Module 2:
PPE Assets
1
INTERNATIONAL FINANCE
AND ACCOUNTING
Elements of Financial Statements
2
Assets
÷ Future benefits Equity = Assets – Liabilities
¢ Cash inflow
¢ Cost reduction Main components of equity:
¢ Receive service
• Capital transactions with owners
÷ Past transaction/events
¢ Purchase or self-creation • Income/Expenses accumulation
÷ Control
Income involves increase in equity
Liabilities • Increase in Asset
÷ Future outflow of benefits • Decrease in Liability
¢ Cash outflow Expenses involve decrease in equity
¢ Provide service • Decrease in Asset
÷ Past transaction/events • Increase in Liability
÷ Obligation
3
Property, Plant, and Equipment (PPE)
4
Property, plant, and equipment (PPE) are identifiable
tangible assets representing a major component of the
total assets, and have some special characteristics:
Held for use in the business—not to sell as inventory
Tangible
Used in the operation of the business to help create revenue
Relatively expensive
Last a long time—usually for several years
May be sold or traded in
Measuring the Cost of PPE
5
The historical cost principle of measurement: A business
must carry an asset on the balance sheet at its cost or the
amount paid for the asset
The cost of an asset = The sum of all the costs incurred to
bring the asset to its intended purpose, net of all
discounts
Typical Costs to Include in PPE
6
Determining Cost
7
Cost includes:
• Purchase price, non-refundable taxes, less discounts and
rebates
• All costs necessary to bring asset to location and make it
ready for use
• Obligations to remove, restore asset when it is retired (asset
retirement costs)
These costs are capital expenditures
• Benefit future periods
Costs that benefit only the current period are
expensed and are called operating expenditures
Ethical Issues
8
When there are choices to be made in accounting such as
whether a cost should be expensed or capitalized, or how
to allocate costs using the relative-fair-value method,
accountants may face an ethical dilemma
For example, a company can capitalize a cost that should
have been expensed, causing the current period’s net
income to be inflated
Capitalize all costs that provide a future benefit
for the business, and expense all other costs
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Main Topics on PPE
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Depreciation of PPE assets
Impairment of PPE assets
Depreciation of PPE asset
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What is depreciation
¡ The allocation of the cost of property, plant, and equipment (except
for land) over its useful life
¡ Gradually take a portion out from the asset, and put it into expense
Purpose of depreciation
¡ To match the asset’s cost (expense) against the benefit (revenue)
earned by the asset
It is NOT a cash outflow
Amortization for intangible assets
Effect of Depreciation on Accounting Reports
12
Depreciation:
Dr. Depreciation expense
Cr. Accumulated depreciation
On the Balance Sheet On the Income Statement
PPE asset Revenue
Less: Accumulated depreciation Less: COGS
Net Book value of PPE asset Less: Depreciation expense
Less: …. expense
Net Income
Depreciation of PPE asset
13
Depreciation involves estimates
Estimated useful life:
¡ Length of the service period expected from the asset
¡ Can be expressed in years, units of output, kilometres, etc.
Estimated residual (or salvage) value:
¡ The expected cash value at the end of the asset’s useful life
Cost – Residual value = Depreciable/Amortizable cost
Depreciation Methods
14
Assume a truck was purchased on January 1, 2020,
and the year end is December 31
Data for Recording Depreciation for a Truck
Cost of truck $65,000
Estimated residual value 5,000
Depreciable cost $60,000
Estimated useful life: Blank
Years 5 years
Units of production 400,000 units
(kilometres)
Depreciation Methods
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Depreciation Methods
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Assume a truck was purchased on January 1, 2020,
and the year end is December 31
Data for Recording Depreciation for a Truck
Cost of truck $65,000
Estimated residual value 5,000
Depreciable cost $60,000
Estimated useful life: Blank
Years 5 years
Units of production 400,000 units
(kilometres)
Depreciation Method: Straight-Line
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Cost − Residual value
Straight−line Depreciation =
Useful life in years
$65,000 − $5,000
=
5
= $12,000 per year
The entry to record each year’s Depreciation is:
Dec. 31 Depreciation Expense—Delivery Truck 12,000
Accumulated Depreciation—Delivery Truck 12,000
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Depreciation Method: Straight-Line
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Straight-Line Depreciation for a Truck
Depreciation for the Year
B
Asset Depreciati l
a
Depreciable Depreciation Accumulated Asset Book
Date Cost on Rate n
k Cost Blank Expense Depreciation Value
B
l
a
Jan. 1, 2020 $65,000 Blank n
k Blank Blank Blank $65,000
Dec. 31, 2020 Blank 1/5 × $60,000 = $12,000 $12,000 53,000
Dec. 31, 2021 Blank 1/5 × 60,000 = 12,000 24,000 41,000
Dec. 31, 2022 Blank 1/5 × 60,000 = 12,000 36,000 29,000
Dec. 31, 2023 Blank 1/5 × 60,000 = 12,000 48,000 17,000
Dec. 31, 2024 Blank 1/5 × 60,000 = 12,000 60,000 5,000
Depreciation Methods: Units-of-Production
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1. Calculate the cost per unit
Units−of−production
Cost − Residual value
Depreciation per unit =
Useful life in units of production
of output
$65,000 − $5,000
=
400,000 kilometres
= $0.15 per kilometre
2. Multiply the cost per unit by the number of units produced
or used in the period
Example: Assume the truck was driven 90,000 km in Year 1;
120,000 km in Year 2; 100,000 km in Year 3; 60,000 km in
Year 4; and 30,000 km in Year 5
Depreciation Methods: Units-of-Production
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Units-of-Production Depreciation for a Truck
Depreciati Asset
B
on Per Number of l
a
Depreciation Accumulated Book
Date Asset Cost Kilometre Kilometres n
k Expense Depreciation Value
B B
l l
a a
Jan. 1, 2020 $65,000 Blank n
k Blank n
k Blank $65,000
Dec. 31, Blank $0.15 × 90,000 = $13,500 $13,500 51,500
2020
Dec. 31, Blank 0.15 × 120,000 = 18,000 31,500 33,500
2021
Dec. 31, Blank 0.15 × 100,000 = 15,000 46,500 18,500
2022
Dec. 31, Blank 0.15 × 60,000 = 9,000 55,500 9,500
2023
Dec. 31, Blank 0.15 × 30,000 = 4,500 60,000 5,000
2024
Depreciation Method:
Double-Declining-Balance (DDB)
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Multiplies the straight-line depreciation amount by two
This is an accelerated Depreciation method (amortizes
more in the earlier years)
1. Compute straight-line rate (1/5 = 20% per year)
2. The DDB rate is 20% × 2 = 40%
3. Multiply the asset’s book value (cost – accumulated
Depreciation) against the DDB rate
DDB Depreciation = Asset book value of the period × DDB rate
= $65,000×0.40
= $26,000
Depreciation Method:
Double-Declining-Balance (DDB)
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Double-Declining-Balance Depreciation for a Truck
Asset Asset
Asset DDB B
la
Book Bl
Depreciation Accumulated Book
Date Cost Rate n
k Value an
k Expense Depreciation Value
B
la Bl
Jan. 1, 2020 $65,000 Blank n
k Blank an
k Blank $65,000
Dec. 31, Blank 0.40 × $65,000 = $26,000 $26,000 39,000
2020
Dec. 31, Blank 0.40 × 39,000 = 15,600 41,600 23,400
2021
Dec. 31, Blank 0.40 × 23,400 = 9,360 50,960 14,040
2022
Dec. 31, Blank 0.40 × 14,040 = 5,616 56,576 8,424
2023
B
Dec. 31, Blank Blank la
n
= 3,424* 60,000 5,000
2024 k
*Depreciation in 2021 is the amount needed to reduce the asset’s book value to the residual value of $5,000 ($8,424 − $5,000 = $3,424).
Comparing Depreciation Methods
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Amount of Depreciation per Year
Amount of Depreciation per Year
Year Straight Line Units of Production Double Declining
Balance
2020 $12,000 $13,500 $26,000
2021 12,000 18,000 15,600
2022 12,000 15,000 9,360
2023 12,000 9,000 5,616
2024 12,000 4,500 3,424
Total $60,000 $60,000 $60,000
Straight-line: best for assets that generate revenue evenly over time
Units of Production: best for assets that wear out to physical use
DDB: best for assets that produce more revenue in the early years
Depreciation Methods, Summary
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Straight-line
¡ Depreciation exp. = (Cost – Residual Value) / useful life
Double Declining Balance (DDB)
¡ Depreciation exp. = Asset Book Value * DDB rate
÷ First year depreciation = Cost * DDB rate
÷ No need to deduct the Residual Value
÷ however, the Asset Book Value cannot go below Residual Value
Units of production
¡ Depreciation per unit = (Cost – Residual Value) / Potential Units
Class Exercise
25
Prepare a depreciation schedule to calculate the following items for year 1-4:
1. Depreciation expense
2. Accumulated depreciation
3. Net book value
Main Topics on PPE
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Depreciation of PPE assets
Impairment of PPE assets
Impairment
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The long-term assets’ fair value may drop, due to internal
or external shocks,
¡ External events: a decline in market value, an increase in
market interest rate, e.g., decline in the crude oil price
(Suncor)
¡ Internal events: physical damage, obsolescence or idleness of
an assets, worse-than-expected economic performance of the
asset
If fair value of the assets fall below the carrying value (i.e.,
the assets are impaired), need to write down the assets’
value and record an impairment loss.
Impairment
28
Carrying
Value (i.e.,
$ reported
on the
book)
Fair Value
(i.e., actual
$ worth of
the asset)
Impairment: How?
29
Impairment exists if
¡ The carrying value of asset > Recoverable amount
Recoverable amount is measured as higher of
1. Fair value less cost to sell
2. Value in use (present value of future net cash flows)
Impairment loss = carrying value - recoverable amount
Impairment
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Carrying Value
(Net Book
Value)
Impairment Loss
Fair Value
(Recoverable
amount)
Impairment: How?
31
Impairment: When?
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Level of Testing
Assets are evaluated for impairment based on Cash Generating Units
(CGU): e.g., by business segment, by geographic location
Compare the carrying amount of the CGU with its recoverable amount
Timing of Testing
Annual impairment testing is mandatory for CGUs with:
÷ Goodwill, or other intangibles with indefinite life
Or else, impairment testing required when there is a trigger event, e.g.:
÷ Significant reduction in the asset’s market value
÷ Change in the market, economy, legal environment that has an adverse
effect
Example
33
As a result of the decline in crude oil price environment, Mooncor Energy Inc.
performed impairment tests on its Oil Sands segment as at December 31, 2022.
The long-term assets of the CGU has a net book value of $2.2 billion. The
company based its cash flow projections on WTI oil price.
Fair value 1,700 M Expected cash flow 2023 400 M
Costs to sell 100 M Expected cash flow 2024 500 M
Expected cash flow 2025 700 M
Expected cash flow 2026 800 M
Risk-adjusted cost of capital 12%
FV less cost to sell = 1.6 billion; Value in use = 1.76 billion
Recoverable amount = 1.76 billion
Impairment loss = $2.2 – 1.76 = $440 million
Suncor Impairment
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“The recoverable amount estimate is most sensitive to price and
discount rate.”
“A 5% average decrease in price over the life of the project would have
resulted in an impairment charge of approximately $1.0 billion (after-
tax) on the company’s share of the Fort Hills assets. A 1% increase in
the discount rate would have resulted in an impairment charge of
approximately $0.5 billion (after-tax) on the company’s share of the
Fort Hills assets.”
--Suncor Inc. 2015 Annual Report
Reversal of Impairment Losses
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Reverse impairment loss when recoverable amount
exceeds new carrying amount:
• If changes in estimates used to determine original impairment
loss or change in how recoverable amount is determined.
Reversal only up to original carrying amount.
Recognize reversal in income immediately.
U.S. GAAP does not allow reversal.
Example: Reversal of Impairment Loss
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Example: Reversal of Impairment Loss
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Ethical Issues
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Accounting of impairment involves estimates
A company when estimating impairment may have
the incentive to make more favorable estimates
about future cash flows and discount rate in order to
report lower impairment loss, inflating the current
period’s net income
Class Exercise
39
Comparison of IFRS vs. US GAAP
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Impairment under IFRS = carrying amount >
recoverable amount
¡ Recoverable amount is the greater of net selling price and
present value of future net cash flows
Impairment more likely under IFRS since discounted
cash flows are used
¡ U.S. GAAP uses undiscounted future cash flows
Comparison of IFRS vs. US GAAP
41
IFRS:
¡ Reverse impairment loss when recoverable amount exceeds
new carrying amount:
¡ Reversal only up to original carrying amount
¡ Recognize reversal in income immediately
U.S. GAAP allows no reversal
Case Analysis
42
Choose a multinational corporation that reports or discloses about
PPE and depreciation in its annual report
¡ What are the major categories of PPE on the company's balance sheet?
¡ What depreciation method(s) does the company use for its PPE? Any
differences for different categories of PPE assets? Any changes in
depreciation method compared to past?
¡ Compared to other depreciation methods, how does the chosen
depreciation method impact the company's financial statements,
including the income statement, balance sheet, and cash flow
statement?
¡ Are there any significant investments or disposal of PPE assets in that
year?
¡ What criteria does the company use to test for impairment of its PPE
assets?
¡ Are there any specific reasons (market conditions, technological
advancements, or regulatory requirements) or factors that lead to
impairment of the company's PPE assets?
Summarize the information into 1-2 slides and designate one or two
speaker(s) to present to class