Assignment
ABC plc, a listed firm in the stock exchange had shown a long period of sustained growth until the global financial crisis occurred in 2008. The firm had used external borrowings substantially for expansion of its businesses, which it had been rolling over on maturity. However, during the financial crisis it became harder to roll over the loans as they matured. To make matters worse, sales revenues fell by 25% for the financial year 2008/2009, debtors took longer to pay, and margins fell. But, the Managing Director did not want to report a loss especially in his tenure. Moreover, in case of reporting a loss, it would be the first time in the company's history, which might panic investors/financiers.
Later, the Finance Director of the company asked the Financial Controller to make every effort to show a profit in this year as opposed to a loss. He suggested him to: (i) shift a number of expenses to prepayments; (ii) to lower provisions for doubtful debts; and (iii) not to depreciate new assets in the year of purchase, rather commence depreciation in the next financial year on the argument that they would take a while to become fully operational.
In the previous financial year, the company had moved into a new line of business where a small number of customers had made advance payments. The company recognized these payments as revenue, and later the auditors were persuaded to allow this on the argument that it was immaterial in the overall group financial statements. Otherwise, advanced payments should have been recognized as liability in the previous financial year. Fortunately, that new line of business had grown substantially in the current financial year. The Finance Director suggested the Financial Controller to continue the practice of recognizing advanced payments as revenue as they did previously on the argument that a precedent had been set the year before.
The Financial Controller recognised that could be considered as ‘creative accounting' and was reluctant to do what he was instructed. When he tentatively made this comment to the Finance Director, he assured him that this was only temporary, and when the economy would recover next year, all the discretionary adjustments would be reversed. After all, it was not as if the company was not going to be prosperous in the future. The Finance Director emphasized that these adjustments were, after all, a win-win situation for everyone.
Required:
Critically discuss the accounting issues indicated in the above scenario in the light of existing financial reporting standards. (Five accounting issues and reference the related accounting standards)