Nette, a public limited company, manufactures mining equipment and extracts natural gas. The directors are uncertain about the role of the lASB's Framework for the Preparation and Presentation of Financial Statements (the Framework) in corporate reporting. Their view is that accounting is based on the transactions carried out by the company and these transactions are allocated to the company's accounting period by using the matching and prudence concepts. The argument put forward by the directors is that the Framework does not take into account the business and legal constraints within which companies operate. Further, they have given a situation which has arisen in the current financial statements where they feel that the current accounting practice is inconsistent with the Framework.
Situation:
Nette purchased a building on 1 June 2003 for $10 million. The building qualified for a grant of $2 million which has been treated as a deferred credit in the financial statements. The tax allowances are reduced by the amount of the grant. There are additional temporary differences of $40 million in respect of deferred tax liabilities at the year-end. Also, the company has sold extraction equipment which carries a five-year warranty. The directors have made a provision for the warranty of $4 million at 31 May 2004 which is deductible for tax when costs are incurred under the warranty. In addition to the warranty provision, the company has unused tax losses of $70 million. The directors of the company are unsure as to whether a provision for deferred taxation is required.
(Assume that the depreciation of the building is straight line over ten years, and tax allowances of 25% on the reducing balance basis can be claimed on the building. Tax is payable at 30%.)
Required:
(a) Explain the importance of the 'Framework' to the reporting of corporate performance and whether it takes into account the business and legal constraints placed upon companies.
(b) (i) Explain, with reasons and suitable extracts/computations, the accounting treatment of the above
situation in the financial statements for the year ended 31 May 2004.
(ii) Discuss whether the treatment of the items appears consistent with the 'Framework'.