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Amos Tiriki Headline Electronics (ATHE) develops and manufactures innovative computer peripherals. It sells its products to variety of vendors in its home country and the...

      

Amos Tiriki Headline Electronics (ATHE) develops and manufactures innovative computer peripherals. It sells its products to variety of vendors in its home country and the vendors sell in turn to corporate and individual customers.
The company is in the process of finalizing its draft financial statements for the year ended 31 December 2007. The finance director is locked in a major debate with a partner in charge of external audit. During the year the company spent a material amount on attending a major tradefair in Cheptulu Town. This was the first time that the company had attended the event. The trade fair is the biggest opportunity for the companies such as ATHE to talk to potential customers from all over the world. All major multinational electronics companies are represented at this annual event. The fair lasted for five days in June 2007. It is now January 2008 and not a single order has been generated from new customers who might have seen ATHE’s presentation at the trade fair.
The partner in charge of the external audit feels very strongly that the cost of attending the fair should be written off as an expense. ATHE’s finance director feels equally strongly that the cost should be capitalized as an asset. He argues that the contacts made at the trade fair are likely to take years to generate new business and that the investment in attending should be carried forward until those orders start to come in. He argues further that the cost should be capitalized on the grounds that they meet the definition of an asset, as laid down by the IASB’s Frame work for the preparation and presentation of financial statements (Framework)

Required:

a) Discuss the finance director assertion that the money spent on attending the fair should be treated as an asset.

b) Explain the importance of the Framework to the reporting of corporate performance and whether it takes into account the business and legal constraints placed.

c) Discuss the assertion that the external auditor might be the primary beneficiary of having a clear and unequivocal Framework that sets out the basis for financial reporting

  

Answers


Martin
a) The criteria implied by the definitions of the elements of financial statements appear to have been met:
- the presence at the trade fair has created an economic benefit (in the form of creating an awareness in the minds of potential customers)
- this is controlled by the company
- this arises as a result of a past transaction or event (the attendance at the trade fair).
It is however, debatable whether the cost should be recognized as an asset:
- the amount to be capitalized can be measured reliably, but
- there is very little evidence to date that an asset has actually been created
The auditor’s interpretation of events is probably the correct one. The finance director’s assertion that sales will arise in the future sounds rather optimistic. Ideally, there should be something rather more substantive. This would not have to take the form of actual orders received, but could include ongoing correspondence with potential customers who had been followed up after the event, the dispatch of trade samples to prospective buyers, or a significant level of inquiries.

b) The Framework for the Preparation and Presentation of Financial Statements provides a conceptual underpinning for the International Financial Reporting Standards (IFRS). IFRS are based on the framework and its aim is to provide a framework for the formulation of accounting standards. If accounting issues arise which are not covered by accounting standards then the ‘framework’ can provide a basis for the resolution of such issues. The framework deals with several areas:

(i) the objective of financial statements.
(ii) the underlying assumptions
(iii) the qualitative characteristics of financial statements
(iv) recognition in financial statements.
(v) recognition in financial statements.
(vi) measurement in financial statements
(vii) concepts of capital and capital maintenance.

The framework adopts an approach which builds corporate reporting around the definitions of assets and liabilities and the criteria of recognizing and measuring them in the statement of financial position. This approach views accounting in a different way to most companies. The notion that the measurement and recognition of assets and liabilities is the starting point for the determination of the profit of the business does not sit easily with most practicing accountants who see the transactions of the company as the basis for accounting.
The framework provides a useful basis for discussion and is an aid to academic thought. However, it seems to ignore the many legal and business roles that financial statements play. In many jurisdictions, the financial statements form the basis of dividend payments, the starting point for the assessment of taxation, and often the basis of executive remuneration. A balance sheet, fair fair value system which the IASB seems to favour would have a major impact on the above elements, and would not currently fit the practice of accounting. Very few companies take into account the principles embodied in the Framework unless those principles themselves are embodied in an accounting standard. Some International Accounting Standards are inconsistent
with the framework primarily because they were issued earlier than the framework. The Framework is useful basis for financial reporting but a fundamental change in the current basis of financial reporting will be required for it to have any practical application. The IASB seems intent on ensuring that this change will take place.
The ‘Improvements project’ (IAS 8 Accounting policies, changes in accounting estimates and errors) makes reference to the use of the framework where is no IFRS or IFRIC in use.

c) The external auditors’ primary duty is to express an opinion on whether the financial statements ‘present fairly’. One of the biggest problems faced by the auditor is in defining the quality of fair presentation and deciding whether any particular set of financial statements gives such a view.
External auditors frequently face criticism from aggrieved users of financial statements who complain that they have been misled by the adoption of inappropriate and unacceptable accounting policies. The auditor often finds it difficult to refute such claims because:

- accounting standards are not always sufficiently prescriptive to enable the auditor to defend such complaints on the basis that all applicable standards have been complied with-there is often room for some disagreement over whether a standard’s requirements have been met.
- accounting standards do not cover every single eventuality-indeed many past accounting scandals have involved accounting issues that were not the subject of standards (e.g. the special purpose entities’ that were used in the Enron affair to keep assets and liabilities out of the consolidated statement of financial position).

Ideally, the Framework would enable the auditor to fill in some of the gaps in existing regulations and legislation. The framework provides a number of qualitative benchmarks that might be used to measure the quality of the information provided in a set of financial statements. The auditor can use those criteria in negotiating finalized versions of those statements with the directors in order to ensure that any subsequent complaints or concerns can be addressed in terms of formal set of benchmarks for financial reporting.
marto answered the question on February 13, 2019 at 08:16


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