Question

counting estimates. iges in (b) The directors of Tunshill are disappointed by the draft profit for the year ended 30 September 2010. The company's assistant accountant has suggested two areas where she believes the reported profit may be improved: (i) A major item of plant that cost $20 million to purchase and install on 1 October 2007 is being depreciated on a straight-line basis over a five-year period (assuming no residual value). The plant is wearing well and at the beginning of the current year (1 October 2009) the production manager believed that the plant was likely to last eight years in total (i.e. from the date of its purchase). The assistant accountant has calculated that, based on an eight- year life (and no residual value) the accumulated depreciation of the plant at 30 September 2010 would be $7-5 million ($20 million/8 years x 3). In the financial statements for the year ended 30 September 2009, the accumulated depreciation was S8 million ($20 million/5 years x 2). Therefore, by adopting an eight-year life, Tunshill can avoid a depreciation charge in the current year and instead credit $0-5 million (S8 million S7-5 million) to the income statement in the current year to improve the reported profit. (ii) Most of Tunshill's competitors value their inventory using the average cost (AVCO) basis, whereas Tunshill uses the first in first out (FIFO) basis The value of Tunshill's inventory at 30 September 2010 (on the FIFO basis) is $20 million, however on the AVCO basis it would be valued at $18 million. By adopting the same method (AVCO) as its competitors, the assistant accountant says the company would improve its profit for the year ended 30 September 2010 by $2 million. Tunshill's inventory at 30 September 2009 was reported as $15 million, however on the AVCO basis it would have been reported as $13-4 million Required: Comment on the acceptability of the assistant accountant's suggestions and quantify how they would affect the financial statements if they were implemented under IFRS. Ignore taxation. Solution: A) Management's choices of which accounting policies they

Answer 1

1. Acceptability of change in useful life of a non-current asset and resultant amount of depreciation:

International Financial Reporting Standards allow the organization to make change in the method of depreciation or the amount of depreciation if there is further evidence to prove better reflection if depreciation amount in the financial statements. In this case evidence provides that the useful life of the plant earlier assessed at 5 years will be 8 years thus, making change in the amount of depreciation will be completely in line with IFRSs. Thus, since, the accumulated amount of depreciation should have been $7.5 million instead of actual $8 million hence, the company should credit the balance $0.5 million in the profit and loss account. In addition there will be no requirement to charge depreciation for the year ending on September 30, 2010 since the accumulated amount of $7.5 million of depreciation is including the current year’s depreciation.

Thus, the change in amount of depreciation including accumulated depreciation is allowed under IFRSs.

As a result of the change the profit of the company for the financial year ending on 30^th September, 2010 will increase by;

Annual depreciation charge under earlier estimated useful life of 5 years

= (20 million /5) = $4 million

Since, no depreciation will have to be charged for the financial year 2009-10 thus, the profit will be higher by $4 million. In addition the written back of excess depreciation of (8 million – 7.5 million) = $0.5 million will also increase the profit. Thus, the overall profit as a result of change in accounting estimate will be (4 million + 0.5 million) =$4.5 million for the financial year ending on 30^th September, 2010. .

2. Change in method of inventory valuation:

Change in inventory valuation method is acceptable as long as it is within the framework provided by the IFRSs. In this case the assessment of the Assistant Accountant of Tunshill is incorrect. The change in method of inventory valuation from FIFO to Average cost method (AVCO) will not result in increase of profit. In fact the use of AVCO method would reduce the current profit for the financial year ending on 30^th September, 2010 by {(20 million – 18 million) - (15 million – 13.4 million)} = $0.4 million. This is because the use of AVCO will reduce the closing stock as well as opening stock of the company.

Hence, use of AVCO method will reduce the profit for the financial year ending on 30^th September, 2010 by {(20 million – 18 million) - (15 million – 13.4 million)} = $0.4 million.