Property, Plant & Equipment Prepared by Kent Wilson Chapter 11 Property, Plant & Equipment Prepared by Kent Wilson

Objectives Understand the nature of property, plant and equipment Understand initial measurement and recognition criteria Alternative measurement subsequent to initial recognition The cost model The revaluation model Understand the factors to consider when selecting measurement models

Objectives 7. Accounting for derecognition 8. Implement the disclosure requirements of IAS 16

The Nature of Property, Plant & Equipment IAS 16 defines property, plant & equipment as: Tangible items Assets with a specific use within the entity They are expected to be used during more than one period Excludes assets held for sale (IFRS 5) Normally divided into classes: Land Buildings Machinery Motor vehicles

Initial Recognition of Property, Plant & Equipment Cost of an item is recognized as an asset if: It is probable that economic benefits will flow to the entity and The cost can be reliably measured Where future economic benefits are not expected to flow to the entity, costs incurred should be expensed Significant parts (with different useful lives) are required to be separately accounted for Aircraft (Component Depreciation)

Initial Measurement of Property, Plant & Equipment Initially measured at cost which includes: Purchase Price Directly attributable costs Initial estimate of the costs of dismantling and removing the item or restoring the location site

Measurement Subsequent to Initial Recognition IAS 16 allows a choice of two possible measurement models: Cost model Revaluation model The choice of model is an accounting policy decision The policy that is chosen must be applied to a whole class of assets May change policy, but only if it results in more relevant or reliable information

Revaluation Model In 2006, Ernst & Young LLP provided an overview of 65 selected large, multinational companies reporting using IFRS. Only one company used the revaluation option for any of its PP&E. In another study, Hans B. Christensen and Valeri Nikolaev of the University of Chicago looked at the valuation choices made by 1,539 German and UK companies in the first year of preparing IFRS financial statements. They found that only 3% of the companies chose to use fair value accounting for at least one class of assets.  

The Cost Model IAS 16 requires that assets are carried at cost less any accumulated: Depreciation Impairment losses Repair and maintenance costs are expensed as incurred, not capitalized Capitalization requires increased probable future economic benefit (at time of expenditure)

Depreciation IAS 16 includes the following definitions: Depreciation – the systematic allocation of the depreciable amount of an asset over its useful life Depreciable amount – the cost of an asset less its residual value Residual value – the estimated value that an entity would currently obtain from disposal if the asset were at the end of it’s useful life Useful life – the period over which an asset is expected to be available for use by an entity

Review of Residual Values and Useful Lives The residual value and useful life of property, plant and equipment should be reviewed at least at the end of each financial year. If expectations differ from previous estimates, these should be accounted for as a change in an accounting estimate in accordance with IAS8. The asset's depreciable amount is revised to reflect any change in residual value and then this amount is allocated as depreciation over the remainder of the asset's expected useful life.

Depreciation Depreciation is a process of allocation designed to reflect the fall in the value of the asset in a pattern consistent with the consumption of economic benefits by the entity IAS 16 does not specify how this allocation process should be undertaken Various depreciation methods are used in practice: Straight line method Diminishing-balance method (Declining balance) Units-of-production method

Component Depreciation US GAAP Depreciable base: component depreciation is allowed, but is rarely done because it complicates the accounting. IFRS Depreciable base: IAS 16.43 states, “each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately.”

Component Depreciation Example 1: A company acquires a truck at a cost of $60,000. The service life is expected to be four years. Based on reliable historical data, the company believes the truck can be sold at the end of four years for $10,000. Additionally, the tires must be replaced every two years. The transmission must be replaced every three years. On the initial date of acquisition, the tires have a cost of $4,000 and the transmission has a cost of $6,000. What is the depreciable base and service life using US GAAP and IFRS? Assume the company chooses not to use component depreciation using US GAAP.

Depreciation Example 1 solution: Depreciable base Service life US GAAP IFRS Truck 4 years $ 50,000 $ 40,000 Tires 2 years – 4,000 Transmission 3 years – 6,000 $ 50,000 $ 50,000 US GAAP Depreciation: 50,000/4 = $12,500 annual depreciation

IFRS Depreciation Example 1 solution: Service life Depr. Basis Depr. Truck 4 years $ 40,000 $ 10,000 Tires 2 years 4,000 2,000 Transmission 3 years 6,000 2,000 $ 50,000 $ 14,000

The Revaluation Model As an alternative to the cost model, IAS 16 allows the revaluation model to be used for classes of assets Measurement basis is fair value (FV) Frequency of revaluations is not specified, but must be performed with sufficient regularity such that the carrying amount of assets is not materially different from their FV Revaluation performed on a class basis Accounting performed on an asset-by-asset basis

Applying the Revaluation Model: Revaluation Increases IAS 16 para 39 outlines principles: An increase is recognized in comprehensive income The gain is transferred to equity (revaluation surplus)

Applying the Revaluation Model: Revaluation Decreases IAS 16 para 40 outlines principles: A revaluation decrease Recognition in P & L (Loss) A revaluation decrease following a previous increase Elimination of revaluation surplus Recognition in P & L Reversal of deferred tax liability

The Revaluation Model: Transfers from Asset Revaluation Surplus (ARS) Transfers may be made from the Asset Revaluation Surplus in the following circumstances: When a revalued asset is derecognized, the balance in the ARS may be transferred to retained earnings When a revalued asset is being depreciated, the ARS may be progressively transferred to retained earnings over the useful life of the asset

Periodic Valuation Example 2: A company that reports using IFRS acquired weight-lifting equipment on January 1, 2011, at a cost of $10,000. This is the company’s only equipment. The company uses fair value for its equipment using IAS 16. On December 31, 2012, the net book value is $8,000 (cost of $10,000 less accumulated depreciation of $2,000), while the fair value is determined to be $8,800. What journal entries would be required to record the revaluations in 2012?

Periodic valuation Carrying value Example 2 solution: Accumulated depreciation $ 2,000 Equipment $ 2,000 (To eliminate accumulated depreciation.) Equipment $ 800 Revaluation surplus – equipment (OCI) $ 800 (To write equipment up to fair value.)

Periodic Valuation Example 3: A company that reports using IFRS acquired an excavator on January 1, 2010, at a cost of $10,000. This excavator represents the company’s only piece of equipment. The company uses fair value for its equipment using IAS 16. This excavator is being depreciated on a straight-line basis over its 10-year useful life. There is no residual value at the end of the 10-year period. In both 2010 and 2011, depreciation would be $1,000. On December 31, 2011, the fair value is determined to be $8,800. On December 31, 2013, the fair value is determined to be $5,000. The company’s accounting policy is to reverse a portion of revaluation surplus related to the increased depreciation expense. Determine what accounts would be impacted if this activity is recorded for 2010 through 2013.

Periodic valuation Example 3 solution: 2010: Equipment $ 10,000 Cash $ 10,000 (To record purchase of equipment.) Depreciation expense $ 1,000 Accumulated depreciation $ 1,000 (To record depreciation.) 2011: Depreciation expense $ 1,000 Accumulated depreciation $ 1,000 Accumulated depr. $ 2,000 Equipment $ 1,200 Revaluation surplus – equipment (OCI) 800 (To record revaluation.) 2012: Depreciation expense $ 1,100 Accumulated depreciation $ 1,100 (To record depreciation.) Reval. surplus – equip. (OCI) $ 100 Retained earnings $ 100 (To reverse portion of reserve surplus related to increased depreciation expense. Note that this journal entry is optional.)

Periodic valuation Example 3 solution (continued): 2013: Depreciation expense $ 1,100 Accumulated depreciation $ 1,100 (To record depreciation.) Reval. surplus – equip. (OCI) $ 100 Retained earnings $ 100 (To reverse portion of reserve surplus related to increased depreciation expense. Note that this journal entry is optional.) Accumulated depreciation $ 2,200 Reval. surplus – equip. (OCI) 600 Loss 1,000 Equipment $ 3,800 (To record devaluation of equipment.)

Choosing Between the Cost Model & the Revaluation Model Revaluation model provides more relevant information However, there is a cost disincentive of adopting the revaluation model Cost model harmonizes with US GAAP Differing impacts on profit & loss

Derecognition IAS 16 para 67 identifies two occasions where derecognition should occur: On disposal Where no future economic benefits are expected When items are sold, a gain or loss is recognized, and included in the profit or loss for the period

Disclosure IAS 16 para 73 - 79 outline requirements: Information on a class-by-class-basis Measurement bases Any restrictions on title Selection of depreciation methods Revaluation information

Homework Exercises 11.5, 11.14, 11.17 DUE THURSDAY, September 11