ppt t/a carnegie et al, accounting financial and organisational decision making © mcgraw-hill...

15.1PPT t/a Carnegie et al, Accounting Financial and Organisational Decision Making© McGraw-Hill Australia Pty Ltd, 1999

ACCOUNTINGACCOUNTINGFinancial and Organisational Financial and Organisational

Decision MakingDecision Making

Chapter 15

Assets and ExpensesSlides written and designed by

Tony Van Eekelen


Chapter 15: Assets and Expenses

Learning ObjectivesLearning Objectives

• In this chapter you will be introduced to :– The nature of assets– the nature of expenses– the difference between assets and expenses– the criteria for the recognition of assets and

expenses– the influence of conservatism in accounting for

assets and expenses



Learning ObjectivesLearning Objectives– the allocation problems in asset

and expense determination, especially in cases of inventories, marketable securities, depreciable assets and intangible assets

– the lack of precision generally in accounting for assets and expenses



IntroductionIntroduction

• Within the accounting system there exists certain elements which constitute the financial statements.

• These elements are assets, liabilities, expenses and revenues.

• How are these elements defined and when are they recognised?



Definition & RecognitionDefinition & Recognition

• Definition: the identification of the attributes the elements should possess to be identified as such

• Recognition: the determination process which decides whether an element should be report or accounted for in the financial statements.



ConservatismConservatism

• Due to very nature of business and its reporting, uncertainty exists.

• Due to this uncertainty, accounting has a assumption of conservatism in what is reported.

• Conservatism means caution or prudence.



ConservatismConservatism• Accountants

– anticipate losses

– never anticipate gains

– choice of value for asset is always the lowest

– liabilities are never understated.

• Makes reports more reliable.• Conservative approach to historical cost is to

value at lower of original cost or recoverable amount.



The definition and recognition of assets The definition and recognition of assets and expensesand expenses

• The basis for the definition and recognition criteria is based upon the International Accounting standards (IAS) and the Australian statements of accounting concepts (SACs)



AssetsAssets

• An asset must have the following characteristics:– a resource offering future economic benefit

through use or exchange

– controlled by the entity

– must have been derived by a past external transaction

– Measurement in $A and at original cost unless net realisable value is lower.



ExpensesExpenses

• An expense must have the following characteristics:– some economic benefit has been consumed or

lost during the period– the benefit must have been derived from a past

external transaction– withdrawals are not expenses but reductions in

capital



Stability of asset definitionsStability of asset definitions

• As the business world is dynamic is nature, the elements within the financial statements must also evolve.

• In 1922, Paton defined assets as:– any consideration, materials or otherwise,

owned by a specific business enterprise and of value to that enterprise



Stability of assets definitionsStability of assets definitions

• Based upon ownership not just control.

• Must have some value, thus economic benefit.

• Past definitions looked at the process not the properties.

• Recently, this has changed, due to the resurgence of the balance sheet as important.



Properties of assets and expenses Properties of assets and expenses and their recognitionand their recognition

• IASC– a resource controlled by the enterprise as a result

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

• SAC 4– future economic benefits controlled by an entity

as a result of past transaction or other past events.



Three main characteristicsThree main characteristics

Future Economic benefitFuture Economic benefit

ControlControl

Past event or transactionPast event or transaction



Future economic benefitFuture economic benefit

• IASC– ……is the potential to contribute, directly or

indirectly, to the flow of cash and cash equivalents to the enterprise. ……it may be a productive one that is part of the operating activities of the enterprise. It may also take the form of convertibility into cash or cash equivalents or a capability to reduce cash outflows, ...



Future economic benefitFuture economic benefit

• Assets are used to provide goods and

services in exchange for net cash inflows.

• For not-for-profit entities

– benefits the entities by enabling them to meet

their objectives of providing needed services



ControlControl• The capacity of the entity to benefit from

the asset and to deny or regulate the access of others to that benefit.

• Ownership is not essential to control asset.– lease of motor vehicle no ownership but has

control over its use.



Occurrence of past transaction or other Occurrence of past transaction or other eventevent

• An event or transaction must be evident giving the control of the asset to the entity.

• Via cash, credit or barter

• Or via discovery - mining

• Event or transaction must be past, not future.



Recognition of assetsRecognition of assets

• IASC framework specifies:– …an element should be recognised if:– it is probable that any future economic benefit

associated with the time will flow to or from the enterprise; and

– the item has a cost or value that can be measured with reliability



RecognitionRecognition

• Recognised if, and only if, it is “probable”• Probable means that it is more than likely,

ie greater than 50% chance



ExpensesExpenses

• IASC framework defines expenses

as:– Expenses are decreases in economic benefits

during the accounting period in the form of

outflows or depletion of assets or

incurrences of liabilities that result in

decreases in equity, other than those

relating to distributions to equity

participants

Economic Benefits

Expen

ses

Expen

ses

consumedconsumed ExpensesExpenses

Expenses

Expenses



ExpensesExpenses

• SAC 4– Expenses are consumptions or losses of

future economic benefits in the form of reductions in assets or increases in liabilities of the entity, other than those relating to distribution to owners, that result in a decrease in equity during the reporting period

• Major emphasis is on losses



Recognition of expensesRecognition of expenses

• IASC framework recognises expenses as “.. decrease in future economic benefits related to a decrease in an asset or an increase in a liability has arisen that can be measured reliably”(para. 94)

• Problem: to determine the amount of expired economic benefit for the period?



Allocation ProblemAllocation Problem

• To decide the amount to be appropriated to an expense or to an asset is not a simple task.

• The problem stems from the concepts of accounting period, continuity and capital maintenance.

• Problems in all areas especially inventories, marketable securities, depreciable and intangible assets

Expenses



InventoryInventory

• Inventory accounting relates to what is on hand and the calculation of the cost of sales.

• In chapter 5, we covered the two methods of recording inventory transactions [physical & perpetual] now how do we value inventory.



InventoryInventory

• To achieve the matching of inventory costs under the historical cost system, two conditions are necessary:– all units of the same type of inventory

purchased over the life of the firm are purchased at the same price

– the purchase price of each individual item of inventory can be identified with certainty.



InventoryInventory

• First condition is unlikely to hold

• Thus there is a need to identify the cost at purchase and transfer it a sale.

• This method can be time consuming and in some cases to difficult.

• Alternative approaches are available based upon assumption about the order in which the goods are sold.



Inventory cost allocation methodsInventory cost allocation methods

• Two methods methods exist • FIFO - first in, first out

– assumes that the goods first received into inventory are sold first

• LIFO - last in, first out– assumes that the goods most recently received

into inventory are the first to be sold



Example of FIFO & LIFOExample of FIFO & LIFO

• Purchases:Date Number Cost Total

June 12 250 0.40 100

June 18 150 0.50 75

June 25 400 0.60 240

Total 800

• SalesJune 19 200

June 27 250

Total 450



FIFOFIFO

Cost of goods sold Units Unit cost $ Total Cost $

250 0.40 100

150 0.50 75

50 0.60 30

Total units sold 450 205

Cost of inventory on hand 350 0.60 210

Total units available 800 415



LIFOLIFO

Cost of goods sold Units Unit cost $ Total Cost $

June 19 150 0.50 75

50 0.40 20

June 27 250 0.60 150

Total units sold 450 245

Cost of inventory on hand 150 0.60 90

200 0.40 80

Inventory on hand 350 170

Total units available 800 415



Comparison of FIFO & LIFOComparison of FIFO & LIFO

FIFOLIFO

Cost of goods sold$205 $245

Ending Inventory $210 $170

Total available for sale $415 $415



ComparisonComparison

• Inflationary times cost of goods sold for LIFO is generally larger.

• In US can use LIFO thus reducing taxation payments. (inflationary times)

• LIFO is inconsistent with historical cost

• IASC allows LIFO, but in Australia LIFO is not allowed for taxation purposes and by the standards



Weighted Average CostWeighted Average Cost

• The cost of inventory is determined by applying the weighted average cost of all inventory at the time of sale.

• Under the perpetual recording system, the cost of inventory will need to be recalculate after each purchase.



Using previous exampleUsing previous example

Cost of goods sold Unit sold WAC Total cost

June 19 200 87.50

June 28 250 136.46

450 223.96

Inventory on hand 350 0.54583 191.04

Total units available 800 415.00

0.4375400

50.015040.0250

0.54583600

60.04004375.0200



Lower of cost or net realisable valueLower of cost or net realisable value

• IAS2 states that inventories should be measured at the lower of cost and net realisable value.

• This is consistent with the measurement rule that assets should be valued based upon their future economic benefits to the entity.



Marketable securitiesMarketable securities

• Marketable securities are all investments in securities which can be traded through an exchange or other organised market.

• Due to the changing price of the security, a problem arises.

• The lower of cost or net realisable value approach is used.

• In US can use the portfolio approach



Depreciating assetsDepreciating assets

• Depreciation is the process of allocating the cost of a non-current asset over its life.

• The more economic benefits used to generate revenue, the larger the depreciation charge.



Depreciating assetsDepreciating assets

• Factors which determine the level of economic benefit consumed are– usage,– obsolescence,– indirect relationship with products– the pattern of benefits are not easily identified– taxation requirements– time



Profit or loss on sale Profit or loss on sale

• It is not the same as profit from operations but a prior-period adjustment made necessary by the understandable inability of the entity to predict accurately the actual scrap value of the asset or its actual useful life.

• Usually the profit/loss on sale is determined by the difference between the book value and the proceeds from sale, however, this becomes ‘cloudy’ when a trade-in is involved.



What costs to include?What costs to include?

• When determining the cost of an asset it must be recorded at the original cost.

• In some cases there are additional costs which have been incurred to acquire the asset.

• The definition of an asset and an expense gives us five (5) general rules when determining the cost of an asset.



5 rules of asset cost5 rules of asset cost

1. Installation costs:– The cost of an assets includes all costs necessary

to render an asset suitable for its intended use.

2. Group asset costs:– Where a group of assets is acquired for the

purpose of acquiring only one of the assets, the entire purchase price relates to the desired asset.




3. Maintenance vs. improvements:– Any cost incurred to obtain the benefits initially

expected from an asset is a maintenance expense of the current period. Any cost incurred to increase lifetime benefits beyond the original expectation gives rise to an additional asset for improvement.




4. The unit being accounted for:– Where objects associated with the costs arising

out of a related set of transactions have either different life expectancies or different identities, the firm may choose to recognise more than one asset.




5. Replacement vs maintenance:– Where the expenditure results in the replacement of

an entire asset, the old asset is removed from the accounts and the cost of the new asset is capitalised.

– Where the expenditure results in the replacement of only part of an asset, it is treated as a maintenance expense of the period, unless the expenditure is expected to increase materially the asset’s condition and potential.



Major overhaulsMajor overhauls

• A major overhaul differs from maintenance expense in that it extends the useful life of the asset, increases its productive capacity or reduces the operating costs.

• Thus it has the characteristics of an asset and it should be included in the cost of the asset and depreciation should be adjusted for the remaining life of the asset.



Intangible and other non-current assetsIntangible and other non-current assets

• Two types:– unidentifiable - goodwill

• purchased or self developed• different methods off treatment

– stay on balance sheet as asset– write off in year of acquisition– amortise over number of years.

• Preferred method is amortisation over 5 years with a maximum of 20 years.

– Identifiable - patents;• at lower cost and amortised



Research and development costsResearch and development costs

• Research is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding

• Development is the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials,….



Research and development costsResearch and development costs

• Asset determination will depend upon the asset recognition test.

• Uncertainty, requires all research costs to be expensed.

• AASB1011 requires that R&D costs be carried forward as assets to the extent that such costs, together with unamortised deferred costs in relation to that project, are expected beyond any reasonable doubt to be recoverable.

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