ACC201 Financial Accounting T219: Assessment 3- Australian Accounting Standards Analysis-Solution 1
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.
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.
Required:
a) Explain the circumstances under which goodwill is recognised and how any subsequent write-off occurs under AASB 136.
b) Explain why a significant goodwill write-off may signal a ‘flawed investment strategy
Question 3
Tooth Ltd acquires Nail Ltd, effective 1 March 2020. At the date of acquisition, Tooth Ltd intends to close the 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, the 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.
Required
a) Explain the accounting for restructuring provisions with reference to AASB137.
b) Under AASB137, Should Tooth Ltd create a provision for restructuring as part of its acquisition
accounting entries?
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?
Executive Summary
The report evaluates the interpretation of accounting standards, including AASB 138 intangible assets, AASB 36 impairment of assets and AASB 137 that is restructuring provisions. Question on AASB 138 covered understanding of the recognition of brands as intangible assets and their treatment as per the accounting standard. Secondly, case in question 2 relates to AASB 136 that is impairment of goodwill discussing overpricing of shares during acquisitions and subsequent write-offs of goodwill. Lastly, the third question discussed AASB 137 that is recording provision in connection with restructuring and acquisition.
Answer 1:
Brands are recognized as intangibles under AASB 138 when they meet the recognition criteria of intangible assets. IAS 38 or AASB 138 defines intangibles as an identifiable asset which has no physical existence and cannot be valued. A brand is recognized as an intangible asset if it fulfills the criteria of AASB138/IAS38. One in internally and the second is acquired externally. Brands can either be acquired externally or generated internally. It would be recognized as internally generated if it meets the criteria of para 57. However, if externally acquires, it is recognized at cost and amortized afterward. The standard-setter faced challenges to determine the value of intangibles at which they must be recognized. It might be easier to set the value of the externally acquired brand, but it is quite difficult to assess the cost of internally generated brand. Hence the recognized cost of brands may not be fully reliable as there might be an issue of duplication of recognition or over/under valuation in the statement of financial position (Artsberg & Mehtiyeva, 2017).
Answer 2
- AASB 136 related to the impairment of assets. The objective of this standard is that assets are recognized at no more than its recoverable market value. Goodwill is one of the assets. Goodwill is an intangible asset that is recognized as a result of a business combination. The price that one company is willing to pay significantly more than the fair market value of another company is known as goodwill. This may include brand name, loyal customers, high repute, etc. Goodwill has an indefinite life as per AASB 136, but that is tested for impairment at the end of each reporting period regardless of impairment indicators. Some companies may prefer to write off goodwill by amortizing it over a 10-year period (CFI Education, 2019).
- Impairment is charged as an expense in the income statement, and the carrying value of the asset is reduced by the amount impaired which ultimately reduces net worth of the company. Goodwill writes off is an important event that signals flawed investment strategy. In the event of acquisitions, overpricing is exploited when management pays over and above than the fair value of the acquired business. Hence share over pricing at acquisition predicts subsequent write-offs of goodwill. Hence over-priced company acquisitions are over-paid for strategic miss-fit (Gu & Lev, 2015).
Answer 3:
- AASB 137 is a standard that highlights accounting for provisions, i.e., liabilities of uncertain timing and amount. A provision is an amount recorded in liabilities that may would cover future obligations of companies. It is recorded so as to make the current year’s balances give a more accurate view. A provision is recognized if a probable outflow of economic resources is expected as a result of a constructive or legal obligation. Restructuring provisions are recognized in the event of restructuring plans such as sale or termination as a specific line of business, closures of business sites, reorganizations, and change in structure of management. Restructuring provisions only accommodate direct expenditures that arise from restructuring (Loftus, 2018).
- Provisions are recognized at acquisitions only if the acquirer has obligations at the date of acquisition. Tooth Ltd should create provisions as part of its acquisition entries because at the date of acquisition, restructuring was planned, and obligation existed as they intended to close a division of its business completely.
- If Tooth Ltd plans to close one of its own facilities instead of closing a division of its acquire. Restructuring provisions will definitely be recognized, however no accounting entries would be made as part of acquisition entries. The restructuring charge would go to the financial statement of Tooth Ltd itself. The charge will only be made if Tooth Ltd has constructive obligation towards those who would be affected by the restructuring of the business (Henderson, Peirson, Herbohn, Artiach, & Hpwieson, 2017).
Recommendations &Conclusion
We have analyzed three standards in total from the list of accounting standards. The first standard that has been analyzed is AASB 138, i.e. recognition of intangible assets by discussing brand value and its relevant accounting treatments as per accounting standards. We further discussed the challenges that the accounting settlers faced while establishing the recognition of intangible assets. However, whatever difficulties came, it was important to recognize brand name as it plays a vital role in bringing profits to the business. For example, if Coca-Cola brand name is used by a lemonade company, it won’t bring of any use as it will not bring any higher profits. It is only valuable for Coca-Cola itself. T has no value if separated from the company. It is recommended that appropriate amortization method must be used to reflect the true value of the brand and not overestimate assets.
Secondly, we have seen that investors have not been benefitting while they buy shares during acquisitions. Shares are overly priced by charging the cost of acquired goodwill as well. However, this goodwill is later written-off and gives losses to the investor. This exploitation must be avoided by adding some restrictions to the standard of Impairment of assets, especially regarding immediate write-offs of goodwill. There must be an extended tenure during which no write-offs be allowed after acquisition.
Lastly AASB 137 regarding provisions was discussed, which included the treatment of restructuring provisions. The case of Tooth Ltd and its acquisition was connected to a plan of restructuring. The restructuring charge is explained in the standard how it should be treated, but there are inconsistencies and non-clarity of what amounts be used as provisions as it is an estimation of future costs that would be incurred by the company.
References
Artsberg, K., & Mehtiyeva, N. (2017). A literature review on intangible assets: Critical questions for standard setters. Retrieved September 15, 2019, from https://pdfs.semanticscholar.org/f855/30d9d9b5ad7b7d58e3b8fe855ad2a6553cb3.pdf
CFI Education. (2019). Goodwill: An intangible asset created when the purchase price is higher than the fair market value. Retrieved September 15, 2019, from https://corporatefinanceinstitute.com/resources/knowledge/accounting/goodwill/
Gu, F., & Lev, B. (2015). Over Priced Shares, Advised acquisitions and Goodwill Impairment. The Accounting Review , 86 (6), 1995-2022.
Henderson, S., Peirson, G., Herbohn, K., Artiach, T., & Hpwieson, B. (2017). Issues in Financial Accounting (16 ed.). Australia: Pearson.
Loftus, J. (2018). Financial Reporting (2 ed.). Milton, QLD: John Wiley and Sons.
