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ADMS 3585 (22)
Liona Lai (6)
Chapter 10

ADMS 3585 Chapter 10.docx

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Department
Administrative Studies
Course Code
ADMS 3585
Professor
Liona Lai

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Property, plant, and equipment (PP&E) - include long-term resources such as office, factory, and warehouse buildings, investment property, equipment (machinery, furniture, tools), mineral resource properties - aka tangible capital assets, plant assets, or fixed assets Depreciation - amortization of property, plant, and equipment Depletion - amortization of mineral resource properties Amortization - used for intangibles - may be used in a general sense to refer to the allocation of the cost of any long-lived asset to different accounting periods Definition of PPE 1. held for use in the production of goods and services, for rental to others, or for administrative purposes - not intended for sale in the ordinary course of business 2. used over more than one accounting period and are usually depreciated 3. tangible • any items that have multiple uses and are regularly used and replaced within the accounting period are classified as inventory • major spare parts and standby or servicing equipment used only with a specific capital asset and useful for more than one period are classified as items of PPE • Biological assets (living plants and animals) – PPE o ASPE: same acctg principles used for other items of PPE o IFRS: specific standards for biological assets Recognition Criteria 1. Future economic benefits 2. Cost can be reliably measured Capitalized - Included in asset’s cost if both criteria for recognition met - recognize as PPE Expensed - Costs incurred but recognition criteria not met - Repair and ongoing maintenance Unit of measure - What level of asset to recognize Componentization (required in IFRS) - Degree may be based on significance of individual parts to the whole asset - Different components may have different useful lives and depreciation will be different - ASPE: done only if practical BE10-2 Playtime Corporation purchased a new piece of equipment for production of a new children's toy. According to market research tests, the toy is expected to be very popular among preschool-aged children. The equipment consists of the following significant and separable parts: injection unit (useful life of six years), clamping unit (useful life of six years), and electrical equipment (useful life of three years). The equipment also includes other parts (useful life of five years). Discuss (a) the recognition criteria for recording purchase of the equipment, (b) how the equipment purchase should be recorded if Playtime prepares financial statements in accordance with IFRS, and (c) how the equipment purchase should be recorded if Playtime prepares financial statements in accordance with ASPE. a) the equipment can be recognized as PPE since its cost can be reliably determined (purchase cost) and it can generate future benefits for the company as it will be used to produce a toy that is projected to be very popular among preschoolers b) Under IFRS, the purpose should be recorded according to its individual components based on the useful life of each component c) Under ASPE, the company do not have to componentize but can choose to if practical for them Cost Elements - All expenditures needed to acquire the asset and bring it to its location and ready it for use should be capitalized o item’s purchase price net of trade discounts and rebates, plus any non-refundable purchase taxes and duties o employee costs needed to acquire or construct the asset; delivery and handling costs; site preparation, installation, and assembly costs; net material and labour costs incurred to ensure it is working properly; and professional fees o estimate of the costs of obligations associated with the asset's eventual disposal. (e.g., some or all of the costs of the asset's decommissioning and site restoration) - Not capitalized o Initial operating losses o costs of training employees to use the asset o costs associated with a reorganization of operations o administration and general overhead costs o costs of opening a new facility, introducing a new product or service, and operating in a new location Temporary Use of Land During Construction • IFRS o Capitalization of costs stops when asset is in place and ready to be used as mgmt intended, even if it has not begun to be used or is used at less than desirable capacity level o Principle of being a necessary cost to acquire and get in place and ready for use strictly applied o Temporary use of land and associated net cost or revenue is not necessary to develop the asset being constructed – not capitalized but recognized in income • ASPE o Capitalization of costs stops when asset is substantially complete and ready for productive use as determined in advance by mgmt o Any net revenue or expenses generated prior to substantial completion and readiness for use are included in asset’s cost Self-Constructed Assets - Only directly attributable costs (costs directly related to the specific activities involved in the construction process) are capitalized Borrowing Costs • IFRS: capitalize if directly attributable to cost of acquiring, constructing, or producing PPE • ASPE: can choose between capitalizing and expensing Dismantling and Restoration Costs - Asset retirement costs added to PPE asset cost - IFRS o recognize costs of both legal and constructive obligations o Include acquisition costs only, not product costs - ASPE o recognize costs associated with legal obligations only o Costs include both retirement obligations resulting from acquisition and its subsequent use in producing inventory BE10-3 Barnet Brothers Inc. purchased land and an old building with the intention of removing the old building and then constructing the company's new corporate headquarters on the land. The land and old building were purchased for $570,000. Closing costs were $6,000. The old building was removed at a cost of $48,000. After readying the land for its intended use, and while waiting for construction to begin, Barnet generated net revenue of $4,000 from using the land as a parking lot. Determine the amount to be recorded as the land cost, and the treatment of the net revenue of $4,000, if Barnet prepares financial statements in accordance with (a) IFRS and (b) ASPE. a) Under IFRS, land cost = 570,000 + 6,000 + 48,000 = $624,000. Net revenue of $4,000 should be treated as income: Dr. Cash and Cr. Rent revenue b) Under ASPE, net revenue of $4,000 will be deducted from the cost of land: Dr. Cash and Cr. Land. Land cost = 570,000 + 6,000 + 48,000 – 4,000 = $620,000 BE10-4 Northern Utilities Corporation incurred the following costs in constructing a new maintenance building during the fiscal period. a. Direct labour costs incurred up to the point when the building is in a condition necessary for use as management intended, but before Northern Utilities begins operating in the building, $73,000 b. Additional direct labour costs incurred before Northern begins operating in the building, $6,000 c. Material purchased for the building, $82,500 d. Interest on the loan to finance construction until completion, $2,300 e. Allocation of plant overhead based on labour hours worked on the building, $29,000 f. Architectural drawings for the building, $7,500 g. Allocation of the president's salary, $54,000 What costs should be included in the cost of the new building if Northern prepares financial statements in accordance with IFRS? With ASPE? (Assume that if there is no specific guidance from GAAP, Northern's management would consider a building ready for productive use when Northern begins operating in the building, and would prefer not to capitalize interest costs directly attributable to the acquisition, construction, or development of property, plant, and equipment.) a) IFRS – a, c, d, e, f = 194,300 b) ASPE – a, c, e, f = 192,000 Measurement of Cost  Cash discounts not taken  Deferred payment terms  Lump-sum purchases  Nonmonetary exchanges – share-based payments  Nonmonetary exchanges – asset exchanges  Contributed assets and government grants Cash Discounts - discount taken, reduction in asset’s purchase price - record cost at net-of-discount whether discount is taken or not Deferred Payment Terms - record cost at PV of note; difference recognized as interest Example: assume that Sutter Corporation purchases a specially built robot spray painter for its production line. The company issues a $100,000, five-year, non-interest-bearing note to Wrigley Robotics Ltd. for the new equipment when the prevailing market interest rate for obligations of this nature is 10%. Sutter is to pay off the note in five $20,000 instalments made at the end of each year. Assume that the fair value of this specially built robot cannot readily be determined. PVFOA of note (i=10, n=5) = 20,000 x 3.79079 = 75,816 Equipment 75,816 Notes Payable 75,816 At end of Year 1: Interest Expense (75,816 x 10%) 7,582 Notes Payable 7,582 Notes Payable 20,000 Cash 20,000 Lump-Sum Purchases - allocate costs based on relative fair values example: several assets purchased for 80,000 Fair Value Inventory 25,000 25% 20,000 Land 25,000 25% 20,000 Building 50,000 50% 40,000 100,000 80,000 Nonmonetary Exchanges Share-Based Payments  IFRS: FV of asset; if cannot be reliably determined, FV of shares  ASPE: whichever is more reliable (usually FV of asset) BE10-9 Wizard Corp., a private company, obtained land by issuing 2,000 of its no par value common shares. The land was appraised at $85,000 by a reliable, independent valuator on the date of acquisition. Last year, Wizard sold 1,000 common shares at $41 per share. Prepare the journal entry to record the land acquisition if Wizard elects to prepare financial statements in accordance with IFRS and with ASPE. For both IFRS and ASPE: Land 85,000 Common Shares 85,000 E10-3 (2) Producers issues 13,000 no par value common shares in exchange for land and buildings. The property has been appraised at a fair value of $1,630,000, of which $407,000 has been allocated to land, $887,000 to the structure of the buildings, $220,000 to the building HVAC heating, ventilation, air conditioning, and $116,000 to the interior coverings in the buildings (such as flooring). Producers' shares are not listed on any exchange, but a block of 100 shares was sold by a shareholder 12 months ago at $57 per share, and a block of 200 shares was sold by another shareholder 18 months ago at $33 per share. Land 407,000 Building – structure 887,000 Building – HVAC 220,000 Building – interior coverings 116,000 Common Shares 1,630,000 Asset Exchanges - general principle: FV of assets given up; if cannot be reliably measured, FV of new asset o gains/losses recognized in income - except if one of the following is true: o Transaction lacks commercial substance o Fair values not reliably measurable  carrying amount of assets given up, adjusted for any cash or other monetary assets  asset acquired cannot be recognized more than fair value; carrying amt > FV, record at lower FV and recognize loss Commercial Substance - significant change in company’s expected future cash flows and therefore its value a) amount, timing, or risk of future cash flows associated with assets received is different from the configuration of cash flows for assets given up b) specific value of part of the entity affected by the transaction has changed as a result c) difference in (a) or (b) is significant relative to FV of assets exchanged Ability to Measure Fair Values - helps reduce risk that entities can assign arbitrarily high values to assets exchanged to report gains Accounting for Asset Exchanges Meets Both Criteria Does Not Meet Either Criteria Apply FV standard Exception to FV Standard:  Cost of assets rcvd = FV of assets given up or  Cost of assets rcvd = carrying amt of assets given up assets acquired if more reliably measurable  No gain recognized. Loss recognized if carrying amt  Diff bet carrying amt and FV – gain/loss of assets given up > FV of assets acquired Boot - transaction’s monetary requirement - as it decreases – likelihood that nonmonetary increases (evaluate for commercial substance) Example 1: Assume that Information Processing, Inc. trades in its used machine for a new model. The machine given up has a book value of $8,000 (original cost of $12,000 less $4,000 accumulated depreciation) and a fair value of $6,000. It is traded for a new model that has a list price of $16,000. In negotiations with the seller, a trade-in allowance of $9,000 is finally agreed on for the used machine. Fair value of assets given up: Purchase price of machine acquired = Cash paid (16,000 – 9,000) 7,000 Fair value of machine given up 6,000 Cost of new machine = fair value of assets given up 13,000 (commercial substance) Fair value of old machine 6,000 Book value of old machine (8,000) Loss on disposal of used machine 2,000 Equipment (new) 13,000 Accumulated depreciation – equipment (old) 4,000 Loss on Disposal of Equipment 2,000 Equipment (old) 12,000 Cash 7,000 Example 2: Cathay Corporation exchanges several used trucks plus cash for vacant land that might be used for a future plant site. The trucks have a combined carrying amount of $42,000 (cost of $64,000 less $22,000 of accumulated depreciation). Cathay's purchasing agent, who has had previous dealings in the second-hand market, indicates that the trucks have a fair value of $49,000. In addition to the trucks, Cathay pays $4,000 cash for the land. Fair value of assets given up: Fair value of cash given up 4,000 Fair value of trucks given up 49,000 Cost of land = fair value of assets given up 53,000 Land 53,000 Accumulated depreciation - trucks 22,000 Trucks 64,000 Cash 4,000 Gain on disposal of trucks (49,000 – 42,000) 7,000 Example 3: Westco Limited owns a number of rental properties in Western Canada as well as a single property in Ontario. Management has decided to concentrate its business in the west and to dispose of its one property outside this area. Westco agrees to exchange its Ontario property for a similar commercial property outside Lethbridge, Alberta, owned by Eastco Limited, a company with many properties east of Manitoba. The two properties are almost identical in size, rentals, and operating costs. Eastco agrees to the exchange but requires a cash payment of $30,000 from Westco to equalize and complete the transaction. Assume an evaluation by both Westco and Eastco management indicates that there is an insignificant difference in the configuration of future cash flows and that commercial substance is not indicated. What entry would be made by each company to record this asset exchange? Westco Eastco Building 520,000 540,000 Accumulated depreciation 100,000 145,000 Carrying amount 420,000 395,000 Fair value 615,000 645,000 Carrying amt of building given up 420,000 395,000 Cash paid 30,000 Cash received (30,000) Cost of building acquired 450,000 365,000 Westco Buildings (new) 450,000 Accumulated depreciation – Buildings (old) 100,000 Buildings (old) 520,000 Cash 30,000 Eastco Buildings (new) 365,000 Accumulated depreciation – Buildings (old) 145,000 Cash 30,000 Buildings (old) 540,000 Contributed Assets and Government Grants - non-reciprocal transfers (nothing given in exchange) - use asset’s fair value donated assets - capital approach o used when asset donated by owner (rare) o credit Contributed Surplus – Donated Capital - income approach o reflects contributions in net income - source is not owner government grants - cost reduction method o reduce asset cost (and therefore future depreciation) by amount received o reports assets at less than FV - deferral method o record amount received as a deferred credit and amortize to revenue over asset’s life o not consistent with conceptual framework since deferred revenue does not meet def of liability - donation of land o may be deferred and taken into income over future periods o taken directly into income when rcvd if can’t associate grant with future periods - awarded for incurring certain current expenditures (i.e.payroll) o recognized in income in the same period as related expenses Example: assume that a company receives a grant of $225,000 from the federal government to upgrade its sewage treatment facility. 10-year life, straight-line depreciation Cost reduction: Cash 225,000 Equipment 225,000 Depreciation Expense – reduce by 22,5000 every year (increase in revenue per year) Deferral: Cash 225,000 Deferred revenue – government grants 225,000 Deferred revenue – government grants 22,500 Revenue – government grants 22,500 E10-21 Lightstone Equipment Ltd. wanted to expand into New Brunswick and was impressed by the provincial government's grant program for new industry. After being sure that it would qualify for the grant program, it purchased property in downtown Saint John on June 15, 2014. The property cost $235,000 and Lightstone spent the next two months gutting the building and reconstructing the two floors to meet the company's needs. The building has a useful life of 20 years and an estimated residual value of $65,000. In late August, the company moved into the building and began operations. Additional information follows: 1. The property was assessed at $195,000, with $145,000 allocated to the land. 2. Architectural drawings and engineering fees related to the construction cost $18,000. 3. The company paid $17,000 to the contractor for gutting the building and $108,400 for construction. Lightstone expects that these improvements will last for the remainder of the life of the building. 4. The provincial government contributed $75,000 toward the building costs. a) Assuming that the company uses the cost reduction method to account for government assistance, answer the following: 1. What is the cost of the building on Lightstone Equipment's statement of financial position at August 31, 2014, its fiscal year end? Purchase: Land 145,000 74.359% 174,744 Building 50,000 25.641% 60,256 195,000 235,000 total building cost = 60,256 + 18,000 + 17,000 + 108,400 = 203,656 Land 174,744 Buildings 203,656 Cash 378,400 Cash 75,000 Buildings 75,000 Carrying amount of building = 203,656 – 75,000 = 128,656 2. What is the effect of this capital asset on the company's income statement for the company's year ended August 31, 2015? Depreciation Expense 3,183 Accumulated Depreciation – Buildings ((128,656 – 65,000)/20) 3,183 Carrying amount of building = 128,656 – 3,183 = 125,473 Decrease in depreciation expense, increase in net income by 3,750 b) Assuming the company uses the deferral method to account for government assistance, answer the following: 1. What is the cost of the building on Lightstone Equipment's statement of financial position at August 31, 2014? Purchase: Land 145,000 74.359% 174,744 Building 50,000 25.641% 60,256 195,000 235,000 total building cost = 60,256 + 18,000 + 17,000 + 108,400 = 203,656 Land 174,744 Buildings 203,656 Cash 378,400 Cash 75,000 Deferred revenue – government grants 75,000 2. What is the effect of this capital asset on the company's income statement for the company's year ended August 31, 2015? Depreciation Expense 6,933 Accumulated Depreciation – Buildings ((203,656 – 65,000)/20) 6,933 Deferred revenue – government grants 3,750 Revenue – government grants (75,000/20) 3,750 increase in net income by 3,750 Costs Associated with Specific Assets Land - purchase price - closing costs (title to land, legal fees, recording fees) - costs of getting land ready for intended use (removal of old building, grading, filling, draining, clearing) - costs of assuming any liens (taxes in arrears, mortgages, encumbrances on property) - any additional land improvements that have an indefinite life purchased to construct a building - all costs incurred up to excavation for new building considered land costs - amounts received from salvaged materials treated as reductions in land cost land improvements - charged to Lan
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