financial reporting Case Study

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Financial ReportingCase studyAtif SaeedSubmitted: 15thApril 2020Atif Saeed1Admission # 16508Financial ReportingK/617/3296
Financial ReportingNameAtif SaeedTask 1Detailed Notes:Describe assets within a business organisation.Apply depreciation to a business organisation’s assets.Prepare a business organisation’s asset register.Explain the purpose and functions of control accounts.Prepare control accounts for example data.Prepare reconciliation statements of control accounts with schedule of tradepayables and trade receivables.Prepare, from an example trial balance, financial statements for a singleentity.Prepare, from incomplete records, financial statements for a single entity.Word count10,891Date15thApril 2020Atif Saeed2Admission # 16508Financial ReportingK/617/3296
Table of ContentsS.No.DescriptionPage No.1Assets within a business organization41.1Classification of assets41.2Depreciation accounting81.3Business organization's asset register122Control accounts142.1Purposes and function of control accounts142.2Preparing control accounts142.3Reconciliation of control accounts with receivables and payables173Preparing financial statements183.1Trial balance183.2Preparing financial statements from incomplete records183.3Preparation of final accounts263.4Preparing financial statements from a given trial balance29References321.Assets within a business organizationAtif Saeed3Admission # 16508Financial ReportingK/617/3296
An asset is essentially a resource held by the business. For a particular item to be treated as anasset for accounting purposes it should have the following characteristics:A probably future benefit must exist i.e., this simply means that the item must be expectedto generate some future monetary benefit for the organization through its use within thebusiness or through its hire or sale.The business must have an exclusive right to control the benefit e.g., for a businessoffering holidays and barges, the canal system may be very valuable resource, but as thebusiness will not be able to control the access of others to the canal system, therefore itcannot be regarded as an asset of the business.The benefit must arise from some past transaction or event. This mean that thetransaction which would give the right to the business to claim benefit must have alreadyoccurred and will not arise at some future date.The asset must be capable of measurement in monetary terms i.e., if the item cannot bereliably measured in monetary terms then it will not be regarded as an asset for inclusionon the balance sheet of an organization, e.g., the title of a magazine (for example Men’sHealth) created by its published might be an extremely valuable to that publishingbusiness but will not be treated as an asset because the value of this magazine is difficultto be quantified.1.1.Classification of assets- The sort of items that usually appear as assets in the balancesheet of an organization include, real estate property, plant, machinery and equipment,fixtures and fittings, patents, trademark, trade receivables, prepayments, goodwill,investments etc., i.e., not only physical items but also items which gives organization non-physical rights to certain benefits. Assets that have physical substance are referred to astangible assetsand the ones with no physical substance but the ones that still provideexpected future benefits are referred to asintangible assets; both categorized as beingeither current or non-current assets.Current assets –are those that will be realized, consumed or sold in the normaloperating cycle of the business or are assets held primarily for trading purposes i.e.,expected to be sold within the next year and include cash and cash equivalent / liquid andeasily marketable short-term investments. The most common current assets are cash,inventories and trade receivables (i.e., receivables from customers who owe money forgoods supplied on credit to them).oTrade receivableswere previously measured in accordance with InternationalAccounting Standards (IAS) 39 and as per IAS 32 were defined as a contractual rightto receive cash or another financial asset from another entity. In terms of IAS 39, suchfinancial assets are measured at amortized cost as they fall in the category ‘loans andreceivables’. However, recently IAS 39 was replaced with International FinancialReporting Standards (IFRS) 9; which as opposed to IAS 39, states that a financial assetshall be measured at fair value unless it is measured at amortized cost in accordancewith the following two conditions such as:i.the asset is held in the business model whose objective is to hold assets in orderto collect contractual cash flows.ii.The contractual terms of the financial asset gives rise on specified dates to cashflows that are solely payments of principal and interest (i.e., time value of moneyand credit risk associated with principal) on the principal amounts outstanding.The purpose of this revision in the recognition method by the International AccountingStandards Board (IASB) is to develop a more forward looking model which wouldrecognize expected losses on a more timely basis compared to the existing mode inIAS 39 which is an “incurred loss” model i.e., delaying the recognition the creditlosses until there is evidence of an actual event.oPrepayment /pre-paid expenses –are expenses which have already been paid butrelated to a future accounting period and are therefore are shown as an asset on thestatement of financial position of an organization. Examples of prepaid expensesinclude rent paid in advance, a subscription to a trade association paid in advanceetc.oInventoriesare current assets which include, assets which are held for sale or are inthe process of being produced for such sale or are in the form of materials or suppliesAtif Saeed4Admission # 16508Financial ReportingK/617/3296
to be consumed in the production process or rending or services. According toInternational Accounting Standards – IAS 2, inventories should be measured at thelower of cost or net realizable value (i.e., estimated selling price in the ordinarycourse of business less estimated cost of completion and cost of selling the items e.g.,purchase price, costs of conversion and other administrative, storage and sellingcost).i.Cost of inventories- should be assigned by specific identification of theirindividual costs for items that are not ordinarily interchangeable and for good orservices produced and segregated for specific projects. IAS 2 allows the use ofcost estimation techniques e.g., the retail method standard or the cost method,provided the resultant estimates are close to the cost. The standard costsmethod takes into consideration the normal levels of labor, supplies andmaterials, capacity utilization and efficiencies; which are regularly reviewed toensure they approximate the actual costs. On the other hand, the retail methodis often used in the retail industry for measuring inventories of large numbers ofrapidly changing items with similar margins for which it is not possible orimpracticable to use other costing methods. The cost of the inventory isdetermined by reducing the sales value of the inventory by the percentage grossmargin.ii.Net realizable value (NRV)– Assets are generally not carried at amounts thatare expected to be realized from their sale or use. However, in the case ofinventories, this amount can fall below cost when items are damaged or becomeobsolete or where the cost of completion may have increased. Typical situationswhere the NRV of inventory can be lower than its cost include e.g., an increase incost or a fall in selling price, a physical deterioration in the condition ofinventory, errors in producing or purchasing.Non-current assets –are the assets which are held for long-term operations andcomprises tangible and intangible assets such as property, plant and equipment,trademarks, goodwill etc.oTangible non-current assetsmay include the following assets:i.Property, plant and equipment –which according to IAS 16 are the tangibleassets that are held by an entity for use in the production or supply of goods orservices, for rental to others, or for administrative purposes and are expected tobe used during more than one period. Other definitions which are relevant forproperty, plant and equipment under IAS 16 include definitions of:Costwhich is the amount of cash or cash equivalents paid or the fair valueof the other consideration given to acquire an asset at the time of itsacquisition or construction.Fair valueis a price that would be received to sell an asset or paid totransfer a liability in an orderly transaction between market participants atthe measurement date.Carrying amountis the amount at which an asset is recognized afterdeducting any accumulated depreciation and impairment losses.Recognition of property, plant and equipment in the business’s accountsdepends on two criteria, a).it is probable that all the future economic benefitsrelated to the assets will flow to the entity andb).the cost of the asset to theentity can be measured reliably. Once recognized as an asset, the items areinitially measured at cost which according to IAS 16 comprises the followingcomponents:Purchase price, including any import duties paid but excluding sales tax paidand any trade discounts received.Initial estimates of decommissioning costs (i.e., dismantling and removingthe items) and restoring the site on which it is located.Cost which are directly attributable to bringing the asset to working conditionfor its intended use, e.g., initial delivery and handling costs, installation andassembling costs, staff costs which are directly related to construction oracquisition of the asset, professional fees etc.Atif Saeed5Admission # 16508Financial ReportingK/617/3296
Any subsequent expenditure is added to the carrying amount of the asset, butonly after it has satisfied the recognition criteria discussed above. All othersubsequent expenditures are simply recognized as an expense in the period inwhich they are incurred. For the measurement subsequent to the initialrecognition of property, plant and equipment, the standard (IAS 16) offers topossible treatments i.e., to keep an asset recorded at cost or revaluing it at fairvalue. The cost model is essentially carrying the asset at cost less depreciationand any accumulated impairment loss. On the other hand, the revaluation modelentails revaluing the asset as of a particular date and carrying it at the revaluedamount; less any subsequent accumulated depreciation and accumulatedimpairment losses. For example, when considering land and building, the marketvalue of such assets represents their fair value. In the case of plant andequipment, the market value, if measured reliably, can be considered as the fairvalue. However where the market value is not available, depreciatedreplacement cost should be used. In order to avoid disclosing a mix of values andcosts from different dates in the financial statements and to prevent selectiverevaluation of certain assets and, it is important that when one of the property,plant and equipment is revalued, the whole class of the assets to which thatparticular asset belongs to, should be revalued at the same time.ii.Investment property –comprising land or building maybe owned by anorganization for investment purposes rather than for use in the business. It maytherefore generate cash flows largely independent of other assets which theorganizations holds. StandardIAS 40 relating to the treatment of investmentproperty defines investment property as an asset held to generate rental incomeand capital gains and not for use in the ordinary course of business. Examples ofinvestment property may include a commercial or a residential building ownedby an organization and leased out under an operating lease or/ and a propertythat is being constructed for future use as an investment property.Aninvestment property is initially measured at its cost, including its transactioncosts. A property which is held under a lease and classified as an investmentproperty is accounted for as if it were a finance lease. The asset is recognizedlower of its fair value and the present value of the minimum lease payments andan equivalent amount is recognized as a liability. Subsequent to initialrecognition, for the measurement as prescribed by IAS 40 requires anorganization to choose between two models:The fair value model which should be applied for all the investmentproperties of an organization; regardless of whether it is owned or leased,under IAS 16 requires the following condition to be met:a)After initial recognition an entity that chooses the fair value modelshould measure all of its investment property at fair value, except in theextremely rare cases where this cannot be measured reliably.b)A gain or loss arising from a change in the fair value of an investmentproperty should be recognized in the net profit or loss for the period inwhich it arises.c)The fair value of investment property should reflect market conditions atthe end of the reporting period.The cost model in IAS 16 requires the investment property to be measured atdepreciated cost less any accumulated impairment losses. An organizationthat chooses the cost model should disclose the fair value of its investmentproperty.iii.Borrowing costs –accounted for as tangible non-current assets particularlyrelate to borrowings for construction of certain assets. Under IAS 23, whichrequires capitalization of borrowing costs defines the borrowing costs as theinterest and other costs incurred by an organization in connection with theborrowing of funds for qualifying assets i.e., an asset that necessarily takes asubstantial period of time to get ready for its intended use or sale. Depending onthe circumstances, inventories, manufacturing plants, power generationAtif Saeed6Admission # 16508Financial ReportingK/617/3296
facilities, investment properties etc. may be considered as qualifying assets. Thestandard lists that may be included in borrowing costs:Interest on bank overdrafts and short-term and long-term borrowingsAmortization of discounts or premiums relating to borrowingsAmortization of ancillary costs incurred in connection with the arrangementof borrowings.Finance charge in respect of finance leaseForeign exchange differences arising from foreign currency borrowings to theextent that are regarded as adjustment to the interest costs.oIntangible non-current assets –are non-current assets with no physical substanceand includes goodwill, intellectual rights (e.g., patents, performing rights andauthorship rights) and research and development costs. Intangible asset, inaccordance with IAS 38, is capitalized in the accounts and amortized over its usefullife (with the exception of goodwill which is tested for impairment on annual basis andfalls outside the scope of IAS 38 i.e., covered by IFRS 3 – Business Combinations).Another element of the definition of an intangible asset is that it must be under thecontrol of the entity which should be able to enjoy the future economic benefits fromthe asset and prevent access of others to those benefits e.g., technical knowledge orknow-how only exists if it is protected by a legal right. Upon initial recognition, thereare two methods that can be used to measure the value of the intangible assets i.e.,thecost modelwherein an intangible assets is carried at cost less any accumulatedamortization and less any accumulated impairment losses and therevaluationmodelwhich allows for an intangible asset to be carried at revalued amount whichessentially represents its fair value at the date of valuation less any accumulatedamortization and impairment losses.i.Goodwill –according to the accounting standard IFRS 3 is an asset representingthe future economic benefits arising from acquisition of other assets in businesscombination that are not individually identified and cannot be separatelyrecognized. It is created by good relationship between a business and itscustomers. While the value of goodwill to a business might be considerable, it ishowever not usually valued in the accounts of a business at all (i.e., referred toas internally generated goodwill) and will not be recorded in the financialstatements. However, when a business is sold there is likely to be somepurchased goodwill in the selling price which is determined as follows - The sellerand the buyer agree on a price for the business without specifically quantifyingthe goodwill. The purchased goodwill will then be the difference between thepurchased consideration and the value of the identifiable net assets in the booksof the new business. After initial recognition, the acquired goodwill is measuredat cost less any accumulated impairment loss; a test carried out in accordancewith the IAS 36 guidelines for impairment of assets which compares the carryingvalue of the asset with its recoverable amount. If the carrying amount is greaterthan the recoverable amount, then an impairment loss has to be recognized.ii.Research and development costs –within which research component inaccordance with the guidance provided in IAS 38 should be written off as anexpense as they are incurred. This is because, at the research stage of a project,it cannot be certain that future economic benefit will flow to the organization dueto likelihood of the project being unsuccessful. Development costs on the otherhand may qualify for recognition as intangible assets provided the following strictcriteria is met:the technical feasibility of completing the intangible asset should be in placeintention to complete the intangible asset and use or sell itability to use or sell the intangible asset should be demonstratedhow the intangible asset will generate probably future economic benefits i.e.,is there a market for it or can it be internally used?ability to measure the expenditure attributable to the intangible asset duringits developmentAtif Saeed7Admission # 16508Financial ReportingK/617/3296
The development costs may include, the design, construction and testing of pre-production prototypes and models, jogs, moulds etc.1.2.Depreciation accounting –the need to depreciate non-current assets arises from theaccruals assumption. Money spent in purchasing an asset then the amount spent must atsome time be charged against profits. If the asset is consumes economic benefits a number ofaccounting periods, it would be inappropriate to charge any single period with the whole ofthe expenditure. Instead the cost should be spread over the useful life of that asset i.e., aview which is adopted by IAS 16 in governing the account for depreciation. IAS 16 furtherdefines depreciable amount of a depreciable asset is the historical cost or other amountsubstituted for historical cost in the financial statements, less the estimated residual value.The amount substituted for historical cost will normally be current market value after arevaluation of the assets have taken place. IAS 16 requires the depreciable amount to beallocated on a systematic basis to each accounting period during the useful life of the asset.The useful life is either:the period over which a depreciable asset is expected to be used by the organization orthe number of production or similar units expected to be obtained from the asset by theorganization.The factors which should be considered when estimating useful life of a depreciable assetinclude, expected physical wear and tear, obsolescence and legal limits on the use of theassets. Once the useful life has been determined, it should then be reviewed at least annuallyand depreciation rate adjusted for the current and future periods if expectations varysignificantly form the original estimates.1.2..1.Depreciation methods –Depreciation is a means of spreading the cost of anon-current asset over its useful life in order to match the cost of asset with theconsumption of the asset’s economic benefits. The depreciation charge for eachaccounting period is charged to the P&L and also deducted from the non-current assetbalance to get the asset’s carrying value. The deducted depreciation amount and thefuture deductions in each successive account period are accumulated over time, tillthe time it becomes equal to the cost of the non-current asset i.e., the carrying valuebecomes nil. For example, if a current asset costing £40,000 has an expected life of 4years and an estimated residual value of nil, it might be depreciated by £10,000 p.a.Cost of theasset£Depreciationcharge forthe year£Accumulateddepreciation£Carryingamount atthe end ofyear£ABC= A - CAt thebeginning ofasset’s life40,0000040,000Year 140,00010,00010,00030,000Year 240,00010,00020,00020,000Year 340,00010,00030,00010,000Year 440,00010,00040,000040,000As shown, at the end of year 4 the full £40k of depreciation charges have been made inthe statement of profit and loss for the four years. The carrying amount of the non-current asset at the end of the 4thyear will be nil. As such, in theory the business will nolonger use the non-current asset which needs replacing. There are several differentmethods of depreciation such as, straight line method, reducing balance method,accelerated deprecation method etc. However, for the purposes of this paper we willAtif Saeed8Admission # 16508Financial ReportingK/617/3296
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