ACC201 Financial Accounting T219: Assessment 3- Australian Accounting Standards Analysis-Solution 2
Executive Summary
The assignment solution discusses the implementation of AASB 138, AASB 136, and AASB 137 as per the provided case studies. All these standards suggested that disclosure of material information is necessary for the companies as it influences the decision-making process of the investors and related stakeholders.
Question 1)
Wayne Upton (2001, p. 71) in his discussion of the lives of intangible assets noted that the formula for Coca-Cola has grown more valuable over time, not less, and that Sir David Tweedie, former chairman of the IASB, jokes that the brand name of his favourite Scotch whisky is older than the United States of America — and, in Sir David’s view, the formula for Scotch whisky has contributed more to the sum of human happiness.
Required:
Outline the accounting for brands under AASB 138/IAS 38 and discuss the difficulties for standard setters in allowing the recognition of all brands and formulas on statements of financial position.
Definition:
In order to be recognized as intangible assets, it is important that brands should meet definition related to the intangible assets and their related recognition criteria. According to the Australian accounting standard board 138 or international accounting standard 38, the intangible non-monetary asset is considered to be an asset without physical substance.
If any asset related to brands is meeting this definition of intangible assets, then it is important for that intangible asset to meet the recognition criteria as well before considering it a recognized and complete intangible asset. As far as recognition of intangible assets is concerned, intangible assets are acquired on their costly acquisition of the intangible assets is combined with the business on their fair value. During the recognition of intangible assets, it is also mandatory to conduct internally generated research to meet the recognition criteria. After conducting all these recognition criteria, the rest is similar to property, plant, and equipment (Loftus, 2018).
Recognition:
Before intangible assets are recognized in the balance sheet of the company, it is mandatory for them to meet the recognition criteria (Lumen, 2019). Specifically speaking, there are two aspects of the recognition criteria for intangible assets. The first aspect is the expected future economic benefit which can be generated by that specific intangible asset while the second aspect of the recognition criteria is the cost at which the intangible asset can be measured.
According to Australian accounting standard board 138, the influence of probability of the future economic benefit related to the intangible asset is reflected in shape of measurement of the acid in the fair value of the Asset.
Measurement:
As far as intangible assets are concerned, the general rule related to their environment is measurement at cost. In the form of a business combination, then the cost of that specific intangible asset is calculated on the basis of its fair value. It is important that the intangible asset should meet the provided and appropriate definition of the acid in order to recognize it on the balance sheet of the company as a separate asset (Bamber & Parry, 2014).
Question 2)
Gu and Lev (2011) argue that the root cause of many goodwill write-offs is that the shares of the buyer are overpriced at the acquisition date.
Figure 7.8 presents eBay’s cumulative stock return against the S&P 500 index from 2003. In mid-September 2005, eBay acquired the internet phone company Skype for $2.6 billion. On 1 October 2007, it announced a massive goodwill write-off of $1.43 billion (55% of the acquisition price) related to the Skype acquisition.
Gu and Lev argue that the root cause of this behaviour is the incentives of managers of overvalued firms to acquire businesses, whether to exploit the overpricing for shareholders’ benefit or to justify and prolong the overpricing to maintain a facade of growth. Goodwill write-offs are accordingly an important business event signalling a flawed investment strategy.
Part A) Explain the circumstances under which goodwill is recognised and how any subsequent write-off occurs under AASB 136.
Goodwill mostly arises when a business acquires another business or which is also known as a business combination. Goodwill is calculated as the excess amount greater than the fair value of the net assets which have been acquired by the company. Goodwill is calculated according to the cash-generating unit in the company on a separate basis or overall basis. Goodwill is based upon the expected benefit which can be extracted after the business combination. Impairment calculated for the Goodwill is first allocated to the goodwill before allocating to other assets related to cash-generating units in the company (Loftus, 2018).
Once the Goodwill has been written off by the management, then it can never be reversed according to the accounting standards. Goodwill can also be defined from an accounting perspective as a premium amount paid by the acquiring company which is above the fair value of that specific Net Asset which is being acquired. A goodwill impairment loss is generally calculated and recognized in the financial records when the recoverable amount related to the cash-generating unit decreases below the amount related to carrying value (Australian Government, 2015).
Part B) Explain why a significant goodwill write-off may signal a ‘flawed investment strategy.
A significant amount of right of related to Goodwill can be because of the fact that acquisition party in the acquisition process has over estimated the future expected earning capacity of the business or asset which is being acquired (Marek Muc, 2019). It is because of the fact that the company acquiring the business is paying a significantly higher price for the business under acquisition which results in flawed investment strategy.
According to the case study, eBay was required to write off approximately 55% of the acquisition value related to Skype mostly because of the fact that eBay was required to pay over the estimated price for Skype at the time of acquisition.
Question 3)
Tooth Ltd acquires Nail Ltd, effective 1 March 2020. At the date of acquisition, Tooth Ltd intends to close a division of Nail Ltd. As at the date of acquisition, management has developed and the board has approved the main features of the restructuring plan and, based on available information, best estimates of the costs have been made. As at the date of acquisition, a public announcement of Tooth Ltd’s intentions has been made and relevant parties have been informed of the planned closure. Within a week of the acquisition being affected, management commences the process of informing unions, lessors, institutional investors and other key shareholders of the broad characteristics of its restructuring program. A detailed plan for the restructuring is developed within 3 months and implemented soon thereafter.
Part A) Explain the accounting for restructuring provisions with reference to AASB137.
In the case of restructuring, it is important from the accounting perspective that carrying amount related to the beginning as well as the ending of the financial year should be disclosed properly in the financial records of the company. Additional provisions related to the financial year should also be disclosed, including the increase in the level of current provisions. Amount utilized from the provision during the current financial year should also be disclosed in the same financial year. On used amount during the financial year should be reversed during the same financial period. Not required by the management to disclose comparative information in the last financial year in case of restructuring from an accounting perspective.
Part B) Under AASB137, Should Tooth Ltd create a provision for restructuring as part of its acquisition accounting entries?
As far as the creation of a provision is concerned, it is mandatory for the management of the company to disclose the carrying amount related to the beginning of the financial year and the end of the financial year. It is also important for the management to properly disclose the provisions related to the financial year, including the increase in the currently available provision. It is a basic requirement under Australian accounting standard board 137 which requires the management to properly disclose provisions during the restructuring process. Provisions should be disclosed because most of the time they are considered to be material, and it is important to disclose material information in order to improve the decision-making process of the investors and related stakeholders. Any provision influencing the decision-making process of the shareholders is required to be appropriately disclosed in the financial records by the management (Federal Register of Legislation, 2015).
Part C) How would your answer change if all the circumstances are the same as those above except that Tooth Ltd decided that, instead of closing a division of Nail Ltd, it would close down one of its own facilities?
If the management decides to close one of their own facilities, it will be mandatory for the management to disclose this information appropriately to the shareholders and related stakeholders of the company in order to positively improve the decision making of the shareholders and stakeholders. As far as disclosure related to provisions is concerned, it is mandatory for the management to provide detailed information regarding the provisions related to the closing facility in financial statements and notes to the accounts for the interest of shareholders and related parties (Bamber & Parry, 2014).
Recommendations/Conclusion
It is recommended that management should always disclose provisions in case of restructuring the company. It is also important that management should properly disclose the goodwill value as it is required by the AASB 138, but management should make sure that the goodwill is falling within the definition of an asset and is recognizable.
References
Australian Government, 2015. AASB 136 – Impairment of Assets – August 2015. [Online] Available at: https://www.legislation.gov.au/Details/F2015L01622 [Accessed 14 September 2019].
Bamber, M. & Parry, S., 2014. Accounting and Finance for Managers. 1st ed. London: Kogan Page.
Federal Register of Legislation, 2015. AASB 137 – Provisions, Contingent Liabilities and Contingent Assets – August 2015. [Online] Available at: https://www.legislation.gov.au/Details/F2015L01607 [Accessed 14 September 2019].
Loftus, J., 2018. Financial Reporting. 2nd ed. Milton, QLD: John Wiley and Sons.
Lumen, 2019. Introduction to Intangible Assets. [Online] Available at: https://courses.lumenlearning.com/boundless-accounting/chapter/introduction-to-intangible-assets/ [Accessed 14 September 2019].
Marek Muc, 2019. IFRS 3 Business Combinations. [Online] Available at: https://ifrscommunity.com/knowledge-base/ifrs-3-business-combinations/ [Accessed 14 September 2019].
