Provisions and Contingencies in the Financial Statements
Dsicuss about the Conceptual Framework For Financial Reports.
The requirement for the business organizations is to make compliance with different kinds of principles and standards while performing the business operations. One of such area is accounting operations of the companies. It is the obligation on the Australian business entities to make compliance with the standards of Australian Accounting Standard Board (AASB), Australian Accounting Standards and other accounting regulatory body while conducting the accounting and financial reporting related transactions (Nobes 2014). The aim of this essay is to assess the financial statements of one of the Australian business entities, Farm Pride Foods Ltd, and then to address different kinds of financial issue in the company. Some of the major areas taken into consideration in this essay are provisions, contingences, measurement issues, lease accounting, description of non-current assets, qualitative characteristics, alternative valuation method and others.
As per the 2017 Annual Report of Farm Pride Foods Ltd, the company has two types of provisions; they are Current provisions and Non-current provisions. The main items under current provision are employee benefits, annual leave and long service leave. The major items under non-current provision are long service leave benefits and aggregate employee benefits ability. In the year 2017 and 2016, the company recognized additional provisions of $961,000 and $820,000 respectively. Provision used during the years is $790,000 and $699,000 for 2017 and 2016 respectively (farmpride.com.au 2018).
In the 2017 Annual Report, Farm Pride Foods Ltd has disclosed a contingent liability related to the allegation made by the Australian Competition and Consumer Commission (ACCC) on Farm Pride Foods Ltd for Egg Cartel Appeal. The full court of the Federal Court of Australia heard the appeal on 15th August 2016. This is the only case of contingency recorded by Farm Pride Foods Ltd in the annual report (farmpride.com.au 2018).
As per the 2017 Annual Report of Farm Pride Foods Ltd, the company recognizes their provisions when the company has a constructive or legal obligation due to any past event and this obligation makes it probable that there will be a future flow of economic benefits or cash outflow that can be reliably measured. The company uses the current pre-tax rate for discounting the provisions in case the time value of money is material. At the time of using the discounting method, the increase in provision as a result of passage of time is considered as a finance cost (farmpride.com.au 2018).
Measurement Issues and Lease Accounting
The 2017 annual report also states that Farm Pride Foods Ltd uses to disclose the contingencies of their business based on the net of the amount of Goods and Service Tax (GST) recoverable or payable to the taxation authority. The increase in contingent rental provisions is done with reference to the CPI or market (farmpride.com.au 2018).
In the 2017 Annual Report, Farm Pride Foods Ltd has disclosed a contingent liability related to the allegation made by the Australian Competition and Consumer Commission (ACCC) on Farm Pride Foods Ltd for Egg Cartel Appeal (farmpride.com.au 2018). There can be both against and for argument for the inclusion of this incident in the financial statement. For the inclusion of any incident as contingent liability, companies are needed to reasonably estimate the value of the contingent liability. However, it can be observed that Farm Pride Foods Ltd has not provided any value of this liability. Thus, it cannot be a contingent liability. On the other hand, a contingent liability is a potential liability that may occur depending on the outcome an uncertain future event. In this context, it needs to be mentioned that Farm Pride Foods Ltd will have to pay compensation or fine in case they cannot win the case in future. Thus, the outflow of future benefit is depending on an uncertain event. For this reason, this incident can well be included in the financial statement as a contingent liability (Bova 2016).
As per the 2017 Annual Report, Farm Pride Foods Ltd has two types of leases; they are operating leases and finance leases. Under operating leases, the major lease item of Farm Pride Foods Ltd is the property that is considered as the non-cancellable leases with lease terms varying from 1 to 11 years; and the rents of these leases are required to pay in advance. Under financial leases, the major lease items of Farm Pride Foods Ltd are various items related to plant and machinery. Under this lease, the lease term varies from 1 to more than 5 years. These are the major lease items reported by the company in the financial statements (farmpride.com.au 2018).
It needs to be mentioned that Farm Pride Foods Ltd follows certain rules for the classification and presentation of their leases. Farm Pride Foods Ltd has done the classification of lease in two categories; they are financial leases and operating leases; and the classification is done depending on the economic substance of the agreement for the reflection of risk and benefits of ownership (farmpride.com.au 2018). In case of finance leases, they are subjected to capitalization that includes a guaranteed residual value. Effective interest rate is used for deriving the interest expenses. Straight line method is used for the depreciation of the leased assets. In case of operating leases, Farm Pride Foods Ltd recognizes them as operating expenses on the straight line basis. The company considers the operating lease incentives as liabilities and they are subject to amortization on the straight line basis. It needs to be mentioned that Farm Pride Foods Ltd has presented their lease as expenses; and they have not recorded their leases in the statement of financial position according to the standards of AASB 117 Leases (Wong and Joshi 2015).
Description of Non-current Assets
From the above discussion, it can be seen Farm Pride Foods Ltd has both operating and financial leases; property is one of the major items under the operating leases. As per the hypothetical situation, Farm Pride Foods Ltd has started to establish a business facility on one of the properties they have leased under operating leases. As per the rules, lease term is regarded as the most crucial difference between operating leases and finance leases (Barone, Birt and Moya 2014). In financial leases, the lessee is allowed to use the asset for the maximum part of the economic life of the asset where for operating lease, the lessee is allowed to use the assets for smaller part of the economic life. Thus, it can be implies that the development of business facility on the property will require to use the asset for maximum part of the economic life of the property. For this reason, it is required for Farm Pride Foods Ltd to make the necessary reclassification of leased property to classify them under finance lease (Krische, Sanders and Smith 2013).
In the 2017 Annual Report, Farm Pride Foods Ltd has reported many three types of non-current assets; and one of them is Property, Plant and Equipment. As per the consolidated statement of financial position of Farm Pride Foods Ltd, the values of property, plant and equipment for the year 2017 and 2016 are $30,282,000 and $31,353,000 respectively. The company states property, plant and equipment at historical after deducting depreciation and any accumulated impairment losses (farmpride.com.au 2018). At the same time, the company recognizes the repair and maintenance expenses related to this non-current asset in the profit or loss in the value of the time of incurrence. Depreciation is charged on plant and equipment based on the straight-line method and land is not subjected to depreciation. This non-current asset is depreciated over their estimated useful lives starting from the time of their purchase or acquisition. Depreciation on leasehold improvements is done over the shorter or estimated useful lives of the improvements (farmpride.com.au 2018).
According to the AASB Conceptual Framework, financial statements need to posses the fundamental as well as enhancing qualitative characteristics. Relevance is one major fundamental qualitative characteristic of financial statement (aasb.gov.au 2018). Relevant financial information has the ability to make positive impact on the decision-making process of the users. From the above discussion, it has been stated that Farm Pride Foods Ltd uses historical cost method for the recognition and reporting of property, plant and equipment. In the presence of historical cost method, it is not always possible for satisfy the ‘relevance’ characteristic of financial statement as the considered historical cost of property, plant and equipment may not match with the current cost due to the change in the factors of price. For this reason, Farm Pride Foods Ltd should adopt the fair value method as an alternative approach for the valuation of property, plant and equipment in order to bring relevance in the financial reports (aasb.gov.au 2018).
Conclusion
The whole study indicates towards the fact that it is essential for the companies to make compliance with all the required accounting standards and regulations for effective financial reporting. As per the above discussion, Farm Pride Foods Ltd has both operating and finance leases; and in some areas, the company is required to reclassify some of the lease items. At the same time, the presence of both provisions and contingent liabilities can be seen in the financial statements. Moreover, Farm Pride Foods Ltd is required to consider alternative valuation approach for property, plant and machinery like fair value accounting.
References
Aasb.gov.au. (2018). Conceptual Framework for Financial Reporting. [online] Available at: https://www.aasb.gov.au/admin/file/content105/c9/ACCED264_06-15.pdf [Accessed 11 May 2018].
Barone, E., Birt, J. and Moya, S., 2014. Lease accounting: a review of recent literature. Accounting in Europe, 11(1), pp.35-54.
Bova, M.E., 2016. The Fiscal Costs of Contingent Liabilities. International Monetary Fund.
Farmpride.com.au. (2018). Annual Report 2017. [online] Available at: https://www.farmpride.com.au/wp-content/uploads/2017/09/2017-Farm-Pride-Foods-Ltd-Annual-Report.pdf [Accessed 11 May 2018].
Krische, S.D., Sanders, P.R. and Smith, S.D., 2013. Management credibility and investment risk: An experimental investigation of lease accounting alternatives. Behavioral Research in Accounting, 26(1), pp.109-130.
Nobes, C., 2014. International Classification of Financial Reporting 3e. Routledge.
Wong, K. and Joshi, M., 2015. The impact of lease capitalisation on financial statements and key ratios: Evidence from Australia. Australasian Accounting Business & Finance Journal, 9(3), p.27.
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