The Expense and Criteria of an Asset Disclosed in the Financial Statements of the Company - Assignment Example

Company Accounting Company Accounting Question: Requirement For the calculation of income tax liability the accounting profit is to be adjusted for the carrying amount of the equipment and the tax exempted revenue. Thus the amount of accounting profit for the year 30 June 2011 becomes: Accounting Profit $ 18,500 Carrying amount of equipment sold $ 18,000 Royalty Revenue (exempt from tax) $ (5,000) Rent Revenue $ (16,000) ------------ Tax - Adjusted Accounting Profit $ 15,500 The tax rate is 30%. The amount of the income tax for the year 30 June 2011 thus becomes: Income tax liability = 30% * $15,500 = $4,650 Requirement 2: Journal Entry: The journal entry for recording the income tax liability in the financial statements of the company is: Dr. Income tax Expense (Statement of Financial Performance) $ 4,650 Cr. Income tax Liability (Statement of Financial Position) $ 4,650 Requirement 3: Treatment: Doubtful Debts Expense: Doubtful debts represent that balance of amount which will not be recoverable out of the total trade receivables of the company. This is considered to be a trade expense thus is accounted for in the income statement of the company. Rent Revenue: Rent revenue is defined as an income generated by the company through renting out any of its assets. It can include machinery, equipment or property. All kinds of income generated by the company are included in the profit and loss account of the company. But for tax purposes it is taxable under savings income heading so it will be deducted from the profit of the company and taxable separately as the savings income has a different tax rate. Entertainment Expense: Entertainment expense comprises of the expense incurred during the process of entertaining the clientele of the company. As the entertainment expenses incurred on the employees is not an allowable expense for tax purposes, it is assumed that this expense relates to the one incurred on the clientele unless otherwise stated. Thus it will also be included in the profit and loss account of the company for tax purposes as a deductible. Requirement 4: Calculation of Deferred Tax Asset and Liability: Calculation of tax base values of assets: MOTOR VEHICLE: Book Value ($) Tax Base ($) Motor Vehicle (Cost) 18,000 18,000 Motor Vehicle (Acc. Depreciation) (15.750) (18,000) ------------------- ---------------- 2,250 Nil Thus Deferred Tax Liability = 2,250 * 30% = $675 EQUIPMENT: Book Value ($) Tax Base ($) Equipment (Cost) 100,000 100,000 Equipment (Accumulated Depreciation) (60,000) (45,000) ------------------- ----------------- 40,000 55,000 Deferred Tax Asset = ($55,000-$40,000) * 30% = $ 4,500 RECEIVABLES: Tax Base = $12,000 Thus deferred tax liability = 12,000 * 30%= $3,600 RENT RECEIVBALE: Tax Base = $2,800 Thus deferred tax liability = 2,800 * 30% = $840 Total Deferred Tax Liability = $675+$3,600+$840 = $ 5,115 Thus the new deferred tax asset and liability becomes $4,500 and $5,115 respectively. Requirement 4: Journal Entries: Deferred Tax Asset: Dr. Tax Expense (Statement of financial performance) $ 1,950 Cr. Deferred Tax Asset (Balance sheet) $ 1,950 Deferred Tax Liability: Dr. Tax Expense (Statement of financial performance) $ 2,370 Cr. Deferred Tax Liability (Balance sheet) $ 2,370 Question 2: REPORT Executive Summary This report is designed for the purpose of reflecting on the new accounting policy change that is being implemented by the company which requires the company to disclose its advertisement expense as an asset as opposed to be treated as an expense as it incurs. In this report it was observed and suggested that the criteria for the policy change implemented by the company met the recognition criteria of an asset as set by the AASB (Australian Accounting Standard Board), and was of material balance to be disclosed in the financial statements of the company. Introduction: The purpose of this report is to determine if the new policy of the company to record its advertisement expenses as an asset is true and fair according to Australian Accounting Standard Board. For that purpose, it will be determined if the expense meets the criteria of an asset according to the definition provided by the board. Definition of an Asset: According to the Australian accounting standard board (AASB) Statement of accounting concepts SAC 4, assets have been defined as the future economic benefits that are controlled by the entity as a result of any past transactions or any other past events. The advertisement expenses that the company is categorizing as an asset have not been incurred yet, they are expected to incur so that revenue can be generated in the future. For further analysis of this change in the accountancy policy it will be determined if the criteria for recognition of an asset is met by the expenses. Recognition Criteria: According to SAC 4, the criterion that has to be met for the recognition of an asset includes: The probability that the economic benefits relating to that expenses will flow into the entity, Now if the nature and implications of the advertisement expense is analyzed, it can be seen that the company expects these advertisement expenses to generate future income for the company. The company expects that the future sales of its new product “Lite Lager” will help the company recover the loss in its profitability. And the advertisement of that product will be playing a vital role in achieving the sales level that the company is targeting. The cost of the asset can be measured reliably. The cost of the advertisement expenses has been reliably measured by the company to be $23 million. This cost has been charged against the profits of the year ended 30 June 2010, and currently they are categorized under “deferred expenditure” in the balance sheet. So far the advertisement expenses are compliant with both the probability criteria and the reliability criteria defined by the AASB. Change in the Accounting Policy: In the eyes of many researchers the distinction between the control and the ownership of the company plays a vital role in determining the accounting policy changes that are implemented in a company. It has been observed that the managers of a company try to implement the policy changes that they see fit as they exercise control over the management of the company and the changes implemented by them might not be acceptable or may be confusing to the shareholders of the company (Smith, 1976). Some researchers argue that the changes in the accounting policies are there to benefit the managers. As through those changes they can attain any level of profitability in a given period and thus derive advantage from the incentives policy of the company on the basis of the represented financial performance of the company (Moses, 1987). Now if the company’s policy change is analyzed in accordance to the point of views of these researchers, the main flaw that can be seen is that all the expense has been charged against the profits of June 2010. The shareholders might argue that if all the expense will be charged at once, how will the future benefits be matched against their relative costs that were incurred in order to generate those revenues? As, to the shareholders may be, because of this accounting treatment the managers are trying to make the future profits smoother as compared to the profits of 30 June 2010, thus enabling the managers to extract incentives for themselves. This might lead to some kind of tension between the shareholders and the managers of the company. In response to that the managers can argue that the steps taken by them were the result to the response they saw fit to the current economic changes nation wide. As the steps taken by them are to ensure higher sales revenue for their new product “Lite Lager”, so that higher profitability can be generated which will eventually benefit the shareholders of the company. As in the present, the managers view the corporate reporting regulations as a social system. And according to this approach a reporting regulation is designed by examining the system’s norms, and the policies thus made are to reflect the interdependencies of the system with the internal and external social and economical factors. The factors that are responded to are the ones that are considered to be the most sensitive to the organization and those which are influenced by the culture around the organization (Harrison, McKinnon, 1986). Thus the whole policy change can lead to some tension among the shareholders of the company and the management board of the company. Materiality: According to AASB1031, information is deemed material if its omission, misstatement or non-disclosure can adversely affect the decisions of the users of the financial statements in regards to their allocation of resources, and can also affect the discharge of accountability on part of the management of the company or any other governing body of the company. A material item must be reported according to the rules and regulations defined by the AASB, which state that the items relating to the profit and loss account are to be compared with the appropriate operating profit or loss and the income or expense amounts of the company for the current or number of years which ever seems fit. To judge the materiality of the advertisement expense of the company for the year ended 30 June 2010, the expense amount will be compared to the profit for the year 30 June 2010. The advertisement expense is approximately ten times the profit earned by the company that year. The threshold for determining the materiality of a transaction or balance defined by the AASB1031 is at least 10%. This would thus unarguably conclude that the balance was to be disclosed as of material nature. Conclusion: Thus it has been concluded that the expense meets the criteria of an asset defined by the AASB in SAC4, and the balance was of material nature thus has to be disclosed in the financial statements of the company. Bibliography AASB, Statement of Accounting Concepts SAC4 1995, Definition and Recognition of the Elements of Financial Statements, Available at: Accessed at: [10-Jan-2012] Smith, D.E. 1976, The Effect of the Separation of Ownership from Control on Accounting Policy Decisions, The Accounting Review, Vol. 51, No. 4, pp. 707-723, (article consists of 17 pages), Published by: American Accounting Association, Stable URL: http://www.jstor.org/stable/246120 Moses, D.O. 1987, Income Smoothing and Incentives: Empirical Tests Using Accounting Changes, The Accounting Review, Vol. 62, No. 2, pp. 358-377, (article consists of 20 pages), Published by: American Accounting Association, Stable URL: http://www.jstor.org/stable/247931 Harrison, G.L. ,McKinnon, J.L. 1986, Culture and accounting change: A new perspective on corporate reporting regulation and accounting policy formulation, Accounting, Organizations and Society, Volume 11, Issue 3, Pages 233-252, ISSN 0361-3682, 10.1016/0361-3682(86)90023-1. (http://www.sciencedirect.com/science/article/pii/0361368286900231) AASB 1031, Materiality, Available at: < http://www.aasb.gov.au/admin/file/content102/c3/AASB1031_9-95.pdf> Accessed at: [10-Jan-2012] Read More