Accounting for tangible fixed Assets

Transcription

1 Accounting for tangible fixed Assets Fixed assets are used (not consumed) in operations of a business provide benefits beyond the current accounting period Fixed assets are either acquired or self constructed For self construction the rules for self construction of inventory apply with regard to valuation (IAS 2), possibly borrowing costs are recognized Most relevant IFRS: IAS 16 Property, Plant and Equipment Definition according to IAS 16.6: Property, plant and equipment are tangible items that: (a) are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and (b) are expected to be used during more than one period. 1

2 Capitalization of property, plant and equipment IAS 16.7: The cost of an item of property, plant and equipment shall be recognized as an asset if, and only if: (a) It is probable that future economic benefits associated with the item will flow to the entity; and (b) the cost of the item can be measured reliably. (general recognition rules for an asset apply) Valuation at initial recognition: Historical Cost Historical Cost for specific examples: Land historical cost includes purchase cost, legal fees, demolition costs of old structures etc. Buildings and equipment historical cost includes all costs of acquisition and preparation for use 2

3 Example: determining acquisition cost A firm purchases a new intranet that needs to get installed The following costs are incurred: Catalogue list price Trade discount: 10%; cash discount terms: 2/10, n/ Freight cost including insurance 280 Repair costs (unintentionally, a worker dropped a box) 400 Wires and other fixtures 500 Installation 500 Initial tests; consulting fees 450 Cost to be capitalized:

4 Subsequent valuation Cost model: asset is valued at historical cost less any accumulated depreciation and any accumulated impairment losses Revaluation model: an asset whose fair value can be measured reliably shall be measured at its fair value at the date of the revaluation less any accumulated depreciation and any accumulated impairment losses Revaluations shall be made with sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the end of the reporting period If an item is revalued, the entire class of assets shall be revalued (consistency principle) An increase in value is recognized in other comprehensive income 4

5 Depreciation of tangible fixed assets Depreciation: The process of allocating the cost of tangible assets to the periods that benefit from these assets. Firm needs to determine The useful life of an asset The residual value of the asset at the end of its useful life If the residual value is material and can be measured reliably it reduces the depreciable amount The depreciable amount of an asset shall be allocated on a systematic basis over its useful life The residual value and the useful life are to be reviewed at least at the end of each financial year Any changes in expectations are to included prospectively (according to IAS 8) 5

6 Depreciation continued Fixed assets are depreciated if their useful life is finite this applies to buildings and equipment It does not apply to land Depreciation is not for valuation depreciation charges reflect that assets wear out (asset costs are charged to expense) but it does not reflect a decline in fair market value net book value = asset cost that has not yet been allocated as an expense replacement cumulative depreciation as a provision for replacement internal financing Note, however, that financing is a matter of cash flows not of bookkeeping! 6

7 Depreciation versus impairment Write-downs Depreciation/Amortization Impairment Impairment is for valuation and reflects loss in market value loss in utility estimation and measurement problems 7

8 Asset Impairment Impairment carrying value higher than recoverable amount Calculation of a possible impairment loss : impairment loss = depreciated cost less recoverable amount Net selling price: fair value cost of disposal 8

9 The useful life of assets determines depreciation period ( depreciable life ) and depreciation charges is defined in terms of the time during which the asset is expected to be used by the company The asset management policy may provide the disposal of assets after a specified time or after consumption of a certain proportion of the economic benefits embodied in the asset. Therefore, the useful life of an asset may be shorter than its economic life. depreciable life: a time period, e.g. ten years, or an estimate for total production or usage, e.g units or hours physical deterioration and obsolescence limit useful life 9

10 Depreciation Methods most common methods: 1. activity or usage method 2. straight-line method 3. sum-of-the-years -digits method 4. declining-balance method Requirement: depreciation method employed must be systematic Shall reflect the pattern in which the asset s future economic benefits are expected to be consumed by the entity The first requirement is fulfilled by all methods, the second is case specific 10

11 1 - Activity or Usage Method if assets mainly wear out through use it is rational to depreciate on the basis of usage life of asset estimated in terms of output or input advantage: low-output (input) periods generate low depreciation charges estimation e.g. based on a product life cycle Year Units produced Depreciation charge ( ) Depreciation charge in year 1: =

12 2 Straight-Line Method usability constant over time or no reasons for another pattern rational to spread depreciable cost uniformly over the asset s life fairly constant repair/maintenance cost Income (after Rate of Year Depreciation charge ( ) Book value depreciation) return* _ ,67% ,69% ,09% ,11% ,29% ,00% ,33% residual value: * income / average total assets 12 12

13 3 Sum-of-the-Years -Digits Method decreasing charge method rational if asset has increasing repairs and maintenance Remaining Depreciation Depreciation Book value Year Depreciation base ( ) life in years fraction charge year-end / / / / / / / / n( n + 1) 7(7 + 1) 56 sum of the years = in the example: = =

14 4 Declining-Balance Method (again a) declining charge method constant percentage applied to a decreasing book value no estimate of the useful life required, only a yearly depreciation rate needed Rate on de- Depreciation Balance Accumu- Book value Year Depreciation base ( ) clining balance expense lated depreciation year-end % % % % % % %

15 Determining the depreciation rate for given life and salvage value: SV n SV = ( 1 d) AC d =1 n AC with SV: salvage value AC: acquisition cost n: useful life, and d: the depreciation rate 15

16 Comparison of depreciation charges Purchase price: ; salvage value: ; useful life: 7 years Depreciation charges under different methods depreciation charge years straight-line sum-of-the-years declining balance activity 16

17 Depreciation for intra-period purchases and sales Depreciable life of an asset starts when the asset is available for use This is typically not the beginning of the financial year Depreciation ceases at earlier of the date that the asset is classified as held for sale or derecognized (IAS 16.55) if asset is purchased or sold during the year depreciation charges need to be adjusted According to IFRS apportion of depreciation charges on a pro rata temporis basis is required 17

18 Example: Depreciation charges for office equipment purchased in February 2004 purchase price: the straight-line depreciatiopn method used useful life: 7 years sold on 31st of May 2006 fiscal year ends December 31 Year Annual Depreciation Rate Depreciation Period Depreciation Charge ,000 11/12 11, ,000 12/12 12, ,000 5/12 5,000 18

19 Revisions of Depreciation Rates useful life is only an estimate, subject to change depreciable amount can change (see next slide) changes are handled in current and prospective periods, no revision of earlier periods! Example change in useful life: asset with depreciation base of and useful life of 5 years; in year four, useful life is reestimated to be 8 years overall. Year Total Depreciation charge initial charges: = revised charges: =

20 Revisions of Depreciation Base Postacquisition expenditures: betterments or maintenance? repair and maintenance cost: necessary to maintain asset betterments costs incurred to improve the asset What characterizes a betterment (capital improvement)? Increase the asset s useful life Improve the quality of the asset s output Increase the quantity of the asset s output Reduce the costs associated with operating the asset material amount of investment relative to acquisition cost Improvements are capitalized. 20

21 Revision of depreciation method Accelerated method is replaced by straight line method at the time when the accelerated book value would exceed the one resulting from the straight line method applied to the rest of the useful life. Example: AC = 100; n = 10; SV = 0; d = 20%. depreciation straight line revised dec. Balance depreciation depreciation 20,00 10,00 20,00 16,00 8,89 16,00 12,80 8,00 12,80 10,24 7,31 10,24 8,19 6,83 8,19 6,55 6,55 6,55 5,24 6,55 6,55 3,93 6,55 6,55 2,62 6,56 6,56 1,31 6,56 6,56 0,00 100,01 21

22 Gains and losses on sales of tangible assets not every asset is held until the end of its useful life sales price different from current book value: gain/loss from sales results Example : computer that has a useful life of three years is sold after two years for a price of 1.000; original cost was Sales price Less book value Cost Accumulated depreciation Gain 300 Income statement presentation: in most cases, gains/losses included in other income Journal entry: Cash Accumulated depreciation Computer equipment Gain on sale of equipment