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School of Accounting

ACCT 1511: Accounting and Financial Management 1B

Semester 2, 2013

Topic 2

Assets (1): Application of Financial Reporting Principles

Student Handout

Contents: 1. Learning Objectives (LO) 2. Tutorial Questions 3. Lecture Materials

Website: http://telt.unsw.edu.au

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Introduction and Learning Objectives

At the end of this week, you should:

LO1. Understand the definition and recognition criteria for assets and expense, and why they are important.

LO2. Be technically competent in journal entries and T-accounts relevant to assets.

LO3. Be technically competent in calculating gains/ losses on disposals and related journal entries.

LO4. Understand the link between cost, asset and expense.

LO5. Appreciate that accrual accounting involves judgement.

Required Readings

Required Readings

Trotman, Gibbins & Carson (TGC) – Chapter 6.3-6.4

Trotman, Gibbins & Carson (TGC) – Chapter 10.1-10.5 and 10.7-10.8

The Accounting Framework Additional References Additional References http://www.aasb.com.au AASB 3 Business Combinations AASB 116 Property, Plant and Equipment AASB 138 Intangible Assets

For Week 2 Lecture

1. Bring this handout (including all the attachment). 2. Bring a calculator.*

*Please make sure to get your calculator approved by the university prior to the exam (https://my.unsw.edu.au/student/academiclife/assessment/examinations/Calculator.html).

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Tutorial Questions for Topic 2

PASS Class Preparation Question:

Trotman and Gibbins:

Problem 6.15

Tutorial Preparation Questions:

Trotman and Gibbins:

Problem 6.16

Problem 6.12

Problem 10.18

Problem 10.24

Tutorial Homework Questions:

Trotman and Gibbins (see below):

Past Exam Questions (see below):

Problem 10.15 (adapted)

Problem 10.17 (adapted)

Question 3 from mid-session exam 2011,

semester 2 (adapted)

Tutorial Group Work Allocation:

Group 1: Question 3 from mid-session exam 2011, semester 2, part A and B

Group 2: Question 3 from mid-session exam 2011, semester 2, part C

Group 3: Problem 10.17

Group 4: Problem 10.15

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Mid-session exam 2011, semester 2: Question 3 (6 MARKS) Adapted.

TuneIn Pty Ltd produces headphones using cutting edge technology. The company spends

significant effort on improving its technology, and employees have a legal duty to maintain

confidentiality. A project to create a new sound technology that was started in 2008 had a

significant breakthrough in the beginning of 2009 that finally caused the management to

believe that all costs could be recouped through future sales. It is expected that the project

would be ready for production and sales within a year or two.

In 2008, TuneIn Pty Ltd incurred costs of the project amounted to $65,000 and the activities

were concerned with obtaining new knowledge and finding suitable materials. In 2009,

TuneIn Pty Ltd incurred costs of $75,000 in assembling a pre-production prototype and an

additional $20,000 testing the prototype.

Required:

(a) How much of the project costs can be recognised as assets on TuneIn Pty Ltd’s 2008

balance sheet? If no assets can be recognised on the balance sheet, write “Zero”. [1 mark]

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If you have recognised any assets in TuneIn Pty Ltd’s 2008 balance sheet (question (a)

above), explain how the transaction satisfies the essential characteristics and recognition

criteria of Assets. If you have not recognised any assets, explain how the transaction does

not satisfy these criteria.

(b) Application of essential characteristics: [3 marks]

Future benefit:

Control:

Past event/transaction:

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(C) Application of recognition criteria: [2 marks]

Probable:

Reliable measurement:

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Problem 10.17 (Adapted): Repairs versus Capitalising

Gibbs Ltd operates a manufacturing facility to produce its key products. On 1 July 2012, the

balance of an equipment account was as follows:

Manufacturing equipment $120,000

Accumulated depreciation ($78,000)

During 2013 financial year, Gibbs Ltd incurred the following costs which were paid in cash:

Equipment maintenance and repairs $1000

Major equipment upgrade to improve efficiency $35,000

The equipment has an expected useful life of 20 years, and residual value of is $7,200. Gibbs

Ltd depreciates equipment on a straight line basis.

Required:

a) What is the journal entry that was made on 30 June 2012 for depreciation on

manufacturing equipment? Show your workings.

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b) Indicate the effects of the two costs during 2013 on assets, liabilities and shareholders’

equity:

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c) Give the journal entries to record the two costs during the 2013 financial year:

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Problem 10.15 (Adapted): Asset Disposal

Cavalier sold two assets in the 2013 financial year end. On 1 July 2012, prior to their

disposal, the following were shown in the company’s account:

Machine Costs Residual

value

Expected

useful life

Accum. dep’n

(straight line)

1 $40,000 $5,000 7 years $15,000

2 $62,500 $7,500 10 years $0

Machine 1 was sold on 1 July 2012 for $10,000 cash. Machine 2 was sold on 30 June 2013

for $30,000. $20,000 was received in cash, and the remaining $10,000 on credit.

Required:

What journal entries are required to record the disposal of Machine 1?

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What journal entries are required to record the disposal of Machine 2?

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Lecture Workshop

2010 Session 2 Mid-semester Exam (Adapted) QUESTION 1 (VERSION A)

The following information is taken from the accounts of Ray Ltd.

$000

Motor Vehicles, 1 January 2006 620

Motor Vehicles, 31 December 2006 740

Accumulated Depreciation – Motor Vehicles, 1 January 2006 230

Accumulated Depreciation – Motor Vehicles, 31 December 2006 290

Depreciation Expense – Motor Vehicles, year ended 31 December 2006 150

Gain on sale of motor vehicle, year ended 31 December 2006 10

Cost price of motor vehicles sold during the year 130

Required:

By using relevant t-account(s),

(1) calculate the cash proceeds from sale of Motor Vehicle, and

(2) calculate the cash paid for the purchase of a new Motor Vehicle.

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(3) Write down the journal entry for the sale of motor vehicles during the year.

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(4) Discuss how the concepts of “cost”, “asset” and “expense” relate to the motor vehicle.

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2010 Session 2 Mid-semester Exam (Adapted)

QUESTION 3 (VERSION A)

Your Boss is an entrepreneur who has worked hard over 20 years to build a successful chain

of cafes in Sydney with a recognised name, “Moonbacks & Co”. Your Boss wishes to borrow

money from the bank to fund further expansion. You have been hired as the accountant to

prepare the financial statements for this company and have been asked whether the goodwill

from the successful business can be recognised as an asset in order to make it easier to

borrow from the bank.

Required:

According to the AASB Framework and AASB3 Business Combinations, what is the

appropriate treatment for this business goodwill? Apply ALL elements of the relevant

definition and recognition criteria in your answer.

(a) Should goodwill be recognised as an asset? [1 mark, but must be consistent with

application of definition and recognition criteria, on the next page, in order to be awarded]

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QUESTION 3 (CONTINUED)

(b) Application of definition criteria: [3 marks]

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(c) Application of recognition criteria: [2 marks]

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ACCT1511 Assets (1)

General Principles

Topic 2

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Accrual Accounting

Income Statement & Balance Sheet

Asset v. Expense

Recognition

Measurement

Effect

Revenue v. Liability v. Equity

Asset Expense Definition Revenue Liability

Equity

With thanks to Dr Cheng Lai

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Classifications In The Balance Sheet

3 general classes (assets, liabilities and

equity) are further subdivided.

Assets

Current assets

Non-current assets

Intangible assets

Liabilities and equity

Current liabilities

Non-current liabilities

Share capital

Retained earnings

Other reserves

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Assets & Liabilities: Definition & Recognition

Does the item have all the essential

characteristics of an A (L)?

Does the A (L ) meet both

the recognition criteria?

Details might appear in

the annual report

Separately disclosed in

the notes

A (L) recognised in the

entity’s balance sheet

Yes No

Yes No

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Assets: Definition

“An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity” (AASB Framework, paragraph 49)

Essential characteristics: – Future economic benefit (or service potential)

– Controlled by the entity

– Result of past events

Examples?

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Future Economic Benefits

The potential to contribute, directly or

indirectly, to the flow of cash and cash

equivalents to the entity. (para. 53)

e.g. Does it form part of operating activities, can

we sell for, or convert it into, cash, or does it

have the capability to reduce cash outflow......

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Control

An entity controls the asset if it controls the

benefits expected to flow to the entity.

Although the capacity of an entity to control

benefits is usually the results of legal rights,

an item may nonetheless satisfy the definition

of an asset even when there is no legal

control.

E.g. Certain types of leases; by keeping

know-how obtained from a development

activity secret/confidential etc.

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Past Event

Entities normally obtain assets by purchasing or

producing them, but other transactions or

events may generate assets.

e.g. grants/donations, discovery of mineral deposits.

Transactions or events expected to occur in the

future do not, in themselves, give rise to assets. e.g. Intention to purchase inventory does not, of itself,

meet the definition of an asset.

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Assets: Definition

Non-essential characteristics:

– Acquisition at cost … but may discover gold

deposit

– Tangibility … but may be intangible

– Exchangeability … but cannot sell goodwill

separately from acquired business

– Legal enforceability … but lessee does not

legally own leased equipment

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Assets: Recognition

Only when the item meets two recognition

criteria (AASB Framework, paragraph 83):

1. It is probable that any future economic benefit

associated with the item will flow to the entity;

and

2. The item has a cost or value that can be

measured with reliability.

Two VERY IMPORTANT things to note:

1) Do not confuse probability of FEB in recognition criteria with

potential of FEB in Asset Definition.

2) Note that it is enough to measure either cost or value with

reliability (i.e. one of them is enough).

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Example 1

i.

ii.

iii.

A storage warehouse purchased for cash

Essential characteristics: Benefits

Control

Past transaction

Recognition criteria: Probable

Measured reliably

(a)

(b)

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Example 2

i.

ii.

iii.

Essential characteristics: Benefits Control Past transaction

Recognition criteria: Probable Measured reliably

(a)

(b)

A highly specialised equipment without resale or residual value

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Current vs. Non-Current Assets

AASB 101, para. 57:

An asset shall be classified as current when it satisfy any of the

following criteria:

a)it is expected to be realised in, or is intended for sale or

consumption in, the entity’s normal operating cycle;

b) It is held primarily for the purposes of being traded;

c) It is expected to be realised within twelve months after the

reporting date; or

d) It is cash or cash equivalent (as defined in AASB 107 unless it

is restricted from being exchanged or used to settle a liability for

at least twelve months.

All other assets shall be classified as non-current

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Current Assets (ACCT1501)

Cash and cash equivalents can include overnight money

market accounts and other very liquid investments

Short-term investments include trading securities and

available-for-sale securities

Trade debtors and other receivables are reported net of

allowance for doubtful debts

The proper presentation of inventories includes

disclosure of basis of valuation, method of pricing and

stage of completion in the case of manufacturing firms

Prepaid expenses are expenditures for benefits

expected to be received within 1 year or the operating

cycle

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Non-Current Assets

Long term investments may be – investments in securities (eg bonds, shares, long-term

notes)

– investments in tangible non-current assets (eg land not used in operations)

– investments set aside in special funds (eg sinking fund, pension fund)

– investments in affiliated entities

Property, plant and equipment consists of properties of a durable nature used in the regular operations of the firm

They include land, building, machinery, furniture, tools and wasting resources (eg timber, minerals)

Most PPE assets (except land) are either depreciable or depletable, i.e. expensable

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Non-Current Assets continued

Intangible assets lack physical substance and are not financial instruments (see next slide)

They include patents, licences, copyrights, franchises, goodwill, trademarks

Non-current assets with limited life are written off (amortised) over their useful life

Indefinite life assets (eg goodwill) are assessed periodically for impairment

other assets non-current asset section vary widely in practice: They may include deferred charges, non-current receivables, intangible assets, assets in special funds, deferred income tax, property held for sale, advances to subsidiaries

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Intangible vs Tangible Assets

An intangible asset is an identifiable non-monetary asset without physical substance (AASB 138, para 8)

It must meet the essential characteristic of an asset: i.e. control, FEB, past event/transaction

In addition, it must be identifiable: An asset meets the identifiable criterion...when it:

a) It is separable, that is, is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset or liability; or

b) Arises from a contractual or other legal right, regardless of wether those rights are transferable or separable from the entity or from other rights or obligations

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The definition excludes monetary items: i.e.

financial instruments are not Intangible assets

Typical intangible assets include:

patents, licences, copyrights, franchises,

trademarks etc.

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Intangible Asset Recognition

Only when the item meets two recognition

criteria (AASB 138, paragraph 21):

1. It is probable that the expected future

economic benefit that are attributable to the

asset flow to the entity; and

2. The item has a cost that can be measured

with reliability.

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Separate Acquisition

Because....the effect of probability is reflected

in the cost of the asset. Therefore, the

probability recognition criterion.....is always

considered to be satisfied for separately

acquired intangible asset (AASB138, para 25)

In other words, if we buy an intangible asset,

for example a patent, we recognise it as an

asset on the balance sheet.

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Internally Generated Intangibles/R&D

It is difficult to assess whether an internally

generated intangible asset qualifies for

recognition because of problems in:

a) Is there an identifiable asset that will

generate expected future benefits

b) Determining the cost of the asset reliably.

(i.e. is the cost incurred part of the day to day

operation or is it specific to the asset?)

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Internally Generated Intangibles/R&D

To asess, whether an internally generated

assets meets the criteria for recognition, an

entity classifies the generation of the asset into

(AASB 138, para 52): a) A research phase

b) A development phase

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So what is Research?

Research is original and planned investigation

undertaken with the prospect of gaining new

scientific or technical knowledge and

understanding.

e.g. 1) Activities aimed at obtaining new knowledge; 2) the search

from evaluation and final selection of, applications of research

findings or other knowledge; 3) the search for alternatives for

materials, devices, products processes systems or services; 4) and

the formulation, design, evaluation and final selection of possible

alternatives for new or improved materials, devices, products,

processes, systems or services.

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So what is development?

Development is the application of research findings

or other knowledge to a plan or design for the

production of new or substantially improved

materials, devises, products, processes, systems or

services before the start of commercial production

or use.

e.g. 1) the design, construction and testing of pre-production or pre-

use prototypes and models; 2) the design and tools, jigs, moulds and

dies involving new technology; 3) the design, construction and

operations of a pilot plant that is not of a scale economically feasible

for commercial productions; and 4) the design, construction and

testing of a chosen alternative for new or improved materials,

devices, products, processes, systems or services.

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Research - Accounting Treatment

No intangible asset arising from research (or from the

research phase of an internal project) shall be

recognised. Expenditure on research (or on the

research phase of an internal project) shall be

recognised as an expense. (AASB 138, para 54).

Why?

In the research phase of an internal project, an entity

cannot demonstrate that an intangible asset exists that

will generate probable future economic benefits...

(AASB 138, para 55).

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Development – Accounting Treatment

An intangible asset arising from the development (or from the

development phase of an internal project) shall be

recognised if, and only if, an entity can demonstrate all of the

following: a) the technical feasibility of completing the intangible asset so

that it will be available for use or sale.

b) its intention to complete the intangible asset and use or sell it

c) its ability to use or sell the intangible asset

d) how the intangible asset will generate probable future

economic benefits....

e) the availability of adequate technical, financial or other

resources to complete the development and to use or sell the

intangible asset

f) its ability to measure reliably the expenditure attributable to the

intangible asset during its development.

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Some Intangible asset are never recognised

as asset if they are internally generated. Internally generated brands, mastheads,

publishing titles, customer lists, and items

similar in substances shall not be recognised

as intangible assets (AASB 138, para 63)

Why? Expenditure on internally generated brands,

mastheads, publishing titles, customer lists and

items similar in nature cannot be distinguished from

the costs of developing the business as a whole

(AASB 138, para 64)

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Goodwill – A special case

Goodwill is non-current intangible asset, but it is

not identifiable....

Goodwill is an accounting concept meaning the

value of an entity over and above the value of

its separate identifiable assets less liabilities.

- because of synergies, reputation, loyalty

of clients, staff knowledge etc.

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Recognising and Measuring Goodwill

Goodwill as of the acquisition date is

measured as:

1)The consideration transferred,

2)less the fair value of the net identifiable

assets acquired and the liabilities assumed.

(AASB 3: somewhat simplified Much more

of this in Accounting 2B).

i.e. purchased goodwill is calculated as the amount paid for a

business less the fair value of the net assets obtained.

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Simple Illustration

Cost of Business: $30,000

Fair Value of Identifiable Assets: $40,000

Fair Value of Liabilities Assumed: $20,000

Fair Value of Net Assets: $20,000

Goodwill: $10,000

Dr Identifiable Assets 40,000

Dr Goodwill 10,000

Cr Liabilities 20,000

Cr Cash 30,000

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Goodwill

Only purchased goodwill included.

Internally generated goodwill shall not be

recognised as an asset (AASB 138, para 48)

Why?

in some cases, expenditure is incurred to generate future economic

benefits....[and] is often described to as contributing to internally

generated goodwill. Internally generated goodwill is not recognised

as an asset because it is not an identifiable resources controlled by

the entity that can be measured reliable at cost (AASB 138, para

49)

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Amortisation and Impairment of Intangibles

- An entity must assess whether useful life is

finite or indefinite. - If finite, the intangible asses is amortised.

- E.g. leases, franchises, patents etc.

- If indefinite, the asset is not subject to

amortisation, but would need to test annually

for impairment (impairment is next week).

- E.g. goodwill.

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Test Your Understanding

Are these assets and can it be recognised?

1. A box of paper clips.

2. A deposit received by a company for

services to be rendered.

3. List of subscribers to an Internet service.

4. CBA’s satisfied customers.

5. Employees of a firm: “Our people are our

greatest assets”.

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Assets & Expense : Another Approach

Does the item have all the essential characteristics of an Asset?

Does the Asset meet both

the recognition criteria? Expense

Asset recognised in the

entity’s balance sheet

Yes No

No

Yes

We have incurred a cost/expenditure.

Dr Asset or Expense? XXX

Cr Cash/Accounts Payable XXX

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Expenses: Definition

“… decreases in economic benefits during the

accounting period … other than the owners’

distributions” (AASB Framework, para 70)

Essential characteristics:

– Decreases in economic benefits

– Other than the owners’ distributions (i.e.

Dividends)

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Expenses: Recognition

Recognition (AASB Framework, para 94):

– Decrease in future economic benefits, either

decrease in asset or increase in liability

– Can be measured with reliability

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Cost v. Asset v. Expense

A matter of classification? A matter of timing?

Is “Cost/Expenditure” and “Expense “

interchangeable?

Cost/expenditure = Amount of cash/equivalents

paid or fair value of consideration given

Definition: Asset (capitalise) or Expense

Transformation: – Asset to Expense (e.g. depreciation)

– Expense to Asset (e.g. Manufacturing)

(More in Management Accounting)

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Depreciation – an expense (ACCT1501)

Property, plant, and equipment usually have

limited useful lives:

– That is, the economic benefits are consumed over time.

– For example, if a machine was purchased 10 years ago, the

future economic benefits are likely to be much less now than

when the machine was originally purchased.

Depreciation is the systematic allocation of the

depreciable amount of an asset over its useful life.

Depreciation is a process of

ALLOCATION OF COST - NOT VALUATION

Matching Principle

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Calculating depreciation (ACCT1501)

Depreciation starts when the asset is ready

for use as intended by the management.

To choose a depreciation method, we need to

make judgments on: – useful life

– residual value (sale or scrap)

– pattern of flow of benefits over the useful life.

• i.e. the pattern of revenue will determine how we

allocate the costs in the appropriate periods.

Useful life, Residual value and pattern of flow

will need to be reassessed annually. 40

Residual value (ACCT1501)

Estimated useful Residual Value defined:

“The estimated amount that an entity would currently

obtain from disposal of the asset, after deducting the

estimated costs of disposal, if the asset were already

of the age and in the condition expected at the end of

its useful life”

The residual value is used to calculate the

depreciable amount (the amount that must be

allocated over the life of the asset).

Depreciable Amount = Asset Cost - Residual Value

The depreciable amount must be allocated on a

systematic basis over an asset’s useful life.

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Useful life (ACCT1501)

Estimated useful life defined:

– The period of time over which an asset is

expected to be available for use by an entity; or

– The number of production or similar units

expected to be obtained from the asset by the

entity.

Note:

– Useful life relates to an assets expected utility to

the enterprise.

– Useful life differ from physical life of the asset.

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Depreciation methods

Three Common Methods (ACCT1501): – straight-line

– reducing balance

– units of production

Are these methods Reliable? Relevant? – All depreciation methods are an approximation

– The apparent precision of any depreciation

method is illusory

– But they are Verifiable (Reliable in the sense

that it uses established methodology)

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Journal entry

For all depreciation methods:

Dr Depreciation expense

Cr Accumulated depreciation (what type?)

Why not Cr Asset directly? Why 2 accounts?

What is the value of an asset after

depreciation? What is the value of an asset?

When is the value of an asset Reliable?

Why depreciate asset?

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Illustration

A machine with an original cost of $50,000

and accumulated depreciation of $24,000 (as

at 30 June 2008)

It was sold on 1 August 2008 for $21,000

cash.

The straight line method was used to record

depreciation on the old asset.

The annual amount of depreciation was

$12,000.

Required: Prepare journal entries to record

the events explained.

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Illustration (Cont.)

Recording depreciation up until the date of disposal

Dr Depn Exp 1,000 Cr Acc Depn 1,000 Removing the non-current asset from the company’s books. Dr Cash 21,000 Dr Acc Depn 25,000 Cr Machinery 50,000 Dr Loss on Sale 4,000 Why do we have estimation error?

Historical Cost 50,000

Acc Depn 25,000

Carrying/Book Value 25,000

Cash received (Market

Value)

21,000

Accounting Gain/(Loss)

because of estimation

error

(4,000)

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Example: Purchase of Notebook Computer

See AASB 116 Property, Plant and Equipment

Purchase of Notebook

– Purchase price $1,400

– Delivery charge $100

Questions:

1. An asset?

2. Recognise on B/S?

3. Measurement?

4. Then what?

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Example: Purchase of Notebook Computer

Depreciation – Straight-line

– 3 years

– No residual value

Cost?

Asset?

Expense?

Case: Notebook – Account Balances

Year

Cost

Accumulated Depreciation

Carrying Value

(Asset)

Depreciation

Expense

1

2

3

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Journal Entries

Beginning year 1:

Dr Notebook

Cr Cash (purchase price)

Cr Cash (delivery charges)

End year 1 to 3:

Dr Dep’n Expense

Cr Accumulated Depreciation

End year three to de-recognise the asset

Dr Accumulated Depreciation

Cr Notebook

Comparison Tangible and Intangible with

Limited Useful Life

Tangible

Tangible Asset

Depreciation Expense

Accumulated

Depreciation (Contra

Asset)

Depreciation Methods

– Straight line

– Reducing balance

– Etc

Just the terminology

Intangible

Intangible Asset

Amortisation Expense

Accumulated

Amortisation (Contra

Asset)

Amortisation Methods

– Straight line

– Reducing balance

– Etc

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Accrual Accounting requires Judgement

Income Statement & Balance Sheet

Asset v. Expense

Recognition

Measurement

Effect

Revenue v. Liability v. Equity

Asset Expense Definition Revenue Liability

Equity

With thanks to Dr Cheng Lai

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Lecture Workshop

Refer to lecture handout