Accounting and Financial Reporting: Explanation for Accounting Issues

This memorandum explains accounting issues related to financial information and recognising assets and liabilities at fair value based on norms of AASB, corporation act etc. It covers issues related to adjusting consolidated financial statements at fair value, consideration of equity accounts while revaluing assets, and existence of equity accounts for indefinite period.

Accounting and Financial
Reporting
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Table of content
Memorandum 3
Issue 1 3
Issue 2 4
Issue 3 5
References 8
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Memorandum
To: Daniel Ford (Director, Power ltd.)
From: Julia (CFO, Cargo ltd.)
Date: 1st March, 2019
Subject: Explanation for accounting issues
To resolve issues related with financial information and recognising assets and liabilities at
fair value here is the explanations. These are based on norms of AASB, corporation act etc.
Issue 1
First issue raised by board of directors of Power ltd is related with adjusting consolidated
financial statements at fair value. According to AASB standard 13 all assets and liabilities
are required to be measured at fair value. It is a market based valuation and not entity based
measurement (Hoque, 2018).
Market information and observable market transaction might or might not be available for
some assets and liabilities (Berger, 2018). Main objective of fair value measurement in
both the situations is to identify the rate at which orderly transactions are taking place
between market participants. It should be as per current market conditions. Concept of fair
value focuses on accounting measurement of assets and liabilities. This standard applied on
organisations that own equity instruments. AASB 3 includes standards for business
combinations. It happens in form of merger, acquisition etc. The main objective of this
standard is to improve reliability, relevance and comparability of financial information
provided by one business to another. There are several principle that helps the acquirer in
recognising acquired assets and liabilities of acquire (Dyckman and Zeff, 2019). It also
states that classification of financial assets and liabilities are measured at fair value. There
are certain measurement principles related with an acquisition. As per these regulations,
acquirer must measure identifiable assets and liabilities at their fair value on the acquisition
date. All other components related with non-controlling assets are also to be measured at
fair value until and unless Australian Accounting Standards requires other measurement
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basis (Kranacher and Riley, 2019).
These provisions related with consolidated financial statement explain that it is essential
that all assets and liabilities are to be measured at their fair value. Therefore, it has been
explained that consolidated financial statements are prepared at per these standards of
AASB.
Issue 2
Another issue raised by your directors is related with consideration of equity accounts
while revaluing assets. They also have doubts about recognition of liabilities by using
equity accounts such as income (Endenich and Trapp, 2018). Equity accounts refer to
financial representation of business ownership. This account forms when any residual
earning generated by operations and any payment received by owner of business. Some of
common equity accounts are given below:
Common stock: It includes sale of stock directly to investors at par value.
Preferred stock: It refers to par value of preferred stock. There are special rights and
privileges to these shares as compare to common stock.
Additional paid in capital: It refers to the amount paid by investors which is more than
par value. These stocks are sold directly by the issuer.
Retained earnings: It refers to the amount that is retained by business from profit after
paying dividends to shareholders. This earning is used for further investments in
infrastructure or other profitable sources.
Treasury stock: This is known as contra account as it contains amount that is paid to
investors in order to buy back shares from them. It reduces total amount of equity as it had
negative balance (West, 2018). Each equity account except treasury stock holds natural
credit balances. In case retained earnings account has debit balance then it indicates
whether business has suffered losses or it has issued more dividends.
Revaluation refers to an adjustment that is to be made for recording current market value of
assets. According to AASB 10 which is concerned with consolidated financial statements,
at the time of purchase fixed assets are recorded at their cost price. It is common that
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market value of assets changes over the time. So it is decision of organisation whether they
will continue with historical cost or they will use revaluation method. This helps in making
financial records up to date as per current market value. Revaluation model includes
upwards and downwards adjustment in value of asset. This is because of appreciation and
depreciation. Cost model only includes downwards adjustments. Revaluation model is very
helpful when a business is looking for acquisition, merger or demerger (Kothari, 2019). It
assists in negotiating fair price of assets before being acquired by another company. There
are two types of revaluation. Positive revaluation reflects increase in book value of assets.
The revenue earned is not be recorded in income statement. But, it is essential that this gain
must be credited to an equity account named revaluation surplus account. This account
holds all the positive revaluations of company till the time assets are sold or disposed.
When negative revaluation takes place then loss should write off against any surplus from
revaluations. Therefore, revaluation surplus account is the equity accounts that it to be used
by Power ltd. When the revalue asset is completely sold by organisation then any
remaining surplus is required to be credited to retained earnings account of firm. This
revenue can only be used while creating books of accounts as per international financial
reporting standards. Firm that uses generally accepted accounting concepts cannot use this
surplus. There is a recognition criteria that is to be followed in recognising liabilities.
These are recognised in books of accounts only when company is required to settle it.
Liabilities are to be measured in financial statements while preparing consolidated books of
accounts (Abdel-Khalik, 2019).
Equity accounts cannot be used for recognition of liabilities. It is required to maintain
books of accounts in conformance of International Financial Reporting Standards if an
company wants to use this revenue in general purpose (Haseeb, 2018). Surplus amount
generated from revaluation of assets must be transferred to retained earnings. Liabilities
are payable from normal profit earned by company from basis business operations.
Issue 3
Last issue identified by directors of Power limited is related with existence of equity
accounts for indefinite period. Merging of two business entities is a best option for growth
of business. In this scenario, two firms allocate their resources in order to earn profits.
Acquirer Company holds ownership of all the accounts and financial statements of other
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entity. There is several equity accounts that are hold by acquire but after acquisition there
existence is in the hands of acquirer. Revaluation reserve is to be identified and transferred
to capital reserve of new firm. There are several other equity accounts like common stock,
preferred stock, and retained earnings and additional paid up capital. Their existence
remains same after acquisition but certain changes takes place (Brookfield, 2018). It affects
equity accounts of both the companies but in different ways. These are influenced by
various determinants such as size of business, economic environment, and management of
acquisition process. Conditions of acquisition also affect existence of various equity
accounts of both the companies. Business that has been acquired suffers the most. Due to
these stockholders of acquiring firm has to experience some fall down in its value. Worth
of newly merged company are more than other firm (Jefrey, 2018). Since, the equity
accounts belong to Cargo ltd which has been acquired by power ltd so decision related with
their existence is in hands of new company. After acquisition there will be changed
policies and reforms and operations will take place as per these new methods.
As per the appropriate law related with acquisition there are several methods related with
accounting after acquisition. When a company acquires another company then acquirer
entitled to record transactions as per acquisition method (Masadeh, Mansour, and Salamat,
2017). This method starts that existence of normal accounts and equity account of acquired
firm exists till 4 to 5 years and after that it completely belongs to the acquirer. Some of the
steps that affect existence of equity accounts are as follows:
● Tangible assets and liabilities that were acquired are to be measured.
● Intangible assets and liabilities are also accounted.
● Equity accounts such as revaluation surplus account, common stock, and retained
earnings are also measured again.
Stocks and equity accounts are revalued at fair value in order to record it at as per current
market rate. If there are some reserves in previous company then the acquirer identifies
such reserves (Kinsella, 2019). After that, these are recorded in accounts of new company
in same form as these are shown in previous accounts. In these cases general retained
earnings of old firm become capital reserves in acquirer’s books of accounts. At the time of
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revaluation of assets there is certain surplus earned by acquirer which is called as
revaluation surplus. It is treated as an important equity account (Baker and Wick, 2019).
After completion of equity process, this surplus also becomes revaluation reserve of
acquirer. Therefore, in case of acquisition of Cargo ltd by Power ltd decision related with
existence of equity accounts is with acquirer. After acquisition, consolidated books of
accounts are to be prepared. Assets and liabilities are revalue on the basis of fair value.
In this memorandum, I have given reasons and explanations related with issues raised by
directors of Power ltd. These explanations are based on appropriate acts and laws related
with acquisition.
Julia
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References
Books and journals
Abdel-Khalik, A.R., 2019. How enron used accounting for prepaid commodity swaps to
delay bankruptcy for one decade: The shadowy relationships with big banks. Journal of
Accounting, Auditing & Finance. 34(2). pp.309-328.
Baker, R. and Wick, S., 2019. A narrative on integrating research and theory into
undergraduate accounting curriculum. Meditari Accountancy Research. 27(2). pp.325-344.
Berger, T.M.M., 2018. IPSAS explained: A summary of international public sector
accounting standards. John Wiley & Sons.
Brookfield, D., 2018. Risk and organizational effectiveness: The role of accounting systems
as a managerial process. Journal of Organizational Effectiveness: People and Performance.
5(2). pp.110-123.
Dyckman, T.R. and Zeff, S.A., 2019. Important Issues in Statistical Testing and
Recommended Improvements in Accounting Research. Econometrics. 7(2).p.18.
Endenich, C. and Trapp, R., 2018. Signaling effects of scholarly profiles–The editorial teams
of North American accounting association journals. Critical Perspectives on Accounting. 51.
pp.4-23.
Haseeb, M., 2018. Emerging issues in islamic banking & finance: Challenges and
Solutions. Academy of Accounting and Financial Studies Journal. 22. pp.1-5.
Hoque, Z., 2018. Methodological issues in accounting research. Spiramus Press Ltd.
Jefrey, C. ed., 2018. Research on professional responsibility and ethics in accounting.
Emerald Publishing Limited.
Masadeh, W., Mansour, E. and AL Salamat, W., 2017. Changes in IFRS 3 Accounting for
Business Combinations: A Feedback and Effects Analysis. Global Journal of Business
Research, 11(1), pp.61-70.
Kinsella, S., 2019. Visualising economic crises using accounting models. Accounting,
Organizations and Society.
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Kothari, S.P., 2019. Accounting Information in Corporate Governance: Implications for
Standard Setting. The Accounting Review. 94(2). pp.357-361.
Kranacher, M.J. and Riley, R., 2019. Forensic accounting and fraud examination. Wiley.
West, A., 2018. After virtue and accounting ethics. Journal of Business Ethics. 148(1). pp.21-
36.
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