Can you check and advise me if there are anythings that needs to be corrected or added. Thank you!

Hi there,

I have an assignment due soon.

Can you check and advise me if there are anythings that needs to be corrected or added.

Thank you!

Mariko

Case Study

Two Rocks Ltd is a highly successful engineering company that manufactures filters for air-conditioning systems. Due to its dissatisfaction with the quality of the filters currently available, on 1 January 2017 it commenced a project to design a more efficient filter. The following notes record the events relating to that project.

Required

       i.           Explain how intangible assets are initially measured, and whether the measurement differs depending on whether the assets are separately acquired; acquired in a business combination; or internally generated by an entity.

(3 marks)

     ii.           Explain how costs incurred for research and development activities by Two Rocks Ltd between the months of January to June 2017 should be accounted for under NZ IAS 38. Please justify your decisions with reference to the criteria in NZ IAS 38.

(10 marks)

   iii.           Provide all the necessary journal entries to account for the events that occurred between January and June 2017 for Two Rocks Ltd (no narrations necessary).

(7 marks)

2017

January           Paid $145,000 in salaries of company engineers and consultants who directly and only conducted basic tests on available filters with varying modifications.

February         Spent $165,000 on developing a new filter system, including the production of a basic model. It became obvious that the model in its current form would not be successful because the material in the filter was not as effective as required.

March             Acquired the fibres division of Sand Hill Ltd for $330,000. The fair value of the tangible assets of this division were: property, plant and equipment $180,000; inventories $60,000.

                       This business was acquired because one of the products it produced was a fibrous compound sold under the brand name Foamy that Two Rocks Ltd considered would be excellent for including in the filtration process. By buying the fibres division, Two Rocks Ltd acquired the patent for this fibrous compound. Tow Rocks Ltd valued the patent at $50,000 and the brand name at $40,000 using a number of valuation techniques. The patent had a further 10 year life but was renewable on application. Further costs of $54,000 were incurred on creating the new filter system during March.

April               Spent a further $135,000 on revising the filtration process to incorporate the fibrous compound. By the end of April, Two Rocks Ltd was convinced that it now had a viable product because preliminary tests showed that the filtration process was significantly better than any other available on the market.

May                Developed a prototype of the filtration component and proceeded to test it within a variety of models of air-conditioners. The company preferred to sell the filtration process to current manufacturers of air-conditioners if the process worked with currently available models. If this proved not possible, the company would then consider developing its own brand of air-conditioners using the new filtration system. By the end of May, the filtration system had proved successful on all but one of the currently available commercial models. Costs incurred were $65,000.

June     Various air-conditioner manufacturers were invited to demonstrations of the filtration system. Costs incurred were $25,000 including $12,000 for food and beverages for the prospective clients. The feedback from a number of the companies was that they were prepared to enter negotiations for acquiring the filters from Two Rocks Ltd. The company now believe it had a successful model and commenced planning the production of the filters. Ongoing costs of $45,000 to refine the filtration systems, particularly in the light of comments by the manufacturers, were incurred in the latter part of June.

My assignment work:

Two Rocks Ltd.

Introduction:

Two Rocks Ltd is a leading engineering company specialising in filters for air-conditioning systems. To develop the quality of the filters to address its dissatisfaction and thereby improve future income for years to come, the company conducted a project to design a more efficient filer.

Section i: Measurement difference between intangible assets

NZ IAS 38 states that intangible assets are defined as identifiable non-monetary assets that cannot be seen, touched or physically measured. The measurement of an intangible asset is a considerable matter to an entity as it affects its profitability that appears on financial statements. However, not all intangible assets are recognised in statements. The recognition and measurement are determined by whether assets are internally generated or acquired by an external party. The accounting standard clarifies different measurements between assets; acquired separately, acquired as part of a business combination or internally generated.

According to the recognition and measurement clause in NZ IAS 38, an intangible asset should be measured initially at cost only when acquired from an external party. With intangible assets acquired separately, the cost includes purchase price less directly attributable costs of bringing the asset to working condition such as employee benefits, professional fees and testing cost. However, when intangible assets are acquired as part of a business combination, the rule changes. In this case, cost of assets should be its fair value at the acquisition date. An example can be seen in Two Rocks Ltd that acquired the fibres division of Sand Hill Ltd where the cost was measured at fair value of intangible assets such as patent for fibrous compound and brand name. This measurement complies with NZ IAS 38 33 which states "if an intangible asset is acquired in a business combination, the cost of that intangible asset is its fair value at the acquisition date." Deegan & Samkin, (2013) defines fair value as the price that would meet expectations of market participants that probability of future economic value deriving from the asset would be certain.

Internally generated intangible assets such as brand names, mastheads, publishing titles and customer lists cannot be recognised within an original entity, instead these assets should be expensed (Deegan & Samkin, 2013). Although these assets have been internally generated and developed to the extent that is very valuable when it is sold, these assets would not appear on statements of an original entity unless it is acquired by an external party. NZ IAS paragraph 64 states the reason that expenditure on internally generated intangible assets are unidentifiable from other resources.

·        

Section ii: Research and Development activities

This section explains how research and development costs incurred by Two Rocks Ltd between January and June 2017 should be accounted for under NZ IAS 38. According to the standard, the costs incurred for research and development fall into the category of internally generated intangible assets and require specific recognition criteria. The key determinant to account for the costs is whether the expenditure will give rise to future economic benefit and can be measured reliably.

January 2017

Two Rocks Ltd spent funds for salaries of the company engineers and consultants who conducted basic tests on available filters with various modifications. This cost should be expensed as incurred because the tests would aim at obtaining new knowledge to develop its current filters which falls into research activities. NZ IAS 38 54 and 55 state that research cost for an internal project should be expensed when it is incurred and if an entity cannot demonstrate whether the expenditure will give rise to future economic benefits. At this early stage, the company cannot determine that the expenditure will generate future income.

February 2017

The expenditure for developing new filter system should be expensed. This differs from the previous expense incurred in January because the cost was incurred from the development phase of an internal project. However, the unsuccessful result of using a basic model for the production does not meet the criteria for the recognition as an intangible asset under NZ IAS 38 57, which states that "the technical feasibility of completing the intangible asset so that it will be available for use or sale". Also, the use of ineffective material in the filter is inconsistent with "new or improved materials" stated in the paragraph 59 (d). Thus, the expenditure for internally developed new filter system would be expensed.

March 2017

The company acquired the fibres division of Sand Hill Ltd at fair value for a current asset of inventories, tangible assets of property, plant and equipment, and the patent and the brand name. According to NZ IAS 38 33, if an intangible asset is acquired as business combination, the cost should be assessed at its fair value at the acquisition date. The fair value reflects that buyers and sellers would agree on the transaction which implicit the probability of future economic benefits. Also, the use of valuation techniques to assess the purchase price by the company for the patent and brand name adequately demonstrates its reliability in measurement. Another key determinant is that a fibrous compound purchased under the brand name Foamy is considered to be an excellent item if it is included in the filtration process which means it would be very variable to the company. Whether intangible assets are capitalised depends on the probability of future economic benefits flowing to the entity, and the cost is reliably measured (External Reporting Board, 2018). Obviously, the patent and brand name would satisfy the recognition requirement to be capitalised on the statement of the company. Further costs incurred on creating the new filter system would still be expensed because the filtration process has not yet revised at this stage and the viability of the development has still appeared uncertain.

April 2017

The expenditures on revising the filtration process with the fibrous compound incorporated would be capitalised on the statement because the preliminary tests proved that the filtration process developed significantly and becomes superior on the market. Thus, this significant development is considered to satisfy all the recognition criteria stated under NZ IAS 38 57. Further to that, paragraph 59 (d) specifically states the development activities including the design and construction for new or improved materials, devices, products, processes and systems which applies to this case.

 May 2017

The successful results of the tests conducted within various models of air conditioners suggest that the developed filtration system is capable enough to use and sell on the market (External Reporting Board, 2018). Obviously, it is expected to provide future economic benefits to the company. Therefore, the expenditure incurred during the development and process of the new system would be capitalised on the statement.

June 2017

The costs of demonstrations of the filtering system conducted by the company and food and beverages for the prospective clients should be recognised as an expense. Paragraph 69 (c) of NZ IAS 38 includes "expenditure on advertising and promotional activities" which is applied to above costs. After the demonstrations, the company has successfully promoted the newly developed filters to many clients to the extent that future income appears certain. Thus, the ongoing costs subsequently incurred to refine the filtration systems should be capitalised on the statement.

Section iii: Journal Entries

January 2017  Dr       Salary Expense                                             145,000

                                   Cr       Cash                                                               145,000

February         Dr       Filter System Expense                                   165,000                      

                                   Cr       Cash                                                               165,000

March             Dr       Property, Plant and Equipment                     180,000

                       Dr       Inventories                                                      60,000

                       Dr       Patent (Intangible Asset)                              50,000

                       Dr       Brand Name (Intangible Asset)                     40,000

                                   Cr       Cash                                                               330,000

                       Dr       New Filter System Expense                                      54,000

                                   Cr       Cash                                                               54,000

April               Dr       Filtration Process (Intangible Asset)            135,000

                                   Cr       Cash                                                               135,000

May                Dr       Filtration Process (Intangible Asset)             65,000

Cr       Cash                                                               65,000

June                Dr       Demonstrations Expense                               13,000

                       Dr       Food and Beverages Expense                        12,000

                                   Cr       Cash                                                               25,000

                       Dr       Refined Filtration System (Intangible Asset) 45,000

                                   Cr       Cash                                                               45,000