Rules Governing Accounting of Non-current Tangible Assets Under IAS - Essay Example

Rules Governing Accounting of Non-current Tangible Assets under IAS Introduction A critical review has been carried out in this write up about the matters prescribed under International Accounting Standards and directly affecting the accounting treatment of non- current Tangible assets. The main related standard is IAS 16 with other standards dealing with such issues in parts. 1(a). Accounting procedure under IAS 16 for non- current tangible assets In order to understand the accounting treatment of non- current tangible assets as addressed by IAS 16 the entire issue needs a detailed observatory discussion under following accounting issues: 1. Initial & Subsequent recognition of non- current tangible assets 2. Description of cost at initial recognition 3. Component approach 4. Impact of residual value 5. Depreciation and Derecognition of assets 1. Initial and subsequent recognition of non- current tangible assets IAS 16 sets single set of principles for recognition of assets both at initial stage as well for subsequent recognitions. These principles are assets would be recognized when a) that it is probable that future economic benefits from asset shall flow to the entity, and b) that cost of the asset can be measured reliably. It may be noted that these principles cannot be followed in respect of day to day repairing and maintenance of PPP, and accordingly IAS 16 has directed those expenses to be expensed with. In subsequent recognition of tangible assets, IAS 16 has provided the option of fair value as on the date of such recognitions with riders that such option once adopted would continue till derecognition of the asset, in any way; and further that the option of revaluation, if adopted shall be applicable to the entire band of the asset. 2. Description of cost at initial recognition This is an important issue dealt in very carefully under IAS 16. Besides the cost of asset IAS 16 has concentrated on issue of cost of bringing the asset to location and the asset made available under present conditions of its operations as per management intentions. The important thing is that by prescribing this rule IAS 16 has put a limit to capitalization of expenses once the asset starts operating as per intention of management. Another important feature is that ‘employee benefits’ accruing during construction or development of assets as per intended use also need to be capitalized. Further, cost of testing any item of asset for ensuring its functioning is also required to be capitalized. For example testing fee paid to a laboratory for testing the quality of a part of machinery is capital cost during initial recognition. But when such cost is incurred after the operation of machinery has started, such costs would be treated as revenue expenditure. IAS 16 states that cost of dismantling and removing an asset and restoration it where it is located should be capitalized. But the important feature of IAS 16 is that cost that is incurred subsequent to initial recognition on replacing or making addition to such asset or its part should also be capitalized if such costs meet the recognition principles of accrual economic benefits to entity and reliable measurement of such subsequent cost. This is clearly the departure from earlier practices of capitalization of assets. When an asset is acquired in exchange of other, the rule is to assess fair value of both asset and if fair values of asset given up can assessed reliably, then that would be the cost of the exchanged asset. But if the fair value of new asset acquired is more evident, then fair value of such asset would be used as cost of asset. However there is another possibility of the use of carrying value of asset given up as the cost of asset acquired. This happens when transactions lack commercial substance or when fair value of neither of asset can be measured reliably. 3. Component approach A tangible asset having different parts of valuable importance in its functioning should be dealt with not as a complete unit so far as its recognition and applicability of depreciation is concerned. Every part should be given due importance and dealt with separately. This is what component approach or theory stresses upon; and IAS 16 has given this theory its due prominence. There may be assets, that require replacements at regular intervals, or assets like air crafts have regular inspections costing amount of future economic benefit to airline, or a plant having different segment but of valuable importance for the product. Transactions relating to these replacements, inspections or segments should be treated separately while dealing with their recognition as asset, cost or value to be recognized, depreciation , and finally while derecognizing those as assets. Normally these parts of one asset have different useful lives providing economic benefits to the entity at different pace. IAS 16 has stressed the applicability of this theory through its different provisions. ‘The component approach to property, plant, and equipment is nothing new and should be followed if the amount initially recognized for a specific asset comprises different major components of that asset that have different useful lives or provide benefits to the entity in a different pattern’. (Scheepers, 2003) 4. Impact of Residual Value IAS 16 states very clearly that residual value of any asset is estimated as the estimated amount that the entity would currently obtain at the time of estimation from disposal of asset less the estimated cost of disposal. This has made a lot of difference in approach for estimating the residual value. The estimation of residual value is at current time and not at the time of end of useful life. Secondly, residual value has to be estimated every time assets are considered for revaluation, that is to say first at initial recognition and then on every balance sheet date till the end of useful life. The importance of such estimation again and again is keep residual value always estimated taking into account the prevailing circumstances. With this approach finally the entity would definitely reach at more or less correct estimation at the end of useful life, but the changing depreciation every time with prospective effects would be a matter of concern with accountants. Deprecation has to be charged with prospective effects even when the fair value exceeds carrying amount so long as residual value does not exceed carrying value. 5. Depreciation and Derecognition of assets Depreciation will commence from the date when asset is available to entity as per the requirement of management. That means depreciation would be charged in accounting at times when the entity might not have actually started using the asset. IAS 16 specifies that depreciation ceases when asset is derecognized. In other words using the asset is no criteria now. Availability of asset and derecognition may cause situations when assets are not actually used but being depreciated in books of accounts. Assets lying idle during useful life will be carry depreciation while calculating the income or loss. Under such circumstances where is the importance of principle of ‘matching cost with revenue’. An assets not being used for earning revenue would be adding to cost by way of charge of depreciation. PPE will be derecognized either on disposal or withdrawal from use, or when they cease to provide economic benefits to the entity. Gains from disposal would not recognized as revenue but added to equities, unless losses were earlier charged to revenue under certain circumstances. All the above important events carry accounting impacts. At some issues these standards are carrying along controversies because of direct conflict with basic accounting principles at certain places. But the overall approach of IASs is unconventional. 1 (b): Other International Accounting Standards dealing with Non- current Tangible assets Borrowing Costs As per revised IAS 23 all those borrowing costs on procuring a non- current tangible asset would be capitalized w.e.f. January 1, 2009 that are directly attributable to acquisition, construction, or production of such asset. Indirectly attributable costs would be charged to revenue. Whereas IAS 16.23 states that all those interests accruing on deferred payments for PPE shall become part of initial cost of the asset for recognition as capital cost. Take an example, when a bank loan is sanctioned and utilized for acquiring an asset, interest on that is a directly attributable borrowing cost,; and when loan is sanctioned bank but not utilized by entity say for few months due to non selection of an appropriates asset, then charges levied by bank for this non utilization period would be an indirect cost. As per IAS 16, delayed period charges as well as interest on actual use would be the cost of asset, where as per IAS 23 only the interest for period when loan was actually utilsed for procuring asset would be the cost of asset. Thus contradiction exists for the treatment of borrowing costs of assets under the two recently revised standards. Impairment of non- current assets IAS 36 dealing specifically with impairment issue of assets, and IAS 16 dealing exclusively with Property, Plant, and Equipments, both have the similar rules of dealing with impairment losses. At every revaluation of fixed asset IAS 16 suggests to take the excess fair value over carrying cost to equities and not to revenue as revenue profits. All erosions, meaning excess of carrying cost over fair value, are dealt by treating those as revenue loss. Similar is the situation with IAS 36 Investment Properties Investment tangible properties like land and building are dealt with under IAS 40. Any change such investment properties for other purposes require the same treatment as when assets are revalued under IAS 16. In fact IAS 40 follows the rules prescribed under IAS 16. Non- monetary grants of land Under IAS 20, entities have the option to account for such grant of land either at nominal value of non- monetary grant or at fair value of such land on the date of grant. That means rules for treat of land under both IAS 16 and IAS 20 do not carry any contradiction and ascribe to the same procedure. References: Scheepers, D. The component approach towards property, plant and equipment. Accountancy SA, January 2003. p20, 21. International Accounting Standard 16 International Accounting Standard 23 International Accounting Standard 36 International Accounting Standard 40 International Accounting Standard 20 Read More