Topic 6: Provisions: Ethics Self Study Questions Solutions
1. H&P Problem 26.3, page 976
Determine the Facts
ACCT2011: Financial Accounting A
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BUSINESS SCHOOL
Pham is an accountant in business being Chief Accountant at the Bank of Australia. The bank’s loan portfolio appears to have become too heavily weighted with high-risk loans. Pham has formed the view that the bank’s bad debts provision should be substantially increased to reflect the higher risk, but her recommendation has been emphatically rejected by the managing director. An appeal to the bank’s auditor has also been unsuccessful because the auditor has favoured the more extensive experience of the managing director.
Define the Ethical Issue
Key stakeholders include Pham, the managing director, the auditors, the bank’s shareholders and the bank’s depositors.
The most immediate decision problem for Pham is how should she respond to the rejection of her recommendation.
Identify the Major Principles, Rules and Values
Major professional ethical principles are integrity (Pham should promote honesty with regard to the bank’s financial statements); objectivity (Pham should not be influenced by the fact she is employed by the bank); competence and due care (Pham should ensure that the calculation of the provision reflects appropriate accounting practices, calculations, etc.); and confidentiality (Pham should not disclose the private information of the bank without permission). Students can refer to APES 110, Section 100, paragraph 100.5, Section 110 (Integrity), Section 120 (Objectivity), Section 130 (Professional Competence and Due Care) and Section 150 (Professional Behaviour).
Specify the Alternatives
Students may identify several options. Having already tried to persuade the managing director and the auditors, options could include:1
a. Document her concerns within the bank’s systems and present these to the board/audit committee.
b. Document her concerns within the bank’s systems and present these to a regulator (e.g. ASIC).
c. Document her concerns within the bank’s systems and resign.
Compare Values and Alternatives – See if a Clear Decision Emerges
1 Other options not reviewed here might include gathering more evidence to provide stronger support for her concerns which might then be used to persuade the managing director and/or auditor as to the seriousness of the risks.
Option (a) – informing the board/audit committee is in compliance with all of the ethical principles identified above. One strength is that it respects the bank’s right to confidentiality.
Option (b) – going to the outside regulator may satisfy most of the ethical principles identified above but does breach the general duty of confidentiality to Pham’s employer.
Option (c) – documenting the information and resigning is in compliance with all of the ethical principles identified above but might seem to be lacking in courage as it leaves the alleged problems within the bank unresolved (perhaps leading to even greater costs later).
Assess the Consequences
Each of the options stresses the need for Pham to formally document what her concerns are and that she lodges them within the records of the bank. Apart from allowing her to clearly demonstrate the available evidence that supports her concerns, it also makes those in the bank with greater authority the responsible parties if the bank does not act on the advice and Pham’s concerns ultimately prove to be correct.
Option (a) – going to the board/audit committee keeps the alleged problem confidential and so may minimise any reputation cost to the bank if the concerns turn out to be valid. If the board or audit committee is dominated by a managing director with a strong personality, then appealing to those two committees may be ineffectual and Pham faces a strong risk of being sacked from her job.
Option (b) – going to the outside regulator leads to potential risks to Pham’s reputation if she fails to convince the regulator as to the validity of her concerns or could have serious reputation effects for the bank if her concerns are made public (e.g. the share price might drop and/or depositors at the bank may lose confidence and try to take all their money out). These risks might be managed by the regulator depending upon how it chooses to respond to Pham’s claims.
Option (c) – resigning leaves the alleged problems unresolved, potentially letting the problem get worse over time. In addition, Pham loses her livelihood in the short run for no clear benefit.
Make Your Decision
Pham should ensure the validity of her evidence and approach the board or audit committee to persuade them to allow the changes to the provision. If this is unsuccessful and there is a very significant risk to the public interest, Pham should consider whistle blowing to the regulator. (Seeking legal advice first would be appropriate.)
2. Adapted from “Financial Reporting” 3rd ed, Loftus et al. (2020), p. 286
a) Calculate the provision for warranty balance at 30 June 2020.
180,000 0.890 160,200
No defects (80% x $nil cost)
Minor defects (15% x $1,000,000) = 150,000 Major defects (5% x $6,000,000) = 300,000 Discount factors at 6%
Total annual amounts
Total 30 June 2020
414,810 414,810
150,000 120,000 .943 254,610
(i) Prepare all necessary journal entries for the year ended 30 June 2020. Include all workings.
Particulars
Warranty expense
Provision for warranty
Provision for warranty on sales for year ended 30 June 2020
$414,810 $ nil $414,810
Balance of provision for warranty at 30 June 2020 Less opening balance at 1 July 2019
Adjustment required
3. Adapted from “Financial Accounting” 9th ed, Deegan, C. (2020), Example 10.3 pp.382-383
a) Calculate the provision for restoration costs balance at 1 July 2017: Obligation of $750,000 x .527 (discount factor of 6%, n = 11) = $395,250
b) Prepare all necessary journal entries for the year ended 30 June 2018. Include all workings.
Particulars
Provision for restoration costs
Recognition of damages/restoration provision
Interest expense
Provision for restoration costs
Recognition of interest for year ended 30/06/18
$395,250 x 6% = $23,715 (interest) + $395,250 (carrying amount at 1 July 2017) = $418,965 (carrying amount at 30 June 2018)
Adapted from “Financial Reporting” 3rd edition, Loftus et al. (2020), p. 283
a) An amount of $42,000 owing to Petal Ltd for services rendered during May 2022.
Present obligation/Past event
Present obligation as a result of a past obligating event
There would have been a contract between Petal Ltd and creating a present obligation for the services. The past obligating event are the services that have been provided by Petal Ltd to .
Outflow/Probable
An outflow of resources embodying economic benefits is settlement
Without any further information about the contract, it is likely will settle this amount.
Reliable estimate
Consider whether an amount can be calculated with some degree of reliability
There is a high degree of reliability for the amount owing as the $42,000 is stated in the contract between Petal Ltd and .
Conclusion Amount should be recognised as a liability in ’s financial statements at 30 June 2022.
Particulars
30/06/19 Professional services 42,000 Accounts payable
Recognise amount owing to Petal Ltd
b) Costs of $12,000 estimated to be incurred for relocating an employee from ’s head office location to another city. The staff member will physically relocate in July 2022.
Present obligation/Past event
Present obligation as a result of a past obligating event
Conclusion
Assuming has not accepted responsibility nor entered into contracts with external parties before 30 June 2022, there would not be a past obligating event or a present obligation.
The amount should not be recognised in financial statement at 30 June 2022 as there is not an obligating event.
Outflow/Probable
An outflow of resources embodying economic benefits is settlement
When the staff member physically relocates in July 2022, it is likely the amount will be settled.
Reliable estimate
Consider whether an amount can be calculated with some degree of reliability
Costs of $16,000 have been estimated.
c) Provision of $40,000 for the overhaul of a machine. The overhaul is needed every 5 years and the machine was 5 years old at 30 June 2022
Students are advised to refer to AASB 137 Examples 11 and 11A for further guidance.
Present obligation/Past event
Present obligation as a result of a past obligating event
Conclusion
There is no present obligation or past event because any decision to overhaul the machine relates to ’s future decisions and operations.
Amount should not be recognised in ’s financial statements at 30 June 2022.
Outflow/Probable
An outflow of resources embodying economic benefits is settlement
As the decision is about ’s future operations, at 30 June 2022 it is not likely there will be an outflow of resources.
Reliable estimate
Consider whether an amount can be calculated with some degree of reliability
An estimate of $40,000 for the overhaul costs has been determined.
d) Damages awarded against resulting from a court case decided on 26 June 2022. The judge has announced that the amount of the damages will be set at a future date, expected to be in September 2022. has received advice from its lawyers that the amount of the damages could be anything between $50,000 and $7 million.
Students are advised to refer to AASB 137 Example 10 for further guidance.
Present obligation/Past event As the outcome of court case has established ’s responsibility, Present obligation as a result of a there is a present obligation for the underlying obligating event.
past obligating event
Outflow/Probable
An outflow of resources embodying economic benefits is settlement
Considering the judge has announced the damages are expected to be set in September 2022, it is likely will settle an amount.
Reliable estimate
Consider whether an amount can be calculated with some degree of reliability
will need to decide whether they can calculate a reliable estimate with the advice/information they have received from their lawyers. At 30 June 2022, the amount of damages could be anything between $50,000 and $7,000,000. If possible, would need to make a best estimate of the anticipated damages.
Conclusion
On the basis can calculate a best estimate, this amount should be recognised as a provision in ’s financial statements at 30 June 2022. However, if is unable to determine a best estimate, then the event should be disclosed as a contingent liability in the notes to the 30 June 2022 financial statements.
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