Question

Case Study 1

Having spent 20 years in a US based company as Chief Accountant, Mohammed faced a lot of challenges upon joining the VH Manufacturing Company in his hometown in India. He was appointed as Chief Accountant and, at the same, was also involved in coordinating the various projects of the company outside the country. Basically, Mohammed followed US-GAAP based guidelines for financial reporting in his earlier portfolios, hence shifting to a new company posed him challenges as he must follow IFRS guidelines for financial reporting. Though both the US GAAP and IFRS are authoritative statements, there were significant differences in the guidelines. Mohammed believed that adopting US GAAP is more comfortable as it provided him detailed and specific rules for financial reporting, which is not the case with IFRS.

It was during an internal audit carried out in the accounting department, the auditors came out with a report of the following observations related to treating various revenue and expenses.

1. All the expenses towards the repair and maintenance of plant and machineries are treated as operating expenses in the financial statements.

2. Mohammed was strict in reporting revenues; hence, the revenues were under- estimated. As per the audit, they estimated that RO240,000 which the company may consider as revenue from the various projects are reported as unearned revenue (customer advances).

3. The company used the FIFO method for valuing inventory consistently over the last few years. Since Mohammed joined the company, he has used LIFO method for valuing inventory.

4. During the year, the company has taken a loan for capital expenditure, but due to a temporary cash crunch the money was used the cash to pay salaries to the staff. The issued was discussed with the bank and thereafter the bank has issued a letter instructing the company to repay the loan on the grounds of violation of the covenant/loan agreement. Mohammed has reported the loan as non-current liability in the financial statements.

5. While writing off impairment losses, Mohammed has used two-step method for write- offs as he mentioned that this was the practice he followed in the previous company where he worked.

The management called Mohammed for an explanation regarding the above observations. Yasir, a friend of Mohammed, has been always a critic of using accounting standards. He considered that adherence to the conceptual frameworks are not necessary to prepare reliable financial statements. As the purpose of financial statements is to communicate the financial results and financial position to internal and external stakeholders, the organization should

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follow a customized accounting framework that best suits it instead of using accounting standards set by international bodies.

Based on the above case, answer the following;

(Maximum word count for Case Study is 400 Words)

(3+4+3 = 10 Marks)

1. “Mohammed believed that adopting US GAAP is more comfortable as it provides the accountant a detailed and specific guideline for financial reporting, which is not the

case with IFRS”. Do you agree with Mohammed? Justify your answer.

2. Do you consider that Mohammed followed IFRS while preparing the financial statements? (The arguments should be based on the findings of the auditor. Briefly discuss each of the auditor’s observation and verify whether Mohammed followed the

prescribed reporting standards.

3. In your opinion, do you consider that accounting standards are required for preparing

financial statements? Do you think that following accounting standards (for example, reporting fixed assets at their cost price less accumulated

Answer 1

1) Mohammed in right in his argument that adopting US GAAP provides an accountant a detailed and specific guideline for financial reporting than IFRS. The reason is that IFRS are principles-based whereas GAAP are rules-based. As a result of which, there is more scope for different interpretations while applying the theoretical framework and principles of IFRS for which detailed disclosures need to be made in the financial statements. However, principles contained in IFRS are more logically correct because they represent the substance of business transactions in a better way.

2) No, Mohammed has not followed IFRS due to the following reasons-

A) After his joining, the company has followed LIFO method for inventory valuation which is not allowed as per IFRS rules but US GAAP allows its use.

B) Mohammed has used two step method for writing off impairment losses which is not in accordance with IFRS rules where one step approach requires impairment testing to be performed on existence of impairment indicators.

C) Mohammed has not reported revenues as per IFRS on revenue from contracts with customers which recommends a five step model for recognition of revenue. However, he has underestimated revenues by following a much strict policy.

D) Mohammed is not following IFRS because he has not reported the loan on which the bank has issued a letter to the company for repayment under current liabilities, however as per IFRS, liabilities which are to be settled within a period of 12 months should be classified as current liabilities.

E) All the expenses towards the repairs and maintenance of plant and machinery are treated as operating expenses in the financial statements where IFRS provides for capitalisation of costs of a previously identified component if there is a probability of future economic benefits for the entity and its measurement can be done reliably.

3) Yes, accounting standards are required for preparing the financial statements because their main objective is to facilitate transparency, reliability, comparability and consistency of financial statements. They help in standardisation of accounting policies and principles of a country with a view to record the transactions of all companies in a similar manner. They provide the framework of rules and regulations for reporting and accounting in a country with a view to enhance the confidence of the users of financial statements. Accounting standards present a true and fair view of the financial position of an entity.