Effects Of Accounting Policy Choices On Financial Results And Reporting Requirements

Explaining How Accounting Policy Choices Affect Financial Results

1.Accounting policies are considered as the particular principles, bases, practices, conventions and rules that are used by the organization in preparation and presentation of their organization. The accounting policies are crucial for providing the information of financial statements in more reliable and transparent way. It is the extension of the accounting regulation in form of laws, by-laws, standards, guidance and interpretation. The information included in the financial report must be presented in such a way that it shall be free from misrepresentation and inconsistency (Bohusova and Nerudova 2015).

The choice of accounting policies and selection and application of those policies in accordance with the IFRS (International Financial Reporting Standards) has significant effect on the computation of the assets, capital, liabilities and the incomes and expenses which in turn impacts the financial position of the organization such as the income statement and balance sheet. In this globalized world, it is crucial to have good idea of IFRS as compared to the other requirement of management for the organization. Among the various policies on accounting, the choice if a particular policy has an impact on the valuation of the items in the financial statements. However, the various accounting policies make it complicated to assess the financial situation and performance realistically for some of the organizations. It is obvious that the different solutions of accounting for provisions, amortizations and revaluations, it will give different outcomes for the same accounting head. The International Accounting Standards and the accounting policies and any alterations in the accounting projections and errors particularly handle the alterations in the policies in accounting (Ifrs.org 2017).

Therefore, different accounting policies chosen by the organization have significant effects on their accounting estimates presented in the financial statements. The accounting policies chosen for the balance sheet and the income statements have both direct and indirect effect on computation of the major ratios for analysing the performance of the organization. However, the chosen accounting policies based on which the financial statement of the organization are prepared must be disclosed through the notes on account to give the clear and transparent view of the financial statement to the users like shareholders, creditors, customers and the potential investors. Further, the users of the financial report must analyse the information contained in the statement of the organization from various former aspects. In the table below it is shown how the accounting policy selection alters and influences the financial performance and position of the various major users of the financial reports like governments, stakeholders and management of the organization (Peters 2016).

ASIC’s Focus on Material Disclosures of Decision-Useful Information

2.ASIC called for providing the information related to the financial statements that are used for preparation of the reports. Particularly, the organizations shall adopt the realistic valuations and suitable accounting policies to provide more efficient communication regarding that information.  As part of the ASIC’s Financial Reporting Surveillance Program, they selected the financial reports for the purpose of review both on the risk-based criteria and random to analyse the compliance with the Accounting standards and Corporation Act (Asic.gov.au 2017). The auditors and the directors shall consider how the selection of accounting policies can impact the reported results under the financial reports. These take into consideration the treatment of revenue recognition, off-balance sheet arrangement and the cost expenses that shall not be involved in the value of the assets, rebates, inventory pricing and accounting for tax. The surveillance of the ASIC will continue focussing on the material disclosures for the information that are crucial for the projection of accounting estimates, impact of the newly applied reporting requirements and selection of significant accounting policy (EY. com 2017). The areas to be focussed on that are required to be consistent with previous periods are mentioned below:

• Revenue recognition
• Impact on standards of revenue and the financial instruments
• Expenses deferral
• Tax accounting
• Arrangements of the off-balance sheet items
• Judgements of estimates and accounting policies
• Valuation of assets and testing for impairment.

3.As per the latest requirement of ASIC for improving the reporting of the financial statements, some areas have been selected that are regarded as concern area for past few years. The concern area includes the policies regarding the revenue recognition and the CPA from Australia is in the view that there shall be an appropriate policy for recognition of revenue for reflecting the substances related to the underlying transaction. The organizations who complies with the IFRS while preparing their financial statement, their auditors shall take into consideration the impact of the newly applicable IFRS 15 – Revenue from contracts with the customers and make the appropriate disclosures under the standard’s requirement. IFRS 15 – Revenue from contracts with customers was issued during May 2014 by International Accounting Standard Board (IASB) and the standard was applicable from the accounting period starting on or after 1^st January 2017 and from CPA library the copy for the same can be obtained. The AASB 118 – Revenue is applicable from the accounting period starting on or after 1^st January 2005. ASIC will continue behaving sensitively for the choices of policies at the time of recognition of revenue as suitable application takes into account the revenue recognition timing and reveals the substances for underlying transaction and these are important for applying the suitable policies for revenue recognition (Picker et al. 2016).

Importance of Appropriate Revenue Recognition Policy According to CPA Australia

Moreover, the review of the directors and auditors includes assuring that the revenue are recognized using proper accounting policies and as per the substance of underlying substances. It ensures the below mentioned things:

• Assets are differentiated properly into the financial assets category and non-financial asset category (Sedki, Smith and Strickland 2014)
• The control of the goods that are sold has passed on to the buyer
• When the revenue are taken into consideration with respect to both providing the services and selling of goods then revenue is appropriately allocated to the substances and then recognized accordingly.
• Recognition of revenue are properly made in the financial reports based on the instrument class method
• Services with regard to the revenues are performed accordingly

Taking into consideration all the above discussion, it can be said that the CPA Australia are in the view that the appropriate accounting policy for recognition of revenue demands the “appropriate application” for “timing of negotiation” to reveal the substance for underlying transactions (apesb.org.au 2017).

4.Aim of IFRS 15 / AASB 15 – Revenue from contracts with customers is to specify that the companies at the time of preparing their financial statement must apply the information related to nature, amount, timing, forecasting of revenue and uncertainties related to the cash flows. Requirement of cost for performing the activities relate to the contracts are recognised only after the criteria that are mention below are accomplished:

• Cost improves or helps to generate the organisational resources that will be used by the company for fulfilling the future period’s performance obligation
• Cost that are incurred relate directly to the contract or specific foreseen contract
• Costs that are incurred are expected to be recovered

The costs that are mention above are the costs associated with overheads, direct material and direct labour that are relevant to the contracts. Further, costs must be identified for the consideration that are received or are receivable after giving effects of the trade discounts and volume rebates that may be offered by the company (IASB 2015). However, the revenues are taken into account only after the following conditions are accomplished:

• The organization has passed on the relevant risk and rewards to the buyer related to the possession of the goods
• Cost incurred or to be incurred with the relevant transactions can be computed reliably
• The company does not retain the ownership and control related to the goods that has been sold (Wagenhofer 2014).
• The amount realised or to be realised from the sale of the goods can be computed reliably.
• There is a possibility that the economic benefits linked with the associated transaction will gained by the company.

Considering the above factors it can be said that the criteria for recognition of revenue under IFRS 15 / AASB 15 – Revenue from contracts with customers and IAS 18 /AASB 118 – Revenue are in compliance with the requirements of ASIC and CPA for ‘appropriate application’ for the ‘timing of recognition’ for recognition of revenue and thus are complied with the substance for underlying transactions (AASB 2014).

5.Name of the selected company is “RIO TINTO”

The financial statement of the company is prepared as per the IFRS and the regulations of the AASB and IASB. The revenue of the company for the year 2014, 2015 and 2016 in the financial statements are recognised as follows:

Year 2014 – revenue from sales are comprised of the sales made to the third parties. All the costs related to handling and shipping of the goods is accounted as operating cost. The billing amounts for the customers for handling and shipping are segregated as the sales revenue only when the company is responsible for payment of freight. Revenue from sales does not take into account the applicable taxes on sales. Royalties payable on mining are accounted as operating cost and if they form part of profit-based-tax then it is included as part of taxation. Revenue received from the sale of considerable by-products like gold is accounted under the sales revenue. However, the sundry revenue associated with the the main activities of generation of revenue is credited to the operating cost. Swap arrangement of third party commodity for receipt and delivery of smelter grade alumina are adjusted within the operating cost. Further, sales from the copper concentrate are accounted at the invoiced amount that is the net of refining and treatment charges (RioTinto Online 2017). The revenue from sales are recognised only after accomplishment of the following criteria:

• The organization has passed on the relevant risk and rewards to the buyer related to the possession of the goods
• Cost incurred or to be incurred with the relevant transactions can be computed reliably
• The company does not retain the ownership and control related to the goods that has been sold
• The amount realised or to be realised from the sale of the goods can be computed reliably.
• There is a possibility that the economic benefits linked with the associated transaction will gained by the company.

Analysis of AASB 118 and AASB 15 Revenue Recognition Criteria

Year 2015 – revenue from sales are comprised of the sales made to the third parties. All the costs related to handling and shipping of the goods is accounted as operating cost. The billing amounts for the customers for handling and shipping are segregated as the sales revenue only when the company is responsible for payment of freight. Revenue from sales does not take into account the applicable taxes on sales. Royalties payable on mining are accounted as operating cost and if they form part of profit-based-tax then it is included as part of taxation. Revenue received from the sale of considerable by-products like gold is accounted under the sales revenue. However, the sundry revenue associated with the the main activities of generation of revenue is credited to the operating cost. Swap arrangement of third party commodity for receipt and delivery of smelter grade alumina are adjusted within the operating cost. Further, sales from the copper concentrate are accounted at the invoiced amount that is the net of refining and treatment charges. The revenue from sales are recognised only after accomplishment of the following criteria:

• The organization has passed on the relevant risk and rewards to the buyer related to the possession of the goods
• Cost incurred or to be incurred with the relevant transactions can be computed reliably
• The company does not retain the ownership and control related to the goods that has been sold
• The amount realised or to be realised from the sale of the goods can be computed reliably.
• There is a possibility that the economic benefits linked with the associated transaction will gained by the company.

Year 2016 – Revenue from sales are comprised of the sales made to the third parties. All the costs related to handling and shipping of the goods is accounted as operating cost. The billing amounts for the customers for handling and shipping are segregated as the sales revenue only when the company is responsible for payment of freight. Revenue from sales does not take into account the applicable taxes on sales. Royalties payable on mining are accounted as operating cost and if they form part of profit-based-tax then it is included as part of taxation. Revenue received from the sale of considerable by-products like gold is accounted under the sales revenue. However, the sundry revenue associated with the the main activities of generation of revenue is credited to the operating cost. Swap arrangement of third party commodity for receipt and delivery of smelter grade alumina are adjusted within the operating cost. Further, sales from the copper concentrate are accounted at the invoiced amount that is the net of refining and treatment charges. The revenue from sales is recognised only after accomplishment of the following criteria:

• The organization has passed on the relevant risk and rewards to the buyer related to the possession of the goods
• Cost incurred or to be incurred with the relevant transactions can be computed reliably
• The company does not retain the ownership and control related to the goods that has been sold
• The amount realised or to be realised from the sale of the goods can be computed reliably.
• There is a possibility that the economic benefits linked with the associated transaction will gained by the company.

From the evaluation of the annual reports of Woolworths for the year 2016, 2015 and 2014, it is identified that the recognition method for sales revenue of the company are same for all the three years and there is no alteration or significant inclusion or exclusion in the policies of revenue recognition.

Review of a Company’s Financial Reports and Accounting Policies

6.Considering the IAS 18 / AASB 118 – Revenue and IFRS 15 / AASB 15 on revenue from contracts with customers, choices regarding the accounting policies are as follows:

Normative accounting theory – this theory seeks to recommend the bases regarding the measurement, accounting, contents of financial statement and specific accounting processes. It does not take into account the present scenario of the organization, instead it suggests what the people shall do and in what way. Thus, the normative theory is not completely analysed through the forecasted value rather it is analysed through logical consistency. Therefore, this theory tries to explain which information regarding the financial statements is to be collected, communicated and analysed (Deegan 2013).

Positive accounting theory – this theory aims to predict the actions, for example, which accounting policies shall be selected and in what way the newly proposed standards of accounting will impact the organization. Further, it aims to explain and predict the following:

• Activities need to be performed in association with the selection of the accounting policies
• How the company will be affected in complying the newly applied standards on accounting

The main objective of positive accounting theory is to get clear understanding and projection of selected accounting policies with regard to various companies. It recognises the impacts on the economies and is in the view that the impact on the economies actually exist. As per this theory, the companies are willing to increase their existence in the industry to efficiently operate their business (Christensen, Nikolaev and Wittenberg?Moerman 2016).

Statement of accounting policy – Accounting policies are crucial for understanding the information from the financial reports in a better way. An organization shall clearly state the policies it used while preparing their financial reports. It is further crucial to disclose the accounting policies that it used as different accounting policy gives different outcomes for the same account head. If the accounting policies used in the financial statements are not disclosed properly then it will not be possible to compare the financial performances of the organization with other organizations (Collison et al. 2016).  

Therefore, while choosing the accounting policy, the organization must take into consideration the following factors:

• Prudence
• Materiality
• Substance over form
• Fairness
• Objectivity

Considering the above all policies, it is concluded that it will be appropriate for the company to opt the Statement of accounting policy for IFRS 15/AASB 15 – Revenue from contracts with customers and IAS 18/AASB 118 – Revenue as it enables the company to take into consideration various crucial things like materiality, prudence and objectivity. However, whatever policy is chosen by the organization it must be disclosed properly in the notes to accounts (Savage, Douglas and Barra 2013).

References 

AASB, C.A.S., 2014. Financial Instruments. Project Summary.

Asic.gov.au. (2017). ASIC Home | ASIC – Australian Securities and Investments Commission. [online] Available at: https://www.asic.gov.au/ [Accessed 23 May 2017].

Bohusova, H. and Nerudova, D., 2015. US GAAP and IFRS convergence in the area of revenue recognition. Economics and Management, (14), pp.12-19.

Christensen, H.B., Nikolaev, V.V. and Wittenberg?Moerman, R., 2016. Accounting information in financial contracting: The incomplete contract theory perspective. Journal of Accounting Research, 54(2), pp.397-435.

Collison, D., Jansson, A., Larsson-Olaison, U., Power, D.M., Cooper, C., Gray, R., Ferguson, J., Sikka, P., Unerman, J., Yuval Millo, Y. and Jonnergård, K., 2016. The Modern Corporation Statement on Accounting.

Deegan, C., 2013. Financial accounting theory. McGraw-Hill Education Australia.

https://www.apesb.org.au. (2017). APES 110 Code of Ethics for Professional Accountants. [online] Available at: https://www.apesb.org.au/uploads/standards/apesb_standards/standard1.pdf [Accessed 23 May 2017].

https://www.ey.com. (2017). The new revenue standard affects more than just revenue. [online] Available at: https://www.ey.com/Publication/vwLUAssets/EY-applying-ifrs-the-new-revenue-standard-affects-more-than-just-revenue/$FILE/EY-applying-ifrs-the-new-revenue-standard-affects-more-than-just-revenue.pdf [Accessed 23 May 2017].

IASB, F., 2015. Revenue from Contracts with Customers. Exposure Draft.

Ifrs.org. (2017). IFRS – Home. [online] Available at: https://www.ifrs.org/Pages/default.aspx [Accessed 23 May 2017].

Peters, M., 2016. The new IFRS 15 standard: implementation challenges for Belgian companies.

Picker, R., Clark, K., Dunn, J., Kolitz, D., Livne, G., Loftus, J. and van der Tas, L., 2016. Applying international financial reporting standards. John Wiley & Sons.

RioTinto Online. (2017). https://www.riotinto.com/. [online] Available at: https://www.riotinto.com/ [Accessed 24 May 2017].

Savage, A., Douglas, C., and Barra, R. (2013). Accounting for the Public Interest: A Revenue Recognition Dilemma. Issues in Accounting Education, Vol. 28, No. 3, pp. 691-703.

Sedki, S.S., Smith, A. and Strickland, A., 2014. Differences and similarities between IFRS and GAAP on inventory, revenue recognition and consolidated financial statements. Journal of Accounting and Finance, 14(2), p.120.

Wagenhofer, A., 2014. The role of revenue recognition in performance reporting. Accounting and Business Research, 44(4), pp.349-379.

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