Items of property, plant, and equipment that qualify for recognition should be initially measured at cost.

Cost is defined as “… the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition or construction or, where applicable, the amount attributed to that asset when initially recognized under the specific requirements of other IFRSs, for example, IFRS 2 Share-based Payment”.

Cost includes the costs of acquiring or constructing the asset and costs incurred subsequently to add to or replace part of the asset.

In addition, the cost of an item of property, plant, and equipment could include costs incurred relating to leases of assets that are used to construct, add to, replace part of, or service an item of property, plant, and equipment, such as depreciation of right-of-use assets.

Cost is usually the price paid. The cost of a self-constructed asset is the aggregate of the cost of material, labor, and other inputs used in the construction. The cost of an item of property, plant, and equipment comprises:

• The purchase price, including import duties and non-refundable purchase taxes less any trade discounts and rebates.
• Directly attributable costs of bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management.
• The initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located (decommissioning obligations) if the obligation is incurred either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period.
• Borrowing costs on qualifying assets.

Capitalization of directly attributable costs Entity A, which operates a major chain of supermarkets, has acquired a new store location. The new location requires significant renovation expenditure. Management expects that the renovations will last for three months, during which the supermarket will be closed. Management has prepared the budget for this period, including expenditure related to construction and remodeling costs, salaries of staff who will be preparing the store before its opening, and related utilities costs. Management should capitalize the costs of construction and remodeling the supermarket, because they are necessary to bring the store to the condition necessary for it to be capable of operating in the manner intended by management. The supermarket cannot be opened without incurring the remodeling expenditure, and thus the expenditure should be considered part of the asset. However, the cost of utilities and storage of goods are operating expenditures and are not necessary to bring the store to the condition necessary for it to be capable of operating in the manner intended by management. These costs should be expensed. However, careful consideration should be given to the cost of salaries of staff directly related to construction and remodeling.

Examples of directly attributable costs are:

• The cost of employee benefits as defined in IAS 19 arises directly from the construction or acquisition of the item.
• The costs of site preparation.
• Initial delivery and handling costs.
• Installation and assembly costs.
• Professional fees.
• Costs of testing whether the asset is working properly (commissioning costs), after deducting the net proceeds of the sale of any items produced while bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management (such as samples produced during testing).

What employee benefit costs can be capitalized as part of a self-constructed asset? Employee benefits are all forms of consideration given by an entity in exchange for service rendered by employees. The types of benefit include: ·        Short-term employee benefits, such as wages, salaries and social security contributions, paid annual leave and paid sick leave, profit sharing and annual bonuses, and non-monetary benefits such as medical care, cars, housing, and free or subsidized goods or services. ·        Post-employment benefits, such as pensions, other retirement benefits, post-employment life insurance and post-employment medical care. ·        Termination benefits. ·        Share-based payments. Employee benefit costs are most relevant where an asset is being self-constructed, although some costs might also be capitalized during the commissioning phase. Not all of the above costs will be eligible or relevant during that period. For example, termination benefits paid to employees who have left employment would not be relevant, because they would not be involved in constructing the asset.

What employee benefit costs can be capitalized for acquired or self-constructed assets? Only directly attributable labor costs (wages and employee benefits) that relate to the time spent by employees on constructing or acquiring a specific asset should be capitalized. Time spent on other potential acquisitions or developments cannot be included. For example, an internal surveyor might carry out surveys on five different properties as part of the process to determine which one of those properties the company will buy. The cost of these surveys should not be capitalized as part of the cost of the property which is subsequently bought. However, the cost of a survey of a property after the decision to purchase it (for example, to confirm that decision) would be capitalized. Only the proportion of employee costs that is related to a particular project should be capitalized. If a site engineer spends 30% of his time on a particular development project, only 30% of his employee costs should be capitalized.

What professional fees can be capitalized? External professional fees incurred in finding a suitable asset, which is then acquired or constructed, can be capitalized. External professional fees should only be capitalized as part of the cost of an asset where they relate directly to the acquisition or construction of the asset. Costs on speculative projects and costs of aborted plans should not be capitalized. Other professional fees incurred in acquiring an asset, such as legal fees and stamp duty, would be included in the cost of an asset.

What directly attributable labor costs should be capitalized? Entity A is constructing an asset and is capitalizing labor costs that are directly attributable to bringing the asset to its working condition. Do such costs include social security contributions and pension costs of the staff whose labor costs are being capitalized in accordance with IAS 16? Costs that are directly attributable to bringing the asset into the location and condition necessary for it to be capable of operating in the manner intended by management should be included in its measurement. Attributable costs for a self-constructed asset include the labor costs of own employees (for example, site workers, in-house architects and surveyors) arising directly from the construction of the specific asset. Employers’ social security contributions and pension costs are both part of staff costs and so fall within the meaning of labor costs in this context. Therefore, they should be included in the amount capitalized under IAS 16. Pension costs are accounted for under IAS 19. Any post-employment costs included in the cost of assets under IAS 2 or IAS 16 should include the appropriate proportion of the components of pension costs under IAS 19.

Exposure draft on amendments to IAS 16: proceeds before intended use In June 2017, the IASB issued proposed amendments to IAS 16 regarding proceeds before intended use. The amendments would prohibit deducting from the cost of an item of property, plant and equipment any proceeds from selling items produced while bringing that asset to the location and condition necessary for it to be capable of operating in the manner intended by management. I nstead, an entity would recognize those sales proceeds and the costs of producing those items in profit or loss in accordance with applicable standards.

Only costs that are directly attributable can be capitalized. Many costs incurred in start-up situations (such as opening a new mine or a manufacturing or retailing operation) must be expensed. Costs that are not ‘directly attributable’, and cannot be capitalized as described in the standard, are as follows:

• Costs of opening a new facility.
• Costs of introducing a new product or service (including costs of advertising and promotional activities).
• Costs of conducting business in a new location or with a new class of customer (including costs of staff training).
• Administration and other general overhead costs.

Capitalization of feasibility costs Entity A is developing a building for its own use. It incurs costs for the development prior to obtaining planning permission. There are effectively two phases to the development: a feasibility stage, where all costs should be expensed; and a development phase, where qualifying costs are capitalized. The entity establishes during the feasibility stage if the property can be built to its proposed specifications and in compliance with the respective building codes and environmental regulations. The construction of the building is still uncertain and it is not probable that future economic benefits will flow to the entity. Once feasibility is established and the developer has committed to the building, the probability criterion has been met. Costs incurred during the development stage would be recognized as part of the cost of the property, plant and equipment. Obtaining planning permission might fall into either category, depending on whether it is seen as part of the feasibility stage or part of the development stage. Judgement in applying the recognition criteria determines the categorization. If the costs do not meet the definition of an asset, they are an expense and should be recognized as such in the income statement.

Replacement roof as a component An entity might acquire an asset at a price that reflects future expenditure that is necessary to bring the asset to the location and condition necessary for it to be capable of operating in the manner that management intends. A building might be acquired that requires substantial renovation such as a new roof. The subsequent cost of replacing the roof is capitalized, because the cost meets the asset recognition criteria in the standard. It increases the future economic benefits expected to be obtained from the building and can be reliably measured. Components of an asset are not separate classes of assets and are not separately disclosed in the financial statements.

Gain on replacement of insured assets Entity A carried plant and machinery in its books at C200000. The plant and machinery were destroyed in a fire. The assets were insured ‘new for old’ and were replaced by the insurance company with new machines that cost C2 million. The replacement machines were sourced by the insurance company and the entity did not receive the C2 million as cash compensation. Entity A accounts for the loss in the income statement on de-recognition of the carrying value of the plant and machinery. Entity A separately recognizes a receivable and a gain in the income statement, resulting from the insurance proceeds under IAS 37, once receipt is virtually certain. The receivable should be measured at the fair value of the assets that will be provided by the insurer.

Capitalization of directly attributable costs Entity A, which operates a major chain of supermarkets, has acquired a new store location. The new location requires significant renovation expenditure. Management expects that the renovations will last for three months, during which the supermarket will be closed. Management has prepared the budget for this period, including expenditure related to construction and remodeling costs, salaries of staff who will be preparing the store before its opening, and related utilities costs. Management should capitalize the costs of construction and remodeling the supermarket, because they are necessary to bring the store to the condition necessary for it to be capable of operating in the manner intended by management. The supermarket cannot be opened without incurring the remodeling expenditure, and thus the expenditure should be considered part of the asset. However, the cost of utilities and storage of goods are operating expenditures and are not necessary to bring the store to the condition necessary for it to be capable of operating in the manner intended by management. These costs should be expensed. However, careful consideration should be given to the cost of salaries of staff directly related to construction and remodeling.

Capitalization of feasibility costs Entity A is developing a building for its own use. It incurs costs for the development prior to obtaining planning permission. There are effectively two phases to the development: a feasibility stage, where all costs should be expensed; and a development phase, where qualifying costs are capitalized. The entity establishes during the feasibility stage if the property can be built to its proposed specifications and in compliance with the respective building codes and environmental regulations. The construction of the building is still uncertain and it is not probable that future economic benefits will flow to the entity. Once feasibility is established and the developer has committed to the building, the probability criterion has been met. Costs incurred during the development stage would be recognized as part of the cost of the property, plant and equipment. Obtaining planning permission might fall into either category, depending on whether it is seen as part of the feasibility stage or part of the development stage. Judgement in applying the recognition criteria determines the categorization. If the costs do not meet the definition of an asset, they are an expense and should be recognized as such in the income statement.

Can overheads be capitalized as part of the cost of property, plant and equipment? Capitalization of general and administrative overheads is prohibited by IAS 16. However, it might be permissible to capitalize a systematic allocation of fixed and variable production overheads. Fixed production overheads are indirect costs of production and include depreciation and maintenance of factory buildings and equipment and the cost of factory management and administration. A proportion of relevant overheads would be included in cost.

Capitalization of debt modification gain or loss An entity has a specific borrowing to finance its qualifying asset. The borrowing cost is capitalized in accordance with IAS 23. The specific borrowing is modified in such a way that this does not result in DE recognition. The entity recalculates the loan’s carrying amount by discounting the new modified cash flows at the original effective interest rate. Does management have to capitalize the modification gain or loss under IAS 23? Solution: It depends. There are two valid views that can be supported to account for the modification gain or loss on a specific borrowing relating to a qualifying asset under IAS 23: 1) No capitalization: IAS 23 specifically refers to ‘borrowing costs’ as including ‘interest expense calculated using the effective interest method as described in IFRS 9’. We can interpret this strictly, and any modification gain or loss does not fit into this definition, so it should be recognized in profit or loss. This is also consistent with IFRS 9, which explicitly states that a modification gain or loss should be recognized in profit or loss and, whilst this refers to a modification of a financial asset, IFRS 9 states that the requirements also apply to the modification of a financial liability. 2) Capitalization: An alternative view sees the modification gain or loss as the result of cash flows discounted using the original effective interest rate, and it is therefore part of applying the effective interest rate method. The list of possible borrowing costs in IAS 23 is also not exhaustive, and so the modification gain/loss can be included under borrowing costs as an ‘other cost an entity incurs in connection with the borrowing of funds’ in accordance with IAS 23. Both views are acceptable and so an accounting policy choice should be made. The policy choice should be applied consistently to all modification gains or losses on specific borrowings to finance qualifying assets. If the second view is applied, only the portion that relates to the acquisition, construction or production period is capitalized, with the remainder recognized in profit or loss.

Measurement of foreign exchange differences for capitalization as borrowing costs There are two methods that are used to estimate the amount of foreign exchange differences that can be included in borrowing costs, as follows: ·        the portion of the foreign exchange movement can be estimated based on forward currency rates at the inception of the loan; or ·        The portion of the foreign exchange movement can be estimated based on interest rates on similar borrowings in the entity’s functional currency. An entity cannot capitalize costs that are identified as a portion of the foreign exchange movements as borrowing costs that are in excess of actual total costs incurred, using any method. Other methods might be possible. Management uses judgement to assess which foreign exchange differences can be capitalized. The method used to determine the amount that is an adjustment to borrowing costs is an accounting policy choice. The method should be applied consistently to foreign exchange differences, whether they are gains or losses.

Example – Period of capitalization Entity A has purchased a piece of land, formerly used for agricultural purposes, in order to construct a new factory. Entity A has applied to the local authorities for permission to change the use of the land from agricultural to industrial. The process is expected to last six months, but entity A’s management is confident that approval will be given, as the new factory will bring 1,000 new jobs to the area. Entity A has financed the purchase of the land with a bank loan, which will be repaid over seven years. The application to the local authorities for the change in use of the land is an activity necessary to prepare the asset for its intended use. Entity A can, therefore, capitalize borrowing costs in respect of the loan used to finance the land’s purchase while local authority approval is awaited. This conclusion relies on the expectation that the local authorities will approve the change in use of the land. If entity A was to become aware, during the approval process, that approval is unlikely to be given, it should cease capitalizing borrowing costs and test the asset for impairment.

Capitalization during interruption in construction activities Normally, interest capitalization ceases when construction activities cease. However, capitalization can continue when construction activities are interrupted and the interruption is a necessary and foreseeable part of the process of bringing the asset to working condition for its intended use. Interest can continue to be capitalized during interruptions in construction activities that are normally interrupted during winter months or for periodic and predictable flooding. A long-term strike by construction workers would generally not be regarded as necessary and foreseeable. Capitalizing borrowing costs would cease during an extended strike. Similarly, capitalizing borrowing costs should be suspended in situations of political unrest that disrupts the construction work for an extended period.

Can start-up costs be capitalized? Start-up costs and similar pre-production costs do not form part of the cost of an asset. Initial operating losses incurred prior to an asset achieving its planned performance are recognized as an expense, and are not capitalized. The same applies to operating losses that occur because a revenue-earning activity has been suspended during the construction of an item of property, plant and equipment. An example might be where a hotel is being refurbished and is, therefore, closed for a period. All costs incurred in that period (such as rents and wages) would be expensed as incurred, because they would not form part of the cost of improvements.

Can overheads be capitalized as part of the cost of property, plant and equipment? Capitalization of general and administrative overheads is prohibited by IAS 16. However, it might be permissible to capitalize a systematic allocation of fixed and variable production overheads. Fixed production overheads are indirect costs of production and include depreciation and maintenance of factory buildings and equipment and the cost of factory management and administration. A proportion of relevant overheads would be included in cost.

Directly attributable costs can be capitalized only until the asset is “capable of operating in the manner intended by management”.

If an asset is purchased or constructed and can operate in that manner immediately, but is not brought into use immediately, costs incurred while the asset is standing idle cannot be capitalized. Costs that might fall into this category are as follows:

• Costs incurred while an item capable of operating in the manner intended by management has yet to be brought into use or is operated at less than full capacity.
• Initial operating losses, such as might be incurred while demand for an item’s output builds up.
• Costs of relocating or reorganizing part or all of an entity’s operations.

Operating costs incurred in the start-up period An amusement park has a ‘soft’ opening to the public, to trial run its attractions. Tickets are sold at a 50% discount during this period, and the operating capacity is 80%. The official opening day of the amusement park is three months later. Management claims that the soft opening is a trial run necessary for the amusement park to be in the condition capable of operating in the intended manner. Accordingly, it believes that the net operating costs incurred should be capitalized. The net operating costs should not be capitalized, but should be recognized in the income statement. Even though the amusement park is running at less than full operating capacity (in this case, 80% of operating capacity), there is sufficient evidence that it is capable of operating in the manner intended by management. Therefore, operating costs in this period should be expensed as incurred.

Can initial operating losses be capitalized? Initial operating losses in the start-up phase for a new hotel or bookshop are not costs that can be capitalized. Similarly, marketing and similar costs associated with generating demand for the services of the item of property, plant and equipment cannot be capitalized as part of the asset. Expenses incurred while a plant that is able to be operated at normal levels but is not yet doing so are expensed.

What ‘incremental’ costs can be capitalized? Entity A has an existing freehold factory property, which it intends to knock down and redevelop. The entity will move its production facilities to another (temporary) site during the redevelopment period. The following incremental costs will be incurred: set-up costs to install machinery in the new location; right-of-use asset depreciation; and removal costs to transport the machinery from the old location to the temporary location. Can these costs be capitalized into the cost of the new building? Constructing or acquiring a new asset might result in incremental costs that would have been avoided if the asset had not been constructed or acquired. These costs are only included in the cost of the asset if they are directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. The incremental costs described above are not for the construction of the new factory and therefore do not meet the requirements of IAS 16 and must be expensed.

Can site development costs be capitalized? Entity B operates bars and is expanding by developing new sites. When looking at expanding in a particular area, the entity generally identifies a number of potential sites, commissions’ drawings, enters into discussions with the site owners, and picks one site to develop. The entity then goes through the planning process and develops the site. Can the external costs, including site selection, be capitalized? External costs that are directly attributable to a specific site that is being developed can be capitalized. Site preparation is a directly attributable cost. Site preparation might reasonably include external costs of identifying a specific site that was developed. However, the costs of site selection relating to sites not eventually selected cannot be capitalized, as these costs are not directly attributable to the developed site. An entity might incur expenditure in carrying out a feasibility study prior to deciding whether to invest in an asset or in deciding which asset to acquire. Expenses incurred for feasibility assessments should be expensed as incurred, because they are not linked to a specific item of property, plant and equipment. However, where the costs are directly attributable to specific assets, they are capitalized. For example, a fee payable to a broker or agent only if a suitable property is identified and purchased should be included in the cost of the property acquired.

What costs can be capitalized during the start-up phase of a mobile network? A mobile phone operator might be setting up a new network in a new territory, involving the construction of the network system (such as new transmitter towers). Costs that do not relate to the construction of the physical asset, but rather relate to setting up the new business as a whole, even though they are incurred during the construction phase of the new network, do not qualify as part of the cost of the asset. Decommissioning or similar costs (such as dilapidation expenditure) can often arise in connection with leases and leasehold improvements. For example, a lease might allow the tenant to tailor the property to meet their specific needs but require that the tenant returns the property at the end of the lease in its original state. The tenant constructs internal walls and makes other cosmetic changes to the property. Remediation at the end of the lease will require dismantling the internal walls. The tenant creates an obligation to remove the wall, which it cannot avoid, and must therefore recognize a provision for that obligation in accordance with IAS 37. The cost to the tenant of the leasehold improvement is the cost of building the wall and the cost of restoring the property at the end of the lease. Both costs are capitalized when the internal wall is built and will be recognized in the income statement over the useful life of the asset (generally the expected lease term) as part of the depreciation charge.

The cost of a self-constructed asset is determined using the same principles as for an acquired asset. Any internal profits are eliminated in arriving at such cost. The cost of abnormal amounts of wasted material, labor or other resources incurred in the production of a self-constructed asset are not included in the cost of the asset.

Other specific types of abnormal costs that would also be excluded are costs related to design errors, industrial disputes, idle capacity and production delays.

Constructing or acquiring a new asset might result in other incremental costs that would have been avoided only if the asset had not been constructed or acquired. These should not be included in the cost of the asset if they do not bring the asset into the location and condition necessary for it to be capable of operating in the manner intended by management.

The costs of retraining employees, in particular, cannot be capitalized, because the entity does not have control over the employees and so the recognition criteria are not met.

An item of property, plant and equipment can be put to an alternative use during construction or development activity. An example is the use of a construction site as a car park until construction begins.

These incidental operations are not necessary to bring the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. Any revenue and costs attributable to such incidental operations are recognized in profit and loss.

Decommissioning costs

Decommissioning costs are included in the cost of an item of property, plant and equipment if there is a corresponding obligation recognized as a provision under IAS 37. The entity might have an obligation as a direct consequence of acquiring or constructing property, plant and equipment to incur further costs that it cannot avoid.

The decommissioning costs to be paid at the end of the asset’s life are as much a cost of acquiring or constructing the asset as the costs incurred at the start of the asset’s life.

Remediation expenses for a lease Decommissioning or similar costs (such as dilapidation expenditure) can often arise in connection with leases and leasehold improvements. For example, a lease might allow the tenant to tailor the property to meet their specific needs but require that the tenant returns the property at the end of the lease in its original state. The tenant constructs internal walls and makes other cosmetic changes to the property. Remediation at the end of the lease will require dismantling the internal walls. The tenant creates an obligation to remove the wall, which it cannot avoid, and must therefore recognise a provision for that obligation in accordance with IAS 37. The cost to the tenant of the leasehold improvement is the cost of building the wall and the cost of restoring the property at the end of the lease. Both costs are capitalised when the internal wall is built and will be recognised in the income statement over the useful life of the asset (generally the expected lease term) as part of the depreciation charge.

Decommissioning and restoration obligations Decommissioning costs typically arise in the oil and gas, mining, telecommunications and electricity industries, where environmental damage might result from the construction and commissioning of the facility. Examples are oil platforms, mobile phone masts and nuclear power plants. Similar costs are incurred in a number of other industries, such as environmental clean-up and restoration costs of landfill sites.

Changes in estimate of decommissioning obligations

There are often changes in the initial and subsequent estimates of decommissioning costs of an asset, particularly where asset lives are long. These changes in estimate could be due to changes in legislation, inflation, technology, the timing of the decommissioning, or other factors.

Changes in the measurement of decommissioning liabilities, and changes in the discount rate for assets accounted for under the cost model, are broadly added to or deducted from the cost of the related asset in the period of the change in estimate for assets accounted for under the cost model.

Changes in the measurement of decommissioning liabilities and related discount rates for assets accounted for under the revaluation model are recognized as changes to the revaluation surplus in OCI unless they represent an impairment charge. Impairments are recognized in the income statement.

Determining the amount of a decommissioning provision to be capitalized as an asset There are two ways of determining the amount of the provision to be capitalized as an asset when a decommissioning obligation arises. An asset has a life of 30 years and, due to a change in legislation, after ten years an obligation arises in respect of decommissioning costs relating to the installation of the asset. A provision of C900, 000 is calculated and recorded as a liability. The two methods relate to how much of the provision can be capitalized as an asset; either: ·        the whole C900,000 is capitalized as part of the asset’s cost and depreciated over the remaining useful economic life of 20 years (subject to recoverability); or ·        Only C600, 000 of the provision is capitalized and depreciated over the remaining useful economic life of 20 years, as the asset is one third of the way through its useful life. The remainder of the provision (C300,000), which is the amount that would have been recognized as depreciation in the first ten years of the asset’s life if the obligation had been in existence, then, is recognized immediately in the current year’s profit and loss account. Neither approach is prescribed by IAS 16 or IFRIC 1. The first approach might best reflect the specific circumstances, given that there is a current change in legislation and the change arises from new developments.

Decommissioning costs arising later in the asset’s life An obligation for decommissioning might only become apparent later in the asset’s life. This might result from a change in legislation in respect of environmental damage. Costs that meet the recognition criteria under IAS 37 for a provision are capitalized as part of the asset’s cost to the extent that they related to the asset’s installation, construction or acquisition. Obligations that arise during an asset’s life, as a result of damage incurred through the asset’s use to produce inventory, are production costs of that inventory and are not capitalized. Provisions arising in respect of the wear and tear of a leasehold property, which must be rectified at the end of the lease under the lease terms, are costs of using the property. The costs are expensed as incurred.

The amount of any deduction cannot exceed the asset’s carrying amount. Any deduction that would give rise to a ‘negative asset’ is immediately recognized in the income statement.

Additions increase the carrying amount of existing assets, and the entity should assess if there are impairment indicators and test the asset accordingly.

The adjusted depreciable amount of the asset is depreciated over its remaining useful life. Once the asset has reached the end of its useful life (that is, when it is no longer being used by the entity), changes in the decommissioning or restoration liability are recognized in profit and loss as they occur. This applies irrespective of whether the assets are measured using the cost or the revaluation model.

The periodic unwinding of the discount is not a borrowing cost for the purpose of IAS 23 and does not qualify for capitalization under IAS 23. It is charged to the income statement as a finance cost as it occurs.

  Cost – treatment of variable or contingent consideration for the purchase of property, plant and equipment

An entity might acquire an item of property, plant and equipment for an initial payment plus agreed additional payments contingent on future events, outcomes or the ultimate sale of the acquired asset at a threshold price. The entity will usually be contractually or statutorily obligated to make the additional payment if the future event or condition occurs.

This is often described as variable or contingent consideration for an asset. The accounting for contingent consideration of an asset has been discussed by the IFRS IC. The IC determined that this issue is too broad, and so it did not add the issue to its agenda. The IC suggested that the IASB should address this issue comprehensively.

At the outset, it has to be analyzed carefully whether or not the future payment is related to the cost of the asset. If it is determined that the future payment is related to the cost of the asset, there is diversity in practice in accounting for contingent consideration of an asset, with two approaches observed in practice.

The first approach is a cost accumulation model, whereby contingent consideration is not considered on initial recognition of the asset, but it is added to the cost of the asset initially recorded, when incurred or when a related liability is remeasured for changes in cash flows.

The second approach is a financial liability model, whereby the estimated future amounts payable for contingent consideration are recorded on initial recognition of the asset, with a corresponding liability.

Any remeasurements of the related liability and any additional payments are either recognized in the income statement or capitalized. The cost accumulation model is more common in practice.

Both approaches to accounting for contingent consideration are acceptable. This is a policy choice that should be applied consistently to all similar transactions and appropriately disclosed.

  Deferred payment terms

The cost of an item of property, plant and equipment is the cash price equivalent at the date when the asset is recognized. An item of property, plant and equipment could be acquired on payment terms that are deferred beyond normal credit terms. The cost, in those circumstances, is the discounted amount, being the cash price equivalent.

The difference between this amount and the total payments is treated as interest payable over the period of credit, unless it is capitalized during the period of construction in accordance with IAS 23.

Payment for an asset deferred beyond ‘normal credit terms’ – example The commercial property market in a particular city is very slow. As an inducement to potential purchasers, a seller of commercial property in that city advertises a property for sale at ‘no interest for the first three years after purchase, market rate of interest thereafter’. Other property sellers in the city are making similar offers. A buyer purchases a property on those terms. IAS 16 requires imputation of interest if payment for an item of property is deferred beyond ‘normal credit terms’. In this circumstance, the three-year interest-free period does not represent normal credit terms. The intention of IAS 16 is to ensure that the asset is recognized at its current cash sale price; the ‘normal credit terms’ requirement is intended to recognize that settlement of cash purchases often takes a few days, weeks, or even months (depending on the industry and national laws), and imputation of interest is not required in those circumstances. However, particularly for a large item such as a property, the cash sale price would be significantly lower if cash payment is made up-front rather than deferred for three years. If the deferral period is greater than what can be considered normal credit terms, the imputed interest element should be recognized.

Time value of money on deposit paid for the acquisition of an asset – example Company A has two choices regarding payment for an item of property, plant and equipment: it can pay the list price of CU10,000 when the asset is delivered in 2 years’ time; or it can pay CU5,000 as an up-front, non-refundable deposit, and make a final payment of CU3,500 when the asset is delivered. Company A chooses to pay the deposit. Because such a substantial deposit is paid up-front, the total amount that Company A is required to pay is reduced; that is, the time value of money associated with the up-front payment is reflected in the total amount payable. The deposit is non-refundable and, therefore, it is not a financial asset. Nevertheless, the deposit represents not only a payment on account for the asset but also, in effect, provides financing to the supplier. Therefore, it is appropriate to recognize the implicit financing as part of the cost of the asset by unwinding the time value of money over time, using the discount rate implicit in the original transaction (14 per cent in the above example), as follows. Year Carrying amount of deposit b/fwd. Interest income at 14% Final payment Carrying amount of deposit/asset c/fwd. 1 CU5,000 CU700 CU5,700 2 CU5,700 CU800 CU3,500 CU10,000 Including the time value of money as part of the cost of the asset is consistent with IAS 16, as discussed earlier in this section.

  Government grants

The carrying amount of assets can be reduced by the amount of any related government grants. Government grants are dealt with in IAS 20.

  Assets acquired in a non-cash exchange

An item of property, plant and equipment could be acquired in exchange for another non-monetary asset or for a combination of non-monetary and monetary assets. The cost of the acquired item is measured at fair value, unless the transaction has no commercial substance or the fair value of neither the asset received nor the asset given up can be reliably measured.

Fair value is adjusted by the amount of the monetary assets given up or received. If the acquired item is not measured at fair value, it is measured at the carrying amount of the asset given up.

Consideration received including both non-monetary and monetary assets Entity A exchanges surplus land with a book value of C100, 000 for cash of C200, 000 and plant and machinery valued at C250, 000. The transaction has commercial substance. The plant and machinery would be recorded at C250, 000, which is equivalent to the fair value of the land of C450, 000 less the cash received of C200, 000.

A transaction has commercial substance if the entity’s future cash flows are expected to change as a result of the transaction. Exchange transactions will have a business purpose, and the exchange of assets that are not identical is likely to result in a change in the entity’s cash flows. If the expected difference in the cash flows is significant, the exchange has commercial substance.

When does an exchange of assets have substance? An exchange of non-cash assets has commercial substance when: The configuration of the cash flows of the asset received is expected to differ from the configuration of the cash flows of the asset given up. ‘Configuration of the cash flows’ means the risk, timing and amount of the cash flows. The exchange of a factory that is fully operational in exchange for a Greenfield site to construct a new factory manifestly meets the ‘change in cash flow’ test. The entity-specific value of the part of the entity’s operations affected by the transaction changes as a result of the exchange. The exchange of a working mine and equipment for a rail line near another mine, which allows the entity to transport product at considerable cost savings, is an example of a change in the cash flows of the entity’s operations.

Commercial substance will often be clear without the entity having to perform detailed calculations. Swapping commodities in different locations or exchanging similar assets are FAQs of where the cash flow change test will not be met.

Exchange of assets that lack commercial substance Entity A exchanges car X with a book value of C13,000 and a fair value of C13,250 for cash of C150 and car Y which has a fair value of C13,100. The transaction lacks commercial substance, because the entity’s cash flows are not expected to change as a result of the exchange; in other words, the entity is in the same position as it was before the transaction. The entity recognizes the assets received at the book value of car X. Therefore, it recognizes cash of C150 and car Y as property, plant and equipment with a carrying value of C12, 850.

The fair value of an asset is reliably measurable if

(a) the variability in the range of reasonable fair value measurements is not significant for that asset or

(b) the probabilities of the various estimates within the range can be reasonably assessed and used when measuring fair value.

Where both the fair value of the asset given up and the fair value of the asset received can be estimated with equal reliability, the fair value of the asset given up is used to measure the cost of the asset received. However, if the fair value of the asset received can be measured with more reliability, that value is used.

Cost of donated assets

An asset might, in unusual circumstances, be acquired by an entity through donation or contribution for no consideration and no issuance of shares. There is no specific guidance in IFRS for this type of transaction.

The entity should develop an accounting policy and apply it consistently. There are two approaches generally observed in practice: assets are recognized at fair value when the entity obtains control of the asset; or they are recognized at nil value.

  Capitalization of borrowing costs

Borrowing costs that are attributable to the acquisition, construction or production of a qualifying asset are capitalized as part of the cost of that asset. All other borrowing costs should be expensed in the period incurred.

An entity can choose, but is not required, to apply the standard to borrowing costs directly attributable to the acquisition, construction or production of:

a. a qualifying asset measured at fair value (for example, a biological asset); or

b. inventories that are manufactured, or otherwise produced, in large quantities on a repetitive basis.

Borrowing costs are capitalized when all of the following criteria are met:

• the entity has a qualifying asset (that is, an asset that necessarily takes a substantial period of time to get ready for its intended use or sale);
• expenditures have been incurred on the qualifying asset;
• borrowing costs have been incurred; and
• activities are undertaken that are necessary to prepare the asset for its intended use or sale.

Qualifying assets

A qualifying asset is defined as “an asset that necessarily takes a substantial period of time to get ready for its intended use or sale”.

Qualifying assets are not limited to property, plant and equipment, but also include assets such as inventories that require a ‘substantial period of time’ to bring them to a saleable condition.

An asset that normally takes more than a year to be ready for use will usually be a qualifying asset. Once management chooses the criteria and types of assets, it applies this consistently to those types of assets.

Assets that are ready for their intended use or sale when acquired are not qualifying assets.

A service concession arrangement where the operator recognizes an intangible asset could also be a qualifying asset. If the operator recognizes an intangible asset in exchange for the construction services, it will capitalize borrowing costs incurred during the construction phase.

Measurement Subsequent to Initial Recognition

An entity adopts either the cost model or the revaluation model for property, plant, and equipment after initial recognition. The policy choice is by class of assets, not individual assets within a class. An entity might, therefore, have one or more classes of assets on a cost basis, and other classes of assets on a revaluation basis.

A class of assets is a grouping of assets of a similar nature and use in an entity’s operations. Revaluation must be applied to an entire class of assets. If a single item of property, plant, and equipment is revalued, the entire class of property, plant, and equipment to which that item belongs should be revalued. This applies to consolidated financial statements so that items of property, plant, and equipment in the same class across different entities in the group need to be accounted for consistently.

The definition of fixed assets does not permit classes of assets to be determined solely on a geographical basis but is otherwise reasonably flexible. An entity can adopt meaningful classes that are appropriate to the type of business and assets held by an entity. Separate disclosures must be made, however, for each class of assets, with each class of assets presented as a separate category in the table of movements in the notes to the financial statements.

Items of property, plant, and equipment under the cost model are carried at cost less accumulated depreciation and accumulated impairment losses.

Items of property, plant, and equipment under the revaluation model are carried at fair value at the date of revaluation, less any subsequent accumulated depreciation and any subsequent accumulated impairment losses. Revaluations should be carried out with sufficient regularity that the carrying amount does not differ materially from that which would be determined using fair value at the end of the reporting period.