Problem
Depreciation under ASPE and IFRS (20 Marks)Realtor Inc. is a company that owns five large office buildings that are leased out to tenants. Most of the leases are for 10 years or more with renewal clauses for an additional five years. Currently, Realtor Inc. is a private company that follows ASPE. Recently Rita Mendoza was hired as the controller. Ms. Mendoza has suggested to Habib Ganem, the owner and sole shareholder of the company, that the company should consider switching to IFRS. She explained that under ASPE, the buildings are recorded at cost and then depreciated and tested for impairment when events occur that might indicate a decline in value. However, under IFRS, she explained, the buildings could be classified as investment properties and adjusted to fair value every year. In addition, there is no impact on the income statement, since no depreciation is recorded on the investment properties. Finally, Ms. Mendoza stated that there is no impairment testing required for investment properties under IFRS, so there would never be any impairment losses to be recognized. Mr. Ganem was intrigued with this idea. He had just been looking at the calculation of the bank loan covenants and had found that the company's debt to asset ratio was very close to the maximum that would be allowed. He wanted to take this year's annual financial statement, once completed, to the bank and ask for revisions on the covenants, since he was also looking at the possible purchase of some new properties. He particularly liked the idea of no depreciation having to be recorded on these assets, which would also improve the company's times interest earned ratio (calculated as Earnings before interest and taxes/Interest expense). Mr. Ganem decided to call his banker to discuss this change and get her thoughts. I
Task
You are the loan officer at the bank. What comments would you make to Mr. Ganem about the controller's suggestions? In particular, explain the impact on the balance sheet and the income statement under both the cost model and the fair value model and the resulting impact on the existing covenants. From a banker's point of view, which method for reporting the investment properties would be most useful? Make a final recommendation to Mr. Ganem.