Individual Assignment Application of Professional Judgment On - PDF document

ACCG224: Financial Accounting and Reporting Session 1, 2019 Individual Assignment Application of Professional Judgment On Impairment Testing Part I - Research-Based Report (15%) Due: Monday 29 April, 5pm Word limit: 1,200 words Part II – Video Oral Presentation (5%) Due: Monday 6 May, 5pm Time limit: 4 minutes S1 2019 ACCG224 Page 1

Part I – Research based report (15%) “In a perfect world, investors, board members, and executives would have full confidence in companies’ financial statements. They could rely on the numbers to make intelligent estimates of the magnitude, timing, and uncertainty of future cash flows and to judge whether the resulting estimate of value was fairly represented in the current stock price. And they could make wise decisions about whether to invest in or acquire a company, thus promoting the efficient allocation of capital. Unfortunately, that’s not what happens in the real world, for several reasons. First, corporate financial statements necessarily depend on estimates and judgment calls that can be widely off the mark, even when made in good faith …..” (Sherman and Young, 2106, p.1). The above clearly shows how crucial it is for accountants to apply their professional judgments in arriving at the most reasonable/appropriate accounting choices which can be quite a challenging process. There is not necessarily one correct answer in most cases, and therefore accountants need to be vigilant while dealing with financial and non-financial information. As a student intern and future accountant, you have recently joined the accounting department of an ASX listed company. Your supervisor, the accountant, has sent you an email containing a Media Release (MR) from the Australian Securities & Investment Commission (ASIC) relating to 2018 financial reports. As a future accountant, and to demonstrate your understanding of professional judgments applied to undertake impairment testing and asset valuations, you have been asked to look into the company’s annual report, undertake required research and present on the company’s position relating to impairment testing as well as prepare a report for presentation to other finance team members and the audit committee. A link to the MR is provided below: https://asic.gov.au/about-asic/news-centre/find-a-media-release/2018-releases/18-159mr-major-changes- affecting-reported-net-assets-and-profit-and-other-focuses-for-30-june-2018-reporting Please copy and paste the above link in the browser for it to work. Relevant extracts from the link FOCUSES FOR 30 JUNE 2018 FINANCIAL REPORTS Accounting estimates 2. Impairment testing and asset values The recoverability of the carrying amounts of assets such as goodwill, other intangibles and property, plant and equipment continues to be an important area of focus. It is important for directors and auditors to ensure: a. cash flows and assumptions are reasonable having regard to matters such as historical cash flows, economic and market conditions, and funding costs. Where prior period cash flow projections have not been met, careful consideration should be given to whether current assumptions are reasonable and supportable; b. discounted cash flows are not used to determine fair value less costs of disposal where forecasts and assumptions are not reliable. Fair value less costs to sell should not be viewed as a means to use unreliable estimates that could not be used under a value in use model; c. value in use calculations: o use sufficiently reliable cash flow estimates S1 2019 ACCG224 Page 2

o do not use increasing cash flows after five years that exceed long term average growth rates, and without taking into account offsetting impacts on discount rates, and o do not include cash flows from restructures and improving or enhancing asset performance d. cash flows used are matched to carrying values of all assets that generate those cash flows, including inventories, receivables and tax balances; e. different discount rates are used for cash generating units (CGUs) where the risks are different and the CGUs are located in different countries, and that similar discount rates are used where the risks are similar; f. CGUs are not identified at too high a level, including where cash inflows for individual assets are not largely independent; g. CGUs for testing goodwill are not grouped at a higher level than the operating segments or the level at which results are monitored for internal management purposes; h. corporate costs and assets are allocated to CGUs on an appropriate basis where it is reasonable to allocate them; i. appropriate use of fair values for testing exploration and evaluation assets during the exploration and evaluation phase; and j. royalty relief or earnings multiple models are not used unless they are sufficiently reliable and market based assumptions are available that are specific to the company’s assets and circumstances. Key disclosures 7. Estimates and accounting policy judgments Disclosures regarding sources of estimation uncertainty and significant judgments in applying accounting policies are important to allow users of the financial report to assess the reported financial position and performance of an entity. Directors and auditors should ensure disclosures are made and are specific to the assets, liabilities, income and expenses of the entity. Disclosure of key assumptions and a sensitivity analysis are important. These enable users of the financial report to make their own assessments about the carrying values of the entity’s assets and risk of impairment given the estimation uncertainty associated with many asset valuations. Preparers should be particularly mindful to make these disclosures as this information may be revealed under key audit matter disclosures in the new enhanced audit reports for listed entities. The above extracts of the 2018 ASIC media release are calling for attention to be placed on the company’s practice of using professional judgments in arriving at the most reasonable estimates and then disclosing the sources or basis of their judgments leading to the accounting information in the financial reports. Specifically, the ASIC report has pointed at the process of ‘Impairment testing and Asset Valuation’ because in carrying out the impairment testing, professional judgments are required to estimate the cash flows, the discount rates, the CGUs, the allocation of corporate assets and costs to CGUs and the appropriate use of fair values . Further, the report also highlights on the need for businesses to provide sufficient disclosures around the judgments applied. The highlights of the ASIC report are strongly indicating that companies need to be vigilant in carrying out the impairment testing and asset valuation and then provide sufficient disclosures so that the users of accounting information can carry out their own assessments about the impairments of the assets in their decision making process. S1 2019 ACCG224 Page 3

Required: To complete this assignment, you will need to select a suitable company yourself that meets the following criteria:  The company must be a constituent of the S&P/ASX 300 index (www.asx300list.com);  The company must publish audited annual financial reports in English, fully complying with IFRS or AASB standards and  The company must have a 30 June year end. Your report must address each of the following: a) The role of professional judgment in accounting and two implications on the users of accounting information if the professional judgment has not been made in the most reasonable/appropriate manner. (5 marks) b) Provide a detailed explanation of the impairment write-down(s) made by your company for the year ended 30 June 2018. Your explanation should include a discussion - of the asset/s that were impaired; - the type of estimations required to write the impairment; - the amount of the impairment write-down and - relevant disclosures in the 30 June 2018 financial report in relation to impairment testing (10 marks) c) Based on your findings in part b, critically discuss whether the professional judgments applied in the impairment write-down of the assets to estimate the cash flows, the discount rates, the CGUs, the allocation of corporate assets & costs to CGUs and the appropriate use of fair values have been reasonable/appropriate. Recommend actions (if any) for improvement in the application of professional judgments relating to these estimations. Please refer to the ASIC media release and other relevant information sources to answer the above question. (15 marks) d) Based on your findings in part c, critically analyse to what extent the professional judgments applied on impairment write-downs satisfy the fundamental characteristics of useful financial information and the objective of financial reporting. (10 marks) S1 2019 ACCG224 Page 4