Accounting Case Writing: Wellness Fitness Ltd

1302 words - 5 pages

To: John ClaytonFrom: ControllersRE: Recommended accounting policies in light of new business plans and lending conditionsROLE: Accounting controllers hired to assess 2014 financial statements to advise on appropriate accounting policies due to changes in business plans and new lending conditions.USERS: As Wellness Fitness Limited's (WFL) CEO, you want to maximize net income and shareholders' value. The two external shareholders are users who also want to maximize net income and shareholder value to increase their return. Finally, Morgan Bank is another user who wants to ensure that financial statements comply with IFRS standards and GAAPs. They also want to ensure that the company complies with the current ratio covenant and is financially stable to repay the requested bank loan. The bank is the most critical user because without this sizeable loan, the company would be unable to grow and expand its membership.CONFLICTS: Management will want to recognize revenue right away and defer expenses to maximize income. This may not comply with IFRS which conflicts with the bank's objectives.CONSTRAINTS: As a public company and as requested by the bank, annual audited financial statements must be prepared using IFRS standards. To receive the bank loan, the year-end current ratio must not drop below 1.2:1, as stated by the bank's covenant. Ethics is another constraint because users will want to ensure that management is not biased in fulfilling personal goals; financial statements should accurately reflect the business' financial position.ISSUE #1: Depreciation of Capital AssetsDepreciation on capital assets was not recorded. Under accrual accounting and IFRS, a portion of the cost of these capital assets must be expensed each month to reflect their use. Depreciation is not a fictitious expense; it is a non-cash expense that cannot be ignored because cash is not exchanged. By not recording it, expenses are understated and net income is overstated, making the financial statements unreliable to users. To fix this issue, depreciation should be recorded on capital assets to reflect their net book value. This satisfies the bank since statements will now comply with IFRS and the current ratio will not change. However, net income will decrease following this adjustment, thus going against your objective to maximize net income.ISSUE #2: Membership Fee - Revenue RecognitionThis issue is about when to recognize the $10,000 revenue collected from members for future yoga classes. It was prematurely included as revenue in the 2014 fiscal year, and because service has not been provided, net income in 2014 is overstated and understated in 2015. Alternatives to when revenue can be recognized include: when the classes begin; after each class is held; evenly throughout the period; after all classes have been held. Under IFRS, there are 5 criteria that must be met for revenue to be recognized: (1) Most risks and rewards of ownership have been transferred from seller to...

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