1

FRANCESCA PEDERCINI MIT151043

Introduction
The fourth level of IASB Conceptual Framework (2010) identifies the essential elements that
constitute financial statements: assets, liabilities, equity, income and expense, whose measurement
basis and measurement techniques are stated in the fifth level of Conceptual Framework (2010)1.
In the following report, methods related to assets and liabilities will be analyzed by reporting on
examples of companies that adopt them. Further, the pros and cons of each method will be
explained and possible reasons of their implementation discussed.
Assets measuring methods
AABS 116 concerns all tangible assets (such as property, plant and equipment - PPE) held for use
and whose cost or value can be measured reliably and which produce benefits for the entity in the
long term. The scope of AABS 116 is to determine recognition of the assets, the estimation of
their carrying amounts, depreciation applied and, when necessary, impairment for losses2.
The initial recognition must be done at cost of acquisition which, according to the AASB16 is
the cash or equivalent cash paid for or the fair value of other considerations given to acquire an
asset; thereafter an entity must apply for each class3 of assets - either the cost model or the
revaluation model.
By using the cost model, the carrying amount of the asset is equal to its initial cost whose
accumulated depreciation and impairment losses are deducted. In other words, there is no
revaluation to value due to the changing conditions and cost of repairs and maintenance being
expensed as incurred. Sub sequential costs are capitalised only if they bring probable future
economic benefits associated with the asset; that is, when the capacity of the assets has decreased
over time, expenditure made to bring back the assets is capitalised4.
According to the cost model, an asset will keep being reported at its original cost and its carry
amount is defined by deducting depreciation and impairment for losses. Many companies favor
this method, for example the H&M group and Catapult which report their PPE at acquisition cost

1

Henderson, S., Peirson, G., Herbohn, K., Artiach, T., & Howieson, B. (2013). Issues in financial accounting. Pearson
Higher Education AU.
2
Australian Accounting Standards Board [AASB]. (2010). Property, Plant And Equipment (AASB 116). Retrieved
from http://www.aasb.gov.au/admin/file/content102/c3/AASB116_07-04_ERDRjun10_07-09.pdf.
3

With the term class AASB 116 refers to a group of assets whose use and nature are similar in the contest of the
entitys operations.
4
Jubb, P., Langfield-Smith, I., Haswell, S., (2009). Company Accounting 5th edition, Cengage Learning Australia

2 FRANCESCA PEDERCINI MIT151043

less accumulated depreciation (using the straight line method) and any accumulated write-downs5.
Also, both these companies test the book value of PPE for impairment according to the general
rule - if the book value of the asset exceeds the recoverable amount the impairment for losses is
recorded.

H&M (2015), Annual Report 2015, p 98 note 12, Stockholm, Sweden

Catapult Sports (2015), Annual Report 2015, p. 45 note 4.10, Dockland, VIC.

This a general rule contained in AABS 116 since land has unlimited useful life.

3 FRANCESCA PEDERCINI MIT151043

There are several reasons behind the adoption of a cost model such as objectivity that can be
verified by documentary evidence6.
Other factors that influence entities are simplicity and convenience embodied in this method, as it
does not require constant estimation in the changing current market values of assets. The cost
model also makes the calculation of annual depreciation easier, as it does not have to be constantly
reviewed. Moreover, the model avoids extra keeping costs related to revaluation as well as extraaudit costs associated with the annual review. In addition, US GAAP does not allow a revaluation
model for non-current assets, therefore some entities prefer the cost model for harmonization
reasons7.
Another factor that makes the cost model more appealing for companies keen to report a high
profit is associated with the depreciation amount, which is lower than the one calculated with
using the revaluation model. In case an entity disposes an asset, when the asset is measured at cost
any gain or loss is reported in the statement of profit or loss, whereas the profit or loss is irrelevant
when the asset is measured according to the revaluation model. The reason behind this is due to
the close match between the value in the financial statement and the market one8.
However, criticism has been expressed against the cost model, as it brings about uncertainty on the
real assets value as changes in value are not taken into account. Thus, it fails to give true and fair
view of an entities state of affairs9.
Conversely, under the revaluation model the carrying amount of each assets belonging to the
same class must be recognised at its re-valued amount, which is fair value at revaluation date less
any subsequent accumulated depreciation and any subsequent accumulated impairment losses10.
AABS113.9 defines fair value related to an asset as the amount for which an asset could be
exchanged between knowledgeable, willing parties in an arms length transaction. In light of this,
fair value is considered as an exit price and methods to measure prescribed under the AABS113
are the market approach, the cost approach and the income approach along with a hierarchy of
inputs (from Level 1 to Level 3) are to be considered. If an assets carrying amount is increased as
a result of a revaluation, the increase shall be recognised in other comprehensive income and

6

Jubb, P., Langfield-Smith, I., Haswell, S., (2009). Company Accounting 5th edition, Cengage Learning Australia
Thompson, Kevin. Advantages and Disadvantages of Historical cost Accounting. Associated Content. 2007. 3
November 2008
8
Hoggett, J., Leo, J., Sweeting, J. (2014) Company Accounting 10th edition, Wiley
9
Jaijairam, P. (2013). Fair value accounting vs. Historical cost accounting. The Review of Business Information
Systems (Online), 17(1), 1
10
Jubb, P., Langfield-Smith, I., Haswell, S., (2009). Company Accounting 5th edition, Cengage Learning Australia
7

4 FRANCESCA PEDERCINI MIT151043

accumulated in equity under the heading of revaluation surplus. However, the increase shall be
recognised in profit or loss to the extent that it reverses a revaluation decrease of the same asset
previously recognised in profit or loss11.
Under AABS116 there is no specification of how often entities need to revaluate assets, but it
states that revaluation must be of sufficient regularity so that carry amount and fair value do not
differ significantly. Also, similar to the cost model, revaluation model is applied to a class of asset
and not just a singular asset, therefore avoiding selective revaluation and maintaining a consistent
measurement for the same type of asset12.
Despite the aforementioned method seemingly reporting a better true and fair view, there are
several disagreements about the use of fair value, due in part to fluctuations that assets experience
over time stemmed from ongoing adjustment in accordance to market price13. Significant impacts
incur on the daily operation of the business and, specifically, on the balance sheet both investors
and creditors assess for the creditworthiness of the company based on the value of assets (Zyla,
2010). Thus, a drop in assets value entail problems, such as solvency being weakened, which in
turn will discourage investors. Jaijairam (2013) opposed this method for its complexity and, above
all, an example of pro-cyclicality is when an economic cycle is in downturn - asset prices decline
too, resulting in depressed earnings14. Lastly, managers who have a profit-based bonus in place are
reluctant to use the revaluation model, because an increased asset basis would result in a lower
return on investment (ROI).
Despite these effects, what are the incentives for managers to adopt the revaluation model? It is
beneficial for entities needing to report higher asset value, due to the increasing value that results
from it. An example of this would be when an entity has a debt with covenants and has to maintain
the debt asset ratio under a certain limit (usually 50%), the effect of the revaluation is to increase
the asset base and, in turn, reduce the debt asset ratio15.
Abacus Property Groups land and building not held for sale were initially measured at cost and
thereafter measured at fair value less accumulated depreciation.

11 Deegan,

C., (2012). Australian Financial Accounting, 7th Edition, McGraw-Hill Education Australia, Higher
Education.
12
Hoggett, J., Leo, J., Sweeting, J. (2014) Company Accounting 10th edition, Wiley
13
Henderson, S., Peirson, G., Herbohn, K., Artiach, T., & Howieson, B. (2013). Issues in financial accounting.
Pearson Higher Education AU.
14
Monday S E, (2009), IAS 16 and the Revaluation Approach: Reporting Property, Plant and Equipment at Fair Value
15
Deegan, C., (2012). Australian Financial Accounting, 7th Edition, McGraw-Hill Education Australia, Higher
Education.

5 FRANCESCA PEDERCINI MIT151043

Abacus Group (2015), Annual Accounts 2015, p. note 114 n.17, Sydney NSW

In this particular case, Abacus belongs to the financial sector which commonly has one of the
highest Debt/Equity ratios, thus the reason behind its revaluation model choice could be that
increasing revaluation would convey the information of higher value of company collateral assets,
thereby persuading debt holders of Abacus ability to pay back debt. In addition, by enhancing
debt ratios and specifying current exit values of building and lands, debt could be reduced too.

Depreciation
Depreciation is the allocation of the cost of a PPE expenses over its useful life. This allows an
entity to recognise expenses in accordance with the period concept16. All PPE, except for land,
undergo a reduction in value over time due to wear and tear and a decline of future economic
benefits17. This decrease is annually recognised as depreciation expenses, which adds up to the
contra-account accumulated depreciation of the previous periods.

16

Jubb, P., Langfield-Smith, I., Haswell, S., (2009). Company Accounting 5th edition, Cengage Learning Australia
Carlon, S., Loftus, J., Mladenovic, R., Kieso, D. E., & Weygandt, J. J. (2003). Accounting: building business skills.
Milton, Queensland: Wiley.
17

6 FRANCESCA PEDERCINI MIT151043

Depreciation methods that can be used to allocate the depreciable amount over its useful life are
specified under AABS 116. The streamline methods include: the straight-line method, the
diminishing balance method and the units of production method. The depreciation policy adopted
will have a significant impact on the profits of an entity, since depreciable assets comprise a
significant portion of total assets, therefore an entity must choose which method closely reflects
the expected pattern of consumption of the future economic benefits embodied in the assets18.
The depreciation method chosen should be consistently applied over the useful life of an asset in
order to enhance the comparability of financial statements across different financial years.
Nevertheless, AABS 116.61 requires an entity to review the depreciation method at the end of
each financial year in order to evaluate whether the depreciation method should be changed in
case a significant change in the expected consumption of future benefits has been manifested.
The assumption under the straight-line depreciation is that future benefits are consumed at the
same rate each financial year, thus the amount of the depreciation is the same for each year. This
method is largely used since it is very simple and it is recommended when the use of the assets is
uniform over the useful life. As example of this can be seen in the notes of the following financial
reports, both Catapult and H&M (p. 45 note 4.10 and p. 98 note 12 respectively), distribute the
depreciation linearly over the assets expected useful life.
The diminishing-value method charges depreciation at a higher rate in the earlier years of an
asset. As a result, in early years depreciation expenses are higher when compared to the straight
line method, but this effect will be balanced as the life of the asset progresses and the depreciation
expense will be lower. Despite this method being largely unpopular, Actinogen Ltd is an example
that does. Actinogen Ltd is a clinical-stage biotechnology company compelled in researching a
cure against Alzheimer and similar age-related diseases. It is a typical example of how a company
would use the diminishing-value method. The depreciation rates used for all classes of assets
during the past financial year are the following:
Plant and Equipment
Office and Equipment
Computer equipment
General Pool Asset >$1,000

7,5% to 37,5%
40%
25% to 66,67%
37%

Actinogen (2015) Financial Statement 2015, p. 41 note 2 (f), Sydney, NSW

18

Radu M, (2013), The Impact Of Depreciation On Costs, Annals of the University of Petroani, Economics, 13(1),
2013, 251-260

7 FRANCESCA PEDERCINI MIT151043

The reason behind this choice could hinge on the technology that Pharmaceuticals &
Biotechnology industrys use, which tend to change quite significantly over time as improvements
are made. Hence, Actinogen expects to receive more benefits from those assets during the earlier
stage of their lives and the older the assets becomes the less benefits are expected to be received.
Lastly, another reason for Actinogen using this method is receiving higher tax-deductions in the
first few years of claim.
The last depreciation method, units of production assume that the useful life is expressed in total
units of production, thus it is commonly used for machine or property that are not in constant use.
The main advantage of this method is that no depreciation is charged when the assets is not in use,
due to its correlation between the material wear and tear and asset activity. On the other hand, this
method is not advised when the assets earning potential will diminish over time, regardless of its
inactivity for technological obsolesce.
Impairment
In accordance with AASB116.53, all PPE must be tested for impairment with the requirements of
AASB136, where an impairment loss is identified as the amount by which the carrying
amount of an asset or a cash-generating unit (CGU)19 exceeds its recoverable amount. The
recoverable amount is identified as the higher between the PPE fair value less costs to sell (net fair
value, NFV) and its value in use (ViU)20. The purpose of the impairment test is to evaluate the
recoverability of the asset, which is not a feature of the depreciation allocation process. Although
the depreciation process takes place every year, the impairment test for PPE does not need to be
done at the end of every financial year, but only when there is an indication (enough evidence)
that an asset may be impaired21.
The impairment test for individual asset concerns that the carry amount is tested for impairment
against either net fair value and value in use. If either is greater than the carrying amount, there is
no impairment, whereas if one of the two is lower, the carrying amount needs to be tested against

19

The CGU is the smallest identifiable group of assets (AABS 136.6):

that generates cash inflows from continuing use, and
that are largely independent of the cash inflows from other assets or groups of assets.
20
Value in use is the present value of the net cash flow expected to receive for using the asset.
21
Hoggett, J., Leo, J., Sweeting, J. (2014) Company Accounting 10th edition, Wiley

8 FRANCESCA PEDERCINI MIT151043

the second one as well. Commonly, ViU is adopted when NFV cannot be found using active liquid
market but when NFV can be easily obtained, the use of ViU is not accepted22.
However, several doubts have been expressed regarding the ViU, since it tends to depend on
managements expectations rather than on market ones. However, AASB 136,33-54 directs the
estimation of cash flows to avoid manipulation by managers.
When the asset is measured using the cost model and impairment is found, this has to be
recognized in profit and loss statements and there is no need to write off any existing accumulated
depreciation, as the impairment can be included in it.
Conversely, under the revaluation model the impairment is treated as a revaluation decrement and
part of the accumulated depreciation needs to be reversed and the asset value is written down; in
case the asset had a revaluation increment, the revaluation surplus created needs to be reversed.
In 2008, Nokia recognised an impairment loss of EUR 55 million derived from the decision of
discontinued and selling the production site of mobile devices at Bouchum, Germany. Another
impairment loss of EUR 35 million is associated with the sale of the manufacturing site in Durach,
Germany. Nokia use the fair value against the carrying amount to determine the impairment loss.
The impairment loss was determined as the excess of the book value of transferring assets over the
fair value less cost to sell for the transferring assets. The impairment loss was allocated to
property, plant and equipment and inventories. Investments in associated companies.

Nokia Corporation (2009), Annual Accounts 2009 p.30 note 13, Espoo, Uusimaa, Finland

22

Henderson, S., Peirson, G., Herbohn, K., Artiach, T., & Howieson, B. (2013). Issues in financial accounting.
Pearson Higher Education AU.

9 FRANCESCA PEDERCINI MIT151043

Conclusion
As it has been seen in this paper AABS provides entities a choice of how to measure their asset,
depreciation and impairment. There is no imposition on which method an entity should adopt and
the choice depends upon the entities, and the needs of their management. Before adopting any
method, accounting management need to think about the consequences of accounting polices as
they will be reflected on the financial statement and, therefore, in the eye of the shareholders.

10 FRANCESCA PEDERCINI MIT151043

References
Abacus Group (2015), Annual Accounts 2015, pp. note 114 n.17, Sydney NSW
Actinogen Ltd (2015) Financial Statement 2015, pp. 41 note 2 (f), Sydney, NSW
Catapult Sports (2015), Annual Report 2015, p. 45 note 4.10, Dockland, VIC
Cheng, C., Lin, S., (2009), When do firms revalue their assets upwards? Evidence from the UK,
International Journal of Accounting and Information Management, 17(2), pp. 166 188
Deegan, C., (2012). Australian Financial Accounting, 7th Edition, McGraw-Hill Education
Australia, Higher Education.
Henderson, S., Peirson, G., Herbohn, K., Artiach, T., & Howieson, B. (2013). Issues in financial
accounting. Pearson Higher Education AU.
H&M (2015), Annual Report 2015, p. 98 note 12 Stockholm, Sweden
Hoggett, J., Leo, J., Sweeting, J. (2014) Company Accounting 10th edition, Wiley
International Accounting Standards Board (IASB), (2010). Conceptual Framework for Financial
Reporting IFRS
Jaijairam, P. (2013). Fair value accounting vs. Historical cost accounting. The Review of Business
Information Systems (Online), 17(1), 1
Jubb, P., Langfield-Smith, I., Haswell, S., (2009). Company Accounting 5th edition, Cengage
Learning Australia
Monday S E, (2009), IAS 16 and the Revaluation Approach: Reporting Property, Plant and
Equipment at Fair Value
Nokia Corporation (2009), Annual Accounts 2009, Espoo, Uusimaa, Finland
Radu M., (2013), The Impact Of Depreciation On Costs, Annals of the University of Petroani,
Economics, 13(1), 2013, 251-260
Zyla, M. L., (2010). Fair value measurements: Practical guidance and implementation. Hoboken,
New Jersey: John Wiley & Sons

11 FRANCESCA PEDERCINI MIT151043

PART 2
a)
Based on the company past experience and expectations, for the year 15, 15% of the goods sold
will present minor defects and 5% will present major defects. According to the AASB 137 par 24
the company assesses the likelihood warranty obligations to be incurred as a whole. The company
will then determine the amount that will be paid in the 15 (current liabilities) and the amount to
be paid in 16 (non-current liabilities).
Expected value of the cost of repairs for prod w/ minor defects:
15% *2,000,000 = 300,000
Expected value of the cost of repairs for prod w/ major defects:
5% *12,000,000 = 600,000
Amount

Minor defects

300,000

100%

Expected in 15 provision for

warranties in
current Liabilities
300,000

Major defects

600,000

40%

240,000

Total

900,000

Expected in 16 provision for

warranties in noncurrent Liabilities

0%

60%

360,000

540,000

360,000

However, non-current liabilities need to be discounted at 6% to be recognized in the balance sheet

at 30/06/2014. Therefore:
Non-current liabilities:

!"#,!!!
!,!" !

= $,

Current liabilities end of FY 2014

Provision for warranties

$540,000

Non - Current liabilities

Provision for warranties

$320,399

TOTAL PROVISION FOR WARRANTIES

$860,399

b) According to AABS 137.59 Provisions shall be reviewed at the end of each reporting period
and adjusted to reflect the current best estimate. If it is no longer probable that an outflow of
resources embodying economic benefits will be required to settle the obligation, the provision
shall be reversed. However, provision calculated for products sold in 2014 with extended
warranties are still considered valid.
Expected value of the cost of repairs for products w/ minor defects:
12% *2,000,000 = 240,000

12 FRANCESCA PEDERCINI MIT151043

Expected value of the cost of repairs for prod w/ major defects:
3% *10,000,000 = 300,000
Amount

Minor defects
Major defects

240,000
300,000

Total

540,000

100%
20%

Expected in 16 provision for

warranties in
current Liabilities
240,000
60,000

0%
80%

300,000

Expected in 17 provision for

warranties in current
Liabilities
240,000
240,000

However, non-current liabilities need to be discounted at 6% to be recognized in the balance sheet

at 30/06/2015. Therefore:
Non-current liabilities:

!"#,!!!
!,!" !

= ,

Also, there is a carry forward amount for provision for warranties from the previous year.
Current liabilities = $360,000 (FY14 Non - Current Liab at their original value) + $300,000 = $660,000
Therefore, for FY15 the balance would be the following:
Current liabilities end of FY 2015
Provision for warranties
Non - Current liabilities of FY 2015

$660,000

Provision for warranties

$213,599

TOTAL PROVISION FOR WARRANTIES

$873,599

b) AASB 116 states that depreciating he subsequent expenditure on modification or improvement of

an asset will depend upon whether the improvement or modification retains a separate identity or
whether the expenditure becomes an integral part of the asset.
In case the expenditure becomes an integral part of the asset, its depreciable amount must be
allocated over the remaining useful life of that asset. Conversely, if the expenditure of an
extension conserve a separate identity and it will be capable of being used after that asset is
disposed, then its depreciable amount will be allocated independently of the existing assets,
according to its own useful life.
In the case of BBM, the new piece of plant will replace an old part of plant, therefore it means that
the new piece is an integral part of plant and machinery that needs to be depreciated over the
remaining useful life of plant and machinery.

13 FRANCESCA PEDERCINI MIT151043

30/06/2014
Historical cost
Accumulated depreciation
Carrying Amount
Useful life
Depreciation expense
Depreciation rate

Part to be replaced
$400,000
$120,000 (3years)
280,000
10y
$40,000 per year
40,000/400,000

Year

Cost (part of
Depreciation
Accumulated
Book value at
the plant)
expense
depreciation
end FY
At acquisition
400,000
400,000
2012
40,000
40,000
360,000
2013
40,000
80,000
320,000
2014
40,000
120,000
280,000

At the end of 2016 part of the plant need to be replaced and therefore we need to accelerate the
depreciation of it over the 2 remaining year. In this case, considering that the carrying amount
$280,000 BBM records the following entry to depreciate it:
30.06.2015
Depreciation expense
Accumulated depreciation

$160,000
$160,000

Catch up depreciation

Depreciation expense
Accumulated depreciation

$40,000
$40,000

Normal Annual depreciation

30.06.2016
Depreciation expense
Accumulated depreciation
Year

$80,000
$80,000

Cost (part of
Depreciation
Accumulated
Book value at
the plant)
expense
depreciation
end FY
At acquisition
400,000
400,000
2012
40,000
40,000
360,000
2013
40,000
80,000
320,000
2014
40,000
120,000
280,000
2015
160,000
280,000
120,000
2016
80,000
360,000
40,000

14 FRANCESCA PEDERCINI MIT151043

Further, in June BBM writes off the old part of the plant which is completely depreciated.

Depreciation expense

$400,000

Accumulated depreciation

$400,000

A new component costing $500,000 is replaced on 30.06.2016 and at that point in time the
remaining useful life for the whole Plant and equipment is 5years, therefore the useful life of the
new part will be depreciated over this period at the normal depreciation rate (10%).

Historical cost
Useful life
Depreciation expense

Part to be replaced
$500,000
5y
$100,000 per year

30/06/2016
Plant & Machinery
Accounts payable

$500,000
$500,000

30/06/2017

Depreciation expense new part

Accumulated depreciation new part

$100,000
$100,000

d) In accordance with AASB 137 a liability is a present obligation of the entity arising from past
events, the settlement of which is expected to result in an outflow from the entity of resources
embodying economic benefit. A provision is a liability of uncertain timing or amount.

Stickney C., Weil R., Schipper K., Francis J., (2006), Financial Accounting: An Introduction to Concepts, Methods
and Uses 14th edition, pp 115 118

15 FRANCESCA PEDERCINI MIT151043

Since the court has ordered BBM to pay a precise amount ($1,500,000), the remaining amount to
be paid ($700,000) has to be considered a liability under trade and other payables, which should
be settle in the next FY. Most likely, before the court passed the judgment, in the notes there was
a mention of a contingent liability, since it couldnt be recognized as liability due to the
impossibility to make realisable measurement and because it existence was confirmed only by the
occurrence of a future event which are not controllable by BBM23.
e) In the Framework 2010 an assets is defined as a resource controlled by the entity as a result of
past event and from which future economic benefits are expected to flow to the entity.
A contingent asset is a possible asset that arises from past events and whose existence will be
confirmed only by the occurrence or non-occurrence of one or more uncertain future events not
wholly within the control of the entity.
At this point in time BBM is clear that the court found in its favour, therefore there is a present
obligation as a result of an obligation event and there is a probable outflow. However, the hearing
for damages has not been schedules and, therefore, the court has not stated which amount BBM is
entitled to obtained. BBM has just estimated the amount it will received, therefore, since there is
still uncertainty it, the estimated amount will be disclose as contingent asset in the notes of the
financial report.
f) A bank guarantee is considered a contingent liability since, according to the decision tree
(AASB137 2010) there is a present obligation whose probable outflow is remote, due to the sound
financial position of Small BBM. As consequence, the existence of this bank guarantee will be
disclosed in the Notes of the financial statement.

Australian Accounting Standards Board [AASB] 2010, AASB 137 Provisions, Contingent Liabilities and Contingent
Assets, Canberra, viewed 18 July 2016, <http://www.aasb.com.au>

23 Stickney C., Weil R., Schipper K., Francis J., (2006), Financial Accounting: An Introduction to Concepts, Methods

and Uses 14th edition, pp 115 118.