Disclosures of Sources of Estimation Uncertainty and Judgements in Applying Accounting Policies - Case Study Example

BUSINESS RESEARCH REPORT] (Name) (Instructor/Tutor) (Course/Subject) (Institution/ University) (City, State) (Date) To: Board of Directors From: Subject: AASB 101: Presentation of Financial Statements in AnaeCo Limited Date: 29th April, 2013. Contents Contents 2 References 9 Executive Summary Business entities should provide adequate disclosure regarding sources of estimation uncertainty and judgements in applying accounting policies, according to AASB 101. This report seeks to analyse the requirements, according to AASB 101, on disclosures of sources of estimation uncertainty and judgements in applying accounting policies are in AnaeCo Limited Company. The report also provides information about any potential gap between AnaeCo limited’s current practice, and the accounting standard requirements, and recommends necessary actions that will satisfy the ASIC reviewers. Introduction The compiled AASB 101, Presentation of Financial Statements applies to annual reporting which beginns on or after 1st of July, 2012. It includes amendments that were made after 1st of July, 2012. This standard lays down the basis for presentation of general purpose financial statements of a business enterprise to guarantee comparability with the enterprise’s prior year financial statements, as well as, with other enterprises’ financial statements. AASB 101 stipulates the general requirements for financial statements presentation and the guiding principles of this structure and the least requirements for such content of financial statements that business entities present to the public (Australian Accounting Standards Board, Memorandum, 2012). AASB 101 applies to every required entity for the preparation of financial reports with consideration to the Corporations Act, general purpose financial statements of every reporting entity and financial statements, which are or are held to be general purpose financial statements. a) The Requirements According to AASB 101, Disclosures of Sources of Estimation Uncertainty and Judgements in Applying Accounting Policies are; AASB 101; Paragraph 122 An enterprise should make known, the judgements, in the summary of considerable accounting policies or notes, except for those which involve estimations that the entity’s management has made while applying the accounting policies of the entity, and which have a high considerable effect on the amount recognized in the financial statements (Australian Accounting Standards Board, 2011). AASB 101; Paragraph 125 Secondly, a business entity should disclose information about any assumptions that it makes regarding the future and other significant sources of estimation uncertainty at the end of the fiscal period, which have a significant risk of resulting in material adjustment in relation to the carrying assets and liabilities amount. Such notes should include the nature of the assets and liabilities of the entity and their carrying amount as at the end of a financial period (Australian Accounting Standards Board, 2012). b) The Current Accounting Practice of AnaeCo Regarding Disclosures of Sources of Estimation Uncertainty and Judgements in applying Accounting Policies Asset Impairment The Anaeco Group assesses whether there is an indication that an asset may be impairment, at each reporting date. In this case, such an indication exists, the Group company makes an estimation of the asset recoverable amount (AnaeCo, 2012). An estimate of the asset’s recoverable amount is also made when the annual impairment test for assets is necessary. Secondly, the group makes an assessment to find out any indications of the existence of previously recognised impairment losses or if they may have decreased, in which case it makes an estimate of the recoverable amount (AnaeCo, 2012). In case of a change in the estimates used for the determination of assets recoverable total because of the recognition of the previous impairment loss, then a previously recognised impairment loss is reversed (AnaeCo, 2012). The carrying amount of the asset is then increased to its recoverable amount. The increased amount cannot be more than the carrying amount, which could have been established less depreciation if impairment loss had not been recognised for the asset in the previous years (AnaeCo, 2012). The reversal is normally recognised in the profit and loss account except when the asset is carried at a re-valued amount (AnaeCo, 2012). In this case, the reversal is treated as a revaluation increase. Then, the depreciation charge is adjusted in future periods so as to allocate the revised carrying amount of the asset, less any residual value for the remaining period of the asset’s useful life (AnaeCo, 2012). Significant Accounting Judgements, Estimates and Assumptions The following judgements that have the highest considerable effect on the amounts recognised in the financial reports, apart from those concerning estimates have been made by management in the process of applying the Group’s accounting policies. The technology development expenditure that may be capitalised by the Group is determined by distinguishing the cots that have a direct relationship to the Group’s criteria for capitalisation in the accounting policy (AnaeCo, 2012). Nature of performed work by staff and third party consultants is evaluated as it includes a judgemental apportionment of costs. Design, assembly and operation of pilot plants are not rated the same scale as commercial use and design, construction and testing of alternative or improved systems (AnaeCo, 2012). Tax losses and net temporary differences are used to estimate deferred tax assets. There is no estimated value of deferred tax assets that have been brought to account because management cannot conclude that it is likely to have available tax profits in the future to utilise tax losses and net temporary differences (AnaeCo, 2012). The Group uses estimates and assumptions of future events to determine the accruing amount of certain assets and liabilities. Impairment of non-financial assets, long term contracts, long service leave, estimation of useful lives of assets and share based payment transactions are the main assumptions and estimates that have a significant risk of causing a substantial adjustment to the carrying amounts of certain assets and liabilities (AnaeCo, 2012). The group’s long term engineering services contracts are accounted for, using the stage of completion method (AnaeCo, 2012). Profit on long term contracts is recognised according to the stage of completion while the stage of completion is measured by use of the actual costs incurred in providing contract services as a percentage of the total forecasted cost s of contract completion (AnaeCo, 2012). The company has to formulate judgements regarding the time of completion of the contract. The total forecast costs for contract completion include estimates of all future costs, whether the contract in question is expected to make a profit or not. At times, the estimates of these future costs include the costs used to settle any outstanding claims or disputes (AnaeCo, 2012). The Group estimates the probability of the current employees attaining the required service period to qualify for long service leave benefits to determine its long service leave obligations (AnaeCo, 2012). The cost of share transactions is measured using the fair value of the shares on the date that they are granted. An external value determines the fair value of shares (AnaeCo, 2012). The asset’s useful lives base on the historical experience, lease terms for leased equipment and turnover policies for vehicles. The asset condition undergoes assesment annually and considered against the remaining useful life (AnaeCo, 2012). The Group makes adjustments to the useful lives of the assets when it is necessary. c) Potential Gaps Between AnaeCo Limited’s Current Practice and the Accounting Standard Requirements AnaeCo Limited followed the majority of the accounting standard requirements in the preparation of the annual report. For instance, the company did not ignore the significance of asset impairment because the reported assets value did not exceed market capitalization (AnaeCo, 2012). Secondly, the carrying amounts of the assets were properly disclosed in the company’s financial documents and annual report (AnaeCo, 2012). AnaeCo Limited made adequate disclosure about going concern. As much as the company’s net liabilities and net current liabilities increased tremendously, compared to the previous periods, the company provided information on how it will fund its future operations (AnaeCo, 2012). It should also be noted that the operating loss of the company, after income tax increased considerably, as compared to the previous year. The Group, according to the directors’ opinion would have access to sufficient cash to fund AnaeCo Limited’s expenditure for a period that is not less than 12 months from the date of preparation this year’s report (AnaeCo, 2012). Also, the company provided adequate segment reporting in its annual financial report. However, AnaeCo Limited exhibited some significant gaps between its current practice and the accounting standard requirements. For instance, Anaeco Limited’s financial report did not include any adjustments pertaining to the recoverability or classification of recorded assets or liabilities totals that might be essential should the Group fail to access funds to finance its operations and continue has a going concern (AnaeCo, 2012). Secondly, the company did not observe proper asset and liability classification guidelines. For example, AnaeCo Limited’s financial report classified receivables as non current assets AnaeCo, 2012). Accounting Standard requirement recognizes receivables as current assets. Third, the financial report, classified loans under current liabilities and hire purchase liabilities under long term liabilities (AnaeCo, 2012). d) Recommended Actions to satisfy the Potential ASIC Reviewers In the upcoming annual report, AnaeCo Limited will use the following guidelines to eliminate significant gaps between the company’s current practice and the accounting standard requirements. First, directors will have to evaluate values in accordance to their knowledge of business and economic conditions. Secondly, they will have to carry out a realistic assessment of the company’s prospects and future cash flows (Niven, 2012). They will also pay significant attention on the company’s ability to finance its debts at suitable costs and comply with lending agreements. Directors will ensure adequate disclosure of off-balance sheet arrangements details and disclose any exposures. There should be reasons explaining why such arrangements are not in the balance sheet (Niven, 2012). As for the classification of liabilities and assets, AnaeCo Limited directors will make sure that they engage in processes that will guarantee the correct classification of assets and liabilities. This classification involves current and non-current liabilities or assets (Niven, 2012). The directors will evaluate the classification of assets and liabilities in regard to their knowledge of the company’s business and its financing strategies. AnaeCo Limited shall continue to disclose segment information to enable users to assess the company’s effect on the environment. These effects include the nature and financial effects of AnaeCo Limited’s operative activities, as well as the economic environments in which the company operates. The directors will also keep on providing full information about segments which are the components of the company’s business. Directors of AnaeCo Limited will ensure that disclosures in the next annual report will assit its users to have a clear understanding of the market. Users will also understand credit and liquidity risks that contribute to the company’s use of specific financial instruments (Niven, 2012). Directors will have to disclose the fair values of the company’s financial assets by the use of a three level hierarchy (Niven, 2012). This should reflect the quantity of observable market information used. It should also include the methods and assumptions made by the directors in cases where observable market data does not exist. Directors will have to analyse impaired assets and ageing assets past their useful lives but are not impaired (Niven, 2012). Finally, directors will have to classify future income as intangible assets, under an amortised cost of nil, and not at fair value of the financial assets. This is because it is impossible to revalue some intangible assets to fair value while other assets can only be revalued where there is an active market (Niven, 2012). References AnaeCo. 2012, June 30. AnaeCo Annual Report 2012. Retrieved April 17, 2013, from http://www.anaeco.com/index.php?option=com_content&task=view&id=107&Itemid=62 Australian Accounting Standards Board. 2011. AASB Compiled: Presentation of Financial Statements. Retrieved April 17, 2013, from http://www.aasb.gov.au/admin/file/content105/c9/AASB101_09-07_COMPmay11_07-11.pdf Australian Accounting Standards Board. 2012, January 31. Memorandum. Retrieved April 17, 2013, from http://www.aasb.gov.au/admin/file/content102/c3/2012_Feb_AP_16.1_RDR_Overlapping_disclosures.pdf Niven, D. 2012, February 29. Improving Investor Reporting. 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