Webinar Slides: International Accounting for Property, Plant and Equipment

CBIZ & MHM Executive Education Series™ IFRS: Accounting for Property,

Plant & Equipment Presented by: Marco Pulido, Shareholder

April 22, 2014

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Today’s Presenter

Marco Pulido, CPA Shareholder 310.268.2746 | [email protected] Marco has 15 years of experience in public accounting working with U.S. GAAP, IFRS and other foreign accounting standards in the U.S., Europe and in Latin America with Big 4 accounting firms. He has experience with SEC filers (foreign and domestic) and private companies. Marco is a CPA certified in California and has IFRS certifications by the Institute of Chartered Accountants in England and Wales (ICAEW) and the American Institute of Certified Public Accountants (AICPA). Technical accounting expertise includes the following industries: Energy (Oil & Gas) - Retail, Distribution & Manufacturing - Transportation - Utilities - Consumer Services - Construction/Real Estate - Health Sciences – Financial Services – Agriculture.


Today’s Agenda

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Principal concepts of IAS 16

Elements of cost

Cost vs. revaluation model

Component approach

Other issues

IFRS vs. US GAAP

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Scope of IAS 16

Applies in accounting for property, plant and equipment (PP&E) except when another standard requires or permits a different accounting treatment Leased assets: follow IAS 17, Leases Properties satisfy definition of an investment property: follow

IAS 40, Investment Property

<IAS 16.2, 4, 5>


Scope of IAS 16

IAS 16 does not apply to: Biological assets related to agricultural activities (IAS 41) PP&E classified as held for sale (IFRS 5) Exploration and evaluation assets (IFRS 6) Mineral rights and mineral reserves such as oil, natural gas

and similar non-regenerative resources <IAS 16.3>

However, it does apply to PP&E used to develop or

maintain the above assets.


Question: Should a hotel be accounted as PP&E (IAS 16) or an investment property (IAS

40)? a) IAS 16 b) IAS 40 c) Can be either

Example – Classification of a Hotel as PPE or Investment Property


Question: Should a hotel be accounted as PP&E (IAS 16) or an investment property (IAS

40)? a) a - IAS 16 b) b - IAS 40 c) c - Can be either Response: Answer - C : The key is whether the owner operates the property or not:

If the principal cash flows that are generated by the owner are from the daily or weekly occupancy of the hotel and the owner provides direct services to the hotel guests, the hotel is a property that is used in the production of services. IAS 16 applies.

If the principal cash flows are generated from renting the property for a large period of time, e.g.

years, the hotel is an investment property. IAS 40 applies, even if the owner provides auxiliary services, such as cleaning or

maintenance.

The administration of the entity should analyze the facts and circumstances on a case-by-case basis.

Example – Classification of a Hotel as PPE or Investment Property


Classification of Spare Parts – Inventory vs. PP&E

Inventory PP&E • Major spare parts and stand-by

equipment, with a useful life of less than one year

• The majority of spare parts • Spare parts are recognized as costs as

they are used.

<IAS 2.6>

• Major spare parts and stand-by equipment, with a useful life of greater than one year

• Depreciation starts once use commences.

• Useful life = the lesser between the useful life of the spare part or the related PP&E ‒ Except when the PP&E can be

substituted and the spare part can be used in the new PP&E

<IAS 16.8>

No specific guidance under U.S. GAAP Diverse practices may exist


Example – Classification of Items at a Restaurant

Background: A restaurant has an inventory of silverware and dishes. Additions to inventory stock are expensed. The inventory turnover for these items is two years. Question: Yes or No - Is it appropriate to classify silverware and dishes as PP&E?


Example – Classification of Items at a Restaurant

Background: A restaurant has an inventory of silverware and dishes. Additions to inventory stock are expensed. The inventory turnover for these items is two years. Question: Yes or No - Is it appropriate to classify silverware and dishes as PP&E? Response: Answer - Yes. These items are tangible assets held for use in the supply of goods and services and

are expected to be used for more than one year. They should not be included in current assets.


Example – Classification of PP&E That Will Not be Used

Background: An entity receives property as payment for a receivable from a customer, which it intends to sell and

not use in its operations. The entity plans to sell the asset within the next 12 months. Question: Yes or No – Should this property be classified as PP&E?


Example – Classification of PP&E That Will Not be Used

Background: An entity receives property as payment for a receivable from a customer, which it intends to sell and

not use in its operations. The entity plans to sell the asset within the next 12 months. Question: Yes or No – Should this property be classified as PP&E? Response: Answer - No This property does not meet the definition of PP&E under IAS 16.6 since it is not maintained for its

use. The property should be classified as a current asset in accordance with IAS 1.57.


Initial Measurement at Cost

Includes: Purchase price, import duties and non-refundable purchase taxes, 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

Cost to dismantle and remove an asset and restore site May include:

Fair value gains / losses on qualifying cash flow hedges for purchases in foreign currency

Excludes: Income from incidental operations Advertising and promotional activities Staff training Relocating or reorganizing part or all of the operations <IAS 16.16, 19-21>

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Purchase price, plus import/transport

fees and taxes

Initial estimate of the costs of dismantling and removing the item and restoring the site

Elements of Cost

Fair value gains and losses on qualifying cash flow hedges for purchases in

foreign currency

<IAS 16.16 and 17>

Directly attributable costs

Installation and assembly costs

Costs of testing, professional fees

Costs of site preparation

Initial delivery and handling costs

Borrowing costs


Example – Improvements to PP&E

Background: An entity is uprgrading parts of a motor related to machinery. It estimates that this

improvement will improve the productivity and output related to the machinery. The entity values PP&E at cost. Question: Can the cost of this improvement be capitalized?


Example – Improvements to PP&E

Background: An entity is uprgrading parts of a motor related to machinery. It estimates that this

improvement will improve the productivity and output related to the machinery. The entity values PP&E at cost. Question: Can the cost of this improvement be capitalized? Response: Yes. This upgrade will improve the productivity of the motor, leading to an increase in

output. This improvement will increase productivity, and if the following conditions are met, may be capitalized: It is probable that the entity will obtain future economic benefits. The cost of the asset or improvement can be measured reliably.

<IAS 16.7>


Borrowing Costs

Entities must capitalize borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset that form part of the cost of that asset. This accounting also applies when an entity pays a third party for the

construction or production of an asset. U.S. GAAP refers to these costs as “capitalized interest”

Other borrowing costs are recognized as an expense Special consideration should be given to the interest rate that will be

used to calculate the amount of interest to capitalize > However, IAS 23 does not require capitalization similar to

U.S. GAAP for: Qualifying assets measured at fair value

Inventories manufactured/produced in large quantities on a repetitive basis


Exchange of Assets

Cost of the asset acquired

Transaction has commercial substance and fair value can be measured reliably

Transaction lacks commercial substance or fair value of both asset

received and asset given up cannot be measured reliably.

Fair value of the asset given up

Carrying amount of the asset given up

An exchange transaction has commercial substance if: The configuration (i.e. risk, timing and amount) of the cash flows of the asset received differs from that of the asset given up and the difference is significant relative to the fair value of the assets exchanged, or The entity-specific value of the portion of the entity’s operations derived from the asset received differs from that of the asset given up and the difference is significant relative to the fair value of the assets exchanged.

<IAS 16.24 and 25>


Subsequent Measurement – Cost or Revaluation Method

Subsequent measurement

Cost model Cost Less accumulated: – Depreciation – Impairment losses

Revaluation model Revalued amount Less accumulated: – Depreciation – Impairment losses

<IAS 16.30 and 31>

Revaluation model is also known as the “fair value option” for PP&E.


Conditions for Using the Revaluation Model

Accounting policy applied consistently Fair value can be measured reliably Used for an entire class of PP&E

Grouping of assets of a similar nature and use in an entity’s operations, such as:

Revaluations must be made with sufficient regularity Items within the same class of PP&E revalued simultaneously <IAS 16. 31, 36 and 37>

• Aircraft • Motor vehicles • Furniture and fixtures • Office equipment

• Land • Land and buildings • Machinery • Ships


Revaluation Model Illustration

Recorded in equity in

Revaluation Reserve (OCI)

Recorded through income

statement if asset was previously

written down via income statement

Adjusted against

existing credit balance in the Revaluation

Reserve (OCI)

Recorded through income statement to the extent that there

is no credit balance in the Revaluation

Reserve (OCI)

Increase in value Decrease in value

Revaluation


Depreciation

Focus on components Each significant component of an asset should be depreciated separately (generally

considered 5% to 10% of total value of asset). Generally not a requirement under U.S. GAAP

Depreciation method Should reflect the pattern of the consumption of the economic benefits of the asset,

examples include straight-line, double-declining, units of production, etc. Useful life

Period over which an asset is expected to be available for use by an entity; or Number of production or similar units expected to be obtained from the asset by an

entity Residual value

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

Should be reviewed at the end of each period May adjust up or down, only down under U.S. GAAP Amount to depreciate = cost – residual value

<IAS 16.6, 43, 53, 60 and 62>


Example – Residual Value

Question (Yes or No): Should estimated inflation and variations in market value be

considered for the remaining useful life when determining the residual value?


Example – Residual Value

Question: Should estimated inflation and variations in market value be

considered for the remaining useful life when determining the residual value?

Response: No, since residual value is defined as the estimated value

that the entity would obtain at the moment for the sale of the asset assuming it has reached the end of its useful life <IAS 16.6>

Hence, inflation or estimated future variations in market value should not be considered.


Component Approach

Each part of an item of PP&E with a cost that is significant in relation to the total cost of the item shall be depreciated separately. Significant is generally defined as 5% to

10% of total value of the asset Only relevant if components have different

useful lives > May result in differences with US GAAP

For example, the airframe and the engines of an aircraft have different useful lives, while the value of the engine is significant.


- Comparison of the cost allocated to the component to the total cost of the PP&E

- Allocate the cost and determine the useful life of each of the components for depreciation purposes

> Differences with US GAAP: – - More detailed depreciation calculation

– - May result in higher or lower depreciation expense, depending on the life of the individual components

– - Any changes in an asset’s components would effect depreciation and be disclosed as a change in estimate

- Current IT system considerations is a practical issue

Considerations for Component Approach


Considerations for Component Approach

Comparison of the cost allocated to the component to the total cost of the PP&E

Allocate the cost and determine the useful life of each of the components for depreciation purposes

> Differences with US GAAP: More detailed depreciation calculation May result in higher or lower depreciation expense,

depending on the life of the individual components Any changes in an asset’s components would effect

depreciation and be disclosed as a change in estimate.

Current IT system considerations is a practical issue.


Replacing or Renewing a Component

Acquisition of a separate asset Write off of carrying amount of replaced / renewed

component to the residual value The carrying amount of an item of PP&E is derecognized on

disposal or when no future economic benefits are expected from its use or disposal.

<IAS 16.67>


Major Inspections and Overhauls

If criteria for recognition are met, i.e. future benefits and reliable measurement, costs associated to major inspections and overhauls are recognized as a separate component:

Upon the initial recognition of an asset, and To determine the inherent value associated to an overhaul upon acquisition of

an asset, the estimated cost of the overhaul that will be incurred may be used (this is a component included in the cost of the asset at the acquisition date).

any remaining carrying amount of the replaced asset is written-off. > Differences with US GAAP: U.S. GAAP provides three methods:

1. Deferred and amortized over the period until the next overhaul 2. Expensed as incurred 3. Accounted for as part of the cost of the asset

<IAS 16.14>


Example – Major Inspections and Overhauls

Background: An entity acquires a machine which requires an overhaul every three years. The price for the machinery is $1 million. It is estimated that every overhaul will cost

$200,000 and that the equipment has a useful life of 10 years. Question: How should the entity initially record the purchase of the machinery? a) Record an asset for $1 million and depreciate over 10 years. b) Record two assets – the machinery for a value of $800,000 and depreciate over 10 years,

and the estimated cost of the overhaul of $200,000 and depreciate over three years. c) Record an asset for $800,000 and depreciate over 10 years, and record an expense for

$200,000.


Example – Major Inspections and Overhauls

Background: An entity acquires a machine which requires an overhaul every three years. The price for the machinery is $1 million. It is estimated that every overhaul will cost

$200,000 and that the equipment has a useful life of 10 years. Question: How should the entity initially record the purchase of the machinery? a) Record an asset for $1 million and depreciate over 10 years. b) Record two assets – the machinery for a value of $800,000 and depreciate over 10 years,

and the estimated cost of the overhaul of $200,000 and depreciate over three years. c) Record an asset for $800,000 and depreciate over 10 years, and record an expense for

$200,000. Response Answer b). Record two assets of $800,000 and $200,000, depreciated over 10 years and

three years, respectively.

<IAS 16.14>


Dismantlement, Removal and Restoration Costs

Future costs to be incurred for dismantlement, removal and restoration must be capitalized Initial recognition is capitalized to related asset and a corresponding

liability is recognized for present value of future estimated cost, discounted using an appropriate risk-adjusted discount rate.

Changes in the estimate of the obligation are recorded in accordance with IAS 37 “Provisions, Contingent Liabilities and Contingent Assets”

Discount rate is a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the liability (IAS 37.47)

Asset – depreciated over the remaining useful life of the related PP&E Liability – the “unwinding” of discount is recognized in profit and loss as

finance cost as it occurs Differences with U.S. GAAP: Discount rate under U.S. GAAP remains

constant during the “unwinding” of the discount. IFRS requires periodic updates to the discount rate.


Changes in the

carrying amount of the

liabilities

Cost Model

Revaluation Model

Excess recognized in profit or loss.

Adjust the cost of the related asset.

- Alters revaluation surplus or deficit - Accounted for consistently with other

changes to the revaluation surplus or deficit.

- If decrease in the liability exceeds the carrying amount that would have been recognized had the asset been carried under cost model, the excess shall be recognized in net profit and loss.

If decrease in liability is more than

carrying value

Other cases

Dismantlement, Removal and Restoration Costs


Questions?


Join us for these upcoming IFRS courses: July 10: Accounting for Foreign Currencies Under IFRS September 4: Business Combinations Under IFRS October 23: Consolidated Financial Statements Using IFRS November 20: The Impact of IFRS on Income Taxes

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Webinar Slides: International Accounting for Property, Plant and Equipment