GODFREYHODGSON HOLMES TARCA CHAPTER 7 ASSETS Assets defined • IASB (AASB) Framework for the Preparation and Presentation of Financial Statements: – an asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity 2 Assets defined Three essential characteristics: – future economic benefits – control by an entity – past events • exchangeability • recognition rules 3 Future economic benefits • Future economic benefits are the potential to contribute. either directly or indirectly. to the flow of cash and cash equivalents to the entity – profit seeking entity – not-for-profit entity • Relate to economic resources – scarcity – utility 4 . and the service or benefit embodied in it 5 . such as a building or machine.Future economic benefits • An asset is something that exists now • Has the capability of rendering service or benefit currently or in the future • Distinguish between the object. but it is not an essential characteristic of an asset • Does not rely on legal enforceability 6 .Control by an entity • The economic benefit must be controlled by the entity • An entity’s right to use or control an asset is never absolute • Ownership is often concurrent with control. Past events • Control as a result of a past event • Planned assets are excluded • Event can be interpreted in different ways – executory contracts 7 . Exchangeability • Some argue that a 4th essential characteristic is that an asset be exchangeable • Separable from an entity 8 . Exchangeability • MacNeal A good that lacks exchangeability must lack economic value because its purchase or sale must forever remain impossible. and thus no market price for it can ever exist – goodwill • subject to evaluation not measurement 9 . Asset recognition • The extent and timing of the recognition of assets is important because it can have economic consequences for preparers and users of financial statements 10 . Asset recognition • Recognising assets on the balance sheet involves recognition rules – conventions and authoritative pronouncements • Recognition criteria – the future economic benefits must be probable – the asset must be capable of being measured reliably 11 . but not gains 12 .Asset recognition • Past recognition criteria – – – reliance on the law determination of economic substance of the transaction or event use of the conservatism principle: anticipate losses. in turn.Asset measurement • All the elements of accounting are linked and measurement of profit flows from measurement of the change in net assets • The rules and practices governing asset recognition and measurement will also affect measurement of profit and. capital (equity) 13 . Asset measurement • Once the definition and recognition criteria have been met. the accountant must decide how to measure the asset – several measurement approaches available – qualitative characteristics of financial information • Once measured – on balance sheet – restricted to just note disclosure 14 . Tangible assets • Traditional approach has been to measure assets at historical cost • IASB standards permit subsequent remeasurement using a number of approaches – fair value • exit value or value in use • UK and Australian firms could use values other than historical cost for many years 15 . Intangible assets • Accounting measurement has generally been conservative – cost (less accumulated amortisation and impairment) is commonly used – fair values from an active market – internally generated intangibles cannot be recognised 16 . What are the divergent arguments for recognising customer relationships in a business combination? Is it a true intangible asset? 17 . Financial instruments • FASB/IASB – derivatives are measured at fair value rather than cost • IASB – committed to the use of fair value measurement for financial instruments 18 . What are the objectives of the fair value measurement project? 19 . Challenges for standard setters • FASB/IASB intend to address the issue of measurement in Phase C of the conceptual framework project – consider measurement concepts. principles and terms – evaluate and rank measurement methods • qualitative characteristics 20 . Which measurement model? • Fair value is the frontrunner • Both the IASB and FASB support greater use of fair value measurement 21 . What are the arguments for and against fair value measurement? 22 . How to calculate fair value measurement • Various valuation techniques to calculate fair value – the market approach • observable prices • actual transaction data 23 . How to calculate fair value measurement • Various valuation techniques to calculate fair value – the income approach • conversion of future amounts .cash flows or earnings – to a single discounted present amount 24 . How to calculate fair value measurement • Various valuation techniques to calculate fair value – the cost approach • the amount that currently would be required to replace its service capacity (current replacement cost) 25 . Under what circumstances is this reclassification allowed? 26 .In response to the credit crisis the IASB changed the rules to allow entities to choose to reclassify some financial instruments from a fair value measurement basis to a cost basis. How to calculate fair value measurement • The valuation must emphasise market inputs – assumptions and data that market participants would use in their estimates of fair value 27 . How to calculate fair value measurement • Three hierarchical levels for the inputs – Level 1 – quoted prices for identical items in active markets. income and cost approaches 28 . without adjustment – Level 2 – quoted prices for similar items in active markets. adjusted as appropriate for differences – Level 3 – estimated fair value using multiple valuation techniques consistent with the market. Issues for auditors • Auditing fair values creates difficulties because it requires the application of valuation models. frequently. the use of valuation experts 29 . and. Issues for auditors • Auditors need to – understand the client firm’s processes and relevant controls for determining fair values – make a judgement on whether the client firm’s measurement methods and assumptions are appropriate and likely to provide a reasonable basis for the fair value measurement – appreciate management’s potential biases and likely errors • incentives 30 . Issues for auditors • There is the potential that corporate failures will lead to legal action against auditors who failed to approach their audit of asset fair values appropriately 31 . Summary • Defining assets • Recognition and measurement criteria • Asset recognition and the measurement of income and capital are interrelated • Mixed attribute measurement model and fair value measurement methods • Issues arising for standard setters and auditors 32 . Key terms and concepts • • • • • • • • • Assets Definitions Future economic benefits Control Past events Exchangeability Asset recognition Asset measurement Fair value measurement 33 . 34 .