How even Inc. is a private company that expects to "go public" and become publicly traded soon. Accordingly, it expects to be adopting IFRS by 2014. 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 the 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 on the transition to IFRS.
1. The first 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 that the company, on transition at January I, 2014, can 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, 2014 (debt is expected to be $ 1,700 million):
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 on the balance sheet, income statement, bonuses, and the debt to fixed asset covenant.