Question:
Discuss about the Political Nature of Accounting Standard.
The business corporations need to develop and disclose all the relevant financial and non-financial information to the end-users for promoting transparency in the business operations. The development and preparation of financial reports by a business corporation require the adoption of specific accounting policies and procedures as directed by the IASB (International Accounting Standards Board). The accounting policies and procedures are developed by the IASB on the basis of various accounting theories such as normative and positive theory of accounting. The accounting theories has lead to the development of a conceptual accounting framework that has stated the four basis qualitative characteristics to be possesses by financial information (Marley and Pedersen, 2015). These qualitative characteristics are relevancy, reliability, comparability and understandability that are required to be possessed by financial information for meeting the needs and expectations of the end-users. The accounting policies help the businesses to develop a specific accounting strategy for developing high-quality financial reports. In this context, the present report is aimed at analyzing and examining the specific accounting policies and estimates of an ASX listed firm, that is, Wesfarmers limited. The compliance the financial reports of the company as per the standard accounting policies is evaluated in the report along with the comparison of its accounting strategy with its rival companies, that is, Woolworths Limited.
The accounting policies adopted by Wesfarmers in development of its financial reports are in accordance with the Corporations Act 2001 and Australian Accounting Standards Board (AASB). The financial statements of the company are developed as per the historical cost basis except for investment held by associates, financial instruments and available for sale investment that are measured at the fair value. The financial figures in the general purpose financial statements are presented in Australian dollar by rounding off to their nearest million values. The company develops its general purpose financial statements as per the principle of consolidation according to Companies Act (Wolk, Dodd and Rozycki, 2012). The principle of consolidation requires all business entities to integrate the financial information of all their subsidiaries as a single economic entity. The acquisition of subsidiaries is accounted through the use of acquisition method of accounting that involves identifying and measuring the fair value of assets, liabilities and non-controlling interest at the date of acquisition. The company has also adopted significant accounting policies as per the AASB rules for monitoring and controlling the risk involved in its business operations. For example, the company have adopted AASB 7 standard for controlling the risk exposure relating to the financial transactions involving transferring of assets (Wesfarmers: Annual Report, 2016).
The risk management policy of the company is actively involved in managing and controlling the risk related to market exposure, foreign exchange, credit rating and liquidity risk. The company manages the liquidity risk through introducing flexibility in its capital structure by forecasting the ratio of debt and equity (Kenny, 2009). The company manages the market risk exposure through the use of sensitivity analysis that helps it in predicting the movements of foreign currencies. The company also uses hedging for addressing the foreign currency risk and therefore minimizing its foreign currency risks (Wesfarmers: Annual Report, 2016).
The accounting mangers have authority to introduce some specific changes in the standard accounting policies and procedures for achieving certain corporate objectives and goals. The fact can be supported from the findings of positive theory of accounting which states that accounting managers selects the specific accounting policies that helps in maximizing the value of firm. As per the theory, the accounting methods selected by a firm should reflect its best financial performance and as such some discretion is provided to the management for introducing flexibility in the accounting framework. Thus, the accounting regulations implemented by IASB should not eliminate the managerial flexibility and there should be left considerable scope for accounting managers to influence the financial statements.
As such, it can be inferred from the analysis of financial reports of Wesfarmers, that the mangers have adopted certain judgments and estimates in the standard accounting policies. For example, the carrying value of assets and liabilities are estimated on the basis of future situations that can impact the materiality of the financial statements in the future reporting period of the company. In addition to this, the recoverable amount of non-current assets during impairment testing is esteemed on the basis of the future cash inflows of assets. The useful lives of the fixed assets of the company such as property, plant and equipment are estimated through the application of judgment of management in support with the internal consultation obtained from experts. Also, the net realizable value of inventories is estimated by the management on the basis their sales price in the normal course of business. Therefore, the estimates and judgments made by the management during the adoption of specific accounting policies may pose a materialistic risk in the financial statements developed by the company. However, the flexibility provided to the management should not distort the financial performance of the company for maximizing the personal benefits of the managers but should be only done for achieving the corporate goals and objectives (Wesfarmers: Annual Report, 2016).
The accounting strategy is developed on the basis of specific accounting policies implemented by a firm for the preparation of its general purpose financial statements. The accounting strategies are developed on the basis of corporate mission and values in order to develop the financial performance of a company as per its strategic goals and objectives. The Wesfarmers accounting policies are developed as per the industry norms in order to attain a competitive edge over the competitors. The Wesfarmers Limited is a supermarket giant of Australia and therefore need to implement competitive accounting strategies for outperforming the competitors. The main competitor of the company in Australian retail market is Woolworths Limited. Both the companies develop their financial reports as per the Corporations Act and AASB standards. However, there exist some significant difference between the accounting policies and procedures adopted by the both the companies. The carrying value of assets and liabilities in Wesfarmers are estimated on the basis of future vents but it incorporates the use of hedging for estimating the fair value of assets and liabilities (Wesfarmers: Annual Report, 2016).
The Woolworths Limited, on the other hand, does not implement the use of hedge accounting for recognizing the estimated carrying value of assets and liabilities for the next reporting period. The capital structure maintained by Wesfarmers can also be regarded to be better as compared to Woolworths (Woolworths: Annual Report, 2016). This is because Wesfarmers have maintained a higher level of equity as compared to debt in its capital structure while Woolworths have a high level of debt liabilities in comparison to equity. Thus, it can be said that Wesfarmers possess good investment quality as compared to Woolworths because it does not have higher financial obligations and therefore there is less risk for the investors. The Wesfarmers have also maintained a simple income statement as compared to Woolworths that possess complex structure. The income statement of Woolworths is rather complex that makes it difficult to be understood by the end-users with numerous sub-sections. However, both the companies are showing positive financial performance with the increase in dividends provided to the shareholders. The growth strategy pursued by both the companies is significantly different from each other with Wesfarmers increasing its cash flows by selling the asset base. On the contrary, Woolworths Limited is increasing its cash flows through investing in new ventures. Thus, it can be said that management of Wesfarmers have introduced flexibility in the accounting policies to maintain a competitive edge over its industry peers (Sheridan, 2016).
In addition to this, the management also exercises discretion in disclosing the information related to incentives facing managers. The Wesfarmers Limited have adopted a remuneration committee in order to provide recommendations to the Board in deciding over the matters the remuneration structure to be adopted for its key management personnel. The incentive schemes of the company are based on achievement of certain performance targets. The company provides annual incentives to its KMP on the basis of achievement of strategic objectives whereas the long-term incentives are provided on the basis of maximizing the shareholder value. Therefore, the management has adopted the specific incentive policies that are in accordance with its corporate goals and objectives. The management holds discretion in deciding the incentive policy but has maintained that the incentive schemes does not lead to occurrence of nay fraudulent activities such as manipulation of financial information by the KMP for maximizing their incentives (Albrecht, 2010). The management has aligned the incentives received by the KMP with the performance targets to avoid the occurrence of any fraudulent activities in order to maximize personal gains by the KMP. The change in the accounting policies are carried out by the management for achieving certain accounting objectives. For example, the change in the accounting policies related to measurement of its financial instruments, managing incentive plans of managers and norms for attaining competitive advantage are carried out by the management as per the business operations of the company (Wesfarmers: Annual Report, 2016).
On the basis of the review of the notes to accounts below the financial statements of the company it can be said that disclosures provided are reliable, relevant, comparable and understandable. So it can be said that disclosures made by the company meets the requirements of the accounting standards and shareholder’s of the company (Mintz, 2013). The financial and non financial information provided in the notes to accounts have been included as per the defined accounting policies taken by the company to draft the financial statements. It has been seen that there have not any footnotes under financial statements that will guide the accounting standards used to prepare the financial statements (Henderson et al., 2015). As the footnotes have not been provided under the financial statements, there has been violation of understandable principle of conceptual accounting framework. As per the understandable principle of the conceptual framework, annual report must be prepared in such a way that it can be easily understood by the users of the annual report. Footnotes help the users to check which accounting standard has been used to calculate the value of different items in the financial statements. For example, IAS 16 or AASB 116 has been used to calculate the value of property, plant and equipment (Gray and Manson, 2007).
The notes to financial statements are detailed information on how each accounting standards has been implements by the company and there are specific guidelines described under Generally Accepted Accounting Principles (GAAP) to prepare each notes to accounts. GAAP contains the defined set of accounting principles that need to be followed by the business entities for preparation of the financial statements and notes to financial statements (Bragg, 2010). The current performance of the Wesfarmers is very strong and notes to accounts have explained the performance of the company in the same manner as the financial statements of the company. For example, income earned from various CGUs of the company are combined and shown under the notes to accounts in very proper way so that it can be easily identified which unit has contributed more as compare to other. Notes to accounts are such that they must provide the real financial performance of the company. Any information has been missed in the financial statements than it must be included in notes to accounts so that each and every financial data can be included in annual report (Wesfarmers: Annual Report, 2016).
Wesfarmers has used the Australian GAAP to prepare the financial statements and notes to accounts. Australian GAAPs have been drafted after considering the IAS accounting standards. The IAS accounting standards have been drafted by the international accounting body and they are defined in such manner that requirement of each class of companies can be fulfilled together with the requirement of the users of the annual report. So it can be said that GAAP reflects the perfect pictures of the financial statement and also provide the base for the company where they can show financial data that are regarded as the key measures to success (Horngren et al., 2012). Also it must be noted that no rules is so perfect that there can’t be any error. The Australian GAAP has although drafted from the IAS standards but there are some issues that need to be considered for revision (Wesfarmers: Annual Report, 2016).
Every company has to disclose the information regarding their operating segments as profits from each segments has to be reviewed for analysis purpose. In case any operating segment is providing loss regularly than proper steps can be taken to reform the operating segment or close it down to shift the assets to the operating segment that is giving enough revenue. In the annual report of the Wesfarmers, there has been proper disclosure of the financial data from the operating segments. All these disclosures are made as according to the AASB standards (Wesfarmers: Annual Report, 2016). The major operating segments of the Wesfarmers are retail, department stores, industries and other operating segments. Retail operating segment is presented as the Coles and it is biggest unit in the Wesfarmers. There is sufficient disclosure regarding the operating segment like revenue earned through each operating segment and profit made after expenses incurred in respective segments. Complete financial analysis can be conducted through financial information provided in the annual report (Wesfarmers: Annual Report, 2016).
Although there have sufficient discourses in the annual report of the Wesfarmers but still some issues may pertain while preparing the annual report. This part of the assignment will define various issues that are included in the annual report and can be regarded as the potential red flag. While preparing the annual report various accounting judgments and assumptions have been taken that has impacted the material characteristics of the financial data (Mumba, 2013). The assumptions and judgments have been taken in the annual report that requires the need to provide sufficient disclosures regarding each financial item. It has been reviewed from the annual report that accounting transactions involved in the financial instruments have impacted the profitability of the company a lot. There has been increase in inventory a lot which is not satisfied with the small increase in the sales value. It can be judge from the income statement and the balance of the company (Bamberg and Spremann, 2012). So there is requirement to provide how the inventory has increased a lot in the notes to accounts. Reasons must be sufficient enough to clarify why such increment has been done (Wesfarmers: Annual Report, 2016).
It has been seen that there was unusual increase in net income as compare to cash flows from the operating activity because most of the sales are done on the basis of credit sales and there was enough balance available in accounts receivables (Horngren et al., 2012). In order to finance the operations company mainly dependent on the current assets and retained earnings left over in previous years. So it can be said that company has not used R&D partnerships, SPEs or the sale of receivables to finance the operations. There has been no large assets write offs by the company that has impacted the value of fixed assets (Hussey and Ong, 2017). There are some adjustments related to the tax adjustments in the last fourth quarter of the annual reporting period. Auditor has provided the qualified reports with no changes to the annual report. There many related party transactions and it has been clearly provided under notes to accounts (Wesfarmers: Annual Report, 2016).
The analysis of Wesfarmers annual report has revealed that it has effectively complied with the conceptual accounting framework principles in development of its financial reports. The normative theory of accounting has argued that financial information should possess the qualitative characteristic of relevancy, reliability and comparability in order to meet the objective of financial reporting. The normative theory of accounting has lead to the development of conceptual accounting framework to provide guidance to the business in developing high-quality financial reports that possess all the qualitative characteristics. However, the accounting policies and estimates used by the company are significantly influenced by the accounting standard-setting environment (Hoffman, 2016). The accounting policies developed by accounting board of various countries are in accordance with the political environment. There is significant different between the accounting policies of the board of various countries due to political context. The country-specific issues such as tax structure may impact the accounting procedures of Wesfarmers while it operates in different foreign countries. For example, Wesfarmers have made voluntary disclosures regarding the policies adopted by it for disclosing the tax structure. The company has voluntarily adopted a tax transparency code to decide over the matters relating to its tax structure (Wesfarmers: Annual Report, 2016). This is done by the company to comply with the conceptual accounting framework principles while operating in different countries. The company is making voluntarily disclosures for achieving its corporate goals and objectives of diversifying its business operations in different geographical units (Mirza, and Ankarath, 2012).
Conclusion
Thus, it can be said from the overall discussion that accounting policies and strategies plays a significant role in developing quality financial reports. The businesses should adopt the specific accounting policies that are in accordance with conceptual accounting framework principles in order to meet the needs and requirements of end-users. The analysis of accounting policies of Wesfarmers has indicated that the company has maintained high-quality in its financial reports by disclosing all the relevant information as per the conceptual accounting framework principles. The management of the company has also incorporated some discretion while deciding over the matters related to incentive policies and competitive policies. The flexibility in the accounting framework is required by businesses to achieve their strategic goals and objectives. However, the Board of Directors must ensure that the discretion power provided to the management should not distort the financial performance in any way.
References
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Wesfarmers: Annual Report. 2015. [Online]. Available at: https://www.wesfarmers.com.au/docs/default-source/reports/2015-annual-report.pdf?sfvrsn=4 [Accessed on: 26 September, 2017].
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