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Draft a letter in response to an email received from a client - Mr Martin Wahlburg, the Managing Director of Shadow Ltd, raising 2 key accounting issues regarding his company

Cover letter
Kaplan and associates
396 Ann street, Brisbane, QLD 4000
To
Mr Martin Wahlburg
Managing director
Shadow Ltd
Dear Martin,

We understand that Shadow Ltd has acquired new patents and is confused of the accounting practice as per AASB. First of all, I would like to congratulate you on your company's initiatives. Secondly, patents come under intangible assets and we can carry out the suitable accounting procedures for you.

I also noticed that one of your machines is accounted with low depreciation charges which can lead to obsoleteness in the near future. While that is an urgent issue, we definitely have a solution for the same. We would begin with the impairment test to understand the present value and issue an accounting statement for the same.

While we understand your concerns, we would also like to inform you that our results and operations are as per AASB and Corporations Act 2001 and they are standard. Along with this cover letter, we have enclosed two documents - one to account your patents and the other to study the depreciation and impairment values of Shadow's equipment.

We hope you find them useful and apply them immediately so that the accounting is in place before the financial year ends.

Thanking you,
Regards,
Miley Jaspen
Manager
Kaplan and associates

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Issue 1.
Shadow Ltd is also in the process of preparing an application for a patent for a new process of softening leather. It has spent a number of years refining this process. Our company accountant for Shadow Ltd is unsure how to account for patents under AASB's. Please prepare a detailed report on the principles of how to account for patents, using the examples above to illustrate the appropriate accounting procedures.

Solution:

Issue 1: Accounting for patents
It is evident that Shadow Ltd has acquired 2 patents that will be useful for the manufacturing of leather handbags. Further, the firm is in a plan to register a new patent in due course of time about leather softening process.
Patents fall under the category of intangible assets as per AASB 138. As soon as the licenses are obtained, Shadow Ltd has all the ownership rights and AASB 117 does not hold in this case. All the patents acquired have future economic benefits.
There are 2 cases that need to be assessed here - accounting for acquired patents and new patent.

Acquired patents:
Shadow Ltd will have to first list down the amount spent towards a patent and the future economic benefit as a result of the new business communication (AASB, 2014). Any amount that will be incurred in the development of the project using this patent will be listed in the financial statement.
Since they are purchased, it is important to report the fair value of both the costs as per the revaluation model.

Internal patent:

The cost of development of the asset will have to be calculated first and this has to be recognized under AASB. Expenses spent during the research phase and development phase will have to be listed separately. Here are the expenses that need to be included in the accounts statement:
- Search of research findings
- Alternatives for existing products/materials/processes
- Design and evaluation of alternatives
- Technical feasibility
- Usage or selling costs

While these are basic expenses, AASB 119 demands listing the employee benefit cost in the generation of a new patent(AASB, 2014). Further, the legal fees, patent amortization followed by license should also be listed.
At this stage, Shadow Ltd has to ensure that administrative costs, operating losses, staff training costs are not added to the expense list.

In both the cases, it is important to calculate the useful life of a patent. Based on the usefulness, the finite/infinite life can be calculated. According to AASB 136, it is also possible for a patent to have an indefinite useful life and in such a case, it does not have to be amortized.

At the end, you may have to add any repair losses or operational losses and your patent accounting is done. This is simple and you can affix it along with your general financial statements. Make sure that the intangible assets are reported separately and not along with the tangible assets.

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Issue 2.
I have also been analysing the financial reports provided by the accountant, who has been with the firm for a number of years. The other company directors have expressed concern over depreciation charges being made in relation to the company's equipment. In particular, they believe that the depreciation charges are not high enough in relation to the factory machines because new technology applied in that area is rapidly making the machines obsolete. The directors' concern is that the machines will have to be replaced in the near future and, with the low depreciation charges, the fund will not be sufficient to pay for the replacement machines. Please discuss and summarise our options for accounting for our equipment correctly.

Solution:

Issue 2: Depreciation charges

Shadow Ltd has identified that the depreciation charges of the company's equipment are low such that they can go obsolete and might not help the organization even in the case of replacement of machines. Hence, there is a need to understand how equipment is accounted and depreciation charge is calculated. In the following section, the method is explained in accordance to the AASB 116 issued in the year 2004.

The depreciation amount is generally applied periodically based on the usefulness of the asset and it is essential for Shadow Ltd to review the residual value and useful life regularly. This usefulness can be calculated with the factors like expected asset usage, legal limits like expiry date, technical obsolescence and operational factors.

The depreciation of equipment will have to be calculated for every part of the item and compared to the total cost of it. As per AASB 108, the accounting policies state that depreciation is calculated when the equipment is being used and available in the organization (AASB, 2004). When there is no production, it is set to zero. This has to be identified first. It can be derecognized if the equipment is fit for disposal or guarantee no economic benefits.

The next step that Shadow Ltd should carry out is to include the original equipment cost, accumulated depreciation, contractual commitments and income statements in particular to the equipment. Finally, it can be re-evaluated with the price index at that point. If the depreciation charge is identified to be still low, the equipment can be treated as individual items and then measured to find out if they shall be used in any other equipment. It becomes obsolete only when it is no more of use or not fit for even exchanges. If it is in working condition, it is certain that the depreciation charges cannot be too low and there are options to enhance further.

Shadow Ltd has to perform frequent inspection of the equipment and revaluation of the plants available to understand if they are obsolete or the usefulness persists. With the annual year ending, a swift action is preferred so as to avoid last minute operational losses.

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