University Case Study: AASB 138 and Financial Reporting of R&D Project

This case study report examines Technology Enterprises' research and development (R&D) project and its accounting treatment under AASB 138. The company, seeking to modify its battery recharging technology, faces challenges in recognizing the R&D asset. The report analyzes the CEO's desire to inflate the asset's value versus the accountant's adherence to historical cost. It delves into the extent to which AASB 138 rules impact the comparability of financial statements, discussing fair value versus value in use. The report highlights the complexities of accounting for intangible assets, including the valuation of the R&D project and the implications of different valuation methods. The analysis includes a discussion of the CEO's perspective and provides recommendations for the company to accurately reflect its financial position, emphasizing the importance of transparent and reliable financial reporting. The case study concludes by emphasizing the importance of accurate valuation and clear disclosure in the notes to accounts to ensure investors have a realistic view of the company's financial performance.

FINANCIAL ACCOUNTING
2019

AASB 138
Executive Summary
The report revolves around Technology Enterprises, a company engaged in R&D in 2017
for the modification of recharging batteries used in the products. In this report, the major
emphasis is on accounting for the financial assets and the rules present in AASB 138 that
reduces the financial statements comparability. In short, the focus is provided on investors
and the concern is taken on a prior form.
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AASB 138
Contents
Introduction.................................................................................................................................................4
1. Accounting for the project...................................................................................................................4
2. Extent to which rules of AASB 138 reduce the comparability of financial statements........................5
3. Response to CEO..................................................................................................................................6
Conclusion...................................................................................................................................................8
References...................................................................................................................................................9
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AASB 138
Introduction
An asset is any physical utility item which helps in revenue generation and makes the
organization generate turnover. Intangible assets are those assets which cannot be seen, touched
or felt physically, but the benefit of which is reaped by the organization in many forms. These
assets generate revenue, earn profits and benefit the organization in many ways. This is how
intangible assets come into the picture. Intangible assets include assets such as Goodwill, brand
recognition and intellectual property, such as patents, trademarks, and copyrights. They do not
derive their benefits from contractual claims.
1. Accounting for the project
Intangible assets can be so considered only if it is certain that there will be economic benefits to
the company from the asset in the future, and these economic benefits will flow into the
company. Also, these benefits should be measurable in economic terms. Only then, the
intangible assets can be recognized. Research and development is another important element of
an intangible asset. The cost needs to be added as a capital asset. It cannot be expensed out.
Intangible assets as per IAS 38 must be valued at cost or acquisition value only. It cannot be
recognized at any other value (AASB 138, 2017).
There are different contentions of each party to the valuation process. The CEO contends that
‘R&D asset’ should make the financial statements look great. He wants to show that it is worth
$4 000 000 in the balance sheet and add an extra $3 000 000 to profit because it cost only $1 000
000. The accountant says that he has not yet finalized the books of accounts, but he also contends
that he is sure that the accounting standard AASB 138/IAS 38 ensure that the intangible asset is
measured at historical cost. Also, all costs incurred after the capitalization to be recognized as
revenue expenses and be treated accordingly. The CEO is of the view that the accountant is not
discussing fair ideas. He is inclined towards showing the investors that their project has gone
successfully and that the project has yielded multiple profits. He is of the view that the
accounting principles as stated and followed by the accountant are conservative and shall hamper
the growth and well-being if the company. It is said by him that these conservative accounting
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AASB 138
principles will make the share price of the company go down, and this will make the investors
believe that the project was a failure and that it did not work as planned.
But the right contention is going to be the following:
The company should choose in between two alternatives. It can either record the asset at $1000,
000 and can show in the balance sheet at the acquisition cost less its accumulated impairment.
The intangible assets are generally written off or impaired or depreciated over its approximate
useful life. And the same can be done. However, if the accountant is confident about the
valuation of the fair value, the same can be varied accordingly and shown in the balance sheet.
The fair value can be representative of the market value or realizable cost of the asset. The CEO
wants to record the transaction at a cost which is highly inflated than actual. He wants the value
of the asset should be more than what is actually even there. He wants to recognize at 4,000,000
as the value of the asset, that is the value shall appear in the balance sheet. And he also says that
since the actual acquisition cost of the asset is only $1, 000,000, the rest $3, 000,000 to be
included as profit. As in this way the value would be inflated by a net $6, 000,000. This
intention is absolutely incorrect. Thus validation cannot be accepted at so all as this would
portray a false picture to the investor.
2. Extent to which rules of AASB 138 reduce the comparability of
financial statements
There are multiple ways in which an intangible asset may appear in the books of accounts. For
research and development expenses being recorded as intangible assets, they are recorded at their
cost or acquisition value. The cost or acquisition value includes all expense that had been
incurred in bringing about the effective research and development expenses to use. In the given
scene, the research and development costs came up to be 1,000,000. However, the fair market
value and the liquidation scenario of the company determines how much will be valued and
carried in the books (Marsh, 2009). If the fair value can be righteously computed, they can be
presented viable, and the determination is possible for such assets, and the account team. And/or
management is certain that the value so computed is correct, the research and development
expenses can be valued at the fair value (AASB Standard 138, 2018). However, the contention
to value the same at its value in use is absolutely incorrect and dispensable. Even IAS38 states
the same and it is a wrong practice to value the intangible asset at its acquisition cost when the
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AASB 138
fair market value is available, correctly determinable, and conveniently relied upon (Libby,
Libby & Short 2012).
Intangible assets cannot be revalued or impaired during their useful life. This restriction by the
standard makes it difficult to make financial reporting’s comparable. Where on one hand, the
other assets are valued differently, intangible assets are valued at cost or fair value, the method of
valuation can be different or different companies (Leo, 2011). This makes a comparison if
values challenging. There are multiple types of intangible assets too. The valuation method is
different for the internally acquired goodwill, the generated goodwill, and the incidental
goodwill. The valuation of assets at values higher than the fair value is an incorrect contention
though (OHM, 2018).
The company can also record the value of the asset at its fair market value and mention the
source of the computation, the reliability and the strength of its fact is valid. This will lead to a
rise in the value of an investment in the books, it will also lead to an increase in profits and
thereby increase in the shares price.
3. Response to CEO
Intangible assets are the ones which can silently win the game by increasing or decreasing the
financial health of the company. Thus, their valuation is of prime importance. The valuation,
classification, treatment of profit, is all governed by the accounting standard AASB 138/IAS 38.
Investors believe and rely on financial statements as published by the company. They take
financial decisions based on the same. The money invested is the responsibility of the company
and the management group. If the company paints a false picture and the investor relies on it and
invests his money, the management is like for the damage as much as the auditor of those
financial statements. In order to make the investors believe that the company is performing well,
it tried to show the inflated value of assets and the profit derived thereon by using the value in
use method of valuation of the intangible asset (Steenkamp & Steenkamp, 2016). This contention
of the company does not go in good taste. If the company has to alter its image before the people,
it has to make sure that the investors and users of financial information get the right picture
(Melville, 2013). The company has spent $100,000 as of the cost of time sent in searching for
and evaluating the decision of purchase of alternative materials. It has spent $700,000 as costs
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AASB 138
for designing models and construction of prototypes and testing the efficiency of built and design
of these prototypes by ensuring they work as they are expected to. The company has also spent
$200,000 as costs of time spent on training workers and employees and their constant follow up
training so that they understand the working, design, and functioning of the prototypes properly
and desired results are achieved. The value in use was estimated at using the present value
computation technique came up to be $4,000,000. However, the fair market price or fair value of
the asset is supposed to be around $3,000,000. The actual cost, however, is 1,000,000. The fair
value comes to this value to ensure that the costs incurred by potential buyers in order to modify
the design to suit their preferences and needs are also addressed. There are different contentions
of each party to the valuation process. The CEO contends that ‘R&D asset’ should make the
financial statements look great. He wants to show that it is worth $4 000 000 in the balance sheet
and add an extra $3 000 000 to profit because it cost only $1 000 000.
The accountant says that he has not yet finalized the books of accounts, but he also contends that
he is sure that the accounting standard AASB 138/IAS 38 ensure that the intangible asset is
measured at historical cost. Also, all costs incurred after the capitalization to be recognized as
revenue expenses and be treated accordingly (Williams, 2012).
The CEO is concerned with the view that the accountant is not discussing the ideas that are fair.
Moreover, it is being shown that the business has done reasonably well and accounted for strong
profits. As per his opinion, the accounting principles stated and followed by the accountant are
conservative and will erode the growth and well-being of the company (Laux, 2014). The
acquisition cost of the asset was $1,000,000. However, since the fair market value is
ascertainable, the company will have an advantage if it is considered at the fair market value.
The incorrect picture of showing higher value in the financial statements is absolutely incorrect.
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AASB 138
Conclusion
Since the company wants to mitigate the risk of its investor having a false impression of the
company that it is not performing well, the company should highlight this in the notes to
accounts. It definitely might not increase the share price of the shares of the company. It might
also not show the assets at a high value. But it will show the high intrinsic value of the company
which has strong financial fundamentals. This company should highlight the same in the notes.
The company can alternatively also record the value of the asset at its fair market value and
mention the source of the computation, the reliability and the strength of its fact is valid. This
will lead to a rise in the value of an investment in the books, it will also lead to an increase in
profits and thereby increase in the shares price.
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AASB 138
References
AASB 138. (2017) AASB Summary for Businesses. Available from:
https://legalvision.com.au/aasb-138-intangible-assets-summary-for-businesses/ [Accessed 30
April 2019]
AASB Standard 138. (2018) Compiled AASB Standard. Available from:
https://www.aasb.gov.au/admin/file/content105/c9/AASB138_07-04_COMPjun14_07-14.pdf
[Accessed 30 April 2019]
Laux, B. (2014) Discussion of The role of revenue recognition in performance reporting.
Accounting and Business Research. [online]. 44(4), 380-382. Available from:
http://www.ccsenet.org/journal/index.php/ijbm/article/viewFile/4235/3672 [Accessed 30 April
2019]
Leo, K. J. (2011). Company Accounting. Boston:McGraw Hill
Libby, R., Libby, P & Short, D. (2012) Financial accounting. New York: McGraw-Hill/Irwin.
Marsh, C. (2009) Mastering financial management. Harlow: Financial Times Prentice Hall.
Melville, A. (2013) International Financial Reporting – A Practical Guide. 4th edition, Pearson,
Education Limited, UK
OHM, M. (2018) New Leasing Standard AAB 16. Available from: https://www.hlb.com.au/new-
leasing-standard-aasb-16-brings-significant-impacts/
Steenkamp, N & Steenkamp, S. (2016) AASB 138: catalyst for managerial decisions reducing
R&D spending?. Journal of Financial Reporting and Accounting. 14, 116-130. Available from:
10.1108/JFRA-02-2015-0026 [Accessed 30 April 2019]
Williams, J. (2012) Financial accounting. New York: McGraw-Hill/Irwin.
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