australian accounting standards

31790356. recognise the adjustment as an expense of the current period rather than making retrospective adjustments to prior period balances (for example, debit an inventory write-down expense and credit the balance of inventory)

Where an error in an account balance is discovered after financial statements have been issued, the accounting standard that applied previously to balance sheets, AASB 1040 permitted the subsequent reissue of the financial statements showing the amended figures. Alternatively, if replacement financial statements were not issued (which was often the case), AASB 1040 (and AASB 1018, which related to statements of financial performance) required the correction to be made in the period in which the error was discovered. That is, if it was decided not to issue amended financial statement AASB 1040 (and AASB1018) required that the error be corrected in the financial period in which the error was discovered, with appropriate adjustments made to the affected items that are still recognised in the balance sheet. Therefore AASB 1040 required the adoption of either the first or third listed option listed earlier.

With the release of AASB 108 ‘Accounting Policies, Changes in Accounting Estimates and Errors’ in July 2004, the required approach to accounting for prior period errors has changed. AASB 108 mandated a retrospective basis for the correction of errors, adopting the perspective that the financial statements be presented as though the error never occurred. That is, if a prior period error is discovered, the requirements in Australia now state the use of the second option listed above. It has been mentioned in Financial Company Accounting that retrospective adjustments have been typically opposed by Australian accounting regulators and as such has been a major change to Australian accounting procedures.

Inappropriate deferring of expenses as assets

The AASB Framework defines an asset as ‘a resource controlled by the entity as a result of past events and from which economic benefits are expected to flow to the entity.’ Furthermore the AASB framework states that in order for an asset to be recognised in the balance sheet future economic benefits must be both probable and capable of reliable measurement.

Given that the recognition criteria are based on measurement and probability the recognition of an asset will frequently depend on professional judgement. It is, therefore, possible that an expenditure that is deemed an asset by one account preparer might be considered an expense by another. Such differences of opinion will have obvious consequences for the reported profits of reporting entities.

As indicated earlier the essence of an asset is the ‘future economic benefits’ that the item will generate. Further, it must be ‘probable’ that these economic benefits will be generated and the asset must posses a cost or a value that can be measured reliably. However, the notion of whether future revenue will be generated by current expenditure is not always clear. For example, advertising expenditure, and its uncertainty of generating future returns even though the concept of undertaking advertising is to generate future benefits. Because the returns are uncertain, it is usual for expenditure such as advertising to be written off as incurred. Furthermore the future economic benefits to be derived from advertising cannot generally be 'measured reliably', which is one criterion for asset recognition in the AASB Framework. AASB 138 'Intangible Assets' would also act to preclude the recognition of advertising expenditures as an asset. However, if an advertising campaign has been paid for upfront but the advertising services have not been provided by balance date, the expenditure would typically be treated as a current asset in the form of a prepayment.

If a firm capitalises certain expenditures, rather than writing them off as incurred, its assets and profits will obviously be higher in the year of deferral. However, it should be noted that in the years subsequent to the deferral, the profits of a firm will be higher if it has already expensed items rather than capitalising them, this is because there is nothing to depreciate/amortise in subsequent years. Firms that capitalise such expenditures will report higher depreciation/amortisation charges and therefore lower profits in future periods.

Like mentioned earlier, certain expenditure is not always clearly defined and it is not easy to generally classify expenditure as an asset or an expense. Choosing one or another also affects the outcome of the financial statements that may be positive or negative to users of these statements; therefore, a high degree of professional judgement is necessary.

AASB 136 Impairment of an Asset

Write-off of expenses to retained earnings AASB 108

The objective of the Standard AASB108 is to prescribe the criteria for selecting and changing accounting policies, together with the accounting treatment and disclosure of changes in accounting policies changes in accounting estimates and correction errors. The Standard is intended to enhance the relevance and reliability of an entity’s financial report and the comparability of those financial reports over time and with the financial reports of other entities.

[Pr.32] As a result of the uncertainties inherent in business activities, many items in a financial report cannot be measured with precision but can only be estimated. Estimation involves judgements based on the latest available, reliable information.

For example. Estimates may be required of:

• Bad debts;
• Inventory obsolescence;
• The fair value of financial assets or financial liabilities;
• The useful lives of, or expected pattern of consumption of the future economic benefits embodied in, depreciable assets; and
• Warranty obligations

Premature recognition of revenue for example through attaching all revenue to one component of a contract involving multiple deliverables.

The primary issue in accounting for revenue is determining when to recognise revenue. Revenue is recognised when it is probable that future economic benefits will flow to the entity and these benefits can be measured reliably. AASB 118 ‘Revenue’ identifies the circumstances in which these criteria will be met and, therefore, revenue will be recognised. It also provides practical guidance on the application of these criteria.

Recognition of revenue will depend on which category revenue falls in. As paragraph 1 of AASB 118 states, AASB 118 is to be applied to accounting for revenue arising from transactions and events pertaining to:

1. the sale of goods;
2. the rendering of services; and
3. the use by others of entity assets yielding interest, royalties and dividends.

In relation to the question asked, part (b) the rendering of services, seems to fit in order to provide a possible solution to the issue listed above. Paragraph 4 of AASB 118 further states:

The rendering of services typically involves the performance by the entity of contractually agreed task over an agreed period of time. The services may be rendered within a single period or over more than one period.

Revenue that arises from these contracts is dealt with in the standard AASB 111 ‘Construction Contracts’. When the outcome of a transaction involving the rendering of services can be estimated reliably, revenue associated with the transaction is recognised by reference to the stage of completion of the transaction at the reporting dare. As stipulated at paragraph 20 of AASB 118, the outcome of a transaction can be estimated reliably when the following are satisfied:

1. the amount of revenue can be measured reliably;
2. it is probable that the economic benefits associated with the transaction will flow to the entity;
3. the stage of completion of the transaction at the reporting date can be measured reliably; and
4. the costs incurred for the transaction and the costs to complete the transaction can be measured reliably.

[Pr.21] The recognition of revenue by reference to the stage of completion of a transaction is often referred to as the percentage of completion method. Under this method, revenue is recognised in the reporting periods in which the services are rendered. The recognition of revenue on this basis provides useful information of the extent of service activity and performance during a period. AASB 111 Construction Contracts also requires the recognition of revenue on this basis. The requirements of that Standard are generally applicable to the recognition of revenue and the associated expenses for a transaction involving the rendering of services.

[Pr.30] The stage of completion of a contract may be determined in a variety of ways. The entity uses the method that measures reliably the work performed. Depending on the nature of the contract, the methods may include:

• The proportion that contracts costs incurred to work performed to date bear the estimated total contract cost;
• Surveys of work performed; or
• Completion of a physical proportion of the contract work

For practical purposes, when services are performed by an indeterminate number of acts over a specified period of time, revenue is recognised on a straight-line basis over the specified period unless there is evidence that some other method better represents the stage of completion. When a specific act is much more significant than any other acts, the recognition of revenue is postponed until the significant act is executed.

3. Discuss the premise that compliance with accounting standards does not necessarily coincide with good corporate governance.

Under the Australian Stock Exchange (ASX) Listing Rule 4.10, companies are required to disclose in their Annual Report the extent to which they have followed the best practice recommendations of the ASX Corporate Governance Council. Corporate governance is the system of which companies are directed and managed. It influences how the objectives of the company are achieved, how risk is monitored and assessed and how performance is optimised.

A good corporate governance structure is one which creates value and provides an accountability and control system that creates equilibrium with the risk involved. Corporate governance is said to be a “set of processes, customs, policies, laws and institutions affecting the way a corporation is directed, administered or controlled” 

There is no single model of good corporate governance. There are however, 10 core principles that the ASX Corporate Governance Council believes underlie good corporate governance. Although the Council’s recommendations are not mandatory and cannot prevent corporate failure or mistakes in corporate decision-making, they can provide a reference point for enhanced structures to minimize problems and optimize performance and accountability.

What constitutes good corporate governance will evolve with the changing circumstances of a company and must be tailored to meet those circumstances. Best practice must also evolve with developments both in Australia and overseas.

Financial reporting is a crucial element necessary for the corporate governance system to function effectively. Current accounting standards allow a degree of choice of method in determining the method of measurement, criteria for recognition, and even the definition of the accounting entity. The exercise of this choice to improve apparent performance (popularly known as ) imposes extra information costs on users. In the extreme, it can involve non-disclosure of information. An example of misleading financial reporting is the Enron collapse. Enron concealed huge losses by creating illusions that a third party was contractually obliged to pay the amount of any losses. However, the third party was an entity in which Enron had a substantial economic stake.

Nonetheless, good financial reporting is not a sufficient condition for the effectiveness of corporate governance if users do not process it, or if the informed user is unable to exercise a monitoring role due to high costs.

Like mention earlier, there are no set rules for achieving good corporate governance but principles that might help achieve this concept. Accounting standards are basically on the same lines as those of achieving good corporate governance. They are a set of ‘rules of the road’ that govern the way in which financial statement are prepared so that different financial statements are comparable. Historically, they have been drawn up on a national basis at an individual country level, similar to rules of the road. However, with the increasing globalisation of business, there has been a need to make financial statements comparable across national boundaries and this was the driving force behind the adoption of the international standards in Australia in 2005.

Furthermore, accounting standards are there to help entities comply with the laws governed in the Corporations Act and consecutively eliminate fraud. Although these standards are not compulsory and abiding to appropriate standards is not either, but failing to do so may lead to consequences.

---

REFERENCE

Australian Securities and Investment Commission 2000, ASIC Accounting Focus Promasic Accounting Focus Promotes Investor Confidence, viewed 22 April 2008, 

<http://www.asic.gov.au/asic/pdflib.nsf/LookupByFileName/99-220.pdf/$file/99-220.pdf>

Australian Securities and Investment Commission 2000, New ASIC Surveillance Targets Books and Records, viewed 23 April 2008

<http://www.asic.gov.au/asic/pdflib.nsf/LookupByFileName/98-250.pdf/$file/98-250.pdf>

Australian Securities and Investment Commission 2000, Surveillance of  Company Financial Reports, viewed 23 April 2008, 

<http://www.fido.asic.gov.au/asic/pdflib.nsf/LookupByFileName/00-100.pdf/$file/00-100.pdf>

Parliament of Australia 2006, Chapter 2 - Report on Annual Report and the activities of ASIC, viewed 22 April 2008, <>

Wikipedia 2008, Corporate Governance, viewed 24 2008, <http://en.wikipedia.org/wiki/Corporate_governance>

---