Inventory to PPE

Discussion in 'Technical Queries' started by Anthony Norton, Nov 17, 2016.

  1. Anthony Norton

    Anthony Norton

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    Hi all,

    New to accounting, but dealing with a couple of accounting projects in my company. Scenario goes like this:

    Our firm sells some products to dealers. After the product is consumed, the packaging material is bought back by our company for recycling purposes. These recyclable packaging materials have always been treated as Inventory in our reporting, but now we intend to convert them to Property Plant and Equipment. These materials are depreciable. We use IFRS. What is the accounting treatment going forward and how do we reconciliate the conversion to PPE from Inventory?
     
    Anthony Norton, Nov 17, 2016
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  2. Anthony Norton

    Fidget VIP Member

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    Presumably these materials are now going to be consumed within the business rather than held for use as part of the sale of a product, in which case you're just reclassifying the materials from Inventories to PPE.

    So you're going to credit inventories and debit PPE with the value of the materials. The value should probably be whatever the inventory value is since that should already be cost or net realisable value, so that will become the 'cost' in PPE.

    Going forward, a decision needs to be taken over the useful life of the 'new' PPE and chosen method of depreciation which should be applied from the date the reclassification takes place.
     
    Fidget, Nov 17, 2016
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  3. Anthony Norton

    Anthony Norton

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    Sorry, I should have made myself clearer. When we buyback the packaging material, we recycle them by repackaging the consumable product in them, before selling again. The whole process repeats. Will there be any difference to your approach as mentioned above? Also, do you mind also advising upon how the accounting treatment will be like after the conversion? I.e all relevant accounts like Accounts Receivables, COGS etc. I know this may seem basic but I really am still picking up the fundamemtals. Thanks so much.

     
    Anthony Norton, Nov 17, 2016
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  4. Anthony Norton

    Fidget VIP Member

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    erm.. yes, I'm afraid it does make a difference. Basically, you're currently treating the materials correctly - ie as inventories.

    You can't reclassify it to PPE as this would be to reclassify it as a non-current asset for use within the business, when it does not meet that definition because it is a material used as part of the sale of an end product. So you have to continue recording it as inventory in current assets.

    To try and clarify: If you had machinery that made this packaging, then the machinery would count as PPE, whilst the end product i.e the packing, would be classified as inventory. This is because the machinery would continue to be used in the business over its useful life, whilst the product it makes is to be sold as part of an end product.
     
    Last edited: Nov 18, 2016
    Fidget, Nov 18, 2016
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  5. Anthony Norton

    Radek Výtisk

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    Well, I have some experience from beverage industry where you use returnable packages (bottles) which you basically give to your customers and take them back from them which is a situation very similar to what you are describing.

    You should determine whether the durability of your packaging is longer that one year in which case you might be able to classify it as PPE.

    However, as this is clearly a change in accounting policy, according to IFRS you'll have to do the adjustment retrospectively, meaning that you'd have to retrospectively calculate impact on the COGS and retained earnings (quite a challenging task if you ask me).

    Let me know if you needed more details on how to approach this.
     
    Radek Výtisk, Dec 19, 2016
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  6. Anthony Norton

    Anthony Norton

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    Hi Radek,

    Thank you for your reply. Indeed, the situation is similar. I have now already created a model to measure the impact on the Profit and Loss. Basically, the deposit portion of the bottles sold should rightfully go to a deposit liability account. All this while we have parked the deposit portion in revenue, so I am now deducting the amount of deposit from revenue. Next I need to reverse Cost of Goods Sold, because PP&E does not have COGS, so that is an addition. I determined useful life to be 7 years (a calculated value), but advise from my accounting team was to assume 50% of the years already used up, so now I depreciate the materials by 3.5 years, which is a minus from the P&L. Next is the Release of deposit liability. This is when the materials are destroyed or lost in the market, so a portion of our deposit liability is now a gain on the P&L since we do not need to buyback the lost materials. Total impact to the P&L however, is about $1,000,000. I don't know if this is normal or not, because I expected the impact to be 0.

    Management has also asked for a double entry accounting treatment for inception of this conversion, which must go live by 1 Jan 2017. With only a little more than a week to the new year, I want to propose the following accounting entries:

    DR PP&E (+ve)
    CR Inventory (-ve)
    CR Deposit Liability (-ve)
    DR P&L (which actually taps on our reserves because we did not budget for this impact at all)

    The DR P&L entry is a result of summing the first 3 entries, so that it balances out. Final value for this entry is $375,000, which makes it a loss on the P&L. Going forward throughout the year, we will need to factor in revenue, COGS, depreciation and the suspense account. The reason why I am breaking up the accounting treatment is because we have decided to increase our deposit on the packaging materials (this is because with PP&E our customers do not need to pay VAT on the materials and so we can tell them that the deposit has increased). Hence we need to relook at the contracts we have with our customers and this involves a lot of communication before it can go as planned for the full accounting. For now, by 31st Dec we need to do the inception accounting.

    Again, is there anything that you find wrong with the approach so far? Once again, I have 0 experience with accounting (I am a fresh graduate with a chemical engineering degree), but I am reading up a lot, so please point out if I have overlooked anything. I am bothered particularly by the $1,000,000 gain impact to the P&L.
     
    Anthony Norton, Dec 20, 2016
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  7. Anthony Norton

    Radek Výtisk

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    Well, in order to get it right, let's first look at what it would look like if you just bought the new packaging in 2016:

    Let's assume that it cost $ 1,000

    So, you would make following double entry:

    Dr PPE $ 1,000
    Cr Cash/Liability $ 1,000

    Now, let's assume that you want to depreciate these over 3.5 years as you said. So in 2016, you would make this entry:

    Dr Depreciation charge $ 285.71
    Cr PPE (accumulated dep'n) $ 285.71

    I don't know where do you account for depreciation in P&L, some companies do it to Admin expenses, some put in in CoS, I've seen it in multiple places. But basically, what matters is the amount.

    Now, let's assume that your customers bought products that needed all those packagings. CoGS were $ 500 and you sold it for $ 1,000. Now, you also wanted a deposit against those packages, so following entries will be made (neglecting VAT for this moment):

    Dr Cash $ 2,000
    Cr Sales $ 1,000
    Cr Received deposits $ 1,000

    Dr CoGS $ 500
    Cr Inventory $ 500

    Well, the question is, what entries did you make for the first part in the past, you should find out and let me know, we can then think of a corrective entries. Note one thing, that the received deposits should not be adjusted, they are separate transaction.
     
    Radek Výtisk, Dec 20, 2016
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