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Financial Accounting Change In Method Of Depreciation

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Question:

Discuss about the Financial Accounting Change in Method of Depreciation.
 
 

Answer:

Ethics and Governance

The accounting professional and ethical standard board was being established in order to provide a proper code of conduct of ethics for the accountants. Ethics and governance are the important part of the professional activities of the professional accountants. The accountants must maintain effective internal controls, transparency and corporate governance in their operations. Thus it is the ethical duty of the accountants to maintain transparency in the financial statements as the financial statements are used by shareholders and investors in order to take their investing decision. Thus the accounting standards should be accordingly used by accountants in order to maintain the financial transparency. It is yet other ethical duty of the accountant to prepare true and accurate financial position of the company. (Hauswald R., Marquez R., 2009)

There should be effective internal controls and availability of the procedures in order to ensure correct financial reporting. The company should maintain proper relationship between the shareholders and the management. They must ensure that the decisions undertaken by the management should be taken in accordance with the needs and requirements of the society. Thus the concept of governance requires that company fulfills its accounting responsibility and all its fiduciary duties towards the society. The ethics requires that the accountants must ensure that fundamentals of accounting are taken into consideration while preparing the books of accounting. The balance sheet and the profit and loss account of the company are prepared ethically keeping in view the social responsibility towards the society. Thus the financial statements should be prepared ethically and all the changes in the financial statements which are material must be correctly shown in the financial statements. The accountants must prepare accountants in accordance with law of accounting. (Philomena Leung, Barry J. Cooper, 2005)

 

Depreciation

As per the provisions of AASB 1021, depreciation is charged on the concerned depreciation asset and the amount of depreciation must be systematically allocated over the life of the asset. The depreciation is to be charged over the useful life of the asset and the useful life of the asset is to be calculated in accordance with the physical wear and tear of the asset, level of obsolescence, and other factors affecting the asset. As per the provisions of this standard, company needs to undertake regular review in regard to the rates of depreciation and the method of depreciation used for charging the depreciation in the books of account. The rates of depreciation are accordingly reviewed within a year and accordingly adjustment and the rate of depreciation should be charged in a manner so as that the value of asset is covered during the useful life of asset and of some changes need to be done in the depreciation rate then it should be done so that the most correct assessment is made in regard to the useful life of the asset. (AASB, 1997) The method of depreciation should also be checked regularly in order to ensure that it is being used in order to present better financial position of the company. If there are changes in the economic benefits that may flow from the asset in the future period then the method of depreciation must also be changed in order to present the change in the future economic benefits that may flow towards the company. Thus change in the method of depreciation can only be done when it is required as per the rules of law, or the future economic benefits in regard to assets change or it will present the financial statements in a true and fair manner. (Batten P., Shying M., Mayne K., 2013)

 

Change in the method of depreciation

When there is a change in the rate of depreciation charged in the books of account or the change in the method of depreciation used for charging depreciation in regard to the asset, then this change will be recorded in the books of account as the change in the estimate of accounts. The changes in the financial statements due to change in the accounting estimate must be done in the year in which the change is done in regard to the accounting estimate, and the change should also be done in the future years if it will affect the financial position of future years. The depreciation that is charged in previous years must not be changed due to change in the accounting estimate by way of changing the method of depreciation or changing the rate of depreciation. (David Edgerton, 2016)

Role of accountant in changing depreciation method

It is the responsibility of the accountant to change the method of charging depreciation only when it is being required by the provisions of law and the change will lead to preparation of true and fair financial statements. The changes cannot be done just for the sake of changing the amount of depreciation leading to a change in the net profits of the company. When there is a change in the method of charging depreciation, the reason for change in the method of charging depreciation should be correctly disclosed in the books of account. The effects of changing the method of depreciation should be implemented from the current year in which the change had been done and it should be carried in the future years if it effects the future years also. The accountants are not having the right to change the effect of depreciation retrospectively and thus the accountants cannot change the accounts of the previous period. (AASB, 2009)

 

Responsibility towards the stakeholders

The accountants must ensure that the stakeholders of the company are having correct information in regard to the change in the accounting estimate that is the change in the method of charging depreciation. The stakeholders must get full information in regard to reason of change in the method of depreciation and the amount of change should also be correctly disclosed in the notes to the financial statements. The annual report of the company must provide must provide detailed information in regard to change in the method of the charging depreciation to the books of account and they must express the clear reason for changing the method and also the benefit that will be received by way of changing the method of depreciation. (Craig Deegan, 2014)

Impact of AASB 116

The AASB 116 is being applied in regard to recording the value of property, plant and equipment. The cost of the asset in regard to the amount that had been paid in regard to acquisition and the installation of the asset will be recorded as the initial cost of the asset. But the value of the asset will only be recorded if the asset will give economic benefits in the future period and will provide cash flows in the future period. This standard requires that subsequent cost that will be incurred in regard to retention of the value of the property will also be added in the value of cost. (Valarie Wilson, Suellen Freeman, John Freeman, 2015)

The AASB 116 requires that depreciation is to be accordingly deducted from the cost of the property, plant and equipment. The property, plant and the equipment will include cost incurred for the purchase of the asset, cost incurred for the preparation of the site, cost incurred for the delivery, cost of installation, and other professional fees. Thus the cost that is directly attributable to purchase of the property, plant and equipment will be included in the total cost of the property, plant and equipment. The standard requires that the company can choose to use from the cost model or the revaluation model. The method chosen by the company will apply to the whole series of the property, plant and equipment. The depreciation will be then reduced from the cost of the equipment which is calculated as per AASB 116. Thus the change in method of charging depreciation will then affect the value calculated as per the AASB 116. The depreciation is to be deducted from the cost thus the increase in the depreciation will lead to reduction in the net cost of property, plant and equipment. The decrease in the amount of depreciation will then lead to increase in the net cost of property, plant and equipment. Thus the reason for change in the method of depreciation and the value of property, plant and equipment as per AASB 116 should be clearly shown in the notes to the financial statements. (Alexander Mills, William Woodford, 2015)

 

Conclusion

Thus in this case, Sunshine limited is having the view that it wants to reduce the level of profits in the coming two years and increasing the profits in the year 2018 and 2019. Thus the accountant of the company that is Maria Mars had thought of a plan to change the method of depreciation from the straight line method to the sum of digits method as the straight line method records the same amount of depreciation every year on the other hand the sum of digits method will require that amount of depreciation charged declines year by year. But the change in method of depreciation should be done by way of valid reason only not just for the purpose of increasing profits. Thus in this case the contention of Maria was not correct as he had decided to change the method of charging depreciation just for the sake of increasing profits.

Recommendations

Maria had not used the valid reason to change the method of depreciation but still he should disclose the method of charging depreciation in the notes to financial statements. And he should also give the clear reason of changing the method of depreciation in order to present true and fair information to the stakeholders.

 

References:

  1. Robert Hauswald, Robert Marquez, 2009, “Governance Mechanism and Corporate Transparency”; Available at: https://www1.american.edu/academic.depts/ksb/finance_realestate/rhauswald/papers/Governance%20Mechanisms.pdf
  2. Philomena Leung, Barry J. Cooper, 2005, “Accountants, Ethical Issues and the Corporate Governance Context”; Available at: https://onlinelibrary.wiley.com/doi/10.1111/j.1835-2561.2005.tb00255.x/abstract
  3. Australian Accounting Standards Board, 1997, “AASB 1021: Depreciation”; Available at: https://www.aasb.gov.au/admin/file/content102/c3/AASB1021_8-97.pdf
  4. Peter Batten, Mark Shying, Kerry Mayne, 2013, “Valuation and Depreciation”; Available at: https://www.cpaaustralia.com.au/~/media/corporate/allfiles/document/professional-resources/notforprofit/guide-to-valuation-and-depreciation.pdf?la=en
  5. Ron Dagwell, Graeme Wines, Cecilia Lambert, “Corporate Accounting in Australia”; Published by Pearson Higher Education, Business and Economics, 2015
  6. David Edgerton, 2016, “Guide to Valuation and Depreciation”; Available at: https://www.cpaaustralia.com.au/~/media/corporate/allfiles/document/professional-resources/public-sector/guide-to-valuation-and-depreciation
  7. Australian Accounting Standards Board, 2009, “AASB 116: Property, Plant and Equipment”; Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB116_07-04_COMPjun09_01-09.pdf
  8. Henderson S., Peirson G., Herbonn K., Howieson B., “Issues in Financial Accounting”, Published by Pearson Higher Education, 2015
  9. Philomena Leung, Barry J. Cooper, 2005, “Accountants, Ethical Issues and the Corporate Governance Context”; Available at: https://onlinelibrary.wiley.com/doi/10.1111/j.1835-2561.2005.tb00255.x/abstract
  10. Gary John Previts, Peter Wolnizer, “A Global History of Accounting, Financial Reporting and Public Policy”; Published by Emerald Group Publishing, 2011
  11. Alexander Mills, William Woodford, “Company Accounting”, Published by Pearson Higher Education, 2015
  12. Miracel Griff, “Professional Accounting Essays and Assignments”, Published by Lulu Press, 2014
  13. Craig Deegan, “Financial Accounting Theory”, Published by McGraw Hill Education Australia, 2014
  14. Valarie Wilson, Suellen Freeman, John Freeman, “Accounting: A Practical Approach”; Published by Pearson Higher Education, 2015
  15. John Hynes Farrar, “Corporate Governance: Theories, Principles and Practice”, Published by Oxford University Press, 2005
  16. Gregory E.P. Shailer, “Introduction to Corporate Governance in Australia”, Published by Pearson Education Australia, 2004
OR

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