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
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Assets defined
Three essential characteristics:
– future economic benefits
– control by an entity
– past events
• exchangeability
• recognition rules
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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
4
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
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Control by an entity
• The economic benefit must be controlled by
the entity
• An entity’s 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
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Exchangeability
• Some argue that a 4th essential characteristic
is that an asset be exchangeable
• Separable from an entity
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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
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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 firm’s processes and
relevant controls for determining fair values
– make a judgement on whether the client firm’s
measurement methods and assumptions are
appropriate and likely to provide a reasonable
basis for the fair value measurement
– appreciate management’s 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
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Assets
Definitions
Future economic benefits
Control
Past events
Exchangeability
Asset recognition
Asset measurement
Fair value measurement
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