Concerns Related to Recognition of Different Accounting Items - Assignment Example

Maria McKenzie, McKenzie & Associates 777 South Terrace, Adelaide SA 5000 Con Pewter Managing Director, Pewter Ltd Level 6, 510 King William Street, Adelaide SA 5000, 13th January 2017 Dear Pewter Ref: Concerns Related to Recognition of Different Accounting Items I have gone through your concerns and must say that they pose a serious challenge to a person that is not well-conversant with accounting matters. In fact, most of our concerns reflect some of the technical components that have been a basis of debate for a couple of years now. It is important to remember first-hand that accounting is a profession that is fairly dependent on already laid-out procedures and processes that define how transactions and accounting items should be recognised and recorded in different aspects. I must assure you that these concerns are safely in my hands and in the subsequent section of this letter; I will be able to lay-out them in a way that would fairly be understandable. In the subsequent sections, I will lay out my findings of these three concerns while making sure that I put in some references for your future research and counter-checking. I will provide possible solutions to these concerns in section as below A. Deferred Tax Assets & Deferred Tax Liabilities In regards to the concern related to recognition of both deferred tax assets and liabilities (DTLs & DTAs), it is safe to understand what they both mean. Deferred tax assets will always arise whenever reported income on a company’s financial reports is deemed to be far much less in comparison to the taxable income. For most cases, deferred tax assets are certainly pre-paid taxes and fairly postulate expected decreases of future reported taxes. Some of the most notable deferred tax assets include; product warranty reserves and future pension. On the other hand, deferred tax liabilities come up whenever the level of reported income within a company’s financial statement is deemed to be greater when compared to the real taxable income amounts. For most of the cases, deferred tax liabilities are perceived to be the additional amounts of taxes that will be paid in future for current operations. Perfect examples of deferred tax liabilities include; non-deductible intangibles. Notably, a deferred tax liability is expected to recognised for all of taxable temporary differences expect in such occurrences where it either arises from goodwill or in the case of basic recognition of a given asset that is deemed to be a portion of a business combination or affects taxable profits or even accounting profits for that matter(AASB112: http://www.aasb.gov.au/admin/file/content105/c9/AASB112_07-04_COMPsep11_07-12.pdf). Consequently, a company is expected to recognise a deferred tax asset for all major deductible temporary differences except in the case that it is part of a business combination. In essence, DTAs will temporary raise the level of reported asset-base but would not assist with the generation of operating profits as DTLs are noted to be a fundamental source of interest-free financing as a whole. Following this line of arguments, it is important that the company accounts for current tax liability as well as deferred tax assets and deferred tax liabilities. Disclosure for these two accounting items can be done in two notable ways that include; explicit presentation as DTAs and DTLs or record them within the notes section of the financial statements. In the course disclosure; it is expected that all of the accounting items that relate to tax are disclosed separately within the financial statements; the specific amounts of deferred tax items that arise out of origination and reversal of temporary differences. Of particular interest to note, measurement of DTAs and DTLs are done in relation to the existing tax laws and rates for which in Australia stands at 30% (AASB112). It is worth to note that the company is only allowed to offset either DTAs and DTLs in the event that it has acquired a legally enforceable right and shows immediate intentions to settle both of these items in a simultaneous manner. The company is expected to prepare a tax reconciliation note that seeks to reconcile the expected tax-base with the real tax presented within the financial statements. In fact, expected tax should be reconciled with current and deferred taxes within the profit and loss account segment. B. Warranty Expense Recognition First of all, it is important to understand what warranty expense entails. It refers to the underlying cost that is already incurred or is expected to be incurred for the purpose of repair or replacement of the products it sells. It is safe to note that the total amount of warranty expense is thereby restricted by the overall warranty period for which it occurs. Certainly, it should be made clear that immediately after a warranty period of a product expires; a business will no longer be expected to incur any level of warranty costs. The amounts related to warranty expense should be recognised within the similar period for which the products were sold and in the event that a company is able to ascertain whether the expense would be incurred then it should go ahead to approximate the overall amounts of expense. The matching principle calls for companies to record and recognise expenses related to a sale within a similar period for which it was reported just as when sales revenues and transactions are made. FASB- Standards No. 5 Accounting for Contingencies; (http://www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175820910926&blobheader=application/pdf) identifies product warranty as a commitment that should be incurred in relation to the sale of goods or even services that would eventually call for extended performance by the seller after the sale transaction has been finalised. However, in the event that there is incapacity to make a reasonable approximation of the estimate of the amounts incurred in relation to the warranty in question, at the exact time when a sale was made, due to possible uncertainties related to possible claims might hinder the accrual process of approximation. Taking a closer look at the stipulations made as above, the Board should understand that the variances are allowed in estimating the warranty costs. It is however; not a good idea not recognise the expense at the time when the sale of products or service takes place since there is a huge probability that the customer might come back for future performance on the sold item. It is only wise that the company continue making reasonable approximations on the product or service and recognise it to avoid overstatement of revenues. Obligations related to the warranties would mostly come up when there are probable claims for products or services sold like in the case of injuries or damages that relates to product defects. FASB- Standards No. 5 Accounting for Contingencies; (http://www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175820910926&blobheader=application/pdf). As opposed to overlooking probable chances for claims, the company should make efforts to make reasonable estimates of potential loses that relate to the sale. In the event that the underlying warranty liability is deemed to be both probable and can be easily estimated; then it is only fair that the company accountant goes ahead to accrue them within the exact period of the sale as a liability and an expense for future warranty reference. A crucial point to note for the Board lies in the supposition that in case where the historical minimal warranty expenditures exists, then there would be no need for the company to recognise the warranty liability in advance of actual costs but should just recognise the costs attributed to the insignificant number of warranty claims as they are submitted by the clients. C. Goodwill, Unrecorded Patent & Shares According to FASB’s Statements of Financial Accounting Standards No. 141- Business Combinations, the acquisition method of an entity should be subjected to the overall acquisition method that includes recognition and measurement of goodwill or a gain from a bargain purchase (http://www.fasb.org/cs/BlobServer?blobkey=id&blobwhere=1175820919432&blobheader=application/pdf&blobcol=urldata&blobtable=MungoBlobs). The recognition -condition for this stipulation requires that the acquirer apply the principle and condition that would allow for the recognition of some assets or even liabilities within its financial reports. A perfect example will be when the acquirer fails to identify some of the notable assets since they were developed and posted internally. However, on the company’s part; the fair value of identifiable net assets cannot be recognised as goodwill. Prior to recognition of a gain or bargain purchase, the acquirer shall reassess if it has been correctly identify all of the presumed assets and possible additional assets. It will be crucial to understand that goodwill is recognised within a business combination as a definite amount of assets that represents the future economic benefits that arises from other set of assets that are acquired in the process but that are not individually identified and separately identified. Internally generated cannot be recognised as asset since it is not an identifiable resource, which means that it is inseparable or even does not arise from contractual or even other legal rights. Notable differences that might exists between the fair value of an entity and carrying amount of identifiable net assets at any given moment in time could depict a significant level of facets that can affect the fair value, however; these differences cannot represent the cost of intangible assets that are possessed by the controlled entity(AASB 138- Intangible Assets; http://www.aasb.gov.au/admin/file/content105/c9/AASB138_08-15_COMPoct15_01-18.pdf). For the case of unrecorded patent, which is a form of intangible asset, is recognised whenever it is ascertained that there is probability that the expected future economic benefits that are related to this asset will flow to the company and, also when the cost related to the unrecorded patent can be successfully measured in a more reliable way. In the case that the Canadian company offers shares, then yes, the Pewter Ltd will be a shareholder in this Canadian company and the shares would be accounted as shares held in non-controlling venture. I hope, with the above discussed information, that the company will make informed decisions that conform to the existing set of standards for each concern raised. In case of any further clarification, do not hesitate to mail me for further assistance. Sincerely, Maria McKenzie. Read More