Financial Accounting: Classification of Expenses, Disclosures of Accounting Policies, Depreciation, Amortization and Impairment Policies

This article discusses the classification of expenses, disclosures of accounting policies, depreciation, amortization and impairment policies in financial accounting. It also includes a case study of Wesfarmers Ltd. for better understanding.

Running head: FINANCIAL ACCOUNTING
Financial accounting
Name of the student
Name of the university
Author note

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Table of Contents
Task 1.........................................................................................................................................2
a) Classification of expenses...............................................................................................2
b) Reasons behind different methods for classifying the expenses.................................3
Task 2.........................................................................................................................................4
Disclosures of Accounting Policies, Estimates and Errors....................................................4
Task 3.........................................................................................................................................6
Depreciation, Amortization and Impairment policies............................................................6
Reference....................................................................................................................................8

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Wesfarmers, since its establishment during 2014 as Western Australian farmers
Cooperative, the company reached to the level of topmost listed companies in Australia. The
company has its headquarter in Western Australia and the diverse business of the company
includes the business of home improvements, hotels, supermarkets, liquor, departmental
stores, office stores and industrial divisions for fertilizers, energy, chemicals, coal and various
industrial safety products. The main objective of the company is to deliver satisfactory return
to the shareholders through satisfying the requirements of customers. The company also
provides healthy and safe working environment to the employees and are responsible for the
expectations and attitudes of communities under which it operates its activities
(Wesfarmers.com.au 2018).
Task 1
a) Classification of expenses
Expenses under the income statement are classified either by function or by nature.
Where the expenses are classified by nature the expenses are disclosed as per the nature, for
instance, transportation cost, depreciation, wages, rents expenses and salaries. The expenses
are not reallocated under the different functions of the company that is the selling cost,
COGS, other expenses and administration expenses (Weil, Schipper and Francis 2013). This
method of disclosing the expenses are used under single step income statement and is
generally used by the small businesses owing to its simplicity. However, the main limitation
of this method is that under this method the gross profit of the company cannot be calculated.
On the other hand, where the expenses are classified by function the expenses are
disclosed as COGS, administrative expenses and selling expenses. This method enables the
calculation of operating profit and gross profit under the income statement. The classification

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by function approach requires further disclosures of the expenses by nature either under the
income statement or under the notes (Robinson et al. 2015).
Looking into the Income statement and comprehensive income statement under the
annual report of Wesfarmers for the year ended 30th June it is observed that the expenses
under the income statements are classified by nature and not by function. This is concluded as
the expenses are classified as impairment expenses, employee benefit expenses, depreciation
and amortization for instance (Wesfarmers.com.au 2018).
b) Reasons behind different methods for classifying the expenses
The reasons of classifying the expenses under different methods are as follows –
 The classification is depended upon various factors like type of the industry to
which the company belongs, type of activities carried out by the company,
historical factors and nature of the company. Based on these factors the most
appropriate method is used.
 As both the methods has its own advantages and disadvantages, the managements
are required to choose the most reliable, suitable and relevant method for the
company (Needles, Powers and Crosson 2013).
 The method is also selected based on the types of cost that is mostly incurred by the
company. For instance, if the company is a manufacturing company then the cost
associated are material, labour and overheads. Therefore the company will classify
the expenses by nature to present the income statement more clearly and more
precisely.

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Task 2
Disclosures of Accounting Policies, Estimates and Errors
AASB 108 deals with the Accounting Policies, Change in Accounting Estimates and
Errors. As per the standard, accounting policies refers to the specific principles and
conventions which the company follows in preparation of the financial statements (Abed, Al-
Badainah and Serdaneh 2012). As per AASB 108, change in accounting estimates occurs
when there is a new development or on the basis of some future consideration. As per
paragraph 10 of Australian Accounting Standards (AASB), if any standard which does not
apply to any transaction than the management judgement will be considered in applying
appropriate accounting standards which are significant in economic decision making needs of
the investors or stakeholders or which are reliable to the financial statements (AASB 2014).
As per paragraph 13 the companies must maintain consistency in accounting policies for
similar transaction unless another accounting standard provides categorization of the same in
other accounting standards. As per paragraph 19, an organization will be accountable for the
change in the accounting policies of the company resulting from the application of the
accounting standard relating to transitional provisions. The paragraph further states that when
there is any particular change in the accounting policies then such a change in the accounting
policies will apply retrospectively. However this will be not be applicable if the case is
impractical to implement retrospective changes. The disclosure requirements of AASB 108
states that the company needs to disclose the standard name, the nature of change in
accounting policies, the retrospective change in the accounting policies (Wang 2014). The
change in accounting estimates such as change in recording of doubtful debts, obsolete
inventories and fair value of financial assets and liabilities. The change in accounting

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estimates is recorded to the extent that such a change will have effects on the assets and
liabilities of the company.
As per the annual reports of the company the company needs to incorporate the
accounting standards in the notes to accounts as shown in the financial statement of the
company. The company has recorded some of the accounting policies, however other
accounting which the company follows need to be mentioned clearly in the notes to accounts
in the financial statements. Another aspect which is a bit unclear from the analysis of
Wesfarmers ltd show that certain accounting estimates are as per the judgement of the
management and it is not clear how much appropriate this can be as per AASB 108. For
example, revenue which is acquired from sales of gift cards are recognized when such cards
are redeemed and when customers buys goods or products using such a card. This is based on
the judgement of the management and estimates which can have material impact if such
estimates changes (Wehrfritz and Haller 2014). The company follows straight line method of
depreciation as depicted in the notes to accounts of the company. Another area of concern
may be the estimate regarding the deferred tax assets. The notes to account states that the
eligible future capital gains are utilized as tax assets which are not that much probable (Ball,
Kothari and Nikolaev 2013).

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Task 3
Depreciation, Amortization and Impairment policies
Depreciation may be defined as the reduction in the value of the assets of a company
over time. These reduction in the value of the asset may be due to natural wear and tear,
damage, obsolescence and other factors (Bull 2014). Depreciations is charged for fixed assets
or tangible assets whereas amortization is charged for intangible assets of the company
(Akintoye 2012). Impairment of assets is defined as reduction in the value of the assets of the
company when the carrying amount of the assets is less than the expected amount which can
be recovered from the assets (Amiraslani, Iatridis and Pope 2013).
As per the financial statements of Wesfarmers ltd, the company has property, plant
and equipment which consist of Freehold land, Buildings, leasehold improvements, plant,
vehicles, mineral leases and equipment. The company follows the policy of measuring the
carrying amount of the property, plant and machinery by measuring the cost relating to the
asset less the amount of depreciation and impairment. The cost of the asset also includes part
of the of costs associated with replacing parts of the assets. The depreciation policy of the
company as stated in the notes to accounts is charged on a straight line basis on property,
plants and equipment over the useful life of the asset. As mentioned in the notes to account
the estimated useful life of the buildings is between 20 and 40 years, plant is between 3 years
to 20 years. Land is not depreciated as per the policy of the company. The expenditure
incurred on mining areas on which production has began is amortised over the life of the
mine. The company only charges amortization on mines if the production on such mines has
started. The depreciation amount as shown in the income statement of the company for the
year 2016 is $ 1296 million. Revaluation of foreign currency is shown in the financial
statements of the Wesfarmers ltd. There has been a revaluation in the spot rate of the foreign

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bonds which the company owns. The carrying amount of such foreign bonds as shown in the
financial statements is of the amount $ 2864. The company utilizes cash flow hedges in order
to mitigate the risks of variability. The impairment of asset testing is done in groups which
comprises of property, plants and equipment, intangible assets and goodwill. The impairment
testing is done on an annual basis for intangible assets and goodwill which have indefinite
life. In other cases impairment is done when the management is certain that there are
adequate signs that the asset has been impaired or where the impairment amount which was
previously recognized has changed. The impairment calculations of the company are based
on the corporate plans and business forecast as prepared by the management of the company.
the discounting rate which is used for the calculations of impairment amount is based on the
weighted average cost of capital or through the use of benchmarking market rates. The
discount rate of the company as shown in the notes to account is 8.9% and the growth rate of
the company is shown at 3% which is used in the calculation of the impairment loss which is
incurred by the company.

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Reference
AASB, C.A.S., 2014. Business Combinations. Disclosure, 66, p.77.
Abed, S., Al-Badainah, J. and Serdaneh, J.A., 2012. The level of conservatism in accounting
policies and its effect on earnings management. International Journal of Economics and
Finance, 4(6), p.78.
Akintoye, I.R., 2012. The Relevance of Human Resource Accounting to Effective Financial
Reporting. International Journal of Business Management & Economic Research, 3(4).
Amiraslani, H., Iatridis, G.E. and 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.
Ball, R., Kothari, S.P. and Nikolaev, V.V., 2013. Econometrics of the Basu asymmetric
timeliness coefficient and accounting conservatism. Journal of accounting research, 51(5),
pp.1071-1097.
Bull, R.J., 2014. Accounting in business. Butterworth-Heinemann.
Needles, B.E., Powers, M. and Crosson, S.V., 2013. Principles of accounting. Cengage
Learning.
Robinson, T.R., Henry, E., Pirie, W.L. and Broihahn, M.A., 2015. International financial
statement analysis. John Wiley & Sons.
Wang, C., 2014. Accounting standards harmonization and financial statement comparability:
Evidence from transnational information transfer. Journal of Accounting Research, 52(4),
pp.955-992.

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Wehrfritz, M. and Haller, A., 2014. National influence on the application of IFRS:
Interpretations and accounting estimates by German and British accountants. Advances in
Accounting, 30(1), pp.196-208.
Weil, R.L., Schipper, K. and Francis, J., 2013. Financial accounting: an introduction to
concepts, methods and uses. Cengage Learning.
Wesfarmers.com.au., 2018. Wesfarmers.com.au. [online] Available at:
https://www.wesfarmers.com.au/docs/default-source/reports/2016-annual-report.pdf?
sfvrsn=4 [Accessed 6 Feb. 2018].