QUESTION

On successful completion of this course, you will be able to:

1. Critically analyse the theoretical and practical aspects of a range of current accounting issues
2. Evaluate the need for the development of a conceptual framework for  accounting
3. Explain the influence of conceptual frameworks on accounting practice
4. Evaluate the limitations of some present accounting practices
5. Describe the development and role of accounting standards in Australia and internationally
6. Apply appropriate accounting standards to solve a given accounting problem

Prescribed textbook:

Issues in financial reporting-custom publication Author/s: Elsayed, M Year: 2012. Edition 3rd edn

Publisher McGraw Hill Australia Pty Ltd, North Ryde, NSW

Related topics:

Ch. 1 :The Australian external reporting environment

Ch. 2 : The conceptual framework of accounting

Ch. 5 & 6:Depreciation and revaluation of non-current assets

Ch.8: Accounting for intangible assets

Ch.9:Accounting for heritage assets and biological assets

Ch. 11: Accounting for leases

Ch. 13: Accounting for employee benefits

Ch. 23: Accounting for superannuation plans

Ch. 21:Accounting for the extractive industries

Ch. 35: Accounting for foreign currency transactions

Ch. 25:Segment reporting

Ch. 24:Events occurring after balance sheet date

Due date: Thursday 12^th April, 2012

Length: Approximately 2000 words

Referencing Style: Harvard (author-date)

Objectives

This assessment item relates to the course learning outcome numbers 1 and 5.

The assignment should be written in an essay format and include an introduction and a conclusion. The use of headings is strongly recommended so that the different sections of your answer can be easily identified. You should refer to the relevant sections in the Guide for Students for information on researching a topic, writing an essay and referencing. You may also wish to seek assistance from the Communications Learning Centre (CLC) for additional assistance on how to research and write an assignment.

The assignment should be prepared using a Word Processing Package. Use Times New Roman font, 12 font size and 1.5 line spacing.

Question 1 Total 17 marks

There are four sources of external financial reporting regulations in Australia.

Required:

a) Briefly discuss the objectives and functions of each of these sources. 12 marks

b) In your opinion, is it necessary to have all four of these sources? Justify your answer by discussing the purpose of each source of regulation. If you believe it is not necessary to have these sources, which source(s) do you think can be abolished, and why? 5 marks

Question 2 Total 9 marks

Barmunda Pty Ltd harvests lavender and produces personal care products (for example, body wash, soap, hand cream, and powder) and home fragrances (for example, linen spray, and room freshener). The company also does embroidery on merchandise (for example, on sleepwear and towels) and sells these products.

You have been given the following information about Barmunda Pty Ltd:

• Sales for the financial year ending 30 June 2011 was:

Personal care products $10 000 000

Merchandise $ 5 600 000

Home fragrances $ 4 700 000

• Barmunda Pty Ltd employs fifty-five (55) permanent staff, twenty (20) who have been employed by Barmunda Pty Ltd since it commence operations in1995 and fifteen (15) who have been employed by Barmunda Pty Ltd for more than ten years.

• Barmunda Pty Ltd had the following assets and liabilities as at 30 June 2011.

Historical cost of property, plant and equipment (PPE) $11 000 000

Accumulated depreciation of PPE $ 3 000 000

Other non-current assets $ 1 000 000

Current assets $ 4 000 000

Total liabilities $ 7 770 000

Required:

a) Advise the Management Committee of Barmunda Pty Ltd as to whether the company would be considered a reporting entity in accordance with SAC 1 ‘Definition of the Reporting Entity’. Justify your answer by discussing (a) the definition of a reporting entity and (b) discussing each of the three criteria above separately. 8 marks

b) What will be the implications for Barmunda Pty Ltd if it is considered to be a reporting entity? 1 mark

SOLUTION

Introduction

Financial Reporting is the reporting of the financial activities of an entity in a structured, precise and clear manner, so as to serve the information purposes of the various stakeholders to the entity (Libby,2011).The Government of Australia has laid down several procedures for financial reporting and such reporting is mandatory for certain types of entities. For entities like Public sector organizations and banks, disclosure of financial reports as per prescribed government procedures is a must. Such organizations are answerable to the public and are under the control of the government. In other organizations like large corporations the extent of stringency would depend upon the control factor, if the ownership is separate from management then reporting of financial activities become more stringent. For sole proprietorship or partnership firms, the reporting procedures may be much simpler and less stringent.

Objectives and Functions of the Four Sources of External Financial Reports.

The four sources of external finance are known by various names, these are as follows:

Balance Sheet

Profit and Loss Statement

Changes in Equity Statement

Cash Flows Statement

Balance Sheet

Balance Sheet is also known as statement of financial position. It is a report of an entity’s assets, liabilities and owner’s equity. Owner’s equity includes share capital, preferred stock, capital surplus, retained earnings, treasury stock, stock options, and reserve. The balance sheet does not pertain to a period of time but a particular point of time, all the other financial statements pertain to a certain period of time. This particular period or point of time is generally the end of a trading period or a financial year.

In a balance sheet the assets and liabilities are not grouped haphazardly. They are grouped according to serve certain underlying purposes. The grouping of assets and liabilities is also called marshalling and differs according to the type of entity.

Liquidity or Reliability Criteria: In this type of grouping the assets are sequenced as per their convertibility into cash and liabilities are grouped as per the order of which they can be settled. Sole Proprietors and partnership firms find this grouping useful.

Permanence Criteria: this type of grouping is reverse of the above. In this, permanent assets are mentioned first and the fixed liabilities are mentioned first under the liability side, the floating liabilities are mentioned after the fixed liabilities. This type of grouping is found useful by companies.

Mixed Sequencing: this type of grouping is found useful by banks and is a combination of the above two criteria. The assets are sequenced as per liquidity criteria and liabilities are sequenced as per permanence criteria.

The balance sheet also enables classifying the various assets, liabilities and capital of an enterprise and determining suitable treatment and valuation for each of the classes of these. Assets of an enterprise are valued as per nature of enterprise and purpose of holding the assets. Assets can be classified into fixed, current, liquid, fictitious, wasting, contingent and outstanding assets. Liabilities can be grouped into fixed, current, contingent and outstanding liabilities. Capital can be classified into fixed, circulating, working, loan and watered capital.(www.accountingformanagement.com,2012)

Profit and Loss Statement

The profit and loss statement is also known as statement of comprehensive income. In short it is referred to as P&L statement and is a report of an entity’s income, expenses and profits for particular time duration, generally a financial year. This report reflects the operational performance of an entity. The P&L statement shows the revenues of an entity during a particular time period and the cost and expenses incurred on these revenues. The cost and expenses include depreciation and taxes. The net income figure is attained by deducting the expenses from the gross income figure. The P&L statement enables decision makers to know the various sources of revenues and cost associated with each and to plan their future actions accordingly for their benefit i.e the decision makers can analyze separately each cost item separately with respect to their usefulness, cost reduction and substitutability. The P&L statement reflects the cash flow generating capabilities of an entity.

Changes in Equity Statement

Is a periodic report that shows the changes in an entity’s equity during a particular time duration, generally a financial year. The equity statement is significant for entities having complex and diverse equity structures. The various types of stock transactions are shown under different heads. By analyzing the equity statement it is possible to gauge the effects on the retained earnings and dividends.(www.ipec.org,2012)

.

Cash Flows Statement

Is a periodic report that shows an entity’s cash flow details. Cash flow includes both cash outflow and cash inflow. It is also called funds flow statement. The cash flow statement is categorized under operational, investing and financing heads. Such categorization enables prioritization of cash flow related decisions. Cash Flow statement shows an entity’s liquidity and ability to fulfill its short term obligations.

Justification and Purpose of Each Source

External financial reporting is mandatory for certain types of entities like Public sector or Government owned companies and Public Ltd companies. Sole proprietorship and partnership firms may be exempted from submitting detailed reports, for example small and medium enterprises with no investments and withdrawals from owner (except dividends) may be exempted from preparing statement of changes in equity,but if at any time they may have to prove their viability infront of external agencies like banks, Income tax or other government or public bodies, then they can be asked to produce certain financial documents based on their financial statements. The four financial statements mentioned above needs to be maintained by all entities whether big or small, public or private for their internal purposes and these are the documents that comprehensively express the financial position of an entity. Non maintenance of any of the above mentioned statement would result into an incomplete picture regarding an entity’s financial position.

The different users and stakeholders who require financial statements are:

• Owners and managers for making business related decisions.

• Employees, staff and labour unions for negotiation,compensation determination purposes.
• Present and prospective investors.

• Financial institutions and banks, lenders.

• Government authorities.

• Vendors and contractors.

• Media and the general public.

The purpose of each of the sources of financial position is mentioned in brief as follows:

Reporting Entity

According to SAC 1, the Definition of a Reporting Entity is given as follows:

“‘entity’ means any legal, administrative, or fiduciary arrangement, organizational structure or other party (including a person) having the capacity to deploy scarce resources in order to achieve objectives” (paragraph 6);

and

“Reporting entities are all entities (including economic entities) in respect of which it is reasonable to expect the existence of users dependent on general purpose financial reports for information which will be useful to them for making and evaluating decisions about the allocation of scarce resources” (paragraph 40). (www.aasb.gov.au, 2012)

From the above definitions on entity and Reporting entity it is clear that all forms of organizations can be considered as entity. Further entities become Reporting entitities if they are answerable to certain stakeholders, such as lenders, contractors etc. Stakeholders share a responsibility and accountability relationship and hence for fulfillment of such relationship proper accounting of activities by the Reporting Entities are required.

It is also stated in SAC1 that in cases where it is not clear that users dependent on general purpose financial reports exist or not, the identity of the entity whether reporting or non reporting will be based on the following factors:

Separation of Management from Economic Interest: as per SAC1 “The greater the spread of ownership/membership and the greater the extent of the separation between management and owners/members or others with an economic interest in the entity, the more likely it is

that there will exist users dependent on general purpose financial reports as a basis for making and evaluating resource allocation decisions”.

As per the above definition, it is clear that if an entity has a separation between its owners and managers i.e if the owners do not themselves manage the business but appoint managers to run the business and the greater the degree of separation, the greater will be the requirement for general purpose financial reports and hence such entities will be considered as Reporting Entities as per Australian accounting standards.

Economic or Political Importance/Influence: As per SAC1 “Economic or political importance/influence refers to the  ability of an entity to make a significant impact on the welfare of external parties. The greater the economic or political importance of an entity, the

more likely it is that there will exist users dependent on general purpose financial reports as a basis for making and evaluating resource allocation decisions. Reporting entities identified on the basis of this factor are likely to include organizations which enjoy dominant positions in markets and those which are concerned with balancing the interests of significant groups, for example, employer/employee associations and public sector entities which have regulatory powers”.

As per the above definition it is clear that entities which have significant economic or political impact on the welfare of external parties or society, such as laborers, workers, consumers, environment etc are very much likely to have users of general purpose financial reports .hence such entities will be considered as Reporting Entities as per Australian accounting standards. Such entities would include public sector or government owned organizations, welfare groups etc.

Financial Characteristics: explained in next paragraph

Financial Characteristics

As per SAC 1 the characteristics of a reporting entity among other characteristics includes:

“Financial characteristics that should be considered include the size (for example, value of sales or assets, or number of employees or customers) or indebtedness of an entity.—– The larger the size or the greater the indebtedness or resources allocated, the more likely it is that there will exist users dependent on general purpose financial reports as a basis for making and evaluating resource allocation decisions.” (paragraph 22)

(www.aasb.gov.au,2010)

As is clear from the above definition, the size of a firm is reflected by its sales, number of employees, value of assets and liabilities. If these parameters assume a substantial figure,then the entity becomes considerable as a Reporting Entity, as such entities will have stakeholders or users who are dependent on general purpose financial reports as basis of taking decisions regarding their various interests in the entity.

Hence mainly on the basis of financial characteristics Barmuda Pty Ltd., the firm can be considered as a ‘Reporting Entity’.

The basic financial characteristics provided in the question for Barmuda Pty. Ltd for year ending June 2011are

Implications

Ans.

If Barmuda Pty Ltd is considered as a reporting entity, then:

• It will have to enroll itself with the Government and provide all the details pertaining to enrollment.
• It will have to register itself with the Australian Government, and provide all the required details for the same.
• Submit AML/CTF (Anti Money Laundering and Counter Terrorism Financing) reports to the Australian Government.
• Identify Customers as per type of customers in accordance with prevailing government rules.
• Act in accordance with Government Enhanced Customer Due Diligence (ECDD) with respect to all transactions with other countries which fall under ‘prescribed foreign country’ category.
• Conduct Ongoing Customer Due Diligence (OCDD) as per Government rules.
• Submit reports to the Government regarding International Funds Transactions,Threshold Transactions and Suspicious Matters, whenever applicable.

(http://www.austrac.gov.au, 2012)

If Barmuda Pty Ltd is considered as a reporting entity, then it will have to furnish the required financial reports to the government as per their prescribed format and procedures. A firm may have its own method of preparing financial statements and all entities must prepare their internal financial statements for their own purposes. The data required by government can be obtained from these internal financial reports. If the prescribed format by the government suits the internal purposes of the entity, then the entity can adopt a single method of preparing financial statements, instead of preparing multiple statements which can be time consuming.

Conclusion

A business has several stakeholders, within the firm as well as outside the firm, for taking decisions pertaining to their interests in the firm; the stakeholders require certain financial reports. A reporting entity has more viability than non reporting entities with respect to government, public, customers, vendors and contractors. Proper reporting of financial activities enhances the image of an entity and hence as well as its prospects.

Reference

Libby, 2011.Financial Accounting, 6^th edition, India: Tata McGraw-Hill Publishing Company Limited.

Accountingformanagement.com, 2012.Balance Sheet viewed on 29^th march 2012, http://www.accountingformanagement.com/balance_sheet.htm

Merrill Lynch1993, How to Read a Financial Report. Statement of Changes in Shareholders’ Equity Basics viewed on 28^th march 2012, http://www.jpec.org/handouts/jpec97.pdf

Jim Paul 2010, Conceptual Framework: The Reporting Entity ,viewed on 28^th march 2012, http://www.aasb.gov.au/admin/file/content102/c3/June_10_Agenda_paper_10_2_Staff_Paper_Conceptual_Framework_Reporting_Entity.pdf

AUSTRAC 2010,AML/CTF Act Obligations ,viewed on 28^th march 2012,  http://www.austrac.gov.au/amlctf_act_obligations.html

JD15

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