Accounting Standards Analysis For Magneta Limited, Greymouth Ltd, And Prime Media Ltd Essay.

Question 1 - Magneta Limited – AASB 108 And AASB 116

On 1 July 2014, Magenta Ltd purchased an item of machinery for $200,000 to be used In the manufacture of furniture. The machinery had an estimated useful life of 8 years and a zero residual value. Magenta Ltd uses the straight-line method of depreciation for items of property, plant and equipment. In accordance with AASB 116 Property, Plant and Equipment, Magenta Ltd uses the cost model as its accounting policy to measure items of property, plant and equipment.

On 30 June 2017, Magenta Ltd changed its accounting policy in relation to the measurement of items of property, plant and equipment from the cost model to the revaluation model. On this date the fair value of the item of machinery was determined to be $135,000.

On 30 June 2018, the fair value of the item of machinery was determined to be $92,000.

On 1 July 2019, the item of machinery was sold for $60,000 cash.

(a) Under what circumstances does AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors permit an entity to make a voluntary change in an accounting policy? How should Magenta Ltd account for the change in accounting policy from the cost model to the revaluation model?

(b) Based on the requirements of AASB 116 Property, Plant and Equipment, provide appropriate journal entries in relation to the item of machinery from 1 July 2014 to 1 July 2019.

On 1 January 2014 Greymouth Ltd commenced construction of a chemical manufacturing plant which was to be used to manufacture a range of chemical compounds. The chemical manufacturing plant cost $3 million to construct and became operational on 30 June 2016. The estimated useful life of the chemical manufacturing plant is twenty five years from 30 June 2016.

Because the chemical manufacturing plant satisfies the definition (in the Work Health and Safety legislation) of a ‘major hazard facility’, it must be licensed by the local government. Greymouth Ltd obtained its licence for the chemical manufacturing plant on 30 June 2016. The cost of obtaining the licence was negligible and the licence is valid for the life of the chemical manufacturing plant. A condition of the licence is that, at the end of its useful life, the chemical manufacturing plant must be decommissioned. Decommissioning involves dismantling the chemical manufacturing plant and recycling some of the equipment at the local government’s recycling facility.        

As at 30 June 2016, Greymouth Ltd estimates the cost of decommissioning the chemical manufacturing plant at the end of its useful life to be:

Greymouth Ltd believes that a discount rate of 5% is appropriate to adjust for the risks specific to this liability.

(a) Explain why the cost of decommissioning the chemical manufacturing plant satisfies the definition of a provision in AASB 137 Provisions, Contingent Liabilities and Contingent Assets.

(b) Determine the amount that, in your judgement, Greymouth Ltd should recognise as a provision as at 30 June 2016. In your answer, you should:

• Briefly explain the three methods that, according to AASB 137 Provisions, Contingent Liabilities and Contingent Assets, can be used by an entity to estimate the amount to be recognised as a provision,
• Discuss which method (or methods) are appropriate in this situation,
• Identify and justify which method, in your judgement, is the most appropriate to use in this situation, and
• Use this method to calculate the amount of the provision.

(c) Provide the appropriate journal entries in relation to the provision as at 30 June 2016 and 30 June 2017.

Prime Media Ltd is a digital marketing company that undertakes online marketing functions for its customers. In May 2017, Prime Media Ltd hired an external consulting firm to review its operations. One of the recommendations made by the external consultants was that the computer software used by Prime Media Ltd to produce online advertisements was outdated and should be replaced. Management of Prime Media Ltd prepared a report that outlined the following options for the replacement of the computer software:

• Option 1: acquire a licence from Digital Solutions Ltd to use their computer software package. The licence could be acquired immediately for $60,000 and would last five years. A condition of the licence is that Prime Media Ltd is prohibited from selling, transferring, licensing, renting or exchanging the computer software even after the licence has expired.
• Option 2: internally develop a computer software package. It would take between 8 and 12 months to develop the computer software at an estimated cost of $40,000. The computer software would be patented at an additional cost of $15,000.
• Option 3: internally develop a computer software package. It would take between 8 and 12 months to develop the computer software at an estimated cost of $40,000. The computer software would not be patented.

(a) For each of the three options, explain whether the computer software satisfies the definition of an intangible asset in accordance with AASB 138 Intangible Assets. In particular, explain whether the computer software satisfies the criterion of identifiability in the definition of an intangible asset.

(b) For each option that satisfies the definition of an intangible asset, explain the recognition criteria that would be applied by Prime Media Ltd.

Question 1 - Magneta Limited – AASB 108 And AASB 116

Financial statements of every company provide the insights about how the company is working and performing. It informs about the financial position at the particular date and the financial performance of the company over the period of time. Financial statements are prepared from the books of accounts which in turn are prepared on the basis of the provisions of the defined accounting standards and the conceptual framework of accounting. Accounting standards, apart from making the accounting entries, help in the presentation of the financial statements in the true and fair manner. The main objective of this report is to analyze the provisions of the different accounting standards as required by the different case studies and describe how the case study shall be solved and made available for further analysis. With these considerations, the report has been divided into different heading and sub headings wherever required.

Magneta Limited has purchase machinery on 1^st of July 2014 at the cost of $200000 and since then the company has been following the cost model. But on 30^th of June 2017, the company has decided to change the accounting policy from the cost model to the revaluation model. In the first section, the accounting treatment of the change in method is detailed and in the second section, the journal entries have been given.

1. Aasb 108 – Accounting Policies, Changes In Accounting Estimates

The Australian Accounting Standard 138 is related to the accounting policies that are adopted by companies for their accounting purpose and the how the company makes the changes in their accounting estimates. As per the paragraph 20 and 21 of the Australian accounting standard number 108, following are the circumstances where standard permits voluntary adoption of the standard (Australian Accounting Standard Board (AASB), 2011):

• If the company makes the standard applied in their company before its application date then it cannot be inferred that the company has made the standard applicable on voluntary basis.
• In case there is no Australian accounting standard on the particular subject, event or any transaction, then if the company changes the accounting policy on the basis of the pronouncements made by the other bodies which set accounting standards then it can be said that the company has changed the accounting policy on the voluntary basis.  

While changing the method of accounting, the revalued cost so identified crossed the cost then the amount shall be transferred to Revaluation Surplus and devaluation in future years are transferred from the revaluation surplus. The assets are then valued at the revalued amount less the cost of depreciation and the impairment if any (Taplin, Tower and Hancock, 2002).  

1. Aasb 116 – Property Plant And Equipment

Following are the Journal Entries in relation to Property, Plant and Equipment.

(Australian Accounting Standard Board (AASB), 2010)

The company is engaged in the area of the construction of chemical manufacturing plant. The construction has been started since 1^st of January 2014. The company has obtained the license and is required to dismantle the plant at the time of the expiry of the life of the license. The accounting treatment has been discussed under the following headings.

1. Aasb 137 – Provisions, Contingent Liabilities And Contingent Assets

In accordance with the provisions of the Australian Accounting Standard 137, provisions are defined as the amount which has been kept aside by the management of the company so as to set off the same provision against the liability which may or will generate in the future. Thus, a provision is defined as the amount which has kept as the reserve due to the probability that the future obligation will definitely occur (Wells, 2011.)  

As per the AASB 137, provision shall be recognized only when:

• Liability has occurred in the present due to the acts made in the past by the company,
• Due to which the company is liable to pay the amount as discussed for settlement   (Australian Accounting Standard Board (AASB), 2010)

Question 2 - Greymouth Ltd - AASB 137

In the given case of Greymouth Limited, the cost of decommissioning satisfies the definition criteria of the provision. It is in the sense that the cost of decommissioning has arisen at the time of the obtaining the license that the company will be required to dismantle the chemical manufacturing plant after the expiry of the license and thus is the result of past event and hence the same shall be classified as the provision.   

1. Recognition Of Provision

Methods To Estimate The Amount To Be Recognized As The Provision

The accounting standard 137 has prescribed three methods which help in estimating the amount which is required to recognize as the provision. Following are the methods:

• Best Judgment – Under this method of recognizing the provision, the amount which the company is required to pay to the party in the rational manner is to be recognized as the revenue. It is the amount which helps in settling the liability at the period end.
• Present Value- Under this method of recognizing the provision, the amount of provision is equal to the present value of the expenditure that is required to be incurred at the future period. The discount rate used for calculating the present value is the cost of capital of the company or the rate of return of the company
• Occurrence of Future Event– This method is used when there are more than the probable chances that the future event will of course occur and the amount of provision in such case is the amount equal to the obligation that will arise in the future event in case that event occurs.

Appropriate Method in the given case study

In the given case study the appropriate method will be the present value method. It is because the liability at that time cannot be judged in the best terms. Also the future event method will also not be applicable as the amount cannot be ascertained on rational basis. Therefore, the present value method is the best method in the give case.

Calculation of the Amount of the Provision and its Justification

The company shall account for the provision by using the method of the present value method. The present value shall be calculated after applying the risk and uncertainty to each item of cost separately and discounting the same at the given discounting rate.

As per the risk and uncertainty method, the probability of occurrence of the cost of $500000 is very high and it comes around $400000 which more than higher outcome therefore keeping in view the present value method, the amount of $447166 shall be recognized as the provision.    

1. Journal Entry

1. Definition of the Intangible Asset and checking for each option

As per paragraph number 8 of the Australian Accounting Standard 138 on Intangible assets, intangible assets are defined as the asset which does not have the physical substance and does not have the monetary consideration but is an identifiable asset. Along with paragraph number 8, paragraph number 9 provides that the intangible assets are those assets which are:

• Identifiable
• Control over the resource and
• Carries the future economic benefits

An asset is said to identifiable asset if it is:  

• Separable or capable of being separated and divided on its own from the entity and can be referred to as the saleable item, licensable, rentable or exchangeable or
• Arise from the rights which are contractual in nature or any other legal rights despite of the fact whether these rights are transferable from the company or separable from the other similar rights and the obligations (Australian Accounting Standard Board (AASB), 2015)

An asset is said to have been controlled if:

• The company has been able to control the future economic benefits that the asset will accrue. This control majorly depends upon the legal rights associated with the assets under consideration
• It is not always necessary to have the legal rights to have the control over the resource rather the company by controlling the operations; the company will be able to control the resource (Firoz and Ansari, 2010)  

An asset is said to have the future economic benefits, if it:

• Increases the revenue of the company or
• Helps in reduction of the cost or production or any other similar thing in the future.

Therefore, for fulfilling the definition of the intangible asset, the asset shall be identifiable, have control over resource and will be able to generate the future economic benefits.

Option 1 – In this option, the computer software so acquired does not satisfy the definition of the intangible assets. It is because the asset is not clearly identifiable as the same cannot be sold, transferred, licensed, rented or exchanged or nothing can be done if the company intends to do so.  As the first criteria of definition has not been met and hence are not the intangible assets.

Option 2 - This has also satisfied the definition of the intangible assets. It is because the asset is internally generated and easily separable, secondly the company has the full control over the resource and can utilize in the way which is best for the company and will definitely generate future economic benefit by saving the cost of $5000 as compared to Option 1.

Option 3 - This has also satisfied the definition of the intangible assets. It is because the asset is internally generated and easily separable, secondly the company has the full control over the resource and can utilize in the way which is best for the company and will definitely generate future economic benefit by saving the cost of $20000 as compared to Option 2 and $ 15000 as compared to option 1 as the software will not be patented in Option 3.

Therefore, as per the definition criteria, out of three two options have met the same.

1. Recognition Criteria

As per paragraph number 21 of the Australian Accounting Standard 138 on the Intangible Assets, the intangible asset shall be recognized only if:

• It is clear that the asset will flow the future economic benefits to the company and
• The cost of the asset so identified can be measured reliably.

In case of the internally generated asset, along with the above recognition criteria, the company has to follow the criteria mentioned in the paragraph number 52 to 67 for all kind of internally generated intangibles.  Two phases has been provided for recognition – one is the Research phase and second is the development phase.

In case of research phase, all the expenses will be charged to the statement of the profit and loss and nothing will be recognized as the asset and in case of the development phase, an intangible asset shall be recognized if company will be able to show that following is present:

• Technical feasibility that the asset is ready for its use
• Intention of developing the asset
• Ability of the company
• How it will be able to generate the future economic benefits
• The ability of the company to measure the cost in reliable terms as to how much has been spent during the development phase.  

In option 2, the asset will be recognized with cost of $40000. The patent of $ 15000 will be recognized only after it is available for use and it is patented and will be considered as the separate asset.

In option 3, the cost of asset of $40000 will be recognized as the asset.   

Conclusion

Accounting standards are very important for every company as it not only specifies the definition but also specifies what is required to be done and in what manner. To conclude, every company shall follow the accounting standards clearly.

It is to recommend that all the three companies shall complete their accounting in all respects.

References

Australian Accounting Standard Board (AASB), (2010),"AASB 137 Provisions, Contingent  Liabilities and Contingent Assets"  Retrieved from

https://www.aasb.gov.au/admin/file/content105/c9/AASB137_07 -04_COMPoct10_01-11.pdf

Australian Accounting Standard Board (AASB), (2010),"AASB 116 Property, Plant and  Equipments" Retrieved from  https://www.aasb.gov.au/admin/file/content102/c3/AASB116_07-04_ERDRjun10_07 -09.pdf

Australian Accounting Standard Board (AASB), (2011),"AASB 108 Accounting Policies, Changes  in Accounting Estimates andErrors" Retrieved from https://www.aasb.gov.au/admin/file/content105/c9/AASB108_07-04_COMPmay11_07 -11.pdf

Australian Accounting Standard Board (AASB), (2015),"AASB 138 Intangible Assets" Retrieved  from https://www.aasb.gov.au/admin/file/content105/c9/AASB138_08 -15_COMPoct15_01 -18.pdf

Firoz, M. and Ansari, A.A.,( 2010)," Environmental accounting and international financial  reporting standards (IFRS)"- International Journal of Business and Management, 5(10),  pp.105-112.

Taplin, R., Tower, G. and Hancock, P., 2002, June. Disclosure (discernibility) and compliance of  accounting policies: Asia–Pacific evidence. In Accounting Forum (Vol. 26, No. 2, pp. 172 -190). Blackwell Publishers Ltd..

Wells, M.J., 2011. Framework-based approach to teaching principle-based accounting  standards. Accounting Education, 20(4), pp.303-316.