ACC 4001 (ACCOUNTING THEORY & POLICY) RECOGNITION AND MEASUREMENT IN FINANCIAL STATEMENT

Section 3

Recognition
Recording the basic element of the financial statement. The concept of accounting recognition define the basic principles that determine: Timing of revenue, expense in the bank income statement. Timing of asset and liability in the balance sheet.

Measurement
Determine the amount of asset, liability, revenue and expense in the financial statement.

ELEMENT IN FINANCIAL STATEMENT

ASSET LIABILITY REVENUE

EXPENSE

REVENUE RECOGNITION AND MEASUREMENT

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

Types of revenue
Sale of goods Rendering of services Construction contracts Interest, Royalties, Dividends

received.

 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.

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.

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.

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 even over two years. 10,000 / 24 = 417 revenue recognised per month.

 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.

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)

EXPENSES

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

Expenses Recognition
Decrease in future economic benefits related to
decrease in an asset increase of a liability can be measured reliably

Accrual basis
Recognized when incurred Goods or services are earned

Cash basis
The goods and services are actually paid

Matching principle
recognition of revenue results in recognition of expenses

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

Example
Wages, salaries and other employee entitlements/costs Rental charge The cost of assets consumed in the provision of goods and services : depreciation

Asset Recognition & Measurement

Plant Property and Equipment

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)

 Material Asset
Cost is material economic life is determined for the whole house 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

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)

 Constructed PPE
Cost incurred = (material + labour + overhead + other resources)

Deffered Payment
Total cost incurred on recognition whether they paid or not

Assets Exchange
Measure at fair value

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 Trade discount (-)10% Insurance and shipment Import duties and taxes Delivery costs Installation charges Testing of machinery General admin costs Dismantling costs Early settlement (-)2%

600,000
8,000 500,000 100,000 12,000 10,000 5,000 17,000

Purchasing price
Less: Trade discount

600,000
(60,000) 540,000

Initial cost of machinery

Insurance on shipment Import duties and taxes Delivery costs Testing Installation charges

8,000 500,000 100,000 10,000 12,000

Dismantling costs

17,000
1,187,000

LIABILITIES

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. 2. 3. 4. 5. Payment of cash Transfer of other asset Provision for services Replacement of an obligation with other obligations Conversion of the obligation to equity

Liability recognition
Two recognition thresholds:
1.
2.

The outflow of resources embodying economic benefits (such as cash) will result from the settlement of a present obligation 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).

Contingent liability
If an obligation meets the definition of a liability but fails to meet the recognition criteria, it is classified as a contingent liability.

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 be required 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

ISSUE ON REVENUE RECOGNITION

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, the present value of each set of cash flows is the same which is

RM770.

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).

FIGURE 1

Here is a summary of first and second contract:

 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?

ISSUES ON INTANGIBLE ASSET

Goodwill

Issues on intangible asset

Goodwill
Is an asset or not? Measurement of goodwill Should goodwill be depreciated or amortised?

Is goodwill an asset?
Internally generated goodwill is not recognized as an asset
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 the company. Such differences can not be regarded as representing the cost of 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 and contingent liabilities.

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 noncontrolling interests either at the fair value of their proportion of identifiable assets and liabilities, or at full fair value

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.

 Recognizing goodwill based on partial goodwill method:

The fair value of the assets (-) The fair value of the liabilities Identifiable net assets (fair value) (-) Minority interest (20% 190,000) Net Assets acquired

$ mil 370,000 (180,000) 190,000 (38,000) 152,000

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

 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.

The fair value of the assets (-) The fair value of the liabilities Identifiable net assets (fair value) (-) Non-controlling interest (fair value) Net Assets acquired

$ mil 370,000 (180,000) 190,000 (45,000) 145,000

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

Treatment for goodwill measurement, subsequent to initial recognition

IFRS 3 Business combination requires that goodwill acquired in a business combination should 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