Case Study

Assessment Type: Case study report — theory and calculations — individual assessment
Purpose: To allow students to apply the technical knowledge of relevant accounting standards to financial reporting settings. This assessment relates to learning outcomes c, d.
Value: 30% Due Date: Week 9 – 8:00 pm Wednesday of Week 9
Submission: Submission must be made to the Moodle Assignment Link on the KOI Moodle Subject
Home Page by 8.00 pm Wednesday of Week 9. A printed copy must be submitted to the Lecturer at the Week 9 Lecture to assist with marking. All assignments must have a signed KOI Assignment Coversheet included with the submission.
Topic: Research Individual Assignment
Task Details: Technology Enterprises Ltd, a listed company, commenced a research and development (R&D) project in July 2017 to modify the method of recharging batteries used in its products. The project was successfully completed in June 2018 and the company applied for a patent for the design.
Technology Enterprises Ltd plans to modify all products in its consumer range over the next two years and has incorporated these plans into its financial budget. The entity expects to derive economic benefits from the new battery recharging technology over the next 10 years
The accountant was unsure how to account for the project so they used the New Project R&D account to accumulate the salaries of all engineers involved in the project during the year ended 30 June 2018. The following analysis of the salaries expenditure is based on the engineers’ time sheets.

Cost of time spent searching for and evaluating alternative materials 100000
Cost of time designing models, and constructing and testing prototypes 700000
Cost of time spent on training maintenance workers for the new design 200000

The value in use of the design, estimated using present value techniques, is $4 000 000. However, the fair value of the design is estimated to be only $3 000 000 because the only potential buyer would need to modify the design to adapt it to its own products.
The following conversation took place between the chief executive officer (CEO) and the accountant (ACC).
CEO:
ACC:
CEO: That ‘R&D asset’ should make our financial statements look great this year. We can show 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.
I haven’t finalised accounting for it yet but I am quite sure the accounting standard requires us to measure it at historical cost, and some of it will probably have to be recognised as an expense.
It isn’t fair. These conservative accounting rules make it impossible to show investors that our project was successful — and expensing any of it will cause our share price to go down because the investors will think it didn’t work.
Required
1 . How should the project be accounted for in the financial statements for the year ended 30 June 2018? Justify your answer with reference to relevant paragraphs of AASB 138/1AS 38.
2. To what extent might the rules or restrictions in AASB 138/1AS 38 reduce the comparability of financial statements?
3. Write a response to the CEO, drawing on your understanding of AASB 138/1AS 38 and the efficient market hypothesis (refer to chapter 2 of Loftus). Include a recommendation as to how the company might mitigate their concerns about investors’ interpretation of the information reported in the financial statements
Research requirements: Students need to support their analysis with reference to relevant material from the text and a minimum of eight (8) suitable, reliable, current and academically acceptable sources — this should include at least 2 peer-reviewed academic journal articles.
Presentation: 2000 + 10% word short report format. Title page, executive summary, table of contents, appropriate headings and sub-headings, recommendations/findings/conclusions, in-text referencing and reference list (Harvard — Anglia style), attachments if relevant. Single spaced, font Times New Roman 12pt, Calibri 1 1 pt or Arial 10 pt.

Research Individual Assignment

Executive Summary
The report shows the importance of using IAS 38 and AASB 138 in the recognition and measurement of the research and development costs of Technology Enterprises Ltd. The research and development costs of Technology Enterprises Ltd are measured\d at cost for time spent in searching for alternative materials, testing, constructing and designing prototypes of the new design of batteries. The report also shows why it is challenging to achieve comparability in the financial statements using the IAS 38 and AASB 138 as well as the report. The report further shows the response to the CEO on why he should allow the use of the AASB 138 and IAS 38 in the presentation of the new design.

Table of contents

Executive Summary 2
Table of contents 3
1.0 Accounting for Research and Development project 4
1.1 Initial measurement 4
1.2 Subsequent Measurement 4
1.3 The rationale of Accounting –IAS 38 and AASB 138 5
2.0 How AASB 138 and IAS 38 Restrict Comparability in financial statements 5
3.0 Response to the CEO 6
3.0 Recommendations/Findings/Conclusions 7
4.0 References 8

1.0 Accounting for Research and Development project
1.1 Initial measurement
The new design project will be measured in two ways to the financial statements of Technology Enterprises Ltd. The total research and development costs comprise of the cost of the time spent evaluating and searching alternative materials, cost of time designing models, constructing and testing prototypes and cost of time spent on training maintenance workers for the new design.
The cost of time for searching and evaluating alternative materials as well as the cost of time spent designing, constructing and testing models will be capitalised and will be recognised in the balance sheet as an intangible asset of the company. These cost form part of the development costs of the company. The cost of time spent on training maintenance workers will be expensed in the income statement as a cost. The costs of training cannot be capitalised since they have been incurred indirectly in the development of the new design of the batteries.
Amount to the Income Statement
Item $
Training maintenance workers 200,000
Amount to the Balance Sheet
Item $
cost of time for searching and evaluating alternative materials 100,000
cost of time designing models, constructing and testing prototypes 700,000
Research and Development (Intangible assets) 800,000
The amounts will be accounted for in the current period as they have been incurred in the development of the new design of the batteries. Also, they are incurred since they have been developed and the company aims at selling them to users of their products; thus Technology Enterprises Ltd will generate economic benefits from the new design of the batteries.
1.2 Subsequent Measurement
The research and development costs are measured using either the cost or revaluation model. Using the cost model the assets will be recognised at cost less accumulated amortisation. The research and development costs will be amortised at cost every financial year from the next fiscal year. In the current year, there is no amortization as the new design was developed and there is expected to be no amortization during the year of development.
On the other hand, while using the revaluation model the value in the balance sheet will be carried at fair value at the date of revaluation less the accumulated amortisation until that time of the revaluation. The fair value of design will be estimated by referring to the value of the design in the active market. Therefore, the value of the design needs to be evaluated to ensure that it is not recorded at a value lower than its fair value in the market. Then, the research and development cost will be recorded at fair value in the financial statements to show the increase in the value of the design at $3000,000 and a revaluation gain of $2000,000 will be presented in the income statement.
1.3 The rationale of Accounting –IAS 38 and AASB 138
The research and Development project of Technology Enterprises Ltd involved the modification of the batteries used in its products. Therefore, since the design is owned by the company, there was an intention to patent the design by the company. Therefore, the patent will be recognised as an intangible asset of the company in the financial statements.
Intangible assets are accounted for in the financial statements according to the provisions of IAS 38 or AASB 138. IAS 38 requires that for an item to be recognised as an intangible asset, the item needs to be identifiable, have control as well as has future economic benefits. Therefore, the new design of batteries is an intangible asset since it is identifiable as it can be transferred or be sold to another person. Also, the design has control as Technology Enterprises Ltd will be able to obtain economic benefits from the sale of the batteries (Smalt and McComb, 2016, pg.1). Moreover, the new design is likely to generate future revenues for the company.
According to IAS 38, the design will be recognised in the financial statements at cost (Agyei-Mensah, 2019, pg.1). However for it to be recognised, the asset needs to show that it is probable that future economic benefits of the asset will flow to the company and its cost can be measured reliably (AASB 138 par 21). Therefore, if the asset does not meet the criteria for the recognition, it will be recognised as an expense when it is incurred in the financial statements.
2.0 How AASB 138 and IAS 38 Restrict Comparability in financial statements
The AASB 138 restricts revaluation of internally generated assets if they are not initially recognised at cost (Dinh et al., 2018, pg.247). In this case, these assets have been internally generated; therefore this means they lack an active market for those designs; therefore revaluation may be severe. The carrying amount of the assets and the revalued amounts will be materially different thereby impacting on the financial statements. Also, the amortisation movements on the intangible assets are likely to affect the fair value of the intangible assets.
If an intangible asset carrying amount is increased as a result of revaluation, the increase is credit in equity as a revaluation reserve. However, when the amount is recognised in the profit and loss account the value is reconciled against the revaluation. Therefore, this leads to a reversal of all the revaluations in the financial statements. Due to this, the changes in different accounting years cannot be reported in the right financial statement. The treatment for revaluation is regarded differently based on both the cost model as well as the revaluation model.
Also, according to AASB 138 paragraph 86, a decrease in the revaluation of the intangible assets is recognized in the statement of profit or loss of the company. The amount of the revaluation reserve is also debited to reduce the balance against the revaluation decrease. Therefore due to these effects have to be treated in the financial statements to affect every transaction that occurred during the financial year.
Consequently, these effects about intangible assets make it difficult to evaluate a company’s comparability in the financial statements. The accounting treatments off revaluation gains and losses are accounted for differently as in one financial year where the valuation of carrying amount increases the effect is treated in the equity as revaluation reserves. Moreover, in some cases, a decrease is credited in the statement of profit or loss. Therefore, this proves that there are inconsistencies in the treatment for revaluation gains and losses, especially when dealing with internally generated intangible assets. Nevertheless, when transactions relating to intangible assets are treated differently in the financial statements, this makes it difficult for them to be compared with other financial years.
Comparability is intended to improve the quality of the financial reports which allows the users of the financial information. Comparability is a qualitative characteristic which requires similar transactions to look similar while the different transactions to look different in the financial statements (Unerman, Bebbington, and O’dwyer, 2018. pg.497). Comparability is enhanced when the financial statements are presented in a manner that allows comparison with past financial years. In this case, certain intangible assets are not affected by past events thus making it challenging to ensure comparability. The conceptual framework provides that the usefulness of financial statements is enhanced through comparability with past events in the company. Comparability information in the financial statements can also be used to develop future projections. The forecasted projections can be adopted by the company as a basis for current accounting and decision making in the firm as well as for the users of the financial information.
Generally, it is challenging to achieve comparability in the subsequent measurement of the intangible assets of a particular firm. In this case, the fair value measurement of intangible assets arises a critical issue which most firm may fail to address in the financial statements of a company (Zambon, 2017, pg.165). The accounting choices a firm may use in presenting financial information may also lead to the loss of comparability in the financial information presented in the financial statements of the company. Also, the adoption of IAASB and IAS does not guarantee the comparability of the financial statements as the rules and restrictions which involves the accounting standards only require proper recognition and measurement of financial statement information. The standards also ensure accounting transactions are treated in the right accounting period as well as incurred and presented in the correct financial statements. Moreover, comparability does not factor in other disclosures which are relevant to the presentation of the financial statements even though the disclosures are material.
3.0 Response to the CEO
The AASB is established through a consultative process to ensure there are high quality and value information for the users of the financial statements. Therefore, the standards prescribed by the Australian Accounting Standards Board are to be adhered to while presenting the financial information in the financial statements of the company. Therefore, any update or new information on the accounting standards have to be evaluated, and all companies adopting to particular accounting standards are informed, and they are required to adopt the update in the current financial year.
Consequently, the CEO of Technology Enterprises Ltd needs to ensure the accountant complies with the AASB 138 and the IAS 38 to ensure that the financial information avoids the efficient marketing hypothesis. The efficient marketing hypothesis arises when an investor seeks to gain higher returns from an investment that has quoted its profits higher than the market value of the stocks (Pilbeam, 2018, pg.1). In this case, the CEO is demanding for the overstatement of the financial statements by recording a higher value for the research and development at $4,000,000, yet the value of the research and development is estimated to be $3,000,000. Higher profits of the company may sway the investors, but there are likely to affect future returns of the company and may significantly lead to a loss in the value of the company stocks. Therefore, there is a need for proper accountability of the research and development cost to ensure faithful representation and completeness of the transactions of the company.
The efficient market hypothesis works in a manner that the stocks of a firm will trade at fair value that is, either buying undervalued stocks at a bargain or sell the overvalued stocks at a premium to gain profits of the company. Therefore, overvaluing the value of the research and development of the company will mean that the amount is overvalued and this may be a higher risk to the company in the estimation or future revaluation of the research and development costs of the Technology Enterprises Ltd. Therefore, the CEO needs to allow the research and development cost of the project to be recognised and measured according to the AASB 138 and IAS 38 to facilitate proper recognition in the current financial year as well as allow subsequent measurement in the coming fiscal years. Also, any adjustments in the market relating to revaluation the assets during a specific accounting period they are treated in the significant entry of the financial statements.
Nevertheless, the CEO needs to know the adoption of the AASB and the IAS allow financial information to be decisively useful to the investors in the company. These standards facilitate proper accounting as well as ensure faithful representation and substance over the form of the financial information. Also, it is prudent to apply the accounting standards as the investors can form a basis for evaluation of the Technology Enterprises Ltd financial information.
3.0 Recommendations/Findings/Conclusions
The report shows how the company needs to adopt the use of the accounting standards in the presentation of the financial statements of the company. In this case, Technology Enterprises Ltd needs to apply AASB 138 or IAS 38 in reporting the research and development costs which are treated as intangible assets of the company. The application of the standards will help the financial information presented in the financial statements to be useful and aid in the decision making of the company. Also, the company needs utilise the AASB 138 and IAS 38 in reporting for the intangible assets of the company as a way of reducing the efficient market hypothesis that is used by investors before investing in the company. The financial statements have to present decision-useful information which will aid in helping the investor to make salient decisions in investing in the company as well as understanding the financial information of the company. All in all, the supplication of AASB 138 and IAS 38 Intangible assets showed how the company would account for the new design. The new design will be recognised at costs for the cost of time spent in searching for alternative material, developing new models, testing and constructing prototypes for the new battery designs. The cost of training maintenance staff is to be treated as an expense in the profit and loss account of the company.

4.0 References
Agyei-Mensah, B.K., 2019. IAS-38 disclosure compliance and corporate governance: evidence from an emerging market. Corporate Governance: The International Journal of Business in Society.
Australian Accounting Standards (AASB) 138, 2019. Intangible assets. Available from https://www.essaybishop.com/write-my-essay/aasb.gov.au/admin/file/content105/c9/AASB138_07-04_COMPjun14_07-14.pdf
Dinh, T., Kang, H., Morris, R.D. and Schultze, W., 2018. Evolution of intangible asset accounting: Evidence from Australia. Journal of International Financial Management & Accounting, 29(3), pp.247-279.
International Accounting Standards (IAS) 38. Intangible assets. Available from https://www.iasplus.com/en/standards/ias/ias38
Pilbeam, K., 2018. Finance & financial markets. Macmillan International Higher Education.
Smalt, S.W. and McComb, J.M., 2016. Accounting for internally generated intangible assets. International Journal of Accounting and Taxation, 4(1), pp.1-15.
Unerman, J., Bebbington, J. and O’dwyer, B., 2018. Corporate reporting and accounting for externalities. Accounting and Business Research, 48(5), pp.497-522.
Zambon, S., 2017. Intangibles and intellectual capital: an overview of the reporting issues and some measurement models. In The economic importance of intangible assets (pp. 165-196). Routledge.

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