with international financial reporting standards. Asian Social Science, 11(11), p.318.

Leuz, C. and Wysocki, P.D., 2016. The economics of disclosure and financial reporting regulation: Evidence and suggestions for future research. Journal of Accounting Research, 54(2), pp.525-622.

Macve, R., 2015. A Conceptual Framework for Financial Accounting and Reporting: Vision, Tool, Or Threat?. Routledge.

Martin, X. and Roychowdhury, S., 2015. Do financial market developments influence accounting practices? Credit default swaps and borrowers? reporting conservatism. Journal of Accounting and Economics, 59(1), pp.80-104.

Martínez?Ferrero, J., Garcia?Sanchez, I.M. and Cuadrado?Ballesteros, B., 2015. Effect of financial reporting quality on sustainability information disclosure. Corporate Social Responsibility and Environmental Management, 22(1), pp.45-64.

Tassadaq, F. and Malik, Q.A., 2015. Creative Accounting & Financial Reporting: Model Development & Empirical Testing. International Journal of Economics and Financial Issues, 5(2), pp.544-551.