HI6026: Accounting Theory and Current Issues - ASX

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Question: Accounting

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Accounting Assignment

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Introduction The report presents an overview and evaluation of the various practices and their accounting implications as relevant for the firm, Bio-Sustainable Feeds (BSF) Ltd. It has been given that BSF is a bio-research firm in Australia, trading on the Australian Stock Exchange. One of the key areas of focus for the company’s research is that of plant based feeds. It has been established by external experts that the use of plant based feeds would be beneficial in resolving the issues of fish based feed, but there have been several issues identified regarding the same. Hence, BSF’s research has shifted to the use and incorporation of bacteria or other products from waste for producing fish feed. The company received a grant of $500 million AUD in 2013 and since then it has already spent $550 million and further commits to spending $200 million AUD as development cost. The net market value of the patent as calculated by BSF is around $700 million AUD if sold in two years or around $200 million AUD per year for almost ten years if the same is produced and sold. The report hence provides an overview of the way the research is valuable to the society and the problems with early research carried out by the firm. The report also discusses the differences between research and development from an accounting point of view and provides a measure of the fair market value of the patent. 2. Nature and Value to Society of Research by BSF Ltd The research that is being carried by BSF is of major value and significance for the society because it is focused upon the development of alternative feeds. Jacquet et al (2010) explain that the alternative feeds initiative has been developed and is being promoted for providing health benefits to people. Aquaculture fish currently used contains high amounts of fish oil as well as fish meal because these two ingredients offer the required fatty acids and amino acids that are beneficial for essential and required growth of cultured species (Jacquet et al 2010). However, the costs of these fish meat and fish oil are very high and hence the alternative feeds research is being carried out to identify alternative feeds that can offer the benefits of fish oil and fish meal so that the various health benefits of farmed seafood can still be offered. Nasopoulou and Zabetakis (2012) argue that the biggest advantage and value to the society of alternative feeds to the society is that it would help in providing all dietary needs and requirements to people at lower costs due to lower usage of fish meal and fish oil. Another major benefit and positive impact of alternative feeds and alternative feed research as carried out by BSF is that it would help in reducing the dependence on marine fish feed, which would save the marine environment and would have other environmental benefits as well. NSDA (2011) argues that fish meal and oil are the major sources of protein for people all over the world, especially those in Europe and Asia and hence this has led to very high dependence of people on marine animals ad mammals, which is having adverse environmental impacts. Hence, the use of alternative feeds would help in overcoming these environmental issues, which would add value to sustenance of the society. In addition, the health and nutrition level of sea animals are also improving. Lenihan-Geels et al (2013) argue that there are several human health benefits of consuming seafood and hence the researchers working on alternative feed are trying to find ways and alternatives that can change dietary ingredient of food consumed by sea animals. This will thus lead to higher nutrition of fish and other animals present in water and will also result into higher health benefits for the people. In fact, according to Brinker and Reiter (2011), researchers can even identify and develop new ingredients that can offer higher health benefits to consumers. Thus, it can be deduced that the research that is being carried out by BSF adds lot of value to the society by improving human health and by also resulting into different environmental benefits. 3. Problems with Early Research by BSF Ltd Early research that was carried out by BSF Ltd was focused on the development of plant based feed, wherein it was proposed that plant-based feed would be converted into fish-based feed for generating the desired protein sources. However, the use of plant-based feed has been criticized largely by experts. The report published by CBC (2016) established and revealed that around 30 kg of plant based feed was required to produce only 1 kg of high value fish and hence it was argued that the use of food crops for growing luxury fish was not feasible because it would result into lack of crops for consumption. Similar discussions have been presented by Caruso (2015) as well, who argue that the number of people living on plant based diet is almost double of those living on meat-based diet and thus making use of plants and plant feed for the generation of fish feed can lead to food shortages in the world, thus leading to disruption in the food chain of the environment. However, it is not only the shortage of plant that has been identified as a problem with the earlier research done by BSF, but it has also been argued that plant based fish feed can harm health of people. While on one hand it can be argue that the alternative fish feed would result into higher proteins intake for people, thus leading to major health benefits, Boissy et al (2011) argues that the practice is not sustainable. As discussed by Boissy et al (2011), the fish that are generally consumed by people and have different health benefits, usually consume other fishes and are hence carnivorous in nature and hence the plant based fish feed would have no health benefits for consumers. Similar discussions by Krogdahl et al (2010) establish that plant-based fish feed would result into lower amounts of omega-3 fatty acids that are healthy and beneficial for consumers and hence would add no health related value. Another problem with early research done by BSF Ltd has been found to be that it can lead to malnutrition and starvation among people. Van Huis (2013) explains that plant based fish feeds would reduce the amount of plants and crops available for consumption of people and also the nutrition value of seafood consumed by people would go down massively. Thus, the earlier research based on the use of fish or plants for converting them into fish based feed seems to have multiple challenges and problems and that is the reason why the research of the firm has shifted towards the use of bacteria for producing fish feeds. 4. Research and Development: Differences, Importance and Accounting Though Research and development (R&D) is usually considered together as one term or one process for any given company or entity, there are some differences that have been established between the two concepts. Penuel et al (2011) argue that the accounting standards and discussions also usually tend to differentiate between research and development. Penuel et al (2011) have explained the basic difference between research and development and established that while research refers to the process of investigating the principles, operations and functioning of different products and services, development is the end process that incorporates the development or production of the final product. As discussed by modern experts, research and development process grows and continues as a continuous process, wherein the first step is the basic research in which generic research is carried out on a given subject, which is followed by applied research in which the target of research is extremely specific and then there is the development of product or service to be offered (Vonortas, 2012). Thus, research in brief is the process and development is end result, which is usually based on the research carried out before that. There have been found to be several differences in the accounting of the two processes, research and development as well. The research expenditure in accounting is generally not treated as investment, but is treated as costs and expenses, whereas the development expenditures are usually treated as capital investment. Drury (2013) explains the rationale for the difference and has explained that it is not necessary that research expenditures would result into something new but development costs usually result into the development of a new product or service. Hence, due to these differences, accounting treatments of the two costs are also different (Drury, 2013). The expenses of research are usually not capitalized but rather are deducted from the profit and loss account. On the other hand, the expenses of development are first capitalized and are the amortized. The results and income that would be obtained from any form of expenditure done for research are highly uncertain in nature and it cannot be said with certainty regarding the profits that are made because of specific research and hence the value of assets created by it cannot be recorded on the balance sheet with complete certainty, whereas the same for development costs can be shown (Kothari et al 2010). Hence, the way research and development are accounted for by companies, tends to differ. There are several reasons and motivations because of which firms tend to engage in different activities related to R&D. Barreto (2010) argues that the most common and important reason why firms tend to engage in R&D is because it helps them in coming up with and developing new products and services as compared to their competitors, thus leading to higher revenues and higher profits. In addition, another reason why some companies engage in R&D is to be able to come up with something new that can resolve existing issues and problems of the world, thus leading to changes in the world (Moss et al 2010). Hence, though research and development can differ from each other, they are essential for firms. 5. Fair Market Value Patent Fair market value of any asset, as defined by Power (2010), refers to the value at which the asset can be sold provided that both the parties involved in transaction, i.e. buyer and seller, are aware and knowledgeable about the product and are under no pressure to either buy or sell. According to the discussions by Power (2010), fair market value of any given asset is usually higher than its book value or net market value. Lhaopadchan (2010) argues that any future contract wherein the payment is to be made in the future makes use of fair market value calculation so that the time value of money can be accounted for. In simpler words, the accounting standards (IFRS) and IAS have defined fair value of an asset as the amount that the buyers would be willing to pay for on the day the transaction of purchasing and selling the asset is actually carried out (Lhaopadchan, 2010). Hence, fair market value of any asset is usually higher than the net market value of the same. The formula usually used for calculating fair market value is: P= Ct1+rtt Wherein Ct refers to the cash flow that would occur at the end of time t, r is the discount rate of interest and t is the time period. The expected net market value of the patent of the alternative aquaculture feed being developed by BSF has been given to be $700 million AUD if it is sold in the next two years or $200 million AUD per year for ten years if is produced and sold. Hence, the fair market value of the patent must include and incorporate the time value of money to provide suitable valuation if the patent is bought or sold at the end of the time period. The key assumptions that can be made from the discussions are that the patent would still be in demand and the feed would be successfully developed and sold. It is also assumed that the market conditions would remain the same after two years or ten years, which would mean that the demand for the patent would be same and the need of buyers and sellers would also remain the same with respect to the project (Guthrie et al 2011). Hence, the fair market value of the patent is: Sold in Two years: Future value of $700 million at the discount rate of 8% at the end of two years: FV =$816.48 million AUD However, if it is produced and sold then the cost is $200 per year for ten years, total of $2,000 million of revenues would be earned for ten years. Hence, with a discount rate of 8% at the end of ten years, FV= (200*1.08^0) + (200*1.08^1) + (200*1.08^2)+……+ (200*1.08^10) = $3,129 million AUD Hence, keeping the market conditions and other variables the same, it can be said that fair market value of the patent is higher than its net market value because of time value of money, which leads to appreciation. Journal Entries

Table above present the journal entries for all the R&D transactions as observed for BSF from 2013 to 2016. Jørgensen and Messner (2010) have explained that research and development costs can be recognized in financial accounts of the firm as an expense during the period in which it is incurred and hence when these costs are recognized as expense, the costs are usually not capitalized or recorded in the form of an intangible asset. The grant received from CSIRO and its expenditures are given above, which shows that the $500 grant that has been received has been shown as a credit to the company because it receives that amount. This amount of $500 has been hence recorded as a capital income, which is deferred in nature and would be hence used in the future for expense purposes. Hence, the credit is the grant received and debit is because it is the income not received by the firm. Since CSIRO required the company to spend at least $100 million every year on alternative aquaculture feeds, $100 million in 2014 and 2015 has been debited as research expense and $100 million has been credited in response to the deferred capital income of 2013, which is being expensed later. This has thus helped in adjusting the grant over a period of time.

Table above presents the journal entries for the development costs that are to be incurred by the firm for developing an alternative aquaculture feed. Assuming that the patent would be sold at $700 million after two years, $700 million has been recorded as deferred income. The company would earn $700 million over the development cost of $200 million and hence $500 million has been recorded as the future profit that would go to the profit and loss account of the firm. 7. Evaluation of BSF’s Assertion Regarding Patent Values It has been asserted by BSF Ltd. that the value of patent that was stated or affirmed was done on the basis of the fact that BSF would have complete control over the technology of developing bacteria based feeds. However, the assertion does not seem to be completely reasonable because there are already studies and researches that have been carried out on the subject and there are also patents related to the same. The discussions presented by Brodin (2014) in Norway reveal that bacterial meal is already largely being used and added to compound feed in addition to fishmeal and oils to improve the nutritional value and quality of the feed that is generated. According to Brodin (2014), the feed produced in the country is making use of bacterial meal that is then grown on natural gas that emerges from North Sea for providing proteins to farmed fish. In addition, as discussed by Helmer (2016), a California based company has also been successful in the development of fish feed that is being based on methane eating bacteria and would help in improving the society by having health, economic and environmental benefits. Also, the patent would be developed with the funding received from CSIRO. Though the given condition of funding reflects that BSF only had to spend $100 million per year on the research of an alternative aquaculture feed and hence the assertion of BSF of having complete control would be valid, Dodgson et al (2011) argue that government grants for research include shared control of the final product that is developed so that the government can leverage upon the benefits. There are several accounting laws and requirements that define the same. ASC 730-20 of FASB accounting standards that defines the research and development arrangements. Flood (2014) explains that there are different provisions under ASC 730-20 that defines control in cases when research is completely or partially funded by an external party. According to the requirements, when an entity receives cash for funding, he or she is liable to provide something in return (Flood, 2015). Hence in this case, since BSF agreed to offer research on a different feed, it can have the control. However, the fact that the feed was asked by the government, CSIRO would also have control on the same or else the research will become futile for it. Thus, the assertion of BSF seems to be reasonable only to some extent not completely. 8. Conclusion The report discusses and leads to the conclusion that the research being carried out BSF is highly beneficial and advantageous for the society and the environment as well. The company’s fair market value seems to be higher and it can hence sell its patents at higher value provided the market conditions remain the same, but the assertion that it will have complete control over the patent seems slightly unreasonable.

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