Plant and Equipment Property, Plant and Equipment I- Nature of Accounting Issues Businesses purchase and use a variety of fixed assets, such as equipment, furniture, tools, machinery, buildings, and land. These fixed assets are long-term or relatively permanent assets. Also, they are tangible assets because they exist physically. They are owned and used by the business and are not offered for sale as part of normal operations. Perhaps the most descriptive titles these assets are known under are plant assets or property, plant and equipment.
Depending on the industry, the plant assets of a business can be a significant part of its total assets. That is why the accounting for these long-term assets has important implications for a company’s reported results. In this paper, we discuss the proper accounting for the acquisition, use, and disposition of property, plant, and equipment. Before going over a brief overview of the nature of accounting issues, we ought to take a deeper look at what plant assets really are.
The major characteristics of property, plant, and equipment are as follows: * They are acquired for use in operations and not for resale. Only assets used in normal business operations are classified as property, plant, and equipment. For example, an idle building is more appropriately classified separately as an investment. Also, land developers or sub dividers classify land as inventory. * They are long-term in nature and usually depreciated. Property, plant, and equipment yield services over a number of years.
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Companies allocate the cost of the investment in these assets to future periods through periodic depreciation charges. The exception is land, which is depreciated only if a material decrease in value occurs, such as a loss in fertility of agricultural land because of poor crop rotation, drought, or soil erosion. * They possess physical substance. Property, plant, and equipment are tangible assets characterized by physical existence or substance. This differentiates them from intangible assets, such as patents or goodwill. Unlike raw material, however, property, plant, and equipment do not hysically become part of a product held for resale. The content of this paper will be centered on the four main accounting issues we face when dealing with property, plant, and equipment. The first one is computing the costs of these plant or fixed assets; the following one is how to allocate the costs of those fixed assets–depreciation- (less any salvage amounts) against revenues for the corresponding periods; the third one is how to account for expenditures such as repairs, additions and improvements to these plant assets; and finally how to record their disposal.
The following table provides a summary of these accounting issues: II- Historical Background of the Accounting Rules in the U. S and Internationally * IFRS Standards Background Information An important and considering factor for understanding the International Financial Reporting Standards is having a little history about it how it came to be. Before we go any further about property, plant, and equipment, we must first discuss the history and background of how the standards under IFRS originated and the importance of defining why it originated.
In order to understand IFRS, we need to examine what the International Financial Reporting Standards are. With that in mind, we want to reference the authors of Understanding IFRS Fundamentals: International Financial Reporting Standards, “IFRS are a set of standards promulgated by the International Accounting Standards Board (IASB), an international standard-setting body based in London” (Ankarath 2).
This quote tells us who makes IFRS and where IFRS originated from.
The International Accounting Standards Board made it clear that when developing the standards, they wanted to make them clearly stated and based on principles instead of rules-based like U. S. GAAP. In other words, IFRS are rooted in “the approach [principles-based, that] focuses more on the business or the economic reality of transactions and the underlying rights and obligations instead of providing prescriptive rules” (Ankarath 2).
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This basically means that IFRS is not setting certain rules to be followed and are instead giving guidance in the form of principles.
We now want to look into the International Accounting Standards Board and framework for the preparation and presentation of financial statements. The conceptual frameworks are split into five categories and are in the following order: the objective of financial statements; underlying assumptions; the qualitative characteristics that determine the usefulness of information in financial statements; the definition, recognition, and measurement of the elements from which financial statements are constructed; and the concepts of capital and capital maintenance (Ankarath 11).
The standards under IFRS are beginning to become much more popular across the world for several different reasons. The International Financial Reporting Standards are currently being used by at the very least 100 countries and “[was] expected that by 2011, more than 150 countries [would] have adopted them” (Ankarath 1).
We happen to find this important because it seems that a lot of countries are starting to adopt IFRS to report their financial statements. One of the reasons why many countries made the switch over to IFRS is because “the decision of the U. S.
SEC to allow foreign private issuers to list their securities on U. S. stock exchanges using IFRS and without reconciling to U. S. GAAP has also made it incumbent upon accountants, finance professionals, analysts, and bankers to become proficient in IFRS” (Ankarath 1).
Another significant factor when dealing with IFRS is the rise of globalization and businesses within countries wanting to have the flexibility and ability to compete worldwide. This made countries seek and adopt accounting standards to give investors, creditors, financial analysts, and the financial statements needed to be comparable and of high-quality.
This became a difficult issue because companies ran into the problem of not being able to compare financial statements unless they were under a certain set of standards. With that being said, “International Financial Reporting Standards are increasingly becoming the set of globally accepted accounting standards that meet the needs of the world’s increasingly integrated global capital markets” (Ankarath 2).
Introduction The Accounting profession has been established since the early 1900 s. The profession has continued to develop in response to the needs of users of financial statements for financial information to support decisions and informed judgments. This paper will discuss the various accounting standards and their relationships, accounting theories, and evaluate the role of ethics in ...
* U. S. GAAP Standards Background Information
In order to fully understand the topic of plant, property, and equipment, we first must consider how the FASB has implemented its standards in the past. So before we go any further into the “nuts and bolts” and foundation of the accounting standards followed under U. S. GAAP, we first want to discuss what GAAP is, who created GAAP, how it was created, and the hierarchy of GAAP after codification. The answers to these questions will give us a better understanding of U. S. GAAP and the historical background needed to fully understand how U. S. GAAP works in practice with respect to fixed assets.
According to Steven Bragg, author of Wiley GAAP 2011: Interpretation and Application of Generally Accepted Accounting Principles, “the phrase “generally accepted accounting principles” is a technical accounting term that encompasses the conventions, rules, and procedures necessary to define accepted accounting practice at a particular time” (Bragg 1).
The main concerns under GAAP are the measurements of economic activity, as mentioned earlier, GAAP used a more rules-based approach and “thus GAAP is a reaction to and a product of the economic environment in which it develops” (Bragg 2).
The creation of U.
S. GAAP dates back to the stock market crash of the 1930’s. Its original goal was to try and help pick the economy back up. With the economy being in distraught, “the AICPA created a special committee to work with New York stock exchange toward the goal of establishing standards for accounting procedures” (Bragg 2).
This committee did not get very far in achieving its goals because of limited resources and lack of research efforts. The APB (Accounting Principles Board) was then used in order to have better research and to report its findings to the division of the AICPA concerning accounting principles.
However, the APB was not as successful as they hoped for and this made forth for the Financial Accounting Standards Board (FASB) to try and solve these problems of poorly written accounting procedures. The FASB was formed in 1972 and “is recognized as authoritative through Financial Reporting Release 1 of the SEC and through Rule 203 of the AICPA code of professional conduct” (Bragg 3).
IFRS is also referred to as International Financial Reporting Standards. They are set of standards of accounting developed by International Accounting Standards Board (IASA). They are becoming the standards in the globe to be used for preparation of financial statements for the public companies. IASB is independent body which sets accounting standards which is based in London (McLaughlin, 2009). ...
The FASB issues many types of pronouncements to help ensure that companies using U. S.
GAAP are doing so by the book and “the FASB staff is empowered to issue implementation guides” to help companies report their financial statements to be comparable (Bragg 3).
Another important creator of U. S. GAAP that we want to briefly explain is the Emerging Issues Task Force (EITF) that was formed by the FASB in 1984 in order to help assist current and future issues to be raised. We now want to shift our topic away from the creators of U. S. GAAP and discuss how the 5-level hierarchy got condensed into two categories and briefly explain the hierarchy of GAAP after codification.
An important date in history is July 1, 2009, when the FASB Accounting Standards became the official source of authoritative, nongovernmental U. S. generally accepted accounting principles (Bragg 7).
This codification or condensation in our opinion made the 5-level hierarchy split into two categories that reorganizes the large number of U. S. GAAP pronouncements into roughly 90 accounting topics and each has some sub-topics. The way the codification is arranged is simply by topic, subtopics, sections, and subsections to make it easier for accountants to follow the rules and it also makes it easy for accountants to look up.
The four main areas of the codification for topics are as follows: presentation, financial statement accounts, broad transactions, and industries. An example we found as to how to read the codification is through “a hybrid classification developed by the FASB that follows the structure of XXX-YY-ZZ-PP, where XXX=topic, YY=subtopic, ZZ=section, and PP=paragraph” (Bragg 8).
As you can see this makes it very easy for anyone to find the topic they are looking for because everything is broken down by code.
We also must account for what happens when there are updates to the codification and the way the FASB handles this is through organizing the new standards using the same section heading as those used in the codification. Whenever there is a new standard they are “deemed to be non-authoritative in their own right; [and] instead, the new standards serve only to update the codification and provide the historical basis for conclusions of a new standard” (Bragg 9).
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Now that we have discussed some background information of U. S.
GAAP, we are now ready to examine these standards with respect to property, plant, and equipment. III. Recognition and Measurement The International Accounting Standards, or IAS, and Generally Accepted Accounting Principles, or GAAP are both essential tools in helping accountants provide accurate financial information and reports to shareholders, external users and internal users. There are differences and similarities as well as advantages and disadvantages between the two sets of recognition and measurement rules when it comes to the requirements under the topic of Property, Plant, and Equipment.
Even though under IFRS, the International Financial Reporting Standards, it is globally accepted amongst most countries, GAAP provides easier comparability, a more straight forward cost system and may be less costly in the long run. Before comparing the similarities and differences between the recognition and measurement rules of property, plant and equipment in IFRS and GAAP, it must first be clarified whether accountants within the United States are even allowed to apply IFRS guidelines in reporting.
According to one of the well-renowned and respected accounting firms, McGladrey it has been a constant and ongoing debate within the Securities Exchange Commission or SEC for the final decision on determining which set of reporting standards to adopt. The recognition and measurement rules for property, plant and equipment is located in the International Accounting Standard (IAS) 16 under IFRS and in the Accounting Standards Codification (ASC) 360 of FASB.
First, to determine what is recognized as Property, Plant and Equipment under IAS 16: it must be a tangible item, held for use in the production or supply of goods and services. Then, recognition under IFRS requires the entity to apply “the general asset recognition principle to all property, plant and equipment costs at the time they are incurred, including initial costs and subsequent expenditures” (IN6) meaning that they are all measured at cost at initial recognition, and after that the entity can choose either to apply the cost or revaluation model.
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Under GAAP, however, property, plant and equipment are still measured under the cost model: the carrying amount is equal to the initial cost minus accumulated depreciation minus accumulated impairment losses. Also, it is noted that during the construction period in preparing the asset to become ready for its final stage of intended use, certain interest costs are capitalized. Since the revaluation method is not allowed under U. S. GAAP, it can be argued that IFRS would be a more accurate model of reporting the costs of property, plant and equipment.
Under valuation, IFRS uses the cost model, like in GAAP mentioned above or it can use the revaluation model in which it recognizes the carrying value of property, plant, and equipment assets at fair value at the date of revaluation minus accumulated depreciation since revaluation date minus accumulated impairment losses since revaluation date. According to IAS 16 if the carrying value is less than fair value at revaluation date, then the carrying value is increased to fair value and recognized in comprehensive income.
On the other hand, if the carrying value is greater than fair value at revaluation date, then the carrying value is decreased to fair value, decreasing revaluation surplus which is then recognized in profit or loss. Measurement at recognition under IFRS standards also include a lot of the obligations in anticipating the disposal element of an asset, such as requiring entities to both include the costs of removal, restoration and dismantlement of an aspect of property, plant and equipment as well as measuring a property, plant and equipment asset at fair value if there is commercial substance in an exchange involving a non-monetary asset.
For the issue of recognition and measurement of depreciation in an asset of property, plant or equipment IFRS and GAAP both allow the same depreciation methods including: straight line, accelerated, and units-of-production. They both allocate the cost of the asset over its useful life, and have the option of component depreciation; however, it is not often used in US GAAP, while component depreciation is required under IFRS if the useful lives of the component are different.
GAAP requires the recognition of an impairment loss under certain events that change the book value of an asset, like a significant decrease in market price, a significant change in its physical condition or how it is being used to name a few. The measurement of depreciation is a two-step process involving two tests. First, applying the recoverability test, which is required only when the undiscounted sum of future cash flows is less than the book value and thus, the entity will record depreciation at cost basis, for example: debiting depreciation expense and crediting accumulated depreciation on the income statement.
Second, is measuring an impairment loss of the revaluation, which is the fair value minus the book value. Then, to adjust the property, plant and equipment assets to fair value and record revaluation surplus, the entity will debit accumulated depreciation for its cost, and credit the asset and its revaluation surplus for the difference between fair value and book value.
In analyzing the differences and similarities between the recognition and measurement guidelines that GAAP and IFRS provide, it can be seen that a convergence between the two reporting standards may be the best solution to a more uniform and easy to comprehend universal accounting principles. The cost method is used in GAAP for both the initial costs and thereafter, while both the cost method and revaluation method is used in IFRS allowing the cost basis to be raised to fair market value, this then allows for appreciation without creating a capital gain.
Regarding the recognition and measurement of depreciation and impairment losses, there are also both similarities and differences between IFRS and GAAP and the conceptual framework. It has consistently been an ongoing issue in the convergence of the guidelines of recognition to using the fair value measurement and revaluation option for property, plant and equipment over the cost model of US GAAP, but only time can tell what is decided for the future of accounting reporting. IV- Presentation and Disclosure Rules
There are presentation and disclosure rules that both IFRS and GAAP set forth in order to provide adherence and cooperation amongst many for the sake of a better understanding and communication of the financial statements for different entities. Presentation rules amongst IFRS and US GAAP are very similar but there are some differences. For presentation of financial statements under IAS 1, there are many requirements and guidelines set in order to provide a structure for financial statements that everyone could understand.
There is an exact objective for providing presentation rules for financial statements and that is to be able to compare information with previous periods or with other financial information from other entities. “The objectives of IAS 1 are to ensure comparability of presentation of that information with the entity’s financial statements of previous periods and with the financial statements of other entities (Wiley IFRS).
Usually, the presentations of financial statements include the Balance sheet, income statement, a cash flow statement, and a statement of changes in equity. Now with IAS 1 revised, the balance sheet is called the statement of financial position and there is a statement of comprehensive income included. With presentation rules under US GAAP, the presentation of comparative financial statements’ objective is to clearly bring out the nature of certain events and changes in an entity.
According to U. S GAAP, financial statements for a period should also show the financial position at the end of the period, earnings and net income for the period, cash flows during the period, and investments by and distributions to owners during the period. Comprehensive income for the period is included in one statement, or two separate but consecutive statements, only if the reporting entity is required to report comprehensive income.
The statement of financial position, the income statement, and the statement of changes in equity should be presented for one or more previous years and also for the present years. Just by looking at the presentation of the financial statements, it is recognized that there are many similarities between IFRS and US GAAP. Therefore it is not much of surprise to see there is an abundance of similarities under both IFRS and US GAAP with the subject of property, plant, and equipment disclosures but there are few differences that should be acknowledged.
Under IFRS, IAS 16 provides disclosure requirements and a specific way of presentation for property, plant and equipment. The information that needs to be disclosed is the gross carrying amount, the accumulated depreciation, and the detailed reconciliation of the carrying amount at the beginning and end of the period. Other information includes the measurement bases used for determining the gross carrying amount and the depreciation methods and rates or useful lives.
Restrictions and contractual commitments related to property, plant, and equipment and compensation for assets impaired, given up or lost must be disclosed as well (Friedrich, 2009).
For example, with each class of long-lived asset the amount of impairment losses recognized in profit or loss for each period being reported upon must be stated under the comprehensive income statement. Or if any impairment losses were recognized in other comprehensive income and in revaluation surplus in shareholders’ equity it should be disclosed as well.
If the items of property, plant, and equipment are stated at revalued amounts then there are certain requirements that the entity must disclose such as: * the effective date of the revaluation * whether an independent valuer was involved * the methods and significant assumptions applied in estimating the items’ fair values * the extent to which the items’ fair values were determined directly by reference to observable prices in an active market or recent market transactions on arm’s-length terms or were estimated using other valuation techniques * for each revalued class of property, lant, and equipment, the carrying amount that would have been recognized had the assets been carried under the cost model * the revaluation surplus, indicating the change for the period and any restrictions on the distribution of the balance to shareholders (Friedrich, 2009) Although US GAAP does not have a comprehensive standard that reports long-lived asset, its definition of property, plant and equipment is very similar to IAS 16. For example, with impairments of long-lived assets to be held and used, a description of the events and circumstances of the impairment should be stated.
The amount of the impairment loss should as well be stated, along with it recorded in the income statement. Another aspect that should be considered is the methods used to determine the fair value. This information must be disclosed as well. Items of property, plant and equipment cannot be revaluated because it is not permitted under U. S GAAP. Another important difference that can be discussed deals with investment property. Under U. S GAAP, investment property is considered and treated to be held for use or held for sale. This is not the case with IFRS.
In fact, IFRS discusses investment property under IAS 40 instead of IAS 16 that was previously discussed. Determining the similarities and differences amongst IFRS and U. S GAAP provides a better and clearer distinguishing of presentation and disclosure rules with the subject of property, plant, and equipment. We found that there were many similarities in the presentation and disclosures of property, plant, and equipment but one difference that really stood out. Although IFRS and U. S GAAP both record their property, plant, and equipment cost as historical, IFRS allows revaluation of assets.
Up to this point, we have assumed that companies use the historical cost principle to value long-lived tangible assets or fixed assets after acquisition. However, under IFRS companies have a choice: they may value these assets at cost or at fair value. * In testing for impairments of plant assets, GAAP uses a two-step model to test for impairments. As long as future undiscounted cash flows exceed the carrying amount of the asset, no impairment is recorded. The IFRS impairment test is stricter. However, unlike GAAP, reversals of impairment losses are permitted. The accounting for impairments is different under GAAP and IFRS.
A fixed tangible asset is impaired when a company is not able to recover the asset’s carrying amount either through using it or by selling it. To determine whether an asset is impaired, on an annual basis, companies review the asset for indicators of impairments—that is, a decline in the asset’s cash-generating ability through use or sale. This review should consider internal sources (e. g. , adverse changes in performance) and external sources (e. g. , adverse changes in the business or regulatory environment) of information. If impairment indicators are present, then an impairment test must be conducted.
This test compares the asset’s recoverable amount with its carrying amount. If the carrying amount is higher than the recoverable amount, the difference is an impairment loss. If the recoverable amount is greater than the carrying amount, no impairment is recorded. Recoverable amount is defined as the higher of fair value less costs to sell or value-in-use. Fair value less costs to sell means what the asset could be sold for after deducting costs of disposal. Value-in-use is the present value of cash flows expected from the future use and eventual sale of the asset at the end of its useful life.
Future Developments: As a result of these divergences between U. S GAAP and IFRS with respect to accounting for property, plant and equipment; the two boards have in plan to examine the measurement bases used in accounting for fixed assets with respect to revaluations specifically. As part the conceptual framework project, fair value measurement might be recommended in the converged conceptual framework for property, plant and equipment. However, it will be a very difficult change to adopt due to conservatism proponents who still prefer the historical cost model.
Works Cited: Ankarath, Nandakumar, et al. Understanding IFRS Fundamentals: International Financial Reporting Standards. Hoboken, New Jersey. John Wiley & Sons Inc. , 2010. Print. Bragg, Steven M. Wiley GAAP 2011: Interpretation and Application of Generally Accepted Accounting Principles. Hoboken, New Jersey. John Wiley & Sons Inc. , 2010. Print. “FASB: Property, Plant and Equipment. ” FASB: Financial Accounting Standards Board. N. p. , n. d. Web. 26 Nov. 2012. <http://www. fasb. org/jsp/FASB/Page/SectionPage>. Kieso, Daniel E. , Jerry J.
Weygandt, and Terry D. Warfield. “Wiley: Intermediate Accounting, 14th Edition. ” Wiley: Intermediate Accounting, 14th Edition. N. p. , n. d. Web. 26 Nov. 2012. <http://www. wiley. com/WileyCDA/WileyTitle/productCd-EHEP001739. html>. “Summary of IAS 16 Property, Plant and Equipment. ” IFRS. N. p. , n. d. Web. 26 Nov. 2012. <http://www. ifrs. com/blog/post/summary-of-ias-16-property-plant-and-equipment>. “Http://mcgladrey. com/pdf/us-gaap-vs-ifrs-property-plant-equiment. pdf. ” U. S GAAP vs IFRS: Property, Plant and Equipment. McGladrey, n. d. Web. 26 Nov. 2012.