Semester 1 Week 6 PP (Non-current assets) Flashcards
How do we determine if we have an asset?
To have an asset requires control and future economic benefits. Companies spend lots of money on things they don’t control – for example staff training. UK companies spend billions each year on staff training and development. They obviously expect to gain economic benefits but does that mean they control their staff? Of course not!
MKZ Plc. is a large pharmaceutical company they have asked for your advice on 2 items:
1. MKZ has spent £4million on advertising its new brand of headache pill. The finance director expects substantial sales to arise from this.
2. MKZ owns the patent and exclusive rights to the Ezquit anti-smoking drug. Due to substantial side effects, Ezquit never got beyond initial testing stages and cannot be marketed for sale. The directors see no other potential use for the patent.
Advise the directors if these are assets.
- There is no asset, although MKZ expects economic benefits there is no element of control – they cannot force people to buy based on the advertising.
- Although MKZ controls the rights to the drug, there are no expected economic benefits – there is therefore no asset.
What are Separable and Legal/Contractual rights assets?
Separable means the asset is capable of being sold on it’s own.
Legal or contractual rights means there is some enforceable right to use.
If not it is considered part of goodwill.
- Absomo acquired the “Unilock” brand name for £230,000 from a competitor three years ago.
- Webbmore paid £4m to acquire a train franchise, the franchise is not transferrable to any other party.
- Finn has recently bought the Middle Roti restaurant. The restaurant holds a prestigious three starts in the East Central restaurant awards.
Advise the three companies how the above should be treated.
- Absomo should treat the brand as an intangible asset. The fact that the brand is worth £230,000 suggests it will bring economic value, whilst the fact it has been bought means that it is separable.
- Although the franchise is not separable (cannot be transferred to any other party) it arises from legal and contractual rights and is therefore an asset.
- The award is not separable (couldn’t give it to another restaurant) and doesn’t arise from any legal or contractual rights. It will likely bring benefits to the business through reputation etc. but is part of the overall goodwill.
Do we recognise intangible assets that a business creates itself?
In general intangible assets that the business has created itself are not to be recognised.
Why?
1. Incentive for companies to over-record
2. Where would the gain go?
Gumball Plc. set up their “Engstrom” brand of clothing five years ago. Since then the brand has become extremely profitable and is regarded as one of the foremost fashion brands in Europe.
Gumball want to recognise the brand as an asset, the directors consider it to be worth £2.2 million.
Dr Brand Asset £2.2m
Cr P/L gain (?) £2.2m
Being recognition of brand
Is this £2.2 m money that can be passed to the shareholders?
Where does this £2.2 m come from? Brands are generally unique and difficult to value.
For this reason internally generated assets are not usually allowed.
What do we do with Research and Development?
The exception to not capitalising internally generated assets is development expenditure.
Research is “original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding.” It is not capitalised.
Development is applying knowledge or findings to “design or produce new, or substantially improved, materials, devices, products, systems or services” before these are commercially produced. It is capitalised.
What is the criteria to be met when determining if something is development expenditure or not?
IAS 38 lays down stringent measures over whether something is development expenditure or not this is the PIRATE criteria:
PROBABLE the development will generate future economic benefits
INTENTION to complete the development for use or sale
There is the availability of RESOURCES (financial, technical, other) to complete the development.
The company has the ABILITY to use or sell it.
Has to be TECHNICALLY feasible to complete the development so that it is ready for use or sale
The ability to reliably measure the EXPENDITURE of the development project.
All these conditions must be met to allow capitalisation. If they are the development work must be capitalised.
Capitalisation should include all directly attributable costs, it should not include any general costs.
Capitalisation can only begin when a project has met the criteria of development – it is not possible to retrospectively capitalise expenditure.
Capitalisation ceases when the asset is ready for use (for example the product being developed goes into production).
Smith Plc. is developing a new diet drug, £2.2m was spent in the year ended 31 December 20X5 on research and development of the drug.
On 30 April 20X5 the conditions were met for the work to be classed as development, by this stage £1million had been spent. The remaining £1.2m was spent between April 30 20X5 and the end of the year.
Describe how this should be treated in the year ended 31 December 20X5.
£1.2m should be capitalised, the remaining £1m should be written off to the P/L as an expense, it is not possible to subsequently recategorise expenditure if a project subsequently meets the criteria for development.
Do we depreciate intangible assets?
An intangible asset is written off over it’s useful economic life – but we call this amortisation rather than depreciation.
Some intangible assets (for example brands) are considered to have an indefinite useful life and are therefore not amortised.
Brown acquires a car under a five year lease, legal title remains with the lease company.
During the 5 years Brown has the right to use the car as it wishes.
Whose asset is this?
The car is therefore Brown’s asset and should be capitalised by them as such.
We call this idea substance over form it does not matter who legally owns the asset (the form of the transaction) but who controls it (the substance of the transaction).
What is a Right of Use asset?
When we acquire an asset under lease we call this a right of use asset (ROU), this means we have the exclusive rights to use the asset for a specified period of time (i.e. we control the asset).
This is the amount that is capitalised.
Murdoch Ltd. acquire a piece of earth moving machinery under a 5 year lease. The machinery has a useful life of 12 years.
Based on ROU, how long will they have rights to this machinery and will it be capitalised?
In this case the ROU asset will represent the exclusive rights to use the asset from years 0-5 and will be capitalised.
What is the other side of the transaction when borrowing money for the asset?
The other side of the transaction will be a creditor, in essence we are borrowing money to acquire an asset.
Crawford Ltd. acquire a vehicle under a 5 year lease. Were Crawford to have bought this vehicle cash the purchase price would have been £20,000.
Prepare the journal to account for this acquisition.
Crawford are essentially borrowing £20,000 to acquire the vehicle with no money down.
The journal therefore would appear as this:
Dr ROU asset vehicle – cost £20,000
Cr lease liability £20,000
Being acquisition of vehicle
