Depreciation and cost model

Introduction to Property, Plant, and Equipment (PPE)

• Definition and recognition criteria for PPE.

• Importance of understanding tangible assets:

  • Held for use in production or supply of goods/services, rental, or hedging.

  • Expected to be used for more than one financial period.

Key Definitions

• Tangible Assets: Physical items used in operations that are not for sale, expected to be used over multiple periods.

• Elements of Cost:

  • Items to include/exclude in asset costs are discussed.

• Capitalization:

  • Begin when ownership or authoritative rights transfer to the company.

  • Stop when asset is ready for use—determined by management's judgment (includes condition, location, operational capability).

Depreciation

• Occurs after the asset is ready for use; new costs should not be capitalized but instead start depreciating.

• Depreciation Methods:

  • Straight-line

  • Diminishing balance

  • Production unit

Cost Model

• Assets are depreciated based on historical cost.

• Useful Life: Determined at management's discretion (may vary across companies).

• Depreciable Amount: Defined as cost minus residual value.

  • Residual Value: Expected recoverable amount once the asset reaches the end of its useful life, minus any selling costs.

• Important to correctly calculate both residual and depreciable amounts for accurate financial reporting.

Carrying Amount

• Reflects how much of the asset is left after accounting for accumulated depreciation; cannot be less than residual value.

Derecognition of Assets

• Process of removing an asset from financial records when it's sold, damaged, or disposed of.

• Profits/losses from derecognition go to the Statement of Comprehensive Income (SCI).

• Steps for derecognition include:

  • Depreciate the asset until disposal date.

  • Transfer remaining balances to disposal account reflecting gains/losses from the transaction.

Accounting and Journal Entries

• Asset Disposal:

  • Debit accumulated depreciation, credit the asset account, and record the cash received (or loss).

• Any profit or loss from asset disposal is recorded after assigning the carrying amount against proceeds received.

• Exceptions for insurance payouts on asset losses require separate accounting treatment.

Insurance Claims

• Insurance claims for damages should be treated cautiously in journal entries:

  • Generally, some expected payouts are recorded as assets when “virtually certain” compensation will be received.

  • Recognition of those claims typically happens after loss recognition, affecting profits appropriately.

Examples:

• Example of selling an asset leading to profit/loss tracking.

• An example of trading in an asset and specifics on calculating costs, highlighting basic principles of asset disposal accounting.

• Distinction between regular asset sales and insurance claim procedures.

Conclusion

Understand how management's decisions impact the valuation and recognition of assets, and prepare for potential variance in management practices across different companies.