Accounting Costs
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Part A
a) When looking at if we should capitalize the costs incurred to comply with government standards, we should first look at the measurement of a capital asset as per the CICA handbook section 3061. The part that pertain to this case from the handbook section is 3061.17 where “the cost of an item of property, plant and equipment includes installation costs including architectural, design and engineering fees, legal fees, survey costs, site preparation costs, freight charges and transportation insurance costs, duties and testing and preparation costs.” Furthermore the section discusses betterments to assets and how they are defined and if they should be capitalized. The section defines a betterment as “the cost incurred to enhance the service potential of an item of property, plant or equipment.” A betterment would include the following; when there is an increase in the previously assessed physical output or service capacity, operating costs are lowered, the life or useful life is extended, or the quality of output is improved. The section than states the cost incurred in the maintenance of the service potential of an item of property, plant and equipment is a repair, and not a betterment. The case states that the company must purchase landfill sites to dump the waste and then they must cover once they are full and then watch to make sure that there will no damage to the environment for 30 years. It then states that they have to measure the greenhouse emissions and send the results into the Department of Natural Resources. As far as the greenhouse emissions testing it would not be appropriate to capitalize these costs. After the above definition of cost capitalized in section 3061, the greenhouse emission testing does not fit into the definition as stated. The environmental expense is simply a cost that the company must incur to continue on with its day to day operations. It should not be capitalized nor is it a betterment to the existing assets that the company has to complete its business operations. However, the landfill site is a cost that should be capitalized as per section 3110 of the CICA handbook. In this section it discusses an asset retirement obligation, which it defines as “a legal obligation associated with the retirement of a tangible long-lived asset that an entity is required to settle as a result of an existing or enacted law, statute, ordinance, or written or oral contract or by legal construction of a contract under the doctrine of promissory estoppel.” The section discusses the recognition of this obligation and that it should be amortized as it is capitalized in the cost of the asset. Since the landfill is mandatory as per the environmental regulation, they must monitor the site for 30 years after it is full to make sure there is no environmental damage. Therefore it is a legal obligation by a statue, and therefore as per GAAP and the CICA handbook should be capitalized.
Part B
The $100,000 site closing provision was calculated as follows:
300,000 tons (Thunder Bay)
500,000 tons (Vaughan)
800,000 tons
800,000 tons/ 1000 tons * $125
=$100,000
This is not appropriate according to GAAP because they did not recognize the fair value of the liability for an asset retirement obligation in the period in which it was incurred if they have a reasonable estimate of fair value which is the $125 per ton. This is the rule according to section 3110.05. As well, section 3110.11 states that a liability for the ARO is incurred for more than one reporting period, and for landfill sites it is incurred every time waste is incurred in that period. The above method only recorded the cost of the two landfill site that is to be retired in the current period. The bottom line is that if a company knows they must retire the asset they must set up an ARO in that period and not just when the asset is being closed.
The proper method to account for the site closing costs is as follows:
8,000,000 tons / 1000 tons * 125
=$1,000,000
Present Value= 1,000,000 / (1.05^10)
= $613,913
The information was known that currently there is about 8,000,000 tons of waste in the used landfill sites and that there are 10 years remaining in the sites useful life. From that information and from our estimated $125 per 1000ton cost we can figure out the present value of the ARO. The proper method has an ARO liability of $613,913 and increases their landfill site asset by $613,913. Their incorrect method shows a site provision liability of $100,000 when it should be showing $613,913 making their liabilities understated by $513,913. It is unclear where the other half of the $100,000 entry was made but from what is seen their asset turnover ratio has decreased. The company is ignoring all other obligations with the other landfill sites knowing they must be retired at an estimated cost and they are decreasing their liabilities because of this. The financial statements are misleading in that sense which make them seem like they have less obligations in that period.
Part C
The events indicating that the carrying amount of landfill sites may not be recoverable are; operating costs have increased by 10% over the past three years, general and administrative expenses have increased due to environmental regulations, and revenues have decreased due to an increase in the local competition.
Kingston
1. Recoverability test
Future Cash Flows from Assets:
Revenue = (collection revenue + disposal revenue) * # of tons transported
Rev = ($35 + $40) * 7 500
= $562 500
Less future expenses = (collection expense + disposal expense) * # of tons
Exp = ($30 + $25) * 7 500
= ($412 500)
Less Maintenance Costs = Annual Maintenance cost
Maintenance Cost = ($20 000)
Annual Gross Profit (AGP) = Revenues Ð- Expenses Ð- Maintenance Cost