LOS A requires us to:
distinguish between costs that are capitalized and costs that are expensed in the period in which they are incurred.
a. When a firm incurs some expenditure, it is either capitalized as assets or expensed during the period.
b. Those expenditures whose benefits are expected to be realized over multiple accounting periods are typically capitalized. When an expense is capitalized,
i. the non-current assets as reflected in the balance sheet increase, and
ii. there is a cash outflow from investing activities.
c. When the future economic benefit of expenditure seems unlikely, they are expensed during the accounting period itself.
d. When an asset is capitalized, it is recorded at:
i. cost, the usually fair value of its acquisition,
ii. plus the cost that is necessary to bring the asset to its actual use.
This capitalized cost is usually expensed as depreciation, amortization, etc. over the useful life of the asset.
e. When an asset is depreciated,
i. the non-current asset as reflected in the balance sheet decreases,
ii. net income decreases,
iii. retained earnings decreases, and
iv. equity decreases.
f. When an item of outflow is expensed in the current accounting period,
i. the net income decreases by the entire after-tax amount,
ii. no related asset is recorded
iii. there is operating cash outflow, and
iv. there is no impact on any future period.
1. Purchase of Tangible Assets
a. When a tangible asset is acquired through an exchange of an asset:
i. The amount of the asset capitalized usually equals the fair value of the asset received, which normally equals the fair value of the asset given up.
ii. From the balance sheet, the carrying value of the asset given up at exchange is removed and the fair value of the asset acquired is added. If the fair value of the asset acquired is greater than the book value of the asset given up, then there is again on the income statement; otherwise, there is a loss. If however, the fair value of the asset is unascertainable then the fair value should be considered equal to the book value of the asset given up, and hence, there would be no gain and no loss.
b. When a tangible asset is acquired through purchase, then:
i. It is capitalized at purchase cost plus all the expenditure necessary to bring the asset to its intended use.
ii. Any subsequent expenditure related to the long-lived assets are capitalized:
# if they are expected to provide economic benefits beyond one year, and/or
# they extend the asset’s useful economic life.
2. Borrowing Costs
a. When the long-lived assets are acquired or constructed (especially those having the longer lead time for construction), then the interest cost of borrowing is generally capitalized.
b. The interest expense is usually a part of investing cash outflow.
c. If the borrowed funds acquired for purchase/construction of an asset are, instead, reinvested and interest income is earned on it, then:
i. under IFRS the income earned is deducted from the borrowing cost and the net figure is capitalized as the cost of a long-lived asset,
ii. however, under GAAP the gross figure of the interest expense is capitalized as the cost of the asset; the interest income is reported on the income side of the income statement as ‘other income’.
For example:A company incurred the following expenditure for the purchase of machinery:
How much amount would you capitalize (to the machinery and otherwise), and how much expensed during the period? Solution:The amount that needs to be capitalized, to the asset account is:
The cost of repair of the building is also a capital expense, as it will increase the economic life of the asset, i.e. building. But this cost would not be added to the machinery cost. In fact, this cost would be capitalized to the building (and resultantly, the value of the building would increase by $ 2,000). The amount that needs to be expensed during the year is:
|