Application of the Accounting Theory - Example

The Victorian Desalination Plant By student’s name Course code+ name Professor’s name University name City, state Date of submission Table of Contents Executive Summary 3 Introduction 4 Accounting Theories applicable to the Victoria Desalination Plant Case Study 4 The Stakeholder Theory 4 The Positive Accounting Theory 5 Agency Theory 5 System-Based Theories on water and water prices regulation 6 The Public Interest Theory 6 The Economic Theory 6 Political Economic Theories 7 Measurement and Valuation of an asset 7 The Measurement of the Desalination Plant as an asset 7 Asset Valuation Techniques 8 Accounting assumptions and principles arising from the case study 9 The Initial cost of the Desalination Plant 9 Conclusion 9 References 11 Executive Summary The investment by state governments in desalination plants in Australia has its basis in accounting theories. The positive accounting theory provides that the desire to pursue self-interests guides an individual’s action. The need for more revenue by the state governments acts as an incentive to the large investments in the construction plants. Other accounting theories such as the stakeholder theory and agency theory also explain the actions by the state governments. System based theories such as the public interest theory, the economic theory, and the public economic theory explain the basis for water and water prices regulation. The construction of the Victorian Desalination Plant contains many aspects of accounting principles and theories that appear in the course of the transactions. The report evaluates the compliance of the project to accounting standards in Australia and highlights the weaknesses in the project. It focuses on the measurement of the desalination plant to establish whether or not it has potential economic benefits flowing to AquaSure Company. The different variation techniques applied in the Australian water industry are discussed, and the impact of such methods is provided. Introduction This report looks at accounting theories and how they apply to the Victorian Desalination plant case study. The report also looks into accounting standards and principles and how they are applicable in the case study presented. Accounting Theories applicable to the Victoria Desalination Plant Case Study The Stakeholder Theory The stakeholder theory deals with the management of an organization and is concerned with the morals and values that are incorporated in managing the corporation (Corfield 1998, 2). The theory demands that the management of an organization should weigh their intended actions based on the impact on shareholders, employees and customers. The managerial perspective of the stakeholder theory requires an organization’s management to identify certain activities and direct resources to them for the benefit of legitimate stakeholders. The concern by State Governments about the lengthy drought arose from the effect that such occurrences had on the shareholders of these States. The shareholders for the state governments can be considered as the corporations, businesses, and individuals who contribute to the revenue required to run the states. The Victorian government had to invest in the desalination plant for the benefit of the companies and individuals residing in the state. The fact that these stakeholders could locate to other areas due to the drought led to the investment and construction of desalination plants in major cities. These plants had many benefits for the stakeholders in the state and, as a result, the governments had to invest (Donaldson and Preston 1995, 85). The Positive Accounting Theory State Governments invest lots of money in the construction of desalination plants because such measures will create more sources of revenue for the government. The Positive accounting theory is based on the idea that individuals will be driven by self-interests in their actions. As a result, all actions by an individual will be directed towards increasing their wealth. This concept clearly explains the basis for the decisions of state governments to invest in desalination plants (Gaffikin 2007, 8). The construction of desalination plants ensures that the residents of different states such as Victoria have access to water. The scarcity of water in Australia means that the state governments stand to gain from investing in such plants. According to the positive accounting theory, state governments invest in desalination plants because of the potential revenue that will be collected once the plants are operational. The investment is not based on the interests of the stakeholders but rather of the state government in the collection of funds. These investments are made based on the desire by these governments to collect more revenue (Angus 2014, 5). Agency Theory The agency theory asserts that agents perform their duties or tasks based on the responsibilities bestowed upon them by the principal. State governments are the agents of the people. They have to ensure that they perform their duties in the best interests of the principal. As a result, due to drought, state governments have to invest in desalination plants for the benefit of the citizens (Gaffikin 2007, 8). The Victorian government is an agent of the people. The fact that drought affects the interests of the people means that the state has to respond to safeguard their interests through investing in the desalination plant. System-Based Theories on water and water prices regulation The idea of regulation is based on the idea that the operation of market forces does not always serve the interests of the public. There are certain areas where natural monopolies arise such as in the supply of water, electricity and gas. In such cases, regulation is necessary to ensure fair trading. There are certain regulation theories that can be used to explain why water prices are regulated in Australia. The Public Interest Theory The public interest theory asserts that regulation is necessary to correct inequitable markets in certain areas. According to this theory, the purpose of regulation is to ensure that the interests of the public are safeguarded where such a result would not be achieved if the issue is left to the market. The regulation of water and water prices by states is to ensure that public interest is safeguarded. Water suppliers are likely to increase water prices as a way to gain more profits at the expense of the public. Regulation in Australian states is used as a way to ensure that the public is protected from such suppliers. The Economic Theory The economic theory of regulation states that political leaders will act in ways that will ensure their re-election into office. The theory states that regulators will put measures to curb certain behavior for their benefit. Based on this theory, states in Australia regulate water and water prices with the intention of appeasing the public. The goal is to remain in office. Such regulation, in most cases, serves private interests. However, where private and public interests are the same, the citizens benefit (Gipper et al. 2013, 41). To ensure that they please the electorate, politicians enforce measures to regulate water prices to safeguard public interests. Political Economic Theories The regulation of water prices can also be explained through the political, economic theories. According to these theories, regulation is necessary for addressing the social inequalities that exist among social classes due to market forces. Water suppliers in Australia are companies owned by wealthy individuals. The regulation of water prices is, therefore, necessary to protect the citizens who have less economic power. Measurement and Valuation of an asset The Measurement of the Desalination Plant as an asset According to paragraph 49 of Conceptual Framework 2013, an asset can only be a resource that is under the control of an entity and from which economic benefits are expected to flow in future. This position is further reinforced by paragraph 89 of the Conceptual Framework. In this case, the desalination plant is the asset. Paragraph 55(a) provides that economic benefits may flow from the production of goods and services to be sold by the entity. The plant produces water to be used by residents and companies. Through the sale of water, AquaSure acquires economic benefits. Any entity that owns an asset has the right to exchange such a resource with another party for other resources or other favorable terms (Paragraph 4.8(a)(iii) of ED 264 Exposure Draft 2015). The desalination plant cannot be exchanged for other assets by AquaSure. This is because though they have the rights of ownership, the agreement is for the construction of the plant, collect revenue for some years and transfer the asset to the state government. Regarding the exchange with other assets, the desalination plant does not qualify as an asset. According to paragraph 4.14(d) of the Exposure Draft 2015, the fact that an asset must have potential economic benefits includes the transfer of the resource to settle certain liabilities. The desalination plant remained with AquaSure as a way to settle the debt the state owed to the entity for the construction. This meets the requirement for an asset. However, the entity cannot proceed to settle its liabilities through the asset since it has to revert to the state in 2039. An asset can ensure the flow of economic benefits to an entity where such a resource can be distributed to the owners especially in the case of insolvency. The desalination plant cannot be transferred to the owners of the entity. Regarding paragraph 55(b), the plant is not an asset. Asset Valuation Techniques The valuation of assets of an entity is meant to provide a fair value for the resources. The objective is to estimate the price of the asset as at that time taking into consideration the depreciation of the asset (Paragraph 23 of AASB 116- Property, Plant, and Equipment). The cost if the item or property is determined such that an entity can easily exchange or sell the resource after the valuation or measurement. The valuation of the resources is carried out using different techniques that are broadly divided into the historic cost or fair value (Comisari et al. 2015, 21). Fair value is determined by the market value of the asset. However, this technique is inapplicable in many circumstances. As a result, entities are forced to use other valuation techniques such as current replacement cost and the income approach. These techniques provide different values of the assets (IFRS 2015, 72). The effect of the use of different values has an impact on water prices. In cases where the value of the asset is high, the cost of production of water may be considered to increase and hence the price of water increases. Further, water businesses that use a valuation technique whose results portray a higher value for the asset, their financial statements portray a financially strong entity. Accounting assumptions and principles arising from the case study i. The fact that the cost of 263 hectares of land purchased by the government was not added to the initial cost breached the full disclosure principle. According to this principle, an entity ought to reveal all information that would affect the understanding of the statements. ii. The refund of the overpayments to consumers was reflected as a decrease in the assets or the resources of Melbourne Water and the other four water businesses. The entry on the balance sheets indicated a decrease of value in the resources. The Initial cost of the Desalination Plant Items of property that are acquired and are necessary for an entity to obtain future economic benefit are considered as assets. These items should be included in the initial costs of the asset. The 32-year lease on a strip of coastal land, the leased crown land and the 27 year rental of the built pipe should all be included in the initial costs. The cost of the 263 hectares of farm land also forms part of the initial cost. This is because these properties contribute to the ability of the entity to acquire future economic benefit from the plant. Conclusion The investment by state governments in desalination plants in Australia has its foundations in the stakeholder theory, the positive accounting theory, and the agency theory. These theories suggest that people act in certain ways for personal benefits. However, in this case, the benefit to the public is enormous. The regulation of water and water resources ensures that the interests of the public are safeguarded. The water industry in Australia needs to be streamlined especially in ensuring that it conforms to accounting standards and principles. There should be a prescribed asset valuation technique to be used by all suppliers and stakeholders as a way to guarantee uniformity and protect consumers. Principles such as the full disclosure principle should be applied in the water industry. Transactions involved in water projects should be well recorded and presented in the financial statements of water suppliers and stakeholders. This will ensure that such information is reliable to outsiders. Stringent measures should be applied to ensure that water suppliers conform to the standards set by the Australian Accounting Standards Board. References Angus, O 2014, Theories of Accounting: Evolution and developments, income determination and diversities in use, Research Journal of Finance and Accounting, 5(19), 1-16. Australian Accounting Standards Board 2013, AASB 116- Property, Plant, and Equipment, Available at http://www.aasb.gov.au/admin/file/content105/c9/AASB116_07-04_COMPjun14_07-14.pdf [Accessed 10 February 2016] Australian Accounting Standards Board 2013, AASB 13- Fair Value Measurement, Available at http://www.aasb.gov.au/admin/file/content105/c9/AASB13_09-11_COMPdec12_07-13.pdf [Accessed 10 February 2016] Australian Accounting Standards Board 2013, Framework for the preparation and presentation of financial statements, Available at http://www.aasb.gov.au/admin/file/content105/c9/Framework_07-04_COMPdec07_01-09.pdf [Accessed 10 February 2016] Australian Accounting Standards Board 2015, ED 264- Conceptual framework for financial reporting, Available at http://www.aasb.gov.au/admin/file/content105/c9/ACCED264_06-15.pdf [Accessed 10 February 2016] Comisari, P, Feng, L and Freeman, B 2015, Valuation of water resources and water infrastructure assets, Australian Bureau of Statistics. 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