ACCA F7 (INT) Financial Reporting - Study text - 2010

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Chapter 7: Tangible non-current assets

(b) Reducing balance method: $3,300 × 25% = $825 (carrying value at end of Year

2 = $2,475)

Straight‐line

method

Reducingbalance

method

Unitsof

productionmethod

Year1

$$$

Cost 4,4004,4004,400

DepreciationforYear1 (750) (4,400×25%) 1,100 (28,000×0.03) (840)



–

––––

–

–––– 

–

––––

Carryingamount,endofYear1 3,6503,3003,560



DepreciationforYear2 (750) (3,300×25%) 825 (26,000×0.03) (780)



–

––––

–

–––– 

–

––––

Carryingamount,endofYear2 2,9002,4752,780



–

––––

–

–––– 

–

––––

2.3 A change in the method of measuring depreciation

IAS16 requires depreciation methods to be reviewed at least annually. It only allows

a change in the method of measuring depreciation where this would give a

presentation of the entity’s financial results and financial position that is more fair.

Where there is a change in the depreciation method used, this is a change in

accounting estimate. A change of accounting estimate is applied from the time of

the change, and is not applied retrospectively. The carrying amount (cost minus

accumulated depreciation) of the asset at the date of the change is written off over

the remaining useful life of the asset.

Example

Entity L owns a machine which originally cost $30,000 on 1 January Year 1. It has no

residual value. It was being depreciated over its useful life of 10 years on a straight-

line basis. At the end of Year 4, when preparing the financial statements for Year 4,

Entity L decided to change the method of depreciation, from straight-line to the

reducing balance method, using a rate of 25%.

Required

Calculate the depreciation charge for Year 4.

Answer

The change in accounting estimate is made at the end of Year 4, but is applied to the

financial statements from 1 January Year 4. The reducing balance method of

depreciation is applied to the Year 4 statements.

Cost on 1 January Year 1 30,000

Depreciation for Years 1 to 3 (30,000 × 3/10) (9,000)

–

––––––

Carrying amount at end of Year 3 21,000

–

––––––

Depreciation for Year 4 will therefore be $21,000 × 25% = $5,250.

Paper F7: Financial reporting (International)

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2.4 A change in the asset’s useful life

IAS16 requires useful lives to be reviewed at each year-end. Any change is a

change in accounting estimate. The carrying amount (cost minus accumulated

depreciation) of the asset at the date of change is written off over the (revised)

remaining useful life of the asset.

Example

Entity M owns a machine which originally cost $60,000 on 1 January Year 1. It has

no residual value. It was being depreciated over its useful life of 10 years on a

straight-line basis. On 31 December Year 4 Entity L revised the total useful life for

the machine to eight years.

Required

Calculate the depreciation charge for Year 4 and subsequent years.

Answer

The change in accounting estimate is made at the end of Year 4 but may be applied

to the financial statements from Year 4 onwards.

Cost on 1 January Year 1 60,000

Depreciation for Years 1 to 3 (60,000 × 3/10) (18,000)

–

––––––

Carrying amount at end of Year 3 42,000

–

––––––

Remaining useful life at the end of Year 3 = 8 – 3 years = 5 years.

Depreciation for Year 4 and subsequent years will be $42,000 ÷ 5 years = $8,400.

Chapter 7: Tangible non-current assets

De-recognition of non-current assets

 General rules on de-recognition

 Disposal of assets ‘held for sale’

3 Derecognition of non-current assets

3.1 General rules on de-recognition

When an asset is de-recognised, its carrying amount is removed from the statement

of financial position. IAS16 Property, plant and equipment states that the carrying

amount of an item of property, plant and equipment should be derecognised in the

following circumstances

 on disposal of the asset, or

 when no future economic benefits are expected to arise from its use or from its

disposal.

If a non-current asset is disposed of, the gain or loss on the disposal should be

included in profit or loss in the period in which the disposal occurs. The gain or loss

should not be included in sales revenue.

The gain or loss on the disposal is calculated as:

Net disposal proceeds X

Minus: Carrying amount (X)

–

–––––

Gain/(loss) on disposal X/(X)

–

–––––

3.2 Disposal of assets ‘held for sale’

Special rules apply where an asset has been classified as ‘held for sale’ under IFRS5

Non-current assets held for sale and discontinued operations.

IFRS5 states that an asset held for sale should be measured at the lower of its:

 carrying value, and

 fair value minus the costs to sell.

This means that any loss is recognised at the time that the asset is classified as held

for sale.

For example, suppose that an asset is reclassified as ‘held for sale’, when its carrying

amount is $20 million. If its fair value minus estimated costs to sell is $17 million,

the asset should be re-valued at $17 million and a loss of $3 million should be

reported in the period.

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Any gain is not recognised until the actual disposal. The gain is calculated according

to the general rules described above. For example, suppose that an asset is

reclassified as ‘held for sale’, when its carrying amount is $20 million. If its fair value

minus estimated costs to sell is $24 million, the asset ‘held for sale’ should be valued

at $20 million. A gain on disposal will be included in profit for the period when the

disposal actually occurs.

A loss could still arise under these general rules where the asset has fallen further in

value between the time of its classification as held for sale and the time of its actual

disposal.

A held for sale asset:

 is included within current assets in the statement of financial position, and

 is not depreciated.

Example

A machine was purchased on 1 January Year 1 for $80,000. It had a useful life of 8

years and no residual value.

On 31 December Year 4 the machine was classified as held for sale. The machine

was sold on 30 June Year 5.

Required

Calculate the entries in the statement of comprehensive income for Year 4 and Year

5 on the following bases.

(a) Assuming that

(1) on classification as held for sale the machine’s fair value was estimated at

$50,000 and the costs to sell were estimated at $1,000 and

(2) the machine was sold for $48,000.

(b) Assuming that

(1) on classification as held for sale, the machine’s fair value was

estimated at $41,000 and the costs to sell at $2,000 and

(2) the machine was eventually sold for $37,500.

Answer

Part (a)

End of Year 4:

The asset held for sale is valued at the lower of:

 carrying value = $40,000 (= 80,000 × 4/8)), and

 fair value minus costs to sell = $49,000 (= 50,000 – 1,000)

The machine therefore remains at its carrying value of $40,000.

Chapter 7: Tangible non-current assets

Year 5:

On sale, the statement of comprehensive income will include (in profit and loss) a

profit on disposal of $8,000 (= $48,000 – $40,000).

Part (b)

End of Year 4:

The asset held for sale is valued at the lower of:

 carrying value = $40,000 (= $80,000 × 4/8))

 fair value minus costs to sell = $39,000 (= $41,000 – $2,000).

The machine is therefore written down to $39,000. The statement of comprehensive

income for Year 4 will include an impairment loss of $1,000 (= $40,000 – $39,000).

Year 5:

On sale there will be a further $500 of loss on disposal of $1,500 (= $39,000 –

$37,500).

Disposal of assets held for sale and valued under the revaluation model

IFRS5 states that when an asset is valued under the revaluation model and re-

classified as ‘held for sale’:

Step (1) The asset must be revalued to its fair value immediately before

classification as ‘held for sale’ (Step 1)

Step (2) On classification as ‘held for sale’, the asset is revalued to fair value

minus costs to sell (Step 2).

Step (1) is dealt with in the usual way for the revaluation model, and there will be a

gain or loss on revaluation.

The effect of Step (2) is that the estimated costs to sell are treated as an impairment

loss in the statement of comprehensive income, and the loss arises when the asset is

classified as ‘held for sale’.

Paper F7: Financial reporting (International)

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Disclosure requirements of IAS16 and IAS23

 Disclosure requirements of IAS16

 Disclosure requirements of IAS23

4 Disclosure requirements of IAS16 and IAS23

4.1 Disclosure requirements of IAS16

IAS16 Property, plant and equipment requires the following disclosures in the

notes to the financial statements, for each major class of property, plant and

equipment.

 The measurement bases used (cost or revaluation model)

 The depreciation methods used

 The useful lives or depreciation rates used

 Gross carrying amounts and the accumulated depreciation at the beginning and

at the end of the period

 A reconciliation between the opening and closing values for gross carrying

amounts and accumulated depreciation, showing:

− Additions during the year

− Disposals during the year

− Depreciation charge for the year

− Assets classified as held for sale in accordance with IFRS5

− Acquisitions of assets through business combinations

− Impairment losses

− The effect of revaluations.

The following is an example of how a simple table for tangible non-current assets

may be presented in a note to the financial statements.

Property

Plant and

machinery

Total

$m $m

Cost

At the start of the year 7,200

2,100 9,300

Additions 950

350 1,300

Additions through business combinations 10

5 15

Classified as held for sale (40)

(15) (55)

Disposals (260)

(170) (430)

–

––

–

–––

–

–––

At the end of the year 7,860

2,270 10,130

–

–––

–

–––

––

–

–––

Chapter 7: Tangible non-current assets

Accumulated depreciation and impairment losses

At the start of the year 800

1,100 1,900

Depreciation expense 120

250 370

Classified as held for sale (10)

(5) (15)

Accumulated depreciation on disposals (70)

(130) (200)

Impairment losses 30

8 38

Reversal of impairment losses (5)

(3) (8)

–

–––

–

––––

–

–––––

At the end of the year 865

1,220 2,085

–

–––

–

––––

–

–––––

Carrying amount

At the start of the year 6,400

1,000 7,400

–

–––––

–

–––––

–

–––––

At the end of the year 6,995

1,050 8,045

–

–––––

–

–––––

–

–––––

For your examination, you should be able to prepare a similar table for non-current

assets, using data provided in a question or obtained from your solution to an

earlier part of the question.

Disclosure is also required of the following information.

 Details of assets pledged as security for liabilities

 The amount of expenditure included in property, plant and equipment in

respect of assets in the course of construction

 The amount of contractual commitments for the acquisition of property, plant

and equipment

 The amount of compensation received from third parties in respect of assets

impaired, lost or given up.

 For assets that have been revalued:

− the effective date of revaluation

− whether an independent valuer was involved

− the methods and significant assumptions used in estimating fair values

− the extent to which fair values were determined by prices in an active market

or by recent arm’s length transactions

 for each revalued class of assets, what the carrying amount would have been

under the cost model

 the total revaluation surplus, showing the movements in the revaluation reserve

in the period.

4.2 Disclosure requirements of IAS23

IAS23 Borrowing costs requires the following disclosures in the notes to the

financial statements.

 The amount of borrowing costs capitalised during the period

 The capitalisation rate used to determine the amount of borrowing costs eligible

for capitalisation.

Paper F7: Financial reporting (International)

Government grants: IAS20

 Introduction and definitions

 Accounting treatment of government grants

 Disclosure requirements

5 Government grants: IAS20

5.1 Introduction and definitions

In many countries the government provides financial assistance to industry. The

most common form of such assistance is a grant of cash from local or national

government. Such grants are defined by IAS20 as:

 grants related to assets, or

 grants related to income.

Grants related to assets are for the purchase or construction of long-term assets.

Conditions may be attached to a grant, specifying the type of assets that should be

purchased with the grant, or the location of the assets, or the period in which they

are to be acquired or held.

Grants related to income are any other government grants.

5.2 Accounting treatment of government grants

IAS20 states that grants should not be recognised until there is reasonable assurance

that:

 the entity will comply with any conditions attaching to the grant, and

 the grant will be received.

Once these recognition criteria are met, the grants should be recognised in profit or

loss over the periods necessary to match them with their related costs.

Neither type of grant should be credited directly to shareholders’ interests in the

statement of financial position. They must be reported on a systematic basis through

the income statement (profit or loss).

Grants related to income

For grants related to income, IAS20 states that an ‘income approach’ should be used,

and the grant should be taken to income over the periods necessary to match the

grant with the costs that the grant is intended to compensate.

Chapter 7: Tangible non-current assets

IAS20 allows two methods of doing this:

 Method 1. Include the grant for the period as ‘other income’ for inclusion on

profit or loss for the period

 Method 2. Deduct the grant for the period from the related expense.

For example, suppose that a company receives a cash grant of $30,000 on 1 January

Year 1. The grant is towards the cost of training young apprentices, and the training

programme is expected to last for 18 months from 1 January Year 1. Actual costs of

the training were $50,000 in Year 1 and $25,000 in Year 2.

The grant should be recognised partly in profit for Year 1 ($20,000, which is 12

minths/18 months × $30,000) and partly in Year 2 (the remaining $10,000). The grant

should be taken to income either by:

 recording the grant as other income ($20,000 and $10,000 in Year 1 and Year 2

respectively), or

 deducting $20,000 from the training costs in Year 1 and $10,000 from the training

costs in Year 2.

At the end of Year 1, there is a liability of $10,000 in the statement of financial

position for the grant received but not yet recognised in income.

Grants related to assets

For grants related to assets, IAS20 allows two methods of doing this:

 Method 1. Deduct the grant from the cost of the related asset. The asset is

included in the statement of financial position at cost minus the grant.

Depreciate the net amount over the useful life of the asset.

 Method 2. Treat the grant as deferred income and recognise it as income on a

systematic basis over the useful life of the asset.

For example, suppose that a company receives a grant of $400,000 from the

government towards the cost of an asset that cost $1,000,000 and which has an

estimated useful life of 10 years and no residual value.

 One way of accounting for the grant would be to record the asset at cost net of

grant ($600,000) and depreciate this amount over ten years.

 The other method is to record the asset at cost ($1,000,000) and depreciate over

ten years, and also to account for the grant as deferred income (a liability in the

statement of financial position) and ‘release’ the grant as income over the next

ten years, possibly at the rate of $60,000 per year.

These two methods achieve the same effective result.

Example: grant related to income

Entity N has received a grant of $30,000 in relation to training costs of $100,000.

Required

Show how the costs and the grant could be presented in the financial statements in

accordance with IAS20.

Paper F7: Financial reporting (International)

Answer

Statement of comprehensive income (extracts)

Method1

$

Trainingcosts (100,000)



Governmentgrantreceived 30,000



Method2



Trainingcosts(100,000–30,000) (70,000)

Example: grant related to an asset

On January Year 1 Entity O purchased a non-current asset with a cost of $500,000

and received a grant of $100,000 in relation to that asset. The asset is being

depreciated on a straight-line basis over five years.

Required

Show how these amounts could be reflected in the financial statements prepared at

the end of Year 1 in accordance with IAS20.

Answer

Method 1:

Statementoffinancialposition

Property,plantandequipment $

Cost(500,000–100,000) 400,000

Accumulateddepreciation (80,000)



–

–––––––

Carryingamount 320,000



–

–––––––



Includedinstatementof

comprehensiveincome

$

Depreciationcharge($400,000/5years)

80,000



Method 2:

Statementoffinancialposition

Property,plantandequipment $

Cost 500,000

Accumulateddepreciation (100,000)



–

–––––––

Carryingamount 400,000



–

–––––––

Deferredincome(=liability)

Governmentgrant(100,000–20,000) 80,000

ACCA F7 (INT) Financial Reporting - Study text - 2010 - Emile Woolf Publishing

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