CHAPTER 9
LONG TERM ASSETS I:
PROPERTY, PLANT AND
EQUIPMENT
Property, Plant, and Equipment
• These items represent a major source of future service
potential
• Valuation is important because it indicates to financial
statement users the physical resources available to the firm
and may give some indication of future liquidity and funds
flow.
• Objectives
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5
Accounting and reporting to investors on stewardship
Accounting for the use and deterioration of plant and equipment
Planning for new acquisitions, through budgeting
Supplying information for taxing authorities
Supplying rate-making information for regulated industries
Accounting for Cost
• Initial cost represents sacrifice of resources
given up now to accomplish future
objectives
• Preferred measurement technique is
discounted present value of future receipts Indicates future services potential
• Acquisition cost implies that this process
has taken place
Accounting for Cost
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Some problems
Group purchases
Self constructed assets
Removal of existing assets
Non-monetary exchange
Donated or discovery values
Financial Analysis of Property, Plant and
Equipment
• Company’s asset replacement policy
• Examine investment activity is the
statement of cash flows
Cost Allocation
• Capitalization implies future service
potential
• The matching concept requires expiration of
future service potential to be recorded in the
period incurred
• This is termed cost allocation
• Since actual expiration of future service
potential is difficult to ascertain - method of
cost allocation should be systematic and
rational
• Depreciation is a form of cost allocation
The Depreciation Process
• Issues:
1 Establishing the proper depreciation base
2 Determining useful service life
3 Choosing a cost allocation method
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Straight-line
Accelerated
Units of Activity
Group and composite
Retirement and replacement
Compound interest
Capital Vs. Revenue
Expenditures
• Question is whether to capitalize or charge
to expense expenditures required for an
existing long-term asset
• Criteria
– Prolong life or increase efficiency - capitalize
– Ordinary and necessary - expense
Recognition and Measurement
Issues
• User needs are currently not being satisfied
• Suggests a current value approach
International Accounting Standards
• The IASC has issued pronouncements on
the following issues:
1 Property, plant and equipment in IAS No. 16,
“Property, Plant and Equipment.”
2 Interest capitalization in IAS No. 23,
“Borrowing Costs.”
3 Impairment of assets in IAS No. 36,
“Impairment of Assets.”
IAS No. 16
• Recognize items as assets when economic benefit
will flow to enterprise and cost can be measured
• Preference is to depreciate historical cost of assets
• But, allows revaluations to current market value
• Requires recording of impairments
• Depreciation charge should reflect pattern of
benefits
• If change in pattern of benefits is noted, change
depreciation method to reflect new pattern
FASB Staff Review of IAS No 16
• Several differences:
1 Revaluation of assets distorts intercompany
comparability
2 Unclear and inconsistent guidelines for
determining fair value
3 No discussion of accounting for the extractive
industries
4 Failure to specify rules for capitalization of
subsequent expenditures related to assets
IAS No. 23
• Benchmark treatment: recognize interest
cost in period incurred
• Alternative treatment: capitalize avoidable
interest
• FASB staff review expressed concern over
ability to choose treatments
IAS No. 36
• Requires an impairment loss to be recognized on
items of property, plant and equipment whenever the
recoverable amount of an asset is less than its book
value
• The recoverable amount is the higher of the asset’s
selling price, or value in use (present value of future
cash flows)
• An impairment loss is recognized as an expense on
the income statement
• FASB staff reaction noted different approaches to
recognition and measurement of impairment losses