4 Tangible Non-Current Assets

Question 1

According to IAS 16. PPE are tangible assets that are….

1.
2.

Answer 1

… held (purchased or constructed) by an entity, for use in PRODUCTION or supply of goods, for RENTAL to others, or for ADMINISTRATIVE purposes

AND
… expected to be used during more than one period

Question 2

What is…

1. the carrying amount?
2. the initial carrying amount?
3. the subsequent carrying amount?

Answer 2

1. also known as the net book value
2. its cost
3. the amount at which an asset is recognized after deducting any accumulated depreciation and accumulated impairment loss

3 = 2 - accumulated depreciation - impariment losses

Question 3

Whats the difference between capitalising costs and expensing them? Why does it matter? What do businesses prefer doing?

1. Difference
2. Impact Profit
3. Asset Value
4. Businesses Preference and why

Answer 3

• Capitalising Costs: Recording a cost as an asset. (put on BS) -> distributing costs acorss entire useful life//Expensing Costs: Recording a cost as an expense in the period incurred (in IS)
• Impact on Profits: Capitalising spreads costs over time, boosting short-term profits; expensing reduces profits immediately
• Asset Value: Capitalising increases total assets on the balance sheet.
• Business Preference and Why
  Preference: Capitalising costs.
  Reason: To increase short-term profits and enhance the balance sheet appearance

Question 4

What do the following accounting standards entail:

1. IAS 16
2. IAS 23
3. IAS 40

Answer 4

1. property plant equipment
2. borrowing costs
3. investment property

Question 5

Borrowing Costs | Definiton (IAS 23)

1. Definition
2. Relation to directly attributable
3. Relevant costs

Answer 5

interest and other costs that an entity incurs in connection with the borrowing of funds

-> Directly attributable to the acquisition, construction or production of a “qualifying asset” are to be capitalised

Relevant costs are those borrowing costs that would have been avoided if the expenditure on the qualifying asset had not occurred

Question 6

Qualifying asset | Definiton and examples

Answer 6

an asset which takes a
substantial time to prepare for its
intended use or for sale

Qualifying assets include:
 Construction work-in-process
 Manufacturing plants
 Investment Properties
 Intangible assets
 They do not include:
 Inventories produced over short time
scales

Question 7

For how long can a business capitalise borrowing costs?

The capitalisation of borrowing costs should start when….

1.
2.
3.

And stop when….

1. 2.

Answer 7

• Activities are taking place to prepare the asset for its intended use or sale AND
• Expenditure is being incurred on the asset AND
• ## Borrowing costs are being incurredwhen substantially all activities necessary to prepare the
  asset are complete for its intended use

Question 8

What is a significant by-product of revaluing assets?

1.
2.
3.
4.

Answer 8

• the effect on gearing (the proportion of debt in the capital structure of the firm)
• revaluations usually increase the carrying values of assets and equity; borrowings are unchanged
  -> gearing decreases
• when comparing a firms gearing levels, we need to look at revaluation policies and reserves

Question 9

Investment Property | Definition and Examples

Answer 9

• a property held to earn rentals or capital appreciation or
  both, as opposed to being used to produce goods /
  services or for admin, or sale in the ordinary course of
  business

Examples:
 Land held for long-term capital appreciation
 Land held for undecided future use
 Building leased out under an operating lease
 Vacant building held to be leased out under an operating
lease

Question 10

What is NOT investment property? (IAS 40)

1.
2.
3.
4.
5.

Answer 10

The standard provides a list of items that are not
investment properties:
 Property held for use in the production of goods or services
 Property held for sale
 Property under construction
 Owner occupied property
 Property occupied by employees

Question 11

When is investment property masured and where?

1.
2.
3.

Answer 11

• measured at fair value
• changes are then directly recognzied in income statement
• OR, it can be measured AT COST as defined by IAS 16; here, the fair value must also be disclosed

Question 12

EXCEPTION: Investment properties when measured under the fair value model are….

Answer 12

…. not depreciated!

(normally, under IAS 16 most tangible non current assets except for land are depreciated)

Question 13

Revision: Whats an asset?

1.
2.
3.
4.

Answer 13

• resource that is controlled by entity
• … result of past events
• … future economic benefit expected
• is recognized if it is probable that future economic benefits will flow and the cost can be measured reliably

Question 14

Whats the formula for the cost of an item of PPE acc to IAS 16?

Answer 14

• here our initial recognition is measured AT COST
• cost of an item of PPE = purchase price including import duties + non refundable purchase taxes - trade discounts + any directly attributable costs of bringing the asset to working condition for its intended use

Question 15

What happens when the business uses some of its general-purpose borrowings to obtain a qualifying asset?

1.
2.
3.

Answer 15

• general purpose borrowings = not specifically taken for the asset
• the borrowing costs attributable to the qualifying asset need to be estimated
• typically done by applying a weighted average borrowing rate of the company to the expenditures incurred on the qualifying asset during the period it qualifies for capitalization

Question 16

On initial recognition, IAS 16 requires that items of PPE should be measure…

Answer 16

…at cost

Cost of an item of PPE = purchase price incl. import duties + non-refundable purchase taxes - trade discounts + any directly attributable costs of bringing the asset to working condition for its intended use

Question 17

Directly attributabkle costs include…

1.
2.
3.
4.
5.

Answer 17

1. costs of site preparation
2. delivery and handling costs
3. installation costs
4. professional fees (for architects and engineers)
5. dismantling and restoring site

Question 18

How do we handle self constructed items of PPE?

1.
2.
3.

Answer 18

• recignized at their cost
• handled as if the constructed PPE item is made available by the business for sale
• cost of constructed PPE = cost of producing the asset for sale (i.e. without any profit element)

Question 19

Whats a qualifying asset?

1.
2.
3.

Answer 19

• asset which takes a substantial time to prepare for its intended use or for sale
• e.g. construction work in progress, investment properties, manufacturing plants, intangible assets
• NOT: inventories produced over short time scales

Question 20

The capitalisation of borrowing costs should start when…
1.
2.
3.

should stop when….
4.

Answer 20

1. … activities are taking place to prepare the asset for its intended use or sale AND
2. … expenditure is being incurred on the asset AND
3. borrowing costs are being incurred
4. when substantially all activities necessary to prepare the asset for its intented use are complete. (its DONE)

Question 21

What happens when the business uses some of its general purpose borrowings to obtain a qualifying asset?

1.
2.

Answer 21

• then the borrowing cost (i.e. interest charge) must be ESTIMATED for the qualifying asset
• take a weighted average of the company´s borrowing costs for the time that the asset counts as a qualifying asset

Question 22

Subsequent expenditure (e.g. maintenance) is normally…

Exceptions to this are:
1.
2.
3.
4.

Answer 22

expensed.

1. they will be capitalised if excess future economic benefits will flow
2. extend useful life & increase quality (e.g. 15% revenue increase: IAS 16 qualifies this cost to be capitalized)
3. upgrade to improve quality of output
4. adopting new production processes to significantly reduce costs

Question 23

Depreciation is…

Answer 23

…. an attempt to measure the proportion of the non-current asset used up to generate the current periods revenue

Question 24

Why is this wrong: Depreciation is a way of showing how non current assets lose value over time

Answer 24

not reflecting real value, just rough value

Question 25

IAS 16: Which measurements do we use in the following?

1. initial recognition?
2. subsequent measurement?

Answer 25

1. at cost
2. A. cost model or 2. revaluation model

Question 26

What is…

1. the cost model?
2. the revaluation model?

Answer 26

1. most common approach for measuring PPE; after recignition items are carried at cost less accummulated depreciation and any accumulated impariment losses
2. after initial recognition items are carried at revalued amount; revalued amount = fair value (i.e. market value) at the date of revaluation minus any subsequent accummulated depreciation and any subsequent accumulated impairment losses

Question 27

What are preconditions for measuring PPE according to the revaluation model?

1.
2.
3.
4.

Answer 27

• reliable measurement of the fair value of the PPE item
• application to entire class of PPE items not just one!!
• regular revaluations for the entire class of PPE items simultaneuosly
• revaluations usually every 3-5 years

Question 28

How do we account for revaluation gains for PPEs?

Answer 28

• debit PPE item
• credit a revaluation surplus reserve under equity (classified as other comprehensive income in SoCI)
• why not treated as income? -> bc its an unrealized gain; by excluding it from profit its not available for payment dividends or tax

(But: if previously we had revaluation decrease (aka expense); then the increase now is stated as inome on the I/S (+10 OCI up; -10 OCI and -10 I/S)

Question 29

What are downsides from too high profit?

Answer 29

• too high dividends
• market value going up is not directly realized

Question 30

How do we account for revaluation losses?

Answer 30

• credit PPE item
• debit an expense -> directly shown on the I/S!

BUT: if asset already has surplus, then any following revaluation decrease is charged

Question 31

How do we calculate the revised depreciation amount after revaluation a PPE?

Answer 31

• new value of the asset
• minus its residual value

-> subsequent annual depreciation charges will be based upon this revised amount
-> they will continue for the remainder of the assets useful life

Question 32

When a revalued asset is sold, then…

1.
2.
3.
4.
5.

Answer 32

• the revaluation surplus becomes realized
• this is transfered to retained earnings
• transfer recorded in statement of changes in equity
• no effect on comprehensive income

-> transfer implies that a previously unrealized gain has now become realized

Question 33

Whats thei impact of revaluation on F/S comparisons between firms?

Answer 33

• effect on gearing (leveraging), i.e. the proportion of debt in the capital structure of the firm (the higher the gearing is, the higher the proportion of debt in your company is)
• revaluations ususally increase carrying values of assets and equity, and borrowing stay unchanged -> gearing DECREASES

Question 34

Define Investment Property

Answer 34

• property held to earn rentals or capital appreciation or both (as opposed to being used to produce goods/ services or for admin, or sale in the ordinary course of business)

e.g.: land held for LT capital appreciation; land held for undecided future use; building leased out under an operating lease

Question 35

Whats NOT investment property?

1.
2.
3.
4.
5.

Answer 35

Property…

• held for sale in production for goods or services
• held for sale
• under construction
• owner occupied
• occupied by employees

Question 36

When can a non current asset be classified as held for sale?

1.
2.

Answer 36

1. asset must be available for immediate sale in its present condition AND
2. its sale must be highly probable (requires management commitment; activeky seeking buyer; expected to complete the sale in one year)

Question 37

What can be said regarding assets held for sale and depreciation?

1.
2.
3.

Answer 37

• they are NOT depreciated
• they are measured at the lower value between: carrying amount vs fair value less selling costs
• presented seperately on the face of the financial statements