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This case study is concerned with subsequent costs.
Facts
CASE STUDY 1
Road Truckers Inc. has acquired a heavy road transporter at a cost of $100,000 (with no breakdown of the component parts). The estimated useful life is
ten years. At the end of the sixth year, the power train requires replacement, as further maintenance is uneconomical due to the off-road time required. The
remainder of the vehicle is perfectly roadworthy and is expected to last for the next four years. The cost of a new power train is $45,000.
Required
Can the cost of the new power train be recognized as an asset, and, if so, what treatment should be used?
Solution
The new power train will produce economic benefits to Road Truckers Inc., and the cost is measurable. Hence the item should be recognized as an asset.
The original invoice for the transporter did not specify the cost of the power train; however, the cost of the replacement—$45,000—can be used as an
indication (usually by discounting) of the likely cost, six years previously. If an appropriate discount rate is 5% per annum, $45,000 discounted back six
years amounts to $33,500 [$45,000/(1.05)] 6 , which would be written out of the asset records. The cost of the new power train, $45,000, would be added to
the asset record, resulting in a new asset cost of $111,500 ($100,000 – $33,500 + $45,000).
Measurement at Recognition
An item of property, plant, and equipment that satisfies the recognition criteria should be recognized initially at its cost. The Standard specifies that cost comprises
• Purchase price, including import duties, nonrefundable purchase taxes, less trade discounts and rebates
• Costs directly attributable to bringing the asset to the location and condition necessary for it to be used in a manner intended by the entity
• Initial estimates of dismantling, removing, and site restoration if the entity has an obligation that it incurs on acquisition of the asset or as a result of using the
asset other than to produce inventories
Examples of directly attributable costs include
• Employee benefits of those involved in the construction or acquisition of an asset
• Cost of site preparation
• Initial delivery and handling costs
• Installation and assembly costs
• Costs of testing, less the net proceeds from the sale of any product arising from test production
• Borrowing costs to the extent permitted by IAS 23, Borrowing Costs
• Professional fees
Examples of costs that are not directly attributable costs and therefore must be expensed in the income statement include
• Costs of opening a new facility (often referred to as preoperative expenses)
• Costs of introducing a new product or service
• Advertising and promotional costs
• Costs of conducting business in a new location or with a new class of customer
• Training costs
• Administration and other general overheads
• Costs incurred while an asset, capable of being used as intended, is yet to be brought into use, is left idle, or is operating at below full capacity
• Initial operating losses
• Costs of relocating or reorganizing part or all of an entity’s operations
This case study is concerned with directly attributable costs.
Facts
CASE STUDY 2
Extravagant 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