Accounting Treatment for Pre-paid Fees - Provision for Loss on Prepaid Fees - report on findings

Executive Summary

This report has been prepared for the Department of Human Services and follows on from the previously issued ‘Discussion Paper – Validation of accounting treatment of pre-paid fees’. This report specifically addresses the methods of calculating and valuing a provision for loss on pre-paid fees, journal entries to record any provision, and the appropriate accounting policy and associated note disclosures in the financial statements. Data to illustrate and support our discussions was supplied by two Trusts – The Necropolis and The Geelong Cemeteries Trust.

The following information (as a minimum) is required in order to appropriately assess a provision:

• The amount of the fee received from the customer;
• The nature of the goods and services to which the fee relates; and
• The present value of the expenditure required in order to settle each obligation associated with the fee received.

Two valuation approaches are discussed in relation to the determination of the present value of the expenditure; being:

1. Valuation Approach 1 - The cost required today (or at reporting date) to deliver the particular good or service;

2. Valuation Approach 2 - The best estimate of the expenditure required to settle the obligation, taking into account the time value if money (i.e. the present value of the future cash flow).

Risks and difficulties in the application of these valuation approaches have been identified to include, for example:

• Use of inconsistent definitions for the classification of costs. Inconsistent classifications may lead to mis-statement of Trusts’ liabilities, comparability of reported results across the industry as well as over time being hindered, and inappropriate decisions being made based on reported information. It was noted however that these risks are minimised by the implementation of the Cemeteries common Chart of Accounts (‘CCA’).
• Differences in the methodology applied to assign indirect and overhead costs to total cost for provision of the good and service. Similar risks as those noted in respect to inconsistent classification of costs apply to use of different methodologies.
• High level of subjectivity involved in assessment of data inputs – such as time period in which the contract is likely to be settled, forecast inflation rate and discount rate - with the application of valuation approach 2. Due to subjective nature of these inputs, agreement on common rates and methodology (to promote consistency) may be difficult to obtain.
• High degree of manual assessment and calculation required (particularly if Valuation approach 2 is applied) leading to increased risk of transposition and other human errors. From our review, observations and findings (including consideration of information provided by the two nominated Trusts), we recommend: · Use of Valuation Approach 1 as the most practical, efficient and effective method for the Trusts to adopt in the valuation of any provision for loss on pre-paid fees. This may need to be reviewed in the future where a provision for loss on pre-paid fees is likely to be material to the Trust and its results.