CHAPTER 9 LONG TERM ASSETS I: PROPERTY, PLANT AND EQUIPMENT

Property, Plant, and Equipment These items represent a major source of future service potential Valuation is important because it indicates to financial statement users the physical resources available to the firm and may give some indication of future liquidity and funds flow. Objectives 1Accounting and reporting to investors on stewardship 2Accounting for the use and deterioration of plant and equipment 3Planning for new acquisitions, through budgeting 4Supplying information for taxing authorities 5Supplying rate-making information for regulated industries

Accounting for Cost Initial cost represents sacrifice of resources given up now to accomplish future objectives Preferred measurement technique is discounted present value of future receipts - Indicates future services potential Acquisition cost implies that this process has taken place

Accounting for Cost Some problems –Group purchases –Self constructed assets –Removal of existing assets –Non-monetary exchange –Donated or discovery values

Financial Analysis of Property, Plant and Equipment Company’s asset replacement policy Examine investment activity is the statement of cash flows

Cost Allocation Capitalization implies future service potential The matching concept requires expiration of future service potential to be recorded in the period incurred This is termed cost allocation Since actual expiration of future service potential is difficult to ascertain - method of cost allocation should be systematic and rational Depreciation is a form of cost allocation

The Depreciation Process Issues: 1Establishing the proper depreciation base 2Determining useful service life 3Choosing a cost allocation method –Straight-line –Accelerated –Units of Activity –Group and composite –Retirement and replacement –Compound interest

Capital Vs. Revenue Expenditures Question is whether to capitalize or charge to expense expenditures required for an existing long-term asset Criteria –Prolong life or increase efficiency - capitalize –Ordinary and necessary - expense

Recognition and Measurement Issues User needs are currently not being satisfied Suggests a current value approach

International Accounting Standards The IASC has issued pronouncements on the following issues: 1Property, plant and equipment in IAS No. 16, “Property, Plant and Equipment.” 2Interest capitalization in IAS No. 23, “Borrowing Costs.” 3Impairment of assets in IAS No. 36, “Impairment of Assets.”

IAS No. 16 Recognize items as assets when economic benefit will flow to enterprise and cost can be measured Preference is to depreciate historical cost of assets But, allows revaluations to current market value Requires recording of impairments Depreciation charge should reflect pattern of benefits If change in pattern of benefits is noted, change depreciation method to reflect new pattern

FASB Staff Review of IAS No 16 Several differences: 1Revaluation of assets distorts intercompany comparability 2Unclear and inconsistent guidelines for determining fair value 3No discussion of accounting for the extractive industries 4Failure to specify rules for capitalization of subsequent expenditures related to assets

IAS No. 23 Benchmark treatment: recognize interest cost in period incurred Alternative treatment: capitalize avoidable interest FASB staff review expressed concern over ability to choose treatments

IAS No. 36 Requires an impairment loss to be recognized on items of property, plant and equipment whenever the recoverable amount of an asset is less than its book value The recoverable amount is the higher of the asset’s selling price, or value in use (present value of future cash flows) An impairment loss is recognized as an expense on the income statement FASB staff reaction noted different approaches to recognition and measurement of impairment losses