Once upon a time, there were two companies...

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2 Once upon a time, there were two companies... Cinderellahas assets worth (machinery only), with total amount of liabilities (to be repayedin two weeks) equal to Snowwhite has both cash and liabilities equal to As a columnist in Fairy Business News, you have to reccomendone company (over the other) Which one would you recommend and why? 2

3 Current ratio: Liquidityratio that measuresa company's ability to pay short-term obligations. Current Ratio formula is: Provided that you are a bank, there are three almostidentical applicants for the loan, and you can approve only 1 application, which one would you approve? Alpha, CR = 0.2; Bravo, CR = 0.68; Charlie, CR = 0.15 Rule of the thumb: The higher, the better How can you increase your current ratio? 3

4 There are many terms used for non-current assets (e.g. buildings, cars, machinery, software): Capital assets Fixed assets Long-term assets 4

5 IAS 1: At the end of a year, your company has following assets: buildings; merchandise; material, cash; computers Which of them are current? Why? 5

6 Let s imagine, that in 2007 you ve provided a loan of to your customer. At the end of each year your customer will pay you Interest rate is 4.2 % p. a. The loan should be paid back in full at the end of 2010 At the end of 2008, what will be the impact of the loan on your non-current assets? 6

7 Loan (BoP) Interest rate Interest Repayment Loan (EoP) ,20% ,20% ,20% ,20%

8 At the end of 2008, the overall amount of loan is worth , measured at amortized costs 2 00ois a current portion of the loan is a non-current portion of the loan 8

9 purchase (individually or as a part of business combination) transfer in exchange for assumption of liabilities self-manufacturing gift governmental grant 9

10 Should the company expense or capitalize related expenditures? If the expenditures are expensed, they immediately decrease net income and total assets If the expenditures are capitalized (recognized as a cost of an asset), there is no direct impact on total assets or net income Net income is affected in the period of realization (e.g. sale) of the underlying asset Thus, it is necessaryto establish the rule for recognition of an asset (capitalization) and measurement of its cost 10

11 Should the company expense or capitalize related expenditures? Balance Sheet Non-current assets Retained earnings (previous and current net Expenses 0 Income 0 income) Current assets Other equity Net income 0 Non-current liabilities Current ratio 0,83 Current liabilities Total Total Return on assets (net income / assets) 0,00% Current assets BB BB Income Statement Non current assets Total Total Expenses Income Total 0 Total 0 Current liabilities Non-current liabilities BB BB Total Total

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13 Why there is need (if any) for recognition of different classes of non-current assets? 1. They have a different level liquidity (ability to be exchanged for cash 2. There is a different pattern of economic benefits to be derived from such assets (sale vs. lease, lease vs. continuous use in production) 3. Some of the a exposed to an impairment while others are subject of possible appreciaton(e. g. land, pieces of art) 13

14 Why there is need (if any) for recognition of different classes of non-current assets? 1. As a result, there are different risks and benefits associated with such assets and they have to be measured differently recognized as different classes of non-current assets 14

15 Covered by IAS 16 Only tangible assets (e. g. buildings, cars, computers, fixtures, airplanes, machinery) Definitionin IAS 16.6:... tangible items held for use during more than one period in the production or supply of goods or services, for rental to others, or for administrative purposes Recognition criteriain IAS 16.7 (it will result in increase of cash or decrease of expenditures, the cost shall be measured reliably) 15

16 Initial measurement is made upon acquisition of a non-current asset (in fact, all assets) this is the amount at which the asset should be registered in accounting books (general ledger and journal) Subsequent measurementis made at each reporting date (i. e. end of an accounting period) 16

17 Elements of costs Which of these could be included in the cost (i. e. initial book vale) of a computer a) purchase price b) refundable value added tax c) nonrefundable value added tax d) transportation e) trainingofastaff f) installation g) administration and general overhead See IAS

18 Elements of costs Which of these could be included in the cost (i. e. initial book vale) of a computer a) purchase price b) refundable value added tax c) nonrefundable value added tax d) transportation e) trainingofastaff f) installation g) administration and general overhead See IAS

19 You have purchased a computer from Jones Co. Cash price is Purchase contract will be settled in 2 years; at that time you will pay What will be amount of initial cost at which the computer should be initially recognized? 19

20 The computer should be recognized at Difference of 210 (= ) is deferredand recognized in future periods as financial cost Each year, financial cost would be computed based on effective interest rate:, % 20

21 There is issue of : -impairment of assets - appreciation of assets (e. g. land, buildings) - subsequent cost incurred in relation with the PP&E IAS 16 assume two models for subsequent measurement Cost Model Revaluation Model 21

22 1.An asset has been acquired for 1 000, its fair value is As a result, the amount of asset is increased by 200, revaluation surplus (equity) is increased by An asset has been acquired for 1 000, so far impairment allowance s are equal 300, fair value is As a result, impairment allowances are derecognized (decreased by 300), amount of the asset is increased by 500 and revaluation surplus is increased by 200 Creation and discharging of impairment allowances is made through net income 22

23 3.Carrying amount of an asset is 1 200, revaluation surplus (created in former periods) is 200, fair value in current period is 700 As a result, revaluation surplus would be depleted to zero (by 200), impairment allowance isincreasedby 300, asset should be increased by 500 Creation and discharging of revaluation surplus is made through the equity rather than through net income 23

24 Capitalized only if they enhance economic benefits of already recognized assets As a result, expenditures for repairs and maintenance are never capitalized under IAS 16 Each major component, which have different patterns of related economic benefits is depreciated independently (e. g. lift and rest of the building) 24