MGT220H5 Final: Exam Notes

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Randolph Christopher Small

CHAPTER 7: CASH AND RECEIVABLES Understanding Cash and Accounts Receivable • Managing and controlling cash and accounts receivable are critical objectives for many companies • Key concerns relating to management and control of cash include: o Implementing appropriate internal controls, including regular bank reconciliations o Minimizing “idle” cash • Key concerns relating to management and control of accounts receivable include: o Implementing appropriate internal controls, including appropriate credit policies o Speeding up the collection cycle Financial Asset “Any asset that is: (i) cash; (ii) a contractual right to receive cash or another financial asset from another party; (iii) a contractual right to exchange financial instruments with another party under conditions that are potentially favourable to the entity; or (iv) an equity instrument of another entity” What is Cash? • Cash is reported as a current asset if it is readily available to pay current obligations and is free of restrictions • Cash consists of coins, currency, available funds on deposit at the bank, and petty cash • Also includes money orders, certified cheques, cashier’s cheques, personal cheques, bank drafts, and usually savings accounts • Post-dated cheques, travel advances, and stamps on hand are not classified as cash Reporting of Cash • Reporting cash needs special attention in the case of the following: 1. Restricted cash 2. Cash in foreign currencies 3. Bank overdrafts 4. Cash equivalents Restricted Cash • Compensating balances: minimum cash balances maintained by a corporation in support of existing borrowings • These funds are not available for use by the corporation, but the bank can use the restricted cash • Petty cash, special payroll, and dividend accounts are examples of cash set aside for a special purpose (usually not material) • If the restricted cash balance is material, must be segregated from regular cash for reporting purposes • Classified as current or non-current assets depending on date of availability or expected disbursement • Note disclosure of restricted cash is required Foreign Currencies • Amount held in foreign currencies is reported in Canadian dollars on the date of the statement of financial position (i.e. balance sheet date) • The exchange rate on the date of the statement of financial position is used to translate foreign currencies into Canadian dollars • If restrictions exist on the foreign funds, those funds are reported as restricted Bank Overdrafts • Overdrafts represent cheques written in excess of the cash account balance • Overdrafts are reported as current liabilities (often reported as accounts payable) • In general, bank overdrafts should not be offset against the Cash account • However, bank overdrafts may be offset against available cash in another account if both accounts are at the same bank Cash Equivalents • Defined as “short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.” • Original maturity is generally three months or less • Typical examples: treasury bills, money-market funds, commercial paper • ASPE excludes equity securities • Under IFRS, some equity instruments can be classified as cash equivalents (for example, preferred shares acquired within a short time of their maturity date) • Cash equivalents are reported at fair value Receivables: Introduction • Loans and receivables are specific claims against customers and other parties for cash (or other assets) • Receivables are classified as either current (short-term) or noncurrent (long-term) • Classified as current receivables if there is the expectation to collect within one year or operating cycle (whichever is longer) • Receivables can be classified as either trade receivables or nontrade receivables Accounts Receivable: Issues • Trade receivables include: o Accounts receivable (verbal promise to pay, normally within 30 to 60 days) o Notes receivable (written promises with specified terms, e.g. interest rate and due date) • Nontrade receivables include the following: 1. Advances to employees or other officers 2. Receivables from the government (e.g. GST recoverable, income tax receivable) 3. Dividends and interest receivable 4. Amounts owing by insurance companies Accounts Receivable: Trade Discounts vs. Cash Discounts • Trade discounts are discounts given to customers often for different quantities purchased (often quoted as a percentage) • Trade discounts are generally not recorded; the price charged (net of the discount) is recorded by the seller as a receivable and revenue • Cash discounts (or sales discounts) encourage customers to pay faster; they are recorded • Example of cash discounts: 2/10, n/30; the customer will receive a 2% discount if payment made within 10 days and the gross amount of the invoice is due in 30 days Accounts Receivable: Recording Cash Discounts • Two methods: gross method and net method • Gross method records discounts when customers pay within discount period o “Sales Discounts” are deducted from sales on the income statement o Most common method • Net method records accounts receivable net of the discount; discounts forfeited by customers are recorded when not taken o Preferred method but rarely used o “Sales Discounts Theoretically Forfeited” is recorded as “Other revenue” if customer does not take the discount Example of Gross Method • $10,000 sales on credit (terms 2/10, n/30) Dr. Accounts Receivable 10,000 Cr. Sales Revenue 10,000 • Customer pays account within discount period Dr. Cash 9,800 Dr. Sales Discounts 200 Cr. Accounts Receivable 10,000 Example of Net Method • $10,000 sales on credit (terms 2/10, n/30) Dr. Accounts Receivable 9,800 Cr. Sales Revenue 9,800 • Customer pays account after discount period Dr. Cash 10,000 Cr. Sales Discounts Forfeited 200 Cr. Accounts Receivable 9,800 Impairment of Accounts Receivable • Short-term receivables are reported at their net realizable value (NRV) • The NRV is the net amount of cash expected to be collected, which is not necessarily the amount legally receivable • Calculated as: 𝐺𝑟𝑜𝑠𝑠 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 − 𝑒𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑢𝑛𝑐𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑏𝑙𝑒 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑎𝑛𝑑 𝑎𝑛𝑦 𝑟𝑒𝑡𝑢𝑟𝑛𝑠,𝑎𝑙𝑙𝑜𝑤𝑎𝑛𝑐𝑒𝑠,𝑜𝑟 𝑐𝑎𝑠ℎ 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡𝑠 • Loans and receivables impaired if these is “significant adverse change” in expected configuration of cash flows (i.e. timing or amount) Estimating Uncollectible Receivables The Allowance Method • Records estimated impairment to properly value accounts receivables and record the bad debts as expense in the same accounting period as the sale (matching concept) • Receivables are reported at their estimated net realizable value – i.e., net of an Allowance for Doubtful Accounts • The estimate of uncollectible accounts may be based on: o Allowance Procedure Only: management frequently analyses accounts receivable, estimates uncollectible amounts and adjusts the Allowance for Doubtful Accounts o Mix of Procedures: initially may use percentage of sales (or net sales), but must still adjust at year-end to ensure that Allowance for Doubtful accounts is appropriate • Regardless of procedure used, net accounts receivable at year-end must be reported at net realizable value (key focus is on measurement of accounts receivable at net realizable value) Allowance Procedure Only • Uses past collection experience to estimate uncollectible accounts • Focus is to report accounts receivable at net realizable value o Does not focus on matching bad debt expense to sales • Any existing balance in Allowance for Doubtful Accounts is used to calculate the current year’s bad debt expense • Can use: Percentage-of-receivables or aged receivable analysis Mix of Procedures • Initial use of “percentage-of-sales” approach is based on the relationship between sales and bad debts • Matches the estimated cost of bad debts to sales generated in the same accounting period • Any existing balance in the balance sheet account (Allowance for Doubtful Accounts) is initially ignored when calculating the current period’s bad debts expense • Receivables are also reviewed at year-end to ensure that balance is appropriate, and adjustment to Allowance for Doubtful Accounts is made Mix of Procedures: Example • Dockrill Corp. reports the following balances for its first year of operations (2014): Net credit sales: $400,000 • The company estimates bad debts at 2% of net credit sales • Determine estimated bad debts expense for 2014 Balance Sheet Presentation • Short-term accounts receivable are shown at their net realizable value as follows: Accounts Receivable $ xxx Less: Allowance for Doubtful Accounts xxx Net Realizable Value $ xxx Allowance Method: Writing Off Accounts Receivable • When a specific customer’s account is determined to be uncollectible, the following entry is made: Dr. Allowance for Doubtful Accounts x Cr. Accounts Receivable–specific customer x (for the amount to be written off) • If payment is received after write-off of account, the account is reinstated and payment is recorded: Direct Write-off Method • If uncollectible amounts are highly immaterial, the allowance method is not required • Instead, direct write-off method can be used • Record bad debt expense only when specific account is determined to be uncollectible: Dr. Bad Debt Expense x Cr. Accounts Receivable x • No allowance account is used Recognition of Short-Term Notes Receivable • Notes receivable differ from accounts receivable as they are supported by a promissory note (with specific terms) • All notes contain some interest • Notes are either: o Interest bearing • Have a stated rate of interest or o Zero-interest bearing (or non-interest bearing) • Interest rate not always stated • Interest amount is the difference between the amount borrowed and the face amount Interest Bearing Short-Term Notes Receivable • Example: On March 14, 2014, Accounts Receivable of $1,000 is exchanged for a 6% six- month note Non-Interest Bearing Short-Term Notes Receivable • On February 23, 2014, a $5,000 nine-month non-interest bearing note is issued; 8% is the implied interest rate Long-term Loans Receivable • Long-term loans receivable are recognized at fair value – i.e. the present value of the future cash flows o When the stated interest rate is the same as the market interest rate, the note or loan is issued at its face value o When there is a difference between interest rates, the note or loan is issued at a premium or a discount (i.e. the present value is greater or less than the face value) Long-term Loans Receivable – Interest Bearing Notes • Example: Morgan Corp. issues a $10,000, 10% three-year note; market interest rate is 12% and annual interest payments are $1,000 (10% x $10,000) • In calculating the note’s present value, use 12% market rate to discount all future cash flows as follows: ($10,000 x .71178) + ($1,000 x 2.40183) = $9,520 • The note is issued at a discount (as proceeds < face) • At date of issue, the company has an unamortized discount of $480 (to be amortized over the 3 years) • The discount represents interest income to be recognized over the 3-year life of the note • $9,520 x 12% = $1,142 (first year interest income) • Book value of Notes Receivable is now: $10,000 – ($480 - $142) = $9,662 • Interest Income for second year: $9,662 × 12% = $1,159 • Under straight-line method (as opposed to the effective interest rate method), initial discount of $480 is recognized as interest income evenly over 3 years at $480/3 yrs = $160 per year • IFRS requires the use of effective interest method of amortization • ASPE does not specify the amortization method Derecognition of Receivable • The holder of accounts or notes receivable may transfer them to another company for cash • The transfer may be: o A secured borrowing o A sale of receivables • Holder retains ownership of receivables in a secured borrowing transaction; the receivables are used as collateral • Holder transfers ownership of receivables in a sale • Specific standards are still in state of flux, so focus is on key concepts Borrowing vs. Sale Treatment: IFRS 9 (effective Jan 1, 2015) Borrowing vs. Sale Treatment: ASPE Accounting for Transfers of Receivables: ASPE Secured Borrowing (Highlights) • Account for receivable (now collateralized) same way as before secured borrowing: o Collect accounts receivable o Record sales returns and sales discounts o Absorb bad debts expense • Account for new liability (e.g. note payable): o Record a finance charge (if applicable) o Record interest expense on note payable o Pay the note periodically from collections Sale of Receivables (e.g., Factoring) • Ownership of receivables transferred to the purchaser (the factor); receivables recorded as an asset in the purchaser’s books • If sold without recourse, purchaser is fully responsible for collections of the receivables • Seller records any retained proceeds as “due from factor” (a receivable) which covers possible sales discounts and sales returns and allowances • Seller records gain/loss on sale of receivables (normally a loss, representing the finance charge) • Seller records any recourse liability (if receivables are sold with recourse (i.e., seller’s guarantee)) Presentation of Trade Accounts and Notes Receivable • Segregate types of receivables (i.e. ordinary trade accounts, due from related parties and other receivables segregated) • Separate current from non-current receivables • If > 1 year, report amount and maturity date • Use allowance account to record impairments (IFRS also requires reconciliation of changes in the allowance account during accounting period) • Income statement disclosure of interest income, impairment losses, and any reversals of such losses Analysis Comparison • Both ASPE and IFRS are in state of flux • IFRS generally requires more extensive disclosures • The two sets of standards are very similar • ASPE does not require use of the effective interest method, whereas IFRS generally does • Impairment Provisions and derecognition of financial assets are two issues that remain under study by IASB – may generate additional differences in the near future CHAPTER 8: INVENTORY Inventory Classification • Inventory is classified as a current asset • A merchandising company: o has one inventory account on the balance sheet called Merchandise Inventory; o the cost of the inventory sold is transferred to Cost of Goods Sold (COGS) on the income statement • A manufacturing company: o will normally have three inventory accounts on the balance sheet: raw materials, work in process and finished goods; o Cost of Goods Manufactured (COGM) is used by a manufacturer which is similar to the COGS Inventory Cost Flows Inventory • Definition of Inventory: Inventories are “assets: a) held for sale in the ordinary course of business; b) in the process of production for such sale; or c) in the form of materials or supplies to be consumed in the production process or in the rendering of services.” Items to Be Included in Inventory • Legal title to goods generally determines items to be included in inventory • The following goods are included in the seller’s inventory: 1. Goods in transit (if seller has title during shipment, i.e., if shipped f.o.b. destination) 2. Goods out on consignment 3. Goods sold under buyback agreements 4. Goods sold with high rates of return that cannot be estimated Effect of Inventory Errors Example Given for the year 2014: COGS = $1.4 million Retained Earnings (R/E) = $5.2 million December 31 inventory errors both discovered after 2014 books were closed: 2013: inventory overstated by $110,000 2014: inventory overstated by $45,000 Calculate correct 2014 COGS and R/E at Dec. 31, 2014 Costs Included in Inventory • Inventory cost includes “all costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition” • These costs include: o Product costs including invoice, freight, and other direct acquisition costs o Conversion costs which include direct labour and fixed and variable overhead • Period costs (selling, general, and administrative) are not inventoriable costs Other issues to consider: • Purchases discounts: gross method vs. net method • Vendor rebates: cash rebates related to inventory generally recorded as a reduction to the cost of inventory • “Basket” purchases and joint product costs: total cost allocated to units based on relative sales value Interest or borrowing costs • Under IFRS, interest costs are included as product costs if manufacturing of inventory takes a long time (otherwise, company has a choice whether to capitalize interest costs or not) • Under ASPE, interest costs may be either capitalized or expensed, but policy must be disclosed Purchase Commitments • Where a company commits to purchase inventory, but title has not passed to the buyer • Non-cancellable purchase contracts are not recorded, but if material, they are disclosed in the notes to the financial statements • Loss provision is recognized on onerous contracts (even though no specific requirement under ASPE) o Onerous contracts are contracts where unavoidable costs to complete the contract are higher than expected benefits Inventory Accounting Systems • An accurate inventory accounting system is important for: o ensuring availability of inventory items o preventing excessive accumulation of inventory items • Just-in-time (JIT) inventory order systems have helped reduce inventory levels • The perpetual system maintains a continuous record of inventory changes • The periodic system updates inventory records in the ledger only periodically Perpetual System • Purchases of inventory and cost of inventory sold are recorded directly in the Inventory account • Cost of freight, purchase returns and allowances, and purchase discounts are all recorded in the Inventory account • Cost of Goods Sold (COGS) is debited and Inventory is credited when inventory is sold • A subsidiary ledger is maintained for individual inventory items on hand • Periodic inventory counts are still required to ensure reliability • Any differences between the inventory balance and the physical count are captured in a separate account called Inventory Over and Short (or may be recorded as an adjustment to Cost of Goods Sold) Periodic System • Inventory purchases are recorded as a debit to a Purchases account • Cost of Goods Sold and Inventory accounts are not kept up to date • The quantity and cost of inventory on hand is determined by taking a physical inventory count • Cost of Goods Sold is determined at the end of the period • Under both periodic and perpetual inventory systems, physical counts of inventory are conducted at least once a year as there is the risk of loss and errors (e.g. waste, breakage, theft) • Freight, purchase returns and allowances, and purchase discounts are recorded in separate accounts Perpetual and Periodic Systems: Example Fesmire Limited reports the following data: Beginning Inventory: 100 units at $6 Purchases: (all credit) 900 units at $6 Defective units (returned) 50 units at $6 Sales: (all credit) 600 units at $12 Ending Inventory: 350 units at $6 Perpetual System Periodic System Cost Formulas IFRS and ASPE recognize three acceptable cost formulas: 1. Specific identification 2. First-in, First-out (FIFO) 3. Weighted average cost • The ending inventory in units is the same in all three methods; the cost is different • The cost of goods sold and the cost of ending inventory are different • The cost of purchases is the same in all three methods Specific Identification • Each item sold and purchased is individually identified • Required for goods that are not ordinarily interchangeable; and that are produced and segregated for specific projects • Advantages: o Matches actual costs with revenue o Ending inventory reported at specific cost • Disadvantages: o May be costly to implement and maintain o May lead to income manipulation o May be difficult to allocate certain costs (e.g., storage, shipping) to specific inventory items Weighted Average Cost • Justification for using weighted average cost formula: o Reasonable to cost inventory based on an average cost o Costs assigned closely follows the actual physical flow o Simple to apply, objective, less subject to income manipulation o Ending inventory cost on balance sheet is made up of average costs • Moving-average cost formula refers to a weighted-average method used with perpetual records (both units and dollars) First-In, First-Out (FIFO) • Advantages: o Attempts to approximate physical flow of goods o Ending inventory made up of most recent costs, therefore close to its replacement cost o Does not permit manipulation of income • Disadvantages: o Current costs not matched to current revenues, as oldest cost of goods are used with current revenue o When prices are changing rapidly, gross profit and net income are distorted Choice of Cost Formula • Inventory standards limit the choice of cost formula • Specific identification is required in some cases • Should choose the best method that: 1. best reflects the physical flow 2. reflects the most recent costs in the inventory account, and 3. use this method for all inventory assets with same characteristics Cost Formulas • LIFO is not acceptable because: 1. LIFO does not represent actual inventory flows reliably 2. Costs assigned to ending inventory (oldest costs) do not represent recent cost of inventory on hand 3. Can distort reported income on the income statement • LIFO has never been allowed by CRA Cost Formulas: Example Call-Mart reports the following transactions for March: Date Purchases Sales Balance (units) 1 Beginning (500 @$3.80) 500 2 1,500 units (@$4.00) 2,000 15 6,000 units (@$4.40) 8,000 19 Sold 4,000 units 4,000 30 2,000 units (@$4.75) 6,000 Determine the cost of goods sold and the cost of ending inventory, under each cost formula. Weighted-Average Formula Date Purchases Unit Cost Purchase Cost March 1 500 units $3.80 $ 1,900 March 2 1,500 units $4.00 $ 6,000 March 15 6,000 units $4.40 $26,400 March 30 2,000 units $4.75 $ 9,500 10,000 units $43,800 Moving-Average Formula Date Purchases Unit Cost Purchase Cost On Hand March 1 500 units $3.80 $ 1,900 $ 1,900 March 2 1,500 units $4.00 $ 6,000 $ 7,900 March 15 6,000 units $4.40 $26,400 $34,300 Mar. 19 New Unit Cost calculated – to use for Cost of Goods Sold $34,300/8,000 units = $4.2875 and 4,000 @ $4.2875 = $17,150 March 19 4,000 units remaining 17,150 March 30 2,000 units $4.75 $ 9,500 26,650 New Unit Cost calculated—to use as COGS for next sale and for inventory $26,650/6,000 units = $4.4417 NOTE: With each new purchase, a new average unit cost is determined First-In, First-Out Formula Date Purchases Unit Cost Purchase Cost March 1 500 units $3.80 $ 1,900 March 2 1,500 units $4.00 $ 6,000 March 15 6,000 units $4.40 $26,400 March 30 2,000 units $4.75 $ 9,500 Basic Valuation Issues • Most inventory is valued using a cost-based system at “lower of cost and net realizable value” • Specialized inventory (e.g. biological assets, including plants and animals) may use a “net realizable value” model (or “fair value less cost to sell”) • Under the typical cost-based system, ending inventory valuation requires answers to each of the following: 1. Which physical goods should be included as part of inventory? 2. What costs should be included as part of inventory cost? 3. What cost formula should be adopted? 4. Has there been an impairment in value of inventory items held? Lower of Cost and NRV • Inventory is initially recorded at cost • Inventory is valued at the lower of cost and net realizable value (LC&NRV) • Net realizable value (NRV) is the estimated selling price less the estimated costs to complete and sell Determining Lower of Cost and NRV Item Cost NRV LC&NRV Spinach $80,000 $ 120,000 $ 80,000 Carrots 100,000 100,000 100,000 Cut beans 50,000 40,000 40,000 Peas 90,000 72,000 72,000 Mixed vegetables 95,000 92,000 92,000 Final inventory value $ 384,000 Comparison of cost and NRV should be done on an item-by-item basis Grouping inventory for purposes of valuation is permitted only under certain circumstances Recording the LC&NRV Under the Direct Method: • The Inventory account is recorded at its net realizable value at year end if the NRV is less than cost • Loss becomes part of cost of goods sold on the income statement Recording Decline in NRV– Direct Method (Perpetual Inventory System) Inventory At Cost At NRV Adjustment Beginning $65,000 $65,000 $-0- End of year $82,000 $70,000 $12,000 Under the Direct method: Dr. Cost of Goods Sold 12,000 Cr. Inventory 12,000 Recording Cost vs. NRV Under the Indirect (Allowance) Method: • Inventory reported at cost with declines and recoveries recorded through an Allowance (valuation) account on the balance sheet; a Loss account is reported on the income statement • Recovery of market value decline is recorded up to but not exceeding original cost Recording Decline in NRV: Indirect Method (Perpetual Inventory System) Inventory At Cost At NR Adjustment Beginning $65,000 $65,000 $-0- End of year $82,000 $70,000 $12,000 Under the Allowance method: Dr. Loss Due to Decline in NRV 12,000 Cr. Allowance to Reduce Inventory 12,000 Exceptions to the LC&NRV Model • Inventories measured at Net Realizable Value if: o Sale is assured, or there is active market and minimal risk of not completing the sale, and o Costs of disposal can be estimated • Inventories measured at Fair Value Less Cost to Sell include o Inventories of commodity broker-traders o Biological assets and agricultural produce at point of harvest • There is no specific ASPE guidance on measurement of these assets Gross Profit Method of Estimating Inventory • Gross profit method is used to estimate ending inventory • Estimates may be required in such situations: interim reporting, fire loss, testing reasonableness of cost from an actual inventory count • Method is based on the three assumptions: 1. Beginning inventory + purchases = cost of goods available for sale 2. Goods not sold are in ending inventory 3. Cost of goods available for sale – cost of goods sold = ending inventory Gross Profit Method: Example Given: • Beginning inventory (at cost): $ 60,000 • Purchases (at cost): $ 200,000 • Sales (at selling price): $ 280,000 • Gross profit percentage on sales: 30% • Estimate the ending inventory using the gross profit method Understanding Markups Disclosure and Presentation • Examples of required disclosures: 1. Measurement policy 2. Total inventory, as well as inventory by classification 3. Amount of inventory recognized as expense on the income statement (usually reported as cost of goods sold) 4. Any amount of inventory pledged as security for liabilities • IFRS has more disclosure requirements than ASPE Common ratios Comparison of IFRS and ASPE • Major different between IFRS and ASPE relates to a specific IFRS standard covering biological assets and agricultural produce at the point of harvest • ASPE has no specific guidance in this area CHAPTER 10: ACQUISTION OF PROPERTY, PLANT, AND EQUIPMENT Property, Plant, and Equipment • Also known as tangible capital assets, plant assets, and fixed assets • Examples: land, building, equipment, and natural resource properties • Major characteristics include: 1. Acquired and held for use in operations and not for resale 2. Long-term in nature and usually subject to depreciation 3. Possess physical substance (tangible) Asset Components • Both IFRS and ASPE require componentization, although IFRS guidance is more detailed • Components of a single asset (e.g. roof of a building) should be recognized separately if they make up a relatively significant portion of the asset’s total cost • Significant professional judgment is required in applying componentization, and other factors to consider include differing useful lives and differing patterns of economic benefits Cost Elements • Capitalized cost of property, plant, and equipment includes all expenditures needed to: o acquire the asset (purchase price, net of discounts and rebates) o bring it to its location and to state where it is ready for use (including delivery, site preparation, installation, assembly, professional fees, etc) o discharge obligations associated with asset’s eventual disposal (e.g. site restoration) • IFRS and ASPE share the above approach, but sometimes differ in specific application Self-Constructed Assets • These are assets constructed by the business for use in operations • The cost of self-constructed assets includes: o Direct materials, o Direct labour, o Directly attributable overhead (e.g. variable manufacturing overhead) Borrowing Costs • Under IFRS, borrowing costs that are incurred during acquisition, construction or production of qualifying assets must be capitalized as part of the asset’s cost • ASPE allows a choice of capitalizing or expensing such interest costs • Most common approach is explained in Appendix 10A Dismantling and Restoration Costs • Companies are often responsible for costs associated with dismantling the asset, removing it, and restoring the site at the end of its useful life • These costs are often referred to as asset retirement costs and meet the recognition criteria for capitalization as part of PP&E asset costs • IFRS and ASPE share the above approach, but sometimes differ in specific application Cash Discounts • When cash discounts are offered on the purchase of plant assets, the Net-of-Discount Method is the preferred method • The asset cost is reduced by the discount amount even if discount is not taken Deferred Payment Terms Deferred Payment Contracts • Assets, purchased through long-term credit, are recorded at the present value of the consideration exchanged • When no interest rate is stated, the cash price of the purchased asset is used to determine imputed interest rate • Interest expense is recognized over the term of the deferred payment contract Deferred Payment Contracts Example: Sutter Corporation, given: • Five-year, $100,000 non-interest bearing note issued in exchange for new equipment • Market interest rate = 10% • Payable over 5 years—$20,000 per year • Record acquisition of equipment Lump-Sum Purchases • Lump Sum Purchase o Cost of assets, acquired at a single lump sum price, is allocated to assets on the basis of their relative fair market values • Example: Inventory, land, and building purchased for lump sum of $80,000 • Fair market values for these assets are: Non-Monetary Exchanges Share-Based Payments • When property is acquired by issuing shares, the fair value of the asset received or the fair value of the shares given up is used for the cost of the asset o ASPE and IFRS have slightly different application of this general approach • If the fair value of the asset received cannot be readily determined, and the shares given up are actively traded, the market value of publicly traded shares is used Asset Exchange • Monetary exchange of assets occurs when: o Non-monetary assets (e.g., PP&E) are acquired for cash or other monetary assets (e.g., accounts and notes receivable), or o Non-monetary assets are disposed of in exchange for monetary assets • Non-monetary transaction or exchange of assets occurs when: o Non-monetary asset is exchanged for another non-monetary asset Exchange of Non-Monetary Assets • The basic ASPE standard is that the non-monetary exchange is valued at: o the fair value of the asset given up, or o the fair value of the asset received whichever is more reliably measurable, and o gain or loss on the exchange is recognized in income • Monetary transactions are accounted for on the same basis Exception to standard: • If one or more of the following conditions exist: 1. transaction lacks commercial substance, 2. fair values are not determinable, • Then: o new asset cost equals book value of assets given up, and o no gain is recognized (but losses are recognized) E
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