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Accounting Standard Setting under the Australian Conceptual Framework and Application in Business Practices
Introduction
A conceptual framework establishes the concepts and provides the guidelines that underlie financial reporting. As a coherent system of notions that flow from an objective, which in turn serve to identify the purpose of financial reporting, a conceptual framework also provides guidance on the identification of the boundaries of financial reporting. Its concepts further provide guidance on the selection of transactions, related events, and circumstances to be presented, and how such elements should be summarized and ultimately reported (Financial Accounting Standards Board [FASB], 2008). One such conceptual framework is the Australian Conceptual Framework that for this discussion is taken to have informed the preparation of the Wesfarmers financial report for the year ending June 2016. Throughout the report, a number of Australian standards and interpretations applicable for the year under investigation (2016) are apparent. Two such concepts are the AASB 10 Consolidate Financial Statements and the AASB 2013-3 Amendments to AASB 136 – that gives guidelines for the Recoverable Amount Disclosures for Non-Financial Assets (International Accounting Standards Board [IASB], International Financial Reporting Standards [IFRS] Foundation, and International Accounting Standards Committee [IASC], 2010). The decision by Wesfarmers to write-down its assets totaling between $1.8 billion and $2.3 billion in its 2016 financial year led to a significant wipe out of the organization’s full-year profit (Wesfarmers LLC, 2016). Underlying the profit of Wesfarmers after tax fell 3.6% to $2,353 million. The report further indicates that after accounting for the conglomerate’s asset impairments, the statutory net profit stood at $407 million compared to the $2,440 million realized during the 2015 financial year (Wesfarmers LLC, 2016). According to the firm’s statement, the pre-tax non-cash impairments of Target and Curragh (of $1,266 million) stemmed primarily from the poor trading results and a reduced economic outlook in the case of Target.
Under the Australian Conceptual Framework, assets are said to be impaired when their net carrying value is greater than the projected future undiscounted cash flow such assets are capable of providing and the amount they can generate when disposed of (IASB, IFRS, and IASC, 2010). AASB thus mandates that all impaired assets must be recognized once they show evidence of a total lack of recoverability of the net carrying amount. According to FASB (2008) asset impairment occurs in four fundamental ways. First, due to significant declines in the usage rate of the property. Second, due to changes in technology. Third, as result of unforeseen changes in business regulation and climate, and fourth due to reliable forecasts of a significant decline in the profitability of the asset in the long-term. Once in its assessment, a company has determined that an asset is impaired (where the AASB defines assets in paragraphs 4.5-4.23 and BC4.23-BC4.44), it can write-down the asset or classify it as an asset for disposal (IASB, IFRS, and IASC, 2010). According to the AASB guidelines under sections 4.5-4.23, assets are recognized in the statement of financial position of a firm when and only when, the asset in question is probable that its future economic benefits as embodied in the asset will eventuate. Paragraphs BC4.23-BC4.44 further recognizes assets in financial statements only when possessing a cost or other values capable of being measured reliably (Public Sector Accounting Standards Board [PSASB] and Australian Accounting Standards Board [AASB], 1995). In this latter perspective of impairment, Wesfarmers in its 2016 financial year report categorizes the write-down in the balance sheet under Non-current assets as a deferred tax assets entry of value ($1,042) (Wesfarmers LLC, 2016).
Question (b):
As indicated in Wesfarmers 2016 Financial Year Report, write-downs are usually mirrored in an organization’s income statement as an above-the-line expenditure, thereby reducing the value of the net revenue in the process (Australian Accounting Standards Board [AASB], 2015). Studies, however, show that because write-downs are just but paper losses (that is, they tend to lower the net income thus reducing a company’s tax burden), reporting them is not always a bad thing (Public Sector Accounting Standards Board [PSASB] and Australian Accounting Standards Board [AASB], 1995). It was, therefore, necessary for Wesfarmers to account for this write down because it prepares financial statements per the accepted accounting principles and because such asset values carry the potential of impacting both the balance sheet and income statement at some point. Because when an asset is impaired, it is not worth as much or remains useful for the period initially estimated, the Australian Conceptual Framework requires the taking of an impairment loss as well as reducing the resulting carrying value on the company’s financial statement (AASB, 2015; Marz, 2016).
On the recording of asset write-down, accounting rules suggest that a write-down in a company’s inventory is noted down by reducing the initial amount reported as inventory (FASB, 2008). In the statement, the business reduces such account inventory by either a credit or a crediting entry into a similar contra inventory account. The resulting debit entry in the write-down inventory is entered and recounted in an account such as Loss on Write-Down of Inventory (which is an income statement account). If such amount is relatively small, Wesfarmers can alternatively report it as part of the firm’s cost of goods sold. However, if the said amount is significant, AASB rules demands that it be reported as a separate line on the income statement (AASB, 2015).
Question (c):
On the impact on profitability, write-downs reduce the profit margin since they reduce the net income. It also reduces the amount reported as owner’s equity (the stockholder’s equity). Hence, for organization’s balance sheet and in the book-keeping equation, the owner’s equity or the asset inventory is reduced. That said, two financial statements are impacted when taking the asset impairment loss of a firm during any given fiscal period. The loss is reported as indicated above on the Wesfarmers financial statement where other operating expenses and income are reported (Marz, 2016). Here, the impairment loss reduces the net profit of the firm. However, it has no immediate impact on the cash balance of the company. Correspondingly, accounting rules also require the writing down of the company’s carrying value that is reported on that year’s balance sheet to the fair value calculated (AASB, 2015). In other words, the firm reduces the current carrying value by the amount represented by the impaired loss. In the subsequent accounting periods, the company also adjusts the amount of annual deductible depreciation for the reason that prior depreciation was calculated and based on the asset’s old carrying value (AASB, 2015). This value is recorded as part of depreciation and amortization ($1, 296) in Wesfarmers 2016 income statement (Wesfarmers LLC, 2016).
Question (d):
One of the impacts of the Target investment on the Financial Performance of Wesfarmers in 2016 was the $195 million full year loss, dragged down by the hefty clean bill the conglomerate incurred in cleaning up the bills for its trouble operations (Low, 2016). According to the report, Target’s revenue increase by only 0.5% to $3.5 billion. The operating loss included restructuring costs and provisions of $145 million to significantly reset the business operations including policy initiatives to relocate the store support center, reduce inventory, and streamline the supply chain. On the underlying basis, Wesfarmers recorded a loss of $50 million due to the high levels of stock clearance and the impact of the lower exchange value of the Australian dollar (Low, 2016). Moreover, because of the Target problems combined with weaker sales growth at the Coles Supermarket Chain Store and losses from the coal business, the full-year net profit for Wesfarmers dipped by more than 83% to just $407 million (Wesfarmers LLC, 2016).
Question (e):
In its FY 2016 report, Woolworths records a full-year pre-tax loss of $1.235 billion (after-tax loss of $972.7 million in the first half-year results) and a 40.8% decline in underlying earnings from the food and petrol business located in Australia (Farrer, 2016; Woolworths Limited, 2016). Woolworths' net profit for the year slipped from $2.146 billion recorded in FY 2015 as it took $2.628 billion of write-downs that were mostly linked to the firm’s ongoing exit from its underperforming Big W stores and hardware sector. Earnings before interest and tax also dropped from $2.97 billion recorded in 2015 to $1.76 billion. Although Masters Sales’ for the FY 2016 period were $1.1 billion (an increase of 21.8% over FY 2015 period), the pre-tax and before interest loss stood at $233.5 million (Hyam and Ong, 2016). The Woolworths investment in Masters is recorded in the 2016 FY Annual Report under the consolidated statement of financial position as assets held for sale (disposal) ($1,100.5) and as deferred tax assets under Non-current assets ($1,110.0) (Woolworths Limited, 2016). This values impacted Woolworth’s profit for the FY 2016 period in three ways. Firstly, there was Master’s net loss of $1.235 vs. Group’s $2.146 profit. Secondly, the company registered a 1.23% decline in sales revenue to $58.086 billion, and lastly, the business showed a 39% to 33% dividend slump (Woolworths Limited, 2016).
Conclusion
One of the impacts of write-downs is the reduction of pre-tax profits. Other than that, write-downs are also a form of destruction of the shareholder's equity as they artificially reduce the total carrying value of assets reported on the organization’s balance sheet. In the long run, they in turn also artificially boost the profitability metrics of a firm such as ROE by lowering the denominator. Because write-downs are special charges that usually do not feature on the income statement of a firm because they are bundled in other line item entries, these non-recurring items if unaddressed distort the operating earnings of a firm by overstating the core operating costs of the company. These can have a significant impact on the investment outlook for the business.
References
Australian Accounting Standards Board (AASB), 2015. Conceptual Framework for Financial Reporting (ED/2015/3). [Online] Available through: International Accounting Standards Board (IASB) and International Financial Reporting Standards (IFRS) <http://www.aasb.gov.au/admin/file/content105/c9/ACCED264_06-15.pdf> [Accessed January 24, 2017].
Farrer, M., 2016. Woolworths suffers $1bn loss as Masters Debacle and price war take their toll. The Guardian, February 26. [London]. [Online] Available at: <https://www.theguardian.com/business/2016/feb/26/woolworths-suffers-1bn-loss-as-masters-debacle-and-price-war-take-their-toll> [Accessed January 24, 2017].
Financial Accounting Standards Board (FASB), 2008. Conceptual Framework for Financial Reporting. In: Proposed Conceptual Framework for Financial Reporting: Objective of Financial Reporting and Qualitative Characteristics of Decision-Useful Financial Reporting Information (14th ed.). Chap. 2. [Online] Available at: <http://www.wiley.com/legacy/college/kieso/0470374942/ifrs/ch02.pdf> [Accessed January 24, 2017].
Hyam, R., & Ong, T., 2016. Woolworths reports almost $1 billion loss in half-year results. Australian Broadcasting Corporation (ABC) News, February 26. [Sydney]. [Online] Available at: <http://www.abc.net.au/news/2016-02-26/woolworths-reports-almost-$1-billion-loss/7202004> [Accessed January 24, 2017].
International Accounting Standards Board (IASB), International Financial Reporting Standards (IFRS) Foundation, & International Accounting Standards Committee (IASC), 2010. The conceptual framework for financial reporting 2010. [Online] Available at: <http://www.ifrs.org/News/Press-Releases/Documents/ConceptualFW2010vb.pdf> [Accessed January 24, 2017].
Low, C., 2016. Wesfarmers result savaged by Target, Coal. The Sydney Morning Herald, August 24. [Sydney]. [Online] Available at: <http://www.smh.com.au/business/retail/wesfarmers-result-savaged-by-target-coal-20160823-gqzhda.html> [Accessed January 24, 2017].
Marz, M., 2016. Asset Impairment on a Financial Statement. Chron Hearst Newspapers, Feb. [Houston]. [Online] Available at: <http://smallbusiness.chron.com/asset-impairment-financial-statement-80858.html> [Accessed January 24, 2017].
Public Sector Accounting Standards Board (PSASB), & Australian Accounting Standards Board (AASB), 1995. Statement of Accounting Concepts: Definition and Recognition of the Elements of Financial Statements (SAC 4 [3/95]). [Online] Available through: Australian Accounting Research Foundation website <http://www.aasb.gov.au/admin/file/content102/c3/SAC4_3-95.pdf> [Accessed January 24, 2017].
Wesfarmers LLC, 2016. Wesfarmers 2016 Annual Report. [pdf] [Online] Available at: <http://www.wesfarmers.com.au/docs/default-source/reports/2016-annual-report.pdf?sfvrsn=8> [Accessed January 24, 2017].
Woolworths Limited, 2016. Woolworth Group 2016 Annual Report. [pdf] Woolworth Holdings. [Online] Available at: <https://wow2016ar.qreports.com.au/xresources/pdf/wow16ar-full.pdf> [Accessed January 24, 2017].
