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ACC701 Understanding AASB 138 and Intangible Assets in Technology Enterprises Assessment 2 Answer

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ACC701 Financial Accounting T119




Answer

Auditing and assurance

AASB-138

Introduction 

Every organization needs to comply with the IFRS rules and AASB accounting standards to strengthen the reporting framework on international level. This report reveals the key understanding on the AASB 138 and recording of the intangible assets in the books of account of company. In the starting of this report, application of the AASB 138 in context with the recording of the intangible assets in the Technology enterprises Limited has been done. After that valuation model and its implication has been made to assess the true and fair view of the recorded assets in the books of account of company. By using the AASB 138, company could easily determine the expenses made on the intangible assets whether need to be treated as capital expenditure or revenue expenditure

Answer to the question no- 1

To understand the accounting of the new project constructed for recharging the batteries by Technology Enterprises Limited, it is necessary to analyse the provisions provided by AASB 138, Intangible Assets.  Every assets in the books of account of company is not recorded as intangible assets. As AASB 138 is framed in accordance with the guidelines set by IAS 38, analysis of the case on the basis of AASB 138 is enough. Following are the different provisions which are important to check for doing correct accounting in the present situation.

Whether project completed by Technology Enterprises Limited can be recognised as an intangible asset?

These are the provisions which deal with the sole consideration to decide whether or not to recognise expenditure incurred on a project as an intangible asset or not in the books of accounts:

Paragraph 9:
Before recognising any asset as intangible asset, whether acquired or internally generated it is necessary to check where the asset qualifies to be intangible asset. This paragraph provides as illustrative definition of intangible assets and set examples of some common intangible assets. “Scientific or technical knowledge” has been considered as an intangible asset when the same is either acquired, or maintained, or developed or enhanced by the organisation. This is used to illustrate the recorded the intangible asset and same is supported by using the notes to account of company. 

Paragraph 18:An “intangible asset” (as defined in Paragraph 9) can be recognised in the books only when the recognition conditions set by Paragraph 21 are fulfilled.  The intangible assets are recorded and recognise as per the set process and provision given under the paragraph 21. 
Paragraph 21:
two conditions are main to enable an intangible asset to survive the recognition criteria and are as follows:
1) The management measures the cost of intangible assets reliably.
2) “Expected future economic benefits” flow to the organisations because of the use of sale of intangible asset. The probability of these “expected future economic benefits” depends upon the judgement laid by management by taking into account a best estimate of futuristic environment (as said by Paragraph 22). Also, the management judgement as influenced mainly by external evidence is responsible to decide the degree of probability attached to flow of “expected future economic benefits” (as said by Paragraph 23) (Russell, 2017).

 After assessing the case of the Technology enterprises company, it is considered that company has been indulged in operating the project. However, the question arise whether the undertaken project would be considered as intangible assets or not. In the given case, the project generated by Technology Enterprises Limited shall modify and improvise the manner in which the organisation currently recharges its batteries (Cheung, Evans,  & Wright., 2008). The project specifications fall in the list of Scientific or Technical Knowledge, development of which is an intangible asset as per Paragraph 9. Also the development fulfils the recognitions criteria laid by Paragraph 21 because management of Technology Enterprises Ltd estimates the benefits of the technology to flow to organisation for next 10 years. At the same time, the cost of development is being measured reliably by organisation (Russell, 2017).

Hence, the expenditure on project meets the recognition criteria of an internally generated intangible asset.

Accounting of the internally generated intangible asset

The following provisions deal with the accounting of the intangible asset in the financial statement of Technology Enterprises Ltd:

Paragraph 24:Organisations while recognising intangible assets in financial statements have to follow the cost model for the first time, i.e. initially the intangible assets can be recorded at cost.
Paragraph 52:Before any expenditure can capitalised, the expenditures incurred on generation of intangible asset have to be categorised in two phases, i.e. research phase and development phase (Cheung, & Lau, 2016).
Paragraph 53:If organisation is unable to demarcate between the research phase and development phase, it shall be assumed that all the expenditures are incurred in research phase only.
Paragraph 54:None of the expenditure incurred in the research phase can be capitalised.
Paragraph 56:Several examples have been provided for expenditures considered to have occurred in research activity. One of them is searching for alternative materials, products, devices, services, etc. 
Paragraph 66:Examples have also been provided of the expenditure which shall be considered as development expenditure and are allowed to be capitalised. Cost of materials and services utilised by organisation for generation of intangible asset is one of the development expense (Fraser, 2018)
Paragraph 67:Several examples of expenditures that are explicitly disallowed to be capitalised have been provided. Training staff to operate the new devices is one of them.

 

On the basis of the above provision the three kinds of expenditure as incurred by Technology Enterprises Limited can be categorised as follows:

ExpenditureNature and relevant provisionCapitalisation amount
Cost of time spent searching for evaluating material alternative : $10,000Research activity (Paragraph 56)0
Cost of design model and construction of prototype: $70,000Development activity (paragraph 66)70,000
Cost of time spend on training for new design: $20,000Specifically excluded to be capitalised (Paragraph 67)0
Cost of intangible asset$70,000

 Paragraph 24 requires accounting initially at cost, and cost as computed above comes to be $70,000.

This shows that the cost of the project which would be recorded in the books of account of the company would be $ 70,000 for this intangible assets (Su, & Wells, 2018). 

Answer to the question no- 2

In the globalised era, it is very much important for organisations to improve the comparability of their financial statements at the international level as well. AASB 138, Intangible Assets have been modified in line with IAS 38, Intangible Assets to bring conformity with this requirement. All the listed entities all over the world have to do accounting in respect of Intangible assets in accordance with the accounting standards applicable for their country. However, around 138 countries in world have complied with IAS 38 and their accounting standards dealing with Intangible asset accounting are equivalent to IAS 38. Hence a situation is created in economy where every listed entity is using same provisions to deal with the accounting of Intangibles. The recognition, measurement, impairment, revaluation, disposal, amortisation, etc. for intangible assets are similar for every listed entity over the world (Garg, 2017).

The rules and restrictions set by AASB 138, if looked from this angle prove to bring uniformity of operations and hence an increased comparability of financial statements. However, a different angle of looking at the provisions of AASB 138 shows some different results. The rules of standard are flexible enough to allow management to use their judgement in deciding about the probability of future economic benefits, the expected use of asset in business, expected life of asset, etc. As there is use of judgement, every entity shall show different result, which can at some level hinder comparability. Though, the effect of same is not significant. This rule reveals that by using the recognized methods given under the AASB 138, company could easily identify the methods to determine whether the project should be considered as intangible assets or not (Steenkamp, & Steenkamp, 2016).

Answer to the question no-3

Response to CEO in relation to market hypothesis

After initial recognition, Paragraph 71 of AASB 138 allows an organisation to switch to revaluation model or remain stuck to the cost model of measurement for intangible assets. The following provisions can be observed:

  • Paragraph 74: organisations opting for cost model are required to show the internally generated intangible asset at cost in books and the cost has to be deducted by the amount of accumulated amortisation and any impairment loss, if applicable on the intangible asset.
  • Paragraph 75: in case revaluation model of accounting is adopted for measuring intangible assets in the books, the value attributable to intangible asset shall be equal to the fair value, as existent on the date of revaluation as reduced by any subsequent impairment loss and amortisation cost on accumulated basis.

However, before the revaluation model can be adopted, the organisation has to check where an active market is in existence for the intangible asset which entity wants to revalue (Hu, Percy, & Yao, 2015). The fair value as available from the active market can only be used to revalue the assets. 

NOTE: an active market refers to existence of a market where intangible assets of homogenous category of the one generated by entity are traded. In that market there are willing buyers and sellers of the asset and the public too is made aware of the price of the asset (Bond, Govendir, & Wells, 2016).

  • Paragraph 81: in case of absence of an active market, only cost model can be used by an organisation to measure its intangible assets in the books (Dahmash, Durand, & Watson, 2019).

In the given case, the present value of $400,000 is not the fair value. This is so because no active market stands for the asset generated by organisation as, there are no homogenous assets; there are no willing buyers and sellers; and the price is also not available to public. Hence, the valuation of asset cannot be done at $400,000. Neither the profit of $100,000 can be booked. The asset has to be measured at cost less amortisation expense (Ritter, & Wells, 2016).

Amortisation expense: cost of asset/ expected life

: 70,000/10

: $7,000 per year (using straight line amortisation method)

Therefore, by using the costing model, the value of the assets could easily be determined. However, the computed amortisation expenses will be set off per year from the recorded intangible assets. This amount will be used while implementing the impairment test as per the IAS 136 to identify the true value of the recorded assets in the books of accounts (Godfrey, & Koh, 2011).

Recommendations to mitigate the concerns of investor interpretation

  • The annual report of organisation must include the disclosure in relation to the application of AASB 138, Intangible Assets. The disclosure is intended to reflect the effect of application of the recognition and measurement provisions of AASB 138 on the books of Technology Enterprises Ltd. This shall help the investors is understanding the reasons behind the company’s decision to book intangible asset using the development costs alone. 
  • The expected benefits in quantitative as well as in qualitative terms must be made available in the financial statements of the organisation. The quantitative benefits could be represented in terms of expected cash flows which the entity expects and qualitative cash flows shall be in the form of increase brand image and product performance.
  • The computation of the amortisation expenses needs to be made by using the costing model which will eventually help company to identify the impairment loss while implementing the impairment test (Wyatt, 2015).
  • Proper disclosure regarding the impairment loss and amortisation expenses needs to be made in the notes to the account of company. 
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