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Accounting in Practice - Tangible Assets
Accounting in Practice - Tangible Assets
Accounting in Practice - Tangible Assets
Accounting in Practice - Tangible Assets
Accounting in Practice - Tangible Assets
Accounting in Practice - Tangible Assets
Accounting in Practice - Tangible Assets
Accounting in Practice - Tangible Assets
Accounting in Practice - Tangible Assets
Accounting in Practice - Tangible Assets
Accounting in Practice - Tangible Assets
Accounting in Practice - Tangible Assets
Accounting in Practice - Tangible Assets
Accounting in Practice - Tangible Assets
Accounting in Practice - Tangible Assets
Accounting in Practice - Tangible Assets
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Accounting in Practice - Tangible Assets

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A report on the use and implementation of IFRS accounting standards in regards to long term tangible assets with a focus on BAE Systems and Rolls Royce.

A report on the use and implementation of IFRS accounting standards in regards to long term tangible assets with a focus on BAE Systems and Rolls Royce.

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  • 1. Corporate Reporting With reference to the measurement of tangible non-current assets, critically evaluate whether financial statements prepared using IFRS’s provide useful information. Use specific examples from the annual reports of FTSE 100 companies to illustrate your points.Written byJason Cates
  • 2. © Jason Cates, 2012Reproduction for the following uses is authorised provided the source is acknowledged inline with the Copyright, Designs and Patents Act 1988;Private and research study purposes, performance, copies or lending for educationalpurposes, criticism and news reporting, incidental inclusion and copies and lending bylibrarians. Further details of authorised use under the above Act is available from the UKCopyright Service.This publication may be made available online at SlideShare.net/AdrJasonCates for publicuse no earlier than 09:00hrs (GMT) on 21 January 2013 as deemed appropriate by theacknowledged source.This paper has referenced appropriate sources in line with Harvard Referencing.Any queries regarding this publication should be sent to:AdrJasonCates@GoogleMail.com orLinkedIn.com/in/AdrJasonCatesTo be delivered to the University of Hertfordshire on or by3 December 2012Ordered by Jason Cates to be printed26 November 2012Printed in the United Kingdom 1
  • 3. Hans Hoogervorst, chairman of the IASB, said at the International Association for Accounting Education and Research conference in Amsterdam on 20 June 2012 that he “was struck by the multitude of measurement techniques that both IFRSs and US GAAP prescribe”.With reference to the measurement of tangible non-current assets, critically evaluatewhether financial statements prepared using IFRS’s provide useful information. Use specificexamples from the annual reports of FTSE 100 companies to illustrate your points. 2
  • 4. ContentsAim .......................................................................................................................................................... 4 Structure and Introduction ................................................................................................................. 4Comparison ............................................................................................................................................. 6 Fair Value vs. Historic Cost .................................................................................................................. 6 PPE (Valuation and Lifespan) .............................................................................................................. 6 Aircraft ................................................................................................................................................ 7 Conclusions ......................................................................................................................................... 8Implications ........................................................................................................................................... 10 Comparability .................................................................................................................................... 10 Relevance .......................................................................................................................................... 10 Reliability........................................................................................................................................... 11 Understandability ............................................................................................................................. 11Conclusions ........................................................................................................................................... 12Formalities ............................................................................................................................................ 13 Signatories......................................................................................................................................... 13 References ........................................................................................................................................ 14 Appendix ........................................................................................................................................... 15 Note 1 – Depreciation and Impairment for year ended 31st December 2011 .............................. 15 Note 2 –Percentage Calculations for Depreciation....................................................................... 15 3
  • 5. Part IAimThe aim of this paper is to evaluate the usefulness of financial statements prepared in line with theIFRS standards with a focus on the measurement of tangible non-current assets. This is in light of arecent statement made by Hans Hoogervorst, chairman of the IASB, stating that he “was struck bythe multitude of measurement techniques that both IFRSs and US GAAP prescribe”. (Hoogervorst,H., 2012)Structure and Introduction The above aim will be carried out by comparing the valuation techniques utilised by bothBAE Systems and Rolls-Royce in terms of their implementation of IAS 16 and IAS 36. At this point, it is appropriate that we define the term “useful” in the context of this paper.In this case, there are 4 key characteristics of usefulness. These are comparability, relevance,reliability and understandability. (Elliot & Elliot, 2012) The implications on these key characteristicsdue to differing interpretations of the IFRS standards will be evaluated later on in this paper. As stated, the companies utilised in this paper are BAE Systems and Rolls-Royce. This is dueto their comparability in terms of industry and types of asset held. This comparability will helpfacilitate the evaluation of their measurement of tangible non-current assets with a focus on howthey differ, why they differ and its effect on “usefulness”. (Bloomberg, 2012) BAE has total assets worth £23.101bn, £16.720bn in non-current assets and PPE worth £2.496bn(11% of total assets). (BAE, 2012) This is while Rolls-Royce has total assets worth £16.423bn,£8.108bn in non-current assets and PPE worth £2.338bn (14% of total assets). (Rolls-Royce, 2012) Allas at 31st December 2011. This shows BAE is the larger of the two companies in terms of total assets,but with both companies having relatively similar PPE figures. These figures and their treatment will 4
  • 6. be evaluated with a focus on their implications concerning “usefulness” under the 4 key aspectsmentioned earlier. This paper will then conclude by answering the question; do “financialstatements prepared using IFRS’s provide useful information?” 5
  • 7. Part IIComparisonFair Value vs. Historic Cost In relation to fair value vs. using historic value, the valuation method utilised depends on thenature of the business and the relevance each method has to the business. As stated above, PPEmakes up 11-14% of total assets. Therefore, the difference fair value accounting will have ontangible non-current assets is relatively immaterial. Thus, whichever method they utilise will havelittle impact on the key accounting ratios such as gearing and/or return on capital employed. Additionally, the benefits of using fair value may be outweighed by the costs involved, bothfinancially and in terms of being time consuming. This issue relates specifically to aircraft wherethere may be significant difficulty determining fair value during the “course of construction”. Assuch, the matters of cost and materiality are key issues when weighting the use fair value againstthat of historic cost.PPE (Valuation and Lifespan) As stated in BAE’s Annual Report 2011, “all fixed asset investments are stated at cost lessprovisions for impairments.” and “Depreciation is provided, normally on a straight-line basis, towrite off the cost or valuation of tangible fixed assets over their estimated useful economic lives”. Italso states that BAE considers its buildings to have an estimated life of “up to 50 years” and otherequipment to having estimated lives of “10 to 15 years”. Simply speaking, BAE values its “tangibleassets” at historic cost minus accumulated depreciation and impairment. (BAE, 2012) Additionally, Rolls-Royce’s annual report states that “Depreciation is provided on a straight-line basis to write off the cost, less the estimated residual value, of property, plant and equipmentover their estimated useful lives. No depreciation is provided on assets in the course of 6
  • 8. construction”. This is in line with BAE’s valuation policy, but the difference lies in the assignedlifespans of these non-current assets. (Rolls-Royce, 2012) In terms of property, BAE depreciates its buildings for “up to 50 years” with an average of 22years; Rolls-Royce on the other hand uses the life span of “five to 45 years” with an average of 21years. This apparently minor difference saw BAE’s depreciation charge £4M lower in 2011 than if ithad used the average lifespans utilised by Rolls-Royce. (Rolls-Royce, 2012) In terms of plant and equipment, Rolls-Royce’s policy is to depreciate these over “five to 25years” and at an average of 12.9 years in 2011. This is while the average for BAE in 2011 was 12.7years. This difference saw BAE’s depreciation charge £3M higher in 2011 than if it had used theaverage lifespans utilised by Rolls-Royce. (BAE, 2012) (Rolls-Royce, 2012)Aircraft Although inventory is generally considered a current asset, companies such as Rolls-Royceand BAE produce inventory that often takes more than a year to manufacture. In addition, Rolls-Royce leases out much of its inventory rather than selling it. As such, some inventory may becategorised as PPE. Therefore, how this inventory is valued is relevant when considering themeasurement of tangible non-current assets. (BAE, 2012) Both BAE and Rolls-Royce have included a separate category for “aircraft” in their PPE, butwith Rolls-Royce separating out completed aircraft and those “In Course of Construction” with bothcategories being treated differently. Both companies show their aircraft “In Course of Construction”simply at cost. Then once completed, these aircraft are then depreciated over their assigned lives.For BAE, this life is “up to 15 years” and Rolls-Royce, “five to 20 years” with an average of 16 years.Due to this difference in inventory lifespans, BAE’s depreciation charge was £8m higher in 2011 ascompared to the average lifespans used Rolls-Royce. (BAE, 2012) (Rolls-Royce, 2012) 7
  • 9. In addition, Rolls-Royce’s separation of complete and incomplete inventory allows users todetermine the effects this may have on the company’s short-to-medium term profitability. Thisrelates to the rate of depreciation being charged as well as the level of long-term inventory open tobeing leased out. (Rolls-Royce, 2012) However, in their 2011 annual report, BAE states that theytreat these two categories of inventory differently, but they fail to state how much inventory isassigned to each category. (BAE, 2012) This lack of transparency by BAE has a negative impact ontheir information’s usefulness.Conclusions In 2011, BAE depreciated its tangible non-current assets at a rate of 6.1% per year ascompared to 6.6% per year by Rolls-Royce. Therefore, in proportion to the total value of tangiblenon-current assets, it is Rolls-Royce who pays the higher level of depreciation. However in 2011, BAEcharged 14 times more impairment in proportion to its tangible non-current assets. (BAE, 2012)(Rolls-Royce, 2012) This difference in treatment comes down to the nature in which these companies operate.In the case of Roll-Royce, it tends of lease out long-term inventory to a greater extent than BAE.Thus, its future cash flows and inventory lifespans can be estimated more accurately. Due to thisincrease in accuracy, there may be less need for Rolls-Royce to impair its assets. (Rolls-Royce, 2012) This is unlike BAE who has to account for greater uncertainty while estimating future cashflows. This includes, among other things, uncertainty relating to the long-term value of it’s aircraft.Furthermore, BAE’s future cash flows may also be partially dependant on performance targets suchas delivery dates. This includes budget overruns and/or penalties for late delivery. Therefore, aircraftvalue and expected future cash flows may be lower than accounted for, thus leading to a greaterneed for BAE to impair such assets. However, these penalties can be measured relatively accurately,therefore leading to an accurate level of impairment being charged. (BAE, 2012) 8
  • 10. To conclude, in stable economic conditions, Rolls-Royce will see its profits impaired whencompared to BAE due to their higher rate of depreciation. However, in downward economicconditions, BAE may have to impair the value of its assets to a greater extent than Rolls-Royce due toits higher book value of its assets. This will make BAE appear to be fairing comparably worse off insuch economic downturns, but “better off” in more stable economic conditions. This is in spite of thefact that in reality, both companies may be facing very similar trading conditions, but have simplyrecognised this differently in the accounts. 9
  • 11. Part IIIImplications This paper will now consider how the above treatment of tangible non-current assets affectsthe usefulness of information provided by companies such as BAE Systems and Rolls-Royce.Comparability This issue of comparability, or lack of, has been a continuing theme throughout this paper.As stated, the difference in the way the two companies discussed operate has brought about adifference in their accounting policies. As stated, although both companies’ value assets usinghistoric cost, difference arises in relation to the lifespans they assign these assets as well as the levelof impairment each asset then incurs throughout its life. This reduces the comparability of theiraccounts and thus hinders their usefulness to users. (BAE, 2012) (Rolls-Royce, 2012)Relevance It can be argued that in order to be relevant, accounts should be tailored to the company inwhich they represent, sometimes at the expense of comparability. Again, this has been a continuingtheme throughout this paper. By allowing the companies the flexibility to tailor the standards, theinformation provided by these companies then becomes more relevant, but less comparable.Therefore, a balance has to be struck between these two sometimes conflicting issues in order forthe information provided to be considered “useful”. An example of this is aircraft valuation. Rolls-Royce depreciates its aircraft over 25 years andin 2011; saw impairments of £2m (0.46% of cost). In comparison, BAE depreciates its aircraft over 15years and saw impairments of £14m (1.44% of cost) in the same year. This lower rate of depreciationand impairment seen at Rolls-Royce reflects the nature of their operations in terms of leasing out 10
  • 12. aircraft to a far greater extent than BAE. This increases relevance, but hinders comparability. (BAE,2012) (Rolls-Royce, 2012)Reliability Due to the difference in treatment of similar assets by both companies discussed in thispaper, this leads to the question as to whether their treatment of such assets is reliable. In terms ofBAE, the fact that they are having to impair their assets, namely their aircraft, much more so thatRolls-Royce shows that their depreciation policy may not be as reliable as that of Rolls-Royces. (BAE,2012) (Rolls-Royce, 2012) This may be due to greater certainty as to Rolls-Royces future cash flowsdue to leasing out aircraft rather than selling them on. Thus, reliability depends on the nature of the company and to what extent they canaccurately value such tangible non-current assets.Understandability In terms of understandability, although minor differences do exist between these twocompanies, their implementation of IFRS standards does remain relativity similar. This will helpfacilitate understandability for those who are accustomed to analysing such information. However, ifcompanies do diverge in their implementation of the IFRS standards, a lack of transparency willhinder the information’s understandability to readers, thus hindering the information’s usefulness tostakeholders. 11
  • 13. Part IVConclusions To conclude, in regards to tangible non-current assets, information provided in line with theIFRS standards can provide useful information. However, the degree of this usefulness depends onwhich qualitative characteristic is more relevant to the given situation. This is due to different qualitative characteristics applying in varying degrees in differentsituations. These differences increase the risk of potential conflict arising between these qualitativecharacteristics and in such cases, which qualitative characteristic should take precedence? These potential conflicts continue to hinder the usefulness of information. Further guidanceis therefore required for companies on how to overcome these conflicts. This may require adaptingor adding to the current IFRS standards in order to better facilitate this “conflict resolution”. Thismay include, but not exclusively, ranking the qualitative characters in order of precedence. This willallow companies to focus on the characteristics that best promote “usefulness” as outlined in thispaper. 12
  • 14. Part VFormalitiesSignatoriesI commend this paper to the University of Hertfordshire to be delivered on or by 26 November 2012.Jason Cates ___________ Mail: AdrJasonCates@GoogleMail.com Portfolio: SlideShare.net/AdrJasonCates LinkedIn: LinkedIn.com/in/AdrJasonCates 13
  • 15. References(In line with Harvard Referencing)BAE Systems (2011) Annual Report 2011. [Online] Available at:http://www.baesystems.com/cs/groups/public/documents/document/mdaw/mdu2/~edisp/baes_045566.pdf [Accessed: 14th October 2012]Bloomberg (2012) Aerospace/Defence Companies. [Online] Available at:http://www.bloomberg.com/markets/companies/aerospace-defense/ [Accessed: 16th October2012]Elliot, B. & Elliot, J. (2012) Financial Accounting and Reporting. 15th edn. Malaysia: Pearson.Rolls Royce (2011) Annual Report 2011. [Online] Available at: http://www.rolls-royce.com/Images/RR_full_AR_2011_tcm92-34435.pdf [Accessed: 14th October 2012]Hoogervorst, H. (2012) The imprecise world of accounting. [Online] Available at:http://www.ifrs.org/Alerts/Conference/Documents/HHoogervorstJune2012theimpreciseworldofaccounting.pdf [Accessed: 2nd October 2012] 14
  • 16. AppendixNote 1 – Depreciation and Impairment for year ended 31st December 2011 Land & Plant & BAE Systems £Millions Buildings Machinery Aircraft Total Cost 2195 2551 759 5505 Depreciation 101 201 34 336 Impairment 29 - 14 43 (BAE, 2012) Land & Plant & Rolls Royce £Millions Buildings Machinery Aircraft Total Cost 806 2387 439 3632 Depreciation 39 185 15 239 Impairment - - 2 2 (Rolls-Royce, 2012)Note 2 –Percentage Calculations for DepreciationBAE - Depreciation as a Percentage of Cost for 2011 (£Millions)Land & Buildings 101/2195 4.6%Plant & Machinery 201/2551 7.9%Aircraft 34/759 4.5%Total 336/5505 6.1% (BAE, 2012)Rolls Royce - Depreciation as a Percentage of Cost for 2011 (£Millions)Land & Buildings 39/806 4.8%Plant & Machinery 185/2387 7.8%Aircraft 15/439 3.4%Total 239/3632 6.6% (Rolls-Royce, 2012) 15

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