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Handling Warranty Expenses Recognition

Discuss about the Financial Accounting for Participative Review Process.

After going through the current issues that are mentioned in your letter with suitable approach and reviewing the on-going problems that you are facing at present, we have come-up with various recommendations that may help you to overcome the issue or at least minimise the issues. In this letter I will state some suggestions step by step and the suggestions are aligned with the Corporation Act 2001 and the Australian Accounting Standards Board (AASB). Hoping that the suggested recommendations will help you to resolve the queries raised by you in the communication letter.

Respected Sir,

After going through your letter addressing the issues that are currently faced by you, the below mentioned recommendations are provided that will help you to overcome the issues.

The 1st issues that the company are currently facing are the frequent variance with regard to the warranty expenses that were previously recognised by the company in comparison with the actual cost attributed to replace or fix the faulty products. However, recently it has been decided in the board meeting that the warranty cost will be recognized only after the actual expenditure towards the warranty cost. The company are expecting to resolve the issues associated with the warranty cost in this manner. As per the AASB, the organization must prepare their financial statement excluding the cash flow statement based on the accrual methods of accounting. When the company prepares its financial statements based on the accrual basis for accounting, it can recognize the items, for instance, expenses, incomes, equities, liabilities and assets when they fulfil the required recognition and definition criteria for the required framework. As per the accrual method of accounting the impacts of the transactions and the associated other events are taken into account only after they take place and not accounted for the provision. Further, they are recorded in the periods to which they relate and the financial statements related to that period. If the company follows the accrual method of accounting they will be able to get the true picture of their financial responsibilities that has to be performed with the available resources. This will be advantageous to the company as it will enable the business to manage the financial activity properly. The debts and incomes can be analysed more accurately with the accrual method of accounting. Further, it will be effective for monitoring the activities and managing the finance. Under the accrual method the companies will receive the immediate reflection regarding how much money they are spending through the expense reports. The business can further analyse the financial trends and can update their cash flow statement on current basis. Moreover, the cash accounting method takes into consideration ‘after the fact’ method of accounting. On the contrary, the accrual accounting makes it simple for the business executives in planning the futures. As the profits that can earned and expenses that have to carried out are updated on daily basis the executive s can prepare their future strategies immediately regarding the improvements of sales or generation of more profits. This will assist the company to become progressive that is very important for the viability and sustainability of the company over the long-run. Therefore, it is suggested to the company to account for the warranty cost based on the accrual method of accounting as it will enable them to recognise the expenses towards warranty cost only after the expenditure takes place. It will further assist the company to minimise the gap between the provision of warranty cost and the recognition of actual cost.

Handling Revenue Recognition

The second problem that the company are facing is the problem associated with the recognition of revenue. The company is entered in an agreement with various retailers. Under the agreement, the company will provide various products to the retailer, which will be displayed by them at the front window of the store. As a charge for the display the company will pay an amount of $ 600 per square meter as the fee to each of the store for each month. The revenue from the sales will be returned by the store after deduction of $ 600 as fee. However the unsold goods after each quarter will be returned back to the company and the company will add the goods to the inventories and deduct that amount of goods from the revenue. The company is in the view that the payment of fees are not required to be shown in the statement separately as the cost is associated with carrying on the business. As per AASB 118, revenue shall be recognized at the fair value of consideration that is receivable or received. Moreover, the revenue shall be recognised only when the risks and rewards associated with the goods are transferred to the buyer, the amount if the revenue can be computed reliably and the costs that are expensed or to be expensed with regard to the transaction can be reliably measured.  Further as per the AASB 1004 and the Australian Accounting Standard (AAS) 15 ‘Revenue’, expenses are differentiated to deliver the information related to various aspects of the financial performance. The information related to the expenses can be provided in any of the two ways. 1st option is to classify the information as per their nature for instance, depreciation, rent, salaries or the fees. 2nd option is, for the retailing or manufacturing organizations the expenses can be classified as the administrative expenses, distribution expenses or the cost of sales. The classification delivers a signal that the expenses may vary indirectly or directly, with the changes in the production or sales level of the industry. The choice of representing the expenses depends on the sole discretion of the organization. However, any of the methods selected, it is mandatory for the organizations to show the expenses related to the sales separately in the income statement. Further as per the AASB 1019 and AAS2 for inventories suggest that the amount of inventories on hand shall be reported at net realizable value on the reporting date and the losses associated with the inventories must be shown separately and shall not be included under the cost of sales. Further, any reversal or writing–down of the inventories shall be shown in the financial statement on the reporting date appropriately. Moreover, the impact of revision with regard to the accounting estimates shall be recognized as expenses or revenue in the financial statement of the period in which it is revised, if the revision has an impact only on the reporting period or in the future period and current period of the revision, if it affects both the future and current period. The accounting forecasts for the prior period shall not be revised with the retrospective effect from the prior financial period. When there is an issue regarding the revision of the accounting estimates, then the transaction is considered as the revision of the accounting estimates.

With regard to the presentation of financial statements as per the AASB standards, under the statement of comprehensive income, the cost of selling the goods or cost expensed for earning the revenue must be shown under the separate head rather than showing the sales less cost of goods sold as net amount. The format can be as follows:

Particular

Amount ($)

Income from sales / Revenue

XXX

Less: Cost of goods sold

XX

Gross margin

XXX

Less: Other Expenses

XX

Net margin

XX

By giving the appropriate effect for the above mentioned issues mentioned by you can be solved. Accrual method of accounting will assist the company to recognize the items, for instance, expenses, incomes, equities, liabilities and assets immediately, when they fulfil the required recognition and definition criteria for the required framework. It will help the company to prepare the future budgets and estimating the revenue and expenses. Further, as per AASB 118, revenue shall be recognized at the fair value of consideration that is receivable or received. As per the AASB 1004 and the Australian Accounting Standard (AAS) 15 ‘Revenue’, expenses are differentiated to deliver the information related to various aspects of the financial performance. Further as per the AASB 1019 and AAS2 for inventories recommends that the amount of inventories on hand shall be reported at net realizable value on the reporting date and the losses associated with the inventories must be shown separately and shall not be included under the cost of sales. Therefore, it is suggested that the company shall take into consideration all the suggested things when they will prepare their financial statement next time.

From,

Maria McKenzie  

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.

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

Deegan, C., 2013. Financial accounting theory. McGraw-Hill Education Australia.

Goodwin, J., Atilgan, Y., Simsir, S.A. and Ahmed, K., 2016. Investor reaction to accounting misstatements under IFRS: Australian evidence.

Henderson, S., Peirson, G., Herbohn, K. and Howieson, B., 2015. Issues in financial accounting. Pearson Higher Education AU.

Jin, K., Shan, Y. and Taylor, S., 2015. Matching between revenues and expenses and the adoption of International Financial Reporting Standards. Pacific-Basin Finance Journal, 35, pp.90-107.

Palmer, P.D., 2013. Exploring attitudes to financial reporting in the Australian not?for?profit sector. Accounting & Finance, 53(1), pp.217-241.

Rahman, A.R., 2013. The Australian Accounting Standards Review Board (RLE Accounting): The Establishment of Its Participative Review Process. Routledge.

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