sample essay of BAO 2203 Corporate Accounting

Assignment on Asset Measurement Rules Prescribed in AASB and Impact of Adoption of IFRS


Abstract

The purpose of this essay is to discuss the asset measurement rules and revaluation of non-current assets which are addressed by AASB standards. This essay will give a detailed description of their role in relation to the AASB standards that can affect Profit and Loss statement and Balance Sheet and share prices.

This essay also includes the significant changes in the accounting treatment of intangible assets and prior period errors, and those are under an adoption of IFRS. The impact of adoption will be critically discussed on these two issues.

Introduction

Asset, Liabilities, Equity, Income and Expense these five elements compose the Financial Statement. There are several methods and measurement rules to record the transactions and prepare the Financial Statement. These Financial Statements are relied on the record of single transaction. So how to record the single transaction is very important. After adopting of IFRS, the accounting treatment of some issues has significant changes. The Part A of this essay will discuss how the asset measurement rules and revaluation of non-current assets addresses in AASB standards affect Profit and Loss statement and Balance Sheet. Then it will show how these factors relate to the companies’ share price. The Part B will critically discuss the impact of the adoption of IFRS on intangible assets and prior period errors. It also will describe the significant changes in these two issues.

Part A: Measurement rules and Revaluation of Non-Current Assets

- Assets Measurement Rules

Generally, there are two classifications of asset- current asset and non-current asset. Current assets are cash and other types of assets that are held mainly for sale, or are reason ably expected to be converted to cash, sold or consumed by a business entity within its operation cycle or are expected to be realized within 12 months after the entity’s reporting date. (Hoggett, Edwards & Medlin, 2006, p.154) As defined, it can be inferred that the holding period of current is very short. During the specific period, the nature and the value of the current asset can’t be changed obviously. So generally, for one category of current asset, there is only one measurement rule. Then it has low power to affect Profit and Loss Statement and Balance Sheet.

Another classification of asset is non-current asset which is not easily convertible to cash or not expected to become cash within the next year. (http://www.investorwords.com, 2008) An important and common category of non-current is “property, plant and equipment”. This kind of asset is a main component of company’s asset and capital. So how to record this kind of asset is important.

Briefly, there are two measurement rules for the “Property, plant and equipment”, first one is recording at cost, recoverable amount and the second one is recoding at revalued amount. In AASB, these two rules called “Cost model” and “Revaluation model”. Determining which model to be used during the transaction record is vitally, because different model generates different results. Next, the essay will explain why the different caused.

About the “Cost model”, as AASB 116 Para 30 states,

Cost Model:

After recognition as an asset, an item of property, plant and equipment shall be carried at its cost less any accumulated depreciation and any accumulated impairment losses. (Claire Locke, 2008, p.480)

Clearly, this model is base on the historical cost. Under the historical cost measurement basis, an asset is recorded at the fair value of the consideration given to acquire it at its acquisition date. (Hoggett, Edwards & Medlin, 2006, p.496) It is to say that, using this model, the entity will ignore the changes of market during the different periods. Consequently, when recording some accounts have bearing on the value of assets such as depreciation and impartment loss, it is also base on the historical cost, and their amount are also compare with the historical cost.

On the other hands, the revaluation model the asset is carried at a revalued amount less any subsequent accumulated depreciation and any accumulated impairment losses. (http://www.activa.com.au, 2008)

Compared with the cost model, the revaluation model is more complicated. Firstly, it’s base on the fair value, it defined as assets are essentially carried at the market value where the asset is traded on an active market. (Fargber & Wise, 2008, p.38) When using this model, the accountants should consider the fair value carefully. Because the environment changed everyday, the market price may also change a lot. Meanwhile, when recording depreciation, impairment loss and such accounts like this, it also needs to use fair value as benchmark. In the different period, the market price is different, so the amount of depreciation and other accounts will be different. Secondly, there are more accounts when using revalue model than using cost model. Basically, when using revaluation model, it has “Revaluation reserve”, “Reversal of previous impairment loss” and such accounts like this. The nature of these accounts depends on the results of revaluation. And these kind accounts can not be shown in the cost model, because cost model lacks the process of revaluating.

- Affect to financial statements

As mentioned at the beginning of essay, single record can affect the Financial Statement, so it is easy to get why using different measurement rules can affect Profit and Loss Statement and Balance Sheet. Using “Revaluation Model” has more accounts and the amounts of some accounts are different from “Cost Model”. And when single transaction is transferred to the Financial Statement, different amount and different accounts causes the different results of Financial Statements. For example, when using cost model, there is no “Reversal of previous impairment loss” account, but when using “Revaluation Model”, this account should be treated as income or expense. Obviously, this account should be transferred to the Profit and Loss Statement, it can increase or decrease the profit. After the Profit and Loss Statement is completed, the Net Profit is calculated. Then, credit the Net Profit to the Balance Sheet. The process indicates that only one single account can affect the Financial Statement, as many differences between Cost Model and Revaluation Model are discovered, the gap of the Financial Statement will be huge when using different models. So, it is clear that, using different measure rules can affect the Financial Statements a lot. Another example is the impairment loss. Pursuant to AASB 136, different approaches to accounting for an impairment loss of property, plant and equipment will be required depending upon whether the cost model or revaluation model has been adopted. Therefore, if an asset has been revalued, the impairment loss will be recognised by reducing the balance of the revaluation reserve as it pertains to the previous revaluation. Otherwise, the impairment loss is recognised by recognising an expense directly. (Deegan, 2008, p.216)

- Affect to share price

From the Financial Statement, the position and performance of the financial situation are shown clearly. The investors buying the share is one of the invest activities. Before they buy the share, they will analyse the Financial Statement carefully. Some factors shall be considers carefully, such as price per unit of earnings (from the income statement), price per unit of net worth (from the balance sheet). (http://en.wikipedia.org, 2008) This rate indicates whether they should buy the share, and how much they should buy. And for economic view, a price of goods is affect by the demand, when demand is increase, the price will grow up, so is the share price. The more profit the company can made, the more share will be need, so the price of share will increase. On the other hand, the share price is related to the retained earnings account, which shown on Balance Sheet. As mentioned above, this item is also base on the single transaction. Consequently, the share price of the company is affected by the Financial Statement.

Part B: IFRS & its Impact on Australian Financial Reporting

International Financial Reporting Standards (IFRS) are standards and interpretations adopted by the International Accounting Standards Board (IASB). IFRS requirements are those established by the IASB who have developed, in the public interest a set of high standard, understandable and enforceable global accounting standards. Many of the standards forming part of IFRS are known by the older name of International Accounting Standards (IAS) which was issued between 1937 and 2001 by the board of the International Accounting Standards Committee (IASC). In April 2001 the IASB adopted all IAS and continued their development, calling the new standards IFRS. (http://en.wikipedia.org/, 2008) However, adopting IFRSs have led to significant changes in some standards and minor changes in others, and those were considered a “principles based” set of standards in that they established broad rules as well as dictating specific treatments. Intangible assets and prior period errors both are good instances to changes in the accounting treatments.

Intangible assets are defined as identifiable non-monetary assets that cannot be seen, touched or physically measured, which are created through time and effort and that are identifiable as a separate asset. There are two primary forms of intangibles, those are legal intangibles (such as copyrights, patents, trademark and goodwill) and competitive intangibles (such as collaboration activities, leverage activities and structural activities). (http://en.wikipedia.org, 2008) The treatment of intangible assets changed dramatically with the adoption of IFRSs. For instance, the cost of research, mastheads and brand names must be expensed as incurred currently, however, such costs could be capitalised and included within the balance sheet to the extent that certain deferral tests were satisfied before 2005. Refer to such changes, some companies were required to remove a large amount of money from their balance sheet of assets on the adoptions of IFRSs. In addition, the revaluation of intangible assets is greatly restricted under IFRSs compared with the former position under Australian Accounting Standards. There is no “active market” to many intangible assets, but for others which get “active market” may be revalued to fair value, and the associated prices are publicy available. For another example, prior to 2005, goodwill was required to be systematically amortised over a period not in excess of 20 years. (http://www.iasplus.com, 2008) Goodwill is not subject to amortisation, but is assessed for impairment at least annually (IFRS3.54 and IAS36.10). Impairment is charged to the income statement (IAS36.60), and impairment provisions on goodwill are not subsequently reversed (IAS36.124). According to the ‘Basis for Conclusions to IAS 38 “Intangible Assets”’, in revising IAS 38 and developing IFRS 3, the Board affirmed the view in the previous version of IAS 38 that identifiably is the characteristic that conceptually distinguishes other intangible assets from goodwill. The results of significant changes it would seem that the value of more and more companies is being based increasingly on their intangible asserts, rather than on their tangible assets in resent times.

AASB 108 ‘Accounting Policies, Changes in Accounting Estimates and Errors’ deals with the correction of errors made in previous accounting periods. An entity may have an error in the value of an element on their financial statements and it may not be found until the next accounting period. For example, an organisation may have made an error in valuing its inventory. If an asset has been overstated, there are a number of ways to correct this error. According to Deegan (2007), this error could be corrected by reissuing the financial statement of the previous period with the corrected error, or by decreasing opening retained earnings and reducing the balance of opening inventory. Also, the adjustment can be recognised as an expense of the current period rather than making adjustments to prior period balances. The previous accounting standard AASB 1040 ‘Statement of Financial Position’ required the correction of the error to be made in the period in which the error was discovered (Deegan, 2007). In 2004, the AASB 1040 was replaced by the AASB 108. The AASB 108 states that prior period errors are to be corrected when realised. Paragraph 42 of AASB 108 requires that ‘an entity shall correct material prior period errors retrospectively in the first financial report authorised for issue after their discovery by restating the comparative amounts for the prior periods 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’. Under IFRSs, the finanicial statements are adjusted as if the error had never occurred, the opening balances will be amended in a retrospective manner (Deegan, 2007). In other words, the retrospective manners such as prior period errors shall be adjusted and presented as the retained earnings at the beginning of the earliest prior period, and the beginning balance of other relevant items as well as to other comparative data disclosed in the prior period presented shall be adjusted along with. However, treatment as prior period adjustments should not be applied to the normal, recurring corrections and adjustments which are the natural result of the use of estimates inherent in the accounting process. For example, changes in the estimated remaining lives of fixed assets affect the computed amounts of depreciation, but these changes should be considered prospective in nature and not prior period adjustments. (http://www.hud.gov, 2008)

Conclusion

Although different measurement rules bring different results, but no matter a company use which measurement rules to record the transaction, the purpose is the same, which is making the Financial Reports understandability, relevance, reliability and comparability. The cost model and revaluation model have their own advantages and disadvantages. It’s easy to record and understand when using cost model. Using revaluation can reflect the current market situation. But some people believe that the market-value accounting approach was “exaggerating” the market turmoil, leading to write-downs that were “excessive”. (David Reilly, 2008)In my opinion, the small company should use cost model to record the non-current asset, because they don't have many asset to be recorded and they don't have enough money or person to investigate the market to decide the fair value of the asset. But for the large company, especially the company listed on the ASX, they should use revaluation model, as this model can affect the share price a lot. The share price impasses the future of the company.

Adoption of IFRS in accounting treatments of issues has given rise to significant changes, especially intangible assets and prior period errors. Both have impacted on corporate financial statements which would be useful for reporting entities to tell financial statements readers, and consequences of adopting IFRS for subsequent corporate finacial performance and finacial position reporting would be given to readers clearly. Therefore adopting it would have reduced the ‘shocks’ that were felt when the IFRS-compatible finacial statements were first applied (Deegan, 2007). It also would change the companies’ promotions for perceived benefits by adopting IFRS.

Bibliography

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Hoggentt, J., Edwards, L. & Medlin, J. 2006, Financial accounting in Australia, 6th edition, John Wiley & Sons, Brisbane.

Reilly, D., 2008, Write-downs blamed on the accounting rules, The Australian, Monday March 3, 2008

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