ACCT207 Financial Accounting | Measurement of Assets

Issue 1: Measurement of Assets

At our recent board meeting, Ambrose a director of our company suggested that we no longer need to show our non-current assets at their cost value in the balance sheet. Is this correct? Could you please outline our options? Would you advise us to show all our assets at cost value, fair value, or market value or just increase those assets that have appreciated in the market?

Valuation of Non-Current Assets at Cost Value

Australian Accounting Standard, AAS – 38 deals with the revaluation of non-current assets, which requires that either the cost basis or the fair value basis shall be used to measure the class of non - current assets. The Australian Accounting Standard, AAS - 10 issued in December 1999, had a limited scope for non-current assets measured on the cost basis to the recoverable amount test. The class of non-current assets shall be measured either on the cost basis or on the fair value basis[1]. Therefore it is correct to say that there is no need to show non-current assets at their cost value in the balance sheet any longer.

As per AAS – 10, the option left with the company to value its non-current assets other than on cost basis is to value at the fair value basis or at the carrying amount. According to AAS - 10 “Recoverable Amount of Non-Current Assets”, when a non-current asset which has been measured on the cost basis is written down to its recoverable amount in the course when its carrying amount is greater than its recoverable amount[2]. In the event of making a change of valuation from cost basis to the fair value measurement, such reversal and previously recognised asset write-down shall be accounted for as reversal of recoverable amount write down as profit or loss.

With different options available to value the non assets at cost value or fair value or market value or mere increase in value as per market appreciation, it is suggested to adopt fair value measurement. According to AASB – 13, fair value means the price that would be exchanged between the buyer and seller when an asset is to be sold or a liability is to be transferred at the measurement date[3]. Broadly three widely used valuation techniques used for fair value measurement are the cost approach, the market approach and the income approach. Valuation techniques used to measure fair value shall be applied consistently. However, there can be adopted a change in the valuation technique used for measurement of the asset, if that re

Issue 2 Warranty Expenses

The board is also concerned with the frequent variances in a number of warranty expenses that were initially recognised compared to the actual cost of the warranty the company paid/incurred to fix/replace the faulty products. Therefore at the most recent board meeting, it was agreed to stop recognising the warranty expenses before the warranty cost is actually incurred. The directors are wandering why we should complicate a very simple way of calculating warranty expenses – why not “stick with” recognising the expense when we pay for it. This way we won’t have to deal with all these variances. What do you think we should do and why?

Recognition of the warranty expense

These days the products purchased come with one or other type of warranty. Warranty means a guarantee given on the product where it will be repaired or replaced within a certain period of time. Like you purchase a mobile handset which comes with a one-year warranty, that means any manufacturing defect that occurs during a year of purchase will be either rectified or the handset will be replaced with a new one[6]. There are no charges for availing such a warranty but which comes as an additional benefit to the buyer of the product and can be availed, in a specified period chosen by the manufacturer.

When the warranty is provided by a company on its product, there is an obligation on the company to repair or replace the defect or product. Now such an obligation generate a liability on the company at the time of sale is made. According to the matching principle, a company shall match its revenue with its expenses. Like if the mobile is sold in 2017, but if the expense of warranty claim is booked in 2018, the company violates here the matching principle[7]. The expense on account of warranty occurred since the sale was made, thus this expense is a cost of the sale and is required to be matched with the revenue of that particular sale.

There are many estimates required in accounting, which even includes warranties expenses. For recording the warranty expense as well as the liability, three things are required namely, units of product sold in a year; percentage of product that will need repair or replacement based on last years’ statistics; and the average cost of repair or replacement that is required under warranty[8]. Thus, calculations begin by calculating units that will need repair or replacement and the cost of such a repair or replacement (Units needing repair or replacement x cost of replacement or repair). The unit that needs repair can be calculated by arriving the expected defective rate based on previous years’ defective products received for repairs in the company. Thereafter the journal entry is recorded with the calculated figure of warranty expense which is debited and crediting the estimated warranty liability. In the event of a defect, the customer files a claim with the company[9]. Then the company when fulfils the claim, the amount of warranty liability is reduced by the same amount which fulfilled the claim. The replacement or repair amount is recorded at the cost and not retail value.

Therefore, it is suggested for the company to record and disclose the warranty expense in accordance to the AASB – 137 Provisions, Contingent Liabilities and Contingent Assets. Disclosure of the liability and expense in the year of sale is a more accurate presentation of the financial status of the company to its stakeholders[10].

Issue 3 Long Service Leave

We currently have a number of employees who have been with us at Byrne Limited for a number of years – at least five (5) of them have been with us since the company commenced operations in 2005. Our staff department has accurately calculated the long service leave owing to employees as $150,000, in respect of past services.

Our usual practice is to show the long service leave expense in the Statement of Comprehensive Income when the employee actually takes leave and is paid. We have no idea when these staff will take their long service leave, so we don’t believe we need to show this as a liability in the financial statements. Saroo, our director has suggested we should still disclose it as a contingent liability. What do you think we should do and why?

Long Service Leave and financial reporting

Employee benefits include long-term employee benefits which include long-service leave or sabbatical leave. Funds are created to compensate for such an expense arising as and when in future. A number of assets which are held by a long-term employee benefit fund are the assets which are although held by a business but is legally separate from the entity and are for the sole purpose of making payment or funding such employee benefits and cannot be returned to the entity. There are disclosure requirements as per AASB 124 of employee benefits for key management personnel and AASB 101 for disclosure of employee benefits expense[11]. An entity shall take into consideration the net total of this expense or income, current service cost; interest cost; the expected return and on any reimbursement right recognised as an asset; actuarial gains and losses immediately recognisable; past service cost immediately recognisable, and the effect of any curtailments or settlements. Long service leave can be classified current where 6 years of service has been completed by the employee; and non-current where less than 6 years have been completed by an employee. As per AASB – 124, an entity shall be required to disclose the compensation of key management personnel in total and for other long-term benefits[12].

Therefore, based on the materiality concept, AASB 101, AASB 124 and AASB 119 there is a need to make certain calculations to derive at the amount to be pooled for the purpose of long service leave every year and then to make reduction in the pool in the year of actual payment so as to reflect and true and fair picture of the financial status of the entity to the stakeholders is suggested. Also in the event of a transfer of an employee to another place, there is a requirement where the employee benefit liabilities should be transferred at the same value by the transferor and the transferee. At the book value of the transferor, the employee benefit liabilities shall be transferred. 

Issue 4: Revenue Recognition

We currently have a number of non-cancellable contracts for rendering services to Byrne Limited clients. To overcome dealing with clients who do not pay for services rendered, the company has a policy that the buyer of services must pay for all of the services at the date of signing the contract or two weeks thereafter.

A contract of $12,000 for the rendering of services to a customer is entered into on 15 April 2017. The services are delivered continuously over a 1-year period commencing on 1 May 2017. The buyer pays for all of the services to Byrne Limited on a 1 May 2017 which will be delivered on a monthly basis, commencing on 1 May 2017.

Our usual practice is to show the service revenue in the Statement of Comprehensive Income when the money is received. Ambrose, a director of our company takes an alternative view that this is deferred income and should only be recognised as revenue over the period of the contract when the service is performed. Saroo another director says what we are doing is correct. Saroo states that since the contracts are non-cancellable the revenue should be recognised when the buyer pays for all the services otherwise we will have to deal with numerous journal entries – why not “stick with” recognising the revenue when we receive it. What do you think we should do and why?

Revenue Recognition

According to AASB 15 under a contract, a customer obtains goods or services from an entity which is its output in exchange for consideration. The agreement is recognisable when either party’s right can be identified; the timing, risk or amount of provider cash can change and the consideration will be collected. The transaction price is defined as consideration to which a provider is entitled to transferring the goods or services. Post-determination of transaction price, the same is allocated to distinct performance obligated to be made as a part of the agreed contract[13]. The transaction price at the beginning of the contract is allocated on a selling price. In addition to the general allocation, the transaction price is not subsequently adjusted to changes in selling prices, and any changes in the price after the contract has begun.

Revenue recognition from a contract shall be done when the provider performs obligation by making the transfer of goods or service.

Under AASB 15, revenue recognition is possible even if partial payment of consideration is considered probable when goods or services are transferred. The AASB may even let recognition relatively earlier than this. Also, the accounting standard may require variable consideration to be recognised only to the extent where it's highly probable that there will be no revenue reversal in the future[14]. The core principle is that an entity recognises revenue to portray the transfer of goods or services in an amount which reflects the consideration. An entity recognises revenue when it fulfils the obligation by performing by transferring a good or service to its customer. A performance obligation shall be considered to be satisfied either at a point in or over time. For performance obligations which are satisfied over a span of time, revenue recognition may be done by adopting an appropriate method in order to make a measurement of the entity’s progress in comparison to complete performance obligation[15].

Specifically according to AASB 15 an entity is required to disclose amount of revenue recognised from contracts, including the categorised disaggregation of revenue; opening as well as closing contract balances, receivables, contract assets & contract liabilities; performance obligations, in addition to when the performance was satisfied and the transaction price allocated to the outstanding obligations; significant judgements and changes; and assets recognised from the costs to fulfil a contract. Therefore based on the principles of accrual and disclosure requirements of AASB it is suggested to recognise the revenue on monthly basis or based on the performance of the service as agreed upon with the customer rather than recognising revenue in the month of May when the whole amount was received. Thus the view of a director named Ambrose to defer income recognition when the service is performed is apt and is suggest for the more accurate presentation of the financial position of the entity, even though will complicate accounting and reporting to a certain extent but will facilitate clear and appropriate disclosures without last hour adjustments in the time of compulsion.

Issue 5: Goodwill, Unrecorded Patent and Shareholder

We recently decided to sell one of our divisions to a New Zealand company since we have decided not to focus on that particular line of business. Negotiations are still ongoing however it looks like the New Zealand company is willing to pay an additional $300,000 on top of the fair value of identifiable net assets agreed by both of us. If this deal doesn’t go through, can we recognise this $300,000 as goodwill in our books? We are also unsure of how to account for an unrecorded patent which we will transfer to them? In return for this division, the New Zealand company will issue us some shares as well. Does this mean we will be shareholders of this New Zealand company? If so, then how should we account for these shares?

Goodwill Recognition

A purchased goodwill is possible to be accounted for more reliably based on the amount paid than internally generated goodwill. However, goodwill can be recognised as an asset when the future benefits embodied in the said assets is probable to result, and it holds either a cost or other value possible to be reliably measured. Thus s as per AASB 1013 such purchased goodwill is a sheer reflection of future benefits which vendor generated internally before the date of acquisition which post-acquisition will be expected to flow to the acquirer[16]. Also, there should be appropriate amortization of the purchased goodwill to be recognised as an expense on a straight-line basis, during the span starting from the date of acquisition until the time such benefits are expected to arise, in the profit and loss account. Thus the additional amount of $300,000 over the fair value of identifiable net assets can be recognised as goodwill will appropriate disclosures and amortisation requirements.

Accounting for unrecorded patent

Intangible elements are also treated under AASB - 116: Property, Plant and Equipment. This Standard applies to expenditure incurred on training, start-up, advertising, research and development activities, where research and development expenses are incurred for the purpose of development of some knowledge. Therefore, an intangible component which is knowledge embodied in the physical element of the asset is primary. An intangible asset shall be recognised if future economic benefits are expected to flow and the cost of such asset can be reliably measured. An intangible asset shall be initially measured at cost[17]. Therefore, transfer of the unrecorded patent to the acquiring company may result in flaws in financial disclosure if cannot be proved to be an internal project in the development phase with all expenses accounted for. Therefore either it should be first recorded in books at the appropriate value and then transferred or it the amount of $300000 shall not be shown as a patent transfer but goodwill.

Record of shares given by acquirer

A number of shares to be given by the acquiring company will definitely make the entity one of their shareholders. The transaction shall be accounted for as an investment in an associate depending on the amount of shareholding or on the equity method.

Bibliography

Arqawi, Bayan M., William J. Bertin, and Laurie Prather. "The impact of product warranties on the capital structure of Australian firms." Australian Journal of Management 39, no. 2 (2014): 207-225.

Bodle, Kerry Anne, Kerry Anne Bodle, Patti J. Cybinski, Patti J. Cybinski, Reza Monem, and Reza Monem. "Effect of IFRS adoption on financial reporting quality: Evidence from bankruptcy prediction." Accounting Research Journal 29, no. 3 (2016): 292-312.

Carlon, Shirley, Alfred Tran, and Binh Tran-Nam. "How close are taxable income and accounting profit? An empirical study of large Australian companies." (2013).

Deegan, Craig. Financial accounting. McGraw-Hill Education Australia, 2016.

Fischer, Dov. "Backward Design for Intermediate Financial Accounting 2." (2016).

Guthrie, James, and Tsz Ting Pang. "Disclosure of Goodwill Impairment under AASB 136 from 2005–2010." Australian Accounting Review 23, no. 3 (2013): 216-231.

Holland, David. "Simplifying income recognition for not-for-profit entities." Governance Directions 68, no. 11 (2016): 666.

Hudson, Matthew. "No setting off unfair preferences." Australian Restructuring Insolvency & Turnaround Association Journal 28, no. 3 (2016): 34.

IASB, FASB. "Revenue from Contracts with Customers." Exposure Draft (2015).

Komninos, James, and RSM Bird Cameron. "IMPACTS OF REVENUE RECOGNITION CHANGES IN THE CONSTRUCTION INDUSTRY." (2017).

Li, Xue, Rahat Munir, and Alan Kilgore. "Association between Key Management Personnel Remuneration and the Performance of Authorized Deposit-Taking Institutions in Australia." International Journal of Accounting and Financial Reporting 5, no. 1 (2015): 123-160.

Li, Xue, Rahat Munir, and Alan Kilgore. "Association between Key Management Personnel Remuneration and the Performance of Authorized Deposit-Taking Institutions in Australia." International Journal of Accounting and Financial Reporting 5, no. 1 (2015): 123-160.

Picker, Ruth, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, and Leo Van der Tas. Applying international financial reporting standards. John Wiley & Sons, 2016.

Tilt, Carol A., Maria Xydias-Lobo, Flavia Rodricks, and Giao Reynolds. "Integrated reporting and sustainability: perceptions of the accounting profession." (2016): 1-3.

Tucker, Basil P., and Stefan Schaltegger. "Comparing the research-practice gap in management accounting: A view from professional accounting bodies in Australia and Germany." Accounting, Auditing & Accountability Journal 29, no. 3 (2016): 362-400.

Wagenhofer, Alfred. "The role of revenue recognition in performance reporting." Accounting and Business Research 44, no. 4 (2014): 349-379.

Yao, Dai Fei Troy, Majella Percy, and Fang Hu. "Fair value accounting for non-current assets and audit fees: Evidence from Australian companies." Journal of Contemporary Accounting & Economics 11, no. 1 (2015): 31-45.

[1] Tucker, Basil P., and Stefan Schaltegger. "Comparing the research-practice gap in management accounting: A view from professional accounting bodies in Australia and Germany." Accounting, Auditing & Accountability Journal 29, no. 3 (2016): 362-400.

[2] Tilt, Carol A., Maria Xydias-Lobo, Flavia Rodricks, and Giao Reynolds. "Integrated reporting and sustainability: perceptions of the accounting profession." (2016): 1-3.

[3] Yao, Dai Fei Troy, Majella Percy, and Fang Hu. "Fair value accounting for non-current assets and audit fees: Evidence from Australian companies." Journal of Contemporary Accounting & Economics 11, no. 1 (2015): 31-45.

[4] Picker, Ruth, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, and Leo Van der Tas. Applying international financial reporting standards. John Wiley & Sons, 2016.

[5] Deegan, Craig. Financial accounting. McGraw-Hill Education Australia, 2016.

[6] Arqawi, Bayan M., William J. Bertin, and Laurie Prather. "The impact of product warranties on the capital structure of Australian firms." Australian Journal of Management 39, no. 2 (2014): 207-225.

[7] Carlon, Shirley, Alfred Tran, and Binh Tran-Nam. "How close are taxable income and accounting profit? An empirical study of large Australian companies." (2013).

[8] Wagenhofer, Alfred. "The role of revenue recognition in performance reporting." Accounting and Business Research 44, no. 4 (2014): 349-379.

[9] Fischer, Dov. "Backward Design for Intermediate Financial Accounting 2." (2016).

[10] Hudson, Matthew. "No setting off unfair preferences." Australian Restructuring Insolvency & Turnaround Association Journal 28, no. 3 (2016): 34.

[11] Li, Xue, Rahat Munir, and Alan Kilgore. "Association between Key Management Personnel Remuneration and the Performance of Authorized Deposit-Taking Institutions in Australia." International Journal of Accounting and Financial Reporting 5, no. 1 (2015): 123-160.

[12] Li, Xue, Rahat Munir, and Alan Kilgore. "Association between Key Management Personnel Remuneration and the Performance of Authorized Deposit-Taking Institutions in Australia." International Journal of Accounting and Financial Reporting 5, no. 1 (2015): 123-160.

[13] Komninos, James, and RSM Bird Cameron. "IMPACTS OF REVENUE RECOGNITION CHANGES IN THE CONSTRUCTION INDUSTRY." (2017).

[14] Holland, David. "Simplifying income recognition for not-for-profit entities." Governance Directions 68, no. 11 (2016): 666.

[15] IASB, FASB. "Revenue from Contracts with Customers." Exposure Draft (2015).

[16] Guthrie, James, and Tsz Ting Pang. "Disclosure of Goodwill Impairment under AASB 136 from 2005–2010." Australian Accounting Review 23, no. 3 (2013): 216-231.

[17] Bodle, Kerry Anne, Kerry Anne Bodle, Patti J. Cybinski, Patti J. Cybinski, Reza Monem, and Reza Monem. "Effect of IFRS adoption on financial reporting quality: Evidence from bankruptcy prediction." Accounting Research Journal 29, no. 3 (2016): 292-312.