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CORPORATE REPORTING

TOPIC ONE:

Brief overview of the regulatory reporting and conceptual frameworks

Accounting for Asset Acquisitions

Measurement of Property, Plant & Eq ui p ment postacquisition

OVERVIEW OF THE REGULATORY REPORTING FRAMEWORK

Entities Other than Private Entities have legislative responsibilities (Compan ies A c t 1965, Financial Reporting Ac t 1997) to prepare external financial reports

The needs of external users are protected by minimum reporting requ irements which i nc l u d e the contents of financial statements

Financial Reporting Foundation (FRF)

Overs i g ht ro l e over th e MASB

The Malaysian Accounting Standards Board (MASB)

Develops and issues accounting and financial reporting stand ard s i n Mal aysi a ( comp liance i s man d atory un d er s26D of Fin Rep Act)

Implemented a plan for convergence (i.e. full compliance) with IFRS to be completed by 1 January 2012

Rationale is to provide worldwide consistency in the preparation of financial statements

The focus of this subject: to consider particular FRS that are most relevant to the preparation of General Purpose Financial Statements

2

OVERVIEW OF THE CONCEPTUAL FRAMEWORK

Nature and purpose : sits o utside of the actual FRS but sets out the concepts that underlie the preparation and presentation of financial statements to external users

Outlines the following:

Users and their needs

Objectives of financial statements

Qualitative characteristics of financial statements

Elements of financial statements

Recognition and measurement of these e l ements

CORPORATE REPORTING

PART ONE:

Accounting for Asset Acquisitions

FRS 116: Property, Plant & Equipment

FRS 3: Business Combinations

FRS 138: Intangible Assets

Deegan references

Ch 4 & Ch 8 pp 250 253, 268 279

OBJECTIVES

By the end of this session you should be able to:

Explain the nature of PPE and the recognition and measurement criteria for PPE

Record the acquisition of PPE

Explain the nature of a business combination

Recognise and measure the net assets acquired under the acquisition method for a business combination

Record the acquisition of a business combination

Explain the nature of goodwill acquired in a business combination and how it fits in the framework of intangible assets

ASSET ACQUISITIONS

Businesses generally acquire PPE to capacity

Note: PPE vs Inventor y / Receivables

Typ es of ac q uisitions :

Individual PPE item(s)

FRS 116

A b us i ness combinat ion

FRS 3

Control of another entity

FRS 127

The nature of the acquisition will dictate the recognition and measurement

FRS 116: P roperty, Plant and Equi pment

Defined in para 6:

…tangible items that:

(a) are held for use in the production or supply of goods or

services, for rental to others, or for administrative purposes;

and

(b) are expected to be used during more than one period

Key features:

Tangible (i.e. physical assets)

Used as part of operating activities

Non current

FRS 116 : Property, Pl ant an d Equ i pment

Recognition (para 7)

The cost of an item of property, plant and equipment shall be recognised as an asset if, and only if; ( a) it is pro bable t h at f uture economic benefits associated with the item will flow to the entity; and (b) th e cost o f th e item can be measured reliably.

Cost vs value – even if FV can be measured, if cost cannot then an asset shall not be recognised (some exceptions)

FRS 116 : Property, Pl ant an d Equ i pment

Recogn iti on issues ( cap ita li s i ng vs wr iti ngo ff costs)

Spare parts carried as inventory and recognised in P&L as consumed

Other costs of a recurrin g nature to service and maintain PPE are recognised as R&M expense in P&L (not included in carrying amount of PPE)

Costs of major overhaul (including major replacement components) may be included in CA (or recognised as separate asset)

Costs of improvements are included in CA

FRS 116: P roper t y, Plant and Equi pment

Measurement at Recogn i ti on (para 15)

An item of PPE that qualifies for recognition as an asset s h all be measured at its cost.

Definition of Cost (para 6)

“… the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition or const ruc tion …”

FRS 116: Property, Plant and Equipment

Examples of consideration

C as h

Agreement to pay out or take over a loan / other debt

Credit (debt finance)

Iss u e of shares (eq u it y finance)

Any combination of these

FRS 116: Property, Plant and Equipment

Elements of Cost The cost of PPE comprises:

(a) its purchase price, including import duties and nonrefundable taxes, after deducting trade discounts and rebates; (b) any costs directly attributable to bringing the asset to the location and condition necessary for it to be capa bl e of operat ing in t h e manner intended by mgt; and (c) the initial estimate of costs of dismantling and removing the item and restoring the site …(at the end of the useful life)

FRS 116: Property, Plant and Equipment

Examp les of direc tly att r ib u table cost s:

employee costs arising from construction or acquisition

costs of site preparation

delivery and handling costs

installation and assembly costs

cost s o f testing to ensure proper f unc tion

professional fees (legal, brokerage)

Generally, costs of a nonrecurring nature e.g. insurance d uring d elivery vs annual insurance

FRS 116: Property, Plant and Equipment

Oth er issues

Recognition of costs in the CA of an item of PPE cease when the item is in the location and condition necessary for it to be capable of o perating in the manner intended by mgt (regardless of whether or not item has been brought into use)

Finance costs are not capitalised unless the item satisfies the criteria for a qualifying asset

FRS 116: Property, Plant and Equipment

Qualif ying asset s

Para 5:

An asset that necessarily takes a

substantial period of time to get ready for its intended use

Para 8: An entity shall capitalise borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset

FRS 116: Property, Plant and Equipment

Lecture Example: Determine the cost of PPE (assume sales tax of 10% applies)

KL Ltd purchases 2nd hand equipment

Vendor ’s original cost = RM 100, CA = RM60

Market value of equivalent equipment RM55

KL Ltd pays vendor RM30,000 and issues 4,000 ordinary shares currently trading at RM6.25

KL Ltd incurs additional sales tax exclusive costs as follows:

delivery

RM1,500

Installation

RM1,000

transit insurance

RM500

annual insurance

RM1,200

FRS 116: Acquiring a group of assets

Where an entity makes a single purchase of a group of assets not deemed a business combination the acq uirer:

measures the cost according to the FV of the consideration

allocates this cost to the nonmonetary assets on the basis of their relative FVs at the date of purchase

Lecture example: KL Ltd acquires land and farm machinery for RM450,000 (GST excl). The fair values of t h ese items are as follows:

Land RM350,000

Tractor RM120,000

Accessories RM30,000

FRS 116: Acquiring a group of assets

The FV of the consideration is RM450,000

The FV of the assets acquired is RM500, 000

As each asset needs to be recorded separately we need to determine a cost for each based on their relative fair values

Item

FV @ acq

Relative cost

Land

350,000

Tractor 120 ,000 Accessories 30,000

500 ,000

FRS 3: Business Combinations

Id entif ying a b us iness combination ( para 3)

An entity shall determine whether a transaction or other business event is a business combination

If the assets acquired are not a business, the re p orting entity shall account for the transaction as an asset acquisition (=> FRS 116 as per previous two slides)

FRS 3: Business Combinations

D efin itions (Appen dix A)

Business – An integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form o f dividends , lower costs or other economic benefits directly to investors or other owners…

Business combination – A transaction or other event in which an acquirer obtains control of one or more bus inesses .

FRS 3: Business Combinations

Th e entity s h all account for each b us iness combination by applying the acquisition method. This req uires:

a)

identifying the acquirer (who gets control)

b)

determining the acquisition date (when control is obtained)

c)

recognising and measuring the identifiable assets acquired, the liabilities assumed and any non controlling interest in the acquiree; and

d)

recognising and measuring goodwill or a gain from bargain purchase

FRS 3: Business Combinations

I mp lied by th e prev ious s lide is th at a b us iness may be acquired by either:

A direct acquisition – whereby the acquirer purchases assets and liabilities from the acquiree and the assets and liabilities are now absorbed into the acquiring entity

An indirect acquisition – whereby the acquirer obtains a controlling interest in another entity (and therefore its assets) by purchasing shares of t h e acquiree or s h ares of t h e parent of t h e acquiree

FRS 3: Business Combinations

O ur focus for now is th e direc t acquis ition ( => noncontrolling interest not relevant yet)

Recognition

Para 10 : As of the acquisition date, the acquirer shall recognise, separately from goodwill, the identifiable assets acquired (and) the liabilities assumed

FRS 3: Business Combinations

Appen dix A: D efin itions

An asset is identifiable if it either:

is separable i.e. capable o f being separated or divided from the entity and sold (or) transferred regardless of whether the entity intends to do so; or

arises from contractual or other legal rights , regardless of whether those rights are transferable or separable from the entity

FRS 3: Business Combinations

M easurement

The acquirer shall measure the identifiable assets acquired and the liabilities assumed at their acquisitiondate fair values.

Appendix A: definitions

Fair va lue – t h e amount for w hi c h an asset could be exchanged, or a liability settled, between knowled geable, willing parties in an arm’s len gth transaction.

FRS 3: Business Combinations

Acquisitionrelated costs (para 53)

Acquisitionrelated costs are costs the acquirer incurs to effect a business combination. Those costs include finder’s fees, professional and consulting fees (including valuation fees).

Th e acquirer s h all account for ( suc h) cost s as expenses in the periods in which they are incurred and the services are received (except for costs associated with issuing debt or equity securities).

Note difference with FRS 116 – part of directly attributable costs and included in cost of asset

FRS 3: Business Combinations

G ood will Para 32: The acquirer shall recognise goodwill as of the acquisition date measured as the excess of (a) over (b) below:

a) The consideration transferred … (by the acquirer refer Slide 8)

b) The net of the acquisitiondate amounts of the identifiable assets acquired and the liabilities assumed

Goodwill = Consideration less FVNA NB: FVNA = FV of (A – L)

FRS 3: Business Combinations

G ood will – d efined in Appen dix A

An asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and sep arately reco g nised

Goodwill represents FEB that the acquirer believes will flow f rom th e net asset s acquire d ( either in their own right or when added to acquirer’s existing assets)

These FEB are not individually identifiable, but the acq uirer was p re p ared to p ay for them

FRS 3: Business Combinations

Bargain purch ases Para 34: Occasionally an acquirer will make a bargain purchase, which is a business combination in which the amount in paragraph 32 ( b) exceeds the aggregate o f the amounts specified in paragraph 32(a). the acquirer shall recognise the resulting gain in profit or loss on the acquisition date. The gain shall be attributed to the acquirer.

Gain on bargain purchase = FVNA less Consideration

FRS 3: Business Combinations

C ons id eration > FV of NA acquire d

=> G ood w ill recogn ised as an asset in BS

Consideration < FV of NA acquired (or FV of NA acquired > Consideration)

=> Gain on bargain purchase recognised as revenue in P&L

FRS 3: Business Combinations

Lecture Example

Y Ltd’s books disclose the following:

Gross Assets = RM45m (excluding cash)

Liabilities = RM20m

X Ltd agrees to acquire the net assets of Y Ltd for RM27m cas h

Directors of X Ltd place a fair value on Y Ltd’s net assets of RM22m

X Ltd incurs additional costs (e.g. legal and valuation fees) directly attributable to the acquisition of RM1m

Directors of X believe these assets and liabilities satisfy the definition of a business

FRS 3: Business Combinations

X LTD - GENERAL JOURNAL

Date

Details

DR

CR

 

Asset # 1 Asset # 2 Asset # 3

42m

 

Liabilities

20m

Acquisition of net assets

Acquisition-related costs

FRS 3: Business Combinations

Issues when recognising assets acquired at FV:

Receivables of RM150, WDV = RM145, FV = RM140

Recognise book value of gross receivables, raise provision for difference b/w GA & FV

Depreciable NCA: GA = RM500, WDV = RM350, FV =

RM400

Recognise FV, ignore any accumulated dep’n

FRS 3: Business Combinations

Same scenario as previously except X Ltd agrees to acquire the share capital of Y Ltd for RM27m X Ltd now controls Y Ltd and recognises shares acquired as an asset

X LTD - GENERAL JOURNAL

Date

Details

DR

CR

Acquisition of shares in Y Ltd

NB: Goodwill not recognised until consolidation

FRS 3: Business Combinations

Original example with consideration of RM18m

X LTD - GENERAL JOURNAL

Date

Details

DR

CR

Asset # 1 Asset # 2 Asset # 3 Liabilities

42m

20m

Acquisition of net assets

Closing entry

35

FRS 3: Business Combinations

Disclosures

The acquirer shall disclose information that enables users … to evaluate the nature and financial effect of a business combination that occurs during the current period

Appendix B provides an extensive list of specific items for disclosure (for each acquisition) as guidance to preparers

Details of ac quiree

Date of acquisition

Mgt’s reason for acquisition

Nature of consideration

Details of net assets acquired

Goodwill or gain on purchase

FRS 138: Intangible Assets

Definition of intangible assets (para 8)

An identifiable, non monetary asset without p hy sical substance

Monetary assets – money held and assets to be received in fixed or determinable amounts of money (e.g. cash, receivables)

Exam ples of Intang ible Assets

Patents (protecting an invention)

Trademarks (distinctive name or symbol e.g. Coke, golden arches)

Reg istere d names ( McDonald s )

Copyrights (intellectual property)

Mastheads (typical in media – New Idea, Women’s Day)

Research & development (R&D)

These are all identifiable

They can be separated from the entity and sold, or

They arise from contractual or other legal rights

FRS 138: Intangible Assets

Where does goodwill fit into this framework?
FRS 3 definition of goodwill

An asset representing future economic benefits that are not capable o f bein g individually identif ied and separately recognised

Future economic benefits of goodwill

Para 11: …(Goodwill) represents a payment made by the acquirer in anticipation of future economic benefits

Product name and reputation

Relationships with suppliers, staff, customers

L ocati on of b us i ness & market s

Distribution channels

FRS 138: Intangible Assets

Control Acquirer has the power to obtain the future benefits and restrict the access of others to those benefits

Reliable measurement The acquirer has paid for it (must have a belief that some future benefit will flow from paying an amount in excess of FVNA) in an arm’s length transaction bet ween a willing buyer an d seller

Goodwill exhibits FB, C & RM but is a special case

FRS 138: Intangible A sset s

I nternally generated goo dwill s h all no t be recogn ised as an asset. (para 48)

Goodwill must be purchased (either direct or indirect acquisition)

Internal goodwill may exist , but it cannot be recognised

Recognition criteria

Future benefit?

Control?

Reliable measurement?

SUMMARY

PPE recognised on acquisition at cost

Cost includes purchase price, nonrefundable taxes and costs directly attributable to getting asset to the location and condition necessary for it to be capable of operating in the manner intended by mgt

Business combinations reco g nised on acq uisition at acquisitiondate fair values (purchase costs recognised as expenses)

Goodwill on acquisition recognised as asset at consideration > fair value of net assets

Gain on acquisition recognised as revenue at consideration < FVNA and taken to P&L

CORPORATE REPORTING

PART TWO:

Measurement of PPE postacquisition

FRS 116: Property, Plant & Equipment

FRS 136: Impairment of Assets

Deegan reference

Chapter 6

OBJECTIVES

At the end of this session you should be able to:

explain the alternative ways in which PPE can be measured af ter initial recognition

record increments and decrements under the revaluation mo d el

explain, calculate and record an impairment loss

exp lain an d apply th e repor ting imp lications of revaluations and impairment adjustments

FRS RELEVANCE

FRS 116 : P roperty, Pl ant an d Equ i pment

Recognition

Measurement at recog nition

Measurement after recognition

Revaluations

Depreciation

Dereco g nition

FRS 136: Im p airment of Assets

Identification, recognition and measurement

As it relates to PPE

FRS 116: Pro pert y, Plant and Equi pment

Para 6 definition: Property, plant and equipment are tangible items that:

(a) are held for use in the production or supply of goo ds or serv ices, for rental to ot h ers, or for administrative purposes; and

(b) are expec ted to be used dur ing more th an one period.

Para 15: … (at recognition) shall be measured at cost

But values of PPE are likely to change over time => how relevant are carrying amounts based on cost?

MEASUREMENT AFTER RECOGNITION

Para 29: An entity shall choose either the cost model…or the revaluation model… as its accounting policy and shall apply t h at po licy to an ent ire c lass o f PPE

M gt choice b /w cost and revaluation model

Is applied on a class byclass basis

Chosen method must be applied to all assets in that class

Ensures consistency across similar assets, limits opp ortunistic measurement

Can choose different method from class to class

DEFINITION OF A CLASS OF PPE

Para 37: … a group i ng of assets of a similar nature and use in an entity’s operations. The following are examples o f separate classes:

land

land & buildings

machinery

ships

aircraft

mo tor vehic les

furniture & fixtures

o ffice equ ipment

Why is classification important?

Consistency in valuations

Objectivity ( scope for Manipulation)

THE COST MODEL

Para 30 After recognition as an asset, an item of PPE shall be carried at its cost less any accumulated depreciation and any accumulated impairment losses

Mgt makes conscious choice not to revalue PPE

Depreciation applied base d on cost

Assets subject to impairment test under FRS 136

THE REVALUATION MODEL

Para 31 Af ter recogn it ion as an asset, an item o f PPE w h ose fair value can be measured reliably shall be carried at a revalued amount , being it s fair val ue at th e date o f the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses.

Management makes conscious choice to revalue PPE

Depreciation applied based on revalued amount (=> reference to subsequent)

Assets subject to impairment test under FRS 136 (common to both methods)

FAIR VALUE

Para 6 definition

the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction

Paraa a 32 : Obtainina

g valva uaationso s

A quoted market price in an active and liquid market

L & B – usually determined from market based evidence by appraisal that is normally undertaken by professionally qualified valuers

P & E – market value determined by appraisal (from directors)

FREQUENCY OF REVALUATION

Para 31 ( cont’d) Revaluations shall be made with sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined usin g fair value at the end o f the reportin g period.

Para 34 suggests every 3 to 5 years unless frequency of significant changes is thought to warrant more often or whenever circumstances arise where FV is thought to be materially different to CA

TYPES OF REVALUATIONS

Revaluation > CA => Incremental i.e. upwards Revaluation < CA =>Decremental i.e. downwards After revaluation, new CA is the revalued amount

REVALUEDAM OUNT

REVALUEDAM

OUNT

REVALUEDAM OUNT
REVALUEDAM OUNT
EXISTING CARRYING AMOUNT
EXISTING
CARRYING
AMOUNT
REVALUED AMOUNT
REVALUED
AMOUNT

53

ACCOUNTING FOR THE INCREMENT

Increment = FV less CA prior to revaluation (not applicable under cost model)

para 39:

If an asset’s carrying amount is increased as a result of a revaluation, the increase shall be recognised in other comprehensive income and accumulated in equity under the heading of revaluation surplus. (More to come)

ACCOUNTING FOR A REVALUATION

Para 35: W h en an item of PPE is revalued , any accumulated depreciation at the date of revaluation is treated in one of two ways:

(a) The gross method ( b ) The net method

The distinction between the two is in the treatment of accumulated depreciation

THE NET METHOD

Para 35 any accumulated depreciation at the date of revaluation is… (b) eliminated against the gross carrying amount of the asset an d t h e net amount restated to t h e revalued amount of the asset.

After this process:

Accum d ep ’n = zero

Asset a/c balance = revalued amount

Su bsequent d ep ’n calcu lat ions b ased on new revaluation amount

LECTURE ILLUSTRATION 1.1: Incremental revaluation

D etails of an asset on 31 D ecem b er 2011:

EQUIPMENT (gross amount)

625,000

ACCUMULATED DEPRECIATION

250,000

CARRYING AMOUNT

375,000

The directors have adopted the revaluation model for this class of asset . It h as b een d eterm ined th at th e fair value of this equipment, obtained by independent valuation, is RM450,000. There have been no prior revaluations.

GROSS METHOD

Para 35 any accumulated depreciation at the date of the revaluation is (a) restated proportionately with the change in the gross carrying amount of the asset so that the carrying amount of the asset after revaluation equals its revalued amount.

After this process:

GA and AD = proportionately re stated

CA = revalued amount

Subsequent dep ’n calculations based on new revaluation amount (in the asset account)

ACCOUNTING FOR A DECREMENT

I f Fair value < Carry i ng amount

Decrement = CA prior to revaluation less FV

Para 40:

If an asset’s carrying