ACCA P2 (INT) Corporate Reporting - Study text

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Chapter 10: Non-current assets

If one item in a category of property, plant and equipment is re-valued, then the fair

value of all other items in the same class must also be re-valued. A class would

usually be defined as land and buildings, or machinery, or fixtures and fittings.

Generally, companies choose to revalue land and buildings whilst using the cost

model for all other classes of assets.

The revaluations must be kept up-to-date, but IAS 16 does not define any fixed

intervals for revaluations. It simply requires that when the revaluation model is

used, revaluations should be made sufficiently often to ensure that the carrying

amount of the assets does not differ materially from their fair value.



Example

An asset was purchased for $500,000, and was believed to have a useful economic

life of ten years and no residual value. At the end of year 8 the asset is re-valued and

found to have a fair value of $150,000.

Required

Explain the accounting treatment of the revaluation and the subsequent

depreciation of the asset.



Answer

At the date of revaluation, but before the revaluation is made, the asset is stated in

the statement of financial position as follows:

$000

Cost

500

Accumulateddepreciation(500/10)×8years (400)

––––––––––––––––

Netbookvalue 100

––––––––––––––––

There are three elements to dealing with a revaluation:

 The asset cost must be adjusted to its re-valued amount

 The accumulated depreciation must be eliminated

 The increase in the carrying value of the asset is taken directly to the revaluation

reserve in equity.

The double entry will therefore be as follows:

$000 $000

Assetvaluation(500–150)

350

DR Accumulateddepreciation 400

CR Revaluationreserve

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These adjustments will alter the carrying value of the asset to $150,000 (from

$100,000), accumulated depreciation is $0 and the revaluation reserve for the asset is

increased by $50,000.

Depreciation after revaluation

Depreciation charges after revaluation, for inclusion in profit or loss, must be based

on the revised value (= re-valued amount).

In the example above, the $150,000 carrying value will be depreciated over its

remaining life of two years, at $75,000 per year. This will be the depreciation charge

each year in profit or loss.

An annual reserve transfer may be made each year from the revaluation reserve

directly to accumulated profits, for the difference between depreciation based on

historical cost and depreciation on the re-valued amount. This transfer is made

direct between the reserves and is not reported in profit or loss:

$

Depreciationbasedonhistoricalcost($500,000/10years)

50,000

Depreciationbasedonthere‐valuedamount 75,000

Transferfromrevaluationreservetoaccumulatedprofit

25,000

(fortheexcessdepreciationcharge) 

In this example, the effect after two years is that the asset will be fully depreciated

and the balance on the revaluation reserve for the asset will have been reduced to

$0.

Revaluations using an index

An alternative way of expressing the change in the asset’s value is to use a cost

index or price index. Using the above example, and an index of 150 for the

revaluation, the revaluation could instead be recorded as follows:

OriginalValue

Index

Revalue

Cost

$500,000 150% $750,000

Accumulateddepreciation $400,000 150% $600,000

Netbookvalue

$100,000 150% $150,000

As the net book value has increased, it is assumed that the replacement cost of the

asset has increased. The cost is therefore adjusted, together with the accumulated

depreciation. The journal entry to record this adjustment should be:

$ $

Cost 250,000

CR Accumulateddepreciation

200,000

Revaluationreserve

50,000

Chapter 10: Non-current assets

Revaluation losses

A revaluation may indicate that an asset has dropped in value rather than increased.

The accounting treatment is exactly the same as for the treatment of impairment.

The accounting treatment of impairments is explained later.

1.7 Depreciation

Depreciation does not measure the change in the value of a non-current asset. It is

simply an accounting method for allocating the cost of an asset to profit or loss over

the asset’s expected useful life. The depreciation charge has the effect of spreading

the cost/fair value of the asset over the periods that will benefit from its use.

The depreciation charge for the year (whether based on cost or revalued amount) is

recognised in profit or loss.

All tangible non-current assets must be depreciated. The only exception to this rule

is land, which normally has an indefinite useful life (unless it is used in mining or

similar industries).

Each significant part of an item of property, plant and equipment must be

depreciated separately. This allows for assets that have two or more major

components with differing useful lives and where different depreciation methods

may be appropriate.

Accounting for depreciation should be familiar to you already. The following

example may refresh your knowledge:



Example

An asset is purchased for £200,000 and is believed to have a useful life to the

company of five years before it is scrapped for an expected £50,000.

Required

(a) Calculate the annual depreciation charge.

(b) At the start of the third year, the company restructures its operations and as a

result the total asset life is believed to be only four years, with the residual

value unchanged. Explain the impact on the depreciation expense.



Answer

(a) Annual depreciation:

Cost less residual value

Expected useful life

$200,00 - $50, 000

5 years

= $30,000 per year

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(b) If estimates are revised, the carrying value of the asset at the date of the new

assessment should be written off over its remaining expected life, using the

new estimates. The new remaining expected life is two years. The change in

estimate is not applied retrospectively. A prior year adjustment must not be

made when dealing with the revision of an estimate.

Net book value at the start of year 3 = $200,000 – (2 years × $30,000) = $140,000

This net book value will be written off over the remaining useful life of 2

years.

Revised depreciation =

$140,000 - $50,000

2 years

= $45,000 per year

Depreciation and components of non-current assets

A non-current asset may have several components (as explained earlier).

For example, a property has two elements, the

land and the buildings. IAS 16

requires that the land and building element must be treated as separate assets.

 The land element is (usually) not depreciated as it has an indefinite useful life.

 The building must be depreciated, even if its value has increased, as it does have

a finite useful life.

 However, if the expected residual value of a building is expected to equal or

exceed the cost, then depreciation will be zero as there is no ‘depreciable cost’ to

the company.

Some assets contain several components with very different useful lives. For

example an aeroplane consists of the external structure, the avionics system, engine

and cabin interior. Depreciation must therefore be calculated on each of these

components over their individual useful lives, using their individual residual

values.

1.8 Disposal of non-current assets

When a non-current asset is de-recognised, its carrying amount is removed from the

statement of financial position. IAS 16 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.

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 on the disposal is calculated as:

Net disposal proceeds X

Minus: Carrying amount (X)

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

Chapter 10: Non-current assets

IAS 16 does not allow the gain on disposal to be included in the revenue line of the

statement of comprehensive income or income statement, but it does not specify

where it should be shown. It simply states: ‘The gain or loss arising from

derecognition of an item of property, plant and equipment shall be included in

profit when the item is derecognised…Gains shall not be classified as revenue.’

Disposal of a re-valued asset

On disposal of a re-valued asset it must be remembered that the revaluation gain

has already been recognised in the revaluation reserve. Therefore the gain on

disposal is calculated based on the re-valued carrying value.

If there is still a balance on the revaluation reserve relating to this asset, the balance

in the revaluation reserve should be reduced to zero. This should be included in

other comprehensive income for the period and there should be a direct transfer of

the balance from the revaluation reserve to the accumulated profits reserve.

It is not permitted to release the revaluation reserve to profit or loss for the year in

which the asset is disposed of. This practice is called ‘recycling’ and is not permitted

by IAS 16.



Example

On 1 April Year 1, a company buys a machine, with an expected life of 20 years. By

the end of 31 March Year 5, the carrying value is as follows:

$

Cost

180,000

Accumulateddepreciation(4years×$9,000) (36,000)

–––––––––––––––– ––––

Netbookvalue 144,000

–––––––––––––––– ––––

The asset is re-valued to $200,000 on 1 April Year 5, resulting in a gain on

revaluation. The gain of $56,000 ($200,000 – $144,000) is credited to the revaluation

reserve on this date. On 1 April Year 7, the asset is sold for $229,000.

The financial year of the company ends on 31st March.

After the revaluation, annual depreciation is based on the re-valued amount of the

asset ($200,000) and its remaining useful life (16 years). The annual depreciation

charge is therefore $12,500, which is $3,500 higher than the depreciation charge

based on the historical cost of the asset.

Required

How should the disposal be accounted for?

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

Answer

The disposal on 1 April Year 7 would be recorded as follows:

(a)

Carrying amount prior to disposal on 1 April Year 7

$

Machineryatvaluationat1AprilYear7

200,000

Accumulateddepreciation($200,000/16years)×2yrs (25,000)

–––––––––––––––– ––––

Netbookvalue 175,000

–––––––––––––––– ––––

(b)

Revaluation reserve

On 1 April Year 5, when the asset was re-valued, the revaluation reserve was

$56,000. The company is allowed to make a reserve transfer each year

following revaluation for the amount of the additional depreciation arising

from the revaluation.

The historical cost depreciation was $9,000 per annum, and the revised

depreciation is $12,500. Therefore over the past two years since the

revaluation, the entity will have transferred $3,500 each year from the

revaluation reserve to accumulated profits, to offset the additional

depreciation effect on the income statement.

The revaluation reserve at 1 April Year 7 is therefore $56,000 – (2 years ×

$3,500) = $49,000.

(c)

Profit on disposal – included in profit or loss for year to 31 March Year 8.

Saleproceeds 229,000

Minus:Netbookvalueondisposal (175,000)



––––––––––

Profitondisposal

54,000



––––––––––

(d) Other comprehensive income for year to 31 March Year 8 and transfer from

revaluation reserve to retained earnings reserve on 1 April Year 7.

Revaluation

reserve

Retained

earnings

$ $

At1AprilYear7 49,000 X

Transferondisposalofnon‐currentasset

(49,000) 49,000

–––––––––––––––– ––––

At31MarchYear8 0 Y

–––––––––––––––– ––––

Chapter 10: Non-current assets

1.9 Assets held for sale

IFRS 5: Non-current assets held for sale and discontinued operations is based on the

equivalent US standard. It provides special rules for the measurement and

classification of assets that are ‘held for sale’.

Held for sale

To be classified as ‘held for sale’, an asset or disposal group (a group of assets to be

sold as a single transaction) must meet all of the following conditions:

 The asset(s) must be available for immediate sale.

 The sale must be considered highly probable. This means that:

−

senior management must be committed to the disposal plan

−

an active programme to find a buyer has begun

−

the asset is being marketed at a reasonable price, and

−

completion of the sale is anticipated in the next 12 months.

 An asset that is to be ‘abandoned’ rather than sold does not meet these

conditions. So if a company plans to scrap an asset or just stop using it, then the

normal rules of IAS 16 (for calculating a gain or loss on disposal) will apply.

Measurement of assets that are ‘held for sale’

Assets held for sale should be measured at the lower of:

 carrying value (net book value), and

 fair value minus costs to sell (market price minus any disposal costs).

Once an asset is classified as held for sale and the reassessment of value has taken

place, no future depreciation should be charged on the asset before it is sold.

Disclosures in the statement of financial position

Assets that are held for sale should be disclosed separately from other assets in the

statement of financial position.

If it is a ‘disposal group’ that is held for sale, then the assets in the disposal group

and the liabilities within the group should be separated, and the assets and

liabilities held for sale should be shown separately from the other assets and

liabilities in the statement of financial position.

Additional disclosures should be given in the notes to describe the asset(s) held for

sale, the circumstances of the sale, the amount charged on the re-measurement, and

the segment to which the asset(s) belong.

Paper P2: Corporate Reporting (International)

Investment property (IAS 40)

 Definition

 Measurement options

2 Investment property (IAS 40)

2.1 Definition

IAS 40: Investment property defines an investment property as land or buildings that

are held (by its owner or by a lessee under a finance lease):

 to earn rental income, or

 as an investment that is expected to increase in capital value, or

 both for rental income and capital appreciation.

Property is

not investment property in any of the following circumstances, and so in

these circumstances property does not come within the scope of IAS 40:

 Property intended for sale in the ordinary course of business (for example,

property of a house builder awaiting sale will be accounted for as inventory

under IAS 2).

 Property being built for a third party. This is a construction contract under IAS

11.

 Property occupied by the owner (IAS 16) or owner occupied and awaiting

disposal (IFRS 5).

 Property that is currently being constructed for use as an investment property.

During the period of construction, the asset is accounted for under the rules of

IAS 16.

Where an investment property is leased to a parent or subsidiary company, this

does

not qualify as an investment property in the consolidated accounts, because

from the group’s perspective it is not an external investment. However, it

is treated

as an investment property in the

individual accounts of the lessor (the owner).

For a property held under an operating lease agreement, the company can choose

on a property-by-property basis whether to recognise this as an investment

property.

2.2 Measurement options

The investment property should initially be recorded at cost. In line with IAS 16, the

cost should include any directly-related costs of acquiring the asset, such as legal

fees and non-refundable taxes.

Chapter 10: Non-current assets

Where the property is held under a finance lease, it should be measured in

accordance with IAS 17 at the

lower of:

 its fair value, and

 the (discounted) present value of the expected future lease payments.

Once recognised, the company can select one of two accounting policies, which

must be applied to all its investment properties:

 fair value model, or

 cost model.

Fair value model

If the fair value model is chosen, each investment property should be valued at fair

value with the resulting gain or loss being recognised in profit or loss.

Fair value is defined as ‘the price at which the property could be exchanged

between knowledgeable and willing parties in an arm’s length transaction’. This is

the market price that the company could recover by selling the asset in an active

market to a company outside the group. If an active market does not exist, the

standard discusses various methods of approximating the fair value using, for

example, prices in less active markets or discounted cash flow projections.

An investment property acquired under an operating lease requires further thought.

The standard treatment under IAS 17 for an operating lease is to exclude the asset

from the lessee’s statement of financial position. However, if the company chooses

to recognise this as an investment property under the fair value model (see above),

then it is required to treat the lease as a finance lease and bring the asset into the

statement of financial position in order to give it a fair value. This treatment is only

possible if the company is using the fair value model for its investment property.

Otherwise the standard accounting treatment for operating leases is required (and

the asset stays out of the statement of financial position of the lessee).

Depreciation is never charged on investment properties under the fair value

model

Cost model

If the cost model is chosen by an entity for its investment property, the cost of the

property is measured in accordance with the standard rules of IAS 16

Property, plant

and equipment

The cost model requires the investment property to be depreciated over its useful

economic life, again in accordance with IAS 16 rules.

When investment property is measured at cost, the fair value must be disclosed in a

note to the financial statements.

Paper P2: Corporate Reporting (International)

Intangible assets (IAS 38)

 Scope of IAS 38

 Recognition and measurement of intangible assets

 Sources of intangibles

 Research and development expenditure

 Amortisation of intangible assets

3 Intangible assets (IAS 38)

3.1 Scope of IAS 38

An intangible asset is an identifiable non-monetary asset without physical

substance.

IAS 38 Intangible assets deals with accounting for intangibles such as patents,

trademarks, licences, computer software, databases, broadcasting rights, non-

competition agreements, customer contracts and customer relationships.

IAS 38 does not cover intangibles that are within the scope of another standard, for

example:

 deferred tax assets (IAS 12)

 leases (IAS 17)

 assets arising from employee benefits (IAS 19)

 financial assets (IAS 39)

 goodwill acquired in a business combination (IFRS 3)

 non current intangible assets classified as held for sale (IFRS 5)

 mineral rights and expenditure on the exploration for, or development and

extraction of, minerals, oil and natural gas (IFRS 6).

3.2 Recognition and measurement of intangible assets

An intangible asset must be recognised only when three conditions are met:

 the asset must be identifiable

 there must be probable future economic benefits from the asset and

 the measurement of the cost of the asset must be reliable.

All three conditions must be met before an intangible can be recognised in the

financial statements.

 The asset must be identifiable:

−

it must capable of being separated or divided from the entity and sold,

transferred, licensed, rented or exchanged (as a separate item), or

−

it arises from a contractual or other legal right.

ACCA P2 (INT) Corporate Reporting - Study text - 2010 (Emile Woolf)

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