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.
Cost of time spent searching for and evaluating alternative materials 100 000 Cost of time designing models, and constructing and testing prototypes 700 000 Cost of time spent on training maintenance workers for the new design 200 000
The value in use of the design, estimated using present value techniques, is $4 000 000. However, the fair value of the design is estimated to be only $3 000 000 because the only potential buyer would need to modify the design to adapt it to its own products.
The following conversation took place between the chief executive officer (CEO) and the accountant (ACC).
CEO: That 'R&D asset' should make our financial statements look great this year. We can show it is worth $4 000 000 in the balance sheet and add an extra $3 000 000 to profit because it cost only $1 000 000.
ACC: I haven't finalised accounting for it yet but I am quite sure the accounting standard requires us to measure it at historical cost, and some of it will probably have to be recognised as an expense.
CEO: It isn't fair. These conservative accounting rules make it impossible to show investors that our project was successful — and expensing any of it will cause our share price to go down because the investors will think it didn't work.
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
Students need to support their analysis with reference to relevant material from the text and a minimum of eight (8) suitable, reliable, current and academically acceptable sources –this should include at least 2 peer-reviewed academic journal articles.
Presentation: 2000 + 10% word short report format. Title page, executive summary, table of contents, appropriate headings and sub-headings, recommendations/findings/conclusions, in-text referencing and reference list (Harvard – Anglia style), attachments if relevant. Single spaced, font Times New Roman 12pt, Calibri 11 pt or Arial 10 pt.
Interpretation and representation 20% Calculations 20% Analysis 20% Assumptions 20% Communication 20%
Total mark will be scaled to a mark out of 30 subject marks.
This report has been prepared on the basis of the legal compliance of the accounting standards of the provisions provided by AASB 138, this standard focuses on the recording of the true and fair view of the Intangible assets in the books of account of company which strengthen the transparency of the recorded asset for its stakeholders. This report reveals the key understanding on the project undertaken by Technology enterprises Limited for its business use and enterprise plans to incorporate the use of the intangible asset technology in business. This shows the legal accounting standards compliance as per the AASB 138. It is considered that in the case of Technology enterprises Limited, there is need to analysis the economic benefits which are expected by organisation and considered to be probable to flow for coming 10 years. The expenditure on the intangible asset have also been assessed as per the AASB 138 for its recording purpose.
Provisions of AASB 138:
The provisions provided by AASB 138, Intangible assets and IAS 38, Intangible Assets are similar. The current question has been solved by following the provisions laid by AASB138, Intangible Assets.
Paragraph 9 defines an intangible asset to include the acquisition, maintenance, development or enhancement of scientific or technical knowledge as well as trademarks under the definition of intangible assets. As per paragraph 18 of AASB 138, an intangible asset can only be recognised in the financial assets, when it complies with the definition of intangible asset and also meets the recognition criteria laid by the accounting standard (Russell, 2017). Paragraph 21 lays the conditions for an intangible asset to meet the recognition criteria. As per this paragraph, recognition of an intangible asset is possible only when a certain probability of flow of expected future benefits purported by the intangible asset exists. Also the organisation is able to reliably measure the cost of asset. Paragraph 22 and 23 of AASB 138 states the use of best estimate by management for ascertaining the future economic benefits by use of supportable and reasonable assumptions.
As per Paragraph 24 of AASB 138, the recognition of intangible assets should be initially done on cost basis. Paragraph 52 of the accounting standard requires an organisation to distinguish an intangible asset into research phase and development phase to check upon the recognition criteria (Malone, Tarca, & Wee, 2016). If the distinction is not possible to be done, the entire expenses incurred upon the probable asset are considered as incurred in the research phase and shall not be capitalised. This is as per the requirement of Paragraph 53. Paragraph 54 exclusively marks the expenses incurred in research phase to be treated as revenue expenses as and when they occur.
Paragraph 57 however allows the entity to mark the expenditures incurred in development phase to be treated as the cost of intangible assets when certain conditions are met. These conditions deal with the technical feasibility for completion of asset, ability of the asset to be sold or used, intention of the entity to generate the asset for use or sale, capability of the asset to generate future economic benefits, entity’s ability to measure the expenditure incurred in development phase reliably and the availability of resources with organisation to develop and further use or sell the assets (Cheung, & Lau, 2016).
Paragraph 66 of AASB 138 specifies the cost incurred by entity on materials and related services for generation of intangible asset to be inclusive in the cost of intangible asset. While Paragraph 67 exclusively eliminates expenditure incurred to train staff for operating intangible asset from being included in the cost of intangible asset (Hu, Percy, & Yao, 2015).
The project commenced by Technology enterprises Limited is successfully completed in 2018 June and the enterprise plans to incorporate the use of the intangible asset technology in business. The economic benefits as expected by organisation are probable to flow for coming 10 years. The expenditure on the intangible asset included the following:
|Cost of time spent searching for evaluating material alternative||$10,000|
|Cost of design model and construction of prototype||$7,000|
|Cost of time spend on training for new design:||$ 20,000|
Analysis of case:
as the development of the project is complete and the organisation is able to reliably estimate the cost of development along with probable estimation of expected economic benefits from the life of asset, the development made by entity meets the recognition criteria of the internally generate intangible asset according to AASB 138. The relevant paragraphs (i.e. paragraph 9, 18, 21-23) have already been presented above.
As far as accounting for the intangible asset is considered, this could be done at cost only for the initial level as specified by Paragraph 24. The cost is the expenditure incurred in development phase only excluding the research phase expenses and staff training expenses (i.e. as per paragraph 52-54, 57, 66-67 of AASB 138).
Hence, for Technology enterprises Ltd. the cost which has to be accounted in financials for the internally generated intangible asset shall include: Cost of design model and construction of prototype: $ 70000. The cost spent on research for material alternative and for training of staff shall be ignored. The relevant paragraphs have already been discussed earlier.
|Details of the case||Expenses incurred in different phases||Capitalisation allowed or not allowed||AASB 138 and relevant paragraph for the same||Capitalized amount|
|Cost of time spent searching for evaluating material alternative : $10,000||Research phase||No||56||0|
|Cost of developing and designing construction of prototype: $70,000||Considered under the development phase||Yes||66||$70,000|
|Cost for the time indulged in training and development: $20,000||Not available||No||67||0|
|COST OF INTENALLY GENERATED INTANGIBLE ASSET||$70,000|
Also, the present value has been ignored at this stage because Paragraph 24 allows recognition of internally generated intangible assets initially at cost only, and not at fair value. Hence the contention made by Accountant is correct.
The AASB 138 has been framed in accordance with the guidelines set by IAS 38. The standard had been mandatorily required to be applied for annual reporting by the Australian Listed entities from a period beginning from 1st January 2005. Since then more than a decade has already passed and every Australian Listed entity is following the standard. Every entity reports intangible assets in financial statements only when they meet the recognition criterion laid by this standard. The valuation of the intangible assets if recognised is also done as per the provisions of this standard by every entity. Also, the amortisation, impairment, revaluation and further actions dealing with intangible assets are also undertaken by listed entities in a manner provided by the provisions of AASB 138 only (Bodle, Brimble, Weaven, Frazer, & Blue, 2018).
|Life of the assets||Cost of the assets||Amortisation expenses|
|10 years||$ 70000||70,000/10= $ 70000|
In an era where every comparable organisation is following the same set of rules and restrictions, the chances of these rules and restrictions bringing a bar upon comparability never arises. The only manner in which the comparability of financial statements might lose to some extent is the use of management expectations as allowed by the accounting standard. Management of different organisations can formulate varying expectations in relation to their intangible assets as regard to probable economic benefits, fair value, impairment, and etc. This is the only place where the reporting for intangible assets by different entities shall seem difficult to be compared. Rest other rules and restrictions laid by the standard only work towards bringing uniformity and increasing comparability of financial statements (Mita, Utama, & Wulandari, 2018). Also as AASB 138 complies with IAS 38, the comparability at international level is also increased.
Response to CEO:
AASB 138 provides flexibility to organisation to make subsequent measurement of intangible assets after initial recognition either using cost model or revaluation model, as stated by Paragraph 71. According to Paragraph 74, when organisations use Cost Model, the accounting shall measure intangible asset by deducting impairment loss or amortisation expenses on accumulated basis from the initial cost. However as per Paragraph 75, if entity opts for Revaluation model, the measurement shall be equivalent to the fair value on the date of revaluation of asset as deducted by amortisation or impairment loss for subsequent period.
However, Paragraph 75 calls for the requirement to have fair value determined upon the basis of an active market. An active market as defined by the standard means a market where homogenous items are traded with availability of willing sellers and buyers along with price availability to public. I
In current case value in use for the intangible asset as per present value basis is $400,000. Also, only a single potential buyer exist for whom modifications shall be required. Hence, there is no existence of any active market for the intangible asset developed. So, the valuation has to be done only using the cost model. At reporting date management can only reduce amortisation cost from the cost as spread over the life of 10 years of intangible assets, i.e. $7,000 every year (70,000/10). No expected profit by reducing entire research and development expenditure from present value can be recorded (Brunelli, 2018).
Recommendations to the organisation about mitigation of concerns about investor’s interpretation:
As per CEO, the reporting of Intangible asset on cost model shall bring the share price down because of lower amount of asset value being recorded, and no recording for estimated profits. The investors might feel the project is not operating successfully. The contention of CEO might look reasonable, but still is incorrect. The following recommendations are suggested (Auditing and Assurance Standards Board, 2015b).
After assessing the international accounting standard, it could be inferred that, AASB 138 provides flexibility to organisation to make subsequent measurement of intangible assets and the same is recognized by the company by either using cost model or revaluation model, as stated by Paragraph 71. The impairment test as implemented under the IAS 136 is use to assess the residual or true and fair value of the recorded intangible assets in the books of account of company. Nonetheless, all the cost incurred for the intangible assets would be considered for the value of these assets. It is analysed that the cost is the expenditure incurred in development phase only excluding the research phase expenses and staff training expenses. The AASB 138 has been framed in accordance with the guidelines set by IAS 38 which is used to strengthen the transparency of the recorded intangible items in the books of account of company.