Research, Start-up Cost of New Business - Essay Example

Running Header: Research, Start-up Cost of New Business Student’s Name Lecturer Course Title Date Learning Point The paper focuses on establishing the reaction of investors regarding start-up costs capitalization and amortization. Various aspects of start-up cost are treated differently in different regions during tax returns documentation. In Greek accounting, start-up costs are normally capitalized and amortized, a practice that initiates different views among scholars and different reaction among investors. The paper clearly evaluates the reaction of investors regarding capitalization and amortization of intangible assets, tangible assets, as well as liabilities that include legal obligations, accrued expenses, and provisions expenses. The evaluation establishes that investors have considers intangible assets to be riskier, with expenses related to research and development being perceived to contain no value significance. Legal obligations liabilities are perceived more negatively than other liabilities. Other Theoretical Views Related to Article Topic Intangibles accounting has turn to be increasingly significant issue since they became part of increasing significance in modern economies. Initially, resources utilized on intangible assets were not regarded as valuable investments and thus, they were never capitalized in the balance sheet. On the contrary, they have been expensed and therefore documented as costs, which were hardly anticipated to create future benefits, after considering the substantial risk usually related with the future intangible assets benefits. This according to Hoegh-Krohn and Knivsfia (2000, p. 244), could deceive investors depending on the financial statement as their prime information source. In their views Hoegh-Krohn and Knivsfia amortization and capitalization of intangible assets for their useful period will more likely match expenses with future advantages. This is believed to augment the financial statements informativeness. However, since intangibles are hard to objectively record, the financial statements value-relevance will be lowered if non-existing or doubtful assets are documented. In Hoegh-Krohn and Knivsfia views, the extent we can go in intangible assets recognition is resolute by the trade-off between the way reliability and the relevance of capitalization of intangible asset impact the accounting informtiveness. Thus, to be able to enhance the informativeness and eventually the financial reports value-relevance, all intangible cost have to be capitalize and then amortized for their useful period, as long as they attain particular asset recognition criteria. If the intangible assets portfolio economic value is below its cost, the portfolio has to be recorded to its economic value. However, in case its economic value augments in later dates, the carrying value has to be re-valued or reserved not over the cost. However, in case the asset acknowledgement criteria is not attained, then intangible resources have to be expensed in the time that they are earned (Hoegh-Krohn & Knivsfia, 2000, p. 245). According to Lev and Sougiannis (1996, p. 108), there has been presumed absence of association between R & D costs and resulting benefits. This was the main reason as to why the FASB made a decision in 1974 for full R & D expensing in all public corporations financial reports. However, there has been R & D investment unprecedented growth over number of decades in the western nations which invokes needs for changes. Lev and Sougiannis (1996, p. 107) conducted a research to evaluate R & D capitalization value relevance by estimating the capital of R & D of large public companies sample. The researchers found the approximations to be economically meaningful and statistically reliable. After adjusting the sample firms’ book value and reported earnings for capitalization of the R & D, they established that adjustments of these forms are value-relevant to the investors. The researchers therefore documented substantial inter-temporal relation between R&D capital of firms and resulting stock returns. This proposed either a methodical mispricing of the R&D-intensive firms’ shares, or a compensation for more-market risk aspect related with R &D. The results according to the researchers proposed that capitalization of R&D statistically result to provision of economically and reliable relevant information. This contradicted the FASB Statement No. 2 major tenet that claims that there is no direct association between R&D costs and particular future revenue. Another study conducted by Ely and Waymire (1999, p. 19) established that investors have taken a cynical perspective of intangible assets. Based on the research offering managers with augmented chances for intangible assets, capitalization might not unambiguously augment the quantity of reliable information accessible to investors. This proposes that the capitalization of intangible reliability may not mislead investors as proposed by FASB. In addition, according to Guha (2013, p. 14) intangible assets current holds more value that most tangible assets following the development of technology and knowledge in the provision of various services in India. Thus Guha feels that they need to be capitalized. A similar view is shared by Lev and Zarowin (1999, p. 353) who believe that the decline in the USA usefulness of reported cash flow, book values, and earning is because of the raising significance of intangible assets in the prosperity of modern firms’ activities, and also due to conventional accounting inability to properly justify intangible accounts. They therefore support that intangible assets need to be capitalized. Although the American accounting system still employs the initial concept of expensing the intangible assets, there is almost an anonymous agreement that intangible assets have gained value with time. In this regard, their capitalization needs to be reconsidered. My Opinion There have been a number of changes in the world that have completely changed the current situation from the situation that was experienced at that time. In this regard, some intangible assets are currently more valuable in many organizations than valuable assets. For instance, assets such as knowledge management, and research and development have resulted to increase in revenue and investment in most companies in the world, particularly technology companies which were not famous when these rules were being made. A company can considerably earn a lot of in the future by effective investment on the research and development asset at the business start-up. Thus, expensing some intangible assets would distort the actual meaning of assets in a balance sheet. In my opinion, there is a need to classify intangible assets even further by separating the intangible assets that contain value-relevance from those that do not contain it. Generalization in this matter makes it hard for different accountants to consider what is best for the company and what is best for the investors. Based on the research, Greece has gotten it right by considering capitalization and consequently amortization of some of intangible assets, however; they should not have capitalized the entire start-up cost. Some costs are never recoverable and thus, they should be expensed. Although the research shows negative investors perception toward capitalization of all intangible assets, it is possible that their views could have changed with the current changes taking place in the world. Not all intangible assets lacks future financial benefits, and similarly, not all start-up costs are recoverable, thus a balance need to be enhanced for justified reporting to all who include the business owners, investors and tax authorities. Main Keywords Amortization – process of spreading out a huge payment over a longer time period Capitalization- classifying assets as an asset with inherent value which a business can be used by a business to help it make profit in the long run. Expensing – reporting an assets as that which its economic value has been exhausted in revenue creation in the current time Assets – credible future economic benefits controlled or obtained by a certain entity following past events or transactions Tangible assets – assets with physical substance for instance equipment, plant property Intangible assets – assets with no physical substances that are typified by rights or other similar advantages. Also defined as non-monetary asset with no physical substance held for application in the supply or production of services and goods, for administrative services, or for rental to others: They include R&D, knowledge management, patent, trade names, trademarks, licenses, operating rights, future interests, franchise, record masters, copyright, brand master, secrete processes, and advertising among others. R & D – Research and Development Topic in the Accounting Standard The accounting process is highly guided by international accounting standards (IAS) as well as the adopted national accounting standards, which mostly conform to the international standards or which differ slightly based on a region or the body governing these standards in a region. The issue on how to handle intangible assets in accounting is addressed in the IAS 38. According to IAS cost of starting a business is required to be expensed according to the ISA standards (Campbell & Strachan, 2015). Nevertheless, intangible assets are regarded to have future economic benefits and thus, instead of being expensed, they are amortized for a period of time which they are regarded to be useful. Nevertheless, this rule does not apply to all intangible assets based on the current rules. They are highly guided by the intangible assets accounting standards. According to IAS 138 section, intangible assets adhering to the applicable criteria of recognition are originally measured at cost, then evaluated at cost by use of the revaluation model, and systematically amortised over their useful period; except where an asset contains an unlimited useful period, where it is not amortised. This provision was adopted after 2004 March revision. This provision resulted to change of accounting principles in various parts of the world treating intangible assets differently as per what they considered right following this provision. The statement also separated research phase from development phase. The research phase is regarded as a stage that highly initiate business expenses with a high level of uncertainty on whether the resulting outcome will be of any benefit to a company. In this regard, the Australian accounting rules demand that research intangible asset should be expensed rather than capitalized in the balance sheet. On the contrary, the development phase is perceived as a more certain section containing high anticipation of bringing future economic benefits to a company. In this regard, this stage requires to be capitalized. However, capitalization should only occur after commercial and technical feasibility for the asset use or sale has been ascertained. This rule is highly observed in Hong Kong and Australia among other nations. Although a number of countries tries to adhere to the set international accounting standards, there are still a few that defect based on their own accounting system or based on other factors. According to Ernst & Young (2011, p.2), although convergence still remain to be highly prioritized on the International Accounting Standard Board (IASB) and the US Financial Accounting Standard Board (FASB), the process of convergence is structured to only handle the most important variations or/and parts which the Boards have noted as having the highest need for improvement. In this case, the 1974 ISA provision demanded that all intangible assets be expensed. However, some countries found it important to capitalize such intangible expenses long before the international law has establish the changing need to do so. This created various reactions from both accounting bodies and investors in various regions. Nevertheless, effective re-evaluation of the case after a long time resulted to the establishment that the cost can be capitalized or expensed, based on the particular nature of the intangible assets and its contribution to the future benefits in a firm. Although the convergent international standards will be highly similar, variations will continue to persist between the International Financial Reporting Standards (IFRS) as reported by the IASB and US GAAP as broadcast by the FASB. While the research is separated from development and expensed, as development is capitalized in ISA, the US GAAP provide that costs earned to restore, maintain, and develop intangible asset as expense, expect for cost related to computer software and web development anticipated to be sold or for internal use. In addition, according to the ISA, goodwill that is internally created should not be acknowledged as asset. On the contrary, the FASB in Statement no. 142 addresses on how to account for intangible assets used in combination of other assets to create a long term benefit in an organization. According to the statement, these assets cannot be documented individually since they cannot bring the befit as individual entities. On the contrary they should be accounted for as integrated assets. In this regard, some intangible assets such as goodwill should not be amortized but should be capitalized. These changes were made after the realization that goodwill and intangible assets do not decrease at a similar rate or time as perceived in the past standards. The statement also offered guidance on intangible assets testing to identify those assets that should not be amortised due to impairment. It also demanded for information disclosure regarding goodwill as well as other intangible assets in the years following their acquisition which was not required previously. Thus, each country has the right to follow standards derived by its national accounting body, after its consideration of the international law and how applicable it can be for their particular accounting techniques. In this regard, slight valuation can highly be experienced in accounting standards. Critically Analysis for the Article According to the paper, the Greek companies considered capitalization and consequent amortization of start-up cost, contrary to the international accounting standards where start-up cost is expensed and intangible assets amortized. This move created different reaction from scholars and investors. The paper particularly focuses on the reaction of the investors who are concerned about the risk involved in the capitalization of research and development. The Greek companies accounting rules defies the provided international standards of accounting. Based on these standards, start-up cost is expensed and thus, it is treated as an expense, apart from cases where tangible assets are purchased. Nevertheless, cost of intangible assets can only be deducted through amortization, since the law has imposed a limit to the amount that should be expense as the business start-up cost, at once. Moreover, the ISA clearly separates research from development while defining their treatment in accounting. The paper therefore presents rare situation which is bound to create different reaction from investors. Nevertheless, the author has clearly managed to demonstrate that this is unusual situation by clearly demonstrating that it goes against the ISA and it is not followed by many. He also clearly explains the Greeks’ believe and why they normally employ this technique, its impact to the company and the tax authorities. Basically, the technique is found to be highly beneficial to the tax authorities since it increase their revenue. Thus, the author can be said to have provided intensive theoretical background of the situation, siting relevant contradiction that initiated the need to conduct his research. The researcher has employed viable research method which is approved by scholars in the accounting field. The estimates are conducted by applying cross-section regression by use of Ordinary Least Squares Method. In this regard, the obtained results can be said to be highly reliable and can be used to make viable conclusion regarding the situation. In addition to this, the researcher used data from viable sources and for an extensive period of time. Accounting Laboratory of the Department of Finance and Accounting database is a legible source of data that can highly reflect the actual situation on the ground. The final sample size was also highly reasonable. The researcher worked with a sample size of 220 firms. The viable statistical measures were used to define the regression coefficients and thus, increasing chances of obtaining accurate results. The researcher clearly documents the employed equation to the reader, defining all coefficients used to compute the final values. The research results are also clearly displayed in tables making it easier for the reader to read, relate, and make conclusion on the obtained results. The results are also clearly discussed to ensure that the reader clearly understand the documented results and what they imply. The paper is professional structured with the abstract and introduction sections, a section describing start-up cost accounting in Greece, research methodology, Data, results and conclusion. Nevertheless, the paper abstract is not clearly structured to differentiate between the research aim, the research methodology, results, and recommendation or conclusion. They have all been mixed up for the reader to deduce this on his or her own. Although the paper lacks the literature review section, it has employed various past professional literatures to lay the research ground and assist the reader to understand the actual situation based on the International Accounting Standards and also based on the Greece operational standards. The paper has also failed to separate the obtained results from the results discussion part. They two have been integrated, though not in a confusing way. The author has highly managed to simplify the language used in the paper to enhance extensive understanding, despite using complex regression research methodology. The research results have clearly managed to address the research objectives. The outcome demonstrated the negative valuation of capitalization of start-up costs by the market. This makes this practice questionable and less preferred. The research also demonstrates consistency between the current research and the previous research regarding the investors’ perception on assets and liabilities capitalization and expensing. It has also recognizes that investors consider future returns connected to intangible assets riskier compared to those of tangible assets. In addition, legal obligations are negatively valued by investors while other liabilities are ignored. The research can be said to create a clear picture of what happens when unusual situation is presented in the business, especially before its workability is ascertained. Research and development are highly separated in the current ISA, where research is considered as an expense without future anticipation of benefits to the business. Thus, it is highly risky to be capitalized and thus, the research results can be considered to be highly viable based on this concept. Analysis of UAE Outcome While Greek applies the ISA to develop their local accounting standards, the United Arab Emirates uses the International Financial Reporting Standards to develop their internal or regional accounting standards. In this regard, there are various variation experienced between the two countries with regard on how they treat their start-up cost. According to Ernst & Young (2011, p. 16), the IFRS principles demand that the expenditure cost should only be capitalized as an asset if the cost can be reliably measured, if it is likely that the future economic advantages will flow to the business, and if the cost is directly associated to an asset under construction and not associated to either maintenance activities or production activities. Thus, it simply forbids the capitalization of start-up cost, in all other cases, apart from when the cost is channelled to the development of tangible assets. In all other cases, this is basically considered as cost. The IFRS principals define cost to contain any expense incurred to prepare the site and to establish a business prior to business operation. Cost based on the IFRS comprises of purchase price which include non-refundable purchase taxes and import duties, after subtracting rebates and trade discounts. Any expenses directly associated to developing asset to the condition and location necessary for it to be able to operate effectively, as well as the initial cost attributed to restoring the site. Internal intangible assets developed are only recognized if they have a likelihood of creating future economic advantages, which are credible to the asset. They are also recognized if the asset cost can reliably be measured. This is the main condition in which the research and development is treated in the UAE. It can therefore been said that the UAE employ almost similar techniques in the reporting of start-up cost as those employed in majority of countries. Instead of capitalizing this cost, UAE normally expense it. Just like in ISA guided countries, UAE only recognizes a tangible assets only if it clearly demonstrates the ability to generate future financial benefits to the company. In addition to this, their cost must be highly measurable otherwise; surety of future economic benefit should not be the only satisfied criterion. Other intangible costs such as advertising costs are considered as expenses and thus they are expensed in UAE. Greece on the other hand does not consider the economic benefit of an intangible asset. It simply capitalizes all of them creating high balance sheet values and providing the government with a higher taxation amount. This does not in any way benefit the business owner and it is perceived as risky by the investors, particularly where the included intangible assets do not have any anticipation of generating income to the company in the future or where the expense used is immeasurable and thus, it is hard to say when the employment of this asset will create profits to the company. UAE also expense costs such as the advertisement cost despite having an anticipated benefits of generating high revenue to the company in the future. This means the UAE accounting principles highly protects the company’s welfare than that of Greece. Although Greece is guided by the ISA rules, it has highly defied most of these rules with regard to the treatment of intangible assets during the start of business. Start-up cost is regarded as an asset which is contrary to the ISA standards that define it as an expense, with some exceptional. Similarly, it differs from the UAE which also perceive the start-up cost based on IFSA and similar to ISA as an expense. UAE has highly tried to adopt the IFSA standards comprehensively and thus, they do not have the extreme cases of deviation from the standard that guides their accounting principles. Greece case is highly exceptional, and makes it highly questionable by most investors. This is unwelcomed situation in UAE which adopted the IFSA to encourage international investors and to enhance their international trade. Conclusion The ISA clearly defines start-up cost as an expense that need to be expensed in the balance sheet, apart from tangible assets. In this regard, intangible assets also regarded as cost and they are amortized based on this law. This standard has highly been observed across different parts of the world, with a few exceptions Greece being one of them. The country considers capitalizing all intangible assets at the start-up of a business even those that are not regarded to contain any future benefit in a firm. Consequently, this has made its accounting reporting technique questionable by many. Investors have also considered is highly risky to capitalize some intangible assets such as research and development at the start-up. Although development needs to be capitalized based on the ISA after its benefits are ascertained, research is regarded as an expense surrounded by a number of uncertainties and thus it should never be capitalized. References Campbell, A. D & Strachan, B. J, 2015, “Startup costs: Book vs. tax treatment,” Journal of Accountancy, [online] available at: < http://www.journalofaccountancy.com/issues/2015/nov/startup-costs-book-vs-tax-treatment.html> [Accessed on 13 June 2016]. Deloitte., IAS 38 – Intangible assets. [online] Available at < http://www.iasplus.com/en/standards/ias/ias38> [Accessed on 13 June 2016]. Ely, K & Waymire, G, 1999, “Intangible assets and stock price in the pre-SEC era,” Journal of Accounting Research, vol. 37, pp. 17-44. Ernst & Young, 2011, “US GAAP versus IFRS: the basic,” [online] Available at: < http://www.ey.com/Publication/vwLUAssets/US_GAAP_v_IFRS:_The_Basics/$FILE/US%20GAAP%20v%20IFRS%20Dec%202011.pdf> [Accessed on 13 June 2016] Guha, A, 2011, “Assessment of intangible assets vis-à-vis companies capital,” doi.org/10.2139/ssrn.2254168 Hevas , D. L, 2005,”The value relevance of star- up costs and other balance sheet items: some Greek evidence,” Managerial Finance, vol. 31,no.2, pp. 55 – 65. Hoegh-Krohn, N. E. J & Knivsfia, K. H, 2000, “Accounting for intangible assets in Scandinavia, the UK and US, and by the IASC: Challenges and a solution,” The International Journal of Accounting, vol. 35, no. 2. Pp.243-265. Lev, B & Sougiannis, T, 1999, “Penetrating the book-to-market black box: The R&D effect,” Journal of Business Finance and Accounting, vol. 26, no. 3-4, pp. 419 – 445. Lev, B & Zarowin, P, 1999, “The boundaries of financial reporting and how to extend them,” Journal of Accounting Research, vol. 37, no. 3, pp. 353 – 386. References Read More