Theory & Current Issues in Accounting

Question: Historical cost accounting and leasing. First question is mandatory and second question can be choose from other two. two questions need to be done from three? Answer: Historical Cost Accounting is the accounting procedure in which the value of the fixed asset acquired by the company continues to be recorded in the balance sheet at its purchase Price / acquisition cost. As per General Accepted accounting Principles (GAAP) historical cost Method has been used to record the asset in the balance sheet. Based on General Accepted accounting principle (GAAP) most of the Asset is recorded in the balance sheet at its original cost although there may be huge change in the value of the Asset overtime. For Example: Say, the Company head office which was bought by the company is recorded in the books of the company at $500,000 in 1945. The same continue to be recorded at $500,000 although there is a huge change in the value of such Land building. The Historical Cost Accounting does not lead the Asset to reflect its true value in the balance sheet. However, as per General Accepted Accounting Principle (GAAP) not all the asset is recorded at historical cost. For example marketable securities which has been recorded in the balance sheet at market value. Further As per AASB 101 Presentation of Financial Statement the entity whose functional currency is the currency of hyperinflationary economy needs to disclose the approach adopted by him during the preparation of the financial statement. That is they need to disclose whether Historical cost approach has been followed or current cost approach has been followed in the preparation of the financial statement. (Board, 2009). Historical Cost method is basically followed by the Private sector organization. Accounting Standard of Australia AAS21 also requires the private organization to follow the Historical Cost Method. As per Accounting Standard of Australia AAS 21, all the asset acquire by the entity to be initially recorded in the books of accounts at the original cost plus any expenditure which has been incurred to bring the asset to the present location and condition i.e. to say the incidental expenses also need to be added with the cost of the asset. It has to be noted that when initially the cost has been incurred to purchase the asset, the cost / purchase price of the asset is said to be the current cost but with the passes of time the asset and the cost incurred to bring the asset become history and is known as historical cost. Further, this fact also cannot be ignored that every asset has certain lifetime after which they are of no use. By showing the asset at historical cost in the balance sheet sometimes seems to be difficult for the management of the company and also to the shareholder to take long term decision. They are unable to value the company based upon the figure shown in the balance sheet. This is the biggest short coming of the Historical cost system. To overcome such short coming experts has formulated current cost system. However, current cost is not clearly capable of precise measurement of the value of the asset, as the historical cost is capable of. (Christene, 2013) Change in Accounting from Historical cost Accounting to any other accounting is not easy for the organization. The change in the accounting policy is only possible if it is as per the accounting standard which has been issued by the Australian Accounting Standard board. As per Accounting Standard AASB 1001 on Accounting policy issued by the Australian Accounting Standard board also permits a change in accounting policy: If it is necessary to comply with the other accounting standard. In case where no accounting policy is applied and the change in accounting policy would lead to overall improvement of the financial statement. And If an accounting standard permits alternative accounting policies and the change in accounting policy would lead to overall improvement and reliability of the financial statement. (Board, Accounting Policy, 1999) The Three Alternative which is considered to be the substitute of Historical cost concept are: Economic Price Method or Present Value Method Replacement Price Method Net realizable value Method or Market Price Method ( (Diewert, 2005) Net realizable Value Method is the method in which the asset is valued in the balanced asset at estimated realizable value of the First Asset. That is to say, it is valued in the balance sheet at the net realizable value that the asset can bring if it has been sold in the market at the balance sheet date. The major problem with net realizable value is that to find the net realizable value potential set of buyer needs to be determine along with the policy to determine their correct price bids. Replacement Price Method: It is the current market cost of purchasing a physically identical replacement for an asset currently being held by the enterprise. The net realizable value and replacement cost of an asset can be regarded as the selling and buying prices for the asset in the relevant second hand market. Replacement cost will generally exceed the corresponding net realizable value due to the existence of transactions costs. The shortcoming of replacement price method is that replacement is not reproducible this means that different estimate to replace the Asset. Second shortcoming is that replacement cost is not additive. This means that the replacement cost is different if group of asset has been replaced rather than replacement of the single Asset. Economic Price Method / Net Present Value: This is the method in which the value of the asset has been determined on the basis of estimated cash flow generated by the cash. That is to say the value is determines on the basis of the difference between cash inflow and cash outflow. It has also two demerits. First one is that it is difficult to determine the future cash flow as they are uncertain and second one is that even we estimated the future cash flow it is difficult to segregate such cash flow on the individual asset as the revenue will be generated on the basis of net revenue flows of individual Assets. 1. Provision of Warranty as at 30 June 2014 is as follows: Estimated cost of repairs: For Item Sold with No Defect = 80% of Nil = Nil For Item Sold having minor Defect = $1,000,000 * 15% = 150,000 For Item Sold having major defect = $600,000 * 5% = 300,000 Total Provision for Warranty = 450,000 Claim to be Settled with minor defect in FY 2015 = 150,000 Claim to be Settled with major defect in In FY 2015 = 40% * 300,000 = 120,000 In FY 2016 = 60% * 300,000 = 180,000 Present value of Claim to be Settled in FY 2015 = (150,000+120,000) = 270,000 Present value of claim to be settled in FY 2016 = 0.892 * 180,000 = 160,715 Therefore, Total Provision to be created = 270,000 + 160,715 = $430,715 2. Warranty Position as on 30 June 2015: Estimated cost of repairs: For Item Sold with No Defect Nil For Item Sold having minor Defect = $1,000,000 * 12% = 120,000 For Item Sold having major defect = $5,000,000 * 3% = 150,000 Total Provision for Warranty = 270,000 Claim to be Settled with minor defect in FY 2016 = 120,000 Claim to be settled with major defect in In FY 2016 = 20% * 150,000 = 30,000 In FY 2017 = 80% * 150,000 = 120,000 Present value of Claim to be Settled in FY 2016 = (120,000+30,000) = 150,000 Present value of claim to be settled in FY 2017 = 0.892 * 120,000 = 107,143 Total Provision for the Financial Year 2015 sale = (150,000 + 107,143) = 257,143 Previous Year Provision i.e. 2014 to be settled in FY 2016 = 180,000 So, Provision as on 30 June 2015 = 257,143 + 180,000 = 437,143 3. Movement in Warranty Provision for the yea: Opening Balance of Provision = 430,715 Less: Amount Paid during the Period = (200,000) Balance remaining = 230,715 Closing Balance of the Provision should be = 437,143 Provision need to be created during the year = (437,143 230,715) = 206,428 1.The perspective change in depreciation required is: Value of Asset as on 30 June 2014=$140,000 Replaced in May 2016 Month remaining = 22 month Depreciation rate SLM = 140,000 / 22 *12 = 6,363 Per Month. 1.E) Provision is something which is uncertain and for which a reliable estimate has to be made. But liability is something which has already been admitted by the entity. In the given case since the court has already ordered the company to pay the plaintiff of 1,500,000 out of which company has paid 800,000 therefore the remaining is considered as liability and not the provision. 2.F) Asset is something which the company possesses and which helps the company to reduce the burden. But in the given case although the court found the case in favor of the assesses the claim estimated by the company cannot be treated as Asset as the amount has not been determined. It is to be considered as Contingent Asset since the inflow of economic benefit is probable but the amount is not certain. So, no Asset is recognisd only disclosure needs to be made in the books of account. 3.G) Bank Guarantee meets the definition of a contingent liability and not the provision. Because in case of Bank guarantee there is a present or possible obligation but probably it will not require any outflow of resources. But in Case of provision there is present obligation resulting from the past vent which requires the outflow of resources. References: Board, A. A. (1999). Accounting Policy. AASB 1001 , 24. Board, A. A. (2009). Financial Reporting in Hyperinflationery Economy. Complied Accounting Standard , 9. Christene, H. B. (2013). Fair Value Accounting for Non- Financial Asset. Review of Accountign Studies , 4. Diewert, W. E. (2005). Measurement of Business Capital, Income and Performance. Tutorial Presented at the University Autonoma , 35.