Accounting Ppaper

Balance Sheet

Under IFRS, audited financial statements consist of four statements. It misses the statement of changes in equity and the statement of cash flows. The balance sheet needs to be reviewed since it does not balance. It misses the bank loan of $2,000,000 on the statement. In addition, the format needs to be reviewed. Certain balance sheet elements are not correctly placed in order. For example, under assets, the current assets should be stated first. The accumulated depreciation needs to be allocated for each asset. The income statement has to be reviewed as well. The gross profit equals the sales revenues minus the cost of goods sold. The order in the income statement is not correctly placed.

Issue #1

Case Facts & Analysis:

The engines products are made using the most recent technology. It shows the technical feasibility and adequate resources of the product. The owner is passionate about the product and expects future sales to be substantial. Hence, it shows the intention of completing the asset and it is probable to generate future economic benefits. The ability to use or sell is demonstrated through the fact that these engines are used for the snowmobiles as it contributes to the vehicles’ safety and performance. However, there is uncertainty about the exact costs of the asset. The only criteria missing is the measurability of the costs.

Appropriate Treatment:

The general rules for capitalization are future economic benefit and measurability of asset’ cost.

Internally developed assets have more stringent criteria. IFRS suggests that development costs may be capitalized if all six criteria for capitalization is met.

Recommendation:

Five criteria out of six are satisfied. Once you will be able to measure the costs, it satisfies the six criteria for capitalization. The research costs are always expensed. Assume that the six criteria are met, certain development costs such as engineers wages, direct materials can be capitalized. IAS 38 indicated that advertising costs must be expensed as it is hard to quantify the future economic benefits. Under IFRS, if the patent is purchased, the cost can be capitalized. However, if the patent is internally developed, it will only be capitalized if the six criteria are met. Penalties and building overhead are normally expensed as they do not bring any future benefits unless otherwise. Administrative staff wages can be capitalized if the staff’ job position is directly related to the development activities; otherwise, it has to be expensed.

Effects on the Financial Statements & Users of Financial Statements:

The choice of capitalizing or expensing has an impact on the balance sheet and the income statement. Capitalizing costs and depreciating them over time will show a smoother pattern of reported income. Expensing have higher variability in the income. Capitalizing items will have a higher profitability than expensing. The impact on the net income will greatly influence the retained earning, which will later on impact the shareholders’ equity. Hence, the choice of capitalizing or expensing can impact your debt-to-equity ratio. As a result, it will affect your bank covenant.

Issue #5

Case Facts & Analysis:

A penalty of $200,000 is fined in 2018 for waste emissions from the past six years. An estimated renovation cost of $800,000 is essential for the continuing operation. However, it does not provide any enhancement to the production itself.

Appropriate Treatment:

The general rules for capitalization are future economic benefit and measurability of asset’ cost.   In order to capitalize the subsequent expenditure related to existing assets, it must bring additional future benefit.  

Recommendation:

The penalty is fined in later years. However, this information in the subsequent events period relates to an event prior to, so the penalty should be recognized now. The fines fees should be expensed since it does not satisfy the criteria of future benefits. The renovation costs could be expensed or capitalized. The renovation costs could not provide any enhancement opportunities to the production process itself. Hence, it could not bring any future benefits. However, these costs directly contributed to the ongoing concern of the company. Hence, the renovation costs are the main fact why the company could still bring future benefit. Without the renovation, the plant would be closed and the production line would be cut. Therefore, the renovation costs of $800,000 could be capitalized.