ACCT860 Financial Accounting (2)

ACCT860 Financial Accounting

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ACCT860 Financial Accounting

Question 1. Inventories

The Conceptual Framework says that accounting information should be useful to investors and creditors. NZ IAS 2 requires that inventories be measured at the lower of cost or net realizable value. Briefly explain the usefulness of the inventory figure resulting from this rule.

NZ IAS 2 is an accounting standard developed by the International Accounting Standard board (IASB). It provided guidance on the classification and valuation of inventories. It defines inventories as the assets that are held for sale during the normal undertakings of a business. Inventories also comprise of the assets that are used in the process of making a sale. Finally, inventories refer to the assets in the form of materials or supplies that are used in making the products or service delivery. IAS 2 requires the assets that re regarded as inventories to be recorded at lower costs or net realizable value. Cost comprises of the cost and the conversion costs, which refers to the costs that are used in converting inventory to its location or condition. It facilitates the capitalization of the variable overheads and fixed overheads (Robinson et al., 2015). The fixed overheads should be allocated in a systematically and consistently in relation to the usual output levels. If the output is lower than expected, the excessive overhead should be regarded as an expense and not capitalized. On the other hand, if the output is significantly higher than the fixed overhead, each of the unit should be decreased to ensure the inventory is not overvalued. If multiple products result from one process and it is difficult to separate each of the costs involved in making the product, a rational and consistent means of allocating each of the costs should be used. Organizations should use First-in, First-out (FIFO) principle, which involves considering the items that are used first in the inventory reporting date and valuing them using the most updated price. If the net realizable value of the items is lower than the cost of inventory, the loss should be regarded as an expense during the period in which the reduction in the value of the item occurs.

Briscoe Group estimates the cost of inventories using the weighted average formula (see note 3.1.3 to Briscoe Group 2019 financial statements). During an inflationary period, what would have been the impact on profit if Briscoe Group had adopted FIFO instead of the weighted average formula?

FIFO is an inventory method that assumes that the products that were purchased first would be the first to be sold. This implies that the items that remain in the inventory at the end of the accounting period are the ones that were most recently purchased. On the other hand, the weighted average is an inventory method where the cost of each item is determined using the weighted average of similar items at the start of the accounting period and the cost of identical items bought or produced during period. The weighted average formula is used when the inventory items are so intertwined such that it is difficult to assign a specific value to each individual unit. Conversely, the FIFO method is based on the assumption that a cost flow removes the costs from the inventory account if the inventory items have been purchased at different prices over time (Robinson et al., 2015).

Adopting FIFO instead of the average formula would have made it difficult for Briscoe Group to calculate the cost of inventory. It would have reduced the profit of the company. The company expected the inventory to be sold at a price that is lower than the cost. The value of the inventory was expected to have reduced between the date of the stocktake and the balance date (Robinson et al., 2015).

Briscoe Group estimates the cost of inventories using the weighted average formula (see note 3.1.3 to Briscoe Group 2019 financial statements). According to NZ IAS 2, explain whether the Group can use the specific identification formula to determine the cost of its inventories.

Any company can use the weighted-average method in calculating the value of inventories in a situation where the prices are increasing and the cost of goods sold is less than the one used in LIFO but more than the one determined using FIFO. This implies that when using LIFO, the inventory would not be badly understated. However, it would not be updated if the FIFO method was used. Therefore, the weighted-average assumes the middle ground. It enables a company to manipulate its income using the weighted-average through the purchase or failure to purchase goods near the end of the financial year. As such, the averaging process limits the impact of purchasing or failure to purchase. Therefore, Briscoe did not err in using the weighted-average method in calculating inventory. This is because it expected inventory to sell for less than the cost of purchasing it. The value of the inventory reduced between the date of the stocktake and the balance date.

Question 2. Property, plant & equipment

NZ IAS 16, para. 29 allows two alternative models for the subsequent measurement of property, plant and equipment: the cost model or the revaluation model. Briefly explain whether this choice is consistent with the qualitative characteristics of accounting information.

According to NZ IAS 16, paragraph 29, an entity should use either cost model or the revaluation model as its accounting policy. It should apply this accounting policy in plant, property, and equipment. Initially, the PPE measurements should be undertaken at cost. However, subsequent policy decision should be undertaken using the cost model or the revaluation model. In the cost model, the value of an asset is the determined using its cost less the accumulated depreciation and the impartment model. On the other hand, in the revaluation model, if the fair value of the asset can be determined reliably, the revalued amount should be similar to the fair value at revaluation less any subsequent depreciation that has been accumulated and the impairment losses. NZ IAS 16 paragraph 29 claims that the revaluing of one asset should be accompanied by the revaluation of all assets in that class. For example, is a firm has 8 machinery and 4 buildings, the revaluation of building and machinery should be accompanies by the revaluation of all the buildings and machinery and not simply one of the building or machinery.

There are several differences between the cost model and the revaluation model. For instance, the cost model determines the cost incurred to acquire asses whereas the revaluation model measures the fair value of the assets. On the other hand, the cost model does not have biases in the valuation of assets as opposed to the revaluation model that may assign a higher value to an asset. The revaluation model is also more complicated than the cost model. Nevertheless, the revaluation model provides a more accurate depiction of the worth of a firm in comparison to the cost model.

However, the IFRS Framework does not provide the normative guidance and consistency with other IFRS support accounting needs. In addition, IASB does not apply the notion of consistency in determining the lease accounting requirements. For instance, despite the fact that the entities are provided the right to choose either cost model or revaluation model in accounting non-financial assets, it does not provide entities with the right to use the revaluation model except in specific instances. IFSR 16 requires entities to account for lease liabilities using the present value of lease payments.

Instead of requiring the disclosure of the carrying amount of PPE (i.e., the gross carrying amount net of accumulated depreciation), NZ IAS 16, para. 73 (d) requires an entity to disclose, for each class of (PPE), separately the gross carrying amount and the accumulated depreciation. Does this disclosure provide useful information to users? Explain.

NZ IAS 16 para. 73(d) focuses on plant, property, and equipment. It requires entities to disclose each class of property, plant, and equipment separately the gross carrying amount and the accumulated depreciation. It is related to paragraphs 58-64 of IAS 36, which details the principles for recognition and measurement of impairment loss for an asset. Impairment loss occurs if the recoverable amount is less than its carrying amount. Therefore, the asset should be depreciated from its carrying amount to the recoverable amount. If the value of the asset is measured using the cost model, impairment loss should be acknowledged immediately in the profit and loss. Paragraph 73(d) of IAS 16 should also be referenced when making accounting entry for the loss. Paragraph 73(d) of IAS 16 requires entities to provide accounting entry of the gross carrying amount and the accumulated depreciation, which should also comprise of accumulated losses, at the start and end of the accounting period. Therefore, when there are impairments, there is no need for an entity to write off any existing accumulated depreciation or develop a different accumulated impairment account. The entity should simply include the accumulated depreciation. It is preferable to refer to the accumulated depreciation as Accumulated Depreciation and Impairment Losses (Picker et al., 2019).

An entity owns beef cattle that forms the breeding stock of its agricultural activity. The entity also owns a tractor and trailer for transporting feed to the cattle. Briefly discuss whether the cattle and the tractor and trailer meet the definition of property, plant and equipment, and are within the scope of NZ IAS 16.

IAS 41 provides provisions on the treatment of agriculture accounting. It has a significant impact on agricultural activities, which involve the use of biological assets such as living animals or plants. It also includes the harvested agricultural produce such as milk, eggs, and meat. The same distinction is used in plantations where the trees have to be felled or harvested as is the case in sugarcane. Nevertheless, it is vital to note that biological assets do not comprise of bearer plants. Bearer plants refer to plants that are used in the supply or production of certain agricultural produce. They bear the produce for more than one period. In addition, they are less likely to be sold like other agricultural produce unless they are sold as incidental scrap. Bearer plants would include grape vines, tea bushes, and rubber trees. They are accounted for using IAS 16. They are subjected to depreciation and impairment when they reach maturity. On the other hand, IAS 41 is used in the accounting of biological assets such as plants and animals. The agricultural activity involves the biological transformation of the entity. IAS is not applicable to bearer plants, which are regarded as Property, Plant, and Equipment according to IAS 16. However, IAS 41 does not cover bearer plants related to agriculture. It does not also cover the products that are derived from the processing after the harvesting of the agricultural products. These include carpet, processed meat, wine, or tea. IAS 41 does not also cover the land where the agricultural activities take place. The land is covered under IAS 16 since it is a PPE. IAS 41 does not also cover any tangible assets that are related to agricultural undertakings. These include rights and licenses. Agricultural activities that are not managed are not also covered by IAS 41. These activities include ocean fishing. Exploitation of non-regenerative resources such as oil, natural gas, minerals, and other similar resources is also not covered by the IAS 41. Therefore, the entity that owns the cattle that form the breeding stock for beef cannot regard them as Property, Plant, and Equipment. The cattle are simply reared for production of beef. They do not produce beef more than once. Therefore, the accounting of the cattle would be controlled by IAS 41 instead of IAS 16. However, IAS 41 would not cover the processed beef products derived from the cattle. On the other hand, the tractor that is used to deliver feed to the cattle should be regarded as property, plant, and equipment. It is used several times in the delivery of the feed. It can only be sold as incidental scrap.

Question 3. Financial Reporting Case

If you want to buy shares in the bus company, briefly discuss what accounting and non-accounting information you would consider relevant for the decision to invest in the company.

The bus should be considered as property, plant, and equipment. As such, just like other property, plant, and equipment it would undoubtedly wear out or become obsolete, which would require it to be sold or traded for new assets. The depreciation of the assets should be updated. Disposal of assets should follow various steps. These include the updating the depreciation date of the asset, writing off the costs of the assets, writing off the accumulated depreciation, recording any consideration that should be received or paid after the sale of the asset, and recording any gains or losses after the disposal of the asset.

Most entities dispose property, plant, and equipment by selling it. Comparing the book value of the asset and its selling price would help in determining whether the sale of the asset resulted in a gain or a loss. If the selling price is higher than the book value of the asset, the entity would have made a gain. On the other hand, if the selling price of the asset is less than the book value of the asset, the entity would have a loss whereas if the book value of the asset is similar to the selling price, the entity would not have made a gain or loss.

The bus has two components, the engine and the body. The cost allocated to the engine is $40,000 whereas the costs allocated to the body is $20,000. The bus company does not intend to the engine would be replaced after ten years with the body being replaced after 4 years. The bus company intends to scrap the bus after ten years. It would not recoup anything after the sale of the bus. Therefore, the lifetime of the second engine would be ten years whereas the lifetime of the second body would be 16 years. Since the bus was involved in an accident, its rate of depreciation would increase. It was forced to replace the body. Therefore, the lifetime of the second body would be 16 years from the date of replacement. The bus company was also forced to replace the engine four years after the accident. The lifetime of the engine is 10 years.

Therefore, as an investor, one should consider the original cost of the bus, the expected depreciation of the engine prior to the accident, the cost of the new body purchased by the bus company after the accident, the total cost of the engine replacement, and the depreciation of the engine and the body after the accident.

Give journal entries until 30 September 2018. Show all relevant calculations.

DebitCredit

Cash 60,000

Engine 40,000

Body20,000

Accumulated depreciation after accident

Body20,000

Engine8,000

New Body Purchased25,000

Selling price 5,000

References

Picker, R., Clark, K., Dunn, J., Kolitz, D., Livne, G., Loftus, J., & Van der Tas, L. (2019). Applying IFRS standards. Hoboken, NJ: John Wiley & Sons.

Robinson, T. R., Henry, E., Pirie, W. L., & Broihahn, M. A. (2015). International financial statement analysis. Hoboken, NJ: John Wiley & Sons.