27th August 2018
Mr. Peter Pepper
The managing director of Pepper limited
Level 5, 49 William Street
Brisbane QLD 4000
Dear Sir,
This letter is in response to your email regarding the accounting issues being faced by your firm after the appointment of new management accountant. I have come to know after reading your email that the main accounting issues pertaining to the assets that your firm is facing is much larger charges pertaining to depreciation due to implementation of changed method of depreciation calculation.
In response to address your accounting issues, I would like to address the queries by answering the questions mentioned below:
The first explanation is regarding the difference between impairment, depreciation and revaluation losses are explained using relevant sources. As per my accounting knowledge, depreciation is one of the methods of accounting that is used for accounting the decline in value of tangible assets and allocating its cost. I would like to acquaint that the International accounting standard requires specification about noncurrent assets having useful lives to depreciate and the method that has been employed for depreciation. The reporting entity is required to disclose specific information about the amount that is depreciated and the depreciable assets.
Secondly, I would like to give an explanation about assets impairment. Impairment of asset intends to ensure that the carrying value of assets of reporting entity is not more than their recoverable amount. It is required by the entity to conduct test concerning impairment when there is an indication of the assets impairment. This is done except for certain intangible assets and goodwill where it is required to conduct annual impairment test. To make you aware, the applicable standard concerning assets impairment is IAS 136 impairment of assets that requires defining of recoverable amount.
Lastly, revaluation is another important concept that I would like to address. Businesses are provided with the option of carrying fixed assets at the revalued amount using revaluation model. In order to ensure that there is no material difference between the fair value and carrying value of assets, fixed assets should be revalued continually. An increase in value of assets resulting from revaluation is represented as revaluation surplus and a decrease in value is represented as an expense in the profit and loss statement.
I would also like to address your concern about the impact of depreciation charge on profitability. Any change in the method of depreciation should be accounted as a change in the estimate of accounting. If the effect of such change is in particular period, then recognition of such effect must be done in that reporting period. The prior reporting period depreciation should not be changed either by an adjustments in the operating statement through accumulated loss and retained profits or through profit and loss. Depreciation charge or depreciation expense under the accounting standard is the estimated amount of future economic benefits. The accounting standard says that an element of approximation is contained in the amount of depreciation expenses. This calls for annual reviewing of the factors relating to the existing methods or rate of depreciation. The profit presented on the income statement of reporting entity is directly impacted the amount of depreciation charge. Reporting entity would generate lower net income and thereby lower profit if the depreciation expenses are larger and vice versa (Gissel 2016). However, the amount of net income reported on income statement is not directly affected by accumulated depreciation.
While addressing the requirement of changes for depreciation, impairment and revaluation, I would intend to give the explanation in a simpler way to facilitate your understanding. For depreciation, different enterprises adopt different accounting policies and the view presented in the financial statements is appreciated by the accounting policies disclosure. It is required by business entity to change the depreciation methods and such change is dependent upon the factors such as the type of assets, present business circumstances and the nature of such assets. Allocation of depreciation is done fully in the accounting period if the depreciable assets do not have any material value. Sometimes, it is also required by reporting entity to use a combination of methods of depreciation. A change in the depreciation method is done only if such change would result in appropriate presentation of financial statements and if it’s required by statute. In such case, recalculation of depreciation is done in accordance with the new method from the date of implementation (Liapis and Kantianis 2015).
In addition to this, change in method of valuation can be attributed to several factors of which changes in internal financial reporting require organization to identify the items for additional disclosures. The reporting entity dealing with the impairment of assets has been faced with changes in the practice as per IAS 136 (Del Giudice et al. 2016). If there is any change in estimated amount for determining the recoverable amount of assets, it is required to reverse the impairment loss in the prior period.
Regarding the revaluation of assets, it can be said that revaluation is done due to internal and external factors affecting the operations of business. It is certainly possible that assets might be overstated or understated which needs to be balanced so as to present true and fair market value. Change in revaluation should be done depending upon different circumstances that helps in negotiating fair value before any strategic decision on part of company (Bond et al. 2016). Sometimes, the regulatory requirement calls for creating revaluation reserves using any particular revaluation model.
Your concern about the disclosure requirement has been addressed by using relevant sources relating to the accounting standard. The accounting standard AASB 116 depicts the accounting treatment for plant, property and equipment. Assets whose value can be measured reliably should be carried at revalued amount after their recognition. The financial statement of reporting entity should disclose the basis of measurement that is used for determining the methods of depreciation that is used and gross carrying amount of depreciation (Su and Wells 2015). Reporting entity is also required to disclose carrying amount reconciliation at the end and beginning of period about any acquisition through business combination and any amount of impairment loss recognized according to AASB 136. The depreciation method adopted by entity along with the applicable rate of depreciation and their estimated useful lives should also be disclosed as it will assist users in providing financial information (Aasb.gov.au 2018).
The impairment testing relating to all tangible and intangible assets is dealt by the standard IAS 136. It is required by this particular standard that the carrying value of such assets should not be more than their recoverable amount. Entities are required to conduct testing of all such assets that are within the scope of potential impairment when there exist any indicator for impairment. In addition to this, the recoverable amount of cash generating unit to which the asset belong should be determined by entity. Recognition of impairment loss should be done when the recoverable amount is less than the carrying amount of assets (Small et al. 2017). Impairment loss is treated as a decrease in revaluation if the revalued assets are impaired assets. For conducting impairment testing and impairment loss, organizations should make extensive disclosure. In addition to this, disclosure should be made about the amount of impairment that is reversed and recognized. Any assumptions applied in the valuation such as discount rate and growth should also be disclosed. Method of valuation and the approach used for determining the proper assumptions also need to be disclosed (Ey.com 2018).
For the application of revaluation model, an entity is required to make disclosure about each class of tangible and intangible assets. Amount of accumulated depreciation at the beginning of period should be disclosed along with increase and decrease resulting from revaluation. In addition to this, there should be the disclosure of impairment loss in accordance with AASB 136 that is reversed in profit and loss (Iasplus.com 2018).
The points discussed above intend to solve the accounting issue that you are facing. It depicts the applicable accounting standards that are consistent with determining revaluation, depreciation and impairment. Information about the accounting treatment would help in solving the queries of managers due to the implementation of changes in depreciation method.
Yours sincerely,
(Signature)
Graduate accountant
Montana and associates
References list:
Aasb.gov.au. (2018). [online] Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB116_07-04_COMPjun09_01-09.pdf [Accessed 27 Aug. 2018].
Bond, D., Govendir, B. and Wells, P., 2016. An evaluation of asset impairment decisions by Australian firms and whether this was impacted by AASB 136.
Del Giudice, V., Manganelli, B. and De Paola, P., 2016, July. Depreciation methods for firm’s assets. In International Conference on Computational Science and Its Applications(pp. 214-227). Springer, Cham.
Ey.com. (2018). [online] Available at: https://www.ey.com/Publication/vwLUAssets/Impairment_accounting_the_basics_of_IAS_36_Impairment_of_Assets/$FILE/Impairment_accounting_IAS_36.pdf [Accessed 27 Aug. 2018].
Gissel, J.L., 2016. A case of fixed asset accounting: Initial and subsequent measurement. Journal of Accounting Education, 37, pp.61-66.
Hu, F., Percy, M. and Yao, D., 2015. Asset revaluations and earnings management: Evidence from Australian companies. Corporate Ownership and Control, 13(1), pp.930-939.
Iasplus.com. (2018). IAS 36 — Impairment of Assets. [online] Available at: https://www.iasplus.com/en/standards/ias/ias36 [Accessed 27 Aug. 2018].
Liapis, K.J. and Kantianis, D.D., 2015. Depreciation methods and life-cycle costing (LCC) methodology. Procedia Economics and Finance, 19, pp.314-324.
Small, R., Smidt, L. and Joseph, A., 2017. Impairment of assets-does it actually matter?. Professional Accountant, 2017(30), pp.20-21.
Su, W.H. and Wells, P., 2015. The association of identifiable intangible assets acquired and recognised in business acquisitions with postacquisition firm performance. Accounting & Finance, 55(4), pp.1171-1199
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