ACCA paper f 7 financial reoirting F7FR session07 d08

Ü Useful life is either the period of time over which an asset is expected to be used, or the number of production or similar units expected to be obtained from the asset.. Ü Residual v

OVERVIEW

Objective

Ü To prescribe the accounting treatment for tangible non current assets

RECOGNITION

Ü Scope

Ü Exclusions

Ü Definitions

DISCLOSURE

INTRODUCTION

SUBSEQUENT COSTS

Ü Criteria

INITIAL MEASUREMENT

AT COST

Ü Running costs

Ü Part replacement

Ü Major inspection or

overhaul costs

Ü For each class

Ü Others

Ü Items stated at

revalued amounts

Ü Encouraged

Ü DERECOGNITION

RECOVERY OF CARRYING AMOUNT

DEPRECIATION REVALUATIONS

MEASUREMENT AFTER RECOGNITION

Ü Accounting policy

Ü Cost Model

Ü Revaluation Model

Ü Fair value

Ü Frequency

Ü Accumulated

Depreciation

Ü Increase/decrease

Ü Accounting standards

Ü Depreciable amount

Ü Depreciation methods

Ü Non depreciation

Ü Impairment

Ü Compensation

Ü Accounting treatment

Ü Derecognition date

Ü Components of cost

Ü Exchange of assets

1 INTRODUCTION

1.1 Scope

Ü This standard shall be applied in accounting for property, plant and equipment except when another IFRS requires or permits a different treatment

1.2 Exclusions

Ü IAS 16 does not apply to

̌ biological assets that relate to agricultural activity (IAS 41)

̌ mineral rights and reserves such as oil, natural gas and similar non-regenerative resources

1.3 Definitions

Ü Property, plant and equipment are tangible assets that:

̌ are held for use in the production or supply of goods or services or for

rental or for admin purposes and

̌ are expected to be used during more than one period

Ü Depreciation is systematic allocation of depreciable amount of an asset over

its useful life

Ü Depreciable amount is the cost (or other amount substituted for cost) less its

residual value

Ü Useful life is either the period of time over which an asset is expected to be

used, or the number of production or similar units expected to be obtained

from the asset

Ü Cost is the amount of cash/cash equivalents paid or the fair value of other

consideration given to acquire an asset at the time of its acquisition or

construction

Ü Residual value is the estimated amount that an entity would currently

obtain from the disposal of the asset, after deducting the estimated costs of

disposal, if the asset were already of an age and in the condition expected

at the end of its useful life

Ü Fair value is the amount for which an asset could be exchanged between

knowledgeable, willing parties in an arm’s length transaction

Ü Carrying amount is the amount at which an asset is recognised in the

statement of financial position after deducting any accumulated

depreciation and accumulated impairment losses thereon

Ü Impairment loss is the amount by which the carrying amount of an asset

exceeds its recoverable amount

Ü Entity-specific value – The present value of the cash flows expected to arise

from the continuing use of an asset and from its disposal at the end of its

useful life

2.1 Criteria

Ü An item of property, plant and equipment shall be recognised when:

̌ it is probable that future economic benefits associated with the asset will flow to the

entity, (satisfied when risks and rewards have passed to entity), and

̌ the cost of the asset to the entity can be measured reliably

Commentary

Usually readily satisfied because exchange transaction evidencing purchase identifies

cost For self-constructed asset, a reliable measurement of cost can be made from

transactions with third parties for the acquisition of materials, labour and other inputs

used

Ü In certain circumstances it is appropriate to allocate the total expenditure on an asset to its component parts and account for each component separately

Ü Property, plant and equipment shall initially be measured at cost

3.1 Components of cost

Ü Purchase price, including import duties and non-refundable purchase taxes (after

deducting trade discounts and rebates.)

Ü Directly attributable costs of bringing the asset to location and working condition, for example:

̌ costs of employee benefits (e.g wages) arising directly from construction or

acquisition;

̌ costs of site preparation;

̌ initial delivery and handling costs;

̌ installation and assembly costs;

̌ costs of testing proper functioning (net of any sale proceeds of items produced); and

̌ professional fees (e.g architects and engineers)

̌ Borrowing costs (IAS 23 requires the capitalisation of borrowing costs related to a qualifying asset)

Ü An initial estimate of dismantling and removal costs (i.e “decommissioning”) the asset

and restoring the site on which it is located The obligation for this may arise either:

̌ on acquisition of the item; or

̌ as a consequence of using the item other than to produce inventory

3.2 Exchange of assets

Ü Cost is measured at fair value of asset received, which is equal to fair value of the asset given up (e.g trade-in or part-exchange) adjusted by the amount of any cash or cash equivalents transferred Except when:

̌ the exchange transaction lacks commercial substance; or

̌ the fair value of neither the asset received nor the asset given up is reliably

measurable

Ü Whether an exchange transaction has commercial substance depends on the extent to which the reporting entity’s future cash flows are expected to change as a result of the

transaction

Ü The issue is whether subsequent expenditure is capital expenditure (i.e to the statement

of financial position) or revenue expenditure (i.e to the profit or loss)

4.1 Running costs

Ü The carrying amount of an item of property, plant and equipment does not include the costs of day-to-day servicing of the item

Ü Servicing costs (e.g labour and consumables) are recognised in profit or loss as

incurred

Ü Often described as “repairs and maintenance” this expenditure is made to restore or

maintain future economic benefits.

4.2 Part replacement

Ü Some items (e.g aircraft, ships, gas turbines, etc) are a series of linked parts which require regular replacement at different intervals and so have different useful lives

Ü The carrying amount of an item of property, plant and equipment recognises the cost of replacing a part when that cost is incurred, if the recognition criteria are met

Ü The carrying amount of replaced parts is derecognised (i.e treated as a disposal)

Ü A common term used to describe these type of assets that have more than one major component, with different useful life, is that of a ‘complex asset’

4.3 Major inspection or overhaul costs

Ü Performing regular major inspections for faults, regardless of whether parts of the item are replaced, may be a condition of continuing to operate an item of property, plant and equipment (e.g a ship)

Ü The cost of each major inspection performed is recognised in the carrying amount, as a replacement, if the recognition criteria are satisfied

Ü On initial recognition an estimate will be made of the inspection costs and that amount will be depreciated over the period to the 1st inspection This amount is part of the original cost recognised and is not an additional component of cost

Ü Any remaining carrying amount of the cost of the previous inspection (as distinct from physical parts) is derecognised

Illustration 1

An airline is required by law to perform a major overhaul on each aeroplane’s

engines every five years The engines may be identified as assets with a

separate life from the rest of the aeroplane and written off to zero over five

years Overhaul expenditure might at first sight seem to be a repair to the

aeroplane but it is actually a replacement of the engine As such it must be

capitalised

5.1 Accounting policy

Ü An entity may choose between the cost model and the revaluation model However, the

same policy must be applied to each entire class of property, plant and equipment

Ü Classes include land, land and buildings, factory plant, aircraft, vehicles, office

equipment, fixtures and fittings’ etc

5.2 Cost Model

Ü Carry at cost less any accumulated depreciation and any accumulated impairment losses

5.3 Revaluation Model

Ü Carry at a revalued amount, being fair value at the date of the revaluation less any subsequent accumulated depreciation and any accumulated impairment losses

Ü To use this model fair values must be reliably measurable

Ü All revalued assets are still depreciated, unless the asset is land

6.1 Fair value

6.1.1 Land and buildings

Ü Market value is determined by appraisal normally undertaken by professionally

qualified valuers

6.1.2 Plant and equipment

Ü Fair value is usually market value determined by appraisal

Ü If there is no market-based evidence of fair value (e.g because items are of a specialised nature or rarely sold), fair value is estimated using:

̌ depreciated replacement cost; or

− Depreciated replacement cost is what a new equivalent asset would cost (i.e replacement cost) less depreciation Items of plant and equipment are often insured for this amount if not for replacement cost under a “new for old” policy

̌ an income approach

6.2 Frequency

Ü Revaluations must be made sufficiently regularly to ensure no material difference between carrying amount and fair value at the end of the reporting period

Ü Frequency depends on movements in fair values When fair value differs materially from carrying amount, a further revaluation is necessary

Ü Items within a class may be revalued on a rolling basis within a short period of time provided revaluations are kept up to date

6.3 Accumulated Depreciation

Ü At the date of the revaluation accumulated depreciation is either:

(i) restated proportionately with the change in gross carrying amount so that the carrying amount after revaluation equals its revalued amount;

(ii) eliminated against gross carrying amount and the net amount restated to the revalued amount

Example 1

$

Required:

Determine the accounting entries required to restate the net amount at a

revalued amount of

(a) $1,100

(b) $900

Solution

Cost

Accumulated depreciation

Net amount

$ $

Dr

Dr

Cr

$ $

Dr

Cr

Cr

6.4 Increase/decrease

Ü On an asset-by-asset basis:

̌ Increase shall be credited directly to a revaluation reserve and included within

“other comprehensive income”

̌ However a revaluation increase must be taken to profit or loss to the extent that it reverses a revaluation decrease of the asset that was previously recognised as an expense

̌ Decrease shall be recognised as an expense in profit or loss for the period

̌ However, a revaluation decrease must be charged directly against any related revaluation surplus to the extent that it is covered by that surplus

Illustration 2

An asset was purchased for $100 on the 1 January 2006 The entity has adopted

the revaluation model for subsequent measurement of the asset

Asset Revaluation

reserve Profit or loss

31.12.2006 120 20 Cr The surplus is taken to revaluation reserve

31.12.2007 105 5 Cr

A deficit is taken to the profit or loss unless it reverses a surplus held

on the asset

Again the deficit is taken to revaluation reserve but only to the extent it reverses the previously recognised surplus with the rest to profit or loss

That part of the surplus that reverses the previously expensed deficit is taken to the profit or loss The rest is taken

to revaluation reserve

Ü For simplicity annual depreciation has been excluded from this illustration However, depreciation would be charged each year before the revaluation adjustment is made

Ü The revaluation surplus may be transferred directly to retained earnings when the surplus is realised Realisation occurs as the asset is consumed or disposed of If the transfer is made over the remaining life of the asset then the transfer to retained

earnings will be an annual transfer based on the difference in depreciation charge under historical cost and the revalued amount

Ü However, it is not reclassified (i.e it is not included within profit or loss on disposal)

7 DEPRECIATION

7.1 Accounting standards

Ü Depreciable amount shall be allocated on a systematic basis over the useful life of the asset Note that the term depreciable amount is the cost or revaluation Depreciation is based on the carrying value in the statement of financial position

Ü Depreciation method, useful life and residual value must be reviewed at least at each financial year-end If expectations differ from previous estimates the change(s) are accounted for as a change in an accounting estimate in accordance with IAS 8

Ü The depreciation method shall reflect the pattern in which the asset’s economic benefits are consumed

Ü The depreciation charge for each period shall be recognised as an expense unless it is included in the carrying amount of another asset

Ü Each part of an item of property, plant and equipment that is significant (in relation to total cost) is separately depreciated

7.2 Depreciable amount

7.2.1 Useful life

Ü Factors to be considered:

̌ expected usage assessed by reference to expected capacity or physical output;

̌ expected physical wear and tear (depends on operational factors e.g number of shifts, repair and maintenance programme, etc);

̌ technical obsolescence arising from:

− changes or improvements in production; or

− change in market demand for product or service output;

̌ legal or similar limits on the use (e.g expiry dates of related leases)

Ü Asset management policy may involve disposal of assets after a specified time therefore useful life may be shorter than economic life

Ü Repair and maintenance policy may also affect useful life (e.g by extending it or

increasing residual value) but do not negate the need for depreciation

7.2.2 Depreciation period

Ü Depreciation commences when an asset is available for use

Ü Depreciation ceases when an asset is derecognised (e.g scrapped or sold), or when the asset is classed as held for sale in accordance with IFRS 5

Example 2

An asset which cost $1,000 was estimated to have a useful life of 10 years and

residual value $200 After two years, useful life was revised to 4 remaining

years Calculate the depreciation charge for each of the first three years

Solution

Year 1 Year 2 Year 3

Accumulated depreciation

_ _ _

_ _ _

Charge for year

7.2.3 Land and buildings

Ü These are separable assets and are dealt with separately for accounting purposes, even when they are acquired together

̌ Land normally has an unlimited useful life and is therefore not depreciated

̌ Buildings normally have a limited useful life and are depreciable assets

7.3 Depreciation methods

Ü Straight-line ⇒ a constant charge over useful life

Ü Reducing/diminishing balance ⇒ a decreasing charge over useful life

Ü Sum-of-the-units ⇒ charge based on expected use or output

Ü Review at least at each financial year-end and, if significant, change method Account for as a change in accounting estimate and adjust depreciation charge for current and future period