ACC510 Financial Reporting

TDM Ltd is a manufacturing business at Mudjimba on the Sunshine Coast. You are the accountant for the company and the following items/issues relate to the financial year ending 30^th June, 2016:

1. Photographs of the company’s founders and original buildings, which are of great sentimental and historical value only.
2. TDM Ltd is being sued for negligence by Zero Ltd and the legal advice is that it is likely the company will lose the case in court.
3. TDM Ltd is being sued for negligence by Badger Ltd and the legal advice is that it is likely the company will win the case in court.
4. Obsolete plant and equipment is now (as at 30 June 2016) retired from use by the company.
5. TDM Ltd has received a donation of $20,000.

Required:

Explain how TDM Ltd should account for each of the above items. You must justify your answer by reference to the AASB Conceptual Framework’s definitions and recognition criteria for assets, liabilities, income and/or expenses as applicable. You must also state which General Ledger accounts are to be debited and credited.

On 1^st July, 2016, SC Airlines Ltd acquired a new aeroplane for a total cost of $10 million dollars. The following breakdown of the costs to build the aeroplane was given by the manufacturers.

All costs include installation and labour costs associated with the relevant part.

It is expected that the aircraft will be kept for 10 years and then sold. The main value of the aircraft at that stage will be the body and the engines. The expected selling price is $2.1 million, with the body and engines retaining the existing proportionate value.

Costs in relation to the aircraft over the next 10 years are expected to be as follows:

• Aircraft body: This requires an inspection every 2 years for cracks and wear and tear, at a cost of $10,000.
• Engines: Each engine has an expected life of 4 years before being sold for scrap. It is expected that the engines will be replaced in 2020 for $4.5 million and again in 2024 for $6 million. These engines are expected to incur annual maintenance costs of $300,000. The manufacturer has informed SC Airlines that a new prototype engine with an extra 10% capacity should be on the market in 2022, and that existing engines could be upgraded at a cost of $1 million.
• Fittings: Seats are replaced every 3 years. Expected replacement costs are $1.2 million in 2019 and $1.5 million in 2025. The repair of torn seats and faulty mechanisms is expected to cost $100,000 per annum. Carpets are replaced every 5 years. They will be replaced in 2022 at an expected cost of $65,000, but will not be replaced again before the aircraft is sold in 2026. Cleaning costs amount to $10,000 per annum. The electrical equipment (such as the TV) for each seat has an annual repair cost of $15,000. It is expected that, with the improvements in technology, the equipment will be totally replaced in 2022 by substantially better equipment at a cost of $350,000. The electrical equipment in the cockpit is tested frequently at an expected annual cost of $250,000. Major upgrades to the equipment are expected every 2 years at expected costs of $250,000 (in 2015), $300,000 (in 2017), $345,000 (in 2019), and $410,000 (in 2024). The upgrades will take into effect the expected changes in technology.
• Food preparation equipment: This incurs annual costs for repair and maintenance of $20,000. The equipment is expected to be totally replaced in 2022.
  

Required:

• Start by establish the issues for your analysis by addressing the following:
  1. the advantages of a components approach versus a simple depreciation of the $10 million dollars over the 10-year period.
  2. Since AASB 116 requires initial recognition at cost and then provides a choice between either the cost model (impairment) or the revaluation model (increment and/or decrement) – discuss the advantages and/or disadvantages in applying either model to the aeroplane as a whole – indicating which would be the most appropriate as a result or if treated as components then which would be most applicable to the components you have identified.
  3. Basis for selecting the method of depreciation according to AASB 116.
• Discuss how the costs relating to the aircraft should be accounted for (treated) with respect to:
  1. Aircraft body;
  2. Engines;
  3. Fittings;
  4. Food preparation equipment.
  5. Where relevant consider/discuss issues such as:
     1. the treatment of the upgrades of cockpit equipment.
     2. accounting for inspections.

• Determine the expenses to be recognised for the financial year 1^st July 2016 to 30^th June 2017.
  1. Aircraft body;
  2. Engines;
  3. Fittings;
  4. Food preparation equipment;
  5. Total Expenses.

In the discussion by Upton (2001, 71) regarding the lives of intangible assets it is noted that the formula for Coca-Cola has grown more valuable over time, not less, and that Sir David Tweedie, former chairman of the IASB, jokes that the brand name of his favourite Scotch whisky is older than the United States of America — and, in Sir David’s view, the formula for Scotch whisky has contributed more to the sum of human happiness.

Required:

Outline the accounting treatment for brands under AASB 138/IAS 38, and discuss the difficulties for standard setters in allowing the recognition of all brands and formulas on statements of financial position.

Provisions are recognised as a liability in the statement of financial position whereas contingent liabilities are not recognised in the financial statements but disclosed in the notes to financial statements. Paragraph 12 of AASB 137/IAS 37 Provisions, Contingent Liabilities and Contingent Assets states that ‘in a general sense, all provisions are contingent because they are uncertain in timing or amount’.

Required:

1. Discuss possible reasons as to why provisions are recognised in the financial statements whilst contingent liabilities are not.
2. Determine whether the following items would be classified and recoded as liabilities or not (provide a brief explanation for your decision):
   1. Provision for long-service-leave;
   2. Dividends payable;
   3. Preference shares.

The definition of asset given in the conceptual framework states that an item is to be classified as asset if the firm controls it as a resource resulted from the past events. This implies that the item must be under control of the firm and the firm should own it due some transaction taken place in past (AASB, 2015). Further, the recognition criteria of asset states that an item of asset should be recognized if it is probable that the firm will receive economic benefits accruing from it in future. The item of asset should be recognized in books at the cost incurred in acquiring it or the fair value in the absence of cost (AASB, 2015). In case of photographs of the company’s founders and buildings, the company should recognize as asset if it probable that the company will be benefited in future. If the recognition is made at fair value, the asset account would be debited with corresponding credit to equity account.

            TDM Limited should recognize a liability in the form of provision against the amount that would be payable as compensation to Zero Ltd in the settlement of the case. The probability of losing the case is high, thus, it is advisable that the company recognizes provision. As per AASB 137, an entity should make provision in the books when it is probable that outflow of resources would be required to settle a liability arising in future (AASB 137, 2010). In order to recognize the provision, the profit and loss would be debited with corresponding credit to provision for liability account.     

            In this case the probability of outflow of resources to settle the liability is low because the probability of wining the case is high. If TDM Limited wins the case, there would be no liability to pay for compensation. Hence, it could be inferred that there is a remote possibility of outflow of economic resources (AASB 137, 2010). The AASB 137 states that in the cases when there is remote possibility of outflow of economic resource, the entity should recognize contingent liability, which is an off balance sheet item. In the current case the probably of winning is high which implies a remote possibility of liability arising to pay compensation. Thus, the company should recognize contingent liability in the books (AASB 137, 2010). No account would be debited or credited.

            In this case, the asset account would be reduced by the cost of plant and equipment thus; it would be credited with corresponding debit to accumulated depreciation account (Wisdom & Hasselback, 2008).

            In this case, TDM Limited has received donation of $20,000 for which it will have to debit the cash account and credit the donation account under liability accounts (Epstein & Jermakowicz, 2008). The donation account would either be shown under equity or liability depending upon the circumstances in which donation is received.

            Under the component approach of depreciation, the depreciation on assets is charged on every part of asset separately. This implies that all the significant and material parts of the asset are depreciated separately. On the other hand, the simple approach of depreciation advocates charge of depreciation on all parts of the asset under one asset pool. The component approach of depreciation is considered better than simple depreciation approach because it results in better accounting treatment. The parts of assets which are significant in value and that differ in useful life and which are capable of use on individual basis should be depreciated separately (Benesh & Bryant, 2017).       

            As per the provisions of AASB 116, the entity may follow two models such as cost model or revaluation model after making initial recognition of asset. The cost model provides for recording of the item of asset of historical cost basis whereas the revaluation model provides for recording of the items of assets at the fair value (AASB, 116).  If the fair value of items of asset could be ascertained reliably then revaluation model is considered appropriate because it better reflects the value of assets. However, in the cases when the fair value can not be ascertained reliably, it is better to apply cost model. The cost of aircraft as a whole is $10 million and its useful is estimated to be 10 years. However, there are components having significant cost and different useful lives such as engine. The engine of aircraft has useful life of 4 years and it also forms a significant part of overall cost of aircraft (AASB, 116).

            Therefore, if the aircraft is depreciated as a whole, the company should adopt cost model because a reliable estimate of fair value of the aircraft as a whole could not be made. However, in case the components approach is adopted for depreciation, the company should adopt revaluation model (Benesh & Bryant, 2017).           

Aircraft body

            The aircraft body is a significant part of aircraft and it costs $3 million which is significant part of the overall cost. Thus, the company should capitalize the aircraft body and recognize this as an asset (AASB, 116).    

 Engines

            The engine is also a significant part of the aircraft having total cost of $4 million, thus the company should capitalize the engine as well by recognizing it as asset in the books (AASB, 116).    

            Further, the fittings such as seats and carpets are also capable of being used for more than one accounting period, thus, the same should be capitalized in the books (AASB, 116).

Food preparation equipment

            The food preparation equipment is also for use for more than one accounting period and hence the same needs to be capitalized (AASB, 116).

Aircraft body

            Depreciation expense for 2016-17:

                        (3000000-0)/10=         $300,000        

Depreciation expense for 2016-17:

                        (4000000-0)/4=           $1,000,000

Depreciation expense for 2016-17 on Seats

                        (1,000,000-0)/3=         $333,333

            Repair and maintenance expense=    $100,000

            Total=  $1,333,333                                         

Depreciation expense for 2016-17 on carpet

                        (50,000-0)/5=  $10,000

Cleaning cost=            $10,000

Electric equipment repair=    $15,000

            Depreciation expense for 2016-17:

            (250000-0)/5= 50,000

            Repair and Maintenance=      $20,000

Reference List:

AASB 116. Property, plant and equipment. Retrieved June 08, 2017, from http://www.aasb.gov.au/admin/file/content105/c9/AASB116_07-04_COMPjun14_07-14.pdf

Benesh, B.K. & Bryant, M.K. 2017. Depreciation Handbook. LexisNexis.