Week 3 Accounting for Property Plant Equipment PPE

Week 3: Accounting for Property, Plant & Equipment (PPE) Financial Accounting BFA 201

Learning Objectives To demonstrate your understanding of: 1. Financial Statements (specifically the Statement of Financial Position) 2. Current & Non Current Assets 3. Depreciation BFA 201_13 2

Readings and references • Deegan Ch 4 & 5, scan Ch 7 – Scan to ensure you are familiar with the fundamental concepts covered in these chapters; they revisit many of the areas already completed in your prerequisite units. • AASB 116 & Scan AASB 101 & 102 3

Independent Study Tasks Tutorial questions (for workbooks) • Not yet advised Independent study questions (not for workbooks) • Not yet advised 4

General Purpose Financial Statements • AASB 101 applies to the general purpose financial statements of all entities prepared in accordance with IFRS • AASB 101: 9 restates the purpose of financial statements from the AASB Framework which is: ‘provide information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions’ • GPFS are therefore communication tools to a wide range of users

General Purpose Financial Statements • AASB 101 specifies the: • components of a complete set of financial statements; • Overall considerations in preparing financial statements; • Structure and content of particular financial statements • Implicit in the presentation of financial statements are required disclosures. AASB 101 therefore deals with issues such as: • preparation on a going concern basis • accrual basis of accounting • materiality and aggregation • frequency of reporting • Presentation and disclosure of financial statements is covered more comprehensively in topics 10 and 11

General Purpose Financial Statements The complete set of financial statements Statement of financial postition Statement of comprehensive income Statement of changes in equity Statement of cash flows Notes to the financial statements

General Purpose Financial Statements • AASB 101: 10 indicates that a complete set of financial statements contains the following: • • • A statement of financial position; A statement of comprehensive income; A statement of changes in equity A statement of cash flows Notes which include accounting policies and explanatory notes; and • A statement of financial position if there are retrospective changes. • The titles listed above are not mandatory and entities may choose to use other titles (e. g. Income statement, balance sheet, cashflow statement).

General Purpose Financial Statements • The main topic of today concerns property, plant and equipment, which is an asset in the statement of financial position (balance sheet) • In this session we will briefly look at some aspects of the presentation and disclosures in the statement of financial position • Later in the semester, this and the other financial statements and required disclosures will be examined in more detail.

Statement of Financial Position • AASB 101 prescribes: • • The presentation requirements for assets and liabilities; and Disclosure requirements for a balance sheet and its components. • Presented as at the end of a reporting period • an abridged post balance day adjustments trial balance that lists the balances of assets, liabilities, and equity in the ledger accounts on one particular day.

Statement of Financial Position • AASB 101 does not required the statement of financial position to be presented using a single format. Presentation of assets and liabilities Current / noncurrent categories In order of liquidity • The traditional current/non current categories can be used, or assets and liabilities can be presented in order of liquidity (para. 60)

Statement of Financial Position • AASB 101: 54 also indicates that at a minimum, there should be line items in the statement of financial position for certain items including: • • Property, plant and equipment; Inventories; Biological assets Trade and other receivables; Cash and cash equivalents; Trade and other payables; Provisions; Issued capital and reserves. • See paragraph 54

Statement of Financial Position • AASB 101: 66 defines a current asset as an asset that satisfies any of the following criteria: • It is expected to be realised in, or is intended for sale or consumption in, the entity’s normal operating cycle; • It is held primarily for trading purposes; • It is expected to be realised within 12 months after the reporting period; • It is a cash or cash equivalent • The operating cycle of an entity is the time between the acquisition of assets for processing and their realisation in cash or cash equivalents (para 68) • All other assets are to be classified as non-current assets (including tangible, intangible and long-term financial assets)

Statement of Financial Position • AASB 101: 669 defines a current liability as an asset that satisfies any of the following criteria: • It is expected to be settled in the entity’s normal operating cycle; • It is held primarily for trading purposes; • It is due to be settled within 12 months after the reporting period; • There is no unconditional right of deferring settlement beyond 12 months after the reporting period • All other liabilities are to be classified as non-current liabilities

XYZ GROUP LTD Balance Sheet as at 30 June 20 X 4 Consolidated NOTE ASSETS Parent 20 X 5 20 X 4 $ $ Current Assets Cash and cash equivalents X x X Trade receivables X x X Investments X x X Inventories X x X Other current assets X x Total Current Assets X 0 x 0 X 0 0 Non Current Assets Available for sale investments X x x X x Other financial assets X x x X x Investments in associates X x x X x Deferred tax assets X x x X x Property, plant and equipment X x X X X Goodwill X x X X X Other intangible assets X x X X X Other non-current assets X x X X X Total Non Current Assets Total Assets 0 0 $0 $0

LIABILITIES Current Liabilities Trade and other payables X x X Short term borrowings X x x Current tax payable X x x Short term provisions X x x Current portion of long term borrowings X x X Other current liabilities X x X Total Current Liabilities 0 0 Non Current Liabilities Long term borrowings X x X Deferred tax liabilities x X Long term provisions x X Other non-current liabilities x X Total Non Current Liabilities 0 0 Total Liabilities $0 $0 Net Assets $0 $0 Equity Share capital X x X Other reserves X x X Retained earnings X x X 0 0 Parent interest X x x Non-controlling interest X x x Total Equity $0 $0

Lecture Example 3. 1

Assets: Definition and Recognition • AASB Framework defines an asset (para 49): • A resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity Result of a past event Control Expected economic benefits

Assets: Definition and Recognition • AASB Framework (para 83) indicates that provided an asset meets the definition, it will be recognised in the financial statements if: • • It is probable that an future economic benefit will flow to the entity; and The item has a cost or value that can be reliably measured. Meets definition Probable future economic benefits Measured reliably

Assets: Definition and Recognition • Update: Following discussions with the IASB and FASB a number of shortcomings have been identified with the existing definition of an asset (see page 69 of Deegan) • It is proposed that a new definition be developed: An asset of an entity is a present economic resource to which the entity has a right or other access that others do not have

Current Assets Current assets are dealt with AASB 101: 66 Expected to be realised; sold or consumed in normal operating cycle Cash or cashequivalent Current Assets Held primarily to be traded Realised within 12 months 24

Current Assets • Current assets usually comprise: • • Cash assets (including short-term deposits) Accounts receivable Investments maturing within 12 months Inventory 25

Accounts Receivable • Accounts receivables are: • Amounts due to the entity as a result of the provision of goods and services on credit terms • Measured at the undiscounted amount that is expected the entity will ultimately receive 26

Accounts Receivable • If an amount of $1, 000 is considered doubtful: Doubtful debts expense 1 000 Provision for doubtful debts 1 000 • If efforts to recover the debt are unsuccessful, it must be written off: Provision for doubtful debts Accounts receivable 1 000

Accounts Receivable • If the debt is subsequently repaid Cash at bank 1 000 Accounts receivable 1 000 And Accounts receivable Provision for doubtful debts 1 000

Accounts Receivable (Alternative) • If the debt is subsequently repaid Cash at bank 1 000 Accounts receivable 1 000 And Accounts receivable Doubtful debts recovered 1 000

Inventories – AASB 102 • Inventories are assets held for future sale or use in manufacturing or rendering services • AASB 102 applies to all inventories except: • Work in progress under construction contracts; • Financial instruments; • Biological assets • Inventories may be divided into three categories: • Goods ready for sale • Work in progress • Raw materials • These 3 categories make up the definition of inventories under paragraph 6.

Inventories – AASB 102 • AASB 102: 10 • The cost of inventories shall comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition • Includes: duties; inward freight

Inventories – AASB 102 Accounting for Inventory Perpetual • Continuous • COGS recorded as occurs • Not continuous Periodic • Relies on physical stocktake to determine the value of closing stock • COGS = OI + P - CI

Inventories – AASB 102 • FOB destination: • Control does not pass until the purchaser receives the merchandise from the common carrier • Merchandise should be included in the seller’s inventory until the buyer receives it • FOB shipping point: • Control passes when the seller delivers the merchandise to the common carrier • Merchandise should be included in the buyer’s inventory after it has been delivered to the common carrier by the seller

Inventories – AASB 102 • Cost flow assumptions • AASB 102 allows the use of one or more of the following methods: • specific identification • weighted-average cost • first-in first-out (FIFO) • AASB 102 does not permit the use of: • last-in first-out (LIFO)

Inventories – AASB 102 • The lower of cost and net realisable value rule • AASB 102 para 9 • This rule requires that an item of inventory should be carried at the lower of its: – Cost and – Net realisable value (NRV) • If the NRV falls below cost: – The inventory should be written down (and the loss expensed) • Eg. Selling price falls; inventory is damaged; becomes obsolete • If the circumstances that previously caused inventories to be written down change, the amount of the previous writedown can be reversed (subject to the upper limit of the original writedown.

Applying the Lower of Cost and Net Realisable Value Rule • If NRV > cost… item is left as cost (Upwards revaluations of inventory not allowed by AASB 102) • If NRV is less than cost, the item must be written down to the net realisable value (para 34) Dr Inventory write down expense (or COGS) Cr Inventory The write down may be reversed if circumstances that previously caused the write down change. Dr Inventory Cr Reversal of writedown (income)

Lecture example 3. 2 • Mammoth Company purchased an item of inventory for resale. The purchase price was $1000. • Mammoth intended to sell the item for $1300, but subsequently found that its net realisable value was only $850. • At the end of the reporting period after the write down, the item of inventory was still on hand. The management of Mammoth found that its initial estimate of a net selling price of $1300 was now correct and the net realisable value was $1300. • Required: Prepare the journal entries for each of the listed events.

Lecture Example 3. 2 Inventory 1 000 Cash at bank Inventory write down expense 1 000 150 Inventory Reversal of writedown (income) 150 150

AASB 116 Property, Plant and Equipment

The Nature of Property, Plant and Equipment (AASB 116) See Para. 6 definition: • ‘Tangible’ (physical) assets • Specific use (e. g. production, supply, rental, administration) • Expected to be used for greater than one accounting period • Excludes assets held for sale, biological assets and mineral rights and reserves (covered by other AASBs) • May be divided into classes for disclosure. eg: – Land; Class = group of assets of a similar – Machinery; nature and use in an entity’s – Motor vehicles operations – Office equipment

Initial Recognition of Property, Plant and Equipment (AASB 116) AASB 116 para 7 : The cost of an item of property, plant and equipment shall be recognised 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 BFA 201/SJA 41

Acquisition cost of assets (AASB 116) If an item qualifies as an asset it must be recognised at ‘cost’ (para. s 15 and 16): (a)purchase price, including import duties and nonrefundable purchase taxes after deducting trade discounts and rebates (b)any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management; and (c) initial estimates of the costs of dismantling and removing the item and restoring it. 42

Acquisition cost of assets (AASB 116) ‘Directly attributable costs’ include (para 17): (a) Costs of employee benefits arising from the construction or acquisition of the item of property, plant and equipment (b) Costs of site preparation (c) Initial delivery and handling costs (d) Installation and assembly costs (e) Costs of testing whether asset is functioning properly, after deducting the net proceeds from selling any items produced while bringing the asset to that location and condition (e. g. samples) (f) Professional fees 43

Initial measurement At Cost (of acquisition) + location costs • Purchase price (at fair value) Purchase price includes duties and taxes but excludes rebates and discounts • Directly attributable costs required to bring the asset to the location and condition necessary for it to operate Refer section 4. 7 of text for detailed lists of items specifically included and excluded from this component • Initial estimate of costs of dismantling, removing the item or restoring the site Eg- an offshore oil platform

Initial Recognition At cost (of acquisition) + location costs: Plant and equipment 10 000 Cash at bank 10 000 Depreciation: Depreciation expense Accumulated depreciation 1 000

Depreciation – AASB 116 Allocation of cost / revalued amt Systematic expense over useful life Method not prescribed but must reflect expected consumption of FEBs Estimates must be reviewed annually BFA 201_BS 11

Allocation of cost: 4 Issues Base (cost) Method Dep. Expense Residual Value Useful Life

Depreciation Methods (para 62) • Straight Line = Cost – Residual value Useful life (in years) • Units of production = Cost – Residual value Useful life (in units of production)

Depreciation Methods • Diminishing-balance = Carrying amount x Deprec. rate Depreciation rate = amt) [1 - ⁿ√Residual value] cost (or other revalued • Sum-of-digits = Yrs remaining ÷ sum-of-digits X (cost – residual value) {sum-of-digits = 1+2+3+4+5 OR n(n+1)/2}

Depreciation of Property, Plant and Equipment • Depreciation is a process of allocation (paras 50 and 60) • Recognition of the decrease in the service potential of a noncurrent asset across time • Allocate a proportion of the acquisition cost of the asset to particular financial periods throughout the asset’s useful life • Depreciation is recognised even if the fair value of an asset is greater than the carrying amount (para 52) • If depreciable assets form significant proportion of total assets the choice of depreciation policy has significant effect on profits

Depreciation of Property, Plant and Equipment – Allocation considerations • Depreciation is an allocation process, not the consideration of variations in valuations. • In determining how to allocate the cost of an asset address three issues: – – – • What depreciable base should be used for the asset? What is the asset’s useful life? What method of cost apportionment is most appropriate for the asset? Allocation of depreciable amount is recognised as an expense.

Depreciation of Property, Plant and Equipment – Depreciable Amount • Historical cost of a depreciable asset (or revalued amount) less its residual value • The residual value is the amount expected to be obtained from disposal of the asset at the end of its useful life less the estimated costs of disposal. – If equal to or greater than the carrying amount, no depreciation is recorded (para 54). – Based on professional judgement

Depreciation of Property, Plant and Equipment – Determination of useful life • Reflects the asset’s useful life to the entity holding the asset; not necessarily its economic life • Estimated period of time, or total service (in terms of production), over which future economic benefits are expected to be consumed by the entity • Factors to consider: – – physical life (wear and tear) technical obsolescence (out of date as result of technological advances) commercial obsolescence (fall in market demand for goods and services produced by the asset) Legal life (e. g. patents, licences)

Depreciation of Property, Plant and Equipment – Method of cost apportionment • The accounting policy that an entity must adopt for depreciation is specified in paras 50 and 60 of AASB 116, namely the systematic allocation of the cost or other revalued amount of an asset over it useful life in a manner that reflects the pattern in which the assets future economic benefits are expected to be consumed.

Lecture example 3. 3 A photocopying machine was purchased on 1 st July 2000 for $12, 500. It was expected to have a useful life of 5 years at the end of which it was estimated that it would have a residual value of $2, 500. It was also anticipated that during the 5 years, 200, 000 copies would be produced. In calculations of depreciation using the reducing balance method the company uses a rate that is 1½ times the straight-line method. The copies made by the photocopier in each year were: • 2001 – 50, 000 2002 – 60, 000 • 2003 – 40, 000 2004 – 20, 000 • 2005 – 30, 000 Required: Calculate the depreciation charge each year using straight line, diminishing-balance and units of production

Lecture example 3. 3 a) Straight-line $12, 500 - $2, 500 5 years (20%) Depreciation expense each year is $2, 000 b) Diminishing balance - Rate is 30%

Lecture example 3. 3 c) Units of production $12, 500 -$2, 500 Rate is 5 cents per unit. 200, 000 d) Sum of digits [$12, 500 -$2, 500] x yrs remaining 15

Depreciation of Property, Plant and Equipment – Method of cost apportionment • Should best reflect the economic reality of the asset’s use • Consider underlying physical, technical, commercial and/or legal facts • Para 62 of AASB 116 notes three methods – straight-line method – Diminishing balance method – Units of production method – (OTHER – sum of the years’ digits)

Depreciation of Property, Plant and Equipment – Straight line method • Depreciation expense is calculated as: Cost Residual (salvage) value Useful life • This method is appropriate when benefits to be derived from the asset are expected to be uniform throughout the asset’s useful life 59

Depreciation of Property, Plant and Equipment – Sum of the years’ digits method • Calculated by multiplying cost residual by successively smaller fractions • Denominator in fraction is calculated by adding the years in the asset’s useful life • Numerator changes each year, and is the years remaining in the asset’s useful life at the beginning of the period • Appropriate when economic benefits expected to be derived are greater in the early years than the later years 60

Depreciation of Property, Plant and Equipment – Diminishing balance method • Depreciation expense is calculated on the asset’s opening written-down value • Written down value: – Cost (or revalued amount) less accumulated depreciation • Percentage of depreciation expense calculated as 1 nth root of (residual value/original cost) • Appropriate when economic benefits expected to be derived are greater in the early years than the later years

Depreciation of Property, Plant and Equipment – Units of production method • Depreciation expense is calculated as: no. of units produced x (cost residual) total expected production • Appropriate where useful life may be more related to production output than time

Depreciation of Property, Plant and Equipment – When to start depreciating an asset • From the time an asset is first put into use, or is held ready for use • If constructing an asset, it is not depreciated until ready for use • If an asset is able to be used but not actually used for a number of periods, the asset is still depreciated from the time it was able to be used – accounts for obsolescence rather than wear and tear

Depreciation of Property, Plant and Equipment – Revision of depreciation rate and method • Residual value and useful life must be reviewed at least annually under AASB 116 • If the expected useful life or residual value are different from that previously expected the entity must revise the depreciation rate • The depreciation method must also be reviewed annually. AASB 116 provides the method must be changed where there is a significant change in pattern of benefits from the asset. • Of course, material changes in depreciation charges must be disclosed.

Modifiying Existing Non-Current Assets • • Expenditure on modifications or improvements should be capitalised where: – Expenditure is material; and – Expenditure is expected to enhance the service potential of the asset The capitalised expenditure must be depreciated: – Additions that become an integral part of the asset are to be depreciated over the asset’s remaining life – Additions that retain a separate identity are to be depreciated on the basis of their own useful life. 65

Land buildings • Where acquired together, cost must be apportioned between land buildings (AASB 116) • buildings to be depreciated over time • land not depreciated (unlimited useful life)

Other considerations • Separate components (para 43) – Parts can be depreciated separately eg. aircraft body & engines • Revision of life, rate, method, residual value: – Rework depreciation charge taking account of amount already used – Prospective recognition i. e. relates to current and future periods (AASB 108 para 36) • Improvements – capitalise • Derecognition – ‘net basis’ para 71

Lecture example 3. 4: Changes Defiant company purchased machinery in 2000 for $60, 000. At the time of the purchase, its estimated useful life was eight years with a residual value of $4, 000. Depreciation was charged until 2004 (five years) on a straight line basis. At the beginning of 2005 it was estimated that its useful life was now ten years (an increase of two years) and that the residual value would be $4500 at the end of its useful life. Required: • Calculate depreciation expense for each year.

Lecture example 3. 4 (a) 2000 – 2004 Depreciation = (60, 000 – 4, 000)/8 = $7000 per annum. Depreciation expense Dr $7000 Accumulated depreciation Cr $7000 (b) 2005 – 2009 Depreciation = (60, 000 – 35, 000 – 4, 500)/5 = $4100 pa Depreciation expense Dr $4100 Accumulated depreciation Cr $4100

Derecognition BFA 201_BS 11

Derecognition of property, plant and equipment • Para 67 identifies two occasions where derecognition (what we used to call disposal) of an item of property, plant and equipment should occur: – On disposal, such as the sale of the asset; – When no expected future economic benefits are expected, either from future use or disposal • When asset sold, gain or loss recognised which is the difference between: – the carrying amount of an asset (cost or revalued amount less accumulated depreciation); and – the amount received for the asset at fair value

Derecognition of property, plant and equipment • Because the carrying amount is net of depreciation and impairment losses, it is necessary to calculate the depreciation from the beginning of the reporting period up to the point of sale. • The gain or loss on sale is included in the profit or loss for the period, with the gains not being classified as revenue • Only the disclosure of the gain or loss on sale is required to be dislcosed, as opposed to the separate disclosure of the income and the carrying amount of asset sold.

Derecognition of property, plant and equipment – Journal entry to record sale Dr Cash at bank Cr Gain/Loss on sale of asset Dr Dr Gain/Loss on sale of asset Accumulated depreciation Cr Asset

Disposal of assets (Derecognition) • Gain or loss on disposal: – Shall be included in profit or loss Remember: Do not classify gains as revenue • Associated Revaluation Surplus – May be transferred to retained earnings – NOT to profit & loss

Lecture Example 3. 5 • Sandon Point acquired an item of machinery on 1 July 2008 for a cost of $100, 000 • When the asset was acquired it was considered that the asset would have a useful life to the entity of 5 years, after which time it would have no residual value • It was considered that the pattern of economic benefits would best be reflected by applying the sum of digits method • Contrary to expectations, on 1 July 2010 the asset was sold for $70, 000 • What was the profit on disposal and what are the journal entries to record the disposal?

Lecture Example 3. 5 n(n + 1) ÷ 2 = 5 × 6 ÷ 2 = 15 First year depreciation = 5 ÷ 15 × $100 000 = $33 333 Second year depreciation = 4 ÷ 15 × $100 000 = $26 667 Total accumulated depreciation at 1 July 2010 = $60 000 Asset carrying amount = $40 000 [$100 000 - $60 000]. The accounting entry would be: Dr Cash at bank Dr Acc. depreciation—machinery Cr Gain on sale of machinery Cr Machinery 70 000 60 000 30 000 100 000

Lecture Example 3. 5 Depreciation 33 333 Accumulated depreciation Depreciation Accumulated depreciation 33 333 26 667

Depreciation 0 Accumulated depreciation Disposal 0 100 000 Machinery Accumulated depreciation 100 000 60 000 Disposal Cash at bank 60 000 70 000 Disposal Gain on disposal 70 000 30 000

AASB 116: Disclosure requirements • For each class of depreciable asset, the following must be disclosed: – Measurement bases used for determining gross carrying amount – Depreciation methods used – Useful lives or depreciation rates used – Gross carrying amount and accumulated depreciation at the beginning and end of the period – Detailed reconciliation of the carrying amount at the beginning and end of the period

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