Copyright © 2003 Americas’ SAP Users’ Group

FASB Update For Capital Asset Management

Philip J. Zbojniewicz, CPAEli Lilly and CompanyMay 20, 2003

Session Code: 1406

Key Learning Points

Learn how you can influence the accounting standard setting process.

Develop a high-level understanding of recently-issued accounting standards that impact accounting and financial reporting for fixed assets.

Learn about a proposed new accounting standard that will have broad influence on accounting and reporting for property, plant, and equipment.

Accounting Jeopardy

Accounting Jeopardy

Large telecommunication company that made

news headlines due to transfers from line cost

expenses to capital accounts.

Accounting Jeopardy

Acronym for the primary rule-making body for generally

accepted accounting principles in the USA.

Accounting Jeopardy

The number of formal Statements of

Financial Accounting Standards that have

been promulgated by the FASB.

Accounting Rule Making Bodies

Financial Accounting Standards Board (FASB)

Securities and Exchange Commission (SEC)

American Institute of Certified Public Accountants (AICPA)

Emerging Issues Task Force (EITF)

Hierarchy of Accounting Rules

How Is An Accounting Rule Created?

Suggestions from industry groups, stock market analysts, etc.

Rule-making body may determine need for new rule based on changes in business environment.

Rule-making body discusses issue for a period of time. If rule deemed necessary, an Exposure Draft of proposed rule issued for public comment.

Public comment letters evaluated, revisions made to rule if appropriate.

Key Learning Points

Learn how you can influence the accounting standard setting process.

Develop a high-level understanding of recently-issued accounting standards that impact accounting and financial reporting for fixed assets.

Recently Issued Accounting Standards

SFAS No. 143, Accounting for Asset Retirement Obligations

Effective this year (fiscal years after 6/15/2002)

Certain capital-intensive industries will be significantly impacted (public utilities, waste management companies, and companies in the extractive industries)

SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets

Effective in 2002

Supersedes SFAS No. 121

SFAS No. 143 - Asset Retirement Obligations

Accounting for legal obligations associated with retirement of tangible long-lived assets (e.g., property, plant and equipment).

Can result from acquisition, construction, development, and (or) normal operations.

Legal obligation defined as an obligation that a party is required to settle as a result of:

Existing or enacted law

Statute

Ordinance

Written or oral contract based on promise of expectation of performance

SFAS No. 143 – Continued

Liability for asset retirement obligation recognized in period incurred.

Liability is measured at its “fair value”.

An offset to the liability should be capitalized as part of the underlying long-lived asset.

Asset depreciation and interest for the retirement liability accretion should be recognized in the income statement.

Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement.

SFAS No. 143 – Continued A plan or intention to dispose of an asset does not

require recognition.

Obligations resulting from improper operation of an asset are not ARO’s (e.g., environmental remediation).

Examples of ARO’s:

Removal of leasehold improvements

Decommissioning nuclear facilities

Removal of offshore oil and gas facilities

Closure obligation associated with landfills

Post-closure obligations associated with mining activities.

SFAS No. 144 – Asset Impairments

Assets Subject To Impairment Rules

Property, plant and equipment

Capital leases

Intangibles subject to amortization*

Long-term pre-paids

* Goodwill and intangibles that are not amortized are subject to impairment under FAS 142.

Impairment Process

Do Indicators of Impairment Exist?

Significant decrease in Market Value of asset?

Significant adverse change in use or condition of asset?

Significant adverse change in legal factors or business climate?

Costs significantly greater than expected amount to acquire or construct?

More-likely-than-not asset will be sold or disposed of before the end of its’ useful life?

Current period/historical operating and cash flow losses?

Impairment Process -- Continued

If indicators of impairment are present, review cash flows from asset.

If sum of estimated undiscounted future cash flows from assets less than the carrying amount, asset is impaired and must be written down to its “fair value”:

Amount at which the asset could be bought or sold in a current transaction with a willing buyer.

Quoted market price, prices for similar assets, present value method, cash flows discounted using a risk-free rate

Probability-weighted cash flows are permitted, not required

Assets To Be Sold

Criteria for “held for sale”:

Management commits to plan to sell the asset

Asset is available for immediate sale

Active program to locate a buyer exists

Sale of asset is probable within one year

Asset is actively marketed at a reasonable price relative to market value

Unlikely that significant changes in the plan for sale will occur

Recorded at fair value less cost to sell

Asset is no longer depreciated

Assets To Be Disposed Other Than By Sale

Examples: Abandonment, Exchange

Classified as “held and used” and depreciated until disposed of.

Committed to plan of abandonment:

Asset to be abandoned is considered disposed of when it ceases to be used.

Evaluate whether asset is impaired and write down if necessary.

Evaluate whether to shorten depreciable life.

SFAS No. 144 - Reporting & Disclosure

Reporting:

Impairment loss should be recognized in income from continuing operations (income from operations if presented)

Disclosures:

Long-lived assets to be “held and used”:

Description of impaired asset (facts leading to impairment)

Amount of loss and income statement caption if not separate

Method for determining fair value

Long-lived assets “held for sale”:

Expected manner and timing of disposal

Carrying amount of assets to be disposed of if not separate

Gain or loss recognized and income statement classification

Top 10 Signs Of A Bad Accountant

10.Brags that 20% of his clients have never been convicted of tax evasion.

11.Lets you claim your imaginary friend as a dependent.

12.You hear her on the phone saying, “Have I ever let you down, Mr. Kozlowski?”

13.His “short form” looks suspiciously like a cocktail napkin.

14.Used to be some sort of financial big shot in Orange County.

Top 10 Signs Of A Bad Accountant

5. On your 1040, lists your occupation as “sucker”.

4. You notice that his "calculator" is just a broken VCR remote.

3. Advises you to save postage by filing your taxes telepathically.

2. Considers watching reality TV shows a charitable deduction.

1. Says at least five times, “Here’s a little trick I taught Willie Nelson.”

Key Learning Points

Learn how you can influence the accounting standard setting process.

Develop a high-level understanding of recently-issued accounting standards that impact accounting and financial reporting for fixed assets.

Learn about a proposed new accounting standard that will have broad influence on accounting and reporting for property, plant, and equipment.

Proposed Statement of Position (SOP) for PP&E

Why are new rules needed?

Current guidance is high level which lends itself to much diversity in practice (i.e., gray areas of interpretation).

Diversity in practice creates comparability issues among companies and within industries.

Particularly noticeable in companies that capitalize internal labor and overhead.

Replacement assets are capitalized without removing NBV of old assets

Guidance intended to parallel previously issued rules for software development (SOP 98-1).

Overview of Proposed SOP Themes

Project stage framework and accounting for costs incurred.

Preliminary, Pre-Acquisition, Acquisition-or-Construction, In-Service stages.

Eligible capital costs defined for each stage.

Planned major maintenance activities.

Component accounting (level of detail).

Additional presentation and disclosure.

Preliminary Stage

Activities include exploration of opportunities for acquisition or construction of PP&E.

An entity may conduct feasibility studies and other activities related to asset selection for the purpose of obtaining management’s approval to move forward with particular PP&E acquisition or construction.

Internal and external costs related to PP&E that are incurred during the preliminary stage should be charged to expense as incurred.

Pre-Acquisition Stage

Preliminary stage ends and Pre-acquisition stage begins when the acquisition or construction of specific PP&E is considered probable.

Probable is defined in FASB Statement No. 5, Accounting for Contingencies, as “likely to occur”.

Certain activities and types of costs may be similar to those incurred during the preliminary stage except that in the pre-acquisition stage they occur after it is probable that the entity will acquire specific PP&E.

Project Stage Framework Example

Preliminary or Pre-Acquisition Stage?

An entity determines it is probable that it will build a manufacturing plant that will be used in its operations.

The entity acquires options on two parcels of land (one parcel in City X and one parcel in City Y) and currently owns two other vacant parcels in City Z. Only one parcel of land ultimately will be used to build the plant.

The entity is currently performing market distribution and labor studies to determine the location of the plant among the four alternatives.

Project Stage Framework ExamplePreliminary or Pre-Acquisition Stage?

The probability determination for purposes of moving from the preliminary stage to the pre-acquisition stage is applied at the specific PP&E level rather than at the project level.

In order to achieve the probability threshold, it must be probable that the entity will acquire a specific parcel of land (or use a specific parcel of existing land) and construct the plant on that land.

The entity is in the preliminary stage with respect to the manufacturing plant.

Pre-Acquisition Stage

Capital costs = Directly identifiable costs attributed to specific PP&E:

Incremental direct costs incurred in transactions with third parties.

Costs directly related to pre-acquisition activities performed by the entity for the specific PP&E. Only payroll and payroll benefit-related

costs of employees (e.g., health insurance) who devote time to a PP&E pre-acquisition stage activity.

Pre-Acquisition Stage

General and administrative costs (G&A) and overhead costs should be charged to expense as incurred whether incurred internally or externally.

But…Here’s an inconsistency…

The rule-makers acknowledge that third party costs incurred often include an element of the third party’s administrative overhead.

That overhead is considered to be an incremental direct cost in accordance and accordingly should be capitalized.

Acquisition-or-Construction Stage Capital costs include:

Third party incremental direct costs of acquiring, constructing, or installing the PP&E.

Certain internal costs incurred by the entity relating directly to the acquisition, construction, or installation of the specific PP&E:

Payroll and payroll benefit-related costs of employees.

Depreciation of machinery and equipment used directly in the construction or installation of PP&E.

Inventory (including spare parts) used directly in the construction or installation of PP&E.

Costs directly related to pre-production test runs of PP&E that are necessary to get the PP&E ready for its intended use.

Acquisition-or-Construction Stage The following should be expensed:

Internal G&A and overhead costs, including rent, depreciation, and all costs of support functions.

Similar to the pre-acquisition stage, G&A costs and overhead costs should be charged to expense whether incurred whether internally or with an external party.

However, if external costs include an element of the third party’s administrative overhead, that element is considered to be an incremental direct cost and should be capitalized.

Companies that self-construct assets say, “Hey, that’s not fair!!!”

Acquisition-or-Construction Stage

Demolition costs incurred by an owner or lessor should be charged to expense as incurred and included in results of operations, except when incurred in conjunction with an acquisition or lease of real estate and demolition:

Is contemplated as part of the acquisition an occurs within a reasonable period of time.

These demolition costs should be capitalized as part of the cost of the real estate.

Whether the demolition costs are capitalized as land or building depends on the nature of the costs.

Accounting Jeopardy – Daily Double!

•Emeril’s•K-Paul’s Louisiana Kitchen•Antoine’s•Bacco•Brennan’s•Broussard’s

In-Service Stage

Begins once a PP&E asset or component is substantially complete and ready for its intended use.

During this stage, an entity may incur the following types of costs:

Repairs and maintenance of existing components

Replacement of existing components

Acquisition of additional components.

In-Service Stage

Costs of repairs and maintenance activities and all other PP&E related costs incurred during the in-service stage should be charged to expense unless the costs are for:

Acquisition of additional components of PP&E or

Replacement of existing components of PP&E.

Costs of replacing PP&E, with the exception of removal costs, represent the acquisition of a new component of PP&E and should be capitalized.

During replacement if existing PP&E or a component is removed from service, the remaining net book value (or a reasonable estimate) should be charged to depreciation expense in the period of replacement.

Project Stage Framework Summary

Preliminary Stage

Pre-Acquisition Stage

Acquisition-or-Construction Stage

In-Service Stage

Prior to time when acquisition of specific PP&E becomes probable

Acquisition of specific PP&E is probable but has not yet occurred

Acquisition has occurred or construction has commenced but PP&E is not yet substantially complete and ready for its intended use

Subsequent to when PP&E is substantially complete and ready for its intended use

Project Stage Accounting Summary

Preliminary Stage

Pre-Acquisition Stage

Acquisition-or-Construction Stage

In-Service Stage

Expense, except for options to acquire PP&E

Only capitalize directly identifiable costs

Only capitalize directly identifiable costs. In case of real estate, property-related costs may be capitalized.

Capitalize replacements and additions; expense repairs and maintenance; expense net book values of replaced PP&E

Planned Major Maintenance Activities Entities typically incur costs required to keep PP&E properly

maintained or running efficiently.

Examples include cleaning, servicing, replacement, or repair, as well as costs of replacement components and minor parts.

These accounting methods for planned major maintenance activities are not permitted:

Accrual of a liability prior to incurring actual costs.

Deferral and amortization of the entire cost of maintenance activity.

Recognition of additional depreciation or amortization to cover the future costs of a planned major maintenance activity (the “built-in overhaul” method)

Component Accounting

A component is a tangible part or portion of PP&E that:

Can be separately identified as an asset and depreciated or amortized over its own separate expected useful life and

Is expected to provide economic benefit for more than one year.

If a component has an expected useful life that differs from the expected useful life of the PP&E asset to which it relates, the cost should be accounted for separately and depreciated or amortized over its separate expected useful life.

Presentation and Disclosure

In addition to existing presentation and disclosure requirements under GAAP, the carrying amounts of the following categories of PP&E should be disclosed:

Land and land improvements Buildings and building improvements Machinery and equipment Construction in progress

Above categories should be further subcategorized if costs within a category are significant in relation to that category and have expected useful lives significantly different from that of the category as a whole.

Presentation and Disclosure

For example, an entity should subcategorize the “buildings and building improvements” category into subcategories such as:

Tenant improvements (leasehold improvements)

Integral equipment, such as heating, ventilation, HVAC, and elevators.

Building “shell.”

For each category or subcategory, the range of useful lives should be disclosed.

Also disclose the nature and total amount of the costs it characterizes as repairs and maintenance expense for each period.

Presentation and DisclosureExpected

Amount Useful LivesLand and Improvements: Land 1,000,000$ Land Improvements 200,000 10-15 years

1,200,000 Buildings: Roofs 200,000 20-25 years HVAC 100,000 10 years Elevators 100,000 7 years Leasehold Improvements 200,000 12 years Building Shell and Other 1,500,000 50 years

2,100,000 Machinery & Equipment: Vehicles 100,000 5 years Manufacturing Equipment 550,000 12 years Computers 80,000 3 years Other 20,000 5-10 years

750,000

Total Land & Depreciable PP&E 4,050,000 Less: Accumulated Depreciation (750,000) Net Land & Depreciable PP&E 3,300,000

Construction in Progress: Warehouse 120,000 Production Facilities 1,000,000 Administrative Buildings 300,000

1,420,000 Total Net PP&E 4,720,000$

Final Jeopardy

New Orleans' version of the donut, it’s square (no hole) and dusted with powdered sugar.

Comment Letter Follow-Up Actions

AICPA received over 400 comment letters on the proposed SOP. Deliberations have been in process since May 2002.

Major modifications thus far:

Certain overhead costs should be eligible for capitalization. Task Force to further examine support functions (e.g., project purchasing and accounting) to see if costs should be capitalized.

Degree of component accounting left to mgt.’s discretion.

Removal costs should be considered a cost of placing the replacement asset in service.

Income statement treatment of disposals deemed out of scope.

Final SOP to be issued “in the future”.

Copyright © 2003 Americas’ SAP Users’ Group

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Session Code: 1406