4-1 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by...

4-1 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

Chapter 4

An overview of accounting for assets


Objectives

• Understand the definition of an asset and the associated asset recognition criteria

• Understand the process involved in determining whether particular expenditures should be recognised as assets (capitalised) or expensed

• Be able to describe some of the various asset measurement rules currently being applied within Australia


Objectives (cont.)

• Be aware of the disclosure requirements contained in AASB 101 ‘Presentation of Financial Statements’ as they pertain to a reporting entity’s assets

• Be able to explain how to calculate the acquisition cost of an asset


Post-2004 numbering of Australian Accounting Standards

• As we will be discussing particular accounting standards it is useful to discuss how the standards are numbered.

• Accounting standards issued by the International Accounting Standards Board (IASB) were until 2003 referred to as International Accounting Standards (IAS)—older standards

• Accounting standards issued by the IASB from late 2003 are referred to as International Financial Reporting Standards (IFRSs)—newer standards

• The number allocated to AASB standards will depend on whether the ‘adopted’ standard relates to an ‘old’ or ‘new’ international standard


Post-2004 numbering of Australian Accounting Standards (cont.)

• Where the adopted standard relates to a standard with an IAS prefix, the Australian standard will be numbered from AASB 101 to AASB 199

• Where the Australian standard relates to a standard with an IFRS prefix, the Australian standard will be numbered from AASB 1 to 99

• Where Australia releases a standard that does not have an international equivalent, the numbering system will be from AASB 1001 to AASB 1099


Definition of assets

The AASB Framework definition of an asset:• A resource controlled by the entity as a result of past events

and from which economic benefits are expected to flow to the entity

– the above is the ‘definition’ of assets. Apart from the definition we also need to consider:

When we recognise assets How we are to measure assets How we are to classify and disclose assets


Definition of assets• Following from the definition, three essential characteristics

are required of an asset1. Expected to provide future economic benefits2. Must be controlled by the entity3. Transaction or event giving rise to the control must have

occurred

‘Future economic benefits’• Service potential being the essence of assets• Common to both profit-seeking and not-for-profit entities

Future economic benefits can be described as the scarce capacity to provide benefits to the entities that use them, and is common to all assets irrespective of their physical or other form


Definition of assets (cont.)

Concept of control• Control concept not specifically defined in the AASB

Framework• Control not restricted to legal ownership• Capacity of the entity to benefit from the asset in

pursuit of the entity’s objectives and to deny or regulate access of others to those benefits


Recognition criteria for assets

Under AASB Framework (par. 49)• An asset is to be recognised in the balance sheet

only when– it is probable that future economic benefits embodied in the

asset will eventuate; and– the asset possesses a cost or other value that can be

measured reliably.


Recognition criteria for assets (cont.)

‘Probable’• Not defined specifically in the AASB Framework• Considered to mean when expected probability of

future benefits arising is greater than 50%• If it is considered ‘improbable’ that future economic

benefits will flow beyond current accounting period, the asset needs to be expensed in the income statement (AASB Framework, par. 90)

• ‘Probability’ is a matter for professional judgment


Recognition criteria for assets (cont.)Evaluating the probability of future benefits• What was once considered an asset might need to be

expensed later– Dr Loss on write-down of asset

Cr Asset

• Professional judgment call that machine will generate positive cash flows is assessed at less than 50%

• If, at a given time, expenditure not deemed likely to generate future economic benefits then the asset should be expensed in the period when it becomes apparent that insufficient benefits will be realised – referred to as an impairment loss

Refer to Worked Example 4.1 on pp. 158-159—Asset recognition and probable economic benefits



Impairment of assets• AASB 136

– when recoverable amount of an asset is less than its carrying amount —the carrying amount of the asset must be reduced to recoverable amount (impairment loss)

– ‘recoverable amount’ is the higher of an asset’s net selling price and its value in use

– ‘carrying amount’ is the amount at which an asset is recorded in the accounting records (after deducting accumulated depreciation and accumulated impairment losses)



Impairment of assets (cont.)• Reinstatement of assets:

If in a subsequent period the recoverable amount of an asset increases towards formal levels (benefits now probable)– the asset can be recognised when it so qualifies

Dr Asset

Cr Gain from reinstatement of asset previously written off



‘Impairment of assets’

AASB 136– An impairment loss recognised for an asset in prior years

must be reversed when, and only when, there has been a change in the estimates used to determine the asset’s recoverable amount since the last impairment loss was recognised. If this is the case, the carrying amount of the asset must be increased to its recoverable amount.



Impairment of assets (cont.)• Some accounting standards specifically exclude reversal for

particular types of assets- for example, once an intangible asset (brand name, patent, development expenditure) is written off it cannot be reinstated, even where future economic benefits are deemed probable (is this conceptually sound?)

Effect• Balance sheet understates assets controlled by entity

AASB 136 (reversal of prior period impairment losses)• Overridden by other accounting standards that provide

requirements for specific classes of assets



Asset measurement• Rules of measurement may vary across different types

of assets• Various measurement rules currently in use in

Australia– for example, inventory at lower of cost and net

realisable value and non-current assets at fair value

Result

• Sum of total assets will not reflect either cost or net market value



Asset measurement (cont.)• One method of valuation to apply to all assets unlikely,

e.g. market value or fair value• Measurement practices (under AASB Framework)

need to be consistent with accounting standards• Significant changes to generally accepted accounting

practice likely to be opposed by significant proportion of financial statement preparers


Recognition criteria for assets (cont.)Asset measurement (cont.)• Determining appropriate measurement bases for some assets

is problematic– are there ‘economic benefits’?– museums, art galleries, botanical gardens?

‘heritage assets’: often negative cash flows

• Valuation of biological assets, e.g. trees on plantation– based on cost of seedlings?– take into account maintenance costs?– consider present value (with assumptions)?

Refer to Table 4.1 on page 161—Some classes of assets and their associated measurement rules – what does the number ‘total assets’ actually represent given that we are combining the values derived from so many different measurement bases?



Historical cost vs present value/market value• Preferred basis of management considered by

Houghton and Tan (1995)• Surveyed CFOs and found:

– 80% satisfied with historical cost in current modified form

– historical cost objective and verifiable, easily understood and widely known

• Questionable whether shift from historical cost would be successful


General classification of assets

Current assets• AASB 101 ‘Presentation of Financial Statements’• Current asset (balance sheet) if

(a) expected to be realised in, or intended for sale or consumption in, the entity’s normal operating cycle

(b) it is held primarily for the purpose of being traded

(c) it is expected to be realised within 12 months after the reporting date; or

(d) it is a cash or cash equivalent (under AASB 107 ‘Cash Flow Statement’


General classification of liabilities

Current liabilities

• AASB 101 ‘Presentation of Financial Statements’

• Current liability (balance sheet) if:(a) expected to be settled in the entity’s normal operating cycle

(b) it is held primarily for the purpose of being traded

(c) it is due to be settled within 12 months after the reporting date; or

(d) the entity does not have an unconditional right to defer settlement of the liability for at least 12 months after the reporting date.

• When an entity’s normal operating cycle is not clearly identifiable, its duration is assumed to be 12 months


How to present a balance sheet

• Two basic approaches (under AASB 101, par. 51)1. current/Non-current presentation

2. liquidity presentation

• Current and non-current assets and current and non-current liabilities are to be presented separately, except:– when presentation in order of liquidity provides information

that is reliable and more relevant

• In which case all assets and liabilities to be presented broadly in order of liquidity


How to present a balance sheet (cont.)

AASB 101• Does not prescribe a single format• Commentary (pars 53 and 54)

– If goods and services supplied within clearly identifiable operating cycle, classification into current/non-current deemed useful for decision making, e.g. working capital vs long-term operations

– If financial institution—a decreasing order of liquidity format more suitable, i.e. more relevant for decision makers



AASB 101• Requires specific disclosures in relation to the

duration of an operating cycle• If current vs non-current method adopted and entity

has a single, clearly identifiable operating cycle greater than 12 months, the length of the operating cycle must be disclosed


How to present a balance sheet (cont.)AASB 101• Appendices offer illustrations of formats:

– current/Non-current approach (see Exhibit 4.3, p. 169)– liquidity approach (see Exhibit 4.2, p. 167)

• Entities may elect to provide subtotals, e.g.(a) total assets less total liabilities equals net

assets/equity; or

(b) total assets equals total liabilities plus total equity.


How to present a balance sheet (cont.)Pursuant to AASB 101, the face of the balance sheet is to include, at a minimum, aggregate line items that represent

(a) property, plant and equipment

(b) investment property

(c) intangible assets

(d) financial assets

(e) investments accounted for using equity method

(f) biological assets

(g) inventories

(h) trade and other receivables

(i) cash and cash equivalents

(j) trade and other payables


How to present a balance sheet (cont.)Specific disclosures (under AASB 101) (cont.)(k) provisions

(l) financial liabilities

(m) liabilities and assets for current tax (AASB 112)

(n) deferred tax liabilities and assets (AASB 112)

(o) minority interest (presented within equity)

(p) issued capital and reserves (attributable to equity holders of parent)

Additional lines can be presented (par. 72), taking into account:

• The nature and liquidity of assets

• The function of assets within the entity

• The amounts, nature and timing of liabilities



Entities may choose to provide other subtotals in addition to those provided in the exhibits, such as:• Total assets less total liabilities equals net

assets/equity; or• Total assets equals liabilities plus equity


Determination of future economic benefits

• Can be derived from the use of the asset within the reporting entity or through sale of the asset to an external party

• Where the recoverable amount is less than its cost, the asset should be written down to its recoverable amount (AASB 136)– recoverable amount being the higher of an asset’s net selling

price and its value in use– write-down referred to as recognition of ‘impairment loss’


Determination of future economic benefits (cont.)

• Where recoverable amount of asset is to be based on market value, future cash flows are often easy to determine

• If an asset’s value is to be determined by its value in use, determining this value can be highly subjective (e.g. specialised asset)

• AASB 136: ‘value in use’—the present value of estimated future cash flows expected to arise from the continuing use of an asset and from its disposal at the end of its useful life



• If an asset is held for a number of periods, the service potential of the asset is expected to decline over time—it should be recognised as an expense

• The asset should be amortised over the period of its useful life

• If there is a uniform flow of economic benefits over a fixed period, the asset should be expensed on a time basis



• If the benefit to the business is for an indefinite period with a specified minimum term, the asset should be amortised over the minimum term

• If time is indeterminate or so extended that it is not practical to determine an apportionment of expenditure based on assessments of expected related revenue, amortisation should be done on a time basis over a short period (say five years)


Acquisition cost of assets

A number of accounting standards are relevant:• Intangible assets (AASB 138)

- intangible assets: non-monetary assets without physical substance, e.g. patents, trademarks, customer lists, research and development

- excludes the recognition of certain intangible assets for balance sheet purposes, e.g. internally generated goodwill, mastheads, research expenditure


Acquisition cost of assets (cont.)

Intangible assets (cont.)

For intangible assets that can be recognised for balance sheet purposes (e.g. development expenditure) the ‘cost’ of an internally generated intangible asset comprises all expenditure that can be directly attributed to it and is necessary in preparing the asset to be capable of operating in the manner intended by management



Intangible assets (cont.)‘Costs’ could include

• Expenditure on material and services used or consumed in generating the intangible asset

• Salaries, wages and other employment-related costs involved directly in generating the asset

• Expenditure that is directly attributable to generating the asset (e.g. fees and amortisation of patents and licences)


Acquisition cost of assets (cont.)Property, plant and equipment (AASB 116)

This class to be recognised as an asset when and only when(a) it is probable that future economic benefits associated

with the asset will flow to the entity; and

(b) the cost of the asset or, when the asset is carried at a revalued amount, the fair value of the asset can be measured reliably



Property, plant and equipment (AASB 116) (cont.)

If item qualifies as an asset it must be recognised at ‘cost’. Cost includes(a) purchase price, including import duties and non-refundable

purchase taxes after deducting trade discounts and rebates

(b) any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management; and

(c) initial estimates of the costs of dismantling and removing the item and restoring it



Property, plant and equipment (AASB 116)‘Directly attributable costs’ include

(a) costs of employee benefits arising from the construction or acquisition of the item of property, plant and equipment

(b) costs of site preparation

(c) initial delivery and handling costs

(d) installation and assembly costs

(e) costs of testing whether asset is functioning properly, after deducting the net proceeds from selling any items produced while bringing the asset to that location and condition (e.g. samples)

(f) professional fees


Acquisition cost of assets (cont.)Acquisition of property, plant and equipment other than by cash• If acquired in exchange for equity instruments (e.g. shares) cost is fair value of equity instruments issued (fair value: amount for which an asset can be exchanged between knowledgeable, willing parties in arm’s length transaction)

• ‘Fair value of consideration’ Used to measure acquisition cost of asset. When consideration is the purchaser’s own equity instruments (e.g. shares not listed on the stock exchange) the fair value of the asset acquired is used to measure the value of the equity issue



Acquisition of property, plant and equipment other than by cash (cont.)Acquisition can also be based on an exchange of assets (property, plant and equipment)

Cost of asset measured as the fair value of the asset given up, adjusted by the amount of any cash or cash equivalents that are transferred


Acquisition cost of assets (cont.)If fair value of asset is given up or that of the asset being received can be reliably determined (e.g. asset is unique), cost of property, plant and equipment acquired in exchange for a similar asset is to be measured at the carrying amount of the asset given up in the exchange

Note: Subsequent accounting periods will require adjustments to the value of the asset (post-acquisition) by way of depreciation, recognition of impairment losses or, possibly, asset revaluations

Refer to Worked Example 4.3 on page 177—Determining the acquisition costs of assets


Determining the cost of an asset

• Assume that an asset (land) is acquired for the following consideration– cash: $100,000– shares: 20,000 shares with a market value of $4.00 each– machinery: Cost $50,000, accumulated depreciation, $15,000– market value $30,000.

• What is the cost of the land, and what are the journal entries?

• What if the land had been acquired at no cost?



What about borrowing costs (capitalise or expense)?

AASB 123—‘interest and other costs incurred by an entity in connection with the borrowing of funds’

‘Benchmark treatment’—borrowing costs to be recognised as an expense in the period in which incurred

AASB 123 (par. 11)—an exception being: ‘borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset shall be capitalised as part of the cost of that asset’



What about borrowing costs (capitalise or expense)? (cont.)‘Qualifying asset’—an asset that necessarily takes a substantial period of time to get ready for its intended use or sale

‘Substantial period of time’—generally more than 12 months

Borrowing costs to be included are those that that would have been avoided if the expenditure on the asset had not been incurred

Capitalisation of borrowing costs to cease when substantially all the activities necessary to prepare the asset for its intended use or sale are completeCapitalising borrowing costs results in deferring expenses to later periods (e.g. depreciation or cost of sales)



Resources acquired at no cost (e.g. donation)To be recognised as an asset to the extent that it is expected to provide probable and measurable future economic benefits

– Dr AssetCr Donation income (or similar)

In the books of the entity donating the asset:– Dr Donation expense (or similar)

Cr Provision for depreciationCr Asset



Resources acquired at no cost (e.g. donation)Note: strict interpretation of AASB 116 would mean initially no cost

nor revenue recorded as result of donation but entity likely to revalue asset to fair value. Para 16 - an item of property, plant and equipment that qualifies for recognition as an asset shall be measured at cost.

Refer to Worked Example 4.4, pp. 181—Accounting for an asset acquired at no cost


Additional subsequent expenditure

• Additional expenditure subsequent to purchase is either– capitalised if expected to increase future economic benefits;

or– expensed if expected to maintain current level of future

economic benefits

• Capitalised value of non-current asset and any subsequent capitalised improvements are to be depreciated over expected useful life of the asset


Additional subsequent expenditure (cont.)

AASB 116• An entity does not recognise in the carrying amount of an item of

property, plant and equipment the costs of the day-to-day servicing of the item. These costs are recognised in the profit and loss as incurred. Costs of day-to-day servicing are primarily the costs of labour and consumables, and may include the cost of small parts. The purpose of these expenditures is often described as for the ‘repairs and maintenance’ of the item of property, plant and equipment.


Discovery of errors in prior periods

Example: Prior period inventory valued in excess of net realisable value (overstated)

AASB 108 ‘Accounting Policies, Changes in Estimates and Errors’An entity is to correct material prior period errors retrospectively in the first financial report authorised for issue after their discovery by

(a) restating comparative amounts for the prior period(s) presented in which the error occurred; or

(b) if the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and equity for the earliest prior period presented.

Result: A retrospective basis for the correction of errors, thus adopting the perspective that the financial statements are presented on the basis that the error never occurred


Summary

The purpose of the chapter is to explore a number of issues that relate to assets

– assets are defined as resources controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity

– requires recognition criteria to apply—AASB Framework states that for an asset to be recognised, the future economic benefits must be both probable and capable of reliable measurement

– recognition of assets therefore based on professional judgment (see recognition criteria)

– for different classes of assets (later chapters) other criteria for recognition will need to be applied pursuant to the relevant accounting standards


Summary (cont.)

• Classes of assets are typically measured using different measurement rules

• There are no paragraphs within the AASB Framework that provide measurement rules for assets generally—each accounting standard that addresses the method of accounting for a particular class of assets typically provides measurement rules specific to that class

• AASB 116 ‘Property Plant and Equipment’ and AASB 138 ‘Intangible Assets’ were addressed in in the chapter

• Cost of acquisition of an asset is considered to be the purchase consideration plus any costs incidental to the acquisition

• Purchase consideration is typically measured in terms of the fair value of the assets given up in exchange

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