Expense Classification: A Case Study Of AGL Energy Limited

Classification of Expenses in Income Statements

Expense is the budgeting and accounting term that is commonly used for mentioning any spending. It is the reduction in owner’s equity takes place due to usages of the assets for generating revenue and for other activities it is the part of the company’s operation. AGL Energy Limited is the integrated energy company that provides gas, electricity and associated products, services to business and wholesale customers all over Australia. It carries on its activities through investment segments, group operations and energy markets (AGL | Electricity Providers | Gas Suppliers | Solar Energy | AGL, 2018).

In the income statements various expenses are deducted from the revenue to arrive at the net profit figure. Company that classifies its expenses by nature in the income statement, the expenses are shown as material cost, labour cost, depreciation, amortization, wages, salaries and rents for instance (Needles, Powers & Crosson, 2013). Further the expenses are not reallocated further under any other head. On the contrary, the company that classifies its expenses by function in the income statement, the expenses are presented under broad head like COGS, selling expenses and other expenses.  However, under the method of classifying the expenses by function, the expenses are further disclosed by nature in the face of the income statement or through notes (Wahlen, Baginski & Bradshaw, 2014).

It is recognized from the annual report of AGL Energy Limited for the year ended 30^th June 2016 that the expenses of the company in the income statement has been classified by nature and not by function (AGL | Electricity Providers | Gas Suppliers | Solar Energy | AGL, 2018).

As it can be observed from the above that expenses are recorded as finance costs, amortization and depreciation, it can be concluded that AGL Energy Limited classifies the expenses under the income statement by nature and not by function.

Classifications of expenses are made in different ways based on the nature and purpose of the business.  The expenses are classified in such a way that all the information related to expenses is meaningful. It is the the 1^st step of the management towards the process of decision-making associated with costs and expenses. The concept of cost is vague in nature until it is classified under logical groups.  Some possible reasons for classification of costs using various methods are –

• The management classifies the cost on the basis of its activities, operation, industry type and other factors that can present various expenses of the company in most appropriate manner.
• The expenses are classified on the basis of the costs that are incurred by the company at the maximum level. For example, the manufacturing companies record their expenses by nature method as it is important for them to present the costs associated with labour, overheads and materials.

Taking into consideration the above factors, the most reliable, relevant and suitable method of classification is used by the company.

Expense Classification at AGL Energy Limited

AASB 108 or IAS 8 on “Accounting policies, changes in accounting estimates and errors” is used for applying and selecting the accounting policies, recording the changes for reflecting and estimating the corrections for errors related to prior period. It requires compliance with particular IFRS that is applicable to any event, transaction or condition and therefore delivers the guidance for developing the accounting policies for various items.  The main objective of the standard is to recommend the norms for changing and selecting the accounting policies along with the accounting treatments and the disclosures. It ensures the improvement of the reliability and relevancy of the company’s financial statement. Each company registered under the ASX shall comply with the requirement of AASB 108 and prepare their financial statement accordingly (AASB, 2014).

Analysing the annual report of the AGL Energy Limited for the year ended it is observed that the following requirements has not been complied as per the requirement of AASB 108 –

• The company did not mention the accounting policies applicable to it and their application date
• The company did not mention regarding the transitional provision, if any.

In few instances the company applied their estimates and judgements. However, the appropriate basis for applying the judgements and making the estimates has not been mentioned in the annual report (AGL | Electricity Providers | Gas Suppliers | Solar Energy | AGL, 2018).

• The company did not report the 5 year comparative figures as per the requirement of AASB.

Item	2016 (m)	2015 (m)
Plant, property and equipment	$ 6,482.00	$ 6,958.00

It has been identified from the annual report of AGL Energy Limited that the value of Plant, equipment and property has been reduced from $ 6,958 million to $ 6,482 million. While disclosing the item under the non-current assets of the balance sheet, these assets need significant judgements for determining key assumptions that will support expected future cash flows of business and utilization of relevant assets (Weil, Schipper & Francis, 2013).  

Item	2016 (m)	2015 (m)
Depreciation and amortization	$    478.00	$    379.00

It has been observed from the annual report of AGL Energy Limited that the amount of depreciation charged has been increased from $ 379 million to $ 478 million.

Plant, equipment and property of the company are measured at the cost reduced by accumulated depreciation and impairment losses, if any. The cost of the asset includes the expense that is attributed directly for construction or acquisition of the asset (AASB, 2014). Further the construction or acquisition costs of the qualifying assets are capitalised. The costs may also involve the transfer from any losses or gains or any other comprehensive income on the qualifying cash flows that can be hedged from the foreign currency purchase for plant, equipment and property (Robinson et al., 2015). The company recognise the losses or gains on retirement or disposal of the asset is recognised under the income statement.

The projected useful life, depreciation and residual values are adjusted and reviewed at the closing of each period, if appropriate (Wang, 2014). The projected useful lives of the asset for the purpose of computing the depreciation are as follows –

• Plant and equipment – 3 to 35 years or on the basis of relevant usages of units
• Freehold building – 50 years

Leasehold improvements – 20 years or lease period, whichever is lower

Depreciation on plant, property and equipment is charged on the basis of straight-line method or on the basis of use units for writing off cost for each of the assets and allocated over the expected useful life of the asset after deducting the expected residual value. Further, the leasehold improvements are amortised by the company over the relevant lease period or projected useful life, whichever is lower. However, the land is not considered for depreciation (Del Giudice, Manganelli & De Paola, 2016).

The company measures the impairment loss through comparing the carrying amount of the investment and its recoverable amount (Amiraslani, Iatridis & Pope, 2013). The loss contributed to impairment is recognized under the income statement and the loss is reversed if any indication is there that there may exists the favourable changes in the estimated that is used for determining recoverable amount (Amiraslani, Iatridis & Pope, 2013). 

Reference

AASB, C.A.S., (2014). Business Combinations. Disclosure, 66, p.77.

AGL | Electricity Providers | Gas Suppliers | Solar Energy | AGL. (2018). Agl.com.au. Retrieved 7 February 2018, from https://www.agl.com.au/residential

Amiraslani, H., Iatridis, G. E., & Pope, P. F. (2013). Accounting for asset impairment. London: Cass Business School.

Amiraslani, H., Iatridis, G.E. & Pope, P.F., (2013). Accounting for asset impairment: a test for IFRS compliance across Europe. London, UK: Centre for Financial Analysis and Reporting Research, Cass Business School. Standards, Regulations, and Financial Reporting, pp.199-223.

Del Giudice, V., Manganelli, B., & De Paola, P. (2016, July). Depreciation methods for firm’s assets. In International Conference on Computational Science and Its Applications(pp. 214-227). Springer, Cham.

Needles, B.E., Powers, M. & Crosson, S.V., (2013). Principles of accounting. Cengage Learning.

Robinson, T.R., Henry, E., Pirie, W.L. & Broihahn, M.A., (2015). International financial statement analysis. John Wiley & Sons.

Wahlen, J., Baginski, S., & Bradshaw, M. (2014). Financial reporting, financial statement analysis and valuation. Nelson Education.

Wang, C., (2014). Accounting standards harmonization and financial statement comparability: Evidence from transnational information transfer. Journal of Accounting Research, 52(4), pp.955-992.

Weil, R.L., Schipper, K. & Francis, J., (2013). Financial accounting: an introduction to concepts, methods and uses. Cengage Learning.