PPE, IA, Inventory and other current assets –revisionAdvanced AccountingFall 2014

Agenda

• Property, Plant and Equipment – IAS 16• Impairment of PPE – IAS 36• Borrowing costs – IAS 23• Intangible assets – IAS 38• Inventory – IAS 2

PPE – IAS 16Property, plant and equipment are tangible items that:• are held for use in the production or supply of goods or

services, for rental to others, or for administrative purposes• are expected to be used during more than one period.Tangible items have physical substance and can be touched.

An item of property, plant and equipment should be recognised as an asset when:– it is probable that future economic benefits associated with the asset will flow to the entity– the cost of the asset can be measured reliably.

Measurement on initial recognition

A tangible noncurrent asset should initially be measured at its cost. Its cost comprises:

• its purchase price

• any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management, i.e. it is ready for use (whether or not it is actually in use)

• the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located. This might apply where, for example, an entity has to recognise a provision for the cost of decommissioning an oil rig or a nuclear power station.

Measurement on initial recognition – con`d

Directly attributable costs include commissioning costs (e.g. sea trials for a ship, testing a computer system before it goes live).The following costs, specifically identified, should never be capitalised:

• administration and general overheads• abnormal costs (repairs, wastage, idle time)• costs incurred after the asset is physically ready for use• costs incurred in the initial operating period (e.g. initial operating losses and any further costs incurred before a machine is used at itsfull capacity)• costs of opening a new facility, introducing a new product (includingadvertising and promotional costs) and conducting business in anew location or with a new class of customer (including trainingcosts)• costs of relocating/reorganising an entity’s operations

Subsequent costWhere additional costs are incurred after the asset becomes operational, the entity applies the normal recognition principle for assets: is it probable that future economic benefits will flow to the entity?

The costs of day-to-day servicing (repairs and maintenance) should not be capitalised; rather than increasing economic benefits, they protect those expected at the time of the initial capitalisation. Instead, they should be recognised in profit or loss as they are incurred.

In contrast, the cost of replacing parts of items of property, plant and equipment is normally capitalised as it meets the recognition criteria.

Measurement after initial recognitionIAS 16 allows a choice between the cost model and the revaluation model.• Under the cost model, property, plant and equipment is valued at cost

less accumulated depreciation.• Under the revaluation model, property, plant and equipment is

carried at fair value less any subsequent accumulated depreciation.• Fair value is normally open market value (not existing use value).

Depreciated replacement cost may be used where there is no reliable market value (for example, because the asset is specialised or rare).

• Revaluations must be made with ‘sufficient regularity’ to ensure that the carrying amount does not differ materially from the fair value at each reporting date.

Measurement after initial recognition – cont`d• If an item is revalued, the entire class of assets to which the

item belongs must be revalued.• If a revaluation increases the value of an asset, the increase is

disclosed as other comprehensive income and credited to other components of equity under the heading ‘revaluation surplus’ unless it reverses a previous decrease in value of the same asset that has been recognised as an expense. It should then be recognised in profit or loss. • If a revaluation decreases the value of the asset, the decrease

should be recognised immediately in profit or loss, unless there is a revaluation reserve representing a surplus on the same asset.

DepreciationAll assets with a finite useful life must be depreciated.Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life.The depreciable amount of an asset is its cost less its residual value.The residual value is the amount that the entity would currently obtain from disposal, net of selling costs, if the asset were already of the age and in the condition expected at the end of its useful life.

Depreciation• IAS 16 does not prescribe a depreciation method, but the method used must

reflect the pattern in which the asset’s future economic benefits are expected to be consumed.

• Depreciation begins when the asset is available for use and continues until the asset is derecognised, even if it is idle.

• If an asset is measured at historical cost, the depreciation charge is based on historical cost.

• If an asset has been revalued, then the depreciation charge is based on the revalued amount.

• The residual value and the useful life of an asset should be reviewed at least at each financial year-end and revised if necessary.

• Depreciation methods should also be reviewed at least annually.• Any adjustments are accounted for as a change in accounting estimate under IAS

8 Accounting policies, changes in accounting estimates and errors, rather than as a change in accounting policy. This means that they are reflected in the current and future statements of profit or loss and other comprehensive income.

Depreciation of separate componentsCertain large assets are in fact a collection of smaller assets, each with a different cost and useful life.

DerecognitionAssets are derecognised either on disposal; or when no future economic benefits are expected from their use or disposal.• The gain or loss on derecognition of an asset is the

difference between the net disposal proceeds, if any, and the carrying amount of the item.• When a revalued asset is disposed of, any revaluation

surplus may be transferred directly to retained earnings, or it may be left in equity under the heading revaluation surplus. The transfer to retained earnings should not be made through the statement of comprehensive income.

DisclosuresThe following should be disclosed for each class of property, plant and equipment:• the measurement bases used for determining the gross carrying amount• the depreciation methods used• the useful lives or the depreciation rates used• the gross carrying amount and the accumulated depreciation (aggregated

with accumulated impairment losses) at the beginning and end of the period

• a reconciliation of the carrying amount at the beginning and end of the period showing: additions; disposals; increases or decreases resulting from revaluations and from impairment losses; depreciation; and other changes.

If items of property, plant and equipment are stated at revalued amounts, information about the revaluation should also be disclosed.

Impairment of assets - IAS 36Impairment is a reduction in the recoverable amount of an asset or cash generating unit below its carrying amount.An entity should carry out an impairment review at least annually if:• an intangible asset is not being amortised because it has

an indefinite useful life• goodwill has arisen on a business combination

Otherwise, an impairment review is required only where there is evidence that an impairment may have occurred.

Indications of impairmentIndications that an impairment might have happened can come from external or internal sources.• External sources of information• Internal sources of information

Calculating an impairment lossAn impairment occurs if the carrying amount of an asset is greater than its recoverable amount.

The recoverable amount is the higher of fair value less costs to sell and value in use.

Fair value less costs to sell is the amount obtainable from the sale of an asset in an arm’s length transaction between knowledgeable, willing parties, less the costs of disposal.

Value in use is the present value of future cash flows from using an asset, including its eventual disposal.

Example 1An item of plant is included in the financial statements at a carrying amount of $350,000. The present value of the future cash flows from continuing to operate the plant is $320,000. Alternatively, the plant could be sold for net proceeds of $275,000.What is the recoverable amount?Is the plant impaired?

SolutionThe recoverable amount is determined taking the greater of net selling costs and value in use. Net selling costs are $275,000 and value in use is $320,000 so the recoverable amount is $320,000.

To determine whether the plant is impaired, the carrying amount is compared to the recoverable amount. The carrying amount at $350,000 is greater than the recoverable amount, so the asset must be written down to its recoverable amount. Therefore, the impairment loss is $30,000.

Recognising impairment losses in the financial statementsAn impairment loss is normally charged immediately in the statement of profit or loss and other comprehensive income to the same heading as the related depreciation (e.g. cost of sales or administration).• If the asset has previously been revalued upwards, the

impairment is recognised as comprehensive income and is debited to the revaluation reserve until the surplus relating to that asset has been exhausted. The remainder of the impairment loss is recognised in the profit or loss.• The recoverable (impaired) amount is then depreciated

over its remaining useful life.

Example 2At 1 January 2013 a noncurrent asset had a carrying amount of $20,000, based on its revalued amount, and a depreciated historical cost of $10,000. An impairment loss of $12,000 arose in the year ended 31 December 2013.

How should this loss be reported in the financial statements for the year ended 31 December 2013?

SolutionA loss of $10,000 ($20,000 – $10,000) is recognised as other comprehensive income and debited to the revaluation surplus within other components of equity. The remaining loss of $2,000 is recognised as an expense in the period.

Borrowing costs – IAS 23Interest should only be capitalised if it relates to the acquisition, construction or production of a qualifying asset, i.e. an asset that necessarily takes a substantial period of time to get ready for its intended use or sale.• The interest capitalised should relate to the costs

incurred on the project and the cost of the entity’s borrowings.• The total amount of finance costs capitalised during

a period should not exceed the total amount of finance costs incurred during that period.

Borrowing costs – cont`dInterest should only be capitalised while construction is in progress.• Capitalisation of borrowing costs should commence when:– expenditure for the asset is being incurred– borrowing costs are being incurred– activities that are necessary to get the asset ready for use are in progress.Capitalisation of finance costs should cease when substantially allthe activities that are necessary to get the asset ready for use arecomplete.• Capitalisation of borrowing costs should be suspended duringextended periods in which active development is interrupted.• When construction of a qualifying asset is completed in parts andeach part is capable of being used while construction continues onother parts, capitalisation of finance costs relating to a part shouldcease when substantially all the activities that are necessary to getthat part ready for use are completed.

Borrowing costs – cont`dDisclosure requirementsThe financial statements should disclose:• the accounting policy adopted for

borrowing costs• the amount of borrowing costs capitalised

during the period• the capitalisation rate used.

Intangible assets – IAS 38An intangible asset is an identifiable nonmonetary asset without physical substance.An intangible asset should be recognised if all the following criteria are met.• It is identifiable.• It is controlled by the entity (the entity has the power to obtain

economic benefits from it).• It is expected to generate future economic benefits for the entity.• It has a cost that can be measured reliably.These recognition criteria apply whether an intangible asset is acquired externally or generated internally.

MeasurementWhen an intangible asset is initially recognised, it is measured at cost. After recognition, an entity must choose either the cost model or the revaluation model for each class of intangible asset.• The cost model measures the asset at cost less

accumulated amortisation and impairment.• The revaluation model measures the asset at fair

value less accumulated amortisation and impairment.

AmortisationAn entity must assess whether the useful life of an intangible asset is finite or indefinite.• An asset with a finite useful life must be amortised on a

systematic basis over that life. Normally the straightline method with a zero residual value should be used. Amortisation starts when the asset is available for use.• An asset has an indefinite useful life when there is no

foreseeable limit to the period over which the asset is expected to generate net cash inflows. It should not be amortised, but be subject to an annual impairment review.

Research and development expenditure• Research is original and planned investigation

undertaken with the prospect of gaining new scientific or technical knowledge and understanding.• Development is the application of research

findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use.

Inventories - IAS 2Inventories are measured at the lower of cost and net realisable value.Cost includes all purchase costs, conversion costs and other costs incurred in bringing the inventories to their present condition and location.Net realisable value is the expected selling price less the estimated costs of completion and sale.

Inventories – con`d• IAS 2 Inventories allows three methods of arriving at cost:– actual unit cost– firstin, firstout (FIFO)– weighted average cost (AVCO).

• The same method of arriving at cost should be used for all inventories having similar nature and use to the entity. Different cost methods may be justified for inventories with different nature or use.

• Entities should disclose:– their accounting policy and cost formulas– total carrying amount of inventories by category– details of inventories carried at net realisable value.

Example 3(a) Materials costing $12,000 bought for processing and assembly for a profitable special order. Since buying these items, the cost price has fallen to $10,000.

(b) Equipment constructed for a customer for an agreed price of $18,000. This has recently been completed at a cost of $16,800. It has now been discovered that, in order to meet certain regulations, conversion with an extra cost of $4,200 will be required. The customer has accepted partial responsibility and agreed to meet half the extra cost.

How should the following be valued?

Solution(a) Value at $12,000. The $10,000 is irrelevant. The rule is lower of cost or net realisable value, not lower of cost or replacement cost. Since the materials will be processed before sale there is no reason to believe that net realisable value will be below cost.(b) Value at net realisable value, i.e. $15,900 (contract price $18,000 – constructor’s share of modification cost $2,100), because this is below cost.

Non-currentassets held for sale (IFRS 5)A noncurrent asset or disposal group should be classified as ‘held for sale’ if its carrying amount will be recovered principally through a sale transaction rather than through continuing use.A disposal group is a group of assets (and possibly liabilities) that the entity intends to dispose of in a single transaction.• IFRS 5 applies to disposal groups as well as to individual noncurrent

assets that are held for sale.• A disposal group may include goodwill acquired in a business

combination if the group is a cashgenerating unit to which goodwill has been allocated (IAS 36).

• Subsidiaries acquired exclusively with a view to resale are classified as disposal groups held for sale if they meet the conditions below.

Non-currentassets held for sale (IFRS 5)IFRS 5 requires the following conditions to be met before an asset or disposal group can be classified as ‘held for sale’.• The item is available for immediate sale in its present condition.• The sale is highly probable.• Management is committed to a plan to sell the item.• An active programme to locate a buyer has been initiated.• The item is being actively marketed at a reasonable price in

relation to its current fair value.• The sale is expected to be completed within one year from the

date of classification.• It is unlikely that the plan will change significantly or be

withdrawn.

Measurement of assets and disposal groups held for saleItems classified as held for sale should be measured at the lower of their carrying amount and fair value less costs to sell.• Where fair value less costs to sell is lower than carrying

amount, the item is written down and the write down is treated as an impairment loss.

• A gain can be recognised for any subsequent increase in fair value less costs to sell, but not in excess of the cumulative impairment loss that has already been recognised, either when the assets were written down to fair value less costs to sell or previously under IAS 36.

• An asset held for sale is not depreciated, even if it is still being used by the entity.

Example 4On 1 January 2010 AB acquires a building for $200,000 with an expected life of 50 years. On 31 December 2013 AB puts the building up for immediate sale. On that date the building has a market value of $220,000 and expenses of $10,000 and tax of $5,000 will be payable on the sale. Describe the accounting for this building.

SolutionUntil 31 December 2013 the building is a normal non-current asset governed by IAS 16, being depreciated at $200,000 / 50 = $4,000 pa. The carrying amount at 31 December 20X4 is therefore $200,000 / (4 ×$4,000) = $184,000.

On 31 December 20X4 the building is reclassified as a noncurrent asset held for sale. It is measured at the lower of carrying amount ($184,000) and fair value less costs to sell ($220,000 – $10,000 = $210,000). Note that any applicable tax expense is excluded from the determination of costs to sell.

The building will therefore be measured at 31 December 20X4 at$184,000.

Presentation in the statement of financial positionIFRS 5 states that assets classified as held for sale should be presented separately from other assets in the statement of financial position. The liabilities of a disposal group classified as held for sale should be presented separately from other liabilities in the statement of financial position.• Assets and liabilities held for sale should not be offset and

presented as a single amount.• The major classes of assets and liabilities classified as held for sale

must be separately disclosed either on the face of the statement of financial position or in the notes.

• Where an asset or disposal group is classified as held for sale after the reporting date, but before the issue of the financial statements, details should be disclosed in the notes (this is a non-adjusting event after the reporting date).

Questions ?