ch07

GODFREYHODGSONHOLMESTARCACHAPTER 7 ASSETS

Assets definedIASB (AASB) Framework for the Preparation and Presentation of Financial Statements:

an asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity

*

Assets definedThree essential characteristics:future economic benefitscontrol by an entitypast events

exchangeabilityrecognition rules

*

Future economic benefitsFuture economic benefits are the potential to contribute, either directly or indirectly, to the flow of cash and cash equivalents to the entityprofit seeking entitynot-for-profit entityRelate to economic resourcesscarcityutility*

Future economic benefitsAn asset is something that exists nowHas the capability of rendering service or benefit currently or in the futureDistinguish between the object, such as a building or machine, and the service or benefit embodied in it*

Control by an entityThe economic benefit must be controlled by the entityAn entitys right to use or control an asset is never absoluteOwnership is often concurrent with control, but it is not an essential characteristic of an assetDoes not rely on legal enforceability*

Past eventsControl as a result of a past eventPlanned assets are excludedEvent can be interpreted in different waysexecutory contracts*

ExchangeabilitySome argue that a 4th essential characteristic is that an asset be exchangeable Separable from an entity*

Exchangeability MacNeal A good that lacks exchangeability must lack economic value because its purchase or sale must forever remain impossible, and thus no market price for it can ever existgoodwillsubject to evaluation not measurement

*

Asset recognitionThe extent and timing of the recognition of assets is important because it can have economic consequences for preparers and users of financial statements*

Asset recognitionRecognising assets on the balance sheet involves recognition rulesconventions and authoritative pronouncementsRecognition criteriathe future economic benefits must be probablethe asset must be capable of being measured reliably

*

Asset recognitionPast recognition criteriareliance on the lawdetermination of economic substance of the transaction or eventuse of the conservatism principle: anticipate losses, but not gains

*

Asset measurementAll the elements of accounting are linked and measurement of profit flows from measurement of the change in net assetsThe rules and practices governing asset recognition and measurement will also affect measurement of profit and, in turn, capital (equity)*

Asset measurementOnce the definition and recognition criteria have been met, the accountant must decide how to measure the assetseveral measurement approaches availablequalitative characteristics of financial information

Once measured on balance sheetrestricted to just note disclosure*

Tangible assetsTraditional approach has been to measure assets at historical costIASB standards permit subsequent remeasurement using a number of approachesfair valueexit value or value in useUK and Australian firms could use values other than historical cost for many years*

Intangible assetsAccounting measurement has generally been conservativecost (less accumulated amortisation and impairment) is commonly usedfair values from an active marketinternally generated intangibles cannot be recognised*

What are the divergent arguments for recognising customer relationships in a business combination? Is it a true intangible asset?*

Financial instrumentsFASB/IASBderivatives are measured at fair value rather than costIASB committed to the use of fair value measurement for financial instruments*

What are the objectives of the fair value measurement project?*

Challenges for standard settersFASB/IASB intend to address the issue of measurement in Phase C of the conceptual framework projectconsider measurement concepts, principles and termsevaluate and rank measurement methodsqualitative characteristics*

Which measurement model?Fair value is the frontrunnerBoth the IASB and FASB support greater use of fair value measurement*

What are the arguments for and against fair value measurement?*

How to calculate fair value measurementVarious valuation techniques to calculate fair valuethe market approach observable prices actual transaction data*

How to calculate fair value measurementVarious valuation techniques to calculate fair valuethe income approachconversion of future amounts - cash flows or earnings to a single discounted present amount*

How to calculate fair value measurementVarious valuation techniques to calculate fair valuethe cost approachthe amount that currently would be required to replace its service capacity (current replacement cost)*

In response to the credit crisis the IASB changed the rules to allow entities to choose to reclassify some financial instruments from a fair value measurement basis to a cost basis. Under what circumstances is this reclassification allowed?*

How to calculate fair value measurementThe valuation must emphasise market inputsassumptions and data that market participants would use in their estimates of fair value*

How to calculate fair value measurementThree hierarchical levels for the inputsLevel 1 quoted prices for identical items in active markets, without adjustment Level 2 quoted prices for similar items in active markets, adjusted as appropriate for differencesLevel 3 estimated fair value using multiple valuation techniques consistent with the market, income and cost approaches*

Issues for auditorsAuditing fair values creates difficulties because it requires the application of valuation models, and, frequently, the use of valuation experts*

Issues for auditorsAuditors need tounderstand the client firms processes and relevant controls for determining fair valuesmake a judgement on whether the client firms measurement methods and assumptions are appropriate and likely to provide a reasonable basis for the fair value measurementappreciate managements potential biases and likely errorsincentives*

Issues for auditorsThere is the potential that corporate failures will lead to legal action against auditors who failed to approach their audit of asset fair values appropriately*

SummaryDefining assetsRecognition and measurement criteriaAsset recognition and the measurement of income and capital are interrelatedMixed attribute measurement model and fair value measurement methodsIssues arising for standard setters and auditors*

Key terms and conceptsAssetsDefinitionsFuture economic benefitsControlPast eventsExchangeabilityAsset recognitionAsset measurementFair value measurement*

*

**