Consolidated and Separate Financial Management

Question: Discuss about the Consolidated and Separate Financial Management. Answer: Introduction: I am pleased to inform you that I have found out resolution to the accounting issues being raised by the directors. The Issue-1 relates to accounting for employee benefits which is dealt with in by AASB 119, issue-2 mainly relates to calculation of goodwill of a parent company and its accounting treatment, while the issue-3 involves problems related to accounting for income taxes which is dealt with in by AASB 112. My endeavors have been to clearly identify the issue and find out the resolution for the same. I hope that it will help the board of directors and other managerial personnel to prepare the financial statements in compliance with the legal provisions. The detailed discussion on each issue is given as follows: In the current issue the directors are worried about adverse financial performance of the company. The management budgeted profits at $1,800,000, but the actual profits expected to be earned are $1,440,000 which depicts a deficit of $360,000. The directors wish to curve out this deficit, for which they have suggested to postpone recognition of provision towards long leave service and annual leaves amounting to $260,000. The directors are of the view that non-recognition of provision for long leave service and annual leaves would bring the deficit down by a big margin. Further, the directors contend that non-recognition of the provision for long leave service and annual leaves is justified because this payment relates to future periods. In this regard, it is necessary to verify the contention of the directors by referring to the provisions of AASB 119 and the fundamental accounting concepts. The AASB 119 deals with the accounting for employee benefits which covers short term, long term, as well as post employment employee benefits. As per the provisions of AASB 119, the firm has to recognize expense in regard to paid leaves as and when the related services have been rendered by the employees (AASB 119, 2011). Thus, as the employees render the services, the payment in regard to services leaves get accrued in the hands of the firm. The fundamental concept of accrual also states that a firm should recognize all expense as and when it incurs the obligation to pay, regardless of the period in which these expenses are to be paid (Gilbertson and Lehman, 2008). Thus, there is no scope for non-recognition or postponement of the provision for long service and annual leaves. Therefore, considering the provisions of AASB 119 and the fundamental principal of accrual, it is advisable to the board of directors to make provision for whole amount of $260,000 in the profit and loss statement. Writing back the provision to the income statement will be in violation of the provisions of AASB 119 and the accounting principles (AASB 119, 2011). Thus, for the sake of improving the financial performance of the current year, the directors can not violate the legal and ethical provisions of accounting and financial reporting. In the current case, Annies Boutiques Ltd acquired 70% stake in Lucys Gallery Ltd, which brings in the relationship of parent and subsidiary between the two companies (Gia, 2009). Annie Boutiques Ltd is the parent company and Lucys Gallery Ltd will be the subsidiary company in this case. Now, the board of directors wants to recognize goodwill in regard to the investment made in Lucys Gallery Ltd. In this case since Annies Boutiques Ltd is the parent company, thus, it will have to prepare the consolidated financial statements. The consolidated financial statements are required to be presented to show the combined financial performance and position of the group as a whole (Gia, 2009). The directors are concerned whether they can recognize goodwill or not in the present case. The answer to this query raised by the board of directors is in affirmative, which means that goodwill can be recognized (AASB 127, 2007). However, the goodwill can be recognized only in the consolidated financial statements and not in the standalone financial statements of Annies Boutiques Ltd. The procedure to recognize goodwill will have to be followed as prescribed in the AASB 127, Consolidated and Separate Financial Statement. The accounting standard prescribes that the parent company will recognize goodwill or capital reserve, as the case may be, at time of consolidation (AASB 127, 2007). The goodwill or capital reserve will be computed by the parent company by comparing the carrying amount of its investment and the portion of equity in subsidiary. As example of computation of goodwill for Annies Boutiques Ltd is given as follows: Goodwill on consolidation for Annies Boutiques Ltd Particulars Amount ($) Carrying amount of investment (70% share capital of Lucys Gallery Ltd in the books of Annie Boutiques) 500,000.00 Less: Portion of Annie Boutiques in equity of Lucys Gallery Ltd (Assuming total equity of Lucys Gallery Ltd to be $400,000) 280,000.00 ($400,000.00*70%) Goodwill 220,000.00 Thus, assuming that the carrying amount of investment made by Annie Boutique Ltd in Lucys Gallery Ltd as $500,000 and the value of total equity of Lucys Gallery Ltd as $400,000, it could be observed that the parent company can recognize goodwill of $220,000. However, in this regard it should be noted that goodwill will arise only when the carrying amount of parents investment is higher than its share in the subsidiarys equity. If the carrying amount is lower, the result will be capital reserve, which is regarded as unrealized profit (AASB 127, 2007). Further, it is also advised that recognition of goodwill will not affect the profit and loss statement, thus, the contention of the directors that profit will increase after recognition of goodwill is incorrect. In the current case, the issue under consideration relates to accounting treatment of current and deferred tax in the financial statements. The Australian Accounting Standard Board (AASB) has issued AASB 112, Income Tax which provides for rule for computation of deferred tax and its presentation in the financial statements (AASB, 112). As per the provisions contained in the standard, an entity has to make provision for deferred tax liability that would arise in future. The deferred tax liability or asset arises due to the temporary differences between accounting and income tax provisions in relation to certain items of income and expenses. The temporary difference here means that the difference in accounting and income tax with respect to certain items is reversible in future (AASB, 112). In computation of deferred tax, it should be kept in mind that when company claims or income tax authorities allow an expense in excess of what has been debited in the income statement, the result would be deferred tax liability. The analogy behind this rule is that since the company has already claimed expense for income tax purpose, thus, in future years it will have to pay more taxes which give rise to liability (Delaney and Whittington, 2008). The deferred tax liability is debited to the income statement and thus, it reduces the profit figure. In the statement of financial position, the deferred tax liability is shown under non-current liability. Further, the company can also recognize deferred tax asset if it expects to get income tax benefits in the future years. However, the recognition of deferred tax asset should be with caution considering the concept of prudence (Delaney and Whittington, 2008). In regard to the current case, the directors contend that deferred tax liabilities are to be paid to the income tax authorities along with current tax, thus, these should be shown under current liabilities. In this regard, the directors are made aware that deferred tax liabilities are not paid to the income tax authorities (Delaney and Whittington, 2008). Further, the provision for deferred tax liability is made for the future payments which may arise in long term, say 4 or 5 years. Therefore, it is advisable to the directors to present the deferred tax liabilities under non-current liabilities in the statement of financial position (Delaney and Whittington, 2008). References AASB 119. 2011. Employee Benefits. [Online]. Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB119_09-11.pdf [Accessed on: 19 January 2017]. AASB 127. 2007. Consolidated and Separate Financial Statements. [Online]. Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB127_07-04_COMPjul07_07-07.pdf [Accessed on: 19 January 2017]. AASB. 112. Income Tax. [Online]. Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB112_07-04_COMPsep11_07-12.pdf [Accessed on: 19 January 2017]. Delaney, P.R. and Whittington, O.R. 2008. Wiley CPA Exam Review 2009: Financial Accounting and Reporting. John Wiley Sons. Gia, K.P. 2009. Consolidated Financial Statements in IAS/IFRS and German GAAP - Major Differences Explained. GRIN Verlag. Gilbertson, C.B. and Lehman, M.W. 2008. Fundamentals of Accounting: Course 2. Cengage Learning.