Each and every business organization operating across the world is required to report the performance of its business over a specified period of time to those who are interested in the operations of the company. Thus, in order to provide the performance updates to various user groups, business organizations prepare financial statements. The primary objective of preparing financial statements is to communicate information regarding the use of resources by the business entity and its performance over a specified period of time. Financial statements are prepared periodically and help users in identifying relevant information over a period of time. Analysis of the financial statements involve evaluating the environment in which the organization operates, strategies followed by the business organization, financial position and performance of the business organization. The information provided in the financial statements is also used for comparing the performance of the organization with that of its competitors. However, this comparison can only be made if the accounting policies followed by the organization are in line with the accounting policies and standards prescribed in this regard.
Accounting policies, thus, serve as particular principles, rules, principles and conventions which are used by a business organization for the preparation as well as presentation of its financial statements. The main purpose of preparing periodic financial statements on the basis of accounting policies is that it ensures that there is consistency in the financial statements over different accounting years. This consistency makes the financial statements more reliable to extract relevant information by different user groups.
Although, the use of accounting policies help in maintaining consistency in presenting financial statements over the years, but mostly the accounting policies are used to beautify the financial statements. The accounting policies that are chosen by the respective business organization may have a deep impact on the financial results. For example, there are various accounting policies available to record revaluations of assets, depreciation and amortization. Each policy affects the financial statements in a different manner. In other words, the entity’s choice of method to be adopted will have an impact on the financial results.
Thus, accounting policies provide the business organizations a way to manipulate the financial results in the direction they want. All the business organizations strive to maximize their performance in terms of their market value so that maximum profits can be earned by them (Brown & Whittington, 2008). An example of International Accounting Standard can be taken in this context. IAS 8 “Accounting Policies, Changes in Accounting Estimates and Errors” specifically deals with changes in accounting policies (Mance & Katunar, 2018). Any change in accounting policies must be carried out carefully as these have an impact on the financial statements of an entity.
As discussed above, accounting policies provide a way to the management of the company to manipulate their financial results in a manner which is beneficial for all the stakeholders of the company. However, it is not necessary that all the changes made in the accounting policies are for the purpose of making the financial statements reliable. Some choices of accounting policies are also adopted to portray a good picture of the operations of the organization. This can be termed as manipulation. The term manipulation can be defined as “any intentional act or omission designed to deceive others, that results in losses to third persons i.e. the victims of manipulation” (Association of Certified Fraud Examiners, 2007).
Thus, it can be said that the choice of accounting policies has a huge impact on the costs that are incurred by the business organizations and also their revenues. Therefore, different accounting policies that are adopted significantly affect the interpretation of the financial statements with the help of ratio analysis. The accounting policies so adopted not only affect the balance sheet of a business organization but also affects the income statement. The choice of accounting policies affect the ratios such as capital gearing ratio and return on capital employed, calculated in a direct as well as indirect manner. Therefore, in order to gain an in depth knowledge about the financial statements of a company, it is essential for the users to extract raw information from the annual report rather than completely relying on the accounting policies being followed (Alayemi, 2015).
Reason behind ASIC choice to focus its investigation on material disclosures of decision useful information such as assumptions supporting accounting estimates, significant accounting policy choices?
The Australian Securities and Investments Commission or ASIC has contributed significantly in making the system of reporting the financial position of the companies operating in Australia transparent and free from complexities. In this context, the ASIC has taken many significant steps. One such step taken by ASIC is that it now aims to focus its attention on ensuring that the business organizations present the most important information in the financial statements and annual reports. The commissioner of ASIC said that, ‘As in previous reporting periods, directors and auditors should focus on values of assets and accounting policy choices” (ASIC, 2016). He further stated that ASIC has observed that over the years the companies and business organizations make use of assumptions which are unrealistic while testing the asset value. Many times, the business organizations have used inappropriate approaches to present their financial statements in various areas which include revenue recognition.
ASIC further clarifies that the focus of the top management of companies and the auditors auditing such organizations must be on reducing the complexity of the reporting and must also focus on the choice of accounting policies. The focus of ASIC is on ensuring that the companies lay down financial statements in such a manner that the information relevant for different user groups is available at a glance. Often, the financial statements presented before the user groups in the form of annual reports are so bulky that relevant information is lost in other irrelevant information. ASIC suggests that the business organizations must focus on assumptions that support accounting estimates and information; choices of significant accounting policies and their impact on financial statements (ASIC, 2018).
For the communication of effective information through financial statements, companies and other business organizations must adopt valuations for assets which are realistic and adopt such accounting policies which are appropriate. This step by ASIC is taken by considering the public interests. ASIC, in order to ensure that the accounting estimates and the choice of accounting policies are appropriate, encourages those who prepare the financial statements and the auditors of such financial statements, to consider asset valuations and their impairment. It also suggests that the fair values that have been attached to the financial assets must also be based on such inputs, assumptions as well as models which are appropriate (BDO, 2018).
Apart from different valuations and disclosure requirements, the ASIC also urges the business organizations to choose their accounting policies after considering their impact on the results that are being reported to the public at large. Various accounting policies that must be focused upon include revenue recognition, tax accounting, capitalization of expenses related to assets, pricing of inventory, rebates and treatment of arrangements which are off the balance sheet (ASIC, 2018).
The main reason why ASIC is focusing on reducing the clutter is that it wants that the information which is material to various user groups must reach them properly and should not get lost in the clutter. This is being done for the purpose of protecting the investors from various frauds due to the manipulation of accounts. One of the most important disclosure reform is the introduction of materiality concept. This has been introduced for the purpose of putting a stop to the proliferation of accounts. Also ASIC is encouraging business organizations to provide information which is material in the first few pages of the report. The literature suggests that reducing irrelevant information from the financial statements would provide greater amount of clarity to the internal as well as external stakeholders of the business organization (Amato, 2014); (Singh & Peters, 2015).
Reason why CPA Australia, with reference to ASIC, believes that ‘a suitable revenue recognition policy’ requires the ‘appropriate application’ of ‘the timing of recognition’ therefore ‘reflecting the substance of underlying transactions’?
In Australia, the standard related to the recognition of revenues was introduced for the purpose of ensuring that the principles related to revenue recognition are consistent across the organizations. This standard is applicable to each and every business organization, industry and company operating in Australia. This standard deals with evolving business models and contracts with customers. The contracts include contingent pricing agreements, licensing agreements and various other arrangements which are complex to record. Revenues are one of the most significant factors that have a direct impact on the operations of a business, control processes, compensations systems and crucial business dealings and hence this cannot be ignored.
However, as per ASIC, the recognition of revenues plays a significant role in evaluating the performance of a business organization and company. Apart from how much revenue is to be recognized, another factor that plays a key role in the determination of revenue to be recognized is the timing of the recognition of revenues. The time at which the revenue is required to be recognized plays an important role in the preparation of financial statements for a specific period of time (PWC, 2018).
Recently, the accounting standard for the recognition of revenues was updated in response to the increasing issues in the financial sector with respect to inconsistencies across the industries as well as business organizations operating under such industries with respect to recognition of revenue. Apart from this, ASIC also believes that it is essential to bring the accounting standards that are being followed in Australia at par with those standards being used at international levels. ASIC strongly believes that for the development of a suitable policy for recognizing revenues, the timing factor needs to be focused upon, as it is the only way to reflect the true substance of the transactions (In The Black, 2018). The policy to be developed must be focused on coming out with the standards that will help business organizations to undertake tax planning and other major transactions consistently because these transactions have a direct bearing on the revenues of business organizations. The business organizations while recording revenues must consider the timing of revenue received for such contracts. If the services are rendered or the goods have been delivered before the balance sheet then the revenue shall be recognized in the same year in which the transaction takes place. Such provisions throw light on the significance of the timing factor in recognizing revenues (CPA Australia, 2018).
Thus, in other words, it can be said that new principles and policies on revenue recognition signifies that the aim of ASIC is to bring about standardization and consistency in reporting the revenues. These steps would help in bringing about transparency in dealings and help in bringing about true and fair view to the investors as well as other stakeholders in the business organization and companies. Furthermore, the difference between industry specific guidelines would get eliminated. This will help the business organizations in recognizing the true substance of the underlying transactions (Ct Inovations, 2018).
Extent to which the revenue recognition criteria in AASB 118 / IAS 18 Revenue and AASB 15 / IFRS 15 Revenue from Contracts with Customers meets the ASIC and CPA requirements of an ‘appropriate application’ of ‘the timing of recognition ‘of revenue and therefore represents the substance of underlying transaction.
In view of the changing needs and requirements of business organizations and the international standards, the ASIC introduced a new standard on revenue recognition. The ASIC has introduced AASB 15/IFRS 15 which deals with revenues from the contracts with customers (CPA Australia, 2015). In this standard, ASIC has introduced a five step model which will help business organizations in identifying exactly when to recognize the generated revenue and what amount must be recognized. As per the standard, revenue is required to be recognized as and when the control on goods has been transferred to the customer (Deloitte, 2018). Depending on the situation and different criteria to be met, revenue can be recognized either at a point of time or over a period of time. There will be certain impacts of the introduction of this standard over the business organization. The impacts will be as follows:
These new requirements under the revised standard would ensure that the substance of the transaction is maintained and is not lost because of the receipt of revenues over a period of time. Furthermore, more clarity in the dealings can easily be observed which will help in simplifying the process of accounting (KPMG, 2017).
The company selected is AEERIS LTD. It is the developer and provider of early warning networks. It aims to provide asset management and hazard reduction technologies. The ticker code of AEERIS on ASX is AER.
Review of annual financial reports for 2014, 2015 and 2016
In FY2015 AEERIES made its position for the sustainable growth of the company. There has been improvement in corporate governance policies, financial and operational activities structure, protocols of benchmarking and management systems. There has been an increase in consolidated net assets by $3,021,529 from 2014 to $4,173,080 in 2015. The capital also increased by $4,000,000.
There has been decrease in net assets for FY2016 by $1,449,383 from 2015 to $2,723,679 in 2016. The decrease was affected by various reasons including expense of $1,110,270 on intangible assets, decrease in cash by $ 1,339,471 and spent on plant and machinery of $22,459. (Aeeris Ltd., 2015).
Revenue for the reporting years 2014, 2015 and 2016
|
Revenue from consolidating operations |
FY 2014 |
FY 2015 |
FY 2016 |
|
Revenue |
211,090 |
971,979 |
1,446,773 |
|
Other income |
1,017 |
22,939 |
54,932 |
|
R & Refund |
– |
188,948 |
413,942 |
|
Total Revenue |
212,107 |
1,183,866 |
1,915,547 |
The financial statements of the company are prepared in adherence with Corporation Act. The company reflected revenue growth of 61% in FY2015. The increase in revenue was the outcome of demand from existing clients for upgrading their services and expansion of product portfolio. There was a cost incurred for becoming a public company and investment in technology development resulting in net loss of $ 722, 216.
There has been an increase in revenue from FY 2014 to FY 2016. There has been decrease in net assets from 4,173,080 to 2,723,697 in 2016. The income tax for the company includes current income tax expense and deferred tax expense. The values of assets are measured on the basis of accounting standards (Aeeris Ltd, 2016).
There was an increase in total income by 62% in FY 2016. Total revenue of the company is calculated by adding the revenue, other income for the company and research and development fund and subtracting the cost of sales. The company is focusing on achieving operational break even in 2017. It is working on establishing a financial base to increase the revenue on earnings in upcoming years. The company received a loss of $ 361,943 at an EBITDA level (Invest Smart, 2018).
Variations in revenue over this period
Currently Aeeris company’s expenses are higher than its income from its daily operations. AASB provides accounting standards. The company follows the accounting principles of Australian Accounting Standards and Interpretations of the Australian Accounting Standards. The according to financial reporting under Australian Accounting Standards is a profit entity.
The financial statements are prepared on accrual basis including the historical costs and also prepared on the basis of fair value of current assets and liabilities. The amounts in the financial statements are in dollar. There is no variation in the policies used for the preparation of financial statements of the company for the reporting year 2014, 2015 and 2016. The preparation of financial statement is based on polices of AASB 118, IAS revenue and IFRS from contracts with customers (CPA Australia, 2012).
Explain the choices of accounting policies with regards to AASB 118 / IAS 18 Revenue and AASB 15 / IFRS 15 Revenue from Contracts with Customers by reference to the relevant accounting research literature on factors influencing firms’ accounting policy choice.
There are various factors that influence the choice of accounting policy and these can be enumerated using various theories of accounting such as positive accounting theory, normative accounting theory and statement of accounting policies. The positive accounting theory will help in determining the accounting policies that can be chosen by a firm and the manner in which business organizations will react owing to the introduction of new standards on accounting (Watts, 2004). Since, AASB 15 / IFRS 15 Revenue from Contracts with Customers, is a newly established standard, therefore, this accounting theory can be useful in finding out the impact on business organizations because of this new introduction (CPA Australia, 2015). This introduction of a new accounting standard will lead to the introduction of some changes in the manner in which the business organizations operate (EY, 2017). The organizations would be required to change their systems, accounting policies as well as their systems to adapt to the new standard. This introduction of a new accounting standard on revenue recognition will certainly lead to changes in the amount of tax paid because of the timing of recognizing the revenues. Similarly, the existing contracts with customers will also be required to be changed as per the new requirements (BDO, 2017).
Similarly, normative accounting theory aims to state what information related to accounting and finance must be collected, evaluated and communicated to the stakeholders and various other user groups (Riahi-Belkaoui, 2004). In this regard, ASIC has started to focus on reducing the clutter while presenting the financial statements and has been encouraging business organizations to present that information on the first few pages of the annual report which is of utmost significance. IAS 18, Revenue also states that the accounting policies used for determining the revenue must be disclosed properly (CPA Australia, 2015).
References
Aeeris Ltd. (2015) Annual Report 2015 [online]. Avaialbe from: https://www.aeeris.com/downloads/aeeris_2015_annual_report.pdf [Accessed 10 May 2018].
Aeeris Ltd (2016) Annual Report 2016 [online]. Avaialbe from: https://www.aeeris.com/downloads/aeeris_2016_annual_report.pdf [Accessed 09 May 2018].
Alayemi, S.A. (2015) Choice of Accounting Policy: Effects on Analysis and Interpretation of Financial Statements. American Journal of Economics, Finance and Management, 1(3), pp.190-94.
Amato, N. (2014. Cutting the Clutter. Journal of Accountancy (217(2), pp.28-30.
ASIC (2016) ASIC calls on preparers to focus on useful and meaningful financial reports [online]. Avaialbe from: https://www.adviservoice.com.au/2016/12/asic-calls-preparers-focus-useful-meaningful-financial-reports/ [Accessed 09 May 2018].
ASIC (2018) 16-428MR ASIC calls on preparers to focus on useful and meaningful financial reports [online]. Avaialbe from: https://asic.gov.au/about-asic/media-centre/find-a-media-release/2016-releases/16-428mr-asic-calls-on-preparers-to-focus-on-useful-and-meaningful-financial-reports/ [Accessed 09 May 2018].
Association of Certified Fraud Examiners (2007) Managing the Business Risk of Fraud: A Practical Guide [online]. Avaialbe from: https://www.acfe.com/uploadedfiles/acfe_website/content/documents/managing-business-risk.pdf [Accessed 09 May 2018].
BDO (2017) AASB 15 Revenue from Contracts with Customers [online]. Avaialbe from: https://www.bdo.com.au/en-au/services/audit-assurance/ifrs-advisory-services/aasb-15 [Accessed 09 May 2018].
BDO (2018) ASIC calls on preparers to focus on useful and meaningful financial reports (Focus areas for 31 December 2016 financial reports) [online]. Avaialbe from: https://www.bdo.com.au/en-au/accounting-news/accounting-news-december-2016/asic-calls-on-preparers [Accessed 09 May 2018].
Brown, R. & Whittington, M. (2008) Financial statement analysis and accounting policy choice: What history can teach us. Journal of Applied Accounting Research, 8(3), pp.1-47)
CPA Australia (2012. Accounting Concepts and Principles [online]. Avaialbe from: https://www.cpaaustralia.com.au/documents/study-manual-accounting-concepts-and-principles.pdf [Accessed 09 May 2018].
CPA Australia (2015) IAS 18 Revenue [online]. Avaialbe from: https://www.cpaaustralia.com.au/~/media/corporate/allfiles/document/professional-resources/ifrs-factsheets/factsheet-ias18-revenue.pdf?la=en [Accessed 10 May 2018].
CPA Australia (2015) IFRS 15 — Revenue from Contracts with Customers [online]. Avaialbe from: https://www.iasplus.com/en/standards/ifrs/ifrs15 [Accessed 08 May 2018].
CPA Australia (2018) Familiar look to ASICs focus areas for 31 December financial reports financial reports [online]. Avaialbe from: https://www.cpaaustralia.com.au/media/familiar-look-to-asics-focus-areas [Accessed 11 May 2018].
Ct Inovations (2018) Revenue Recognition – Why Is It So Important? [Online] Available at: https://ctinnovations.com/2014/07/revenue-recognition-why-is-it-so-important/ [Accessed 09 May 2018].
Deloitte (2018) AASB 15 Revenue from Contracts with Customers [online]. Avaialbe from: https://www2.deloitte.com/au/en/pages/audit/articles/aasb-15-revenue-contracts-customers.html [Accessed 07 May 2018].
EY (2017) Presentation and disclosure requirements of IFRS 15 [online]. Avaialbe from: https://www.ey.com/Publication/vwLUAssets/ey-Applying-Revenue-Disclosures-July-2017/$File/ey-Applying-Revenue-Disclosures-July-2017)pdf [Accessed 10 May 2018].
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Riahi-Belkaoui, A. (2004) Accounting Theory. 5th ed. Singapore: Seng Lee Press.
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