Feed Back On Issues Raised By Muppet Ltd Accounting Team

Non-Current Asset Valuation and Recognition

Discuss about the Feed Back on Issues Raised By Muppet Ltd Accounting Team.

I confirm receipt of the email sent to us  on Tuesday 13th March 2018 concerning accounting issues that you needed detailed clarity on and hereby affirm that am responding to it write away to the best  of  our capacity.

Australian Accounting Standards requires that every financial statement prepared and presented should have supporting notes and annexes that give more disclosure on what is contained in the statements. This disclosure is expected to be precise and direct to the point so as to help the users of information make the decision in case the preparers of the statements are not around. However, if the preparers are around there is nothing wrong with the users of information requesting for clarity since the preparers have due diligence and have the responsibility of informing the users as it is in the case of Muppet Ltd.

Therefore am informing Muppet Ltd that it is in order and within the peripherals of our work environment for them asking for clarity on the issues that seemed not clear from their side. The two issues raised by Muppet Ltd is material enough to be given priority as am doing since they form part of decision making when it comes to firms financial position and operations in totality. The first item is on non-current asset valuation and recognition which is outlined by AASB 116.The regulation categorizes asset into two i.e. those which are tangible and those which are intangible. Tangible meaning it is visible and can be felt by touching it while intangible meaning invisible and can’t be touched. Although the two categories have two different physical characteristics the truth of the matter is that the means of valuation, recognition and measurement tend to be the same Bragg (2017.Pg 28.)

Paragraph 15 of AASB 116 defines recognition based on its economic status of the asset in delivering its services but more so-on the initial cost of purchasing. AASB 116 paragraph 16 dictates that asset is to be valued at historical cost which indeed is the cost spent on acquisition of the asset. Paragraph 23 of AASB 116 further explains that the amount spent to purchase an asset becomes the historical cost of it. This is only recognized on the day of purchase and that is when it forms the base cost. AASB 116 actually declares that first-time asset valuation should be done at historical cost before subjection to other factors that could be affecting it up or down as per the expectation of IAS 16.

Depreciation Value Captured in the Books of Accounts

Muppet Ltd assets have applied this principle and especially the property plant and equipment is valued at a base historical cost value of 450000 Australian Dollar. Besides the historical cost being the initial cost value of an asset there indeed exist increase or decrease of the value of an asset depending on the tier phase level applicable. The decrease is major as a result of the natural loss of value or rather a deterioration of the same due to the economic life of an asset. I wish to inform Walther (2009.Pg 3) the management of Muppet Ltd that the requirement on valuation explains that there exist no constant values of an asset because the asset value differs depending on its use as well as the duration of life of that asset.

This dynamism of asset value explains as to why an asset cannot retain its historical value however awesome it is in performing its operations.

Muppet Ltd production manager should note that all assets lose value as long as it’s in operation and was recognized at initial cost thus reduces the historical cost in a systematic mode outlined in the method of reducing the value. Therefore it should be known that however reliable and promising an asset is in delivering its functions, at long last it loses value up to salvage point. Occasionally this value is seen to be on annual basis thus by virtual of piling up cumulatively is what is referred to as accumulated depreciation that does the reduction value directly from the base.

Muppet Ltd depreciation value captured in the books of accounts is cumulative in nature thus affecting the historical cost value. The below illustration shows how depreciation affects the value of an asset by assuming that the PPE asset has an economic lifespan of 15 years and the asset has been in operation for 5 years;

=Annual depreciation value=450000/15=30000, therefore the 1st year is only when the historical cost is affected;

1st Year Value=4500000-30000=420000, 2nd Year Value=420000-30000=390000

3rd Year Value=390000-30000=360000, 4th Year Value=360000-30000=330000

5th Year Value=330000-30000=300000, this forms the net book value of the asset at the 5th year, however, we can factor the accumulated depreciation once by doing the annual rate=30000*5=150000 hence less directly from historical cost=450000-150000=hence giving us the same net book value of 300000. Therefore it is a requirement that at the end of every financial year depreciation annual value should be accounted in the profit or loss account for that period and subsequent adjustment be done on the asset value as for net book value Dunbar (2017.Pg 7) need in the statement of financial position as done in Muppet Ltd books reporting net book value of Australian Dollar of 300000.

Recognition of Carrying Amount of Asset

This net book value is what determines the disposable value of an asset since the actual position and physical state of an asset is expected to be established before disposal for fairness ground Haswell (2008.Pg 42.) As one disposes of an asset there occur gain or loss or even at break-even depending on the value being sold. The benchmark for disposal is the net book value whereby in this case of  Muppet Ltd the 300000 is the base value now not the 450000 when it comes to disposal of an asset. With this in mind I wish to inform the directors that it is possible to sell the asset at an amount more than 200000 or comfortably thou it has to be above the benchmark 300000 so as to gain on disposal or sell less than 300000 like the claim made by directors of 200000 and make a huge loss on disposal of 100000 Jackson (2010.Pg 765.)

Recognition of the carrying amount of an asset is done on revaluation as either up or down thus causing revaluation surplus or deficit that is mostly accounted for in the statement of profit or loss and other comprehensive income but especially on the comprehensive part Hu (2015.Pg 937.) While the base revaluation based on the statement of changes in equity together with the surplus and deficit on revaluation Hanlon (2014.Pg 89.)

The second issue in dismay is on why there is a difference between the pre-tax profit reported and the income tax reported whereas all originated from the same mode of business. I first agree with the team that this difference has been there and it is mainly caused by the presence of different items used in preparation which are not used in others Watts (2016.Pg 420.) For instance, you might fight there are items used in accounting for income tax but not in the calculation of profit Fraser (2016.Pg 17.)

One of these factors is the revenue reported in sales whose payment is not complete thus allowing the sales be captured in the profit or loss account but not in the income tax since it will be waiting until when that income will be paid in full and recognized. Similarly to this is the revenue and expenses reported in the income tax and not in the profit or loss account especially advance payments and accruals this creates the difference because in the profit loss account is not factored in Marshall(2016.Pg 500). Last but not least is on non-allowable deductions the likes of depreciation, amortization, and loss on asset impairment which is factored in the profit or loss account but not in the income tax account.

Muppet Ltd financial statements, items and other books of account are prepared, valued, measured, recognized and accounted for as per the regulation and its disclosure done in the notes pursuant to AASB 112 and that of AASB 116 paragraph 73.

Yours Sincerely,

Ellen Lyrial (Ms.)

References;

Bragg, S.M., 2017. Fixed Asset Accounting. AccountingTools LLC.

Dunbar, K. and Laing, G.K., 2017. Deconstructing the Accounting Standard AASB 13 Fair Value: Exit vs Entry Price for Assets. The Journal of New Business Ideas & Trends, 15(2), pp.12-19.

Fraser, L.M. and Ormiston, A., 2016. Understanding Financial Statements. Pearson Higher Ed.

Hanlon, D., Navissi, F. and Soepriyanto, G., 2014. The value relevance of deferred tax attributed to asset revaluations. Journal of Contemporary Accounting & Economics, 10(2), pp.87-99.

Haswell, S. and Langfield?Smith, I., 2008. Fifty?Seven Serious Defects in ‘Australian’IFRS. Australian Accounting Review, 18(1), pp.46-62.

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.

Jackson, S.B., Rodgers, T.C. and Tuttle, B., 2010. The effect of depreciation method choice on asset selling prices. Accounting, Organizations and Society, 35(8), pp.757-774.

Marshall, R. and Lennard, A., 2016. The reporting of income and expense and the choice of measurement bases. Accounting Horizons, 30(4), pp.499-510.

Walther, L.M. and Skousen, C.J., 2009. Using accounting information. Bookboon.

Watts, R.L. and Zuo, L., 2016. Understanding practice and institutions: A historical perspective. Accounting Horizons, 30(3), pp.409-423.