Accounting Policies, Changes In Accounting Estimates, And Essay. (70 Characters)

Retrospective Application

1. Biotran Ltd is a biotechnology company that researches and develops new drugs for the treatment of a wide range of health issues. Biotran Ltd’s accounting policy in relation to research and development expenditure is based on the requirements of AASB 138 Intangible Assets which requires all research expenditure to be expensed as incurred and only permits the capitalisation of development expenditure in very limited circumstances when specified criteria in AASB 138 Intangible Assets are satisfied. During the year ended 30 June 2016, Biotran Ltd incurred research expenditure of $26 million (which was expensed), development
expenditure of $38 million (of which $18 million was capitalised) and reported total comprehensive income of $8 million.

In February 2016, the Australian Accounting Standards Board (AASB) announced that they intend to amend AASB 138 Intangible Assets to permit entities to capitalise research expenditure and to make it easier for entities to capitalise development expenditure. The AASB intends to issue the revised AASB 138 Intangible Assets in early 2018.

In July 2015, at the beginning of the current reporting period, Biotran Ltd decided to change its accounting policy for the valuation of materials inventories (used in research and development) from a weighted-average cost (WAC) method to a first-in, first-out (FIFO) method. Biotran Ltd believes that the FIFO method more accurately reflects the usage and flow of inventories. Also in July 2015, Biotran Ltd made changes to the estimated useful life and residual value of its buildings to reflect concerns that the commercial property market would decline due to reduced demand and excess capacity.

Required

(a) Explain the term ‘accounting policy’ and distinguish between ‘retrospective application’ and ‘retrospective restatement’.

(b) Assume that the AASB issues a revised AASB 138 Intangible Assets in 2018 that permits the capitalisation of research expenditure and makes it easier to capitalise development expenditure. According to AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors, how would Biotran Ltd account for this change? 

(c) According to AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors, under what circumstances is Biotran Ltd permitted to change its accounting policy for the valuation of materials inventory? How, according to AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors, should the change be accounted for?

(d) Biotran Ltd has determined that the cumulative effect of the change in accounting policy for the valuation of inventories is a decrease in profit of $180,000 as at 1 July 2015 (the beginning of the current reporting period) but that it is impracticable to determine the individual period-specific effects of the change in accounting policy on the prior periods presented. What should Biotran Ltd do in this situation?

Retrospective Restatement

(e) According to AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors, how should Biotran Ltd account for the changes in the estimated useful life and residual value of its buildings? 

2. Benson Ltd is a manufacturing company that operates a production facility in the Sydney suburb of Alexandria. In January 2016, residents living adjacent to the production facility complained that groundwater was being contaminated from waste discharged from Benson Ltd’s production facility. In May 2016, environmental officers from the City of Sydney Council confirmed the existence of groundwater contamination although they did not regard the contamination as particularly serious. Benson Ltd immediately responded by implementing new procedures for the storage and disposal of waste material to prevent any further contamination from occurring. Although Benson Ltd is not required by law to restore the contaminated environment, the company made a series of public announcements that it would undertake to restore the contaminated environment in two years’ time.

As at 30 June 2016, Benson Ltd estimates the cost of restoring the contaminated environment as follows:

Cost                Probability

$420,000          20%
400,000            70%
300,000              5%
200,000              5%

Also on this date the risk-free discount rate, based on two-year government bonds, is 6%. However, Benson Ltd believes that a discount rate of 4% is appropriate to adjust for the risks specific to this liability.

Required

(a) How is a provision defined in AASB 137 Provisions, Contingent Liabilities and Contingent Assets? Why would Benson Ltd’s obligation to restore the contaminated environment be classified as a provision?

(b) 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.

(c) How has Benson Ltd taken risk into account to estimate the amount to be recognised as a provision? What is an alternative approach to taking risk into account? 

(d) Determine the amount that, in your judgement, Benson Ltd should recognise as a provision as at 30 June 2016. Justify the approach that you used to calculate the amount. 

3. On 1 July 2012, Lynx Ltd paid $700,000 to acquire a machine that was to be used in the manufacture of steel sub-assemblies. On this date, management of Lynx Ltd estimated that the machine had a useful life of ten years and a residual value of $100,000. In accordance with AASB 116 Property, Plant and Equipment, Lynx Ltd uses the revaluation model as its accounting policy to measure items of property, plant and equipment and the straight-line method of depreciation.

The fair values of the machine for the first three years were as follows:

• 30 June 2013: $685,000
• 30 June 2014: $620,000
• 30 June 2015: $520,000

On 31 December 2015, Lynx Ltd sold the machine for $500,000 cash.

Required

Based on the requirements of AASB 116 Property, Plant and Equipment, provide (where necessary) appropriate journal entries in relation to the measurement of the machine as at:

• 30 June 2013,
• 30 June 2014,
• 30 June 2015, and
• The sale of the machine on 31 December 2015

Retrospective Application

Accounting policies as per Australian Accounting Standard Board 108 refers as the particular methods, systems, actions, judgments, rules and ideology adopted by management of an entity in presentation and preparation of the books of accounts and financial statements which helps them to disclose all the material facts relating to the financial and non financial affairs of the company and are adherence to generally accepted accounting principles and international financial reporting standards. The accounting policies usually applied by an entity in agreement with complex transactions happen in any business related to Depreciation, valuation of Goodwill,  Inventory valuation, calculation of research and development cost, preparation of consolidated financial statements.

Retrospective application in relation to accounting policies means applying a new accounting policies in any particular year as if it is applied from the first year in which transaction relating to such accounting policy starts.

Retrospective Restatement refers as revising the values of previous years account balances in respect of error occurred in previous period and their identification, existence and presentation in financial statements of an entity as these error was never happen.

If the revised AASB 138 relation to intangibles which indicates the revision in methods of capitalization of research and development costs are Changes in Accounting Estimates as per AASB 108. Change is estimates are happen due to change in any laws and new inventions in accounting which requires the adjustment of book value of assets recognized in its financial statements by an entity in a particular period.

 In the given case of Biotran Limited, the change in accounting estimate in relation to research and development expenditure shall be accounted for in the current and future financial statements on prospective basis only in the year and years for which such change in estimated effects the profit or loss of an entity. So the Biotran will take the effect in the profit and loss account for the year 2018 and thereafter.

 The accounting policy can be changed only if it is permitted only if it is required by the applicable laws for the time being in force and if the change in policies results in better presentation of the financial statements of an entity.

In the given case of Biotran Ltd, the company is permitted to change its accounting policy in valuation of material inventory from Weighted average to FIFO only if :

• It is required as per the Australian Accounting Standard to Board to value the inventory at FIFO method
• And such change in valuation of inventory provides the more accurate information about the financial performance of the company

The accounting treatment of change in accounting policy can be done retrospectively or as per the provisions of laws according to which changes in accounting policy happen.

Retrospective Restatement

In the case of Biotran Ltd, the change in valuation of material inventory is done as per the choice of the company to provide more accurate information and such change shall be applied as Retrospective Application of change in accounting policy.

There are two situations in which retrospective application cannot be applied by an entity in respect of change in accounting policy. They are:

i. Difficult  to determine the effect in relation to particular periods

ii. Difficult to ascertain the total effect due change in policy

If an entity shall not able to determine the effect in of change in policy in particular periods, then an entity shall take the effect of such change in the book values of the assets and liabilities effected from such  at the start of period for which change identified and the subsequent effect of the same in the equity component of an entity

The Biotran Ltd will shall decrease the value of inventories mention in the head Current Assets as on 1st July, 2015 and correspondingly decrease the value of General Reserves shown as Equity Component   on 1st July 2015 by $ 180,000 in current reporting period.

The change in accounting estimate will bring corresponding change in assets or liabilities of an entity shall be accounted for by adjusting book values of that assets or liabilities in the period for which change is take place in an entity.    

In the given siuation, BIotran Ltd on account of changes in estimated useful life and residual value of its building should account for the effect on depreciation expense of building in the current year and for the future year over the remaining revised useful life of building.  

As per Australian Auditing Standard Board 137, Provisions are defined as tentative amount and timing recognized as a liability to an entity. It is the amount set aside by the company for its doubtful economic duty which may arise in future.

The provision in the books of accounts of entity be identified if there is liability for an entity arises in the current period from the past acts of entity and it sure that the entity has to pay money for settlement of such liability and the amount to be paid can be guessed rationally by the management of an entity.

In the case of Benson Ltd, the obligation in relation to restoring the effected environment be regarded as provisions in the financial statements as:

• the company has constructive obligation in current year from its previous years actions
• the amount has to be spent by company in next two years in restoring the environment to fulfill its obligation   
• the cost of restoration can be estimated by the company in a reasonable manner

Changes in Accounting Estimates

The following are the three commonly used methods as AASB 137 for recording the amount of provisions in the books of account of an entity:

i. Best Judgment- In this method the provision is recognized at an amount which an entity is require to pay or incur at the end of the particular period in the rational manner to settle the obligation at the end of  particular period.

ii. Present Value- In this method, the amount of provision is calculated by the present value of future expenditure which an entity is expected to incur to settle the obligation. This method applied in case where change of money has material impact with passage of time.

iii. Future Event- In this method, the value of provision will be the amount require to resolve the obligation in particular future event. The provision in this method is only recognized when the there is substantive chances of happening of future event.

The expected value of that has to paid by an entity in settling the future obligation is the another approach measuring the value of provision under risk and uncertainty method.

In the case of Benson Ltd., the expected value that may be paid by company which is determine by the best judgment and after applying prudence approach to settle the obligation and recognition of provision in the books of account.

Under Risk and Uncertainty method of value of the provision, the value of provision is the more likely outcome from circumstance and event in measurement of the obligation of an entity.

In the given case of Benson Ltd., the manner of risk taken into account for estimate the amount of provision is the expected result of costs that is likely to be incur and the chances of its occurrence from restoration of contaminated environment by the company.

The company should recognized the amount of Provision calculated by Present value of  Risk and Uncertainty for group transaction. The most single most likely outcome that is cost of $ 400,000 is more than the other outcomes and is it highest probable outcome. But the other possible results are higher and lower than the most likely result, the best approach to settle the possible obligation is more higher than the present value of most likely result that is $ 400,000 costs as on 30 June, 2016.  Thus, the value will be calculated using the expected value method.

Value of Provision  = [( $ 420,000 X 20%) + ( $ 400,000 X 70%) +( $ 300,000 X 5%) +

( $ 200,000 X 5%)] / ( 1.04)²

= $ 359, 652

Reference

AASB Official Website, (2010),"Provisions, Contingent Liabilities and Contingent Assets" available onhttps://www.aasb.gov.au/admin/file/content105/c9/AASB137_07-04_COMPoct10_01-11.pdf accessed at 06/05/2017   

AASB Official Website, (2010),"Property, Plant and Equipmentss" available on https://www.aasb.gov.au/admin/file/content102/c3/AASB116_07-04_ERDRjun10_07-09.pdf accessed at 06/05/2017   

AASB Official Website, (2011),"Accounting Policies, Changes in Accounting Estimates and Errors" available on https://www.aasb.gov.au/admin/file/content105/c9/AASB108_07-04_COMPmay11_07-11.pdf accessed at 06/05/2017

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.