Financial Accounting A
Topic 6: Provisions; Ethics
These notes only summarise key points Textbook reading is essential
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Provisions
Text Readings:
: Ch 10 pp 380-383 & 390 –394 (See eReserve)
Other Readings:
– Framework paragraphs 4.26 – 4.47, 5.7
– AASB137: Provisions, Contingent Liabilities and Contingent Assets
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Textbook Readings:
– H&P Chapters:
– Ch 26, pp. 961-974.
Other Readings:
– APES 110 Code of Ethics for Professional Accountants
– “Danger signs in audited accounts”, AFR 08/05/2019
– “Profit or ethics? Macquarie’s European dilemma”, AFR 30/01/2020
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Learning objectives
Provisions
1. Describe which provisions should be treated as liabilities and apply the appropriate accounting treatment ( O 10.4 pp 380-383).
2. Discuss the nature of a contingent liability and understand how it should be disclosed in the notes to an entity’s financial statements ( O 10.7 pp 390-394).
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Learning objectives
1. Explain the nature of ethics (H&P LO 26.1).
2. Distinguish between rules-based and values-based ethics (H&P LO 26.2).
3. Describe the foundational ethical principles and their application (H&P LO 26.4).
4. Describe the fundamental ethical principles of the accounting profession (H&P LO 26.6).
5. Incorporate ethics into decision making in a way that reflects ethics in a systematic and justifiable manner (H&P LO 26.7).
6. Describe some of the ethical issues facing Australian accountants (H&P LO 26.9).
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Provisions
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Definition & recognition of elements of financial statements (example: liabilities)
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Does the item have all three essential characteristics of a liability?
Does the liability meet both the recognition criteria?
Details might appear in the notes or in the annual report
Liability recognised in the entity’s balance sheet.
(In other words, a journal entry is required.)
In some cases, separately disclosed in the notes (Not recognised, no journal entry)
Introduction
– This topic extends definition and recognition elements for liabilities and investigates the unique characteristics and recognition criteria for transactions and events that come under AASB137: Provisions, contingent liabilities and contingent assets.
– As you will learn, these transactions and events involve uncertainty about the recognition criteria, such as the probability of an event occurring or reliably measuring an amount.
– AASB 137 provides guidance for decisions about the accounting treatment when there is such uncertainty.
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Introduction
Borrowings
Accounts payable
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Contingent liabilities
Very Low UNCERTAINTY Very High
Objective 1
Describe which provisions should be treated as liabilities and apply the appropriate accounting treatment
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( O 10.4 pp 380-383)
Liability provisions
Definition:
– A provision is a liability of uncertain timing or amount (AASB 137 para 10).
Recognition:
– A provision shall be recognised when:
(a) an entity has a present obligation (legal or constructive) as
a result of a past event;
(b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and
(c) a reliable estimate can be made of the amount of the obligation.
– If these conditions are not met, no provision shall be recognised (AASB 137 para 14).
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Liability provisions
Present obligation means:
– A duty or responsibility to act/perform in a certain way towards an external party
– not always necessary to know who the external party is
– Many obligations are legally enforceable (eg., arise from
contracts such as accounts payable for goods received)
– Many obligations also arise from normal practices such as a duty to behave in a particular way (known as a constructive obligation).
– A mere intention to sacrifice economic benefits does not amount to an obligation. An obligating event must leave the entity with no realistic alternative to settling the transaction.
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Definition and recognition criteria
– In rare cases it is not clear whether there is a present obligation. In these cases, a past event is deemed to give rise to a present obligation if, taking account of all available evidence, it is more likely than not that a present obligation exists at the end of the reporting period (AASB 137 para 15).
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Provisions
– Many types of items meet the definition and recognition criteria of liabilities.
– These include e.g., provisions for warranties, refunds,
– Where no present obligation exists to an external party a
liability does not exist.
– e.g. setting aside a reserve for a future event
Refer to AASB 137 Appendix C Examples
In some situations present value calculations are used – Refer to the key concepts you learnt in Topic 5
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AASB 137 Appendix C Examples
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Provisions: Amount to be recognised
– Amount recognised is based on best estimate of the expenditure required to settle the obligation (para 36)
– Often requires professional judgment (para 38).
– Need to consider risks and uncertainties when calculating expected value (para 39).
Refer to Worked Example 10.2 Deegan pp 381-382
– Present value calculations are used when the effect of the time value of money is material (para 45).
– Present value calculations would not normally be done for periods of less than 12 months.
– Material means the omission or misstatement of an amount would influence users’ decisions (AASB 108, para 5). So, if more than 12 months but the amount involved is not material, it is acceptable not to apply present value calculations. This requires professional judgement.
The University of SydneyRefer to Worked Example 10.3 Deegan pp 382-383 Page 16
Worked Example 10.2 Deegan
pp 381-382
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Provisions: Example
– Jet Ltd provides a one year warranty on the engines it manufactures and sells.
– In 2019 Jet sells 1,000 engines.
– Past experience indicates that approximately 10% of engines sold will require repairs and the average repair cost will be $150 per engine.
– Actual repair costs in 2020 amount to $14,200.
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Provisions: Example
Recognise provision in 2019:
Dr Warranty expense 15,000 Cr Provision for warranty
(10% x 1,000 x $150)
Record actual repairs in 2020:
Dr Provision for warranty Cr Cash/spare parts, etc
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14,200 14,200
Provisions: Example
What about excess of $800?
1. Either reverse back to expense
Dr Provision for warranty 800
Cr Warranty expense OR
2. Recognise lower expense when accounting for the provision arising from 2020 sales.
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Worked Example 10.3 Deegan
pp 382-383
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Objective 2
Discuss the nature of contingent liabilities & their accounting treatment
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( O 10.7 pp 390-394)
Contingent liabilities
Definition:
– A contingent liability is(AASB 137 para 10):
a) a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non- occurrence of one or more uncertain future events not wholly within the control of the entity; or
b) a present obligation that arises from past events but is not
recognised because:
i. itisnotprobablethatanoutflowofresourcesembodyingeconomic benefits will be required to settle the obligation; or
ii. the amount of the obligation cannot be measured with sufficient reliability.
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Contingent liabilities: Accounting treatment
– A contingent liability is not recognised in financial statements (AASB 137 para 27).
– Note disclosure is required unless the possibility of an outflow of resources is remote (AASB 137 para 28).
– For each class of contingent liabilities where the possibility of outflows is higher than remote, estimate of financial effects, uncertainties and reimbursements are disclosed in the notes to financial statements (AASB 137 para 86).
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Refer to Worked Example 10.8 Deegan p 391
Worked Example 10.8 Deegan
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AASB 137 Appendix B: Decision Tree
This is a visual tool to assist you to understand AASB 137. Written exam questions will require written answers.
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Provisions and contingent liabilities: Summary
– Accounting for provisions and contingent liabilities requires financial statement preparers to have a good understanding of the nature and effects of the underlying transactions and events on entities’ operations.
– Sometimes the underlying transactions and events affect entities’ operations over several accounting periods, often requiring different accounting treatment and use of present value calculations.
– While AASB 137 provides guidance when accounting for provisions and contingent liabilities, financial statement preparers still need to make several professional judgements.
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Ethics in accounting
Ethics are important in all professions, including accountancy. A code of ethics addresses the way professionals are expected
to behave.
Practicing ethics and identifying the ethical challenges that face the accounting profession requires critical thinking.
Refer to “Danger signs in audited accounts” Reading
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Objective 1
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Explain the nature of ethics
(H&P LO 26.1)
What are ethics?
– Concerned with behaviour, and what is good and right for human beings.
– What conditions, attributes and characteristics do we need in order to do the best we can in a particular situation?
– Not only individuals, but communities
– Aristotle (384-322 BCE) argued ethics relates to the way
power is exercised and shared within communities.
– He asked: “Should power be exercised to promote the well being of the community or the self-interest of a few?”
Refer to “Profit or ethics? Macquarie’s European dilemma” Reading
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Relevance of ethics in the context of accounting
– Recognising that ethics is concerned with conditions that promote well being.
– Results in accountants thinking about what characteristics are necessary to achieve excellence in accounting practice.
– Recognising that ethics is also about power and how it is exercised.
– Provides valuable insights into what might be ‘good’ behaviour in accounting practice because accountants are often in more powerful positions than their clients.
– Understanding what skills and attributes accountants need and how they exercise those skills and attributes.
– Makes ethics a highly relevant and practical matter for accountants to understand.
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Relevance of ethics in the context of accounting
– Little doubt that there is widespread concern about business ethics.
– Unethical behaviour damages:
– The reputation of all accountants.
– The reputation of Australian business.
– It may also have broader social and environmental consequences.
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Objective 2
Distinguish between rules-based and values-based
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approaches to ethics
(H&P LO 26.2)
Bases for ethical judgments
Two approaches for making ethical judgements:
1. Right/wrong perspective
– When we make ethical judgements with reference to specific rules or law.
– Binary perspective—either right or wrong—black or white. 2. Good/bad perspective
– When we make ethical judgements with reference to an individual’s value judgements, not to rules.
– Allows for grey areas.
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Right/Wrong and Good/Bad?
– Right/wrong or rules-based approach?
– Rules are not independent of a good/bad or values-based
– Rules may appear to be objective:
– But they are ultimately derived from subjective value judgements.
– Values are more fundamental than rules because rules are derived from a community’s values.
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Objective 3
Describe the foundational ethical principles and their application
(H&P LO 26.4)
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Foundational ethical principles
– Multicultural societies have differences in values and customs, but this does not mean ‘anything goes’.
– Three shared ethical principles from which communities derive values:
1. Beneficence – the duty to do good and avoid harm.
2. Justice – the duty of universal fairness or equity.
3. Respect for persons – the duty to respect the rights and dignity of others.
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Objective 4
Describe the fundamental ethical principles of the accounting profession
(H& P LO 26.6)
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Ethical principles of the Australian accounting profession
– ‘Code of Ethics for Professional Accountants’. – Three general messages:
1. The Code is mandatory for all members of the three professional bodies:
– non-compliance can lead to disciplinary proceedings.
2. Some jurisdictions may have requirements and guidance that differ from the Code.
3. Members should also be guided by the spirit of the Code.
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Fundamental principles of The Code
Integrity:
– To be straightforward and honest in all professional and business relationships.
Objectivity:
– To not allow bias, conflict of interest or undue influence of others to override professional or business judgment.
Professional competence and due care:
– To maintain professional knowledge and skill at the level required to ensure that clients or employers receive competent professional services.
– To act diligently in accordance with applicable technical and professional standards when providing their services.
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Fundamental principles of The Code
Confidentiality:
– To respect confidentiality of information acquired as a result of professional and business relationships and not disclose such information to third parties without proper and specific authority, unless there is a legal duty to disclose.
– To not use confidential information to their personal or third party advantage.
Professional behaviour:
– To comply with relevant laws and regulations; and – To avoid any action that discredits the profession.
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Latest developments
– The Accounting Professional & Ethical Standards Board (APESB) issued a restructure Australian Code of Ethics for Professional Accountants (including Independence Standards) in November 2018.
– The restructured Australian Code will be effective from 1st January 2020.
– Auditor independence sections are now included as Independence Standards.
– A strong focus on independence, professional judgement and professional scepticism.
– New guidance on professional judgement and professional scepticism.
– Important to obtain an understanding of facts and circumstances when exercising professional judgement.
– Clarifies that compliance with the fundamental principles supports the exercise of professional scepticism.
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Disciplinary proceedings
– Disciplinary procedures of two major Australian professional accounting bodies are similar:
– They begin with a complaint about a member.
– In CPA Australia, written complaints are referred to the
Manager Professional Conduct.
– If it is believed there is a case to answer, the complaint is referred to the One Person Tribunal or the Disciplinary Committee.
– Several different penalties may be imposed:
– Fines, censure, reprimand, suspension, expulsion, publication of
complaint and penalty details.
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Objective 5
Incorporate ethics into decision making in a systematic and justifiable manner
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(H&P LO 26.7)
Ethical decision making
– Values can be applied in the context of two core skills in ethics: – Decision making (we will focus on this aspect in ACCT2011). – Policy (rule) making.
– Decision making is about:
– Attempting to resolve a specific problem that is occurring at
a specific time, at a specific place. – Most decisions need to be:
– Systematic – Justifiable
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Ethical decision making
– Decision making requires:
– Adoption of a process that encourages consideration of the
various ethical dimensions of a problem.
– Consideration of potential short-tem and long-term consequences for ourselves and others.
– Many different decision-making models offered by philosophers, academics, professional bodies.
– The American Accounting Association (AAA) model of ethical decision making is one example.
– We will apply the steps provided by the AAA on the next slide to some accounting/professional problems.
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Ethical decision making
Steps in the AAA model of ethical decision making (p.972):
– Determine the facts
– Define the ethical issue
– Identify the major principles, rules and values
– Specify the alternatives
– Compare value and alternatives—see if a clear decision emerges
– Assess the consequences
– Make your decision
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Objective 6
Describe some of the ethical issues facing
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Australian accountants
(H&P LO 26.9)
Ethical issues facing Australian accountants
– Accountants face a wide variety of ethical issues in the practice of their profession.
– Three ethical issues most frequently encountered (Leung and Cooper):
– Conflict of interest.
– Client proposals to manipulate financial statements. – Client proposals for tax evasion.
– Work of Leung and Cooper illustrates clearly that ethical problems are a major issue for Australian accountants.
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Next topic – Topic 7
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