University of Economics, Prague Faculty of Finance and Accounting Department of Financial Accounting and Auditing Non-current tangible and intangible assets (IAS 16 & IAS 38) 1FU486 IFRS David Procházka
Agenda Basic characteristics of non-current tangibles IAS 16: Measurement IAS 16: Depreciation IAS 16: Impairment IAS 16: Derecognition Basic characteristics of non-current intangibles IAS 38: Recognition IAS 38: Measurement IAS 38: Amortisation
1 Basic characteristics of non-current tangibles Property, plant and equipment are tangible assets 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 The cost of an item of property, plant and equipment shall be recognised as an asset if, and only if: - it is probable that future economic benefits associated with the item will flow to the entity - the cost of the item can be measured reliably The asset is reported on balance sheet at its carrying amount: - carrying amount is the amount at which an asset is recognised (initial costs or fair value) after deducting any accumulated depreciation and accumulated impairment losses
PPE Measurement Depreciation Impairement (IAS 36) Initial costs Revaluation model Methods Estimates Components Borrowing costs (IAS 23) Govern. grants (IAS 20) Dismantling (IAS 37)
2 IAS 16: Measurement 2.1 Initial measurement An item of PPE should be initially measured at its cost, which are necessary to bring the asset into working condition at its intended location: - purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates - any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management - dismantling costs, which is an entity obliged to incur when removing the item and restoring the site on which it is located - borrowing costs (IAS 23) incurred in connection with the acquisition of the asset Examples of directly attributable costs: - costs of employee benefits (as defined in IAS 19 Employee Benefits) arising directly from the construction or acquisition of the item of property, plant and equipment
- costs of site preparation - initial delivery and handling costs - installation and assembly costs - costs of testing whether the asset is functioning properly, after deducting the net proceeds from selling any items produced while bringing the asset to that location and condition - professional fees What cannot be capitalised as an asset: - costs of opening a new facility - costs of introducing a new product or service (including costs of advertising and promotional activities) - costs of conducting business in a new location or with a new class of customer (including costs of staff training) - administration and other general overhead costs
Included in asset's costs Purchase price Delivery costs Site preparation costs Legal fees Testing costs Subsequent enhancement of the asset Borrowing costs Excluded from asset's costs Repairs; renewals; repaintings Administration of the asset Training costs Wastage General overheads
Financing of the asset acquisition: - by finance lease => separate treatment in IAS 17 - by bank loan => IAS 23 has to be followed - by trade credit when payment for the asset is deferred beyond normal credit terms => the arrangement contains a financial component and IAS 23 applies similarly as for bank loans - with a government grant => IAS 20 is applied The acquisition costs of an item of PPE obtained through a barter transaction (having commercial substance) are measured: - at the fair value of the asset acquired, if reliably measurable; or - at the fair value of the asset disposed, if reliably measurable; or - at the carrying amount of the asset given up 04-E01; 04-E02
2.2 Subsequent expenditures Subsequent expenditures are capitalised as an asset only if they: - enhances the economic benefits provided by the asset (extension of useful life; increasing of productivity; reducing material costs) or - are incurred within the overhaul (major inspection at usually regular intervals) of the asset - replace a component of a complex asset Any other expenditures on day-to-day servicing (repair and maintenance, small parts, etc.) are immediately expensed into P&L 04-E03
2.3 Revaluation model IAS 16 allows an accounting choice of PPE measurement as at balance sheet day between - traditional cost model - revaluation model (using fair value) Conditions for revaluation model: - revaluations shall be made with sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the end of the reporting period - if an item of property, plant and equipment is revalued, the entire class of property, plant and equipment to which that asset belongs shall be revalued Accounting for the revaluation: - the increase shall be recognised in other comprehensive income and accumulated in equity under the heading of revaluation surplus; however, the increase shall be recognised in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognised in profit or loss
- the decrease shall be recognised in profit or loss; however, the decrease shall be recognised in other comprehensive income to the extent of any credit balance existing in the revaluation surplus in respect of that asset - the revaluation surplus included in equity shall be transferred directly to retained earnings when the asset is derecognised (i.e. no reclassification to P&L) - alternatively, the revaluation may be partly transferred to retained earnings; the amount of the surplus transferred would be the difference between depreciation based on the revalued carrying amount of the asset and depreciation based on the asset s original cost 04-E04; 04-E05
Treatment of revaluations under the IAS 16 fair value model Into OCI Cost Into P&L
3 IAS 16: Depreciation 3.1 Definitions Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life Depreciable amount is the cost of an asset, or other amount substituted for cost (e.g. fair value), less its residual value Residual value of an asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life Useful life is: - the period over which an asset is expected to be available for use by an entity; or - the number of production or similar units expected to be obtained from the asset by an entity
3.2 Depreciation procedure Identify a depreciable asset Single item Component Bundle of assets Determine its depreciable amount Cost less residual value Period Determine its useful life Number of units Calculate depreciation using an appropriate method Straight-line Accelerated Units-of-production Review and update all underlying estimates regularly Useful life Residual value Depreciation method
(1) Identification of a depreciable asset Each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately Parts with the same depreciation method and the same useful life may be grouped for the calculation of depreciation charges Unit of depreciation is: - a single asset in most cases - a bundle of (small) assets of similar function (e.g. kit of tools) - a component of a single asset with different useful life and/or depreciation method from the remainder (e.g. aircraft; heavy machinery; buildings; etc.)
(2) Depreciation method and depreciation period The depreciation method used shall reflect the pattern in which the asset s future economic benefits are expected to be consumed by the entity The selection of an appropriate method is based on the nature of an asset and its expected usage by the entity: - means of transport (cars; vehicles; aircraft); machinery and production lines => usually unit of production method (or accelerated methods as a proxy) - other assets straight-line method The choice of depreciation method is inseparable from the determination of depreciation period; depreciation period shall reflect: - expected usage of the asset (expected capacity or physical output) - expected physical wear and tear (depending on repair and maintenance programme) - technical or commercial obsolescence - legal or similar limits on the use of the asset (e.g. finance leases)
(3) Review of estimates The residual value and the useful life of an asset: - shall be reviewed at least at each financial year-end - if expectations differ from previous estimates, the change(s) shall be accounted for as a change in an accounting estimate (IAS 8) The depreciation method applied to an asset: - shall be reviewed at least at each financial year-end - if there has been a significant change in the expected pattern of consumption of the future economic benefits embodied in the asset, the method shall be changed to reflect the changed pattern - the change of a depreciation method is a change in an accounting estimate (IAS 8)
3.3 Accounting for depreciation Depreciation is relevant for almost all PPE: - land is an exception, as it contains unrestricted stream of benefits - however, in certain cases (e.g. waste dump; mines) land might be depreciated The depreciation charge for each period: - shall be recognised in P&L unless it is included in the carrying amount of another asset Depreciation is recognised even if the fair value of the asset exceeds its carrying amount: - depreciation is not a function of (decreasing) market value of assets, but rather a consequence of matching revenue with costs The residual value of an asset its carrying amount: - stop to depreciate as depreciable amount would be negative - restart to depreciate as soon as the residual value subsequently decreases below the asset s carrying amount
Depreciation: IAS 16 Property, Plant and Equipment & IAS 38 Intangible Assets - starts when it is available for use (when it is in the location and condition necessary for it to be capable of operating in the manner intended by management start vs finish) - ceases if the asset is derecognised or reclassified as held for sale (IFRS 5) - does not cease when the asset becomes idle or is retired from active use (unless the asset is fully depreciated), if time-based methods are applied - under units-of-production method, no depreciation charge is incurred, if there is no production Land and buildings: - are accounted for separately, even when they are acquired together - an increase in the value of the land on which a building stands does not affect the determination of the depreciable amount of the building 04-E06; 04-E07
Timing Recognition Depreciation starts asset is available for use Depreciation ceases asset is derecognised asset is transferred to IFRS 5 Depreciation is stopped no production residual value > carrying amount Depreciation is an asset used in production of inventory (IAS 2) used in the development phase (IAS 38) Depreciation is an expense used for administrative purposes used in the research phase (IAS 38)
4 IAS 16: Impairment Value of an asset reported in BS Lower of Carrying amount Recoverable amount Higher of Cost less Accumulated depreciation Fair value less cost to sell Value in use
Impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount Recoverable amount is the higher of an asset s fair value less costs to sell and its value in use To determine whether an item of PPE is impaired, an entity applies IAS 36 Compensation from third parties for items of PPE that were impaired, lost or given up shall be included in profit or loss when the compensation becomes receivable Impairments or losses of items of PPE, related claims for or payments of compensation from third parties and any subsequent purchase or construction of replacement assets are separate economic events and are accounted for separately as follows: - impairments are recognised in accordance with IAS 36 - derecognition of PPE retired or disposed of is determined in accordance with IAS 16 - compensation from third parties are accounted for in accordance with IAS 16 - the cost of items of PPE restored, purchased or constructed as replacements is determined in accordance with IAS 16
5 IAS 16: Derecognition The carrying amount of an item of property, plant and equipment shall be derecognised: - on disposal or - when no future economic benefits are expected from its use or disposal The gain or loss on derecognition: - shall be included in P&L (unless IAS 17 requires otherwise on a sale and leaseback) - gains shall not be classified as revenue - shall be determined as the difference between the net disposal proceeds, if any, and the carrying amount of the item
6 Basic characteristics of non-current intangibles In certain industries, the most important item of assets (e.g. pharmaceutics; public defence; etc.) In many cases, an intangible is just a thought or idea Intangibles are usually unique => problems with valuation and future benefits Plausible (non-accounting) classification: - technological (software; patents; business secrets; databases; prototypes) - rights arising from legal contracts (franchises; licences; broadcasting, music and movie rights; land rights; branding) - customer based (clients databases; loyalty programmes) - marketing (trademarks; journal titles; protected names; brand names) - intellectual property (copyrights for movies, music, games, literature, photos, etc.) - goodwill
7 IAS 38: Recognition 7.1 General principles The recognition of an item as an intangible asset requires an entity to demonstrate that the item meets: - the definition of an intangible asset and - the recognition criteria Intangible asset is an identifiable non-monetary asset without physical substance Definitional features: Identifiability (distinguishable from goodwill): - asset is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, identifiable asset or liability, regardless of whether the entity intends to do so - asset 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
Control: IAS 16 Property, Plant and Equipment & IAS 38 Intangible Assets - an entity controls an asset if the entity has the power to obtain the future economic benefits flowing from the underlying resource and to restrict the access of others to those benefits - in the absence of legal rights, it is more difficult to demonstrate control, but not impossible Future economic benefits Recognition criteria: Standard requirements taken from the Framework, i.e.: - it is probable that the expected future economic benefits that are attributable to the asset will flow to the entity - the cost of the asset can be measured reliably
7.2 Specifics of internally generated assets Difficulties with an internally generated intangible asset: - whether and when there is an identifiable asset that will generate expected future economic benefits - determining the cost of the asset reliably In some cases, the cost of generating an intangible asset internally cannot be distinguished from the cost of maintaining or enhancing the entity s internally generated goodwill or of running day-to-day operations Internally generated goodwill: Shall not be recognised as an asset: - it is not an identifiable resource controlled by the entity that can be measured reliably at cost - difference between the fair value of an entity and the carrying amount of its identifiable net assets cannot represent the cost of intangible assets controlled by the entity
Special items A: IAS 16 Property, Plant and Equipment & IAS 38 Intangible Assets Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance Shall not be recognised as intangible assets: - expenditure on these items cannot be distinguished from the cost of developing the business as a whole (i.e. cannot be separated from internally generated goodwill) Research and development (R&D): Research is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding Development is the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use
Research Expense Development: phase A Expense Development: phase B Asset
An intangible asset arising from development shall be recognised if, and only if, an entity can demonstrate all of the following: - the technical feasibility of completing the intangible asset so that it will be available for use or sale - its intention to complete the intangible asset and use or sell it - its ability to use or sell the intangible asset - how the intangible asset will generate probable future economic benefits - the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset - its ability to measure reliably the expenditure attributable to the intangible asset during its development.
7.3 Specifics of externally acquired assets Some items (Special items B) shall not be capitalised, regardless they are acquired internally of externally: - expenditure on start-up activities (however it may be included in acquisition costs of PPE) - expenditure on training activities (no effective control over the staff) - expenditure on advertising and promotional activities - expenditure on relocating or reorganising part or all of an entity However, prepayments for these item is recognised as an asset (with immediate expensing once the services related to the item are consumed) Expenditures on items, that cannot be recognised if internally generated, can be recognised as an asset, if purchased (or otherwise externally acquired) supposed that general principles for recognition are met 04-E08
8 IAS 38: Measurement 8.1 Initial measurement of assets The initial measurement of an intangible asset very much depends on the way, how it was acquired Internally acquired intangible assets (if conditions are met for the recognition) are measured at the cost Externally acquired intangibles: - at cost, if purchased for cash - at fair value, if acquired in non-monetary transaction or purchased in business combination (except for goodwill, which is calculated as residuum) Determination of acquisition costs similar to PPE
Internally generated assets Goodwill Research Special items A&B Development Cannot be recognised as an asset Cannot be recognised as an asset Cannot be recognised as an asset Cost, if an asset recognised
Externally acquired assets Purchase By business combination Barter transaction Special items B Acqusition costs Fair value 3-step hierarchy Cannot be recognised as an asset
8.2 Revaluation model Revaluation model might be used as an alternative, if an asset s fair value is determined with the reference to an active market: - a market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis It is uncommon an active market to exist for an intangible asset: - some exceptions (taxi licences, fishing licences, production quotas, emission quotas) - never for brands, newspaper mastheads, music and film publishing rights, patents or trademarks, as these assets are always unique The fact that an active market no longer exists for a revalued intangible asset may indicate that the asset may be impaired and IAS 36 is to be applied All other things similar to IAS 16
9 IAS 38: Amortisation 9.1 Useful life The useful life of an intangible asset: - finite (length of period; number of production units) - indefinite (no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity) Indefinite (undetermined) does not mean infinite (endless) Useful life of contractual assets may not exceed the contractual period; the option for renewal prolongs useful life only if there is evidence to support renewal by the entity without significant cost
9.2 Amortisation principles Assets with finite useful life: - are amortised and the procedure is similar to IAS 16 - residual value only with reference to an active market or if there is commitment by a third party to purchase the asset at the end of its useful life - all estimated subject to regular reviewing (at least annually) Assets with indefinite useful life: - are not amortised - the useful life has to reviewed (at least) annually - if indefinite changes to finite => start to amortise because of change in estimate (IAS 8) - subject to impairment tests annually (IAS 36)
David Procházka Department of Financial Accounting and Auditing Faculty of Finance and Accounting University of Economics, Prague W. Churchill Sq. 4 Prague, 130 67 Czech Republic Web: https://webhosting.vse.cz/prochazd Email: <prochazd@vse.cz>