Financial Reporting

Question Time With Steve – January 2010

Some areas of financial reporting are particularly complex and in many cases accountants will revert back to official standards or publications which may result in complexities becoming even more confusing. In this, and subsequent articles, I will look at a couple of the most commonly asked questions concerning areas of financial reporting which pose difficulties when dealing with the situation(s) in real life practice.

Can a company who changed from the ‘depreciated historic cost’ model of accounting for fixed assets to the ‘revaluation model’ switch back to depreciated historic cost?

FRS 15 ‘Tangible Fixed Assets’ allows an entity to switch from the cost model to the revaluation model but I am of the opinion that it is not possible to switch back because of the provisions in FRS 18 ‘Accounting Policies’.

A change from the cost model to the revaluation model is a change in accounting policy. A change in accounting policy is made because the change will result in financial statements giving a true and fair view. Under FRS 18 the directors are required to assess their accounting policies to see if they remain appropriate for their particular circumstances. Clearly at some point in time, the directors established that the cost model was no longer an appropriate basis for measuring the applicable class of asset and the revaluation model was.

I am of the opinion that market (fair) value would always achieve truth and fairness as opposed to the asset’s original cost and if an entity has chosen the revaluation model subsequent to adopting the cost model, then clearly they did this to accord to the truth and fairness principles. I therefore cannot see how depreciated historic cost would prevail over fair value.

I have a client who offers goods on interest-free credit over three years’. How should they account for the ‘notional interest’?

Where sales are made on an interest-free period then there should be an amount attributed to notional interest, particularly in common situations such as credit periods of two to three years. Where periods of credit are less than a year then this is more complex because it will all depend on the materiality on the discount. Application Note G at paragraph 8 says:

‘Where the effect of the time value of money is material to reported revenue, the amount of revenue recognised should be the present value of the cash inflows expected to be received from the customer in settlement. The unwinding of the discount should be credited to finance income as this represents a gain from a financing transaction’.

In terms of accounting for the notional interest over the 3 year period, then turnover needs to be reduced by the amount of notional interest and then accounting for it by debiting debtors and crediting interest over the 3 year period in this instance.

A company operates in the retail industry selling electrical equipment. On some of its TV equipment it offers warranties which allow any defects in the TV equipment to be made good that become apparent within 1 year from the date of sale. Past experience suggests that the company does receive warranty claims. Should the company make a provision and if so, how much?

The warranties meet the definitions of provisions in FRS 12 because:

• A legal obligation exists and which it is more likely than not to arise.

• The sale of the TV equipment gives rise to the obligating event because the normal one-year warranty that is offered with the TV equipment can be legally enforced.

• It is more likely than not that a transfer of economic benefits will be made.

• The company’s past history of claims will enable the value of provisions to be reliably estimated.

Provisions for warranties should therefore be made and the amount of the provisions should be the directors’ best estimates based on the past history of claims.

Steve Collings FMAAT ACCA DipIFRS is Audit and Technical Manager at LWA Ltd and a freelance technical author. He also lectures on financial reporting and auditing issues.