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Audit and Assurance: Evaluation of AASB 138 Accounting Standards Assessment 2 Answer

Assessment 2
Assessment Type: 
Case study report — theory and calculations — individual assessment 

Purpose: To allow students to apply the technical knowledge of relevant accounting standards to financial reporting settings. This assessment relates to learning outcomes c, d.
Submission: Submission must be made to the Moodle Assignment Link on the KOI Moodle Sub ect Home Page by 8.00 pm Wednesday of Week 9. A printed copy must be submitted to the Lecturer at the Week 9 Lecture to assist with marking. All assignments must have a signed KO1 Assignment Coversheet included with the submission.
Topic: Research Individual Assignment
Task Details: Technology Enterprises Ltd, a listed company, commenced a research and development (R&D) project in July 2017 to modify the method of recharging batteries used in its products. The project was successfully completed in June 2018 and the company applied for a patent for the design. 

Technology Enterprises Ltd plans to modify all products in its consumer range over the next two years and has incorporated these plans into its financial budget. The entity expects to derive economic benefits from the new battery recharging technology over the next 10 years.
The accountant was unsure how to account for the project so they used the New Project R&D account to accumulate the salaries of all engineers involved in the project during the year ended 30 June 2018. The following analysis of the salaries expenditure is based on the engineers' time sheets.

Required 

1. How should the project be accounted for in the financial statements for the year ended 30 June 2018? Justify your answer with reference to relevant paragraphs of AASB 138/IAS 38. 

2. To what extent might the rules or restrictions in AASB 138/IAS 38 reduce the comparability of financial statements? 

3. Write a response to the CEO, drawing on your understanding of AASB 138/IAS 38 and the efficient market hypothesis (refer to chapter 2 of Loftus). Include a recommendation as to how the company might mitigate their concerns about investors' interpretation of the information reported in the financial statements 

Answer

Audit and Assurance

Introduction 

With the ramified economic changes, every organization needs to comply with the IFRS Rules and AASB accounting standards to strengthen the reporting frameworks and maintain the transparency in the recorded items of the organization.  In this report, AASB 138 accounting standards have been evaluated in the consideration of the recording of the intangible assets in the books of account of the company. It is the responsibility of management to measure the cost of intangible assets in a reliable way. However, the implication of the IAS 136 accounting standards is followed by listed companies to assess the true and fair value of the assets by deducting the impairment loss identified by implementing the impairment test.  In the end, recommendation has been given to the board of directors to record the intangible assets in the books of account.  

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 analyze the provisions provided by AASB 138, 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 the project completed by Technology Enterprises Limited can be recognized as an intangible asset? 

There are many provisions that deal with the analysis as well as consideration to decide whether to recognize an expenditure incurred on a project in the books of accounts as an intangible asset or not:

Paragraph 9:
It is very important to check whether an asset qualifies to be considered as an intangible asset before recognizing the same. This must be done for both the internally generates assets as well as the acquired asset. There is an illustrative definition regarding intangible assets and some example of common intangible assets. “Technical and scientific knowledge” is considered an intangible asset if the same is acquired, maintained, developed or enhanced by the organization.
Paragraph 18:
Recognition of “intangible assets” (as defined in Paragraph 9) has been done in books only when the conditions given in Paragraph 21 are fulfilled.
Paragraph 21:
There are two conditions that are very important to enable an intangible asset so that it can survive recognition conditions.
  1. It is the responsibility of management to measure the cost of intangible assets in a reliable way.
  2. "Expected future economic benefits" flow to the organization as there is a usage of sale of intangible assets. Probability of "expected future economic benefits totally depends upon the judgment of the management by considering the best estimate about the future environment. The judgment of the management is also influencing by external evidence and it has the responsibility to judge the degree of probability attached to the flow of “expected future economic benefits” (as said by Paragraph 23).

 

As per the given case, a project created by Technology Enterprises Limited is supposed to modify and improve the way by which organization currently recharge the batteries. Project specifications come under the list of Scientific and Technical knowledge and development is known as an intangible asset as per paragraph 9. With the help of development, there is a fulfilment of recognition criteria given in Paragraph 22. The reason being is the management of Technology Enterprises Ltd consider technology benefits to sustain with the organization for the next 10 years. The cost of development can be measured by the organization in a reliable way (Stevenson, 2012).

So, basically, the expenditure on the project completely meets the recognition criteria of internally generated intangible assets.

Accounting of the internally generated intangible asset

Below are the provisions that basically deals with the accounting of intangible assets in the financial statement of Technology Enterprises Ltd:

Paragraph 24:
It is necessary for organizations to follow the cost model for the very first time at the time of recognition of intangible assets in the financial statement. This method is used because, in the starting, intangible assets can be recorded as per the cost.
Paragraph 52:
Expenditure incurred on the generation of intangible assets need to get divided into two parts i.e. development phase and research phase. It is necessary to complete this before any expenditure can be capitalized (Kober, Lee & Ng, 2012).
Paragraph 53:
In some of the cases, if an organization is unable to differentiate between the development phase and research phase, then it is automatically assumed that all expenses belong to the research phase only.
Paragraph 54:
It is not allowed to capitalize the expenditure incurred in the research phase.
Paragraph 56:
Examples that considered to have occurred in research activity are searching for services, products, and devices.
Paragraph 66:
There are some examples of the expenditure that are considered as development expenditure and that can be capitalized are the cost of material and services used by the organization to create intangible assets is considered as development expense
Paragraph 67:
Examples of the expenses that are disallowed for capitalization purpose like training provided to the staff to l=make them learn the usage of new devices.

 

According to the above provision, there are mainly three types of expenditure incurred by Technology Enterprises Limited and it is categorized as follows-

Expenditure
Nature and the relevant provision
Capitalization amount
Cost of time involved in  searching for evaluating material alternative: $100000 
Research activity (Paragraph 56)
0
Cost of the design model and construction of prototype: $700000
Development activity (paragraph 66)
700000
Cost of time spent on training for the new design: $200000
Specifically excluded to be capitalized (Paragraph 67)
0
Cost of intangible asset
$700000


 Paragraph 24 needs accounting at a cost in the starting, and cost as computed above comes to be $ 700000

This shows the cost of the recorded intangible assets= $ 700000

Answer to the question no- 2

As there is globalization across the globe, so it is important to improve the comparison of organizational financial statements at international level as well as the organizational level. There is a modification of AASB 138, in line with IAS 38 and intangible assets bring conformity with such requirements (Mishra & Hussain, 2014). There are many listed companies all around the globe that needs to do the accounting of their intangible assets according to the applicable accounting standards as per the country. However, there are around 138 countries that already have a compilation with IAS 38 and their accounting standards mainly deals with the accounting of intangible assets is almost equal to IAS 38. So, there is an economic condition where every organization is somewhere doing their asset accounting by using the same provision that uses for the accounting of intangibles. The measurement, impairment, disposal, amortization, recognition, and revaluation for intangible assets is the same for every listed country in the world (Dinh, Eierle, Schultze & Steeger, 2015).

There are many rules and regulations set by AASB 138 if we look from this angle to make all the operations uniform so that there can be an increase incomparability of the financial statements. But, the different angle of considering AASB 138 reflect some different results. The standard rules are known to be sufficiently flexible to allow management so that they can use their judgment in judging the probability of upcoming economic benefits, use of the assets in the business as per the expectations and expected life of the asset. As it is all about the judgment, so every entity has some different results that lead in hindering the comparability and its effect is not even significant (Bleibtreu & Stefani, 2018).

Answer to the question no- 3

Response to CEO in relation to the market hypothesis

According to Paragraph 71 of AASB 138, it allows an organization to change the revaluation model and to stuck on the cost model of measurement for intangible assets after the initial recognition. Below are the provisions that have been observed-

  • Paragraph 74: It is required for the organization to show the generation of intangible assets in their books of accounts if they want to opt for cost models. Afterward, that cost has to be deducted by the accumulated amortization and impairment loss (He, Evans & He, 2016).
  • Paragraph 75: When there is a case where revaluation model of the accounting has been used for measurement of intangible assets in the books of accounts, so the total value of intangible assets shall be equivalent to the fair value. The reason for this is the existent on the revaluation date is reduced by subsequent impairment loss as well as amortization cost on the accumulated basis (Bozzolan, Laghi & Mattei, 2016).


But, before adopting the revaluation model, it is the responsibility of the organization to check whether any active market still exists for intangible assets which need to be revalued. Only fair value from the active market can be used for the revaluation of assets.


NOTE: The meaning of an active market is the existence of a market where there is a trade of intangible assets of the homogenous category of any entity. In such markets, there are many buyers and sellers of the asset are available and the public is also aware of the assets as well as the price of the asset.


  • Paragraph 81: When there is not the availability of an active market then in such cases only cost model works and it has to be used by the organization to measure the intangible assets in books of accounts (Mates, 2009).

In the above case, the present value given of $ 400,000 is not the fair value because there is no market stand for the assets created by the organization because there is an absence of homogenous assets. There are no interested sellers as well as buyers, even price is also unavailable to the public. So, the valuation of asset is wrong, and it can't be done at $400,000 and profit equal to $100,000 can't be booked. The asset should be measured at a cost minus amortization expense (Amiram, Bozanic & Rouen, 2014).

Amortization expense: cost of asset/ expected life

: 70, 0000/10

 : $7000 per year (using straight-line amortization method) 

Recommendations to mitigate the concerns of investor interpretation

  • It is important for every organization to include disclosure of the application of AASB 138, Intangible assets in its annual report. This disclosure clearly reflects the impact of application, measurement, and recognition of AASB 138 on the books of Technology Enterprises Ltd. It helps the investors to understand the company's decisions regarding the booking of intangible assets using the development cost.
  • It is mandatory to mention the expected benefits in qualitative and quantitative terms in the financial statements of the organization. The representation of quantitative benefits can be done in the terms of expected cash flows that the entity can expect, and qualitative cash flows can be shown by the increase in the brand image and the enhanced performance of the product. By declaring it, it becomes very easy to deeply describe the position and profitability of the organization in front of the investors and stakeholders (Steenkamp & Steenkamp, 2016).
  • The board of directors of the company should focus on the implication of the IAS 136 accounting standards to assess the true and fair value of the assets by deducting the impairment loss identified by implementing the impairment test.  

Conclusion 

After assessing the given case study given in this, it is found that if the proper AASB 138 is followed then the company could easily maintain the true and fair view of the recorded items in the books of account.  It is analyzed that where revaluation model of the accounting has been used for measurement of intangible assets in the books of accounts, so the total value of intangible assets shall be equivalent to the fair value. It is considered that if Technology Enterprises Limited wants to maintain the transparency in the recorded items then it will help it to maintain the proper transparency in the recorded items of the financial statement. 

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