Please explain Part C) summarize the difference in net income and in stockholders' equity over the 20 year life of the building using the 2 different sets of accounting rules.
Abacab Company's shares are listed on the New Market Stock
Exchange, which allows the use of either international financial
reporting standards (IFRS) or U.S. GAAP. On Jan 1, Year 1, Abacab
Company acquired a building at a cost of $10 million. The building
has a 20-yr. useful life and no residual value and is depreciated
on a straight-line basis. On January 1, Year 3, the company hired
an appraiser who determines the fair value of the building (net of
any accumulated depreciation) to be $12 million.
IAS16, "Property, plant, and equipment," requires assets to be
initially measured at cost. Subsequent to initial recognition,
assets may be carried either at cost less accumulated depreciation
and any impairment losses (the cost model) or at a revalued amount
equal to fair value at the date of the revaluation less any
subsequent accumulated depreciation and impairment losses (the
revaluation model). If a firm chooses to use the revaluation model,
the counterpart to the revaluation of the asset is recorded as an
increase in Accumulated Other Comprehensive Income (stockholders'
equity). Subsequent depreciation is based on the revalued amount
less any residual value.
(U.S.GAAP) required items of property, plant, and equipment to be
initially measured at cost. U.S.GAAP does not allow property,
plant, and equipment to be revalued above original cost at
subsequent balance sheet dates. The cost of property, plant, and
equipment must be depreciated on a systematic basis over its useful
life. Subsequent to initial recognition, assets must be carried at
cost less accumulated depreciation and any impairment loss.
a) Determine the amount of depreciation expense recognized in Year
2, Year 3, and Year 4 under (a) the revaluation model of IAS 16 and
(b) U.S. GAAP.
b) Determine the book value of the building under the two different
sets of accounting rules at January 2, Year 3; December 31, Year 3;
and December 31, Year 4.
C) summarize the difference in net income and in stockholders’
equity over the 20-year life of the building using the 2 different
sets of accounting rules.
Solution:
a. | |||||||
Cost of the machine | $ 10,000,000.00 | ||||||
year of Life of the machine | 20 | ||||||
Annual depreciation | $ 500,000.00 | ||||||
Depreciation upto Jan- year 3 | $ 1,000,000.00 | ||||||
Book Value as on Jan-1 year 3 | $ 9,000,000.00 | ||||||
Increased Value | $ 12,000,000.00 | ||||||
Remaining Life | $ 18.00 | ||||||
Annual Depreciation for remaining period | $ 666,666.67 | ||||||
IAS 16 | US GAAP | ||||||
Depreciation for year 2 | $ 500,000.00 | $ 500,000.00 | |||||
Depreciation for year 3 | $ 500,000.00 | $ 500,000.00 | |||||
Depreciation for year 4 | $ 666,666.67 | $ 500,000.00 | |||||
b. | |||||||
IAS 16 | |||||||
Year | Beginning | Depreciation | Ending Value | ||||
1 | $ 10,000,000.00 | $ 500,000.00 | $ 9,500,000.00 | ||||
2 | $ 9,500,000.00 | $ 500,000.00 | $ 9,000,000.00 | ||||
3 | $ 12,000,000.00 | $ 666,666.67 | $ 11,333,333.33 | ||||
4 | $ 11,333,333.33 | $ 666,666.67 | $ 10,666,666.67 | ||||
5 | $ 10,666,666.67 | $ 666,666.67 | $ 10,000,000.00 | ||||
US GAAP | |||||||
Year | Beginning | Depreciation | Ending Value | ||||
1 | $ 10,000,000.00 | $ 500,000.00 | $ 9,500,000.00 | ||||
2 | $ 9,500,000.00 | $ 500,000.00 | $ 9,000,000.00 | ||||
3 | $ 9,000,000.00 | $ 500,000.00 | $ 8,500,000.00 | ||||
4 | $ 8,500,000.00 | $ 500,000.00 | $ 8,000,000.00 | ||||
5 | $ 8,000,000.00 | $ 500,000.00 | $ 7,500,000.00 | ||||
C. | |||||||
Under GAAP, Income will be charged 500,000 depreciation each year and no gain or loss on revaluation is recognised. | |||||||
Under IAS 16, Depreciation charge is 500,000 for the first 2 year. Thereafter 666,667 for each year. A Gain of 4million is to be recognised as Accumulated Other Comprehensive Income in year 3. | |||||||
What ever method is applied the total over 20 years effect is same. |
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