Accounting Theory & Issues Bio-Sustainable Feeds (BSF) Ltd

Question: Describe about the Accounting Theory Issues for Bio-Sustainable Feeds (BSF) Ltd . Answer: Introduction In the recent years, the focus of the organizations on the research and development activities has been more than ever before. The organizations are spending a lot of money on researching new products and finding new ways of doing business. The primary objective of undertaking a research is to explore something new and unique that the other organizations do not have (ACCA, 2016). The benefits of the research are not one time; the organization is benefited over the number of years. For the accounting purposes, it is an issue that the benefits of the research accrue over the number of periods. Due to the accrual of the benefits over the number of periods, the expenses incurred on the research and development activities are not immediately written off in the income statement. Thus, it becomes necessary for the organizations to capitalize the appropriate proportion of the research and development expenses and recognize that as an asset in the books of accounts (Weygandt, Kimmel, and Kies o, 2009). In the above context, a report has been presented here that focuses on the accounting treatment of the research and development expenses incurred by Bio-sustainable Feeds (BSF) Ltd, which is a company engaged in the research and development activities in Australia. Further, the report also covers the impact of the research being undertaken by the company on the society. Additionally, the report also covers the valuation of patent of Bio-sustainable Feeds (BSF) Ltd, along with the discussion on critical issues in relation to such valuation. The Nature of the Research being done by BSF Ltd and Its Value to the Society In the current case study, Bio-sustainable Feeds (BSF) Ltd is a company listed on the Australia Stock Exchange (ASX). The company undertakes the researches in the field of Bio-technology and currently it is engaged in researching sustainable aqua culture feeds. The research on the plant based feed is under process, which involves exploration of the fish feed material that is to be produced using the plants such as canola, corn, soya-bean and sunflower. This research involves a total resource outlay of approximately $360 million AUD and till now the company has incurred $120 million AUD on this research. Through this research, the company is endeavored to find out the fish feed material that is more energetic and powerful. The plant based fish feed involves diversion of 30 kg material in producing 1 kg high value fish. Though, the research on the plant based fish feed was taken up with the primary purpose of reducing the problems with the fish based feed, however, it could not happen. The problems got even more severe as the fish dying rate increased from 1/20th to 1/3rd from the use of plant based fish feed. Further, the environmentalists also alleged that the plant based fish feed is causing miss-utilization of the good quality human food. The environmentalists alleged that putting 30 kg of human food in producing 1 kg high value fish is not justifiable. The consumption of the human food in the production of fishes would get increased at a large scale if the plant based fish feed is used. This situation is expected to affect the poor people of the society adversely as they would not be able to get the good quality food. Further, the plant based fish feed would eliminate the use of small fishes in production of the high value fishes, which is also not favorable for the society (Lichfield, 2005). The poor people of the society, who earn their livelihood by capturing and selling small fishes to the big production houses, will lose 3that opportunity after implementation of the plant based fish feed. Further, it is also alleged by the environmentalists that this research is expected to make poor the poorer and rich the richer. This way, the research will cause imbalance in the society and economy. Thus, the impact of the plant based research being undertaken by the company on the society is evaluated to be negative (McGee, 2012). However, the company has responded to the concerns of the environmentalists positively by stopping the pant based fish feed research. The company has now undertaken a research, which will explore the bacteria based fish feed. In this research, the company is finding a new fish feed that will be produced using bacteria, thus, it will eliminate the need for consumption of the good quality human food in feeding fishes. In the bacteria based fish feed, the company will use dumps, sewage, food processing plants. Problems with the Early Research Done by BSF Ltd The early research conducted to explore the plant based fish feed was alleged to be adversely affecting the society and the environment. The environmentalists accused that the plant based fish feed is as bad as the fish based feed was, thus, there is no additional benefit emanating from the use of food based fish feed. The major problem with the plant based fish feed was the increase in the dying rate of the fishes. The use of plant based fish feed increased the dying rate of the fishes from 1/20th to 1/3rd of the total fishes being produced. The increased dying rate of the fishes was the huge loss to the fish producers and thus, this research could not sustain. Further, the consumption of the good quality human food in producing the plant based fish feed was also very high, which increased the problems of the poor people of the society. The human food, which should have been reached to the people, was now being diverted to the production of fish feed. Research and Development: Nature, Differences, and Accounting Treatment The research and development activities and innovations have become the corner stone of the strategy formulation for the organizations (Harris Trainor, 2009). In the present era, the firms are concentrating more on gaining the competitive advantages through exploring new products and finding out new ways of running the business. The competition is so stiff that the firms need to endeavor continuously to adopt new things and maintain uniqueness in the operations to survive. Thus, the research and development activities are critical to maintain sustainability of the business operations in this cut throat competition (Harris Trainor, 2009). For accounting purposes, the research and development activities are divided into separate segments or phases. The separation of the research and development activities is necessary to identify the revenue and capital nature of the expenses incurred on the research. The accounting standard 1011 provides the description and the definitions of the activities that are to be included in the research and development (AASB 1011, 1987). As per the accounting standard, the research and development implies a work carried out to acquire new knowledge, developing a new product, or finding out a new process design. The major element in the research and development activities is the involvement of the innovation and technology (AASB 1011, 1987). The research activities are the preliminary activities performed in relation to any research undertaken by an entity. These activities are performed in the initial phase of the entire research program. The research activities are preliminary and as basic that on completion of these activities, the entity can not be sure of getting an intangible asset developed. Thus, for recognition of the intangible assets in the books of accounts, the entity needs to complete the activities of the development phase (AASB 1011, 1987). The development activities are taken up upon completion of the research activities, which are basic and necessary. The accounting standard bifurcate the research activities into two parts such as basic and applied research activities. The basic research is conducted by an entity for the advancement of the knowledge. Further, the basic research is undertaken by the entity without having fixed any aim or goal, thus, it may be in certain circumstances a never ending process. Due to this reason, the expenses incurred on the research activities in a basic research are always charged to the profit and loss account (AASB 1011, 1987). These expenses are never considered for deferral because the estimation of the future benefits associated with the expense being incurred can never be made reliably. The applied research is conducted with the predefined goals and thus, the outcome of the research is identifiable at the time of initiation of the research. However, it should be noted that though the outcome of the research is identifiable, but the probability of its achievement is not known. In order to consider the deferment of the cost incurred on the research and development activities, it is necessary to establish with the strong probability that the research outcome will be achieved (AASB 1011, 1987). Therefore, the expenses incurred on the research activities in the applied research are also generally charged to the profit and loss account unless the circumstances warrant otherwise. In regard to development activities, the accounting standard states that the same are undertaken to take the preliminary research findings to the next level and reach to the research outcome (AASB 1011, 1987). The activities performed in the development phase of the research are by nature indicative of the future benefits. As far as the research goes into the development phase, the likelihood to avail the future benefits by the entity increases. Therefore, the cost incurred on the development activities is considered for deferral and amortization in the books of accounts. The development cost is not charged to the profit and loss account as soon as it is incurred but it is accumulated and amortized in the proportion of the benefits of research received by the entity over the number of years (AASB 1011, 1987). Fair Market Value of Patent Patent gives intellectual property right to the holder to use the product or process in respect of which the patent has been registered. The benefits of patent are received by the holder in the form of revenues over the number of years, thus, it is essential to recognize it as asset in the books of accounts (AICPA, 2016). The patent is recognized as intangible asset in the books of accounts. The principles of accounting provide that the purchased patent is recognized as intangible asset in the books based in the amount paid to the seller. Thus, the recognition of the purchased patent does not give rise any issues, but the measurement of the internally generated patent is critical. The accounting principles require that the internally generated patent is recognized based on the costs incurred in developing the patent (De Vries, 2012). The initial recognition of the patent is made on cost basis; however, the entity may adopt the fair value based recognition of the patent later on. The fair value of the patent is determined based on the estimation of the amount that the entity would fetch by selling the patent in the open market. Alternative, the fair value of patent could also be ascertained by discounting the benefits expected to be received by the entity over the number of future periods (De Vries, 2012). In the case of Bio-sustainable Feeds (BSF) Ltd, the benefits to be received from the use of patent by the company have been given. Thus, the fair value of the patent in this case has been computed by discounting future benefits from the use of patent as follows: Year Cash Flows PVF@8% Present Value 1 - 0.93 - 2 700.00 0.86 600.14 3 200.00 0.79 158.77 4 200.00 0.74 147.01 5 200.00 0.68 136.12 6 200.00 0.63 126.03 7 200.00 0.58 116.70 8 200.00 0.54 108.05 9 200.00 0.50 100.05 10 200.00 0.46 92.64 Total 1,585.50 The fair value of patent is worked out to be $1585.50 million AUD for Bio-sustainable Feeds (BSF) Ltd. Journal Entries for RD Transactions and Explanation for Treatment of Grant Journal Entries for the RD Transactions From 2013 to 2016 Year Description Debit (AUD$ M) Credit (AUD$ M) 2013 Research and Development Expense 360.00 Cash 360.00 (Research expense on plant based fish feed paid) Profit and Loss Account 360.00 Research and Development Expense 360.00 (Research expense on plant based fish feed charged to profit and loss account) Cash 500.00 Government Grant 500.00 (Grant received from CSIRO) Government Grant 340.00 Profit and Loss Account 340.00 (Grant credited to profit and loss account to the extent of expenditure on research) 2014 Nil 2015 Nil 2016 Research and Development Expense 160.00 Cash 160.00 (Research expense on bacteria based fish feed paid) Profit and Loss Account 160.00 Research and Development Expense 160.00 (Research expense on bacteria based fish feed charged to profit and loss account) Government Grant 160.00 Profit and Loss Account 160.00 (Grant credited to profit and loss account to the extent of expenditure on research) Bio-sustainable Feeds (BSF) Ltd is engaged in the research and development operations for more than two decades. Currently, the company is undertaking a research for exploration of sustainable aqua-culture feeds. In relation to this research, the company has received grant amounting to $500 million AUD from CSIRO, a government agency. The grant was received in the year 2013 and till the end of the year 2016 the company has expensed an amount of $520 million AUD ($360+$160 million AUD). The accounting treatment in respect of the government grant is prescribed in the AASB 120 issued by the Australian Accounting Standard Board (AASB 120, 2009). As per the relevant provisions, the government grant is credited to the profit and loss account to the extent the cost incurred on the research and development activities has been charged to the profit and loss account. Further, if the development cost is deferred, the grant received is deducted from the carrying amount of the deferred costs of r esearch and development. In the case of Bio-sustainable Feeds (BSF) Ltd, the grant was received by the company in the year 2013 for an amount of $500 million AUD, but the cost incurred on research activities out this amount was $340 million AUD, therefore, only $340 million AUD of the total amount received as grant has been credited to the profit and loss account. In the years 2014 and 2015, the company did not incur any cost on the research and development activities, thus, nothing has been credited to the profit and loss account from the government grant account. In the year 2016, the company started a new research for exploration of bacteria based fish feed and incurred $160 million AUD. Against this cost, an equivalent amount of $160 million AUD has been credited to the profit and loss account in the year 2016. It has been observed that the company has not yet undertaken the development activities in relation to the bacteria based research. Therefore, the entire cost incurred on the research has been charged to the profit and loss account. In respect of the bacteria based fish feed research, the company estimates to incur an amount of $200 million AUD in the upcoming years. Thus, as the company has not incurred cost on the development phase yet, no intangible asset like patent can be recognized in the books of accounts. Therefore, the value of patent in the books of Bio-sustainable Feeds (BSF) Ltd should be nil. Evaluation of the Managements Assertion Made in the Prospectus in Regard to Patent The management of Bio-sustainable Feeds (BSF) Ltd has asserted in the prospectus that company holds exclusive control over the bacteria based feeds technology. As an accountant of the company, it is essential to determine the fairness of the assertion made by the management in the prospectus. The valuation, measurement, and recognition of the intangible assets are the sensitive matters and require the proper and adequate consideration of the accounting principles. In respect of internally generated intangibles, the accounting principles state that an entity can not recognize patent (or other intangibles) in the books of accounts until the development activities has been initiated (Bragg, 2011). Further, it is necessary to ensure that the value of the intangible can be measured reliably and with required precision. In the case of BSF Ltd, it has been observed that the previous research conducted to explore the plant based fish feed has been found to be worthless. Thus, the expenditure incurred by the company on this research can not be capitalized in the books of accounts. On this research, the company y incurred $360 million AUD, which all have to be charged to the profit and loss account. After stopping further activities on this research, the company imitated a new research, which was to explore the bacteria based fish feed. In respect of this research, it has been observed that the company has incurred $160 million AUD on the research activities till the end of the accounting year 2016. The development activities on this are yet to start and the company estimates an amount of $200 million AUD to incur in the upcoming years. The provisions of the AASB 1011 require that the substantial part of the development activities in respect of a research should be completed before considering the same for recognition in the books of accounts as intangible asset (AASB 1011, 2016). Thus, Bio-sustainable Feeds (BSF) Ltd could hold or control the intangible asset like patent in respect of bacteria based research only when the research is substantially completed. Taking into account the provisions of the accounting standard, it could be inferred that Bio-sustainable Feeds (BSF) Ltd does not hold control over the bacteria based fish feed technology as yet. The expenditure incurred on the bacteria based research by the company does not meet the criteria for recognition in the books as patent. Therefore, the assertion made by the management in the prospectus that the company holds exclusive control over bacteria based feed technology appears to be grossly wrong. Summary The report presented here deals with the accounting treatment of the research and development expenditure incurred by Bio-sustainable Feeds (BSF) Ltd. The company is engaged in research and development operations for exploration of the sustainable aqua-culture feeds. This report addresses various issues pertaining to the accounting treatment of the research and development expenditure and suggests criteria to the management of the company to identify the revenue and capital part of the research and development expenditure. Further, the report also covers the accounting treatment of the government grant received in connection with the research operations. Apart from this, the report also covers the valuation, measurement, and recognition of the patent. References Weygandt, J.J., Kimmel, P.D., and Kieso, D.E. (2009). Financial Accounting. John Wiley Sons. Lichfield, N. (2005). Community impact evaluation: principles and practice. Routledge. McGee, J.P. (2012). Best practices in assessment of research and development organizations: summary of a workshop. National Academies Press. Harris, R. Trainor, M. (2009). Why Do Some Firms Undertake RD Whereas Others Do Not? Retrieved September 16, 2016, from https://www.spatialeconomics.ac.uk/textonly/serc/publications/download/sercdp0020.pdf AASB 1011. 1987. Accounting for Research and Development Costs. Retrieved September 17, 2016, from https://www.aasb.gov.au/admin/file/content102/c3/AASB1011_5-87.pdf AICPA. (2016). Practical Applications of Patent Valuation Approaches and Methods. Retrieved September 17, 2016, from https://www.willamette.com/pubs/presentations/reilly_patent_valuation_methods_aicpa_110711.pdf De Vries, D. (2012). Leveraging patents financially: a company perspective. Springer Science Business Media. AASB 120. (2009). Accounting for Government Grants and Disclosure of Government Assistance. Retrieved September 17, 2016, from https://www.aasb.gov.au/admin/file/content105/c9/AASB120_07-04_COMPjul08_01-09.pdf Bragg, S.M. (2011). Wiley GAAP 2012: interpretation and application of generally accepted accounting principles. John Wiley Sons. ACCA. (2016). Research and Development. 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