Case Sudies on PPE, Boorrowing Cost & Investment Proprety

IFRS 2483 views 12 replies

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Case Study -1

Entity A is constructing an asset and is capitalizing labour costs that are directly attributable to bringing the asset to its working condition. Do such costs include social security contribution and pension costs of the staff whose labour costs are being capitalised in accordance with IAS 16 ?

IAS 16 states that costs that are directly attributable to bringing the asset into the location and condition necessary for it to be capable of operating in the manner intended by management should be included in its measurement.

Where an item of PPE is being constructed by the entity, attributable costs include the labour cost of own employees arising directly from the construction of the specific asset. Employers; social security contributions and pension costs are part of staff costs and so fall within the meaning of labour cost. Therefore, they should be included in the amount capitalised under IAS 16.

Pension costs are governed by IAS 19 “Employees benefits”. This standard clearly says that any post – employment costs included in the cost of assets under IAS 2 or IAS 16 included the appropriate proportion of the components of pension cost that are charged to income under IAS 19

Replies (12)

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Case Study - 2

At the beginning of the year the entity, in the UK, has a $1M foreign currency loan. The interest rate on the loan is 4% and is paid at the end of the period. An equivalent borrowing in sterling would carry and interest rate of 6%. The sport rate at the beginning of the year 1 ₤ = $ 1.55 and at the end of the year its 1 ₤ = $ 1.50

The expected interest cost on ₤ borrowing would be ₤ 645,161 @ 6% = ₤ 38,710.

The actual cost of the $ loan is : ₤

Loan at the beginning of the year $ 1M @ 1.55 645,161

Loan at the end of the year $ 1M @ 1.50 666,667

Exchange Loss 21,506

Interest Paid : $ 1M at 4% = $ 40K @ 1.50 26,667

Total 48,173

Interest on sterling equivalent : ₤ 645,161 @ 6% 38,710

Difference 9,463

The total actual cost of the loan exceeds the interest cost on a ₤ equivalent loan by ₤ 9,463. There fore , only ₤ 12,043 (₤ 21,506 - ₤ 9,463) of the exchange difference of ₤ 21,506 may be treated as interest.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Case Study - 3

In Mar 2007, Entity A ordered 4 aircraft, which will be delivered after 4 years.

There is a down payment for each aircraft upon signing the contract. The remaining payment schedule for each aircraft varies based on the expected delivery date.

Entity A funds all payments with bank borrowing

The manufacturer starts the production planning for the first aircraft, including ordering parts from suppliers, soon after the agreement was signed.

The plane’s physical assembly takes place within the last six months prior to delivery.

However, the production of the individual parts takes place up to 24 months before delivery.

Entity A, received information from the manufacturer that the production of the parts for the first planes started in Feb, 2008.

No action has yet been undertaken by the manufacturer for the production of other three aircraft

Can the borrowing costs incurred by entity A be capitalised ?

The aircraft is a qualifying assets, as its construction takes substantial period of time to complete.

The borrowing costs incurred A are, therefore capitalised.

Entity A incurs expenditure on the aircraft by making a prepayment. It also incurs the borrowing cost as the bank borrowing was obtained.

Capitalisation of the borrowing starts when the manufacturer starts the construction activity.

The construction activity started in Feb 2008, but only in relation to one aircraft. The borrowing costs incurred in relation to this one aircraft can, therefore be capitalised for Feb 2008.

The borrowing costs incurred on the prepayment made in relation to the remaining three aircraft are expensed until the construction process begins

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Case Study - 4

An entity constructs a new head office building commencing on 1st Sep which continues without interruption until after the year end on 31st Dec. Directly attributable expenditure on the asset is $100K in Sep and $250K from Oct to Dec.

The entity has not taken out any specific borrowing to finance the construction of the asset, but has incurred finance cots on its general borrowing during the construction period. During the year the entity had 10% debenture in issue with a face value of $ 2M and an overdraft of $500K, which increased to $750K in Dec on which interest was paid at 15% until 1st Oct, afterward its increased to 16%.

The capitalisation rate of the general borrowings of the entity during the period of construction is calculated as follows :

Finance Cost on $ 2m 10% debenture during September – Dec $ 66,667

Interest @ 15% on overdraft of $500K in September $ 6,250

Interest @ 16% on overdraft of $500k in Oct to Nov $ 13,333

Interest @ 16% on overdraft of $750K in Dec $10,000

Total Finance Cost in Sep – Dec $ 96,250

Weighted average borrowings during period :- ((2m x 4) + (.5m x 3) + (.75m x 1)/4)

= $ 2,562,500

Capitalisation Rate :-Total finance cost in period/ weighted average borrowings.

= 96,250 / 2,562,500 = 3.756%

Therefore the weighted average carrying amount of the asset during the period is $ 475 K (( $100K + $ 350K + $ 600K + $ 850K)/4)

The capitalisation rate, there fore, reflects the weighted average cost of borrowings for the 4 month period that the asset was under construction. On an annualized basis 3.756% gives a capitalisation rate of 11.268% per annum which is what would be expected on the borrowings profile.

Therefore, the total amount of borrowing cost to be capitalised

= Weighted average carrying amount of asset X Capitalisation Rate

= $ 475,000 x 11.268% x 4/12

= $ 17,841

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Case Study - 5

A subsidiary obtained an interest-free loan from its parent and used to construct a qualifying asset. Can the accretion of interest using the amortised cost method be capitalised as borrowing costs in the subsidiary’s separate financial statements ?

Yes, The interest calculated using the effective interest method is an element of borrowing costs that is considered for the capitalisation

IAS 39 requires initial recognition of the liability at fair value. The subsidiary has an accounting policy choice regarding how to account for the difference between the fair value of the loan and the amount of funds received from the parent.

This difference may be treated as either an addition to the subsidiary’s equity or as income in the income statement. This should reflect the transaction’s economic substance. When treated as income, the gain does not represent a reduction of borrowing costs.

The liability is subsequently measured at amortised cost, with interest accrued using the effective interest rate method. The interest determined using the effective interest method is an element of borrowing costs and is considered when determining the costs eligible for capitalisation

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Case Study - 6

An item of PPE cost $100 and is depreciated over 10 year on a straight- line basis, with nil residual value. At the end of year 1, the asset is revalued to $ 135. At the end of year 2, the asset’s value has fallen to $50. However an impairment review has revalued that the recoverable amount of the asset is $60.

In 1st yr, revaluation gain of $45, is recognised in the statement of changes in equity.

In 2nd yr, After Depreciation for the year $15, there is a revaluation loss of $70.

Under IAS 16, the revaluation loss of $70 is first matched against the previous surplus on the same asset counted in the revaluation surplus in reserves. The remaining $25 will be charged to P/L A/c.

IAS 16 permits a transfer to be made from the revaluation surplus to retained earning as the asset is used and the surplus is realised. The surplus may be realised as the asset is depreciated.

In this example $5 of the surplus would have been realised in year 2. If this amount had been transferred to retained earning the balance left on the revaluation surplus would be $40. In that case $40 will be adjusted to revaluation surplus and $ 30 will be charged to P/L A/c.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Case Study - 7

A group acquired a subsidiary during the year. In the post – acquisition, consolidation financial statements the group wishes to include in the fixed assets note the gross figures for cost and accumulated depreciation fixed assets acquired with the subsidiary. The net book value will agree to the fair value table. Is this acceptable ?

IAS 16 requires for each class of PPE the gross carrying amounts and the accumulated depreciation at the beginning and end of the period and a reconciliation of the carrying amount at the beginning and end of the period.

The reconciliation should show :

1. Details of additions 2. Acquisitions through business combinations

3. Assets classified as held for sale or included in a disposal group.

4. Revaluation increase or decrease 5. Impairment Losses 6. Depreciation

7. Net exchange Difference 8. Other Movement

The actual cost attributed to the fixed assets acquired should be included under the heading “acquisitions through business combinations”. It should not be inflated to show “gross cost and gross depreciation”. As it’s the fair value of the asset that represents the cost of acquisitions through business combination.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Case Study - 8

In 2001, an investment property with a carrying amount of $ 1M is destroyed by fire. The building element of the property was carried at $ 300K.

A claim is made for compensation to the entity’s insurers, but has not been agreed at the time that the financial statement for 2001 are issued.

In 2002 the claim is agreed and the entity receives $500 K in compensation. Also, in 2002 a replacement building is constructed at a cost of $ 400 K.

In 2001 the entity recognise an impairment loss of $ 300 k in respect of the loss of the building. The land element is not impaired. But the entity would continue to account for that element as investment property.

The insurance claim has not been agreed at the end of 2001 and so no compensation is receivable at the end of 2001 and none can be recognised.

In 2002 compensation of $ 500 k is receivable and so is recognised in the income statement for the year.

The compensation may not be offset against the cost of the replacement building. Instead the cost of the replacement building of $ 400 K is capitalised and added to carrying amount of the investment property.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Case Study - 9

-ABC & Co., has an item of plant with an initial cost of Rs. 100,000. At the date of revaluation accumulated depreciation amounted to Rs. 55,000. The fair value of asset, by reference to transactions in similar assets, is assessed to be Rs. 65,000. Find out the entries to be passed?

Method – I: - Accumulated depreciation A/c Dr 55,000

To Asset A/c Cr 55,000

Asset A/c Dr 20,000

To Revaluation reserve A/c Cr 20,000

Method – II:- Carrying amount (100,000 – 55,000) = 45,000

Fair value (revalued amount) 65,000

Surplus 20,000

% of surplus (20,000/ 45,000) 44.44%

Asset A/c (100,000 x 44.44%) Dr 44,440

To Accumulated Depreciation A/c (55,000 x 44.44%) Cr 24,442

To Surplus on Revaluation A/C Cr 20,000

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Case Study - 10

Land cost $100K New carrying amount $120K Tax rate 30%

Which leads to TTD (Taxable temporary difference)= (120-100)k = 20k

Hence DTL =20K*0.3= $6000.

The asset revaluation reserve raised= (20-6)k =$14000

Journal Entries

Land A/c Dr 20000

To Asset revaluation reserve A/c Cr 20000

Asset revaluation reserve A/c Dr 6000

To Deferred Tax Liability Cr 6000

The above two entries can now be combined into:

Land A/c Dr 20000

To Deferred Tax Liability Cr 6000

To Asset revaluation reserve Cr 14000

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Case Study - 11

XYZ Inc. is installing a new plant at its production facility. It has incurred these costs:

1. Cost of the plant (cost per supplier’s invoice plus taxes) $2,500,000, 2. Initial delivery and handling costs $200,000. 3. Cost of site preparation $600,000 4. Consultants used for advice on the acquisition of the plant $700,000 5. Interest charges paid to supplier of plant for deferred credit $200,000 6. Estimated dismantling costs to be incurred after 7 years $300,000 7. Operating losses before commercial production $400,000

Please advise XYZ Inc. on the costs that can be capitalized in accordance with IAS 16.

According to IAS 16, these costs can be capitalized:

1. Cost of the plant $2,500,000

2. Initial delivery and handling costs 200,000

3. Cost of site preparation 600,000

4. Consultants’ fees 700,000

5. Estimated dismantling costs to be incurred after 7 years 300,000

Total $4,300,000

Interest charges paid on “deferred credit terms” to the supplier of the plant (not a qualifying asset) of $200,000 and operating losses before commercial production amounting to $400,000 are not regarded as directly attributable costs and thus cannot be capitalized. They should be written off to the income statement in the period they are incurred.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Case Study - 12

On 1st Jan 2001, an item of property is offered for sale of Rs. 10M, with payment terms being three equal installment on 1st Jan 2001, 31st Dec 2001 & 31st Dec 2002. The property developer is offering a discount of 5% if payment is made in cash at the time of completion of the sale and purchase agreement (Implicit rate is 5.36%)

Please pass the journal entries ?

On 1st Jan 2001 Tangible Fixed Assets A/c Dr. 9.50 M

To Cash A/c Cr. 3.33 M

To Accounts Payable Cr. 6.17 M

On 31st Dec 2001 Interest Expenses A/c Dr. .33 M

Accounts payable A/c Dr. 3.00 M

To Cash A/c Cr. 3.33 M

On 31st Dec 2002 Interest Expenses A/c Dr. .17 M

Accounts payable A/c Dr. 3.16 M

To Cash A/c Cr. 3.33 M

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Case Study - 13

XYZ Inc., a listed company in Germany, ventured into construction of a mega shopping mall in south Asia. The company’s board of directors aftermarket research decided that instead of selling the shopping mall to a local investor, the company would hold this property for the purposes of earning rentals by letting out space in the shopping mall to tenants. The construction of the shopping mall was completed and the property was placed in service at the end of 20X1.

According to the company’s engineering department the computed total cost of the construction of the shopping mall was $100 million. An independent valuation expert was used by the company to fair value the shopping mall on an annual basis According to the fair valuation expert the F.V of the shopping mall at the end of 20X1 and at each subsequent year-end thereafter were

2001 $100 million 2002 $120 million 2003 $125 million 2004 $115 million

The independent valuation expert was of the opinion that the useful life of the shopping mall was 10 years and its residual value was $10 million.

What would be the impact on the profit and loss account of the company if it decides to treat the shopping mall as an investment property under IAS 40

(a) Using the “fair value model”; and

(b) Using the “cost model.”

(a) Fair value model :- If the company chooses to measure the investment property under the fair value model it will have to recognize in net profit or loss for each period changes in fair value from year to year. Thus the impact on the P/L A/c for the various years would be

Year Cost($ millions) Fair value ($ millions) P / L A/c ($ millions)

20X1 100 100 0

20X2 120 20

20X3 125 5

20X4 115 (10)

(b) Cost model :- If the company decided to measure the investment property under the cost model it would have to account for it under IAS 16 .Therefore, the fluctuations in the fair value of the investment property from year to year would have no effect on the profit and loss account of the entity. Instead, the annual depreciation which is computed based on the acquisition cost of the investment property will be the only charge to the net profit or loss for each period (unless there is impairment which will also be a charge to the net profit or loss for the year).

Based on the acquisition cost of $10M, a residual value of $10 M, a useful life of 10 years, and using the straight-line method of depreciation, the annual impact of depreciation on the net profit or loss for each year would be 9 M