Non-current assets, agriculture and inventories

Property, plant and equipment

 

 

IAS 16 Property, plant and equipment: Initial recognition

 

Definition

 

IAS 16 defines property, plant and equipment as 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’ (IAS 16, para 6).

 

Tangible items have physical substance and can be touched.

 

Initial recognition

 

An item of property, plant and equipment should be recognised as an asset when:

 

• it is probable that the asset’s future economic benefits will flow to the entity

 

• the cost of the asset can be measured reliably.

 

Property, plant and equipment should initially be measured at its cost.

 

According to IAS 16, this comprises:

 

• the purchase price

 

• costs that are directly attributable to bringing the asset to the necessary location and condition

 

• the estimated costs of dismantling and removing the asset, including any site restoration costs. 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.

 

IAS 16 says that the following costs should never be capitalised:

 

• administration and general overheads

 

• abnormal costs (repairs, wastage, idle time)

 

• costs incurred after the asset is physically ready for use (unless these costs increase the economic benefits the asset brings)

 

• costs incurred in the initial operating period (such as initial operating losses and any further costs incurred before a machine is used at its full capacity)

 

• costs of opening a new facility, introducing a new product (including advertising and promotional costs) and conducting business in a new location or with a new class of customer (including training costs)

 

• costs of relocating/reorganising an entity’s operations.

 

 

Measurement after initial recognition

 

IAS 16 allows a choice between:

 

• the cost model

 

• the revaluation model.

 

Under the cost model, property, plant and equipment is held at cost less any accumulated depreciation.

 

Under the revaluation model, property, plant and equipment is carried at fair value less any subsequent accumulated depreciation.

 

If the revaluation model is adopted, then IAS 16 provides the following rules:

 

• 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.

 

• 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 presented as other comprehensive income (and disclosed as an item that will not be recycled to profit or loss in subsequent periods) and held in a ‘revaluation surplus’ within other components of equity.

 

• 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.

 

 

 

 

Depreciation

 

All assets with a finite useful life must be depreciated. Depreciation is charged to the statement of profit or loss, unless it is included in the carrying amount of another asset.

 

IAS 16 says that depreciation must be allocated on a systematic basis, reflecting the pattern in which the asset’s future economic benefits are expected to be consumed. Depreciation methods based on the revenue generated by an activity are not appropriate. This is because revenue reflects many factors, such as inflation, sales prices and sales volumes, rather than the economic consumption of an asset. In practice, many entities depreciate property, plant and equipment on a straight line basis over its estimated useful economic life.

 

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

 

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.

 

chapter 5

 

Illustration: Change in depreciation estimates

 

An asset was purchased for $100,000 on 1 January 20X5 and straight line depreciation of $20,000 per annum was charged (five year life, no residual value). A general review of asset lives was undertaken and the remaining useful life of this asset as at 1 January 20X7 was deemed to be eight years.

 

Required:

 

What is the annual depreciation charge for 20X7 and subsequent years?

 

 

 

Solution

 

Carrying amount as at 1 January 20X7 (3/5 × $100,000)	$60,000
Remaining useful life as at 1 January 20X7	8 years
Annual depreciation charge ($60,000/8 years)	$7,500

 

 

 

Depreciation of separate components

 

Certain large assets are in fact a collection of smaller assets, each with a different cost and useful life. For example, an aeroplane consists of an airframe (which may last for 40 years or so) plus engines, radar equipment, seats, etc. all of which have a relatively short life. Instead of calculating depreciation on the aeroplane as a whole, depreciation is charged on each component (airframe, engines, etc.).

 

For example, an entity buys a ship for $12m. The ship as a whole should last for 25 years. The engines, however, will need replacing after 7 years. The cost price of $12m included about $1.4m in respect of the engines.

 

The annual depreciation charge will be $624,000 made up as follows:

 

Engines: $1.4m over seven years = $200,000 pa, plus

 

The rest of the ship: $10.6m over 25 years = $424,000 pa.

 

 

Derecognition

 

IAS 16 says that an asset should be derecognised when disposal occurs, or if no further economic benefits are expected from the asset’s 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 the revaluation surplus within other components of equity.

 

 

 

 

Test your understanding 1 – Cap

 

Cap bought a building on 1 January 20X1. The purchase price was $2.9m, associated legal fees were $0.1m and general administrative costs allocated to the purchase were $0.2m. Cap also paid sales tax of $0.5m, which was recovered from the tax authorities. The building was attributed a useful economic life of 50 years. It was revalued to $4.6m on 31 December 20X4 and was sold for $5m on 31 December 20X5.

 

Cap purchased a machine on 1 January 20X3 for $100,000 and attributed it with a useful life of 10 years. On 1 January 20X5, Cap reduced the estimated remaining useful life to 4 years.

 

Required:

 

Explain how the above items of property, plant and equipment would have been accounted for in all relevant reporting periods up until 31 December 20X5.

 

 

The impact on the financial statements

 

IAS 16 Property, Plant and Equipment permits entities to use a cost model or a revaluation model. This choice will have a big impact on the financial statements.

 

Example

 

Entities A and B are identical in all respects, except for their accounting policy for property, plant and equipment.

 

Both entities purchased an asset four years ago for $200,000. This was deemed to have a useful economic life of 10 years. Its fair value at the start of the current reporting period was $350,000.

 

Entity A uses the cost model. The current year depreciation charge on the asset is $20,000 ($200,000/10). The carrying amount of the asset in the statement of financial position at the year end is $120,000 (6/10 × $200,000).

 

Entity B uses the revaluation model. The asset was revalued at the start of the year by $210,000 ($350,000 – (7/10 × $200,000)). The depreciation charge on the asset in the current year is $50,000 ($350,000/7). The asset has a carrying amount

amount in the statement of financial position of $300,000 ($350,000 – $50,000).

 

Extracts from the financial statements of both entities are provided below:

 

Statement of profit or loss
	A	B
	$000	$000
Revenue	220	220
Operating costs	(180)	(210)
	–––––	–––––
Profit from operations	40	10
	–––––	–––––

 

 

Statement of financial position
	A	B
	$000	$000
Share capital	50	50
Retained earnings	90	60
Other components of equity	–	210
	–––––	–––––
Total equity	140	320
Borrowings	100	100
Total equity and liabilities	–––––	–––––
	240	420
	–––––	–––––
Operating profit margin	18.2%	4.5%
Return on capital employed	16.7%	2.4%
Gearing (debt/debt + equity)	41.7%	23.8%

 

 

Entity B’s upwards revaluation has increased equity in the statement of financial position. This reduces its ROCE, making entity B appear less efficient than entity A. However it also means that entity B’s gearing is lower than entity A’s, making it seem like a less risky investment.

 

 

 

Disclosure requirements

 

Disclosures required by IAS 16 include:

 

• the measurement bases used

 

• depreciation methods, useful lives and depreciation rates

 

• a reconciliation of the carrying amount at the beginning and end of the period

 

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

 

2 Government grants

 

 

IAS 20 Government grants: Definitions

 

IAS 20 Accounting for Government Grants and Disclosure of Government Assistance defines the following terms:

 

Government grants are transfers of resources to an entity in return for past or future compliance with certain conditions. They exclude assistance that cannot be valued and normal trade with governments.

 

Government assistance is government action designed to provide an economic benefit to a specific entity. It does not include indirect help such as infrastructure development.

 

 

 

General principles

 

Recognition

 

IAS 20 says that government grants should not be recognised until the conditions for receipt have been complied with and there is reasonable assurance that the grant will be received.

 

Grants should be matched with the expenditure towards which they are intended to contribute in the statement of profit or loss:

 

• Income grants given to subsidise expenditure should be matched to the related costs.

 

• Income grants given to help achieve a non-financial goal (such as job creation) should be matched to the costs incurred to meet that goal.

 

Grants related to assets

 

Grants for purchases of non-current assets should be recognised over the expected useful lives of the related assets. IAS 20 provides two acceptable accounting policies for this:

 

• deduct the grant from the cost of the asset and depreciate the net cost

 

• treat the grant as deferred income and release to profit or loss over the life of the asset.

 

Repayments and other issues

 

Repayments

 

A government grant that becomes repayable is accounted for as a revision of an accounting estimate.

 

• Income-based grants

 

Firstly, debit the repayment to any liability for deferred income. Any excess repayment must be charged to profits immediately.

 

• Capital-based grants deducted from cost

 

Increase the cost of the asset with the repayment. This will also increase the amount of depreciation that should have been charged in the past. This should be recognised and charged immediately.

 

• Capital-based grants treated as deferred income

 

Firstly, debit the repayment to any liability for deferred income. Any excess repayment must be charged against profits immediately.

 

Government assistance

 

As implied in the definition set out above, government assistance helps businesses through loan guarantees, loans at a low rate of interest, advice, procurement policies and similar methods. It is not possible to place reliable values on these forms of assistance, so they are not recognised.

 

 

 

Illustration – Government grants

 

On 1 June 20X1, Clock received written confirmation from a local government agency that it would receive a $1m grant towards the purchase price of a new office building. The grant becomes receivable on the date that Clock transfers the $10m purchase price to the vendor.

 

On 1 October 20X1 Clock paid $10m in cash for its new office building, which is estimated to have a useful life of 50 years. By 1 December 20X1, the building was ready for use. Clock received the government grant on 1 January 20X2.

 

Required:

 

Discuss the possible accounting treatments of the above in the financial statements of Clock for the year ended 31 December 20X1.

 

 

 

Solution

 

Government grants should be recognised when there is reasonable assurance that:

 

• The entity will comply with any conditions attached, and

 

• It is reasonably certain that the grant will be received.

 

The only condition attached to the grant is the purchase of the new building. Therefore, the grant should be accounted for on 1 October 20X1.

 

A receivable will be recognised for the $1m due from the local government. Clock could then choose to either:

 

• Reduce the cost of the building by $1m

 

In this case, the building will have a cost of $9m ($10m – $1m). This will be depreciated over its useful life of 50 years. The depreciation charge in profit or loss for the year ended 31 December 20X1 will be $15,000 (($9m/50 years) × 1/12) and the building will have a carrying value of $8,985,000 ($9m – $15,000) as at 31 December 20X1.

 

• Recognise deferred income of $1m.

 

In this case, the building is recognised at its cost of $10m. This will be depreciated over its useful life of 50 years. The depreciation charge in profit or loss for the year ended 31 December 20X1 will be $16,667 (($10m/50 years) × 1/12) and the building will have a carrying value of $9,983,333 ($10m – $16,667) as at 31 December 20X1.

 

The deferred income will be amortised to profit or loss over the building’s useful economic life. Therefore, income of $1,667 (($1m/50) × 1/12) will be recorded in profit or loss for the year ended 31 December 20X1. The carrying value of the deferred income balance within liabilities on the statement of financial position will be $998,333 ($1m – $1,667) as at 31 December 20X1.

 

Disclosure requirements

 

IAS 20 requires the following disclosures:

 

• the accounting policy and presentation methods adopted

 

• the nature of government grants recognised in the financial statements

 

• unfulfilled conditions relating to government grants that have been recognised.

 

 

 

3 Borrowing costs

 

 

IAS 23 Borrowing costs

 

Borrowing costs are defined as ‘interest and other costs that an entity incurs in connection with the borrowing of funds’ (IAS 23, para

 

Borrowing costs should be capitalised if they relate to the acquisition, construction or production of a qualifying asset. IAS 23 defines a

 

qualifying asset as one that takes a substantial period of time to get ready for its intended use or sale.

 

Capitalisation period

 

Borrowing costs should only be capitalised while construction is in progress.

 

IAS 23 stipulates that:

 

• Capitalisation of borrowing costs should commence when all of the following apply:

 

–   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 borrowing costs should cease when substantially all the activities that are necessary to get the asset ready for use are complete.

 

• Capitalisation of borrowing costs should be suspended during extended periods in which active development is interrupted.

 

Borrowing costs eligible for capitalisation

 

Where a loan is taken out specifically to finance the construction of an asset, IAS 23 says that the amount to be capitalised is the interest payable on that loan less income earned on the temporary investment of the borrowings.

 

If construction of a qualifying asset is financed from an entity’s general borrowings, the borrowing costs eligible to be capitalised are determined by applying the weighted average general borrowings rate to the expenditure incurred on the asset.

 

IAS 23 is silent on how to arrive at the expenditure on the asset, but it would be reasonable to calculate it as the weighted average carrying amount of the asset during the period, including finance costs previously capitalised.

 

 

 

Illustration – Borrowing costs

 

On 1 January 20X1, Hi-Rise obtained planning permission to build a new office building. Construction commenced on 1 March 20X1. To help fund the cost of this building, a loan for $5m was taken out from the bank on 1 April 20X1. The interest rate on the loan was 10% per annum.

 

Construction of the building ceased during the month of July due to an unexpected shortage of labour and materials.

 

By 31 December 20X1, the building was not complete. Costs incurred to date were $12m (excluding interest on the loan).

 

Required:

 

Discuss the accounting treatment of the above in the financial statements of Hi-Rise for the year ended 31 December 20X1.

 

 

 

Solution

 

An entity must capitalise borrowing costs that are directly attributable to the production of a qualifying asset. The new office building is a qualifying asset because it takes a substantial period of time to get ready for its intended use.

 

Hi-Rise should start capitalising borrowing costs when all of the following conditions have been met:

 

• It incurs expenditure on the asset – 1 March 20X1.

 

• It incurs borrowing costs – 1 April 20X1.

 

• It undertakes activities necessary to prepare the asset for intended use – 1 January 20X1.

 

Capitalisation of borrowing costs should therefore commence on 1 April 20X1. Capitalisation of borrowing costs ceases for the month of July because active development was suspended. In total, 8 months’ worth of borrowing costs should be capitalised in the year ended 31 December 20X1.

 

The total borrowing costs to be capitalised are $333,333 ($5m × 10% × 8/12). These will be added to the cost of the building, giving a carrying amount of $12,333,333 as at 31 December 20X1. The building is not ready for use, so no depreciation is charged.

 

 

 

Disclosure requirements

 

IAS 23 requires the following disclosures:

 

• the value of borrowing costs capitalised during the period

 

• the capitalisation rate.

 

 

 

4 Investment property

 

 

IAS 40 Investment property: Definitions

 

IAS 40 Investment Property relates to ‘property (land or buildings) held (by the owner or by the lessee as a right-of-use asset) to earn rentals or for capital appreciation or both’ (IAS 40, para 5).

 

Examples of investment property are:

 

• land held for capital appreciation

 

• land held for undecided future use

 

• buildings leased out under an operating lease

 

• vacant buildings held to be leased out under an operating lease.

 

The following are not investment property:

 

• property held for use in the production or supply of goods or services or for administrative purposes (IAS 16 Property, Plant and Equipment applies)

 

• property held for sale in the ordinary course of business or in the process of construction of development for such sale (IAS 2 Inventories applies)

 

• property being constructed or developed on behalf of third parties (IFRS 15 Revenue from Contracts with Customers applies)

 

• owner-occupied property (IAS 16 applies)

 

• property that is being constructed or developed for use as an investment property (IAS 16 currently applies until the property is ready for use, at which time IAS 40 starts to apply)

 

• property leased to another entity under a finance lease (IFRS 16 Leases applies).

 

 

 

 

Measurement

 

On recognition, investment property shall be recognised at cost.

 

After recognition an entity may choose either:

 

• the cost model

 

• the fair value model.

 

The policy chosen must be applied to all investment properties.

 

If the cost model is chosen, investment properties are held at cost less accumulated depreciation. No revaluations are permitted.

 

Change from one model to the other is permitted only if this results in a more appropriate presentation. IAS 40 notes that this is highly unlikely for a change from the fair value model to the cost model.

 

The fair value model

 

Under the fair value model, the entity remeasures its investment properties to fair value each year. No depreciation is charged.

 

All gains and losses on revaluation are reported in the statement of profit or loss.

 

If, in exceptional circumstances, it is impossible to measure the fair value of an individual investment property reliably then the cost model should be adopted.

 

 

 

Transfers

 

Transfers to or from investment property can only be made if there is a change of use. There are several possible situations in which this might occur and the accounting treatment for each is set out below:

 

Transfer from investment property to owner-occupied property

 

Use the fair value at the date of the change for subsequent accounting under IAS 16.

 

Transfer from investment property to inventory

 

Use the fair value at the date of the change for subsequent accounting under IAS 2 Inventories.

 

Transfer from owner-occupied property to investment property to be carried at fair value

 

Normal accounting under IAS 16 (cost less depreciation) will have been applied up to the date of the change. On adopting fair value, there is normally an increase in value. This is recognised as other comprehensive income and credited to the revaluation surplus in equity in accordance with IAS 16. If the fair valuation causes a decrease in value, then it should be charged to profits.

 

Transfer from inventories to investment property to be carried at fair value

 

Any change in the carrying amount caused by the transfer should be recognised in profit or loss.

 

Illustration: Investment property

 

Lavender owns a property, which it rents out to some of its employees. The property was purchased for $30 million on 1 January 20X2 and had a useful life of 30 years at that date. On 1 January 20X7 it had a market value of $50 million and its remaining useful life remained unchanged. Management wish to measure properties at fair value where this is allowed by accounting standards.

 

Required:

 

How should the property be treated in the financial statements of Lavender for the year ended 31 December 20X7.

 

 

 

Solution

 

Property that is rented out to employees is deemed to be owner-occupied and therefore cannot be classified as investment property.

 

Management wish to measure the property at fair value, so Lavender adopts the fair value model in IAS 16 Property, Plant and Equipment, depreciating the asset over its useful life and recognising the revaluation gain in other comprehensive income.

 

Before the revaluation, the building had a carrying amount of $25m ($30m

 

• 25/30). The building would have been revalued to $50m on 1 January 20X7, with a gain of $25m ($50m – $25m) recognised in other comprehensive income.

 

The building would then be depreciated over its remaining useful life of 25 years (30 – 5), giving a depreciation charge of $2m ($50m/25) in the year ended 31 December 20X7. The carrying amount of the asset as at 31 December 20X7 is $48m ($50m – $2m).

 

 

 

Illustration – ABC

 

ABC owns a building that it used as its head office. On 1 January 20X1, the building, which was measured under the cost model, had a carrying amount of $500,000. On this date, when the fair value of the building was $600,000, ABC vacated the premises. However, the directors decided to keep the building in order to rent it out to tenants and to potentially benefit from increases in property prices. ABC measures investment properties at fair value. On 31 December 20X1, the property has a fair value of $625,000.

 

Required:

 

Discuss the accounting treatment of the building in the financial statements of ABC for the year ended 31 December 20X1.

 

 

 

Solution

 

When the building was owner-occupied, it was an item of property plant and equipment. From 1 January 20X1, the property was held to earn rental income and for capital appreciation so it should be reclassified as investment property.

 

Per IAS 40, if owner occupied property becomes investment property that will be carried at fair value, then a revaluation needs to occur under IAS 16 at the date of the change in use.

 

The building must be revalued from $500,000 to $600,000 under IAS 16. This means that the gain of $100,000 ($600,000 – $500,000) will be recorded in other comprehensive income and held in a revaluation reserve within equity.

 

Investment properties measured at fair value must be revalued each year end, with the gain or loss recorded in profit or loss. At year end, the building will therefore be revalued to $625,000 with a gain of $25,000 ($625,000 – $600,000) recorded in profit or loss.

 

Investment properties held at fair value are not depreciated.

 

 

 

 

Impact on financial statements

 

Assume that two separate entities, A and B, both buy an identical building for $10m on 1 January 20X1 and classify them as investment properties. Each building is expected to have a useful life of 50 years. By 31 December 20X1, the fair value of each building is $11m.

 

Entity A measures investment properties using the cost model. Entity B measures investment properties at fair value.

 

Extracts from the financial statements of the two entities are provided below:

 

Statement of financial position

 

Entity A    Entity B

 

$m $m

 

Investment properties                                                                                                                 9.8                                                                                                               11.0

 

Statement of profit or loss
	Entity A	Entity B
	$m	$m
Depreciation	(0.2)	–
Gain on investment properties	–	1.0

 

Assuming no other differences between the two entities, entity B will report higher profits and therefore higher earnings per share than entity A. Entity B will also show higher equity in its statement of financial position, so its gearing will reduce.

 

As this example shows, the fact that IAS 40 permits a choice in accounting policy could be argued to reduce the comparability of financial information.

 

 

 

Disclosure requirements

 

In respect of investment properties, IAS 40 says that an entity must disclose:

 

• whether the cost or fair value model is used

 

• amounts recognised in profit or loss for the period

 

• a reconciliation between the carrying amounts of investment property at the beginning and end of the period.

 

 

 

5 Intangible assets

 

 

Definition and recognition criteria

 

An intangible asset is defined as ‘an identifiable non-monetary asset without physical substance’ (IAS 38, para 8).

 

An entity should recognise an intangible asset should be recognised if all the following criteria are met.

 

• The asset is identifiable

 

• The asset is controlled by the entity

 

• The asset will generate future economic benefits for the entity

 

• The cost of the asset can be measured reliably.

 

An intangible asset is identifiable if it:

 

• ‘is separable (capable of being separated and sold, transferred, licensed, rented, or exchanged, either individually or as part of a package), or

 

• it arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations’ (IAS 38, para 12).

 

If an intangible asset does not meet the recognition criteria, expenditure should be charged to the statement of profit or loss as it is incurred. Once the expenditure has been so charged, it cannot be capitalised at a later date.

 

Examples of intangible assets

 

Examples of intangible assets include:

 

• goodwill acquired in a business combination

 

• computer software

 

• patents

 

• copyrights

 

• motion picture films

 

• customer list

 

• mortgage servicing rights

 

• licences

 

• import quotas

 

• franchises

 

• customer and supplier relationships

 

• marketing rights.

 

Please note that the accounting treatment of goodwill arising on a business combination is dealt with in IFRS 3 Business Combinations rather than IAS 38 Intangible Assets.

 

Meeting the recognition criteria

 

• Identifiability

 

Intangible assets such as customer relationships cannot be separated from goodwill unless they:

 

– arise as a result of a legal right, if there are ongoing supply contracts, for example

 

– are separable, i.e. can be sold separately. This is unlikely unless there are legal contracts in existence, in which case they fall under the previous bullet point.

 

• Control

 

The knowledge that the staff have is an asset. It can be possible for the entity to control this knowledge. Patents, copyrights and restraint-of-trade agreements will give the entity legal rights to the future economic benefits and prevent other people from obtaining them. Therefore copyrights and patents can be capitalised.

 

• Probable future economic benefits

 

An intangible asset can generate future economic benefits in two ways. Owning a brand name can boost revenues, while owning the patent for a production process may help to reduce production costs. Either way, the entity’s profits will be increased.

 

When an entity assesses the probability of future economic benefits, the assessment must be based on reasonable and supportable assumptions about conditions that will exist over the life of the asset.

 

• Reliable measurement

 

If the asset is acquired separately then this is straightforward. For example, the purchase price of a franchise should be capitalised, along with all the related legal and professional costs.

 

However, the cost of internally generated intangible assets cannot be distinguished from the cost of the entity’s day-to-day operations. Therefore, internally generated intangible assets are not recognised on the statement of financial position unless they relate to research and development activity (see later in this chapter).

 

Measurement

 

Initial recognition

 

When an intangible asset is initially recognised, it is measured at cost.

 

Subsequent recognition

 

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.

 

The revaluation model

 

The revaluation model can only be adopted if fair value can be determined by reference to an active market. An active market is one

 

where the products are homogenous, there are willing buyers and sellers to be found at all times, and prices are available to the public.

 

Active markets for intangible assets are rare. They may exist for assets such as:

 

• milk quotas

 

• European Union fishing quotas

 

• stock exchange seats.

 

Active markets are unlikely to exist for brands, newspaper mastheads, music and film publishing rights, patents or trademarks.

 

Revaluations should be made with sufficient regularity such that the carrying amount does not differ materially from actual fair value at the reporting date.

 

Revaluation gains and losses are accounted for in the same way as revaluation gains and losses of tangible assets held in accordance with IAS 16 Property, Plant and Equipment.

 

Amortisation

 

An 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 straight-line 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.

 

 

 

 

Test your understanding 2 – Innovate

 

Ten years ago, Innovate developed a new game called ‘Our Sports’. This game sold over 10 million copies around the world and was extremely profitable. Due to its popularity, Innovate release a new game in the Our Sports series every year. The games continue to be best-sellers.

 

The directors have produced cash flow projections for the Our Sports series over the next five years. Based on these projections, they have prudently valued the Our Sports brand at $20 million and wish to recognise this in the statement of financial position as at 30 September 20X3.

 

On 30 September 20X3, Innovate also paid $1 million for the rights to the ‘Pets & Me’ videogame series after the original developer went into administration.

 

Required:

 

Discuss the accounting treatment of the above in the financial statements of Innovate for the year ended 30 September 20X3.

 

Research and development expenditure

 

Research is defined as ‘original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding’ (IAS 38, para 8).

 

Research expenditure cannot be recognised as an intangible asset. (although tangible assets used in research should be recognised as plant and equipment).

 

Development is defined as ‘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’ (IAS 38, para 8).

 

IAS 38 says that development expenditure should only be recognised as an intangible asset if the entity can demonstrate that:

 

• the project is technically feasible

 

• the entity intends to complete the intangible asset, and then use it or sell it

 

• the intangible asset will generate future economic benefits

 

• it has adequate resources to complete the project

 

• it can reliably measure the expenditure on the project.

 

 

Test your understanding 3 – Scone

 

During the year ended 31 December 20X1, Scone spent $2 million on researching and developing a new product. The entity has recognised all $2 million as an intangible asset. A breakdown of the expenditure is provided below:

 

	$m
Research into materials	0.5
Market research	0.4
Employee training	0.2
Development activities	0.9

 

The expenditure on development activities was incurred evenly over the year. It was not until 1 May 20X1 that market research indicated that the product was likely to be profitable. At the reporting date, the product development was not yet complete.

 

Required:

 

Discuss the correct accounting treatment of the research and development expenditure in the year ended 31 December 20X1.

 

 

 

Disclosure requirements

 

IAS 38 states that an entity must disclose:

 

• The amount of research and development expenditure expensed in the period

 

• The amortisation methods used

 

• For intangible assets assessed as having an indefinite useful life, the reasons supporting that assessment

 

• The date of any revaluations, if applicable, as well as the methods and assumptions used

 

• A reconciliation of the carrying amount of intangibles at the beginning and end of the reporting period.

 

 

6 Impairment of assets (IAS 36)

 

Definition

 

Impairment is a reduction in the recoverable amount of an asset or cash-generating unit below its carrying amount.

 

IAS 36 Impairment of Assets says that 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 an indication that impairment may have occurred.

 

Indications of impairment

 

IAS 36 lists the following indications that an asset is impaired:

 

• External sources of information:

 

–   unexpected decreases in an asset’s market value

 

– significant adverse changes have taken place, or are about to take place, in the technological, market, economic or legal environment

 

– increased interest rates have decreased an asset’s recoverable amount

 

– the entity’s net assets are measured at more than its market capitalisation.

 

• Internal sources of information:

 

–   evidence of obsolescence or damage

 

– there is, or is about to be, a material reduction in usage of an asset

 

– evidence that the economic performance of an asset has been, or will be, worse than expected.

 

Calculating an impairment loss

 

An 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 is defined in IFRS 13 as the price received when selling an asset in an orderly transaction between market participants at the measurement date.

 

Costs to sell are incremental costs directly attributable to the disposal of an asset.

 

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

 

If fair value less costs to sell is higher than the carrying amount, there is no impairment and no need to calculate value in use.

 

Illustration: Impairment of item of plant

 

An 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. The plant could be sold for net proceeds of $275,000.

 

Required:

 

Is the item of plant impaired and, if so, by how much?

 

 

Solution

 

The recoverable amount is the greater of the fair value less costs to sell and the value in use. The fair value less costs to sell (net selling price) is $275,000 and the value in use is $320,000. The recoverable amount is therefore $320,000.

 

To determine whether the plant is impaired, the carrying amount is compared to the recoverable amount. The carrying amount of $350,000 is greater than the recoverable amount, so the asset must be written down to its recoverable amount. The impairment loss is $30,000 ($350,000 – $320,000).

 

Measurement of recoverable amount

 

Recoverable amount is defined as the higher of the fair value less costs to sell and the value in use.

 

• Measuring fair value less costs to sell

 

Fair value should be determined in accordance with IFRS 13 Fair Value Measurement.

 

Direct selling costs might include:

 

–   legal costs

 

–   stamp duty

 

– costs relating to the removal of a sitting tenant (in the case of a building).

 

Redundancy and reorganisation costs (e.g. following the sale of a business) are not direct selling costs.

 

• Measuring value in use

 

Value in use is calculated by estimating future cash inflows and outflows from the use of the asset and its ultimate disposal, and applying a suitable discount rate to these cash flows.

 

With regards to estimates of cash flows, IAS 36 stipulates that:

 

– The cash flow projections should be based on reasonable assumptions and the most recent budgets and forecasts

 

– The cash flow projections should relate to the asset’s current condition and should exclude expenditure to improve or enhance it

 

– For periods in excess of five years, management should extrapolate from earlier budgets using a steady, declining or zero growth rate

 

– Management should assess the accuracy of their budgets by investigating the reasons for any differences between forecast and actual cash flows.

 

The discount rate should reflect:

 

–   ‘the time value of money, and

 

– the risks specific to the asset for which the future cash flow estimates have not been adjusted’ (IAS 36, para 55).

 

 

 

Recognising impairment losses in the financial statements

 

An impairment loss is normally charged immediately in the statement of profit or loss and other comprehensive income.

 

• If the asset has previously been revalued upwards, the impairment is recognised as a component of other comprehensive income and is debited to the revaluation reserve until the surplus relating to that asset has been reduced to nil. The remainder of the impairment loss is recognised in profit or loss.

 

• The recoverable (impaired) amount of the asset is then depreciated/amortised over its remaining useful life.

 

Test your understanding 4 – Impaired asset

 

On 31 December 20X1, an entity noticed that one of its items of plant and machinery is often left idle. On this date, the asset had a carrying amount of $500,000 and a fair value of $325,000. The estimated costs required to dispose of the asset are $25,000.

 

If the asset is not sold, the entity estimates that it would generate cash inflows of $200,000 in each of the next two years. The discount rate that reflects the risks specific to this asset is 10%.

 

Required:

 

• Discuss the accounting treatment of the above in the financial statements for the year ended 31 December 20X1.

 

• How would the answer to part (a) be different if there was a balance of $10,000 in other components of equity relating to the prior revaluation of this specific asset?

 

Cash-generating units

 

It is not usually possible to identify cash flows relating to particular assets. For example, a factory production line is made up of many individual machines, but the revenues are earned by the production line as a whole. This means that value in use must be calculated (and the impairment review performed) for groups of assets, rather than individual assets.

 

These groups of assets are called cash-generating units (CGUs).

 

Cash-generating units are segments of the business whose income streams are largely independent of each other.

 

• In practice they are likely to mirror the strategic business units used for monitoring the performance of the business.

 

• It could also include a subsidiary or associate within a corporate group structure.

 

Test your understanding 5 – Cash generating units

 

An entity has three stages of production:

 

• A – growing and felling trees

 

• B – creating parts of wooden furniture

 

• C – assembling the parts from B into finished goods.

 

The output of A is timber that is partly transferred to B and partly sold in an external market. If A did not exist, B could buy its timber from the market. The output of B has no external market and is transferred to C at an internal transfer price. C sells the finished product in an external market and the sales revenue achieved by C is not affected by the fact that the three stages of production are all performed by the entity.

 

Required:

 

Identify the cash-generating unit(s).

 

 

 

Allocating assets to cash-generating units

 

The carrying amount of a cash-generating unit includes the carrying amount of assets that can be attributed to the cash-generating unit and will generate the future cash inflows used in determining the cash-generating unit’s value in use.

 

There are two problem areas:

 

• Corporate assets: assets that are used by several cash-generating units (e.g. a head office building or a research centre). They do not generate their own cash inflows, so do not themselves qualify as cash-generating units.

 

• Goodwill, which does not generate cash flows independently of other assets and often relates to a whole business.

 

Corporate assets and goodwill should be allocated to cash-generating units on a reasonable and consistent basis. A cash-generating unit to which goodwill has been allocated must be tested for impairment annually.

 

Allocation of an impairment to the unit’s assets

 

If an impairment loss arises in respect of a cash-generating unit, IAS 36 requires that it is allocated among the assets in the following order:

 

• goodwill

 

• other assets in proportion to their carrying amount.

 

However, the carrying amount of an asset cannot be reduced below the highest of:

 

• fair value less costs to sell

 

• value in use

 

 

Illustration 1 – Impairment allocation within CGU

 

Tinud has identified an impairment loss of $41m for one of its cash-generating units. The carrying amount of the unit’s net assets was $150m, whereas the unit’s recoverable amount was only $109m. The draft values of the net assets of the unit are as follows:

 

	$m
Goodwill	13
Property	20
Machinery	49
Vehicles	35
Patents	14
Net monetary assets	19
	––––

150

 

 

The net selling price of the unit’s assets were insignificant except for the property, which had a market value of $35m. The net monetary assets will be realised in full.

 

Required:

 

How is the impairment loss allocated to the assets within the cash-generating unit?

 

 

 

Solution

 

Firstly, the impairment loss is allocated to the goodwill, reducing its carrying amount to nil.

 

The impairment loss cannot be set against the property because its net selling price is greater than its carrying amount.

 

Likewise, the impairment loss cannot be set against the net monetary assets (receivables, cash, etc.) because they will be realised in full.

 

The balance of the impairment loss of $28 million ($41m – $13m) is apportioned between the remaining assets in proportion to their carrying amounts. So, for example, the impairment allocated to the machinery is $14 million ((49/(49 + 35 + 14)) × 28m)

 

The table below shows how the impairment will be allocated.

 

	Draft	Impairment	Revised
	values	loss	value
	$m	$m	$m
Goodwill	13	(13)	–
Property	20	–	20
Machinery	49	(14)	35
Vehicles	35	(10)	25
Patents	14	(4)	10
Net monetary assets	19	–	19
	––––	––––	––––
	150	(41)	109
	––––	––––	––––

 

 

Test your understanding 6 – Factory explosion

 

There was an explosion in a factory. The carrying amounts of its assets were as follows:

 

	$000
Goodwill	100
Patents	200
Machines	300
Computers	500
Buildings	1,500
	–––––

2,600

 

–––––

 

The factory operates as a cash-generating unit. An impairment review reveals a net selling price of $1.2 million for the factory and value in use of $1.95 million. Half of the machines have been blown to pieces but the other half can be sold for at least their carrying amount. The patents have been superseded and are now considered worthless.

 

Required:

 

Discuss, with calculations, how any impairment loss will be accounted for.

 

 

Impairment if reasonable allocation is not possible

 

If no reasonable allocation of corporate assets or goodwill is possible, then a group of cash-generating units must be tested for impairment together in a two-stage process.

 

Example

 

An entity acquires a business comprising three cash-generating units, D, E and F, but there is no reasonable way of allocating goodwill to them. After three years, the carrying amount and the recoverable amount of the net assets in the cash-generating units and the purchased goodwill are as follows:

 

	D	E	F	Goodwill	Total
	$000	$000	$000	$000	$000
Carrying amount	240	360	420	150	1,170
Recoverable amount	300	420	360		1,080

 

 

Step 1: Review the individual units for impairment.

 

F is impaired. A loss of $60,000 is recognised and its carrying amount is reduced to $360,000.

 

Step 2: Compare the carrying amount of the business as a whole, including the goodwill, with its recoverable amount.

 

The total carrying amount of the business is now $1,110,000 ($1,170,000

 

– $60,000). A further impairment loss of $30,000 must then be recognised in respect of the goodwill ($1,110,000 – $1,080,000).

 

 

 

Reversal of an impairment loss

 

The calculation of impairment losses is based on predictions of what may happen in the future. Sometimes, actual events turn out to be better than predicted. If this happens, the recoverable amount is re-calculated and the previous write-down is reversed.

 

• Impaired assets should be reviewed at each reporting date to see whether there are indications that the impairment has reversed.

 

• A reversal of an impairment loss is recognised immediately as income in profit or loss. If the original impairment was charged against the revaluation surplus, it is recognised as other comprehensive income and credited to the revaluation reserve.

 

• The reversal must not take the value of the asset above the amount it would have been if the original impairment had never been recorded. The depreciation that would have been charged in the meantime must be taken into account.

 

• The depreciation charge for future periods should be revised to reflect the changed carrying amount.

 

An impairment loss recognised for goodwill cannot be reversed in a subsequent period.

 

Impairment reversals

 

Indicators of an impairment reversal

 

External indicators of an impairment reversal are:

 

• Increases in the asset’s market value

 

• Favourable changes in the technological, market, economic or legal environment

 

• Decreases in interest rates.

 

Internal indicators of an impairment reversal are:

 

• Favourable changes in the use of the asset

 

• Improvements in the asset’s economic performance.

 

Impairment reversals and cash-generating unit

 

If the reversal relates to a cash-generating unit, the reversal is allocated to assets other than goodwill on a pro rata basis. The carrying amount of an asset must not be increased above the lower of:

 

• its recoverable amount (if determinable)

 

• the carrying amount that would have been determined (net of amortisation or depreciation) had no impairment loss been recognised for the asset in prior periods.

 

The amount that would otherwise have been allocated to the asset is allocated pro rata to the other assets of the unit, except for goodwill.

 

Impairment reversals and goodwill

 

Impairment losses relating to goodwill can never be reversed. The reason for this is that once purchased goodwill has become impaired, any subsequent increase in its recoverable amount is likely to be an increase in internally generated goodwill, rather than a reversal of the impairment loss recognised for the original purchased goodwill. Internally generated goodwill cannot be recognised.

 

 

 

Test your understanding 7 – Boxer

 

Boxer purchased a non-current asset on 1 January 20X1 at a cost of $30,000. At that date, the asset had an estimated useful life of ten years. Boxer does not revalue this type of asset, but accounts for it on the basis of depreciated historical cost. At 31 December 20X2, the asset was subject to an impairment review and had a recoverable amount of $16,000.

 

At 31 December 20X5, the circumstances which caused the original impairment to be recognised have reversed and are no longer applicable, with the result that recoverable amount is now $40,000.

 

Required:

 

Explain, with supporting computations, the impact on the financial statements of the two impairment reviews.

 

Test your understanding 8 – CGUs and impairment reversals

 

On 31 December 20X2, an impairment review was conducted on a cash generating unit and the results were as follows:

 

Asset	Carrying	Impairment	Carrying amount
	amount		post-impairment
	pre-impairment
	$000	$000	$000
Goodwill	100	(100)	Nil
Property, plant	300	(120)	180
and equipment	–––––	–––––	–––––
	400	(220)	180
	–––––	–––––	–––––

 

The property, plant and equipment was originally purchased for $400,000 on 1 January 20X1 and was attributed a useful economic life of 8 years.

 

At 31 December 20X3, the circumstances which caused the original impairment have reversed and are no longer applicable. The recoverable amount of the cash generating unit is now $420,000.

 

Required:

 

Explain, with supporting computations, the impact of the impairment reversal on the financial statements for the year ended 31 December 20X3.

 

 

 

Disclosure requirements

 

IAS 36 requires disclosure of the following:

 

• losses recognised during the period

 

• reversals recognised during the period

 

For each material loss or reversal:

 

• the amount of loss or reversal and the events causing it

 

• the recoverable amount of the asset (or cash generating unit)

 

• whether the recoverable amount is the fair value less costs to sell or value in use

 

• the level of fair value hierarchy (per IFRS 13) used in determining fair value less costs to sell

 

 

• the discount rate(s) used.

 

 

 

7 Non-current assets held for sale (IFRS 5)

 

IFRS 5 Non-current Assets Held for Sale and Discontinued Operations says that a non-current asset or disposal group should be classified as ‘held for sale’ if its carrying amount will be recovered primarily 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.

 

Classification as ‘held for sale’

 

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.

 

Assets that are to be abandoned or wound down gradually cannot be classified as held for sale because their carrying amounts will not be recovered principally through a sale transaction.

 

Test your understanding 9 – Hyssop

 

Hyssop is preparing its financial statements for the year ended 31 December 20X7.

 

• On 1 December 20X7, the entity became committed to a plan to sell a surplus office property and has already found a potential buyer. On 15 December 20X7 a survey was carried out and it was discovered that the building had dry rot and substantial remedial work would be necessary. The buyer is prepared to wait for the work to be carried out, but the property will not be sold until the problem has been rectified. This is not expected to occur until summer 20X8.

 

Required:

 

Can the property be classified as ‘held for sale’?

 

• A subsidiary entity, B, is for sale at a price of $3 million. There has been some interest from prospective buyers but no sale as of yet. One buyer has made an offer of $2 million but the Directors of Hyssop rejected the offer. The Directors have just received advice from their accountants that the fair value of the business is $2.5 million. They have decided not to reduce the sale price of B at the moment.

 

Required:

 

Can the subsidiary be classified as ‘held for sale’?

 

 

 

Measurement of assets and disposal groups held for sale

 

Items classified as held for sale should, according to IFRS 5, 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.

 

• If a non-current asset is measured using a revaluation model and it meets the criteria to be classified as being held for sale, it should be revalued to fair value immediately before it is classified as held for sale. It is then revalued again at the lower of the carrying amount and the fair value less costs to sell. The difference is the selling costs and these should be charged against profits in the period.

 

• When a disposal group is being written down to fair value less costs to sell, the impairment loss reduces the carrying amount of assets in the order prescribed by IAS 36

 

– Impairments are firstly allocated to goodwill and then to other assets on a pro-rata basis.

 

• 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.

 

Test your understanding 10 – AB

 

On 1 January 20X1, AB acquires a building for $200,000 with an expected life of 50 years. On 31 December 20X4 AB puts the building up for immediate sale. Costs to sell the building are estimated at $10,000.

 

Required

 

Outline the accounting treatment of the above if the building had a fair value at 31 December 20X4 of:

 

• $220,000

 

• $110,000.

 

 

 

 

Test your understanding 11 – Nash

 

Nash purchased a building for its own use on 1 January 20X1 for $1m and attributed it a 50 year useful economic life. Nash uses the revaluation model to account for buildings.

 

On 31 December 20X2, this building was revalued to $1.2m.

 

On 31 December 20X3, the building met the criteria to be classified as held for sale. Its fair value was deemed to be $1.1m and the costs necessary to sell the building were estimated to be $50,000.

 

Nash does not make a reserves transfer in respect of excess depreciation.

 

Required:

 

Discuss the accounting treatment of the above.

 

 

 

Presentation in the statement of financial position

 

IFRS 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.

 

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 period).

 

 

 

Illustration – Presentation

 

Statement of financial position (showing non-current assets held for sale)

	20X2	20X1
ASSETS	$m	$m
Non-current assets
Property, plant and equipment	X	X
Goodwill	X	X
Financial assets	X	X
	––––	––––
	X	X
Current assets	––––	––––
Inventories	X	X
Trade receivables	X	X
Cash and cash equivalents	X
Non-current assets classified	X	X
as held for sale
	––––	––––
	X	X
	––––	––––
Total assets	X	X

 

 

 

Changes to a plan of sale

 

If a sale does not take place within one year, IFRS 5 says that an asset (or disposal group) can still be classified as held for sale if:

 

• the delay has been caused by events or circumstances beyond the entity’s control

 

• there is sufficient evidence that the entity is still committed to the sale.

 

 

If the criteria for ‘held for sale’ are no longer met, then the entity must cease to classify the assets or disposal group as held for sale. The assets or disposal group must be measured at the lower of:

 

• ‘its carrying amount before it was classified as held for sale adjusted for any depreciation, amortisation or revaluations that would have been recognised had it not been classified as held for sale

 

• its recoverable amount at the date of the subsequent decision not to sell’ (IFRS 5, para 27).

 

Any adjustment required is recognised in profit or loss as a gain or loss from continuing operations.

 

Disclosure requirements

 

In the period in which a non-current asset or disposal group has been classified as held for sale, or sold, IFRS 5 says that the entity must disclose:

 

• a description of the non-current asset (or disposal group)

 

• a description of the facts and circumstances of the sale or expected sale

 

• any impairment losses or reversals recognised.

 

 

 

8 Agriculture (IAS 41)

 

 

Definitions

 

IAS 41 Agriculture applies to biological assets and to agricultural produce at the point of harvest.

 

Definitions

 

A biological asset is ‘a living plant or animal’ (IAS 41, para 5).

 

Agricultural produce is ‘the harvested product of the entity’s biological assets’ (IAS 41, para 5).

 

Harvest is ‘the detachment of produce from a biological asset or the cessation of a biological asset’s life processes’ (IAS 41, para 5).

 

Application of IAS 41 definitions

 

 

A farmer buys a dairy calf.

 

The calf grows into a mature

 

cow.

 

The farmer milks the cow.

 

 

The calf is a biological asset.

 

Growth is a type of biological transformation.

 

The milk has been harvested.

 

Milk is agricultural produce.

 

 

Biological assets

 

Recognition criteria

 

A biological asset should be recognised if:

 

• it is probable that future economic benefits will flow to the entity from the asset

 

• the cost or fair value of the asset can be reliably measured

 

• the entity controls the asset.

 

Initial recognition

 

Biological assets are initially measured at fair value less estimated costs to sell.

 

Gains and losses may arise in profit or loss when a biological asset is first recognised. For example:

 

• A loss can arise because estimated selling costs are deducted from fair value.

 

• A gain can arise when a new biological asset (such as a lamb or a calf) is born.

 

Subsequent measurement

 

At each reporting date, biological assets are revalued to fair value less costs to sell.

 

Gains and losses arising from changes in fair value are recognised in profit or loss for the period in which they arise.

 

Biological assets are presented separately on the face of the statement of financial position within non-current assets.

 

Physical changes and price changes

 

The fair value of a biological asset may change because of its age, or because prices in the market have changed.

 

IAS 41 recommends separate disclosure of physical and price changes because this information is likely to be of interest to users of the financial statements. However, this disclosure is not mandatory.

 

 

 

Inability to measure fair value

 

IAS 41 presumes that the fair value of biological assets should be capable of being measured reliably.

 

If market prices are not readily available then the biological asset should be measured at cost less accumulated depreciation and accumulated impairment losses.

 

Once the asset’s fair value can be measured reliably, it should be remeasured to fair value less costs to sell.

 

 

 

Test your understanding 12 – Cows

 

On 1 January 20X1, a farmer had a herd of 100 cows, all of which were 2 years old. At this date, the fair value less point of sale costs of the herd was $10,000. On 1 July 20X1, the farmer purchased 20 cows (each two and half years old) for $60 each.

 

As at 31 December 20X1, three year old cows sell at market for $90 each.

 

Market auctioneers have charged a sales levy of 2% for many years.

 

Required:

 

Discuss the accounting treatment of the above in the financial statements for the year ended 31 December 20X1.

 

Agricultural produce

 

At the date of harvest, agricultural produce should be recognised and measured at fair value less estimated costs to sell.

 

Gains and losses on initial recognition are included in profit or loss (operating profit) for the period.

 

After produce has been harvested, it becomes an item of inventory. Therefore, IAS 41 ceases to apply. The initial measurement value at the point of harvest is the deemed ‘cost’ for the purpose of IAS 2 Inventories, which is applied from then onwards.

 

 

 

Assets outside of the scope of IAS 41

 

IAS 41 does not apply to intangible assets (such as production quotas), bearer plants, or to land related to agricultural activity.

 

• In accordance with IAS 38, intangible assets are measured at cost less amortisation or fair value less amortisation.

 

• Bearer plants are used to produce agricultural produce for more than one period. Examples include grape vines or tea bushes. Bearer plants are accounted for in accordance with IAS 16 Property, Plant and Equipment.

 

– However, any unharvested produce growing on a bearer plant, such as grapes on a grape vine, is a biological asset and so is accounted for in accordance with IAS 41.

 

• Land is not a biological asset. It is treated as a tangible non-current asset and accounted for under IAS 16 Property, Plant and Equipment.

 

– When valuing a forest, for example, the trees must be accounted for separately from the land that they grow on.

 

Test your understanding 13 – GoodWine

 

GoodWine is a company that grows and harvests grapes. Grape vines, which produce a new harvest of grapes each year, are typically replaced every 30 years. Harvested grapes are sold to wine producers. With regards to property, plant and equipment, GoodWine accounts for land using the revaluation model and all other classes of assets using the cost model.

 

On 30 June 20X1, its grape vines had a carrying amount of $300,000 and a remaining useful life of 20 years. The grapes on the vines, which are generally harvested in August each year, had a fair value of $500,000. The land used for growing the grape vines had a fair value of $2m.

 

On 30 June 20X2, grapes with a fair value of $100,000 were harvested early due to unusual weather conditions. The grapes left on the grape vines had a fair value of $520,000. The land had a fair value of $2.1m.

 

All selling costs are negligible and should be ignored.

 

Required:

 

Discuss the accounting treatment of the above in the financial statements of GoodWine for the year ended 30 June 20X2.

 

 

 

Agriculture and government grants

 

If a government grant relates to a biological asset measured at its cost less accumulated depreciation and accumulated impairment losses, it is accounted for under IAS 20 Accounting for Government Grants.

 

If a government grant relates to biological assets measured at fair value less costs to sell, then it is accounted for under IAS 41 Agriculture as follows:

 

• An unconditional government grant related to a biological asset measured at its fair value less costs to sell shall be recognised in profit or loss when it becomes receivable.

 

• A conditional government grant related to a biological asset measured at its fair value less costs to sell, shall be recognised in profit or loss when the conditions attaching to the government grant are met.

 

Disclosure requirements

 

IAS 41 says that an entity must disclose:

 

• The aggregate gain or loss arising during the period on the initial recognition of biological assets and agricultural produce and from the changes in fair value less costs to sell of biological assets

 

• A description of each group of biological assets

 

• The methods and significant assumptions used when determining fair value

 

• A reconciliation of the carrying amounts of biological assets between the beginning and the end of the reporting period.

 

 

 

9 Inventories

 

 

IAS 2 Inventories

 

Inventories are ‘measured at the lower of cost and net realisable value’ (IAS 2, para 9).

 

Cost

 

Cost, according to IAS 2, includes all purchase costs, conversion costs and other costs incurred in bringing the inventories to their present condition and location.

 

• Purchase costs include the purchase price (less discounts and rebates), import duties, irrecoverable taxes, transport and handling costs and any other directly attributable costs.

 

• Conversion costs include all direct costs of conversion (materials, labour, expenses, etc), and a proportion of the fixed and variable production overheads. The allocation of fixed production overheads must be based on the normal level of activity.

 

• Abnormal wastage, storage costs, administration costs and selling costs must be excluded from the valuation and charged as expenses in the period in which they are incurred.

 

IAS 2 Inventories allows three methods of arriving at cost:

 

• actual unit cost

 

• first-in, first-out (FIFO)

 

• weighted average cost (AVCO).

 

Actual unit cost must be used where items of inventory are not ordinarily interchangeable.

 

Net realisable value (NRV)

 

NRV is defined by IAS 2 as the expected selling price of the inventory less the estimated costs of completion and sale.

 

Disclosure requirements

 

Entities should disclose:

 

• their accounting policy and cost formulae

 

• the total carrying amount of inventories by category

 

• details of inventories carried at net realisable value.

 

 

 

 

Illustration – Valuation of inventories

 

An entity has the following items of inventory.

 

• 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.

 

• 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.

 

Required:

 

In accordance with IAS 2 Inventories, at what amount should the above items be valued?

 

Solution

 

• Inventory is valued at the lower of cost or net realisable value, not the 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. Therefore the inventory should be valued at its cost of $12,000.

 

• The net realisable value is $15,900 (contract price $18,000 – constructor’s share of modification cost $2,100). The net realisable value is below the cost price. Therefore the inventory should be held at $15,900.

Test your understanding 1 – Cap

 

The building

 

The building would have been recognised on 1 January 20X1 at a cost of $3m ($2.9m purchase price + $0.1m legal fees). Recoverable sales tax is excluded from the cost of property, plant and equipment. General administrative costs of $0.2m will have been expensed to profit or loss as incurred.

 

Depreciation of $0.06m ($3m/50 years) would have been charged to profit or loss in each of the years ended 31 December 20X1, 20X2, 20X3 and 20X4.

 

Prior to the revaluation on 31 December 20X4, the carrying amount of the building was $2.76m (46/50 × $3m). In the year ended 31 December 20X4, a gain on revaluation of $1.84m ($4.6m – $2.76m) would have been recognised in other comprehensive income and held within equity.

 

In the year ended 31 December 20X5, the building would have been depreciated over its remaining useful life of 46 (50 – 4) years. The depreciation charge in the year ended 31 December 20X5 would therefore have been $0.1m ($4.6m/46) leaving a carrying amount at the disposal date of $4.5m ($4.6m – $0.1m).

 

On 31 December 20X5, a profit on disposal of $0.5m ($5m – $4.5m)

 

would be recorded in the statement of profit or loss.

 

The revaluation gains previously recognised within OCI and held within equity are not reclassified to profit or loss on the disposal of the asset. However, Cap could do a transfer within equity as follows:

 

Dr Other components of equity	$1.84m
Cr Retained earnings	$1.84m

 

The machine

 

The machine would be recognised on 1 January 20X3 at $100,000 and depreciated over 10 years. Depreciation of $10,000 ($100,000/10) will be charged in the years ended 31 December 20X3 and December 20X4.

 

On 1 January 20X5, Cap changes its estimate of the machine’s useful economic life. This is a change in accounting estimate and therefore dealt with prospectively. The carrying amount of the asset at the date of the estimate change is $80,000 (8/10 × $100,000). This remaining carrying amount will be written off over the revised life of 4 years. This means that the depreciation charge is $20,000 ($80,000/4) in the year ended 31 December 20X5.

 

 

 

Test your understanding 2 – Innovate

 

According to IAS 38, an intangible asset can be recognised if:

 

• it is probable that expected future economic benefits attributable to the asset will flow to the entity

 

• the cost of the asset can be measured reliably.

 

Cash flow projections suggest that the Our Sports brand will lead to future economic benefits. However, the asset has been internally generated and therefore the cost of the asset cannot be measured reliably. This means that the Our Sports brand cannot be recognised in the financial statements.

 

The Pets & Me brand has been purchased for $1 million. Therefore, its cost can be measured reliably. An intangible asset should be recognised in respect of the Pets & Me brand at its cost of $1 million.

 

In subsequent periods, the Pets & Me brand will be amortised over its expected useful economic life.

 

 

Test your understanding 3 – Scone

 

Expenditure on research, market research and employee training cannot be capitalised and so must be written off to profit or loss.

 

In relation to development activities, $0.3 million (4/12 × $0.9m) was incurred before the product was known to be commercially viable. This amount must also be written off to profit or loss.

 

In total, $1.4 million ($0.5m + $0.4m + $0.2m + $0.3m) must be written off from intangible assets to profit or loss:

 

Dr Profit or loss	$1.4m
Cr Intangible assets	$1.4m

 

The intangible asset recognised on the statement of financial position will be $0.6 million ($2m – $1.4m). No amortisation will be charged because the product is not yet complete.

 

 

 

Test your understanding 4 – Impaired asset

 

• The value in use is calculated as the present value of the asset’s future cash inflows and outflows.

 

	$000
Cash flow Year 1 (200 × 0.909)	182
Cash flow Year 2 (200 × 0.826)	165
	––––
	347
	––––

 

The recoverable amount is the higher of the fair value less costs to sell of $300,000 ($325,000 – $25,000) and the value in use of $347,000.

 

The carrying amount of the asset of $500,000 exceeds the recoverable amount of $347,000. Therefore, the asset is impaired and must be written down by $153,000 ($500,000 – $347,000). This impairment loss would be charged to the statement of profit or loss.

 

Dr Profit or loss	$153,000
Cr PPE	$153,000

 

• The asset must still be written down by $153,000. However, $10,000 of this would be recognised in other comprehensive income and the remaining $143,000 ($153,000 – $10,000) would be charged to profit or loss.

 

Dr Profit or loss	$143,000
Dr Other comprehensive income	$10,000
Cr PPE	$153,000

 

 

 

Test your understanding 5 – Cash generating units

 

A forms a cash-generating unit and its cash inflows should be based on the market price for its output. B and C together form one cash-generating unit because there is no market available for the output of B. In calculating the cash outflows of the cash-generating unit B + C, the timber received by B from A should be priced by reference to the market, not any internal transfer price.

 

 

 

Test your understanding 6 – Factory explosion

 

The patents have been superseded and have a recoverable amount of

 

$nil. They therefore should be written down to $nil and an impairment loss of $200,000 must be charged to profit or loss.

 

Half of the machines have been blown to pieces. Therefore, half of the carrying value of the machines should be written off. An impairment loss of $150,000 will be charged to profit or loss.

 

The recoverable amount of the other assets cannot be determined so therefore they must be tested for impairment as part of their cash generating unit.

 

The carrying value of the CGU after the impairment of the patents and machines is $2,250,000 (see working below), whereas the recoverable amount is $1,950,000. A further impairment of $300,000 is therefore required.

 

This is firstly allocated to goodwill and then to other assets on a pro-rata basis. No further impairment should be allocated to the machines as these have already been written down to their recoverable amount.

 

 

Allocation of impairment loss to CGU
	Draft	Impairment	Revised
	$000	$000	$000
Goodwill	100	(100)	Nil
Patents	nil	–	Nil
Machines	150	–	150
Computers	500	(50)	450
Buildings	1,500	(150)	1,350
	–––––	–––––	–––––
	2,250	(300)	1,950
	–––––	–––––	–––––

 

The total impairment charged to profit or loss is $650,000 ($200,000 + $150,000 + $300,000).

 

 

 

Test your understanding 7 – Boxer

 

Year ended 31 December 20X2
	$
Asset carrying amount ($30,000 × 8/10)	24,000
Recoverable amount	16,000
	–––––
Impairment loss	8,000
	–––––

 

The asset is written down to $16,000 and the loss of $8,000 is charged to profit or loss. The depreciation charge per annum in future periods will be $2,000 ($16,000 × 1/8).

 

Year ended 31 December 20X5
	$
Asset carrying amount ($16,000 × 5/8)	10,000
Recoverable amount	40,000
	–––––
Impairment loss	nil
	–––––

 

 

There has been no impairment loss. In fact, there has been a complete reversal of the first impairment loss. The asset can be reinstated to its depreciated historical cost i.e. to the carrying value at 31 December 20X5 if there never had been an earlier impairment loss.

 

Year 5 depreciated historical cost (30,000 × 5/10) = $15,000

 

Carrying amount: $10,000

 

Reversal of the loss: $5,000

 

The reversal of the loss is now recognised. The asset will be increased by $5,000 ($15,000 – $10,000) and a gain of $5,000 will be recognised in profit or loss.

 

It should be noted that the whole $8,000 original impairment cannot be reversed. The impairment can only be reversed to a maximum amount of depreciated historical cost, based upon the original cost and estimated useful life of the asset.

 

 

 

Test your understanding 8 – CGUs and impairment reversals

 

The goodwill impairment cannot be reversed.

 

The impairment of the PPE can be reversed. However, this is limited to the carrying value of the asset had no impairment loss been previously recognised.

 

The carrying amount of the PPE as at 31 December 20X3 is $150,000 ($180,000 × 5/6).

 

If the PPE had not been impaired, then its value at 31 December 20X3 would have been $250,000 ($400,000 × 5/8).

 

Therefore, the carrying amount of the PPE can be increased from $150,000 to $250,000. This will give rise to a gain of $100,000 in profit or loss.

 

Test your understanding 9 – Hyssop

 

• IFRS 5 states that in order to be classified as ‘held for sale’ the property should be available for immediate sale in its present condition. The property will not be sold until the work has been carried out, demonstrating that the facility is not available for immediate sale. Therefore the property cannot be classified as ‘held for sale’.

 

• The subsidiary B does not meet the criteria for classification as ‘held for sale’. Although actions to locate a buyer are in place, the subsidiary is not for sale at a price that is reasonable compared with its fair value. The fair value of the subsidiary is $2.5 million, but it is advertised for sale at $3 million. It cannot be classified as held for sale’ until the sales price is reduced.

 

 

 

Test your understanding 10 – AB

 

Until 31 December 20X4 the building is a normal non-current asset and its accounting treatment is prescribed by IAS 16. The annual depreciation charge was $4,000 ($200,000/50). As such, the carrying amount at 31 December 20X4, prior to reclassification, was $184,000 ($200,000 – (4 × $4,000)).

 

• On 31 December 20X4 the building is reclassified as a non-current 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). This means that the building will continue to be measured at $184,000.

 

• On 31 December 20X4 the building is reclassified as a non-current asset held for sale. It is measured at the lower of carrying amount ($184,000) and fair value less costs to sell ($110,000 – $10,000 = $100,000). The building will therefore be measured at $100,000 as at 31 December 20X4. An impairment loss of $84,000 ($184,000 – $100,000) will be charged to the statement of profit or loss.

 

 

Test your understanding 11 – Nash

 

The building would have been recognised on 1 January 20X1 at its cost of $1m and depreciated over its 50 year life.

 

By 31 December 20X2, the carrying amount of the building would have been $960,000 ($1m – (($1m/50) × 2 years)).

 

The building was revalued on 31 December 20X2 to $1.2m, giving a gain on revaluation of $240,000 ($1.2m – $960,000). This gain will have been recorded in other comprehensive income and held within a revaluation surplus (normally as a part of other components of equity).

 

The building would then have been depreciated over its remaining useful life of 48 years. Depreciation in the year ended 20X3 was therefore $25,000 ($1.2m/48). The building had a carrying amount at 31 December 20X3 of $1,175,000 ($1.2m – $25,000).

 

At 31 December 20X3, the building is held for sale. Because it is held under the revaluation model, it must initially be revalued downwards to its fair value of $1,100,000. This loss of $75,000 ($1,175,000 – $1,100,000) is recorded in other comprehensive income because there are previous revaluation gains relating to this asset within equity.

 

The building will then be revalued to fair value less costs to sell. Therefore, the asset must be reduced in value by a further $50,000. This loss is charged to the statement of profit or loss.

 

Test your understanding 12 – Cows

 

Cows are biological assets and should be initially recognised at fair value less costs to sell.

 

The cows purchased in the year should be initially recognised at $1,176 ((20 × $60) × 98%). This will give rise to an immediate loss of $24 ((20 × $60) – $1,176) in the statement of profit or loss.

 

At year end, the whole herd should be revalued to fair value less costs to sell. Any gain or loss will be recorded in the statement of profit or loss.

 

The herd of cows will be held at $10,584 ((120 × $90) × 98%) on the statement of financial position.

 

This will give rise to a further loss of $592 (W1) in the statement of profit or loss.

 

	(W1) Loss on revaluation
		$
	Value at 1 January 20X1	10,000
	New purchase	1,176
	Loss (bal. fig)	(592)
		––––––
	Value at 31 December 20X1	10,584
		––––––

 

 

Test your understanding 13 – GoodWine

 

Land is accounted for in accordance with IAS 16 Property, Plant and Equipment. If the revaluation model is chosen, then gains in the fair value of the land should be reported in other comprehensive income.

 

At 30 June 20X2, the land should be revalued to $2.1m and a gain of $100,000 ($2.1m – $2.0m) should be reported in other comprehensive income and held within a revaluation reserve in equity.

 

The grape vines are used to produce agricultural produce over many periods. This means that they are bearer plants and are therefore also accounted for under IAS 16. Except for land, GoodWine uses the cost model for property, plant and equipment. Therefore, depreciation of $15,000 ($300,000/20 years) will be charged to profit or loss in the year and the grape vines will have a carrying amount of $285,000 ($300,000 – $15,000) at 30 June 20X2.

 

The grapes growing on the vines are biological assets. They should be revalued at the year end to fair value less costs to sell with any gain or loss reported in profit or loss. GoodWine’s biological assets should therefore be revalued to $520,000. A gain of $20,000 ($520,000 – $500,000) should be reported in profit or loss.

 

The grapes are agricultural produce and should initially be recognised at fair value less costs to sell. Any gain or loss on initial recognition is reported in profit or loss. The harvested grapes should be initially recognised at $100,000 with a gain of $100,000 reported in profit or loss. The harvested grapes are now accounted for under IAS 2 Inventories and will have a deemed cost of $100,000.