What is an alternative approach to taking risk into account

Biotran Ltd is a biotechnology company that researches and develops new drugs for the treatment of a wide range of health issues. Biotran Ltd’s accounting policy in relation to research and development expenditure is based on the requirements of AASB 138 Intangible Assets which requires all research expenditure to be expensed as incurred and only permits the capitalisation of development expenditure in very limited circumstances when specified criteria in AASB 138 Intangible Assets are satisfied. During the year ended 30 June 2016, Biotran Ltd incurred research expenditure of $26 million (which was expensed), development expenditure of $38 million (of which $18 million was capitalised) and reported total comprehensive income of $8 million. In February 2016, the Australian Accounting Standards Board (AASB) announced that they intend to amend AASB 138 Intangible Assets to permit entities to capitalise research expenditure and to make it easier for entities to capitalise development expenditure. The AASB intends to issue the revised AASB 138 Intangible Assets in early 2018. In July 2015, at the beginning of the current reporting period, Biotran Ltd decided to change its accounting policy for the valuation of materials inventories (used in research and development) from a weighted-average cost (WAC) method to a first-in, first-out (FIFO) method. Biotran Ltd believes that the FIFO method more accurately reflects the usage and flow of inventories. Also in July 2015, Biotran Ltd made changes to the estimated useful life and residual value of its buildings to reflect concerns that the commercial property market would decline due to reduced demand and excess capacity. Required (a) Explain the term ‘accounting policy’ and distinguish between ‘retrospective application’ and ‘retrospective restatement’. (1 mark) (b) Assume that the AASB issues a revised AASB 138 Intangible Assets in 2018 that permits the capitalisation of research expenditure and makes it easier to capitalise development expenditure. According to AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors, how would Biotran Ltd account for this change? (1 mark) (c) According to AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors, under what circumstances is Biotran Ltd permitted to change its accounting policy for the valuation of materials inventory? How, according to AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors, should the change be accounted for? (2 marks) (d) Biotran Ltd has determined that the cumulative effect of the change in accounting policy for the valuation of inventories is a decrease in profit of $180,000 as at 1 July 2015 (the beginning of the current reporting period) but that it is impracticable to determine the individual period-specific effects of the change in accounting policy on the prior periods presented. What should Biotran Ltd do in this situation? (1 mark) (e) According to AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors, how should Biotran Ltd account for the changes in the estimated useful life and residual value of its buildings? (1 mark) 3 Question 2 Total 6 marks Benson Ltd is a manufacturing company that operates a production facility in the Sydney suburb of Alexandria. In January 2016, residents living adjacent to the production facility complained that groundwater was being contaminated from waste discharged from Benson Ltd’s production facility. In May 2016, environmental officers from the City of Sydney Council confirmed the existence of groundwater contamination although they did not regard the contamination as particularly serious. Benson Ltd immediately responded by implementing new procedures for the storage and disposal of waste material to prevent any further contamination from occurring. Although Benson Ltd is not required by law to restore the contaminated environment, the company made a series of public announcements that it would undertake to restore the contaminated environment in two years’ time. As at 30 June 2016, Benson Ltd estimates the cost of restoring the contaminated environment as follows: Cost Probability $420,000 20% 400,000 70% 300,000 5% 200,000 5% Also on this date the risk-free discount rate, based on two-year government bonds, is 6%. However, Benson Ltd believes that a discount rate of 4% is appropriate to adjust for the risks specific to this liability. Required (a) How is a provision defined in AASB 137 Provisions, Contingent Liabilities and Contingent Assets? Why would Benson Ltd’s obligation to restore the contaminated environment be classified as a provision? (1 mark) (b) Briefly explain the three methods that, according to AASB 137 Provisions, Contingent Liabilities and Contingent Assets, can be used by an entity to estimate the amount to be recognised as a provision. (1 mark) (c) How has Benson Ltd taken risk into account to estimate the amount to be recognised as a provision? What is an alternative approach to taking risk into account? (1 mark) (d) Determine the amount that, in your judgement, Benson Ltd should recognise as a provision as at 30 June 2016. Justify the approach that you used to calculate the amount