Accounting Theory and Practice - Example

Name : xxxxxx Tutor : xxxxxxx Title : Ассоunting Thеоry Аnd Рrасtiсе Institution : xxxxxxx @2015 Q1. “Intangible assets are identifiable, non-monetary assets, so they may not affect the financial statements." Critically assess the statement, showing how intangible assets can get valued and how the financial statements may be affected. Examples are required to illustrate your points Accounting for Intangible Assets Introduction and Overview International accounting standards (IAS 38) defines intangible assets as non-monetary assets that are without physical substance and identifiable. Intangible assets can either be separable or arising from contractual or other legal rights. (http://www.iasplus.com/en/standards/ias/ias38). Examples include goodwill, brands, supply chains, research and development, forms of competitive advantage such as knowledge capital, human capital, customer relations, and efficient organizational structures. Those that meet the requisite recognition criteria then undergo amortization over its useful life. Most firms nowadays have a lot of value flowing from intangible assets compared to property plant and equipment. However, accountants often omit intangible assets from financial statements especially the statements of comprehensive income. Business analysts argue that it is neither conservative nor informative to do so. For example, treating research and development as an expense in the statement of operations results in earnings of high growth companies being underestimated (Baruch Lev, 2012). It usually results in a disconnect between earnings and stock prices. It is the aim of many companies nowadays to maximize profits and have positive cash flows. Intangible assets do not affect these aspects of a business directly hence they are mostly not recognized in financial statements. The Coca –Cola Company, for example, does not report its brand asset on its Statements of Financial Position, however, increased sales as a result of customer loyalty to the Coca-Cola brand serves to justify the omission from the Statement of Financial Position. In this case, the income statement remedies the deficiency in the Statement of Financial Position. (Penman, 2009). It’s worth noting though, that intangible assets are included in the valuation of a firm as they are the drivers of the overall company profitability. Perhaps the other reason intangible assets may get omitted from balance sheets is because intangible assets are rarely stand-alone items. They work together to realize again. The Microsoft brand, for instance, requires “distribution networks” and “customer relations” to produce any business gain to Microsoft Corporation. “Human capital” cannot work without “organizational structure” and listing one without the other in a balance sheet would be inconclusive. Valuation Assets may be valued by directly measuring its worth or by capitalizing the gains attributable to it. Valuing intangibles directly is rather subjective and open to speculation. Hence, the latter is the preferred valuation method. 1. Income method This method gets based on the projected earnings expected to flow as a result of owning the intangible asset over the period for which it remains useful to the company. The earnings are then discounted to obtain the Net Present Value, which then gives an idea of how much that asset is worth. A recent paper by Lev, Radhakrishnan, and Zhang (2009) measured “organization capital” of Wal-Mart, Microsoft, Southwest Airlines, Intel and Dell in terms of earnings performance and in so doing the authors demonstrated a way of valuing “organization capital” as a form of intangible assets. 2. Market Value /Fair View method The value of the intangible asset gets estimated by comparison with existing market data. For example, the market value of a “patent” or “copyright” of similar materials under similar operational conditions would be expected to be similar. A value analyst could then adjust the intangible assets in question bearing in mind these market values. 3. Cost Valuation Method Cost assessment can either be reproduction cost new or replacement cost new. Reproduction cost new is a measure in prevailing prices of the total cost of recreating an exact duplicate of the intangible asset. On the other hand, replacement cost new is a measure of the overall cost of developing a new intangible asset with the same utility as the subject intangible asset. (Holloway and Reilley, 2012). Cost valuation methods, however, are unrealistic due to the variation that could arise from the value of the property and the actual cost that could get incurred in creating it. 4. Calculated Intangible Value (CIV) It is obtained by calculating the difference between the book value and the market value. Due to the constantly changing market value, the value of the intangible asset under this method also keeps changing. CIV can be obtained as follows: i. Calculate the average earnings before tax for at least three years. ii. Calculate the average year-end tangible assets for at least three years. iii. Calculate the firm's return on assets. iv. Compare the ROA obtained above with the industry average ROA for the last three years. v. Determine the surplus Return on assets by multiplying ROA by the mean assets calculated in Step ii above. Find the difference by subtracting the surplus return from the pretax earnings from step i. vi. Determine the mean of corporate tax rates for the consecutive three years and multiply by the excess return. Subtract the resulting value from the excess return. vii. Determine the NPV of the after-tax excess return using cost of capital as the rate of discount. The sole aim of CIV is to obtain a fixed value of the intangible asset. Effect on Financial Statements Intangible assets as per the accepted accounting principles are only recognized if they are acquired, identifiable and definite. Internally developed intangible assets such as the Coca-Cola logo are not shown on the balance sheet since it’s not measurable. Each invisible item other that “goodwill” is reported separately. Impairment loss and amortization if any, gets expensed on the income statement. For continuing operations, goodwill amortization is reported as a separate item Moreover, the notes to financial statements ought to disclose information pertaining acquired intangibles together with their discounted amortization expense for the next five years. Any changes because of that on the value of goodwill should also get included in the notes to financial statements. Conclusion Omission of intangible assets from the statement of financial position does not necessarily result in non-disclosure of any kind. Financial statements would still be conclusive even if intangible assets are not represented in the balance sheets. The income statement remedies the deficiencies of the assessment (Penman, 2009). Valuation of intangible assets should get approached with caution as it is subjective and at times complex. Q2: “An enormous concern seems to be in the harmonization of accounting practices and standards. If the accounting standards were the same all over the word, then surely the understanding of financial statements would be easier”. Critically evaluate this declaration, showing what the difficulties of harmonization are. Harmonization of Accounting Standards and Practices Overview As a result of various differing codes of practice within the various member nations, business analyzes has become complex, and information is harder to compare(Diaconu, 2007). Harmonization of accounting practices and standards has then become a necessity.It is the process of increasing the comparability of accounting practices by setting bands to their degree of variation (Nobles & Parker, 1981). One can view this process as a situation where countries that subscribe to this undertaking adhere to similar accounting standards in their financial reports. The rising global economic integrations have resulted in the need to harmonize accounting standards. Institutions and corporation have become multinational thus harmonizing accounting would best enable them achieve consistency in accounting principles. Without an internationally accepted code of financial reporting, multi-nationals are forced to reconcile their reports to conform to several country-specific accounting principles, a process that is costly and leads to loss of vital information. Harmonization would also lead to improved labor mobility as technical experience would then gets easily shared with the staff would not need to learn new accounting standards. International Accounting Standards Accounting standards gets accepted accounting principles that govern then preparation of financial statements. (Nobes et al., 1997). In an attempt to achieve global harmonization, International Accounting Standards (IAS) have been set up by the International Accounting Standards Board (IASB). The standards were issued by IASC and endorsed and amended by the IASB. Currently, there are forty-one IASs each dealing with a particular item of financial reports. Beginning in 2005, over seven thousand European companies have had to use the IAS. Moreover, there has been a coordination of agendas of the American, Financial Accounting Standards Board, FASB, and the IASB. It will further promote harmonization and make the understanding of financial statements much easier. (Fritz & Lämmle, 2003). There are potential merits associated with alignment that include; 1. More informed investment decisions would facilitate overall growth in global economy. 2. Analysis of businesses in the same sectors would be much easier and better inferences can be drawn. The level of investment risk gets significantly reduced. 3. Reduction in reconciliation expenses incurred by multinationals. 4. As more companies comply with accounting standards, they become eligible for listing on stock exchanges around the world thus facilitating regulation. However, there are potential disadvantages that could arise with harmonization of accounting practices; 1. A general accounting standard would not be flexible enough to cover the particular accounting problems faced by member nations. 2. There are major differences in accounting practices and harmonization would require significant changes to implement. 3. Underdeveloped countries would feel an enormous obligations got placed upon then by the superior countries. The process to harmonize accounting standards would require the implementers to overcome barriers that exist as a result of the diversity of member countries. Nobes (1992) drew the following factors as the main obstacles to harmonization. 1. Legal Systems: - Some countries use the common law where statute law gets underdeveloped while others use the codified law where commercial codes are applied in financial reporting. 2. Business organizations and ownership: - organizational structures differ from country to country, so do the form of ownership. Harmonization would therefore not suit certain forms of ownership, say family ownership. 3. Stock Exchanges: - the stock exchange requirements are usually given more priority since they are designed to protect the investor. 4. Taxation: - the variation in taxation requirements in different countries whereby some use commercial accounting rules as the basis for adjusting tax liability while in others the tax rules determine the financial reporting rules. (A. Ong, 2005). 5. Culture diversity: - the influence of national culture on accounting makes harmonization difficult because countries do not want to lose their national identity. An example is a long rejection by the FASB of international accounting standards by IASB. Conclusion It is evident that there are advantages of harmonization of accounting practices, but there are specific issues that arise due diversity of member countries. States gets reserved in committing funds into changing of international standards, and thus these standards are not as they should be. However, harmonization would make the understanding and application of financial statements to be much easier. To benefit from harmonization, the advocates of the process first have to deal with the barriers that face it. It is a costly process and would require the support of several countries and states, but the advances made by the IAS in achieving harmonization should be a motivating factor. Q3: Code of Corporate Governance (regarding Omani code for public listed companies) Introduction The UK Cadbury Committee Report of 1992 defined corporate governance as the system by which companies gets directed and controlled. Business analysts aim to ascertain whether the corporate governance of a particular company is good or wrong as judged against best practice. The so-called best practices got developed into codes of corporate governance that include the Omani Code for Publicly listed companies, Cadbury Code of Corporate Governance among others. The system must allow for the exercise of independent, objective judgment without fear or favor. (Ghazaleh, 2003). To analyze the above assertion, the report used the Corporate Governance Report of Oman Development Bank (ODB) contained in the Annual Report for the fiscal year 2013. Corporate Governance Report for Oman Development Bank (ODB) for 2013 The report puts forward a declaration that it is free from any material misrepresentation and that it represents a genuine and fair view of the state of affairs in corporate governance. It further advances a disclaimer that the procedures involved in its preparation did not constitute an audit or review based on International Audit Standards (IAS). The report contained the following main aspects: 1. The ODB philosophy that explains its prominent characteristics of corporate governance including; • The responsibilities of its Board of Directors • The role and responsibilities of management. • The internal control systems and their adequacy. 2. The Board of Directors: - the report explained the structure of its Board of Directors. It showed that ODB got managed by the board of directors composed of a Chairman and five directors. 3. The Audit Committee: - the report put forward the roles of the audit committee and mentions that its code of practice was approved by the directors. It also contains the details of directors’ attendance to the audit committee meetings during the financial year of 2013. 4. Risk Management Committee: - the report contained details of the attendance of meetings by the Risk Management Committee. 5. Remuneration: - it discloses the amounts paid to the directors and five senior staff of ODB and that the remuneration paid complied with statutory requirements, in that case, the Commercial Companies Law and specific Royal Decree. 6. Details of non-compliance with the regulations and the penalties because of that. The report asserted that the bank was in full compliance with the requirements of the regulatory authorities. 7. It also contained the means of communication with the shareholders and investors. 8. The professional profile of the statutory auditor for 2013 also got explained in the report. 9. Non-Compliance with Code of Corporate Governance: -Finally, the report revealed the extent of compliance with the code of corporate governance. Code of Corporate Governance for public listed Omani companies. (also reference made from “UK combined code” report) The report by Oman Development Bank complied with the Code of Corporate Governance for public listed Omani companies. The compliance in terms of the board of directors, however, gets limited since it did not disclose the board of trustees qualifications. As per Annexure 4 of the Code: The List of Items to get covered in Report on Corporate Governance, Oman Development Bank complied with all the items except on the Nomination Procedures of the Board of Directors where it failed to disclose the methods. Oman Development Bank also failed to use Annexure 2 that deals with Minimum Information to get placed before the Board. None of the information stipulated by the code got indicated as placed before the board. The report also failed to utilize Annexure 1of the code that deals with the Principles of Corporate Governance. ODB did not disclose its principles of corporate governance whatsoever. The rules for related party transactions (Annexures 19-25 of the Code) were also not disclosed and, therefore,there is no full financial transparency about related party transactions. According to Code Provision A.3.2 of The Combined Code, at least half the board, excluding the chairman should comprise of non-executive directors. ODB report showed full compliance with the provision. The significance of the Information Disclosed. The disclosure on the Corporate Governance Report of Oman Development Bank is significant since it showed that ODB was sensitive to the need and objectives of its shareholders and investors. By doing so, it builds confidence in them as they feel their needs are being met. The disclosures of the internal control systems is also an excellent means of curbing fraud and is significant in making the ODB more sensitive to the risks factors it faced in it business operations. By minimizing the magnitude of prevailing risk in the enterprise, it facilitates access to capital markets and improves the market acceptance of those who buy its goods and services. (Ghazaleh, 2003). Investment risk is a function of political, security and business risk and is of crucial importance to our region. The disclosures in the Corporate Governance Report improved the situation i.e. reduces the perceived investment risk and, therefore, is significant. The disclosure of the professional profile of the statutory auditor gives confidence to the users of the financial reports since an extremely qualified auditor is expected to give a qualified opinion on the state of affairs of a company. Omani Development Bank did disclose the information relating to Deloitte (statutory auditor) and therefore users of the Annual Report got audited information. Conclusion Corporate Governance code is vital in evaluating the effectiveness and transparency of management. Just because the code provides so, it does not mean simply accepting things as they are without evaluating how they will merge with the philosophy and culture of the company in question. The report found out that the business evaluated did, in fact, conform to the provisions of the Omani Corporate Governance Code for publicly listed companies. It, however, did not follow in certain aspects involving disclosures of the qualifications of directors and the principles of corporate governance. The information that the code stipulates as requiring disclosure is significant in determining whether the financial statements represents a genuine and fair view state of affairs in the company. The information also helps foster transparency and raise investor confidence. References. http://www.investopedia.com/terms/c/civ.asp http://www.iasplus.com/en/standards/ias/ias38 Lev, B., S. Radhakrishnan, and W. Zhang. 2009. Organization capital. Abacus, forthcoming. Penman, S. 2010. Financial Statement Analysis and Security Valuation, 4th edition. New York: The McGraw-Hill Companies. B. P Holloway, R. F Reilly, CPA. Intangible Assets Valuation Approaches and Methods, 2012 Diaconu. Paul, Impact of Globalization on International Accounting Harmonization (January 18, 2007. 24 May, 2015. Available at SSRN: http://ssrn.com/abstract=958478 Hati, W. J. and Rakshit, D. (2002). Integrating accounting standards — A step towards Harmonization. Management accountant, ICWAI, May 2002. Aisbitt, S. (2001) ‘Measurement of harmony of financial reporting within and between countries; the case of the Nordic countries’, European Accounting Review, Vol. 10, No. 1.  “International Accounting Standards.” Encyclopedia of Business and Finance. Ed. Allison McClintic Marion. Gale Cengage, 2001. eNotes.com. 2006. 25 May, 2015 http://www.enotes.com/business-finance-encyclopedia/international-accounting-standards Weber, Cameron M. “Harmonization of International Accounting Standards. | Professional Services Accounting Professionals Center from AllBusiness.com.” Small Business Advice and Resources from AllBusiness.com. The National Public Accountant, 1 Oct. 1992. Web. 23 May, 2015. http://www.allbusiness.com/accounting/methods-standards/339832-1.html Talal Abu-Ghazaleh, 2003. Corporate Governance in Oman. (Muscat, Sultanate of Oman). Ellen Kerrigan Dry, . Corporate Governance in the Sultanate of Oman. Read More