International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards

by International GAAP 2019 (pdf)

  received in response to the ED. The feedback summary noted that many respondents

  either disagreed with, or expressed concerns over, the proposed amendments. The

  main areas for further consideration by the IASB were:

  • the recognition of the proceeds and related costs in profit or loss;

  • cost allocation;

  • the determination of when an asset is available for use;

  • the exclusion of depreciation from the cost of items produced before an item of

  PP&E is available for use;

  • the assessment of what constitutes an entities ‘ordinary’ activities; and

  • potential inconsistencies with other standards.

  The feedback summary included three approaches to proceeding with the project:

  • proceed with the ED as published;

  • proceed with the ED with some modifications; or

  • proceed with additional disclosure requirements and consider alternative

  standard-setting approaches.

  No decisions were taken by the Committee and the matter will be discussed by the IASB

  at a future meeting.

  For more details of the development of the interpretation and considerations for

  extractive industries, see Chapter 39 at 12.1.2 and 12.1.2.A.

  4.2.2

  Income received during the construction of property

  One issue that commonly arises is whether rental and similar income generated by

  existing tenants in a property development may be capitalised and offset against the cost

  of developing that property.

  The relevant question is whether the leasing arrangements with the existing tenants are

  a necessary activity to bring the development property to the location and condition

  necessary for it to be capable of operating in the manner intended by management.

  Whilst the existence of the tenant may be a fact, it is not a necessary condition for the

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  building to be developed to the condition intended by management; the building could

  have been developed in the absence of any existing tenants.

  Therefore, rental and similar income from existing tenants are incidental to the

  development and should not be capitalised. Rather rental and similar income should be

  recognised in profit or loss in accordance with the requirements of IFRS 16 together

  with related expenses.

  4.2.3

  Liquidated damages during construction

  Income may arise in other ways, for example, liquidated damages received as a result of

  delays by a contractor constructing an asset. Normally such damages received should

  be set off against the asset cost – the purchase price of the asset is reduced to

  compensate for delays in delivery.

  4.3

  Accounting for changes in decommissioning and restoration

  costs

  IAS 16 requires the initial estimate of the costs of dismantling and removing an item of

  PP&E and restoring the site on which it is located to be included as part of the item’s

  cost. This applies whether the obligation is incurred either when the item is acquired or

  as a consequence of having used the item during a particular period for purposes other

  than to produce inventories during that period. [IAS 16.16]. See 4.1 above. However,

  IAS 16 does not address the extent to which an item’s carrying amount should be

  affected by changes in the estimated amount of dismantling and site restoration costs

  that occur after the estimate made upon initial measurement. This issue is the subject

  of IFRIC 1, which applies to any decommissioning, restoration or similar liability that

  has been both included as part of the cost of an asset measured in accordance with

  IAS 16 and recognised as a liability in accordance with IAS 37. [IFRIC 1.2]. It deals with the

  impact of events that change the measurement of an existing decommissioning,

  restoration or similar liability. Events include a change in the estimated cash flows, a

  change in the discount rate and the unwinding of the discount. [IFRIC 1.3]. This is

  discussed in detail in Chapter 27 at 6.3.

  4.4

  Exchanges of assets

  An entity might swap an asset it does not require in a particular area, for one it does in

  another – the opposite being the case for the counterparty. Such exchanges are not

  uncommon in the telecommunications, media and leisure businesses, particularly after

  an acquisition. Governmental competition rules sometimes require such exchanges.

  The question arises whether such transactions give rise to a gain in circumstances where

  the carrying value of the outgoing facility is less than the fair value of the incoming one.

  This can occur when carrying values are less than market values, although it is possible

  that a transaction with no real commercial substance could be arranged solely to boost

  apparent profits.

  IAS 16 requires all acquisitions of PP&E in exchange for non-monetary assets, or a

  combination of monetary and non-monetary assets, to be measured at fair value, subject

  to conditions:

  Property, plant and equipment 1319

  ‘The cost of such an item of property, plant and equipment is measured at fair value

  unless (a) the exchange transaction lacks commercial substance or (b) the fair value of

  neither the asset received nor the asset given up is reliably measurable. The acquired

  item is measured in this way even if an entity cannot immediately derecognise the asset

  given up.’ [IAS 16.24].

  The IASB concluded that the recognition of income from an exchange of assets does

  not depend on whether the assets exchanged are dissimilar. [IAS 16.BC19].

  If at least one of the two fair values can be measured reliably, that value is used for

  measuring the exchange transaction; if not, then the exchange is measured at the carrying

  value of the asset the entity no longer owns. [IAS 16.24]. For example, if the new asset’s fair

  value is higher than the carrying amount of the old asset, a gain may be recognised.

  This requirement is qualified by a ‘commercial substance’ test. If it is not possible to

  demonstrate that the transaction has commercial substance as defined by the standard

  (see 4.4.1 below), assets received in exchange transactions will be recorded at the

  carrying value of the asset given up. [IAS 16.24].

  If the transaction passes the ‘commercial substance’ test then IAS 16 requires the

  exchanged asset to be recorded at its fair value. As discussed in 7 below, the standard

  requires gains or losses on items that have been derecognised to be included in profit

  or loss in the period of derecognition but does not allow gains on derecognition to be

  classified as revenue, except for certain assets previously held for rental. [IAS 16.68, 68A].

  It gives no further indication regarding their classification in profit or loss. Such

  exchanges of goods and services are also excluded from the scope of IFRS 15 if the non-

  monetary exchange is between entities in the same line of business to facilitate sales to

  customers or potential customers (see Chapter 28 at 3). [IFRS 15.5(d)].

  4.4.1 Commercial

  substance

  The commercial substance test was put in place as an anti-abuse provision to prevent

  gains from being recognised in income when the transaction had no discernible effect

  on the entity’s economics. [IAS 16.BC21]. The commercial
substance of an exchange is to

  be determined by forecasting and comparing the future cash flows budgeted to be

  generated by the incoming and outgoing assets. For there to be commercial substance,

  there must be a significant difference between the two forecasts. The standard sets out

  this requirement as follows:

  ‘An entity determines whether an exchange transaction has commercial substance by

  considering the extent to which its future cash flows are expected to change as a result

  of the transaction. An exchange transaction has commercial substance if:

  (a) the configuration (risk, timing and amount) of the cash flows of the asset received

  differs from the configuration of the cash flows of the asset transferred; or

  (b) the entity-specific value of the portion of the entity’s operations affected by the

  transaction changes as a result of the exchange; and

  (c) the difference in (a) or (b) is significant relative to the fair value of the assets

  exchanged.’ [IAS 16.25].

  As set out in the definitions of the standard, entity-specific value in item (b) above is the

  net present value of the future predicted cash flows from continuing use and disposal of

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  the asset (see 2.2 above). Post-tax cash flows should be used for this calculation. The

  standard contains no guidance on the discount rate to be used for this exercise, nor on

  any of the other parameters involved, but it does suggest that the result of these analyses

  might be clear without having to perform detailed calculations. [IAS 16.25]. Care will have

  to be taken to ensure that the transaction has commercial substance as defined in the

  standard if an entity receives a similar item of PP&E in exchange for a similar asset of its

  own. Commercial substance may be difficult to demonstrate if the entity is exchanging an

  asset for a similar one in a similar location. However, in the latter case, the risk, timing and

  amount of cash flows could differ if one asset were available for sale and the entity

  intended to sell it whereas the previous asset could not be realised by sale or only sold

  over a much longer timescale. It is feasible that such a transaction could meet conditions

  (a) and (c) above. Similarly, it would be unusual if the entity-specific values of similar assets

  differed enough in any arm’s length exchange transaction to meet condition (c).

  Other types of exchange are more likely to pass the ‘commercial substance’ test, for

  example exchanging an interest in an investment property for one that the entity uses

  for its own purposes. The entity has exchanged a rental stream and instead has an asset

  that contributes to the cash flows of the cash-generating unit of which it is a part. In this

  case it is probable that the risk, timing and amount of the cash flows of the asset received

  would differ from the configuration of the cash flows of the asset transferred.

  4.4.2 Reliably

  measurable

  In the context of asset exchanges, the standard contains guidance on the reliable

  determination of fair values in the circumstances where market values do not exist. The

  ‘reliable measurement’ test for using fair value was included to measure these exchanges

  to minimise the risk that entities could ‘manufacture’ gains by attributing inflated values

  to the assets exchanged. [IAS 16.BC23]. Note that fair value is defined by reference to

  IFRS 13 and that the requirements below are specific to asset exchanges in IAS 16.

  ‘The fair value of an asset is reliably measurable if (a) the variability in the range of

  reasonable fair value measurements is not significant for that asset or (b) the

  probabilities of the various estimates within the range can be reasonably assessed and

  used when measuring fair value. If an entity is able to measure reliably the fair value of

  either the asset received or the asset given up, then the fair value of the asset given up

  is used to measure the cost of the asset received unless the fair value of the asset

  received is more clearly evident.’ [IAS 16.26]. If the fair value of neither the asset given up

  nor the asset received can be measured reliably (i.e. neither (a) nor (b) above are met),

  the cost of the asset is measured at the carrying amount of the asset given up; this means

  there is no gain on the transaction. [IAS 16.24].

  No further guidance is given in IAS 16 on how to assemble a ‘range of reasonable fair

  value measurements’ and the guidance in IFRS 13 should be followed (see Chapter 14).

  4.5

  Assets held under leases

  IFRS 16 requires lessees to initially measure the right-of-use asset at the amount of lease

  liability, adjusted for lease prepayments, lease incentives received, initial direct costs

  and an estimate of restoration, removal and dismantling costs. IFRS 16 is discussed in

  detail in Chapter 24.

  Property, plant and equipment 1321

  4.6

  Assets acquired with the assistance of government grants

  The carrying amount of an item of PP&E may be reduced by government grants in

  accordance with IAS 20 – Accounting for Government Grants and Disclosure of

  Government Assistance. [IAS 16.28]. This is one of the accounting treatments available

  which are discussed further in Chapter 25.

  5

  MEASUREMENT AFTER RECOGNITION: COST MODEL

  IAS 16 allows one of two alternatives to be chosen as the accounting policy for

  measurement of PP&E after initial recognition. The choice made must be applied to an

  entire class of PP&E, which means that not all classes are required to have the same

  policy. [IAS 16.29].

  The first alternative is the cost model whereby the item, after recognition as an asset, is

  carried at cost less any accumulated depreciation and less any accumulated impairment

  losses. [IAS 16.30]. The alternative, the revaluation model, is discussed at 6 below.

  Some entities operate, either internally or externally, an investment fund that

  provides investors with benefits determined by units in the fund. Similarly, some

  entities issue groups of insurance contracts with direct participation features and

  hold the underlying items. Some such funds or underlying items include owner-

  occupied property. For many contracts that specify a link to returns on underlying

  items, those underlying items include a mix of assets that are almost all measured at

  fair value through profit or loss. Accordingly, the IASB decided that measurement

  of owner-occupied property at fair value through profit or loss would be consistent

  with the measurement of the majority of the underlying assets and would prevent

  accounting mismatches. [IFRS 17.BC65(c)].

  Consequently, when IFRS 17 is adopted (see 1 above), the subsequent measurement

  requirements in IAS 16 will be amended by adding paragraphs 29A and 29B to permit

  entities to elect to measure owner-occupied properties in such specified circumstances

  as if they were investment properties measured at fair value through profit or loss in

  accordance with IAS 40, despite paragraph 29 (as described above). For the purposes of

  this election, insurance contracts include investment contracts with discretionary

  participation features. An entity shall treat owner-occupied property measured using

  the investment property fair value model as a separate class of PP&E.
[IAS 16.29A-29B].

  5.1

  Significant parts of assets

  IAS 16 links its recognition concept of a ‘part’ of an asset, discussed at 3.2 above, with

  the analysis of assets for the purpose of depreciation. Each part of an asset with a cost

  that is significant in relation to the total cost of the item must be depreciated separately,

  which means that the initial cost must be allocated between the significant parts by the

  entity. [IAS 16.43, 44]. The standard once again refers to the airframe and engines of an

  aircraft but also sets out that if an entity acquires PP&E subject to an operating lease in

  which it is the lessor, it may be appropriate to depreciate separately amounts reflected

  in the cost of that item that are attributable to favourable or unfavourable lease terms

  relative to market terms. [IAS 16.44].

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  A determination of the significant parts of office buildings can be seen in Extract 18.7

  below from Skanska. This policy may have been based on the construction methods

  used for the particular buildings as it is unusual to see a separation between foundation

  and frame for office buildings. In addition, Extract 19.1 in Chapter 19 shows an example

  of the allocation for investment property, although favourable or unfavourable lease

  terms are not identified as a separate part.

  Extract 18.7: Skanska AB (2017)

  Notes including accounting and valuation principles [extract]

  Note 1.

  Consolidated accounting and valuation principles [extract]

  IAS 16 Property, Plant and Equipment [extract]

  Property, plant and equipment that consist of parts with different periods of service are treated as separate

  components of property, plant and equipment. Depreciation occurs on a straight-line basis during the estimated

  useful life, or based on degree of use, taking into account any residual value at the end of the period. Office

  buildings are divided into foundation and frame, with a depreciation period of 50 years, installations

  of 35 years, and non-weight-bearing parts of 15 years. In general, industrial buildings are depreciated over

  a 20-year period without allocation into different parts. Stone crushing and asphalt plants as well as concrete

  mixing plants are depreciated over 10 to 25 years depending on their condition when acquired and without