ACC210 Financial Accounting

ACC210 Financial Accounting

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ACC210 Financial Accounting

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ACC210 Financial Accounting

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Course Code: ACC210
University: Charles Sturt University

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Country: Australia

Question:

Recently, Palmer Ltd experienced a strike by employees that affected several of its manufacturing plants. The group accountant of Palmer Ltd argued that it was not appropriate to recognise depreciation expense during this period as the manufacturing equipment was not being used during the strike. He argued that during the strike the equipment did not depreciate and therefore an inappropriate matching of expenses and revenues would result if depreciation was to be recognised. His argument was based on the following points:

It is inappropriate to recognise depreciation and other expenses in periods for which there are no related revenues arising from production;
The basic driver of depreciation of the manufacturing equipment is wear and tear. As the equipment was not being used during the period, no wear and tear had occurred.

Explain whether the views of Palmer Ltd’s group accountant relating to depreciation are valid. You should refer to the Conceptual Framework and any relevant accounting standards to support your explanation.
The accounting department of Bennett Ltd is in the process of finalising its financial statements for the year ended 30 June 2018. The following items have been identified and the company needs to determine the appropriate accounting treatment for each of them:

a) Long service leave owing to the company’s employees in respect of past services is estimated to total $1,250,000;
b) The company’s machinery needs a complete overhaul every 5 years. The machinery was 5 years old as at 30 June 2018; The company has estimated that the next overhaul will cost $25,000;
c) Bennett Ltd had previously been sued by one of its major suppliers for breach of contract. The court case was decided on 28 June 2018 with the decision going against Bennett Ltd. The judge advised that the damages amount payable by Bennett Ltd to the supplier would be announced during October 2018. The legal team for Bennett Ltd has advised the company that the damages amount could be anywhere between $100,000 and $3 million.

The assignment will be marked according to the following assessment criteria:

logical application of concepts to situations, with adequate justification for choices made
professional presentation, including correct use of spelling, grammar and Harvard referencing.

Explain whether Mr Walters’ proposal is a sound idea, particularly in relation to the effect on the profit or loss statement of Maroons Ltd. You should refer to the
Conceptual Framework and any relevant accounting standards to support yourexplanation.

Answer:

The accountant for Broncobax should follow the following process in estimating the fair value of the acquired device in accordance to AASB 13 fair value measurement;

   Determine the asset that is the subject of measurement.

In the Broncobax case, the asset whose fair value is being determined is the exclusive rights to use the device, which when attached to the outside of the container it display the temperatures of the liquid inside the container. The exclusive privileges to usage of the device can be classified as a non-financial asset as they can be used to the advantage of the company. In determining the asset, which is subject of fair value measurement the accountant needs to consider the physical and legal characteristic of the asset and whether it can be used in isolation or together with other assets.

   Determine the valuation premise consistent with the highest and best use.

The accountant needs to identify the use of the device or asset that can generate the most/highest economic benefits not only to Broncobax but also to any firm, which may be interested in this device. The accountant must also determine if the best economic use of the device is when used together with other assets for example with beer, or as a business (used together with other liabilities and assets). If the device most advantageous use is in combination with other assets or as a business, the fair value of the device is the price that would be received in an arm’s length sale transaction of the asset supposing that the device would be used together with other assets, or  jointly with other assets and liabilities, which are currently available to market participants  (AASB, 2011). However, if the accountant determines that the most profitable use of the device is as a detached asset the fair value of the device is the consideration (price) market participants are willing to pay in an arm’s length transaction to acquire the device.

   Determine the most advantageous/principle market for the assets:

The accountant needs to identify the market with the highest level of activities or sales volume potential for the device. Apparently, the company has not clearly identified the most advantageous market for the device. The accountant needs to evaluate all alternative use of the device and their economic benefit to the firm to determine the most advantageous use of this device. For example, the company can initiate a study on whether the device can be used with a beer bottle, the cost of using it with beer bottles and the benefits. Additionally, the company can explore others uses of the device and even the competitive advantage the competitors would gain using this device.

   Determine the valuation technique:

The are several valuation techniques which the account can apply in valuing the device, including; active market prices, cost and income approach (CPA Australia, 2015). Since there is no active market for the device, the market approach cannot be used in this case. The company has not identified the income the device may generate for the company and hence the most practical approach for the account currently is the cost approach.
Question 2- Depreciation
The views of Palmer’s ltd group accountant are invalid unless the depreciation method the company uses is based on units of production. According to the conceptual framework on depreciation, depreciation of assets does not cease before the asset is either classified as held for sale or the when the asset is derecognized whichever occurs earlier. The suggestion that the no depreciation should be recognized in the period when there was no production is misguided because usage is not the only factor that is considered for depreciation. Other factors such as technical obsolescence, legal limits, and useful life of assets are important in determining the depreciation cost. Additionally, unless the strike period was very long, the useful life of the assets would not change and the aging of assets could still occur during this period. For example, if the predicted useful lives Palmer’s group buildings will not change because the there was a strike, the lease of the property will not be adjusted to account for the days the staff were on strike and neither will be the lives of other fixed assets. The matching principle, which states that expenses should be matched with revenues in the period in which they occur, is not applicable in this case because it associated with the accrual method and relates to reporting periods. It is unlikely that the strike lasted a whole financial year. It is prudent for the company to recognize expenses which are deemed to have occurred even when no revenues were realized. Not all expenses produce revenue and hence failure to generate revenues cannot be an excuse of not recognizing expenses. Moreover, some expenses are fixed in nature such as depreciation and must be recognized regardless of production out. The accountant suggestions imply that depreciation and other expenses vary perfectly with production output, which is not the case.  
Question 3- Research and development expenditure
Mr. Walter suggestion is a sound idea, as it would eliminate the research expenses on the income statement of the firm. According to the conceptual framework, research expenditures should be recognized in the profit and loss statement in the reporting period they are incurred while development cost is capitalized (Australian Accounting Standards Board., 2013). So if the Marron company moves ahead with the idea of this research and development project the research expenses will significantly affect the income and loss statement of the company in a negative way. However, if the company hires another independent company the external company Meninga ltd will recognize the research and development costs and hence this project will not affect the financial statements of the Maroons ltd. When the Marron ltd will acquire the intangible asset, it will recognize the patent as an asset in the balance sheet rather than an expense in the income statement (AASB, 1987). The profitability of Maroons ltd will therefore not be impacted by the purchase of the patent. The idea will, however, have other effects such as Maroon will lose control of the research and development of the product as it will hire an outside firm, and there is a risk of exposing research ideas to third parties. In addition, the cost of the patent may be higher than the total research and development costs the company would have incurred if it undertakes the research and development project itself. The management needs to weigh the benefits and drawbacks of carrying the research project on itself versus those of outsourcing. Other factors that the Maroons company can evaluate other than the effect of research and development cost on it income statement includes; it capacities to carry out this research such as technical knowledge, equipment compared to the capacity Meninga ltd. For example, Meninga can a company specializing in such research and development projects with skilled workforce and equipment enabling it to undertake the project more efficiently and effectively than Maroon’s project. Maroons ltd should also consider if and how the project will affect its operations. The suggestion is a good idea in relation to income and loss statement holding other factors constant.
Question 4 – Classification

a)    Estimated total long service owing of $1,250,000

The long service leaves owing can be classified and treated as a liability because the company has an obligation to pay the employee for their service because of either an well-known pattern of historical practice, published policies, or a satisfactorily specific present statement. The company recognizes and has indicated to it employees that it will accept such obligations and as a result, the entity has created a valid expectation on the part of those employees that it pay such long service leave in respect to past services. The long service leave owing meets the recognition criteria for liabilities as is it a present obligation resulting from past event and can be reliably measured.

b)    Machinery Overhaul costs estimate

 This machinery overhaul can neither be treated as a liability, a provision nor a contingent liability. The cost of the next overhaul can be classified as none of these. The statement does not indicate that the company has been setting aside some money for the overhaul of the machinery and neither is the overhaul of machinery and obligation to an outside party. To be classified as a contingent liability an item should be a current obligation arising from previous dealings and whose existence depends on happening or non-occurrence of one or more uncertain future events which a firm cannot entirely control. A contingent liability can as well be a present obligation, which cannot be recognized because it is unlikely to cause an outflow of economic resources to settle or cannot be reliably measured. The overhaul cost clearly fails the recognition criteria for liability, contingent liability, and provision.

c)    Damages payable

While the obligation to pay the supplier is already determined, the amount of liability is not known and will be known in a future date. The amount to be paid is contingent to the announcement of the judge at the set date. The damages payable meet the recognition criteria for liability but fail to meet the measurement criteria and hence this liability can be recognized by providing a reliable estimate as a provision. The damages payable cannot be treated as a contingent liability as the firm already knows they have a legal obligation to pay the damages because of a past event. Bennett Ltd should recognize the damages payable as a liability, then make a provision based on their best estimate of the damages payable, and disclose the nature of this provision in the notes to financial statements. The company should treat this as provision because it has a present legal obligation, future assets will flow out to settle this liability and a reliable approximation can be made in regard to the amount of the damages payable (Australian Accounting Standards Board., 2014).
References
AASB, 1987. Accounting For Research and Development Costs. [Online] Available at: https://www.aasb.gov.au/admin/file/content102/c3/AASB1011_5-87.pdf[Accessed 10 October 2018].
AASB, 2011. AASB- Fair Value Measurement. [Online] Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB13_09-11.pdf[Accessed 10 October 2018].
Australian Accounting Standards Board., 2013. Compiled AASB Standard AASB 138 Intangible Assets. [Online] Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB138_07-04_FP_COMPdec12_07-13.pdf[Accessed 10 October 2018].
Australian Accounting Standards Board., 2014. Australian Accounting Standards Board.. [Online] Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB137_07-04_COMPjun14_04-14.pdf[Accessed 10 October 2018].
CPA Australia, 2015. CPA Australia IFRS 13 Fair Value Measurement. [Online] Available at: https://www.cpaaustralia.com.au/~/media/corporate/allfiles/document/professional-resources/reporting/reporting-ifrsfactsheet-provisions-contingent-liabilities-and-contingent-assets.pdf?la=en[Accessed 10 October 2018].

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