Corporate Reporting Homework – Day 6

Student: Sara Mirchevska; ID: 4229

Chapter 11: PR Kit Q19 Casino (page 32/156)

a) Casino has three distinct business segments. Management has calculated the net assets, revenue
and profit before common costs, which are to be allocated to these segments. However, they are
unsure as to how they should allocate certain common costs and whether they can exercise
judgement in the allocation process. They wish to allocate head office management expenses;
pension expense; the cost of managing properties and interest and related interest-bearing assets.
They also are uncertain as to whether the allocation of costs has to conform to the accounting
policies used in the financial statements.

Required Advise the management of Casino on the points raised in the above paragraph.

(b) Segmental information reported externally is more useful if it conforms to information used by
management in making decisions. The information can differ from that reported in the financial
statements. Although reconciliations are required, these can be complex and difficult for the user to
understand. Additionally, there are other standards where subjectivity is involved and often the
profit motive determines which accounting practice to follow. The directors have a responsibility to
shareholders in disclosing information to enhance corporate value but this may conflict with their
corporate social responsibility.

Required Discuss how the ethics of corporate social responsibility disclosure are difficult to reconcile

with shareholder expectations.

(c) Casino's directors feel that they need a significant injection of capital in order to modernise plant
and equipment as the company has been promised new orders if it can produce goods to an
international quality. The bank's current lending policies require borrowers to demonstrate good
projected cash flow, as well as a level of profitability which would indicate that repayments would be
made. However, the current projected statement of cash flows would not satisfy the bank's criteria
for lending. The directors have told the bank that the company is in an excellent financial position,
the financial results and cash flow projections will meet the criteria and the chief accountant will
forward a report to this effect shortly. The chief accountant has only recently joined Casino and has
openly stated that he cannot afford to lose his job because of his financial commitments.

Required Discuss the potential ethical conflicts which may arise in the above scenario and the ethical
principles which would guide how the chief accountant should respond in this situation.

Professional marks will be awarded in parts (b) and (c) for the application of ethical principles.

ANSWER

a) Allocation of common costs under IFRS 8 Operating Segments

If segment reporting is to fulfil a useful function, costs need to be appropriately assigned to

segments. Centrally incurred expenses and central assets can be significant, and the basis chosen by
an entity to allocate such costs can therefore have a significant impact on the financial statements.
In the case of Casino, head office management expenses, pension expenses, the cost of managing
properties and interest and related interest-bearing assets could be material amounts, whose
misallocation could mislead users.
IFRS 8 Operating Segments does not prescribe a basis on which to allocate common costs, but it
does require that that basis should be reasonable. For example, it would not be reasonable to
allocate the head office management expenses to the most profitable business segment to disguise
a potential loss elsewhere. Nor would it be reasonable to allocate the pension expense to a segment
with no pensionable employees.

A reasonable basis on which to allocate common costs for Casino might be as follows:

(i) Head office management costs. These could be allocated on the basis of revenue or net assets.
Any allocation might be criticised as arbitrary – it is not necessarily the case that a segment with a
higher revenue requires more administration from head office – but this is a fairer basis than most.

(ii) Pension expense. A reasonable allocation might be on the basis of the number of employees or
salary expense of each segment.

(iii) Costs of managing properties. These could be allocated on the basis of the value of the
properties used by each business segment, or the type and age of the properties (older properties
requiring more attention than newer ones).

(iv) Interest and interest-bearing assets. These need not be allocated to the same segment – the
interest receivable could be allocated to the profit or loss of one segment and the related interest-
bearing asset to the assets and liabilities of another. IFRS 8 calls this asymmetrical allocation.

The amounts reported under IFRS 8 may differ from those reported in the consolidated financial
statements because IFRS 8 requires the information to be presented on the same basis as it is
reported internally, even if the accounting policies are not the same as those of the consolidated
financial statements. For example, segment information may be reported on a cash basis rather than
an accruals basis or different accounting policies may be adopted in the segment report when
allocating centrally incurred costs if necessary for a better understanding of the reported segment
information.

IFRS 8 requires reconciliations between the segments' reported amounts and those in the
consolidated financial statements. Entities must disclose the nature of such differences, and of the
basis of accounting for transactions between reportable segments.

(b) Reconciliation of ethics of corporate social responsibility disclosure with shareholder

expectations

Increasingly businesses are expected to be socially and environmentally responsible as well as

profitable. Strategic decisions by businesses, particularly global businesses nearly always have wider
social and environmental consequences. It could be argued that a company produces two outputs:
goods and services, and the social and environmental consequences of its activities, such as
pollution.

The requirement to be a good corporate citizen goes beyond the normal duty of ethical behaviour in
the preparation of financial statements. To act ethically, the directors must put the interests of the
company and its shareholders first, for example they must not mislead users of financial statements
and must exercise competence in their preparation. Corporate citizenship, on the other hand, is
concerned with a company's accountability to a wide range of stakeholders, not just shareholders.
There may well be a conflict of interest between corporate social responsibility and maximising
shareholder wealth; for example it may be cheaper to outsource abroad, but doing so may have an
adverse effect on the local economy.
However, the two goals need not conflict. It is possible that being a good corporate citizen can
improve business performance. Customers may buy from a company that they perceive as
environmentally friendly, or which avoids animal testing, and employees may remain loyal to such a
company, and both these factors are likely to increase shareholder wealth in the long term. If a
company engages constructively with the country or community in which it is based, it may be seen
by shareholders and potential shareholders as being a good long-term investment rather than in
business for short-term profits.

As regards disclosure, a company that makes detailed disclosures, particularly when these go beyond
what is required by legislation or accounting standards, will be seen as responsible and a good
potential investment, provided they are clear, concise, relevant and understandable. For example,
many quoted companies now prepare social and environmental disclosures following guidelines
such as the International Integrated Reporting <IR> Framework or the Global Reporting Initiative.
The IASB have also provided guidance in the form of an IFRS Practice Statement for entities
preparing a management commentary.

(c) Ethical conflicts

In this scenario, there is a twofold conflict of interest:

(i) Pressure to obtain finance and chief accountant's personal circumstances

The chief accountant is under pressure to provide the bank with a projected cash flow statement
that will meet the bank's criteria when in fact the actual projections do not meet the criteria. The
chief accountant's financial commitments mean that that he cannot afford to lose his job. The ethical
and professional standards required of the accountant are at odds with the pressures of his personal
circumstances.

(ii) Duty to shareholders, employees and bank

The directors have a duty to act in the best interests of the company's shareholders and employees,
and a duty to present fairly any information the bank may rely on. Although the injection of capital
to modernise plant and equipment might appear in the shareholders' and employees' best interests
through generation of future profits, if the new finance is obtained on the basis of misleading
information, it could actually be detrimental to the survival of the company. It could be argued that
there is a conflict between the short-term and medium term interests of the company (the need to
modernise) and its long-term interests (the detriment to the company's reputation if its directors do
not act ethically).

Ethical principles guiding the accountant's response

Specifically here, there is a self-interest threat in the form of the risk of the chief accountant losing
his job and an advocacy threat in the form of disclosing favourable information in order to obtain the
loan finance. The chief accountant's financial circumstances and pressure from the directors could
result in him knowingly disclosing incorrect information to the bank which means that the
fundamental principles of objectivity, integrity and professional competence from ACCA's Code of
Ethics and Conduct may be compromised.

In the case of objectivity, the chief accountant is likely to be biased due to the risk of losing his job if
he does not report a favourable cash flow forecast to the bank. Disclosing the incorrect information
knowingly would compromise his integrity as he would not be acting in a straightforward and honest
manner is his professional and business relationships. Although forecasts, unlike financial
statements, do not typically specify that they have been prepared in accordance with IFRS, the
principle of professional competence requires the accountant to prepare cash flow projections to
the best of his professional judgement which would not be the case if the projections showed a
more positive position than is actually anticipated.

Appropriate action

The chief accountant is faced with an immediate ethical dilemma and must apply his moral and
ethical judgement. As a professional, he has a responsibility to present the truth fairly, and not to
indulge in 'creative accounting' in response to pressure. The chief accountant should therefore put
the interests of the company and professional ethics first, and insist that the report to the bank is an
honest reflection of the current financial position. As an advisor to the directors he must not allow a
deliberate misrepresentation to be made to the bank, no matter what the consequences are to him
personally. The accountant must not allow any undue influence from the directors to override his
professional judgement or undermine his integrity. This is in the long-term interests of the company
and its survival. The chief accountant should try to persuade the directors to accept the submission
of the correct projected statement of cash flows to the bank. If they refuse, he should consider
consulting ACCA for professional advice and if necessary, seek legal counsel.