Provision For Unreported Claims

Depreciation can be treated a part of the cost of a manufacturer’s products or a selling expense or an administrative expense. The nomenclature depends on the functioning of the asset being depreciated. In this case study of Timber Floors Pty. Ltd (TFPL), the assets are either those which are used in the manufacturing process, or are for use as administrative tools or for selling of the products, But they are all being used by the management for earning a business income. Hence, we will include all the depreciation charged as an overhead cost of TFPL’s manufacturing process, says Barkoczy, (2018).

TFPL is a Small Business Entity (SBE) because from 1 July 2016 onwards its turnover is less the $10million per annum, hence the management can use the simplified depreciation rules. Under these rules, the management can –

• Claim full cost of assets costing less than $20,000 in the first year of their purchase until 30 June 2018.
• Pool all assets which have higher costs than the threshold limit and claim a 15% deduction as depreciation in the first year of purchase and a 30% deduction in the subsequent years.
• Deduct the balance at the end of the income year in the Small Business Pool in case the balance, before applying the depreciation, at that time is less than the prescribed asset write-off threshold of $20,000.

When TFPL chooses to use these simplified depreciation rules, it must –

• Use them for working out deductions of all the depreciating assets, except those which are excluded.
• Claim deduction for that portion of the cost of the asset which is being used either for business purposes or for other taxable purposes and not for any personal use.

(See attached Excel Spreadsheet for the Small Business Pool Depreciation Table)

TFPL, before making an estimate of the warranty expenses and liabilities (also known as Unreported Claims), must evaluate –

• The number of product units sold during the income year.
• The percentage of the product units sold which may need repairs or replacement on the basis of previous experiences.
• The average cost of the repair or replacement which is covered under the warranty, as perBarkoczy, (2017).

The following equation is used for calculating the product units eligible for the warranty expense: (Total number of units sold) x (Percentage of defective units)

The following are the recording heads cited in the FASB’s Statement of Financial Accounting Standards No. 5, Accounting for Contingencies.

1. Warranty Liability, which is recorded in the Balance Sheet.
2. Warranty Expense, which is recorded in the Income Statement.

Both these amounts are recorded at the time the product’s sale. In case, these amounts are probable as in the case of TFPL, where the management is assuming both, the number of customers who will be making claims for claiming the warranty and the estimated amount of the claim, assert Barkoczy et al, (2017). Since the warranty liability is probable and has been estimated, Amanda has shown a probable Warranty Expense that may accrue in the current income year ending 30 June 2018 and the Warranty Liability amount will be reflected in the Balance Sheet, as per Barkoczy et al, (2017).

Revenue Expenditure

These expenses, which are short-term expenses, can be bisected into two segments –

Expenditures Incurred to Generate Revenue 

Expenses incurred for meeting the regular operational and running costs of TFPL have been shown under this head. Unlike the capital expenditures, these expenses are fully tax-deducted, to their full value, in the same income year in which they are incurred, as explained by Nethercott, Devos & Richardson, (2018).

Expenditure Incurred to Maintain Revenue Generation

Expenses incurred for ordinary repair and maintenance to keep the assets in working condition but which do not substantially improve or extend the asset’s useful life are covered under this segment, as per Smith & Koken, (2017).

Revenue And Capital Expenditure

Amanda has shown both the segments under ‘Repairs’ in the Income Statement.

These are incurred on fixed assets such as property, plant or equipment. These expenditures are claimed by TFPL over a number of years through their depreciation at pre-determined rates, as explained by Deutsch et al, (2016).

It is essential for organisations such as TFPL to maintain such levels of remuneration which are sufficient not only to attract but also to retain employee’s recruited for posts of responsibility and decision making authority, asserts Barkoczy, (2015). Such employees are essentially required for successful running of the company. The management of TFPL believes in structuring the various components of the remunerations paid to high-end employees so that rewards are automatically linked to the employee’s individual and corporate performance, says CCH, (2017). Even for those in the cadre of non-executive directors, TFPL follows the policy that the level of remuneration must reflect and match the level of responsibilities and the experience which are expected from those in the non-executive director cadre, as per Cassidy, (2016).

In the present case of a director’s daughter, whose remuneration was challenged by the Commissioner, it is essential to explain here that the structure of remuneration of this particular employee included such factors as fees, salary and bonuses, as well as the perks provided to such a high-ranking official who is responsible for taking decisions of business growth for TFPL, says Marsden, (2016). These factors are essential to be taken into account while setting the remuneration of such a valuable employee because it has long-term implications for motivating such employees, asserts Renton, (2017).

TFPL’s long experience of employing such highly paid employees has shown that such motivation drives the employees in giving their best, they are more creative and come out with better ideas for enhancing the success of TFPL through enhanced market share and customer satisfaction, as per Nethercott, Devos & Richardson, (2018). Such steps, which TFPL has been taking previously too in case of such high-end employees have emphasised management’s confidence and has also shown the significance of this structure of remuneration, asserts Deutsch et al, (2016). The motivation which is indicative from the provision of such a suitable salary as remuneration can significantly change the results of the company’s sales and also motivates the shareholders into more investments for increasing the company’s overall performance, says Barkoczy, (2017). As regards the family ties, the present management of TFPL has always noted that family members of directors are not interested in simply having high incentives, instead they are keen to show results which can prove that they are acceptable as independent individuals and are worthy of their remuneration by being an invaluable part of the company’s progress, says Barkoczy, (2018).

Capital Expenditures

There are three different amounts given for finalising the total value of the trading stock of TFPL, on hand, at the end of the income year 2018. The amounts given are –

Closing Stock Valued at Cost Price – $133,567

Closing Stock Valued at Market Price – $135,278

Closing Stock Valued at Replacement Price – $167,889

The management has to select any one value for consideration to be shown as Closing Stock in the Balance Sheet. This is essential as the difference between the total value of the stock at 1 July 2017 and 30 June 2018 will provide the gain or loss derived from the trading stock and calculated for the purpose of taxation under section 70-45 of Income Tax Assessment Act of 1997, as explained by Barkoczy et al, (2017). Under this section, when there is an increase in TFPL’s trading stock value over the period of current income year, it is considered as assessable income. In case there is a decrease in TFPL’s trading stock value over the period of current income year, it is considered as an allowable deduction, as detailed by Smith & Koken, (2017).

To evaluate this consideration, it advisable for Amanda to use the Market Selling Value for determining the closing value of stock, as per CCH, (2017). This is the most appropriate method as it shall clearly reflect the income earning potential of TFPL in case of disposal of its closing stock, if it is sold by the company in normal course of its business, explains Cassidy, (2016). Hence, for practical purposes, say Smith & Koken, (2017), the difference shall be –

= Opening Value of Stock as on 1 July 2017 LESS Closing Value of Stock as on 30 June 2018

= $180,000 – $135,278

= $44,722.

Since the value of stock has decreased over the period of current income year, this amount of $44,722 shall be reflected in the Income Statement of Timber Floors Pty. Ltd. for the year Ended 30 June 2018 as a Deductible Expense, as per Nethercott, Devos & Richardson, (2018).

In the Commonwealth of Australia, a Restraint of Trade Agreement is considered as a Common Law Doctrine, except in the State of New South Wales, where a Restraint of Trade Agreement is governed by the Restraints of Trade Act, 1976 (NSW). In NSW, the Act prevents a party from restricting the other party’s ability of engaging in a trade or an employment opportunity, unless it is proven beyond doubt that the restraint agreement can prove to be of reasonable interest for both the parties as well as the public, assert Nethercott, Devos & Richardson, (2018).

Since TFPL is not operating from NSW, hence it shall be governed by the Commonwealth of Australia Law and the prevailing governing common law principles which are enforceable for Restraint of Trade agreement under the following clauses, and I quote –

• “A contractual provision of restraining trade is prima facie void.
• However, this presumption can be rebutted and the restraint allowed if on the facts of the case it can be established the restraint is reasonable to provide adequate protection by reference to the interests of the parties and the public.
• A goodwill covenant will be considered reasonable if the restraint is confined to an area where the competition of the seller would injure the purchaser.”

An employee of TFPL is entitled to long service leave on the basis of the qualifying period of their continuous service. An employee who has been in continuous service for 10 years is entitled to take equivalent of 8.6667 weeks of their wage payment. In case the employee continues in service for another 5 years, they are entitled to take an additional 4.3333 weeks’ payment of their wage payment. For employees who continue in service beyond 15 years, their access to further leave accrued amount is not subjected to any qualifying period, asserts Marsden, (2016).

All long service leave amounts are paid to the employee at their ordinary rate of wage and is excluding their overtime payments. The amount is paid at the time of availing the leave. Employees also have an entitlement of receiving a proportionate payment of their long service leave in case their employment is terminated after completing 7 years of continuous service. However, the payment of such employees is based on pro-rata long service leave period, as per Barkoczy, (2015).

References

Barkoczy, S. 2015. Australian Tax Case book. CCH Australia Limited, North Ryde, NSW.

Barkoczy, S. 2017. Foundations of Taxation Law. CCH Australia Limited, North Ryde, NSW.

Barkoczy, S. 2018. Core tax legislation and study guide. CCH Australia Limited, North Ryde, NSW.

Barkoczy, S., Rider, C., Baring, J. and Bellamy, N. 2017. Australian tax casebook. CCH Australia, North Ryde, NSW.

Cassidy, J. 2016. Concise Income Tax. Federation Press, Annandale, NSW.

CCH. 2017. Australian Master Tax Guide. CCH Australia Limited, Sydney, NSW.

Deutsch, R., Friezer, M., Fullerton, I., Gibson, M., Hanley, P. and Snape, T. (2016) Australian tax handbook. Thomson Reuters, Pyrmont, NSW.

Marsden, S. J. 2016. Australian Master Bookkeepers Guide. CCH Australia Limited, Sydney, NSW.

Nethercott, L., Devos, K. and Richardson, G. 2018. Australian taxation study manual: questions and suggested solutions. CCH Australia Limited, Sydney, NSW.

Renton, N. E. 2017. Family Trusts: A Plain English Guide for Australian Families of Average Means. John Wiley & Sons, Milton, QLD.

Smith, B. and Koken, E. 2017. The Superannuation Handbook. John Wiley & Sons, Milton, QLD.