Accounting

Accounting for Plant, Property & Equipment, and Intangible Assets (IAS 16, 20, 23, 36, 38, 40, IFRS 5)

Applicable Standards

  • IAS 16: Property, Plant and Equipment
  • IAS 23: Borrowing Costs
  • IAS 20: Accounting for Government Grants and Disclosure of Government Assistance
  • IFRS 5: Non-Current Assets Held for Sale and Discontinued Operations
  • IAS 40: Investment Property
  • IAS 38: Intangible Assets
  • IAS 36: Impairment of Assets

IAS 16: Property, Plant and Equipment

Initial Measurement

Recorded at cost

  • Included costs
    • Purchase cost (after trade discounts but before settlement discounts (e.g. for early cash payments), including transport and handling costs and non-refundable tax e.g. import duties) or direct costs if self-constructed (i.e. no indirect overheads)
    • Relevant borrowing costs
    • Costs directly related to getting the asset ready for use
      • site preparation
      • installation
      • testing the asset
      • professional fees (legal costs, surveyors, architects, etc.)
    • Dismantling and restoration costs
  • Excluded costs
    • Maintenance contract costs. These are revenue expenses and not capital expenses.
    • Early settlement discounts are treated as Income.
    • Abnormal costs arising from errors

Subsequent Expenditure

  • Subsequent expenditure on a non-current asset that enhances economic benefits from the asset, should be capitalized.
  • If a component is replaced, the net book value of that component should be removed from Balance Sheet and the cost of the replacement capitalized and added.

Subsequent Measurements

Two choices:

  1. Cost model, i.e. cost minus accumulated depreciation (based on cost) minus accumulated impairment losses
  2. Revaluation model, i.e. revalue to fair value using open market value, depreciated replacement cost, etc.
    • Note that if the revaluation model is chosen for an asset, it must be applied to assets of the same class (e.g. land, buildings, PP&E are different classes)

Revaluation

Upwards revaluation

  • Accounting entries
    • Dr Non-Current Asset with (Revalued amount – original cost) [essentially Cr Non-Current Asset with original cost, and Dr Non-Current Asset with revalued amount]
    • Dr Accumulated Depreciation with (all accumulated depreciation associated with revalued asset) [essentially eliminating all accumulated depreciation.]
    • Cr Other Comprehensive Income (Revaluation Surplus) with (Revalued amount – carrying value)
  • Subsequent downwards revaluation
    • Dr Other Comprehensive Income (offsets the previous gain recorded in the revaluation surplus associated with this asset)
    • Dr Income Statement (if the drop in value exceeds the ‘buffer’ that existed in the revaluation surplus, the excess beyond that)
    • Cr Non-Current Asset
  • Note that IAS 16 gives a choice of whether to eliminate accumulated depreciation during a revaluation, or to restate it proportionately so that the carrying amount after revaluation equals its revalued amount.

Downwards revaluation

  • Accounting entries
    • Cr Non-Current Asset with (Revalued amount – carrying value)
    • Dr Income Statement
  • Subsequent upwards revaluation
    • Cr Income Statement (to the extent of the previous revaluation loss in the P&L associated with this asset)
    • Cr Other Comprehensive Income (if the rise in value exceeds the ‘buffer’ that existed in the P&L, the excess beyond that)
    • Dr Non-Current Asset

Depreciation of Revalued Asset

  • Depreciation is charged on the revalued amount as per normal
  • Two choices of ways to handle the Revaluation Surplus account
  • (1) Transfer directly (not through P&L) to Retained Earnings when the asset is derecognised (e.g. disposal).
  • (2) Transfer directly any “excess depreciation” from Revaluation Surplus to Retained Earnings
    • Essentially the decrease in value due to depreciation is “split” between Retained Earnings and the Revaluation Reserve, so that eventually when the asset is fully depreciated, the Revaluation Reserve would drop to zero. Essentially the depreciation amount based on the old asset value prior to revaluation, remains within the Retained Earnings (came in from P&L), while the additional excess depreciation due to the revaluation (which also came into Retained Earnings from P&L) is netted off with the Revaluation Reserve.
    • Accounting entry to transfer excess depreciation charge
      • Dr Revaluation Reserve, Cr Retained Earnings with (new depreciation based on revalued amount – old depreciation based on old asset value)

Disposal

Gain/(loss) on Disposal

  • Calculated as (Proceeds – carrying value) at date of disposal
  • Recognised in Income Statement (but not in Revenue)
  • Any remaining revaluation reserve is transferred to retained earnings, and does not go through the P&L.

IAS 23: Borrowing Costs

Eligible Costs

  • When an entity borrows money to acquire or construct a qualifying asset, the cost of the asset must include the actual borrowing costs incurred, less income from the temporary investment of the money borrowed.
  • When general company borrowings are used, the weighted average cost of interest across the general borrowings is applied.
  • The capitalization of borrowing costs (and the subtraction of income from temporary investment) is suspended during the time construction is suspended.

IAS 20: Accounting for Government Grants and Disclosure of Government Assistance

Two types of Grants

  • Capital Grants for buying assets
  • Revenue Grants for other purposes

Revenue Grants

Initial recognition

  • Dr Cash, Cr Deferred Income (liability) with the cash grant amount

Subsequent Matching of Grant with Related Expense

  • In the periods when the related expenses (i.e. expenses incurred to meet the terms of the grant) are incurred, release the grant amount into the P&L either by
    • showing the grant income as a separate line item by itself
    • showing the related expense item, net of the grant income
  • Cr Income Statement, Dr Deferred Income (liability)

Capital Grants

Two accounting treatments allowed

  1. Reduce the cost of the Non-Current Asset by the Grant amount (i.e. Dr Cash, Cr Non-Current Asset). Depreciate the net cost as per normal.
  2. Do the same as for Revenue Grants, i.e. record initially in Deferred Income, then release the Deferred Income into P&L over the useful life of the asset (just like depreciation).

Grants that Reimburse Costs Incurred Previously

  • Immediately recognise the grants in the period when they are received.

IFRS 5: Non-Current Assets Held for Sale and Discontinued Operations

Requirements to be met to be classified held-for-sale

  • Asset available for immediate sale at its present condition
  • Sale is highly probable
    • Active programme in place to find buyers
    • Actively marketed at a reasonable price
    • Management is committed to the disposal plan
  • Sale is expected to be completed within 1 year of classification as held-for-sale

Measurement of Non-Current Asset Held for Sale

  • Lower of
    • Carrying value (i.e. net book value) and
    • Fair value less costs to sell (FVLCTS)
  • No further depreciation is charged to the asset before the disposal.

IAS 40: Investment Property

Definition

  • Land or building held by the owner or by the lessee under a finance lease to
    • Earn rentals and/or
    • Capital appreciation
  • Excludes
    • Property intended for sale in the ordinary course of business (IAS 2: Inventory, e.g. home builders)
    • Property constructed for 3rd parties (IAS 11: Construction Contracts)
    • Property occupied by owner (IAS 16: Property, Plant and Equipment)
    • Property being constructed for the purposes of being an investment property after completion (IAS 16 during construction)
    • Property awaiting disposal (IFRS 5)
    • Property leased to another entity under a finance lease (IAS 17: Leases)
  • For properties held under operating leases (i.e. the company is the lessee), the company can choose whether to recognise it as an investment property.
  • Land held for indeterminate future use is an investment property where the entity has not decided that it will use the land as owner occupied or for short-term sale.

Initial Measurement

  • At cost, same as per IAS 16: Property, Plant and Equipment.

Subsequent Measurement

Two choices (choice to be applied to all properties):

  1. Cost model, i.e. cost minus accumulated depreciation (based on cost)
    • Fair value must be disclosed in notes to financial statements.
  2. Fair value model, i.e. revalue to fair value using open market value, depreciated replacement cost, etc.
    • All gains/losses are recognised in P&L, no revaluation surplus.
    • No depreciation is charged.

For property held under a Finance Lease (i.e. company is the lessee)

  • Per IAS 17: Leases, measured at the lower of
    • Fair value; and
    • Discounted present value of the expected future lease payments

For property held under Operating Lease (i.e. company is the lessee)

  • The company can choose whether to recognise it as an investment property.
  • If yes, same treatment as though it is a Finance Lease.
  • If no, per IAS 17: Leases, the property will be excluded from the Balance Sheet.

IAS 38: Intangible Assets

Definition

  • Conditions to be satisfied
    • Identifiable
      • Can be separated and sold; or
      • Cannot be separated but arises from a contractual or legal right.
    • Non-monetary
    • Asset
      • Expected future benefit that can be reliably measured
  • Excludes
    • Deferred tax assets (IAS 12: Income Taxes)
    • Leases (IAS 17: Leases)
    • Assets arising from employee benefits (IAS 19: Employee Benefits)
    • Financial assets (IAS 39: Financial Instruments)
    • Goodwill acquired in a business combination (IFRS 3: Business Combinations)
    • Non-current intangible assets classified as held for sale (IFRS 5: Non-current Assets Held for Sale and Discontinued Operations)
    • Mineral rights and expenditure on the exploration, development, extraction of minerals, oil and natural gas (IFRS 6: Exploration for and Evaluation of Mineral Assets).
  • Internally-generated intangible assets (e.g. brands, customer lists, etc.) are not recognised because they are not separable, and difficult to reliably measure (special rules apply for R&D).

Initial Measurement

  • At cost.
  • If acquired as part of a business combination, at fair value.

Subsequent Measurement

Two choices (same choice applied to the same class of intangibles):

  1. Cost Model
    • For intangible assets with finite useful life, amortize. Test for impairment if there is evidence indicating possible impairment.
    • For intangible assets with indefinite useful life, test for impairment annually.
  2. Revaluation Model
    • Only allowed if there is an active market to establish fair value

Internally Generated Intangible Assets

Accounting for Research Costs

  • Must be expensed in P&L as incurred.

Accounting for Development Costs

  • Can be capitalized provided it meets ALL of the following criteria (BEAUTI mnemonic)
    1. Benefits: Future economic benefits can be generated. E.g. how it can be used to generate benefits, or the existence of a market to sell
    2. Expenditure on the intangible asset can be reliably measured.
    3. Availability of resources to complete the development.
    4. Used or sold: Intangible asset can be sold or used
    5. Technically feasible to complete the development.
    6. Intention to complete the development then use or sell it.

Accounting for Website Development Costs

  • A website that promotes and advertises the company’s products does not meet the requirement that it will generate future economic benefits, so such costs are expensed.
  • A website that allows customers to place orders will generate future benefits, so such costs can be capitalized.

Accounting for Computer Software Development Costs

  • Software essential to the operation of the hardware is capitalized as part of the hardware cost as per IAS 16.
  • Standalone software packages will fall under IAS 38, to be put through the BEAUTI test.

Initial Recognition for Allowable Internally-Generated Intangible Assets

  • All directly attributable costs including
    • cost of materials and services
    • cost of employee benefits
    • fees to register a legal right
    • amortisation of patents and licences used
    • depreciation of equipment used
  • Does not include costs for
    • SG&A overheads
    • inefficiencies and initial operating losses
    • staff training to use asset

Goodwill (under IFRS 3: Business Combinations)

  • Not amortized,  but tested annually for impairment as per IAS 36: Impairment of Assets.
  • For negative goodwill, or ‘bargain purchase’
    • Recognise a Gain in the P&L immediately, attributable to the Owners of the Parent.
    • The amount of the gain recognised = Parent’s interest in the FV of the net assets – Parent’s cost of investment in the Sub

IAS 36: Impairment of Assets

Definitions

  • Recoverable Amount = Higher of
    • Fair value less costs to sell (FVLCTS)
      • Price in a binding sale agreement with a knowledgeable, willing party at arm’s length, less disposal costs.
      • If there is no binding agreement, use the asset’s market price in an active market less the costs of disposal.
      • If there is no active market, use the outcome of recent transactions for similar assets within the same industry.
      • If there are no market prices at all, DCF can be used. The cash flows in the DCF should reflect the expected cash flows for a typical market participant that holds the asset, not the expected cash flows of the entity doing the impairment testing.
      • Costs to sell include legal costs, stamp duty, cost of removing asset, and direct incremental cost to being an asset into condition for its sale.
    • Value in use (VIU)
      • PV of future cash flows from using the asset, including cash flows at disposal.
      • The discount rate is the required rate of return from a market participant’s perspective, and can include the price of risk and illiquidity.
      • Use of a pre-tax discount rate to discount pre-tax cash flows. In practice, a post-tax WACC is used to discount post-tax FCFF, and the pre-tax discount rate is found using goal seek.
      • Effects of any existing temporary differences and available tax losses are excluded.
      • For investment in Associates, the value in use will be the Parent’s share of the PV of future cash flows (either from operations or from dividends) and proceeds from the disposal of the investment.
  • Impairment loss = asset’s carrying value – its recoverable amount.

Scope

  • Applies to all assets except
    • Inventories (IAS 2)
    • Assets arising from construction contracts (IAS 11)
    • Deferred tax assets (IAS 12)
    • Assets arising on a pension scheme (IAS 19)
    • Financial instruments (IAS 39)
    • Investment property measured at fair value (IAS 40)
    • Biological assets measured at fair value (IAS 41)
    • Non-current assets held for sale (IFRS 5)

Impairment Testing Requirement

  • Annually for
    • Goodwill
    • Intangibles with indefinite useful lives
    • Intangibles that have not yet been used (e.g. capitalized development costs where amortization is not yet started)
  • For all assets, when there is an indication of impairment at the reporting date

Accounting Entries for Impairment Losses

  • For assets held at cost
    • Dr Income Statement (before operating profit)
    • Cr Non-Current Asset
  • For assets using revaluation model
    • Dr Other Comprehensive Income (offsets the previous gain recorded in the Revaluation Surplus associated with this asset)
    • Dr Income Statement (with any excess impairment beyond the Revaluation Surplus)
    • Cr Non-Current Asset

Reversal of Impairments

  • Scope
    • No reversal of impairment on goodwill.
    • Reversal of impairment on other assets/CGUs allowed.
    • Note that an asset’s VIU will simply increase with the passage of time due to the cash inflows becoming closer. This does not increase the service potential of the asset, so this reason by itself is not sufficient to justify a reversal of impairment.
  • Amount
    • Impairment reversal cannot result in the carrying value of the asset exceeding its carrying value had there been no impairment in the first place.
  • Accounting Treatment
    • For assets held at cost
      • Recognise immediately in P&L
    • For assets using revaluation model
      • Reversal of impairment loss is treated exactly like an upwards revaluation.
      • The reversal of any excess impairment loss originally recognised in P&L is also recognised in P&L.
      • Further reversal will be recognised in Other Comprehensive Income (i.e. increases the balance in the Revaluation Surplus Reserve).

Cash Generating Units (CGUs)

Definition

  • If it is not possible to calculate the recoverable amount for an asset (e.g. does not independently produce cash flows), then impairment testing must be performed for the CGU to which the asset belongs.
  • A CGU is the smallest identifiable group of assets (including Goodwill) that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets.

Carrying value of a CGU

  • To calculate the carrying value of CGUs, shared assets (e.g. head office, goodwill, etc.) would need to be allocated to the CGUs, e.g. to that CGU that benefits or uses it the most, or proportionately.
  • Carrying value = Directly attributable assets (tangibles and intangibles) + Net working capital + Allocated share of corporate assets + Allocated goodwill (100% basis) – Attributable liabilities (liabilities are excluded unless the recoverable amount of the CGU cannot be determined without consideration of these liabilities)

Impairment of a CGU

  • The impairment loss of a CGU needs to be allocated to the assets within the CGU.
  • This allocation of impairment loss should not reduce an asset’s value below its recoverable amount.
  • The loss is typically allocated in this order
    1. To any assets that are obviously impaired (e.g. damaged, obsolete)
    2. To goodwill allocated to the CGU
    3. To other assets (whose values can be reduced further) on a pro rata basis (i.e. reducing the values of these other assets will not cause the values to drop below their recoverable amounts. Items such as cash, receivables, and payables are usually stated at net realisable values so cannot be reduced further).

Allocation of Goodwill to CGUs

  • If goodwill cannot be allocated to individual CGUs on a non-arbitrary basis, it is tested for impairment at the lowest level within the entity at which the goodwill is monitored for internal management purposes, which may comprise a group of CGUs.

Difference Between Downwards Revaluation and Impairment [my notes]

  • Both revaluations and impairment testing can apply to the same assets.
  • Both revaluations and impairment testing are separate, on-going requirements with their own processes and rules as specified in IAS 16 and IAS 36.
  • Note that revaluations pertains to specific assets but impairment testing is applied to CGUs, which may be a single asset or which may consist of a group of assets/liabilities.
  • It is not true that impairment is applied only to assets measured using a Cost Model, while downwards revaluation is the equivalent of impairment for assets using a Revaluation Model.
  • Assets using a Revaluation Model can be impaired using the rules of impairment testing (i.e. comparing carrying value with the higher of FVLCTS and VIU).
  • Assets using a Revaluation Model can ALSO be revalued downwards using the rules of revaluation (i.e. comparing carrying value with fair value).
  • IAS 16 does not specify the frequency of revaluations. It just provides guidance to say that a revaluation is necessary if fair value differs materially with carrying value, and the larger the fair value volatility, the more frequent assets should be revalued.
  • IAS 36 does not specify the frequency of impairment test (except for a few intangibles). However it gave examples of “indications” where the asset value might have declined materially, hence impairment testing should be done, e.g. decline in asset’s market value, changes in the environment the entity is operating in, changes in market conditions, change in use of the asset, etc.
  • Think of them as two separate standards with different objectives
    • The Revaluation Model in IAS 16 aims to make the carrying value of assets representative of their fair values throughout their time in the financial statements. This is somewhat like a “mark-to-market” requirement.
    • The impairment testing requirement in IAS 36 aims to make sure that carrying values are not overstated, i.e. it acts as a ‘cap’ to to prevent companies from reporting asset values that are too high. Hence in a sense, IAS 36 does not care about whether your carrying value is understated, technically there is no impairment loss, and IAS 36 does not bother. The conditions specified in IAS 36 for when impairment testing should be done, also means that this is the standard that ensures that companies HAVE to test their asset values when there are material changes in the market environment which might cause their asset values to decline.

-END-

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Discussion

9 thoughts on “Accounting for Plant, Property & Equipment, and Intangible Assets (IAS 16, 20, 23, 36, 38, 40, IFRS 5)

  1. I have a question regarding the revaluation model for PPE.
    Suppose it’s December 31, the end of the book year.
    Book value PPE = 300 (before depreciation for this year)
    Fair value PPE = 400
    Do you first have to do the depreciation of let’s say 300/5 = 60 (assuming useful life of 5 years)
    OR will you immediately revalue the PPE to 400 without depreciating during that year?
    => So actually, my question is: How do we have to combine the depreciation and the revaluation?
    Thanks a lot in advance for your answer!

    Posted by Lien | January 14, 2013, 5:03 pm
  2. Thank you for sharing valuable information. Nice post. I enjoyed reading this post. The whole blog is very nice found some good stuff and good information here Thanks..

    Posted by santoshwebseo | January 30, 2014, 8:14 am
  3. In IAS 16, cost of PPE includes purchase cost (after trade discounts but before settlement discounts (e.g. for early cash payments)). I’d like to know why settlement discounts are not deducted because in 16.23, it is stated that the cost of an item of PPE is the cash price equivalent at the recognition date. Thanks in advance for your answer.

    Posted by Andy | June 20, 2014, 1:36 am
    • Hi Andy,

      16.23 does not contradict the exclusion of early settlement discounts from the cost (note that the early settlement discount is classified as income), rather I see 16.23 as a broad high-level statement, while the initial measurement section serves to elaborate in greater detail what specifically should / should not be included in the cost.

      Without looking at any meeting minutes, I suspect the reason why early settlement discounts are excluded is so that the cost reflected is closer to the “fair value” of the PPE.

      Imagine you have 3 companies, each of them bought Machine X. The price of Machine X was $100. Company 1 paid early and got a discount of $10. Company 2 paid slightly later, and got a discount of $5. Company 3 paid on time, and got no discount. If early settlement discount is included in the cost, then you would have Company 1 reporting the cost of Machine X at $90, Company 2 reporting it at $95, and Company 3 reporting it at $100. So all 3 sets of financial statements are showing different values for the exact same machine even though they bought at the same time and the machines are in the exact same condition. That does not make sense, keeping in mind that the higher-level goal is to reflect the “fair value” of the accounting item at the financial reporting date, which is NOT the same as recording the historical cost to the company. Hence the “fair value” of the machine is truly $100, which is what another 3rd party would need to pay when buying the machine at the same time. The different discounts obtained through early payment should not be included in the initial cost measurement and should be accounted for separately.

      Hope this helps.

      Posted by whatheheckaboom | June 21, 2014, 4:02 am
  4. Thank you for the answer. But I still don’t understand why the capitalised cost was higher than the amount we actually paid.

    Your example is quite illustrative. But some people may argue that all three companies should report the cost of the machine at $90 (which is the price less discounts available). The discounts lost should be treated as a financing expense (similar to interest expense incurred if we borrowed money to buy the machine). What do you think about this argument?

    Furthermore they argue that treating early settlement discount as income is incorrect because the matching principle would be violated. A company does not earn income by just buying the machine (without using it to generate revenue). This seems reasonable.

    In fact, I have a related question: should settlement discounts be deducted from the cost of inventories? According to IFRS, the answer is yes (FYI, it is stated in IFRIC Update Aug 2002 and is repeated in Nov 2004 issue) . But many people still treat purchases discounts (settlement discounts) as an increase in income. Can we use materiality as an explanation?

    Thanks again.

    Posted by Andy | June 23, 2014, 4:25 am
    • Hi Andy, the point is to record the fair value of an asset, not to record down the cash amount paid. Those two figures can be different. I don’t concur with the argument of “discounts lost”, I think the value without early settlement discounts more closely reflects fair value. The matching principle is on matching revenue and costs/expenses in the same period. That doesn’t apply in this case because there is no ‘revenue’ to speak of, so there is no ‘violation’.
      As you noted, settlement discounts should be deducted from the cost of inventories. Yes materiality could be a reason why the auditors allowed those to pass through, and also the local FRS may not follow IAS exactly.

      Posted by whatheheckaboom | June 30, 2014, 1:34 pm

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