Question

Under GAAP, when a company installs safety and/or environmental devices in excess of what the law mandates, it is treated as part of the asset. However; under IFRS these additional expenditures must be expensed immediately. Which method do you prefer? Explain your answer. Also, discuss the implications on the balance sheet and income statement for the year of expenditure and subsequent years of the two methods

Answer 1

Answer: Under GAAP installation of safety and/or environmental devices in excess of what the law mandates, it is treated as part of the asset on the other hand under IFRS these additional expenditures must be expensed immediately, important point to be noted here is that when it is treated as part of the asset, then only a particular percentage of asset value will be allowed as depreciation dpending upon the useful life and net profit will be at the higher side simultaneously net profit to turnover ratio will be also at the higher end, keeping aside the tax part and if expenses immediately then net profit will be at the lower end.

If we talk about preference it's better to reflect as a part of the asset because safety and environmental devices generally have a useful life of more than 1 year.

1st method

Treating as part of the asset

Profit and Loss Statement(Memorandum)

Depreciation 5000

Net Profit/(loss) (5000)

Balance Sheet(Memorandum)

Other Equity 95000 Fixed Asset 100000

Accumulated Depreciation 5000

2nd Method

Treating it as an expense

Profit & Los Statement(Memorandum)

Safety and Environmental Devices 100000

Net Profit/(Loss) (100000)

    Balance Sheet(Memorandum)

Other Equity (100000)

By considering the above example we can see the difference between above-used methods and in the subsequent years under the second method there will be no calculation related to this because it was already treated as an expense and in second method depreciation will be charged similarly as the earlier years