Company Accounting Assessment - Example

Company Accounting Assessment [Student’s Name] [Course Title] [Instructor’s Name] 22 October, 2011 Company Accounting Assessment Before a decision is made to develop a standard, the standard setting board need to satisfy itself that matter to be ruled on represent a significant problem and that the standard will not impose cost on the many for which the benefits are few. Many accounting measurements do not have a single correct answer; therefore, a choice must be made among alternative assumptions under conditions of uncertainty (Horngren & Harrison, 2007). The concept of conservatism holds that when reasonable support exist for alternative accounting method and for different measurement techniques accountants should select the methods or techniques with the least favourable effect on net income and financial position in the current accounting period. However, the peculiar nature of some business concerns requires departure from the stated accounting theory. For instance, agricultural crops are usually reported at market value since it is costly to develop precise cost figures on various crops. Whenever a variation emerges it should be determined whether some peculiar features of the type of business involved can explain it before criticizing the procedure followed. An important feature of developing any theoretical structure is the body of basic definitions or elements to be included in theoretical structure. Assets are referred to as probable ‘future economic benefits’ obtained or controlled by a company as a result of the initial transaction or event. Therefore, AASB 112 does not mislead users of accounting information through recording of Deferred Tax Assets (DTAs). This is because the deferred taxes are under the control of the business and it can use it for economic benefits in succeeding accounting period. For instance, it can use it to reduce the tax burden for that accounting year. Liabilities are defined as probable future sacrifices of economic benefit. They arise from present obligation of a company to make asset transfer or service provision to another entity (in the future) as a result of the first transaction or event. AASB 112 does not mislead users of accounting information through recording of Deferred Tax Liabilities (DTLs). This is because taxes are part of outflows that are brought up within the course of business. When the business has not met its tax obligations and have thus become accrued, they should be considered as deferred liabilities, which the business will have to honour at some time in the future. In this case, the deferred taxes meet the definition of liabilities since the business will have some future economic benefits in order to pay the debt obligation. Oberuc (2004) observes that the ultimate measure of performance is not what the firms earn but how the earnings are valued by investors. Investors, when analyzing the firm will consider the risk inherent in the firm’s operation, the time pattern over which the earning increases or decreases, the quality and reliability of reported earning among other factors. Thus, managers should need to put all these into consideration the decision on the overall firm’s valuation. If a decision maintains or increases the firm’s value, it is satisfactory from a financial perspective. AASB 112 standard of recording DTAs and DTLs, which causes companies with tax losses and significant DTAs report the financial position that may look better than it is in reality affects the quality of investment decision by existing and potential investors. Over the years, several organizations, committees and individuals have developed and published their own conceptual framework of accounting, but no single framework has been universally accepted and relied on in practice. Conceptual framework for financial reporting is based on its objectives, qualitative characteristics and the concept of recognition and measurement (Picker, 2009). According to AASB (2004), stating the financial statements core objectives would be simple if all users had similar needs and interests. Accounting information should be free of bias intended to achieve a predetermined result or to provoke a certain mode of behaviour. Freedom from bias is essential as it improves the quality of decisions by decision makers. Accounting information should show an agreement between a measure and real world phenomenon that the measure is supposed to represent. Amenc and Le Sourd (2003), state that the truth of accounting information should be verifiable by examination of evidence of underlying facts. Information that has been measured and reported similarly is considered comparable (Black, 2003). However, differences in the operating policies among different enterprises results in the adoption of various accounting practices. Whatever practice adopted the company has to maintain consistency in its application in order to allow comparison between different accounting periods (Weygandt, et al., 2009). Recognition and measurement concept explains how, when and which financial elements and transactions should be measured, recognized and reported by the system of accounting. Companies should prepare their financial statements in an acceptable manner so that they can be compared with the previous year’s statement and with the statements of other enterprises. According to Brown and Matysiak (2007), the activities of a business enterprise should be separated and distinguished from those of its owners and other business entities. Since a company is a going concern, probable future benefits should be recorded as assets and probable future outlays as liabilities. Under AASB 112, deferred tax assets (DTAs) is recognizable for deduction of temporary differences, tax losses and tax credits that have not been used as much as taxable profit is probable. DTAs cause a decline in tax payments of future income. They are considered as assets since they are prepaid, which can be misleading, in as much as assets are concerned. Deferred tax liabilities (DTLs) are measured at the tax rate anticipated being applicable during the settlement of liability. DTAs cause a rise in tax payments of future income. Financial statements should be complete in the sense of improving information quality to users of the statements (Fess and Warren, 2004). AASB 112 recognizes tax as an expense to the firm, and a tax rate is subjected to the net income of the company in that year. Deferred Taxes Recognition Both companies recognize DTAs for deductible differences only when it is probable that taxable amounts in the future will be available to be utilized in the temporary differences. However, there is no recognition of DTAs and DTLs for temporary differences in the carrying amount and investment tax bases, in regulated entities where parent company has control over reversal timing of temporary differences, and that the differences will not reverse in the future. Deferred taxes are recognized in the income statement apart from when they relate to transactions recognized in other comprehensive income. Accounting Treatment for Deferred Taxes In both companies, DTAs and DTLs are treated as noncurrent assets and noncurrent liabilities respectively hence they appear in the balance sheet. DTLs are liabilities to the company because they have to be paid at some future time. The company has control over DTAs as they are probable future economic benefits resulting from the previous transaction of the company with the Government. This shows that they are the company’s assets and ought to be recorded, as such, to indicate the correct financial position of the firms (Donald, et al., 2009). Deferred Taxes Disclosure Deferred taxes are disclosed in the notes to the financial statements. Since DTAs and DTLs are not contingent assets and contingent liabilities respectively, there is a need to create provisions in order for them to be recorded as assets and liabilities. Deferred Taxes Company Amount of Deferred Taxes (in $ ‘000’) 2010 2009 DTAs DTLs DTAs DTLs Aristocrat Leisure ASX Code: ALL 104,518 555.2 116,548 695.5 Crown Ltd ASX Code: CWN 68,938 11,317 140,138 235,167 Impact of Deferred Taxes on Financial Statements Recording DTAs in the financial statements leads to reporting a financial position that may look better than it is in reality. DTAs reduce payment of income tax in the future accounting period while DTLs increases payment of future income tax. This cause changes in earnings after tax (EAT). Recording DTAs and DTLs as assets and liabilities respectively, will have the effect of changing the value of assets and liabilities reported in the financial position of the companies. Including DTAs lowers the total assets turnover, return on investment (ROI) and fixed assets turnover since DTAs are recorded as noncurrent assets. The debt ratio will be higher if DTLs are more than DTAs, and lower if DTAs are more than DTLs. Impact on Users’ Decision Making Process The objective of financial reporting is provision of useful information for decision makers (Greite, 2007). Since users of accounting information have varied needs and interests, it is possible to emphasize the needs of some users at the expense of others. Investors are most interested with wealth maximization, as opposed to profit maximization; hence company’s performance and valuations are very crucial to investors. The ultimate measure of company’s performance is not its earnings but how investors value the earnings. A low ROI will discourage existing investors and scare potential investors (Greuning, 2005). If a decision maintains or increases the overall value of the company, it is acceptable from a financial perspective. References AASB (Australian Accounting Standards Board), 2004. Framework for the Preparation and Presentation of Financial Statements. Melbourne: Australian Accounting Standards Board. Amenc, N. and Le Sourd, V., 2003. Portfolio theory and performance analysis. New Jersey: John Wiley and Sons. Black, G., 2003. Students' Guide to Accounting and Financial Reporting Standards. London: Financial Times Prentice Hall. Brown, G.R. and Matysiak, G.A., 2007. Real Estate Investment: A Capital Market Approach. London: Financial Times. Donald, E. et al., 2009. Intermediate Accounting. New Jersey: John Wiley and Sons. Fess, E. and Warren, C., 2004. Accounting principles. Canada: Southwestern Company. Greite, S., 2007. The Development of the Australian Accounting Standards after the End of the G4+1. Sydney: GRIN Verlag. Greuning, H. V., 2005. International financial reporting standards: a practical guide. New York: Routledge. Horngren, C. T. & Harrison, W. T., 2007. Accounting (7th ed.). Upper Saddle River, NJ: Pearson Prentice Hall. Oberuc, R. E., 2004. Dynamic portfolio theory and management: using active asset allocation to improve profits and reduce risk. New York: McGraw-Hill Professional. Picker, R., 2009. Australian accounting standards. Australia: John Wiley & Sons Australia, Limited Weygandt, J. et al., 2009. Managerial Accounting: Tools for Business Decision Making. New York: John Wiley and Sons. Read More