[Accounting Theory & Contemporary Issues]

[15th September, 2014]

Case Study 1: Loss making News pins hopes on pay sites

Question.1

What criteria would management use to decide when to write down impaired assets on the
statement of financial position? Discuss the reasons underlying the write-down of Fox
Interactive Media.
Answer:
According to Australian Accounting Standard Board (AASB) 136 businesses should carry out
their business asset value impairment when:

Market value of the assets get down more than expected

Significant changes found in the technology, economy or in a market where a company

operates.
The asset found physically damaged.

After identification of the asset used as impaired next step is to measure the damage and
recoverable amount can be carry out through impairment loss (Laux, C., & Leuz, C. 2009). In
case of News Corp they will use historical cost model while writing down impairment assets in
their financial statements. The reason why they will use is that this system value assets in a most
conservative way which is quite a need for this business. In conservative system expenses are
recognised and allocated as they happen but revenues are not being amounted in any statement
until their chances to be received are higher. There is some kind of biasness in this system
because we evaluate our expenses more consciously than our revenues. Moreover, the market
value of any asset is also not recognised in this system of accounting however, any decrease in
the value of any asset will promptly recognise. This system calculates profits on the companys
account in a conservative way and yearly income statement shows results of revenues in a very
slow way (Horngren, C. T. 2012).
The Fox Interactive Media is being restructured recently to compete with the upcoming media
and technological challenges in the news market. The market is consistently is changing and the
business of print media and cable news is consistently getting down because people prefer other
social networks rather than specific news papers and channels. As this business run on the basis
of their viewership the medium which gets higher viewership get higher rate for advertisement
and can afford to ask high amount from its customer. The News Corp is also moving toward
social networks and get into mobile applications and on face book etc. They ask for charges to
read their articles and news over there to overcome their cost of impairment.

Question.2
Comment on the timing of the decision by News Corp Management to write down the
MySpace networking site, given the rapid rise of rival Facebook.
Answer:
The social networking site MySpace was found in 2003 in California by Chris DeWolfe and Tom
Anderson. From the very start this site is being very popular in all social mediums and gets
attention because of it musical content sharing on the site. In 2005, a business gets high attention
of media viewers and gets the position of highly viewed website on the internet. While, MySpcae
get highly popularity among corporate world so the News Corp bought it in$580m but two of its
founding owners remained as executives in a corporation (Imhoff, E. A. 2003). In 2006,
MySpace signed a three years advertising contract with Google worth $900m. In 2008, the
downward trend in business of MySpace starts up and high amount of visitors moved to
Facebook. All the management get frustrated because they putting all their efforts and profits in
the promotion of their business in MySpace and still cannot compete with Facebook. They start
losing their advertising target by 10% in 2008 financial year and continuously decrease after that.
In 2009, the share of MySpace falls to 30% in comparison with all social networking sites. They
face a loss of $100m in that year. At this very point News Corporation take a major step to
remove its founding member Chris DeWolfe from its Chief Executive seat and hire a new Chief
Executive from Facebook and plan for some different strategy to compete in social world. They
also cut down their expenses by lying off 700 employees from a company.
For News Corp. Historical accounting system is useful and it typically makes useful any cost
occurs in past on the organisation. This accounting system formed with the old accountants trial
and error spent of the owner operation as in case of MySpace where spending are high because
of over hiring of employees and which needs to be removed to overcome the cost burden. The
historical system based on the excess profit over the selling price of historical cost. So, the profit
is considerable only in cases where it minimizes the cost factor. The business can only be
continued if it is profitable and continued to be profitable for a News Corp.
Question.3

What effect would amortisation of News Corps media assets have on reported earnings
under the historical cost system?
Answer:
In accounting terms amortization is a distribution of a cost of intangible assets like intellectual
property rights, over its estimated useful life of an asset. The amount of loan reduced with the
payment of each month which a borrower pays every month. The cost of an intangible asset is
also distributed like any physical asset annuity payments. Its working is treated as a right of any
intellectual property divided by its projected useful life (Carlin, T. M. 2005).
The amortization of any asset in historical accounting system is like when cost of any asset
become over with its average useful life or its recoverable amount. In this case the method is like
straight line amortization is charged on assets. The change in market price deals as a
supplementary data. In this method of historical cost accounting current prices in an efficient
way without shifting from historical cost method to a accounting of current cost. The efficient
market hypothesis by Bodie tells that market securities always reflect the price similar to the
publicly available information. So, we can say that New Corp shareholders believe in the
information what its personnel provided them to belief.

Case Study 2: Many Small Caps to Flag Orange

Question 1:
What does the headline of the article mean by small cap and flash orange?
Answer:
This article is all about the group of companies in Australia who have taken high amount of
credit from market. In a six month financial analysis these all companies are not seem to working
like that. Most of them are seemed be flush out because of their losing credit worthiness. They
are heavily bound in the credit term and their business profits are not enough to pay their
creditors and owners dividend or profits. It is always known in the accounting terms that
companies should keep small caps or to have small capitalization because it is safer. Although
from working as a small cap company may makes you as an unattractive company for their bulk
of investment (mutual fund). But, by keep yourself as a small cap company you are not overly
depend on your investors or shareholders. This is the main concept of small cap companies in
Australia (Huang, W. 2007).
This concept gradually changes managers mind because every company in Australia wants to do
more project investments and expand their businesses and for this they mostly choose to increase
their market capitalisation or no of shares and take credit from banks or credit institutions. As
this trend follows in all small companies so every company increase its capitalisation in the
market. This is the highly sensitive time period for every company in Australia. At this time
managers and accountants needs to make decision in a way which secure these companies rather
than throwing a snow ball. Its a red flash light for them give a sign of urgency to work
efficiently and to decrease market capitalisation.

Question 2:
Explain the argument that merely by placing an emphasis of matter section in an audit
report you could start a chain reaction.
Answer:
Australia reporting standards AUS 702 are revised in 1996. They review many other accounting
standards and concepts of International Audit Reporting Standards ISA 700. After all discussion
some amendment are made including restricting Auditors issuing a Subject to qualification
opinion, and allowing them to change it under special circumstances by adding Emphasis of
Matter (EOM) paragraph. These attention words Emphasis of Matter gives some attention to
items need to be considered as important for the users of Auditor Reports (Carson, E. et.al.
2006). The Auditor Report is being used in the financial report and viewed by large number of
investors and people linked with a company. The purpose is to no qualify the accounts rather
include an additional paragraph in the Auditor Report. The EOM forced Auditors to give their
own opinion about whether they agree with the managements disclosure in many uncertain areas
which are needed be mentioned in the financial report. In cases where auditor agree with the
opinion of management then they add this paragraph with their opinion draw user attention.

Question 3:
The article discusses bank covenants - explain the impact of asset values on bank covenants
and the potential repercussions for a company.
Answer:
The bank covenant is an agreement which signed by a debtor to get credit from a bank. The
debtor gives a written guarantee to a bank that his business will produce profits enough to pay
back its debts sufficiently or his physical assets are sufficient enough for payment of loan. In
current case of article Australian businesses asset quality is not sufficient enough to fulfil this
bank covenant requirement. The financial strength of companies is getting weaker with the
financial crisis. The banks continuously check the quality and existence of assets of its debtors.
This is how a bank works as they cannot afford to see lose his debtor lose with their money off
course (Moir, L., & Sudarsanam, S. 2007). In the case companies start losing their asset quality
or they increase their debts more than they can pay back. This is a red alert type of situation for
all the creditors in the market and terrible situation for the company managers to handle because
they have to deal with their customer, investors and creditors and to deal all this they are not
having sufficient assets.

References:
Horngren, C. T. (2012). Cost Accounting: A Managerial Emphasis, 13/e. Pearson Education
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Imhoff, E. A. (2003). Accounting quality, auditing, and corporate governance.Accounting
horizons, 17, 117-128. Retrieved 15 September 2014,
http://www.bus.iastate.edu/aclem/592/SS03/Imhoff.pdf
Carlin, T. M. (2005). Debating the impact of accrual accounting and reporting in the public
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2014,
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2014,
http://www.sciencedirect.com/science/article/pii/S0361368209000439
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http://www.tandfonline.com/doi/abs/10.1080/00014788.2007.9730066#.VBetsdddXjk
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