Application of Professional Judgment
Business Research Report
Word limit: 1,200 words
“In a perfect world, investors, board members, and executives would have full confidence in companies’ financial statements. They could rely on the numbers to make intelligent estimates of the magnitude, timing, and uncertainty of future cash flows and to judge whether the resulting estimate of value was fairly represented in the current share price. And they could make wise decisions about whether to invest in or acquire a company, thus promoting the efficient allocation of capital.
Unfortunately, that’s not what happens in the real world, for several reasons. First, corporate financial statements necessarily depend on estimates and judgment calls that can be widely off the mark, even when made in good faith…..” (Sherman and Young, 20166, p.1).
The above clearly shows how crucial it is for accountants to apply their professional judgment in arriving at the most reasonable / appropriate accounting choices / estimates which can be a challenging process. There is not necessarily one correct answer in most cases and therefore accountants need to be vigilant while dealing with such situations.
As a new accountant, you have recently joined the accounting department of an ASX listed company.
Your supervisor, the senior accountant, has sent you an email containing a Media Release (MR) from the Australian Securities & Investment Commission (ASIC) relating to 2019 financial reports where the major concern is relating to Impairment testing and asset values. To demonstrate your understanding of the application of professional judgment applied to undertake impairment testing and asset valuations:
- you have been asked to look into the company’s annual report;
- undertake required research and
- prepare a report for presentation to other finance team members and the audit committee. In their last meeting, the Board of Directors of your company has discussed ASIC's press release 19-143MR Major Financial Reporting Changes and other focuses for 30 June 2019 financial reports:
FOCUSES FOR 30 JUNE 2019 FINANCIAL REPORTS
2. Impairment testing and asset values
The recoverability of the carrying amounts of assets such as goodwill, other intangibles and property, plant and equipment continues to be an important area of focus. It is important for directors and auditors to ensure:
a. cash flows and assumptions are reasonable having regard to matters such as historical cash flows, economic and market conditions, and funding costs. Particularly where prior period cash flow projections have not been met, careful consideration should be given to whether current assumptions are reasonable and supportable;
b. discounted cash flows are not used to determine fair value less costs of disposal where forecasts and assumptions are not reasonable and supportable;
c. cash flows used are matched to carrying values of all assets that generate those cash flows, including inventories, receivables and tax balances;
d. discount rates and other key assumptions are reasonable and supportable;
e. cash generating units (CGUs) are not identified at too high a level, including where cash inflows for individual assets are not largely independent; and
f. for testing goodwill, CGUs are not grouped at a higher level than the operating segments or the level at which results are monitored for internal management purposes.
9. Estimates and accounting policy judgements
Disclosures regarding sources of estimation uncertainty and significant judgements in applying accounting policies are important to allow users of the financial report to assess the reported financial position and performance of an entity. Directors and auditors should ensure disclosures are made and are specific to the assets, liabilities, income and expenses of the entity. Disclosure of key assumptions and a sensitivity analysis are important. These enable users of the financial report to make their own assessments about the carrying values of the entity’s assets and risk of impairment given the estimation uncertainty associated with many asset valuations. The above extracts of the 2019 ASIC media release are calling for attention to be placed on the company’s practice of using professional judgments in arriving at the most reasonable estimates and then disclosing the sources or basis of their judgments leading to the accounting information in the financial reports.
Specifically, the ASIC report has pointed at the process of ‘Impairment testing and Asset Valuation’
because in carrying out the impairment testing, professional judgments are required to estimate thecash flows, the discount rates, the CGUs, the allocation of corporate assets and costs to CGUs and the appropriate use of fair values. Further, the report also highlights the need for businesses to provide sufficient disclosures around the judgments applied. The highlights of the ASIC report is strongly indicating that companies need to be vigilant in carrying out the impairment testing and asset valuation and then provide sufficient disclosures so that the users of accounting information can carry out their own assessments about the impairments of the assets in their decision making process.
To complete this assignment, you will need to select a suitable company yourself that meets the following criteria. The company must:
• be a constituent of the S&P/ASX 300 index (www.asx300list.com);
• publish audited annual financial reports in English, fully complying with IFRS or AASB standards;
• must have a 30 June year end and
• have a significant impairment presented in the annual report
Your report must address each of the following:
a) The role of professional judgment in accounting and two implications on the users of accounting information if the professional judgment has not been made in the most reasonable/appropriate manner. (5 marks)
b) Provide a detailed explanation of the impairment write-down(s) made by your company for the year ended 30 June 2019. Your explanation should include a discussion of
- the asset/s that were impaired;
- the type of estimations required to write / calculate the impairment;
- the amount of the impairment write-down and
- relevant disclosures in the 30 June 2019 financial report in relation to impairment testing
c) Based on your findings in part b, critically discuss whether the professional judgments used to estimate cash flows, discount rates, CGUs, allocation of corporate assets and costs to CGUs and appropriate fair values in the impairment write-down process have been reasonable / appropriate. Recommend actions (if any) for improvement in the application of professional judgments relating to these estimations.
Please refer to the ASIC media release and other relevant information sources to answer the above question. (15 marks)
d) Based on your findings in part c, critically analyse to what extent the professional judgments applied on impairment write-downs satisfy the fundamental characteristics of useful financial information and the objective of financial reporting. (10 marks)
Assessment of report
The research-based report represents 15% of your total mark. Your assignment will be marked out of 60 as shown in the Report Marking Rubric on page 7 of this document and will then be converted to a mark out of 15 percent.
Report submission instructions
Before you start writing your report, it is recommended that you undertake the following (both of these can be accessed through the ‘Assessment Task’ folder on iLearn):
1. Take a look at the sample Business Research Report provided on iLearn.
Structure The report must contain the following (in this order):
• Report cover page (You can design your own cover page)
• Table of contents
• Executive summary
• Reference list
You should include relevant parts of the annual reports that you have used and referred to in your report. Do NOT attach entire annual reports. You can include the relevant parts of annual reports as screenshots rather than copying and pasting content, since it can impact the TurnitIn similarity percentage
Length Total word count limit = 1,200 words. Your word count must be included on your cover page.
Included in word count Excluded from word count
• Report cover page
• Table of contents
• Executive summary
• Reference list
Penalties for exceeding the word limit are as follows:
Word count Penalty
• 1,201 – 1,319 words- • No penalty
• 1,320 – 1,439 words- • 10% of total marks
• 1,440 or more words- • 20% of total marks
Style The report must be presented as follows:
Font: Times New Roman 12-point Spacing: 1.5 times line spacing
Margins: not less than 2.5 cm
Footer Each page must have a footer containing the following:
S1 2020 Your SID Page number
Referencing In text referencing is required for all sources used and a complete list of references must be provided using the Harvard Referencing System.
A copy of the Harvard Referencing System is available under the ‘Assessment Task’ folder on iLearn. Please note that as this is a research assignment it is not appropriate to reference to
textbooks or lecture slides. Plagiarism All assignments will be manually and electronically checked for plagiarism and it is extremely important that you are familiar with the policy on Academic Honesty.
Professional judgment is one of the key aspects which must be taken into consideration while dealing in the financial information of the business. Proper understanding of application of professional judgment is very necessary to undertake several financial decisions like impairment testing and asset valuations. This assignment emphasizes on understanding of the role of professional judgment in accounting, impairment testing & asset valuation and other related areas. To have better understanding, the annual reports of company named Emeco Holding Limited have are taken into consideration.
Professional judgment may be defined as the application of knowledge, experience and training which one has gained, while making decisions for the appropriate procedures and estimates which are required to face any given situation. It is mostly exercised by the professionals including accountants and auditors during course of accounting and auditing respectively (Black, Krupa, & Minutti-Meza, 2019).
Professional Judgment is the essence of the accounting as it assists in making decisions related to the course of action which is required to be taken in given circumstances.
Management of the company at all times desires to show a favorable condition of its own to stakeholders through financial statement while taking into account the relevant principles and standards. Engagement of the professionals which are well versed in identifying all the possible paths to fulfill the management’s desire plays a very important role here. Application of the professional judgment by the engaged professionals in accounting, is crucial part because if they are applied incorrectly, they may cause severe issues which may have negative impact (Locatelli, et al. 2017).
An unreasonable professional judgment impacts the users of the accounting information. Below mentioned are the two implications on the users of an inappropriately executed professional judgment (Emeco Company, (2019).
As the responsibility of professional judgments is flexible in nature, they can be challenged. Hence, it is necessary to document professional judgments properly during their application.
Impairment test may be defined as procedure to evaluate if there is drastic decrease in the fair value company’s asset. The evaluation is done considering the indicators of impairment. Decrease in the fair value may result due to various factors like physical damage, change in the existing law, deficiency in management, etc. Basically, in impairment test the future cash flow and benefits are compared with the carrying amount of the asset. Also, if there is impairment then the assets are revalued in the balance sheet and Impairment loss (difference between the current carrying amount & recoverable amount) is booked in the statement of profit & loss (Goldstein, & Naglieri, 2016).
In case of impairment of asset, the asset is recorded at revalued carrying amount after deducting any accumulated depreciation and accumulated impairment loss.
((Emeco Company, (2019).
After assessing all the details given in the annual report, it has been found that the company has recorded all of its assets and liabilities at its book value and impairment test is consistently implemented on the reporting period with a view to assess the true and fair value. Considering the fact, it is found that by Emeco Holding Limited has charged its impairment loss which arise after implementing the impairment test from its cash generating units. This shows that all the amount recorded by Emeco Holding Limited is true and fair which helps investors to estimate the right decision for their investment decisions (Kuter, Gurskaya, Andreenkova, & Bagdasaryan, 2018). It is analyzed that tangible assets they have tested whenever there are indicators for impairment and all the assets are recorded at lowest levels for which there are separately identifiable cash flows. It shows that company recorded true and fair value of recorded assets and complying with the applicable accounting standard. All the impairment loss have been charged by company from its profit and loss earned during the year and helps in recording the right value in the books of accounts (Emeco Company, (2019). Accountants of the Emeco Holding Limited has made classified all the inventory during the period as held were written done with $6.64 million and recorded these assets at it closing amount (Emeco Company, (2019).
The professional judgment is applied for determining the true value of the assets and liabilities recorded in the books of account.
In the case of the construction contract, details are recorded by using the guidelines implemented by IAS 11. Accountant has recorded these contract skepticism with regard to the profit way obtained from the contract.
Professional contract is also implemented with a view to implement the lease accounting with the applicable standard of IAS 17. This judgment is used to implement the ethical issues related to the financial reporting options. As per the professional accounting judgment, lease is recorded separately in the annual report considering the operating and capital lease (Sun, 2016).
In context with the IAS 138, professionals in company has recorded all of its assets with the implication of the impairment test and determine the right value of the assets. All the impairment loss is set off from the cash generating units except the goodwill amount (Fernandes, Gonçalves, Guerreiro, & Pereira, 2016).
In context with the inventory, professionals has taken judgment to implement the impairment of inventory by 0.04$ million and property, plant & equipment which were previously classified and classified during the period as held were written done with $6.64 million. This is done with a view to keep the true and fair values in the books of accounts (Emeco Company, (2019).