2.4 D IFFICULTIES IN FINANCIAL ACCOUNTING FOR ICT INVESTMENT
2.4.2 Conceptual application of accounting standards to ICT investment
From the earlier researches, there can be the inconsistent classification of ICT asset and expense on the financial statements. Chalalai ( 2008) suggested that only 8% of ASX listed firms report ICT investment in their 2007 financial reports. It was informed by (Henderson et al., 2010) that ICT asset have been unreported in the financial statements. Before concluding about the unreported ICT investment in financial report, we should reconsidered about the hidden cost problems, which stated in (Brynjolfsson and Hitt, 1996), that IT expenditure was hidden in non IT expenditure. The aggregation rules in the accounting standards can be conceptually applied for the classification of ICT investment and provides the explanation to the hidden ICT cost problem.
Quoted from IAS1 and also found in AASB101, “An entity shall present separately each material class of similar items. An entity shall present separately items of a dissimilar nature or function unless they are immaterial”(CPA, 2010, IFRS, 2011a).
“Nature or function” and “Materiality” become the important factors explaining the financial reporting and classification in financial accounting.
a) Classification by Nature and function
In section 2.2, there are two main line items recommended in the accounting standards as the mandatory items to be reported in the financial statement. Those line items are Property Plant and Equipment (PP&E) and Intangible Asset. ICT product and services has similar characteristics to the asset that can be classified into these two line items.
The items described in “Computer Hardware” category and “Telecommunication assets” category by (ABS, 2006) can be categorized as PP&E of an organisation.
There are a lot of recommendations in IAS16 and AASB116 for defining PP&E, but only few shall be considered after the items already pass the requirement to be the organisational asset. First, the item shall have the “physical substance”. Second, it should be used more than one accounting period. The items in “Computer Hardware”
and “Telecommunication assets” naturally have the physical substance.
“Computer Software” in (ABS, 2006) can be considered as Intangible Asset in the accounting context. In addition to the criteria to be an asset, the main criterion to be an intangible asset is “the items without physical substance”. The “Computer software-package”, “Computer software-own account”, “Computer software- customised” are intangible and without physical substance. Consistently, (Nomura, 2004) suggested that software shall be classified under intangible asset.
“Computer Services” in (ABS, 2006) includes the items that can be classified as either Intangible Asset or Expense. For instance, the expenditure on “Customised software services and solution” in “Computer Service” category could be partially capitalised as intangible asset, while it can also be partially recorded as expense.
Other services in this category could be more recorded as Expense excepts when these services are necessary to create the asset that meet the criteria discussed in section 1. For the same nature, “Telecommunication services” could be more recorded as Expense.
ICT asset can be classified and aggregated with the other organisational asset because of their similar functionality in the organisation. For instance, IAS16 and AASB116 define PP&E “are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes”(IFRS, 2011b, CPA, 2010). Similarly, IAS38 and AASB138 also defined the function of the intangible
similar to PP&E(CPA, 2010, IFRS, 2011c). IT investment has been found to provide similar functions including supporting organisational production and services. Due to the similarity in function and nature, “Computer Hardware” and
“Telecommunication” can be classified as PP&E which was considered as non-IT asset by researches (Dewan and Min, 1997, Brynjolfsson and Yang, 1997, Ramirez et al., 2010).
b) Materiality
Section 1 introduced the definition and the relationship between “materiality” and the capitalisation threshold. Apart from this relationship, “materiality” plays an important role for the aggregation and classification of asset and expense in financial statements. Firm has to separately classify and report the class, subclass or line items of asset or expense that are material. Therefore, if IT asset or expense is not material, it can be classified with non IT asset or expense that performs similar function in the organisation. For example, ICT could be classified as either PP&E, Intangible asset, or operating expense.
Quantitatively, a line item of asset or expense is material if its value or its amount exceeds a particular amount, which is calculated from a certain ratio of the base amount. Mentioned in the Accounting Standards AASB 1031 “Materiality”, the base amounts can be the amount of income, asset and revenue(CPA, 2010). (Eilifsen et al., 2005), who summarized the accounting literatures from 1982 to 2005, shows that firm normally use the percentage of income as the materiality threshold while the other use the percentage of revenue and/or asset. The materiality threshold is between 0.01 to 0.025 % of asset and 0.1 to 0.2 of pre-tax income(Cho et al., 2003).
Materiality can be varies depend on different factors. Different choice of the base amounts would give different materiality threshold. Secondly, materiality threshold also depends on who define the threshold. Materiality threshold defined by the investor is very low compare to what is in practice(Cho et al., 2003). Materiality threshold planned by user tend to be the lowest while auditor materiality threshold is between user and preparer(Eilifsen et al., 2005).
Third, the materiality threshold can varies according to firm size. (Eilifsen et al., 2005) point out that for the large firm, auditor has the high materiality threshold than auditor in small firm. Also, (Heitzman et al., 2010, Lo, 2010) supports that firm size explain materiality threshold to separately report the information about a particular expenditure.