Early 2011, Yung Limited acquired 75% interest in Chum Limited. This is the first time of Yung Limited preparing the consolidated statement. A few issues regarding to the first consolidated financial statement have been raised up. This report is used to solve the raised issues and explain general principle of consolidation accounting.
Before the acquisition, Yung and Chum was a competitor to each other. Their financial statement only reflects their own financial position. Thus, the balance and transaction would state in the financial statement. The reason is that they are viewed as two entities from different aspect.
However, after the acquisition, Yung and Chum became a single combined entity as Yung held 75% interest in Chum. It means Yung can direct business decision of Chum according to its preference. This view would be reflected in the consolidated financial statements. Since the consolidated financial statements view Yung and Chum as a single combined entity, the balance due to each other would be eliminated as a result. As Yung and Chum are the single entity, the amount due to Yung is set off by the amount due from Chum. One entity cannot lead money to itself in order to create a liability or asset.
As Yung and Chum are a single entity, transactions with each other are just a transfer of assets or liabilities, or a relocation of assets, this would not recognise as a transaction in the consolidated financial statements. Generally, profit margin is added to those transactions. These profit margins would raise book value of assets in the transactions. The common example is inventory and non-current assets. Those profit margins can only be realised in the sales or disposal to external parties. Thus, the consolidated financial statements would eliminate those unrealised profit also.
Accounting mainly involves analyzing, interpretation and reporting of business transaction records. Accounting provides information for decision making to the management. The purpose of accounting is to maintain proper control of finances of an organization. In other words, accounting is an information system whose purpose is to provide essential information about business financial activities. It ...
According to the above statement, Yung gets the power of control in the Chum. It means every transaction can be related to Yung and its decision. The relationship between Yung and Chum would be a parent-subsidiary, and not just similar to other associate as investor-investee. Therefore, it is required to show consolidated financial statement of Yung and Chum. The distinction between consolidation and equity basis of accounting is power of control. Generally, if an entity holds more than 50% interest of another entity, the entity is required to consolidate the controlled entity.
However, if an entity holds about 20% to 50% interest of another entity, the entity is required to practising the equity basis of accounting. Comparing with the two methods, consolidation basis of accounting would reflect a smaller net income if there are a large amount of inter-company transactions. Equity basis of accounting only show the share of profit in associate as an extra item in the income statement of investor (parent in consolidation).
Thus, it would be a greater net income unless there is a net loss in the associate. In conclusion, different methods change the net income.
The financial statements for equity basis of accounting are only included the investment in associates as non-current assets, and recorded as cost plus fair value adjustments in the net shares of equity. The consolidated financial statements are the combination of the parent and subsidiaries, and goodwill, excluding inter-company balance and cost of control. Thus, Yung’s financial statements would be greater value in statement of financial position if all investments were consolidated, but smaller value in income statement as there are large amount inter-company transactions between Yung and Chum. Equity basis of accounting could provide a greater asset value to Yung, but a smaller net income to Yung also.
The Australian Accounting Standards Board (AASB) is implementing the Financial Reporting Council’s policy of adopting the Standards of the International Accounting Standards Board (IASB) for application to reporting periods beginning on or after 1 January 2005. The AASB is replacing relevant existing AASB Standards with Australian Standards equivalent to those of the IASB. Consequently, the parts ...
Dear Mr. Li,
Memo regarding the revenue cut-off problem of Yung Limited
According to the recent conference with John Au, President of Yung Limited, he reported that the sales of Yung Limited in 2010 incorrectly included sales in 2011. However, we did not discover this material error by our audit work. This material error overstated the profit of Yung in 2010 by 10%, but understated the profit of Yung in 2011 by the same rate. John Au also mentioned that he prefers to ignore this error because he can get benefit from this error as the understated profit.
Ignoring revenue cut-off problem leads to conflicts in ethical and professional. This conflicts with fundamental ethical principles, such as integrity, objectivity and professional behavior. In the integrity aspect, we should not disclose any untrue financial statements. In the objectivity aspect, our professional judgments should not be influenced by reputation of our audit firm and any potential legal sue. In the professional behavior, we should comply with relevant laws and regulations relating to this revenue cut-off problem.
The following are some of my recommendation on this revenue cut-off problem. The first recommendation would be reporting to the board of directors directly. This material error should be report the board of directors of Yung Limited. This report could give directors’ chance to decide the treatment of this material error. They could estimate effect of this material error. The second recommendation would be following John Au’s suggestion, ignoring this material error.
This could be a way to accommodate our client. The third recommendation would be requiring John Au to correct this material error. This could reflect the true financial position of Yung Limited. The fourth recommendation would be convening an extra-ordinary general meeting with all shareholders of Yung Limited. This EGM could give shareholders opportunity to aware this material error, and understand the potential.
Through the many characters of John Steinbecks Of Mice and Men the author of the book attempts to depict the beauty and variety of living on Earth. However, the two main players - Lenny and George, outweigh the abundance of figures. Throughout the book these characters are lking fr a place t, lay their hats. They had been in a lt f truble in the past, mainly t the misfrtune f Lennys incmpetence. ...
Finally, I would recommend asking John Au to correct this material error. Although this correction would make him loss of a bonus, this is a fair treatment to all stakeholders at all. Also, this solution could reflect the professional position of our company.