Topic 3 - Assets (2): Application Of Financial Reporting Principles

From Uni Study Guides
Jump to: navigation, search

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. 387 - 428 - 437.

Measurement

[1] Thunderstruck bought land for $50,000 5 years ago. They hire out the land for $5000 a year for the next 10 years & sell it for $55,000. They believe they can sell it for $65,000 but only $45,000 if urgent. RR = 3.7%, CPI = 2.5%

  • Historical Cost - What we paid for it (reliable) - $50,000
  • Current or Market Value (Value in exchange) - What we could get if we sold it (relevant) - $65,000
  • Value in Use (Present Value) - What it is worth to us (relevant but not reliable) - $79,412
  • Liquidation Value - Urgent sale price - $45,000
  • Price Adjusted Historical Cost - what we paid for it adjusted for inflation (not relevant) - $56,570

At Purchase Date (i.e. at recognition), historical cost = market value. Fair Value is the amount for which an asset can be exchanged between knowledgeable, willing parties in an arm’s length transaction. It is usually an estimate of Market Value.

Measurement, Recognition And Revaluation: Property, Plant & Equipment

[2] [3]

Measurement at Recognition

An item of Property, Plant & Equipment that qualifies for recognition shall be measured at cost. Cost includes:

  • Purchase Price - + import duties & non refundable purchase taxes after deducting trade discounts/rebates
    • E.g. installation & assembly costs, delivery & handling, site preparation costs, employee costs, testing
  • Costs Directly Attributable to bringing the asset to the location & condition necessary for it to capable of operating in the manner intended by management
  • Estimate of Dismantling/Removal Costs & Site Restoration

Measurement after Recognition

A firm must choose between:

  1. Cost Model - After recognition as an asset, an item of PPE shall be carried at its costs less accumulated depreciation & accumulated impairment
  2. Revaluation Model - After recognition as an asset, an item of PPE whose fair value can be reliably measured shall be carried at a revalued amount, being its fair value less any subsequent accumulated depreciation &/or impairment losses
    • Sufficient RegularityRevaluations must be made with sufficient regularity so the carrying amount does not differ materially from what the fair value would be at the reporting date (reduces bias)
    • Must use it for all assets in that asset class – No cherry picking bias. Exceptions for devaluations.

Asset Revaluations

  • Increment – increases the value at which the asset is recorded
  • Decrement – decreases the value at which the asset is recorded
  • Judged from the assets carrying amount

We do not treat increments & decrements similarly - Asymmetric Accounting. Conservatism is the focus as unrealised losses are immediately recognised while gains are not (& are not recognised on the P/L).

Increment

  • DR Asset
    • CR Revaluation Reserve

An owners’ equity account, does not increase period profit. (Recognised in comprehensive income statements)

Decrement

  • DR Loss on Revaluation
    • CR Asset

A loss in the income statement, decreases profit

Increments Reversing Previous Decrements

  • DR Asset
    • CR Gain on Revaluation (until all previous losses are reversed)
    • CR Revaluation Reserve

Decrements Reversing Previous Increments

  • DR Revaluation Reserve
    • CR Asset
  • DR Loss on Revaluation (If needed - Loss > Revaluation Reserve)

Asset Revaluation Examples

Cost = 500,000, Year 1 = 520,000, Year 2 = 500,000, Year 3 = 480,000

  • Year 1: DR Asset 20K, CR Revaluation Reserve 20K
  • Year 2: DR Revaluation Reserve 20K, CR Asset 20K
  • Year 3: DR Loss on Revaluation 20K, CR Asset 20K

Revaluation: 4 Steps

  1. Update Depreciation - DR Depreciation Expense, CR Accumulated Depreciation
  2. Credit Accumulated Depreciation to the asset account to record the asset at carrying value - DR Accumulated Depreciation, CR Asset
  3. Record Revaluation
  4. Increment - DR Asset, CR Revaluation Reserve (Gain on revaluation if reversing previous loss)
    • Decrement - DR Loss on sale (or revaluation reserve), CR Asset
  5. Recalculate Depreciation – if no changes in useful life, residual value or method
    • Increments increase depreciable amount & hence expenses
    • Decrements decrease depreciable amount & hence lower depreciation expenses

Revaluation & Disposal

Example 1: Land is revalued from $100 to $220 (Y1), $200 in Y2, Sold for $200 in Y3

  • Year 1: DR Land 120, CR Revaluation Reserve 120
  • Year 2: DR Revaluation Reserve 20, CR Land 20,
  • Year 3: DR Cash 200, CR Land 200, DR Revaluation Reserve 100, CR Retained Earnings 100

Example 2: Land is revalued from $100 to $180 in year 1, sold for $160 in year 2.

  • Year 1: DR Land $80, CR Revaluation Reserve $80.
  • Year 2: DR Cash 160, DR Loss On sale 20, CR Land 160, DR Revaluation Reserve 80, CR Retained Earnings 80

Example 3: Land is revalued from $100 to $150 (Y1), Sold for $170 in Y2

  • Year 1: DR Land 50, CR Revaluation Reserve 50
  • Year 2: DR Cash 170, CR Land 150, CR Gain on Sale 20, DR Revaluation Reserves 50, CR Retained Earnings 50

Example 4: Land revalued form $100 to $60 in Y1, Sold for 90 in Y2

  • Year 1: DR Loss on Revaluation 40, CR Land 40
  • Year 2: DR Cash 90, CR Land 60, CR Gain on Sale 30

Measurement, Recognition & Impairment: Intangibles

[4] [5]

Measurement at Recognition

An intangible asset shall be measured initially at cost:

  • Purchase Price - + import duties & non refundable purchase taxes after deducting trade discounts/rebates
    • E.g. installation & assembly costs, delivery & handling, site preparation costs, employee costs, testing
  • Costs Directly Attributable for preparing the asset for its intended use.
  • Internally Generated Intangibles - Cost is the sum of expenditure from the date asset 1st met recognition criteria i.e. development phase

Measurement after Recognition

  1. Cost Method
  2. Revaluation Method
    • Fair Value must be determined with reference to an active market
      • Items traded are homogenous, willing buyers & sellers can be found, prices available to public
    • Since intangible assets are unique by nature rarely is an active market found.

Impairment

An entity shall assess at each reporting date whether there is any indication that an asset may be impaired (check if asset values are overstated). Intangible assets with an indefinite useful life & goodwill, irrespective of indication or not, must be tested for impairment at least annually.

Impairment Indicators

  • External Sources
    • Asset market value has declined significantly
    • Changes with adverse effects in the technological, market, economic or legal environment
  • Internal Sources
    • Obsolescence or physical damage
    • Changes making an asset idle or plans to discontinue (restructure assets operations), plans to dispose
    • Internal reporting indicates that economic performance of an asset will be worse than expected

Testing & Recognising Impairment

Compare the Carry Value of the asset on the balance sheet with the highest value we think we can recover from the asset by either selling or using the asset. We know the Carrying Value but need to find the Recoverable Amount (Highest of):

  1. Fair Value LESS Cost to Sell - Amount obtainable from the sale of an asset in an arm’s length transaction between knowledgeable & willing parties, less cost of disposal
  2. Value in use (Present Value of future cash flows)

If carrying amount > recoverable amount it is Impaired. Cost model:

  • DR Loss on Impairment,
    • CR Accumulated Impairment (COST).
  • DR Loss on Revaluation (Revaluation Reserve)

Or via the revaluation model:

  • DR Loss on Revaluation (Revaluation Reserve)
    • CR Asset (REVALUATION MODEL – may only be re-evaluated every 3 yrs).

Reversing Impairment Losses

If an impairment loss has been previously recognised but estimates of the assets recoverable amount have increased, a reversal takes place. The reversal of impairment cannot increase the carrying amount in excess of the carrying amount (net of amortisation/depreciation) had the impairment not taken place. Goodwill cannot be reversed.

  • DR Accumulated Impairment
    • CR Gain on Reversal of Impairment

If asset is carried at revalued amount, any reversal of impairment loss is treated as a revaluation increase.

Inventory

[6] Inventories are assets held for sale in the ordinary course of business. They can be used in the process of production for such sale or can be in the form of materials/supplies to be consumed in the production process or in rendering services. It is valued at the lower of Cost or Net Realisable Value (estimated selling price less costs of completion & to make the sale) (often due to damage, demand, obsolescence), the cost of inventories comprises:

  • Costs of purchase
  • Costs of conversion
  • Other costs incurred to bring the inventories to current location & condition.

Perpetual Inventory Control Method involves recording when inventory quantities when received & sold. It shows how many items should be physically on hand (recognise shortages & overages). Periodic Count Method involves no continuing records of inventory on hand; it is cheap, simpler but has less internal control. COGS need to be deduced.

Inventory Cost Flow Assumptions

In Inflationary Periods, FIFO results in the highest inventory values, lowest COGS & highest NPAT, whilst LIFO results in the lowest valuation, highest COGS & lowest NPAT. Weighted Average results fall between FIFO & LIFO. Overstating inventory, overstates net profits (vice versa) Example: Meeix Ltd. (Page 398 of Textbook) - Refer to the ACCT1501 Study Guide.

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. ASB, UNSW
  2. Trotman, K. and Gibbins, M. (2009) Financial Accounting: An Integrated Approach, 4th edition, Nelson Thomson Learning, pp. 431-433
  3. ASB, UNSW
  4. ASB, UNSW
  5. Trotman, K. and Gibbins, M. (2009) Financial Accounting: An Integrated Approach, 4th edition, Nelson Thomson Learning, pp. 431-434
  6. Trotman, K. and Gibbins, M. (2009) Financial Accounting: An Integrated Approach, 4th edition, Nelson Thomson Learning, pp. 387-405
Personal tools
Namespaces

Variants
Actions
Navigation
Toolbox