Changing the Depreciation Method by Large Mart - Assignment Example

Financial Reporting Student`s Name Professor Institution Date of Submission Question 1 Depreciation refers to value loss of an asset. It is not to be regarded as a cash expense and it is added back when preparing a cash flow statement and since it devalues assets, it is used to decrease the earnings of an organization (Fraumeni and Barbara, 1997). Mostly used depreciation methods are the reducing balance and the sum of digits method. There is also the straight line method which spreads the depreciable balance evenly over the useful life of the asset (Jackson, 2008). Reasons for an organization to change its depreciation method would be; if there is a newly acquired asset, if the organization wants to change the method for all assets or if the company wants to change the depreciable value of an asset (Jackson, 2008). In this case Large Mart intends to completely change the depreciation method and these calls for a change in both the financial statements and the ratios (Fraumeni and Barbara, 1997). The change in the depreciation method is an accounting estimate change but not a change in the company’s policy. However, the change in the depreciation should be in agreement with IAS 16 which requires that the method of depreciation in use should reflect a pattern such that economic benefits in the future should be consumed as per the company’s expectations. According to IAS 8.34, accounting estimate change is effected prospectively but not retrospectively. This is because no error has been discovered that should be corrected in the previous periods. However, the carrying amount will be affected by the new method .According to IAS 8.36, the change in the depreciation is to be included as a profit or a loss. However, IAS 8.37 guides that if the change in an accounting estimate results to changes in assets and liabilities, or an equity item is related to it, then its recognition should be by the adjustment of the carrying amount of the affected asset, equity item or the liability in the change period (FASB, 2005). In the financial statement, there should be a disclosure of the amount and nature of the accounting estimate change in the current accounting period or if the change is expected to have an effect in the future periods. IAS 8.39-40 states that if estimating is impracticable and the amount is not disclosed in the future periods, then that fact should be disclosed. The intention Large Mart CFO of changing the depreciation method does not influence my prior response because it is allowed as stated in IAS 8.34, that accounting estimate change is affected by the current circumstances that an organization may be facing or if there is emergent of new information. It does not therefore relate to previous periods and neither is it a correction of an error (Stansberry and Gary, 2005). Question 2 According to IAS 38.54, development costs are only capitalized if the technicality and its feasibility commercially of the asset is established. The intangible asset must therefore have the potentiality of generating future economic benefits (FASB, 2005). The CFO of Large Mart should be in a position to distinguish between the research phase of a project and the development phase because if he is unable to do so, he should therefore expense the costs of the project as research costs. The requirements that Large Mart needs to fulfill to prove that the development expenditure of study pillow is to be capitalized include; large Mart should show the technical feasibility in the completion of the study pillow for it to be available for use. The company should also show its intention of completing the study pillow and using it. Further, the ability of Large Mart to use the study pillow should be illustrated. They should also show how the study pillow will generate economic benefits in the future by confirming its usefulness in the future. Large Mart should also demonstrate that it has the required resources such as; technical capability, financial ability as well as any other resources that may be required for development completion and its usage. Finally, Large Mart needs to reliably measure the expenditure which relates to the study pillow during its development. Some examples that may be attributable to the development activities which Large mart needs to do to fulfill the requirements are: the construction, designing and the testing of the study pillow in preproduction, tools designing and jigs using technology, making of a pilot of the study pillow which is not feasible economically as well as testing an alternative of an improved or a new materials for use in the study pillow development (Hulten et al., 2010). If Large Mart uses the explained activities to meet the above requirements for capitalization of the development costs, then the CFO will need to know what development costs needs to be capitalized. It is worth noting that internally developed asset includes all the direct costs for creation, production and preparation of the asset to function as expected by the management. IAS 38 explains these costs to include services and materials costs which would be used for generation of the asset. Another cost to be included for capitalization is the employee benefits cost consumed in the making of the asset. Any fees for registration of a legal right are also to be capitalized as well as any patent amortization used in the generation of the intended asset (Hulten et al., 2010). PART B 1) (1.5 mark) – Provide all journal entries that are necessary in the books of Large Mart to account for the purchase and payment of the car and the notebook computer. DR 163 Motor Vehicles $50,000 CR 202 Accounts Payable $50,000 Being the credit purchase of the car on 11th May 201x DR 202 Accounts Payable $50,000 CR 101 Cash at Bank $47,500 CR 120.2 Trade Discounts Received $2,500 Being the payment of the car and the trade discount received on 15th May 201x DR 167 Computers $5,000 CR 101 Cash at Bank $5,000 Being the purchase of the note book computer on 1st May 201x 2) (2.0 marks) – Provide all journal entries that are necessary in the books of Large Mart to account for the revaluation of the car on 1st June 201x AND provide a detailed outline of all required calculations. The sum-of-years’ digits depreciation is calculated as follows: Depreciable Base × Remaining Useful Life Sum of the Years' Digits SYD = 1 + 2 + 3 +...+ n Cost $50,000 Salvage Value $2,000 Useful Life in Years 5 Asset is Depreciated Yearly Fair Value $49,000 Sum of the Years' Digits = 1 + 2 + 3 + 4 +5 = 5(5 + 1) ÷ 2 = 15 Depreciable Base = $50,000 − $2,000 = $48,000 Carrying Amount $32,000 $19,200 $9,600 $3,200 $0 Car Revaluation Fair Value Carrying Amount Surplus/Loss Year 1 $49,000 $32,000 $17,000 Year 2 $49,000 $19,200 $29,800 Year 3 $49,000 $9,600 $39,400 Year 4 $49,000 $3,200 $45,800 Year 5 $49,000 $0 $49,000 DR 163 Motor Vehicles $17,000 CR 360 Revaluation Surplus $17,000 Being revaluation surplus on the car for year 1 on 1st Jun 201x DR 163 Motor Vehicles $29,800 CR 360 Revaluation Surplus $29,800 Being revaluation surplus on the car for year 2 on 1st Jun 201x DR 163 Motor Vehicles $39,400 CR 360 Revaluation Surplus $39,400 Being revaluation surplus on the car for year 3 on 1st Jun 201x DR 163 Motor Vehicles $45,800 CR 360 Revaluation Surplus $45,800 Being revaluation surplus on the car for year 4 on 1st Jun 201x DR 163 Motor Vehicles $49,000 CR 360 Revaluation Surplus $49,000 Being revaluation surplus on the car for year 5 on 1st Jun 201x I have assumed that the fair value of the car was Surplus $49,000 for computation of the surplus/loss which would have been acquired for the useful life of the car. This is because, the question does not specifically state which year the car was revalued. The depreciation method used is some of digits as that is what Large Mart currently used. 3) (0.5 marks) – Provide all journal entries that are necessary in the books of Large Mart to account for the depreciation of the notebook computer for the month of July 201x AND provide a detailed outline of all required calculations DR 611 Depreciation Expense $1,667 CR 167.1 Acc. Dep. Computers $1,667 ($5,000 purchase price - $0 salvage value) ÷ 3 years estimated useful life) = $1,667 Being the depreciation of the note book computer for the month of July 201x References Fraumeni and Barbara. (1997). The Measurement of Depreciation in the U.S. National Income and Product Accounts. Survey of Current Business 77 No. 7 7-42. Financial Accounting Standards Board (FASB). (2005). Accounting Terminology Bulletin 1. 28, Retrieved From . Hulten., Charles R., and Frank C. Wykoff. (1996). Issues in the Measurement of Economic Depreciation: Introductory Remarks. Economic Inquiry 34 No 1: 10-23. Jackson, S. (2008). The Effect of Firms' Depreciation Method Choice on Managers' Capital Investment Decisions. Accounting Review, 83(2), 351-376. Stansberry and Gary. (2005). The Do’s & Don’ts of Depreciation. Rental Equipment Register. 1 June 2004. 28 Read More