International Financial Reporting Standards

UGC – National Level Seminar – IFRS 11th February, 2011 – Session 2

Anand Bathiya – B. Com, A.C.A., LL.B.

Property, Plant & Equipment – IAS 16

Today’s Agenda

• IAS 16 – Property Plant & Equipment ET: 60 minutes

• Q&A ET: 15 minutes

2

Broad Coverage:

• IAS 16

• Q&A

International Accounting Standard 16

Property, Plant and Equipment

UGC – National Level Seminar – IFRS

Session 1

International Accounting Standard 16 - Property Plant & Equipment

- About IAS 16

- Recognition Concepts

- Models of Valuation

- Depreciation

- Disclosures

- Key differences

- Case Studies

- Extract from select Annual Reports

4

Principal Issues:

•Recognition

•Carrying Amount

•Depreciation

•Impairment

•Disclosures

Objective & Scope of IAS 16

The objective of IAS-16 is:

- To prescribe the accounting treatment for PPE

- So that the users of Financial Statements can discern information about the entity’s investment in its PPE and the changes in such investment.

The principal issues in accounting for PPE are:

- The Recognition of assets

- Determination of their Carrying Amounts

- Depreciation charges and Impairment charges

- Disclosures

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

5 Bare unaccompanied IFRS can be downloaded from www.ifrs.org

Converged Indian Accounting Standards can be downloaded from www.icai.org

Exclusions

IAS 16 does not apply to:

a) PPE classified as held for sale

b) Biological assets related to agricultural activity

c) Exploration and evaluation assets or

d) Mineral rights and mineral reserves such as oil, natural gas and similar non-regenerative resources.

However, this Standard applies to PPE used to develop or maintain the assets described in (b)–(d).

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

6

Terminologies

Distinct terminology:

• Fixed Assets – PPE – Non-Current Tangible Assets – Long-Life Assets

• Investment Property – Land & Building held for the purposes of earning rent or for capital appreciation.

• Fair Value - is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction.

• Recognition, Measurement, Presentation and Disclosure.

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

7

Recognition - Concepts

The cost of an item of PPE comprises:

a) its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates;

b) 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.

c) the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs.

d) Borrowing Costs

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

8

Recognition - Issues

T&L Construction Limited introduced a new production line.

The expenditures incurred for this new line include:

1. Rs. 50,000 for the costs of employee in fixing the interior of the factory to suit for the production line,

2. Rs. 100,000 in preparing the factory site,

3. Rs. 5,000,000 in purchasing the machines for the line,

4. Rs. 60,000 in arranging the initial delivery,

5. The installation and assembly costs of the machines of Rs. 55,000,

6. Costs of initial testing of Rs. 40,000,

7. Professional fees in assessing the function and installation of Rs. 20,000,

8. Costs of grand opening the new line of Rs. 30,000,

9. Costs of introducing a new product manufactured by this new production line of Rs. 950,000, and

10. Administration and other general overhead costs in studying the production performance of Rs. 25,000.

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

9

Measurement after recognition

Measurement at Initial Recognition is always at Cost

Measurement after Initial Recognition:

• Cost Model –

After recognition as an asset, an item of property, plant and equipment shall be carried at its cost less any accumulated depreciation and any accumulated impairment losses.

• Revaluation Model –

An item of property, plant and equipment whose fair value can be measured reliably shall be carried at a revalued amount.

• Deemed Cost Model - IFRS 1

A first-time adopter of IFRS has an option to voluntarily account as per Deemed Cost Model

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

10

Revaluation Model

What is Fair Value?

Fair value is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction.

The fair value of

– Land and Buildings ⇒ market-based evidence by appraisal that is normally undertaken by professionally qualified valuers.

– Other Items of PPE ⇒ is usually their market value determined by appraisal.

If there is no market-based evidence of fair value because of the specialized nature of the item of PPE and the item is rarely sold,

⇒ an entity may need to estimate fair value using

• an income or

• a depreciated replacement cost approach.

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

11

Revaluation Model (contd.)

Reduction on revaluation to be taken to Income Statement except to the extent that can be adjusted against revaluation reserve.

• Frequency of revaluation

• No mandatory requirement of professional valuers

Cost and Revaluation Model is applicable to the entire class of PPE. However, Deemed Cost model allows flexibility to apply to selected assets within a class of asset.

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

12

Presentation in FS (Revaluation) IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

13

Z Enterprises

Income statement as at 31 December 2009

Revenue X

Cost of sales (X)

Gross profit X

Other income X

Distribution costs (X)

Administrative expenses (X)

Other expenses (X)

Finance cost (X)

Profit for the year X

Other comprehensive income

Gains on property revaluation 200,000

Exchange differences on translating foreign operations X

Income tax relating to components of other comprehensive income (X)

Total other comprehensive income X

Total comprehensive income for the year X

Presentation in FS (Revaluation) IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

14

Statement of Changes in Equity

Share

capital

Retained

earnings

AFS assets Cash flow

hedges

Revaluation

surplus

Total Non controlling

interest

Total

equity

Balance at

31/12/2008

X X X X X X X X

Changes in equity

2008

Issue of share

capital

Dividends

Total

Comprehensive

income for the year

200,000

Transfer to retained

earnings

Balance at

31/12/2009

X X X X X X X X

Who will value?

The Valuation Professionals Bill, 20** (Act No. ***** of 20**)

Bill pending in Parliament

(i) The institutional structure for the regulation of valuers;

(ii) The participation of various professional bodies in the proposed Council of Valuation Professionals;

(iii) The role of the proposed Valuation Council in recognition of other professional bodies.

(iv) The manner of cancellation of recognition of a professional institute imparting training/education/qualification in valuations if such institute fails to meet the standards required of it for continuation as a recognized institute;

(v) Provisions for Practice as CVP

(vi) Misconduct & Penalties

(vii) The manner of enabling quality in delivery of services by valuation professionals;

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

15

Deemed Cost Model

IFRS 1 – First Time Adoption of IFRS

Deemed Cost:“the amount used as a surrogate for cost or depreciated cost at a given date”. The exemption may be used selectively within the class of assets . A first-time adopter need not use fair value as deemed cost for all assets in the same class. Subsequent depreciation is based on the deemed cost and starts from the date at which the fair value measurement or revaluation was established. Optional exemption arising through IFRS-1. Choice available with the entity. IFRS-1 allows 16 such exemptions to the First-time adopters enabling and encouraging a smoother transition to IFRS.

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

16

Model évaluation IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

17

A. COST MODEL 2005-06 2006-07 2007-08 2008-09 2009-10

Gross Block of Building 1,000,000 900,000 800,000 700,000 600,000

Less: Depreciation (SLM 10%) 100,000 100,000 100,000 100,000 100,000

Net Block 900,000 800,000 700,000 600,000 500,000

B. REVALUATION MODEL 2005-06 2006-07 2007-08 2008-09 2009-10

Gross Block of Building 1,000,000 900,000 800,000 900,000 771,429

Add: Revaluation - - 200,000 - 200,000

Less: Depreciation (SLM 10%) 100,000 100,000 100,000 128,571 128,571

Net Block 900,000 800,000 900,000 771,429 842,858

C. DEEMED COST EXEMPTION 2005-06 2006-07 2007-08 2008-09 2009-10

Gross Block of Building 1,000,000 900,000 800,000 900,000 771,429

Add: Revaluation on transition - - 200,000 -

Less: Depreciation (SLM 10%) 100,000 100,000 100,000 128,571 128,571

Net Block 900,000 800,000 900,000 771,429 642,858

Depreciation

• Component Accounting

• No rate of depreciation – Debated in India

• If residual life and value of the asset differs in subsequent year-end, the same will be a change in accounting estimate.

• The depreciable amount of an asset is determined after deducting its residual value.

• Usage method of depreciation is permitted and depreciation of idle time may not be charged under that scenario.

• An increase in the value of the land on which a building stands does not affect the determination of the depreciable amount of the building.

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

18

Treatment of Depreciation

No prescribed depreciation method – Method to be reviewed at every year end and any change to be effected Prospectively. (Change of Estimate)

Accounting Entry for Depreciation on Revalued Assets:

Depreciation ….. Dr. XX

To Fixed Assets ….. Cr. XX

Revaluation Reserve ….. Dr. XX

To Retained Earnings ….. Cr. XX

At every year-end Depreciation method and useful life needs to be reviewed.

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

19

Derecognition

Distinct terminology:

• Derecognition of assets incase of:

1. On Disposal

2. When no future benefits are expected

• Derecognition profit\loss to be charged to Profit & Loss Account.

• If proceeds of sale are deferred, interest income to recognized accordingly.

• Assets held for sale to be accounted as per IFRS-5 under a separate category and no depreciation to be charged on the same.

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

20

Matters of discussion

Deferred Payment for purchase of Asset to be considered as Finance Cost rather than added to the cost of the Asset

Exchange of Assets to be at their individual Fair Values

Fixed Assets Register to change drastically for incorporating component accounting, revaluation reserve, deferred tax adjustment, depreciation on revaluation, site restoration costs, replaceable costs, etc.

PPE in construction cannot be revalued.

Of 144 companies surveyed which are listed on LSE only 20 adopted Revaluation Approach.

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

21

Disclosures under IAS 16

Disclosures under IAS 16:

The financial statements shall disclose, for each class of property, plant

and equipment:

(a) the measurement bases used for determining the gross carrying amount;

(b) the depreciation methods used;

(c) the useful lives or the depreciation rates used;

(d) the gross carrying amount and the accumulated depreciation at the beginning and end of the period; and

(e) a reconciliation of the carrying amount at the beginning and end of the period showing:

(i) additions;

(ii) assets classified as held for sale

(iii) acquisitions through business combinations;

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

22

Disclosures under IAS 16

Disclosures under IAS 16 (contd.):

(iv) increases or decreases resulting from revaluations and from impairment losses recognised

(vii) depreciation;

(viii) the net exchange differences arising on the translation of the financial statements from the functional currency into a different presentation currency

(ix) other changes.

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

23

Disclosures under IAS 16

Disclosures under IAS 16 (contd.):

(f) the existence and amounts of restrictions on title, and property, plant and equipment pledged as security for liabilities;

(g) the amount of expenditures recognised in the carrying amount of an item of property, plant and equipment in the course of its construction;

(h) the amount of contractual commitments for the acquisition of property, plant and equipment; and

(i) if it is not disclosed separately in the statement of comprehensive income, the amount of compensation from third parties

(j) depreciation, whether recognised in profit or loss or as a part of the cost of other assets, during a period; and

(k) accumulated depreciation at the end of the period.

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

24

Disclosures under IAS 16

Disclosures under IAS 16 (contd.):

(l) residual values;

(m) the estimated costs of dismantling, removing or restoring items of property, plant and equipment;

If items of property, plant and equipment are stated at revalued amounts, the following shall be disclosed:

(a) the effective date of the revaluation;

(b) whether an independent valuer was involved;

(c) the methods and significant assumptions applied in estimating the items’ fair values;

(d) the extent to which the items’ fair values were determined directly by reference to observable prices in an active market or recent market transactions on arm’s length terms or were estimated using other valuation techniques;

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

25

Disclosures under IAS 16

Disclosures under IAS 16 (contd.):

(e) for each revalued class of property, plant and equipment, the carrying amount that would have been recognised had the assets been carried under the cost model; and

(f) the revaluation surplus, indicating the change for the period and any restrictions on the distribution of the balance to shareholders.

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

26

Disclosures under IAS 16

Encouraged Disclosures under IAS 16:

(a) the carrying amount of temporarily idle property, plant and equipment;

(b) the gross carrying amount of any fully depreciated property, plant and equipment that is still in use;

(c) the carrying amount of property, plant and equipment retired from active use and not classified as held for sale in accordance with IFRS 5; and

(d) when the cost model is used, the fair value of property, plant and equipment when this is materially different from the carrying amount.

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

27

Key GAAP differences Indian GAAP Vs. IFRS

# Description IFRS Indian GAAP

1 Replacement costs

Replacement cost of an item of PPE is capitalized if replacement meets the recognition criteria. Carrying amount of items replaced is derecognized.

Replacement cost of an item of PPE are generally are expensed when incurred.

2 Cost of major inspection

Costs of major inspections and overhauls are recognised in the carrying amount of PPE.

Costs of major inspections are expensed when incurred.

3 Revaluation Revaluation needs to be done to the entire class of assets under the revaluation model.

No specific requirement

4 Depreciation PPE are componentized and are depreciated separately.

PPE are not generally componentized and depreciated.

5 Interest If payment is deferred beyond normal credit terms, the difference between the cash price equivalent and the total payment is recognised as interest over the period of credit.

No specific requirement under AS 10.

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

28

Key GAAP differences

# Description IFRS Indian GAAP

6 Depreciation Depreciation rates are not prescribed as they are based on useful life. Unit of Production method can also be applied.

Minimum depreciation rates are as per Schedule XIV. SLM WDV are prescribed.

7 Estimate of residual useful life

Estimates of useful life and residual value need to be reviewed at least at each financial year-end.

No need for an annual review of estimates of useful life and residual value.

8 Revaluation Revaluations are required to be made with sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date.

No specific requirement. For e.g., an enterprise may revalue a whole class of assets within a unit.

9 Site Restoration

Provision on site-restoration and dismantling is mandatory. To the extent it relates to the fixed asset, the changes are added/deducted (after discounting) from the asset in the relevant period.

No guidance in the standard. However, guidance note on oil and gas issued by ICAI, requires capitalization of site restoration cost. Discounting is prohibited under Indian GAAP.

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

29

Key GAAP differences

# Description IFRS Indian GAAP

10 Depreciation on revalued assets

Depreciation on revalued assets needs to be routed through P&L. However, subsequently the equivalent portion of depreciation on revalued asset needs to be transferred to retained earnings.

Depreciation on revalued assets needs to be reduced from revaluation reserve itself.

11 Shift in Models

Movement from Cost Model to Revaluation Model is permitted. But vice-versa not permitted.

No such guidance.

12 Method of Depreciation

Treated as Change in Accounting Estimate as per IAS 8 and given prospective effect.

Treated as Change in Accounting Policies and given retrospective effect.

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

30

Case Studies Facts:

• Green-Dart Logistics Ltd. has acquired a heavy road truck at cost of Rs. 100,000 (with no breakdown of the component parts). The estimated useful life is 10 years. At the end of the sixth year, the Engine requires replacement, as further maintenance is uneconomical due to the off- road time required. The remainder of the vehicle is perfectly roadworthy and is expected to last for the next four years. The cost of a New Engine is Rs.45,000. Assess impact on Gross Block.

Solution:

• The New Engine will produce economic benefits to Green-Dart Logistics Ltd., and the cost is measurable. Hence the item should be recognized as an asset. The cost of the replacement i.e. Rs. 45,000 can be used as an indication (usually by discounting) of the likely cost, six years previously. If an appropriate discount rate is 5% per annum, Rs. 45,000 discounted back six years amounts to Rs. 33,500 [Rs.45,000/(1.05)]6, which would be written out of the asset records. The cost of the new power train, Rs.45,000, would be added to the gross asset record, resulting in a new asset cost of Rs.111,500 (Rs.100,000- Rs.33,500+ Rs.45,000).

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

31

Case Studies

Facts:

• Queenfisher Airways, an aviation company, acquired an aircraft for Rs. 2.1mn. The aircraft is expected to have life of 15 years. Queenfisher Airways is required to have aircraft inspected every three years to ascertain whether they are travel-worthy.

Without the inspection, which requires a high degree of expertise, Queenfisher Airways cannot operate the aircraft. The cost attributable to inspection is Rs. 600,000.

Queenfisher acquired the aircraft on the previous inspection, which was carried out on 1 April 2007, As at 1 April 2010, Queenfisher Airways incurred Rs. 750,000 as the cost of the new inspection.

Solution:

• Queenfisher Airways will recognize the aircraft at Rs.1.5m and depreciate it over 15 years and will recognize the inspection cost at Rs.600,000 and depreciate it over 3 years.

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

32

Case Studies

April 2007 to March 2010

April 2010 to March 2013

Depreciation Charge: Rs.

Aircraft to be depreciated over 15 years=1,500,000/15 years 100,000

Inspection cost to be depreciated over 3 years=750,000/3 years

250,000

Total depreciation to be recognized each year 350,000

Depreciation Charge: Rs.

Aircraft to be depreciated over 15 years=1,500,000/15 years 100,000

Inspection cost to be depreciated over 3 years=600,000/3 years

200,000

Total depreciation to be recognized each year 300,000

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

33

Dr. Reddy’s Laboratories- 2009

Property, plant and equipment

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

34

Vedanta Annual Report Depreciation

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

35

Vedanta Annual Report

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

36

Marks & Spencer - 2008

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

37

Marks & Spencer

IAS 16:

-About IAS 16

-Recognition

-Valuation Models

-Depreciation

-Other Matters

-Disclosures

-Key Differences

-Case Study

-Annual Report

38

UGC – National Level Seminar on

International Financial

Reporting Standards.

Questions invited

or can be subsequently emailed to:

anand@shbathiya.com

Anand Bathiya – B.Com., A.C.A., LL.B.

© S. H. Bathiya & Associates – 2011

www.shbathiya.com

39