Suspending fair value accounting to save the world?

a little girl enjoying her ride, oblivious to sub prime

A friend who is in the know of markets told me that US is suspending fair value accounting for one year as part of its armoury of measures to contain the sub-prime crisis.

I exclaimed, “No way.” I am trying to search for the authoritative article that confirms my friend’s words. Can any help me on this?

My googling led to me to this article by Karey Wutkowski and Emily Chasan from Reuters dated Sep 19, 2008. It did not mention any outright suspension but instead presented the usual arguments for and against fair value accounting.

I would be very disappointed if it was true as the true value of any law/standard can only be realised if it is put through the baptism of fire of current sub-prime financial storm.

A critic highlighted an important “hole” in fair value accounting ie. the complete absence of any markets to provide an indication of value. So the Authorities may probably have to disappoint people like Edgar by suspending fair value accounting while they work furiously trying to calm the global markets to save thousands of jobs and a few hundred billions dollars.

The article mentioned that Fair Value Accounting took effect in US this year. So could it be that the new accounting standard has “encouraged” the revelation of sub prime storm to the current scale.

FRS 18 Revenue

a marriage contract in progress

Hi AWE readers,

In the Exposure Draft of Proposed Improvements to FRSs expiring Oct 3, 2008, I wish to share an interesting portion where ASC proposes guidance on determining whether an entity is acting as a principal or as an agent.

What is the big deal?
The clarification of the status of either principal/agent will determine how much of an invoice/contract you would record as your company’s turnover.

Allow me to illustrate
Let assume an IT system integrator has got a contract to deliver the following:-
1. Ten servers and 100 laptops – $3 millions
2. Consultancy service (including set up and integration) – $0.5 million

Upon completion of the contract, how much should the IT company record as its Sales Turnover? It could be just $0.5 million or seven times more ie. $3.5 millions. So which is it?

Key point
FRS 18 requires you to determine whether you are acting as a PRINCIPAL or as an AGENT.

ASC is proposing the following for adoption to help you.

When is an entity acting as a PRINCIPAL?

  1. the entity has the primary responsibility for providing the goods or services to the customer or for fulfilling the order, for example by being responsible for the acceptability of the products or services ordered or purchased by the customer;
  2. the entity has inventory risk before or after the customer order, during shipping or on return;
  3. the entity has discretion in establishing prices, either directly or indirectly, for example by providing additional goods or services;
  4. the entity bears the customer’s credit risk.

When is an entity acting as an AGENT?

  1. An entity is acting as an agent when it does not have exposure to the significant risks and rewards associated with the sale of goods or the rendering of services. One feature indicating that an entity is acting as an agent is that the amount the entity earns is predetermined, being either a fixed fee per transaction or a stated percentage of the amount billed to the customer.

Source – ED – Proposed Financial Reporting Standard (Oct 3, 2008), ASC

FRS 38 Intangible Assets – Summary

An intangible asset is recognised at cost if and only if:-

  1. the asset meets the definition of an intangible asset;
  2. it is probable that the expected future economic benefits that are attributable to the asset will flow to the entity; and
  3. the cost of the asset can be reliably measured.

Internally generated goodwill, brands, mastheads, publishing titles, customer lists and similar items are not recognized as assets. Intangible items that do not meet the criteria for recognition as an asset is recognized as an expense when incurred. Expenditure that was initially recognised as an expense is not included in the cost of an intangible asset at a later date.

Research Phase
Expenditure on research is recognized as an expense.

Development Phase
Intangible asset arising from development is recognized only if an entity can demonstrate all of the following criteria in getting the intangible asset ready either for use or sale:-
(a) the technical feasibility of completing the intangible asset;
(b) its intention to complete the intangible asset;
(c) its ability to use or sell the intangible asset;
(d) how the intangible asset can generate probable future economic benefits;
(e) the availability of adequate technical, financial and other resources to complete the development; and
(f) its ability to reliably measure the expenditure due to the intangible asset during its development.

Subsequent to its initial recognition, an intangible asset is carried at:
(a) cost, less accumulated amortisation or impairment losses; or
(b) revalued amount (fair value at the date of revaluation), less any subsequent accumulated amortisation or impairment losses.

An entity shall assess whether the useful life of an intangible asset is finite or infinite. The useful life is infinite if there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity. An intangible asset with infinite useful life is not amortised but is tested for impairment at least annually. The depreciable amount of an intangible asset with finite life is amortised on a systematic basis over its useful life.

Gain/loss on derecognition of an intangible asset is the difference between the net disposal proceeds and the carrying amount of the item. The gain/loss is recognized in the profit or loss.

Source – ICPAS ePublication Issue 25/2006 20 Jun 2006

FRS 37 Provisions, Contingent Liabilities and Contingent Assets – Summary

The objective of FRS 37 is to prescribe the accounting standards and disclosure for provisions, contingent liabilities and contingent assets.

A provision is a liability of uncertain timing or amount.

We recognise a provision when:-
(a) an entity has a present legal or constructive obligation as a result of a past event;
(b) it is probable that an outflow of economic benefits will be required to settle the obligation; and
(c) a reliable estimate can be made of the amount of the obligation

A constructive obligation is an obligation where the entity, through its actions, has indicated to other parties that it will accept certain responsibilities and as a result has created an expectation that it will discharge those responsibilities.

Provision is the best estimate of the expenditure required to settle the obligation at the balance sheet date. Provision should be reviewed and adjusted to current best estimate at each balance sheet date.

A constructive obligation to restructure arises only when an entity has:

  • a detailed formal plan for restructuring; and
  • raised a valid expectation in those affected that it will carry out the restructuring by starting to implement that plan or announcing its main features to those affected by it.

A contingent liability is not recognised, but is disclosed unless the possibility of an outflow of resources is remote.

A contingent asset is not recognised, but is disclosed when an inflow of economic benefits is probable.

FRS 37 specifies disclosures about provisions, contingent liabilities and assets.

Source – ICPAS ePublication Issue 23/2006 13 Jun 2006

IFRS Conference – Non Controlling Interest

Non controlling interest is a stake ie. percentage of shareholdings, that is not high enough to control the company’s financial and operating policies.

So assuming if you were buying a 20% stake in a company as a passive investor, how much should you pay for that stake or how much should the seller be selling it for?

20% of net book value? 20% of [fair value of net assets + goodwill]?

Well the answer is:-

20% of value of business LESS the value of non controlling features

Now that we got the formula, we need to work on valuing the business’:-
– assets and liabilities, both tangible and intangible
– goodwill
– non controlling features

Can tell me how?

The moral of the story – We still go a job until the confusion stops.

FRS 16 Property, Plant and Equipment – Summary

FRS 16 prescribes the accounting treatment for property, plant and equipment.

Property, plant and equipment are tangible assets that are in use for more than one accounting period. Cost of property, plant and equipment comprise:-

  1. its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates.
  2. any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management.
  3. the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired or as a consequence of having used the item during a particular period for purpose other than to produce inventories during that period.

Property, plant and equipment are initially recorded at cost. Subsequently, they can be carried either

  1. Cost less any accumulated depreciation and any accumulated impairment losses; or
  2. Revalued amount (Fair value at the date of revaluation), less any accumulated depreciation and any accumulated impairment losses.

If option (b) is chosen, all assets within a class of property, plant and equipment must be revalued and the valuations must be updated regularly.

A revaluation increase shall be credited directly to equity as revaluation surplus, unless it reverses a revaluation decrease of the same asset previously recognized in profit or loss.

A revaluation decrease shall be recognized in the profit or loss. However, the decrease is debited directly to revaluation surplus in equity to the extent of the credit balance in revaluation surplus.

Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. The residual value and the useful life of an asset should be reviewed at least at each financial year-end. If expectations differ from previous estimates, (FRS 8 Accounting Policies, Changes in Accounting Estimates and Errors) is applied.

Impairment is recognised in accordance with FRS 36 Impairment of Assets.

The gain or loss on the derecognition of an item of property, plant and equipment shall be determined as the difference between the net disposal proceeds, if any, and the carrying amount of the item and is included in the profit or loss.

FRS 16 specifies disclosures about property, plant and equipment.

Source – ICPAS ePublication Issue 3/2006 17 Jan 2006

IFRS Conference – What say you?

veg juice in test tubes @$4

This is a situation described by an accoutant from a local bank. Let me know how would you, as the accountant, would advise the bank officer.

Within the same bank, there are two departments, A and B, investing and trading for 2 different investment funds with different objectives.

Dept. A is looking to sell a certain financial instrument that is no longer fit its investment objective. Coincidentally, Dept. B is looking to buy the same financial instrument for its portfolio.

Should Dept A just sell to Dept B directly? And at what price so as to be fair to both sets of investors of the respective funds?

What say you?

IFRS Conference – Revised IFRS 3 on Business Combination

To be effective on July 2009.

Auditors trained in the world of historical cost accounting now have to deal with issues of Fair Value.

1. Stepped acquisition as a way of earning management.
Suppose you had intended to buy 60% stake in the target business with projection that that business would be in net loss in Year 1 and significant profit in Year. To avoid consolidating the bad result of target business into your company from Year 1, you decide to split the acquisition over 2 years ie. 30% in Year 1 and another 30% in Year 2.

2. The magic of 1% stake
If we base on 50% as a measure of control over a company, and you expect your 50%-stake-subsidiary to lose heavily this year and that you do not wish to consolidate that results with other companies in your Group, can you enter into sell-and-buyback contract for the 1% stake ie. sell 1% to demerge the loss-making subsidiary in one year and buy-back 1% to re-consolidate?

3. Internal consistency (within a FRS), external inconsistency (between FRSs)
The choice words from Professor Pearl Tan from SMU. She cited an inconsistency when borrowing costs can be capitalised but pre-acquisition costs must be expensed off to P&L under the revised IFRS 3. Sir Tweedie responded to that comment but I missed the rebuttal sadly.

FRS coming to effect in 2009

1. Revised FRS 1: Presentation of Financial Statements
• effective 1 January 2009
• learn how to prepare the revised formats to financial statements

2. FRS 23: Borrowing Costs
• effective 1 January 2009
• learn how to capitalise interest on qualifying assets

3. FRS 27 – Consolidated and Separate Financial Statements
• effective 1 July 2009.
• learn the new rules for consolidation

4. FRS 103: Business Combinations
• effective 1 July 2009
• learn the new rules for consolidation

5. FRS 107: Financial Instruments: Disclosures
• effective 1 January 2008
• learn about the best practices for the new disclosure requirements under FRS 107

6. INT FRS 113: Customer Loyalty Programmes
• effective 1 July 2008
• learn how to account for reward points for credit and loyalty cards etc

Negative impact of Fair Value is here!

July 29, 2008Australand hit by revaluation, writedown

CapitaLand’s Aussie unit’s half-year earnings slide 79% to A$25.6m

Property revaluation and project writedown have resulted in CapitaLand’s Australian subsidiary, Australand, reporting a 79 per cent year-on-year fall in net profit to A$25.6 million (S$33.4 million) for the half-year ended June 30, 2008.

July 29, 2008Oceanus interim gain halves to 21.3m yuan on goodwill writeoff

Oceanus saw its net profit for the first six months of this year halved from 44.09 million yuan a year ago to 21.27 million yuan, due largely to a hefty goodwill write-off of about 150 million yuan arising from its reverse takeover of TR Networks in April.