Property, plant and equipment

1
Property, plant and equipment
2
Typical coverage of US GAAP

• Definition
• Acquisition of PPE
• General
• Self-constructed assets
• Interest costs during construction
• Initial cost of natural resources
• Valuation at acquisition
• Exchange of non-monetary assets
• Lump-sum purchases
• Deferred payment contracts
• Purchase paid for using company stock
• Costs incurred subsequent to acquisition
• Periodic valuation
• Carrying value
• Impairment

3
Typical coverage of US GAAP

• Cost allocation issues
• Depreciation
• Definition
• Useful life
• Depreciable base
• Depreciation method
• Depletion
• Disposition
• Sale
• Involuntary conversion
• Fully depreciated fixed assets
• Disclosure requirements

4
Executive summary

• IFRS permits periodic revaluation of an entire
  class of fixed assets to fair value. US GAAP
  does not allow revaluation.
• IFRS has a one-step approach for determining
  impairment of fixed assets while US GAAP has a
  two-step approach.
• IFRS allows reversal of impairment losses on
  fixed assets, while this is prohibited using US
  GAAP.
• IFRS requires depreciation of components of an
  asset when the components have different periods
  of benefit. Component depreciation is
  permissible using US GAAP but is not a common
  practice.

5
Progress on convergence

• Impairment was one of the short-term convergence
  projects agreed to by the FASB and IASB in their
  2006 Memorandum of Understanding.
• In their September 2008 meeting, the FASB and
  IASB decided to defer work on convergence on
  impairment until other work is completed.
• Convergence on other fixed-asset-related
  accounting matters is not planned at this time.

6
AcquisitionGeneral

• IFRS

• US GAAP

PPE should be recorded based on the fair value
given up or the value received, whichever is
more clearly evident.
Similar
Costs include purchase price and related taxes,
directly attributable costs and estimated
retirement obligation costs.
Similar
Costs that are not directly attributable should
be expensed as a period cost.
Similar
7
Acquisition General

• US GAAP
• Voluntary investments in safety or environmental
  equipment are capitalized.

• IFRS
• Voluntary investments in safety or environmental
  equipment are expensed, unless they extend the
  economic life of the related asset or a
  constructive obligation exists to improve the
  assets safety or environmental standards.

8
Acquisition General
Example 1 Clean Company wants to be viewed as
the most environmentally friendly company in its
industry. As a result, the company installs
equipment on its smoke stacks to reduce
emissions. The equipment costs 30,000 and has a
three-year life.

• How would this equipment be accounted for using
  US GAAP and IFRS?

9
Acquisition General

• Example 1 solution
• Using US GAAP, this equipment would be
  capitalized and depreciated over its three-year
  life. Using IFRS, the 30,000 cost of this
  voluntary investment in environmental equipment
  might be expensed in year one, unless it extends
  the economic life of the smoke stacks or this
  expenditure fulfills a constructive obligation.

10
Acquisition Self-constructed assets

• IFRS

• US GAAP

Direct cost of materials and labor should be
capitalized.
Similar
A portion of indirect costs can be included in
capitalized costs.
Similar
11
Acquisition Interest costs during construction

• US GAAP

• IFRS

Interest costs are capitalized to the extent that
these costs could have been avoided had the
expenditures been used to repay the debt rather
than to acquire or construct the asset.
Similar, although IFRS uses the term borrowing
costs.
Similar, although IFRS says a substantial
period of time.
The qualifying asset must take a period of time
to complete.
Interest capitalization commences and continues
as long as expenditures and progress are made to
get the asset ready for its intended use.
Similar
Capitalizable interest is based on specific
borrowing if available or weighted-average costs
of borrowings, and cannot exceed actual interest
for the period.
Similar
12
Acquisition Interest costs during construction

• US GAAP
• Interest revenue cannot be netted against
  interest cost.

• IFRS
• Interest revenue is netted against interest cost.
  When funds borrowed to finance the acquisition of
  a qualified asset are temporarily invested, the
  interest cost should be reduced by any investment
  income earned on these funds.

13
AcquisitionInterest costs during construction

• Example 2
• To finance construction of a qualifying asset,
  the company borrows 250,000 on January 1, 2010,
  at an interest rate of 8. The company makes the
  following disbursements during the 24-month
  construction period 100,000 on January 1, 2010
  50,000 on June 30, 2010 50,000 on January 1,
  2011, and 50,000 on June 30, 2011. Construction
  of the asset is completed on December 31, 2011,
  and it is ready for its intended use. During
  the construction period, excess funds are
  invested, which earn 5 in 2010 and 4 in 2011.
• What are the interests that should be capitalized
  using US GAAP and IFRS?

14
AcquisitionInterest costs during construction

• Example 2 solution
• US GAAP The interest cost capitalized for the
  two-year period of 28,000 is calculated by
  determining the portion of the interest cost the
  company incurs during the construction of the
  building that theoretically could have been
  avoided. Interest revenue is not netted against
  interest expense.

15
AcquisitionInterest costs during construction

• Example 2 solution (continued)
• IFRS IAS 23 requires reducing the interest to be
  capitalized by the income earned from temporary
  investment of those borrowings (paragraph 12).
  Therefore, under IFRS, the investment income
  earned is calculated as follows
• Thus, the net interest cost to be capitalized for
  this asset is 20,750 (28,000-7,250) using
  IFRS.

16
Periodic valuationCarrying value

• US GAAP
• Revaluation of fixed assets is not allowed.

• IFRS
• A company can choose to account for PPE and
  natural resources at fair value using the
  revaluation method
• Cost or fair value must be applied to an entire
  class of PPE.
• Different classes can have different policies.
• Fair value is the amount at which an asset could
  be exchanged in an arms length transaction
  between knowledgeable and willing parties.
• A professional appraiser may be used to establish
  fair value.
• Revaluations must be performed periodically to
  ensure the carrying value of that asset class is
  not materially different than its fair value.

17
Periodic valuationCarrying value

• IFRS
• Accounting for revaluation
• Increases in value should be credited through OCI
  to a revaluation surplus account in equity,
  unless it reverses a loss that was previously
  expensed, in which case that portion may be
  credited to income.
• Decreases in value should be expensed unless it
  reverses a previous revaluation surplus account
  relating to the same asset. That portion can be
  debited through OCI to the revaluation surplus
  account in equity.
• If the revalued basis of an asset exceeds the
  cost basis, there will be an increase in annual
  depreciation. To the extent there is an increase
  in depreciation expense, per IAS 16.4-1, an
  entity may reverse the portion of reserve surplus
  related to this increase by debiting revaluation
  surplus and crediting retained earnings.
  Alternatively, this transfer may be computed upon
  disposal.

• US GAAP
• Revaluation of fixed assets is not allowed.

18
Periodic valuationCarrying value

• IFRS
• Accounting for revaluation (continued)
• When an asset is disposed of, any remaining
  related revaluation surplus account in equity may
  be transferred to retained earnings. The
  revaluation surplus can never be credited to
  income.
• If an asset is revalued, an entity may account
  for the accumulated depreciation at the date of
  revaluation in two ways
• Depreciation elimination method The accumulated
  depreciation can be eliminated against the asset
  itself.
• Proportionate restatement method The
  accumulated depreciation can be restated
  proportionately with the change in the gross
  carrying value of the asset so that the carrying
  value of the asset after revaluation equals its
  revalued amount.

• US GAAP
• Revaluation of fixed assets is not allowed.

19
Periodic valuationCarrying value

• US GAAP
• Revaluation of fixed assets is not allowed.

• IFRS
• In 2006, Ernst Young LLP provided an overview
  of 65 selected large, multinational companies
  reporting using IFRS. Only one company used the
  revaluation option for any of its PPE.
• In a recent study, Hans B. Christensen and Valeri
  Nikolaev of the University of Chicago Booth
  School of Business looked at the valuation
  choices made by 1,539 German and UK companies in
  the first year of preparing IFRS financial
  statements. They found that only 3 of the
  companies chose to use fair value accounting for
  at least one class of assets.  

20
Periodic valuationCarrying value

• Example 5
• A company that reports using IFRS acquired
  weight-lifting equipment on January 1, 2009, at a
  cost of 10,000. This is the companys only
  equipment. The company uses fair value for its
  equipment using IAS 16. On December 31, 2010,
  the net book value is 8,000 (cost of 10,000
  less accumulated depreciation of 2,000), while
  the fair value is determined to be 8,800.
• What journal entries would be required to record
  the revaluations in 2010?

21
Periodic valuationCarrying value

• Example 5 solution
• Accumulated depreciation 2,000
• Equipment 2,000
• (To eliminate accumulated depreciation.)
• Equipment 800
• Revaluation surplus equipment (OCI) 800
• (To write equipment up to fair value.)

22
Periodic valuationCarrying value

• Example 6
• A company that reports using IFRS acquired an
  excavator on January 1, 2009, at a cost of
  10,000. This excavator represents the companys
  only piece of equipment. The company uses fair
  value for its equipment using IAS 16. This
  excavator is being depreciated on a straight-line
  basis over its 10-year useful life. There is no
  residual value at the end of the 10-year period.
  In both 2009 and 2010, depreciation would be
  1,000. On December 31, 2010, the fair value is
  determined to be 8,800. On December 31, 2012,
  the fair value is determined to be 5,000. The
  companys accounting policy is to reverse a
  portion of revaluation surplus related to the
  increased depreciation expense.
• Determine what accounts would be impacted if
  this activity is recorded for 2009 through 2012.

23
Periodic valuationCarrying value
Example 6 solution
24
Periodic valuationCarrying value

• Example 6 solution (continued)
• 2009
• Equipment 10,000
• Cash 10,000
• (To record purchase of equipment.)
• Depreciation expense 1,000
• Accumulated depreciation 1,000
• (To record depreciation.)
• 2010
• Depreciation expense 1,000
• Accumulated depreciation 1,000
• (To record depreciation.)
• Accumulated depreciation 2,000
• Equipment 1,200
• Revaluation surplus equipment (OCI) 800
• (To record revaluation.)

2011 Depreciation expense 1,100 Accumulated
depreciation 1,100 (To record depreciation.)
Revaluation surplus equipment (OCI)
100 Retained earnings 100 (To reverse portion
of reserve surplus related to increased
depreciation expense. Note that this journal
entry is optional.)
25
Periodic valuationCarrying value
Example 6 solution (continued) 2012 Depreciation
expense 1,100 Accumulated depreciation
1,100 (To record depreciation.) Revaluation
surplus equipment (OCI) 100 Retained
earnings 100 (To reverse portion of reserve
surplus related to increased depreciation
expense. Note that this journal entry is
optional.) Accumulated depreciation
2,200 Revaluation surplus equipment
(OCI) 600 Loss 1,000 Equipment 3,800 (To
record devaluation of equipment.)
26
Periodic valuation Impairment

• IFRS

• US GAAP

Impairment indicators for an asset include such
items as significant change in its use, projected
losses related to its use, a significant decline
in its market value, etc.
Similar
Similar
An impaired asset must be written down, and the
charge is recorded in income.
27
Periodic valuationImpairment impairment
indicators and recoverability test

• US GAAP
• ASC 360-10-35-21 requires a review for impairment
  indicators in PPE whenever events or changes in
  circumstances indicate that the carrying amount
  of an asset may not be recoverable.
• A recoverability test is required
• If the carrying amount of the asset exceeds the
  sum of the expected net future undiscounted cash
  flows, then the asset is not recoverable and an
  impairment loss must be calculated.

• IFRS
• IAS 36 requires an entity to assess annually
  whether there are any indicators of impairment.
• There is no recoverability test, simply calculate
  an impairment loss if impairment indicators are
  present.

28
Periodic valuationImpairment calculating the
impairment loss

• US GAAP
• The impairment loss is the excess of the carrying
  value of the asset compared to its fair value
  (with fair value calculated according to ASC
  820-10-35).

• IFRS
• IAS 36 determines the impairment loss as the
  excess of the carrying value of the asset over
  its recoverable amount
• The recoverable amount is the higher of the fair
  value less costs to sell or value in use (the
  discounted net present value of expected future
  cash flows from the asset).

29
Periodic valuationImpairment recording the
impairment loss

• US GAAP
• The impairment loss is always reported through
  net income.

• IFRS
• The impairment loss is recognized in OCI to the
  extent that it is reversing a prior upward
  revaluation. Otherwise, it is included in net
  income.

30
Periodic valuationImpairment reversal of the
impairment loss

• US GAAP
• A reversal of the impairment loss is prohibited.

• IFRS
• The impairment loss can be reversed up to the
  newly calculated recoverable amount, but it
  cannot exceed what the original carrying amount,
  net of depreciation, would have been.

31
Periodic valuationImpairment

• Example 7
• At December 31, 2010, a company has a piece of
  equipment it acquired on January 1, 2007, with an
  initial scrap value of 0, which has
  significantly decreased in market value due to
  technological innovations in the industry in
  which the company operates. The equipments
  10-year service life has a net carrying value of
  60,000 (100,000 cost less 40,000 of
  accumulated depreciation). The expected future
  undiscounted cash flows from the use of this
  equipment are 59,000. Additionally, the company
  expects to scrap the equipment in six years at
  the end of its service life, for 2,000.
• Is an impairment loss calculation required using
  US GAAP and IFRS?

32
Periodic valuationImpairment

• Example 7 solution
• Using US GAAP, the carrying value of the
  equipment of 60,000 is less than the expected
  future undiscounted cash flows of 61,000
  (59,000 2,000), so no impairment loss
  calculation is required.
• Using IFRS, an impairment loss calculation is
  required because impairment indicators are
  present.

33
Periodic valuationImpairment

• Example 8
• Use the same facts as the previous example,
  except the scrap value is expected to be 0.
  Additionally, the fair value of the piece of
  equipment is 50,000 and the selling costs are
  minimal. The discounted net present value of
  expected cash flows from this piece of equipment
  is 51,000.
• What, if any, impairment loss should be recorded
  using US GAAP and IFRS?
• Show any required journal entries.

34
Periodic valuationImpairment

• Example 8 solution
• Using US GAAP, the piece of equipment now fails
  the recoverability test. The 60,000 carrying
  value of the equipment exceeds the sum of the
  expected net future undiscounted cash flows of
  59,000. Therefore, an impairment loss must be
  calculated. The impairment loss is the
  difference between the carrying value of 60,000
  and the fair value of 50,000. A 10,000
  impairment loss would be recorded as follows
• Impairment loss 10,000
• Equipment 10,000
• Using IFRS, there are impairment indicators so an
  impairment loss must be calculated. Using IAS
  36, the recoverable amount is 51,000 (the higher
  of the net fair value of 50,000 or the
  discounted net present value of the cash flows of
  51,000). Therefore, a 9,000 impairment loss
  needs to be recorded as follows
• Impairment loss 9,000
• Equipment 9,000

Note that the credit could be recorded to an
accumulated impairment loss account instead of
being recorded directly to the asset account.
This would allow management to easily track
accumulated impairment losses for potential
reversal as discussed in example 9.
35
Periodic valuationImpairment

• Example 9
• Use the same facts as the previous example,
  except in 2012 it is discovered that the
  technological innovations related to this piece
  of equipment are not effective. As a result, the
  fair value of this piece of equipment is now
  41,000. Also, assume the scrap value was always
  0.
• Using IFRS, what amount of the original
  impairment loss of 9,000 can be reversed?
• Show any required journal entries to reverse the
  impairment loss.

36
Periodic valuationImpairment

• Example 9 solution
• Impaired Not impaired
• Net asset value 2010 60,000 60,000
• Impairment 2010 (9,000)
• 51,000
• Depreciation 2011 51,000/(6) (8,500) (10,000)
• Depreciation 2012 51,000/(6) (8,500) (10,000)
• 34,000 40,000
• Reversal of impairment loss 6,000
• 40,000
• Equipment 6,000
• Impairment loss
  6,000

Note that if the impairment was initially
credited to an accumulated impairment loss
account instead of being recorded directly to the
asset account , the accumulated impairment loss
account would be debited instead of the asset
account.
37
Disclosures

• US GAAP
• Revaluing PPE is not allowed.
• Reversal of impairment losses is not allowed.
• Estimates of proven oil and gas reserves.

• IFRS
• For revalued assets
• The effective date of the revaluation.
• The methods and assumptions used in estimating
  fair value.
• Whether an independent appraiser was utilized.
• For revalued classes of assets their net cost
  basis.
• The changes to and balance in the revaluation
  surplus.
• The amount of impairment losses reversed directly
  to equity or through net income.
• Not required.