TREATMENT OF NON-FINANCIAL ASSETS (IAS 16, 17 & 40)

BYIHEANYI ANYAHARA

ASSISTANT DIRECTOR (HEAD, CLAP)FINANCIAL REPORTING COUNCIL

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ICAN IFRS CERTIFICATION TRAINING PROGRAMME

International Financial Reporting Standards AGENDAThe sources for this section include: IAS 16 - Property, Plant and Equipment (PPE)IAS 17 - Leases IAS 23 – Borrowing CostsIAS 40 - Investment Property

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IAS 16 - Property, Plant and Equipment

Scope IAS 16 applies to all PPE except

Assets held for sale (IFRS 5) Biological assets (IAS 41) Exploration and evaluation assets (IFRS 6) Investment property (IAS 40) Mineral rights and mineral reserves such as oil, natural

gas and similar non-regenerative resources And also consider IAS 17 If acquired under a finance lease IFRS 3 If acquired in a business combination

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Definition

Property, plant and equipment - tangible items that: Are held for use in the production or supply of

goods or services, for rental to others, or for administrative purposes; and

Are expected to be used during more than one period

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Recognition  

Component approach Account separately for each material component

with different useful lives or patterns of depreciation

Recognise in PPE the cost of replacing part of such an item when that cost is incurred

Carrying amounts of those parts replaced are derecognised

Cost of a major inspection or overhaul occurring at regular intervals is capitalised where it is identified as a separate component of the asset and the replaced components are fully depreciated 

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Initial Measurement

PPE is initially measured at: Cost includes any directly attributable costs of

bringing the asset to working condition for its intended use cost of site preparation initial delivery and handling costs installation costs professional fees such as for architects and

engineers, and estimated cost of removing the asset and restoring

the site (Asset Retirement Obligation)

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Initial Measurement (Contd)

Deferred payments are discounted General & administration costs are excluded

unless directly attributed to acquisition or restoration

Do not include start-up and pre-production costs unless necessary to bring the asset to working condition

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Initial Measurement (contd)

Costs of dismantling and removing PPE and restoring the site on which it is located (Asset Retirement Obligation - ARO): Recognise as a cost of PPE if it is a legal or

constructive obligation Use best estimate of cost to settle the

obligation Discount to PV using a pre-tax rate that

reflects current market assessments of the risks specific to the liability

Adjust the discount rate at each reporting date 8

ARO Example In accordance with the terms of a lease, the

lessee is obligated to remove its specialised machinery from the leased premises prior to vacating those premises, or to compensate the lessor accordingly

The lease imposes a legal obligation on the lessee to remove the asset at the end of the asset's useful life or upon vacating the premises, and therefore the related costs would be capitalised

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ARO Recognition & MeasurementThe ARO is recognised as part of the cost of

the fixed assets with an offsetting liability The ARO is initially measured as follows

Estimate the cash flows associated with the settlement of the ARO

Discount to PV using a pre-tax rate that reflects current market assessments of the risks specific to the liability

ARO equals the present value of the future payment

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ARO Recognition & Measurement Example

Estimated cost of ARO = N80,000 Expected timing: 10 years from acquisition Applicable discount rate: 7% PV of ARO: N80,000 * .508348 = N40,668

Fixed Asset 40,668 ARO Liability

40,668

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ARO Recognition & Measurement - Example

In subsequent periods, "accretion expense" is recognised and the liability is increased

Accretion Expense 2,847 (40,668 * 7%) ARO Liability 2,847 The discount rate and assumptions regarding

costs to be incurred should be regularly reviewed

Changes to the discount rate and assumptions require a change in estimate (prospective change to asset and liability value)

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Subsequent Costs

Subsequent expenditure on PPE is capitalised when it meets the recognition criteria It is probable that future economic benefits

associated with the item will flow to the entity; and

Cost of the item can be measured reliably This includes replaced components

accounted for separately and major inspection/overhaul

Costs of day to day servicing are expensed

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Subsequent Measurement

Cost model - PPE is carried at cost less accumulated depreciation and any accumulated impairment losses

Revaluation model - PPE is carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses

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Revaluation Model

All assets in a separate class must be revalued Revaluations required regularly so that the

carrying amount does not differ materially from fair value

Land and buildings are usually valued from market based evidence by professionally qualified valuers

If no market-based evidence of fair value, use an income or depreciated replacement cost approach

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Revaluation Model

Surpluses/gains Gains taken to

equity/other comprehensive income (revaluation surplus) unless and to the extent that they reverse a loss previously recognised in the income statement

Deficits/LossesLosses taken to

equity/other comprehensive income (revaluation surplus) to extent of previous surplus on that asset

Excess loss taken to income statement

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Depreciation

Each part of an item of PPE with a cost that is significant in relation to the total cost of the item is depreciated separately

Depreciable amount is the cost (or revalued amount) of an asset less residual value

Depreciable amount is allocated on a systematic basis over the useful life reflecting the pattern of the asset's economic benefits consumed No particular method is prescribed but renewals

accounting for infrastructure assets not permitted Methods must be reviewed annually Change in method is a change in accounting

estimate 17

DepreciationBegins when the asset is ready for useCeases at the earlier of:

When the asset is classified as held for sale (IFRS 5)

When the asset is derecognisedDoes not cease when the asset becomes idle or

is retired from active use unless it is fully depreciated

However, under the usage methods of depreciation, the depreciation charge can be zero while there is no production

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DepreciationUseful life

Expected usage by reference to the asset’s expected capacity or physical output

Expected physical wear and tear Number of shifts for which the asset is to be used Repair and maintenance programme

Technical or commercial obsolescenceLegal or similar limits on the use of the assetMust reassess annually – change in estimate

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Depreciation

Residual value Estimated amount that an entity would currently

obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life

Review of residual values at each balance sheet date Increases in residual value based on current prices at

year end reduce depreciation charges (as change in estimate)

If residual value exceeds the asset's carryinq amount, no depreciation is required

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Derecognition

Cost model Gains/losses on disposal are recognised in the

income statement - net proceeds less carrying amount

Revaluation model Transfer of revaluation surplus to retained

earnings when the surplus is realised by disposal of the asset (no recycling to the income statement)

Surplus is also realised through depreciation (depreciation based on revalued amount less the amount based on original cost)

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IAS 40 – INVESTMENT PROPERTY

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IAS 40 – INVESTMENT PROPERTY Definition

Investment property (IP): property (land or buildings - or part of a building) held (by the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or both rather than for: Use in the production or supply of goods or

services or for administrative purposes; or Sale in the ordinary course of business

Not Biological assets Mineral rights and mineral reserves such as oil,

natural gas and similar non regenerative resources

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Definition

Does not include assets Held for administrative or productive use by

owner; or Held for sale

Generates cash flows largely independent of other assets

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Examples

Land held for long-term capital appreciation Land held for undetermined future use Building leased under one or more operating

leases Vacant building held to be leased Building under construction or development

as investment property

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Initial Measurement

Measure initially at cost including transaction costs and directly attributable expenditures (rules similar to IAS 16)

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Subsequent Measurement

Select either fair value or cost model Fair value model: changes in fair value are

recognised in the income statement Cost model: but fair value must be disclosed

Rebuttable presumption: Fair value can be determined reliably on a continuing basis

Valuation by a certified independent valuer with relevant experience is encouraged but not required

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Investment Property - Fair Value

Price at which the property could be exchanged in an arms-length transaction

FV is time specific, dependent upon market conditions at the reporting date

Best measure of fair value is the current price in an active market for similar property (same location & condition)

FV excludes synergies between the property and other properties

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Consistency of Measurement

If fair value previously used, must continue until there is a change in use: Owner-occupied, or Development for sale begins

If fair value is policy, an individual property can be carried at cost if its fair value cannot be reliably measured Identify at initial recognition

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Transfers to or from Investment Property

Transfer to, or from, investment property shall be made when, and only when there is a change in use evidenced by: Commencement lend of owner occupation

(transfer to or from Property, Plant and Equipment (IAS 16))

Development with view to sale (transfer to Inventories (IAS 2))

Commencing an operating lease to another party (from IAS 2 or IAS 16)

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Transfers to or from Investment Property

Transfer to owner-occupied property or inventories, use fair value at date of change in use

Transfer from owner-occupied property to fair value investment property Apply IAS 16 until change in use Carrying/fair value difference as revaluation per

IAS 16 Transfer from inventories to fair value investment

property, recognise gain/ loss in profit or loss

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Investment Property Held under Operating Lease

Property held under operating lease may be investment property of the lessee Must meet the definition Must use fair value model

If classified as investment property, lessee must use finance lease accounting

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IAS 17: LEASES

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IAS 17: LEASESIntroduction Leases are accounted for according to substance

reflect commercial substance, not merely legal form, for a fair presentation

'Finance' leases have similar substance as borrowing to finance ownership - lessee must account for both the asset and liability

If substance is not similar to borrowing and ownership rights it is an operating lease; lessee accounts 'off balance sheet'; disclose commitment to pay

rentals rentals as operating cost

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RELEVANT IFRS

IAS

SIC INTERPRETATIONS

IFRS INTERPRETATIONS

IAS 17: LEASES

SIC 15: OPERATING LEASE INCENTIVES

IFRIC 4: DOES AN ARRANGEMENT CONTAIN A LEASE?

IFRIC 12: SERVICE CONCESSION ARRANGEMTNEMETNS

IAS 39: FINANCIAL INSTRUMENTS – RECOGNITION

AND MEASUREMENT IFRS 7: DISCLOSURES

SIC 27: EVALUATING THE SUBSTANCE OF LEGAL FORM

OF A LEASE

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What is a Lease?

IAS 17 definition 'an agreement whereby the lessor conveys to

the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time'

First issue - is there a lease? problems where use of assets and provision of

services/outputs are combined; are they leases or do they contain a lease? IFRIC 4

problems where linked transactions include a lease but, viewed as a whole, the substance is that there is no lease SIC-27

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Outside Scope of IAS 17 Lease agreements to explore for or use

minerals, oil, natural gas and similar non-regenerative resources

Licensing agreements for such items as motion picture films, video recordings, plays, manuscripts, patents and copyrights

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What is a Lease?

A lease can result from various arrangements. For example, an agreement with the following characteristics includes a lease

It relates to a specific item, even if the item is not specifically stated or identified in the agreement

The arrangement conveys the right to use an asset, or to receive the asset's output for an agreed period of time if other parties may be able to receive some of the

output, it is highly unlikely that they will do so or the amount is insignificant

The purchaser must make fixed unavoidable payments whether or not it uses the asset or takes the asset's

output 38

Finance and Operating Leases

• Finance lease 'a lease that transfers

substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred'

IAS 17 gives examples of situations that would normally lead to finance lease classification

Operating lease 'a lease other than a

finance lease' default category

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Classification of Leases

Three steps 1.Identify risks and rewards incidental to

ownership of the asset 2.Determine what rewards and risks are

transferred from the lessor to the lessee 3.Determine if transfer represents

'substantially all' • Essentially subjective

additional guidance provided

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Classification of Leases Examples of situations that individually or in

combination would normally lead to a finance lease classification (a) ownership transferred by the end of lease term(b) lessee option to purchase asset at a price expected to be sufficiently lower than fair value at the date the option becomes exercisable for it to be reasonably certain that the option will be exercised (bargain purchase option) (c) lease term for the major part of the economic life of the asset even if title is not transferred

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Classification of Leases Examples of situations that individually or in

combination would normally lead to a finance lease classification (d) at inception the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset

(e) leased assets are of such a specialised nature that only the lessee can use them without major modifications

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Classification of Leases

Examples of situations which could also lead to a finance lease classification (a) if the lessee can cancel the lease, the lessor's losses associated with the cancellation are borne by the lessee (b) gains and losses from the fluctuation in the fair of the residual accrue to the lessee (c) lessee has the ability to continue the lease for a secondary period at a rental that is substantially less than market rent

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Inception of Lease

Inception of lease - matters because it is when classification takes place; and the amounts to be recognised for finance leases at

the commencement of lease term are determined Definition

'earlier of date of lease agreement and of commitment by the parties to the principal provisions of the lease'

Commencement of lease term 'date from which lessee is entitled to use leased

asset' o that's when lease is initially recognised in accounts

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Classification of Leases

At inception of lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset only classification indicator requiring

quantification no % specified (e.g. 90% or more per US GAAP)

Fair-value usual IFRS definition in practice transaction price (purchase or

construction cost) will often be used

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Minimum Lease Payments Not necessarily the same for lessees and lessors

 for both include payments over the lease term that

lessee is required to make, excluding contingent rent and costs for services and taxes to be paid by and reimbursed to the lessor

Plus for lessees any amounts guaranteed by lessee or related party

Plus for lessors  any residual value guaranteed by lessee, related

party or third party unrelated to lessor

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Present Value and Discount Rate To calculate the present value of the

minimum lease payments, must discount at the 'interest rate implicit in the lease' rate that, at the inception of the lease, causes

the aggregate present value of minimum lease payments; and the unguaranteed residual value (for lessor) to be

equal to the sum of: i. the fair value of the leased asset, and ii. any initial direct costs of the lessor

• Lessees have problems in establishing this rate

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Present Value and Discount Rate

Lessee may not know fair value, lessor's unguaranteed residual value or lessor's initial direct costs if not practicable to calculate the rate implicit

in the lease, the lessee's incremental borrowing rate should be used

Lessee's incremental borrowing rate rate of interest the lessee would have to pay

on" a similar lease or to borrow over a similar term, and with a similar security, the funds necessary to purchase the asset

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Initial Direct Costs

'Incremental costs-directly attributable to negotiating and arranging a lease'

Incurred by lessor commissions, legal fees and incremental internal

costs IAS 17 requires that they must be added to the

carrying value of leased assets (whether finance or operating leases); expense if manufacturer or dealer

Incurred by lessee if finance lease, add to asset recognised if operating lease, expense

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Example - Finance Lease Equipment is leased for 5 years (its useful

life) beginning on 1 January 2010 fair value of leased property at 1 January 2010

= N10,000 five annual rentals of N2, 1 00 will be paid in

advance, beginning on 1 January 2010 Assume that rate of interest implicit in the

lease is 6.62%

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PV of Minimum Lease Payments CASH FACTOR PV

1/1/10 (2100)

1.0000 (2,100)

1/1/11 (2100)

0.9379 (1,970)

1/1/12 (2100)

0.8797 (1,847)

1/1/13 (2100)

0.8251 (1,733)

1/1/14 (2100)

0.7738 (1,624)

TOTAL (10,500)

(9,274)

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Example - Finance Lease PV of 5 annual payments of N2, 1 00 in advance,

discounted at 6.62% = N9,274 This amounts to more than 90% of the fair value

of the leased asset at 1 January 2010; IAS 17 presumes that there is a transfer of substantially all the risks and rewards of ownership

Assume that it is classified as finance lease lessee will account as if it had borrowed N9,274 at 6.62% to acquire the asset = substance. Loan repayable in 5 instalments of N2, 1 00. Finance cost (N1,226) allocated to P&L at constant rate

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Finance Lease - Lessee

Capitalise rights and obligations under the lease on 1 January 2010 at the lower of PV of minimum lease payments (N9,274) and fair value of

leased property (N10,000) Property plant & equipment 9,274 Liabilities - finance leases 9,274

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Finance Lease - Lessee Depreciate the asset over 5 years (9,274/5)

Operating profit 1,855 Property plant and equipment

1,855 • Charge interest on the liability at 6.62% in 2010 = 6.62% of N7, 174 (9,274 - 2,100) Finance costs 475 Liabilities - finance leases 475 • Pay rentals of N2, 1 00 annually on 1 January

Liabilities 2,100 Cash 2,100

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Finance Lease - Lessee Movement in the finance lease liability

START PAID FINANCE COST

END

2010 9,724 (2,100)

475

7,649

2011 7,649 (2,100)

367

5,917

2012 5,917 (2,100)

253

4,070

2013 4,070 (2,100)

130

2,100

2014 2,100 (2,100)

0

(10,500)

1,226

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Operating Lease - Lessee Rights over leased property are not recorded

on lessee's statement of financial position; no liability is recognised for future rentals payable - 'off balance sheet'

Note to the accounts discloses the future rental payments

Allocate the total rentals (N1 0,500) as an operating cost on a straight-line basis over the lease term; in the example case at N2,100 per annum

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Operating Lease - Lessee Recognise as expense on a straight line

basis over the lease term 'unless another systematic basis is more representative of the time pattern of the user's benefit'

Operating lease incentives inducements by lessors to persuade lessee to

enter into or renew an operating lease different forms; cash paid up-front to lessee;

lessor reimburses lessee for costs incurred, rent-free period etc

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SIC-I5 Operating Lease Incentives Lessee - benefit recognition

recognise aggregate benefit as a reduction of rental expense over term of lease, unless another systematic basis is more representative; try to ensure that profit or loss reflects true rental charge, whatever the cash flow arrangements between parties

Lessor - cost recognition mirror of lessee accounting

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LESSEE – INCOME STATEMENTFINANCE

2010 2011 2012 2013 2014 TOTAL

DEPRECIATION

1,855 1,855 1,855 1,855 1,854 9274

FINANCE COST

475 367 253 130 0 1226

TOTAL 2,330 2,222 2,108 1985 1,854 10,500

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LESSEE – INCOME STATEMENTOPERATING

2010 2011 2012 2013 2014 TOTAL

RENTALS

2,100 2,100 2,100 2,100 2,100 10,500

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Lessor Accounting Finance lease Operating lease

Present the asset as a receivable at an amount equal to the net investment in the lease  

Recognise interest income at a constant periodic rate on the net investment in the lease  

Deduct rentals from the receivable

Present the asset as a fixed asset in the statement of financial position  

Depreciate the asset over its useful life  

Recognise rental income in profit or loss, usually on a straight-line basis

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FINANCE LEASE - LESSORRecognise finance lease receivable at the lessor's

net investment in the lease - N10,000 Gross investment in the lease at 1/1/10 is

Minimum lease payments receivable 10,500

Unguaranteed residual value 1,000 11,500

Net investment in the lease at 1/1/10 is N11 ,500 less unearned finance income N1 ,500; the same results by discounting the gross investment at the rate of interest implicit in the lease

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Finance Lease - Lessor Receive rentals of N2,1 00 annually on 1 Jan

Cash 2,100 Finance lease receivable 2,100

Each year the asset 'finance lease receivable' changes

At 1 January 2009 10,000 Less: rental paid (2,100)

7,900 Add: interest @ 6.62% 523 At 31 December 2010 8,423

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Finance Lease - Lessee Movement in the finance lease receivable

START PAID FINANCE COST

END

2010 10,000 (2,100)

523

8,423

2011 8,423 (2,100)

419

6,742

2012 6,742 (2,100)

307

4,949

2013 4,949 (2,100)

189

3,038

2014 3,038 (2,100)

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1,000

(10,500)

1,500

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Operating Lease - LessorDepreciate the asset over its useful life; on a

straight line basis the charge would be N1 ,800 per annum

cost (10,000) - estimated residual value (1,000) estimated useful life (5 years)

Allocate rental income (N10,500) to profit or loss on a straight line basis over the lease term; here at N2, 1 00 per annum

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LESSOR – INCOME STATEMENTOPERATING

2010 2011 2012 2013 2014 TOTAL

RENTALS

2,100 2,100 2,100 2,100 2,100 10,500

DEPRECIATION

(1,800) (1,800) (1,800) (1,800) (1,800) (9,000)

TOTAL 300 300 300 300 300 1,500

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LESSOR – INCOME STATEMENTFINANCE

2010 2011 2012 2013 2014 TOTAL

INCOME

523 419 307 189 62 1,500

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Lease of Land and Buildings Single (legal) lease may have to be split into

separate leases of land and buildings for accounting purposes per IAS 17 (revised) not if title to both land and buildings passes

(finance)  if title to land does not pass and land has indefinite

economic life, land is classified as an operating lease; apply the classification criteria to determine whether building is finance or operating  

If need to split minimum lease payments, do so in proportion to the relative fair values of the leasehold interests in land and buildings at inception of lease  

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Lessors - Manufacturers or DealersNo selling profit is recognised on operating

lease On entering into finance lease recognise in

period any selling profit (or loss) per policy re outright sales. Therefore two sources of profit selling profit (or loss) in gross profit finance income recognised over period of

agreement

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Lease Project Problems exist with the current lease requirements-

joint IASB/FASB agenda project finance/operating distinction is arbitrary at the

margin 'all or nothing' approach is criticised all leases involve some transfers of risks and rewards current status Discussion Paper in 2009 ED issued August 2010 Comment deadline December 2010IFRS on workplan for Q2 2011 Discussions still on up till June 15, 2011Unlikely to be compulsory before periods in 2013

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Leases – Project (contd)Significant issues expected amongst others:

SubleasesShort-term leases

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Questions!

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ConclusionMany of the IAS/IFRS are already on the

agenda for review, revision or amendment.We should be able to be abreast of the

current development.Thanks for your active participation

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