Question

Aussie Star Airways Limited (Aussie Star) is a budget airline offering no frills flights to the Asia Pacific region. In accordance with its operating policy, Aussie Star undertakes subsequent major cyclical maintenance checks on its owned and leased fleet of aircraft every four years. The most recent subsequent major cyclical maintenance checks were made in the 2018 financial year. Aussie Star’s directors plan to undertake the next subsequent major cyclical maintenance checks in the 2022 financial year at a cost of $100 million. The subsequent major cyclical maintenance checks will be undertaken by Aussie Star’s maintenance division. Given their conservative accounting values, and appreciating that wear and tear on aircraft is an on-going phenomenon, Aussie Star’s directors propose to recognise an annual accrual and a corresponding expense of $25 million in each of the 2019, 2020, and 2021 financial years. Upon incurring the cost of $100 million in the 2022 financial year, the outgoing will be recognised as an expense and the accrual’s accumulated balance of $75 million will be reversed against the expense. The proposal will result in the cost of $100 million being recognised in equal portions of $25 million in each of the 2019, 2020, 2021, and 2022 financial years.

Required

Referring to the recognition criteria of a liability, explain whether the proposed accrual of $25 million to be recognised in each of the 2019, 2020, and 2021 financial years meets the recognition criteria of a liability when applying the principles of the current conceptual framework.

Answer 1

As per accrual concept of accounting, an expense shall be recognized in the year in which it has accrued rather than in the year in which payment for the same has been made.

In the above case, the company pays for maintenance cost once in every 4 year. However it is to be noted that the wear and tear is an ongoing process and hence company can provide provision for the wear and tear.

Therefore, the above decision for accrual of $25 million to be recognised in each of the 2019, 2020, 2021 financial years meets the recognition criteria for a liability and the accounting prescribed above for the same seems appropriate.