Essay: Accounting Policy's Impact On Financial Results And Disclosures.

On 7 November 2014, the Australian Securities and Investment Commission (ASIC) announced its areas of focus for 31 December 2014 financial reports of listed entities and other entities of public interest with many stakeholders. One of those areas of focus was accounting policy choices. According to ASIC preparers and auditors need to focus on the appropriateness of key accounting policy choices and that its surveillance will focus on material disclosures of key accounting policy choices:

Preparers and auditors should focus on the appropriateness of key accounting policy choices that can significantly affect reported results. These include off-balance sheet arrangements, revenue recognition, expensing of costs that should not be included in asset values, and tax accounting.

ASIC’s surveillance continues to focus on material disclosures of information useful to investors and others using financial reports, such as assumptions supporting accounting estimates, significant accounting policy choices, and the impact of new reporting requirements. ASIC does not pursue immaterial disclosures that may add unnecessary clutter to financial reports.

Source: http://asic.gov.au/about-asic/media-centre/find-a-media-release/2014-releases/14-294mr-focus-for-31-december-2014-financial-reports/<accessed 1/2/2017>

In its commentary on this issue, CPA Australia observed the following:

Accounting policy choices made in respect of off-balance sheet arrangements is another focus area for ASIC. The requirements of AASB 10 Consolidated Financial Statements, AASB 11 Joint Arrangements and AASB 12 Disclosures of Interests in Other Entities should be considered by entities when determining the correct accounting treatment for off-balance sheet arrangements. 

ASIC continues to remain sensitive to the accounting policy choices companies make when recognising revenue, as the appropriate application of the requirements including the timing of recognition and reflecting the substance of underlying transactions, are critical for a suitable revenue recognition policy.

Companies that state compliance with IFRS in their financial statements, and their auditors should pay attention to the potential impact of applying the new accounting standard IFRS 15 Revenue from Contracts with Customers and make appropriate disclosures if required. . IFRS 15 was issued by the International Accounting Standards Board in May 2014, with an application date set for accounting periods beginning on or after 1 January 2017 (a copy of IFRS 15 can be obtained from CPA Library). The Australian Accounting Standards Board’s work program indicates that the Australian version of IFRS 15 will be issued in quarter 4 of 2014.

Source: https://www.cpaaustralia.com.au/media/familiar-look-to-asics-focus-areas<accessed 1/2/2017>

In addition to this information, ASIC released an attachment which provided more detail on its areas of focus with regards to accounting estimates, accounting policy choices and key disclosures, a copy of which is available here:

http://download.asic.gov.au/media/2249282/attachment-to-14-294mr.pdf 

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.

Accounting policy choices

The company’s financial status in relation to its performance and its financial ability can be judged from its financial statements where all factors relating to affairs have been taken into in preparation of the statements. These so prepared financial statements are used by the different stakeholders of the company to assess the viability and relevance of the company in order to invest in the company. The financial statements of the company are prepared by the management of the company and are given to the auditor for verification and issuing the report thereon. The management of the company adopts certain accounting policies which are required as per the relevant accounting standards and makes the accounting entry for each and every transaction entered by the company on that basis only (Mance and Katunar, 2012). But sometimes event happens where the management of the company get themselves entered into the practices which lead to the manipulation in the accounts and thus misrepresenting the financial statements of the company and which in turn misleads the user of the financial statements in taking their decision regarding whether to invest in the company or not or whether to provide funds to the company or not.

International Accounting Standard eight has defined the accounting policy as the set of rules, procedures or policies which are required to be followed by the management of the company in regard to recording of each and every transaction that is made by the company during the whole reporting period. But these accounting policy are always molded by the management of the company in order to have the benefit from the company (Juric, 2014). The benefits are arises only from the two ways. One way is that by increasing the value of the shareholders by increasing the dividend rate or by having the higher earnings per share or by providing the turnover incentive to the directors of the company when they achieve the targets. Therefore in this way accounting policies are used by the management of the company at their own convenience (Alayemi, 2015). Following are the factors which details how the accounting policies affect the financial results of the companies:        

• Valuation of Inventory– As per the accounting standard on inventory the company is required to value the inventory at lower of cost or net realizable value. The cost is the purchase price that the company pays to the vendor and determining the net realizable value again is the question for the auditors. The company generally in order to have the high net profits at the yearend or quarter end get its inventory valued at the cost which may be sometimes more than the net realizable value. This mainly happened in the case of pharmaceutical company where the value of the product is determined on the basis of the expiry date.  
• Recognizing the Revenue– The Company recognizes the revenue as per the accounting standard on revenue recognition. But there has always been the scope for increasing the revenue by either booking the revenue in advance or increasing the rate of the product. This is done mainly because of the interest of the management of the company to have higher net profits to attract more and more investors and simultaneously increasing the incentive payments for the directors and other officers of the company.    

ASIC apart from the laying down the emphasis on the other factors have started focusing on the material information which shall disclosed in order to give information to the users which in turn can make the useful and effective decision. The focus so made has been increased from the period of December 2014. As per the literature given, the areas of the emphasis for the ASIC teams is the impairment of tangible and intangible assets and checking of revenue recognized by the company whether the same has been recognized in terms of the relevant accounting standard or not and whether the matching concept of expense and revenue has been followed by the companies or not. With these areas of focus, the ASIC has chooses to investigate in the following matters:

• Estimates in Accounting– Estimates in accounting are defined as the assumptions for the values that have been created by the management of the company to arrive at the value of the related asset or the liability. Generally estimates are done by the management with regard to the base year results. For instance, while determining the impairment of an asset the company is required to identify the cash generating units and then will identify the cash flows that will be receiving from cash generating units. Thereafter the assets are allocated at cash generating units and the value in use is determined using the discounted cash flow technique and again the discount rate and the cash flows considered will be as per the discretion of the management of the company.  Similarly, while defining the estimates for the expenses which is required to be incurred or will be incurred in the near future shall be made as per the previous year results. Also the bad debts are written off as per the estimates based on the previous year. In case the actual results come different then the estimates are revised and subject to revision. In this way, it has been the first major focus area of ASIC Investigation.   
• Change in Accounting Policies– Accounting policy has been the major decisive factor for each and every user of the financial statements. Change in any accounting policy without any basis will not only make the users of the financial statements confused but also make the management of the company accountable before many regulatory authorities. But these accounting policies have lost its generic nature rather the same has been applied by the company at their own convenience and always leaves the ground for enough manipulation. These manipulations are adopted only to achieve the organizational goals and also to provide the better results to the market of the company including the different stakeholders of the company. ASIC investigation is majorly required in such because of the fact that the companies have been indulging into the practices of window dressing by violating the essence of the very true nature and purpose of the accounting policies. For instance the company generally resists making any off balance sheet arrangements like contingent liabilities. Similarly the revenue is recognized in the manner in which the management desires like that of Lehman Brothers case where the essence of the Repo 105 transaction has been defeated.

References

Alayemi A, (2015), “Choice of Accounting policy : Effects on Analysis and Interpretation of Financial Statements” available on https://www.google.co.in/url?sa=t&rct=j&q=&edata-src=s&source=web&cd=2&cad=rja&uact=8&ved=0ahUKEwiIjfz6-uvTAhXGRY8KHQRqCqIQFggvMAE&url=http%3A%2F%2Ffiles.aiscience.org%2Fjournal%2Farticle%2Fpdf%2F70200037.pdf&usg=AFQjCNE7xDAf38p2oUXi6PpDZfzjwFe8WQ  accessed on 24/05/2017.

Juric D, (2014), “Effect of Accounting policies on Financial Position of Small and Medium Sized Enterprises”, available on file:///C:/Users/admin/Downloads/Effect_Of_Accounting_Policies_On_Financial_Position_Of_Small.pdf    accessed on 24/05/2017.

Mance D and Katunar H, (2012), “Influences on and Consequences of Accounting Policy Choices”, available on https://bib.irb.hr/datoteka/518772.Mance__Katunar_-_Influences_on_and_Consequences_of_Accounting_Policy_Choices.pdf  accessed on 24/05/2017.