Haven't found the Essay You Want?
GET YOUR CUSTOM ESSAY SAMPLE
For Only $12.90/page

Theoretical Aspects and Challenges Essay

The analysis of the proposition that an asset should be recognized in the balance sheet when it is probable that future economic benefits will flow to the entity and the asset has a cost or value that can be measured reliably and that the related expense should be recognized when incurred produces some insights useful for better understanding of the meaning of proposition that could help for accountants prepare reliable financial report for the use of the decision makers particularly the investors.

Recognition principles start the process of putting transactions in the books that would enable financial report preparer to have a stable criteria stated in the form of standards that will serve as guide to companies. This research has found evidence of the application of the asset and expense recognition principles among at least global companies. 1. Introduction and Purpose of Assignment

This paper seeks to analyze the proposition that an asset should be recognized in the balance sheet when it is probable that future economic benefits will flow to the entity and the asset has a cost or value that can be measured reliably and that the related expense should be recognized when incurred. The importance of having the correct insight in better understanding of the meaning of proposition is material for accountants who are duty bound to prepare reliable financial report for the use of the decision makers particularly the investors.

2. Theoretical Aspects and Challenges to Accounting Standards There are challenges to the proposition above as to the possible implications of not having complied with the requirements on possible misstatement of the financial statements. In other words, if the rules are relaxed, there could be more or assets that should be presented for the appreciation of decision makers. What are recognizable as asset will have the effect of deferring a would-be expense and therefore it could increase the income in the earlier period over the latter periods.

If the reverse of the above happens, that is expensing the cost is required since the cash outflow cannot be considered as assets under the recognition principles, then expenses for the earlier period would be higher and necessarily less income over the latter periods. 3. Analysis and Discussion Before the proposition could be carefully analyzed and discussed there is need to analyze the requirements of the proposition. The proposition formulated is conjunction proposition since it has to two clauses. The first one is on asset recognition and the second in on expense recognition.

By dealing first with the requirement of asset recognition is must be made clear that there are elements or conditions and they: (a) It is probable that future economic benefits will flow to the entity; and (b) The cost or value of the asset can be measured reliably. The term “probable” means that the chance of the future economic benefits arising is more likely rather than less likely. For example, research and development cost is not recognized as an asset because it is not probable that future economic benefits will eventuate.

Based on the two conditions, it may be argued that if the probability of future economic benefits is high, no recognition of asset is made unless the cost or other value of the asset is capable of reliable measurement. To illustrate, internally generated goodwill is not recognized as an asset even if the probability of future economic benefits is high because internal goodwill, in contrast to purchased goodwill, cannot be measured reliably. This therefore delineates that needs to be recognized by considering the two criteria together not one in isolation of the other.

For the purpose of this paper the assets the would-be tested for analysis in on plant property and equipment and intangibles. 3. 1 Recognition of property, plant and equipment To apply the asset recognition principle to property, plant and equipment (PPE), it should be restated that said PPE shall be recognized as asset when: a. It is probable that future economic benefits associated with the asset will flow to the entity. b. The cost of the asset can be measured reliably.

In determining whether an item satisfies the first criterion for recognition, an entity needs to measure the degree of certainty attaching to the flow of the future economic benefits on the basis of the available evidence at the time of initial recognition. Said existence of sufficient certainty that the future economic benefits will flow to the entity necessitates an assurance that the entity will receive the rewards attaching to the asset and will also assume the associated risks. This assurance is usually available when the risks and rewards have passed to the recognizing firm or entity.

As to the second criterion for recognition, it could be argued that it is usually readily satisfied when the exchange transaction evidencing the purchase of the asset identifies its cost. For this reason, the recognition principle demands that an entity evaluates all its property, plant and equipment costs at the time they are incurred. These costs include costs incurred initially to acquire or construct an item of property, plant and equipment and costs incurred subsequently to add to, replace part of, or service it.

How should spare parts and servicing equipment be treated under the asset recognition principle? A good challenge to validity of the principle is the case of spare part certain kind of cash outflows that appears to be considered as assets. It may be stated that most spare parts and servicing equipment are usually carried as inventory and recognized as an expense when consumed. But when one dwells on major spare parts and stand-by equipment the latter should qualify as property, plant and equipment when the entity expects to use them during more than one period.

As a result, said spare parts and servicing equipment can be used only in connection with an item of property, plant and equipment and are depreciated over a time period not exceeding the useful life of the related asset. There are also instances of very large and specialized items, in which case an apparently single asset is recommended to break down to its component parts and each component is accounted for separately. This happens when the component parts have different useful life or provide benefits to the entity in a different pattern thus necessitating use of different depreciation rates and methods.

To illustrate, one could consider an aircraft as an item of property, plant and equipment yet a deeper analysis of the aircraft would reveal that it has various components with different useful lives. These component parts of an aircraft could consist of the frame of the aircraft, the engines, the tires, the fittings (seats and floor coverings) and others. Another important item that requires special discussion for PPE recognition is the case of safety and environmental equipment on how to recognize them. Property, plant and equipment may be acquired for safety or environmental reasons.

The acquisition of such property, plant and equipment, as contrasted to spare parts and servicing equipment and therefore not directly increasing the future economic benefits of any particular existing item of property, plant and equipment may pose some question on why it should also be recognized. It may be explained although there is basis to such claim, said safety and environmental equipment may be necessary in order for the entity to obtain the future economic benefit from its related other assets in excess of what it could obtain if such equipment had not been acquired.

To illustrate, chemical manufacturers may need to put up certain new chemical handling processes in order to comply with environmental requirements on the production and storage of chemicals. Such related plant enhancements are recognized as assets to the extent that they are recoverable because without them, the entity is unable to manufacture and sell chemicals. In other words there is legal requirement to have the asset to keep the business operating and functioning legal although actual operation or production is possible even without said chemical handling processes.

3. 2 Recognition of intangibles as asset The recognition of intangibles as asset is same as the criteria to recognize PPE as such there is no need to further explain the same. The there are also costs that need to be capitalized and not capitalized like PPE. What essentially makes PPE different from intangibles is the related expense. In PPE it is called depreciation but in intangibles, it called amortization. Both are also subject to impairment loss. 3. 3 How to measure at the time of recognition?

The international account standards as they stand requires an item of property, plant and equipment that qualifies for recognition as an asset to be measured at cost, where cost is defined as the amount of cash or cash equivalent paid and the fair value of the other consideration given to acquire an asset at the time of acquisition or construction. To understand cost, there is need to know its elements. Basically the cost of an item of property, plant and equipment includes: (1) Purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates.

(2) cost directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. (3) Initial estimate of the cost of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period (Deloitte Touche Tohmatsu, 2008b). The first component of cost above should be easy to understand.

The second component requires some examples of items that are directly attributable to operational status of the asset and these includes: costs of employee benefits arising directly from the construction or acquisition of the item of property, plant and equipment; cost of site preparation; initial delivery and handling cost: Installation and assembly cost; professional fees; and cost of testing whether the asset is functioning properly, after deducting the net proceeds from selling any items produced while bringing the asset to that location and condition, such as sample produced when testing equipment.

By careful analysis of the components of cost, what comes out as examples of costs that are expensed rather than recognized as element of cost of property, plant and equipment are: cost of opening a new facility; cost of introducing a new product or service, including cost of advertising and promotion; cost of conducting business in a new location or with a new class of costumer, including costs of staff training; administration and other general overhead costs; costs incurred while an item capable of operating in the manner intended by management has yet to be brought into use or is operated at less than full capacity; initial operating losses; and costs of relocating or reorganizing part or all of an entity’s operations. 3. 4 The Recognition off the Related Expense to PPE and Intangibles The second clause of the proposition is the related expense recognition when incurred. The proposition is meant to address the expenses related to the plant property and equipment. IAS 36 requires the recoverable amount of asset to be presented in the balance hence PPE should be presented net of accumulated depreciation and impairment loss.

This part of the proposition also cover the expensing of related expenses if they do produce future economic benefit or they do not form part of the three components identified earlier. The expense recognition principle applies the matching principle which asserts the generation of revenues is not without any cost. The matching principle has three applications which include cause and effect, systematic and rational allocation and immediate recognition. In the case of depreciation and impairment loss are systematic and rational allocation and immediate recognition. Under the systematic and rational allocation, some costs are expensed simply allocating them over periods benefited.

The reason for this is that the cost incurred will benefit future periods and that there is an absence of a direct or clear association of the expense with the specific revenue. Under the immediate recognition principle, the cost incurred is expense outright because of uncertainty of future economic benefits or difficulty of reliably associating certain costs with the future revenues. Actually this principle reflects conservative or prudent approach which is the accountant’s general guide for dealing with uncertain situations. An expense is recognized because there are no future economic benefits or economic benefits do not quality for recognition in the balance sheet.

This part of the proposition is now evaluated by observing the actual application of the principles in the real world involving a number of global companies which are required to comply with IAS/IFRS. These companies are Bavarian Motor Works (BMW), Daimler and Peugeot. 3. 4. 1 The case of Daimler Daimler (2007) values its property plant and equipment at acquisition cost or manufacturing cost less accumulated depreciation and any accumulated impairment losses. Further, the company declares that its plant and equipment under lease are stated at lower of present value of minimum lease payments or fair value less related accumulated depreciation and any accumulated impairment losses.

It also recognizes depreciation expense using the straight line method and that property plant and equipment are depreciated over their useful lives (Daimler, 2007). The policy adopted by Daimler is consistent with IFRS which provides for need for impairment to determine the recoverable amount. That fact that its plant and equipment that under finance lease are stated at lower of present value of minimum lease payments or fair value less the related accumulated depreciation and any accumulated impairment losses speaks for compliance with recoverable amount of plant property and equipment in its financial statements by the provision of accumulated depreciation and accumulated impairment losses. Hence, expense recognition principles are also complied with.

As to its policy on other intangible assets, the companies records the said assets at cost and maintains the value of the same at cost less accumulated depreciation and any accumulated impairment losses while intangible asset with indefinite lives are reviewed annually to determine the indefinite life is still supportable and if not a change in the life from indefinite to finite could be made. This proves compliance not only with expense recognition principles but also asset recognition principles. This part of the company accounting policy is consistent with the requirement of IAS 36. 10 since if the intangibles have indefinite life, measure them annually whether there is an indication that it may be inferred is required.

Hence on the contrary the company must be deemed to be still complying if the useful life of the intangible assets is finite in which the case the company could be validly complying with require of IAS 36 (Deloitte Touche Tohmatsu, 2008a) when to amortized over their useful lives of three to ten (3 to 10) years but there is still a company policy that would require review if impairment is warranted for such assets with the definite life. The company must be deemed complying with expense recognition principles by systematic allocation over the period in case of amortization and immediate recognition in case of impairment loss recognized when warranted.

When the company’s review of intangible assets with definite useful life resulted to provision for impairment what the company does is to treat the change in expected useful life as change in accounting estimate (Daimler, 2007). Such practice is still consistent with IAS 36 since the issue in impairment of assets is the determination of recoverable value of assets covered under said international accounting standard. This is to be taken also in the light of the company practice of providing for the proper impairment value. 3. 4. 2 The case of BMW BMW has declared a joint policy for property, plant and equipment and intangibles. Thus the company policy on the recoverability of said assets is done by testing regularly for impairment in accordance with IAS 26 on the basis of cash generating units (BMW, 2007).

As in Daimler, BMW may be deemed to be consistently in applying the principles of IAS 36 which requires the know indications of impairment to determine the recoverable amount. The two companies however differ since BWM uses the cash basis generating units in determining impairment while Daimler uses the lower of present value of minimum lease payments or fair value less the respective accumulated depreciation and any accumulated impairment losses for plant and equipment under finance leases. The difference in the chosen basis however will attain the same objective of IAS 36 (Deloitte Touche Tohmatsu, 2008a) since the use of assets’ cash-generating units (CGU) or the smallest identifiable group of assets is resorted to if it is not possible determine the recoverable amount for the individual assets.

In other words, the most important thing is to determine the proper recoverable amount by the amount of impairment and that the two German companies are still complying with the requirements of IAS 36. (BMW, 2007). 3. 4. 3 The case of Peugeot of France Peugeot (2007) claims compliance also with requirements of IAS 36 on impairment of assets which is consistent with expense recognition principles. The company states as part of its policy that to present its plant property and equipment and intangibles in the financial statements are their recoverable amount and this is done by conducting an impairment at each balance sheet whenever changes in events and circumstances warrant the recognition of impairment after periodic tests and the same is a necessary recognition of expense under the principle of expense recognitions.

It may be summarize that all there three companies, Daimler and BMW from Germany and Peugeot of France declared their compliance with the requirements of international accounting standards on impairment of assets and based on their policies on property, plant and equipment and on intangibles by valuing assets at their recoverable amounts with provision for depreciation expense and impairments loss. Said compliance by companies is necessarily consistent with expense recognition principles. 4. Summary and Conclusion As found in the paper, there is only one way to recognize property, plant and equipment as well as intangibles, that is — cost at the time of recognition.

The recognition of fair value may be allowed as basis of possible revaluation under existing IAS/IFRS after the measured of acquisition at cost. The requirements of probability of future economic benefits and capacity of being measured reliably must really be implemented otherwise the consequence of non compliance is unreliable financial statements that would mislead decision makers. The paper has also found the application of asset recognition and expense principles involving at leas three global companies required under IAS/IFRS. 5.

References BMW (2007), 2007 Annual Report, {www document} URL http://www. bmwgroup. com/annualreport2007/_downloads/BMW_Group_2007.  pdf, Accessed April 4, 2008 Daimler (2007), Annual Report 2007, {www document} URL http://www. daimler. com/Projects/c2c/channel/documents/1488194_DAI_2007_Annual_Report. pdf, Accessed April 4, 2008 Deloitte Touche Tohmatsu (2008), {www document} URL Summary IAS 36 http://www. iasplus. com/standard/ias36. htm, Accessed April 4, 2008 Deloitte Touche Tohmatsu (2008b), Summary of IAS 16 on Property Plant and Equipment {www document} URL http://www. iasplus. com/standard/ias16. htm Peugeot (2007), 2007 Annual Report, {www document} URL http://www. psa-peugeot-citroen. com/document/publication/brochure_resultats_ENG1202842432. pdf, Accessed April 4, 2008


Essay Topics:


Sorry, but copying text is forbidden on this website. If you need this or any other sample, we can send it to you via email. Please, specify your valid email address

We can't stand spam as much as you do No, thanks. I prefer suffering on my own