Financial Accounting and Reporting Pewter Ltd

Question: Describe about the Financial Accounting and Reporting for Pewter Ltd. Answer: Issue 1 As conveyed by Mr Con Pewter, it has been brought to the knowledge of accountants that there is an issue regarding the method to be used for accounting the paid leaves of employees. Accountants advice from the desk of McKenzie and Associates Although the method used by the company is quite simple and makes it easier for accountants to record the long service leaves expense. They account this expense when employees are actually paid the salaries. However, this seems inadequate since it contradicts with the realization concept of accounting principles (Elliott Elliott, 2007). This principle says that all the expenses and losses should be accounted as and when they are realised and not at the time of payment. Hence, I agree with the suggestion of your senior accountant Mr Peter. The method suggested by him seems cumbersome, but it is the correct way of accounting these expenses. The question raised by you that if simple methods are working, then why not stick with them only is quite obvious. But, you see, it will have a significant implications on tour tax calculations and balance sheet credentials (Watts, 2003). It is illustrated by the hypothetical situation given below. Suppose the companys net profit before tax and allowance for Employee Bargaining Agreement for the year is $50,000. In 2015, 2 of its employees have taken leaves as per Employee Bargaining Agreement. One employee had leaves of 4 weeks and the other had the same for 7 weeks. The total salary to be credited to employees account is $14000+ $24,500 = $38,500 respectively. But this credit is done in 2016. So, it will be shown in the accounts of financial year 2016. Besides that, another employee has taken leaves of 6 weeks under the same clause. The salary to be credited is $21,000. This will be credited in 2016 only. Net profit before tax and allowance for Employee Bargaining Agreement is $55,000 for 2016. Tax calculation for 2015 (assuming corporate tax to be 30%): net profit before tax and allowance of Employee Bargaining Agreement is $50,000. As per companys earlier methods, there is no expense of paid leaves in this year. Hence, tax amounts to $15,000, which is a huge amount and net profit is $35,000. Tax calculation for 2016 (assuming corporate tax to be 30%): net profit before tax and allowance for Employee Bargaining Agreement is $55,000. This year there will be an expense of $59,500 for paid leaves. Hence, balance sheet will show loss of $4,500. No taxes will be levied. Instead realization concept should be used (Schn, 2004). 2015 Amount (in $) 2015 Amount (in $) 2016 Profit 50,000 55,000 Paid leave expense (38,500) (21,000) Profit before tax 11,500 34,000 Tax paid @ 30% 3,450 10,200 Net profit 7,050 24,800 Total tax paid = 13,650 (less than earlier) Issue 2 The second issue as communicated with us seems to be regarding the method of accounting to be used to record revenues from sale at stores and deduction of fees to occupy the shelves at the stores. For marketing goods and enhancing sales, it is a good way to book specific places at the store exclusively for the companys products in return of certain amount of fees. It will generate good amount of revenues. To make the payment process simple, it is acceptable that fees should be deducted from the revenues gained. But the question is whether it should be recorded in books the same way. Accountants advice from the desk of McKenzie and Associates I agree to the point that recording net revenue will simplify the matters to a great account. But income statement of a company is not a summary of all the costs and revenues, it shows detailed information to the interested parties of final accounts or stakeholders of the company. It should involve details of each and every point of expenses and revenues generated. If using simple methods is the only motive, then why is there a need to show the amount of cost of goods sold, administrative expenses, etc. separately. They can be summed up and can be shown as a single figure. But then, that would not be the correct way of presenting the income statement. Income statement needs to be informative not only for stakeholders of the company, but also for the company itself. Previous years income statements are commonly used for planning and forecasting for future. Hence, it must clearly show all the expenses and revenues (Gaynor et al., 2011). An example is given to compare a summed up income statement and a detailed- informative income statement. Summed up income statement Particulars Amount (in $) Revenue 800 Cost of sales (396) Gross profit 404 Expenses (298) Net profit before tax and interest 106 Tax and interest paid (52) Net profit after tax 54 Comment: details are not clear. It does not give the clear picture of companys position. Detailed statement Particulars Amount (in $) Sales revenue 800 Cost of sales: Depreciation of factory Depreciation of machinery Depreciation of patents Cost of goods sold Total cost of sales (32) (74) (8) (282) (396) Gross profit 404 Expenses: Salaries Rent Administration costs Total expenses (151) (90) (57) (298) Profit before tax and interest 106 Interest (27) Profit before tax 79 Tax paid (25) Net profit 54 Comment: it gives complete information about the expenses incurred and revenues generated. (Mills Plesko, 2003) Issue 3 As per the details sent to us, I have come across with another issue concerning Deferred Tax Assets (DTA) and Deferred Tax Liabilities (DTL). Your issue is that you are spending so much of money and human resources for recording the details of deferred tax liabilities and deferred tax assets. According to the board members' arguments, time and money should not be wasted on recording temporary differences regarding tax liabilities. You want to avoid recording such details and simplify the procedure for accounting. Accountants advice from the desk of McKenzie and Associates It is advisable for the company to avoid this simplicity. First of all, the companys deferred tax liability is of critical importance for its investors and lenders. If they are not recorded properly, they may have consequences on future periods cash flow statements and balance sheet. Hence, they should be appropriately accounted for (Guenther Sansing, 2000). If you do not record deferred tax liability this year, then it may not have any adverse impact on this years financial statements and cash flows, but will significantly influence next years financial reporting. Reason being the company will have to pay the taxes next year. Hence, it will increase the tax obligations and may show low profits and low performance of the company. This may impact companys goodwill in front of investors and lenders. Hence, such simplicity should better be avoided (PocrnjiĆ¡ et al., 2009). Secondly, arguments given by board of directors that these calculations are mere temporary differences are least significant. Some expenses and revenues are exempted from taxes. Hence, they pose a permanent difference in DTA or DTL. So, these need to be recorded properly in books of accounts (Phillips et al., 2003). Sincerely Ms. Maria Mckenzie References Elliott, B. Elliott, J., 2007. Financial accounting and reporting. Pearson Education. Gaynor, L.M., McDaniel, L. Yohn, T.L., 2011. Fair value accounting for liabilities: The role of disclosures in unraveling the counterintuitive income statement effect from credit risk changes. Accounting, organizations and society, 36(3), pp.125-34. Guenther, D.A. Sansing, R.C., 2000. Valuation of the firm in the presence of temporary book-tax differences: The role of deferred tax assets and liabilities. The Accounting Review, 75(1), pp.1-12. Mills, L.F. Plesko, G.A., 2003. Bridging the reporting gap: A proposal for more informative reconciling of book and tax income. National Tax Journal, pp.865-93. Phillips, J., Pincus, M. Rego, S.O., 2003. Earnings management: New evidence based on deferred tax expense. The Accounting Review, 78(2), pp.491-521. PocrnjiĆ¡, D., Mladineo, L. Pepur, P., 2009. Deferred tax assets and deferred tax liabilities within the scope of International Financial Reporting Standards and Croatian Financial Reporting Standards. Young Science AIESA 2009Participation of PhD. students and young scientific workers on building of society based on knowledge. Schn, W., 2004. International Accounting Standards-A Starting Point for a Common European Tax Base? European Taxation, 44(10), pp.426-40. Watts, R.L., 2003. Conservatism in accounting part I: Explanations and implications. Accounting horizons, 17(3), pp. 207-221.