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The field of accounting is to measure and report the business transactions the company carries out in the day to day operations of the company. In the reporting, the company should establish that the reports that are published are prepared with a view to portray a "true and fair" view of the company's operations, In order to reflect a true and fair view, companies adopt generally acceptable accounting policies and standards. These accounting policies and standards are evolved by leading accounting bodies in the accounting profession who carefully observe, evaluate and publish such polices for the guidance of accounting reports which form are the part of published accounts. Over the years .there is an accounting body of knowledge that has been evolved for adoption of accounting reports.
Accounting policies are the concepts used to record the daily transactions of an entity. The international body that is responsible for the creation of accounting standards is called the "International Accounting Standards Board" (IASB). Their standards are called "International Accounting Standards" (IAS). The "International Financial Reporting Standards" (IFRS's) are created by a board called the "International Standards Board" which is another authorized body that helps in the creation of standards. Â We have the Sri Lankan version of these and these are done by the "The Institute of Chartered Accountants of Sri Lanka" and they are called the "Sri Lanka Accounting Standards" (SLAS).
All Sri Lankan accounts are based on SLAS's. However our standards do not cover all areas in accounting and where there are discrepancies companies tend to use IAS's and IFRS's. The consolidated financial statements are designed and prepared to comply and accord with the Sri Lanka accounting standards. As the selected organisation is from the Sri Lankan context, in instances in which items are not covered by the Sri Lanka accounting standards (SLAS), International standards are followed. Sri Lanka has very few activity in areas such as hedging, SWOPS, etc. these are called "Financial Instruments". Due to this low activity, our standards do not cover them and companies that use such "Financial Instruments" use the standard specified by the international community. Â Financial instruments cannot be recorded in historic cost. This is because these are traded. Thus the IASB discusses other measurements as present value, current cost methods etc.
Thus I have carried a discussion throughout my report based on Historical Cost and Accounting Policies as to how they would affect my understanding based on the selected organization namely Sri Lanka Telecom(SLT) which stands to be the predominant market leader in the fixed line connection. Hence the estimations are based upon the management of SLT are based on the historical events. This includes future occurrences that could be assumed to be believed under reasonable assumptions.
Accounting policies and principles
Thus an accounting policy rises from accounting concepts. Accounting concepts are foundations of preparing and maintaining accounting records. These are being used to prepare and maintain accounts that are consistent and uniform in nature. Thus certain rules or principles are evolved. These principles are classified as concepts and conventions. There are different accounting concepts as business entity, going concern, cost concept, accrual concept, prudence concept etc. As mentioned in SLAS 3 (revised 2005)-presentation of financial statements should comply with the stated concepts.
Gowthorpe (2006, p9) indicates that "Accounting policies are the basic specific principles, bases, convention, rules and practices adopted by an entity in preparing and presenting financial statements" These aspects are covered by IAS 8 revised in December 2003 and SLAS 10.
Thus it is entirely up to the management of SLT to develop policies that provide the most useful information to users of the entity's financial statements. Further IAS 8 Accounting policies, changes in accounting estimates and errors mentions that there are no specific requirements in these international standards, the management of the company should establish accounting policies This is rather volatile according to my understanding as organizations can vague and change policies to their advantage within a certain limit.
Further SLAS10 prescribes to ensure that the financial statements provide comprehensive information to all users in the entity. Financial reporting Standard 18 (FRS 18) issued by the Accounting Board in p21 describes "The objectives against which an entity should judge the appropriateness of accounting policies to its particular circumstances should be relevant, reliable, comparable and understandable". This is illustrated by the fact in which SLT demonstrates a ten year progress of information which depicts the financial position, performance, key financial indicators etc. This provides comparable information to the users of the entity to provide an insight in information.
Further FRS 18 prescribes that the accounting policies made by each organization should relate with the accounting standards. Thus if occurrences and circumstances change the entity should change or vary its accounting policy to suit with the circumstances, This is illustrated by the fact in which the accounting policies adopted by the company is consistently monitored and when policies are used its being indicated. All policies remain consistent from previous years; except for Mobitel a subsidiary of SLT has adopted SLAS16 Employee benefits during the year 2008.
Further SLAS 3 and FRS 18 emphasize the going concern assumption and accruals as it plays a major role in the financial statements. SLT in its accounting policies have objectives in managing capital to safeguard the groups ability to continue as a going concern to provide returns for shareholders and to maintain an optimal capital structure to reduce the cost of capital, SLT monitors the capital on the basis of the gearing ratio, thus the groups policy which was unchanged from 2007 was to maintain the gearing ratio below 35%.Thus the non current borrowings in SLT amounted to a total of Rs.5228 million, but it doesn't value the same in future. As according to my opinion money value deteriorates. Hence borrowings obtained from the government and banks obtained in 2008 would not value the same in the future, since the cost of borrowing is high. In terms of repaying back US dollars the exchange rate could vary because borrowings are repaid back based on historical value.
Financial instruments cannot be recorded in historic cost. This is because these are traded. Thus the IASB discusses other measurements as present value, currents cost methods i.e. As SLAS 3 prescribes that depreciation methods could be selected according to the organization choice. Organizations choose methods that are more advantageous.
Sri Lanka Telecom for instance uses the straight line method in their depreciation policy which denotes a lesser percentage of depreciation comparatively to the reducing balance method. Thus the policy of the organization relates the basis and convention of preparation uses financial statements under the historic cost convention.
Accounting concepts and conventions are the common practices adopted in drafting the accounting statements for a period of accounting. Example it is prudent to report from the company probable losses but not future profits. These accounting concepts conventions come under accounting policies, which are clearly published in the annual reports of the companies. The most commonly used concept is historical cost convention, which adopts to record the asset at cost when purchased. Here cost would be used as the basis of valuation in that particular year. But it need not show the same cost in the subsequent year as this asset could depreciate. But in the case of quoted investments it could vary according to the market demands which could be stated as a note if the value is higher than the cost. As all assets are recorded in historic value, companies such as SLT have subsidiaries as Mobitel under them. Sometimes these companies are created by them and sometimes they buy these small companies. When they buy these companies, they may gain a profit or a loss from that. That needs to be recorded in the books. Since they need to find out the actual amount the company is worth, they calculate something which is called the "fair value of net identifiable assets" For example SLT income and operating cash flows are subjected and varied according to the changes in market interest rates.
The borrowings at variable rates expose the SLT group to adjust to fair value interest rate risk. The Sri Lanka Telecom 2008 annual report and accounts states that the analyses of the interest rates are simulated taking into consideration refinancing, renewal and existing financial reserves. Further SLT does hedging reserves to accord with "fair value of net identifiable assets" This is illustrated by the fact of adjusting a foreign currency transaction difference of Rs.4 million Thus the company hedges certain foreign currency borrowing against its foreign currency revenue streams. The loss of these revaluations amounted to Rs.32 million, as it is deferred and matched against losses from the future revenue streams, to accord with the matching concept. As today's world is highly volatile the FASB prescribes fair value as more transparent and appropriate. Thus SLT uses accounting policies in revenue recognition, adjusting it to market conditions, representing fair value with market fluctuations and trends to comply by SLAS 29 and IAS 18 that defines about revenue.
According to my understanding Historical cost records, assets at its original cost and is commonly used these days. Even the International Accounting Standards Committee framework (IASC) prescribes the most commonly adopted basis of measurement used in financial statements is historical cost. Even the SLT uses historical cost as a policy in recording its financial items. Thus it is being selected since it's an objective way of seeing things and it is easily understood by the users of the entity. However it has its significant defects as well. The asset values reflected on the business may not reflect their real economic value. ( i.e. the cost of replacing such an asset in today's terms.) For example depreciation is based on the cost of the asset which could be understated. Therefore the profits of the company would be seriously overstated. Revaluation techniques are used to counteract this phenomenon.
The convention that to record the asset as the cost and not as an arbitrary value is called the Historical Cost Convention. The principle of valuing the asset as the cost in fixed assets is a fair and true view than considering arbitrary value which arises from market conditions. When market conditions changes we have to revise these values. As in periods of inflation, historical cost tends to mislead aspects such as distributions made out of profits calculated on an historical cost based which might result in reductions of capital. Historical cost accounts can't be adapted to take account of the effects during inflation. As the year 2008 was peeking towards high inflation prices were significantly raising. As a result the historical cost depicted didn't portray the right picture. Thus some of the figures depicted in the annual reports didn't consider these aspects. Hence the rise in operating cost rose by 11% in the year 2007 was a notable factor and according to my opinion the impact of inflation rise has also significantly impacted towards the rise in some of the factors in the context of SLT. One of the main disadvantages of historical cost accounting technique is that it relays on the currency in the reporting country to remain stable and assumes no inflation to be present in the country. In turn it assumes that the asset purchased today will remain the same for a long time to come and that there will not be any price escalations.
Inflation affects different companies differently. Even for companies in the same industry, as the telecommunication industry inflationary pressures would be poles apart and using statements prepared from historical cost convention to compare corporate performance can become quite obstructive. This effect could overcome by using accounting standards as IAS 29 Financial Reporting in Hyperinflationary Economies.
As per my understanding historic cost accounting is based upon the records of transactions that are recorded in monitory terms at which goods or services change hands. Once the transactions are recorded the record that record remains fixed in value and does not change.
Historical cost accounting is easy to understand, but when environment changes in terms of inflationary effects then the historical cost accounts become less useful for decision making.
Historical cost accounts have defects and limitations in an environment of changing prices and if I present according as follows,
Reported results are discrete when matching revenue with cost incurred at an earlier date. Cost of sales would be understayed when there is a price inflation and profit that is earned when preparing in terms of historical cost accounts will not be sufficient to maintain the capital. In other words if I could inform the profit that is earned was measured in the historical cost accounts would be lesser than in real terms than the profit that is measured in current times when there is a change in prices in a inflationary period.
The assets that are valued in the basis cost less the depreciation will not be the same as the current rule of the asset. In terms of Return On Capital Employed (ROCE) the profits would have been overstated and assets are under stated, therefore results shown during inflationary period becomes unreliable. Thus it could be illustrated by the fact that SLT depicts there ROCE as 19.31%, hence the profit after interest denoted as has been overstated whilst assets understated.
The trend of performance over a period on year to year comparisons becomes rather misleading because no adjustment is made for changes in the real value of money.
Certain ratios, such as the "quick ratio" is used in the evaluation of a company by its investors. If the company's assets are old, due to the depreciation charge the asset figure would a lesser amount compared to its real market value. Therefore some of these ratios would be overstated and would show a better performance to that of the actual performance of the company. This would sequentially mislead investors.
It has been the traditional practice to record accounting transactions applying `HistoricalÂ Cost' convention', and also to present the same in financial reports on the same basis. As such, strict adherence to this system neither provides a mechanism nor opportunity for entities to present certain important features of their financial status in a more realistic, acceptable up to date manner.
Therefore, this concept has gradually changed over the years, with Accounting Standards now demanding `more realistic' figures in reports. While presenting financial reports applying `historical cost convention', in general, certain re-presented financial data along with additional information in accompanying notes, provides a `more meaningful and true' status of the entity.
Drawing my attention specifically to "Sri Lanka Telecom" annual report, it can be observed that they have applied the `historical cost', while complying with relevant accounting standards, and accounting policies.
The following aspects are noteworthy of my attention as they assist the users or readers of the annual reports to understand of how transactions are recorded in the historical cost and further accounting policies adopted to get a picture of Sri Lanka Telecom and its financial status as at the given date;-
Recording `excess of the cost of acquisition over the fair value of the Group's share of the identifiable net assets acquired' as "goodwill" .Thus this policy ensures that acquisitions are recorded at current market value. Further according to SLAS 37 and IAS 38 Intangible assets could be decided upon fair value. Once an entity decides this treatment it requires revaluation to be made periodically, which would result in fair value. According to my opinion this would result in a realistic value rather than adhering by historic cost. Further eliminating `unrealized losses' in consolidation and considering as an impairment indicator. Further according to my opinion this provides an advance warning to the management.
Recognition of gain or loss on translation of monetary assets and liabilities in foreign currencies at year end exchange rate, in the Income Statement. The policy adopted in translating results of Group entities gives current market value of the group as a whole. Thus this accounting policy complies with IAS 21 and SLAS 21-The Effects of changes in Foreign Exchange rates.
Transferring of Property, Plant & Equipment of Department of Telecommunications at government valuation in revaluating the assets. This policy adopted in measuring and assessing the attributable historical cost in bringing an asset to working conditions. Further The policy of identifying subsequent costs included in the assets carries amount only, when it is probable that future economic benefits associated items will flow to the group. Writing down of an asset carrying amount immediately to its recoverable amount, when the former is greater than the latter. As the Sri Lanka Telecom annual report states that all property, plant & equipment are stated at historical cost less accumulated depreciation as based on the cost model stated in IAS 16. But there are some exceptional instances when revaluation of assets was performed by the government of Sri Lanka. Thus the accounting policy has complied with the SLAS18 and IAS 16 of Property, Plant and Equipment. According to my understanding Incorporating gains or losses in disposal of assets in Income Statement can be considered as a very prudent policy.
The entity appears to have adopted a very prudent policy in recording its Intangible Assets, some of which are listed as testing of Goodwill annually, and making an adequate Impairment Loss provision to bring the asset down to present day value. Even though the licenses are recognized at historical cost, the licenses are amortized over a finite useful life is carried at cost less accumulated amortization using the straight line method.
World economy under the present financial crisis and current inflationary trends had affected companies performance to a grater extent. Sri Lanka companies are not exceptional The adoption of accounting policies in such conditions becomes a debatable issue in companies' presentation of accounts, The reliability and relevance is critically examined by professional accounting bodies and not portray the true and fair view the companies performance and position at a given date. Users such like investors and analysts are been mislead in not showing company on fair value basis so that they could take meaningful and reliable decision making. Historical cost convention would be ideal when there is no change in monitory value, so that historic cost could be used in preparation of accounts but in inflationary it becomes a questionable issue. Therefore as per my understanding in inflationary conditions companies should adopt fair value accounting on the basis of reliability and relevance, thereby values stated would provide users meaningful information on sustainability of companies operation in a true and fair manner. Further to my understanding accounting policies developed by each entity is a framework and a base to regulate the financial operations in a company.