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Property, plant and equipment

Property, plant and equipment. Typical coverage of US GAAP. Definition Acquisition of PP&E: General Self-constructed assets Interest costs during construction Initial cost of natural resources Valuation at acquisition: Exchange of non-monetary assets Lump-sum purchases

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Property, plant and equipment

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  1. Property, plant and equipment

  2. Typical coverage of US GAAP Definition Acquisition of PP&E: General Self-constructed assets Interest costs during construction Initial cost of natural resources Valuation at acquisition: Exchange of non-monetary assets Lump-sum purchases Deferred payment contracts Purchase paid for using company stock Costs incurred subsequent to acquisition Periodic valuation: Carrying value Impairment

  3. Typical coverage of US GAAP Cost allocation issues: Depreciation Definition Useful life Depreciable base Depreciation method Depletion Disposition: Sale Involuntary conversion Fully depreciated fixed assets Disclosure requirements

  4. Executive summary IFRS permits periodic revaluation of an entire class of fixed assets to fair value. US GAAP does not allow revaluation. IFRS has a one-step approach for determining impairment of fixed assets while US GAAP has a two-step approach. IFRS allows reversal of impairment losses on fixed assets, while this is prohibited using US GAAP. IFRS requires depreciation of components of an asset when the components have different periods of benefit. Component depreciation is permissible using US GAAP but is not a common practice.

  5. Progress on convergence Impairment was one of the short-term convergence projects agreed to by the FASB and IASB in their 2006 Memorandum of Understanding. In their September 2008 meeting, the FASB and IASB decided to defer work on convergence on impairment until other work is completed. Convergence on other fixed-asset-related accounting matters is not planned at this time.

  6. IFRS US GAAP AcquisitionGeneral PP&E should be recorded based on the fair value given up or the value received, whichever is more clearly evident. Similar Costs include purchase price and related taxes, directly attributable costs and estimated retirement obligation costs. Similar Costs that are not directly attributable should be expensed as a period cost. Similar

  7. US GAAP Voluntary investments in safety or environmental equipment are capitalized. Acquisition General IFRS • Voluntary investments in safety or environmental equipment are expensed, unless they extend the economic life of the related asset or a constructive obligation exists to improve the asset’s safety or environmental standards.

  8. Acquisition General Example 1: Clean Company wants to be viewed as the most environmentally friendly company in its industry. As a result, the company installs equipment on its smoke stacks to reduce emissions. The equipment costs $30,000 and has a three-year life. • How would this equipment be accounted for using US GAAP and IFRS?

  9. Example 1 solution: Using US GAAP, this equipment would be capitalized and depreciated over its three-year life. Using IFRS, the $30,000 cost of this voluntary investment in environmental equipment might be expensed in year one, unless it extends the economic life of the smoke stacks or this expenditure fulfills a constructive obligation. Acquisition General

  10. IFRS US GAAP Acquisition Self-constructed assets Direct cost of materials and labor should be capitalized. Similar A portion of indirect costs can be included in capitalized costs. Similar

  11. IFRS US GAAP Acquisition Interest costs during construction Interest costs are capitalized to the extent that these costs could have been avoided had the expenditures been used to repay the debt rather than to acquire or construct the asset. Similar, although IFRS uses the term “borrowing costs.” Similar, although IFRS says a “substantial” period of time. The qualifying asset must take a period of time to complete. Interest capitalization commences and continues as long as expenditures and progress are made to get the asset ready for its intended use. Similar Capitalizable interest is based on specific borrowing if available or weighted-average costs of borrowings, and cannot exceed actual interest for the period. Similar

  12. US GAAP Interest revenue cannot be netted against interest cost. Acquisition Interest costs during construction IFRS • Interest revenue is netted against interest cost. When funds borrowed to finance the acquisition of a qualified asset are temporarily invested, the interest cost should be reduced by any investment income earned on these funds.

  13. Example 2: To finance construction of a qualifying asset, the company borrows $250,000 on January 1, 2010, at an interest rate of 8%. The company makes the following disbursements during the 24-month construction period: $100,000 on January 1, 2010; $50,000 on June 30, 2010; $50,000 on January 1, 2011, and $50,000 on June 30, 2011. Construction of the asset is completed on December 31, 2011, and it is ready for its intended use. During the construction period, excess funds are invested, which earn 5% in 2010 and 4% in 2011. What are the interests that should be capitalized using US GAAP and IFRS? AcquisitionInterest costs during construction

  14. Example 2 solution: US GAAP: The interest cost capitalized for the two-year period of $28,000 is calculated by determining the portion of the interest cost the company incurs during the construction of the building that theoretically could have been avoided. Interest revenue is not netted against interest expense. AcquisitionInterest costs during construction

  15. Example 2 solution (continued): IFRS: IAS 23 requires reducing the interest to be capitalized by the income earned from temporary investment of those borrowings (paragraph 12). Therefore, under IFRS, the investment income earned is calculated as follows: Thus, the net interest cost to be capitalized for this asset is $20,750 ($28,000-$7,250) using IFRS. AcquisitionInterest costs during construction

  16. US GAAP Revaluation of fixed assets is not allowed. Periodic valuationCarrying value IFRS • A company can choose to account for PP&E and natural resources at fair value using the revaluation method: • Cost or fair value must be applied to an entire class of PP&E. • Different classes can have different policies. • Fair value is the amount at which an asset could be exchanged in an arm’s length transaction between knowledgeable and willing parties. • A professional appraiser may be used to establish fair value. • Revaluations must be performed periodically to ensure the carrying value of that asset class is not materially different than its fair value.

  17. Periodic valuationCarrying value US GAAP • Revaluation of fixed assets is not allowed. IFRS • Accounting for revaluation: • Increases in value should be credited through OCI to a revaluation surplus account in equity, unless it reverses a loss that was previously expensed, in which case that portion may be credited to income. • Decreases in value should be expensed unless it reverses a previous revaluation surplus account relating to the same asset. That portion can be debited through OCI to the revaluation surplus account in equity. • If the revalued basis of an asset exceeds the cost basis, there will be an increase in annual depreciation. To the extent there is an increase in depreciation expense, per IAS 16.4-1, an entity may reverse the portion of reserve surplus related to this increase by debiting revaluation surplus and crediting retained earnings. Alternatively, this transfer may be computed upon disposal.

  18. Periodic valuationCarrying value US GAAP • Revaluation of fixed assets is not allowed. IFRS • Accounting for revaluation (continued): • When an asset is disposed of, any remaining related revaluation surplus account in equity may be transferred to retained earnings. The revaluation surplus can never be credited to income. • If an asset is revalued, an entity may account for the accumulated depreciation at the date of revaluation in two ways: • Depreciation elimination method: The accumulated depreciation can be eliminated against the asset itself. • Proportionate restatement method: The accumulated depreciation can be restated proportionately with the change in the gross carrying value of the asset so that the carrying value of the asset after revaluation equals its revalued amount.

  19. US GAAP Revaluation of fixed assets is not allowed. Periodic valuationCarrying value IFRS • 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 a recent study, Hans B. Christensen and Valeri Nikolaev of the University of Chicago Booth School of Business 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.

  20. Example 5: A company that reports using IFRS acquired weight-lifting equipment on January 1, 2009, 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, 2010, 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 2010? Periodic valuationCarrying value

  21. Example 5 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 valuationCarrying value

  22. Example 6: A company that reports using IFRS acquired an excavator on January 1, 2009, 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 2009 and 2010, depreciation would be $1,000. On December 31, 2010, the fair value is determined to be $8,800. On December 31, 2012, 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 2009 through 2012. Periodic valuationCarrying value

  23. Periodic valuationCarrying value Example 6 solution:

  24. Periodic valuationCarrying value 2011: Depreciation expense $ 1,100 Accumulated depreciation $ 1,100 (To record depreciation.) Revaluation surplus – equipment (OCI) $ 100 Retained earnings $ 100 (To reverse portion of reserve surplus related to increased depreciation expense. Note that this journal entry is optional.) Example 6 solution (continued): 2009: Equipment $ 10,000 Cash $ 10,000 (To record purchase of equipment.) Depreciation expense $ 1,000 Accumulated depreciation $ 1,000 (To record depreciation.) 2010: Depreciation expense $ 1,000 Accumulated depreciation $ 1,000 (To record depreciation.) Accumulated depreciation $ 2,000 Equipment $ 1,200 Revaluation surplus – equipment (OCI) 800 (To record revaluation.)

  25. Periodic valuationCarrying value Example 6 solution (continued): 2012: Depreciation expense $ 1,100 Accumulated depreciation $ 1,100 (To record depreciation.) Revaluation surplus – equipment (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 Revaluation surplus – equipment (OCI) 600 Loss 1,000 Equipment $ 3,800 (To record devaluation of equipment.)

  26. IFRS US GAAP Periodic valuation Impairment Impairment indicators for an asset include such items as significant change in its use, projected losses related to its use, a significant decline in its market value, etc. Similar Similar An impaired asset must be written down, and the charge is recorded in income.

  27. US GAAP ASC 360-10-35-21 requires a review for impairment indicators in PP&E “whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.” A recoverability test is required: If the carrying amount of the asset exceeds the sum of the expected net future undiscounted cash flows, then the asset is not recoverable and an impairment loss must be calculated. Periodic valuationImpairment – impairment indicators and recoverability test IFRS • IAS 36 requires an entity to assess annually whether there are any indicators of impairment. • There is no recoverability test, simply calculate an impairment loss if impairment indicators are present.

  28. US GAAP The impairment loss is the excess of the carrying value of the asset compared to its fair value (with fair value calculated according to ASC 820-10-35). Periodic valuationImpairment – calculating the impairment loss IFRS • IAS 36 determines the impairment loss as the excess of the carrying value of the asset over its recoverable amount: • The recoverable amount is the higher of the fair value less costs to sell or value in use (the discounted net present value of expected future cash flows from the asset).

  29. US GAAP The impairment loss is always reported through net income. Periodic valuationImpairment – recording the impairment loss IFRS • The impairment loss is recognized in OCI to the extent that it is reversing a prior upward revaluation. Otherwise, it is included in net income.

  30. US GAAP A reversal of the impairment loss is prohibited. Periodic valuationImpairment – reversal of the impairment loss IFRS • The impairment loss can be reversed up to the newly calculated recoverable amount, but it cannot exceed what the original carrying amount, net of depreciation, would have been.

  31. Periodic valuationImpairment Example 7: At December 31, 2010, a company has a piece of equipment it acquired on January 1, 2007, with an initial scrap value of $0, which has significantly decreased in market value due to technological innovations in the industry in which the company operates. The equipment’s 10-year service life has a net carrying value of $60,000 ($100,000 cost less $40,000 of accumulated depreciation). The expected future undiscounted cash flows from the use of this equipment are $59,000. Additionally, the company expects to scrap the equipment in six years at the end of its service life, for $2,000. Is an impairment loss calculation required using US GAAP and IFRS?

  32. Periodic valuationImpairment Example 7 solution: Using US GAAP, the carrying value of the equipment of $60,000 is less than the expected future undiscounted cash flows of $61,000 ($59,000 + $2,000), so no impairment loss calculation is required. Using IFRS, an impairment loss calculation is required because impairment indicators are present.

  33. Periodic valuationImpairment Example 8: Use the same facts as the previous example, except the scrap value is expected to be $0. Additionally, the fair value of the piece of equipment is $50,000 and the selling costs are minimal. The discounted net present value of expected cash flows from this piece of equipment is $51,000. What, if any, impairment loss should be recorded using US GAAP and IFRS? Show any required journal entries.

  34. Periodic valuationImpairment Example 8 solution: Using US GAAP, the piece of equipment now fails the recoverability test. The $60,000 carrying value of the equipment exceeds the sum of the expected net future undiscounted cash flows of $59,000. Therefore, an impairment loss must be calculated. The impairment loss is the difference between the carrying value of $60,000 and the fair value of $50,000. A $10,000 impairment loss would be recorded as follows: Impairment loss $ 10,000 Equipment $ 10,000 Using IFRS, there are impairment indicators so an impairment loss must be calculated. Using IAS 36, the recoverable amount is $51,000 (the higher of the net fair value of $50,000 or the discounted net present value of the cash flows of $51,000). Therefore, a $9,000 impairment loss needs to be recorded as follows: Impairment loss $ 9,000 Equipment* $ 9,000 *Note that the credit could be recorded to an accumulated impairment loss account instead of being recorded directly to the asset account. This would allow management to easily track accumulated impairment losses for potential reversal as discussed in example 9.

  35. Example 9: Use the same facts as the previous example, except in 2012 it is discovered that the technological innovations related to this piece of equipment are not effective. As a result, the fair value of this piece of equipment is now $41,000. Also, assume the scrap value was always $0. Using IFRS, what amount of the original impairment loss of $9,000 can be reversed? Show any required journal entries to reverse the impairment loss. Periodic valuationImpairment

  36. Example 9 solution: Impaired Not impaired Net asset value 2010 $ 60,000 $ 60,000 Impairment 2010 (9,000) 51,000 Depreciation 2011 $51,000/(6) (8,500) (10,000) Depreciation 2012 $51,000/(6) (8,500) (10,000) 34,000 $ 40,000 Reversal of impairment loss 6,000 $ 40,000 Equipment* $ 6,000 Impairment loss $ 6,000 Periodic valuationImpairment *Note that if the impairment was initially credited to an accumulated impairment loss account instead of being recorded directly to the asset account , the accumulated impairment loss account would be debited instead of the asset account.

  37. US GAAP Revaluing PP&E is not allowed. Reversal of impairment losses is not allowed. Estimates of proven oil and gas reserves. Disclosures IFRS • For revalued assets: • The effective date of the revaluation. • The methods and assumptions used in estimating fair value. • Whether an independent appraiser was utilized. • For revalued classes of assets their net cost basis. • The changes to and balance in the revaluation surplus. • The amount of impairment losses reversed directly to equity or through net income. • Not required.

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