ACCA P2 (INT) Corporate Reporting - Study text - 2010 (Emile Woolf)
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Chapter 9: Statements of cash flows
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$000
Tangiblenoncurrentassets
500
Inventories 200
Tradereceivables
300
Tradepayables
(200)
Taxation(includingdeferredtaxation)
(80)
Bankoverdraft
(320)
–––––––––––––––– ––––
400
–––––––––––––––– ––––
D acquired its interest in S at the date of incorporation of that company, so no
goodwill arose.
Required
Prepare a statement summarising the effect of the disposal as a note to the
consolidated statement of cash flows.
Answer
We know that the cash received from the sale of the shares in the subsidiary is
$550,000. However, a note to the statement of cash flows should present the details
of the net assets disposed of, the proceeds from the sale, and the profit or loss on
disposal. The profit or loss is the difference between the value of the net assets
disposed of and the proceeds from the sale. It is a balancing figure, in the same way
that the purchased goodwill is the balancing figure in a similar note to the statement
of cash flows when a subsidiary has been acquired.
In this example, the subsidiary had a bank overdraft when it was disposed of. The
cash in the subsidiary at the date of disposal was therefore a negative amount. The
group no longer has the bank overdraft, which means that its cash flow position
improved by selling off the subsidiary.
In the statement of cash flows itself, the cash proceeds from the disposal of the
subsidiary (net of cash ‘lost’) is the cash from the disposal proceeds plus the bank
overdraft that is no longer in the group ($550,000 + $320,000 = $870,000).
$000
Netassetsdisposedof:
Tangiblenoncurrentassets 500
Inventories
200
Tradereceivables
300
Tradepayables
(200)
Taxation
(80)
Bankoverdraft
(320)
–––––––––––––
400
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Non‐controllinginterest(20%×400) (80)
–––––––––––––
320
Profitondisposal
230
–––––––––––––
Proceeds 550
–––––––––––––
Satisfiedby:
Cash
550
Extract from the statement of cash flows
Investing activities
Sale of subsidiary (550 + 320) 870
Example
Suppose that the group in the previous example uses the indirect method of
computing the cash flow from operating activities. Inventories were $1,600,000 in
the opening group statement of financial position at the beginning of the year and
$1,500,000 in the closing group statement of financial position.
Required
What figure in respect of inventories would be used as an adjustment in calculating
the cash flows from operating activities?
Answer
$000
Groupinventoriesatthebeginningoftheyear
1,600
Inventoriesdisposedofinthesubsidiary (200)
–––––––––––––
1,400
Groupinventoriesattheendoftheyear
1,500
–––––––––––––
Adjustmentforincreaseininventories (100)
–––––––––––––
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Paper P2 (INT)
Corporate Reporting
CHAPTER
10
Non-current assets
Contents
1 Property, plant and equipment
2 Investment property (IAS 40)
3 Intangible assets (IAS 38)
4 Impairment of assets (IAS 36)
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Property, plant and equipment
Introduction
Initial measurement: cost
Initial measurement of cost: finance costs (IAS 23)
Initial measurement of cost: government grants and IAS 20
Cost of a non-current asset: subsequent expenditure
Valuation after initial recognition
Depreciation
Disposals of non-current assets
Assets held for sale
1 Property, plant and equipment
1.1 Introduction
The main accounting standard relating to the recognition and measurement of
tangible non-current assets is IAS 16 Property, plant and equipment. However, the
following accounting standards are also relevant.
IAS 20 Accounting for government grants and disclosure of government assistance
IAS 23 Borrowing costs
IAS 36 Impairment of assets
IAS 40 Investment property
IAS 28 Intangible assets
All of these accounting standards will be familiar to you from your previous
studies.
2 Property, plant and equipment
2.1 Initial measurement: cost
IAS 16: Property, plant and equipment defines property, plant and equipment (PPE) as
assets that are to be used on a continuing basis in the company’s activities to
provide access to economic benefits.
As PPE, they must be tangible (they must have a physical existence); otherwise they
would be classified as intangible assets. Common examples of PPE are land and
buildings, plant and machinery, motor vehicles, and fixtures and fittings.
Chapter 10: Non-current assets
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A tangible non-current asset should initially be measured at cost. Cost is not simply
the purchase price of the asset. The cost should include the following items:
Purchase costs, including import duties and non-refundable purchase taxes (for
example, non-refundable value added tax: however, purchase taxes are not
included in cost if they are refundable to the entity).
Costs directly related to getting the asset ready for use, including:
− professional fees (for example, the fees of architects or surveyors, and legal
costs)
− costs of site preparation (getting a site ready for installation; for example, the
costs of levelling a factory floor before new machinery is installed)
− installation costs
− costs of testing the asset (for example, the costs of safety test flights for a new
aeroplane).
Dismantling costs. The initial estimate of the costs of dismantling and removing
the asset at the end of its expected life, plus the costs of restoring the site after
use when an obligation to incur these future costs arises at the time the asset is
acquired.
Where the asset has been constructed by the entity, rather than purchased from an
external supplier, the cost should also include the employee costs that directly relate
to the construction and production overhead costs, but not administration and
general overhead costs.
Dismantling costs
When a company acquires an asset it may have an obligation to dismantle the asset
and restore the site once the asset reaches the end of its life. The obligation must be
included in the cost of the asset, at the time that the asset is first recognised.
For example, a company that builds an oil rig in the sea may have an obligation to
restore any damage to the sea-bed once it has finished drilling for oil. A cost for
future site restoration work should be included in the cost of the oil rig, when the
rig is initially recognised as an asset: this cost should be the present value of the
estimated future costs. As a part of the cost of the asset, it will then be depreciated
over the asset’s life.
This treatment ensures that the restoration costs are matched to the associated
income earned from the rig during the rig’s useful life. (Unless the future restoration
costs are capitalised and depreciated, the cost would eventually have to be
accounted for as a ‘one-off’ item of expense at the end of the asset’s life. This would
be inconsistent with the accruals concept of accounting.)
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Example
Entity H has incurred the following costs prior to bringing a machine into full
production:
$
Purchasepricebeforetraderebateandtax 12,200
Traderebate
600
Refundablepurchasetaxes
1,200
Architects’fees
700
Installationcosts
100
Operatinglossespriortoachievingplannedperformance
250
Required
Calculate the amount at which the machine should be stated in the accounting
records of Entity H in accordance with IAS 16.
Answer
The cost of the machine should be stated in the statement of financial position as:
$
Purchasepricelesstraderebate(12,200–600)
11,600
Architects’fees
700
Installationcosts
100
Totalcost
12,400
For self-constructed assets (non-current assets that are constructed by the entity
itself):
internal profits and abnormal costs should be excluded from cost
administrative expenses and other similar overheads should be excluded from
cost
interest costs incurred in the course of construction might be included, in
accordance with IAS 23 Borrowing costs (see below).
1.3 Initial measurement of cost: borrowing costs (IAS 23)
In 2007, the IASB revised IAS 23: Borrowing costs. IAS 23 now requires an entity to
capitalise borrowing costs directly attributable to the acquisition, construction or
production of a qualifying asset as part of the cost of that asset. It is not permissible
to recognise these borrowing costs immediately as an expense in profit or loss.
For example, if an entity takes out a loan to finance the construction of a new
warehouse, the entity must capitalise the cost as part of the cost of the warehouse.
Chapter 10: Non-current assets
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The borrowing costs, as part of the asset cost, will be ‘expensed’ to the income
statement (profit or loss) over the expected life of the asset, as part of the annual
depreciation charges.
The revised IAS 23 states that ‘Borrowing costs that are directly attributable to the
acquisition, construction or production of an asset are included in the cost of that
asset. Such borrowing costs are capitalised as part of the cost of the asset when it is
probable that they will result in future economic benefits to the entity and the cost
can be measured reliably. Other borrowing costs are recognised as an expense in the
period in which they are incurred.’
Capitalisation of borrowing costs may only begin when work on bringing the
asset into use has begun.
Borrowing costs should not be capitalised during extended periods when active
development is interrupted, unless there is just a temporary delay.
Capitalisation of borrowing costs must cease once activities have reached the
stage where the asset is available for use, even if the asset has not yet actually
been brought into use.
Example
A company constructing a new warehouse takes out a loan to finance the
construction, and the interest cost is $12,000 each month. The company should
capitalise those interest costs incurred from the time that work on construction
begins until the time that the warehouse is ready for use.
The cost of constructing an asset may be financed out of general company
borrowings, rather than a specific loan. In this situation, it may be difficult to
identify the borrowing costs linked to one particular asset. IAS 23 requires that in
this situation, the borrowing costs attributable to the asset should be calculated by
reference to the weighted average cost of interest across the range of borrowings.
1.4 Initial measurement of cost: government grants and IAS 20
The government may offer financial support to a company to assist with:
subsidising general expenditure; for example, contributing to employee costs, to
encourage a company to locate its operations in an area of high unemployment
the acquisition or construction of an asset.
Assistance to an entity from the government, in the form of cash grants or in any
other form of assistance, must be accounted for in the entity’s financial statements.
IAS 20 Accounting for government grants and disclosure of government assistance
requires that a government grant should only be recognised when there is
reasonable confidence that the company will meet the conditions for receiving the
grant. Therefore, there must be reasonable confidence that the money will be
received.
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Grants may be related to either:
income: for example, a government may pay a cash grant towards the cost of re-
training employees of an entity, so that they acquire new skills
capital: for example, an entity may be given a government grant towards the
cost of building a new asset, such as a factory in an area of high unemployment.
Government assistance may be in a form other than cash; for example the
government may give land to an entity to build a new factory. Non-monetary items
should be accounted for at fair value.
The general principle is to account for grants and assistance by matching the grant
income to the related cost. Consider the following examples.
Example
A company receives a grant from a government department to assist it with a
programme of staff re-training. The programme is expected to last for 18 months.
In this situation, the grant should be expensed to profit or loss over the same 18
month period as the associated re-training costs are incurred.
Example
A grant is paid to a company to allow it to settle its outstanding accounts payable
and prevent it from going into liquidation.
As the expense of the purchase has already been incurred, the grant should be
released to profit or loss in full in the period the grant is received.
Example
A company receives a grant of $300,000 towards the acquisition of a machine
costing $500,000. The machine has a useful life of five years.
Once again, the grant should be matched against the associated cost. There are two
acceptable accounting approaches in this situation.
Option 1. Deduct the grant from the asset cost so that the asset is recorded at
$200,000, being the net cost to the company.
Option 2. Record the asset at its full cost of $500,000 and take the grant to the
statement of financial position as deferred income. The deferred income is then
released to profit and loss over the useful life of the asset. The effect is to reduce
the depreciation charge.
Both approaches have the same effect on profit or loss and net assets.
Chapter 10: Non-current assets
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In the example above, if Option 1 is chosen and the asset has no residual value,
the cost of the asset is recorded at $200,000 and there will be an annual
depreciation charge of $40,000 for five years.
If Option 1 is chosen, the cost of the asset is recorded at $500,000 and there will
be an annual depreciation charge of $100,000 for five years. In addition, deferred
income of $300,000 is recorded, and this will be released (as realised income) to
profit and loss at the rate of $60,000 each year for five years. The net effect is to
charge a net amount of $40,000 ($100,000 - $60,000) to profit or loss each year.
Note: problems with both methods of accounting
It can be argued that both of these approaches are theoretically unsound, because
they are inconsistent with the principles in the IASB Framework.
Deducting the grant from the cost of the asset is not in accordance with the
principle of recognising asset at the ‘cost’ to the entity.
Treating the grant as deferred income uses an element in the financial statements
(‘deferred income’) that is not recognised in the IASB Framework.
The IASB has expressed its dissatisfaction with the treatment of government grants
as a liability (deferred income) when no liability exists, but a revision to IAS 20 is
not planned in the near future.
1.5 Cost of a non-current asset: subsequent expenditure
Any subsequent expenditure that is incurred on an existing non-current asset
should be capitalised, provided that it can be shown that it enhances the economic
benefits from the asset. For example, subsequent expenditure on an asset should be
capitalised if it means that the asset’s life has been extended, or its output increased,
or the quality of its output has been improved, or operating costs have been
reduced.
(If subsequent expenditure on an asset does not enhance future economic benefits,
the expenditure should be treated as an expense as incurred. For example repairs
and maintenance costs must be included as an expense in profit or loss.)
Where a part of an asset (a ‘component’) is replaced, the cost of the replacement
should be capitalised and the net book value of the component replaced should be
removed from the statement of financial position. This might include the cost of
overhauling an asset.
Example
A shipping company is required to put its ships into dry dock every three years for
an overhaul, at a cost of $300,000. The ships have a useful life of 20 years. A ship is
purchased from a shipbuilder at a cost of $20 million.
When the ship is first acquired, $300,000 of the asset cost should be treated as a
separate component and depreciated over three years. The rest of the cost of the
ship ($19.7 million) should be depreciated over 20 years. By the end of the third year
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an overhaul will be required. The cost of the overhaul is capitalised and added to
the asset’s cost. The cost ($300,000) and accumulated depreciation of the depreciated
component is removed from the accounts.
Example
A building is constructed. The cost of the building includes the cost of the main
construction work, plus the costs of air conditioning, the cost of elevators and the
cost of wall partitions.
The cost of the building should be allocated between component elements, and each
component element should be depreciated separately. For example, the cost of the
elevators should be capitalised and depreciated over their expected useful life.
When the elevators are replaced (whenever this actually happens), the cost of the
new elevators should be capitalised and included in the cost of the building. The net
book value of the old elevators should be taken out of the carrying value of the
building and written off (unless they have a disposal value).
1.6 Valuation after initial recognition
After the initial recognition of non-current assets at cost, IAS 16 allows an entity to
carry its non-current assets:
at cost, using the cost model, or
to revalue them to their fair value, using the revaluation model.
Fair value is normally open market value. If there is no reliable market value (for
example, because the asset is specialised or because sales are rare), depreciated
replacement cost can be used.
Valuation should normally be performed by a professionally qualified valuer. IAS16
does not prescribe a time interval between revaluations.
When the cost model is used, the depreciation of the asset is based on its cost, and
the asset is carried in the statement of financial position at cost minus accumulated
depreciation and any accumulated impairment.
When the revaluation model is used, the asset is re-valued from time to time, and
recorded in the statement of financial position at this re-valued amount. If the re-
valued amount is more than the carrying value of the asset at the time of the
revaluation, there is a revaluation gain. If the re-valued amount is lower than the
carrying amount, there is a revaluation loss.
Any gain arising on revaluation is reported as other comprehensive income
taken directly to equity, as a revaluation reserve and is not reported in profit or
loss.
Any loss on revaluation is included in profit or loss, as a loss in the period,
unless the loss reverses a previous revaluation gain. In this case, the loss is
reported in other comprehensive income and set off against the gain in the
revaluation reserve, and is not reported through profit or loss.