5
Tangible
Non-Current
TANGIBLE NON-CURRENT ASSETS
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Context
Tangible non-current assets were introduced in detail at the F3 level. This chapter provides a reminder of the material which you have seen before, and also introduces the more complex accounting issues of
• Borrowing costs relating to non-current assets
• Government grants (which may or may not relate to the purchase of non-current assets), and • Investment properties – a particular type of non-current asset which has its own accounting rules.
Exam Hints
This area of the syllabus is examined either as part of the published accounts question (Q2) or in its own right within question 4 or 5 of the paper.
Key Learning Points
IAS 16 Property, Plant and Equipment
• A tangible non-current asset is initially recorded at cost which may include: purchase price after any trade discounts, transport and handling costs, non-refundable tax such as import duties, site preparation, installation costs, professional fees, labour costs of the entity’s own employees (Where asset is self constructed), borrowing costs, future dismantling and restoration costs.
• Any abnormal costs such as wastage and costs arising from errors do not form part of the cost of the asset, and must be expensed as incurred
• Subsequent expenditure on a non-current asset may be capitalised where it enhances the economic benefits of the asset in excess of its current standard of performance.
• A complex asset is one which is made up of several constituent parts, each with a different useful life. Each part of the complex asset is depreciated over its useful life and, after this time, the cost of the replacement part is capitalised.
• Where the useful life or residual value of an asset changes, the change is applied on a prospective basis • A change in the method of depreciation is allowed only where the new method is more appropriate. The
change is applied prospectively
• IAS 16 allows non-current assets to be measured using either the cost model or the revaluation model. • Where the revaluation model is applied, it must be applied consistently to all assets in the same class, and
the valuation must be kept sufficiently up to date so that it is not significantly different from fair value • An upwards revaluation is credited to other comprehensive income (other than where it reverses a previous
downwards revaluation recognised in the income statement)
• A downwards revaluation is charged to the income statement (other than where it reverses a previous upwards revaluation recognised in other comprehensive income)
• Depreciation is charged on a revalued asset as normal, based on a depreciable amount of valuation less residual value spread over the remaining useful life.
• A reserves transfer may be made to transfer the difference between the actual depreciation charge and the historical cost depreciation charge from the revaluation reserve to retained earnings
• Where a previously revalued asset is disposed of, any balance remaining in the revaluation reserve relating to this asset is transferred to retained earnings and disclosed in the statement of changes in equity.
IAS 23 Borrowing Costs
• IAS 23 requires that borrowing costs associated with the acquisition, construction or production of a qualifying asset are be capitalised as part of the cost of that asset
• Interest related to specific borrowings is capitalised net of income generated by the investment of surplus funds
• Capitalisation commences when expenditure is being incurred on the asset, borrowing costs are being incurred and activities to prepare the asset for its intended purpose are in progress
• Capitalisation ceases when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete
• Capitalisation is suspended when work on the asset is suspended
IAS 20 Accounting for Government Grants and Disclosure of Government Assistance
• A grant is recognised in the financial statements only when there is reasonable assurance that: o The entity will comply with the conditions attached to the grant, and
o The grants will be received
• A revenue grant is held as deferred income and released to the income statement over the period in which the related expenditure is incurred
• A capital grant is either :
o netted off against the cost of the asset with the net amount spread over the asset’s useful life and charged to the income statement as depreciation; or
o held as deferred income and released to the income statement over the useful life of the asset. • Grants which relate to costs already incurred should be recognised in the income statement in the period
in which they become receivable.
IAS 40 Investment Property
• Investment properties are defined as property (land or a building – or part of a building – or both) held to earn rentals or for capital appreciation or for both rather than for use or sale in the ordinary course of business.
• They are accounted for according to either the cost model of IAS 16 or the fair value model of IAS 40 • Where the cost model is applied, investment property is held at cost less depreciation. It is not revalued • Where the fair value model is applied, investment property is re-measured to fair value each year with any
changes in fair value recognised in the income statement. It is not depreciated.
Relevant Accounting Standards
IAS 16 Property, Plant and Equipment IAS 23 Borrowing Costs
IAS 20 Accounting for Government Grants and Disclosure of Government Assistance IAS 40 Investment Property
Technical Articles
The following article (in two parts) explains property, plant and equipment and is available on ACCA’s website. http://www.accaglobal.com/pubs/students/publications/student_accountant/archive/robins0607.pdf
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Introduction
Tangible non-current assets is one of the biggest balances in the statement of financial position. Although IAS 16 Property, Plant and Equipment is the main accounting standard which provides guidance on this topic, others are also relevant:
IAS 23 Borrowing Costsprovides rules as to when borrowing costs should be capitalised as part of the cost of a non-current asset.
IAS 20 Accounting for Government Grants and Disclosure of Government Assistance
considers how support received from the government, and often related to the purchase of non-current assets, should be reflected in the financial statements.
IAS 40 Investment Propertiesprovides specific guidance on how to account for properties held only for investment purposes rather than to use within a business.
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IAS 16 Property, Plant and Equipment
Property, plant and equipment (PPE) is defined as:
Tangible items that:
(a) are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and
(b) are expected to be used during more than one period.
IAS 16 requires that PPE is shown in the statement of financial position at its carrying value, defined as:
The amount at which an asset is recognised after deducting any accumulated depreciation and any accumulated impairment losses.
IAS 16 provides guidance on the calculation of an asset’s carrying value, and in particular: 1. the initial measurement of PPE, and treatment of any subsequent expenditure 2. the depreciation of PPE
3. the revaluation of PPE 4. the disposal of PPE.
Guidance on accounting for impairments is provided in IAS 36. This is covered in detail in chapter 7.
2.1 TANGIBLE NON-CURRENT ASSETS: MEASUREMENT
2.1.1 INITIAL MEASUREMENT
A tangible non-current asset is initially recorded at cost. This may include: • purchase price after any trade discounts (but before settlement discounts) • transport and handling costs
• non-refundable tax such as import duties • site preparation
• installation costs
• professional fees such as legal costs
• If the asset is self-constructed, labour costs of the entity’s own employees • Borrowing costs (see section 3 of this chapter)
• Future dismantling and restoration costs.
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Illustration
Future dismantling and restoration costs are included as part of the cost of a non-current asset only where these costs are recorded as a provision under IAS 37 (see chapter 12).
An entity builds a research centre in the rainforest at a cost of $250,000, having signed a contract with local government to dismantle the centre and restore the land after 10 years at an estimated cost of $100,000. Assuming a discount rate of 5%, a provision is made for:
$100,000/1.0510 = $61,391.
The debit entry is to the non-current asset cost account, such that the total cost of the research centre is:
$ Building cost 250,000 Restoration cost 61,391 311,391
Each year, the discount is unwound, and recorded as interest:
Year 1 $61,391 x 5% = $3,070
Dr Interest expense $3,070
Cr Provision $3,070
The measurement of the non-current asset is not affected by the unwinding of the discount.
Any abnormal costs such as wastage and costs arising from errors do not form part of the cost of the asset, and must be expensed as incurred.
Exam Hint
In December 08, 7 marks were available for discussion of the treatment of a non-current asset and future clean up costs.The examiner reported that common problems were:
- failure to include the clean up costs as part of the cost of the asset - failure to discount the clean up costs.
Even more common was a failure by those candidates who had discounted the clean up costs to unwind the discount and arrive at a finance cost.
In a different question on the same exam paper, 10 marks were available for the production of extracts of financial statements relating to a non-current asset over 3 years. The examiner commented that a number of candidates calculated the initial cost of the asset wrongly because they deducted a settlement discount from cost. This amount should have been recorded as income.
The initial measurement of non-current assets may also appear in the published company accounts question (Q2), as it did in December 07.
2.1.2 SUBSEQUENT COSTS
Subsequent expenditure on a non-current asset may be capitalised where:
TANGIBLE NON-CURRENT ASSETS
• A component of an asset is treated separately for depreciation purposes and is replaced or restored • A major overhaul restores the asset and the cost of previous overhauls have been reflected in past
depreciation charges.
Any other subsequent expenditure, including repairs, must be expensed to the income statement in the period in which it is incurred.
Learning Example 5.1
Broadoak has recently purchased an item of plant from Plantco. The details of this are: $
Basic list price of plant 240,000 Trade discount applicable to Broadoak 12.5% on list price Ancillary costs:
Shipping and handling 2,750 Estimated pre-production testing 12,500 Maintenance contract for 3 years 24,000 Site preparation costs:
Electrical cable installation 14,000 Concrete reinforcement 4,500
Own labour costs 7,500
Broadoak paid for the plant (excluding the ancillary costs) within four weeks of order, thereby obtaining an early settlement discount of 3%.
Broadoak had incorrectly specified the power loading of the original electrical cable to be installed by the contractor. The cost of correcting this error of $6,000 is included in the above figure of $14,000.
The plant is expected to last for 10 years. At the end of this period there will be compulsory costs of $15,000 to dismantle the plant and $3,000 to restore the site to its original use condition.
Calculate the amount at which the initial cost of the plant should be measured, ignoring discounting.
2.2 TANGIBLE NON-CURRENT ASSETS: DEPRECIATION
Depreciation is:
The systematic allocation of the depreciable amount of an asset over its useful life.
The depreciable amount is:
The cost of an asset, or other amount substituted for cost, less its residual value.
2.2.1 METHODS OF DEPRECIATION
There are two key methods of depreciation, both of which are examined frequently: 1. the straight line method
2. the reducing balance method
Straight Line Method
This method results in a constant annual charge over the asset’s useful life. It is calculated as
Cost – residual value Useful life
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FINANCIAL REPORTING (INTERNATIONAL)
Reducing Balance Method
This method results in a decreasing annual charge over the asset’s useful life. It is appropriate for assets such as motor vehicles and IT equipment which provide greater benefit in earlier years.
In both cases, depreciation is charged from the time that the asset becomes available for use in the normal manner (even if it is not yet being used).
Learning Example 5.2
The following figures are extracted from the trial balance of Telenorth.
$000 $000 25 year leasehold building – cost 56,250
Plant and equipment – cost 55,000 Computer system – cost 35,000 Depreciation 1 October 20X7 (note)
Leasehold building 18,000
Plant and equipment 12,800
Computer system 9,600
Note: Telenorth has the following depreciation policy: Leasehold building – straight line over lease term
Plant and equipment – five years straight line with residual values estimated at $5m Computer system – 40% per annum reducing balance
Depreciation of the leasehold building and plant is treated as cost of sales; depreciation of the computer system is an administration cost.
Calculate the depreciation charge and amounts to be included in the statement of financial position for the year ended 31 September 20X8.
2.2.2 DEPRECIATION OF COMPLEX ASSETS
Complex assets are those which are made up of various component parts, each of which has a different useful life.
In this case, each part of the complex asset is treated separately for depreciation purposes. The part is depreciated over its useful life and, after this time, the cost of the replacement part is capitalised.
2.2.3 CHANGE IN DEPRECIATION ESTIMATES
IAS 16 requires that the residual value and useful life of an asset is reviewed at least at each financial year-end, together with the depreciation method applied to the asset.
If the residual value or useful life has changed, or the depreciation method applied to the asset is no longer appropriate to the pattern of consumption of economic benefits associated with the asset, then these are changed.
TANGIBLE NON-CURRENT ASSETS
Learning Example 5.3
Addingham has owned a non-current asset for 5 years, depreciating the cost of $40,000 on a straight line basis over 20 years. The company has conducted a review of its assets and now believes the asset to have a remaining useful life of 12 years, and a scrap value at the end of that life of $800.
What is the old and new depreciation charge?
2.3 TANGIBLE NON-CURRENT ASSETS: REVALUATION
IAS 16 allows non-current assets to be measured using either the cost model or the revaluation model. Where the revaluation model is applied, the carrying value of a non-current asset is
$000
Valuation X
Accumulated depreciation (X) Impairment losses (X) X
The standard requires that where the revaluation model is applied:
o It is applied consistently to all assets of a class of property, plant and equipment
o Assets are revalued sufficiently regularly that their carrying amount is not significantly different from their fair value
2.3.1 ACCOUNTING FOR A REVALUATION
Upwards Revaluation
Where an asset is revalued upwards, this is accounted for by:
Dr Non-current asset the difference between cost and revalued amount
Dr Accumulated depreciation all depreciation on the revalued asset to date
Cr Other comprehensive income
(revaluation surplus) β
Therefore the credit to other comprehensive income is equal to the difference between the carrying amount of the asset prior to revaluation and its revalued amount.
Downwards Revaluation
Where an asset is revalued downwards, the accounting entries depend on whether the asset has previously been revalued upwards:
Not previously revalued upwards Previously revalued upwards
Dr Income statement Dr Other comprehensive income (to extent revaluation Cr Non-current asset surplus exists in relation to the asset)
Dr Income statement Cr Non-current asset
Where an asset has been revalued downwards and is subsequently revalued upwards, the revaluation surplus is credited to the income statement to the extent that the downwards revaluation was previously charged against profit or loss.
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2.3.2 DEPRECIATION OF A REVALUED ASSET
Depreciation is charged on a revalued asset as normal, based on a depreciable amount of valuation less residual value spread over the remaining useful life.
Depreciation is charged to the income statement, but a reserves transfer may be made to transfer the difference between the actual depreciation charge and the historical cost depreciation charge from the revaluation reserve to retained earnings:
Dr Revaluation reserve excess depreciation Cr Retained earnings excess depreciation
Learning example 5.4
Allisterco buys property on 1 January 20X1 at a cost of $400,000, and commences depreciation on the basis of 5% straight line. On 31 December 20X4, the property is revalued to $750,000. Depreciation continues to be charged over the remaining useful life of 21 years.
On 31 December 20X8, the property is sold for $780,000.
Prepare extracts from the statements of changes in equity and statement of comprehensive income for the year ended 31 December 20X8.
Exam hint
The published accounts questions (Q2) in the December 07, June 08 and December 08 exam papers all included a revaluation which had not yet been accounted for. After each of these sittings, the examiner commented that many candidates had accounted for the revaluation as though it had arisen at the start of the period, even though the question clearly stated that it had occurred at the end. If the question states that a revaluation occurs at the end of an accounting period, ensure that you charge depreciation for the year before revaluing the asset.
2.4 TANGIBLE NON-CURRENT ASSETS: DISPOSAL
The gain or loss on disposal of a non-current asset is calculated as the difference between proceeds and the asset’s carrying value on the date of disposal.
This applies to assets held under both the cost and revaluation model.
Any resulting gain or loss on disposal is recognised in the income statement.
Where a previously revalued asset is disposed of, any balance remaining in the revaluation reserve relating to this asset is transferred to retained earnings and disclosed in the statement of changes in equity.
Learning Example 5.5
Hunt buys a building on 1 March 20X4 costing $500,000. It is depreciated monthly on a straight line basis over 40 years. On 31 December 20X8, Hunt carries out a revaluation exercise and assesses the fair value of the building to be $640,000, and its remaining useful life to be 38 years.
TANGIBLE NON-CURRENT ASSETS
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2.5 TANGIBLE NON-CURRENT ASSETS: DISCLOSURE
The standard disclosure note required by IAS 16 is sometimes required within a question. Even where this is not the case, it often provides a useful layout for workings.
Land and Fixtures and Plant and Total Buildings Fittings Machinery $000
$000 $000 $000
Cost
At 1.1.X8 340 120 100 560
Additions - 50 20 70
Revaluation 100 - - 100
Disposal - (30) (10) (40)
At 31.12.X8 440 140 110 690
Accumulated Depreciation
At 1.1.X8 140 50 20 210
Revaluation (140) - - (140)
Disposal - (12) (2) (14)
Charge for the year 22 28 11 61
At 31.12.X8 22 66 29 117
CV at 31.12.X8 418 74 81 573
CV at 1.1.X8 200 70 80 350
The land and buildings were revalued by a qualified surveyor on 31 December 20X8. They are being depreciated on a straight line basis over 20 years.
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IAS 23 Borrowing Costs
IAS 23 requires that borrowing costs associated with the acquisition, construction or production of a qualifying asset are be capitalised as part of the cost of that asset.
Borrowing costs are defined as:
interest and other costs that an entity incurs in connection with the borrowing of funds.
A qualifying asset is defined as:
an asset that necessarily takes a substantial period of time to get ready for its intended use or sale.
3.0.1 ELIGIBLE BORROWING COSTS
Where an entity borrows money specifically to acquire or construct a qualifying asset, all of the actual borrowing costs incurred, less any income from the temporary investment of the money borrowed, must be capitalised.
3.0.2 PERIOD OF CAPITALISATION
The capitalisation of borrowing costs commences when: o Expenditure on the asset has commenced, and o Borrowing costs are being incurred, and
o Activities necessary to prepare the asset for its intended use are in progress.
The capitalisation of borrowing costs ceases when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete.
If construction of the asset is suspended due to industrial action, for example, then the capitalisation of borrowing costs is also suspended.
Learning Example 5.6
MurphyCo commences building a new head office on 1 May 20X7. The project is anticipated to cost
$400,000 which MurphyCo believes can be financed from reserves. On 1 October 20X7 it becomes apparent that a loan is required to finance the project and $350,000 is advanced from the Northern Bank at a rate of 4%. Half of this is invested in an interest bearing account at a rate of 2.5% until it is required on 1 May 20X8. Building commences throughout the year ended 31 December 20X8, although work is forced to stop temporarily for the month of February due to inclement weather. At 31 December 20X8, it is anticipated that there are a further two months of work before the building is complete.
What borrowing costs must be capitalised in the years ended 31 December 20X7 and 20X8?
3.0.3 DISCLOSURE OF BORROWING COSTS
The following should be disclosed in relation to borrowing costs: o The amount of borrowing costs capitalised during the period
o The capitalisation rate used to determine the amount of borrowing costs eligible for capitalisation.
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IAS 20 Accounting for Government Grants and Disclosure of
Government Assistance
Government grants are monetary amounts paid to a business by the authorities in return for meeting certain conditions such as employing a certain number of people.
They may be categorised as either:
o Capital grants i.e. those grants which are made to contribute towards the acquisition of an asset o Revenue grants i.e. those grants which are made for other purposes such as the payment of wages
4.0.1 RECOGNITION OF GOVERNMENT GRANTS
A grant is recognised in the financial statements only when there is reasonable assurance that: o The entity will comply with the conditions attached to the grant, and
o The grants will be received
The grant should be recognised in the income statement in the period in which the expenditure towards which it was intended to contribute is recognised.
TANGIBLE NON-CURRENT ASSETS
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4.0.2 ACCOUNTING FOR REVENUE GRANTS
The receipt of a revenue grant is recorded by: Dr Cash
Cr Deferred income (liability)
The grant held as deferred income is then released to the income statement over the period in which the related expenditure is incurred:
o Revenue grants which are made to subsidise specific expenditure are recognised in the income statement in the period in which that expenditure is recognised.
o Revenue grants which are made to held achieve a non-financial goal are recognised in the income statement in which the costs of meeting that goal are recognised.
The credit to the income statement may be: o presented as a separate item of income; or
o deducted from the related expense which is then shown net.
4.0.3 ACCOUNTING FOR CAPITAL GRANTS
IAS 20 allows two treatments with regard to the recognition of a capital grant:
1. Deduct grant from cost of the non-current 2. Record grant separately as deferred asset to which it relates income.
Dr Cash Dr Cash
Cr Non-current asset Cr Deferred income
Depreciate the net cost of the non-current Release the deferred income to the income asset over its useful life. statement over the useful life of the Therefore both the grant and the full cost of non-current asset.
the non-current asset are spread over the useful life of the asset.
Note that where the grant is recognised as deferred income in the statement of financial position, this amount will be split between current and non-current liabilities.
4.0.4 GRANTS TO REIMBURSE PREVIOUSLY INCURRED COSTS
Grants which relate to costs already incurred should be recognised in the income statement in the period in which they become receivable.
4.0.5 DISCLOSURE OF GOVERNMENT GRANTS
IAS 20 requires disclosure of the following in relation to government grants:
o The accounting policy adopted for government grants including methods of presentation in the financial statements
o The nature and extent of government grants recognised in the financial statements
Learning Example 5.7
BrownCo is entitled to receive a grant of $30,000 on the condition that it is used to cover part of the cost of the purchase of new safety equipment. The equipment is purchased on 1 December 20X8 at a cost of $55,000.
It is expected to have a useful life of 10 years after which it will require replacing.
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IAS 40 Investment Property
Investment properties are defined as:
Property (land or a building – or part of a building – or both) held to earn rentals or for capital appreciation or for both rather than for use or sale in the ordinary course of business.
The definition would therefore include:
o Land held for a currently undetermined future use o A building leased out under an operating lease
o Land held long term in order to benefit from an increase in market value
It also includes property which is currently under construction but will be used in the future to earn rentals or for capital appreciation.
5.0.1 EXCLUDED PROPERTIES
The following are not within the scope of IAS 40 investment property: o Property intended for sale in the ordinary course of business (IAS 2) o Property being constructed or developed on behalf of third parties (IAS 11) o Owner occupied property (IAS 16)
o Property leased to another entity under a finance lease (IAS 17)
5.0.2 THE ACCOUNTING ISSUE
In effect, acquiring investment properties is an alternative way for a company to utilise surplus cash to earn returns rather than putting it in a bank or using it to purchase stocks and shares. These properties are not used by the business, but rather held to generate income and long term capital growth.
It therefore follows that the accounting treatment for non-current assets is not necessarily applicable to investment properties. In particular, there is little need to depreciate such assets when they are held specifically for long-term capital appreciation.
The provisions of IAS 40 are therefore applied to such investment properties, rather than those of IAS 16 or any other standard.
5.1 ACCOUNTING TREATMENT OF INVESTMENT PROPERTIES
IAS 40 requires that investment properties are initially measured at cost. It then allows a choice of subsequent treatment. Companies can choose to apply either
o The cost model of IAS 16, or o A fair value model
The choice must be applied consistently to all investment properties held by a company, and a change from one model to the other is not allowed unless it results in more appropriate presentation.
5.1.1 THE COST MODEL
Investment properties accounted for using the cost model are held in accordance with IAS 16, at cost less depreciation less impairment losses.
These properties can not be revalued.
5.1.2 THE FAIR VALUE MODEL
TANGIBLE NON-CURRENT ASSETS
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Any change in fair value since the last measurement date is recognised in the income statement.
Properties held under the fair value model are not depreciated.
Learning Example 5.8
In the light of poor market interest rates and a dip in property prices, the financial controller of Abbott Inc was instructed by the managing director in June 20X8 to invest some of the company’s surplus cash in a plot of land costing $1million. This land may be used by Abbott Inc in the future to build a new factory on, or it may be sold to realise a profit, depending on property prices in the coming years.
It is now the year end, 30 June 20X9 and the financial controller is preparing Abbott Inc’s financial statements for presentation to the Board. He knows that the land has fallen slightly in value to $950,000, but is unsure of how to account for it.
Solution 5.1
$
Basic list price 240,000
Trade discount of 12.5% (30,000) Shipping and handling 2,750 Estimated pre-production testing 12,500 Electrical cable installation (14,000 – 6,000) 8,000 Concrete reinforcement 4,500
Own labour costs 7,500
Dismantling and restoration costs 18,000
263,250
- the early settlement discount is treated as income rather than a reduction in the asset cost; - the abnormal costs associated with the cable error are not allowed to form part of the capitalised;
cost per IAS 16
- the maintenance contract is a revenue expense and may not be capitalised.
Solution 5.2
Income Statement for the Year Ended 30 September 20X8 $000
Cost of sales (2,250 + 10,000) 12,250
Administration cost 10,160
Statement of financial position at 30 September 20X8
Leasehold building 36,000
Plant and equipment 32,200
Computer system 15,240
Working $000 $000
Leasehold building
Cost 56,250
Depreciation to 1.10.X7 (18,000) 38,250
Depreciation charge (56,250/25) (2,250) 2,250
CV at 30.9.X8 36,000
Plant and equipment
Cost 55,000
Depreciation to 1.10.X7 (12,800) 42,200
Depreciation charge ((55-5)/5) (10,000) 10,000
CV at 30.9.X8 32,200
Computer system
Cost 35,000
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Solution 5.3
$000 Old depreciation charge ($40,000/20) 2,000 CV at date of change ($40,000 – ($2,000x5)) 30,000 New depreciation charge ($30,000 – 800)/12years 3,125
Solution 5.4
Statement of Financial Position of Hunt at 31 December 20X8 $000
Property 640,000
Revaluation reserve 200,417
Statement of Comprehensive Income for Hunt for Year Ended 31 December 20X8
Depreciation charge 12,500
Other comprehensive income
Revaluation surplus 200,417
Workings
$000 Cost of building 500,000 Depreciation X4 10/12 x $500,000/40 (10,417) Depreciation X5 (12,500) Depreciation X6 (12,500) Depreciation X7 (12,500) Depreciation X8 (12,500) CV at date of revaluation 439,583 Revaluation surplus (β) 200,417 FV at 31 December 20X8 640,000
Solution 5.5
Statement of Changes in Equity for Allisterco for the Year Ended 31 December 20X8
Retained Earnings Revaluation Reserve
$ $
Reserves transfer 367,144 (367,144)
Statement of Comprehensive Income for Allisterco for the Year Ended 31 December 20X8 $
Workings Reserves transfer $ $ Rev Res $ Ret E’gs Cost of property 400,000
Depreciation X1 (20,000) Depreciation X2 (20,000) Depreciation X3 (20,000) Depreciation X4 (20,000) CV on 31 December 20X4 320,000
Revaluation surplus 430,000 430,000 FV on 31 December 20X4 750,000
Depreciation X5 (750/21) (35,714) (15,714) 15,714 Depreciation X6 (750/21) (35,714) (15,714) 15,714 Depreciation X7 (750/21) (35,714) (15,714) 15,714 Depreciation X8 (750/21) (35,714) (15,714) 15,714
CV on 31 December 20X6 607,144
Sale proceeds 780,000
Profit on disposal 172,856
Balance on revaluation reserve at disposal 367,144
Solution 5.6
$000 Year ended 31 December 20X7
$350,000 x 4% x 3/12 3,500
Investment income $175,000 x 2.5% x 3/12 (1,094) Capitalised borrowing costs 2,406 Year ended 31 December 20X8
$350,000 x 4% x 11/12 12,833 Investment income $175,000 x 2.5% x 3/12* (1,094) Capitalised borrowing costs 11,739
* investment income relating to February is not relevant, as interest costs relating to this month are ineligible for capitalisation.
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Solution 5.7
Statement of Financial Position for BrownCo at Method 1: Method 2:
30 June 20X9 netting off separate liability
$000 $000
Non-current asset 23,542 51,792
Non-current liability: deferred income - 25,250 Current liability: deferred income - 3,000
Income Statement for BrownCo for Year Ended
30 June 20X9 $000 $000
Depreciation (1,458) (3,208)
Government grant 1,750
Working Netting off Separate
$000 presentation $000
Non-current asset cost 55,000 55,000
Grant (30,000)
-25,000 55,000
Depreciation (10 years UL; 7 months charge) (1,458) (3,208)
CV at 30 June 20X9 23,542 51,792
Deferred income - 30,000
Credit for y/e 30.6.X9 (30,000/10 x 7/12) - (1,750)
CV at 30 June 20X9 - 28,250
Current liability (30,000/10) 3,000
Non-current liability (β) 25,250
FINANCIAL REPORTING (INTERNATIONAL)
Solution 5.8
This land meets the IAS 40 definition of investment property. As yet the future purpose is undetermined, and therefore despite a possible use of the land by Abbott Inc itself, the land is currently treated as held for capital appreciation.
The land should initially be measured at the cost of $1million, and then either the cost or fair value model of IAS 40 should be applied.
If Abbott Inc currently has any other investment properties, the model applied to these should also be applied to the land, as IAS 40 requires consistency.
If the cost model is applied, the land should be held in accordance with the requirements of the cost model of IAS 16. In other words it should be held at cost of $1million. There is no requirement to depreciate land as its benefits are not consumed.
If the fair value model is applied, the land should be held at its year end fair value of $950,000, with a $50,000 loss recognised in the income statement.
Where the model applied is not dictated by an existing policy, in the light of the current fair value, the cost model seems more attractive in terms of showing a better position and performance in the financial statements. It should, however, be remembered that the policy adopted can not be changed other than to result in a fairer presentation, and therefore adopting the cost model now may mean that future increases in market value can not be reflected in the financial statements.
Learning Summary
• Ensure that you are familiar with the following in relation to non-current assets: o The elements of cost
o Methods of depreciation and changes in depreciation estimates o Rules regarding revaluations
• Learn the rules regarding when borrowing costs must be capitalised, and how much can be capitalised • Learn the different rules for accounting for a capital government grant and a revenue government grant • Learn the definition of an investment property and relevant accounting treatment
• Complete the quick test for Chapter 5 • Watch the video clip called ‘x
6
Intangible
INTANGIBLE ASSETS
Context
This chapter considers intangible non-current assets, and in particular: • How to identify them
• When they should be recognised in the financial statements, and • How they are measured in the financial statements
It also recaps the accounting rules on goodwill, as seen in chapter 1 of this book.
Exam Hints
This topic is often examined as part of the published company accounts question (Q2). Alternatively, it may feature in its own right within question 4 or 5.
Key Learning Points
• In order for an intangible asset to be recognised in the financial statements it must: 1 meet the IAS 38 definition of an intangible asset;
2 meet the IAS 38 recognition criteria.
• An intangible asset is defined as an identifiable non-monetary asset without physical substance.
• An asset is identifiable when it is separable (it can be sold as a single item) or it arises from contractual rights.
• IAS 38 requires that an intangible asset meeting the definition is recognised only where:
• It is probable that the expected economic benefits that are attributable to the asset will flow to the entity, and
• The cost of the asset can be measured reliably.
• Most internally generated intangible assets do not meet the recognition criteria, as their cost can not be distinguished from the costs of developing a business as a whole (e.g. brands, mastheads, customer lists) • Intangible assets which are recognised in the financial statements are measured initially at cost.
• Where an intangible asset has afinite useful life, it is amortised over that useful life, beginning when the asset is available for use.
• Where an intangible asset has anindefinite useful life, then it is not amortised, but is tested for impairment annually, and in between if there are indications of impairment.
• The revaluation model may be adopted for intangible assets only where a fair value can be established by reference to an active market.
• An active market is a market in which all of the following conditions exist: 1 items traded are homogenous;
2 willing buyers and sellers are available; 3 prices are available to the public.
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Research and Development
• Research is defined as original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding.
• Research costs are expensed to profit or loss as incurred.
• 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.
• Development costs are recognised as an intangible asset where they meet the SECTOR criteria. Other wise they are expensed to profit or loss:
1 ability to use orSell the intangible asset;
2 ability to measure reliably theExpenditure on the intangible asset; 3 intention toComplete the intangible asset and use or sell it;
4 Technical feasibility of completing the intangible asset so that it will be available for use or sale; 5 Overall probable future economic benefits;
6 The availability of adequate technical, financial and otherResources to complete the development. • Development costs are amortised in line with the revenues they generate. Amortisation begins when
commercial production or sales commence.
Goodwill
• Purchased positive goodwill is recognised as an intangible asset in the statement of financial position. It is not amortised but is tested for impairment annually.
• Purchased negative goodwill is expensed immediately to profit or loss • Internally generated goodwill can not be capitalised as an intangible asset.
Relevant Accounting Standards
IFRS 3 Business combinations IAS 38 Intangible assets
Technical Articles
The following article explains IAS 38 in respect of R & D and is available on ACCA’s website.
INTANGIBLE ASSETS
1
Intangible Assets – an Introduction
Accounting guidance relating to intangible assets is provided within a number of accounting standards. Of particular relevance to F7 are:
• IAS 38 Intangible assets (which does not include guidance on goodwill) • IFRS 3 Business Combinations (which does include guidance on goodwill)
2
IAS 38 Intangible Assets
In order for an intangible asset to be recognised in the financial statements it must: - meet the IAS 38 definition of an intangible asset;
- meet the IAS 38 recognition criteria.
2.1 DEFINITION OF AN INTANGIBLE ASSET
An intangible asset is defined as:
An identifiable1non-monetary2asset3without physical substance
1. An asset isidentifiablewhen it
• It is separable; in other words it can be sold as a single item, or • It is not separable, but arises from contractual rights.
2. Anon-monetaryasset is any asset other than cash or an asset to be settled in a fixed amount of cash (such as a receivable)
3. Anassetis a resource:
• Controlled by an entity as a result of past events, and
• From which future economic benefits are expected to flow to the entity
Learning Example 6.1
Which of the following examples of potential intangible assets do not meet the IAS 38 definition of an intangible asset?
• Goodwill
• The skills of the workforce
• The rights to produce a particular item to sell • A brand name developed by a company
2.2 RECOGNITION CRITERIA FOR AN INTANGIBLE ASSET
IAS 38 requires that an intangible asset meeting the definition above is recognised only where:
• It is probable that the expected economic benefits that are attributable to the asset will flow to the entity; and
• The cost of the asset can be measured reliably.
Learning Example 6.2
Consider the assets which did meet the IAS 38 definition of an intangible asset in learning example 6.1. Which of these meet the IAS 38 recognition criteria and can therefore be capitalised in the statement of financial position?
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FINANCIAL REPORTING (INTERNATIONAL)
2.2.1 INTERNALLY GENERATED INTANGIBLE ASSETS
Generally speaking, most internally generated intangible assets do not meet the recognition criteria, as their cost can not be distinguished from the costs of developing a business as a whole.
Such assets, which IAS 38 specifically prohibits from being capitalised include: • Internally generated brands
• Mastheads (the title at the top of the front page of a newspaper) • Publishing titles
• Customer lists
IAS 38 also considers internally generated intangible assets in the form of research and development. These are dealt with in section 3.
2.3 ACCOUNTING TREATMENT OF INTANGIBLE ASSETS
2.3.1 INITIAL MEASUREMENT
Intangible assets which are recognised in the financial statements are measured initially at cost.
Where they are acquired as part of a business combination, they are initially measured at fair value. Where fair value can not be established, the intangible is not recognised separately and its value is subsumed within goodwill.
2.3.2 AMORTISATION
Where an intangible asset has afinite useful life, it is amortised over that useful life, beginning when the asset is available for use.
Amortisation should reflect the pattern in which the asset’s benefits arise, or where this can not be established, should be on a straight line basis.
The residual value of an intangible asset is taken to be nil unless:
• There is a commitment by a third party to purchase the asset at the end of its life • There is an active market for the asset which is likely to exist at the end of its useful life.
An active market is defined as:
A market in which all of the following conditions exist: 1 items traded are homogenous
2 willing buyers and sellers are available 3 prices are available to the public
Where an intangible asset has anindefinite useful life, then it is not amortised, but is tested for impairment annually, and in between if there are indications of impairment.
The useful life should also be assessed each period and if it is no longer indefinite, then it must be amortised. This represents a change in accounting policy in accordance with IAS 8 (chapter 14).
2.3.3 IMPAIRMENT
Intangible assets with a finite life are tested for impairment where indications of an impairment are evident.
Intangible assets with an indefinite life are tested for impairment annually and where there are indications of an impairment.
INTANGIBLE ASSETS
In practice examples of assets which are part of an active market are: • Taxi cab licenses
• Airport landing rights • Fishing and milk quotas
By definition, however, most intangible assets are unique and therefore do not qualify as belonging to an active market and so can not be revalued.
Where revaluations are allowed, they should be made sufficiently regularly that the carrying value of the asset is not materially different from its fair value.
Learning Example 6.3
Amadeo, a drinks manufacturer and distributor has prepared its draft financial statements for the year ended 31 July 20X9 showing a profit for the year of $869,000 and total comprehensive income of $1.34 million, after accounting for the following:
1 At the insistence of the Brand Director, a new brand name ‘Red Square Vodka’ has been capitalised in the financial statements at $100,000. This measurement is based on costs incurred during the year to develop and market the brand. The asset is being amortised over a period of 10 years, with a full year’s charge in the current year.
2 Five year distribution rights over Asia were acquired at a cost of $58,000 during the year. The finance manager was unsure of how to treat these and so has capitalised them as a tangible non-current asset at cost, and taken no further action.
3 In the light of the sale of a soft drinks brand ‘fruitfizz’ to a competitor for $450,000, the finance manager revalued a similar soft drinks brand ‘lemoneasy’ to $450,000 at the start of the year. This brand was purchased 3 years ago from another company at a cost of $320,000, and recognised as an intangible asset amortised over 20 years.
What advice would you give to the Finance manager of Amadeo in respect of the above items?
3
Research and Development
IAS 38 provides guidance for accounting for research and development, as costs incurred on these activities may meet the definitions of an intangible asset.
Research is defined as:
Original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding.
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.
3.0.1 ACCOUNTING FOR RESEARCH COSTS
Research costs are sufficiently distant from commercial production to represent an asset. Therefore research costs should be charged as an expense in the income statement as incurred.
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FINANCIAL REPORTING (INTERNATIONAL)
3.0.2 ACCOUNTING FOR DEVELOPMENT COSTS
Development costs are expensed in the income statement unless all of the following can be demonstrated: 1 The technical feasibility of completing the intangible asset so that it will be available for use or sale 2 The intention to complete the intangible asset and use or sell it
3 The ability to use or sell the intangible asset
4 How the intangible asset will generate probable future economic benefits, including the existence of a market (when the asset is to be sold externally)
5 The availability of adequate technical, financial and other resources to complete the development 6 The ability to measure reliably the expenditure on the intangible asset.
Where these criteria are met, development costs are capitalised as an intangible non-current asset.
Exam Hint
The acronym SECTOR may help you to remember the development criteria:
S Sell or use (point 3)
E Expenditure measurable (point 6)
C will Complete (point 2)
T Technically feasible (point 1)
O Overall economic benefits (point 4)
R Resources available (point 5)
Amortisation
Development costs must be amortised in line with the rules of IAS 38 as laid out in section 2.3.2. Amortisation begins when commercial production or sales commence.
Learning Example 6.4
Drummond develops and produces medicinal drugs to combat contagious diseases. In the year ended 31 July 20X9, it was involved in the following:
1 A project to investigate whether a new plant species found deep in the Madagascan rainforest had healing properties. Money spent on the project amounted to $28,400.
2 A project to develop a new pandemic flu vaccine. The project started during the year and is currently at a stage where clinical trials are approximately 12 months away and, assuming that they are successful, sales a further 12 months away. Costs incurred during the year amounted to $38,000 on materials and $145,000 on staff costs. A competitor is also developing a similar project and is thought to be 13 months from commercial production. If the competitor’s product reaches the market first, Drummond is unlikely to achieve sales.
3 An ongoing project to develop a cure for dengue fever. The project was undertaken a number of years ago and meets the capitalisation criteria of IAS 38.To date, $378,000 has been capitalised. During the year the following amounts related to the project:
$176,000 staff costs $90,000 materials costs
INTANGIBLE ASSETS
Exam hints
The amortisation of development costs is normally added to cost of sales within a published company accounts question.
In December 2008, as part of the published company accounts question, candidates were given details of a research and development project which met the IAS 38 recognition criteria mid year and were required to pro-rate expenditure and expense that in the first part of the year and capitalise that in the second half of the year. The examiner reported that very few candidates put this into practice.
In December 2007, question 5 on the exam paper concentrated on development costs. In the first part of the question candidates were required to discuss the definition of an asset and accounting concepts in deciding whether development costs should be expensed or capitalised. In the second part of the question, the requirement was to adjust the accounts of a company which had applied the wrong treatment to development costs, using a prior year adjustment. The examiner commented that this question was clearly attempted last and produced some poor answers. In particular candidates recited the definition of an asset in part (a), and separately listed the IAS 38 recognition criteria, however did not link the two. In part (b) candidates rarely mentioned the prior year adjustment despite its being specifically mentioned in the question.
3.0.3 APPLICATION OF CONCEPTS TO ACCOUNTING FOR R&D
The following accounting concepts are applied in accounting for R&D:
Prudence
All research costs are expensed to profit or loss
Development costs are expensed to profit or loss unless they meet the strict recognition criteria
Accruals
Present costs are matched to future revenues by being deferred as a development costs asset and then amortised over the period in which revenues are earned.
Comparability
Unlike the equivalent UK standard, there is no choice in IAS 38, and therefore all policies are applied consistently to R&D.
4
Goodwill
4.1 PURCHASED GOODWILL
As we saw in chapter 1, purchased goodwill arises where one company purchases a controlling interest in an-other. It is calculated as:
$
Cost of investment X
Non-controlling interest X X Fair value of net assets of acquiree (X)
Goodwill X/(X)
The resulting goodwill (where positive) represents assets not recognised in the statement of financial position of the acquired company, such as its:
• reputation; • customer base; • location, and so on.
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FINANCIAL REPORTING (INTERNATIONAL)
These items do not meet the IAS 38 definition or recognition criteria of an intangible asset and so are not recognised in the consolidated statement of financial position. Instead, their value is absorbed within the over-all value of goodwill.
Purchased goodwill may also arise on the acquisition of an unincorporated business. In this case, goodwill arises in individual company accounts.
4.1.1 ACCOUNTING TREATMENT OF POSITIVE PURCHASED GOODWILL
IFRS 3 Business Combinations provides accounting guidance on accounting for goodwill:
Where purchased goodwill is positive (i.e. the value of the investment exceeds the net assets of the acquiree): • goodwill is recognised in the statement of financial position
• the goodwill is not amortised
• instead it is tested for impairment annually as part of a cash generating unit in accordance with IAS 36 (see chapter 7)
4.1.2 ACCOUNTING TREATMENT OF NEGATIVE PURCHASED GOODWILL
Negative purchased goodwill, or a ‘bargain purchase’ arises where the acquired company is loss making, or for some other reason, sold at price less than the value of its net assets.
The difference between the value of the acquiree and the value of its net assets is recognised in profit or loss in the period in which it arises.
4.2 INTERNALLY GENERATED GOODWILL
Where a company has not been the subject of an acquisition, it may still possess the component assets of goodwill, such as a good reputation or customer base.
This internally generated goodwill can not, however, be recognised in the financial statements as it does not meet the recognition criteria for an asset as detailed within the Framework (see chapter 14).
INTANGIBLE ASSETS
Solution 6.1
Goodwill
Goodwill is a non-monetary asset, however it is not separable, as it is can not be sold as a stand alone asset. Therefore it does not meet the IAS 38 definition of an intangible asset.
Goodwill is, however an intangible asset, dealt with by IFRS 3 Business Combinations.
The Skills of the Workforce
The skills of the workforce are non-monetary, however they are not identifiable, as they can not be sold, and they are not controlled, as an employee may resign and leave the company.Therefore these skills do not meet the IAS 38 definition of an intangible asset and can not be recognised on the statement of financial position.
The Rights to Produce a Particular Item to Sell
This is an identifiable non-monetary asset and can therefore be capitalised in the statement of financial position, assuming that it meets the IAS 38 recognition criteria.
It is identifiable as the right, although it may not be separable, is contractual.
A Brand Name Developed by a Company
This is an identifiable non-monetary asset and can therefore be capitalised in the statement of financial position, assuming that it meets the IAS 38 recognition criteria.
Solution 6.2
The Rights to Produce a Particular Item to Sell
This can be recognised in the statement of financial position, since: • It is probable that expected benefits will flow to the entity, and
• The cost of the asset can be measured reliably (being the price paid for the rights)
A Brand Name Developed by a Company
This can not be recognised in the statement of financial position, since its cost can not be established reliably.
Solution 6.3
Red Square Vodka
IAS 38 specifically prohibits the capitalisation of internally generated brand names as an intangible asset. Although such an asset does meet the definition of an intangible asset, it falls foul of the recognition criteria, as the cost of such a brand cannot be reliably measured.
Therefore the $100,000 should be written off to profit.
The amortisation charged of $10,000 should be added back to profit, and therefore a net adjustment of $90,000 is required to profit.
Distribution rights
Distribution rights meet the IAS 38 definition of an intangible asset, and also meet the recognition criteria, as they will result in probable economic benefits and the cost can be measured reliably. They should therefore be capitalised as an intangible asset.
Currently, they are capitalised as a tangible asset. The reclassification to intangibles will not effect profit.
The distribution rights are for five years and should therefore be amortised over this period. They are cur-rently not being amortised, so assuming a policy of a full year’s charge in the year of acquisition, profits and the carrying value of the asset will reduce by $11,600.
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Lemoneasy
Lemoneasy is a purchased brand and IAS 38 therefore allows its capitalisation at cost and subsequent amortisation. Intangible assets may only be revalued where a fair value can be established by reference to an active market. An active market requires:
- the asset to be part of an homogenous population, and - willing buyers and sellers, and
- publicly available prices.
A brand is unique and therefore not part of an homogenous population. Therefore revaluation is not allowed.
The revaluation gain recorded in other comprehensive income of $162,000 ($450,000 – ($320,000 x 18/20)) should therefore be reversed.
Depreciation charged for the year, based on the revalued amount, of $25,000 ($450,000/18years) should be reversed and a charge of $16,000 based on historical cost recognised.
The carrying value of the asset in the statement of financial position should therefore be $272,000 ($320,000 x 17/20).
In addition any reserves transfer of the excess $9,000 from the revaluation reserve to retained earnings should be reversed.
Revised Statement of Comprehensive Income Amounts $000 $000
Draft profit 869
Red Square Vodka (90)
Distribution Rights (11.6)
Lemoneasy depreciation 9
_____
Revised profit 776.4
Draft other comprehensive income ($1.34m - $869) 471 Revaluation of Lemoneasy (162) _____
Revised other comprehensive income 309 Revised total comprehensive income 1,085.4
Solution 6.4
Plant Species Project
This project meets the IAS 38 definition of research, being investigation into a plant species with the aim of developing knowledge and understanding about its properties. The associated costs must therefore be expensed to profit or loss.
Pandemic Flu Vaccine
This is a development project, as it involves the application of research findings to the manufacture of a new drug.
It does not however meet all of the IAS 38 development expenditure recognition criteria. In particular, the relative proximity of the competitor to commercial production which will render Drummond’s drug unsaleable means that economic benefits are not probable.
6
177 Dengue Fever Cure
This is a development project which already meets the IAS 38 criteria for capitalisation. Therefore the following expenses incurred in the year may be capitalised and increased the existing intangible asset:
$176,000 staff costs $90,000 materials costs
$22,500 depreciation of the laboratory and equipment. $288,600
The $450,000 incurred on a new laboratory and equipment should be capitalised as a tangible non-current asset. Depreciation thereon is capitalised as part of the intangible asset (as shown above) rather than expensed to profit or loss.
Learning Summary
• Learn and ensure that you understand the IAS 38 definition and recognition criteria for an intangible asset • Ensure that you understand the difference between research and development
• Learn the recognition criteria for development costs
• Familiarise yourself with the accounting requirements of IAS 38 regarding intangible assets and research and development
• Ensure that you understand the difference between goodwill and intangible assets, and know how to account for goodwill
7
Impairment
IMPAIRMENT OF ASSETS
Context
This chapter introduces a new topic, not previously seen at the F3 level.
An impairment is a fall in the value of an asset below its carrying value. It is a topic that is extremely relevant to a number of companies in the current economic climate.
The chapter covers:
• When to test for impairments • How to test for impairments, and • How to account for an impairment.
The topic is related in particular to Chapter 5 Non-current assets:Tangible and Chapter 6 Intangible assets.
Exam Hints
This area of the syllabus is examined either as part of the published accounts question (Q2) or in its own right within question 4 or 5 of the paper. The topic has not been examined in the first three sittings of the F7 paper.
Key Learning Points
• An impairment loss is the amount by which the carrying amount of an asset or cash-generating unit exceeds its recoverable amount.
• An impairment test is required for all assets when there is an indication of impairment at the reporting date, and annually for :
o Goodwill acquired in a business combination o Intangible assets with an indefinite useful life o Intangible assets which are not yet available for use. • Internal indications of impairment include:
o Evidence of obsolescence or damage to the asset
o A current period operating loss or net cash outflow from operating activities o A commitment by management to undergo a significant reorganisation o A major loss of key employees
• External indications of impairment include:
o A significant decline in the market value of an asset during the period
o A significant adverse change in the commercial environment in which the entity operates
• An impairment test therefore involves calculating recoverable amount for comparison with carrying value. • Recoverable amount is the higher of fair value less costs to sell and value in use.
• Value in use is the present value of the future cash flows expected to be generated by an asset, including its ultimate disposal.
• Where an asset is held at historical cost, an impairment loss is charged to the income statement • Where an asset is held at a revalued amount, an impairment loss is charged to other comprehensive
income to the extent that a revaluation surplus relating to the asset exists. Any excess loss is charged to the income statement.
• The impaired value of the asset (less any residual value) is depreciated over the remaining useful life • Where it is impossible to calculate recoverable amount for a single asset, an impairment test must be
performed for the cash generating unit (CGU) to which the asset belongs. • Corporate (shared) assets should be allocated to CGUs on a reasonable basis
• Goodwill should be allocated to the CGU(s) expected to benefit from the business combination.
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• An impairment is allocated to a CGU in the following order: 1. to goodwill
2. to other assets on a pro rata basis.
• An impairment loss on goodwill can never be reversed.
• An impairment loss on other assets or a CGU can be reversed where the recoverable amount has increased because of a change in economic conditions or expected use of the asset.
• An impairment loss can be reversed to the extent that the increased carrying amount of an individual asset does not exceed the amount that the asset would have been carried at had there been no initial impairment.
Relevant Accounting Standards
IAS 36 Impairment of assets
1
Impairments – An Introduction
IAS 36 Impairment of Assets deals with the issue of assets being overstated in the statement of financial position.
Where the carrying value of an asset in the financial statements is greater than its value to the business (known as recoverable amount), then the standard requires that the carrying value is reduced.
This reduction in carrying value is known as an impairment loss. IAS 36 defines it as:
The amount by which the carrying amount of an asset or cash-generating unit exceeds its recoverable amount.
Cash-generating units are considered in detail later in the chapter.
1.1 THE OBJECTIVES OF IAS 36
IAS 36 aims to ensure that:
• Non-current assets and goodwill are recorded in the financial statements at no more than their recoverable amount
• Any resulting impairment loss is measured and recognised on a consistent basis
• Sufficient information is disclosed in the financial statements to enable users to understand the impact of the impairment on the financial position and performance of the reporting entity.
In order to achieve this aim, the standard provides guidance on: 1 How often to test assets for impairment
2 How to test assets for impairment, and 3 How to account for any impairment
1.2 ASSETS OUTSIDE THE SCOPE OF IAS 36
The following assets are outside the scope of the standard: o Inventories
o Assets arising from construction contracts (chapter 9) o Deferred tax assets (chapter 11)
o Financial assets within the scope of IAS 39 (chapter 16) o Investment property measured at fair value
o Non-current assets classified as held for sale in accordance with IFRS 5 (chapter 10)
2
When to Test for Impairments
An impairment test is required:
• for all assets when there is an indication of impairment at the reporting date • annually for certain other assets:
o Goodwill acquired in a business combination o Intangible assets with an indefinite useful life o Intangible assets which are not yet available for use.
7
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FINANCIAL REPORTING (INTERNATIONAL)
2.1 INDICATIONS OF IMPAIRMENT
Indications of impairment may be internal to a company or external. IAS 36 suggests the following indications should be considered:
Internal External
o Evidence of obsolescence or damage o A significant decline in the market to the asset value of an asset during the period o A current period operating loss or net o A significant adverse change in the
cash outflow from operating activities commercial environment in which the
o A commitment by management to entity operates undergo a significant reorganisation
o A major loss of key employees
If any of these indications is noted, then an impairment test should be carried out.
3
How to Test for Impairments
An asset is impaired if its carrying value is greater than its recoverable amount. An impairment test therefore involves calculating recoverable amount for comparison with carrying value.
3.1 DEFINITIONS
IAS 36 defines recoverable amount as:
The higher of fair value less costs to sell and value in use.
Fair value less costs to sell is:
The amount obtainable from the sale of an asset in an arm’s length transaction between knowledgeable, willing parties, less the costs of disposal.
Value in use is:
The present value of the future cash flows expected to be generated by an asset, including its ultimate disposal.
o Future cash flows should be based on the most recent budgets and are generally for a maximum of five years.
o The discount rate used should be a pre tax rate reflecting current assessments of the time value of money.
Learning Example 7.1
Vue owns an asset which is budgeted to generate income of $100,000 per annum for the foreseeable future. The asset also needs a budgeted $20,000 in maintenance spending on it next year and then every other year. An appropriate discount rate is 8%.
IMPAIRMENT OF ASSETS
3.2 Summary
Learning Example 7.2
Odeon operates in a market which is suffering from a downturn in the economy. In accordance with IAS 36, it is therefore undertaking impairment testing of a number of assets at the year end, 30 September 20X8:
Carrying value fair value costs to sell value in use
Asset 1 $230,000 $240,000 $10,500 $235,000 Asset 2 $76,400 $98,000 $2,000 $85,000
Asset 3 $18,600 $20,000 $1,500 $17,900 Asset 4 $43,000 $44,000 $3,250 $42,000
What impairment loss (if any) should Odeon record in the year ended 30 September 20X8?
4
Accounting for an Impairment
Where the carrying value of an asset exceeds its recoverable amount, the asset must be impaired, or written down, to its recoverable amount.
The amount of the write down is the impairment loss.
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7
Impairment has occurred where:
Carrying value of asset
Fair value less
costs to sell Value in use
Present value of future cash flows generated by asset. Recoverable
amount of asset
FINANCIAL REPORTING (INTERNATIONAL)
4.1 ACCOUNTING ENTRIES
The accounting entries required to record an impairment loss depend on whether the impaired asset had previously been revalued:
Asset held at historical cost Dr Income statement Cr Non-current asset
Revalued asset Dr Revaluation surplus (other comprehensive income) to the extent that a revaluation surplus relating to the asset exists. Dr Income statement with any excess
impairment Cr Non-current asset
An impairment loss charged to the income statement is reported before operating profit, as an exceptional item if material.
An impairment loss charged to the revaluation surplus is reported as part of other comprehensive income in the statement of comprehensive income.
Learning Example 7.3
Warner has identified the following assets as being impaired:
1 A property which cost $400,000 was revalued to $600,000 on 31 December 20X6 after five years of ownership. At 31 December 20X8, the recoverable value of the asset is calculated to be $550,000. The useful life of the property was estimated to be 50 years on the date of purchase; this has not been revised.
2 A machine which cost $100,000 on 1 July 20X6 had a recoverable value of $70,000 at 31 December 20X8. The machine was being depreciated over ten years on a straight line basis.
Prepare extracts from Warner’s statement of financial position at 31 December 20X8 and Statement of comprehensive income for the year ended 31 December 20X8.
4.2 SUBSEQUENT TREATMENT OF IMPAIRED ASSET
The impaired asset is depreciated over its remaining useful life, with depreciation calculated as:
Impaired value – residual value
Remaining useful life
Learning Example 7.4
Calculate the depreciation charge for the year ended 31 December 20X9 for both assets in learning example 7.3, assuming that Warner has estimated the residual value of both to be nil.
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