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Assignment 2

Course: Advanced Financial Reporting 4.1


Name: Frank Kroeze (2517709)
Group number: 1
Question 1a
As the item at stake is an item of property, plant & equipment, the rules of IAS 16 are
leading in this exercise. The main question is whether in 2014 the new estimates or
the old estimates are applicable. IAS 16.51 and IAS 16.61 refer to IAS 8 for an answer
to this question. IAS 8.36 states that the effect of a change in an accounting estimate
shall be recognized prospectively including it in profit or loss in:

The period of change, if the change affects that period only; or

The period of change and future periods, if the change affects both

IAS 8.38 discusses the item somewhat more deeply. It is stated that:
a change in estimated useful life of a depreciable asset affects depreciation expense
for the current period and for each future period during the assets remaining useful
life.
It seems that, based on this article, the estimate change has consequences for both
2014 and 2015, but I doubt whether this in line with the core principle of faithful
representation. In the assignment text it is stated that at the end of 2014 the
remaining useful life is estimated to be eight years. I doubt whether it is fair to use
the changed estimates for both 2014 and 2015, as the change has only been
recognized at the end of 2014.
However, in line with the articles, the new estimates will be applied to both 2014 and
2015.
Depreciation expense for the period 2010 2013 (assuming that the estimate change
is used):
( 1000 100) / 10 = 90
(original value residual value) / useful life
Book value at 12/31/2013: 1000 4 x 90 = 640
Depreciation expense for the period 2014 2022
( 640 - 100) / 9 * = 60
*

The useful life is 9 years instead of 8 years for the following reason:
in line with the described issue above I have applied the new estimates on
both 2014 and 2015. However, at the 12/31/2014 the remaining useful life is 8
years, but we should also take 2014 in account based on the new estimates,
which means the useful life should be 9 years.

Question 1b
This question dealt with the topic of the revaluation model in IAS 16, discussed in
article 31 42.
In IAS 16.31 it is stated that:
after recognition as an asset, an item of property, plant and equipment whose fair
value can be measured reliably shall be carried at a revalued amount, being its fair
value at the date of the revaluation less any subsequent accumulated depreciation
and subsequent accumulated impairment losses.
This means that the article says you should depreciate, despite the revaluation. This
is done for matching reasons.
Book value at 12/31/2013: 1000 4 * 90 = 640
Fair value at 12/31/2013: 800
The difference of 160 ( 800 - 640) will be recognized in other comprehensive
income and accumulated in equity under the heading of revaluation surplus (IAS
16.39).
The depreciation for 2014 should be based on the new carrying value: 800
Depreciation expense for the period 2014 2022:
( 800 - 100) / 9* = 77.78
*

The useful life is 9 years instead of 8 years for the following reason:
in line with the described of question 1a above I have applied the new
estimates on both 2014 and 2015. However, at the 12/31/2014 the remaining
useful life is 8 years, but we should also take 2014 in account based on the
new estimates, which means the useful life should be 9 years.

Question 1c
In IAS 16.43 it is stated that each part of an item of PPE with a cost that is significant
in relation to the total cost of the item shall be depreciated separately (component
approach). It seems clear that the component mentioned in the question is
significant, meaning that it should be capitalized and depreciated. This view is being
strengthened by IAS 16.13. This article states that an entity should recognize the cost
of replacing part of an item when the recognition criteria are met.
For 2014 this has no consequences, as it seems unfair to depreciate over 2014 as the
item was replaced at the end of the financial year. This view is in line with IAS 16.55,
which states that the depreciation of an asset begins when it is available for use.
This means that the total depreciation expense for the specific component recorded
is 0.
The total depreciation expense for the item of property, plant and equipment is:
( 1000 100) / 10 = 90
(original value residual value) / useful life
The carrying amount of the component at the end of the financial year 2014 is 200,
as nothing is depreciated yet. The carrying value for the total item is: 550 + 200
= 750.

Question 2a
To some extent IAS 16 and IAS 40 are interchangeable. In the physical sense both IAS
chapters discuss the same items, namely real estate. The implication of this similarity
between the two chapters is that the content of both is quite alike. However, there
are differences. IAS 40 can only be applied in the case of real estate being held as
investment. In lecture it was discussed that this means that the items are being held
for renting or later selling for profit.
In the light of this theory it seems that Accor could also have chosen for the option of
applying IAS 40 to the portfolio of HotelInvest. From the perspective of this business
unit the hotels are being held as investment property. The specific unit wants to
make a profit by exploiting the hotel. This fits the description of investment property
(IAS 40.5: property held to earn rentals or for capital appreciation or both).

Question 2b
In IAS 16.55 it is stated that depreciation of an asset begins when it (the asset) is
available for use, when it is in the location and condition necessary for it to be
capable of operating in the manner intended by the management.
Based on the information in the assignment it is not possible to determine whether
the depreciation of the construction in progress is legitimate. Theres insufficient
information to determine whether the asset at stake is already available for use.
However, when the asset is not yet capable of operating in the manner intended by
the management it is clear that there is no depreciation needed.

Question 2c
In IAS 36.6 the definition of a cash-generating unit is discussed:
smallest identifiable group of assets that generates cash inflows that are largely
independent of the cash inflows from other assets or groups of assets.
In IAS 36.66 this definition is discussed more deeply. Here it is stated that if it is not
possible to estimate the recoverable amount (higher of fair value less costs to sell
and value in use) of the individual asset, an entity shall determine the recoverable
amount of the cash-generating unit to which the asset belongs, e.g. example on page
A1192 of the red book.
Concretely, this often means that the value in use cannot be identified.
It seems likely that the recoverable amount of both the hotel and the land can be
identified separately, meaning that the two items should not be considered together
as a cash-generating unit. Both the value in use of the hotel and the land can be
estimated.
The view that the two items should not be considered together as a cash-generating
unit is in line with IAS 16.58, which says that land and buildings are separable assets,
to be accounted for separately, even when acquired together.

Question 2d
In IAS 2.6 the inventory definition is discussed:
Inventories are assets:

a. Held for sale in the ordinary course of business


This part of the definition seems not applicable to the hotel linen. Accor
doesnt want to sell the linen.
b. In the process of production for such sale
This part of the definition could be relevant in the case of the hotel linen. This
linen is used in order to sell the service, which is a stay in the hotel. One could
say that the linen is used to produce the service. Following this part of the
definition one could claim that the linen is part of the inventory.
c. In the form of materials or supplies to be consumed in the production process
or in the rendering of services
It seems clear that the linen is applicable to this part of the definition. The
towels are used in the rendering of services.
Although the definition in IAS 2.6 suggests that the linen could be defined as an
inventory item, one should keep in mind that the inventories are current assets. In
IAS 1.66 the following is stated:
An entity shall classify an asset as current when:
a. It expects to realize the asset, or intends to sell or consume it, in its normal
operating cycle
b. It holds the asset primarily for the purpose of trading
c. It expects to realize the asset within 12 months after the reporting period.
d. The asset is cash or a cash equivalent.
It seems clear that not all of the linen items satisfy these criteria. Not all items are
realized in the normal operating cycle or within 12 months, the items are not held for
sale and it is clear that the items are not cash items. The conclusion is that perhaps
part of the linen items (that satisfy the criteria) can be accounted for as inventory,
but certainly not all.
When turning to IAS 16 the definition of property, plant and equipment is:
Property, plant and equipment are tangible items that:
a. Are held for use in the production or supply of goods or services
The linen items seem to satisfy this criteria. The items are used for the
production of a service: a stay in the hotel.
b. Are expected to be used during more than one period
The definition of period is not explicitly stated in IAS 16. However, when
assuming that a period is a normal operating cycle/business period, it seems
that at least part of the items satisfies the criteria.
Conclusion:
Depending on the definition of normal operating cycle the linen items should/could
be classified as inventory or property, plant and equipment. In the ordinary course of
business the turning point is often 1 year. When the item at stake is expected to stay
on the balance sheet for over a year it is classified as fixed asset (property, plant and
equipment in this case) and when the item is expected to stay on the balance sheet
for less than a year, the item is classified as current assets (inventory in this case).
When following this rule of thumb one should account for part of the linen items as
inventory and for part of the items as property, plant and equipment.

Question 2e
IAS 2.9 states that inventories shall be measured at the lower of cost and net

realizable value.
In IAS 2.28 it is stated that the cost of inventories may not be recoverable if those
inventories are damaged, if they have become wholly or partially obsolete, or if their
selling prices have declined. This seems the case here. One could say that as a result
of the use the selling prices of the towels have declined and one could even argue
that the towels have become wholly or partially obsolete.
Based on these articles one would/could say that the carrying value of the towels
must be reduced.

Question 2f
In beginning one has determine whether or not the item is an asset. For intangibles
the criteria are somewhat stricter, e.g. the definition of control is determined.
In Frw. 4.4a the definition of an asset is stated:
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
As discussed in lecture and stated in Frw. 4.4 there are 4 requirements:
1. Resource
The item is a resource. Accor would rather have the item, the contract, than
not.
2. Controlled by the entity.
In IAS 38.13 the criteria for control are discussed. One of the key points is that
the entity needs to control the future economic benefits from the underlying
resources. In this question this seems to be the case. Accor controls the future
economic benefits, the cash flow from the hotel located in the building
3. Result of past events
This criteria seems to be satisfied.
4. Future benefits are expected to flow to the entity.
It seems reasonable to assume that the positive cash flows will flow to the
entity from the hotel. Before investing in a hotel, Accor will do thorough
research as to the profitability and cash flow expectations.
Conclusion: the item seems to be an asset.
However, IAS 38.8 states an extra criterion for intangible assets: identifiable
An asset is identifiable if either:
a. The asset is separable
The contract can be sold, so the asset is separable.
b. The asset arises from contractual or legal rights, regardless of whether those
rights are transferable or seperable from the entity or from other rights and
obligations.
The item seems to meet the criteria, meaning that it is legitimate to account for it as
if it is an intangible asset.

Question 2g
In general the condition of identifiabillity is key for the decision to recognize an asset
as intangible.
The item should be separable or arising from contractual or legal rights. In the case
of the key money this condition will be relevant as well.

Other, more general, points are the point of control and the point of expected future
benefits.
In order to recognize the item as an asset, the different asset criteria should be
satisfied. In this case that means that Accor has to determine whether the asset is
expected to generate future benefits. However, the control aspect might be even
more relevant, as it might be uncertain that the company can control the future
economic benefits. It is doubtful if the company can restrict the access of others to
the benefits. Every hotel company can open a firm on that hot location.

Question 3a
It is highly unlikely that Bunzl could also recognize the internally generated customer
relationships as asset. In the lecture it was discussed that the rules for self-developed
items are stricter than those for acquired items. This is in line with IAS 38.63. This
article explicitly states that internally generated brands, mastheads, publishing titles,
customer lists and items similar in substance shall not be recognized as intangible
asset. The underlying vision is that these items cannot be measured in a reliable
manner: one cannot capture the costs and benefits.

Question 3b
IAS 38.75 states that after initial recognition (at cost; 38.24), an intangible asset shall
be carried at a revalued amount, being its fair value at the date of the revaluation
less any subsequent accumulated amortization and any subsequent accumulated
impairment losses. Fair value shall be measured by reference to an active market.
However, IAS 38.78 discusses the fact that it is uncommon for an active market to
exist for an intangible asset. This seems to be the case here. There is no market for
customer relationships. When this is the case, IAs 38.81 states, the asset shall be
carried at its cost less any accumulated amortization and impairment losses.
Conclusion: the company cannot choose to account for the item on the basis of the
revaluation model

Question 3c
The general principle of IFRS is fair presentation (IAS 1.15), which means that the
main goal of IFRS is to present fairly the financial position. Its all about the position
at the closing date of the financial year.
When restructuring cash flows would be used in order to predict the total cash flow
from a cash-generating unit, the actual, current financial position would not be
described, but, instead, the future, desired position would be described.
The exclusion of future restructuring cash flows is formally in line with IFRS, because
including these cash flows would lead to an unfair presentation. Besides it makes
sense as well. The main function of the balance sheet is to show the financial position
at the current date, not the possible position at a future date.

Question 3d
The management seems to think that the other CGUs are less risky than the first
three.
The vast majority of goodwill is allocated to the first three CGUs, which means that in
case of an impairment the goodwill will be attacked first. However, this implicates
that, despite a possible impairment, the value of the normal assets will remain the
same. The value of these assets is relatively safe. Obviously, the management
assumes that the first three CGUs are the risky ones, as there is the vast majority of
the goodwill allocated to.

Question 3e
Note: in my opinion there is a mistake in the exercise. It is stated that the growth
rate declines
from 9% to 5%. However, in the notes it is stated that the overall growth rate
is 2,5%. The
discount is in fact 9%.
In IAS 36.55 it is discussed that the used discount rate should be a pre-tax rate that
reflects the current market assessments of the time value of money and the risks
specific to the asset for which the future cash flow estimates have not been adjusted.
This means that the used discount rate for each CGU can differ, which is the case
here, as explained in the notes. There it is stated that where appropriate the
directors have considered alternative market risk assumptions to reflect the specific
conditions arising in individual countries (discount rates ranging from 9% - 18%).
Conclusion:
the lowering overall growth rate doesnt automatically implicate that the goodwill for
North America will also be impaired, even in the light of the impairment in the UK.
The individual growth rates and assumptions can differ between the cash-generating
units.