Dick Smith Holdings Limited - Case Study Example

Table of Contents Table of Contents 1 Abstract 2 Introduction 2 Assets and their measurement criteria 3 Assets and the problem of additivity in the context of the present IASB framework 4 Categorization and treatment of assets in the annual report of Dick Smith Holdings limited 6 The relationship between asset measurement and decision useful information; 8 Conclusion 9 References: 11 Abstract The issue of assets and the criteria for their measurement cannot be overemphasized. The asset measurement base adopted by the company should lead to accurate results if it is to lead to decision useful information. Such information free of errors is useful to the users and stakeholders if they are to make informed investment decisions. This paper looks at what assets are as well as the various criteria available for measuring assets. The paper then looks at the asset additivity problem with regard to the current IASB framework. The additivity problem is found to originate from internally generated goodwill. The paper then analysis the categorization and treatment of various assets in Disk Smith Holdings Limited balance sheet for the year 2014. Finally, the relationship between measurement and decision useful information is examined in detail. Dick Smith Holdings annual report is used for this purpose. It is concluded that organizations ought to apply the right measurement methods accurately if they are to have decision useful information for their decision making purposes. Introduction This paper uses Dick Smith Holdings limited in analyzing the issue of asset measurement and the non additivity problem of assets in respect to IASB provisions. Dick Smith Holdings limited is a leading retailer of consumer electronics having 377 stores across Australia and New Zealand and is the largest store by store footprint (ASX, 2014). In analyzing the issue of assets measurement, various criteria for measuring assets including historical cost and current value measurement bases are explained. The problem of additivity in accounting is also discussed. In this regard, the fair value of a class of assets is noted not to be equal with the total sum of the fair values of the firms’ individual assets. The difference and hence the additivity problem of assets results from internally generated goodwill. The paper also looks at the classification of assets in Dick Smith Holdings balance sheet. The relationship between asset measurement and decision useful information is also examined with respect to Dick Smith Holdings Limited’s annual report. Assets and their measurement criteria “It is surprising and distressing to find so little discussion of the total asset figure in the accounting literature. Since total assets is one of the central concepts of accounting, one would expect to find a good deal of explanation and interpretation.” In regard to this statement, the term assets refer to the economic resources or things that are tangible or intangible that can be owned or controlled to produce value and which is believed to have positive economic value to the firm or individual. In other words, an asset is a representation of value of ownership which can be converted into cash. In its statement of accounting concepts, the accounting standards board (2014) defines an asset as the future economic benefit controlled by the entity resulting from past transactions and past events. It means that for the resource to qualify to be an asset, the entity must have the capacity to benefit from it in its pursuit of its objectives while denying or regulating the access of others to the benefit. Based on the above definition, organizations need to recognize and measure the value of the resources they control in a bid to gauge their ability to help them achieve their objectives and also for the purposes of reporting their net worth to the stakeholders. Various methods of measuring the value of assets exist. IFAC provides the following criteria for measuring the value of assets; a) Historical cost basis Using these criteria, the entity initially reports the asset at the original cost incurred on the asset’s acquisition and includes the related transactional costs. After the initial recognition, the cost is allocated as an expense in form of depreciation for certain assets depending on the service potential of the assets as they are consumed in subsequent periods (Deloitte, 2014). Thus, the measurement of the asset is not changed to reflect changes in price. However, the amount of asset may be reduced through recognition of impairments while it may be increased to reflect any cost additions and enhancements including accrual of interests on the asset. b) Current value measurement bases Under this criterion, several methods exist including; i) Market value- under this base, the asset is measured on the basis of the amount for which the asset could be exchanged between knowledgeable and willing parties at an arm’s length transaction at the reporting date (International accounting standards board (IASB), 2013). This could be the same as historical cost where transaction costs are ignored. ii) Replacement cost- under this method, the entity uses the most economic cost required for it to replace the service potential of the asset at the reporting date in measuring the value of the asset. iii) Net selling price- under the method, the entity uses the amount that it can obtain from selling the asset at the reporting date after the cost of sale has been deducted in measuring the value of the asset (Ifac.org2012). iv) Value in use- in this case, the present value at the reporting date to the entity of the assets remaining service potential and economic benefits where it continues to be used and of the net amount the entity is likely to receive from its disposal at the end of the assets useful life is used in measuring the value of the asset. It should be noted that the above methods would not be ideal for measuring the value of assets in all situations. As such, the measurement basis selected will to a large extent depend on the kind of asset being measured and the evaluation of the extent to which it contributes to the objectives of financial reporting. Assets and the problem of additivity in the context of the present IASB framework It is a widely held fact that fair value measure is not additive implying that the fair value of a set of assets is not equal to the sum of the fair values of each asset. It should be noted that the firm consists of several independent assets and hence the firm cannot be appropriately measured through the summation of the fair values of its identifiable assets (International accounting standards board (IASB), 2010). The excess value of the firm over the sum total of the fair values of its identifiable assets is known as internally generated goodwill. In other words, the problem of additivity of assets in accounting is best explained to result from internally generated goodwill. As such, the issue of accounting for internally generated goodwill and hence additivity problem presents a great valuation problem that involves all of the firm’s resources that contribute to its profitability. Thus, this explains the additivity issue in accounting. Many accounting standards have raised the issue of non additivity in accounting with firms being required to compute the total fair value of each reporting unit every year in a bid to test goodwill allocated to the reporting units for impairment (ASC 350 and IASB 38). IASB has stated that computation of the overall value of a reporting unit through simply aggregating the values of the assets that make up the unit in inappropriate since the overall value of the firm could differ from the fair value of the firm’s components (European accounting association, 2014). As such, the firm should use an overall approach in computing the total value of a reporting unit in the absence of a quoted market price. The requirement to apply an overall method in computing the value of a set of assets for impairment tests is an indication of the additivity issue at the reporting level as identified above. The internally generated goodwill that results from the additivity problem is an indication of the firm’s ability as an individual business to earn higher rates of return on an organized collection of net assets than it would were the assets to be acquired separately (Zanoni, 2009). The additivity problem and hence the internally generated goodwill arises from the synergy between the assets in place organized into a specific system. IASB 38 proposes a number of criteria for measuring the value of internally generated goodwill. Internally generated goodwill can be valued using the direct approach in which the unrecorded goodwill is taken to be equal to the expected present value of abnormal earnings under the residual income formula. On the other hand, the indirect method involves the subtraction of the fair values of the firm’s assets from its enterprise value in the case of business combinations. In this case, enterprise value implies the market value add total debts less cash (Johansen, 2011). As such, it should be recognized that the additivity problem in accounting exists owing to the fact that fair value measure is not additive and the problem arises from the internally generated goodwill for the firm. Categorization and treatment of assets in the annual report of Dick Smith Holdings limited Overview of the company The company is a leading retailer of consumer electronics having 377 stores across Australia and New Zealand and is the largest store by store footprint. The company has 283 Dick Smith stores in Australia, 29 David Jones Electronics powered by Dick Smith stores and 4 move stores. In New Zealand, Dick Smith has 61 Dick Smith stores. This puts the company in the top three with its revenue excessing $1.3 in 2014. The company attained a profit of $42.1 million in 2014 while it employs more than 3500 people. The company’s balance sheet for 2014 revealed that the company had total assets amounting to $335,906,000, total non-current assets amounting to $115,265,000. On the other hand, the company had total current liabilities amounting to $266,807,000, total long-term liabilities amounting to $17,424,000 and total owners’ equity amounting to $166,940,000 in the year 2014. The company has classified its assets in the balance sheet as follows; a) Current Assets These are the assets that are reasonably expected to be sold, consumed or exhausted in the normal operations of the business within the current fiscal year or operating cycle. In this category, the company has classified the following assets (Dick Smith Holdings Limited, 2014); i) Cash and cash equivalents- these amounted to $29,944,000 in the year 2014. Cash and cash equivalents represent the value of the company’s assets that are cash or that could be converted into cash immediately. For Dick Smith Holdings, cash and cash equivalents included cash on hand and in banks and other financial institutions net of outstanding bank overdrafts. In this regard, cash on hand amounted to $792,000 while cash at bank amounted to $29,152,000. Asset type Amount 2012 Amount 2013 Current assets Cash and cash equivalent $29,944,000 $46,538,000 Trade and other receivables $46,668,000 $10,404,000 Inventories $253,814,000 $170,796,000 Financial assets - $5,633,000 Other current assets $5,460,000 $7,834,000 Total current assets $335,906,000 $241,205,000 Figure 1 depicting Dick & Smith Current assets (Dick and Smith, 2013) ii) Trade and other receivables –These represent the receivables that are expected to be received within the current period of operations. In this regard, trade receivables amounted to $8,984,000 while other receivables amounted to $37,704,000. iii) Inventories – these represents the goods and materials that the company held for the ultimate goal of reselling and hence generating profit. In this regard, Dick Smith Holdings had inventories amounting to $253,814,000 iv) Financial assets – these are assets that derive value owing to a contractual claim. They include bank deposits, bonds, stocks and similar assets. During the year 2014, Dick Smith Holdings did not have any financial assets on its balance sheet. v) Other current assets – Dick Smith Holdings ltd had other assets amounting to $5,460,000 in its year 2014 balance sheet. These were composed of prepayments amounting to $3,439,000 and current tax prepayments amounting to $2,021,000. b) Non-current assets These are the company’s long-term investments in that their full value will not be realized during the current accounting period. Such assets are capitalized as opposed to being expensed (International accounting standards board (IASB), 2009). This implies that the company allocates the cost of the asset over the number of years for which the assets will be used as oppose to allocating the entire cost to the accounting year the asset is purchased. The companies noncurrent assets included in Dick Smith Holdings budget for the year 2014 included; i) Plant and equipment- Dick Smith Holdings Limited’s plant and equipment for the year 2014 amounted to $78,764,000. The plant and equipment had an opening balance of $67,554,000 while the company undertook additions amounting to $30,523,000 as well as disposals amounting to $2,050,000 during the year. The company’s accumulated depreciation; amortization and impairment on the other hand amounted to $18,534,000. Long-term assets 2013 2014 Plant and Equipment $78,764,000 $60,259,000 Total non-current assets $36,501,000 $42,881,000 Figure 2 depicting Dick & Smith non-Current assets (Dick and Smith, 2013) ii) Deferred tax asset – the company’s deferred tax asset amounted to $36,501 in the year 2014. This is an asset on the company’s balance sheet that could be used in reducing any subsequent period’s income tax expenses. Deferred tax assets usually arise for a number of reasons including net loss carryovers. However, they are only recorded as assets where it is deemed more likely than not that the asset will be used for offsetting tax in the future fiscal periods. For Dick Smith Holdings limited, deferred tax resulted from provisions and tax losses. c) Total assets This is the summation of the current assets and the noncurrent assets. The company’s total assets in 2014 amounted to $451,171,000. The relationship between asset measurement and decision useful information; One of the objectives of measuring a firm’s assets is to enable the firm make informed investment decisions. Firms should ensure that the measurement methods they employ are decision useful. Two types of assets are used by the firm in generating value. They include in-exchange assets such as cash that generate value on a stand-alone basis as well as the in use assets such as plant and equipment which generate value in combination with other assets. The basis of asset measurement whether based on fair value or historical cost greatly depends on the manner in which the asset generates value. Based on IAS 16, firms should measure their plant and equipment at historical cost while fair value measurement should be used on other assets. For instance, Dick Smith Holdings Limited measures its assets on the basis of historical cost though certain non-current assets and financial instruments are measured at revalued amounts or fair values. Plant and equipment are measured at cost less accumulated depreciation and accumulated impairment losses to date (Adrienna, 2013). In this regard, leasehold improvements and plant and equipment are depreciated over a 5-10 years period while IT equipment is depreciated over 3-5years period. It is worth noting that the asset measurement basis employed by the firm should be accurate if it is to result in decision useful measurement and hence decision useful information. This has been demonstrated in the way Dick Smith Holdings Limited presents its financial report with their basis of measurement of their assets clearly explained. In accordance with the joint conceptual framework by both the financial accounting standards board as well as the international accounting standards board, financial information will be decision useful if it helps the user in forecasting the amount, timing and uncertainty of the entity’s future cash flows. As such, the asset measurement basis used by the firm should lead to decision useful information. As discussed above, Dick Smith Holdings Limited uses a measurement method that links the assets to the manner in which they realize value for the firm (International accounting standards board (IASB), 2008). Thus, this provides decision useful information to the users including investors who are able to see how the company is performing and hence they are able to make informed investment decisions regarding the company. On the other hand, the company can be able to make informed expansion decisions which may include financing or borrowing decisions. For instance using the financial measurement criteria discussed above, Dick Smith Holdings limited management was able to declare an 8 cents dividend to the shareholders while pursuing its expansion strategy (Barth, 2005). These decisions would require accurate information and as such, the measurement method used has to provide decision useful information to the company if the management is to make such decisions which directly affect the welfare of the company. Conclusion This paper has discussed the term asset as being the economic resources held or capable of being controlled by the firm for the purpose of deriving economic benefits. The various methods available for assets measurement have also been discussed. These include the historical cost method as well as the various fair value asset measurement criteria. The term asset and the problem of additivity in the context of the present IASB has also been discussed. The problem has been noted to originate from the internally generated goodwill for the firm while various measurement alternatives have been discussed. Dick Smith Holdings Limited has been used in evaluating the categorization and treatment of various assets in the balance sheet. Various categorizations of assets have been discussed including current assets and non-current assets have been discussed in detail. Finally, the relationship between asset measurement and decision useful information with reference from Dick Smith Holdings Limited year 2014 annual report has been discussed at length. The need for the company to employ the right measurement criteria accurately has been seen as important. This is because measurement information ought to be accurate and hence decision useful. This will enable it to be decision useful so that its users can make quality and informed decisions. References: Deloitte, 2014, IAS 39-Financial instruments recognition and measurement, Retrieved on 5th September 2014, from; http://www.iasplus.com/en/standards/ias/ias39 Ifac.org2012, Conceptual framework exposure draft 3, Retrieved on 5th September 2014, from; http://www.ifac.org/sites/default/files/publications/files/Conceptual%20Framework%20Exposure%20Draft%203%20FINAL%20November%208,%202012_0.pdf ASX2014, Dick Smith Holdings Limited (DSH), Retrieved on 5th September 2014, from; http://www.fool.com.au/tickers/asx-dsh European accounting association, 2014, A review of the conceptual framework for financial reporting, Retrieved on 5th September 2014, from; http://www.efrag.org/files/Conceptual%20Framework%202013/Comment%20letters%20 receiv ed/DCL/CL15_-_EAA.pdf Johansen, B2011, Non-additivity in accounting valuation: Internally generated goodwill as an aggregation of interacting assets, University Paris-Dauphine. Adrienna, A2013, Decision useful asset measurement and asset use: Evidence from IAS 41, London, Rutledge. International accounting standards board (IASB), 2008, Exposure draft: An improved conceptual framework for financial reporting, London, UK IASB. International accounting standards board (IASB), 2009, International accounting standard 41, London, UK: IASB. International accounting standards board (IASB), 2010, Conceptual framework for financial reporting, 2010, UK: IASB. International accounting standards board (IASB), 2013, Discussion paper: A review of the conceptual framework for financial reporting, London, UK: IASB. Zanoni, A2009, Accounting for goodwill, New York, Tailor & Francis. Barth, M2005, Accounting based valuation models and the prediction of equity values, Journal of Accounting, Auditing & Finance, vol. 20, no. 4, pp. 311-345. Dick Smith Holdings Limited, 2014, Annual report 2014, retrieved on 5th September 2014, from; http://dicksmithholdings.com.au/wpcontent/uploads/2014/09/DKS0006_AR_PFO2_Low_res_version.pdf Read More