Course : F0812 Accounting Theory

Year
: February 2011

Assets
Session 6

GODFREY
HODGSON
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

Assets defined
Three essential characteristics:
future economic benefits
control by an entity
past events
exchangeability
recognition rules

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
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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, such
as a building or machine, and the
service or benefit embodied in it
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Control by an entity
The economic benefit must be
controlled by the entity
An entitys right to use or control an
asset is never absolute
Ownership is often concurrent with
control, but it is not an essential
characteristic of an asset
Does not rely on legal enforceability
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Past events
Control as a result of a past event
Planned assets are excluded
Event can be interpreted in different
ways
executory contracts

Exchangeability
Some argue that a 4th essential
characteristic is that an asset be
exchangeable
Separable from an entity

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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

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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

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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
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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, but not gains

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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, in turn, capital (equity)
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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
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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
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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

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What are the divergent arguments for

recognising customer relationships in a
business combination? Is it a true
intangible asset?

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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

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What are the objectives of

the fair value
measurement project?

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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

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Which measurement
model?
Fair value is the frontrunner
Both the IASB and FASB support
greater use of fair value
measurement

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What are the arguments

for and against fair value
measurement?

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How to calculate fair

value measurement
Various valuation techniques to
calculate fair value
the market approach
observable prices
actual transaction data

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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

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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)

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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. Under what circumstances is this reclassification
allowed?

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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

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How to calculate fair

value measurement
Three hierarchical levels for the inputs
Level 1 quoted prices for identical items
in active markets, 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, income and cost
approaches
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Issues for auditors

Auditing fair values creates
difficulties because it requires the
application of valuation models, and,
frequently, the use of valuation
experts

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Issues for auditors

Auditors need to
understand the client firms processes and
relevant controls for determining fair values
make a judgement on whether the client firms
measurement methods and assumptions are
appropriate and likely to provide a reasonable
basis for the fair value measurement
appreciate managements potential biases and
likely errors
incentives

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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

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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

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Key terms and concepts

Assets
Definitions
Future economic benefits
Control
Past events
Exchangeability
Asset recognition
Asset measurement
Fair value measurement
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