Topic 2 - Assets (1): Application Of Financial Reporting Principles

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This article is a topic within the subject Accounting 1B.

Contents

Required Reading

Trotman, K. and Gibbins, M. (2009) Financial Accounting: An Integrated Approach, 4th edition, Nelson Thomson Learning, pp. 293-294 & 415-437.

Definition And Recognition Of Assets

[1] An Asset is a resource controlled by the entity as a result of past events & from which future economic benefits are expected to flow to the entity. Essential Characteristics are:

  • Future Economic Benefits (FEBS) - Potential to contribute directly or indirectly to the flow of cash to the entity
    • Part of operating activities, saleable, convert to cash, cash, capability to reduce cash outflow
  • Controlled by the Entity - If the entity controls the benefits expected to flow to the entity
    • Usually a result of legal rights, but not always e.g. certain leases, confidentiality (RnD)
  • Past Event - Usually obtained, purchased, produced or otherwise generated e.g. donations or gold discovery

Recognition occurs if expected future economic benefits are probable & the item has a cost/value that can be measured reliably.

ACCT151121.jpg

Current And Non Current Assets

An asset is classified as current when any of the following criteria are met:

  • Expected to be realised, intended for sale or consumed in the entity’s normal operating cycle
  • Realised within 12 months
  • Held primarily for the purposes of being traded
  • It is a cash or cash equivalent item

All else is noncurrent. This usually includes long term investments & PP&E (durable & used in regular operations).

Intangible Assets – Separate Acquisition And Internally Generated

[2] An Intangible Asset is an identifiable non-monetary asset without physical substance. It is required to meet the essential characteristics of an asset, recognition criteria & must be identifiable. This means it is:

  • IdentifiableSeparable, able to be separated or divided from the entity & sold, transferred, licensed or exchanged individually or together with a related contract, asset or liability. E.g. Patents, copyrights, goodwill

In a Separate Acquisition (e.g. the purchase of a patent) the probability recognition criterion is always satisfied as it wouldn’t be bought if it wasn’t expected to generate future economic benefits, thus it is reflected in the cost of the asset.

It is much more difficult to assess whether internally generated intangible assets meet the recognition criteria as there needs to be a separate or identifiable asset (that is expected to product future economic benefits). Additionally determining its cost/value reliably is also an issue. Thus the entity classifies the generation of the asset into 2 phases

  • Research - original & planned investigation with the prospect of gaining scientific/technical knowledge
    • Search for alternative materials, devices, products, processes, systems or services
  • Developmental - Application of research findings to a plan for the production of new or improved materials, products, processes, systems or services before the start of commercial production or use
  • Design, construction & testing of pre-production prototypes/models

In Research an entity can’t demonstrate that an intangible asset exists that will generate probable FEBS - Expense. In Development an asset can be recognised if all of the following is demonstrated: **Relies on Judgement**

  • Technical feasibility of completing the intangible asset so it will be available for use or sale
  • Adequate technical, financial or other resources to complete development & to use or sell the intangible
  • Intention to complete the intangible asset & the ability to use or sell it
  • Probably generate FEBS, Reliably measure expenditure attributable to intangible asset in its development

Internally Generated Brands, mastheads, publishing titles, customer lists etc. Won’t be recognised as intangibles as they cannot be separated from the costs of developing the business as a whole

Goodwill: A Special Case

[3] Goodwill is a non-current intangible asset that is NOT identifiable. It is an accounting concept that represents the value of an entity over & above the value of book value (synergies, reputation loyalty etc.). Goodwill is measured as the consideration transferred LESS fair value of net identifiable assets and liabilities assumed*. Only Purchased Goodwill is recognised. Internally generated goodwill is not an identifiable resource controlled by the entity that can be measured reliably at cost.

Recognition And Definition of Expenses

Expenses are decreases in economic benefits during the accounting period other than owners’ distributions. It is recognised if there is a decrease in future economic benefits, either a decrease in assets or increase in liabilities & of it can be reliably measured.

Cost, Assets And Expense

Cost/Expenditure is the amount of cash paid or fair value of consideration given. It is either capitalised as an asset or expensed. Transformations:

  • Asset to Expense -> Depreciation
  • Expense to Asset -> Manufacturing -> More in MGMT Accounting.

Also note, Cost = Purchase price & any costs directly attributable to bringing the asset to the location & conditions necessary for it to be used as intended by management. Betterments (increase earnings or useful life) are capitalised while maintenance is expensed.

Depreciation

[4] Property, Plant & Equipment (PP&E) usually has a limited useful life, so we allocate the cost of the asset over its useful life, in accordance with the matching principle. Since benefits of the asset are consumed over time, the cost should be expensed over time hence spreading the costs of a long-lived asset over all periods that share in the consumption of the assets economic value.

Depreciation Bases And Methods

  • These methods of depreciation are verifiable (Reliable in the sense that is uses established methodology).
  • Estimate depreciation through a judgement on:
    • Residual Value - 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 & condition expected at the end of its useful life.
    • Useful life - Estimated period of time expected to be available for use (# units expected to be produced)
    • Flow of benefits over useful life
    • Depreciable amount = Cost – Residual Value

ACCT151122.jpg

Gains & Losses on Non Current Asset Disposals

[5]

  • DR Cash
    • CR Non Current Asset (Original Cost)
  • DR Accumulated Depreciation
    • CR Gain on Sale OR DR Loss on Sale

End

This is the end of this topic. Click Accounting 1B to go back to the main subject page for Accounting 1B

References

Textbook refers to Trotman, K. and Gibbins, M. (2009) Financial Accounting: An Integrated Approach, 4th edition, Nelson Thomson Learning

  1. Trotman, K. and Gibbins, M. (2009) Financial Accounting: An Integrated Approach, 4th edition, Nelson Thomson Learning, pp. 293-294
  2. Trotman, K. and Gibbins, M. (2009) Financial Accounting: An Integrated Approach, 4th edition, Nelson Thomson Learning, pp. 431-434
  3. Trotman, K. and Gibbins, M. (2009) Financial Accounting: An Integrated Approach, 4th edition, Nelson Thomson Learning, pp. 434-5
  4. Trotman, K. and Gibbins, M. (2009) Financial Accounting: An Integrated Approach, 4th edition, Nelson Thomson Learning, pp. 416-427
  5. Trotman, K. and Gibbins, M. (2009) Financial Accounting: An Integrated Approach, 4th edition, Nelson Thomson Learning, pp. 428-431
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