Question

Guiglano Inc. is a large, publicly held corporation. The following are six selected expenditures that were made by the company duringthe fiscal year ended April 30, 2020. The proper accounting treatment of these transactions must be determined in order to ensure that Guiglano's annual financial statements are prepared in accordance with IFRS.

1. Guiglano spent $3 million on a program that is designed to improve relations with its dealers. Dealers responded well to the project and Guiglano's management believes that it will therefore result in significant future benefits. The program was conducted during the fourth quarter of the 2019–20 fiscal year.

2. A pilot plant was constructed during 2019–20 at a cost of $5.5 million to test a new production process. The plant will be operated for approximately five years. After the five years, the company will make a decision about the economic value of the production process. The pilot plant is too small for commercial production, so it will be dismantled when the test is over.

3. During the year, Guiglano began a new manufacturing operation in Newfoundland, its first plant east of Montreal. To get the plant into operation, the following costs were incurred: (i) $100,000 to make the building fully wheelchair-accessible; (ii) $41,600 to outfit the new employees with Guiglano uniforms; (iii) $12,700 for the reception to introduce the company to others in the industrial mall where the plant is located; and (iv) $64,400 in payroll costs for the new employees while they were being trained.

4. Guiglano purchased Eagle Company for $6 million cash in early August 2019. The fair value of Eagle's net identifiable assets was $5.2 million.

5. The company spent $14 million on advertising during the year. Of that, $2.5 million was spent in April 2020 to introduce a new product to be released during the first quarter of the 2020–21 fiscal year and $200,000 was used to advertise the opening of the new plant in Newfoundland. The remaining expenditures were for recurring advertising and promotion coverage.

6. During the first six months of the 2019–20 fiscal year, $400,000 was spent on legal work on a successful patent application. The patent became effective in November 2019. The patent's legal life is 20 years and its economic life is expected to be approximately 10 years.

Instructions
For each of the six items presented, determine and justify the following:
a. The amount, if any, that should be capitalized and included on Guiglano's statement of financial position prepared as at April 30, 2020.
b. The amount that should be included in Guiglano's statement of income for the year ended April 30, 2020.

Answer 1

1. $3 million dollars spent on a program to improve relations with dealers

In the case of this expenditure, it is given that future economic benefits will flow to the entity and the amount of expenditure can also be measured reliably i.e. 3 million $. However, this expenditure does not form part of the cost of any "property, plant or equipment". It is in the nature of an advertising and promotional activity which will lead to an increase in the sales of the entity in the future.

Hence the amount of this expenditure should be charged to the Statement of income of Guiglano for the year ended April 30, 2020.

2. Construction of a pilot plant to test a new production process

It is given that the plant has a life of approximately five years and its cost can be measured reliably i.e. $5.5 million. Although this plant cannot be used for commercial production directly, it is probable that it will lead to economic benefits to the entity in the future if the testing process is successful and the new production process is adopted.

Hence the amount of this expenditure should be capitalized and included in the Statement of Financial Position as at April 30, 2020.

3. Costs incurred in a new manufacturing plant before the start of commercial operations

In the case of these expenses, the amounts are not material and the purpose of incurring these costs is to facilitate the smooth running of the operations of the plant once commercial production starts. The entity will not be able to generate any future economic benefits from incurring these costs.

Hence all the costs incurred in the new manufacturing plant at Newfoundland should be charged to the Statement of income of Guiglano for the year ended April 30, 2020.

4. Expenditure on investment in Eagle Company

Guiglano Inc. has acquired Eagle Company by paying cash 6 million $. This is an investment transaction and hence the same should be recognised as an asset and included in Guiglano's Statement of Financial Position as at April 30, 2020. Here the difference between the amount paid by Guiglano and the fair value of Eagle Company's assets i.e. (6-5.2) = 0.8 million $ is the goodwill which is included in the investment cost and it should not be amortised separately.

5. Advertising expenditure incurred for new product and for the opening of a new plant in Newfoundland

As already explained in the answer to Q1., advertising expenditure does not result in the obtaining of any "Property, Plant or Equipment" and hence these costs have to be charged to the Statement of income of Guiglano for the year ended April 30, 2020. It is of no relevance that the advertising costs were incurred for new products or for existing products or even for publicity of the new plant.

6. Legal expenditure incurred for obtaining patent

Guiglano Inc. has incurred legal expenditure on obtaining a patent and the patent became effective in November 2019. This has led to obtaining an intangible asset in the form of a patent which has an economic life of approximately 10 years. An intangible asset can be recognized if it meets the following criteria a) It should be identifiable, b) It should generate future economic benefits and c) It should be controlled by the entity.

In the given case, all the 3 conditions are satisfied and hence Guiglano Inc. should capitalize the amount of $400,000 and it should be disclosed as an intangible asset in the Statement of Financial Position as at April 30, 2020.