Question

Forward Solutions Inc. (FSI), a private company based in Vancouver, is one of Canada's major manufacturers of heavy construction equipment, such as tractors and bulldozers. FSI is owned by Chi Ho, who is the President and CEO and makes all strategic decisions. FSI’s accounting functions are handled by the CFO, May Bell. The company plans a major expansion into the United States next year and will raise funding through making a public offering of shares. To prepare for going public, FSI follows IFRS for its annual financial statements. FSI has been able to reduce its debt load over the years, but still relies heavily on its creditors and bank debt for continued support and growth. FSI's banking agreement requires that FSI maintains a total debt to equity ratio of no more than 1 to 1. You have recently been hired as an assistant to the CFO. You have been asked to analyze the following events that occurred in the year ended 31 December 2019, and provide recommendations for how these events should be accounted for appropriately in the year-end financial statements. Since Chi Ho always examines the final financial statements in detail before releasing them to the creditors, it is important for you to provide detailed reasoning so he will understand your accounting recommendations. Prior to any adjustments that you may recommend arising from these issues, FSI's total debt is $5.1 million, and its total equity is $6.7 million.

Required:

In early April, FSI placed an order for a new customized machine to replace one old manufacturing machine. The machine was delivered on November 1, installed and tested at a cost of $30,000 in November and became operational at the beginning of December. FSI obtained a 5-year, $600,000 loan on March 31 to finance the acquisition of the machine. The loan bears interest of 5%, payable annually on March 31. An upfront fee of $49,200 was charged on the loan. The new machine has been recorded at its invoice price of $500,000

Answer 1

Following are the recommendations of the accounting recommendations:

1. Accounting for Installation and testing cost of $ 30,000:

Para 16 of IAS 16: Property, Plant and Equipment refers to the following:

"The cost of an item of property, plant and equipment comprises:

(a) its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates.

(b) any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management.

(c) the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period."

Moreover, examples of directly attributable costs that can be capitalised as mentioned in para 17 of the Standard are installation, assembly costs and costs of testing. Hence, $ 30,000 can capitalized instead of charging off to the Statement of Profit and Loss. Thus, this will not have a negative impact on the debt equity ratio.

2. Accounting for the interest on loan from March 31 - November 1 (November 1 assumed to be the date of installation as well):

Para 8 of IAS 23: Borrowing Costs refers to the following:

"An entity shall capitalise borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset."

As a result, the interest cost of $ 600,000 * 5% * 7 / 12 = $ 17,500 can also be capitalised instead of charging of to Statement of Profit and Loss. Thus, this will not have a negative impact on the debt equity ratio.

3. Accounting for the upfront fees of $ 49,200:

Under IFRS 9: Financial Instruments, an "effective interest rate" method is used to account for the cost of borrowings. Under this method, upfront fees will be amortised over the life of the loan and not charged off on Day 1 itself. As a result, a part of the $ 49,200 will get capitalised under point 2 above as "effective interest" on the borrowing. Thus, this will not have a negative impact on the debt equity ratio.