Week 3 Important Flashcards
Joy Ltd also consulted the accounting firm to be advised on the possibility to carry the land at fair value, instead of at cost, from the next financial year. After carrying out some research, you know that the fair value of the land at the 30 June 2016 is $2,600,000 and the land is located in a fast-developing area where the land prices are expected to increase in the next few years. Furthermore, you also know that the main debt holder of Joy Ltd — as part of its due diligence – reviews – the company’s solvency as measured by the debt-to-assets ratio. In consideration of such circumstances, advise Joy Ltd about the implications of carrying land at fair value instead of at cost. Provide reasons for your answer.
The company could consider the change to fair value, as at the moment the land has already a higher fair value in comparison to the cost, therefore the cost model seems to underestimate the actual value of the land.
In consideration of the due diligence performed by the bank on the debt-asset ratio, it is probably more convenient for the company to move to fair value, because, as it is forecasted a further increase of prices, the debt-asset ratio will progressively improve, giving the company also the possibility to obtain even more fund or not breaching any agreement with the debt holder with respect of its solvency.
The profit won’t be penalised, as land is not depreciated and therefore, the increase in value after revaluation would not lead to an increase of depreciation expenses
What effect will an asset revaluation have on subsequent periods’ profits? Explain your answer.
If an upward asset revaluation has been undertaken for a depreciable asset, then depreciation in subsequent periods will increase, as the depreciation will be based on the higher revalued amount. Profit on sale of the asset, before the completion of its useful life, will also be lower.
The plant and equipment originally cost Townend $600,000 in 2012, but due to market conditions the fair value of the plant and equipment has increased. The directors of Townend Ltd are concerned about the effects of the higher book value on profits—owing to the higher depreciation it is reducing profits. They ask you, the accountant, to reverse the previous revaluation. Being ethical in nature, what would you do?
As the motivation for reversing the previous revaluation entry is to increase reported profits, this is hardly an objective approach to accounting, and hence is not consistent with the ‘representational faithfulness’ recommendations embodied within the AASB Conceptual Framework. It would be a case of ‘creative accounting’. Being ethical, the accountant should resist the pressure to perform the adjusting entry.
