[MUSIC] In this class, we will focus on the problem of the recognition in the balance sheet of tangible assets. Actually, if you look at the structure of the asset section, we can see that non-current assets are those assets that provide value for the company for a period of time which is higher than one year. This idea of providing value for the company for more than one year poses a problem for the recognition, not only In the moment in which they are purchased, but also in the years that follow the first one. And international accounting standards provide some details on how to recognize non-current assets also in the years subsequent to the initial recognition. And in this class, we will provide the example and we will detail how tangible assets with specific reference to property, plant and equipment are recognized within the balance sheet. But pay attention, because this problem of recognition is also the same for intangible and financial assets. So what we are going to discuss for this property, plant and equipment is also the same for the other two categories of non-current assets. The reason why we focus on property, plant and equipment is because if we consider a manufacturing company, this is one of the most relevant element within the overall balance sheet. As I said, in the moment in which the company purchases a property, a plant or an equipment, there is a problem of recognition of this resource within the balance sheet. So we have the problem of recognition of the initial value. This is really simple, because the recognition of the initial value happens at the cost. So basically, the purchasing cost is the cost which is recognized the first time in the moment in which the resource is purchased by the company. The problem arises in the moment in which we need to recognize these assets in the moment subsequent to the initial recognition. And following international accounting standards, we have two main alternatives. The first alternative is to use the so-called cost model, while the second alternative is sort of what is defined as revaluation model. Now we're going to discuss how we can recognize assets, in this case, property, plant and equipment, by using both of the approaches. If a cost model is adopted, the value that is recognized in the balance sheet is calculating by adopting the following formula. It is calculated as the difference between the cost, where the cost is exactly this initial value, minus the accumulated depreciation. This difference between the cost and the accumulated depreciation represents the value of property, plant and equipment that is recognized into the balance sheet. What is the depreciation? The depreciation can be defined as the loss of value of an asset because of its usage over time. The depreciation is based on the idea that the more a company is using a certain asset, the lower the value of the asset itself. So for example, If we think of this equipment. So we have the equipment that is used by the company. The company purchases the equipment in the year 1 and then in the year 2, the value of the equipment will be lower because it will be damaged. At the same time, if we move to the year 3, the equipment will be even more damaged, and that's the reason why its value is lower. It is the same if we think of a car. If you purchase a car, and if you want to resell a car after some years, the value of the car will be lower. So the depreciation is an expense that is recognized into the income statement, which is used to say that basically the more we are using an asset, the lower the value. So the annual loss of value of an asset enter the balance sheet and it is defined as depreciation. There are different approaches for calculating the depreciation. One of the most common approaches for calculating it is to calculate the depreciation by adopting what is defined as straight line approach. So the depreciation is calculated as the ratio between the initial cost, so again the same initial value, divided by the useful life. The useful life represents the number of years for which a company is willing to use a certain asset. If we think, for example, to this equipment, the useful years could be three. So the ratio between the cost and the useful life will give rise to the depreciation. Again, this depreciation is a constant value that enters the annual income statement. While the difference between the cost and the accumulated depreciation represents the value of property, plant and equipment that is recognized within the balance sheet in the measurement subsequent to the initial recognition. Now, we are going to discuss what happens if instead a revaluation model is adopted. If the revaluation model is adopted, the value of property, plant and equipment that is recognized within the balance sheet is the fair value. What is the fair value? The fair value can be defined as the market value, so the value at which a certain resource can be exchanged in the market between the two parties. Of course, the fair value can be higher or lower with respect to the value that we have recognized within the balance sheet, where this value is defined as book value. So usually, once the fair value is recognized in the balance sheet, it is required to calculate the delta as the difference between the fair value and the book value. We can have two different cases, the case in which this delta is higher than zero. This means that the fair value, so the market value, is higher with respect to the book value. So this delta, this difference, is recognized within the balance sheet in the shareholders equity within an element which is defined as revaluation reserve. To say that shareholders have an additional right that is represented by this revaluation reserve. But of course, it can happen that the fair value is lower with respect to the book value. So in the moment in which this delta is lower than zero, in this case, this difference is recognized within the income statement as an expense. As an expense for the portion that exceeds the amount which is recognized in the revaluation reserve. Of course, we can also have the case in which this delta is equal to zero. So in this case, we go back to the previous case of the cost approach, because the fair value equals the book value. Pay attention, because even though we are using a revaluation approach, the depreciation is required. So again, the depreciation should be calculated. In this case, the depreciation is not calculated by considering the cost, but by considering the fair value. And again, the depreciation of the year enters the income statement. Both approaches are allowed by the international accounting standard. So the company can decide either to use the cost approach or to use the revaluation model. What is necessary is that the approach that is adopted should be specified in the notes to the financial statement. [SOUND]
