Question

Question No: 2 10 Marks
Case (a) The National Ferries Company in Oman purchased a new ferry at a cost of OMR 320,000. The facilities
available in that ferry were modern and long lasting. The useful life of the ferry was estimated for 20 years. At the
end of the 8th year the ferry’s wireless and navigation system requires replacement. The company felt that the
maintenance cost of the wireless and navigation system was very high and they decided to replace that wireless and
navigation system immediately. Except the wireless and navigation system, the ferry’s technical parts and other
facilities are sail worthy and are expected to function for the next 6 years without any problem. The National
Ferries Company inquired about the price with the producer of wireless and navigation system and they are ready to
deliver the wireless and navigation system at a price of OMR 85,000.
Case (b) A land was acquired by a manufacturing corporation and the purpose of this acquisition was to construct a
factory building. The corporation wishes to obtain permission from the government authorities. For this purpose,
the corporation needs certificate from the government regarding environment clearance and change of classification
of land etc. The estimated cost for such permission and clearance was OMR 42, 200. The corporation wishes to
capitalize such cost of getting permission from the government and it should be included capitalized under cost of
construction of factory building.
According to the standards of IAS 16 the cost of an item of property, plant and equipment will be provided
if and only if it is probable that asset must provide future economic benefits. And the cost of permission and
clearance must also have to be measured reliably. Further as per the standards of IAS 16 the recognition of the cost
of permission and clearance will be made at the time when it is incurred. As per the principle of recognition, the
corporation has capitalized the cost of obtaining permission and clearance.
Required:
Case (a)
i. On the role of a financial analyst provide your information about whether the cost of the new wireless
and navigation system can be recognized as an asset?
ii. By considering the replacement cost of the wireless and navigation system, what amount would be
reported as an asset? And How would treat this asset in the company’s financial statements?

Case (b)
i. On the role of a financial analyst justify by your explanation about the decision of capitalizing the cost
of obtaining permission and clearance from the government is correct or not.
ii. If it is correct, how would you treat this cost in the cost in the corporation’s financial statements? 300 word

Answer 1

a. Navigation is an important add-on to a fery, which helps the ferry perform its intended function of manoevring in the waters---without which the ferry will be rendered un-usable.

Also, it is only normal & natural that the navigation system requires , regular inspection & service /replacement, when found wanting in its intended functional aspects.

Also as per IAS 16--for property, plant & equipment--

1 .if the company is likely to derive future economic benefits, by incurring these costs,

2. & also if, the cost can be measured reliably

such costs are to be recognised as part of the asset's value   , at the time they are incurred.

So, going by point no.1, as the economic benefits of replacing the navigation system--namely, savings in regular maintenance costs & improvement in its function , thereby increasing income --- benefits to be felt for a series of years & not only in the year of incurring alone

the above navigation system needs to be recognized as an asset

& going by point no.2, as the price is known, $ 85000 --should be added to the carrying value of the ferry , on the date of delivery & invoice,and depreciated from then on, according to the class of assets , to which they belong.

This cost will appear , included in the cost of ferry .on the asset side of the balance sheet, from the year, in which the cash outflow was incurred---it is a capital cost like purchase of an asset.

b. The permission is a pre-requisite, as well as the reason , subsequent to which the factory building , can come into existence

Again, as above, as per IAS 16--for property, plant & equipment--

1 .if the company is likely to derive future economic benefits, from incurring these costs,

2. & also if, the cost can be measured reliably

such costs are to be recognised as part of the asset's value   , at the time they are incurred.

So, going by point no.1, as the economic benefits of building the factory-namely, to manufacture & sell & thereby , earn regular income for a no.of years --- ie. benefits to be felt for a series of years & not only in the year of incurring alone

the above costs should be recognized as part of the factory building's value(addition)

& going by point no.2, as the cost for the permission is known as $ 42200 --should be added to the value of factory building that is to come and depreciated along with it , from the date of completion & commissioning (put to the intended use) of the building.

This cost will appear , included in the cost of ferry .on the asset side of the balance sheet, from the year, in which the cash outflow was incurred

This cost should be treated as a deferred expenditure-pending capitalisation & capitalised along with the factory building , as & when it is completed & put to its intended use.

$ 42200 & such other costs , will keep on accumulating & the total appear on the assets side of the balance sheet, till the fcatory building is completed.

NOTE:

Navigation system replacement can be capitalised immeditely. BUT

the cost towards permission for the fcatory building needs to be recorded asa deferred expenditure-- or capital work-in-progress & capitalised on 100% completion of the asset.