Financial Reporting Disclosures in the Australian Corporate Sector - CCA Ltd - Case Study Example

Contents Executive Summary Accounting standards on asset impairment are set to direct procedures that an organization may follow in ensuring that the organization’s assets are carried at a cost which is not more than its recoverable amount. Accounting standards regarding Write-downs of intangible assets with indefinite life are those that cover assets that do not exist physically such as trademarks and exclusive rights among others. Good will also applies in asset impairment where it is a payment made by an acquirer expecting to get economic benefits in the future from assets that cannot be identified individually or recognized separately. ASIC (Australian Securities and Investments Commission) states the accounting standards that all operating entities should observe in matters of asset impairment such as goodwill allocation on cash generating units, impairment testing, and key assumptions among others. CCA (Coca Cola Amatil) ltd has its own accounting standards which it feels that they do not fully comply with the requirements of ASIC particularly on the matters of asset impairment. There is therefore need for all the companies to ensure that their accounting standards comply with those ASIC on all matters. ASIC accounting standards are also made in reference to the Australia Accounting Standards Board requirements which considers international accounting standards. Introduction Accounting standards on asset impairment are set to direct procedures that an organization may follow in ensuring that the organization’s assets are carried at a cost which is not more than its recoverable amount. An asset may be said to be carried at an amount higher than its recoverable amount where the carrying amount is more than the amount that can be recovered when an asset is put to use or it is sold. When such a situation occurs, the accounting standard on asset impairment requires that the organization should recognize the impairment loss for the asset (Yafeng, 2003). Carrying amount of the asset is defined as the ultimate value of an asset after values of any accumulated depreciation have been deducted plus the accumulated impairment losses. On the other hand, the recoverable amount is defined as the excess amount of an asset’s fair value less its selling costs. It is also the value in use of the stated asset. The fair value less the selling cost is the amount realized when an asset is sold in the best transaction less the costs of disposal such as legal costs and other accruing duties. The value in use of an asset is the current value of future income that is expected to be generated by the asset (Queensland Audit Office, 2004,. Accounting standards regarding Write-downs of intangible assets with indefinite life Intangible assets are those that do not exist physically but they add to the earnings of the company. Such assets include trademarks, exclusive rights, brands, and copyrights among others. Intangible assets that have been developed internally by the company may not appear in its books of accounts. Intangible assets may also be purchased from another company for example where a company, may require to use another company’s technology which is defined in its exclusive rights. According to AASB 136 (Australia Accounting Standards Board), goodwill acquired in an enterprise indicates a payment made by an acquirer expecting to get economic benefits in the future from assets that cannot be identified individually or recognized separately. However, goodwill does not generate cash independently of other assets but it adds to cash flow of several cash generating units. It is further explained that in cases where goodwill relating to an income generating unit that it has not been allocated to, an impairment test should be done on that unit (Australian Accounting Standards Board, 2007). This should be done by comparing its carrying amount, not considering any goodwill, with the unit’s recoverable amount. Therefore, if the carrying amount of the income generating unit includes an intangible asset which is ready for use or has an indefinite useful life and that it can be tested for impairment as part of the unit, then impairment test for this unit should be done annually. Cash generating unit with allocated goodwill shall have impairment test conducted annually and also in cases where there may be signs of impairment on the unit. This should be done by comparing its carrying amount plus the goodwill with the unit’s recoverable amount. However if the recoverable amount shall be found to be more than the carrying amount, the unit and its’ allocated goodwill should not be declared impaired. On the other hand, if the carrying amount of the unit I found to be more than the recoverable amount, then the company should recognize the unit as having impairment loss (Stickney, Weil, Scipper, & Francis, 2009). Accounting standards regarding calculating recoverable amounts Recoverable amount of an asset is the excess of its fair value after deducting its selling cost and its value in use. Therefore to determine as asset’s impairment, the carrying amount of an asset is compared with its recoverable amount. Some of the factors to consider when calculating the fair value less the cost to sell include: where there exist a binding sale agreement, the company should use the price stated in the agreement less the cost of disposing the asset. If the asset can get an active market, the market value should be used less the cost of disposing the asset. If there is not active market, then the selling price of the asset should be estimated art its best value (Australian Securities and Investments Commission, 2011). On the other hand, the value in use should indicate the following elements: an estimated value of cash that the company expects from the asset in future, the expected variations in this value in different timings, the price with uncertainties intrinsic to the asset plus other issues such as liquidity. However, the accounting standards allow various assumptions regarding the cash flow projections which should be reasonable and supportable. These apply is matters such as budgets and forecasts, extrapolation for non budgeted periods. According to ASIC, the budgets and forecasts should not exceed a five-year period. If it has to, then the company should extrapolate from the earlier budgets. The discount rate to be considered in measuring the asset’s value in use should be calculated from its pre-tax rate which indicates the current market assessment with the value of money of that particular time and the risks that may be specific to that asset. The expected growth rate of the asset should be calculated considering the current condition of the asset and not considering any required future restructuring and any other expenses in improving its performance. However, it is important for the management directors to gauge the reasonableness of its assumptions by considering the differences between the asset’s past and the actual cash flow projections (Tomasic, Bottomley, & AcQueen, 2002). The current accounting practice of CCA Ltd CCA carries out its impairment tests by comparing the recoverable value of an asset to its carrying value. Just like the requirements of accounting standards, the recoverable amount is determined as the excess of fair value less the cost to sell and also the value in use. In CCA, an impairment test is done based on the asset’s value in use. On top of the value in use, CCA also calculates the asset’s fair value less cost to sell to ensure that value obtained from whichever method is in excess of carrying amount of the asset. The value in use is obtained by calculating the discounted cash flow that covers a period of fifteen years with the suitable residual amount at the end of fifteen years for each of the cash generating unit. This method of calculating makes use of cash flow forecasts for a period more than five years to ensure that there is minimal reliance on the residual values and it follows the business plans that have been forwarded and approved by the board of management. On impairment tests of CCA’s agreements and intangible assets with indefinite lives, CCA has various major assumptions on which it has based its cash flow forecasts and goodwill. Some of the assumptions include in pricing where it is based on business plans for three years that have been approved by the board of management. Beyond three years, pricing is calculated in consideration to long term inflation expectations. On discount rates, CCA uses rates that are measured as the average capital cost after the tax for each class of cash generating units. The residual value of the cash generating units is calculated using the forecasted growth rates. CCA defines goodwill as the amount in excess of the cost of acquiring an asset over the fair value of the acquired asset. According to CCA, the goodwill is not amortized but its testing is done annually or more frequently if need be. Impairment is therefore calculated by assessing the recoverable amount of the cash generating unit for which the goodwill applies (CCA, 2010). Gap between the CCA’s current practice and the accounting standards requirements After reviewing both the ASIC accounting standards and those of CCA, there are very few issues that CCA has not complied to. However, in most of the requirements, CCA meets the required standards. One area where there is a gap is in calculation of the asset’s value in use. According to ASIC accounting standards, this value should be calculated from its pre-tax rate which indicates the current market assessment with the value of money of that particular time and the risks that may be specific to that asset. However at CCA, the discount rates are calculated based on the average cost after tax for each of the cash generating unit. The other gap is on budgets and cash flow forecasts where according to ASIC, they should apply for a period of five years and if it has to exceed, the company should extrapolate from the earlier budgets. However CCA makes use of cash flow forecasts that go beyond five years to ensure that there is minimal reliance on the residual values (CCA, 2010,. The other gap is in calculating the value in use where according to ASIC, it should be calculated considering the expected variations in this value in different timings. However in CCA, it is calculated as the discounted cash flow that covers a period of fifteen years with the suitable residual amount at the end of fifteen years for each of the cash generating unit. Conclusion and Recommended actions to satisfy the potential ASIC reviewers The main issues of concern to most companies regarding ASIC accounting standards include identification of cash generating units, allocation of goodwill and the assumptions applied in impairment testing, it is recommendable that the company should keep updating its accounting standards annually in reference to the changes that may occur in ASIC accounting requirements. ASIC also makes reference to AASB 136 (Australia Accounting Standards Board) that also puts in consideration international accounting standards. It is therefore important for entities to maintain the international accounting standards to ensure that there is gap between its standards and those of ASIC. Bibliography Australian Accounting Standards Board, 2007, Compiled Accounting Standards AASB 136: Impairment of Assets, AASB, Melbourne Australia. Australian Securities and Investments Commission (ASIC), 2011, Financial Reporting, retrieved on 13th September 2011 from http://www.asic.gov.au/asic/asic.nsf Queensland Audit Office, 2004, QAO Guidelines on Accounting Standard AASB136: Impairment of Assets, QOA, The state of Quensland. Tomasic, R., Bottomley, S. & AcQueen, R., 2002, Corporations law in Australia, Federation Press, Austria. Yafeng, D., 2003, Asset impairment: an analysis on measurement attributes for productive assets, San Francisco, San Francisco State University. Stickney, C., Weil, R., Scipper, K., & Francis, J., 2009, Financial accounting: an introduction to concepts, methods, and uses, Cengage Learning, Boston. CCA, 2010, Annual Report, Sydney, Coca-Cola Amatil ltd. Read More