Treatment of non financial assets ias 16 17 & 40

1. TREATMENT OF NON-FINANCIAL ASSETS
(IAS 16, 17 & 40)
BY
IHEANYI ANYAHARA
ASSISTANT DIRECTOR (HEAD, CLAP)
FINANCIAL REPORTING COUNCIL
1
ICAN IFRS CERTIFICATION TRAINING
PROGRAMME

2. International Financial Reporting
Standards
AGENDA
The sources for this section include:
IAS 16 - Property, Plant and Equipment (PPE)
IAS 17 - Leases
IAS 23 – Borrowing Costs
IAS 40 - Investment Property
2

3. 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
3

4. 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
4

5. 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
5

6. 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)
6

7. 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
7

8. 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

9. 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
9

10. ARO Recognition & Measurement
The 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
10

11. 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
11

12. 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)
12

13. 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
13

14. 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
14

15. 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
15

16. 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/Losses
Losses taken to
equity/other
comprehensive income
(revaluation surplus) to
extent of previous
surplus on that asset
Excess loss taken to
income statement
16

17. 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

18. Depreciation
Begins when the asset is ready for use
Ceases at the earlier of:
When the asset is classified as held for sale (IFRS 5)
When the asset is derecognised
Does 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
18

19. Depreciation
Useful 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 obsolescence
Legal or similar limits on the use of the asset
Must reassess annually – change in estimate
19

20. 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
20

21. 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)
21

22. IAS 40 – INVESTMENT PROPERTY
22

23. 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
23

24. 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
24

25. 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
25

26. Initial Measurement
Measure initially at cost including transaction costs
and directly attributable expenditures (rules similar
to IAS 16)
26

27. 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
27

28. 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
28

29. 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
29

30. 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)
30

31. 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
31

32. 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
32

33. IAS 17: LEASES
33

34. IAS 17: LEASES
Introduction
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
34

35. RELEVANT IFRS
IAS
SIC INTERPRETATIONS
IFRS
INTERPRETATIONS
IAS 17: LEASES
IAS 39: FINANCIAL INSTRUMENTS –
RECOGNITION AND MEASUREMENT
IFRS 7: DISCLOSURES
SIC 15: OPERATING LEASE
INCENTIVES
SIC 27: EVALUATING THE
SUBSTANCE OF LEGAL FORM OF A
LEASE
IFRIC 4: DOES AN ARRANGEMENT
CONTAIN A LEASE?
IFRIC 12: SERVICE CONCESSION
ARRANGEMTNEMETNS
35

36. 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
36

37. 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
37

38. 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

39. 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
39

40. 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
40

41. 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
41

42. 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
42

43. 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
43

44. 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
44

45. 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
45

46. 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
46

47. 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
47

48. 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
48

49. 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
49

50. 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%
50

51. 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)
51

52. 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
52

53. 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
53

54. 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
54

55. 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
55

56. 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
56

57. 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
57

58. 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
58

59. LESSEE – INCOME STATEMENT
FINANCE
2010 2011 2012 2013 2014 TOTAL
DEPRECI
ATION
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
59

60. LESSEE – INCOME STATEMENT
OPERATING
2010 2011 2012 2013 2014 TOTAL
RENTALS 2,100 2,100 2,100 2,100 2,100 10,500
60

61. 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
61

62. FINANCE LEASE - LESSOR
Recognise 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
62

63. 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
63

64. 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) 62 1,000
(10,500)
1,500
64

65. Operating Lease - Lessor
Depreciate 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
65

66. LESSOR – INCOME STATEMENT
OPERATING
2010 2011 2012 2013 2014 TOTAL
RENTALS 2,100 2,100 2,100 2,100 2,100 10,500
DEPRECI
ATION
(1,800) (1,800) (1,800) (1,800) (1,800) (9,000)
TOTAL 300 300 300 300 300 1,500
66

67. LESSOR – INCOME STATEMENT
FINANCE
2010 2011 2012 2013 2014 TOTAL
INCOME 523 419 307 189 62 1,500
67

68. 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
68

69. Lessors - Manufacturers or
Dealers
No 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
69

70. 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 2010
IFRS on workplan for Q2 2011
Discussions still on up till June 15, 2011
Unlikely to be compulsory before periods in 2013
70

71. Leases – Project (contd)
Significant issues expected amongst others:
Subleases
Short-term leases
71

72. Questions!
72

73. Conclusion
Many 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
73