Stakeholders Impacted by Violating AASB 116
Stakeholders may be defined as all those entities which are directly or indirectly impacted by a particular event. The most significant stakeholder in the given case are the shareholders (both current and future) of the company which is apparent from the fact that the company’s general manager intends to get the income in the future to be smooth with no major aberrations so that the investor confidence in the company is not adversely impacted. This is primarily because profitability is one of the most significant criteria used by investors for taking stock investment decision. Besides the shareholders, another key stakeholder are the creditors who tend to extend debt to the company and thus keep a close watch on the financial performance of the debtor besides imposing strict debt covenants so as to safeguard their debt. Since the operating profit is frequently deployed for the calculation of one of the most important liquidity ratio i.e. interest coverage ratio hence this manipulation has implications for this ratio and other indicators of business performance and thus amounts to deceiving the lenders and hence may attract legal suit if this ever comes in public (Deegan, 2014).
Yet another group of significant stakeholder which would be impacted by the given situation would be the regulators such as ASX, AASB since they are responsible for providing a suitable framework which is mutually beneficial for all the stakeholders and ensures accurate information is provided to the stakeholders on a periodic basis. However the company is violating the rules and trying to present an inaccurate picture to the stakeholders by violating the AASB 116 and thus punitive measures must be taken against the company so as to prevent others also from taking such steps. Further another stakeholder in this situation are the accountant and audit services providers as Marion is crossing the line by violating AASB 116 by choice so as to further her interests. As and when if Marion’s actions come in public, they will raise questions over the credibility of the auditing and assurance professions and thus may adversely impact the professions engaged in these services. Additionally if Marion is not rectified it is also possible that the same practice may be repeated in other firms and thus reporting eventually would lose its underlying credibility. Additionally other companies are also stakeholders in the given case as if punitive action is taken against this particular company as a result of violation of AASB 116, then the other companies also would not dare use such techniques to smoothen their earnings while if the given company is not caught then other companies will in the long term be encouraged to use such techniques to present a false picture of their financial performance.
Impact on Accountant and Audit Services Providers
The management of the company tends to act as agent to their principals (i.e. the shareholders) and must act in a manner which is in their best interest. However in the given case the General Manager i.e. Peter Pringle has approached the accountant with the proposal of income soothing which is clearly unethical since it violates the faith and trust of the owners which forms the basis of an agency relationship that Peter shares with the owners of the company. Additionally the profession of the accountant essentially rests on the credibility and faith the users tend to put on their professional opinion with regards to preparation of financial statements which are accurate and faithful representation of the company’s financial position (Gay & Simnett, 2012).
However Marion is clearly violating that faith by acting unethically since she is jeopardizing the interest of many existing and future shareholders just to promote her own monetary interest. This is primarily because her contract is due for renewal and Marion expects that entertaining Peter’s request would ensure that her contract would be renewed again without any hassles. Further Marion is also violating the code of conduct of accountant professionals and hence not just violating the trust of the users but being unethical to the accountant fraternity also because it is very much possible that in due course of time Marion’s actions would come out in the open and thus prove to be an embarrassment for the accountant fraternity and may affect their services adversely (Gay & Simnett, 2012).
There are various different methods to compute differentiation which essentially do not alter the total depreciation expense but alter the breakup of this depreciation expense over the economic life of the asset. As per the given case, the general manager Peter wants Marion to change the current depreciation method i.e. Straight line depreciation method and instead put sum-of-digits method into practice for two financial years i.e. FY2016 and FY2017. Under the straight line depreciation method, the depreciation expense charged in each year would be constant which is unlike the sum of digits method where higher depreciation charges are skewed at the beginning and thus at the end the depreciation charge become very less. It is imperative to note that even though depreciation expense is a non cash expense but still it is an integral component during the computation of net profit in the P & L statement in the financial statements of any entity. Since the net profit of the company is directly linked to the EPS which in turn determines the stock price, hence companies make attempt to ensure that any adverse abrupt movements in EPS should be avoided as this may impact the stock price negatively at least in the short term if not in the long term (Deegan, 2014).
Impact on Reporting and Credibility
In the given case, the general manager is also driven by the same motive i.e. to smoothen the income over the next four years since it is expected that while FY2016 and FY2017 would be favourable for the industry but FY2018 and FY2019 would not be favourable for the industry and thus the financial performance of Pringles may be adversely impacted in FY2018 and FY2019, thus reducing the stock price. Hence intent of Peter is to sacrifice some profits in the good years i.e. FY2016 and FY2017 so that the profits in the relatively years i.e. FY2018 and FY2019 also remain healthy and thus there is no major impact on the EPS. Peter intends to achieve this by charging high depreciation expense in the good years while charging low depreciation expense in the bad years.
As part of the above intent and strategy, he intends to change the depreciation method to sum of digits method as this would increase the depreciation expense in the year FY2016 and FY2017 which would have a moderating impact on the profitability and thus lower down the expectations for the shareholders in the coming years. However for the relatively bad years i.e. FY2018 and FY2019, the higher depreciation of the previous years under the sum of digits method would transform into a lower depreciation expense as compared to the straight line method of depreciation. As a result of this the profitability in FY2018 and FY2019 would get a small boost and hence continuity would be better maintained in the minds of the shareholders since the difference between the profits for FY2017 and FY2018 would reduce and thus would not be shocking for the investors (Deegan, 2014).
It is imperative that the entities while preparing financial statements must adhere to the various accounting standards framed by AASB (Australian Accounting Standards Board) with regards to the recognition, measurement and reporting of various items. The above understanding holds true for depreciation also which despite being a non cash expense has an impact on the accounting profit which is looked upon by plethora of stakeholders as pointed in part A. The relevant accounting standard for understanding the recognition, measurement and reporting of depreciation is AASB 116. As per AASB 116, there are various depreciation methods that may be deployed but the particular method of use under a given case would be determined by the pattern followed during the consumption of any future benefits that are expected from the given asset. Logically from the above statement, it may be also inferred that only when there is any change in the pattern followed during the consumption of any expected future benefits, can the underlying depreciation method currently in use be changed (AASB, 2010).
Additionally AASB 116 requires that the current depreciation method in use must be reviewed periodically i.e. at the close of every financial year and if this review reveals that there is change in consumption pattern of the future benefits associated with the asset, then the depreciation method would need to be changed and explanation to that effect would need to be provided in the relevant notes to account found in the financial statements (AASB, 2010). Therefore from the above discussion it may be concluded that actions of Marion are in gross violation of the AASB 116 as she intends to change the current depreciation method from straight line to sum of digits method even though no visible change has taken place in the pattern followed during the consumption of any future benefits that are expected from the given assets of Pringles
References
AASB 2010. AASB 116-Property, Plant & Equipment, Australian Accounting Standard Board, Available [Online] from: https://www.aasb.gov.au/admin/file/content102/c3/AASB116_07-04_ERDRjun10_07-09.pdf (Accessed on May 21, 2015)
Deegan, C.M. 2014. Financial Accounting Theory, 4th Edition, McGraw-Hill Education Australia, SydneyGay, G. & Simnett, R. 2012. Auditing and Assurance Services in Australia, 5th edn., McGraw-Hill Education, Sydney
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