Analysis of benefits and challenges of utilizing historical cost and fair value accounting for both PPE and intangibles
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In accordance with regulations of IFRS 13 for fair value measurement, fair value is necessarily a market founded system of enumeration and not an entity specific aspect of measurement. Basically, market transactions otherwise market information might possibly be made available or not made available for specific assets and liabilities. Nonetheless, the primary objective of fair value enumeration in each of the two cases can be said to be identical for approximating the price at which particular orderly business transaction to sell or transfer the firm’s assets occurs between market participants right at the enumeration date (Williams 2014). In essence, this specific regulation of IFRS is pertinent when another IFRS permits fair value measurement otherwise disclosures as regards those measurements (reference to paragraph 5 under IFRS 13). As per paragraph 11, a fair value system of measurement is necessarily for a particular asset otherwise a liability. Therefore, at the time of enumerating fair value a particular entity has the need to take into consideration various characteristics of asset/liability if market participants would take into account those characteristics during pricing of firm’s assets/liabilities at the enumeration date. Nevertheless, this type of features comprise of conditions along with locations of the asset together with controls if any on mainly the sell or usage of the firm’s asset (Warren and Jones 2018). Particularly, asset/liabilities calculated at fair value can be a separate asset or else liability or a group of asset/liability.
In essence, historical cost can be identified as the original cost of a particular asset as recorded in the accounting records of a firm. Most of the business transactions recorded in the accounting documents of a business concern are stated at the historical costs (Henderson et al. 2015). In actual fact, a historical cost can be verified by way of accessing the source purchase otherwise trade documents. Nonetheless, historical cost necessarily has the disadvantage of not essentially replicating the real fair value that is expected to diverge from the cost of purchase over a specific time period. According to the accounting standard, historical costs have the necessity for specific adjustments with time. Armstrong et al. (2015) suggests that historical cost differs from several other costs that are necessarily assigned to a particular asset, such as replacement cost else wise cost of inflation adjustment. Nevertheless, historical costs can still be considered as a central notion of recording assets, although fair value is substituting the same for particular types of assets. The ongoing substitution of the historical cost by fair value system of dimension is based on the argument that historical cost represents a conventional image of a firm.
Nevertheless, the choice between utilizing fair value as well as historical cost scheme of accounting can be regarded to be widely argued matter of concern. Nonetheless, the argument essentially dates back to the year 1990s. Most of the accounting standards, IFRS presents a choice between fair value and historical cost measurement system for different non-financial assets. Furthermore, IFRS also has the requirement of an ex-ante commitment that indicates commitment to one of two stratagems of accounting (Francis et al. 2015). Therefore, managers necessarily have a reason to market demands and commit to a particular accounting treatment that can aid in maximizing value of the corporation. In addition to this, fair value accounting system for diverse non-financial assets have the advantage of augmented value relevance along with information content, reduced information asymmetry and increased comparability. Reports recommend that utilization of fair value instead of historical cost is not essentially random and occurs when benefit overshadows the costs (Hermason et al. 2016).
According to the regulations stipulated under AASB 116, fair value can be regarded as an amount for which specific asset could essentially be exchanged primarily well-informed and enthusiastic parties especially in arm’s length business deals. According to paragraph 15 of the directive AASB 116, a specific item of the plant, property as well as equipment that effectively qualifies for recognition and can be regarded as a particular asset can be calculated at cost (Oulasvirta 2016).
As rightly indicated by Laing and Perrin (2014) the directives stipulated under AASB 138 lays down accounting treatment for diverse intangible assets that are essentially not in another accounting regulation. Essentially, this specific standard that is applicable to business entities that need to arrange and present financial declarations according to the regulations of Part 2M.3 of Corporations Act and that too necessarily is a business concern. According to the regulations of the standard AASB 138, cost is basically the carrying amount of specifically cash along with cash equivalents that is disbursed otherwise fair value of diverse other considerations that are made available to acquire a specific asset during period of acquirement. Hu et al. (2015) mentioned that this standard when implemented, the complete amount is ascribed to the specific assets during the time when they are initially identified according to precise necessities of the other standards and treatment of accounting. According to AASB 3, in specific case of a business combination an intangible asset gets acquired, then the cost of that specific intangible asset is presented at fair value at the acquirement date. Fundamentally, fair value of intangible asset might help in reflecting anticipations of market participants at the acquirement date as regards probability that the predictable economic advantages will flow to the business entity (Abbott and Tan?Kantor 2017). However, if a specific intangible that is necessarily acquired in a particular business combination can be separated otherwise it arises from agreements or legal rights, then in that case adequate information exists to calculate asset using fair value dimensions. Business concerns might possibly identify intangible assets along with grants at fair value according to AASB 120. Furthermore, according to the cost model that is described according to paragraph 74 of the regulation AASB 138, after process of initial recognition, a particular intangible asset of a business entity shall essentially be undertaken at a certain revalued amount that is essentially the fair value registered at the date of revaluation after deduction of any consequent accumulated amortisation and subsequent impairment losses. As rightly indicated by Kaya (2014), fair value dimensions along with systems of accounting treatment for PPE can be regarded to be superior to mainly historical cot that is based on characteristics of predictive value, acquired feedback, representational faithfulness, neutrality as well as comparability and timeliness among many others. Basically, verifiability appears to the lone qualitative characteristic that supports the historical cost system over the fair value system.
Edeigba and Amenkhienan (2017) suggest that there are several advantages of utilizing historical cost for valuation of plant, property as well as equipment (PPE) on the balance sheet. Therefore, it is such that historical cost can easily be verified. Usually, the cost that a firm incurs during period of purchase is recorded with different types of contract, expends, transfer taxation-law and many others. In essence, the historical cost of PPE is also used for the purpose of determination of depreciation expenditure that is registered as a deduction from particular historical cost of the firm’s assets pronounced on the balance sheet. Nevertheless, for impairment, there are specific assets of firms that might possibly be registered at a certain amount that is lower than the one calculated on historical cost (Wingard et al. 2016). In point of fact, the utilization of the historical cost can also bear out to be a disadvantage for the financial information users of various financial declarations that has the requirement to comprehend the current value. Again, intangible assets might probably has to be valued for various reasons.
However, it can be witnessed that fair value dimensions in accounting has higher possibility of getting selected for mainly PPE than firm’s other non-financial assets since property makers are usually more liquid. There is more likelihood of adopting fair value when it essentially smoothes the progress of enumeration of performance. In this particular case, value transformation of investment property is somewhat informative of diverse operating performance specifically when capital gains become a significant part of the entire business model (Palea 2014). Nonetheless, fair value accounting treatment also adversely exerts impact on various dimensions of performance mainly if administration of the corporation intends to hold different unproductive assets.
In this current study, Woolworths Limited is selected as a listed firm under the Australian Stock Exchange (ASX), Tesco Plc is chosen as a listed firm under the London Stock Exchange and Alcoa Corporation is selected as listed corporation under the New York Stock Exchange.
Woolworths Limited: Analysis of Woolworths Limited’s consolidated financial assertions reveal the fact that the entire group presents a general purpose financial statement. This deceleration is essentially prepared as well as presented in accordance with the directives of the Corporations Act of the year 2001, regulations of the Australian Accounting Standard and directives of the Interpretations along with International Financial Reporting Standards (IFRS) (Wow2016ar.qreports.com.au 2018). Analytical evaluation of the financial pronouncement of the firm replicates the fact that plant, property as well as equipment (PPE) of the entire group is necessarily calculated at cost taking away accumulated depreciation otherwise amortisation along with accumulated losses from impairment. In particular, cost incurred for various self-constructed firm’s assets contains material cost, overhead proportions along with cost of direct labour. As such, the cost incurred for development properties includes borrowing, holding cost together with development until the asset becomes complete (Steenkamp and Steenkamp 2016). Essentially, the yearly financial declaration of the corporation also states that PPE are essentially assessed as per the stratagem of impairment of firm’s non-financial assets. In addition to this, estimation of economic lives also require correct judgement of the management and are assessed every year (Hu et al. 2015). Particularly, in Woolworth’s case, PPE impairment primarily relates to PPE, assets of the stores along with distribution centres associating to the Home Improvement Business (Wow2016ar.qreports.com.au 2018).
In addition to this, according to the annual report of the firm for the financial year 2016, it can be hereby observed that intangible assets of the firm are calculated at cost deducting particular accumulated amortisation along with losses of impairment. However, at the time when intangible assets are gathered in a specific business combination, particular costs replicate the fair value especially at the date of acquirement. Furthermore, intangible assets of the corporation that has finite lives are essentially amortised with diverse finite lives that are necessarily amortised by way of straight line mechanism over estimated economic lives.
Tesco Plc: Critical analysis of the annual declaration of the firm for the financial year 2016 replicates that the financial pronouncements of the corporation are both prepared as well as presented in conformation to the directives under International Financial Reporting Standards (IFRS) as has been assumed by the entire European Union (EU) (Tescoplc.com 2018). In essence, financial declarations are necessarily prepared as per the requirements of the Companies Act of the financial year 2006 regarding the financial reports of the entire group and in compliance with the article 4 stipulated under IAS Regulation. As such, analysis of the significant accounting policies of the business concern reflects the fact that the PPE is essentially carried and presented at cost less the particular amount of accumulated depreciation along with any detected impairment value. In itself, plant, property as well as equipment (PPE) is depreciated by utilizing the straight line mechanism to necessarily the residual value over the approximated economic lives (Tescoplc.com 2018). Analysis of the financial reports of the firm for the FY 2016 also helps in understanding the fact that non-financial asset of the corporation including intangible assets along with PPE; the entire group assumes impairment testing in which there are specific gauges of impairment. However, in specific cases in which asset does not essentially generate cash flows are independent from other assets (Tran and Zhu 2017). Thereafter, the group estimates the overall recoverable amount of cash generating unit.
Furthermore, annual financial report of the corporation also reads that intangible assets for example, software together with pharmacy licenses of the corporation are calculated at acquirement cost otherwise costs borne for asset development. Furthermore, expenditure for development on a particular project is essentially capitalized when specific criteria are met. In this case, the asset generated will possibly generate economic advantage in the future. Basically, intangible assets that the firm acquires in a particular business combination are identified at fair value at the date of acquisition (Williams 2014). Nevertheless, after the period of initial recognition, particular intangible assets that have finite economic lives are measured at cost deduction of the amortisation along with accumulated losses for impairment. In essence, they are essentially amortised on a straight line manner over the estimate economic life that rovers around 10% -20% of cost every year. For different other non-financial assets including firm’s intangible assets, the entire group assumes impairment testing especially in cases when there are different gauges of impairment.
Alcoa Corporation: Analysis of the annual report of the firm Alcoa Corporation for the financial year 2016 shows that the consolidated financial statements is essentially prepared in compliance to the accounting directives usually assumed in USA that is GAAP. In actual fact, this calls for the firm’s management to undertake particular judgement, approximations along with suppositions (Warren and Jones 2018). Nevertheless, this might possibly exert impact on the recorded amount of the corporation’s assets/liabilities together with diverse disclosures on particular contingent assets as well as liabilities at the pecuniary statement date.
Particularly in Alcoa Corporation, PPE are documented at cost. In essence, depreciation is recorded using the straight line mechanism at specified rates based on estimated economic lives of firm’s assets. As such, for different Greenfield assets of the firm that refer to construction of diverse new assets on diverse undeveloped land, different production methods is used for recording the depreciation. Essentially, these assets need a considerable period (usually greater than one year) to augment the overall production potential (Henderson et al. 2015)
In actual fact, plant, property as well as equipment (PPE) are assessed for impairment whenever there are specific incidents otherwise transformations in conditions. This necessarily replicates that the carrying amount of this category of assets/group of assets might possibly not be recoverable. Again, it can also be witnessed that asset recoverability can be determined by means of comparing estimated undiscounted flow of net cash operations related to carrying amounts of assets/ group of assets of the corporation (Armstrong 2015). Furthermore, impairment losses can necessarily be identified when firm’s assets/group of assets carrying amount go over undiscounted net cash flow. The amount of impairment loss has to be registered is calculated as excess of carrying value of the asset or else group of asset of the firm over its fair value. In this, fair value is determined by way of prominent information acquired from discounted cash flow model. In addition to this, determination of what consists of asset groups, the associated estimated undiscounted net cash flow, and the estimated useful lives of the assets requires substantial judgements (Investors.alcoa.com 2018).
As per the annual report of the corporation Alcoa Corporation, it can be hereby mentioned that goodwill as well as other intangible assets is not inevitably amortised and instead it is examined yearly or more regularly for the purpose of impairment when impairment indicators exist or when management decides to sell or to exit from business (Francis et al. 2015). Essentially, policies of accounting that are stated in the financial assertions elucidates illustratively that a substantial amount of management judgement is involved in the determination process when a specific parameter of impairment is in place. Furthermore, this types of indicators and might possibly takes in deterioration in usual economic situations, unfavourable developments in equity and credit market, undesirable alterations in the market in which the business concern functions. Essentially, these indicators also contain augmentation in costs of input that essentially have unfavourable influence on earnings, downward trend of cash as well as cash flow of the company (Hermason et al. 2016). In essence, impairment tests of mainly goodwill in different previous years presented replicated that the corporation’s goodwill was not in fact impaired. Particularly, intangible assets that have finite economic lives are unavoidably amortised in a normal way using a straight line mechanism over a specific period of time (Investors.alcoa.com 2018).
The calculation of PPE as well as intangible assets of the corporation is moderately consistent among the corporations Tesco Plc and the Australian firm Woolworths Limited, whilst it is somewhat different for Alcoa Corporation. For Tesco Plc, PPE of the firm is essentially carried out at cost less accumulated depreciation together with equipment of the corporation is essentially carried out at cost less accumulated depreciation along with any kind of recognized impairment value. In addition to this, in case of Woolworths Limited, PPE of the overall corporation is necessarily calculated at cost less accumulated depreciation otherwise amortisation along with accumulated losses of impairment. Nonetheless, for Alcoa Corporation, PPE are recorded at cost (Oulasvirta 2016). In essence, depreciation is recorded using straight line mechanism at specified rates based on the estimated useful lives of firm’s assets. However, in case of intangible assets of the firm Tesco Plc, it is calculated initially the cost of acquirement otherwise costs that is borne for asset development. Furthermore, specified intangible asset that has finite economic lives are undertaken at cost deducting accrued amortisation along with accumulated losses of impairment. For Woolworths Limited, intangible assets are calculated at cost and deducting from it accumulated amortisation and losses for impairment. In addition to this, in case of enumeration of intangible assets of Alcoa Corporation, assets that have finite useful lines are essentially amortised using straight line methods.
The present study aids in comprehending diverse benefits of IFRS that permits free choice between fair value and historical accounting mechanism. In essence, IFRS necessarily has an ex-ante commitment to one of the two accounting schemes. In particular, it is according to the management’s concern to limit the overall scope for various actions in the future time period, for let us say, management of firm’s earnings. Therefore, managers have specific incentives to properly react to different market demand and commit to accounting treatment that subsequently can aid in optimization of the overall value of the corporation. Laing and Perrin (2014) suggests that fair value accounting for different non-financial assets of the corporation heads to augmented relevance value along with content regarding information, reduced comparability. Prior reports recommend that the choice to use and adopt the fair value is not undertaken arbitrarily and takes place when the acquired benefits surpass the specified costs. Nonetheless, there are substantiations that help in replicating that net benefits that can be acquired from this fair value accounting treatment is necessarily limited in scope (Hu et al. 2015). Hence it can thus be inferred that the choice between two diverse systems need to be specified in the financial assertions of the corporation following the assumptions of directives of IFRS. Essentially, this has the need to be consistently applied moving forward.
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