Financial Reporting for Harris Ltd - Coursework Example

Financial reporting case study Task Introduction The paper focusses on various questions based on a case study of Harris Ltd. The company faces issues about compliance with different accounting policies. The following are the three matters the company faces: first, the impairment review of intangible assets (research centers). Second, the first court case and last, the second court case. The paper presents the three issues, in a report format, to the finance director describing the appropriate accounting treatment in the financial statement for the year ended 31 December 2014. The role of accounting and reporting standards In light of the varying accounting practices in different countries, the International Finance and Reporting Standards has established guiding principles to facilitate the convergence of the international accounting practices and to improve the quality of the information presented to different users. In the attempt to achieve the convergence in accounting practices, the IFRS has established the following principles: information relevance, information reliability (faithful presentation, neutrality, complete and free from material error and prudence), comparability (consistency and disclosure of accounting policies), understandability and materiality. In addition, the IFRS has also provided a standard definition and guides in recognition of various elements of the financial statements such as revenue recognition, definition of different assets and liabilities (ZüLch & Hendler 2011, pp. 12-18). The reasons why it is necessary to create the financial statements In response to the needs and requirements of various bodies such as the FASB and the IFRS, and different stakeholders in the government and their agencies, customers, the investors, the employees, lenders, suppliers and other trade creditors and the public, it is necessary to create financial statements. The needs of the mentioned stakeholders are as follows: the investors, who provide capital to a company are concerned about the levels of risk and return on their investments. They need financial information to help them decide whether they should buy or sell shares of a particular company. They also need the information that enables them to assess the ability of the business to pay the cash dividend. The second category of people is employees. Employees need to know whether their employer is financially stable. They use this data to evaluate the employer’s ability to implement a fair remuneration package, provide retirement benefits and be able to offer employment chances (Saudagaran, 2009, pp. 150-155). Lenders use financial information to access the ability of a company promptly to pay both the principal and interest on loans. Suppliers and other trade creditors need the financial data to enable them to determine whether their receivables will be paid without default. Customers are interested in financial information to determine the life span of an enterprise, especially when they have a long-term association with a company such as the presenting solutions to both short and long-term problems. Government and their agencies use the financial information to regulate the activities of an organization and to determine tax policies. They also use the information to compute national income. Lastly, the public use financial information to determine the trends and recent development activities of an enterprise to help them assess the possibility of a significant economic contribution to an organization (Saudagaran, 2009, pp. 150-155). The benefits of preparing the financial statements The following are the advantages of making the financial statement: first, the users of the financial statements such as the investors benefit by obtaining valuable information about an organization that facilitates informed decision-making. That is whether to buy or sell stocks of a company. Second, companies benefit by attracting new investors, lenders, and employees. The financial statements provide information used in assessing an organization’s financial condition. Third, the preparation of such statements is in compliance with the requirements of the government and their agencies, thus eliminates the legal consequences of violating such regulations. Lastly, by preparing such information, an organization creates a healthy association with the stakeholders, which creates a goodwill for that particular organization (Saudagaran, 2009, pp. 150-155). The accounting principles The following are some of the accounting principles that forms the backbone of the accounting practices regarding the preparation of the financial statements: Accrual concept, conservatism concept, consistency concept, Economic entity concept, cost concept, full disclosure concept, going concern concept, matching theory, going concern principle and revenue recognition policy. The notion of the accrual principle requires the recording of the accounting transactions to be on the period of their occurrence. In addition, the policy requires that the financial statement present the transactions that occurred during the period of its preparation rather than delaying or accelerating the recognition of the related cash flows. The conservatism principle encourages the acceleration of recognizing expenses and liabilities but advises against doing the same for revenues (Basic Accounting Principles 2015, par. 1-13). The consistency principle implies that firms maintain the implementation of the current policy until such a time that a better policy is formulated. The concept discourages the tendency of continual change in the accounting principle. The cost principle states that the initial cost should be the basis of valuing assets, equity investments and liabilities. The economic entity principle states that the accounting transactions of a firm should be separated from the owner’s or affiliates’. The implementation of the policy was to prevent mixing of such information. The full disclosure principle encourages the provision of all the information that might influence the users’ comprehension of the financial statement. The going concern principle implies that the operation of a company is to continue to the predictable future period. Thus, expenses such as depreciation should be deferred (should not be recognized in their year of occurrence, but at a later date. The matching principle implies that firms should simultaneously record their revenues and the relevant expenses. Last, the revenue recognition principle states that organizations should recognize revenues whose income processes are complete. The policy discourages the premature recognition of revenue (Basic Accounting Principles 2015, par. 1-13). The impairment review at Harris Ltd The company made efforts to review the value of its research centers. The board is indifferent between selling and changing the focus of the center’s investment. The 31 December 2014 drafted financial statement shows that the carrying amount of the research center is £ 700,000. The estimated value in use is £ 550,000 based on discounted forecast net cash flows for the next five years. The company found a buyer who was willing to offer £ 625,000. The disposal and the legal costs associated with the sale would be £ 15,000. According to IAS 36 and FRS 11 the intangible assets are tested for impairment when changes in the circumstances point that the recoverability of the carrying amount is not possible. Both the IAS and FRS states when the impairment exists, the asset’s carrying amount is written down to the amount recoverable (which is the higher value between the value in use and the fair value less selling costs) (UK GAAP vs IFRS 2011, pp. 28). Based on the information, if Harris Ltd decides to change the focus of the research centre (no selling), the following will be the accounting transactions: the new value of the asset will be (fair value – disposal cost) = (625,000 – 15,000) = £ 610,000 (£ 610,000 is higher than £ 550,000). The impairment loss = (£ 700,000 – 610,000) = £ 90,000. The loss is recorded in the profit and loss account as an expense. On the other hand, when Harris Ltd decides to dispose of the asset, the fair value will be the basis of the transaction. After the disposal, the following entries will be made: Debit Credit £ £ Intangible asset 700,000 Disposal of asset 610,000 Impairment loss 90,000 Disposal cost 15,000 Total 700,000 700,000 Similar to the above case, the impairment loss will be recorded in the profit and loss account under expenses (UK GAAP vs. IFRS 2011, pp. 28). The court case 1 The draft financial statement does not contain the expenses that would arise from the tribunal case. In the year 2014, the company’s management made an estimate that the company had 30% of losing the case. On 1 February 2015, Harris Ltd lost the case was to pay a damage fee and legal cost worth £ 60,000 and £ 15,000 respectively. However, the financial controller made no record to the financial statement arguing that the judgment was made in the following fiscal period. Both the regulations provided by the IFRS state that the recognition of the contingent assets and liabilities is not advisable. Such liabilities and assets should only be recognized. However, the recognition is possible when the obligations are probable (UK GAAP vs. IFRS 2011, pp. 30). Concerning Harris Ltd, the management estimated a 30% probability of losing the case. Therefore, the recognition of the contingent liability is appropriate, but only a portion of it 30%* (60,000 + 15,000) = £ 22,500. Consequently, the company should include the £ 22,500 as a contingent liability in its drafted financial statement (UK GAAP vs. IFRS 2011, pp. 30). Court case 2 The company is to pay £ 140,000. The following additional information is available: Estimated probability of losing and paying £ 140,000 10% Estimated probability of losing and paying £ 70,000 70% Total 80% Estimate probability of winning and paying nothing 20% Based on the provision by both FRS 12 and IAS 37, the most probable estimate is 70%. The 10% and 20% are remote. Therefore, Harris Ltd should include contingent liability worth (70%*70,000) = £ 49,000 in the 31 December drafted financial statement. Government grant According to the IFRS, government grant should not be recognized as revenues until there is certainty that the company will adhere to the conditions associated with the grant (UK GAAP Vs IFRS 2011, pp. 18). Concerning Harris Ltd, the condition was to exhaust the grant over a two-year period from the date of receipt. However, the company recognized the full grant as revenue in the financial statement ending 31 December 2014. Based on the IFRS and the terms of the grant, Harris has not met the conditions of the grant. That is; one year from the grant receiving date will be on 28 February 2015. If the company used half of the grant for the respective purpose, half of the grant would be recognized as revenue in the 2015 financial statement. Otherwise, the whole amount should be recognized as income on 31 December 2016. Therefore, the recognition of the full grant as income on 31 December 2014 amounts to a misrepresentation (UK GAAP vs. IFRS 2011, pp. 18). Conclusion Harris Ltd should consider changing the investment focus of the research center rather than disposing it to maintain the ownership and restore the company’s asset base. Based on the revenue recognition principle and the terms of the grant, the company should not recognize the grant as revenue until either half or the whole project is complete. Concerning the court cases, the company should comply with the probable contingent liability guideline provided by both FRS 12 and IAS 37 and include £ 22,500 and £ 49,000 as contingent liabilities, for case 1 and 2 respectively, in the draft financial statement as at 31 December 2014 List of References Basic Accounting Principles 2015, Viewed 26 February 2015, http://www.accountingtools.com/basic-accounting-principles Saudagaran, S. M. (2009). International accounting: a user perspective. Chicago, IL, CCH. UK GAAP vs. IFRS 2011, Viewed 4 March 2015, http://www.ey.com/Publication/vwLUAssets/UK_GAAP_v_IFRS_-_The_basics_-_Spring_2011/$FILE/EY_UK_GAAP_vs_IFRS_-_The%20basics_-_Spring_2011%20.pdf ZüLch, H., & Hendler, M. 2011, International financial reporting standards (IFRS) 2011: Deutsch-Englische Textausgabe der von der EU gebilligten Standards und Interpretationen = English & German edition of the official standards and interpretations approved by the EU. Weinheim, Wiley-VCH Verlag GmbH & Co. KGaA. Read More