Week 3

• Recognition of Asset:

  • An asset is a present economic resource controlled by the entity as a result of past events
  • An economic resource is a right that has the potential to produce economic benefits
  • Potential economic benefits and control are key factors
  • (section 4.3-4.4, IASB Conceptual Framework, 2018)
• Property, Plant, and Equipment (PPE):

  • Covered by IAS16
  • Objective is to prescribe the accounting treatment for PPE
  • Excludes property such as investment property, assets held for sale, biological assets, etc.
  • Recognition criteria for PPE include:
  • It is probable that any future economic benefits associated with the asset will flow to the entity
  • The cost of the asset can be measured reliably
  • Cost includes costs initially to acquire or construct the item and costs subsequently to add to or replace part of it
• Initial Measurement of PPE:

  • Cost includes all costs necessary to bring the asset to working condition for its intended use
  • Includes original purchase price, site preparation costs, delivery and handling costs, installation and assembly costs, related professional fees, estimated dismantling and restoration costs
• Subsequent Measurement - Depreciation:

  • Depreciable amount allocated on a systematic basis over the asset's useful life
  • Annual review needed of residual value and useful life
  • Depreciation method should reflect the pattern in which economic benefits are consumed
  • Depreciation charged to profit or loss
• Revaluation Model:

  • Permits two accounting models: Cost model and Revaluation model
  • Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability
  • Revaluations should be carried out regularly to avoid material differences from fair value
  • Revalued assets are depreciated in the same way as under the cost model
• Revaluation Steps:

  • Calculate surplus
  • Eliminate accumulated depreciation
  • Record the revaluation
  • Depreciate the revalued asset
  • Transfer excess depreciation to retained earnings
• Presentation and Disclosure:

  • Information about each class of PPE
  • Basis for measuring carrying amount and depreciation methods used
  • Useful lives or depreciation rates
  • Gross carrying amount, accumulated depreciation, and impairment losses
  • Reconciliation of carrying amount at the beginning and end of the period
• Key Areas Requiring Judgement:

  • Distinction between capital and revenue expenditure
  • Capitalization of interest relating to qualifying assets
  • Estimates of useful life, residual value, and pattern of usage for depreciation
  • Fair values if revaluation model is adopted
  • Indicators of impairment and recoverable amount
• If CAPITAL expenditure – debit is to statement of financial position
• If REVENUE expenditure – debit is to income statement (reduction of profits)
• A chemical manufacturer installs new chemical handling processes which are necessary to comply with environmental requirements for the production and storage of dangerous chemicals.

  Yes
• On acquisition of a specialised item of machinery a manufacturer purchases spare parts for the motor which drives the machine.  The motor is expected to run without needing replacement parts for 24 months.

  Yes
• A business fits interior partitions into its general office space.

  Yes
• Fair value Accounting

  Fair value is defined as ‘the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date’.(ACCA)
• If an item is revalued, the entire class of assets to which that asset belongs should be revalued. (aka no cherry picking)
• If fair value > carrying amount, accounting for gain is:Dr  Asset (carrying amount)   Cr     Revaluation surplus (an equity reserve)
• If fair value < carrying amount, accounting for loss is:Dr  Revaluation Surplus or Profit and loss (if no RS)   Cr     Asset (carrying amount)
• Revaluation- Issues to be considered

  A current value (fair value) provides more relevant information than values based on historic cost

  Automatically higher asset values?Impact on financial ratios – Asset turnover, ROCE, gearing
• Revaluation- Issues to be considered

  Effect of the model on the income statement:

    Higher depreciation expense

    Profit/loss on disposal
• Revaluation- Issues to be considered

  Costs associated with adopting and maintaining the revaluation model
• 2.Eliminate accumulated depreciation

  Dr Accumulated depreciation 

  Cr Asset 
• 3 Record the revaluation

  Dr  Asset 

  Cr  Revaluation surplus 
• 4.Depreciate the revalued asset

    Dr  Depreciation expense  Cr  Accumulated depreciation
• When doing revaluations create new depreciation expense
• 5.Transfer Excess Depreciation

  Dr  Revaluation surplus   

  Cr  Retained earnings