Acc510 Financial Reporting: Economic Benefit Assessment Answers

Q1.

TDM Ltd is a manufacturing business at Mudjimba on the Sunshine Coast. You are the accountant for the company and the following items/issues relate to the financial year ending 30^th June, 2016:

1. Photographs of the company’s founders and original buildings, which are of great sentimental and historical value only.
2. TDM Ltd is being sued for negligence by Zero Ltd and the legal advice is that it is likely the company will losethe case in court.
3. TDM Ltd is being sued for negligence by Badger Ltd and the legal advice is that it is likely the company will winthe case in court.
4. Obsolete plant and equipment is now (as at 30 June 2016) retired from use by the company.
5. TDM Ltd has received a donation of $20,000.

Required:

Explain how TDM Ltd should account for each of the above items. You must justify your answer by reference to the AASB Conceptual Framework’s definitions and recognition criteria for assets, liabilities, income and/or expenses as applicable. You must also state which General Ledger accounts are to be debited and credited.

Q2.

On 1^st July, 2016, SC Airlines Ltd acquired a new aeroplane for a total cost of $10 million dollars. The following breakdown of the costs to build the aeroplane was given by the manufacturers.

All costs include installation and labour costs associated with the relevant part.

It is expected that the aircraft will be kept for 10 years and then sold. The main value of the aircraft at that stage will be the body and the engines. The expected selling price is $2.1 million, with the body and engines retaining the existing proportionate value.

Costs in relation to the aircraft over the next 10 years are expected to be as follows:

• Aircraft body: This requires an inspection every 2 years for cracks and wear and tear, at a cost of $10,000.
• Engines: Each engine has an expected life of 4 years before being sold for scrap. It is expected that the engines will be replaced in 2020 for $4.5 million and again in 2024 for $6 million. These engines are expected to incur annual maintenance costs of $300,000. The manufacturer has informed SC Airlines that a new prototype engine with an extra 10% capacity should be on the market in 2022, and that existing engines could be upgraded at a cost of $1 million.
• Fittings: Seats are replaced every 3 years. Expected replacement costs are $1.2 million in 2019 and $1.5 million in 2025. The repair of torn seats and faulty mechanisms is expected to cost $100,000 per annum. Carpets are replaced every 5 years. They will be replaced in 2022 at an expected cost of $65,000, but will not be replaced again before the aircraft is sold in 2026. Cleaning costs amount to $10,000 per annum. The electrical equipment (such as the TV) for each seat has an annual repair cost of $15,000. It is expected that, with the improvements in technology, the equipment will be totally replaced in 2022 by substantially better equipment at a cost of $350,000. The electrical equipment in the cockpit is tested frequently at an expected annual cost of $250,000. Major upgrades to the equipment are expected every 2 years at expected costs of $250,000 (in 2015), $300,000 (in 2017), $345,000 (in 2019), and $410,000 (in 2024). The upgrades will take into effect the expected changes in technology.
• Food preparation equipment: This incurs annual costs for repair and maintenance of $20,000. The equipment is expected to be totally replaced in 2022.

Required:

• Start by establish the issues for your analysis by addressing the following:
  1. the advantages of a components approach versus a simple depreciation of the $10 million dollars over the 10-year period.
  2. Since AASB 116 requires initial recognition at cost and then provides a choice between either the cost model (impairment) or the revaluation model (increment and/or decrement) – discuss the advantages and/or disadvantages in applying either model to the aeroplane as a whole – indicating which would be the most appropriate as a result or if treated as components then which would be most applicable to the components you have identified.
  3. Basis for selecting the method of depreciation according to AASB 116.
• Discuss how the costs relating to the aircraft should be accounted for (treated) with respect to:
  1. Aircraft body;
  2. Engines;
  3. Fittings;
  4. Food preparation equipment.
  5. Where relevant consider/discuss issues such as:
     1. the treatment of the upgrades of cockpit equipment.
     2. accounting for inspections.

• Determine the expenses to be recognised for the financial year 1^stJuly 2016 to 30^th June 2017.
  1. Aircraft body;
  2. Engines;
  3. Fittings;
  4. Food preparation equipment;
  5. Total Expenses.

Q3.

In the discussion by Upton (2001, 71) regarding the lives of intangible assets it is noted that the formula for Coca-Cola has grown more valuable over time, not less, and that Sir David Tweedie, former chairman of the IASB, jokes that the brand name of his favourite Scotch whisky is older than the United States of America — and, in Sir David’s view, the formula for Scotch whisky has contributed more to the sum of human happiness.

Required:

Outline the accounting treatment for brands under AASB 138/IAS 38, and discuss the difficulties for standard setters in allowing the recognition of all brands and formulas on statements of financial position.

Q4.

Provisions are recognised as a liability in the statement of financial position whereas contingent liabilities are not recognised in the financial statements but disclosed in the notes to financial statements. Paragraph 12 of AASB 137/IAS 37 Provisions, Contingent Liabilities and Contingent Assets states that ‘in a general sense, all provisions are contingent because they are uncertain in timing or amount’.

Required:

1. Discuss possible reasons as to why provisions are recognised in the financial statements whilst contingent liabilities are not.
2. Determine whether the following items would be classified and recoded as liabilities or not (provide a brief explanation for your decision):
   1. Provision for long-service-leave;
   2. Dividends payable;
   3. Preference shares.

1.

1. The building which are at historical value and the photographs of the founders of the organization are not expected to generate any economic benefit in future. Therefore these assets do not qualify to be recognised as assets as it does not fulfil the recognition criteria for assets. The future benefits here mean the positive contribution to the cash flow of the organization whether directly or indirectly. Therefore, these items will not be recognized as assets.

2.An item to be recognized as liability must fulfil three characteristics that are fulfilled by the situation as follows:

• Past event – a liability to be recognized it requires a transaction or event that has already taken place. Here, the condition is fulfilled as the company is sued on account of negligence
• The responsibility obliges the organization that will leave no space for avoiding future sacrifice. As it is established that TDM will lose the case, it will oblige them to make the payment in future.
• Obliges present obligation that requires settlement. Here, TDM will have to make some outflow of cash for the settlement of the case.

As all the above 3 conditions are satisfied for recognition of liability, TDM Ltd will recognise the amount to be paid for settlement of case sued by Zero Ltd as liability and the outflow of cash shall be debited in profit and loss account (Bond, Govendir & Wells, 2016).

3. In the given scenario as TDM Limited is expecting to win the case of being sued against Badger Ltd for negligence. Therefore, the recognition criteria for liability does not fulfil as TDM Ltd will not have make the cash outflow for the settlement of case. Therefore, in such situation liability will not be recognised. However, the company is suggested to disclose the matter through notes to accounts, if the amount is material.

4.Obsolete equipment and plant that are already retired from the usage of the organization are not able to generate any economic benefits and therefore, must be written off in the financial reports of the company. Thus, as the criteria for recognition does not hold good and not relevant, the item cannot be recognised as asset.

5.The receipt of donation for $ 20,000 meets all the criteria for recognition as follows:

• Control on economic benefits – they will have total control on donation of $ 20,000
• Future economic benefits – donation will enable future cash inflow of $ 20,000
• Past event – money has been received in form of donation

Thus, the receipt of donation will be recognised under asset and the amount of $ 20,000 will be credited in the profit & loss account (Carvalho, Rodrigues & Ferreira, 2016).

2.

1. a)component depreciation will be advantageous as the depreciation is charged on individual component as compared to the depreciation on the whole equipment as done under the simple depreciation method. Therefore, the component depreciation does not affect the income statement directly as in the case of simple depreciation method.

b). Cost model

Advantages –

• Material cost and labour cost are simpler to monitor and control
• The computation under this method can be altered at any time as per the requirement of the organization.

Disadvantages –

• As the nature of this model is nit simple, it consumes more resources an d time of the employees
• Adjustments to the costs are required to be adjusted regularly (Haque, Topal, & Lilford, 2014).

Revaluation model

Advantages –

• It leads to better ratio for debt-equity
• As value of the asset goes-up therefore, increase the net income position of the company
• High value for the assets enables stronger financial position.

Disadvantages –

• As the assets are already shown at fair values, no added benefits arise upon sale
• As the amount of amortization is high, it leads to lower income (Zakaria et al., 2014).

1. c) Depreciation under AASB 116

Depreciation is based on the nature and profit generation capability of the asset. If the asset generates more income in the initial years, the diminishing balance method will be appropriate. On the contrary, where the benefits from the asset are expected to arise equally over the useful life of the asset, the straight-line method will be applied there.

2.Aircraft body

Each component of the aircraft will be considered as separate component and therefore, will be accounted at cost less depreciation value

Engines

Engine of the aircraft will be considered as separate component and therefore, will be accounted at cost less depreciation value

Fittings

Fittings part of the aircraft will be considered as separate component and therefore, will be accounted at cost less depreciation value

Food preparation equipment

Food preparation equipment of the aircraft will be considered as separate component and therefore, will be accounted at cost less depreciation value

3.

a) Aircraft body

Total expenses for aircraft will b e $ 210,000

b) Engines

Total expenses for engines will be $ 10,00,000

c) Fittings

Total expenses for fittings will be $ 453,333.33

d) Food preparation equipment

Total expense for $ 61,666.67

Total expenses for all the above mentioned heads will be $ 17,25,000

3.

1.

Accounting for brands – AASB 138

• Brand acquired
• Brand that are acquired are recognised at cost of acquisition
• The amortisation amount of the asset are computed on the basis of the useful life of the brand and the non-amortisation are provided on the basis of indefinite period
• Initially the brand is recognised at cost and thereafter is recognised at the revalued amount if the market is active.

• Internally generated brand
• This includes the internally generated intangible assets that must fulfil the criterion mention under Para 57 of the AASB 138
• Internally generated assets are excluded from the recognition under Para 63 of AASB 138 (Sinclair & Keller, 2014).

2. Various issues that are faced by the standard setters are as follows:

• Brand amortization – as the useful life of the asset cannot be measured reliably, it becomes quite tough to assess the amortization period and amortization amount.
• Measurement – as the brand is initially recognized at cost and thereafter is recognised at the revalued amount if the market is active, it becomes complex to measure the value of the brands. Further, at what point of time the brand shall be revalued and what will be considered as active market is controversial (Salinas, 2016).

4.

1. Contingent liabilities are the possible obligation that is created from the past events and the result of the event is based on the tentative obligation or future events that are not apparent or are not possible to measure reliably. On the other hand, the provisions are the current liability with regard to uncertain amount or timing. The provisions are identified under the balance sheet whereas the contingent liabilities are disclosed through notes to account. In case of liabilities, obligations for sacrificing the future economic benefits are already established and therefore, are recognised under balance sheet. However, in case of contingent liabilities there is a possibility that the organisation will have to sacrifice the future economic benefits or will not have to sacrifice the future economic benefits. Therefore, it is disclosed through the notes unless the amount of sacrificing the economic benefits are negligible that is too low (Picker et al., 2016).

2.

1. Provision for long-service leave: the long-service leave benefits are paid by the Australian employer to his employees. It is a cost that is to be incurred by the employer to provide benefits to his employees. Therefore, the provision for the long-service leave shall be included under liability.
2. Dividends payable: once the dividend is declared, it is mandatory to make the payments to the employees some time later in near future. Once declared, the company is under obligation to make the payment. However, until the company make the payment the amount of dividend shall be recognised under current liability in the balance sheet (Hennes, 2014).
3. Preference shares: preference share that will be under redemption after some specific period and which is entitled to fixed payment of dividend are recognized under liability. On the contrary, if the shares have no fixed period for redemption and not entitled for dividend, are recognised as equity.

References

Hennes, K. M. (2014). Disclosure of contingent legal liabilities. Journal of Accounting and Public Policy, 33(1), 32-50.

Picker, R., Clark, K., Dunn, J., Kolitz, D., Livne, G., Loftus, J., & van der Tas, L. (2016). Applying international financial reporting standards. John Wiley & Sons.