Acct351 Ch8: Fixed Assets

Fixed Assets def under IFRS ?

°Property, Plant & Equipment (PP&E) are tangible items lasting more than one year and held for use in pn, for administrative purposes, or for rental to others.

An important distinction w inventory ?

An important distinction btwn Fixed Assets & Inventory ?

Fixed Assets : tangible items held for use

Inventory : tangible items held for sale

• « Initial Recognition and Measurement »

Initial Recognition : General rule

• 1st consideration : What costs should be recognized as an asset ?

→ depends on if the asset was purchased or constructed by the compnay and here is the general rule :

IAS 16 states that the cost of PPE should be recognized as an asset iff :

1. it’s probable that future eco benefits associated w the item will flow to the entity

2. the cost of the item can be measured reliably

+ IFRS states that companies can capitalize all costs required to acquire or construct the asset and to prepare it for its intended use.

See pic Slide 6 for the Common costs (+ look exhibit 8-2)

(expl) Do expl 1 : Initial Recognition (Slide 7)

Construction : Borrowing Costs

• How do we treat borrowing costs ?

IFRS allows, for borrowing costs incurred to finance construction, to be capitalized.

IAS 23 states :

• an entity shall capitalize borrowing costs that are directly attributable to the acquisition, construction, or pn of a qualifying asset as part of the cost of that asset.

°directly attributable : thoses that could hv been avoided if the expenditure on the qualifying asset had not been made.

Construction : Borrowing Costs

• How do you determine the rate of interest that can be capitalized ?

It depends on the source of the funds :

• If loan received specifically for the construction : the rate will simply be the one from the loan agreement

• If loan was for general borrowing and the company used some of the funds for construction, an interest rate needs to be calculated.

  Interest rate = weighted average of all the borrowings costs applicable to the borrowings of the company outstanding for the period.

  The amount of interest capitalized will be capped at the amount of interest actually incurred for the period.

(expl) Do expl 2 : Borrowing Costs (Slide 10)

Period of Capitalization

• Cost incurred to build assets and get them ready to be used will be capitalized.

  So, when shouls we stop capitalizing costs ?

IFRS states : PPE related costs stop being capitalized when the asset is ready for use (≠when put into use)

What happens after that ? (when stops capitalizing costs)

What happens after that ? (when stops capitalizing costs)

(After this date, costs will usually be expensed, unless they represent replacement)

After an asset is ready for use, any repairs will be expensed. If a subsequent expenditure has a future benefit, then it can be capitalized.

How does IFRS refer to this ?

How does IFRS refer to this ? (If a subsequent expenditure has a future benefit, then it can be capitalized.)

IFRS refers to this as a replacement.

In what situations should the expenditure be capitalized ?

Replacement vs Repairs

In what situations should the expenditure be capitalized ?

• Replacement of a significant asset component

• Improvement or upgrade of an asset

• An expenditure that is not a reoccurring expense

In the case where there is a replacement, IFRS states that any costs related to the '“old” part would need to be removed.

(expl) Do expl 3 (Slide 13)

Site Restoration Costs

Sometimes, a purchase of PPE will come with a future obligation to dismantle/remove theitem or restore a site to a certain condition.

• How should this type of cost be treated ?

It should be capitalized with th related PPE.

• The future costs will be capitalized w the related PPE at the present value of those costs and depreciated over the same period as the PPE.

• There will also be matching liability with an interest expense recorded over time (more detail in IFA 2)

Categorization of PPE

• When will we consider items separate assets or components of a single asset ?

• Why is it important ?

Componenetization is imoprtant bc if separate asset, it might need to be depreciated over a different period.

IAS 16 :

• Each part of an itme of PPE w a cost significant in relation to the ttl cost should be depreciated separately.

• A significant part of an item of PPE may have a useful life and depr method that are the same as another part of the same asset. Such parts may be grouped in determining depr charges.

Therefore, costs can be categorized based on their depr pattern.

Bundled Purchases

How do we allocate purchases price when we buy a group of assets in a single transaction ?

• If purchase/sale agreement states the price : used to allocate.

• If there is no allocation, should be allocated based on the fair market value of each asset on the day of the sale.

Opportunity for earnings mgmt (who estimate FMV)

• « Subsequent Measurement »

Basis of Measurement

• What are the methods allowed be IFRS for the subsequent measurement of PPE ? (2)

• Historical cost

• Fair value

Under both models, companies still must test their assets for impairment on a periodic basis.

What is the historical cost method ?

Start w the actual cost of the asset when purchased and adjust for depr and impairment.

Historical cost: Recording Depreciation

• What is the goal of recording depreciation ?

To apportion the cost of the PPE over its eco useful life.

It means that, often, the carrying value of PPE will not be equal to its current value.

• expl : assets like real estate may appreciate over time

Historical cost: Recording Depreciation

• What is the depreciable amount of an asset ?

• What is the period over which assets should be depreciated ? (IFRS)

• How does a company chose a pattern of depreciation ?

• Its cost less any residual value (the amount that would be received from the ultimate disposal of the asset).

• Over their useful life (the period of time it is available for use)

• Chooses the one that best reflects the expected pattern of consumption of the assets future economic benefits.

Depreciation patterns

• What are the most common depr method ?

• Straight line : the depreciable amount is allocated evenly over the useful life.

• Declining balance : determines depr as a percentage of assets carrying value.

• Units of production : allocate depreciable amount in proportion of pn capacity in each year.

Note : for assets acquired or disposed during the year, companies need to hv a policy of how much depr to record (based on months, half yr, full yr…)

*changes involving depr methods will often result in changes in estimates

(expl) Do expl 4 : Depr Patterns (Slide 21)

• « Derecognition »

What happens when an asset is sold or disposed of for the fincl statements ?

It must be derecognized (removed) from the fincl statements.

• The difference btwn the amount received as proceeds from the sale/disposal and the carrying amount of the asset will be recorded in net income as a gain or loss.

(expl) Do expl 5 : Derecognition (Slide 24)

• « Other points »

Non-Monetary Exchanges

• What is a non monetary exchange ?

It is when non-fincl assets are echanged (i.e. physical assets instead of cash, receivables…).

How is it treated ?

Non-Monetary Exchanges

How is a non-mo exchange treated ?

General rule : valued at the fair value of assets given up or received, whichever is most reliable (if both are equally reliable, the asset given up should be used).

Except 2 exception under IFRS, which ones ?

What are the 2 exceptions under IFRS for treating non-mo exchange ?

• There is no commercial substance to the transaction.

• Fair value of assets are not reliably measured.

In this case : transation should be measured at the carrying amount of the asset given up.

Commercial Substance

When does a transaction have a commercial substance ?

In either of the following cases :

• The assets exchanged are significantly different in the risk, timing or amount of cash flows.

• The value of the company’s operations will change significantly as a result of the transaction.

If none of these is true, the transaction hv no comcl substance and will be measured at the carrying amount of the asset given up.

(expl) Do expl 6 : Non-Monetary Exchange (Slide 28)

What are the Potential Earnings Management related to PPE ?

• including operating expenses in PPE (not directly attributable, requires prof judgement)

• interest capitalization (dec of whether to finance construction internally or externally, via general borrowing or construction specific borrowing)

• Depreciation (Choice of useful life and amount of residual value are based on estimates. Choice of depr method will also impact company’s earning from one yr to the next).

• Opportunistic disposals of PPE.

How do you present and disclose PPE ?

BS : only ttl carrying amount of PPE

But several points must be disclosed on the notes :

• The breakdown of each significant class of PPE

• The beginning and ending carrying amount of each class

• The cost, accumulated depr and carrying amount of each class

• Amount of depr

• Explanations of chosen acctg policies

Summary of issues and IFRS vs ASPE sol ?

Slide 31 pic