ACCA F7 - Measuring Cost of an Asset

Initial Cost of an Asset

A non-current asset is recognized in financial statements, if and only, if:

 

  1. it is probable that future economic benefits associated with the item will flow to the entity; and

  2. The cost of the item can be measured reliably.

 

When it is said that future economic benefits will flow to the entity, the intent is that the asset contributes to the smooth functioning of the entity. It does not necessarily mean that the asset does not generate any immediate benefits.

 

A hospital is required to maintain safety norms, by way of installation of sprinklers and fire extinguishers at the premises. A violation of the norms may invite closure of the unit itself. The hospital did not suffer from any fire in the past, and there is a least possibility of a fire break-out.

The cost of sprinklers qualifies as an asset. Without installing these sprinklers, the hospital is likely to be shut off. The government authorities are likely to stop functioning of the hospital, if the safety norms are not adhered to. However, the sprinklers would only be recognised as an asset when these are installed.

 

A company buys a generator as a power back-up. Although the generator does not need to run other than in the event of a power failure, it still constitutes as an asset. Here, it is probable that the future economic benefits will flow to the entity.

 

Meaning of cost under IAS 16

 

  • is the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition or construction or, where applicable, the amount attributed to that asset when initially recognised in accordance with the specific requirements of other IFRSs.

 

Cash equivalent price:

The purchase price is the cash equivalent price for the purchase. If there is a deferment of payment beyond normal credit terms, the cash price of the asset is considered for the purpose of capitalization. The remaining part is considered as finance cost and is charged to the SOCI.

Example: AV Ltd sells computers to B Ltd, a subsidiary of AV Ltd. B Ltd agrees to pay for these computers in 6 months’ time. AV Ltd would have sold these computers in market at a price of $5,000, with 15 days credit (normal credit period). However, B Ltd agrees to pay $7,500 for the deferred payment.

Determine the cost of computers in the books of B Ltd.

 

In the above case, B Ltd would take the value of these computers at $5,000. The balance $2,500 is charged as interest / finance cost to SOCI in the books of B Ltd.

 

AV Ltd wants to buy a car for business purposes. The car costs $5,000 on down payment. However, the seller gives an option to AV Ltd to buy the car in 12 equal monthly instalments (EMIs) of $500 each.

How should AV Ltd recognise the cost of car in it books?

 

Option 1: Bought in cash (all down payment)

The cost of the car is $5,000

 

Option 2: Bought on EMIs:

The cost of car is $5,000 (cash equivalent price). The excess payment of $1,000 (6,000 – 5,000) is charged to income statement over the EMI period.

 

IAS 16 suggests that an asset must be initially recognised at cost. The next obvious question which comes to our mind is to what forms the cost of an asset?

 

  1. The cost of an item of PPE comprises of all amounts which are necessary for bringing the asset to the location and condition necessary for its intended use

  2. Also includes the estimate of dismantling costs

  3. The purchase price is the cash equivalent price on recognition date

  4. Costs necessary for bringing the asset to the location and condition necessary for its intended use:

All those costs which are unavoidable to bring the asset for the intended use would form part of the cost of the asset. These would comprise of:

  1. Purchase price (cash equivalent price);

  2. Site preparation costs;

  3. Initial delivery and handling costs;

  4. Import duties and taxes (non-refundable);

  5. Testing costs;

  6. Professional fee (architecture fee);

  7. Present value of restoration costs

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