Author Archives: Karl

Leasing or capitalizing?

There are some people and companies that prefer leasing over owning assets. For the purpose of the argument, we do mean operational lease and not finance lease in here. It’s ownership versus renting.
I guess it comes down to priorities. Whether it’s important for you to own the asset and not worry about cash or simply rent it and pay for it as a regular service you’d buy. One option gives you the ownership but also all the accompanying risks, but doesn’t result in a regular cash outflows. The other option means you’ve got minimal risks and none relating to ownership, but you do have to pay a sum of money each period.

Pro capitalizing people would say that owning an asset gives you the freedom to use it whenever however and modify it as you see fit. They’d also say that not having to worry about regular cash outflows is a huge bonus.
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But PPE increases my expenses significantly!

Does it really? Fact of the matter is that buying a PPE item as I was once announced by one of my surprised friends requires one-off investment in terms of cash whereas renting it means you’re tied to cash outflows for a longer period. This friend of mine in fact thought that buying the asset would result in a one-off expense on the accounts as well. Little did he know that the asset is an investment and depreciated into expenses over a period in time which he got to determine.

Yes, indeed, PPE items do generate expense into the accounts, but the significance of those is entirely up to you really. For how long you think you’ll use the asset? Continue reading →

Replacing parts of a PPE item

Be it components with different useful lives that are to be replaced or some parts of the main item – the treatment is the same.

Your first course of action is to take off the fully depreciated or broken component from the balance sheet. With components that are capitalized separately it’s easier in a way that they already have their cost price and depreciation whilst just broken components which are capitalized as a part of the item there’s one more thing that needs to be done – setting their cost price and accumulated depreciation. How it’s done is relatively easy really.
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PPE components – different useful lives

Property, plant and equipment items are always capitalized with setting a few specific considerations to them alongside with the accounting entry itself. Amongst other things the information set includes also something called a useful life. When we’ve already talked about the meaning behind the useful lives and how they’re used, there’s a little bit more to it that we’d like to share with you.

Namely when you think about bigger machinery and something that does indeed include replaceable components which on their own are also significant of value and do last longer than 12 months, but just not as long as the whole item would. How would you treat those components?
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Not sure I have to pay, what should I do?

Every now and then there are situations which may but may also not result in expenses for the company. It’s called uncertainty and something to measure it is called probability.

In a situation where it’s unsure whether you have to pay anything or not, it’s really difficult to recognize the balance in the accounts as such. In a situation where it’s probable the amount is due, you recognize a provision in the accounts. However, if you believe it’s more unlikely than likely (i.e. the probability is less than 50%), you do not recognize the amount in the accounts. So, as you might have guessed, your first course of action is do assess the probability – it’s all an estimation so there really isn’t a right or wrong answer. What the management estimates, is their decision. Just make sure it’s based on reasonable assumptions and accurate information.
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What should I do with a financial support promise received from another company?

In a situation where your company is facing some potential financial difficulties or is going to face a possible liability that’s so big if paying it, it would mean bankruptcy, there’s an option to receive a promise from the owners or similar to get full financial support if a situation arises. Essentially what’s done, is an agreement between two parties where one side promises to support and the other is agreeing and acknowledging the receipt of such support.

Depending on the reason the support was given – either as something to assure your creditors or some particular financial institution, the first thing you should do, is make sure that the appropriate party is informed of such a support. It’s needless to say I presume that you won’t go about and advertise it publicly, but if asked and if questioned, you’d say that to the other party. It could be that financial institutions or auditors who have suggest for such a support letter, may ask for a copy.
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Figures in the report were misstated

Questions to be asked – By how much? Which figures? Are they in the main statements or notes? Are they cross-referenced to a note that has the right figures? etc.

No, there isn’t a rule of thumb or a guideline with a percentage of some such about how and what is material. Whether a figure is misstated significantly is entirely up to the management to decide. Where does their limit of “material” stand? As always, it’s pretty much along the lines what the readers of the report would find significant and what would alter their decisions. If the misstatement is potentially at a scale that can mislead the investors, owners or suppliers in their actions and decisions, it’s worthwhile to amend the accounts in the annual report or information therein.
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