Accounting for tangible fixed Assets • Fixed assets are

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
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
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/30
– Freight cost including insurance
– Repair costs (unintentionally, a worker dropped a box)
– Wires and other fixtures
– Installation
– Initial tests; consulting fees
Cost to be capitalized:
€ 10.000
8.820
280
400
500
500
450
€ 10.950
3
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
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
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
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
Asset Impairment
•
Impairment Æ 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
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. 70.000 units or 30.000
hours
•
physical deterioration and obsolescence limit useful life
9
Depreciation Methods
•
1.
2.
3.
4.
most common methods:
activity or usage method
straight-line method
sum-of-the-years‘-digits method
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
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 ( € )
1
2
3
4
5
6
7
13.000
15.000
17.000
11.000
5.000
8.000
1.000
10.400
12.000
13.600
8.800
4.000
6.400
800
70.000
€ 56.000
Depreciation charge in year 1: 10 .400 =
13 .000
⋅ 56 .000
70 .000
11
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
Year
1
2
3
4
5
6
7
Depreciation charge ( € )
10.000
10.000
10.000
10.000
10.000
10.000
10.000
Book value
€ 80.000_
70.000
60.000
50.000
40.000
30.000
20.000
10.000
€ 70.000 residual value: € 10.000
* income / average total assets
Income (after
depreciation)
Rate of
return*
5.000
5.000
5.000
5.000
5.000
5.000
5.000
6,67%
7,69%
9,09%
11,11%
14,29%
20,00%
33,33%
12
12
3 – Sum-of-the-Years‘-Digits Method
•
decreasing charge method
– „rational“ if asset has increasing repairs and maintenance
Year
1
2
3
4
5
6
7
Depreciation base ( € )
70.000
70.000
70.000
70.000
70.000
70.000
70.000
„sum of the years“ =
Remaining
life in years
Depreciation
fraction
Depreciation
charge
Book value
year-end
80.000
62.500
47.500
35.000
25.000
17.500
12.500
10.000
7
6
5
4
3
2
1
7/28
6/28
5/28
4/28
3/28
2/28
1/28
17.500
15.000
12.500
10.000
7.500
5.000
2.500
28
28/28
€ 70.000
in the example:
7 ( 7 + 1) 56
=
= 28
13
2
2
n ( n + 1)
2
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
Year
1
2
3
4
5
6
7
Depreciation base ( € )
80.000
59.440
44.164
32.813
24.380
18.114
13.459
Rate on de- Depreciation
clining balance
expense
26%
26%
26%
26%
26%
26%
26%
20.560
15.276
11.350
8.433
6.266
4.655
3.459
Balance Accumu- Book value
lated depreciation year-end
20.560
35.836
47.187
55.620
61.886
66.541
70.000
80.000
59.440
44.164
32.813
24.380
18.114
13.459
10.000
14
Determining the depreciation
rate for given life and salvage value:
SV = (1 − d ) AC
n
•
d = 1− n
SV
AC
with
–
–
–
–
SV: salvage value
AC: acquisition cost
n: useful life, and
d: the depreciation rate
15
Comparison of depreciation charges
•
Purchase price: € 80.000; salvage value: € 10.000; useful life: 7
years
Depreciation charges under different methods
depreciation charge
25.000
20.000
15.000
10.000
5.000
0
1
2
3
4
5
6
7
years
straight-line
sum-of-the-years
declining balance
activity
16
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
Example:
• Depreciation charges for office equipment
• purchased in February 2004
• purchase price: € 84.000
• the straight-line depreciatiopn method used
• useful life: 7 years
• sold on 31st of May 2006
• fiscal year ends December 31
Year
2004
Annual Depreciation
Rate
12,000
Depreciation
Period
11/12
Depreciation Charge
11,000
2005
12,000
12/12
12,000
2006
12,000
5/12
5,000
18
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 €
10.000 and useful life of 5 years; in year four, useful life is
reestimated to be 8 years overall.
Year
Depreciation charge
1
2
3
2.000 2.000 2.000
10.000
„initial“ charges:
= 2.000
5
4
5
6
7
800
800
800
800
8
Total
800 10.000
10.000 - 6.000
revised charges:
= 800
8-3
19
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
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
dec. Balance
20,00
16,00
12,80
10,24
8,19
6,55
5,24
3,93
2,62
1,31
0,00
straight line
depreciation
revised
depreciation
10,00
8,89
8,00
7,31
6,83
6,55
6,55
6,55
6,56
6,56
20,00
16,00
12,80
10,24
8,19
6,55
6,55
6,55
6,56
6,56
100,01
21
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 € 2.100.
Sales price
Less book value
Cost
Accumulated depreciation
Gain
1.000
Income statement presentation:
2.100
1.400
700
300
Journal entry: Cash
Accumulated depreciation
Computer equipment
Gain on sale of equipment
Æ in most cases, gains/losses
included in „other income“
1.000
1.400
2.100
300
22