Accounting for Non-current and Current Assets

8/14/2019 Accounting for Non-current and Current Assets

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LECTURE TWO Accounting for Non Current assets and Current Assets

COMPANY ACCOUNTS - VALUATION OF ASSETS

Many companies now show property at a revaluation amount rather than at cost.

Companies which choose to show assets at revaluation rather than cost have to account forthe difference arising as a result of the revaluation by creating a revaluation reserve. Forexample, if a company which has property with a book value of $1m, based on cost, decidesto show that property on the balance sheet at revaluation of $2m, then a Revaluation Reserveof $1m will have to be created and shown as below:

Balance Sheet as at 31st December 2007 Before AfterRevaluation Revaluation

$000 $000

Issued share capital 6000 6000Revaluation Reserve - 1000Retained Profit 2500 2500

8500 9500Represented by:

Property (at cost) 1000 -Property (at revaluation) - 2000Other fixed assets 5000 5000Net current assets 2500 2500

8500 9500

It should be noted that if assets are revalued then any depreciation of them will be based onthe revaluation figure.

ACCOUNTING FOR RESEARCH AND DEVELOPMENT

Three categories of research and development are identified and defined as follows:-

a) Pure (or basic) research: experimental or theoretical work undertaken primarily toacquire new scientific or technical knowledge for its own sake rather than directedtowards any specific aim or application.

b) Applied research: original or critical investigation undertaken in order to gain newscientific or technical knowledge and directed towards a specific practical aim orobjective.

c) Development: use of scientific or technical knowledge in order to produce new orsubstantially improved materials, devices, products or services to install new processesor systems prior to the commencement of commercial production or commercialapplications, or to improving substantially those already produced or installed.

Only expenditure with an `element of innovation' may be regarded as research anddevelopment activity.


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Accounting policies adopted by companies in respect of research and developmentexpenditure must conform with fundamental accounting concepts, in particular the accrualsand the prudence concepts.

Expenditure on pure/and or applied research should be written off as it is incurred, whilstexpenditure on development of new products or services may, in certain circumstances becarried forward to be matched against future revenues. That is, the expenditure should beclearly identifiable with the development of a particular product or project and it is reasonablycertain that the development will turn out to be profitable in the future.

SAQ1

For the year ended 31st December 2007, Sherwood plc incurred research anddevelopment costs of $193000. Part of this cost, $80000 was related to pure andapplied research, whilst the remainder was related to the development of a newdevice that will be marketed from 2008 onwards. The directors are confident of thesuccess of this new device.

ACCOUNTING FOR GOODWILL

Goodwill is the difference between the value of a business as a whole and the aggregate ofthe fair values of its separable net assets.

Only purchased goodwill should be recognised in financial statements, and that goodwill maynot be treated as a permanent asset but must be either:

a) written off directly against reserves upon acquisition (the preferred method),or

b) subject to an Impairment Review

ACCOUNTING FOR LEASES AND HIRE PURCHASE CONTRACTS

A FINANCE LEASE usually involves the lessee paying the full cost of the asset together withsome element of interest to the lessor, over a period of time. The lessee has the majority ofthe risks and rewards concerned with ownership.

Assets held under finance leases should be capitalised in the books of the lessee and that theassociated creditor should be recognised.

An OPERATING LEASE usually involves the lessee paying a rental for the hire of an asset for aspecified period of time. The lessor retains the risks and rewards associated with ownership.

The rental payment is passed through the profit and loss account as an item of expenditure.

Hire purchase is to be treated in the same way as finance lease.


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STOCKS AND LONG TERM CONTRACTS

In accordance with the matching concept, stock items which remain unsold or unused at theend of an accounting period are carried forward to the next accounting period, so that the costcan be matched with the related sales revenue. Stocks are valued at the lower of cost or net

realisable value, and that the valuation is undertaken separately on different stock groupswhere possible.

Net realisable value is the estimated proceeds from the sale of items of stock less all furthercosts to completion and less all costs to be incurred in marketing, selling and distributingdirectly related to the items in question".

Costs of stock would comprise that expenditure which has been incurred in the normal courseof business in bringing the product or service to its present location and condition. Such costswill include all related production costs, even though these may accrue on a time basis".

Replacement cost and LIFO are generally not appropriate methods.

SAQ2

Given the following information, calculate the figure for closing stock to be shown in theFinancial statements.

Stock Valuation $000

Stock Item FIFO LIFO Net Realisable ValueGroup A 760 740 920Group B 1040 960 1230

Group C 240 220 200

G. LONG-TERM CONTRACT WORK-IN-PROGRESS

A long term contract usually is of more than one years duration. However, where materialamounts are involved it is appropriate to treat any contract which spans the balance sheetdate as long-term.

If a company waited until the contract was fully completed before taking any profit, this would

result in a distortion of results. In order to avoid this, contract turnover and profit is to berecognised over the life of the project to match turnover to costs.

Accounting Treatment

Where the outcome of a contract can be foreseen with reasonable certainty, attributableprofits should be calculated on a prudent basis and included in the accounts. The amount ofprofit taken up should reflect the proportion of work carried out at the accounting date andshould take into account any known inequalities in the profit stream from the contract.

Where the outcome of a contract cannot be assessed with reasonable certainty, no profit


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should be reflected in the profit and loss account in respect of that contract.

If it is expected that the ultimate outcome will be a loss on the contract, all the loss should berecognised as soon as it is foreseen.

Work that has been invoiced but not yet paid for is treated as a debtor in the balance sheetand costs incurred relating to work not yet invoiced is included in the stock and valued at costunder the heading "long-term contract balances".

Please note that attributable profit may be calculated in a number of ways. Another method isto take the value of work certified/invoiced to date, less the cost incurred to date on thatwork.

ExamplePROJECT ALPHA

The project is in its first year, details are as follows:

$000Total contract price 410Costs incurred in year one 132Estimated costs to completion 175Payments on account 120 Value of work certified (at end of year one) 174

Estimated total contract profit is therefore:$000 $000

Contract price 410Less: costs incurred to date 132

costs to complete 175 307Estimated profit on contract 103

The attributable profit for the first year is:value of work certified less costs incurred to date ie $174000 - 132000 = $42000.

This is shown in the Statement of Financial Performance as follows:

$000Included in turnover (value of work done) 174Included in cost (cost of work done) 132

Gross profit 42

In the Statement of Financial Position, the difference between Turnover and Payments onaccount is shown with debtors under the heading "Amounts recoverable on contracts", in thisexample:

$000Turnover 174Payments on account 120 Amounts recoverable on contracts 54


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In this example all costs incurred in the year relate to that part of the contract which has beenvalued by the architect and have been transferred to cost of sales at the year end, leaving azero balance in stocks.

SAQ3You have recently been employed by Wigan plc as assistant to the financial accountant whois, at the moment, preparing the published accounts for the year to 31st March 2007.

The directors are keen to report the highest possible figure for reported profit and you havebeen asked to advise on the treatment of certain items, details of which are given below.

(i)The finished stock consists of three main product lines, A, B and C and the table belowgives relevant financial information relating to each.

Cost Cost Net realisable

Product line (FIFO) (AVCO) Value$ $ $

A 120,000 118,500 157,000B 68,000 66,000 84,000C 43,000 40,000 38,000

(ii)The company has developed a new product which will be launched on the market in June2007. There is general agreement that the new product will be a financial success. The costfor research and development for the year is $28,000 of which $12,000 was fordevelopment of the new product.

(iii)During the course of the present financial year, Wigan plc, took over the business of asole trader. Part of the purchase price was for goodwill which was valued at $50,000.

(iv)On 1st April 2007 the company decided to revalue its freehold premises. These were

shown in last years balance sheet at cost less depreciation $600,000. The revaluation figure

was $2.4 million.


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ANSWERS TO SAQ'S

SAQ1

The $80000 for pure and applied research would have to be written off in the year in which itwas incurred.

The remaining $113000 development expenditure could either be written off immediately asincurred, or carried forward in the balance sheet as an intangible fixed asset and written offover the years in which the new device is marketed.

This option is only available since the cost is clearly identifiable to the new device and thedirectors are confident of the future profitability from sales of the device.

SAQ2

The lower of FIFO cost or net realisable value would be taken for each stock group.

The LIFO cost valuation is not considered acceptable.

Stock valuation:Group A 760 (FIFO)Group B 1040 (FIFO)Group C 200 (NRV)Stock Value $2000

SAQ3

(i) Stock is valued at lower of cost or net realisable value.Both FIFO and AVCO are acceptable methods of stock valuation under the standard.

$Product Line A 120000 (FIFO)Product Line B 68000 (FIFO)Product Line C 38000 (NRV)

$226000

Note that for product lines A and B the FIFO figure is used as this would result in thehigher reported profit figure.

(ii) The research cost of $16000 should be written off immediately against the profit.The development cost of $12000 could be written off also against the profit, but itwould be better in this case to capitalise the cost and write it off over future years asthis would produce the higher profit figure.The capitalisation option is available here because the cost can be identified with theproduct, and future sales are expected to be profitable.

(iii)As this is purchased goodwill it can be recognised in the accounts.It could either be written off immediately against reserves or subject to an impairmentreview each year.


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Immediate write off against reserves would produce the higher profit figure for thisyear as the alternative option would result in some reduction in this year's Statementof Financial Performance which would lower the reported profit figure.

(iv)The company could show the premises at revaluation amount but the depreciationcharge for the year would be based on this higher figure which would result in thelowering of the reported profit.It would be preferable, therefore, to leave the premises at historical cost if you are toreport the highest possible profit for the year.

Documents

Accounting for Non-current and Current Assets