Question

A new accountant has been appointed to the firm of Catherine Ltd, which is a reporting entity that prepares general purpose financial statements according to the AASB standards. This company owns a large number of depreciable assets. Upon analyzing the entity’s current depreciation policy, which is based on straight line depreciation method the accountant realized that financial statements prepared by the entity do not show the true and fair view of company’s financial position. He, with the approval of the board, implemented a new policy based on the diminishing balance method assuming that company assets would reflect the realizable value.  

Required

You are required to discuss this policy change.

In your report:

1. Explain depreciable assets and describe what assets constitute property, plant and equipment in accordance with AASB 116?
2. Explain the recognition criteria for property, plant and equipment.
3. How does an entity choose between depreciation methods, for example, straight-line versus diminishing-balance methods in accordance with Para 60 of AASB 116?
4. Explain which of the two depreciation methods provides the true and fair view of financial position and financial performance of Catherine Ltd.’s financial statements.

Answer 1

1. Explain depreciable assets and describe what assets constitute property, plant and equipment in accordance with AASB 116?

Ans. A depreciable asset is an asset that provides financial benefit for more than one accounting period and have lifespan of more than one period and are considered as operating expenditure. These assets are depreciated over multiple years for reduction in book value. The examples of depreciable assets are land, building, plant & machinery etc. In accordance with AASB 116, examples of PP&E (property, plant and equipment) includes machinery, land, land & building, vehicles, furnitures & fixtures, office equipment etc. These are tangible long term assets for a business firm falling under the head tangible fixed assets in balance sheet of a firm.

2. Explain the recognition criteria for property, plant and equipment.

Ans : As stated above these are long term assets for the firm bearing a life span of more than one period. These assets provide future economic benefit to a firm. These assets are also depreciated over the useful life of assets to spread the cost of assets over its entire life. The second recognition criteria is that the cost of the assets should be economically measurable.

3. How does an entity choose between depreciation methods, for example, straight-line versus diminishing-balance methods in accordance with Para 60 of AASB 116?

Ans: In accordance with Para 60 of AASB 116, a firm chooses the depreication method that most closely shows the expected consumption pattern of the asset to generate future economic benefits. The depreciation method is not changed unless and until there is a change in future consumption pattern of the assets.

4. Explain which of the two depreciation methods provides the true and fair view of financial position and financial performance of Catherine Ltd.’s financial statements.

Ans: For Catherine Ltd.'s financial statements, Straight line method of depreciation will provide the true and fair view of financial position and financial performance. It is a consistent method with fewer errors. It has a good transition from company's income statement to income tax returns. It generates simplicity in the calculation of depreciation amount with higher level of consistency