Xi_Wang_Case_Study_Analysis_Final

1
Evaluation of
application of
accounting
standards and
conceptual
framework in
Mainfreight’s
external
financial report
Xi Wang
26/03/2015
2197 words

Xi Wang 15887071 Page 2
Introduction
This case of Mainfreight indicates the presentation and disclosure of external
financial statement in complying with IFRS. In order to analyse the evaluation of the
presentation and disclosure of external financial statement and the application of
management judgement and estimates; The study firstly explains the necessity in
completion with conceptual framework and accounting standards in the preparation
of external financial statements in Mainfreight’s annual report. Then it evaluates the
presentation and disclosure in the statement of changes in equity and the
professional judgement on both historical cost and fair value estimates.
Necessity of regulating the external financial report
The external financial report is designed to assist external parties with an interest in
the financial activities of an entity to make an investment decision (NZASB, 2015a).
To concern the terms of transparency of financial statement, it cannot only benefit
investors by revealing an entity’s underlying economics in a readily understandable
structure in the financial statement, but also assist a company to reduce its cost of
capital (Barth & Schipper, 2015). It is therefore to be able to obtain the benefits
gained from the quality of transparency, a regulation to restrict the conduct of
financial statement preparers becomes necessary. In addition, as external investors
do not have the necessary power to demand what information should be addressed
in the external financial report to satisfy their own requirements and needs, having
regulation on the external financial report to protect their rights in terms of the true
and fair view becomes necessary.
Why is the conceptual framework necessary?
The conceptual framework can be interpreted as a significant guide on preparation of
financial report to ensure the organizations to provide all necessary advantages to
the external parties from disclosure of external financial report (NZASB, 2015b). One
common feature of the framework is to emphasis on general purpose external
financial reporting. The external financial report providing information to their users
who have no access to the underlying and requiring particular information, to assist
them to make decisions, should consider what relevant information is useful. They
normally make decisions based on the information about the past financial

performance of the organization to predict its future behaviour and economic
outcomes.
In terms of the faithfulness representative, one of qualitative characteristics of
financial statement should be implied as a promise for the organizations to truly
represent what it purports to represent in the external financial report (Kirschenheiter,
2006). It is a subjective interpretation of the quality and accuracy of accounting
signals relating to economic reality (Rayburn, 1989). For example, an accounting
theory can only provide a limited support to the measurement of income when there
is no empirical equivalent existed to be a reference frame, so talking in theory about
economic income is not realistic in the practical tasks (Rayburn, 1989). As a result, it
is significant to have a conceptual framework to solve the subjective problem arisen
from when the representative faithfulness characteristic is needed to be applied.
Why is the Accounting Standard necessary?
Accounting Standard can be interpreted as a legislative foundation to play multiple
roles, including investors in assessing the possible risks of investments; providing
rules of authority to professional bodies; setting up economic scheme, analysing
market values, and the rest. According to a research, the core role of Accounting
Standards is responsible for improving “corporate governance” (Benston, 1982). For
example, due to managers and shareholders have separate ownership and control
to the entity, a conflict interest between them will occur. Thus the managers may
abuse their privilege to expend organizational resources on their own personal
preferences. It points out that the disclosure of external financial report can miss-
evaluate the accounting signals and then indicating untruthful economic income
(Benston, 1982). Therefore, to avoid any general inefficiency in management, it is
necessary to have Accounting Standard to be established and developed.
Presentation and disclosure of information in Statement of Changes in Equity
According to NZ IAS1 para 106, the role of Statement of Changes in Equity is to
provide changes between opening and closing equity, and other detailed equity
accounts allocated into several categories: “ordinary shares, asset revaluation
reserve, foreign currency translation reserve and retained earnings”. (NZASB,
2015c). In accordance with the General Purpose Financial Statement (GPFS),
statement of changes in equity is designed to provide significant information about

owner’s equity reserves which cannot be observed from elsewhere in the financial
statement, thus it can assist external creditors to identify the factors which indicate
the movement of shareholder’s equity reserves. Therefore, based on the
understanding of accounting theory to extend what Statement of Changes in Equity
should contain, I would like to demonstrate two elements – foreign currency
translation and dividend to evaluate what Mainfreight has applied in NZ IAS 1
(Mainfreight, 2014).
In accordance with the GPFS, the financial report must be readily understandable for
all occupational investors, so converting all accounts with different foreign currencies
into one currency used by parent company should consist with the Accounting
Standards (NZASB, 2015c). In this particular case, the Mainfreight‘s annual report
indicates that the company uses functional currency method to evaluate the
measurement of foreign currency hedges against the net investment (Mainfreight,
2014). This measurement can provide all users of financial statement a big clear
picture of the activities of an entity and its profitability. Moreover, the applied
exchange rate occurred at the date of transactions happened is to determine the
market value of shareholder’s equity and effects on its outcome (Bogicevic, 2013).
It is also important to understand the relationship between dividend and retained
earnings presented in the statements of changes in equity in the Mainfreight annual
report. Firstly, dividend paid item is a cash disbursement which is paid to the
shareholders as a return on investment (Mainfreight, 2014). Secondly, retained
earnings for the total comprehensive income refer to the proportion of gross profit
presented in the income statement after distracting the expenses and dividend paid
to the shareholders (Elton & Gruber, 1986). A greater level of dividend pay-out ratio
(refers to the proportion of profit distributed to cash dividend) may represent a better
picture to attract capital contributors, but it has a lack of consideration in its cash flow,
liquidity and tax distribution of dividend to shareholders (Chughtai, Azeem, & Ali,
2013). For example, Harris and Kemsley discovered that dividend taxes and retained
earnings both have significant influence on the implicit valuation of the reinvested
portion of current earnings (Collins & Kemsley, 2000).
Application of professional judgement and accounting estimates

Even though the terms of “professional judgement” is not explicitly defined or
explained in the General Accepted Accounting Standards (GAAP), more complex
information in a modern accounting system has significant needs of the process of
professional judgment (Rentfro, 2000). Because not all transactions or activities
prepared in the external financial statement apply to the scope of existing
accounting standards, it not only requires professional judgment to classify the
appropriate accounting principles, but also to determine the level of informational
details and disclosure (Schmutt & Duncan, 2009). From the point view of the initial
objectivity of accounting principle, to assist investors to make decisions, it requires
the call for professional judgment on analysis of the changes in accounting
estimates (Cenar, 2012). In accordance with NZ IAS 8 para 5, the certain essential
information used in preparation of financial statement at balance date significantly
relies on the use of estimates, because the amount of assumption and prediction of
future events are not available at the end of an accounting period (NZASB, 2015d).
Therefore, both preparers and auditors of financial statement are required to make
professional judgment in the determination of adequacy of evidence to support
estimates and obtain an actual valuation of an entity for decision-making (Schmutt
& Duncan, 2009).
In order to apply a relevant and reliable financial report, and to generate a
professional judgement to assist decision-makers, it is important to understand how
historical cost and fair value estimates apply. Historical cost accounting approaches
to the faithfulness representative characteristic of the GPFS as it is completely
based on fixed and certain inputs (Cenar, 2012). It helps investors to predict future
based on the certainty of initial valuation, but creates uncertainty in future periods
about the true value of assets (i.e. Incurrence of depreciation, depletion and
obsolescence) (Jairam, 2013). However, historical cost only provides reliable
information to assist professional judgement on the existing economic reality, but
does not apply to relevance characteristic of financial information. Therefore, the
inadequate evidence obtained from past transactions and events cannot be enough
to support preparers to make a professional judgement in the determination of
financial statement and of global economic movement.
In accordance with a Mainfreight’s annual report, this company prepared its
financial statements in a manner corresponding to generally accepted accounting

practice in New Zealand (NZ GAAP) with a historical cost measurement as a basis;
and also integrated with fair value method to measure its derivative financial
instruments (Mainfreight, 2014). Thus, it enhances a greater level of adequacy of
evidence to support its professional judgement. For instance, the Group annually
determines the impairment of goodwill based on estimation of cash-generating units
(in note 15) (Mainfreight, 2014). In addition, the Group also determined its fair value
method by a third party – Black Sholes and binomial models (i.e. to measure the
share based payment transactions), so that it cannot only emerge a “fair and true”
view, but also reduce the possibility of occurrence of fraud or errors in the external
financial report (Mainfreight, 2014). Finally, in Note 2, the company measured the
present value of liability for long service leave from estimated future cash flow
based on the accounts of past history (Mainfreight, 2014). This indicates that it used
the historical cost method to measure the liability instead of fair value, as this
method is more reliable for the company to estimate its further liability trend. Overall,
Mainfreight could present its professional judgement by using a combination of two
estimate methods to assess the risks of material misstatement in preparation of
financial statement.
Issues raised from both historical cost and fair value estimates
In order to achieve a high level adequate of evidential support, fair value
measurement is introduced to apply the relevance characteristic to supplement the
deficiency of historical cost estimates. In accordance with Financial Accounting
Standard Board 157, fair value measurement continually applies “as entry value
and exit value” (Penman, 2007). As the actual value of assets may vary during
different periods, to estimate financial statement for the next accounting period, it
should revalue assets at replacement price with unrealized gains or loss, which can
be more relevant to the future event. For example, Enron Capital and Trade
Company (ECT) adopted fair-value accounting to increase its contract value in
order to pay-out its obligations when they claimed bankruptcy (Benson, 2006). As a
result, fair-value generates more relevant evidential support to the future estimates
and professional judgement.
Nevertheless, both historical cost and fair value estimates also have some faults
appearing up when entities use them to manipulate their financial position and

performance (Jairam, 2013). For example, an organization may manipulate an
amount of value of depreciation by using historical cost to increase its residual-
income value. Moreover, managers can also use a historical cost to cover up the
failure of bad investment decisions and the results in deductions of level of equity
and assets (Jairam, 2013). Thus, using historical cost is unlikely to disclose the
financial failure for any entity which attempts to deceive investors about its
profitability and performance.
Furthermore, fair value estimates also can manipulate their financial statement in
different conducts (Jairam, 2013). If entity charges a large OTTI (Other-Than-
Temporary-Impairment) in a lower value, it will underestimate assets, thus it creates
greater income as cash flows are stronger than what its carrying value of an asset
should be. Consequently, to investors considering in returns on equity will be
attracted to make an investment. And also to the entity will incur a loss before future
benefits come. By contrast, using historical cost, the entity will take benefits first,
then suffer from a loss thereafter. Therefore, both investors and creditors are likely
to endure from those manipulations caused by using these two estimate methods
(Jairam, 2013).
Further Thoughts and Conclusion
It is difficult to choose between historical cost and fair value estimates in the
preparation of financial statement, as both methods have advantages and
disadvantages. Historical cost method focus on the cost allocation rather than the
market value of assets, on the other hand, the fair value method has an emphasis on
the continually varying values of assets. Therefore, both methods can be applied to
the same element, but at the different period. From previous discussion on a
Mainfreight annual report, this study explained the necessity of conceptual
framework, accounting standards, the terms of the statement of changes in equity,
and also the application of professional judgement and accounting estimates, it
indicates that it is necessary to prepare external financial report in complying with its
applicable accounting principles and standards, with professional judgement in
determination of the two measurements to support estimates and obtain a
conclusion of the actual value of an entity. In this particular case, Mainfreight overall

did comply with the accounting standards and the general purpose financial
statement.
References
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Benson, G. J. (2006). Fain-value accounting: A cautionary tale from Enron. Journal
of Accounting and Public Policy, 465-484.
Benston, G. (1982). An Analysis of the Role of Accounting Standards for Enhancing
Corporate Governance and Social Responsibility. Journal of Accounting and
Public Pohcy, 5-17.
Bogicevic, J. (2013). Accounting Implications of Foreign Currency Transactions
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Cenar, I. (2012). Call for Professional Judgement Policy and Accounting Estimates
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Chughtai, Azeem, & Ali. (2013, December 4). Determining the Impact of Dividends,
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