Financial Accounting of Disk Smith Holdings Limited - Example

Synopsis When the issue of income is mentioned, many people think of it in terms of revenue. However, as implied by Chambers (1983) revenue is just part of income. This report seeks to describe the issue of income to incorporate all its components other than revenue. Furthermore, the report recognizes the need to use the income measurement bases that will lead to accurate results if it is to lead to decision useful information. The report thus looks at the income measurement criteria and the challenges encountered in measuring income. The paper then analysis the categorization and treatment of various ‘incomes’ in Disk Smith Holdings Limited balance sheet for the year 2014. Finally, the relationship between measurement and decision useful information is examined in detail. Dick Smith Holdings annual report is used for this purpose. It is concluded that organizations ought to apply the right measurement methods accurately if they are to have decision useful information for their decision making purposes. Table of contents Table of Contents Synopsis 1 Table of contents 2 Table of Contents 2 Introduction 3 My understanding of the term ‘income’ and how they are measured 3 Income’ and the problems of measurement 5 The categorization and treatment of ‘income’ in Dick Smith Holdings Limited’s annual report in the context of AASB/IASB standards and framework 6 The relationship between the measurement of ‘income’ and decision useful information 8 Conclusion 10 References: 11 Introduction This report uses Dick Smith Holdings limited in analyzing the issue of income measurement and the claim that Income is often described as a ‘flow’ as distinct from a ‘stock’ (e.g. of net assets or capital). Dick Smith Holdings limited is a leading retailer of consumer electronics having 377 stores across Australia and New Zealand and is the largest store by store footprint (ASX, 2014). In analyzing the issue of income measurement, various criteria for measuring income including historical cost and current value and fair value measurement bases are explained. In addition, a broader definition of income has been given and broadly described. Income has been described to not only include revenue but also as increases in economic benefits during the company’s accounting period in the form of inflows or enhancements of assets or decreases in liabilities which would result in increases in equity other than increases that result from contributions from equity participants(Willard, 2015). In addition, the challenges that face income measurement by accountants and hence companies have been described in detail. The paper also looks at the categorization and classification of income in Dick Smith Holdings balance sheet. The relationship between income measurement and decision useful information is also examined with respect to Dick Smith Holdings Limited’s 2014 annual report. My understanding of the term ‘income’ and how they are measured Income is often described as a ‘flow’ as distinct from a ‘stock’ (e.g. of net assets or capital). In this regard, my understanding of income is that it incorporates more than just the revenue that the company derives from its normal operation activities. In fact, from my understanding of the term income, it can be measured by comparing increase in the company’s balance sheet after subtracting those increases that have been caused by stock related contributions by shareholders. The IASB/AASB framework describe income as increases in economic benefits during the company’s accounting period in the form of inflows or enhancements of assets or decreases in liabilities which would result in increases in equity other than increases that result from contributions from equity participants (Deloitte, 2014). As such, my understanding of the term ‘income’ is that it encompasses both revenues and gains that result in increases in equity other than from stock issuance. For instance, Dick Smith Holdings limited recognized revenue income of $1,227,604,000 in respect to sales of goods and services in the year 2014. Other income recognized by the company included interest income of $519,000, net gain on foreign exchange of $16,000 among others. Revenue is got in the course of the company’s ordinary activities and has been referred to in different names including fees, sales interest, royalties, rent etc. For the case of Dick Smith Holdings limited, the revenue is the sales that the company derives from its consumer electronics brand. Revenue in this case has been recognized in the income section of the company’s statement of comprehensive income. On the other hand, gains include increases in economic benefits. Such would increase gains on financial assets or increase in values of investment that the company makes in other institutions (Mheducation.com, 2015). Gains for instance reserves for example specific gains on assets are required by respective standards to be recognized directly to equity. Such gains are also then reported in the other comprehensive income section of the statement of comprehensive income. However, it should be noted that increases in equity contributions from shareholders although they lead to increased cash to the company are not referred to as income. In the case of Dick Smith Holdings limited, the gains include interest income, discount on acquisition, net gain on foreign exchange as well as gain on sale of fixed assets. Measurement of income depends on the type of income being measured. For instance, measurement of revenue income is guided by AASB 118 on revenue. In this case, Dick Smith Holdings limited has measured revenue income at the fair value of the amount received or receivable (Ifac.org2012). In addition, recognition of revenue income has been done on accrual basis. In the same vein, gains are recognized as income in accordance with their nature in accordance with AASB 101. For instance, interest income is measured and recognized in accordance with AASB 139 while net gain on foreign exchange have been measured and recognized as other income in accordance with AASB 121. In essence, there is no set criterion for measuring income but this is measured with regard to the nature of income in question. However, before each of the above incomes can be recognized as incomes, all the associated expenses that have been incurred in generating them or in relation to them have been subtracted in accordance with the matching principle (Deloitte, 2010). The company’s income has also been reflected by the increase in the amount of shareholders equity from the 2013 amounts to 2014 amounts after increases related to contribution of more capital by shareholders has been subtracted. In this regard, our understanding of income is similar to that which is presented by Chambers (1983) that ‘income is distinct from a stock and that net revenues are just part of the increment in the company’s income. Income’ and the problems of measurement As stated above, income incorporates not just the items of income statement but also items of the balance sheet if the balance sheet approach is to be used. Income refers to increases in economic benefits during the company’s accounting period in the form of inflows or enhancements of assets or decreases in liabilities which would result in increases in equity other than increases that result from contributions from equity participants. In this regard, it implies that measurement of income does not just depend on how revenue from the business’ ordinary activities is measured but also on how other items that is used in composing other income such as increases or decreases in assets and liabilities are measured (European accounting association, 2014). As such, measurement of income is faced by various problems owing to its being composed of various items and the fact that income is measured for different purposes. For instance based on AASB 118, accrual accounting should be used in measuring a firm’s revenue income. However, there are cases where such measurement presents a problem for accountants for instance in the case of long-term contracts that span several accounting periods but customers often making periodic payments as the contracts progresses. The issue is whether revenue from such a contract should be recognized as the contract progresses or the firm should wait for the contract to be completed and then recognize the total revenue and expenses upon completion (Chartered Accountants, 2015). When there is considerable uncertainty as regards the capacity of buyers of a firm’s services or products to pay for them, should the firm recognize the income only when it collects portions of the money under installment method? In this regard, the problem is when income should be recognized which obviously affects income measurement as to the amounts to be recorded. As stated above, income also incorporates gains from assets and liabilities revaluations as well as well as gains on resale of assets. As such, issues pertaining to measurement of assets and liabilities also affect measurement of income. The problem of income measurement therefore arises owing to a number of reasons including the fact that the same assets can be measured on different bases thus resulting in different amounts of income in case of resale or revaluation (International accounting standards board (IASB), 2010). In the same vein, different liabilities are measured using different measurement bases and thus this could give rise to differences in income. In addition, income is also affected by inflation. The challenge that arises is therefore how we treat inflation so as to remove its effect on income and thus arrive at the true income for the firm. The other challenge in income measurement is the fact that new ways of doing business have emerged. This makes the items of income to be measured to have no historical cost for instance for certain financial instruments including interest rate swaps as well as goods and services acquired using shares or share based instruments (International accounting standards board (IASB), 2008). As such, the issue is whether to measure such items on current, historical or fair value basis. The disparity between current value and historical cost also causes problems in income measurement. In addition, the ability to manipulate historical cost results to produce figures that may be regarded as misleading for instance for portfolio investments that have their values go up or down from year to the next poses a problem on how to measure them. In essence, income measurement is faced by many problems as has been discussed above. Such issues include the measurement bases to be used, when income items should be measured and hence recorded as well as how to account for the effects of inflation so as to eliminate them from income so that real income can be reported. The categorization and treatment of ‘income’ in Dick Smith Holdings Limited’s annual report in the context of AASB/IASB standards and framework Overview of the company The company is a leading retailer of consumer electronics having 377 stores across Australia and New Zealand and is the largest store by store footprint. The company has 283 Dick Smith stores in Australia, 29 David Jones Electronics powered by Dick Smith stores and 4 move stores. In New Zealand, Dick Smith has 61 Dick Smith stores. This puts the company in the top three with its revenue excessing $1.3 in 2014. The company attained a profit of $42.1 million in 2014 while it employs more than 3500 people. Income for Dick Smith Holdings limited has been classified as follows; a) Revenue income This is the amount of money that the company derives from selling its brand of electrics during a certain time period. This would include discounts and deductions for the goods returned. After subtracting related costs, the net income for the company is determined. AASB 118 details out how revenue income should be measured. AASB 118 provides for revenue income to be measured at the fair value of the consideration received or receivable (aasb.gov.au). However, this is after taking into account the amount of any trade discounts and volume rebates allowed by the entity. A number of conditions are set out for revenue to be recognized. These include the requirement for the entity to have transferred the significant risks and rewards of ownership of the goods to the buyer. The entity should not retain continuing managerial involvement to the degree usually associated with the ownership nor control over the goods sold. The amount of revenue should also be measurable reliably. It must also be probable that the economic benefits associated with the transaction will flow to the entity (International accounting standards board (IASB), 2013). Lastly, the costs incurred in relation to the transaction should be measurable reliably. In this case, the transactions relating to the revenue income are contained in its income statement. The company had revenue relating to the sale of goods worth $1,227,604,000. However, after subtracting the related expenses, this amounts to an income related to revenue of $19,826,000. b) Interest revenue The company realized interest income of $519,000 in 2014. The company recognizes interest income when it is probable that the economic benefits will flow to the group and the amount of revenue can reliably be measured (Barth, 2005). This is done in accordance to AASB 139. Interest revenue is accrued on a time basis, by reference to the principal outstanding and at all the effective interest rate applicable, which is the rate that exactly discount estimated future cash receipts through the expected lie of the financial asset to that asset’s net carrying amount on initial recognition. c) Other income As stated above, ‘income’ is described income as increases in economic benefits during the company’s accounting period in the form of inflows or enhancements of assets or decreases in liabilities which would result in increases in equity other than increases that result from contributions from equity participants. In this regard, the company realized a net gain in foreign exchange worth $16,000. This income arises owing to the company dealing with various currencies whose exchange rates vary (Barth, 2005). In addition, interest income arises on disposal of a foreign operation. All of the accumulated exchange differences in respect of such operation attributable to the group are reclassified as profit or loss. Any exchange differences that have previously been attributed to non-controlling interest are derecognized though not classified as profit or loss. In essence, Dick Smith Holdings Limited has recognized such income of net gain in foreign exchange in accordance to AASB 121. The company also recognized gain on sale of fixed assets worth $358, 000. This resulted from selling items of fixed assets at prices that were more than their book value and in this regard, the company recognizes such income in accordance to AASB 116. The company has also recognized an item of other income in the year 2014 worth $324,000 (Dick Smith Holdings Limited, 2014). This is in accordance to AASB 101. In conclusion, we can also measure the company’s income for the year 2014 by analyzing the changes in the company’s balance sheet but eliminating increases that might have been caused by capital contribution by shareholders. This is in line with balance sheet based income description. The relationship between the measurement of ‘income’ and decision useful information One of the objectives of measuring a firm’s assets is to enable the firm make informed investment decisions. Firms should ensure that the measurement methods they employ are decision useful. There are various types of income sources for the company as described above. In addition, it has been revealed that the measurement basis for assets and liabilities also determine a company’s income levels (Ann, 2007). This is because they are useful in generating income while their increases and decreases have direct effect on the company’s income. As such, the basis of income measurement whether historical, accrual or fair value basis will greatly determine the final amount of income reported by the firm which will in turn determine the kind of financial related decisions made by the company. Described above is how the company has measured its income despite the challenges described above. For example, it has been revealed that income related to revenue was measured on fair value basis in accordance to AASB 118. In addition, the company has also recognized the gain on sale of assets which were sold above their book value. In addition, it is worth noting that the income has also been reflected in the balance sheet through measuring increases in assets and liabilities after deducting the stock contributed by equity participants. In other words, the measurement basis employed by the firm should be accurate if it is to result in decision useful measurement and hence decision useful information (Willard, 2015). This has been demonstrated in the way Dick Smith Holdings Limited presents its financial report with their basis of measurement of their assets clearly explained. In accordance with the joint conceptual framework by both the financial accounting standards board as well as the international accounting standards board, financial information will be decision useful if it helps the user in forecasting the amount, timing and uncertainty of the entity’s future cash flows. As such, the income measurement basis used by the firm should lead to decision useful information. As discussed above, Dick Smith Holdings Limited uses income measurement methods that links the income sources to the manner in which they realize value for the firm (International accounting standards board (IASB), 2008). Thus, this provides decision useful information to the users including investors who are able to see how the company is performing in terms of generating returns and hence they are able to make informed investment decisions regarding the company. On the other hand, the company can be able to make informed expansion decisions which may include financing or borrowing decisions based on the income it has already measured and that which it expects (Ann, 2007). For instance using the financial measurement criteria discussed above, Dick Smith Holdings limited management was able to declare an 8 cents dividend to the shareholders while pursuing its expansion strategy (Barth, 2005). These decisions would require accurate information and as such, the measurement method used has to provide decision useful information to the company if the management is to make such decisions which directly affect the welfare of the company. Conclusion This paper has discussed the term income as increases in economic benefits during the company’s accounting period in the form of inflows or enhancements of assets or decreases in liabilities which would result in increases in equity other than increases that result from contributions from equity participants.. The various methods available for income measurement have also been discussed to depend with the nature of income in question. The challenges of income measurement have also been discussed in detail. Dick Smith Holdings Limited has been used in evaluating the categorization and treatment of various income sources in the financial statement. Finally, the relationship between income measurement and decision useful information with reference from Dick Smith Holdings Limited year 2014 annual report has been discussed at length. The need for the company to employ the right measurement criteria accurately has been seen as important. This is because measurement information ought to be accurate and hence decision useful. This will enable it to be decision useful so that its users can make quality and informed decisions. References: Willard, J2015, Some observations of the nature of income, generally accepted accounting principles and financial reporting, London, Rutledge. Deloitte, 2014, IAS 39-Financial instruments recognition and measurement, Retrieved on 30th May 2015, from; http://www.iasplus.com/en/standards/ias/ias39 Mheducation.com, 2015, Recognition and measurement concepts, retrieved on 30th May 2015, from; http://highered.mheducation.com/sites/0072994029/student_view0/ebook/chapter1/chbod y1/recognition_and_measurement_concepts.html Ifac.org2012, Conceptual framework exposure draft 3, Retrieved on 30th May 2015, from; http://www.ifac.org/sites/default/files/publications/files/Conceptual%20Framework%20E xposure%20Draft%203%20FINAL%20November%208,%202012_0.pdf Deloitte, 2010, Conceptual framework for financial reporting, Retrieved on 30th May 2015, from; http://www.iasplus.com/en/standards/other/framework ASX2014, Dick Smith Holdings Limited (DSH), Retrieved on 30th May 2015, from; http://www.fool.com.au/tickers/asx-dsh aasb.gov.au, Compiled AASB Standard: AASB 118, Retrieved on 30th May 2015, from; http://www.aasb.gov.au/admin/file/content105/c9/AASB118_07-04_COMPmay09_01- 10.pdf European accounting association, 2014, A review of the conceptual framework for financial reporting, Retrieved on 30th May 2015, from; http://www.efrag.org/files/Conceptual%20Framework%202013/Comment%20letters%20 received/DCL/CL15_-_EAA.pdf Chartered Accountants, 2015, Financial statement presentation-Other comprehensive income, Retrieved on 30th May 2015, from; http://www.charteredaccountants.com.au/Industry-Topics/Reporting/Current- issues/Convergence/News-and-updates/Financial-statement-presentation-other- comprehensive-income International accounting standards board (IASB), 2008, Exposure draft: An improved conceptual framework for financial reporting, London, UK IASB. International accounting standards board (IASB), 2010, Conceptual framework for financial reporting, 2010, UK: IASB. International accounting standards board (IASB), 2013, Discussion paper: A review of the conceptual framework for financial reporting, London, UK: IASB. Barth, M2005, Accounting based valuation models and the prediction of equity values, Journal of Accounting, Auditing & Finance, vol. 20, no. 4, pp. 311-345. Dick Smith Holdings Limited, 2014, Annual report 2014, retrieved on 30th May 2015, from; http://dicksmithholdings.com.au/wpcontent/uploads/2014/09/DKS0006_AR_PFO2_Low_res_version.pdf Ann, T2007, Identifying decision useful information with the matrix format income statement, London, Rutledge. Read More