Howeven Inc. is a private company that expects to "go public" and become publicly traded soon. Accordingly, it expects to be adopting IFRS by 2017. It is a manufacturing company with extensive investments in property, plant, and equipment. The company currently has a profit sharing plan that is based on 30% of earnings after depreciation, but before interest and taxes. There is also a debt to fixed asset ratio covenant that must be maintained for the bank loan.

The controller has been learning about IFRS and has determined that there are three different treatments that the property, plant, and equipment can have upon the transition to IFRS.

1. The first option is to continue using the cost model, as the company has been doing. The company currently uses the straight-line method of depreciation for all of its assets.

2. The second option is for the company, on transition at January 1, 2017, to elect to revalue all of its property, plant, and equipment to fair value. This is a one-time increase in value that is allowed for first-time adopters of IFRS. The company would still use the cost model to depreciate this new value (which becomes the deemed cost) in subsequent years.

3. The third option is to adopt the revaluation model for just the "property and plant" assets. The company would continue to use the cost model for the equipment, as fair market values are not readily available for this type of asset.

The controller has estimated the following numbers at January 1, 2017 (debt is expected to be $1,700 million):

Instructions
You are the Vice-President Finance and must prepare a memo to the board explaining these options. Using the numbers in the table to assist you, discuss the implications of the three options for the balance sheet, income statement, bonuses, and the debt to fixed asset covenant.

Transcribed Image Text:

Remaining Useful Life Estimated Fair Value Carrying Amount at Jan. 1, 2017 Property and plant 25 years $%2,500 million $3,250 million 10 years $1,300 million $1,400 million Equipment