Accounting Standards 1Lecture 4

Non-current assets

1

Accounting standards• Thorough understanding of underpinning concepts n

the conceptual framework• Understanding of the process of deciding how to

include items in the accounts– Definitions of elements (asset and liability)– Criteria for recognition in the accounts– Issues of measurement and disclosure

• Knowledge of the particular standards studied– Write about the requirements of the standard– Apply the provisions of the standard to a scenario

• Critique the standards studied

2

Structure of examination• Section A – compulsory, all numbers– One question worth 50 marks – preparation of

consolidated accounts

• Section B – two questions out of three, each worth 25 marks, mainly written, some numbers– One question on each of the three accounting standards

topics– Knowledge of requirements, application of definitions and

recognition criteria, application to a scenario, critique of standard

3

Elements – IASB framework

• AssetA resource controlled by the enterprise as a result of

past events and from which future economic benefits are expected to flow to the enterprise

• LiabilityA present obligation of the enterprise arising from

past events, the settlement of which is expected to result in an outflow from the enterprise of resources

4

Recognition criteria for assets

It is probable that any future economic benefit will flow to the enterprise

And

The item has a cost or value which can be measured with reliability

5

Measurement issues

• Initial recording is generally at cost• Subsequent expenditure• Loss in value – depreciation, impairment• Revaluations – replacement cost• Valuations at market value or fair value• Regular review

6

Intangible assets

• Can’t see them or touch them – lack of physical substance

• Research and development• Goodwill• Brand names• Copyrights and patents• Licences……….• IAS38 Intangible assets

7

Research and development

• Is there an asset?• A resource controlled by the enterprise?– Yes

• As a result of past events?– Yes

• Future economic benefits are expected to flow?– Maybe

• A battle between prudence and accruals?8

Research

Original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding

IAS38 para 8

– Activities aimed at new knowledge– Evaluation of findings– Search for alternatives for materials, processes,systems– Design/selection of possible alternatives for new or

improved materials processes etc

9

Development• The application of research findings or other

knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use.– Design, construction and testing of pre-production models– Design of tools etc involving new technology– Design etc of pilot plant– Design etc of chosen alternatives for new materials,

processes, systems

10

Accounting treatment

• Write off research as incurred: cannot demonstrate future economic benefit

• Capitalise development only if satisfies ALL the following criteria:– Technically feasible to complete for use or sale– Intention to complete and use or sell– Ability to use/sell– Probable future economic benefit– Available technical, financial and other resources to

complete– Reliable measurement of expenditure

11

Subsequent treatment

• Initial cost is all directly attributable costs necessary to create, produce and prepare the asset to be capable of operating in a manner intended by management.

• During development phase – show as a current asset, but review annually to ensure still meets the criteria and not impaired

• Once production/use starts, amortise over the expected useful life

12

Good points

• Gives definitions for research and development

• Treatment is clear• Gives guidance on when future economic

benefits are probable

13

Problems

• Can be difficult in practice to distinguish the research phase from the development phase

• Can be difficult in practice to judge if the criteria for development expenditure are met

• In practice it is very hard to estimate future development costs and future profitability of the project

14

Goodwill

• Can be– Internally generated – NOT treated as an asset

under IAS 38 – cannot measure cost

– Purchased– Acquired in a business combination

15

Purchased goodwill

• Goodwill can only be purchased as part of the acquisition of a business or subsidiary

• It is calculated as the excess of the purchase price over the fair value of the net assets acquired

• Purchased goodwill: Capitalise under IAS 38• Acquisition of subsidiary: Capitalise under IFRS

3

16

Other intangibles

• Follow IAS 38 goodwill treatment:– Cannot recognise as an asset if internally

generated – Capitalise at cost if purchased as a separate asset– Capitalise at fair value if acquired as part of a

business combination

17

Subsequent treatment

• If the asset has a finite useful life, amortise over the expected useful life – usually straight line with no residual value

• If the asset has an indefinite useful life, carry out an annual impairment test

18

Good points

• Definitions in accordance with the framework• Gives guidance on recognition and

measurement

19

Problems

• If intangible assets can be valued at fair value on the acquisition of a business, why can internally generated intangibles not be valued the same way?

• Fair values can be difficult to measure• Intangibles can be a significant part of a

business, yet are often not included in assets because of measurement difficulties

20

Tangible assets

• IAS 16 Property, plant and equipment• Held for use in the business• Expected to be used during more than one

period• Initial measurement at cost– Purchase price– Directly attributable costs– Estimate of costs of dismantling/restoring site

21

Directly attributable costs

Examples:– Employee costs arising directly from the

construction or acquisition– Site preparation – Delivery and handling– Installation and assembly– Testing– Professional fees

Option to include borrowing costs (IAS 23)

22

Depreciation – definitions IAS 16• Depreciation is the systematic allocation of the

depreciable amount of an asset over its useful life• Depreciable amount is the cost of an asset or other

amount substituted for cost, less its residual value• Useful life is – the period over which the asset is expected to be available

for use– The number of production units expected to be obtained

from the asset• Residual value is the estimated amount to be

received from disposal of the asset at the end of its useful life

23

Depreciation - concepts

• Measuring the using up or wearing out of the asset• Physical, time based or economic• Allocates costs to the periods in which the expected

future benefits arise• If an asset is revalued, depreciation is based on the

revalued amount• DOES NOT – Give a market value for assets– Provide funds for replacement

24

Revaluation• Basic valuation is at cost, but assets may be revalued upwards

provided fair value can be reliably measured. For intangibles there must be an active market to identify fair value

• Valuation must be kept up to date• Must be applied to all assets within a class• Gain goes to revaluation reserve as it is unrealised and is

shown in the statement of comprehensive income• If a revaluation results in a decrease in value, it will first be

debited against any balance in the revaluation reserve in respect of that asset. Any further charges will go to the income statement.

25

Good points

• Established area of accounting with high level of agreement over policies

• Agrees with framework• Revaluation allows more meaningful balance

sheet values• Revaluation must be consistent – class of assets – kept up to date

26

Problems

• Choice over inclusion of interest costs• Depreciation rates are a matter of judgement

and could be manipulated• Choice over whether or not to revalue

27

Impairment• Principles relate to all types of asset• The carrying value of an asset must not exceed its

recoverable amount.• Carrying value means the value in the balance sheet

– depreciated cost/valuation• Recoverable amount is the amount which could be

gained by the business from the asset• It is the higher of net selling price and value in use• Value in use is the future benefits to be gained from

use of the asset – the discounted future cash flows – this is difficult to measure

28

Summary

• Big topic – exam question will cover only part eg R&D, other intangibles or PPE

• Tutorial concentrates on basics and R&D but you need to study the rest

• There will be extra practice questions and revision questions on all aspects of this topic

29