Allocation of Transaction Price - Revenue from Alteration of Customer Contract - Assignment Example

12, June 2012 HONEST & BLONDE (HB), International accounting firm, 2nd Floor Honest and blonde building, 50 Austin Street, Australia. Board of directors, TeleFones4U Company, 5nd Floor TeleFones4U, 101 Queens’ Street, Australia. Send via mail: Telefones4u@cellphone.org Dear esteemed client, REF: Allocation of transaction price: Revenue from alteration of customer contract. We hereby bring into notice our respond to the IASB exposure draft due to major changes made from the previous contract with the customer. The response is made according to the exposure draft: A revision draft ED/2010/6 that deals with revenue from customer contract. TeleFones4u has shown continuous support in adherence and upholding Financial Accounting Standard Board regulation on financial reporting. The company has shown its efforts in simplification and convergence of international revenue accounting and their constant response to various issues rose from our previous comment letters regarding exposure draft. It is to our expectation that company steps in adopting the changes we propose will reduce or eliminate unnecessary and costly changes from the current accounting requirements of the company. Our team of expert strongly support changes made in the consumer contract according to the exposure draft. These changes on customer contract include: Having 60% of the cost as initial payment if the phone was sold separately unlike the previous strategy which was treated as part of contract with the first month’s payment for the contract. Monthly payment of $60 per month for 24 months that allow customer to get accessed to various privileges or services which includes unlimited text message service, unlimited calls service and customer to be given 2GB of data bundles every month. The adoption of above changes will see the company be a notch higher in the telecommunication sector which is the leading currently with domestic market control of more than 60% according to consumer survey conducted on 30th December 2011. It major positive responses is on preparation of annual reports since according to enterprise survey on annual reports preparation, it was noted that the company had outstanding financial reporting framework thus rated as the best among other 100 companies in the same industry of telecommunication. Preparation of annual financial reports is crucial to most of the stakeholders (Investors, customer, suppliers and government) of the company thus TeleFones4U rating gives a good signal on the accountability of the corporate governance of the company in giving the true and fair position of the company performance and position. CRUCIAL AREAS OF CONCERN Contingent cap Contingent cap is very crucial element in financial reporting since it has great impact when residual technique is used in arriving at the contingent value. It mostly arises due to the impact of the customer contract to the channel of distribution (Vodafone, 2012). Contingent cap can be defined as the uncertainty of revenue due to the issue of product delivery since transaction is considered to be final upon the receipt of the phones or the service to the intended customer. In the case of TeleFones4U, where 40% of the price will be paid on installment increases contingent gap for the company reporting which is not a nice idea due to the fact that it is difficult to determine the actual company performance since customer can default leading to loss to the company which will affect the company negatively and the industry as a whole (TELUS, 2012). Therefore, to reduce the above demerit and give way the existence of contingent gap, intensive use of residual techniques should be applied in order to reduce impact on financial reporting caused to high volatility on contingent estimation. In addition, we recommend to TeleFones4U to adopt accounting framework which is mostly used by other telecommunication companies in the industry in order to effectively gauge its contingent gap with those of its competitors in order to avoid being on both extremes. Presence of the contingent gap limits the effectiveness of the use of GAAP standards in arriving at investment decision or gauging of financial performance of the company (Vodafone, 2012). Therefore, we recommend that stakeholders (investors, management and suppliers) should use other measures of performance and investment viability such as, management decisions and industry comparability analysis in order to find a true picture of the company performance (TELUS, 2012). The use of financial and cash-flow ratios will give a false perception of the company financial position. It is not therefore, justifiable to eliminate contingent gap in the organization due to the fact that it will not add economic value to the company but due care need to be taken in determination of this gap and wide application of residual techniques should be used to reduce the impact of the contingent gap in annual financial reporting (Soderstrom and Sun, 2007). Application of stand-alone price allocation methodology: The other issue noted is the stand-alone price allocation methodology will reduce the gap between direct and indirect channels of distribution for the phones and services provided by the company this is according to exposure draft 2012. Therefore, reducing the impact the two brings in the market thus enabling marketing department to have variety of the channel of distributing its products and services. The logic behind convergence of direct and indirect channel of distribution is the fact that compensation given to the consumer incase of handset loss is recognized on income statement immediately the loss is incurred while for the indirect channel of distribution, distributors commission will be recorded as an asset and amortized over the life of the contract between distributor and company. We therefore, recommend that the company accounts department should recognize subsidy as intangible asset while distributor commission as expenses. Volatility on Predictability of future outcomes of the modification of customer contract: Company consideration on change of the contract is considered to have complication on the in determination of future impact on the materiality on the financial reporting which might have negative impact on the current position of the company according to enterprise Survey of 2011. According to company submission on modification of the customer contract, we note that company the pricing of the cellular phones made on regard to the cost of manufacturing which includes variable cost incurred therefore, this aspect is very tricky and cumbersome in accounting and reporting on annual financial reports since they keep on changing according to the market forces of demand and supply thus bringing in unpredictability on the prices of phones which makes it hard in reporting at the end of financial year (Vodafone, 2012). Failure for the company management to take into account such variability on the cost of production can bring negative effect on both management and customer perspective (Saxena et al., 2010). On management perspective, accounting department can easily manipulate the accounting records due to the fact prices always fluctuate thus confusing and avenue of hiding material errors in the financial report submitted by the accounting department. The most appropriate method of reducing the impact of the above approach is adoption of probability approach which requires great expertise not available in the company (Saxena et al., 2010). Therefore, we recommend that TeleFones4U Company should ensure that it adopt a more objective approach on demonstrating recognition of contingent factors and thus stabilizing the prices by arriving at most appropriate cost unlike the use of fluctuating cost without affecting profitability of the company due to increase of variable cost beyond the provision made (Vodafone, 2012). On determination of the contingent factor, we recommend that company should use comparative approach by taking into consideration the market movement in telecommunication sector because use of accounting approach (Portfolio and individual contract approach) is likely not going to work. The approach on recognition of contingent accounting should be made in accordance of IAS 37 which requires one to account for upon occurrence of the predetermined event (Saxena et al., 2010). Contract implementation Cost on revenue recognition standards Exposure draft consideration of the elements of the contract to be used in determination of either it has capital characteristics or not is an issue that it requires to be determined through use of the international auditing standards (IAS 2, 16 and 38) which gives company in-depth understanding on the aspects to be considered in cost categorizing to avoid material errors occurring due to wrong cost classification (Soderstrom and Sun, 2007). Poor classification will result to great divergence on the accounting standards used in the industry thus being difficult for the users of the accounting reports to make their decision by comparing company’s performance with those of other players in the industry (Telstar, 2012). The other important factor is the time which the cost is incurred and how it should be treated in the books of account. We recommend that the company should take extensive research on the practices of the other players in telecommunication industry in order to determine the benchmark period on which a cost can be capitalized instead of recognition as expense in preparation of statement of financial performance and position. For example, most companies might use cost incurred that will spill off to more than five years be capitalized while those less than five years be apportioned as expenses in the period of its existence through amortization i.e. finance lease is a practical example (Telstar, 2012). We recommend to the company to take close look at International Auditing Standards above in classifying cost in order to smoothen financial reporting and give a clear picture of the company performance that can improve stakeholders financial decision making. Contract modification on monthly payment of $60 per month for 24 months text and calls unlimited and 2GB internet bundles: The move by the company to modify previous customer contract to above mentioned modification can give company challenge in reporting thus greater chances of distorting the true and fair principles of financial reporting since it requires create care and experienced expertise to do the allocation treatment effectively (Vodafone, 2012). Therefore, it is unnecessary to modify the previous customer contract of prepaid service since it will be easy to account for in financial reports. In addition, the company non-modification of the contract will ensure that turnover doesn’t drop since according to a marketing agency it is considered that company profit was going to drop upon adoption of the strategy since one get unlimited service just with $60dollars where most of the customers usually spend more than $60 with the prepaid service both on texting, calls and internet services (TELUS, 2012). The other factor considered in arriving at our hypothesis for non-adoption of the modification of the customer contract mentioned above is the cost incurred in creating awareness and the reaction of the customers upon the receipt of the news regarding to the modification (Vodafone, 2012). The cost incurred in creating awareness is estimated to be more than $20million. The cost is expected to reduce on prorata basis at a rate of 20% per year which makes it difficult to account due to complexity in calculation and allocation of the cost to the prices. The complexity in shifting the cost to the customer results from the fact that rates will be constant at $60 per month thus the company will need to bear the burden of the awareness cost. On customer reaction, we are expecting a portion of customers whose monthly spending on calls, texting and internet services falls below $60 dollars per month to move to other networks in order to avoid unnecessary spending (Soderstrom and Sun, 2007). The demerits above can be avoided though adoption of different accounting approaches (Individual or portfolio contract approach) in determining how to report in order to reduce material issues in the financial reports but in TeleFones4U scenario, it is appropriate to use portfolio approach in case the company adopt above modification of customer contract (TELUS, 2012). We recommend that modification of contract on customer transaction prices should be recognized and accounted for upon contract termination and introduction of the new contract of unlimited calls, text and 2GB internet data bundles and its impact be determined using snowballing closeness basis with the previous contract. RECOMMENDATION It will be appropriate for the company to adopt acceptable principle in the financial reporting in order to give a true and fair picture of the company. Therefore, to achieve this objective we recommend that management should; Use residual techniques extensively and retain contingent gap which is relatively similar to those of its major competitors. Use Non-GAAP measures in determination of financial performance to eliminate errors that may occur due to contingent accounting. Estimation on the future predictability of the contingent should be arrived at by looking at telecommunication market trend. CONCLUSION In conclusion, we once again commend on the company management for the continued positive response to correction made on the financial reporting and adherence to the international standards which has converged comparisons of the company performance to those of other counties worldwide. It is therefore our hope that company will take above recommendation in order to avoid reporting shortcomings that might occur during modification and implementation of new customer contract. The change on the allocation of pricing will impact many elements and stakeholders of the company. Therefore, TeleFones4U should carry out extensive awareness and education to reduce confusion and enhance accuracy of the financial decision made by the users of its financial reports i.e. informing investors not to use GAAP measures such financial ratios in arriving at their conclusion. We will be more than ready as Honest and Blonde team to receive any reaction and suggestion in order to achieve beneficial position for TeleFones4U Company and its financial users. Feel free to contact us through Telefones4u@cellphone.org. Sincerely, Mr. Andréa Pique General Manager REFERENCE Archer, S. (1997). The ASB's Exposure Draft Statement of Principles: A Comment. Accounting and Business Research, 27(3), pp.229--241. Christian, D. and Lüdenbach, N. (2013). IFRS essentials. 1st ed. Chichester, West Sussex: Wiley. TELUS. (2012). Comment letter No.283. Saxena, R., Srinivas, K., Rai, U. and Rai, S. (2010). Auditing. 1st ed. Mumbai [India]: Himalaya Pub. House. Soderstrom, N. and Sun, K. (2007). IFRS adoption and accounting quality: a review. European Accounting Review, 16(4), pp.675--702. Taylor, S., Gartside, L. and Taylor, S. (2004). Model business letters, e-mails & other business documents. 1st ed. London: FT Prentice Hall. Telstar. (2012). Comment letter NO.223. Finance Group Accounting. Victoria: Australia Vodafone. (2012).Comment letter No.273 Read More