3100 - Assignment analysing the financial report of Woolworth PDF

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Assignment analysing the financial report of Woolworth...

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ACF 3100 Advanced Financial Accounting

Intangible Assets Research Assignment

Tutor: Alan Fotheringham Tutorial time: 1pm, Thursday Pages: 20 Word count: 2100

Executive Summary This business report will principally debate and evaluate what changes are expected to make towards contemporary accounting treatment for intangible assets, meanwhile, pondering whether and how current accounting requirements confine the recognition of intangibles in Woolworths. Subsequently, researchers would put forward a recommendation on what changes should be made on existing accounting standards of intangibles that the CFO of Woolworths can present to the focus group of the AASB. To fulfil the purpose mentioned above, convinced evidences have been provided for the analysis of current accounting treatment and the status quo of intangibles within most entitles. Because current accounting standard prevents the recognizing of internally generated intangibles unless intangibles are acquired outside, which conflicts with the pervasive and persistent worldwide phenomenon that intangible assets has been proved to be the predominant creator of corporate value and competitive edge. Consequently, those conflicts lead to the shrinking balance sheet, diminishing usefulness of accounting information and loss of accounting relevance, which adversely impact those dependent users related to Woolworths and various entities nowadays. Hence, the modifications for accounting standards are urged by many entities and users to settle the crux of the conflicts. Ultimately, it is concluded that disclosures of intangibles and recognition for intangibles are both worth attempting. Standard setters could ponder two changes on recognition: recognizing internally generated intangibles on the balance sheet at cost or fair value and recognizing R&D on the balance sheet at either cost or fair value. Furthermore, a practicable recommendation concerning the aforementioned problems and conflicts of existing accounting standards is proposed to the CFO of Woolworths. 2

Table of contents Executive summary

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1.0 Introduction

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2.0 Description of intangible assets in Woolworths.

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3.0 Evaluation of current accounting treatment

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3.1 Existing accounting treatment and standard for intangibles 3.2 Problems stem from IFRS 3.3 Conflicts - Existing accounting standards VS. Status quo of intangible assets 3.3.1

Fading usefulness of accounting information and Loss of accounting relevance

3.3.2

Shrinking Balance Sheet

4.0 Changes made to current accounting standards …………………. ………....... . 14. 4.1 Recognition and Measurement for Internally Generated intangible assets 4.1.1

Changes on Recognition

4.1.2

Measurement

4.2 Recognition and Measurement for Research and/or Development costs 5.0 Conclusion

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6.0 Recommendation

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Reference list

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1.0

Introduction

This report will place emphasis on the investigation of what changes should be pondered on the recognition and measurement of intangible assets, considering whether and how current accounting requirements restrain the recognition of intangibles in Woolworths. Then researchers would propose a feasible recommendation which can be taken to the focus group of AASB by the CFO of Woolworths. Presently, as Keys and Ardern (2008) expounded, intangible assets are progressively vital from the external financial reporting standpoint, which is characterised by their increasing prevalence and magnitude. Considerable entities across diversified industries are possessing more than one intangibles. However, existing accounting standards recognise those assets only when they are purchased, hence most of intangibles cannot be recognised in financial reports, forcing entities to estimate their order of magnitude circuitously. More importantly, the hallmark of modern economies is the dominance of intangibles as a value-creation vehicle and principal driver of competitive strength (Lev & Gu, 2016). Evidently, the archaic accounting standard before the rise to prominence of intangibles still rules accounting, which leads to irrelevant accounting and waning information usefulness for users in Woolworths. Consequently, standard-setters should make changes of internally generated intangibles to tackle the pervasive surging intangibles phenomenon.

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2.0

Description of Intangible assets in Woolworths

According to 3.4 Intangible assets of Financial report (Woolworths Annual Report, 2017), some intangibles are currently recognised by Woolworths while others are prohibited from recognizing owing to current accounting requirements. Researchers would emphasis on Financial Report 2017 of Woolworths with a glance at financial data in 2016. 2.1

Intangible assets that Woolworths presently recognises

2.1.1 Liquor, gaming license & other ( primarily customer relationships and property development rights)

1) Common ground As observed in Financial report 2017, there are three aspects need

attention:

Firstly, they rise from the acquisition of business of Woolworths. Secondly, the measurement is cost less accumulated amortisation and impairment losses (if any); In a business combination, cost denotes fair value at acquisition date. Lastly, in 2017, the ‘acquisition of business’ for those intangibles aggregates $2.4 million while ‘other acquisitions’ amount to $ 7.5 million.

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2) Liquor and gaming license It represents the legal permission to entitle the industries to conduct relevant transactions, which ensures the safe and accountable gaming and liquor environments (VCGLR1, n.d.).

3) Other (primarily customer relationships and property development rights) The former is commonly from contracts; besides, they could also arise from regular contact (IAS Plus, Jan 2012). For example, service representatives or daily sales in Woolworths. The latter are unexploited rights which allow developers to change their property. It mainly include activities of land purchase and development for facilities and buildings.

2.1.2 Goodwill in 2016

Based on AASB (2008), goodwill can be recognised as intangibles only when it is purchased through business combination since goodwill cannot be separated from the entity.

As per Woolworths Financial Report 2017, it is observed that: In 2016, the value of goodwill at acquisition date is $5.7 million. Furthermore, goodwill is generally characterised by the excess of cost paid during an acquisition which is over the fair value of the net identifiable

1 VCGLR: The Victorian Commission for Gambling and Liquor Regulation 6

assets acquired. After initial recognition, goodwill is measured at cost less accumulated impairment losses.

2.2

Intangible assets that the company is prevented from recognising in Woolworths

2.2.1 Brand names It denotes a name created by the producer to a product or variety of products, especially trademarks.

As the expenditure to form a brand name are instantly expensed and there exists no acquisition of business for it in Woolworths, which signifies that brand names are internally generated. Therefore, it cannot be recognized.

2.2.2 Customer list It is a list of previous consumers, which aims at assisting the company in building and maintaining business relationship then encourage customer loyalty. Commonly, it should be expensed because of the non-capitalization. Hence, the customer list of Woolworths would be prohibited from recognising due to the nature of internally generated intangibles. 2.2.3 Goodwill in 2017

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As the recognition of goodwill mentioned before, because there are no activities concerning acquisition of business of goodwill in 2017, therefore, it should be prevented from recognising. 3.0

Evaluation of current accounting standards

3.1 Existing accounting treatment and standard for intangibles

As per IAS 38 in IFRS (2004), intangibles are defined as identifiable nonmonetary asset with no physical substance and the following recognition criteria must be met: - There exist future benefits that probably flow into the entity; - The cost can be measured reliably.

Subsequently, intangibles following the recognition criteria are firstly measured at cost, afterwards exploiting the revaluation model, and systematically amortised throughout useful lives (IAS Plus, July 2012). As current IASB2 standards regulated, for those purchased in asset acquisition are recognized at price plus directly attributable cost; For those acquired in business combination, under IFRS 3 Business Combinations, they are recognized at fair value at acquisition date.

However, internally generated intangibles cannot appear in the balance sheet because it is argued that although they meet the assets’ definition, they fail to meet the recognition criteria.

Additionally, IFRS creates a distinction between R&D which is expenditures incurred within the “research phase” is required to be expensed while the other 2IASB: International Accounting Standards Board 8

would be recognized as intangibles if technical feasibility, ability to use or sell, existence of market and reliable measurement can be attested (Forgeas, 2008). However, the threshold for recognising development in IFRS is high and subjective (FASB: Invitation to Comment, 2016).

3.2 Problems stem from IFRS

Furthermore, Inconsistent accounting regarding intangible assets. The consistency of accounting is damaged as only purchased intangibles can be recognised as assets and put into balance sheet (W. Smalt, & McComb, 2016). This also reduces the comparability of intangibles. For instance, numerous intangibles, involving ongoing R&D, generally are recognized as intangibles in business combination whereas the costs of identical exertions outside the business combination are recognized as an expense. Most importantly, waning usefulness of accounting information and the loss of accounting relevance. Due to the prevention of recognising certain intangibles, financial statements are partial and missing information for those unrecognised. Since this problem is the crux of the matter and closely related to Woolworths and various entities nowadays, it will be expounded at length in subsequent discussion.

3.3

Conflicts - Existing accounting standards VS. Status quo of intangible assets

Nowadays, according to The Wall Street - Can the Tech Giants Be Stopped? (Taplin, 2017) states that Amazon, Google, Apple, Facebook, and Walt Disney occupy

enormous amount in market-capitalization. The common ground is that they all 9

‘intangible-rich’, which means their business models completely rely on intangibles (e.g. patents, brands, movie right). Additionally, the ascending tendency in mean market-to-book ratios 3 reveals the significance of unrecognised intangibles and can also be the evidence of the new economy (Keys & Ardern, 2008). Next, three principal conflicts will be elaborated.

3.3.1 Fading usefulness of accounting information and Loss of accounting relevance

Under the “new economy”, users of financial statement demand more information concerning intangible assets.

3 Market-to-book ratios: the ratio of market capitalisation to the carrying amount of

net assets of an entity. 10

Figure 8.1 The Intangibles Revolution. Adapted from Lev, B. & Gu, F. (2016). The End of Accounting and the Path forward for Investors and Managers. Hoboken, NJ: Wiley. 2.1.1 (3)

As portrayed in figure 8.1, the tangible investment rate presents a downtrend over the period, though the intangible investment rate illustrates an uptrend and remains growing. Essentially, this dramatic change can be elucidated in a persuasive reason: corporate value is increasingly stimulated by intangibles, whereas physical asset is only an enabler that all rivals have equal access to and therefore a trivial creator of value and competitive edge.

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Figure 8.2 The Decreasing Accounting Relevance. Adapted from Lev, B. & Gu, F. (2016). The End of Accounting and the Path forward for Investors and Managers. Hoboken, NJ: Wiley. 2.1.1 (3)

The steeply falling bars in figure 8.2 shows an obvious argument: the new market entrants are largely endowed with more intangible capital than their forerunners (up-sloping curve), and their accounting information’s relevance diminished severely based on current accounting standards. In a nutshell, the major cause of the corrosion in accounting information usefulness lies in intangible intensity.

From the observation abstracted from the two charts, despite the surge of intangibles to become the prime value creators of businesses, current accounting system fails to mirror the value of intangible assets in financial reports, fails to correctly account for their influence on companies’ operations, fails to offer

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information concerning the disclosure of these assets to risks of infringement and disruption to investors (Lev & Gu, 2016) Briefly, the failures of current accounting system conflict with status quo of intangibles and hence lead to the vanished accounting’s relevance and weakening usefulness of accounting information.

3.3.2 Shrinking Balance Sheet Actually, the shrinking balance sheet can also be deemed as a more specific manifestation of the waning information usefulness and diminished accounting relevance. It shares parallels with section 3.2.1. Based on present accounting standards, Intangible assets as the most valuable assets for most entities often cannot be recorded as an asset but be expensed as incurred, which would result in the huge deference between market value and book value (Orpurt, 2016) The ‘shrinking balance sheet’ situation applies to Coca-Cola Company. In CocaCola, the leading asset is the extremely valuable brand including its trademark not from its bottling plants or other PPE (Lev & Gu, 2016). Nevertheless, the Coca-Cola Company wrote-off a part of the internally generated intangibles to obey IFRS. Its 2015 Balance Sheet only records trademarks of $6.0 billion and PPE of $12.6 billion. Estimations of trademark and brand value aggregate $80.0 billion (Orpurt, 2016). As result, the users of Coca-Cola’s financial reports cannot possess relevant and accurate accounting information, as such, the information usefulness is sharply deteriorated.

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The same drawback of current accounting standards regarding shrinking balance sheet would certainly happen to users of Woolworths such as investors and creditors, followed by irrelevant accounting and weakening information usefulness.

Therefore, some changes for current accounting standards is required by most entities to address the surging intangibles phenomenon.

4.0 Changes made to current accounting standards

Considering the aforementioned problems and conflicts, substantial modifications in accounting and comprehensive reflection in financial reports are expected towards the dramatic rise of intangibles as the main creator of corporate value. Since the potential disparity occurs between financial statements and the information demands of investors and creditors, several experienced users have consistently urged the recognition and measurement for more intangible assets (FASB. Invitation to comment, 2016)

In brief, two standard-setting modifications could be pondered. One modification is regarding disclosures about internally generated intangible assets. Another modification is requiring recognition of intangible assets. The researchers will emphasize on the latter modification.

4.1 Recognition and Measurement for Internally Generated intangible assets As per (Keys & Ardern, 2008), pondering changes to the prevailing requirements 14

in IAS 38 for the initial accounting of internally generated intangible assets brings the supreme potential for enhancements.

4.1.1 Changes on Recognition Firstly, the definition of intangibles remains in accordance with AASB 1384. Besides, for the recognition criteria, current IAS 38 recognizes intangible assets only if there exist future benefits flowing into firm and the asset can be measured reliably; Costs associated with the development phase can be capitalized for internally generated assets and obey several rigid requirements (Siegel & Borgia, 2007). Hence, it could be suggested that for those internally generated intangibles, the standard-setters can divide them into a particular group in which all intangibles must be internally generated with the nature of uncertain future benefits and relatively subjective measurement. 4.1.2 Measurement 1) Recognition on the balance sheet at cost Under this technique, internally generated intangible assets could be initially recorded on the balance sheet at historical cost. This measurement could be cost-efficient in tackling the concerns of those shareholders who said that recognition would mirror their perception that intangibles create future economic benefits which are controlled by the entity and, thus, should be recognized as an asset. Moreover, some users also specified that recognition at cost would be a beneficial measure to calculate return on 4 IASB 138 Intangible Assets (para 8): An identifiable non-monetary asset without physical substance. 15

investment. 2) Recognition on the balance sheet at fair value In addition to measuring at cost, measurement of fair value on a recurring basis also could be considered by the standard-setters. Within this method, impairment or amortization would not need to be pondered. Though, this approach would be expensive to employ if a company had to regulate fair value on each reporting day. Some stakeholders preferred fair value; yet, some of those stakeholders have stated that the outcomes of the fair value measurement should not be covered in the income statement. It should be noted that standard-setters are commonly keen on fair value, the reason lies in that fair value can provides relevant and up-to-date information.

4.2 Recognition and Measurement for Research and/or Development costs According to FASB Invitation to comment (2016), a basic step concerning recognition of all or most intangibles on balance sheet is requiring recognition of research and/or development costs on balance sheet. The measurement is either at cost or at fair value. This method would resolve the concerns of those investors who declare that R&D is among the most essential assets not recognized on the balance sheet.

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5.0 Conclusion In conclusion, this research stresses on aiding the CFO of Woolworths in reacting to AASB towards what changes to be made on recognition and measurement of intangibles, pondering impacts of current accounting requirements on intangibles; then raise a suggestion for the CFO of Woolworths. Meanwhile, several conflicts between current accounting treatment and status quo of entities have been evaluated. Eventually, conclusion can be drawn that certain modifications for current accounting standards of intangibles are necessary to make. The reason is that the accounting standard for intangibles prevents the recognising of internally generated intangibles unless they are acquired, which incurred conflicts with the status quo of intangibles as the principal value-creator of corporate value. Those conflicts lead to the loss of accounting relevance, fading information usefulness and shrinking balance sheet. Accordingly, two changes are made: recognising internally generated intangibles and R&D respectively on the balance sh...