Part 1: How Accounting Policy Choice can affect financial results

Accounting policy is adopted by each and every organization whether it is small or short as the accounting policy describes the business of the organization and helps in providing the best results to their shareholders and other users of the financial statements. The report has been started with the executive summary detailing the aim of the study. Then introduction has been given detailing the structure of the report. The main body of the report starts from first part detailing how accounting policy can affect the financial results of the company. Second part deals with the reasons for material disclosures of financial information. Third part deals with explanation of the revenue recognition policy. Fourth part deals with explaining matching of ASIC and CPA requirements with revenue recognition and revenue from contracts with customers. Fifth part deals with review of the annual reports of the company. For the purpose of analysis – Woolworths Limited has been selected. Last part deals with explanation of the accounting choices in relation to revenue recognition standards and revenue from contracts with customers keeping in consideration the positive accounting theory. At the last the report has been ended with the conclusion and the proper recommendation. The data for analysis has been obtained from the relevant and reliable secondary sources.  

How Accounting Policy Choice can affect financial results

Financial statements provide the financial as well as non financial information to the users to judge about the financial position and financial performance of the company. Users of the financial statements generally have the view that the financial information so provided by the company is reliable and relevant for their purpose of making decision but in reality there always remain the scope of manipulation in the financial statements so disclosed in order to come up with the expectation of the users. This manipulation occurs generally because of the choices made by the company in the accounting policy adoption (Mance and Katunar, 2012).

As per the International Accounting Standard 8, Accounting policies are defined as the rules, practices and conventions applied by the companies in order to present the financial statements of the company in a uniform and the consistent manner. There has always been the incentive for managers of the company who are engaged in the presentation and preparation of financial statements to mould or change the accounting policy to have benefit in the following terms:

• To give benefit to the shareholders of the company, stakeholders and other users
• To give benefit to the management of the company (Juric, 2014).

Therefore, there is the high possibility of manipulating the accounting treatment of the certain heads of expenditure, income, assets and liabilities. These manipulations are generally happened with the connivance of change in accounting policy.

In the following ways the financial results can be affected by the change in accounting policy (Alayemi, 2015):

Asset Valuation – In most of the assets are valued at Historical cost and are carried at the cost less depreciation and impairment if any and is mentioned as Net Carrying amount. As per the provisions of accounting concepts, there shall be the proper bifurcation of the amount incurred as revenue or capital expenditure. As most of the times, companies in order to have higher asset value capitalize the amount incurred in the value of asset rather than expensing the same in the Profit and Loss Account. Also as per the provisions of Corporations Act 2001, any item costing less than dollar five thousand is required to be expenses off in the same year. But the preparers of the financial statements tend to capitalize the same with the connivance of the auditors.

Part 2: ASIC Focus on Material Disclosures

Revenue Recognition – Different companies adopts different methods for recognizing the revenue. Along with the revenue recognition the principle of matching shall also be followed. Sometimes in order to have less profit the company changes the policy and defers the recognition of revenue in the future years and order to have high profit, the company recognizes the revenue in advance.

Tax – The changes in accounting policy for recognizing revenue is considered with tax base. As the accounting policy is generally changed to reduce the profit and tax thereon. Also the change in depreciation policy is done to reduce the effect of resultant deferred tax assets and deferred tax liabilities and expense thereon.                    

ASIC, though has been focusing on the major issues, from the year ending December 2014 has been in the urge of focusing on the investigation of the material items which are required to be disclosed in the financial statements. In the literature it has been mentioned that the focus areas of the ASIC’s investigation are the impairment of an asset and how it has been recognized, which accounting policy has been chosen and why, how the revenue and expenses has been recognized in the given reporting period and the necessary disclosures required as per the defined accounting standards. The reasons for ASIC investigations on major focus areas in parlance with the research are as follows:

Accounting Estimates – One of the major focus areas is the assumptions made regarding the estimates by the management for various heads. The reasons for the same is to ensure the following:

The assumption regarding the cash flows shall be reliable keeping in regard to the previous year results. This will help in identifying the value in use of an asset and correspondingly the impairment will be done for that particular asset. In case the previous year results are not in commensurate with the predefine objectives of the company then the cash flows of the current year under questions shall be projected with due professional care.

The amortization of the assets shall be reviewed every year and amortized accordingly and checking the basis which the company has undertaken to determine the assets having an indefinite life which in that case will never be amortized.

Accounting Policies– Second focus areas is the choice in accounting policy. The accounting policies are provided by the statutes, laws, rules and regulations which are required to be adopted while accounting for any transaction in the books of accounts. These accounting policies have been liberalized by the preparers and presenters of the financial statements to have the benefit either for the shareholders and stakeholders of the company. Thus, the ASIC investigation is required in these areas as the management of the company will always have the tendency to gain more and more and for that they will put the accounting policy in question and change the accounting policy to achieve the objectives. For instance, the ASIC will investigate in the following areas of accounting policy changes:

Part 3: Belief of CPA Australia in Revenue Recognition Policy

The major area is off balance sheet arrangements which are required to be disclosed as per the accounting standard. The management of the company shall disclose the accounting method adopted for accounting of the joint agreements or similar nature items.

Second area is revenue recognition. The accountants of the company generally deviates the principles and recognizes the revenue keeping in view of the benefits of management and stakeholders of the company.

Therefore, ASIC investigates into material disclosures of information.

Revenue is defined as the inflow of benefits that the company receives from the customers during the routine or normal course of business. It shall bring the addition in the equity of the company at the end of the reporting period other than those which is received from the shareholders of the company. It does not include any amount which is collected on behalf of the third parties like sales tax, excise and other similar duties (IAS 18, 2011).

In the given literature, it is mentioned that the suitable revenue recognition policy requires the appropriate timing of the recognition and which thus reflects the substance of the transaction.

The first major area is the suitable revenue recognition policy. The revenue shall be recognized by every company keeping in consideration the nature and type of the business arrangements and the relevant provisions of the accounting standards. Some companies recognize their revenue when the good are received by the buyer company and some companies requires on the basis of the payment received from the customers. Thus, the company shall have suitable recognition policy and which shall have focus on the two factors namely correct time for recognition and major substance of the transaction. The second major area which lies in the standard is the timing of recognition. The revenue shall be recognized at the time when it has been due according to the terms of the arrangement and the conditions thereof. For instance, if the company sells the goods on free on board basis then the sale shall be booked once the goods is loaded at the custom port and bill of lading is issued. Similarly, the purchaser will book the purchases on the same date. This is because the risks and reward have been transferred when the goods are loaded on the seller custom port. Thus, the timing plays very important part in the revenue recognition policy.

The third area which has been dealt in the statement is substance of the transaction. It means the reality of the transaction and it is so incorporated in the statement of CPA Australia so as to lay down emphasis on the reality of the transaction and how the same is relevant in the revenue recognition. It lays down that along with suitable recognition policy and timing of recognition, the substance of the transaction is very necessary. It is because the revenue recognized shall detail the reality of the transaction detailing how it has happened and on what basis the revenue has been recognized. Thus, the CPA Australia belief is in parlance with the ASIC statements.     

Conclusion

Revenue Recognition Criteria in AASB 118/ IAS 18 and AASB 15/ IFRS 15 with ASIC and CPA

The procedure to recognize the revenue is governed by the International Accounting Standard 18 on Revenue. Each and every transaction is required to be recognized separately and as per the following criteria:

• The company has transferred the risks and rewards of the goods to the buyer
• The company shall not in any case exercises the managerial control over the ownership of the goods or efficient control over the goods
• The amount so charged as the revenue for sale of goods can be measured reliably and
• There are more than probable chances of having the inflows to the company from the transactions so made and
• The cost incurred in relation to sale if any can be measured in actual and reliable terms (IAS 18, 2011).

The revenue from contracts with Customers is governed by the Australian Accounting Standard 15 and it provides the following recognition criteria:

Contract Identification –It must be approved and shall be between two or more parties. It shall identify the right of parties to the contracts regarding the foods or service to be transferred or provisioned. Also contains the payment terms and conditions and shall disclose the timing, extent of risk and the amount of cash flows and may also contain the variation in consideration in case discount or any concession is extended to the customers. .

Combination of Contracts – The Company may combine the contracts with the same party in case the result of both the contracts is interdependent or the obligation of one contract depends on the result of another.

Modifications in Contract – The modifications in the contract generally occur when the scope of the deliverables is increased or when the contract price is changed due to the escalations as per the changing market conditions.

Performance Obligations Identification – The obligations towards the performance of the contract shall be identified from the beginning of the contract. This is identified by considering the goods to be transferred to the customer some are explicitly stated and others are implied with the terms of the contract.

Performance Obligations Satisfaction – It is the point where the revenue is recognized and it shall be recognized when after identifying the performance obligation the company has been able to provide the goods or services to the customers and that too tallies with the specifications made by the customer and also when the ownership and risk is transferred to the customer (AASB 15, 2014).

ASIC and CPA statement of having the suitable recognition policy which states appropriate application of the timing of recognition of revenue is in link with the recognition criteria defined by both the accounting standards. . In each of the standard, the recognition criteria define how to apply and the correct time when to recognize the revenue and also how to maintain the generality and actuality of the transactions. 

Analysis of Financial Reports of the Company in terms of the Revenue for the last three years

The company Woolworths limited has been selected for the purpose of making analysis and interpretation with regard to the revenue recognition policy. The company is registered in Australia and listed in the Australian Stock Exchanges and is one out of ASX 500 companies. The company is engaged in the business of Supermarket where all goods are made available to meet the basic and daily needs of life and is the leading company having super market chains in Australia and across New Zealand (Woolworths Official Website).

Revenue Recognitions made by the company during the last three years –

In the year 2016 – Revenue has been measured at the fair value of the consideration which has been received or will be received in the coming year depending up on the fulfillment of the criteria for recognizing the revenue. The criterion is as follows:

Revenue for goods is to be recognized when the risks and rewards related to goods is transferred to the customers and there are high chances that the revenue will be realized and the amount of revenue so realized or will be realized can be measured reliably.

Revenue from services is to be recognized on the basis of stage of completion method and as mentioned in the terms of the contract (Woolworths Official Website)..

In the year 2015 and 2014, revenue for goods have been recognized in the same manner as in the year 2016 but an extended one line has been mentioned as revenue recognized shall be net of return and discounts.

Thus, in this way there has been no diversion in the revenue recognition policy of the company for the last three years except the revenue from service has been added in the year 2016 and that too in accordance with the recognition criteria as defined in the International Accounting Standard 18.                                              

                                                                                                                        (Amount in $million)

                                                            2016                            2015                            2014

Revenue from Sale of Goods             58085                          58812                          60772

Revenue from Sale of Services           277                              —–                              ——

There has been variation in the figure of turnover but there has been no change in the revenue recognition policy and criteria.

As per the Note number 1 of the significant accounting policy of the annual report of the company, the new standard AASB 15 of Revenue from Contracts with Customers will be effective from 1^st of January 2018 but the Group has started the assessment of the disclosure requirements of the standards (Woolworths Official Website)..   

As per the Watts and Zimmerman, Positive accounting theory helps in explaining and predicting the unobserved phenomena and gives various observations but in no case the theory does not provide any guiding factor. For instance the theory can explain and predict as to which company or firm shall use which accounting policy but it does not describes as to which particular accounting policy or method shall be used by the firm (Watts and Zimmerman, 2015). For instance, positive accounting theory will predict and explain as to why most of the companies are measuring their tangible assets at the historical cost and why some companies are measuring their tangible asset at fair value but it does not describes as to which method of valuation of fixed assets shall be adopted by which firms or companies.

Positive accounting theory has been based on the understanding that the individuals employed in the organization have self interest behavior and have laid down three hypotheses on the basis of which the accounting policy is chosen:

Bonus Plan hypothesis – This hypotheses lay down that the managers shall choose such accounting method which will enhance their bonus earnings. Hence, in accordance with IAS 18, the managers may choose the policy of non deferral of revenue and booking the revenue in the same reporting period.

Debt / Equity Hypotheses – If the ratio is high, then the managers will tend to have such an accounting policy which will help the company to have higher income so as to decrease the financial cost.

Political Hypotheses – If there is likely event that the accounts of the company are required to be audited by the tax authorities then the managers will tend to have incorporated such accounting policy which will help in reducing the net profit of the company and tax burden thereon (Deegan, 2014).  

Thus, these factors influence the pattern of choice made in the accounting policy.  

Conclusion and Recommendation

The accounting policy plays very important role in preparation and presentation of the financial statements of the company. The accounting policy shall be chosen with due professional care and having regard to the predefined standards, laws and act.  The change in accounting policy from year to year mainly depends on the outlook of the company including management and the employees. Through this report, the change in accounting policy and accounting estimates have been reflected with reference to the revenue recognition standards and the policy that has been adopted by the selected company namely – Woolworths Limited.  To conclude, the report has identified the importance of revenue recognition standard and overview of new standard on Revenue from contracts with customers.

It is recommended to change the accounting policy but is shall be in accordance with the relevant accounting standards and other laws and shall be for the benefit of the stakeholders as well as for the company.   

References 

AASB 15,(2014), “Revenue from Contracts with Customers”, available on https://www.aasb.gov.au/admin/file/content105/c9/AASB15_12-14.pdf  accessed on 13/05/2017. 

Alayemi A, (2015), “Choice of Accounting policy : Effects on Analysis and Interpretation of Financial Statements” available on https://www.google.co.in/url?sa=t&rct=j&q=&edata-src=s&source=web&cd=2&cad=rja&uact=8&ved=0ahUKEwiIjfz6-uvTAhXGRY8KHQRqCqIQFggvMAE&url=http%3A%2F%2Ffiles.aiscience.org%2Fjournal%2Farticle%2Fpdf%2F70200037.pdf&usg=AFQjCNE7xDAf38p2oUXi6PpDZfzjwFe8WQ  accessed on 13/05/2017. 

Deegan C, (2014), “Financial Accounting theory”, available on https://www.sekoyen.com/DeeganFAT_3e_Chapter_01.pdf   accessed on 13/05/2017. 

IAS 18, (2011), “Revenue”, available on https://ec.europa.eu/internal_market/accounting/docs/consolidated/ias18_en.pdf  accessed on 13/05/2017. 

Juric D, (2014), “Effect of Accounting policies on Financial Position of Small and Medium Sized Enterprises”, available on file:///C:/Users/admin/Downloads/Effect_Of_Accounting_Policies_On_Financial_Position_Of_Small.pdf    accessed on 13/05/2017. 

Mance D and Katunar H, (2012), “Influences on and Consequences of Accounting Policy Choices”, available on https://bib.irb.hr/datoteka/518772.Mance__Katunar_-_Influences_on_and_Consequences_of_Accounting_Policy_Choices.pdf  

Watts R. and Zimmerman L. (2015), “Positive Accounting Theory : A Ten YearPerspective”,availableon  https://faculty.etsu.edu/pointer/watts%26zimmerman2.pdf accessed on 13/05/2017 

Woolworths Official Website, “Annual Reports, available on https://www.woolworthsgroup.com.au/icms_docs/185865_annual-report accessed on 13/05/2017.