Understanding Assets And Recognition Criteria In Financial Statements
Assets as per AASB’s Framework
According to the AASB’s Framework for the Preparation and Presentation of Financial Statements, assets means a resource which is within the control of the entity occurred as a result of some past events and having future economic benefits for the entity. The future economic benefits may be in the form of generating future revenues, generating cash flow by selling or exchanging of the asset, by settling a liability with that asset, etc.
To a layman, asset means a resource which is valuable for person holding it, valuable means which can generate cash or cash equivalent or can be used in generating cash and cash equivalent or which can be used for the benefit of the person having it. For example, cash in hand, fixed assets, like car, machine, land and building or money receivable from third party, etc.
- According to the AASB’s Framework for the Preparation and Presentation of Financial Statements, the below are the criteria that must be satisfied before recognizing an asset in the Statement of Financial Position:
- The asset should have future economic benefit for the entity
- The asset should have some cost or value associated with it and this cost can be measured reliably
For a layman, an asset should be recorded in the books of accounts, when the asset has some use for that person and has some reliable value or cost associated with it, i.e. the purchase price of the asset. For example, Mr. A has purchased a car, so the car is valuable for Mr. A as Mr. A can use this car for his business and other purpose and has value or cost associated with it. This cost is the purchase price paid by Mr. A to car seller.
- The recognition of the given asset in books is as below:
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Sr. No. |
Particulars |
Whether it’s an asset? |
Should it be recognized in books? |
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1 |
the franchise agreement |
It is an asset, since it has future economic benefits for Wilson Pty Ltd. and is in control of Wilson since, it has the right to use and operate the restaurants through this franchise agreement. |
It should be recognized in statement of financial position as franchise agreement has future economic benefits to Wilson Pty Ltd. These future benefits are the exclusive rights to sell and operate the restaurants in Sydney. Further, the cost can be reliably measured which is the payment of franchisee fee. |
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2 |
the employees |
No, it is not an asset since it is not within the control of the Wilson Pty Ltd. |
The recognition criterion of asset, says that asset should have future economic benefits, means the benefits should flow to the entity for more than one period. Since, the employees are paid for the services performed during the period only, hence they do not future benefits for the company. Hence, they cannot be recognized as an asset. |
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3 |
the restaurant premises |
It is not an asset for Wilson Pty Ltd since it is not with in the control of the entity |
No, the restaurant premises should not be recognized in the books because the rent paid by Wilson is towards the use of the asset for the current period. It does not have future durability. |
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4 |
the equipment and fixtures and fittings |
Yes, equipment and fixtures and fittings are assets since they have future benefits and can be controlled by the entity |
Yes, they should be recognized in statement of financial position as both the criterions for recognition are met. First, they have future economic benefits for the entity in the form of use in the business and their cost i.e. the purchase price is readily available and is reliable. |
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5 |
the advertising costs |
No, it is not an asset, since it does not have future economic benefits |
No, it should not be recognized as the benefit for advertising cost paid is for short term only and no future benefits are there. |
Solution-2 (a)
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Scorpio Ltd |
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STATEMENT OF PROFIT & LOSS AND OTHER COMPREHENSIVE INCOME |
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For the year ended on 30 June, 2017 |
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(Amount in $ ‘000) |
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Particulars |
For the year ended |
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I. |
Revenue: |
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Sales |
540,000 |
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Gain on sale of financial assets |
4,000 |
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Other income |
16,000 |
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Total Revenue |
560,000 |
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II. |
Expenses |
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Cost of goods sold |
310,000 |
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Occupancy expense |
45,000 |
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Distribution expense |
55,000 |
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Administration expense |
50,000 |
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Other operating expenses |
22,500 |
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Finance costs |
27,500 |
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Total expenses |
510,000 |
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III. |
Profit before tax (I-II) |
50,000 |
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Less: Income tax expense |
15,000 |
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IV. |
Profit after tax from continuing operations |
35,000 |
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Loss for the year from discontinued operations |
(5,000) |
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V. |
Profit for the period |
30,000 |
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Other comprehensive income (OCI) |
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(A) Items that may be reclassified subsequently to profit or loss |
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Unrealized gains on cash flow hedges |
13,000 |
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Income tax relating to above |
(4,000) |
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Loss on exchange differences on translation of foreign operations |
(6,500) |
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Income tax savings on above |
2,000 |
4,500 |
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(B) Items that will not be reclassified subsequently to profit or loss |
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Gain from revaluation of property, plant and equipment |
20,000 |
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Income tax relating to above |
(6,000) |
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Loss from re-measurement of defined benefit superannuation plan |
(7,500) |
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Income tax savings on above |
2,000 |
8,500 |
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(C) Reclassification Adjustments |
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De-recognition of financial asset earlier recognized in OCI |
(4,000) |
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Income tax relating to above |
1,000 |
(3,000) |
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VI. |
Total other comprehensive income (A+B) |
10,000 |
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VII. |
Total comprehensive income for the period (V+VI) |
40,000 |
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The adjustment required relating to the gain on the sale of the financial assets being recognized in profit or loss is to record a reclassification adjustment in other comprehensive income. As per AASB 101, reclassification adjustments are those amounts which are or were recognized in other comprehensive income in current or previous periods and now are reclassified to profit and loss account. These amount needs to be deducted from other comprehensive income and credited to the profit and loss account. This is done to avoid inclusion of same amount twice in the statement of profit and loss and other comprehensive income.
In the given case, Scorpio Ltd. has revalued the portfolio in the year ended 30 June, 2016 by the amount of $4,000 through other comprehensive income. On 1 July, 2016, the company sold the portfolio and recognized the gain in P&L along with its tax impact. This leads to inclusion of gain amount twice. Hence, to remove this ambiguity, the amount of other comprehensive income needs to be debited by the amount recognized in FY 2015-16 along with its tax impacts. Hence, the OCI is reduced by $3000 (i.e. gain of $4000 and $1000 as its tax impact).
Asset Definition for a Layman
- No, the change in useful life and the reassessment of the residual value of the machine is not a prior period error instead they are revision in estimates. Estimates are judgements taken on the basis of current information, data and experience. They may change with the time due to change in information, data and experience on the basis of which estimates are prepared. Further, para 32 of AASB 108 clearly states that change in useful life or estimated pattern of consumption of future economic benefits embodied in depreciable assets is a change in estimates.
As per AASB 108, change in estimates should be accounted for prospectively, meaning thereby such change should be reflected in the profit and loss account of the period of change and the future periods. Para 36 of AASB 108, supporting the above fact is reproduced below:
“36 The effect of a change in an accounting estimate, other than a change to which paragraph 37 applies, shall be recognized prospectively by including it in profit or loss in:
(a) the period of the change, if the change affects that period only; or
(b) the period of the change and future periods, if the change affects both.“ (“Accounting Policies, Changes in Accounting Estimates and Errors”, 2018)
So, the changes in residual value estimation and change in useful life, should be accounted for prospectively i.e. from the year ended on 30 June 2016 and thereafter.
- The amount of depreciation in relation to the item of equipment for the year ending
- 30 June, 2015
Depreciation expense = (cost – residual value)/ useful life
Depreciation expense = (400,000-40,000)/10
Depreciation expense = $ 36,000
- 30 June, 2016
Depreciation expense = (Carrying value – revised residual value)/ revised useful life
Depreciation expense = (256,000-46,000)/6
Depreciation expense = $ 35,000
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Particulars |
Amount ($) |
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Cost of Equipment |
$ 400,000 |
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Less: Depreciation expense |
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30 June 2012 |
$ 36,000 |
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30 June 2013 |
$ 36,000 |
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30 June 2014 |
$ 36,000 |
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30 June 2015 |
$ 36,000 |
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Carrying value as on 1 July 2015 |
$ 256,000 |
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Revised Residual value |
$ 46,000 |
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Revised Useful life |
6 |
30 June, 2017
Depreciation expense = (Carrying value – revised residual value)/ revised useful life
Depreciation expense = (256,000-46,000)/6
Depreciation expense = $ 35,000
As per para 39 of AASB 108 “Accounting Policies, Changes in Accounting, Estimates and Errors”, an entity shall disclose the nature and the amount of change in accounting estimate on the current year period and on the future year periods, if there.
The appropriate note disclosure for Spark Ltd’s financial statements for the year ended 30 June 2016 is as below:
During the year, the management decided to review the useful life and residual value of the equipment, so they hired a technical expert for the evaluation for the same. According to the expert, as on 30 June, 2016, the remaining useful life of the equipment was six years and its residual value was $46,000. So, the management revised its estimates on the basis of expert’s report.
The financial impact of above change in estimate is that the useful life is increased by 1 year and residual value has been increased by $6,000. Consequently, the depreciation expense has been reduced by $1000 (i.e. from $36,000 per year to $35,000 per year) for the year ended on 30 June, 2016 and for the coming next 5 years.
References:
Australian Accounting Standards Board (2018). Framework for the Preparation and Presentation of Financial Statements. Retrieved from https://www.aasb.gov.au/admin/file/content105/c9/Framework_07-04_COMPjun14_07-14.pdf
Australian Accounting Standards Board (2018). Presentation of Financial Statements. Retrieved from https://www.aasb.gov.au/admin/file/content105/c9/AASB101_07-15.pdf
Australian Accounting Standards Board (2018). Accounting Policies, Changes in Accounting Estimates and Errors. Retrieved from https://www.aasb.gov.au/admin/file/content105/c9/AASB108_07-04_COMPmay11_07-11.pdf