Question

1. Mikky is a public limited company that prepares financial statements in accordance with

International Financial Reporting Standards. Mikky has a number of bank loans, which are

repayable if it breaches its covenants. The covenants are based on profit before tax and reported assets. A new accountant has recently started working at Mikky and has discovered some issues relating to the financial statements for the year ended 31 December 20X5.

Mikky’s statement of financial position includes an intangible asset. This asset is a portfolio

of customers acquired from a similar business which had gone into liquidation two years ago. The accountant has asked the finance director why the asset has not been amortised in the current period. The finance director replied that he changed the assessment of the useful life of this intangible asset from ‘finite’ to ‘indefinite’. He justified this on the grounds that it is impossible to foresee the length of this intangible asset’s useful life due to a number of factors, such as technological evolution and changing consumer behaviour.

Mikky owns investment properties that are measured using the fair value method. The accountant has discovered that the fair value is calculated as ‘new-build value less obsolescence’. Valuations are conducted by the finance director. In order to determine the obsolescence, the director takes account of the age of the property and the nature of its use. Sales values for similar properties in similar locations are available and are significantly less than the fair value estimated by the director.

Mikky has three main cash generating units (CGUs) which have goodwill attributed to them. The finance director has asked the accountant to perform an impairment test of the CGUs, using the most recent financial forecasts as the basis for value in use calculations. The realised cash flows for the CGUs were negative in 20X5 and far below forecasted cash flows for that period. The directors have significantly raised cash flow forecasts for 20X6 with little justification. The projected cash flows have been calculated by adding back depreciation charges to the budgeted result for the period with expected changes in working capital and capital expenditure not taken into account. The finance director has told the accountant that future promotions and pay rises are dependent on following this instruction.

Mikky has property, plant and equipment acquired under a lease agreement. These are not ‘low value short life’ assets. The finance director has advised the accountant to treat them as low value short life assets in Mikky’s books.

Mikky has notified the world, that is, its stockholders and other regulatory bodies of the discovery of "Overstatements" in its accounts, which according to it, has spanned many years. It quickly appointed ABL Ltd., an independent accounting firm to investigate the "Overstatements". The external auditors of Mikky, XYZ Associates have been the external auditors of the company for over 40 years.

Required:

Discuss the accounting and ethical implications of the above situations from the

perspective of the reporting accountant.                                                    

Answer 1

Accounting and Ethical Implications of below situations

Situation1) Amortization of Intangible assets having indefinite Life

Under IFRS, amortization of intangible asset having indefinite useful life/ or life which cannot be ascertained can't be done. However, Impairment for such assets are carried out each year. Hence, Accountant should conduct an impairment test for intangible asset and record accordingly if any.

Ethically, the company should provide for impairment of intangible asset and record the impairment loss on exceeding the book value of asset than its recoverable amount if any, otherwise it leads to misjudgment by the stakeholders of financial statements.

Situation 2) Valuation of Investments at Fair Value which is more than Sale Value of similar properties

For calculating the fair value method for investments, best mehod is to compare the prices others have paid for something comparable in similar locations. Hence, Finance Director's method is wrong since fair value is esceeding the sales value of similar properties which lead to overvaluation of Investments and misjudgment by the stakeholders of financial statements.

Ethically, Company should correctly revalue its investment and give a rerorespective effect to it.

Situation 3) Impairment of Cash Generated Unit which attached Goodwill to it

Value in use equals the present value of cash flows generated by cash generating unit. The method of calculation by company for cash flows by adding back depreciation is a completely wrong method, since it does not amount to free cash flows. Further, the advise by finance director to treat assets as low value short life assets in Mikky’s books is wrong since it involves goodwill, goodwill having short life is amortized.