Tangible Non current assets Flashcards
What are examples of tangiable( physical substance)?
Buildings, Land, Office equipment and Vehicles.
Why are tangiable non current assets important?
Have huge B/S and I/S effects, as we can see half of TA are tangiable NCA.
Also
Waste management Inc in North America committed fraud, which was what?
avoiding depreciation expenses by assigning and inflating salvage values and extending the useful lives of the garbage trucks that the company owned. They had to restate its FS’s which was the largest in history. It had reportedly overstated pre tax earnings by $1.7 billion.
We are mainly focusing on PPE what is PPE?
1)Tangible
2) Held for use in production or supply of goods or services, for rental to others, or for administrative purposes.
3) Expected to be used during more than one period
An item of PPE should be recognised as an asset if and only what?
It is probable that future economic benefits associated with the item will flow to the entity
* The cost of the item to the entity can be measured reliably
1) Lets look at initial recognition of NCA? What should the initial cost be recorded down as?
2) What is the initial cost if the asset is acquired in exchange for another asset?
3) If payment is deferred then what do you recognise as initial cost?
1)Cost = Purchase price ( might include import duties)+ Directly attributable costs bringing the asset to present location ( e.g. like handling fees) + removal costs( cost of dismantling asset).
2) Cost is measured at fair value.
3) interest must be recognised
What happens with you repair the PPE where does this value go?
But what happens if you do something that extends the uselife of PPE?
If you have rountine repairs or maintence costs, these are put as expenses on the income statement, e.g. company transporting goods and you have multiple trucks, some trucks have punctured typres, and you have to do maintence that goes to expenses.
It is added onto the cost of the asset on the (SOFP) e.g. the same truck, and you replace a very old motor in a truck that extends its useful life by 3 years, so if truck is worth £7000 and you spend £200 replacing the motor, this means the value of the PPE becomes £7,200.
There is 2 basic models for revaluation of PPE, which are what? and do we need to be conisstent. ( subsequent measurement)
Cost model = Cost - Acculmulated dep - Accumulated impairment loss.
Reevaluation model = Every year you will revalue the asset and ask is the asset, the same value as it originally was. So Revalue cost - any accumulated depreciation - accumulated impairment losses?
If we pick one we need to apply it to all assets the same way to avoid cherry picking.
What does depreciable amount mean?
What is Carrying amount ?
How is depreciation allocated?
Cost - Residual value ( requires estimates).
Cost - AD.
Matching princple.
Name 4 depreication methods?
1) Straight line method
2) Reducing balance method
3) Sum of digits method
4) Usuage ( machine hours)
So the frequency of re valuing asset using revaluation method depends on the asset so therefor management. So if you record at cost first, which you need to and do the first valuation what happens if the value is higher than cost or lower than cost.
Then on subsequent measures do the same thing?
- Cost €12,000
- Useful life Four years
Depreciation percentage 40% - Scrap value €2,000
Calculate dep for each of the 4 years using the reducing balance method?
f
Cost €12,000
* Useful life Four years
* Scrap value €2,000
Calculate dep for each of the 4 years using the sum of digits method.
We find depreciable amount then find sum of the digits of years then in the first year ask how many years to useful life and we do that for each year/ sum of digits X depriceable amount
Assume Company X owns land. The carrying value of the land before revaluation is €40,000. The fair value of the land has increased and the current market price is
€50,000. Company X values its PPE using the revaluation model.
* What entries need to be made at the end of the period to bring the carrying value of the asset in line with the principles of the revaluation model?
WHAT WE DO ANYTHING HERE UNDER THE COST MODEL?
Dr Land 10,000
Cr Revaluation surplus 10,000
* Revalued carrying value on the balance sheet is €50,000 and under equity there will be a revaluation surplus of €10,000.\
UNDER THE COST MODEL WE WILL NOT DO ANYTHING, ONLY WHEN WE SELL LAND WE RECOGNISE PROFIT.
REMEMBER THIS ISNT COST MODEL Assume that another piece of land owned by Company X with an initial value of €20,000 recorded a revaluation
decrease last year of €3,000. Due to a changing
economic climate, the industrial activity in the area in
which the land is situated is increasing. The current
market price for that land is estimated at €21,000.
* What entries are needed to bring the carrying value of the asset in line with the principles of the revaluation model in IAS 16?
REMEMBER THIS ISNT COST MODEL
Assume company X owns a piece of land in an area
where the economic activity is deteriorating and the
market prices of land have fallen. The land has a carrying value prior to revaluation of €30,000. The current market price is €25,000.
* What are the journal entries that need to be made at the year-end?
Assume that the land in the books of company X in the
previous activity with a carrying value of €30,000, had
been revalued two years before from €27,000 to €30,000.What journal entries would then be needed to reduce the carrying value of the land to €25,000?
Dr Loss/revaluation decrease (in profit or loss) €5,000
Cr Land €5,000
Two years ago when the revaluation of the land occurred, Company X would have recorded the following in their books:
Dr Land €3,000
Cr Asset revaluation surplus €3,000
Two years later, when Company X needs to record the
decrease in the carrying amount of the land to €25,000,
they will make the following entries in their books:
Dr Asset revaluation surplus 3,000
Cr Land 3,000
Dr Loss – downward revaluation of land (P/L) 2,000
Cr Land 2,000
A company has a plant with a carrying amount of €21,000, being an initial cost of €35,000 and accumulated depreciation of €14,000. The fair value of the asset now is €25,000.
* Show how depreciation will be adjusted under the net
method.
Under this method we first write off the accumulated
depreciation of the plant, which reduces the carrying
value of the plant to €21,000 (€35,000 - €14,000).
Dr accumulated depreciation 14,000
Cr Plant 14,000
* Subsequently we adjust the carrying amount of €21,000 to the fair value of the asset which is €25,000.
Dr Plant 4,000
Cr Gain on revaluation of plant (OCI) 4,000
Suppose we have an asset cost €10,000, useful life five
years, estimated residual value nil. The asset is now three years old and has a carrying value of €4,000.
* After three years, the asset’s value is reviewed and its fair value is €6,000.
* Show how the depreciation will be adjusted under the
gross method.
We start of with the carrying amount we have and the carrying amount it should be It is a 50% increase, so if we were to adjust our AD 50% increase and the same for cost.
Now here there is an example of a change in assumption? An asset which costs £1,000 was estimated to have a useful life of 10 years and residual value £200. After two years, the useful life was revised to 4 remaining years. The revised depreciation using the straight line method would be:
Inital cost - residual value / Uselife life = Deprication expense
1000-200/10 = £80 Depriecation expense was £80 per year ( in year one accumlated depreication is £80.
Year 1
1000- 80 = 920
NBV = 920
Year 2
1000- 160 = £840
Now the change of assumption has happened so
Yout take the NBV you year 2 then calculate from there so
840-200/4 = 160 accumluated depreication
Year 3
840 -( accumlated + 160) = 680
Year 4 you do
840 - 320( accumlated) = 520 or
1000 - 480 = 520
When should a tangiable non current asset be derecognised?
An asset should be removed from the BS on disposal or no future economic benefits are expected
If an asset is disposed gain or loss can be created, which is what?
Net dispoal proceeds - Carrying amount of any PPE
THEY ARE INCLUDED IN PROFIT OR LOSS BUT NOT AS REVENUE.
When are assets impaired?
When the carrying amount > recoverable amount.
What is the recoverable amount?
max (asset’s fair value less
costs to sell , value in use)
It is important that its not always necessary to estimate both, because if one is higher than CA then there is no impairment.
What is value in use ?
Is the present value of the future cash
flows from asset
How do we treat.impairment loss CA - recoverable amountnin the FS when
1) Cost model
2) Revaluation model?
3) Also what do we do with the depreication?
1) Cost model
Dr impairment loss
Cr Asset
2) Revaluation model any impairment loss should be treated as a revaluation decrease
Dr OCI - Revaluation surplus
Cr Asset
However if there is no revaluation surplus in OCI then the impairment is Dr P/L impairment loss.
3) Adjust depreciation for future periods to new CA.
What is the impairment procedure?
If fair value less costs of disposal cannot be determined,
the recoverable amount is
For assets to be disposed off the recoverable amount is what?
At the end of each reporting period, assess whether there is any indication of impairment.
Value in use
recoverable amount is fair value less costs of
disposal.
ABC purchased a machine for £2,000 on 1st January 2019 which had a useful life of 5 years and an estimated residual value of £500. The machine has been depreciated on straight line basis.
However, ABC decided to sell the asset on 1st January 2021 for £1,500 in order to raise cash for the purchase of a new machine.
* How will this disposal be recorded?
The carrying amount of the machine on January 1st 2021 is:
Cost: £2,000
Acc. Depreciation is: 2*(2,000 – 500) / 5 = £600
Carrying amount: £1,400
* The disposal is recorded as:
Cr Machinery 1,400
Dr Cash 1,500
Cr Gain on disposal 100
It might be difficult to calculate value in use for individual asset, as it doesn’t generate cash flows from independent on other assets, so what do we use?
Cash generating units : the smallest identifiable group
of assets that generates cash flows independently of
other assets. So the treatment is same when CA > Recoverable amount ( but remember it is isn’t one item so be consistent)
A health and beauty clinic is specialized in nose corrections. The equipment to perform this surgery consists of three separate machines, each necessary to execute one step in the surgery. So the three machines are a cash-generating unit: a special X-ray (carrying value €400,000), laser machine (carrying value
€200,000), and a robot (carrying value €800,000).
* The value in use for the machines is €1,050,000. The current fair value of the machines less costs to sell is €900,000.
* Will an impairment be recorded?
IF THE BEAUTY CLINIC WAS GOING TO ADOPT A REVLAUATION MODEL WHAT NUMBER WOULD BE THE FV?
We would use 900000 so impairment loss is 600000.
As you can see we proportionally adjust to each machine.
Lets look at the Practical application / Classwork, So we will be looking at what case study?
Delta airlines, it has a lot of ppe, which accounts for a lot of total assets thus depreciation is a massive operating expense, they like to extend useful lives of flight equipment and change the residual values for deprecation purposes, they have done this 4 times since 1986.
Lets look at the Practical application / Classwork Depreication at Delta air lines, What are some of the possible reasons why Delta Airlines may have extended the lives of flight equipment and changed the residual values for depreciation purposes 4 times since 1986?
- Competition and deregulation( bringing compeittive pricing) push airlines to desire to reduce annual depreication amounts in order to report higher net income
- Economically, asset useful lives can change over time due to improvements in construction technology, materials used, planned uses, etc…
Estimate straight-line depreciation expenses for 1992, 1993, 2006 and 2007.
What is fresh start accounting?
“Fresh start” accounting is a set of policies aimed at replacing historical costs with fair values.
Firms can adopt fresh start accounting when filling for
bankruptcy if managers believe that historical costs no longer provide a faithful representation of the underlying economics of the business.
During bankruptcy, fair values could become more informative for creditors trying to assess the amounts expected to receive
We want to look at how a change of assumptions effects valuation, so we will now do question 3?
Estimate the valuation implications of changes in estimates for 1993 and 2007. Use equity capital of $150 million and $250 million and PPE revenues of $10 million and $15 million for 1993 and 2007 respectively. Keep the growth and cost of capital at 1% and 7% respectively.
So we are comparing 1993 and 2007 with no changes vs changes in estimates, so we can see difference. Lets look at 1992-1993, where there is no change in useful life, Calculate Reformulated B/S and I/S ( whilst remembering we have a beginning balance of 150 and we want to reconcile ending balance)?
Assume that the plane is already bought.
And everything is acculumlated, balances.
And in 1993, the useful life is the same in both years and we use the residual value criteria for 1992 for 1993.
New depreication is Cost - Old residual criteria( 10% of cost) / 15 years.
= 68-6.8/15 = 4.08
Remember depreciation in the next year is acculumated so 4.08 + 3.96 = 8.04.
We want to look at how a change of assumptions effects valuation, so we will now do question 3?
Estimate the valuation implications of changes in estimates for 1993 and 2007. Use equity capital of $150 million and $250 million and PPE revenues of $10 million and $15 million for 1993 and 2007 respectively. Keep the growth and cost of capital at 1% and 7% respectively. We will not look at 2007 as its the same princple.
So we are comparing 1993 and 2007 with no changes vs changes in estimates, so we can see difference. Lets look at 1992-1993, where there is no change in useful life, Calculate Reformulated B/S and I/S ( whilst remembering we have a beginning balance of 150 and we want to reconcile ending balance)?
Assume that the plane is already bought.
And everything is acculumlated, balances.
But now the useful life in 1993 is different.
1992 stays the same because the new estimates only kick in in 1993.
In 1993 to calculate depreication first of all we find depreciation of new plane using new estimates in residual value and useful life. 68 - 3.4( residual value 5% instead of 10% of cost / 20 = 3.23
Now the depreciation of the first plane is calculated using old estimates so we need to adjust this.
I brought it for 66 and take away residual value of 5% of cost to get depreicable amount. However i have the plane for one year, so i already accounted for one year depreication of the plane using old estimates, so i have to subract that as well and divide by 19 not 20 ( already depreicated 1 year) .
= 3.09, SO WE ADJUST CA.
So as we can see depreication is lower from 8.04 to 6.32.
We are going to now look at valuation implications by using the residual income valuation formula? First of all
How do we calculate RNOA
RI from residual income calculation
The residual income formula together?
RNOA = OI / NOA_b
Work out RNOA and value of equity using Residual income formula ( find terminal value) before and after the change. Remember the cost of capital at 7 and g = 1% respectively. Hint the change happened in 1993 so thats what we care about.
Analyse it?
We see an increase in performance ( RNOA)
We see an increase in value, due to a difference in depreciation estimates.
To find terminal value we forecast one year assuming that the RI in 1993 grows by 1%.
