Analyse the case study on Sunshine Limited over the accounting issues related to the changing method of depreciation.
Accounting for financial statements of any company requires disclosures of various accounting policies that have been used in preparing the financial statements. Depreciation is the accounting method used to divide the capital cost of the plant, machinery and equipments over the useful life of the assets. There are certain methods of deprecation used to divide the cost of assets over the years and it is compulsory to disclose such method in the notes to financial statement of every. As per the AASB 116, it is also compulsory to disclose the change in accounting of depreciation in the notes to accounts. In this report, case related to Sunshine Limited has been analyzed in order to make comments on the violations of ethics and corporate governance due to non disclosure of the change in the depreciation accounting method in the notes to accounts.
Depreciation is most important aspect in the accounting as it regarded as the major non cash expense that is reported in the income statement of the company. In accounting term, depreciation refers to the method used to allocate the cost of the fixed assets over its life. Depreciation is not a cash flow expense as it divides the cost over the useful life of asset. As per AASB 116, charging depreciation expense to the income statement makes reduction in the value of assets reported in the balance sheet and the main purpose of the depreciation to prepare the company financially to replace the fixed assets after its expiry (Jeffrey, 2016).
There are many methods provided in the AASB 116 to charge the depreciation such as straight line method, Weightage deduction method or sum of year digit method etc. There is no specific provision related to use specific method in case of each category of assets but there is advisory note in the AASB 116 that companies must try maintain consistency in the method of depreciation used in the allocate the total cost over the useful life of assets so that principle of consistency can be followed while performing the process of financial reporting. In the given case study, Sunshine Limited is charging the depreciation using the straight line method of depreciation. Under the straight line method of depreciation, a fixed amount is deducted over the useful life of asset and this fixed amount is calculated through dividing the total cost of assets less salvage value by the useful life of asset. The CEO of the Sunshine Limited has decided to change the method of depreciation from straight line to sum of years digit method in order to meet the sudden downfall in profits due to worst market situation in year 2018 and 2019. Under sum of year’s digit method, the deprecation amount is highly accelerated in initial years followed by the less depreciation amount in last few years of useful life of asset. This method of depreciation is also known as the written down value method where majority of the expense of the depreciation is charged in first few years of the useful life of asset (Zimmerman and Yahya-Zadeh, 2011).
It is important to note here that changing the method of depreciation have the worse impact on the ethical values and principle of corporate governance in the Sunshine Limited. Before making any comment on the corporate values and ethical mistake by the Sunshine Limited it is important to see the major change due to use of written down value method over the straight line method. The written down method charges depreciation in initial years and keep on decreasing as the years of useful life decreases. In case of straight line method, the equal amount of depreciation is charged every year. Overall analysis takes the concern over the point that using the written down value method reduces the profits in initial years and increase them in further years, which is exactly demanded by the CEO of the Sunshine Limited. It gives rise to concern over the issue that changing the depreciation method together with its impacts on profits without informing the shareholders can have adverse impact on the corporate governance and ethical values of the company. Business ethics is the integral part of corporate governance and it refers to the rules, regulations, principles, values that every company should follow while carrying out the financial reporting process (Blake and Gowthorpe, 2005).
In the present case study the changing the method of depreciation is not in interest to stakeholders of the company as it manipulates the profits of the company that shows the misleading picture of the financial statements of the Sunshine Limited. It can ethical to change the method of accounting to make an adjustment to the inflation rate or any suitable reason but changing the method of depreciation just only sake to divert the profits from one year to another in order to create the false picture of profitability position of the company in the eyes of shareholders is truly unethical and give rise to corporate governance issues (Adams, 2002).
The major business activity of the company that is against the ethics and governance rules in accounting is manipulating the business accounts for driving its future growth and influencing the views of its stakeholders. The company has changed its method of calculating deprecation for improving its profitability position in the future period of time. Also, it has concealed the accounting changes adopted by not disclosing it in its general purpose financial statements. This is causing the mis-representation of financial information of the company in the eyes of its shareholders and creditors. The company stakeholders are of the belief that it is achieving good profits as they are not aware of the change in the accounting deprecation policy adopted by it. The company is required to disclose all the relevant and materialistic information in its financial statements as per the principle of conceptual framework of accounting developed by IFRS. The change implemented by the company in the method of calculating deprecation is a major materialistic change as it impacts its profitability position. Therefore, the company is acting unethically by not disclosing such important financial information during its financial reporting (Drury, 2005).
In this context, the stakeholder theory of corporate governance states that corporate managers should consider the interest of each of its stakeholders and develop governance policies as per their interests and objectives. However the company has not complied with the views and opinions of this governance theory. The decision of the company to change its depreciation method will have major impact on the interests of its two major groups of stakeholders that are, shareholders and creditors. The shareholders are the group of people who provide necessary capital to the company for carrying out its operational activities in the form of equity. On the other hand, creditors are the ones who provide financial resources to the company in the form of debt. These stakeholder groups are largely dependent on the information disclosed in the financial reports by the company for valuation of its financial performance and predicting its present and future growth. As such, the company through depiction of its inaccurate profitability position in the financial reports is influencing the perception of its stakeholders and acting unethical towards them (Deegan, 2014).
The AASB (Australian Accounting Standards Board) 116 has stated the business companies to fairly present their financial performance to the external stakeholders. The objective of the standard is to properly account the value of a company’s property, plant and equipment. As per the standard, the deprecation should be calculated presently over each part of an asset through the use of method that reflects its best use. Thus, the company cannot use the method of ‘sum-of-years’ for calculating deprecation for assets as per this AASB standard. Therefore, the company has not complied with this standard accounting rule and is acting against the standard accounting policies and regulations (AASB 116, 2017).
The accountant of the company is responsible for adopting changes in the accounting methods used for calculation of deprecation. In this regard, it is the ethical responsibility of the accountant to implement the use of accounting policies that best serve the interest of the stakeholders. The accounts in the case of facing an ethical dilemma such as that depicted in the case study of Sunshine Ltd should act in accordance with the views provided by the theory of teleological ethics. The accountant of the company is facing with the dilemma of whether acting in accordance with the unethical practice advocated by the general manager or should act rationally. In this context, the theory of teleological ethics states that an individual has a moral obligation to act in a direction that helps in achieving a good outcome. Therefore, the accountant should act ethically in this situation for protecting the interests of the stakeholders of the company. The change of deprecation method of the company would make its stakeholders to take decisions on the basis of false financial information and thus negatively impacting their growth and development (Ketz, 2006).
It can be stated from the overall analysis of the major issues related to ethics and governance that businesses should adopt fair and transparent accounting practices for ensuring their sustainable growth and development. The management of Sunshine Ltd has adopted the use of unethical accounting practices for influencing the views and opinion of its key stakeholders such as shareholders and investors. As such, the non-compliance of the company with the standard accounting policies developed by IFRS and AASB refers to its violation of the ethics and governance rules of accounting. Therefore, the company can be regarded to adopting the use of unethical corporate governance practices for promoting its business growth and thus not acting in the interests of its stakeholders.
The company on the basis of the above discussion held in context of importance of ethics and governance in accounting is recommended to provide a disclosure of change in the deprecation method adopted in its notes to financial statements section. The company should at-least communicate the change in its accounting policies adopted due to use of sum of years digit deprecation method over straight-line method to its internal auditors. The auditors can prove potential help to the company in developing a solution to the problem of maintaining profits in the future period in which it is expecting a downfall in the profit. This would help the company in ensuring continuous growth in profitability in the future period of time through the use of ethical practices. Thus, the company should change its deprecation method to straight line in order to protect the interests of its different stakeholder groups. However, if the company wants to adopt a change in its depreciation method for ensuring its good profitability position in the future period of time then it should provide proper justification to its stakeholders regarding the nature of changes adopted in its deprecation methods. The company also needs to comply with the relevant rules and regulations of the AASB while adopting changes in its accounting policies related to the use of deprecation method (Jeffrey, 2016).
Conclusion
The analysis and evaluation of the case study of Sunshine Ltd has indicated that it is carrying out its accounting practices in an unethical manner without complying with the standard accounting policies and rules developed by AASB. The company on the basis of ethics and governance rues in accounting is advised to provide proper disclosure of the changes in its accounting policy implemented to its stakeholders for ensuring its sustainable growth and development.
References
AASB 116. 2017. [Online]. Available at: https://www.johnwiley.com.au/highered/aas2e/content029/fact_sheets/AASB116_ch10.pdf [Accessed on: 18 January 2018].
Adams, C.A. 2002. Internal organisational factors influencing corporate social and ethical reporting: Beyond current theorizing. Accounting, Auditing & Accountability Journal, 15(2). pp. 223-250.
Blake, J. and Gowthorpe, C. 2005. Ethical Issues in Accounting. Routledge.
Deegan, C. 2014. Financial Accounting Theory. McGraw-Hill Education Australia.
Drury, C. 2005. Management Accounting for Business. Cengage Learning EMEA.
Jeffrey, C. 2016. Research on Professional Responsibility and Ethics in Accounting. Emerald Group Publishing.
Ketz, E.J. 2006. Accounting Ethics: Theories of accounting ethics and their dissemination. Taylor & Francis.
Zimmerman, J.L. and Yahya-Zadeh, M., 2011. Accounting for decision making and control. Issues in Accounting Education, 26(1), pp.258-259.
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