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Hi Mike !
I have the following issues:
1. Operating Leases: The answer by examiner shows the following journal entry regarding capitalisation of leasehold improvements and conversion of building back to its original condition (decommissioning):
DR PPE $10m
CR Income Stat $10mDR PPE $2m
CR Prov. for Decomm. $2mThe question is: I understand the $10m capitalisation but why we would credit the income statement in the first entry above?
Secondly, when we are doing provision, why we are debiting the PPE again. Shouldn’t it be reduced by the provision?
Thank you
Charge $10m to income statement doesn’t make sense to me either. The question doesn’t mention how the company settled the $10m. I assume it was settled by a bank loan, so the entry should be:
DR PPE $10m
CR Loan $10mI understand the $2m restoration cost should be capitalised according to IAS 16, so the depreciation charge will be based on the total $10m + $2m over 6 years and charge the depreciation to income statement.
The $2m provision for decommissioning should belong to a liability account in SOFP.
This $2m provision will stay in SOFP until the the date the actual restoration cost occurs at the end of the lease term, then the entry at that date will be:
DB Prov. for Decomm. $2m
CR Cash/loan $2mPlease correct if I’m wrong.
Thanks.
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Leasehold improvements should be capitalised and written off over the lease term. The company has chaged (Dr) these imporvements as expenses so they need to be reversed (Cr Income statement) and capitalised (Dr PPE).
Any restoration costs are always added to the cost of the asset when it is capitalised. [Strictly speaking we should capitalise the present value of restoration costs and set up a provision for the same amount. Then every year the provision will increase as the interest rate unwinds (liability is one year closer so the present value is larger) and this increase is charged to the income statement as finance costs (Dr income statement Cr Provision)].
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