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2. Stage 2

2.1. Recognition, Measurement, Valuation and Disclosure of Off balance sheet accounting (operating and financial leases)

INTERNATIONAL ACCOUNTING STANDARD 17

A lease is an agreement between two or more persons whereby the lessee will convey with the lessor in return for rent and the right to use an asset for an agreed period of time .In any lease agreement there are two parties who are involved that is the lessor who is the owner and the lessee who hires.

A finance lease is one that transfers substantially all the risks and rewards that go with ownership. Risk will include possibilities of losses from idle capacity, obsolescence, fire, theft and other variations. Contrastingly an operating lease does not transfer the risks and rewards that are incident to ownership .Assets remain property of lessor and it is him who insures that the asset is in good condition for example hiring office space.

 Under an operating lease in the lessor's book, it is treated as any other asset .some depreciation charges incurred in earning rentals are charged to income and the rental income will be recognized on a systematic basis over the lease term even if receipts are not on such a  basis.

 At disclosure in the lessors' books, the gross carrying amounts of the leased assets should be recorded .Accumulated depreciation and impairment losses off the balance sheet date should also be noted. Current year depreciation, current year impairment losses, a general description of the lessor's significant leasing arrangements and future minimum lease payments under non –cancellable operating leases are also disclosed.  In the lessee's books premiums including sublease payments are recognized in the income statement .Future minimum sublease payments expected to be received under non –cancellable leases at the balance sheet date. A general description of the lessees significant leasing arrangements including basis on which rent payments are prepared .Restrictions imposed by lease arrangements such as those concerning dividends additional debt and further leasing will also be disclosed

In finance  leasing disclosure  all risks are incident to ownership are transferred from lessor to lessee and thus the lease rentals receivable are treated by the lessor as  repayments of principal and finance income to re-imburse reward for his investment and services. In the lessee book, a portion of principal amount is paid and interest payable in the unredeemed amount. Lessors account is credited with cash price and debited with asset value and depreciation charged like any other asset implying that a finance lease is capitalized.

Disclosed items are gross investment in the finance lease, net investment in finance lease and present values of   receivable payments due within a year and between various periods. Unearned finance premiums, unguaranteed residual values, contingent rents recognized in income and a general description of the lessors leasing arrangements are also included.

In the lessee book, unrealised interest, total of future minimum sublease payments expected to be received under non- cancellable subleases at the balance sheet date are also included.

In this plight Miller, who represents shareholders and investors, believes that operating leases tend to recognize recording of net liabilities and assets only which distort balance sheets. He suggests that major accounting bodies have to make sure operating leases are also capitalized as is done to finance leasing in order to increase investor confidence. By this GAAPs will have to be reformed in support of his suggestions. Miller‘s claim is also supported by that the Institute of Chartered Accountants of India, Corporate Financial Reporting (page 4), explain that financial statements should be fairly disclosed by the management of companies in order for investors and owners to easily assess them. They also add that managers of companies under the stewardship theory are periodically accountable to their owners for efficient and profitable use through qualified financial reporting.

2.2. Fair-value accounting for impaired assets (historical cost vs. fair value accounting

Recognition

According to Isa 36, (2012) impairment of assets recognises that the prescribed procedures that an entity applies to ensure that its assets are carried at no more than their recoverable amount. An asset is carried at more than its recoverable amount if its carrying amount exceeds the amount to be recovered through use or sale of the asset.

Hence if the recovered amount is less than the carrying amount then the company should recognise the impairment loss. This loss has to be immediately recorded to the profit and loss. In cases where the asset was revalued then the loss can be shown as a decrease in the assets revaluation reserve as stated in the IAS 16.The standard also recognised that if the assets has recovered its value the company can revalue the impairment loss and this is in support of fair value concept. Some participant in the article criticised the use of fair value but rather think historical cost is more appropriate. As much as IASB views the environment market as perfect, in reality it is difficult to attain that. Thus management discretion in valuation of assets may be of much help to the equity of the investors.

Moreover Schuetze,(1987) disclosed that the FASB should be able to answer the question for investment type of assets ,how long should the quoted market price stay below cost before a write down is required? Is it six months, one year or three years may a written down be reversed if the quoted price bounce back. Hence it becomes a problem to management on when to write the impairment loss as the prices of assets can suddenly change. Even though FASB favoured fair value in recognising disclosure of an impairment but they have no hard facts and are still yet to find solution, then this gives the management a go ahead in continuous recognising historical cost concept.

Measurement

According to Titard and Pariser, (1996) state that the inconsistencies in measuring and reporting of impairment of long-lived assets and lack of authoritative guidance reduced relevance and comparability of financial statements. Hence if the impairment has to be done in an enterprise accurate measure is required so that it can be meaningful to users of financial statements. Since most management consider assets as capital investment excluding not for profit organisation view of assets, the FASB has considered fair value as it is usually consistent with the management former decision. Therefore when measuring assets they should be reduced to lower points and identified as cash flows. Though some participants in the article critised fair value, management discretion is difficult to create financial statements that are comparable therefore it may be wise for a business to adopt fair value even though the FASB cannot prove how valid their point is. Therefore the decision is left to the management to consider the best for the enterprise as to either to consider fair value or historical cost.

Valuation

King,(2009) said the erosion of earnings and capital due to a market's perception of losses or due to a cash of liquidity that drives values lower is misleading to investors and other users of financial statements. Therefore accurate valuation in required so that investors will know their actual values of their capitals and earnings per share. Some of the stakeholders in the article realised that valuation of assets at fair value was affecting the shareholders return on investment. As highlighted above the IASB favours fair value than historical cost but in periods of poor economic growth the information from the fair value has little relevance in decision based on balance sheet items. Hence overall use of fair value is efficient in the periods of good fortunes but companies can be better off in recession when valuing their assets at historical cost in recession.

Disclosure

Schueixe, (2009) asked should the write-down be mandatory if there is a chance that the asset will regain its stature or only when impairment is permanent? This is always a dilemma that is faced by the management. The IAS only stresses out the condition that led to the impairment and how it is treated and valued but the disclosure part it was not clear. Although he further gave a solution that FASB should require disclosure of the fair value (estimated price in an immediate, but not forced, sale for cash) of a nonmonetary asset or reasonable groupings of such assets, whenever the fair value of" the asset at the date of the most recent balance sheet is less than its cost. Therefore for the moment the about can act as an initial of organisation disclosure of financial statements.

Recognition. Measurement, Valuation and Disclosure of:

a. Capitalisation of advertising and marketing expenses.

The treatment of advertising and marketing expenses will have a great impact in the financial statements hence also in the decisions they are used for. For example if advertising or marketing expenses are to be capitalised in the books of accounts, the value of the business and the shareholder's value will increase even that was not supposed to be the case given the scenario. Capitalisation of an expense or project expenditure affects the statement of financial position while the profit and loss account is affected by expensing the cost. The rout taken will either widen your profit or decrease it and also determine whether the entity's asset base will decrease or increase. By an entity following accounting rules, it will maintain consistency and give a proper and appropriate treatment of cost.

Executive Committee (EC) Consolidated version as of 24 March 2010 highlighted that expenditure of introducing a new product or a service comprising of advertising and promotional activities should not be included as part of the cost of an intangible asset. This is in conjunction with the International Accounting Standard 38 (IAS38), US Generally Accounting Principle (GAAP) and International Financial Reporting Standard (IFRS) with a view that brands internally generated as a result of advertising and marketing as well as customer list shall not be regarded as an intangible asset especially according to GAAP when such an expense takes place for the first time.

However in accounting literature, there has been some discussions as to the treatment of catalogue a product of advertising and marketing. IAS 38 defines an intangible asset as a non-monetary identifiable asset without physical existence. In paragraph 5 of this standard, it gives reference that it shall apply also to expenditure of advertising among other things. Even if activities such as advertising and marketing may result in an asset which have physical existence for example prototype, the intangible component is primary to the physical element. Standard Interpretation Committee (SIC) 32 also concludes that a designed website which may part of used for selling and advertising is similar in many ways to catalogue and is an intangible asset to be included as per IAS 38.

Technical knowledge and marketing leads to economic future benefits. The results obtained, an entity will be able to control them especially when the knowledge is protected by copyrights or legal rights. A company may also have created customer loyalty and market share from marketing and advertising efforts and thereby expecting customers to trade with the business entity for a foreseeable future. However in the absents of any legal right protecting the relationship with customers, there will be no or insufficient control over future economic benefits and such will not meet the definition of an intangible asset.  

In general, basic advertising and marketing costs which are incurred in the ordinary course of the business shall be treated as expense in the period under review according to IAS 38.

b. Training and development expenses.

Despite  the fact that training, research and development are becoming the centre for entities competitive advantage, the International Accounting Standard Committee (IASC), the Financial Accounting Standard Board (FASB) and other accounting standards bodies each prescribe the accounting recognition and treatment of training and development (Bill Nixon, 1997). Training is the process of upgrading the skills and knowledge of the workforce in light that their skills will increase the efficiency in the operation of the business. Development is defined as the translation of research results or findings in a design for a new process or product.

Training: Most companies rely on Human Resource to generate profit, in annual reports usual a statement will be present stating that people are the most valuable assets of the firm. Regardless of this little if any effort have been made to represent employees as assets in the financial statements. The traditional accounting system tent to penalise managers of an entity who invest in the development of human resources. (American Society for Training and Development, 1970). Accounting theories allow for capitalisation of training costs on conditions that management must prove that the amount is material, verifiable, quantifiable, relevant and objective. In the development stage, training employees will be accounted as part of the intangible asset for example training employees and maintaining the designed website.

However IAS 38 paragraph 68 .C, noted that expenditure on training for the staff to operate the asset shall not be accounted for as part of an intangible asset. As one of its example of expenditure which cannot be recognised as an intangible asset, the standard explicitly provided for training activities to be treated as an expense.

It is provided that a firm may have skilled workforce and be able to train them to improve stuff skills which will result in economic benefits flowing to the firm. In light of that an entity may assume or expect that the skills from the stuff will continue to be available to the entity. However, the entity may not have sufficient economic benefits from trained workforce due to less control in terms of retaining the workers in the business. As such they should not be classified as intangible assets. For the same reason talents (technical) and specific management skills does not meet the definition of intangible asset unless protected by law or legal rights.

Development: Development and research are two activities of a business which are usually carried on together or one after the other. It may be difficult to distinguish between the research phase of the business internal project and the development stage. In cases where the business is unable to separate the two, the cost of that project should be treated as if the whole expenditure was incurred on the research phase. Examples of development projects include the design of moulds, jigs and moulds involving new technology as well as design, construction and testing of an alternative improved or advanced material, product, system or service.

According  to IAS 38 on intangible assets paragraph 57, the development costs shall be treated as an intangible asset of the business if the management can identify that the entity should be able to point out expenditure incurred on the intangible asset during the development stage, should provide for the existence of resources for the completion of the project, the entity should also give clarity on how the intangible will generate economic benefits that is it should point out the existence of a market for the product, when it is probable technically that he project will be complete for the purpose of use or resale, prove its ability and feasibleness of completing the cost and the entity should also provide that it intends to complete the project for sell or use.

If all of the above requirements are met, development expenditure should be capitalise in the balance sheet, but if any of the requirements is missing such an expenditure is to be treated as an expense in the Profit and Loss account.

c. Internal Software Development Expenses.

Software is increasingly becoming an integral part of most business involved in distribution, manufacturing and selling activities. Paul Munter (1999) (KPMG Peat Marwick Scholar) noted that whereas investment put by entities in software development is increasing significantly, the accounting standard setters have been reluctant to acknowledge that expenditure on software development have future economic benefits. Although there uncertainty in terms of the outcome and riskier in treating software development as an intangible asset, there have some calls from different stakeholders such shareholders advocating for capitalisation of internal software development, the reason supporting that being that development and implementation of software is similar to the creation in many aspects with the creation of tangible assets.

There has been a few discussion regarding the accounting treatment of internally developed software (R. G. Walker and G. R. Oliver. 2005). Conflicting views about the treatment of internal software development have been put forward by different accounting standard setting bodies. Some standards such as the U.S Financial Accounting Standard Board (FASB) in its statement 2 (1974) only made reference in passing to the treatment of internally developed software. FASB concluded that expenditure on internal software development should be recognised as an expense when incurred and charged to the Profit and Loss account. However IAS 30 on intangible assets requires that costs incurred on computer software development be treated as an intangible asset if and only if the asset's cost can be measured reliably.

Standard setters have not produced a universally agreed and concreate rules in dealing with expenditure on software development. The treatment of internal software development has only been addressed in discussion of other issues which are meant to decide whether certain activities should be treated as Research and Development or gives rise to intangible asset as in IAS 38.

IAS 38 concluded that during the research phase of the internal software development, (search for better alternative processes, service and formulation, evaluation, design and selection of new alternative system, process or service) should be treated as an expense in the financial statements. However on the construction, design and testing of a chosen alternative for the process or service, the incurred expenditure should be capitalised, the resulting intangible asset to be amortised over its useful life.

The Accounting Standard Executive Committee (AcSEC) in trying to clear up the air on the issue of how to treat internal software development expenditure in financial statements issued a Statement of Position (SOP) 98-1 o accounting for the cost of computer software development. In this statement the committee notes that in the preliminary project stage all costs incurred should be treated as expenses because the company is not at this stage at a position of making a decision of developing a software or buy from a vendor. When the company have decided to develop the software that is at the application development stage, the cost incurred at this stage must be capitalised and recognised as intangible asset to be shown in the balance sheet of the company. At the post implementation stage after the software package have been put in place, the capitalised expenditure on the intangible asset should begin to be amortised over its expected useful economic life

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