2102AFE: Analysis of Accounting Items of Woolworth’s Limited - Financial Accounting Assessment Answer

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Assignment Task

John Daily has recently received a substantial inheritance on the death of his mother. John wants to use this money to his advantage and invest it for his future because he would like to retire early. He is considering buying some shares in Woolworths Ltd because he thinks it would be a stable investment that would provide a good income stream in future years. John has been doing his own research on this company, however, he has some accounting-related issues he would like addressed before he makes the decision to go ahead with this investment.

John has come to you for advice, in your capacity as the senior accountant of the Financial Accounting and Reporting section of Prime Accountants, a chartered accounting firm specialising in small client consultancy. The specific accounting-related issues raised by John are outlined below:

1. John is primarily basing his opinion about investing in Woolworths Ltd on the popularity and profile of this supermarket, given that Woolworths is one of Australia’s major supermarkets. He has accessed the company’s 2015 Annual Report, but is concerned about whether the information in this report can be trusted. John’s best friend has told him that in order for information to be included in financial reports it must exhibit the Conceptual Framework’s qualitative characteristics. John would like you to identify and explain each of these characteristics and what they mean for quality of the information disclosed in the Woolworths Ltd annual report.
2. John is interested in Woolworths Ltd’s asset base because he knows that assets are important in the event of

a company winding up due to bankruptcy or insolvency. a. In relation to Property, Plant, and Equipment, John has become aware that there are two ways to value these assets subsequent to their initial recognition, including the cost model and the revaluation model. He has noticed that Woolworths Ltd uses the Cost model. Compare and contrast these two measurement methods for John and provide a professional opinion of which measurement method provides more reliable information about Property, Plant, and Equipment values. Your professional opinion must be supported by valid arguments from sources that are reliable, reputable, and relevant. b. John has been following the yearly evaluation of the Woolworths Ltd brand published by Business Insider (provided on L@G). He has noticed that the value of the Woolworths’ brand reported in this article is significantly higher than the value of brand names reported in the Woolworth Ltd annual report. Outline for John why these two brand values are different. Identify and explain the reasons why the accounting requirements for internally generated intangible assets are very stringent. Identify and explain to John an example of a real-world company where intangible assets led to problems with the valuation of the company.

Required: Prepare a 1,100 word Letter of Advice for John whereby you fully address each of the issues he has raised, as outlined above, and advise John whether he is able to base his investment decision primarily upon the information disclosed in Woolworths Ltd’s annual report.

Within this process you must ensure that you explain thoroughly all relevant accounting terms because John’s knowledge of them is very limited. He must be able to understand your Letter of Advice. Refer to the accounting standards where appropriate so that John knows the authority on the information.

The current address for John Daily is: 82 Figtree Court, Cleveland, 4163. You may use any address that you feel is appropriate for the Prime Accountants accounting firm.

Purpose of Assessment The purpose of this assessment item is to determine your ability to use written communication skills in an accounting context.

Analysis of Accounting Items of Woolworth’s Limited

With reference to the letter of advice requested in respect of the analysis of few accounting items of financial report of Woolworth’s Limited the following has been issued.

Keeping in mind the requirements the relevant concepts of accounting have been discussed with their meaning and importance. It has been recommended that the market research in addition to understanding the information in the annual report an analysis regarding the share price of the company should be made in order to determine the feasibility of investment.

The qualitative characteristics of Conceptual Framework have been discussed hereunder in order to understand their meaning and their importance in the financial reporting. The qualitative characteristics are of two types:-

• Fundamental Qualitative Characteristics
• Enhancing Qualitative Characteristics

Fundamental Qualitative Characteristics are the qualities that are most essential for the financial statements otherwise the entire purpose of the preparation and presentation of the financial statements would be defeated. These characteristics have been further subdivided hereunder:-

• Relevance – It means that all the material information that is relevant for the economic decision making of the users of financial statements should be disclosed irrespective of the fact that it is used or not.
• Faithful Representation – It means that the information that is contained in the financial report should be complete, unbiased, and free from material misstatement and should give a true and fair view of the affairs of the entity.

The enhancing qualitative characteristics refer to the quality that improves the usefulness of the financial statements. These qualities enhance the fundamental qualitative characteristics. Therefore, in the absence of Fundamental Qualitative Characteristics they would be irrelevant. It can be subdivided further into four parts:-

• Comparability – It means that the financial statements should be prepared in such a manner that the information enables the users to understand the similarities and differences between the entities.
• Verifiability – It means that the information that is present could be confirmed with the help of reliable resources.
• Timeliness – It means that the information that is material is communicated to the users in a timely manner before it loses its importance.
• Understandability – It means that the financial statement is prepared, classified and presented in clear and concise manner that is comprehendible to the users.

AASB 116 prescribes that after the initial recognition of an asset at cost it is at the discretion of an entity to subsequently recognise the asset at cost or revaluation model. In the revaluation model the fair value of the class of the asset is consistently determined and the appropriate accounting treatment is made in the financial statements of the company. In case of an upward revaluation, the increase in the value is recognized in Other Comprehensive Income and the gain is credited to the revaluation surplus of equity. However, in the case of a downward revaluation the decrease is treated as an expense in the profit and loss account. The frequency of revaluation has not been prescribed but the revaluation should be made at such intervals that the carrying value of the asset is not materially different from the fair value on the Balance Sheet date.

The cost model provides the current valuation of an asset on the basis of its historical cost while the revaluation model presents the fair value of an asset on a specified date.

If both the methods are assessed it can be stated that the revaluation model provides a more relevant information for the users. The rationale behind the same is that the asset is recognized at the value that is expected to be obtained at its disposal in market. Therefore, the representation of the value of the class of assets becomes more useful for the users and it helps in correct assessment of the value of equity.

Since the value of asset is regularly measured the impact of loss arising on the impairment of an asset ceases and the financial statements are not majorly impacted with any downward revaluation because the asset is consistently measured on its fair value and the probability of the fall in the value by higher amount is reduced in the given case.

If the report of Business Insider regarding the brand valuation of the company is studied along with the annual report of the company it can be noticed that the value of brand in both the reports is considerably different.

Brand value is an intangible asset. As per AASB 138 intangible asset is an asset that does not have a physical presence and may be non-monetary if they are internally generated. In order to recognize an intangible asset it is important that it must be distinctly recognizable and could be specifically placed on the asset. It must be acquired as a result of acquisition or by other means and the value of the intangible asset could be reliably measured. The intangible assets that are internally generated cannot be classified as an asset in the financial statements. The rationale behind the criteria is to ensure the fair presentation of the financial statements to its users and protect the interest of the users. Internally generated intangible assets cannot be measured reliably therefore, they are not incorporated in the financial statements of the company.

The above factors explain the difference in brand value amount between the Business Insider and the Annual Report of the company. The Business Insider reflects the brand value of the company based upon its current market position and goodwill. The Annual Report of the company only recognizes the value of brand that has been acquired by the company till the given date. The financial statements will recognize only that value of brand which the company has acquired or purchased by the company in exchange of monetary consideration. Therefore, both the figures differ significantly.

All the issues raised in the request have been discussed here keeping in mind the requirements of the requests. The information disclosed in the annual report states about the current financial position of the company and gives a detailed description of the current operations of the company. However, the reports cannot be a sole basis for investment consideration in any company. All other important factors that determine the share price fluctuation have to be studied in conjunction with the report in order to assess the feasibility of investment.