Auditing firm Deloitte faces demands to explain why it signed off on an accounting strategy that disguised massive losses as steadily growing profits at Freedom Foods.

Professor Wells said there is scope for capitalisation of certain expenditures in the Australian accounting standards and the arguments around this can be complex and detailed.
However, another accounting standard known as AASB 136 requires impairment testing for a range of assets and this requires the value of assets be no more than its recoverable amount the higher of its fair value or its value in use, he said.
“The challenge here is that if youve capitalised too many costs, you are going to have problems with impairment testing and that is what is coming to the fore now at Freedom Foods.”
He added that the restatements released by the company on Monday suggest that the assets had been recorded at excessive values.
Impairment testing requires judgment, but it is much less complex and the restatements issued on Monday suggest these assets were recorded at excessive values. It is also suggested by the companys poor performance which would limit calculation of recoverable amount of the asset as either as value in use or fair value, he said.
A similar issue arises for inventory, whereby it must be recorded at the lower of cost and realisable value. Obsolete inventory obviously has little value.
Deloitte and Freedom Foods declined to comment on the issue.
Freedom Foods announced it was looking into the value of its inventory in May and June after discovering obsolete and out-of-date food stock dating as far back as 2017. The restated accounts confirmed the value of the inventory would be written down by $60.1 million, as foreshadowed in June.
Capitalisation can be used to make a company appear financially stronger that it really is, said Yaowen Shan, also a professor in accounting at the University of Technology Sydney.
One of the most common methods of fraudulently making a firm appear financially stronger is through the capitalisation or deferral of expenses, which instantly takes expenses and converts them into assets and boosts income, Professor Shan said.
This is not new and I think the 2002 WorldCom scandal is a classic example of how easy fraud can be executed in a simple way but on a huge scale.
American telecommunications company Worldcom collapsed in 2002 after it was revealed that regular expenses had been fraudulently recorded as investments so as to inflate income. The collapse is one of the largest accounting scandals in US history.
Admittedly, Australian accounting standards are principle based and the applications at the corporate level requires lots of professional judgment. This unfortunately also provides lots of opportunities of frauds and/or manipulation by management due to their various personal incentives, he said.