Generally Accepted Accounting Principles Essay

Assets are separated into components and depreciated by components when they are significant and would have a different depreciation method or life. This is because some of the components would have a higher rate of consumption than the asset as a whole. 5. Disclosure of depreciation or amortization methods and rates is important cause companies have latitude in their choice of policy. As long as the method is rational and systematic and reflects pattern of consumption, the method can be used for financial reporting. Similar companies using dissimilar methods are not comparable, which is the problem disclosure attempts to address. If rates are different for similar assets, comparability is also hurt; again, disclosure is important. 6.

A firm would consider the following factors in their choice of depreciation or amortization methods: nature and use of asset, corporate reporting objectives, industry norms, parent company preferences, the desire to minimize deferred taxes, and the accounting system costs associated with a given method. 7. An asset with a thirty-year life will be depreciated over a shorter period when it is expected to be used (I. E. , to generate revenue) for the shorter period. Depreciation is over an asset’s useful life to the organization, not necessarily over its physical life. 8. Major spare parts would not start depreciating until they are replaced in the asset and being used. Standby equipment are used as a backup and would start depreciating when they are ready for use even though they may never be used. 9.

Straight-line depreciation or amortization is popular because it is simple to calculate, rational and systematic, logically appealing, provides a stable expense pattern, and often portrays the pattern of benefits received (equal each period). 10. Accelerated methods of depreciation or amortization result in a periodic depreciation or amortization charge that is less in each succeeding period than the prior period. An example is the declining balance method. This method is appropriate when an asset contributes to revenue generation more in the early years of its life than in the later years or when the asset’s operating efficiency declines With use.

It is also used by companies seeking an expense/income pattern that is consistent with higher early expenses, and by those seeking to minimize book/tax differences. 1 1 . A company may choose one of the following policies to deal with depreciation of assets acquired part-way through a year: a. Exact calculation of fractional-year depreciation. B. Accounting policy convention (e. G. , all, none or some of the depreciation charged in the first/last year of ownership. ) 12. Group depreciation is applied to situations where average depreciation rates are used to calculate depreciation. Group depreciation is used when a large number of assets are homogeneous in nature. For example, a number Of tools of similar size and characteristics and with similar UsefUl lives may be depreciated as one unit. 13.

Sinking fund method was previously common in the industry and reflected industry practice. It is now not used since it would not reflect the pattern of consumption of benefits. 14. An impairment in value of property, plant and equipment occurs when the carrying value of the asset (or COG) exceeds its recoverable amount. When an asset is determined to be impaired, it is written down to the recoverable mount. 15. If fair value of the cash generating unit is $1 7,000,000 and book value is there is evidence that the assets are impaired. The next Step is to estimate the recoverable amount from the cash generating unit. If the recoverable amount is less than the book value of net assets, an impairment must be recorded.

Goodwill will be written down first, and any remaining impairment loss is allocated to the other assets, except that no asset should be written down below its fair value less costs to sell as a separate asset. 16. Estimates of future revenues, costs, time period and residual values must e made to assess an impairment, often in unsettled business climates. 17. Impairment losses are reversed if fair value subsequently increases except for goodwill. The reversal only reverses the amount of previous losses. 18. The revaluation model is allowed for property, plant and equipment and intangible assets where there is an active market. 19. The fair value model revalues every reporting date and the revaluation model may not be revalued every reporting date.

Changes in value for fair value model go directly to the income statement and revaluation model impacts other comprehensive income and the revaluation surplus in equity. Depreciation is not taken with the fair value model but is taken in revaluation model. 20. For the first time revaluation increases are recognized in OIC and accumulated in the revaluation surplus in equity. Subsequent increases would first reverse any previous downward revaluations in net income then recognize and excess in OIC and revaluation surplus. For the first time revaluation decreases would be recognized in net income. Subsequent decreases would first reverse any upward revaluation amounts in OIC and revaluation surplus and excess in net income. Cases Case 10-1 Overview – Road Safety Incorporated

This case identifies accounting policies that were selected by a new employee that has a motivation to maximize net income to maximize the amount of the bonus he will receive. In addition, the bank has a covenant with a maximum debt to equity ratio so there is the motivation to minimize debt and maximize equity. It must be considered whether the accounting policies selected are in accordance with GAP first as a public company using international accounting standards and secondly as a private company using accounting standards for private enterprises. Ethics are critical to consider in the valuation of the cocoa noting policy. Issues 1. Valuation basis for land and building 2. Warranty Future (deferred taxes) 3. 4. Goodwill 5. Non-monetary transaction 6.

Major spare parts Analysis For each issue the appropriate accounting policy using standards for biblically accountable enterprises (APRS) will be discussed then any difference if accounting standards for private enterprises was selected. The vacant land would qualify for investment property since it is being held for capital appreciation. The building would not qualify as investment property since it is being used in the operations of the business. The land and alluding could both be shown at fair value. The land could use the fair value model as investment property (AS 40) and the fuddling could use the revaluation model in property, plant and equipment (AS 16). However, only changes to the land will go into net income and the land would not be depreciated.

The building would still be depreciated in the revaluation model and increases in value would go into other comprehensive income and then the revaluation surplus. Any appreciation in value would not impact the income statement until the building was sold. The accounting policy suggested by Tom is incorrect for the building but erect for the land. This would have a negative impact on Tom’s bonus. Part B If accounting standards for private enterprise were selected the land and fuddling would be valued using cost. The land would not be depreciated. The building would be depreciated. Any appreciation in value would not impact the income statement until the land or building were sold.

The warranty would be a provision which should be recognized in the period in which the product has been purchased. The provision would be based on estimates based on past history. The amounts may be small if there are few or any warranty costs. The accounting policy recommended by Tom is incorrect. The estimated liability would have a negative impact on the debt to equity ratio and Tom’s bonus. Part B If accounting standards for private enterprise were selected the accounting policy would be the same since warranty costs are estimated and recognized at the time the related revenue is recognized. 3. Future (deferred taxes) The liability method is required for income taxes. This would mean that deferred tax liabilities must be recognized.

Deferred tax assets are Only recognized if it is probable that there will be sufficient taxable profit to use the benefit. Therefore, the past taxable losses would likely be recognized as a deferred tax asset since our company has been profitable. Tom’s recommended policy is incorrect since the recognition of deferred taxes is not optional. Any deferred tax liabilities would have a negative impact on the debt to equity ratio. However, the bank often does not consider deferred taxes (in their contact calculation) so it must be clarified with the bank if these would be included in the debt to equity ratio. If the accounting standards for private enterprises are selected then the liability method would not have to be used.

The company could elect to use he taxes payable method. However, it is only under the liability method that the tax losses could be recognized as a future tax asset if the more likely than not provision was met. If this method was selected future tax liabilities would also need to be recognized. 3. Goodwill There are two issues with the recommended accounting policy selected by Tom. Internal goodwill cannot be recognized therefore RI should not have any existing goodwill on the book’s since this is the first year that a company has been purchased. Goodwill must be tested for impairment on an annual basis. Therefore, Tom’s accounting policy is incorrect.

Existing goodwill must be removed from the Statement of Financial Position. The accounting policy would be identical using accounting standards for private companies in that internal goodwill would not be recognized. However, in these standards testing goodwill for impairment does not need to occur on an annual basis only if an event or circumstance indicates impairment. 4. Non-monetary transaction This is a non-monetary transaction. It would need to be determined if the fair value of either the shares of the technology could be estimated using a valuation. If neither value is determinable which is indicated based on the information that we have the technology should be recognized at the book value Of the shares. Riveter companies. 5. Major spare parts Major spare parts and inspections or overhauls are recognized as a separate component and depreciated over the period until the spare part will be replaced or the next overhaul. Straight line depreciation is appropriate method as long as it reflects the pattern of consumption of benefits. Tom is incorrect in his accounting policy. This will likely increase depreciation expense and reduce net income and Tom’s bonus. Accounting standards for private enterprises would not require the use of impotent accounting (if not practical and when reliable estimates of useful lives of separate assets cannot be made).

Overall recommendation It appears that Tom may have been motivated by his bonus and / or the covenant to select incorrect accounting policies. These do not appear to be ethical decisions. Cases 10-2 – Omega Properties Limited This case presents issues related in different ways to capital assets, impairment, discontinued operations, and revenue recognition. The issues are independent, and require various emphases on reporting vs.. Disclosure. 1. Alpha Express is not doing well as a going concern. Profits are down, partially due to increased competition and partially due to depressed economic conditions. POOL may decide to discontinue the operation, but no decision has been made yet. However, there are clear indications of possible asset impairment.

POOL must review the recoverable amount (higher of fair value less costs to sell and probable future cash flows and compare the present value of those cash flows) with the carrying value of the hotel properties. Since the Alpha group of hotels is still functioning as a chain, the impairment test must be applied for the chain as a whole rather than by individual hotel since the chain would be the cash generating unit. Fifth recoverable amount is less than the carrying value of the chain’s net assets, the capital assets must be written down to reflect the impairment. The possibility that POOL may absorb the Alpha hotels does not reduce the need for an impairment test At present, Alpha is operating as a cash generating unit. 2. The $31 million loan should be reported as a long-term loan receivable.