Question

1) Explain why the impairment of intangible assets causes such difficulty to companies when preparing their accounts.

2) Explain why comparative information is required to be provided in the financial statements.

3)

The following information is provided concerning the accounts of Jazzy Ltd.

You are asked to identify how each of these items is shown in the financial statements.

(a)	gain on revaluation of available-for-sale investments
(b)	dividends paid during the year
(c)	revaluation gain on building (not reversing any previous revaluation)
(d)	transfer to dividend equalisation reserve
(e)	Unsecured notes issued

Answer 1

Solution

1. why the impairment of intangible assets causes such difficulty to companies when preparing their accounts.

Intangible assets with indefinite useful life (including goodwill) are tested for impairment at least annually and others are tested when there are indications of impairment such as legal restrictions, business restructuring, development of new technology, economic changes, etc.

Under US GAAP, impairment test for intangible assets with finite useful life is the same as that for a tangible fixed asset, i.e. it involves the following steps:

• comparing the carrying value with the sum of undiscounted cash flows and
• where the carrying value exceeds the sum of undiscounted cash flows, recognizing any excess of carrying value over the fair value of the asset as the impairment loss.

Under IFRS, comparison is made between the carrying amount of the asset and the higher of fair value (less cost to sell) and value in use and any excess is recognized as impairment.

The impairment test for intangible assets with indefinite useful life is a little different because the sum of their undiscounted cash flows is theoretically infinite. They are reviewed for impairment at least annually by comparing their carrying value with their fair value and recognizing any impairment loss equal to the amount by which carrying value exceeds fair value.

Impairment test for goodwill is more complex. The goodwill is first allocated to different units of the business and each unit is tested for impairment individually and the whole impairment loss is then aggregated.

2. why comparative information is required to be provided in the financial statements.

Comparative financial statements are the complete set of financial statements that an entity issues, revealing information for more than one reporting period. The financial statements that may be included in this package are:

• The income statement (showing results for multiple periods)
• The balance sheet (showing the financial position of the entity as of more than one balance sheet date)
• The statement of cash flows (showing the cash flows for more than one period)

Another variation on the comparative concept is to report information for each of the 12 preceding months on a rolling basis. Comparative financial statements are quite useful for the following reasons:

• Provides a comparison of an entity's financial performance over multiple periods, so that you can determine trends. The statements may also reveal unusual spikes in the reported information that can indicate the presence of accounting errors.
• Provides a comparison of expenses to revenues and the proportions of various items on the balance sheet over multiple periods. This information can be useful for cost management purposes.
• May be useful for predicting future performance, though you should rely more on operational indicators and leading indicators than on historical performance for this type of analysis.

It is customary to issue comparative financial statements with additional columns containing the variance between periods, as well as the percentage change between periods.

3.

a. Gain on revaluation of available-for-sale investments

An available-for-sale security (AFS) is a debt or equity security purchased with the intent of selling before it reaches maturity or holding it for a long period should it not have a maturity date. Accounting standards necessitate that companies classify any investments in debt or equity securities when they are purchased as held-to-maturity, held-for-trading, or available-for-sale. Available-for-sale securities are reported at fair value; changes in value between accounting periods are included in accumulated other comprehensive income in the equity section of the balance sheet.

b. Dividends paid during the year

The dividends declared and paid by a corporation in the most recent year will be reported on these financial statements for the recent year:

· statement of cash flows as a use of cash under the heading financing activities

· statement of stockholders' equity as a subtraction from retained earnings

Dividends that were declared but not yet paid are reported on the balance sheet under the heading current liabilities.

Dividends on common stock are not reported on the income statement since they are not expenses. However, dividends on preferred stock will appear on the income statement as a subtraction from net income in order to report the earnings available for common stock.

c. Revaluation gain on building (not reversing any previous revaluation)

Revaluation gains are recognised in equity unless they reverse revaluation losses on the same asset that were previously recognised in the income statement. In these circumstances, the revaluation gain is recognised in the income statement. Revaluation changes the depreciable amount of an asset so subsequent depreciation charges are affected.

d. transfer to dividend equalisation reserve

Dividend equalisation reserve is a specific, voluntary, revenue reserve to be disclosed under Reserves and surplus.

e. Unsecured notes issued

A common scenario for a short-term notes payable would involve the borrowing of money in exchange for the issuance of a note payable, would appear in the current liability section of the balance sheet .