An overview of accounting for assets

An overview of accounting for assets
Chapter 3 An overview of accounting for assets Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

Definition of assets SAC 4 (par. 14):
• Future economic benefits controlled by an entity as a result of past transactions or other events This is consistent with the definition provided by the IASB Framework: A resource controlled by the enterprise as a result of past events and from which economic benefits are expected to flow to the enterprise Note: The IASB Framework is undergoing changes: • ‘enterprise’ will become ‘entity’ Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

Introduction to accounting for assets
Key issues addressed in the chapter How we define assets Overview of how various classes of assets might be measured How assets are classified and disclosed within the balance sheet Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

Post-2004 numbering of Australian Accounting Standards
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 Number of new AASB standards will depend on whether the ‘adopted’ standard relates to an ‘old’ or ‘new’ international standard (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

Definition of assets Three essential characteristics required of an asset: Expected to provide future economic benefits Must be controlled by the entity 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 SAC 4 (par. 18): 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 (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 (SAC 4, par. 14) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

Recognition criteria for assets
Under AASB Framework (par. 49) (and SAC 4, par. 14): 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. (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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) Possibly (in certain situations) a matter for professional judgment (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 asset should be expensed in the period when it becomes apparent that insufficient benefits will be realised Refer to Worked Example 3.1 on pp. 144–5—Asset recognition and probable economic benefits (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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) (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

‘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. (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 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 (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 3.1 on page 147—Some classes of assets and their associated measurement rules (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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’ Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

How to present a balance sheet
Two basic approaches (under AASB 101, par. 51): Current/Non-current presentation 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 (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

AASB 101: Appendices offer illustrations of formats: Current/Non-current approach (see Exhibit 3.3, p. 156) Liquidity approach (see Exhibit 3.4, p. 157) 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. (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

Specific disclosures (under AASB 101) for property, plant and equipment: investment property intangible assets financial assets investments accounted for using equity method biological assets inventories trade and other receivables cash and cash equivalents trade and other payables (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

Appendices to AASB 101 provide illustrations of the format of the balance sheet under: Current/Non-current approach Liquidity approach Current/Non-current format Refer to Exhibit 3.3, page 156. Liquidity presentation format Refer to Exhibit 3.4, page 157. 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. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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) The higher of an asset’s net selling price and its value in use Write-down referred to as recognition of ‘impairment loss’ (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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) (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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. (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

Property, plant and equipment (AASB 116) (cont.) If item qualifies as an asset it must be recognised at ‘cost’: purchase price, including import duties and non-refundable purchase taxes after deducting trade discounts and rebates 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 initial estimates of the costs of dismantling and removing the item and restoring it. (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

Property, plant and equipment (AASB 116) ‘Directly attributable costs’ include: Costs of employee benefits arising from the construction or acquisition of the item of property, plant and equipment Costs of site preparation Initial delivery and handling costs Installation and assembly costs 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) Professional fees (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

If fair value of asset 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 3.3o on page 163—Determining the acquisition costs of assets (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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’ (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 complete. Capitalising borrowing costs results in deferring expenses to later periods (e.g. depreciation or cost of sales) (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 Asset Cr Donation income (or similar) In the books of the entity donating the asset: Dr Donation expense (or similar) Cr Provision for depreciation Cr Asset (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 3.4, pp. 166–7—Accounting for an asset acquired at no cost Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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. Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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: restating comparative amounts for the prior period(s) presented in which the error occurred; or 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 Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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 (continues) Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

Summary (cont.) Classes of assets are typically measured using different measurement rules There are no paragraphs within the IASB or 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 Copyright  2005 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 4e by Craig Deegan

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