Recognition and measurement

7/28/2019 Recognition and measurement

1/44

ACC 4001 (ACCOUNTING THEORY & POLICY)

RECOGNITION AND MEASUREMENT IN

FINANCIAL STATEMENT

Section 3


2/44

Recognition

Recording the basicelement of the financialstatement. The concept of

accounting recognitiondefine the basic principlesthat determine:-Timing of revenue,

expense in the bank incomestatement.

Timing of asset andliability in the balancesheet.

Measurement

Determine the amountof

asset, liability, revenue

and expense in thefinancial statement.


3/44

ELEMENT IN FINANCIAL

STATEMENT

ASSET

LIABILITY

REVENUE

EXPENSE


4/44

REVENUE

RECOGNITION ANDMEASUREMENT


5/44

Definition of revenue

Gross inflow of economic benefits during

the period from the ordinary activities of

an entity.

Measured gross (different from gains)

Economic benefits means cash or other assets

Results in increases in equity

Ordinary activities


6/44

Types of revenue

Sale of goods

Rendering of services

Construction contracts

Interest, Royalties, Dividends

received.


7/44

Recognition means incorporating an

item that meets the definition of revenue

in profit or loss when it meets the

following criteria:

It is probable that any future economic

benefit associated with the item of

revenue will flow to the entity, and

The amount of revenue can be

measured with reliability.


8/44

Recognition sale of goods

Sale of goods: Recognise revenue when

Risks and rewards are transferred.

Seller has no continuing involvement.

Amount of revenue is reliably measurable.

It is probable that seller will receive the

revenue.

Costs incurred (including those to be

incurred) can be measured reliably.


9/44

Sale of goods: When are risks

and rewards transferred?

Normally: Title is transferred and/or

buyer takes possession.

Risks are retained if: Performance obligation beyond normal

warranty

Example: Goods sold with 2-year warranty

Warranty does not prevent revenue

recognition if estimated cost is

measurable. Normally not a separate

deliverable.


10/44

Recognition rendering of

services Recognise revenue based on stage of completion

when the outcome of the transaction can be

estimated reliably.

Example: Security firm receives 10,000 to

respond to alarms for 2-year period

Service contract stage of completion is evenover two years. 10,000 / 24 = 417 revenue

recognised per month.


11/44

Construction contracts:

Recognise revenue based on stage of

completion when the outcome of the

transaction can be estimated.

Example:- Bridge

Interest, royalties, dividends

Recognise when receive.


12/44

Measurement principle

Principle: Fair value of consideration received or receivable

Net of trade discounts, prompt

settlement discounts, volume rebates

Does not include amounts collected on

behalf of others, such as:

Sales tax, value added tax.

Amounts collected while acting as an agent

rather than principal seller (only the

commission is revenue)


13/44

EXPENSES


14/44

Expenses

Definition

Include both losses & expenses arise in the

ordinary course of business Decrease the economic benefits during the

accounting period

Outflows

Depletion of assets

Incurrence of liabilities decrease in equity


15/44

Expenses Recognition

Decrease in future

economic benefits

related to

decrease in an asset

increase of a liability can be measured

reliably

Matching principle

recognition of revenueresults in recognition

of expenses

Accrual basis

Recognized when

incurred

Goods or services are

earned Cash basis

The goods and services

are actually paid


16/44

Expenses

Measurement

As in the case of income, the measurement of

expenses depends on how assets and liabilities

are measured

The amount of the expense is the reduction in

the amount of the asset that is used up or

the increase in the liability that is incurred


17/44

Example Wages, salaries and other employee

entitlements/costs

Rental charge

The cost of assets consumed in the provision of

goods and services : depreciation


18/44

Asset Recognition &MeasurementPlant Property and Equipment


19/44

PPE Recognition

Recognised an asset when:

Future economic benefits should flow to entity

(enjoy rewards and bears the risk)

Cost can be measured reliably

(where there is an exchange transaction)


20/44

Material Asset

Cost is material economic life is determined for the wholehouse

Single asset

House

Immaterial Asset

Grouped and recognised as single asset

Office equipment

Large Asset

Comprise of few parts and components

Economic life and maintainance for each component different Ship


21/44

Measurement at Recognition

PPE measured at initial cost

(bought/exchanged/constructed)

Initial cost incurred to bring the asset into present location and condition

(initial cost = fv asset)

Asset purchased

(purchase price + direectly attributable cost incurred in bringing

the asset + estimate cost dismantling and removing the asset)


22/44

Constructed PPE

Cost incurred = (material + labour + overhead + otherresources)

Deffered Payment

Total cost incurred on recognition whether they paid

or not

Assets Exchange

Measure at fair value


23/44

Example

Sunshine Sdn Bhd imported a machinery to be used in its factory. The

machinery was delivered on 1 April x2. Costs incurred were:

Invoice price of machinery 600,000

Trade discount (-)10%

Insurance and shipment 8,000

Import duties and taxes 500,000

Delivery costs 100,000

Installation charges 12,000

Testing of machinery 10,000

General admin costs 5,000

Dismantling costs 17,000

Early settlement (-)2%


24/44

Initial cost of

machinery

Purchasing price 600,000

Less: Trade discount (60,000)

540,000

Insurance on shipment 8,000

Import duties and taxes 500,000

Delivery costs 100,000

Testing 10,000

Installation charges 12,000

Dismantling costs 17,000

1,187,000


25/44

LIABILITIES


26/44

What is liability

A liability is defined as

a present obligation of the enterprise arising from past

events, the settlement of which is expected to result in an

outflow from the enterprise of resources embodying

economic benefits (IASB Framework).

The obligation can be settled by:

1. Payment of cash

2. Transfer of other asset

3. Provision for services4. Replacement of an obligation with other obligations

5. Conversion of the obligation to equity


27/44

Liability recognition

Two recognition thresholds:

1. The outflow of resources embodying economic benefits (such

as cash) will result from the settlement of a present obligation

2. The amount at which settlement will take place can be

measured reliably. In case of a bank loan for instance, the past event would be

the receipt of loan principal. The obligation to pay off the loan

would be present from the day the entity receives the loan

principal (i.E. When an obligating event occurs).


28/44

Contingent liability

If an obligation meets the definition of a liability

but fails to meet the recognition criteria, it isclassified as a contingent liability.


29/44

Liability measurement

Historical cost

recorded at the amount of proceeds received in exchange for the

debts

Current cost

Carried at the discounted value or cash equivalent that will berequired to settle the debts currently

Present value

Liabilities are carried at the discounted value of the future net

cash outflows required to settle the liabilities in the normal

course of business


30/44

ISSUE ON REVENUE

RECOGNITION


31/44

The supply of free mobile phone bundled as

part of a contract

Example

Lets assume that, Celcom company supplies a free smart

phone handset if a customer signs up to a 24 month contract

for the supply of a particular package of call and data

services for RM35 per month. Alternatively the same company

supplies the handset without the monthly contract for

RM330 and will provide the same call and data services for

RM20 per month if no handset is provided. However, thepresent value of each set of cash flows is the same which is

RM770.


32/44

Continue

In the first contract the cost of the bundled offer of RM840

(RM35x24).

Second contract the sum of the separate cost of each

component of RM810 (RM330 + RM20x24).

However the first contract profit are higher than second

contract profit of RM30 (RM840-RM810).


33/44

FIGURE 1

H i f fi d


34/44

Here is a summary of first and

second contract:


35/44

Which contract provides the most relevant

information for investors?

So which contract do you think provides the best reflection of the

economics of this transaction and would be most useful to you as

an investor?


36/44


37/44


38/44

Issues on intangible asset

Goodwill

Is an asset or not?

Measurement of goodwill

Should goodwill be depreciated or

amortised?


39/44

Is goodwill an asset?

Internally generated goodwill is not recognized as anasset differences between the market value of a company and the

carrying amount of its net identifiable assets at a certain time

may take into account a whole range of factors affecting thecompany.

Such differences can not be regarded as representing the costof intangible assets controlled by the company

Goodwill which results from business combinations

must be recognized as an asset Goodwill represents the excess cost of business combination

over the fair value of the net identifiable assets, liabilities andcontingent liabilities.


40/44

Measurement of Goodwill

Published = January 2008 ; effect from July 2009

One of the main changes regards non-controlling interests

(NCI), term used in IFRS 3 (R) instead of minority interests

The revised standard gives entities the option to measure non-

controlling interests either at the fair value of their proportionof identifiable assets and liabilities, or at full fair value


41/44

goodwill

Example 1: Initial measurement of goodwill based on IFRS 3

(2004)

At acquisition date ABC Company holds:

Identifiable tangible assets (fair value) $310,000 mil

Identifiable intangible assets (fair value) $60,000 mil Identifiable liabilities (fair value) $180,000 mil

XYZ Company acquires 80% of the shares of the subsidiary for

$200,000 mil.


42/44

Recognizing goodwill based on partial goodwill method:

Goodwill on acquisition = 200.000 - 152,000 = $48,000 mil

$ mil

The fair value of the assets 370,000

(-) The fair value of the liabilities (180,000)

Identifiable net assets (fair value) 190,000

(-) Minority interest (20% 190,000) (38,000)

Net Assets acquired 152,000


43/44

Example 2: Initial measurement of goodwill based on IFRS 3

(Revised)

Considering the same example as previous, the minority interest

was fair valued at $45,000 mil.

Goodwill on acquisition = 200.000 - 145,000 = $55,000 mil

$ mil

The fair value of the assets 370,000

(-) The fair value of the liabilities (180,000)

Identifiable net assets (fair value) 190,000

(-) Non-controlling interest (fair value) (45,000)

Net Assets acquired 145,000


44/44

Treatment for goodwill

measurement, subsequent toinitial recognition

IFRS 3 Business combination requires that

goodwill acquired in a business combinationshould not be amortized

IFRS 136 impairment of Assets goodwill

should be tested for impairment annually

Identify any indication that goodwill is impaired

Any impairment of loss will reduced the value of

goodwill

Documents

Recognition and measurement