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Briefing on ACT3121Contents: Corporate Financial Statements

Balance Sheet Income Statement

Research & Development Costs (R&D) Research Costs Development Costs

Property, Plant & Equipment (PPE) Cost Model vs Revaluation Model Revaluation Account

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Cont.Contents: Statement of Cash Flow (SCF)

Direct Method Indirect Method

Financial Statements Analysis Profitability Ratios Liquidity Ratios Efficiency Ratios Solvency Ratios

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Key areas: Components of Financial Statement

Regulatory Bodies

Internal Use of Financial Statement

External Use of Financial Statement

Corporate Financial Statement

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Internal Use of Financial Statement

Income Statement

Profit & Loss Appropriation Account

Balance Sheet

Cont.

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External Use of Financial Statement

Roles of Companies Act 1965

Financial Reporting Standards (FRS)

Statement of Financial Position (Balance Sheet)

Statement of Comprehensive Income (Income Statement)

Cont.

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Key areas: Research Costs

Development Costs

Amortisation of R&D

Impairment of R&D

Reversal of Impairment

Research & Development Costs

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FRS 138

Research is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding (para 8).

Examples of research activities are: activities aimed at obtaining new knowledge; the search for, evaluation and final selection of,

applications of research findings or other knowledge;

the search for alternatives for materials, devices, products, processes, systems or services; and

Research Costs

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the formulation, design, evaluation and final selection of possible alternatives for new or improved materials, devices, products, processes, systems or services.

Accounting treatment of research costs:

“No intangible asset arising from research (or from the research phase of an internal project) shall be recognised. Expenditure on research (or on the research phase of an internal project) shall be recognised as an expense when it is incurred”.

Cont.

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FRS 138

Development is the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use.

Examples of development activities are: the design, construction and testing of preproduction or

pre-use prototypes and models; the design of tools, jigs, moulds and dies involving new

technology;

Development Costs

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Accounting treatment of Development costs:

Expenditure made on development activities are expense to income when incurred unless it can be demonstrated that that intangible asset exists (i.e. the amount spend on development activities qualify for recognition as intangible asset) that will generate probable future economic benefits.

An intangible asset arising from development (or from the development phase of an internal project) shall be recognised if and only if, an entity can demonstrate all of the following:

Cont.

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the technical feasibility of completing the intangible asset so that it will be available for use or sale.

its intention to complete the intangible asset and use or sell it.

its ability to use or sell the intangible asset. the intangible asset will generate probable future

economic benefits. Among other things, the entity can demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset.

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the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset.

its ability to measure reliably the expenditure attributable to the intangible asset during its development.

Cont.

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Measurement of costs:

All intangible assets shall be measured initially at cost (paragraph 24) that comprise of all directly attributable costs (which include costs of materials and services used or consumed, cost components like employee benefits, fees to register a legal right, and amortization of patents and licenses, etc) capitalized as R&D costs (i.e. intangible assets).

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But exclude: selling, administrative and other general overhead

expenditure unless this expenditure can be directly attributed to preparing the asset for use.

identified inefficiencies and initial operating losses incurred before the asset achieves planned performance; and

expenditure on training staff to operate the asset.

Cont.

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Impairment Loss:

Impairment test is conducted on the intangible assets that are not amortised.

The objective: to ensure that intangible assets are not overstated.

If an intangible asset is impaired, an impairment loss is recorded on the income statement & asset is reduced.

See Illustration 4, pg 300, TLT, FARM 1, 2000

Cont.

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Reversal of Impairment Loss:

The amount of development costs which were previously written down for impairment loss may be written back when: the circumstances or events that led to the write-down now

ceased to exist and; there is persuasive evidence that the new circumstances or

events will persist for the foreseeable future.

See Illustration 5, pg 300, TLT, FARM 1, 2000

Cont.

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Key areas: Initial Recognition Cost Model Revaluation Model Methods to record revaluation

Property, Plant & Equipment

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The Revaluation Model

After recognition as an asset, an item of PPE shall be carried at a revalued amount i.e. fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses.

Revaluation of PPE

1) Land and buildings are determined from market-based evidence (market value) by appraisal e.g. qualified valuers.

2) in the event where there is no market-based evidence of fair value, estimation of fair value shall base on income or depreciated replacement cost.

PPE

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(3) After an item of PP&E is revalued, the whole class of PP&E (similar nature and use in an entity’s operations) shall be revalued.

(4) When the fair value of a revalued asset differs materially from its carrying amount, it should be revalued.

PPE

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Method to Record Revaluations:

Two methods:

1) Adjust the gross carrying amount (cost) and the accumulated depreciation so that the adjusted net carrying amount is equal to the net revalued amount. Often used for plant and equipment.

2) Eliminates the accumulated depreciation at the valuation date so that the net revalued amount is treated as the new gross carrying amount . Often used for land and buildings.

See Illustration A

PPE

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Depreciated Replacement Cost:

Normally used where there is insufficient market data to arrive at Market Value by means of market-based evidence.

How:

The current cost of reproduction or replacement of an asset less deductions for physical deterioration and all relevant forms of obsolescence and optimisation.

PPE

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Accounting Treatment for Revaluation:

Para 39 (Increase of carrying amount resulting form revaluation)

-- credited to equity as revaluation surplus

The increase shall be recognised in profit & loss to the extent it reverses a revaluation decrease of the same asset recognised previously

Para 40 (Decrease of carrying amount resulting from revaluation)

-- debited to equity as revaluation deficit to the extent of any credit balance existing in the revaluation surplus.

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Accounting Treatment for Revaluation:

The revaluation surplus may be transferred to retained earning, when the asset is retired/disposed off.

In this case, the surplus transferred would be the difference between depreciation based on the revalued carrying amount of the assets and depreciated based on the asset’s cost.

Cont.

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Key areas: Rationale of CF

Operating Activities (OA)

Investing Activities

Financing Activities

Methods of Presentation - OA

Statement of Cash Flow

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Other Items:

Interest & Dividend

Interest paid & dividend paid may be classified as operating or financing activities.

Argument: determining net income or cost of obtaining capital resources

Interest received & dividend received may be classified as operating or investing activities.

Argument: determining net income or return from investment made by entity

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Reporting CF from Operating Activities:

An entity should report cash flows from operating activities using either:

direct method: whereby major classes of gross cash receipts and gross cash payments are disclosed; or

indirect method: whereby net profit or loss (before tax) is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows.

Cont.

Direct Method

RM

Cash from Operating Activities

Cash Receipts from Customers XXX

Cash Paid to Suppliers and Employees (XXX)

Cash Generated from Operations XXX

Interest Paid (Can also be in financing) (XXX)

Interest Received (Can also be in investing) XXX

Dividend Paid (Can also be in financing) (XXX)

Dividend Received (Can also be in investing) XXX

Income taxes Paid (XXX)

Net cash flow from operating activities XXX

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Indirect MethodCash flow from Operating Activities RM RM

Net Profit Before Taxation: XXX

Adjustment:

Depreciation XXX

Interest Expense XXX

Investment Income (XXX)

Disposal of Asset (XXX)

Operating profit before working capital changes XXX

Increase/Decrease in Receivables (XXX)/XXX

Increase/Decrease in Inventories (XXX)/XXX

Increase/Decrease in Payables XXX/(XXX)

Cash generated from Operations XXX

Interest Paid (XXX)

Income Tax Paid (XXX)

Dividend Paid (XXX)

Net Cash from Operating Activities XXX28

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Key areas: Profitability Ratios:

Gross profit ratio Profit margin ratio Net profit ratio Return on Assets ratio Return on Equity ratio

Financial Statement Analysis

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Key areas:

Efficiency Ratios Inventory turnover ratio Receivables/ Debtors Turnover Ratio Average collection period Assets Turnover Ratio Inventory turnover Average days in inventory

Cont.

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Key areas: Solvency Ratios

Debt to Equity ratio Debt Ratio

Liquidity Ratios Quick Ratio Current Ratio

Cont.

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Topics: Corporate Financial Statements

Preparation of Balance Sheet & Income Statement

Research & Development Costs (R&D)

Property, Plant & Equipment (PPE) Revaluation Model

Statement of Cash Flow (SCF) Direct Method/Indirect method

Final Exam Questions