According to GAAPs Codification 360: 25-3, fixed assets should be recognised as part of a company’s property when they have been acquired for use in production of goods and services. GAAP defines fixed assets as business properties that last for more than one year and used to produce goods and services to be traded in, when preparing financial statements, accounting for fixed assets is guided by International accounting standard number I6, ISA 16 (FASB, 2011).
The accounting standard regulation requires fixed assets to be accounted for using the matching principle; fixed assets include plants, machinery and motor vehicles (Schroeder, Clark & Cathey, 2011). As much as ISA 16 provides an accounting guidance, accounting for lands and building is a little bit complicated. This paper discusses the difficulty in accounting for lands and building and finally recommends a best strategy that can be adopted in a company. The paper will also discuss long-term liabilities and taxes.
Difficulty accounting for lands and buildings
According to ISA 16, when accounting for fixed assets, a company should have a rate of depreciation that should be expensed over the expected useful life of an asset. The accounting standards do not give a way that the assets useful life should be calculated or the depression rate; it leaves this task to managers of a company to determine an appropriate rate.
When the case becomes to building and lands, it becomes even more complicate since it is difficult to predict whether the value of land and buildings will appreciate or depreciate. The value of land at one particular time is influenced by external factors; there is little that a firm can do to control the external environment that influences the value of such properties. At the end of the year, the value to account for in the balance sheet and the amount to expense in trading account becomes a problem. Some factors that might influence the value of land are development in social amenities in a certain place, wars and unrests in an area where the company is located (Weygand, Kimmel & Kieso, 2010).
According to GAAP’s, after an acquisition of an asset it should be recorded in the books at the value that it was purchase; as much as this will reflect the expense and balance with accounts to be created, the value may change overnight or in the course of negotiation. GAAPs Codification 360: 25-3
“At the date the rights in the preceding paragraph are acquired, both transactions involve a right to receive, at the end of the lease term, all, or a portion, of any future benefit to be derived from the leased asset and shall be accounted for as the acquisition of an asset. Both transactions are referred to as the acquisition of an interest in the residual value of a leased asset” (FASB, 2011).
Another issue when determining the value of land is how to account for brokerage fees and expenses; the question here is, is the cost that was paid to the person who acted as an agent to the company be capitalised. In most land agreements and purchase contracts, the fee is not included in the purchase cost and is seen as an expense to the company that cannot be included in the value of land (Kieso, Weygandt & Terry, 2009).
Best strategy recommendation
When accounting for land and building, companies should use valuation method; although valuation is an expensive task, it can assist a company give the true value of its assets. The changes in the value of the buildings should then the accounted for according to international accounting standards for devaluations and value appreciation. As much as the expense is incurred, it is allowable for taxes so the company stands to benefit in the end. Every year, the land and building asset account should be closed and another one reflecting the real figure is made, any additions, demolition and restructuring should be accounted for as they occur.
The real value of a company is the current market value of its assets, because of the uncertainty of whether the land and buildings will appreciate or not, then using valuation method will offer a current value for better accounting. When historical value of accounting is used, there are chances that the value of land and buildings will be over or undervalued; in case of either then the accounts will not be giving a true and fair financial position of a firm; thus the best accounting strategy for land and buildings is yearly valuation method (Horngren, 2007).
Generalized long-term liability best practice
Long-term liabilities are facilities that are used by companies to finance different operation and they are expected to repay the liability according to the contract entered and pay some interest on the loan. They are financial obligation that a company have to meet; when accounting for long-term liabilities; International accounting standards require that they be accounted for at their fair value. Fair value to be included in the balance sheet does not reflect future interests that will be paid. Interest payable although by its own is a liability to the company (since the company will have to pay the amount with the loan facility, is not realised in the balance sheet). Interests on long-term liabilities should be expensed in the trading account wham they have been incurred.
GAAPs Codification 405: 05-2
“An entity may settle a liability by transferring assets to the creditor or otherwise obtaining an unconditional release. Alternatively, an entity may enter into other arrangements designed to set aside assets dedicated to eventually settling a liability. Accounting for those arrangements has raised issues about when a liability should be considered extinguished. This Subtopic establishes standards for resolving those issues” (FASB, 2011).
The best practice of accounting for long-term liabilities is to have an element that represents the interest that will be paid on the liabilities; the interest should form part of contingent liabilities. In the balance sheet, the figure should be shown under the long-term liability however, when calculation the totals of the liability side of the budget, it should be ignored. In the notes to account, the figure of the contingent account should be elaborated for transparency. When such a policy has been implemented, investors, managers and all stakeholders concerned about the liability rate of the company will have a better picture of the firm (Carlon, 2009).
One thing I would change about accounting for income taxes
Although international accounting and auditing standards offer guideline on taxation, different countries have different taxation policies and legislations. If I were in opposition to change taxation policies in the United States of America, I would focus on treatment of loose tools and spare parts of machinery. Under the current policy, they are accounted for as diminutions and given capital allowance; I would change the policy and allow them to be expensed in a company’s trading profit and loss account as normal expense.
The argument supporting the current policy is that they are part of an asset thus they are not current expenses; their lifetime is long thus they should be capitalised and treated as assets of a company regardless of their financial value. When using my method, I would put on measure to ensure there is transparency and accountability when expensing this figure in the trading account. Any doubt or manipulation should be criminalized.
The reason why I feel that loose tools and spare parts should be expensed in the trading account is that these tools are part of maintenance of assets despite the fact that they will be fixed to the asset and probably add value to the asset. Although to some extent such a policy may open a loophole that can be exploited by corrupt business people, the revenue authority should monitor their purchase and utility.
Carlon, S. et al. (2009). Accounting: Building business skills. New York: John Wiley & Sons.
FASB. (2011). Financial Accounting Standard Board. Web.
Horngren, H. (2007). Accounting Edition 7e. New Jersey Prentice Hall.
Kieso, E., Weygandt, J., & Terry D. (2009). Intermediate Accounting. New York: John Wiley & Sons.
Schroeder, R., Clark, M., & Cathey, J. (2011). Financial accounting theory and analysis: Text and cases. Hoboken, NJ: John Wiley & Sons.
Weygand, J., Kimmel, P.,& Kieso, A. (2010). Financial Accounting: IFRS. Illinois: Northern Illinois University.