Reference no: EM132723848
Explore Enterprises Ltd, a listed company, commenced a research and development (R&D) project in July 2019 to modify the method of recharging batteries used in its products. The project was successfully completed in June 2020 and the company applied for a patent for the design.
Explore Enterprises Ltd plans to modify all products in its consumer range over the next two years and has incorporated these plans into its financial budget. The entity expects to derive economic benefits from the new battery recharging technology over the next 10 years.
The accountant was unsure how to account for the project so they used the New Project R&;D account to accumulate the salaries of all engineers involved in the project during the year ended 30 June 2020. The following analysis of the salaries expenditure is based on the engineers' time sheets.
- Cost of time spent searching for and evaluating alternative materials $150 000
- Cost of time designing models, and constructing and testing prototypes $1 050 000
- Cost of time spent on training maintenance workers for the new design $300 000
- The value in use of the design, estimated using present value techniques, is $6 000 000. However, the fair value of the design is estimated to be only $4 500 000 because the only potential buyer would need to modify the design to adapt it to its own products.
The following conversation took place between the chief executive officer (CEO) and the accountant (ACC).
CEO: That 'R&D asset' should make our financial statements look great this year. We can show it is worth $6 000 000 in the balance sheet and add an extra $4 500 000 to profit because it cost only $1 500 000.
ACC: haven't finalised accounting for it yet but quite sure the accounting standard requires us to measure it at historical cost, and some of it will probably have to be recognised as an expense.
CEO: It isn't fair. These conservative accounting rules make it impossible to show investors that our project was successful - and expensing any of it will cause our share price to go down because the investors will think it didn't work.
Required:
Problem 1. How should the project be accounted for in the financial statements for the year ended 30 June 2020? Justify your answer with reference to relevant paragraphs of AASB 138/IAS 38.
Problem 2. To what extent might the rules or restrictions in AASB 138/IAS 38 reduce the comparability of financial statements?
Problem 3. Writing a response to the CEO, drawing on your understanding of AASB 138/IAS 38 and the efficient market hypothesis. Include a recommendation as to how the company might mitigate their concerns about investors' interpretation of the information reported in the financial statements.