IAS 16 and IAS 40(International Accounting Standards) - Essay Example

(a) How will Gale plc determine whether the building is an investment property or not? As per the presented information, it is hard to determine whether the building is an investment property. This is due to the fact that, according to the definition presented by IAS 40 in iasplus.com website, an investment property refers to such property that includes buildings and land or part of such that is either held by the legal owner or lessee for the purpose of earning rentals or for the reasons of achieving appreciation of capital or even both. Examples of such property are with the inclusion of land that is held for the prospected use in indefinite future or for the purposes of its appreciation in value, a building being leased under the type of lease known as operating lease or even any given property that has been developed or constructed for future utilisation as an investment property. Therefore, owner occupied property that is being held for future disposal does not really fall under investment properties. (iasplu.com, 2011) (b) After initial recognition, describe the accounting treatment that should be adopted for a building in accordance with IAS16, assuming it is not an investment property? IAS 16, as Holt writes, deals with (PPE) Plant, Property and Equipment. The definition put across by IAS 16 with regards to Plant, Property and Equipment is any tangible type of asset which any given entity may hold for rental purposes or for own use and which the same entity expects to utilise for more than a period. This PPE could have been either constructed or bought by the reporting entity. Any item falling under PPE has to be recognised by the reporting entity as an asset. In case the future benefits as well as losses that are expected from the asset can be reasonably quantified, then the item of PPE should be taken in the books of the entity as an asset. PPE, in accordance to IAS 16, is originally recognised in the books at the cost of the item and this is the fair value of the price paid to obtain the asset. The costs that have been incurred in the process of having the asset in its condition of working should be capitalised as the IAS states. These cost outlays may be with the inclusion of architects’ fee in the case of a building. If applicable directly attributable types of overhead costs as well as borrowing costs should form part of the costs. During the stage of production, all earned revenues should form part of the incomes in the income statement as opposed to capitalising the same. Following the initial recognition of such an asset that falls under PPE, like in this case- a building, the given asset should be valued at cost minus any accumulated depreciation or at the amount of revaluation, which is the fair value of the asset minus depreciation. Note that in the case of fair value, such must be reliably measured. There should be subsequent revaluations with enough regularity to allow for the carrying amount to be in the whereabouts of the fair value. Revaluation may bring about a surplus or a deficit and this, according to IAS 16 should be included in the retained earnings. In case of depreciation, the depreciable amount is to be allocated using a systematic way over the useful life of that asset, (in this case the building). (Holt, 2010) (c) After initial recognition, describe the accounting treatment that should be adopted for an investment property in the accounts according to IAS 40? In the process of accounting for property, be it buildings, land or parts of buildings, is to classify such in accordance to IAS 40. If such assets are for capital appreciation or rental purposes as opposed to supply or production of commodities, not intended for disposal or for administration then these should be reclassified from Property, Plant and Equipment to property for investment if such is deemed essential. (Wittsiepe, 2008 p133) An investment property shall be accounted for in the accounts as an asset only under the situation that; there can a reasonable way to determine the cost of such investment property and there is a probability that there are future benefits associated with the property and which are set to flow to the entity under consideration. The investment property in question is to be measured at its cost initially as IAS 40 states. All transaction costs that have been incurred in the process of the property’s acquiring shall form part of the initial measurement. (Finance leases are to be treated as per IAS 17). This standard allows for any given entity to pick either the cost model or the fair value model to account for the investment property. The cost model calls for an investment property’s measurement at depreciated cost following the initial treatment while the fair value model calls for the use of the fair value subsequent to the initial measurement and the changes in the fair value to be recognised in the income statement of the entity. (iasb.org, 2011) (d) Compare and contrast the possible different treatments of the building in Gale plc over the first three years of its life. You should prepare accounting extracts where you think necessary. Assume alterations to the value of the building occur at the year end. (Comment on 2011,2012,2013) Gale plc Journal entries for Building property For years (2011, 2012, and 2013) Date Account and narrative Dr(?) Cr(?) 2011 Building(cost) 5000000 Cash 5000000 Being a purchase of a new building in 2011 costing ?5M December 31 2011 P&L a/c 100000 Building 100000 Being depreciation of the building for year ended 31/12/2011 2012 P&L a/c(depreciation) 100000 Building a/c 100000 Being Depreciation for year 2012 with regards to the building 2013 Building 960000 Revaluation Surplus 960000 Being an increase after revaluation in buildings Revaluation (surplus) a/c 960000 P&L a/c 960000 Being a transfer of the revaluation surplus of the building to P&L a/c P&L a/c 120000 Building 120000 Being the depreciation for the period ending 31/12/2013 In year 2011 there is the acquisition of a building for ?5 million and that causes a reduction in the cash account, which is a current asset account, of the business. The double entry is an increase in the building account, which is a non-current asset account, with a similar amount. In the same year (2011), a depreciation of ?100,000 is to be provided and this leads to a double entry that reduces the building account with that amount and a rise in the provision for depreciation (an expense a/c) account in the company’s P&L a/c. In year 2012, a provision for depreciation of ?100,000 is done. The double entry is a rise in the provision for depreciation account in the P&L a/c and a reduction in the Building a/c, which is a non-current asset account. In year 2013, there is a revaluation upwards of the building by ?960,000. This has a double entry of a rise in the building account and a rise in the revaluation surplus account (which when it increases is credited). The amount in the revaluation surplus account is taken to the P&L a/c as income in the end of the year and this leads to a double entry where the Revaluation surplus a/c is debited and the P&L a/c is credited. This is to close the revaluation surplus a/c at the end of the accounting period. A provision for depreciation is to be provided on the new value of the building and thus, results to a ?120,000 provision for depreciation for that year. The double entry is a debit of ?120,000 on the P&L a/c (provision for depreciation) and a credit to the building a/c with the same amount come the end of the accounting year. (accountingexplained.com, 2011) (e) Explain how the building would be dealt with in the accounts for 2014, assuming property prices do fall. If property prices do fall, the explanation given by IAS 40 and expounded under the journal entries as presented by accountingexplained.com website, it would lead to a reversal of entries as presented by the 2013’s journal entry. The result would be a fall in the value of the building and therefore, the journal entry would be as follows: Account and narrative Dr Cr Revaluation (deficit) a/c xx Building a/c xx Being the amount of revaluation deficit realised in the year 2014 In the journal entry above, the amounts to be put in every account are the amount of fall in value. The case here assumes that there is a revaluation downwards of the building. Thus, the resultant double entry for this should be an increase in the Revaluation deficit a/c which should be a debit with the revaluation amount and a credit on the Building a/c which shows a fall in value, (thus, a credit). Depreciation would now be based on the new amount after revaluation and the revaluation would be reflected in the P&L a/c as follows: Account and narrative Dr Cr P&L a/c Xx Revaluation (deficit) a/c xx Being the transfer of the revaluation amount from the revaluation a/c to the P&L a/c The revaluation deficit amount should be transferred to the P&L a/c. This results to a double entry where the Revaluation deficit a/c is credited and the P&L a/c is debited with the same amount of deficit. This is to close the revaluation deficit a/c at the end of the accounting period. (accountingexplained.com, 2011) Reference list: accountingexplained.com. (2011). Revaluation of fixed Assets. Retrieved 15 November 2011 http://accountingexplained.com/financial/non-current-assets/revaluation-of-fixed-assets Holt, Graham. (2010). IAS 16, Property, plant and equipment. Retrieved 15 November 2011 http://www.acca.co.uk/members/publications/accounting_business/CPD/ias_16 iasb.org. (2011). IAS 40 Investment Property. Retrieved 15 November 2011 http://www.iasb.org/NR/rdonlyres/0E7AB953-8BE4-4799-97BC A3BDE0B01A3E/0/ias40sum.pdf iasplus.com. (2011). Summary of IAS 40. Retrieved 15 November 2011 http://www.iasplus.com/standard/ias40.htm Wittsiepe, Richard. (2008). International financial reporting standards for small and medium-sized enterprises: structuring the transition process. Gabler Verlag. p133. Read More