Accounting policies and disclosure

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Case Study

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Question 1: AASB 108

  1. AASB 108 on Disclosure

AASB 108, as provided for in s334 of the Corporations Act 2001, was mainly crafted with an objective of prescribing useful criteria that can be used in selecting and changing accounting policies. It also provides the guidelines for accounting treatment and disclosure of changes in accounting policies, estimates and corrections of errors. In this case, treatment of advertising expenditure as an asset rather than expense can be considered as an accounting policy because this a specific principle or base that is to be applied by the company in presenting its financial estimates. This guideline requires that accounting policies must be developed in relation to transactions, other events or conditions on the base of Australian Accounting Standards. In that case, the judgment must be made on the bases of the criteria provided for in AASB 108. It provides for two circumstances in which the change in accounting policy can be envisage; one when required by the Australian Accounting Standard and two, when determining a voluntary change in the policy within an aim of preventing financial results in more relevant and reliable information. Your case here lies in the second circumstance because you want to present relevant and reliable information.

On disclosure it stipulates that the users of the information must be informed of the policies that underlie the preparation of the report and any changes together with their effect. The standard provides for two types of disclosures in the initial application of an Australian Accounting Standard and for voluntary changes. When an application of an Australian Accounting Standards is likely to have an effect on the current reporting period or any prior reporting period, an agency is required to disclose the title of the standard, the change in accounting policy made in accordance with transition provision, the nature of the change in accounting policy, a description of the transition provisions, transition provisions likely to have an effect on future periods, and amount of adjustment made for each item affect in the financial statement. In case of voluntary changes, AASB 108.29 provides that when voluntary change has an effect on current reporting period, previous or subsequent period, things to be disclosure include nature of the change, reasons for applying new accounting policy, amount of adjustment for current financial period of each financial item affected, amount of adjustment in relation to prior reporting periods, and the circumstances leading to the condition, including how and when the change will be applied. It is important to note that AASB 108. 29 stipulate that subsequent periods will not be required to repeat the disclosures. AASB 108 Aus2.4 on materiality considerations stipulates that restatements of comparative amounts will only be presented if the effects arising from the change in the account policy are considered material.

One example of a disclosure for change in accounting policy is change in policy relating to exploration and evaluation expenditure as given in Appendix 1 for Paledine Energy Ltd. This policy pertains to change in exploration and evaluation expenditure against profit and loss incurred with exception of acquisition costs and for the expenditure that was incurred after the decision was made to proceed was made, where the expenditure was capitalized as an asset.

This disclosure meets most of the requirements of AASB 108. In order to understand this disclosure, let us take example of a disclosure note 3 titled Voluntary Change in Accounting Policy as contained in Paladine Energy Ltd 2011 annual report. This note specifically highlight that the financial report is prepared on the basis of retrospective application of voluntary change in accounting policy in relation to the exploration and evaluation expenditure. It further clarifies that the new exploration and evaluation expenditure accounting policy is geared towards capitalizing and carrying forward exploration and evaluation expenditure as an asset. It also highlights the date the new policy was adopted as March 31, 2011 and state that it has been applied retrospectively. The reason for applying the new policy is clearly stated that management judges the changes in policy will result in financial report that provides more relevant and reliable information as it increases transparency in treatment of exploration and evaluation expenditure. It also states AASB 6 on exploration for and evaluation of mineral resources as the standard applied. The amount adjustment is also well explained. Therefore, it meets most of the requirements for disclosure.

  1. Disclosure Note

Note 1: Change in Accounting Policy

This financial report is prepared based on application of voluntary change in accounting policy relating to change in treatment of advertising expenditure from an expense rather than an asset. This note is therefore written in light of the provision of AASB 108 for disclosure of the change in accounting policy.

The new accounting policy is to capitalize on the treatment of advertising expenditure from an expense to an asset. Extensive market research has shows the benefits from advertising expenditure in the form of product awareness and increased sales that will be received by the company over a period of four years.

The new accounting policy was adopted in April this year and has been applied retrospectively. The management judges that the change in policy will have many benefits as it will lead to financial report that provides more relevant and reliable information.

The impact of this change in accounting policy on the Consolidated Income Statement, Consolidated Statement of Financial Position, and Consolidated Statement of Cash Flows is shown below:

Consolidated Income Statement:

The effect of Consolidated Income Statement is as follows……….

Consolidated Statement of Financial Position:

The impact on the Consolidated Financial Position is as follows…….

Consolidate Statement of Cash Flows:

The impact on the Consolidated Statement of Cash Flows is as follows…..

Question 2: Depreciation of Non-current Assets

Depreciation can be defined as the allocation of the cost of a non-current asset over its working life. Normally, an asset will gradually diminish in value due to its physical deterioration like tear and wear and it may end up being scrapped at the end of its working life. Depreciation will comply to the matching principles as non-current assets are mainly used to generate revenues, which means some amount of depreciation should be matched with the revenues. When determining the depreciation of non-current asset, there are important judgments that have to be made, regardless of the method of determining depreciation that is to be used. First, the accountant must make a judgment on the usefulness of the asset. The accountant should make judgment, on the basis of the existing life of the product, to determine its usefulness and value that can be equated to revenue. An estimation of the asset’s life will require management’s judgment of its expected future. Second, the decision to select a time or output basis for depreciation charges is another important judgment that has to be made. Third, selecting the method to use in determining the depreciation is also an important judgment that must be made on the basis of the item that is being determined. There is no stipulated best strategy that can be used to making these judgments. It is important to recognize that the judgment made will be based on a personal decision and therefore it is important that management make a judgment that is only in the best interest of the company. Personal feelings or views should not be allowed to override professionalism in making such judgments. The CPA should use accounting principles and ethical guidelines to help make the best of judgments depending on the situation at hand. It is important to recognize that different situations will present different options and ethical challenges and therefore it is important for the CPA to rely on the ethical guidelines and accounting principles in making judgments.

Appendix: Palandine Energy Ltd Disclosure Note

NOTE 3. VOLUNTARY CHANGE IN ACCOUNTING POLICY

The financial report has been prepared on the basis of a retrospective application of a voluntary change in accounting policy relating to exploration and evaluation expenditure.

The new exploration and evaluation expenditure accounting policy is to capitalise and carry forward exploration and evaluation expenditure as an asset when rights to tenure of the area of interest are current and costs are expected to be recouped through successful development and exploitation of the area of interest or alternatively by its sale. Refer to Note 2(s) for the full detail of the new accounting policy.

The previous accounting policy was to charge exploration and evaluation expenditure against profit and loss as incurred; except for acquisition costs and for expenditure incurred after a decision to proceed to development was made, in which case the expenditure was capitalised as an asset.

The new accounting policy was adopted on 31 March 2011 and has been applied retrospectively. Management judges that the change in policy will result in the financial report providing more relevant and no less reliable information because it leads to a more transparent treatment of exploration and evaluation expenditure that meets the definition of an asset and is consistent with the treatment of other assets controlled by the Group when it is probable that future economic benefits will flow to the Group and the asset has a cost that can be measured reliably. AASB 6 Exploration for and Evaluation of Mineral Resources allows both the previous and new accounting policies of the Group.

Given the significance of the exploration programmes that are being undertaken by the Company following the acquisition of Summit Resources Limited, the recent acquisition of the uranium assets of Aurora Energy Resources Inc. and the takeover of NGM Resources Ltd, it was considered appropriate to change the accounting policy.

The impact of the change in accounting policy on the Consolidated Income Statement, Consolidated Statement of Financial Position and Consolidated Statements of Cash Flows is set out below:

Consolidated Income Statement

Exploration and evaluation expenditure related to qualifying areas of interest has been capitalised in accordance with the accounting policy subject to an impairment review. This has resulted in a decrease in exploration and evaluation expenditure of US$17.1M and a net decrease in non-controlling interests of US$1.1M (2010: Nil) for the year to 30 June 2011.

Net loss before and after tax before non-controlling interests has decreased by US$17.1M for the year to 30 June 2011 (2010:US$7.3M).

Basic and diluted loss per share has also been restated. This has resulted in a reduction of 2.3 US cents in the loss per share for the year ended 30 June 2011 (2010: reduction of 1.1 US cents per share).

Consolidated Statement of Financial Position

The carried forward exploration and evaluation asset at 30 June 2011 has increased by US$35.5M. This adjustment represents a decrease in accumulated losses of US$32.5M, an increase in the Functional Currency Translation Reserve of US$4.0M and a decrease in non-controlling interests of US$1.0M.

The carried forward exploration and evaluation asset at 30 June 2010 has increased by US$15.1M. This adjustment represents a decrease in accumulated losses of US$14.5M and a net movement in deferred tax assets and liabilities of US$0.6M.

Cumulative capitalised exploration and evaluation expenditure at 1 July 2009 has increased by US$7.4M.

Consolidated Statement of Cash Flows

Exploration and evaluation expenditure that is capitalised is included as part of cash flows from investing activities whereas exploration and evaluation expenditure that is expensed is included as part of cash flows from operating activities. This has resulted in additional cash outflows from investing activities being reflected for capitalised exploration expenditure of US$17.6M for the year to 30 June 2011 (2010:US$7.4M). This has also resulted in a corresponding reduction being reflected in the net cash outflow from operating activities for the equivalent periods.

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