GODFREY

HODGSON
HOLMES
TARCA

CHAPTER 7
ASSETS

Assets defined
IASB (AASB) Framework for the Preparation and
Presentation of Financial Statements:
an asset is a resource controlled by the entity as a
result of past events and from which future
economic benefits are expected to flow to the
entity

Assets defined
Three essential characteristics:
future economic benefits
control by an entity

past events
exchangeability
recognition rules

Future economic benefits

Future economic benefits are the potential to
contribute, either directly or indirectly, to the
flow of cash and cash equivalents to the entity
profit seeking entity
not-for-profit entity

Relate to economic resources

scarcity
utility
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Future economic benefits

An asset is something that exists now
Has the capability of rendering service or
benefit currently or in the future
Distinguish between the object, such as a
building or machine, and the service or
benefit embodied in it

Control by an entity
The economic benefit must be controlled by
the entity
An entitys right to use or control an asset is
never absolute
Ownership is often concurrent with control,
but it is not an essential characteristic of an
asset
Does not rely on legal enforceability
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Past events
Control as a result of a past event
Planned assets are excluded
Event can be interpreted in different ways
executory contracts

Exchangeability
Some argue that a 4th essential characteristic
is that an asset be exchangeable
Separable from an entity

Exchangeability
MacNeal
A good that lacks exchangeability must lack
economic value because its purchase or sale must
forever remain impossible, and thus no market
price for it can ever exist
goodwill
subject to evaluation not measurement

Asset recognition
The extent and timing of the recognition of
assets is important because it can have
economic consequences for preparers and
users of financial statements

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Asset recognition
Recognising assets on the balance sheet
involves recognition rules
conventions and authoritative pronouncements

Recognition criteria
the future economic benefits must be probable
the asset must be capable of being measured
reliably

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Asset recognition
Past recognition criteria

reliance on the law

determination of economic substance of the
transaction or event
use of the conservatism principle: anticipate
losses, but not gains

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Asset measurement
All the elements of accounting are linked and
measurement of profit flows from
measurement of the change in net assets
The rules and practices governing asset
recognition and measurement will also affect
measurement of profit and, in turn, capital
(equity)

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Asset measurement
Once the definition and recognition criteria
have been met, the accountant must decide
how to measure the asset
several measurement approaches available
qualitative characteristics of financial information

Once measured
on balance sheet
restricted to just note disclosure
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Tangible assets
Traditional approach has been to measure
assets at historical cost
IASB standards permit subsequent
remeasurement using a number of
approaches
fair value
exit value or value in use

UK and Australian firms could use values other

than historical cost for many years
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Intangible assets
Accounting measurement has generally been
conservative
cost (less accumulated amortisation and
impairment) is commonly used
fair values from an active market
internally generated intangibles cannot be
recognised

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What are the divergent arguments for recognising

customer relationships in a business combination? Is
it a true intangible asset?

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Financial instruments
FASB/IASB
derivatives are measured at fair value rather than
cost

IASB
committed to the use of fair value measurement
for financial instruments

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What are the objectives of the

fair value measurement project?

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Challenges for standard setters

FASB/IASB intend to address the issue of
measurement in Phase C of the conceptual
framework project
consider measurement concepts, principles and
terms
evaluate and rank measurement methods
qualitative characteristics

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Which measurement model?

Fair value is the frontrunner
Both the IASB and FASB support greater use of
fair value measurement

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What are the arguments for and

against fair value measurement?

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How to calculate fair value

measurement
Various valuation techniques to calculate fair
value
the market approach
observable prices
actual transaction data

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How to calculate fair value

measurement
Various valuation techniques to calculate fair
value
the income approach
conversion of future amounts - cash flows or earnings
to a single discounted present amount

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How to calculate fair value

measurement
Various valuation techniques to calculate fair
value
the cost approach
the amount that currently would be required to replace
its service capacity (current replacement cost)

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In response to the credit crisis the IASB changed the rules to allow entities
to choose to reclassify some financial instruments from a fair value
measurement basis to a cost basis. Under what circumstances is this
reclassification allowed?

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How to calculate fair value

measurement
The valuation must emphasise market inputs
assumptions and data that market participants
would use in their estimates of fair value

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How to calculate fair value

measurement
Three hierarchical levels for the inputs
Level 1 quoted prices for identical items in active
markets, without adjustment
Level 2 quoted prices for similar items in active
markets, adjusted as appropriate for differences
Level 3 estimated fair value using multiple
valuation techniques consistent with the market,
income and cost approaches

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Issues for auditors

Auditing fair values creates difficulties
because it requires the application of
valuation models, and, frequently, the use of
valuation experts

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Issues for auditors

Auditors need to
understand the client firms processes and
relevant controls for determining fair values
make a judgement on whether the client firms
measurement methods and assumptions are
appropriate and likely to provide a reasonable
basis for the fair value measurement
appreciate managements potential biases and
likely errors
incentives
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Issues for auditors

There is the potential that corporate failures
will lead to legal action against auditors who
failed to approach their audit of asset fair
values appropriately

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Summary
Defining assets
Recognition and measurement criteria
Asset recognition and the measurement of income and capital
are interrelated
Mixed attribute measurement model and fair value
measurement methods
Issues arising for standard setters and auditors

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Key terms and concepts

Assets
Definitions
Future economic benefits
Control
Past events
Exchangeability
Asset recognition
Asset measurement
Fair value measurement
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