BAO2202 Financial Accounting Assignment Report, Semester 2, 2018

This report delves into financial accounting, examining critical aspects such as measurement and recognition issues. It begins by analyzing the enhancing qualitative characteristics of financial reporting, including comparability, verifiability, timeliness, and understandability, as outlined in the conceptual accounting framework, and how these characteristics improve the quality of information for users' decision-making. The report then explores the factors that determine an entity's status as a reporting entity, as defined by the Statement of Accounting Concepts, highlighting the importance of distinguishing management from economic interests, the impact of economic or political factors, and financial characteristics. Finally, it critically assesses the limitations of the historical cost method in measuring the financial value of assets and liabilities, discussing its relevance for decision-making, depreciation provisions, comparability of financial information, and potential for misleading information. The report also includes a comparative analysis between AASB 15 and AASB 18 for reporting revenue by business entities.

Financial Accounting
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Introduction
The present report is developed to examine the measurement and recognition issues that
are present in the financial accounting. The analysis of such issues is highly important for
developing an in-depth understanding of these problems as these influence the decision-making
process of users of general purpose financial reports. The accountants, in this context, have
major responsibility of providing significant information to the users of financial statements for
facilitating them to take investment decisions. The report as such has particularly evaluated the
enhancing qualitative characteristics of financial reporting stated by the conceptual accounting
framework. The factors determined by the statement of accounting concepts for making an entity
as a reported entity is also discussed in the report. Also, it has presented the limitations
associated with historical method of costing to be used for measuring the financial value of
assets and liabilities. Lastly, it has carried out a comparative analysis between AASB 15 and
AASB 18 for reporting revenue by the business entities.
Part 1:Enhancing Qualitative Characteristics Improving the Quality of Information
Provided by Conceptual Accounting Framework
The conceptual accounting framework has identified and stated the fundamental and
enhancing qualitative characteristics of financial reporting. The qualitative characteristics for
financial information has been developed for providing guidance to the financial users regarding
the type of information that is most relevant to be disclosed to present and future investors. The
conceptual framework has stated relevance and faithful presentation to be the fundamental
principle of conceptual accounting framework. The framework has also stated enhancing
qualitative characteristics of financial reporting that are comparability, understandability,
timeliness and verifiability. The financial information disclosed as per the framework qualitive
characteristic must be comparable for facilitating the users to take accurate decisions by selecting
the best possible alternative. The information about a reporting entity can be stated to be
comparable if it can be compared with other similar information provided by other entities. The
reporting entities need to present the financial information of two consecutive years in their
financial reports so that it is easily comparable. It enables the user to identify and understand the
similarities and differences among the financial items. The financial information must be
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prepared with the use of consistent set of accounting methods so that it can be compared easily
from one year to another (Conceptual Framework for Financial Reporting, 2015).
The financial information need to be verifiable in the sense that it can be verified using
direct or indirect method. Direct verification mans that the financial information can be verified
by observation while indirect verification means that it can be verified using accounting policies
and methods used to obtain the value of such financial items. As such, it is essential for the
business entities to report the financial information in a numerical form and should explain the
underlying assumptions and policies used for calculating the value depicted. The verification of
financial information ensures that it has presented the economic phenomena it aims to represent.
The timeliness characteristics of financial reporting states that the financial information provided
must be latest and should not be older to facilitate the decision-making process of users. As such,
the reporting entities need to develop and disclose the financial reports on an annual basis so that
the end-users received current financial information and can take accurate investment decisions.
The fourth and last enhancing qualitative characteristic of financial reporting is
understandability. The reporting entities need to report the financial information in a simple and
understandable format to the end-users. The financial data must be presented in a clear and
specific manner for providing an in-depth understanding of the complex phenomena. The
business entities disclose the notes section to financial reports for providing a discussion about
the significant accounting policies adopted for development and presentation of the financial
information. Therefore, it can be said based on discussion of enhancing qualitative characteristics
that these features should be present in a financial information to make it relevant. However, it
should also be kept in mind that these enhancing qualitative characteristics must be used in
application of fundamental principles of relevancy and faithful presentation. This is necessary to
protect the interest of end-users and meeting the ultimate objective of financial reporting as
stated by the framework. This will help in ensuring the maximization the application of
qualitative characteristics of financial reporting (Whittington, 2008).
Part 2: Relevant Primary Factors Important in Determination of an Entity as a Reporting
Entity
The Statement of Accounting Concept (SAC) has stated that an entity can be regarded as
a reporting entity on which users are dependent for gaining financial information for taking
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investment decisions. The dependent users can be regarded as the users of financial information
who rely on such information for making an evaluation of the financial performance of an entity
for taking pertinent decisions. SAC has defined that the reporting entities are identified based on
dependent users who relies on general purpose financial reports for making resource allocation
decisions (Saccon, 2007). SAC has also identified and stated the preliminary factors to be
considered for determination of an entity as a reporting entity that are discussed as follows:
Distinction of Management from Economic Interest
It is important to have a distinction between the management and the owners for
determination of an entity as reporting entity or other members that are having an economic
interest. The larger the difference between the management and the ownership in a business
entity the more likely is the presence of its dependent users. Therefore, it is an important factor
for classifying an entity as a reporting entity (Whittington, 2008).
Impact of Economic or Political Factors
As per this factor, an entity qualifies for the criterion of a reporting entity based on it
having an impact on the external party’s welfare. The larger is the economic or political power of
an entity it will have more dependent users that rely on the information disclosed by such an
entity for taking important decisions regarding the resource allocation. The business entities have
an influencing political or economic power are dominant one’s having a complete control on the
market. The entities possessing the authority to attain a balance between the interest of other
entities. The example of such business entities includes having regulatory power and employer-
employee associations (Kabalski, 2009).
Financial Characteristics
The dependent users of an entity are also influenced by its financial characteristics and as
such they impact its identification as a reporting entity. The financial characteristics include its
size that can be determined based on sales volume or number of employees and customers
possesses by an entity. The greater the size of an entity larger will be the resource allocation and
therefore it will have a direct impact on its dependent users. Therefore, it can be said that larger
is the size of a business entity greater will be its existing users interested in making resource
allocation decisions (Nawas, 2013).
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Therefore, it can be said that the creation of a company or its structure does not result in
development of a reporting entity. A reporting entity need to satisfy all the above-mentioned
criteria’s for satisfying itself as a reporting entity. The statement of accounting concept has
established the relation between the information need of users to the nature of general purpose
financial reports. It has been carried out by establishing the concept of a reporting entity and the
identification of its boundaries. Therefore, it can be stated based on identification of the factors
required for classifying an entity as a reporting entity that it should be the provider of resources
and should have a dependent base of current users.
Part 3: Limitations of Historical Cost as A Measurement Base in Generating Decision-
Useful Information
The method of historical cost accounting can be regarded as a traditional model used by
accountants for measuring the value of financial assets and liabilities. Historical cost can be
regarded as a measure of value that is used on accounting for determination of the price of an
asset on its balance sheet based on original cost when it was acquired by an entity. This method
of cost accounting is based on the generally accepted accounting principles (GAAP). The model
of historical cost accounting is regarded as a well-established method of accounting that is used
across the world for financial reporting. The method has proved to be very useful for depicting
the pertinent information to the users of financial reports thus facilitating in taking significant
decisions. AASB (Australian Accounting Standards Board) has also directed its business entities
to report the value of financial items such as assets and liabilities using historical method of
accounting. However, the business entities at present are emphasizing on adopting the use of
other cost accounting method for measuring the value of financial items such as assets and
liabilities due to numerous limitations associated within the method of historical costing. These
are stated as follows:
Historical Cost is not Relevant for Decision-Making
The method of historical cost accounting is not regarded to be useful for taking
significant business decisions. The primary role of accounting is to meet the needs of end-users
that relies on such information for taking significant decisions. The primary users of accounting
information are not only interested in ensuring the stewardship of accounting process but also
have specific interest in increase or decrease in the value of investment as depicted by its net
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assets. This is because the value of assets and liabilities calculated using historical method of
accounting does not represent the realistic value. This is because it is based on its original value
at the time of its acquisition and thus is not adequate for present the true and fair value as per the
current market changes. Therefore, it can be said that statement of financial position developed
based on historical costing is not realistic for predicting the future cash flows. The financial
statements developed with the sue of historical method is only a statement of historical facts as it
does not take into consideration the changes in the price level due to market changes. The
monetary value is bound to change during the period of inflation and the instability results in
causing number of distortions in the financial statements (Effiong, 2012).
Insufficient Provision for Depreciation
The depreciation in the method of historical cost accounting is charged on the asset cost.
Depreciation can be regarded as a method of generating funds for replacing the fixed assets when
they become due to be replaced. The charging of depreciation in the method of historical
accounting is assessed based on original price and does not consider the price at which an asset
could be acquired. Therefore, it can be stated that this method does not prove to be adequate in
charging the depreciation as it will result in overstating the profit in periods of inflation
(Rahmawati, 2006).
Non-Comparability of Financial Information
The financial reports that are developed with the use of historical method of cost
accounting does not prove to be useful for comparing the financial information over the years for
a business entity. This is because the value of key financial items tends to fluctuate over the
years due to inflation and thus comparison of the financial information does not prove to be
reliable method for examining the financial statement of an entity. The profits reported by
business are overstated and the value of assets are understated during the period of inflation.
Also, the impact of inflation is not same for all the entities in the market and therefore the
historical cost accounts does not prove to be useful on comparing the performances of business
entities (Munteanu, 2015).
Misleading Information
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The use of historic method of accounting is also not significant in providing a true
impression of the ability of a company to continue its operation at a given level. The historical
method of accounting provides a false impression of the ability of a company to continue its
operations in the future as assets are undervalued with the use of such method of accounting. His
can results in causing negative impact on the interest and welfare of investors who have invested
in the company (Bakar, 2007).
Part 4: Comparison of new revenue standard AASB 15 “Revenue from Contracts with
Customers” and old revenue standard AASB 18 “Revenue”
Australian Accounting Board has adopted the new accounting standard AASB 15 of
revenue recognition and measurement to replace the old accounting standard AASB 18. AASB
15 has been derived from the IFRS 15 “Revenue from the contracts with customers”. The main
objective of AASB 15 is to establish the accounting principles that entities applies to report the
useful information for the users of the financial statements in relation the nature, amount, timing
and uncertainty of the revenue recognition and amount of cash flows from the various contracts
with customers. The main purpose of introducing AASB 15 is supersede the ongoing accounting
standards for two main revenue recognition standards such as AASB 111 construction contract
and AASB 118 Revenue. There are many differences in AASB 15 and AASB 18 as International
Accounting Board has changed how the entities can recognize the revenue in the financial
statements.
The differences between both the standards are specifically related with recognition
criteria, measurement, and disclosures. These are explained in detail below:
Recognition Criteria:
In standard AASB 118 “Revenue” the recognition criteria are divided separately for each
type of transactions. The main transactions that are identified by the AASB 118 are sale of
goods; rendering of services; and Interest, royalties and dividends. There is separate recognition
criteria for each type of transactions such as revenue from the sale of goods are recognized when
entity transferred the risks and rewards of ownership of goods to the buyer. Similarly, from
rendering of service and other income from interest, royalties and dividends entity must apply
separate recognition criteria (AASB 118, 2010). In AASB 15 there are no separate recognition
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criteria for different transactions but it requires entities to recognize the revenue in accordance
with the satisfaction of the performance of obligations defined for each type of contract.
Basically, entities are required to complete the five-step process for recognition and
measurement of revenue from the contracts with the contracts (AASB 15, 2014). The five steps
defined under AASB 15 are identification of contracts that has been made with the customers, to
identify the performance obligation in each contract, determining the transaction of each
contract, allocating the identified transaction price to each performance obligation and lastly
recognition of revenue when each performance obligation has been completed. Here the word
contract has greater meaning as all the things are based on this word. So, it can be said that
transactions identified in AASB 18 has been grouped as one and it was named as contract and
contract is defined in detail to club the definition of sale of goods, rendering of services and
transactions of dividend, royalties and interest (Probono Australia, 2018).
The contract is defined as an agreement between two or more parties and this agreement
creates enforceable rights and obligations. The identification of performance obligations is an
important part in the whole process of revenue recognition under AASB 15(AASB 15, 2014).
Performance obligation is a consideration in form of goods or services, or something like that in
lieu of some consideration. Lastly entities are required to recognize the revenue after completing
two more steps of five step process i.e. calculation of transaction price and allocation of
transaction for each performance obligation. Other point that needs to be taken care of in AASB
15 is that AASB 15 requires entity to combine similar contracts with the same customer and take
them as one for revenue recognition (AASB 15, 2014).
Measurement:
As per AASB 18, revenue must be measured at fair value of the consideration received or
receivable. Fair value is defined as consideration received or receivable in from of cash or cash
equivalents after considering any trade discounts and volume rebates (AASB 118, 2010). While
in AASB 15, revenue must be recognized when performance obligation is satisfied, and
transaction price has been identified and allocated to each performance obligation (AASB 15,
2014). The two main criteria that must be satisfied to measure the revenue are determining the
transaction price and allocation of identified transaction price to each performance obligation.
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Thus, it can be said that there is huge difference between both the standards in relation to the
measurement of revenue.
Conclusion
It can be stated from the overall discussion held in the report that it is the responsibility of
business entities to provide useful information to the users who are dependent on it for taking
significant decisions. In this context, the conceptual framework of accounting has reported the
enhancing qualitative characteristics that should be present within a financial information to
make it relevant for decision-making. These characteristics require the financial formation to be
comparable, verifiable, timeliness and understandability. There also some criterion that an entity
need to satisfy for classifying itself as a reporting entity. The report has also stated the
shortcomings present in the use of historical method of accounting that is adopted by AASB for
measuring and recognition of the value of financial items such as assets, liabilities, expenses and
equity. This include providing misleading and manipulated financial information to the end-users
that can result in taking incorrect investment decisions. As such, it has identified the need for
adoption of other method of measurement such as fair value accounting to measure and
recognize the value of financial assets. The advantages of AASB 15 over AASB 18 for
recognition of revenue is also discussed in the report.
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References
AASB 118. 2010. Revenue. [Online]. Available at:
https://www.aasb.gov.au/admin/file/content105/c9/AASB118_07-04_COMPoct10_01-11.pdf
[Accessed on: 16 September, 2018].
AASB 15. 2014. Revenue from Contracts with Customers. [Online]. Available at:
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September, 2018].
Bakar, N. 2007. Historical Cost VERSUS Current Cost Accounting. [Online]. Available at:
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Conceptual Framework for Financial Reporting. 2015. [Online]. Available at:
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Nawas, R. 2013. Factors affecting the quality of Auditing: The Case of Jordanian Commercial
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Probono Australia. 2018. Impact of Accounting Standard Changes in Recognition of Revenue.
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Whittington, G. 2008. Fair value and the IASB/FASB conceptual framework: an alternative
view”. Abacus 44 (2), pp 139-168.
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