10/24/2008. Reporting and. assets PROPERTY, PLANT AND EQUIPMENT. PROPERTY, PLANT AND EQUIPMENT continued. Chapter 8

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1 Chapter 8 Reporting and analysing non-current assets PowerPoint presentation by Anne Abraham University of Wollongong 2009 John Wiley & Sons Australia, Ltd PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment (PPE) are physical assets used in the business to provide future economic benefits for a number of years According to AASB 116, economic benefits derived from the use of an asset must be recognised on a systematic basis over the asset s useful life This decline is recognised as depreciation expense in the income statement 2 PROPERTY, PLANT AND EQUIPMENT continued Two classes of PPE assets: Property Includes land and buildings Plant and equipment Includes cash registers, computers, office furniture, factory machinery, motor vehicles 3 1

2 Determining the cost of PPE PPE assets are initially recorded at cost in accordance with AASB 116, para 6 The amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire the asset Fair value is the amount for which an asset could be exchanged between knowledgeable willing partners in an arm s-length transaction 4 Determining the cost of PPE continued The cost of an asset Consists of the fair value of all expenditure necessary to acquire the asset and make it ready for use e.g. purchase price, freight costs paid, installation costs (capital expenses) Excludes non-capital expenditures which are expensed immediately 5 Determining the cost of PPE continued Property Cost of land includes purchase price settlement costs (e.g. solicitor s s fees) stamp duty accrued property taxes assumed by purchaser 6 2

3 Determining the cost of PPE continued Example LAND Cash price of property $ Net removal cost of warehouse Solicitor s fee Stamp duty Cost of land $ Determining the cost of PPE continued Plant and equipment Cost includes purchase price freight charges insurance during transit installation costs 8 Determining the cost of PPE continued Example DELIVERY TRUCK Cash price $ Airconditioning Painting and lettering 500 Cost of delivery truck $

4 Determining the cost of PPE continued To buy or lease? In a lease, a party that owns an asset (the lessor) agrees to allow another party (the lessee) to use the asset for an agreed given period of time at an agreed price Advantages of leasing: Reduced risk of obsolescence Little or no deposit Shared tax advantage Assets and liabilities are not reported 10 Depreciation Depreciation is the process of allocating to expense the cost of a PPE asset over its useful (service) life in a rational and systematic manner Carrying amount equals cost less accumulated depreciation 11 AASB 116 outlines 4 factors that contribute to the decline in value of a depreciable asset: 1.Usage of the asset 2.Wear and tear through physical use of the asset 3.Technical and commercial obsolescence. 4.Legal life 12 4

5 Factors in calculating depreciation Cost All expenditures necessary to acquire the asset and make it ready for intended use Useful life Estimate of the expected life based on intended use, need for repair, vulnerability to obsolescence and legal life Residual value Estimate of the asset s value at the end of its useful life 13 Depreciation methods Straight line Reducing balance Units of production Example Delivery truck purchased by Bill s Pizzas Cost $ Expected residual value $ Estimated useful life (in years) 5 Estimated useful life (in kms) Straight-line method Depreciation expense same each year as benefits are consumed at same rate each year Calculation for annual charge: cost of asset residual value useful life of the asset Bill s Pizzas example: Annual depreciation ($ $1 000) / 5 = $

6 Straight-line depreciation schedule BILL S PIZZAS Calculation End of year Depreciable Depreciation Depreciation Accumulated Carrying Year amount x rate = expense p.a. depreciation amount 2010 $ % $ $ $ * Total $ * Cost $ Year 1 depreciation $2400 = Carrying amount $ Journal entry to record depreciation expense Dec 30 Depreciation Expense Delivery Truck Accumulated Depreciation Delivery Truck (To record depreciation expense for the year) Diminishing-balance method Depreciation expense decreases each year as greater benefits are consumed earlier in assets life Calculation n Depreciation rate = 1 r c or 1 (r / c) 1/n 18 6

7 Bill s Pizzas example Annual depreciation rate = 1 ($1000/$13 000) 1/5 = = 40% (approximately) 19 Diminishing-balance depreciation schedule BILL S PIZZAS Calculation End of year Carrying amount Depreciation Depreciation Accumulated Carrying Year beginning i of yr x rate = expense p.a. depreciation amount 2010 $ % $ $ $7 800 * ** Total $ * $ $5200 ** Calculation of $674 ($1685 x 40%) is adjusted to $685 in order for carrying amount to equal residual value. This is because the rate was rounded to 40%, 20 rather than 40.13% using the formula. 3. Units-of-production method Useful life is expressed in terms of total units of production or use expected from the asset Calculation of depreciation cost per unit depreciable cost of asset useful life of the asset Depreciation expense depreciation cost x yearly units of per unit production 21 7

8 Bill s Pizzas example Depreciation per unit = $12 000/ units = $0.12 per unit Depreciation expense = $0.12 x units = $ Units-of-production depreciation schedule BILL S PIZZAS Calculation End of year Units of Depreciation Depreciation Accumulated Carrying Year production (km) x cost unit = expense p.a. depreciation amount $0.12 $ $ $ * Total $ * $ $ Comparison of depreciation methods Year Straight-line Reducing-balance Units-of-production 2010 $ $ $ $ $ $

9 Patterns of depreciation 25 Subsequent expenditure During the useful life of an asset, a firm may incur costs for: a. Ordinary repairs Expenses in maintaining operating efficiency of the asset Expensed in operating statement b. Additions and improvements Costs incurred to increase operating efficiency Expenditure capitalised and depreciated over asset s remaining useful life 26 Impairments All PPE items must be tested for impairment in accordance with AASB 136 An impairment loss is the amount by which the carrying amount of an asset (or a cash-generating unit) exceeds its recoverable amount The recoverable amount is the higher of its fair value less costs to sell and its value in use 27 9

10 Impairments continued Value in use is the present value of net cash flows expected to be derived from using the asset A cash-generating g unit is the smallest identifiable group of assets that generates cash inflows 28 Impairments continued Accounting for impairments To apply the impairment test Calculate fair value less costs to sell and value in use The higher of these two values must be compared with the carrying amount Impairment loss is only recognised if recoverable amount is lower 29 Impairments continued Example Recoverable amount is higher of Net selling price $ Value in use $ Carrying value of $ exceeds recoverable amount Impairment write-down of $7000 required Jun 30 Impairment Loss Accumulated Impairment Loss - Computers (To record impairment write-down on equipment) 30 10

11 Impairments continued Reversal of impairments These are permitted so long as new carrying value is no greater than it would have been had no impairment loss been recognised in previous years 31 Impairments continued Revaluation This is a reassessment of the fair value of a non-current asset at a particular date AASB 116 requires each class of PPE to be measured either on cost basis or revalued basis 32 Impairments continued To record the revaluation journal entries: a. Record depreciation to date of asset revaluation b. Transfer balance of Accumulated Depreciation account to asset account to give asset s carrying amount c. Record the revaluation 33 11

12 Impairments continued Example A firm decides to record equipment at its fair value of $ The equipment was originally purchased for $ and now has a book value of $ Jan 1 Accumulated Depreciation - Equipment Equipment (To close off accumulated depreciation against the asset) Jan 1 Revaluation Expense Equipment (To record revaluation decrement on equipment) 34 Impairments continued If initial revaluations reverse in a subsequent period revaluation increment (decrement) should be offset against previous revaluation decrement (increment) to the extent of the amount of the previous revaluation Example Sep 30 Revaluation Reserve Revaluation Expense Land (To record reversal of revaluation increment of Land A by writing down the Revaluation Reserve by $ and recognising an expense of $30 000) 35 Impairments continued Impairment testing applies to assets held on the revalued basis If impairment is indicated, whole class of assets need not be adjusted The asset which is impaired is written down and it is treated as a revaluation decrement 36 12

13 Disposals of PPE assets PPE assets may be disposed of by Sales Equipment is sold to another party Scrapping Equipment is scrapped or discarded Exchange Existing equipment is traded for new equipment 37 Sale of PPE assets Example (Gain on sale) Wright Ltd sells office furniture on 1 July 2010 for $ cash Original cost was $ Accumulated depreciation to 1 January 2010 is $ Depreciation expense for first 6 months of 2010 is $ Sale of PPE assets continued Recording depreciation Jul 1 Depreciation Expense Office Furniture Accumulated Depreciation Office Furniture (To record depreciation expense for first 6 mths of 2010) Calculation of gain on disposal Cost of office furniture $ Less: Accumulated depreciation ($ $8000) Carrying amount at date of disposal Proceeds from sale Gain on disposal of asset $

14 Sale of PPE assets continued Recording the sale of the asset Jul 1 Cash Accumulated Depreciation Office Furniture Office Furniture Gain on Disposal (To record sale of office furniture at a gain) 40 Sale of PPE assets continued Example (Loss on sale) Assume that office furniture was sold for $9000 rather than $ Calculation of loss on disposal Cost of office furniture $ Less: Accumulated depreciation ($ $8000) Carrying amount at date of disposal Proceeds from sale Loss on disposal of asset $ Sale of PPE assets continued Recording the loss on sale of the asset Jul 1 Cash Accumulated Depreciation Office Furniture Loss on Disposal Office Furniture (To record sale of office furniture at a loss) 42 14

15 PPE records A detailed asset register maintained as an internal control procedure to protect and efficiently manage the PPE Subsidiary ledgers are maintained to keep details of individual assets 43 INTANGIBLE ASSETS Intangible assets are defined in AASB 138 as identifiable non-monetary assets that have no physical substance Examples include: Patents (e.g. Apple ipod) Franchises (e.g. Domino s Pizza) Trademarks (e.g. swoosh of Nike) 44 Accounting for intangible assets Intangible assets can be separated into: a. Identifiable Must be capable of being separated or divided from an entity (whether sold, licensed, rented or exchanged) or must arise from contractual or other legal rights b. Unidentifiable Cannot be separated from the entity itself Collectively referred to as goodwill 45 15

16 Accounting for intangible assets continued Amortisation This is the term used to describe the allocation of the cost of an intangible asset to expense Intangible assets are assumed to have a limited life and are amortised Patents are amortised over legal or useful life, whichever is shorter 46 Accounting for intangible assets continued Example Patent costs $ and has an estimated useful life of 8 years Annual amortisation expense $ = $7500 Recording annual amortisation Dec 31 Amortisation Expense Accumulated Amortisation - Patents (To record patent amortisation) 47 Types of intangible assets 1. Patents Exclusive right granted by IP Australia enabling recipient to manufacture, sell or otherwise control an invention 2. Research and development costs Expenditures that may lead to patents, copyrights, new processes and new products 48 16

17 Types of intangible assets continued 3. Copyright Gives the owner exclusive right to reproduce and sell an artistic or published work 4. Trademarks and brand names Words, phrases, jingles or symbols that distinguish or identify a particular business or product 49 Types of intangible assets continued 5. Franchises and licences A contractual arrangement under the franchisee is granted certain rights 6. Goodwill Represents all favourable attributes that relate to an entity and is defined as future benefits from unidentifiable assets 50 OTHER NON-CURRENT ASSETS We will examine two particular types of assets related to specific industries Agricultural assets Natural resources 51 17

18 Agricultural assets AASB 141 prescribes the accounting treatment and disclosures relating to agricultural activity An agricultural activity is the management by an entity of the biological transformation of biological assets for sale, into agricultural produce or into biological assets A biological asset is a living animal or plant 52 Agricultural assets continued Biological assets must be recognised when the assets can be reliably measured, it is probable future economic benefits will eventuate, and fair value or cost can be reliably measured When harvested, biological assets become agricultural produce and are treated as inventory 53 Agricultural assets continued Agricultural assets comprise grape vines and olive trees They are measured at net market value Any change in net market value during the period is recognised in the income statement Costs are recognised as expenses when incurred Revenue is recognised in period of harvest 54 18

19 Natural resources Entities in extractive industries are involved in the search and extraction from the ground of natural substances e.g. minerals, oils, natural gas Under AASB 6 the capitalisation of preproduction costs is not permitted until a resource is extracted Once production has begun, pre-production costs are charged to inventory by amortisation 55 Natural resources continued Amortisation (depletion) is the periodic allocation of the cost of natural resources to reflect the units removed Example Wallace Tin Mine contains 7M tonnes of ore Capitalised pre-production costs $150M Residual value $10M Current year s production 2M tonnes Direct production costs $10M Depletable amount $140M ($150M $10M) 56 Natural resources continued Formula for calculating depletion 57 19

20 Natural resources continued Journal entry to record depletion Jun 30 Inventory of Ore Accumulated Depletion Tin Mine (To record the depletion for the year) 58 REPORTING AND ANALYSING ISSUES How are non-current assets reported in the financial statements? What methods are used to evaluate the use of non-current assets? 59 Reporting non-current assets in the financial statements See AASB 101 and NZ IAS 1 gives minimum classification which must be shown on balance sheet Under non-current assets Property, plant and equipment Intangibles Also requirements for extensive note disclosures of accounting policies and break-up of summarised accounts into separate categories 60 20

21 Analysis and interpretation 1. Average useful life of PPE assets = average cost of PPE assets depreciation expense Example: Fantastic Holdings Limited ($ in thousands) ($ $19 014)/2 = 8.6 years $ Analysis and interpretation continued 2. Average age of PPE assets = accumulated depreciation depreciation expense Example: Fantastic Holdings Ltd Nick Scali Ltd $7710 = 3 years $ = 4.6 years $ $ Analysis and interpretation continued 3. Asset turnover ratio net sales. average total assets $ sales generated for each $ invested in assets Example: Fantastic Holdings Ltd Nick Scali Ltd $ = 3.3 times $ = 2.9 times ($ $ )/2 ($ $24 432)/

22 Decision Toolkit Bruce Pharmaceuticals Ltd Work through on your own and check your results with the suggested solution provided 64 Demonstration Problems DuPage Ltd Skyline Limousine Ltd Work through on your own and check your results with the suggested solution provided