The Clinics Financial Accounting - Essay Example

?Financial Accounting i) A discussion of justifications for charging depreciation/amortisation and an analysis of the extent to which depreciation/amortisation charges are consistent with the IASB Conceptual Framework. [50 marks] Depreciation is the reduction in cost of an asset after a particular period of time, basically an accounting year. In the final accounts, it is an expenditure that is deducted from the revenue. Deprecation shows the amount of decrease in the past worth of assets. Stakeholders can review this data and identify when to purchase substitute assets for the organization. For instance, an industry frequently replaces its manufacturing equipment at some time throughout its operations. “The terms depreciation and amortization have various meanings in finance and investing. For example, depreciation can refer to the devaluation of a currency, and amortization can be used to describe the payment structure in a common type of loan” (What is the difference between Depreciation and Amortization? 2003). Depreciation is charged to tangible assets, whereas amortization is charged to intangible assets. Fixed or tangible assets are those assets of the organization, which last more than one year, for example: furniture, buildings and machinery. Intangible assets are invisible assets that incur cost to the company, in terms of brand recognition, intellectual property and goodwill. Both amortization and depreciation are non cash cost of the industry and they cause reduction in the earning, whereas, on the other hand, they lead to an increase in the cash flow. The reason for recording depreciation as a cost is to increase the early purchase cost of the fixed asset more than its useful life. Whenever an industry makes its financial statements, it records a cost of depreciation to assign the loss in price of equipment, machines and other fixed assets it has purchased. On the other hand, unlike other costs, depreciation is a non-cash charge. This means that no money is actually paid at the period in which the expenditure is incurred. The function of depreciation is to match the price of a creative asset to the incomes earned from using the asset. Since it is difficult to observe a direct relation to revenues, the asset’s price is usually assigned to the years in which the property is used. “Depreciation systematically allocates or moves the asset’s cost from the balance sheet to expense on the income statement over the asset’s useful life. In other words, depreciation is an allocation process in order to achieve the matching principle; it is not a technique for determining the fair market value of the asset” (What is the Purpose of Depreciation, 2004). The International Accounting Standard Board (IASB) states that it is appropriate for plant and machinery to be depreciated and intangible assets to be amortized by employing a revenue-based amortization or depreciation method. A revenue based amortization or depreciation process is one that is derived from the transaction between price and units, and this considers the possible future fluctuations in price as the basis of depreciation distribute the quantity of an asset that is to be amortized or depreciated. Tax benefits are also likely to arise along with depreciation. While depreciation stands for non-cash payments in the income statement, it does decrease the industry’s net income. Lesser net income will result in a lesser tax liability. To expand this benefit, industries frequently utilize an accelerated depreciation process. According to the International Accounting Standards Committee, depreciation is the part of the depreciable price of an asset more than its expected useful life. “Depreciation for the accounting period is charged to income either directly or indirectly. Thus, it is clear from the above definition that depreciation is a loss arising on account of circumstances, some of which are known whereas others are not” (Need Help with Accounting Assignment? 2002). The Internal Revenue Service provides organizations with an accelerated depreciation method for various asset classes. This permits for further depreciation for assets and ultimately leading to lesser tax liabilities. The important causes of depreciation include wear and tear, effluxion of time, exhaustion, obsolescence etc. Wear and tear refers to a decrease in the performance of asset due to its constant use. When the asset loses its competence, its cost decreases and, therefore depreciation arises. Effluxion of time means the value of the asset might get reduced due to the time period even if it is not in use. In the case of exhaustion, an asset can lose its price after its repeated use. This also includes wear and tear of assets with use in quarries, mines, forest-stand and oil-wells. “External Reason may be due to Obsolescence which is induced by new inventions, improvement, loss of demand due to change in fashion and effluxion of time” (Manas, 2009). In this particular case, clinical charges are calculated on the basis of the use of the scanner and the time needed by the doctor in reporting each case. The cost for the time of scanner is based on the machine hours for specific types of scan. In the method of machine hour rate, the whole number of working hours of a machine throughout its efficient life is calculated, and then, the machine cost is divided by the expected amount of hours of useful life, this provides the rate per hour. The yearly depreciation is found out by multiplying this price by the number of hours the machine essentially runs in a year. “While computing machine hour rate, the fixed and variable expenses need to be segregated to yield a better result. Even if the machine is idle, it does not have any impact on the fixed overheads, whereas it has a significant effect on the variable expenses. Because of these reasons we need to compute Machine Hour Rate in a systematic manner” (Steps for Computation of Machine Hour Rate, 2012). In this case, the clinic’s financial reports the depreciation for scanners is derived from machine hours, which is calculated by situation to the scans which have been due. This is due to the fact that the machines exhaust faster if they are used intensively and following 20,000 hours the maintenance costs start to increase excessively and a new scanner is required immediately. In this case, depreciation is calculated on the basis of the time period for which the machine is used. This method is appropriate because the use of the machine for more than 20,000 hours makes it useless and a new machine will have to be purchased. ii. An analysis of whether the new proposal would or would not allow machine hours to be used as the basis for depreciation and answers to the questions for respondents contained on page 5 of the exposure draft. [30 marks] Amortization is a process of charging regular decrease in the value of intangible assets. As time passes, there is a decline in their value which cannot be seen as in the case of tangible assets. The two terms amortization and depreciation are sometimes used interchangeably. “Amortization refers to the expensing of intangible capital assets (intellectual property: patents, trademarks, copyrights, etc.) in order to show their decrease in value as a result of use or passage of time” (Amortization-What is Amortization, 2002). In the case of depreciation, the assets are tangible and they are considered as long lived capital, which is owned by different business organizations and which are made use of economically for their useful period of life. The useful life period of the properties spread over several accounting periods. With regard to the issue in this paper, depreciation is the cue as scanning machines used in the clinic are tangible assets. There are several methods according to which an entity finds the depreciable or amortable amount of a particular property on a systematic basis. One of the methods is the straight line method according to which if the residual value of the property does not change, a constant charge is put on the useful life of the asset. The second method is the diminishing balance method in which the charge is decreased over its useful time. The last method is the units of production method in which a charge is made on the basis of expected use or output.” “AS 16 and IAS 38 both establish the principle for the basis of depreciation and amortisation as being the expected pattern of consumption of the future economic benefits of assets” (IASB Publishes Proposals for Amendment to IAS 16 Property , Plant and Equipment and IAS 38 Intangible Assets: .Clarification of Acceptable Methods of Depreciation and Amortization, 2012). The aim of the said amendment is to make sure that preparers will not use returns based methods in order to calculate the charges for the depreciation or amortization of the tangible and intangible assets respectively. This is so because revenue based method will reflect a method of financial benefits generated from the property compared to the expected method of consumption of financial benefits embodied in the property. “To allocate the depreciable or amortisable amount of an asset on a systematic basis over its useful life can be used a variety of depreciation and/or amortisation models” (Jess, 1997). The depreciation for the scanners in the clinic is calculated on the basis of the hours for which they are being used, as the scanning machines wear down more quickly if they are used intensively. Another reason is that after the machine is used for 20,000 hours, the machine becomes useless and therefore a new scanner is required. Assets which are tangible and owned by the businesses are used economically for their full life period. But in this particular case, the use of the scanning machines for more than 20,000 hours makes it unfit for further use. Therefore, considering the time for which the machines are used as the basis for depreciation is justifiable. The International Accounting standards Board has published for public opinion on the proposed amendments to IAS 38 that is intangible assets, and IAS 16 that is property, plant and equipment. Both of them establish standards for the basis of depreciation that is the expected method of consumption of the prospective financial benefits of an asset. “The objective of the proposed amendments is to ensure that preparers do not use revenue-based methods to calculate charges for the depreciation or amortization of items of property, plant and equipment or intangible assets” (IASB Publishes Proposals for Amendment to IAS 16 Property , Plant and Equipment and IAS 38 Intangible Assets: .Clarification of Acceptable Methods of Depreciation and Amortization, 2012). This is so because an income based method will reflect a pattern of financial benefits generated through the assets. The aim of the proposed amendment is to make clear that a depreciation or amortization process which will reflect a manner of generation of financial benefits from the assets other than the method of consumption of the economic benefits of the asset will not be the proper method of amortization or depreciation. The result of the proposed amendment is to explain that the process of depreciation or amortization, which has been based on the income that is expected to be created by the use of the asset in a business organization, is not be the accurate method. “The entity selects the method that most closely reflects the expected pattern of consumption of the future economic benefits embodied in the asset” (Staff Paper IASB Meeting, 2012). That method will be applied repeatedly from period to period unless and until there is an alteration in the usual pattern of consumption of those future monetary benefits. The feedback received is that the amendment is justifiable, but, however, clearer wordings should be used in the amendment. Reference List Amortization-What is Amortization. 2002. E-conomic UK. Available at [Accessed on 08 February 2013]. Jess, M. 1997. Proposed Amendments to IAS 16-Property, Plant and Equipment and IAS 38-Intangibile Assets. Enoning. SK. Available at [Accessed on 08 February 2013]. IASB Publishes Proposals for Amendment to IAS 16 Property, Plant and Equipment and IAS 38 Intangible Assets: .Clarification of Acceptable Methods of Depreciation and Amortization. 2012. IFRS. Available at [Accessed on 08 February 2013]. Manas. 2009. Depreciation, Objectives and Reasons. Available at [Accessed on 08 February 2013]. Need Help with Accounting Assignment? 2002. Class of 1. Available at [Accessed on 08 February 2013]. Steps for Computation of Machine Hour Rate. 2012. Preserve Articles. Available at [Accessed on 08 February 2013]. Staff Paper IASB Meeting. 2012. IFRS. Available at [Accessed on 08 February 2013]. What is the difference between Depreciation and Amortization? 2003. Wise Greek. Available at [Accessed on 08 February 2013]. What is the Purpose of Depreciation? 2004. Accounting Couch. Available at [Accessed on 08 February 2013]. . Read More