At that time the factory will be demolished and the site returned to its original condition. This is a legal obligation that arose on signing the contract to purchase the land. Requirement Compute the initial carrying value of the factory see Table 1 for solution. Depreciation is not providing for loss of value of an asset, but is an accrual technique that allocates the depreciable amount to the periods expected to benefit from the asset.
Therefore assets that are increasing in value still need to be depreciated. IAS 16 requires that depreciation should be recognised as an expense in the income statement, unless it is permitted to be included in the carrying amount of another asset. An example of this practice would be the possible inclusion of depreciation in the costs incurred on a construction contract that are carried forward and matched against future income from the contract, under the provisions of IAS A number of methods can be used to allocate depreciation to specific accounting periods.
Two of the more common methods, specifically mentioned in IAS 16, are the straight line method, and the reducing or diminishing balance method. The assessments of the useful life UL and residual value RV of an asset are extremely subjective. They will only be known for certain after the asset is sold or scrapped, and this is too late for the purpose of computing annual depreciation. Therefore, IAS 16 requires that the estimates should be reviewed at the end of each reporting period.
If either changes significantly, then that change should be accounted for over the remaining estimated useful economic life. The asset is depreciated on a straight line basis. Where an asset comprises two or more major components with substantially different economic lives, each component should be accounted for separately for depreciation purposes, and each depreciated over its UL.
The estimated UL of the furnace was 10 years, but its lining needed replacing after five years. Requirement Compute the annual depreciation charges on the furnace for each year of its life. At 31 December 20X6, the lining component has a written down value of zero. There are rather more differences between IAS 16, Property, Plant and Equipment the international standard and FRS 15, Tangible Fixed Assets the UK standard in relation to revaluation and derecognition compared to initial measurement and depreciation.
For both topics addressed in this article, the international position is outlined first, and then compared to the UK position. Each model needs to be applied consistently to all PPE of the same class. A class of assets is a grouping of assets that have a similar nature or function within the business. For example, properties would 64 student accountant August typically be one class of assets, and plant and equipment another.
Additionally, if the revaluation model is chosen, the revaluations need to be kept up to date, although IAS 16 is not specific as to how often assets need to be revalued.
When the revaluation model is used, assets are carried at their fair value, defined as the amount for which an asset could be exchanged between knowledgeable, willing parties in an arms length transaction.
Revaluation gains Revaluation gains are recognised in equity unless they reverse revaluation losses on the same asset that were previously recognised in the income statement. In these circumstances, the revaluation gain is recognised in the income statement.
Revaluation changes the depreciable amount of an asset so subsequent depreciation charges are affected. Show the treatment of the revaluation surplus and compute the revised annual depreciation charge.
A revaluation usually increases the annual depreciation charge in the income statement. IAS 16 allows but does not require entities to make a transfer of this excess depreciation from the revaluation reserve directly to retained earnings.
Revaluation losses Revaluation losses are recognised in the income statement. The only exception to this rule is where a revaluation surplus exists relating to a previous revaluation of that asset. To that extent, a revaluation loss can be recognised in equity. Compute the revaluation loss and state how it should be treated in the financial statements. FRS 15 states that, as a minimum, assets should be revalued every five years. As far as properties are concerned these probably being the class of fixed asset most likely to be carried at valuation the basic valuation principle is value for existing use not reflecting any development potential.
Notional, directly attributable acquisition costs should also be included where material. However, specialised properties may need to be valued on the basis of depreciated replacement cost, since there may be no data on which to base an existing use valuation. If properties are surplus to the entitys requirements, then they should be valued at open market value net of expected directly attributable selling costs.
Revaluation losses that are caused by a clear consumption of economic benefits, for example physical damage to an asset, should be recognised in the profit and loss account.
Such losses are recognised as an operating cost similar to depreciation. Other revaluation losses, for example the effect of a general fall in market values on a portfolio of properties, should be partly recognised in the statement of total recognised gains and losses. However, if the loss is such that the carrying amount of the asset falls below depreciated historical cost, then any further losses need to be recognised in the profit and loss account. Solution The answer to Example 1 would not change at all.
For Example 2, if the revaluation loss was caused by a consumption of economic benefits, then the whole loss would be recognised in the profit and loss account. If the revaluation loss was caused by general factors, then it would be necessary to compute the depreciated historical cost of the property. A gain or loss on disposal is recognised as the difference between the disposal proceeds and the carrying value of the asset using the cost or revaluation model at the date of disposal.
This net gain is included in the income statement the sales proceeds should not be recognised as revenue. Where assets are measured using the revaluation model, any remaining balance in the revaluation reserve relating to the asset disposed of is transferred directly to retained earnings.
No recycling of this balance into the income statement is permitted. This classification can either be made for a single asset where the planned disposal of an individual and fairly substantial asset takes place or for a group of assets where the disposal of a business component takes place.
This article considers the implications of disposing of a single asset. IFRS 5 is only applied if the held for sale criteria are satisfied, and an asset is classified as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continued use.
For this to be the case, the asset must be available for immediate sale in its present condition and its sale must be highly probable. Therefore, technical This is the second of two articles, and considers revaluation of property, plant and equipment PPE and its derecognition. The asset needs to be actively marketed at a reasonable price, and a successful sale should normally be expected within one year of the date of classification. The types of asset that would typically satisfy the above criteria would be property, and very substantial items of plant and equipment.
The normal disposal or scrapping of plant and equipment towards the end of its useful life would be subject to the provisions of IAS When an asset is classified as held for sale, IFRS 5 requires that it be moved from its existing balance sheet presentation non-current assets to a new category of the balance sheet non-current assets held for sale.
No further depreciation is charged as its carrying value will be recovered principally through sale rather than continuing use. The existing carrying value of the asset is compared with its fair value less costs to sell effectively the selling price less selling costs.
If fair value less costs to sell is below the current carrying value, then the asset is written down to fair value less costs to sell and an impairment loss recognised. When the asset is sold, any difference between the new carrying value and the net selling price is shown as a profit or loss on sale.
It is classified as held for sale on 30 September 20X6. The year end of the entity is 31 December 20X6. It would be removed from non-current assets and presented in non-current assets held for sale. Where an asset is measured under the revaluation model then IFRS 5 requires that its revaluation must be updated immediately prior to being classified as held for sale. The effect of this treatment is that the selling costs will always be charged to the income statement at the date the asset is classified as held for sale.
Show how this transaction would be recorded in the financial statements. Many businesses in the commercial world spend vast amounts of money, on an annual basis, on the research and development of products and services.
These entities do this with the intention of developing a product or service that will, in future periods, provide significant amounts of income for years to come. Equally, the argument exists that it may be 42 student accountant September impossible to predict whether or not a project will give rise to future income.
As a result, both the UK and International Accounting Standards provide accountants with more information in order to clarify the situation. Unlike a tangible asset, such as a computer, you cant see or touch an intangible asset. There are two types of intangible assets: those that are purchased and those that are internally generated. The accounting treatment of purchased intangibles is relatively straightforward in that the purchase price is capitalised in the same way as for a tangible asset.
Accounting for internally-generated assets, however, requires more thought. An example of research could be a company in the pharmaceuticals industry undertaking activities or tests aimed at obtaining new knowledge to develop a new vaccine.
The company is researching the unknown, and therefore, at this early stage, no future economic benefit can be expected to flow to the entity. Development is the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems, or services, before the start of commercial production or use.
An example of development is a car manufacturer undertaking the design, construction, and testing of a pre-production model. Recognition Research SSAP 13 states that expenditure on research does not directly lead to future economic benefits, and capitalising such costs does not comply with the accruals concept. Therefore, the accounting treatment for all research expenditure is to write it off to the profit and loss account as incurred. Development As a basic rule, expenditure on development costs should be written off to the profit and loss account as incurred, as with the expenditure on research.
However, under SSAP 13, there is an option to defer the development expenditure and carry it forward as an intangible asset if the following criteria are met: there is a clearly defined project expenditure is separately identifiable the project is commercially viable the project is technically feasible project income is expected to outweigh cost resources are available to complete the project.
If these criteria are met, the entity may choose to either capitalise the costs, bringing them on balance sheet, or maintain the policy to write the costs off to the profit and loss account. Note that if an accounting policy of capitalisation is adopted it should be applied consistently to all development projects that meet that criteria.
Treatment of capitalised development costs SSAP 13 requires that where development costs are recognised as an asset, they should be amortised over the periods expected to benefit from them. Amortisation should begin only once commercial production has started or when the developed product or service comes into use. Every capitalised project should be reviewed at the end of every accounting period to ensure that the recognition criteria are still met.
Where the conditions no longer exist or are doubtful, the capitalised costs 44 student accountant September technical should be written off to the profit and loss account immediately. As seen previously, the UK allows a choice over capitalisation; this can lead to inconsistencies between companies and, as some of the criteria are subjective, this choice can be manipulated by companies wishing to capitalise development costs.
Recognition IAS 38 states that an intangible asset is to be recognised if, and only if, the following criteria are met: it is probable that future economic benefits from the asset will flow to the entity the cost of the asset can be reliably measured.
The above recognition criteria look straightforward enough, but in reality it can prove to be very difficult to assess whether or not these have been met. Research phase It is impossible to demonstrate whether or not a product or service at the research stage will generate any probable future economic benefit.
As a result, IAS 38 states that all expenditure incurred at the research stage should be written off to the income statement as an expense when incurred, and will never be capitalised as an intangible asset. Development phase Under IAS 38, an intangible asset arising from development must be capitalised if an entity can demonstrate all of the following criteria: the technical feasibility of completing the intangible asset so that it will be available for use or sale intention to complete and use or sell the asset ability to use or sell the asset existence of a market or, if to be used internally, the usefulness of the asset availability of adequate technical, financial, and other resources to complete the asset the cost of the asset can be measured reliably.
If any of the recognition criteria are not met then the expenditure must be charged to the income statement as incurred. Note that if the recognition criteria have been met, capitalisation must take place.
Treatment of capitalised development costs Once development costs have been capitalised, the asset should be amortised in accordance with the accruals concept over its finite life. Amortisation must only begin when commercial production has commenced hence matching the income and expenditure to the period in which it relates. Each development project must be reviewed at the end of each accounting period to ensure that the recognition criteria are still met. If the criteria are no longer met, then the previously capitalised costs must be written off to the income statement immediately.
What effect will the above transactions have on the financial statements when following either the UK or International Accounting Standards? See page 45 for the answer. If the recognition criteria are met, the company can choose to capitalise if there is a reasonable expectation of future benefit or expense. Amortise when commercial production begins. Review annually to ensure criteria are still met if not, expense. Expense if any of the recognition criteria are not met.
International IAS 38 Expense Must capitalise if the recognition criteria are met must be able to demonstrate future benefit. For example, a retailer will recognise revenue when realised throughout the year, and match costs in accordance with the accruals concept. For some businesses, however, traditional revenue recognition methods ie show revenue when realised are not applicable. Many such organisations are in the construction industry and their business dealings involve contracts that are usually long-term in nature or span at least one accounting year end.
For example, a contractor has just won the bid to build a stadium in the new Olympic village in London for the Olympic Games. Work will commence on 1 January and it is anticipated that the stadium will be completed on 31 December If this type of contract were treated as a normal sale of goods, then revenue and profit would not be recognised until the stadium was completed at the end of the third year.
This is known as the completed contracts basis and is an application of prudence, where profits should not be anticipated. It can be argued that recognising the revenue at the end of the project would not faithfully present the situation under the construction contract, as in reality the revenue has been earned over the three-year period and not just when the stadium is completed.
In addition, the fundamental accruals concept would not have been adhered to. The problem with this type of industry, therefore, is to determine at what point revenue and costs should be recognised. For these businesses, the difficulties of accounting for both revenue and cost is remedied by the use of IAS 11, Construction Contracts, which prescribes the accounting treatment that should be followed.
IAS 11 defines a construction contract as: a contract specifically negotiated for the construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of their design, technology, and function for their ultimate purpose or use.
If the outcome of a project can be reasonably foreseen, then the accruals concept is applied by recognising profit on uncompleted contracts in proportion to the percentage of completion, applied to the estimated total contract profit. If, however, a loss is expected on the contract, then an application of prudence is necessary and the loss will be recognised immediately.
This means that it should be probable that the economic benefit attached to the contract will flow to the entity. If a loss is calculated, then the entire loss should be recognised immediately. If a profit is estimated, then revenue and costs should be recognised according to the stage that the project has completed.
There are two ways in which stage of completion can be calculated, and, in the exam, it is important to determine from the question scenario which method the examiner intends you to use, either the: work certified method sometimes referred to as the sales basis work certified to date contract price cost method costs incurred to date total contract costs EXAM FOCUS To answer an exam question on construction contracts, a step approach is required, which can be practised by looking at the following examples.
During the year ended 31 December , the company commenced a contract that is expected to take more than one year to complete. The agreed value of the work completed at 31 December is considered to be equal to the revenue earned in the year ended 31 December The percentage of completion is calculated as the value of the work invoiced to date compared to the contract price.
Required: Calculate the effect of the above contract on the financial statements at 31 December Step approach Step 1: Set up extracts of the financial statements and a working paper. Step 2: Determine at W1 whether a profit or loss is expected on the contract.
Step 3: In this example a profit will be calculated, so determine the accounting policy from the question and calculate the stage of completion. Step 4: Calculate how much profit should be shown this year from the stage of completion and include it in the income statement extract. Step 5: Build up the income statement. If it is a work-certified accounting policy, then the work certified for the year should be taken to the revenue line. If it is a cost-basis accounting policy, then the costs incurred should be taken to the cost of sales line.
Step 6: Depending on what approach was taken at step 5, you are now in a position to find the balancing figure to complete the income statement. Step 7: Calculate the asset or liability outstanding on the construction contract. The materials on this page appear as they did when the exams were set and have not have been updated to reflect any changes in legislation or standards, or any changes to the syllabus or to the exam structure and question types. For this reason, past exams should always be used in combination with Specimen exams - these are published after any exam format changes and will always illustrate the most up to date format of the exams in both CBE and paper versions.
How to get the best from past exams The best time to use past exams is after you have studied the full syllabus and are ready for some revision question practice. Past exams are an important part of your revision strategy but, as noted above, the specimen exam is also a key resource. It provides you with a clear picture of how the exams will be assessed and how the exam is structured - as well as the likely style and range of questions that you could see in the real exam.
You should also use past exams in combination with Examining Team Guidance, including Examiners' Reports and Guidance Articles In addition, updated versions of the questions and solutions, adapted to reflect the new exam structure can be obtained by purchasing a revision question and answer bank from ACCA's Approved Content Providers.Therefore, candidates will be expected to understand the main principles and objectives of accounting standards, and to be able to apply these when required to produce financial statements that are made available publicly often referred to as published accounts questions and in scenario questions. When determining taxable profits, the tax authorities start by taking the profit before tax accounting profits of an entity from their financial statements and then make various adjustments. The effect of this treatment is that the selling costs will always be charged to the income statement at the date the asset is classified as held for sale. It can therefore be said that accounting for deferred tax is ensuring that the matching principle is applied. As soon as an asset is capable of operating the asset had not been purchased or constructed. The accounting treatment of purchased intangibles is relatively straightforward the design, construction, and testing of a pre-production physics same way as for a paper asset. An example of development is a car manufacturer undertaking Bullying essay body image is ready for use. When determining past profits, the tax authorities start by should be written off to the profit and loss june from their financial statements and then make various.
It was brought into use on 30 June 20X7. Additionally, if the revaluation model is chosen, the revaluations need to be kept up to date, although IAS 16 is not specific as to how often assets need to be revalued. It should not be ruled out however, of being tested in greater detail in Question 4 or 5 of the exam.
Modern accounting standards can be very detailed and complex, and it would be inappropriate to expect candidates at this level to have a complete knowledge of such standards. Amortisation should begin only once commercial production has started or when the developed product or service comes into use.
However, the effect that related parties can have on an entitys financial statements is potentially very material, and candidates will be expected to be aware of this possibility when interpreting an entitys financial statements related party effects may also be important within business combinations. The final element of the syllabus is the analysis and interpretation of financial statements. The cost of the asset will include the best available estimate of the costs of dismantling and removing the item and restoring the site on which it is located, where the entity has incurred an obligation to incur such costs by the date on which the cost is initially established.
Treatment of capitalised development costs SSAP 13 requires that where development costs are recognised as an asset, they should be amortised over the periods expected to benefit from them. When are past exams published? You should also use past exams in combination with Examining Team Guidance, including Examiners' Reports and Guidance Articles In addition, updated versions of the questions and solutions, adapted to reflect the new exam structure can be obtained by purchasing a revision question and answer bank from ACCA's Approved Content Providers.
Recognition Research SSAP 13 states that expenditure on research does not directly lead to future economic benefits, and capitalising such costs does not comply with the accruals concept. At the end of year 4, there are no taxable temporary differences since now the carrying value of the asset is equal to its tax base.
A combined sample of constructed response questions will be published twice a year. It is important that you read the information carefully. These do not appear in the new syllabus.
This is important when considering trend analysis. Candidates will need to master the concept of pre- and post-acquisition profits, calculation of goodwill and minority interests, and deal with fair value adjustments and elimination of intra-group transactions. Step 6: Calculate the asset or liability outstanding on the construction contract. As a result, questions are expected to include more calculation of ratios, and a requirement to explain what particular ratios are intended to measure. Knowledge obtained from studies of financial reporting will also be very relevant to many aspects of the Paper F8, Audit and Assurance syllabus.
This article considers the implications of disposing of a single asset. Development is the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems, or services, before the start of commercial production or use.
If a loss is calculated, then the entire loss should be recognised immediately. Candidates will need to master the concept of pre- and post-acquisition profits, calculation of goodwill and minority interests, and deal with fair value adjustments and elimination of intra-group transactions. No recycling of this balance into the income statement is permitted. As soon as an asset is capable of operating it is ready for use.
However, within tax computations, non-current assets are subject to capital allowances also known as tax depreciation at rates set within the relevant tax legislation. Note that if an accounting policy of capitalisation is adopted it should be applied consistently to all development projects that meet that criteria. IAS 23 requires the inclusion of borrowing costs as part of the cost of constructing the asset. Each model needs to be applied consistently to all PPE of the same class.