CHAPTER 9

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

2. 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 • Accounting and reporting to investors on stewardship • Accounting for the use and deterioration of plant and equipment • Planning for new acquisitions, through budgeting • Supplying information for taxing authorities • Supplying rate-making information for regulated industries

3. 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

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

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

6. 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

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

8. 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

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

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

11. 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

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

13. 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

14. 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