Effects Of Financial Adjustments On Marvin Co. Ltd’s Income Statements And Balance Sheet

Question:

Discuss about the Issues in Financial Reporting.

This assignment focuses on how the different financial adjustments affect the two main income statements of the company; namely the consolidated profit & loss account and the consolidated balance sheet. The discussion has been done with respect to the given case study of a company named Marvin Co. Ltd whose financial statements are being prepared on 31^st December, 2016 as per the accounting standards of International Financial Reporting Standards (IFRS) (Choi and Wang, 2009).In this assignment, study has been done regarding the impact of  lease contract, Warranty maintenance cost, property revaluation and cost of paying employee termination benefit and bankruptcy of the customer or debtor over the financial health of the chosen company named Marvin Co. Ltd.In order to analyse the impact the relevant journal entries has been discussed and also the changes that will take place in the consolidated balance sheet and profit & loss account of the company are being identified.

The organization of  IFRS is a not-for-profit organization that works for the interest to f the public  and has been established to develop a” single set of high-quality, understandable, enforceable and globally accepted accounting standards—IFRS Standards”. The organization is also involved in the promotion and facilitation of the accounting rules so that the business organization can easily adopt the accounting standards(Li, 2010). The reason behind the development of the accounting standards is to provide understandable accounting principles to all the companies across the world so that the companies get equipped with a set of accounting principles that can be easily use d while preparing their financial statements. A set of good accounting principles is needed to properly regulate the global as a well as the regional capital market (Chen et al.,2010).

1 .Impact of lease contract made between the companies Irish and Marvin Co. Ltd on the consolidated Balance sheet & P/L account

As per the IFRS-16 accounting standard the following entries are to be made with respect to the lease contract made between the Marvin Co. Ltd and the Company Irish

At the end of first year when first instalment of lease has been paid

Right-of-use asset a/c……Dr$400,000

  To lease liability a/c…..Cr $400,000

At the end of 2nd year when 2nd instalment of lease has been paid

Right-of-use asset a/c……Dr$400,000

  To lease liability a/c…..Cr $400,000

At the end of 3nd year when 3rd instalment of lease has been paid

Provision for warranty made by Marvin Co. Ltd

Right-of-use asset a/c……Dr$200,000

  To lease liability a/c…..Cr $200,000

In the consolidated balance sheet of the lease liability will be added to the liability side of the balance sheet. So the liability of the consolidated balance sheet prepared on 31 December,2016 will increase by $400,000

Journal entry for the payment of interest on lease at the end of first year

P/L account ……..Dr.$40,000

To    Expense a/c    …… Cr. $40,000

Journal entry for the payment of interest on lease at the end of second year

P/L account ……..Dr.$40,000

To      Expense a/c   …….. Cr. $40,000

Journal entry for the payment of interest on lease at the end of third year

P/L account ……..Dr.$20,000

To    Expense a/c  ……. Cr. $20,000

From the above journal entry it can be seen that an additional interest expense will be added to the debit side of the profit and loss account and the debit side of the consolidated profit and loss account increase will increase by $40,000 (Kieso et al.,2010).

The machine has a 3 years period of life but as no information has been given regarding the rate of depreciation, therefore no journal entry has been made in relation to the depreciation of machine

The above journal entries are mainly done with respect to the account of Marvin Co. Ltd

1. Impact of Warranty related returns on the financial position of Marvin Co. Ltd

Provision for warranty made by Marvin Co. Ltd is $300,000.

The relevant journal entry:

Warranty Expenses. ……dr.  $300,000

To Warranty Payable:………cr. $300,000

Provision for warranty made by Marvin Co. Ltd is $300,000 is equivalent to 2% of the total gross margin

So the total gross margin is =$150, 00, 000[($300,000/2%)*100]

All equipments in the range are sold at a gross margin of 30% which is equivalent to $150, 00,000

So the actual volume of sales is $500,00, 000

2% of the sold amount is actually expected to return which is an amount of $10, 00, 000

Estimated actual Warranty Liability: $10, 00, 000

Warranty payable a/c…….dr $10, 00, 000

 To    Cash inventory a/c ………….cr $10, 00, 000

So the provision made for warranty liability has to be enhanced by 3 times

Initially the provision for warranty of the company was around $300,000.This amount was only 2% of the gross margin. So the total volume of the gross margin is around $150, 00,000 and as the products of this range are sold at a profit margin of 30%, therefore the total amounts of sales will be $500, 00, 000.As per the historical report 2% of the total goods sold $500,00, 000  is returned for warranty replacements and if the replacements is not possible , then full refund will be given to the customers at the cost of the company(Wehrfritz and Haller,2014). Thus provision for warranty has to be enhanced by 3 times. Thus the warranty payable amount of $10, 00, 000 should be debited to the profit and loss account as warranty expense.

1. Impact property revaluation over the financial position of Marvin Co. Ltd

Financial analysis as per IAS 36- Impairment of Assets

The financial analysis has been done as per IAS 36- Impairment of Assets

The carrying value [Purchase value of the property-Accumulated Depreciation] of the property is $80,000,000

Annual depreciation for the year 2016 is $20, 00,000

So the carrying amount will be ($80,000,000-$20, 00,000)= $78,000,000

After revaluation the fair value of the property is around $70,000,000

As the fair value of the property is less than the carrying amount therefore there will be a downward adjustment.

The amount of the downward adjustment is ($78,000,000-$70,000,000) = $8,000,000

Relevant Journal Entries

Revaluation loss a/c………dr.$8,000,000

To   Building a/c ……..cr. $80,000,000

Here the business has applied the revaluation model. The carrying value of the property on 31 December, 2016 was around $80,000,000.The carrying value of a property is calculated by deducting the accumulated depreciation from the Purchase value of the property. In order to calculate the new carrying amount of the property on 31, December, 2016, the depreciation of the year that amounts to $20, 00,000 has been deducted from the previous carrying amount to calculate the new carrying amount of $78,000,000.As the revaluated fair value of the asset is less than the new carrying amount of the property so Marvin Co. Ltd has to make a downward adjustment in its books of accounts (Cairns et al., 2011).  The amount of revaluation loss has to be deducted from the value of the property that is present under the fixed asset section of the consolidated balance sheet.

1. Impact of paying the termination benefit over the financial health of Marvin Co. Ltd

The managing director Mr John Dickens has received a termination benefit of $500,000, on 31, January, 2017 as he has been dismissed on 31 December, 2016

So the journal entry to be drawn in the books of accounts of Marvin on 31, January, 2017 will be

Relevant Journal Entries

Profit & loss account…….. dr.  $500,000

 To Employee termination benefit a/c …… cr. $500,000

As the employee has been terminated by the company so it is the duty of the company to meet up his all the promised compensation which the terminated employee is eligible to get. On termination the company has cleared the pending amount of $500,000 that is paid by the company on January, 2017(Liapis and Thalassinos, 2013).Thus this amount has to be debited from the consolidated profit & loss account of the company as “employee termination benefit expense”

Due to the liquidation of one of the customer of Marvin Co. Ltd on January, 2017 the company realized that the amount of $ 1 million that is owed by the customer to Marvin Co. Ltd on 31, December, 2016 will be transformed in to bad debt. So the interest amount that is accrued on the amount of debt is $0.2 million .Thus the total bad debt amount of the company is around $1.2 million. This amount of bad debt has to be deducted from the trade receivables [present under the current asset sector of the consolidated balance sheet of the company].

Managing director’s Employee termination benefit

The study of the above financial issues with respect to the company named Marvin Co. Ltd reveals the fact that the financial department of the company has to increase their focus towards the projection of the possible future losses that may heat the financial operations as well as a the asset liability position of the company. A good focus to be given over the maintenance of the fixed asset of the company so that the company get a good revaluation value of the asset that remains higher than the carrying cost of the property. Property maintenance initiative will help the company to avoid the impairment losses.

Besides the company should hold a detailed work to estimate the warranty related cost which the business may have to incur with respect to the goods and services sold. As the policy of the company is to provide full return of purchase price or full replacement with respect to the goods that have been returned under warranty contract, mis-calculation of warranty related cost may badly affect the profit earning capacity of the company. Proper projection has also to be done regarding the costs of employee termination cost, revaluation of assets.

The company should identify the doubtful debtors well in advance so that the company can calculate the possible impact of a sudden wind up of a debtor which owes a lot to the company.A sudden liquidation of a debtor badly affects the liquidity as well as current asset position of the company.

Conclusion:

The above assignment describes that a s the business runs certain financial issues crop up with no prior intimation (Borio, 2011). An efficient business management requires that there should be sufficient human resource and liquid capital resource within the company to handle these issues efficiently. For example in case of the given case study the company Marvin Co. Ltd has to purchase a new machinery of worth $1,300,000 and the company decided to purchase that machine in instalments. This issue or activity requires that the business should have sufficient liquid cash to handle to pay the annual requirement and additionally the finance department of the company has to identify the possible impact of this machine purchase on the financial health of the company in terms of profit and loss statements and balance sheet analysis. Again the warranty cost calculation of the company requires that the company should study the historical data in order to understand the trend of the volume of warranty return before building the provision for warranty.

Reference:

Borio, C., 2011. Implementing the macro-prudential approach to financial regulation and supervision. The Financial Crisis and the Regulation of Finance, pp.101-117.

Cairns, D., Massoudi, D., Taplin, R. and Tarca, A., 2011. IFRS fair value measurement and accounting policy choice in the United Kingdom and Australia. The British Accounting Review, 43(1), pp.1-21.

Chen, H., Tang, Q., Jiang, Y. and Lin, Z., 2010. The role of international financial reporting standards in accounting quality: Evidence from the European Union. Journal of International Financial Management & Accounting, 21(3), pp.220-278.

Choi, J. and Wang, H., 2009. Stakeholder relations Management and the persistence of corporate financial performance. Strategic management journal, 30(8), pp.895-907.

Kieso, D.E., Weygandt, J.J. and Warfield, T.D., 2010. Intermediate accounting: IFRS edition (Vol. 2). John Wiley & Sons.

Li, S., 2010. Does mandatory adoption of International Financial Reporting Standards in the European Union reduce the cost of equity capital?. The accounting review, 85(2), pp.607-636.

Liapis, K. and Thalassinos, E., 2013. A Comparative Analysis for the Accounting Reporting of “Employee Benefits” between IFRS and other Accounting Standards: A Case Study for the Biggest Listed Entities in Greece. International Journal of Economics & Business Administration, 1(1), pp.91-116.

Wehrfritz, M. and Haller, A., 2014. National influence on the application of IFRS: Interpretations and accounting estimates by German and British accountants. Advances in Accounting, 30(1), pp.196-208.