The paper will involve a review of a news item of the collapsing of the Carillion that highlighted the shortcomings in the Accounting standards. Carillion’s used a strategy known as reverse factoring that allowed the ink to settle its obligation with the suppliers and would later the bank. The news article will be related to topics and theories including materiality in disclosures, accounting regulations, and international accounting.
Fig 1: (Trentmann, 2018)
Key Issues in the article
The details how a UK Construction and services company Carillion PLC managed to hide almost half a billion pounds in liabilities due to lax accounting rules for a financing tactic. This was reported by Moody’s Investors Service Inc. in its operation Carillion used a strategy referred as reverse factoring. This involved an arrangement to have a financial institution such as bank to agree to pay the Carilion debts to suppliers faster in exchange of a discount while the company committed to making payment to the bank at a later date.
Carillion was however unable to sustain its operations and went into administration in January. This was after it lost money on different large construction companies. The company owed more than 498 pound ($695.1) million to banks through the strategy in the reverse factoring.
A review of the financial statement of the company indicated that these debts were reported in the other creditors section on the balance sheet thereby excluding it from its borrowing. The company had only indicated 148 pounds in bank loans and overdrafts in the2016 financial year.
The loophole that Carillion used was the lack of any specific reporting guideline on reverse factoring under the International Financial Reporting Standards. There are the guidelines that Carillion adhered to for its financial reports. This approach has two main disadvantages: the scale of liability of banks is not represented in the balance sheet and that a main source of cash from the business was not very clear. The company had issues several profit warning but its liquidating process was initiated in mid-January after it failure of reaching an agreement with lenders on possible ways of restriction the debts.
Major accounting Issues Reported in the Article
The article can be reviewed using a number of topic and theories as discussed in the ACC341. This follows a critical analysis of the issues presented and how approaches can be applied within the accounting discipline. The first topic that the articles related to is on measurement in accounting (Mathews & Perera, 1996). This involves the recognition of financial events are either assets of liabilities. In this case, the main issues presented in the article deals with the recognition of liabilities. The reverse factoring yield to a bank loan or overdraft it is indicated that Carillion presented this as other creditors.
Another topic that the article touched on is the accounting regulation and politics. It is indicated that the Carillion used the International Financial Reporting Standards (IFRS) as it main accounting rules for the financial reports. It is indicated that as per these rules, the was no misrepresentation of the circumstance since the IFRS did not offer guidelines on how the reverse factoring treatment should have been dealt with. One of the regulation that could be used for this case is the mixed measurement method of accounting prescribed in the IFRS and AASB (Deegan, 2013).
Another topic that the article covers in on International Accounting. Carillion adhere to the International accounting standards as prescribed by the International Financial Reporting Standards. The IFRS are provided by the IFRS Foundation and the International Accounting Standards Board with an aim of offer a common global language that business could use in their financial reporting to make it more understandable and comparable in the international business environments (Deegan, 2013). The international accounting is a discipline that is focused on the application of accounting standards for companies with operations overseas and allows easy comparison.
The issue of reverse factoring can be considering under the topic of prescriptive, explanatory, and predictive theories of accounting. This relates with the approach that accountants decide to follow in a certain situation. The concept of reverse factoring on whether to treat it a debt or a payable. The choice selected here may lead to lack of disclosure making it hard to measure the actual implication. In the article Carillion is indicated to have reported this as a payable in other creditors section as opposed to the bank loans and overdraft.
Another topic that is clearly identified on this article is on ethics and professionalism. Despite the queries on how to account for reverse factoring, accountants should act in a professional and ethical correct manner. The article pointed out that Carillion used reporting method as a means of hiding the actual extent of the liability which can be termed as an unethical approach.
The article portrays the shortcomings in the international accounting standards on the measurement and recognition of the liabilities arising from reverse factoring activities of a company. It helps point to the missing guidelines on the IFRS with regards to the reporting of verse factoring. This was the major loophole that Carillion used to misrepresent the actual extent of their liabilities.
Moody reported that the lack of disclosures is likely to make the extent of reverse factoring difficult to measure. This is especially magnified by the laxity of accounting standards to not always require disclosure of this nature of activity. In a situation where the reverse factoring is not reported separately, it can also not be separately reported in the standard credit measures.
The main issue presented in the article presents a concern related with extinguishment method. This situation is said to occur when an organization uses resources from another party to make payments to suppliers and put off that obligation but in turn replace it with a new obligation. The assumption presented in this extinguishing theory is that this needs to be deemed as borrowing. The accounting theory emphasizes on the need of proper recognition and measurement of transaction and events as liabilities. this is noted to be useful in the analysis of the risks associated with the company’s use of long-term debt (Barker & McGeachin, 2011, p. 4). From the article this was this risk lead to the liquidation of Carillion as the company was unable to manage its risk.
The discussion above revolves the shortcoming on the IFRS standards on the exact treatment of the transaction involving reverse engineering. Carillion used this shortcoming and treated the liabilities arising from the reverse transactions as a payable under other credits. This made it unable to manage its long-term which eventually lead to its collapse.
Barker, R., & McGeachin, A. (2011). The Recognition and Measurement of Liability in IFRS. Working Paper.
Deegan, C. (2013). Financial accounting theory. McGraw-Hill Education Australia.
Mathews, M. R., & Perera, M. H. B. (1996). The philosophy of science and research methodology. In Accounting theory and development (3rd ed.) (pp. 38-50). Melbourne : Thomas Nelson.
Trentmann, N. (2018). Carillion Collapse Highlighly Accounting Shortcomings- Moodys. The Wall Street Journal.
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