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Halides Ltd: Issues Raised By The Board Of Directors

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Questions:

Issue 1:

When finalising the financial statements for the year ended 30 June 2014 two significant errors were made and there is debate as to whether we should simply adjust the financial statements in the current year or change last year’s financial statements as well. The IT system of the company was installed 3 years ago at a cost of approximately $3.5 million and was estimated to last 10 years. However the latest technology advancements indicate that this was a very optimistic estimate and that the maximum life span of this equipment will probably be not more than 6 years in total with little or no residual value. It was also discovered in August 2014 that a machine worth $2.2 million purchased in January 2014 was erroneously written off to repairs and maintenance instead of being capitalised. Deberella the marketing director thinks we should just adjust this year’s figures to account for these problems but Peter indicated that it was slightly more complicated than that. Could you please give us some advice on this?

Issue 2:

 A number of employees who work on our strategic management team have been with us for a number of years - at least 12 of them have been with us since the company commenced operations in 2006. In accordance with the Employee Bargaining Agreement (EBA) all employees are entitled to long service leave of 13 weeks if they remain in service for 10 years. They are also entitled to pro rata long service leave after 6 years of service. Our usual practice is to show the long service leave expense in the income statement when the employee actually takes leave and is paid. Of course we maintain a memorandum record of the number of days each employee is entitled to. Peter has indicated to us that he thinks we should consider treating this expense in a different manner, which seems complicated. The directors are wondering why we should complicate a very simple way of calculating long service leave – why not “stick with” recognising the expense when we pay for it? What do you think we should do and why?

Issue 3:

Peter, the new financial controller, has also informed the board that the company will need to present a statement of cash flows with the financial statements in addition to those statements already being presented, which really attracted a lot of attention. Some of the directors thought it was a waste of time to present this statement as it was merely a summarised cash book. Others were of the opinion that it could be useful but didn’t quite know how they would use it. The structure of the statement of cash flows also came into question with one of the directors suggesting that we merely needed to “get a printout” of the cash account and attach it. Another said that we couldn’t just do that as we needed to show “operating, instigating and financing” cash flows in the statement. Could you please clarify this matter for us?

 

Answers:

Handy Halides

Managing Director,
Halides Ltd
Suite 55123, Level 42, Arcade Building
16 256 Giles Street
Docklands Victoria 3008

Dear Mr. Handy Halides

I really appreciate your concern mentioned in your email dated 15th December 2014 and would be delighted to assist you in resolving the issues that have been raised by the board of directors of the company. The response to the issues along with the reference to AASBs, Corporations Act, reference books, journal articles, and/or websites clearly mentioned in the discussion for each of the issue.  I have tried to bring down the key points related to the accounting standards related to each of the issue so that the brief understanding with respect to the issues that have been mentioned is developed.

Issue 1

The first issue that is being faced has two parts. These are

  • Change in the estimated life of the assets
  • Prior period errors related to treatment of cost associated with machine

The treatment is different for both the cases. However both these cases are covered under accounting standard AASB 108, “Accounting Policies, changes in accounting estimates and Errors”.

According to paragraph 32-40 of AASB 108, if the change in the accounting estimate results in change in assets, liabilities or the equity, these changes must be recognized by making adjustments for the carrying amount of that asset, liability or equity in the period of change. Further the net effect is recognized prospectively by considering it as profit or loss. This profit or loss is considered either in the period of change or change in every period in future where the impact will be there. In this case as a result of change in the life of the asset the depreciation will be higher. Since earlier lower depreciation has been considered additional depreciation amount will be considered as loss in the current period. Further the impact on the profitability in future has to be estimated and mentioned in the current year financial statement. No adjustments or change in last year’s financial statements has to be done.

It is important to note that disclosure will have to be made for this with the complete details of the change in the accounting estimate and the impact it is having on the profitability in the current period. Further the expected on the profitability in future periods has to be disclosed.

The treatment for prior period errors is mentioned in paragraph 41-49 of AASB 108. According to this aspect of the AASB 108, material prior period errors are to be corrected retrospectively in the first financial report by restating the comparative amounts for the prior periods presented in which error occurred or restatement of the opening balance of the asset, equity or the liability for the earliest prior period presented in case the error occurred before the earliest prior period. In the present case error occurred in the prior period the restatement of the comparative amounts in the prior period will have to be done.

Further since this is the material error, it must be corrected by retrospective restatement. The disclosures that have to be made in this respect includes the nature of the error, effect on the line item affected and the impact on the earnings per share, the amount of correction and the circumstances if the restatement is impracticable.  

All this is being done considering that both the cases are quite practical or adjustment/ restatement can be done.

Issue 2

It has been mentioned that the issue is related to treatment of long service leave in the financial statement. Currently the long service leave expense is shown in the income statement when the employee actually takes leave and is paid. This is related to the accounting standard AASB 119 “Employee Benefits”. The treatment of long-service benefits is included in paragraph 153 of AASB 119. According to this paragraph, the long-service benefits are considered under Other Long-Term Employee Benefits.

The recognition and measurement of other long term employee benefits is included paragraph 156 of the accounting standard. The measurement of the other long term employee benefits is the net loss/ profit of service cost, net interest on net defined benefit liability (asset) and remeasurements of the net defined benefit liability (asset). The basis of measurement of the service cost is mentioned in the paragraph 66-112, net interest on net defined benefit liability (asset) is mentioned in para 123-126 and remeasurements of the net defined benefit liability is mentioned in  para 127-130. Based on the suitable associated paragraph the value is measured and considered as profit or loss for the company.

 

Issue 3

The issue regarding the presentation of the cash flow statement by the company is included in the accounting standard AASB 107. However in order to provide a direction to this issue three separate accounting standards will have to be referred. These are

  • Corporations Act AASB 101: Preparation of financial statements
  • AASB 107: Cash Flow Statements
  • Statement of Accounting Concepts SAC1

 The accounting standard AASB 107 applies to all companies that must prepare financial statements according to Corporations Act AASB 101. According to AASB 101 the preparation of the financial statements is to be done by the reporting entities. The definition of reporting entity is given in paragraph 2M.3 of the Corporations Act.  

The Corporations Act mentions that reporting entity has the following characteristics

  • Separation of management and ownership
  • Economic or Political importance
  • Size and indebtedness of the entity

Considering these conditions Halides Ltd is having independent board. This ensures that the company is having separate management and ownership. Further since it is being listed on ASX separate management and board has to be ensured. This is to say that any company which is being listed on ASX will have separate management and ownership. Since Halides Ltd is a reporting entity it will prepare the financial report as per AASB 101 which provides the set of financial statements that have to be prepared. These are

  • Statement of financial position
  • Statement of Profit or loss and other comprehensive income
  • Statement of change in equity
  • Statement of cash flows

Considering this cash flow statement has to be prepared. The structure, the type of information and other aspects that have to be included in the cash flow statement are mentioned in the accounting standard AASB 107.

In this case it is mandatory, however, it will be beneficial for companies to prepare the cash flow statement as it provides an insight into the future cash requirements and the source & level of cash that will be generated and required.  

Apart from the issues it has been observed that the belief is that the financial statements are to be prepared in the same way as it was prepared last year that is for the year ended at 30 June 2014. Certainly there aren’t much changes to it but certainly the modifications have been made to certain accounting standards which might affect the way the financial statements are prepared.

I hope the above discussion on the issues do provide the clarity and suitable action may be taken at your end. You are kindly requested to please contact me again in case you still have any doubt or concern related to the issues that have been discussed above or any other issue.

Cc: Peter Johns, Financial Controller, Halides Ltd

Thanks

With Best Wishes & Regards

 

John Jameson

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