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Section 12 – Property, Plant and Equipment and Investment Property
Introduction
Section 12 deals with the initial recognition, subsequent measurement, depreciation and impairment for property, plant and equipment (PPE) and investment property.
This section applies to the accounting for property, plant and equipment and investment property. Property, plant and equipment does not include biological assets related to agricultural activity (see Section 27 Specialised Activities).
One important point to note is that investment property comes within this section and there is no separate section dealing with investment property.
Recognition
Extract from FRS 105 – Section 12.3 -12.7
12.3 A micro-entity shall recognise the cost of an item of property, plant and equipment or investment property as an asset if, and only if:
- it is probable that future economic benefits associated with the item will flow to the micro-entity; and
- the cost of the item can be measured reliably.
12.4 Spare parts and servicing equipment are usually carried as inventory and recognised in profit or loss as consumed. However, major spare parts and stand-by equipment are property, plant and equipment when a micro-entity expects to use them during more than one period. Similarly, if the spare parts and servicing equipment can be used only in connection with an item of property, plant and equipment, they are considered property, plant and equipment.
12.5 Parts of some items of property, plant and equipment or investment property may require replacement at regular intervals (eg the roof of a building). A micro-entity shall add to the carrying amount of an item of property, plant and equipment or investment property the cost of replacing part of such an item when that cost is incurred if the replacement part is expected to provide incremental future benefits to the micro-entity. The carrying amount of those parts that are replaced is derecognised in accordance with paragraphs 12.26 and 12.27.
12.6 A condition of continuing to operate an item of property, plant and equipment (eg a bus) or investment property may be performing regular major inspections for faults regardless of whether parts of the item are replaced. When each major inspection is performed, its cost is recognised in the carrying amount of the item of property, plant and equipment or investment property as a replacement if the recognition criteria are satisfied. Any remaining carrying amount of the cost of the previous major inspection (as distinct from physical parts) is derecognised. This is done regardless of whether the cost of the previous major inspection was identified in the transaction in which the item was acquired or constructed. If necessary, the estimated cost of a future similar inspection may be used as an indication of what the cost of the existing inspection component was when the item was acquired or constructed.
12.7 Land and buildings are separable assets, and a micro-entity shall account for them separately, even when they are acquired together.
OmniPro comment
Section 12.5 makes it clear that spare parts and standby equipment are classified as property plant and equipment when they are expected to be used during more than one period or only used in connection with an item of property plant and equipment. Where this is the case the spare part is depreciated over its useful life which cannot be more than the useful life of the main asset for which the spare parts are utilised. In the notes to the financial statements, an entity should disclose the depreciation rate on spare parts (applicable to ROI entities only as UK entities are not required to disclose accounting policies).
Example 1: Spare parts
A manufacturing company holds a significant stock of critical spare parts for its production equipment. Given that these spare parts are specific to the production equipment itself, and given that they will be used over more than one period, these assets are classified as PPE and depreciated over their expected useful life. In reality on transition the value if previously included in inventory should equal the cost to be transferred to PPE.
A similar example would be where plastic boxes are used for carrying and distributing the main products e.g. vegetables boxes which are used again and again and are not provided to customers on a long term basis as they must be returned. These are classified as fixed assets as opposed to spare parts.
Example 2: Replacement of a major component which was previously not separated
In 2015 a company purchases a new piece of production equipment for CU2,000,000. This equipment incorporates a pump which at the date of acquisition is assumed to have the same useful life of the whole asset of 20 years. However, in year 10, the pump fails, and a new pump has to be purchased for CU400,000. Given that the pump is a large component of the main asset and given that the replacement pump will provide future economic benefits, the new pump will need to be capitalised and the old pump derecognised. At the date of acquisition, the company did not separate the CU2,000,000 cost between the pump and main asset. Therefore, at the date of purchasing the new pump, the company can use the cost of the replacement part to estimate the carrying value of the original pump at the end of year 10 i.e. the estimated NBV of the pump would then be CU200,000 (CU400,000 / 20 years * 10 years). Therefore, in year 10 a loss on disposal of CU200,000 would be posted to the P&L and a CU400,000 addition capitalised and depreciated from that date over the remaining 10 years of the main asset. It cannot be depreciated for longer than the remaining useful life of the main asset of 10 years.
Example 3: Periodic replacement
A company purchased a warehouse for CU2,000,000 which has a specialised ventilation unit which requires replacement every 5 years. The useful life of the warehouse itself is 50 years with no residual value. In accordance with Section 12, each major component part needs to be separately identified and the useful life determined for each. On acquisition, the company can use the estimated future cost of replacing the ventilation unit every 5 years (with no residual value), which was CU300,000. Therefore, at the end of year 5, the company will dispose of the specialist equipment at which stage there is a nil NBV and at the same time capitalise the cost of the new specialised ventilation unit.
Land and buildings are required to be separately identified, even when they are acquired together. This will mean that on acquisition, an exercise will have to be carried out to separate the land element from the buildings element and then depreciate the buildings element accordingly based on the useful life.
Example 4: Separation of land and buildings
Company A purchased a property on one acre of land for CU1,000,000. Under Section 12, it will be necessary for the company to allocate the purchase price between the land and property. The company asks a valuer to split the CU1,000,000 between these two components. It was determined the allocation of CU400,000/CU600,000 to land and buildings respectively was appropriate. The building cost of CU600,000 is depreciated over its useful life from the date of acquisition.
Measurement at initial recognition
Extract from FRS 105 – Section 12.8 – 12.12
12.8 A micro-entity shall measure an item of property, plant and equipment or investment property at initial recognition at its cost
Elements of cost
12.9 The cost of an item of property, plant and equipment or investment property comprises all of the following:
- Its purchase price, including legal and brokerage fees, import duties and non-refundable purchase taxes, after deducting trade discounts and rebates.
- Any costs 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. These can include the costs of site preparation, initial delivery and handling, installation and assembly, and testing of functionality.
- The initial estimate of the costs, recognised and measured in accordance with Section 16 Provisions and Contingencies, of dismantling and removing the item and restoring the site on which it is located, the obligation for which a micro-entity incurs 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.
12.10 The following costs are not costs of an item of property, plant and equipment or investment property, and a micro-entity shall recognise them as an expense when they are incurred:
- 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); and
- administration and other general overhead costs.
12.11 The income and related expenses of incidental operations during construction or development of an item of property, plant and equipment or investment property are recognised in profit or loss if those operations are not necessary to bring the item to its intended location and operating condition.
Measurement of cost
12.12 The cost of an item of property, plant and equipment or investment property is the cash price equivalent at the recognition date. If payment is deferred beyond normal credit terms, the cost is the cash price available at the recognition date. Any excess of the deferred payment amount over the cash price available at the recognition date is recognised as interest and accounted for in accordance with paragraph 9.14(a).
OmniPro comment:
Costs which would deem to meet the condition of a directly attributable cost on top of initial delivery, handling, installation and assembly are:
- The cost of employees that arise directly from construction and acquisition of the item. This includes social security and pension costs.
- Installation and assembly costs;
- Professional fees (however, costs on speculative projects, and cost of aborted plans should be expensed);
- Cost of site preparation and site selection but only for the final site;
- Cost of testing whether the asset is working.
Example 5: Employee costs during construction
A retail outlet is moving into a new premises and incurs the cost of renovation for the store. It also has to incur salary costs for putting stock into the store. In this instance the cost of renovation can be capitalised even where own staff are used, however, the salary costs of employees stocking the shelves must be expensed.
Examples of items which are not directly attributable costs given in Section 12.10 are:
- costs of opening a new facility (note operating rental costs cannot be capitalised which incurred during the fit out stage and getting the store ready for opening);
- 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); and
- administration and other general overhead costs.
Decommissioning costs
Section 12 makes it clear that the cost of decommissioning, dismantling and removing an item to restore it to its original condition should be included in the cost of the asset but only where it meets the requirements for a provision as detailed in Section 16 (i.e. there is a present obligation as a result of a past event where there is a constructive obligation). This is particularly relevant for manufacturing companies or companies who have premises which are leased and have been altered substantially. The amount to be capitalised is the present value of the future obligation for the cost of decommissioning or restoring the site with a provision recognised for the same amount. This amount should then be depreciated over the life of the lease or up to the period when the liability crystallises. It is particularly relevant where a company enters into a lease for a period of time and alters the property for its own purposes (dilapidation provision).
There may be circumstances where the liability does not arise initially on recognition but instead after a new environmental regulation is introduced. It is at that time that the asset should be capitalised.
Once the related asset has reached the end of its useful economic life i.e. when it is no longer in use, any further movement on the provision is posted directly to the profit and loss (IFRIC 1 paragraph 7).
Given the degree of estimation involved in determining the cost of remediation at the date of recognition, where a change to the estimate is made no retrospective adjustment is required. Where an increase in the liability is required the additional amount is added to the related asset in that period (i.e. no retrospective adjustment required) subject to a review for impairment to ensure it is not over stating the asset or where a decrease in the liability is required, it is deducted from the related asset and if it is more than the carrying amount it is posted to the profit and loss. The updated asset carrying amount is then depreciated over its remaining useful economic life. The unwinding of the discount is posted to interest cost in the profit and loss over the assets life. This is discussed further in Section 16 of this website. Note the cost is not allowable for capital allowance purposes on initial recognition.
Example 5A: Decommissioning
A manufacturing plant which leases land for 50 years and constructs a factory on this. As part of the lease agreement it must reinstate the land to its original condition. It builds a plant on the land. At that point a provision is made in the books at its estimated present value cost in 50 years time of CU500,000. The accounting required for this transaction is:
|
|
CU |
CU |
|
Dr Fixed Assets |
500,000 |
|
|
Cr Provision |
|
500,000 |
Being journal to recognise the decommissioning cost
On a yearly basis depreciation is charged to write it down over the 50 year life i.e. CU10,000 per annum.
In year 10 the new estimate of the present value cost to reinstate the land is CU600,000. The NBV at that date is CU400,000 (CU500,000/40 yrs*10yrs). The liability included in the accounts after unwinding of the discount at that time is CU550,000. The journals required at this time are as follows:
|
|
CU |
CU |
|
Dr Fixed Assets (600,000-550,000) |
50,000 |
|
|
Cr Provision |
|
50,000 |
Being journal to write the liability up to the new estimate
From that date the new carrying amount of the asset is CU450,000 (NBV of CU400,000+change in estimate of CU50,000). The depreciation over the remaining life is as follows: New cost of CU450,000/40 yrs =CU11,250
|
|
CU |
CU |
|
Dr Depreciation |
11,250 |
|
|
Cr Accumulated Depreciation |
|
11,250 |
Being journal to reflect the depreciation to be charged from year 10 on.
Self-constructed assets
The principals outlined above are still applicable. However, the cost of abnormal amounts of wasted material, labour or resource incurred in the construction process are expensed. This includes cost of design errors, industrial disputes, idle capacity and production delays.
Only labour costs directly attributable to the assets construction should be capitalised. Therefore, any costs which would have been incurred regardless of whether the item was constructed or not is ignored in relation to administrative expenses for those individuals. Only labour costs for work on that property should be capitalised.
Cessation of capitalisation
Costs recognition should cease once an item of PPE is in the location and condition for it to be capable of operating in the manner intended by management. This is usually the date of practical completion of the physical asset. In essence, the recognition of relocation and reorganisation costs, costs incurred during the run up to full use once an item is ready to be used, and any initial operating costs is not allowed.
Computer software
Computer software for a machine that cannot operate without specific software is an integral part of the machine and is treated as PPE. However, where software is not an integral part it is treated as an intangible. This differs from old GAAP/FRSSE so transition adjustments may be required. A computer which includes both software and hardware is classified as PPE. However, website development costs and specific software is a separate asset and should be classified as an intangible asset.
Property, plant and equipment are stated at cost less depreciation. Software which is considered to be an integral part of the related hardware is capitalised as property, plant and equipment.
Deferred payment terms – measurement of cost
The cost of an item of property, plant and equipment is the cash price equivalent at the recognition date. If payment is deferred beyond normal credit terms, the cost is the cash price that would have been payable had no deferred payment terms been received (if the cash price cannot be determined it can be calculated by present valuing the future payments at a market rate of interest that would be charged on a similar loan with the same credit terms). The difference between the cash price and the actual payment is written off to the profit and loss account as an interest cost on a straight line basis over the credit term as stated in Section 9.
Example 6: purchasing on deferred credit terms
A company purchased a piece of equipment from a related party supplier on preferential terms for CU300,000. The company does not have to pay for the equipment until 2 years after delivery. Under normal trading conditions, the company would have to pay on delivery. As a result, the Company must determine the cash price without the extended credit terms. If we assume for the purposes of this example that the cash price is CU262,031.
(note where the cash price could not be determined an entity could present value the CU300,000 using the rate of interest that would be charged on this balance by a third party. Assume the interest that would be charged by a bank for 2 years on a loan of CU300,000 is 7%. The amount to be recognised as an asset is the present value for the future payment.
CU300,000 / (1+.07)^2 = CU262,031.)
The difference of CU37,969 (CU300,000-CU262,031) is posted as an interest cost over the two year period on a straight line basis.
Exchanges of assets
Extract from FRS 105 – Section 12.13
12.13 An item of property, plant or equipment or investment property may be acquired in exchange for a non-monetary asset or assets, or a combination of monetary and non- monetary assets. A micro-entity shall measure the cost of the acquired asset at fair value unless:
- the exchange transaction lacks commercial substance; or
- the fair value of neither the asset received nor the asset given up is reliably measurable. In that case, the asset’s cost is measured at the carrying amount of the asset given up.
OmniPro comment
In respect to part (b) above, the carrying amount is defined as the amount at which the asset is recognised after deducting any accumulated depreciation and accumulated losses. Where the consideration received comprises both a combination of monetary and non-monetary assets the fair value is adjusted by the amount of the monetary assets.
In deciding whether a transaction has commercial substance regard should be had to the guidance continued in IAS 16, it is regarded as having commercial substance, if:
- The configuration (risk, timing and amount) of the cash flows of the asset received differs from the configuration of the cash flows of the asset transferred; or
- The entity specific value of the portion of the entity’s operations effected by the transaction changes as a result of the exchange. Entity specific value is the present value of the cash flows an entity expects to arise from the continuing use of the asset and from its disposal at the end of its useful life or expects to incur when settling the liability. The post tax cash flows should be used.
- The difference in (a) and (b) is significant relative to the fair value of the assets exchanged (IAS 16.25).
As can be seen judgement will be required as to whether a transaction has commercial substance. However, in order for it to be shown at fair value it not only needs to have commercial substance, but also needs to be able to be reliably measured. If it cannot be reliably measured then it should be stated at the cost of the asset given up.
Example 7: Exchange of assets- assets that lack commercial substance
Company A exchanges van X with a book value of CU20,000 and a fair value of CU25,000 for cash of CU2,000 and van Y with a fair value of CU23,000. This transaction lacks commercial substance as cash flows are not expected to change as a result of the exchange, they are in the same position as before the transaction. Therefore, the company recognises the cost of VAN Y at the CU20,000. Hence accounting entries are to debit bank CU2,000, debit fixed assets CU18,000, credit profit/loss on disposal CU20,000 which is set against the disposal of the NBV of Van X to show a no profit/no loss.
Measurement after initial recognition
Extract from FRS 105 – Section 12.14
12.14 A micro-entity shall measure all items of property, plant and equipment and investment property after initial recognition at cost less any accumulated depreciation and any accumulated impairment losses. A micro-entity shall recognise the costs of day-to- day servicing of an item of property, plant and equipment or investment property in profit or loss in the period in which the costs are incurred.
OmniPro comment:
PPE must be measured at cost less accumulated depreciation and impairment after initial recognition. An entity cannot carry PPE at revalued amount of fair value.
Any repairs must be expensed in the profit and loss when incurred. Any replacements which increase economic activities should be capitalised. See examples 2 & 3 for further details.
Depreciation, depreciation amount and depreciation period
Extract from FRS 105 – Section 12.15 – 12.20
12.15 If the major components of an item of property, plant and equipment or investment property have significantly different patterns of consumption of economic benefits, a micro-entity shall allocate the initial cost of the asset to its major components and depreciate each such component separately over its useful life. Other assets shall be depreciated over their useful lives as a single asset. There are some exceptions, such as land which generally has an unlimited useful life and therefore is not usually depreciated.
12.16 The depreciation charge for each period shall be recognised in profit or loss unless another section of this FRS requires the cost to be recognised as part of the cost of an asset. For example, the depreciation of manufacturing property, plant and equipment is included in the costs of inventories (see Section 10 Inventories).
12.17 A micro-entity shall allocate the depreciable amount of an asset on a systematic basis over its useful life.
12.18 Factors may indicate that the residual value or useful life of an asset has changed since the most recent annual reporting date. If such indicators are present, a micro- entity shall review its previous estimates and, if current expectations differ, amend the residual value, depreciation method or useful life. The micro-entity shall account for the change in residual value, depreciation method or useful life as a change in an accounting estimate in accordance with paragraphs 8.11 to 8.13.
12.19 Depreciation of an asset begins when it is available for use, ie when it is in the location and condition necessary for it to be capable of operating in the manner intended by management. Depreciation of an asset ceases when the asset is derecognised. Depreciation does not cease when the asset becomes idle or is retired from active use unless the asset is fully depreciated. However, under usage methods of depreciation the depreciation charge can be zero while there is no production.
12.20 A micro-entity shall consider all the following factors in determining the useful life of an asset:
- The expected usage of the asset. Usage is assessed by reference to the asset’s expected capacity or physical output.
- Expected physical wear and tear, which depends on operational factors such as the number of shifts for which the asset is to be used and the repair and maintenance programme, and the care and maintenance of the asset while idle.
- Technical or commercial obsolescence arising from changes or improvements in production, or from a change in the market demand for the product or service output of the asset.
- Legal or similar limits on the use of the asset, such as the expiry dates of related leases.
OmniPro comment
The standard makes it clear that repairs and maintenance do not negate the need to charge depreciation.
Depreciation should be calculated by allocating the cost of an asset less its estimated residual value on a systematic basis over its useful life. Depreciation is charged in operating profit unless it is included in the cost of a product i.e. allocation of overheads to inventory. The useful life of an asset is either the period over which an asset is expected to be available for use by an entity or the number of units expected to be obtained from the asset by an entity.
Therefore, if an entity expects to hold an asset for the whole of its life then the asset would only be good for scrap at the end of the life with negligible value. However, where the entity has a policy to dispose of its assets before they reach the end of their economic life or where there is an alternative use at the end of the life, then the residual value will be higher. For example, a company purchases a car which has a useful life of 5 years however the entity intends on disposing this after 3 years, therefore the useful life for the company is 3 years, however the residual value will have to be estimated in order to determine the depreciation charge.
An entity cannot adopt a policy of not depreciating in the year of acquisition but depreciating in full in the year of disposal as this does not reflect the pattern in which the future economic benefits are expected.
Section 12.18 requires the residual value and useful economic life to be reassessed when indicators of a possible change are present at each reporting date, these would include:
- a change in how the asset is used,
- significant unexpected wear and tear,
- technological advancement, and
- changes in market prices. Where this differs then the adjustment required is posted to the profit and loss prospectively.
Section 8 Accounting Policies, Estimates and Errors makes it clear that a change in residual value, depreciation method or useful life is a change in accounting estimate which is adjusted prospectively. The disclosures required by Section 8 have to be included in the financial statements i.e. the effect of the change on the current period must be disclosed (not applicable to the UK but applicable to ROI entities – see Section 8 for the disclosure requirements). Where the residual value increases such that no further depreciation is required or it has been over depreciated, the standard requires that the asset be no longer depreciated and any over charge is not reversed.
The residual value of an asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated cost of disposal, if the asset were of the age and in the condition expected at the end of its useful life (FRS 105 Appendix I). Under Section 28.9, a change in residual value or useful life cannot be adjusted retrospectively in the first set of FRS 105 financial statements, instead they must be adjusted prospectively.
Example 8: Revising a residual value of an asset
In year 1 an asset was purchased for CU100,000. It had an estimated life of 6 years. Its estimated residual value was estimated to be CU10,000. This residual value was assessed for indicators of change at each year end and there were no issues up to the end of year 4. At the start of year 5, due to a change in the market for this type of asset the residual value increased to CU20,000 (being the value of the future residual amount). At the end of year 4, the asset had a carrying amount as follows:
|
|
CU |
|
Cost |
100,000 |
|
Residual Value |
(10,000) |
|
Depreciable Amount |
90,000 |
|
Depreciation (90,000 / 6 yrs * 4 yrs) |
(60,000) |
|
Carrying Amount |
30,000 |
In year 5, the residual amount is CU20,000, therefore the depreciable amount is CU80,000. Deducting depreciation charged to date of CU60,000 leaves CU20,000 to be depreciated over the remaining useful life of 2 years. Therefore, depreciation of CU10,000 is charged in year 5 and year 6.
If we take this example and assume the residual value increases to CU50,000, then the carrying amount in year 5 of CU30,000 is in excess of the residual amount. Therefore no depreciation is required in year 5 and 6 and any over depreciation is not reversed.
Land is not depreciated unless it is land used for extractive purposes. As stated previously on acquisition, there is a need to separate the land from the property so that depreciation can be charged. Disclosure of the change in estimate would be required in the financial statements for ROI Companies only (not required under UK law).
Detailed below is an example of a disclosure requirement for a change in the depreciation rates used (i.e. a change in estimate). This is only applicable for ROI companies as UK companies are not required to disclose this.
Example 9: Change in accounting estimate disclosure – ROI only
During the year ended 31 December 201X the company changed its depreciation method for freehold buildings and leasehold improvements to depreciating same over 50 years on a straight line basis as opposed to 10 years. The effect of same was to reduce the depreciation charge by CU680,000 for the current year. The reason for the change in depreciation method is that the new policy more correctly reflects the useful economic life of these assets.
Commencement and cessation of depreciation
Depreciation begins when the asset is available for use i.e. when the asset is in the location and condition necessary for it to be capable of operating in the manner intended by management.
Depreciation ceases when the asset is derecognised. Therefore, an entity does not stop depreciating an asset merely because it has become idle from active use.
Example 10: Commencement of depreciation
Company A completed construction of a factory on 1 January, but the company did not use this until 1 April. Here the entity should charge depreciation from the date it is ready for use i.e. 1 January.
Depreciation method
Extract from FRS 105 – Section 12.21 -12.22
12.21 A micro-entity shall select a depreciation method that reflects the pattern in which it expects to consume the asset’s future economic benefits. The possible depreciation methods include the straight-line method, the diminishing balance method and a method based on usage such as the units of production method.
12.22 If there is an indication that there has been a significant change since the last annual reporting date in the pattern by which a micro-entity expects to consume an asset’s future economic benefits, the micro-entity shall review its present depreciation method and, if current expectations differ, change the depreciation method to reflect the new pattern. The micro-entity shall account for the change as a change in an accounting estimate in accordance with paragraphs 8.11 to 8.13.
OmniPro comment
The standard specifies three methods which can be used in order to determine how the future economic benefits are used.
1) Straight line method
This is the most common method of depreciation and should be used when the pattern of consumption of assets economic benefits cannot be determined. This method is illustrated in the example on residual values above.
2) Diminishing balance method/sum of digits
This method charges a higher amount of depreciation in the earlier years. In the example below a 20% reducing balance basis is used.
|
|
CU |
|
Cost |
100,000 |
|
Depreciation at 20% (CU100,000 *20%) |
20,000 |
|
NBV |
80,000 |
|
Depreciation at 20% (CU80,000 *20%) |
16,000 |
|
NBV |
64,000 etc. etc. |
3) Units of production method
This method relates depreciation to the asset’s estimated use or output.
Example 11: Depreciation on basis of units of production
A machine cost CU100,000, over its useful life it will produce 200,000 widgets. The asset has no residual value. Therefore, the depreciation charge posted is based on the number of products produced by the machine. Therefore, the depreciation charge per product is CU0.50 (CU100,000 / 200,000 widgets). This can be done on the basis of hours also.
Impairment
Extract from FRS 105 – Section 12.23 – 12.25
Recognition and measurement of impairment
12.23 At each reporting date, a micro-entity shall apply Section 22 Impairment of Assets to determine whether an item or group of items of property, plant and equipment or investment property is impaired and, if so, how to recognise and measure the impairment loss. That section explains when and how a micro-entity reviews the carrying amount of its assets, how it determines the recoverable amount of an asset, and when it recognises or reverses an impairment loss.
Compensation for impairment
12.24 An entity shall include in profit or loss, compensation from third parties for items of property, plant and equipment or investment property that were impaired, lost or given up only when the compensation is virtually certain
Property, plant and equipment or investment property held for sale
12.25 Paragraph 22.7(f) states that a plan to dispose of an asset before the previously expected date is an indicator of impairment that triggers the calculation of the asset’s recoverable amount for the purpose of determining whether the asset is impaired.
OmniPro comment
The standard requires an entity to review for indicators of impairment annually as detailed in Section 27 Impairment of Assets, and where an indicator is identified, an impairment review is required. The standard does not require an impairment review to be performed on an annual basis for assets depreciated over 50 years. This was a requirement under old GAAP/Not required under FRS 102. Where the carrying amount is in excess of the recoverable amount, then an impairment is required to be booked. There is no 5 year look back rule required (was required under old GAAP/FRSSE).
Impairments can be reversed where the event that caused the impairment ceases or there is proof that the selling price is in excess of the impaired amount. Note the reversal cannot result in the carrying amount being in excess of what it would have been carried had no impairment occurred. See Section 22 for an example of this.
A decision to replace an asset is an indicator of impairment, and therefore an impairment review is required. However, if the results still indicates no impairment, an entity will still need to review and adjust the useful economic life and residual value such that depreciation is accelerated such that the asset is depreciated over its remaining useful economic life.
Where compensation is received for an impaired asset/asset lost or given up it should be treated as a disposal/part disposal and the compensation receivable only recognised when it is virtually certain. The related asset would be disposed and any asset purchased from the proceeds would be capitalised assuming they met the capitalisation criteria.
Derecognition
Extract from FRS 105 – Section 12.26 – 12.27
12.26 A micro-entity shall derecognise an item of property, plant and equipment or investment property:
- on disposal; or
- when no future economic benefits are expected from its use or
12.27 A micro-entity shall recognise the gain or loss on the derecognition of an item of property, plant and equipment or investment property in profit or loss when the item is derecognised (unless Section 15 Leases requires otherwise on a sale and leaseback). The micro-entity shall not classify such gains as turnover in the income statement.
OmniPro comment
An asset is derecognised once it has been disposed or when no future economic benefits are expected from its disposal.
The gain or loss on derecognition is the difference between the carrying amount at that date and the net proceeds received. It should be shown within expenses in the profit and loss and not in revenue (unless the entity is involved in the rental of such assets as its principal activity, then this asset would be derecognised from PPE and recognised as inventory).
Example 12: Derecognition
Company A has a tangible fixed asset which has a useful life of 20 years. In year 10, there is a risk that the asset is no longer required, as technology has changed and it is likely there will no longer be demand for the product that it produces. Management expect this to be the case. If this is the case the company believe that it will have no further use and therefore would have a nil scrap value. In year 11, managements’ belief is confirmed. It is in year 10 that the asset should be derecognised as at that point there is an expectation there will be no further economic benefits from use or disposal.
If in the above example, the future economic benefits were reduced but not expected to be eliminated an impairment would have been required.
Disclosure in the notes
Extract from FRS 105 – Section 12.28 – 12.29
12.28 A micro-entity shall determine the amount of any financial commitments not recognised in the statement of financial position for the acquisition of property, plant and equipment or investment property and disclose that amount within the total amount of financial commitments, guarantees and contingencies (see paragraph 6A.2).
12.29 A micro-entity shall disclose an indication of the nature and form of any items of property, plant and equipment or investment property given as security in respect of its commitments, guarantees and contingencies (see paragraph 6A.3).
OmniPro comment
See example disclosures below:
Example 13: Derecognition
- The company had capital commitments of CU30,000 at the year ended 31 December 2016 (2015:CUNil) in relation to the purchase of equipment. This commitment has been secured by a fixed and floating charge on the stock
Transition exemptions
Section 28.10 provides an exemption to allow entities an exemption from Section 12.15 to determine the depreciated cost of each of the major components of an investment property at the date of transition to FRS 105 as opposed to splitting the costs each into their component parts. Where this exemption is applied, a first-time adopter shall apply the following criteria (note this is to be completed on a property by property basis):
Step 1: Determine the total cost of the investment property including all of its components. Where no depreciation had been charged under the micro entity’s previous financial reporting framework, this can be calculated by reversing any revaluation gains or losses previously recorded in equity reserves.
Step 2: The cost of land, if any, shall be separated from buildings.
Step 3: Estimate the total depreciated cost of the investment property (excluding land) at the date of transition to this FRS, by recognising accumulated depreciation since the date of initial acquisition calculated on the basis of the useful life of the most significant component of the item of investment property (e.g. the main structural elements of the building).
Step 4: A portion of the estimated total depreciated cost calculated in step 3 shall then be allocated to each of the other major components (i.e. excluding the most significant component identified above) to determine their depreciated cost. The allocation should be made on a reasonable and consistent basis. For example, a possible basis of allocation is to multiply the current cost to replace the component by the ratio of its remaining useful life to the expected useful life of a replacement component.
Step 5: Any amount of the total depreciated cost not allocated under step 4 shall be allocated to the most significant component of the investment property.
For any acquisitions of investment property after the date of transition this exemption cannot be claimed, hence each major component part must be depreciated other than land.
Principal transition adjustments
1) Spare parts (difference only applicable for entities transitioning from FRSSE/old GAAP)
Section 12.5 makes it clear that -spare parts are classified as property plant and equipment and stand by equipment when they are expected to be used during more than one period or only used in connection with an item of property plant and equipment. Where this is the case the spare part is depreciated over its useful life which cannot be more than the useful life of the main asset for which the spare parts are utilised. Old GAAP/FRSSE provided less guidance therefore, some entities would have classified such spare parts as inventory instead of PPE. As a result on transition to FRS 105, such entities will need to recognise a transition adjustment to correct this.
Example 14: Reclassification of spare parts from inventory to PPE (applicable to FRSSE and old GAAP only)
Company A, has a significant value of spare parts for the production equipment. Under old GAAP/FRSSE these spare parts were treated as inventory. The total value of these spare parts at the date of transition was CU500,000. At the date of transition, the company determines the useful life of the spare parts to be 10 years from the date of transition and the residual value is nil. Assume the date of transition is 1 January 2015 and the corporation tax rate is 10%. The transition adjustment required on 1 January 2015 is (assume for the purposes of the example that the write off when it was classed as inventory differed to that from when it is classed as PPE (note this would be unlikely)):
|
|
CU |
CU |
|
Dr PPE |
500,000 |
|
|
Cr Inventory |
|
500,000 |
In the 31/12/15 i.e. the comparative year for FRS 105, a journal adjustment would be required to account for the depreciation and the current tax impact. Assume current tax is recognised on transition for the tax deduction not allowed in the comparative year but will be allowed as part of transition adjustments in the tax computation going forward over 5 years. The journals required are:
|
|
CU |
CU |
||
|
Dr Profit and Loss – Depreciation (CU500,000 / 10yrs) |
50,000 |
|
||
|
Cr PPE – Spare Parts |
|
50,000 |
||
|
Dr Balance Sheet – corporation Tax (CU50,000 *10%) |
5,000 |
|
||
|
Cr Profit and Loss – corporation Tax |
|
5000 |
||
Journals required in the 31 December 2016 year end assuming the above journals were posted to profit and loss reserves etc.
Assuming no movement has occurred no journals are required on top of what has already been posted to reserves. Even if there was movement in 2016, no current tax journal will be required for that movement as it would be included in the 2016 tax computation. The current tax of CU5,000 above will be recovered over the next 5 years under the tax transition adjustments (i.e. a journal to derecognise CU1,000 (CU5,000/5 years) of this current tax asset is required in the 2016 year and for the four years following this.
|
Dr Corporation tax in P&L |
1,000 |
|
|
Cr Corporation tax in balance sheet |
|
1,000 |
Being journal to reflect the additional deduction for 1/5th of the write down not previously allowed as a deduction up to 31/12/15 under old GAAP which has therefore fallen out on transition to FRS 105. Note this assumes that the tax journal posted will include the transition tax adjustment for the CU1,000 in tax terms when it is finally recognised. If there was no corporation tax in 2016, then the CU1,000 would still be released as a debit to the P&L as it would be no longer refundable from the tax authorities. As no deferred tax can be recognised under FRS 105 it cannot be held as deferred tax asset on the balance sheet as a timing difference, if this were the case. The remaining CU4,000 will still be included as an asset at the year end in the corporation tax nominal and released over the remaining 4 yrs.
2) Transfer of software and website costs to intangibles (applicable to FRSSE and old GAAP only)
Where software and website development costs have previously been included within PPE, on transition an adjustment may be required to transfer these to intangibles where they are not an integral part of the hardware where the company is transitioning from FRSSE/old GAAP (there is no difference between FRS 102 and FRS 105 here hence this is not applicable for entities transitioning from FRS 102). If this is the case, it will merely be a balance sheet reclassification from PPE to intangibles as the useful life etc should remain the same.
Example 15: Transfer of software and website costs to intangibles (applicable to FRSSE and old GAAP only)
Under FRSSE/old GAAP, Company A classified website development costs and software costs which are not an integral part of the asset as property, plant and equipment. Under FRS 105, these should be classified as intangible assets. The NBV of these assets on transition was CU100,000. The journal required on transition is therefore (assuming the date of transition is 1 January 2015):
On 1 January 2015
|
|
CU |
CU |
|
Dr Intangible Assets |
100,000 |
|
|
Cr PPE |
|
100,000 |
For the year ended 31 December 2015 and 2016 a similar adjustment will be required for the NBV at that date assuming the journal is not brought forward year on year. Instead of the write off being called depreciation it will now be called amortisation.
3) Significant part of a fixed asset replaced since the date of transition (applicable to FRSSE and old GAAP only)
Where a significant part of a fixed asset was upgraded/replaced/renovated under FRSSE/old GAAP in the comparative year, this cost was expensed as it was not separately depreciated, a transition adjustment may be required under FRS 105. Under FRS 105, such replacement parts should be capitalised where they provide incremental benefits and the previous amount included in PPE derecognised. Where the initial cost of the item replaced cannot be determined, then applying IAS 16 principals, the depreciated replacement cost can be used. In this particular case a transition adjustment may be required as detailed below. Note this difference is not applicable for entities transitioning from FRS 102 as the rules in FRS 102 are the same as the rules in FRS 105.
Example 16: Significant part of a fixed asset replaced since the date of transition (applicable to FRSSE and old GAAP only)
Company A renovated/replaced the ventilation system in its factory at a cost of CU200,000 on 1 January 2015. The transition date is 1 January 2015. This was a part that requires regular replacing every 5 years. Under FRSSE/old GAAP, this was expensed as it had not previously been separately identified and depreciated nor did it enhance economic benefits above what it would have provided usually. Under FRS 105 it should have been capitalised and the NBV of the old ventilation system disposed of. Assume NBV of the factory is CU800,000 with 8 years useful life remaining on transition. The UEL is 10 years.
Under FRS105 the entity will need to calculate the depreciated replacement cost of the ventilation system. This is calculated as follows:
CU200,000/ useful life of 5 yrs * remaining useful life of 3 yrs (being 5 year life of ventilation unit) = CU120,000
The transition adjustments to be posted in the 31 December 2015 year end (comparative year) are:
|
|
CU |
CU |
|
Dr Fixed Assets |
200,000 |
|
|
Cr Repairs in P&L |
|
200,000 |
Being journal to capitalise the cost previously expensed under old GAAP
|
|
CU |
CU |
|
Dr Loss on Disposal P&L |
120,000 |
|
|
Cr Fixed Assets |
|
120,000 |
Being journal to derecognise the old ventilation system
|
|
CU |
CU |
|
Dr Depreciation (CU200,000/8 yrs – CU200,000/5yrs) |
15,000 |
|
|
Cr Fixed Assets |
|
15,000 |
Being journal to reflect additional depreciation on the new ventilation unit over its remaining UEL
The transition adjustment for 2016 will just be the depreciation journal of CU15,000 assuming the above journals are brought forward to reserves.
4) Purchasing on deferred credit terms (applicable to entities transitioning from FRSSE and old GAAP only and possibly FRS 102 where not accounted for correctly previously)
FRS 105 requires the company to recognise sales and purchases initially at the cash price (or the present value of the receipt at a market rate of interest if the cash price cannot be determined) and to recognise the difference as interest expense over the extended credit term on a straight line basis.
Old GAAP/FRSSE was not as prescriptive hence it may have been possible to recognise the full amount in fixed assets. Under FRS 102 the financing element is required to be released to interest cost on an effective interest rate basis. This may result in differences on transition. The below example illustrates this point (note in the example below it assume the full cost was recognised under previous GAAP, if in fact the effective interest rate was used, the same process would be required to be followed).
Example 17: Purchasing on deferred credit terms (applicable to FRSSE and old GAAP only and possibly adopters from FRS 102 where it was not treated correctly previously)
A company purchased a piece of equipment from a related party supplier on preferential terms for CU300,000 on 1 January 2014. The company does not have to pay for the Property until 2 years after delivery (i.e. 31 December 2015). Under normal trading conditions, the company would have to pay on delivery. Under old GAAP, the CU300,000 was charged to fixed assets and creditors respectively. The NBV at the date of transition (assume the date of transition is 1 January 2015) is CU270,000 with a remaining useful life of 9 years (CU30,000 depreciation charge per annum under FRSSE/old GAAP).
Under Section 12, the Company must recognise the fixed asset at the cash price (or if this cannot be determined the present value of the CU300,000 using the rate of interest that would be charged on this balance by a third party). Assume the cash price is equal to CU262,031.
(For the purposes of illustration also if we assume the cash price cannot be easily determined, the interest that would be charged by a bank for 2 years on a loan of CU300,000 is 7%. The amount to be recognised as an asset is the present value for the future payment.
CU300,000 / (1+.07)^2 = CU262,031)
The difference of CU37,969 (CU300,000-CU262,031) is posted as an interest cost over the two year period on a straight line basis. Therefore the interest charge for 2014 and 2015 should have been:
2014 interest charge = CU37,969/ 2 years = CU18,985. Therefore the required carrying amount at the date of transition is CU281,016 (CU262,031+CU18,985).
2015 interest charge = CU37,969/ 2 years = CU18,984
The NBV required at 1 January 2015 under FRS 105 is= CU235,828 (CU262,031 cost net of finance charge/10 year life at date of acquisition* 9 years remaining at date of transition). The depreciation charge under FRS105 is CU26,203 (CU262,031/10 years).
Assume any deferred tax is stripped out as one journal as part of the overall deferred tax figure and that the interest expense is not tax deductible as the capital allowances are claimed on the gross amount.
The journals required on transition are:
1 January 2015
|
|
CU |
CU |
|
|
Dr Trade Creditors (CU300,000 of creditors-CU281,016) |
18,984 |
|
|
|
Cr PPE (CU270,000 NBV-CU235,828 required NBV) |
|
34,172 |
|
|
Dr Profit and Loss Reserves |
15,188 |
|
|
Being journal to recognise the correct NBV of PPE and of trade creditors under FRS 105 at the date of transition
Journals required in year ended 31 December 2015 assuming the above journals are posted to profit and loss reserves etc.
|
|
CU |
CU |
|
Dr PPE (CU30,000-CU26,203) |
3,797 |
|
|
Cr Depreciation in P&L |
|
3,797 |
Being journal to reverse over depreciation charged under old GAAP
|
|
CU |
CU |
|
Dr Interest Charge |
18,984 |
|
|
Cr Trade Creditors |
|
18,984 |
Being journal to reflect deemed finance interest on the extended credit to bring the balance to CU300,000 prior to the date of payment
Journals required in year ended 31 December 2016 assuming the above journals are posted to profit and loss reserves etc.
|
|
CU |
CU |
|
Dr PPE (CU30,000-CU26,203) |
3,797 |
|
|
Cr Depreciation in P&L |
|
3,797 |
Being journal to reverse over depreciation charged under old GAAP.
Note if the above example stated that under FRS 102, the company had recognised the net amount correctly and released it on an effective interest rate, the journals required would be to reflect the adjustments required to show the interest being released on a straight line basis as opposed to an effective interest rate basis. The journals would be similar, however there would be no need to post the reduction in the depreciation rate journal as the depreciation would be the same under both GAAPs.
5) Investment property carried at cost less depreciation and impairment and not fair value (applicable to FRSSE/old GAAP and FRS 102 transitioners)
Under Section 12 of FRS 105 investment property must be held at cost less accumulated depreciation and impairment. It cannot be held at market value.
FRSSE/old GAAP
Under FRSSE/old GAAP investment property was required to be held at market value on the balance sheet with movements in the market value of the investment property recognised in the STRGL and then to the revaluation reserve unless a devaluation was permanent in nature in which case it was recognised in the profit and loss. Deferred tax was not required to be recognised on any fair value movement.
FRS 102
Under FRS 102, investment property was required to be held at fair value on the balance sheet with the movements in the fair value of the investment property recognised in the P&L with one exception that being that:
- it could be held at cost less accumulated depreciation and impairment where the requirement to fair value caused undue cost or effort for the company.
FRS 102 also required deferred tax to be recognised on any fair value movement.
Impact
Therefore in both cases on transition an adjustment is required to derecognise the investment property at fair value and recognise the property at cost less depreciation and impairment at that date and since the date of transition and the related deferred tax if applicable (note in reality the deferred tax on this fair value adjustment would likely be derecognised as one journal with deferred tax on all other timing differences as discussed in Section 24 of FRS 105, however we have shown the derecognition here for educational purposes). An adjustment may also be required where investment property was held at fair value and this were sold since the date of transition (i.e. in the comparative year).
If under FRS 102 the entity took the option not to fair value investment property due to undue cost or effort then no adjustment will be required on transition.
Where the fair value is below original cost and accumulated depreciation, no adjustment will be required as this would be the cost less accumulated depreciation and impairment amount also. However if a deferred tax asset was recognised on the downward valuation this would need to be derecognised. The below example illustrates uplifts however the same logic would apply if there were downward movements and the downward movement did not result in the investment going below original cost less accumulated depreciation.
As stated above Section 28.10 allows companies an exemption from Section 12.15 to determine the depreciated cost of each of the major components of an investment property at the date of transition to FRS 105. This has been illustrated in the example below. Note there is no requirement to avail of this exemption however where it is not availed of each item within investment property should be depreciated based on its useful economic life.
Example 18: Investment property restated to cost less depreciation and impairment from fair value (applicable to FRSSE/old GAAP entities that transition)
Company A holds 2 investment properties. Under FRSSE/old GAAP investment property was required to be held at market value on the balance sheet with movements in the market value of the investment property recognised in the STRGL and then to the revaluation reserve unless a devaluation was permanent in nature in which case it was recognised in the profit and loss. There was no requirement to recognise deferred tax unless there was a binding agreement to sell.
Under Section 12 of FRS 105 investment property must be held at cost less depreciation and impairment. It cannot be held at market value.
At the date of transition CU75,000 was included in the revaluation reserve with respect to investment property (split CU55,000 to property 1 and CU20,000 to property 2). An uplift of CU100,000 and CU150,000 was recognised in the 2015 and 2016 financial statements respectively (through the STRGL and the revaluation reserve). Assume the uplifts in each year are on property 1.
There are two investment properties at the date of transition and no additional properties were acquired since transition. The total cost of the land included within investment property is CU50,000 split CU25,000 to investment property 1 and CU25,000 to investment property 2. Assume the 2 properties were purchased at the same time on 1 January 2011. Assume that investment property 2 was disposed of on 30 June 2016 and at that date the carrying amount was CU253,977 which equated to the sales price at that date.
Therefore on transition an adjustment is required to derecognise the investment property at market value and recognise the property at cost less depreciation and impairment at the date and since the date of transition.
FRS 105 recognises that it may be a significant amount of work to determine the cost less depreciation amount at the date of transition and as a result included an exemption in Section 28.10(c) of FRS 105 to make the calculation easier. The exemption included provides a 5 step process to determine the cost less depreciation at the date of transition (that being 1 January 2015 for this entity). Assume that the other major components which have different life’s to the structure after the most significant components (that being the structure) are the lifts and the air conditioning system.
Step 1: The total cost of the investment properties at the date of transition is CU331,520 as determined below:
Carrying amount of investment properties at date of transition of CU406,520 less the amount included in the revaluation reserve of CU75,000 = CU331,520.
From review of the accounting records, it is noted that this cost is split CU97,543 to investment property 1 and CU233,977 to investment property 2.
Step 2: The total cost of land included in the cost in step 2 is CU50,000 split CU25,000 per investment property as per the facts.
Step 3: The total depreciable amount is therefore €72,543 for property 1 and €208,977 for property 2 as calculated below:
The most significant component within the depreciable amount for each property is the structure itself. Therefore the useful life of this structure is the basis for determining the net book value under FRS 105 at the date of transition. If we assume the useful life of the structure is 50 years. The NBV at the date of transition is as follows:
Step 4:
Step 5:
Step 6: Calculate the depreciation to be recognised in total on the investment properties in the current and comparative year.
Step 7: Determine the adjustment to be made at the date of transition to profit and loss reserves
Step 8: Adjustment to profit on disposal of investment property where disposed of in the comparative or current year and held at market value.
As investment property 2 was disposed of in 2016 assuming the 2016 accounts were originally prepared under FRSSE/Old GAAP the profit on disposal will have been less (or if applicable loss on disposal would have been more) if the accounts are prepared under FRS 105 as the asset would have been held at cost less depreciation and impairment. As a result a transition adjustment is required.
The transition adjustments to reflect the correct balance under FRS 105 are:
On 1 January 2015:
|
|
CU |
CU |
|
Dr revaluation reserve (being amount in revaluation reserve at date of transition) |
75,000 |
|
|
Dr opening profit and loss reserves (step 7) |
22,522 |
|
|
Cr investment properties |
|
97,522 |
Being journal to restate the investment properties to cost less depreciation and to post the catch up on the depreciation to reserves
In the year ended 31 December 2015:
|
|
CU |
CU |
|
Dr revaluation reserve (being amount in revaluation reserve at date of transition) |
75,000 |
|
|
Dr opening profit and loss reserves (step 7) |
22,522 |
|
|
Cr investment properties |
|
97,522 |
Being journal to restate the investment properties to cost less depreciation and to post the catch up on the depreciation to reserves at date of transition
|
Dr depreciation/administrative expenses (step 6) |
10,891 |
|
|
Cr accumulated depreciation/investment properties |
|
10,891 |
Being journal to reflect depreciation on the investment properties in the year
|
Dr revaluation reserve |
100,000 |
|
|
Cr investment property |
|
100,000 |
Being journal to reverse fair value movement recognised on investment properties in the 2015 year as not permitted under FRS 105
In the year ended 31 December 2016:
|
|
CU |
CU |
|
Dr revaluation reserve (being amount in revaluation reserve at date of transition) |
75,000 |
|
|
Dr opening profit and loss reserves (step 7) |
22,522 |
|
|
Cr investment properties |
|
97,522 |
Being journal to restate the investment properties to cost less depreciation and to post the catch up on the depreciation to reserves at date of transition
|
Dr P&L reserves (step 6) |
10,891 |
|
|
Cr accumulated depreciation/investment properties |
|
10,891 |
Being journal to reflect depreciation on the investment properties for the comparative year
|
Dr revaluation reserve |
100,000 |
|
|
Cr investment property |
|
100,000 |
Being journal to reverse fair value movement recognised on investment properties in the 2015 as not permitted under FRS 105
|
|
CU |
CU |
|
Dr depreciation/administrative expenses (step 6) – 2016 |
7,077 |
|
|
Cr accumulated depreciation/investment properties |
|
7,077 |
Being journal to reflect depreciation on the investment properties in the 2016 year
|
Dr investment properties (step 8) |
48,131 |
|
|
Cr profit on disposal in P&L |
|
48,131 |
|
Dr P&L reserves |
20,000 |
|
|
Cr revaluation reserve |
|
20,000 |
Being journal to reflect the additional profit on disposal of investment property 2 previously not included in P&L as it was held at revalued amount and the reversal of posting under FRSSE/Old GAAP for reclassification of profit realised from revaluation reserve to P&L reserves.
|
Dr revaluation reserve |
150,000 |
|
|
Cr investment property |
|
150,000 |
Being journal to reverse fair value movement recognised on investment properties in the 2016 year as not permitted under FRS 105
Example 19: Investment property restated to cost less depreciation and impairment from fair value (applicable to FRS 102 entities that transition)
If we take the facts as in example 18 and the calculations performed in steps 1-8 but this time assume the movements were recognised through the profit and loss as opposed to the STRGL/revaluation reserve as is required under FRS 102. In addition assume the deferred tax liability recognised on the uplifts in the FRS 102 books was CU15,000, CU35,000 and CU65,000 at 1 January 2015, 31 December 2015 and 31 December 2016.
A transition adjustment is required to derecognise the fair values and restate at cost less depreciation and impairment as well as an adjustment to derecognise the deferred tax impact. In reality the deferred tax on this fair value adjustment would likely be derecognised as one journal with deferred tax on all other timing differences as discussed in Section 24 of FRS 105, however we have shown the derecognition here for educational purposes). The only difference in the steps here is in step Step 7 as the revaluation reserve is not applicable – hence this step is replicated below:
Step 7: Determine the adjustment to be made at the date of transition to profit and loss reserves
The transition adjustments to reflect the correct balance under FRS 105 are:
On 1 January 2015:
|
|
CU |
CU |
|
Dr Opening P&L Reserves (CU97,522-CU15,000) |
82,522 |
|
|
Dr Deferred tax liability |
15,000 |
|
|
Cr Investment properties (step 7) |
|
97,522 |
Being journal to restate the investment properties to cost less depreciation and to post the catch up on the depreciation to reserves at date of transition and derecognise deferred tax
In the year ended 31 December 2015:
|
|
CU |
CU |
|
Dr Opening P&L Reserves (CU97,522-CU15,000) |
82,522 |
|
|
Dr Deferred tax liability |
15,000 |
|
|
Cr Investment properties (step 7) |
|
97,522 |
Being journal to restate the investment properties to cost less depreciation and to post the catch up on the depreciation to reserves at date of transition and derecognise deferred tax
|
Dr depreciation/administrative expenses (step 6) |
10,891 |
|
|
Cr accumulated depreciation/investment properties |
|
10,891 |
Being journal to reflect depreciation on the investment properties in the 2015 year
|
Dr Deferred tax liability (CU35k-CU15k) |
20,000 |
|
|
Cr Deferred tax in P&L |
|
20,000 |
Being journal to reverse deferred tax on fair value movement recognised under FRS 102 in 2015 as it is not permitted to be recognised under FRS 105
|
Dr Other Operating Income in P&L for uplift in 2015 |
100,000 |
|
|
Cr investment property |
|
100,000 |
Being journal to reverse fair value movement recognised on investment properties in the 2015 year as not permitted under FRS 105
In the year ended 31 December 2016:
|
|
CU |
CU |
|
Dr Opening P&L Reserves (CU97,522-CU15,000) |
82,522 |
|
|
Dr Deferred tax liability |
15,000 |
|
|
Cr Investment properties (step 7) |
|
97,522 |
Being journal to restate the investment properties to cost less depreciation and to post the catch up on the depreciation to reserves at date of transition and derecognise deferred tax
|
Dr P&L reserves for 2015 depreciation (step 6) |
10,891 |
|
|
Cr accumulated depreciation/investment properties |
|
10,891 |
Being journal to reflect depreciation on the investment properties for the comparative year
|
Dr Deferred tax liability |
20,000 |
|
|
Cr P&L reserves for 2015 for reversal of Deferred tax in 2015 |
|
20,000 |
Being journal to reverse deferred tax on fair value movement recognised in 2015 as it is not permitted to be recognised under FRS 105
|
Dr P&L reserves – Other Operating Income for 2015 FV movement |
100,000 |
|
|
Cr investment property |
|
100,000 |
Being journal to reverse fair value movement recognised on investment properties in the 2015 as not permitted under FRS 105
|
|
CU |
CU |
|
Dr depreciation/administrative expenses (step 6) – 2016 |
7,077 |
|
|
Cr accumulated depreciation/investment properties |
|
7,077 |
Being journal to reflect depreciation on the investment properties in the 2016 year
|
Dr investment properties (step 8) |
48,131 |
|
|
Cr profit on disposal in P&L |
|
48,131 |
Being journal to reflect the additional profit on disposal of investment property 2 previously not included in P&L as it was held at fair value under FRS 105.
|
Dr Other Operating Income in P&L for uplift in 2016 |
150,000 |
|
|
Cr investment property |
|
150,000 |
Being journal to reverse fair value movement recognised on investment properties in the 2016 year as not permitted under FRS 105
|
Dr Deferred tax liability (CU65k-CU35k) |
30,000 |
|
|
Cr Deferred tax in P&L |
|
30,000 |
Being journal to reverse deferred tax on fair value movement recognised under FRS 102 in 2016 as it is not permitted to be recognised under FRS 105
Example 20: Restatement of investment property to cost less accumulated depreciation and impairment-no adjustment where fair value is less than cost less accumulated depreciation)
Company A held investment property at fair value under FRS 102/FRSSE/old GAAP. Assume 1 January 2015 is the date of transition. The fair value of the investment property at 1 January 2015, 31 December 2015 and 31 December 2016 was CU90,000, CU95,000 and CU80,000 respectively in the FRS 102/FRSSE/old GAAP financial statements. The cost of the investment property was CU130,000 at 1 January 2015 and 31 December 2015 & 2016 which represented the original cost. After applying the 8 steps as per example 18 it was determined the cost less accumulated depreciation for these investment properties should be CU115,000, CU110,000 and CU105,000 at 1 January 2015, 31 December 2015 and 2016 respectively.
FRS 105 requires that investment property be carried at cost less accumulated depreciation and impairment.
Therefore in this case no transition adjustments are required as under FRS 105 the cost less depreciation is greater than the fair value hence it should be stated at the recoverable amount after any impairment. Hence the carrying amount under old GAAP/FRSSE and FRS 102 will remain the same as that required under FRS 105. If in this case at either period end the fair value was higher than the adjustments similar to example 20 and 21 should be followed as applicable.
Note if a deferred tax asset was recognised under FRS 102 (not applicable under FRSSE/old GAAP) then this would also need to be derecognised.
5) Restatement of property, plant and equipment from revalued amount to cost less depreciation and impairment (applicable to FRSSE/old GAAP and FRS 102 transitioners) – also applicable for entities that have applied fair value or revalued amount as deemed cost on transition to FRS 102
Under FRSSE/old GAAP and FRS 102 there was a choice to hold property, plant and equipment at either cost less accumulated depreciation and impairment or revalued amount less accumulated depreciation with movements in valuation recognised in the STRGL(FRSSE) or OCI (FRS 102)/revaluation unless it was considered permanent in which case it was recognised in the STRGL/revaluation reserve (under FRSSE/old GAAP) and Other comprehensive income/revaluation reserve (under FRS 102) where a previous upward revaluation was held and then to the P&L (revaluation policy). Where a revaluation policy was adopted no deferred tax was required to be recognised under FRSSE/old GAAP however it was required to be considered under FRS 102.
FRS 102 (Section 35) also gave entities the possibility to treat a revalued amount or fair value as deemed cost on transition to FRS 102 for the first time.
FRS 105 does not permit any assets to be held at revalued amount/fair value or deemed cost instead tangible fixed assets must be stated at original/historic cost less depreciation and impairment.
Therefore on transition where a revaluation policy was applied under previous GAAP/FRSSE/FRS 102 or in the case of FRS 102, the entity applied the exemption under Section 35 in FRS 102 to have the revalued amount or fair value as deemed cost, a transition adjustment will be required to derecognise the revaluation and restate the assets to cost less depreciation and impairment.
Where the revalued amount is below original cost less related accumulated depreciation, no adjustment will be required as FRS 105 would have required an impairment to be booked so as to state the PPE at no higher than the recoverable amount. However if deferred tax asset was recognised on the downward valuation this would need to be derecognised – only applicable for adopters from FRS 102.
Example 21: Restatement of property, plant and equipment from revalued amount or fair value as deemed cost under FRS 102 to historic cost less accumulated depreciation under FRS 105 (applicable to entities transitioning from FRS 102)
Company A applied a revalued amount as deemed cost under FRS 102 (i.e. claimed exemption under Section 35 to treat fair value/revalued amount as deemed cost). Note this resulted in the carrying amount being included at an amount in excess of the historic cost less accumulated depreciation. Under FRS 102 at the date of transition to FRS 102 the company recognised the uplift in a reserve called ‘other reserve’ or the revaluation reserve.
The amount recognised in the ‘other reserve’ at the date of transition under FRS 102 was CU150,000 less the deferred tax of CU18,750 (as required to recognise this deferred tax under FRS 102). Each year the company transferred the depreciation on the revaluation uplift of CU3,000 from profit and loss reserves to the ‘other reserve’ as the amount included in the ‘other reserve’ is realised. The CU3,000 reflects the additional depreciation charged on the revaluation uplift and the deferred tax impact of this is CU375 assuming a deferred tax rate of 12.5%. Therefore the amount in the ‘other reserve’ before the deferred tax impact of CU18,750 reflects the amount by which the fixed assets are stated above the original cost less depreciation (a check should be performed to ensure that this is the original cost less depreciation by reviewing the accounting records).
On transition to FRS 105 an adjustment is required to derecognise the revaluation and restate the assets to cost less depreciation and impairment. In addition as Section 24 of FRS 105 does not permit deferred tax to be included on the balance sheet this should also be derecognised. In reality the deferred tax on this fair value/revaluation adjustment would likely be derecognised as one journal with deferred tax on all other timing differences as discussed in Section 24 of FRS 105, however we have shown the derecognition here for educational purposes).
Note if the company did not apply the policy of transferring the depreciation charged on the uplift in value from the P&L reserve to the ‘other reserve’ each year, an exercise would need to be performed to determine the original cost less depreciation (it would not be possible to clear out the revaluation reserve to fixed assets as below as some of the amount in the other reserve would have to be set against the profit and loss reserves).
The following journals are required to be recognised on transition:
On 1 January 2015:
|
|
CU |
CU |
|
Dr revaluation/other reserve |
150,000 |
|
|
Cr tangible fixed assets |
|
150,000 |
Being journal to restate the tangible fixed asset to cost less depreciation as required under FRS 105
|
Dr Deferred tax liability |
18,750 |
|
|
Cr Other Reserves |
|
18,750 |
Being journal to derecognise the deferred tax previously recognised on the uplift to other reserves at the date of transition (that being the deferred tax still to be unwound)
In the year ended 31 December 2015:
|
|
CU |
CU |
|
Dr Opening Revaluation reserve |
150,000 |
|
|
Cr tangible fixed assets |
|
150,000 |
Being journal to restate the tangible fixed assets to cost from revalued amount at the date of transition
|
Dr Deferred tax liability |
18,750 |
|
|
Cr Other Reserves |
|
18,750 |
Being journal to derecognise the deferred tax previously recognised on the uplift to other reserves at the date of transition (that being the deferred tax still to be unwound)
|
Dr tangible fixed assets |
3,000 |
|
|
Cr depreciation/administrative expenses in P&L for 2015 |
|
3,000 |
Being journal to reverse the depreciation charge posted on the revaluation uplift in the 2015 year so as to show depreciation charge on the historic amount
|
Dr P&L reserves |
3,000 |
|
|
Cr Other reserve |
|
3,000 |
Being journal to reverse the previous reclassification of the depreciation on the revalued amount from profit and loss reserves to the other reserve as required for 2015 under Company law where a revaluation policy is applied
|
Dr Other Reserves |
375 |
|
|
Cr P&L Reserves |
|
375 |
Being journal to reverse the reclassification under old GAAP of the transfer from P&L reserve to the other reserve for the deferred tax released on the depreciation on the uplift in the 2015 year
|
Dr Deferred tax in P&L – 2015 |
375 |
|
|
Cr Deferred tax liability |
|
375 |
Being journal to reverse the release of the deferred tax on the depreciation on the revalued amount in 2015 as a result of the restatement to historic cost as this is no longer applicable
In the year ended 31 December 2016:
|
|
CU |
CU |
|
Dr Opening Revaluation reserve |
150,000 |
|
|
Cr tangible fixed assets |
|
150,000 |
Being journal to restate the tangible fixed assets to cost from revalued amount at the date of transition
|
Dr Deferred tax liability |
18,750 |
|
|
Cr Other Reserves |
|
18,750 |
Being journal to derecognise the deferred tax previously recognised on the uplift to other reserves at the date of transition (that being the deferred tax still to be unwound)
|
Dr tangible fixed assets |
3,000 |
|
|
Cr P&L Reserves for the 2015 depreciation adjustment |
|
3,000 |
Being journal to reverse the depreciation charge posted on the revaluation uplift in the 2015 year
|
Dr P&L reserves |
3,000 |
|
|
Cr Other reserve |
|
3,000 |
Being journal to reverse the previous reclassification of the depreciation on the revalued amount from profit and loss reserves to the other reserve for 2015 as required under Company law where a revaluation policy is applied
|
Dr Other Reserves |
375 |
|
|
Cr P&L Reserves |
|
375 |
Being journal to reverse the reclassification under old GAAP of the transfer from P&L reserve to the other reserve for the deferred tax released on the depreciation on the uplift in the 2015 year
|
Dr P&L Reserves for Deferred tax – 2015 |
375 |
|
|
Cr Deferred tax liability |
|
375 |
Being journal to reverse the release of the deferred tax on the depreciation on the revalued amount in 2015 as a result of the restatement to historic cost as this is no longer applicable
|
|
CU |
CU |
|
Dr tangible fixed assets |
3,000 |
|
|
Cr depreciation/administrative expenses in P&L in 2016 |
|
3,000 |
Being journal to reverse the depreciation charge posted on the revaluation uplift in the current year
|
Dr Other Reserves |
375 |
|
|
Cr P&L Reserves |
|
375 |
Being journal to reverse the reclassification under old GAAP of the transfer from P&L reserve to the other reserve for the deferred tax released on the depreciation on the uplift in the 2016 year
|
Dr Deferred tax in P&L – 2016 |
375 |
|
|
Cr Deferred tax liability |
|
375 |
Being journal to reverse the release of the deferred tax on the depreciation on the revalued amount in 2016 as a result of the restatement to historic cost as this is no longer applicable
Example 22: Restatement of property, plant and equipment from revaluation policy to historic cost less accumulated depreciation under FRS 105 (applicable to entities transitioning from FRS 102 and FRSSE/old GAAP)
Company A applied a policy of revaluing fixed assets under old GAAP with the movement in revalued amount recognised in STRGL under FRSSE and OCI under FRS 102 and then subsequently to the revaluation reserve unless the revaluation was below the original cost in which case it was only recognised in the P&L if considered permanent. If this is a transition from FRS 102 deferred tax would also need to be considered with the journals similar to example 21 above.
The amount recognised in the ‘revaluation reserve’ at the date of transition under FRSSE and FRS 102 was CU150,000 less the deferred tax of CU18,750 in the case of an FRS 102 adopter (as required to recognise this deferred tax under FRS 102 – n/a for FRSSE). At 31 December 2015 the PPE was revalued downward by CU20,000 which was recognised in the STRGL/OCI and then the revaluation reserve.
Each year the company transferred the depreciation on the revaluation uplift of CU3,000 from profit and loss reserves to the ‘revaluation reserve’ as the amount included in the ‘revaluation reserve’ is realised. The CU3,000 reflects the additional depreciation charged on the revaluation uplift and the deferred tax impact of this is CU375 assuming a deferred tax rate of 12.5% (deferred tax only applicable for FRS 102 adopters). Given the change in the in the revalued amount at the end of the 2015 year this amount changed to CU2,500 for 2016.
Therefore the amount in the ‘revaluation reserve’ before the deferred tax impact of CU18,750 reflects the amount by which the fixed assets are stated above the original cost less depreciation (a check should be performed to ensure that this is the original cost less depreciation by reviewing the accounting records).
On transition to FRS 105 an adjustment is required to derecognise the revaluation and restate the assets to cost less depreciation and impairment. In addition as Section 24 of FRS 105 does not permit deferred tax to be included on the balance sheet this should also be derecognised where the old GAAP of the adopting entity was FRS 102. In reality the deferred tax on this fair value/revaluation adjustment would likely be derecognised as one journal with deferred tax on all other timing differences as discussed in Section 24 of FRS 105, however we have shown the derecognition here for educational purposes).
Note if the company did not apply the policy of transferring the depreciation charged on the uplift in value from the P&L reserve to the ‘revaluation reserve’ each year, an exercise would need to be performed to determine the original cost less depreciation (it would not be possible to clear out the revaluation reserve to fixed assets as below as some of the amount in the other reserve would have to be set against the profit and loss reserves).
The following journals are required to be recognised on transition:
On 1 January 2015:
|
|
CU |
CU |
|
Dr revaluation reserve |
150,000 |
|
|
Cr tangible fixed assets |
|
150,000 |
Being journal to restate the tangible fixed asset to cost less depreciation as required under FRS 105
|
Dr Deferred tax liability |
18,750 |
|
|
Cr revaluation |
|
18,750 |
Being journal to derecognise the deferred tax previously recognised on the uplift to other reserves at the date of transition (that being the deferred tax still to be unwound) NOTE THIS JOURNAL IS ONLY REQUIRED FOR ENTITIES TRANSFERRING FROM FRS 102 – N/A FOR FRSSE/old GAAP
In the year ended 31 December 2015:
|
|
CU |
CU |
|
Dr Opening Revaluation reserve |
150,000 |
|
|
Cr tangible fixed assets |
|
150,000 |
Being journal to restate the tangible fixed assets to cost from revalued amount at the date of transition
|
Dr Deferred tax liability |
18,750 |
|
|
Cr Revaluation Reserves |
|
18,750 |
Being journal to derecognise the deferred tax previously recognised on the uplift to other reserves at the date of transition (that being the deferred tax still to be unwound) NOTE THIS JOURNAL IS ONLY REQUIRED FOR ENTITIES TRANSFERRING FROM FRS 102 – N/A FOR FRSSE/old GAAP
|
Dr tangible fixed assets |
3,000 |
|
|
Cr depreciation/administrative expenses in P&L for 2015 |
|
3,000 |
Being journal to reverse the depreciation charge posted on the revaluation uplift in the 2015 year so as to show depreciation charge on the historic amount
|
Dr P&L reserves |
3,000 |
|
|
Cr Revaluation reserve |
|
3,000 |
Being journal to reverse the previous reclassification of the depreciation on the revalued amount from profit and loss reserves to the other reserve as required for 2015 under Company law where a revaluation policy is applied
|
Dr tangible fixed assets |
20,000 |
|
|
Cr Deferred tax liability (CU20k*12.5%) |
|
2,500 |
|
Cr OCI/ STRGL/ revaluation reserve (CU20k-CU2.5k) |
|
17,500 |
Being journal to reverse revaluation movement recognised in the 2015 year under old GAAP as not permitted under FRS 105. (NOTE THE DEFERRED TAX ELEMENT IS ONLY APPLICABLE UNDER FRS 102 – IT WOULD NOT BE POSTED IF AN ENTITY WAS TRANSITIONING FROM FRSSE/OLD GAAP)
|
Dr Revaluation Reserve |
375 |
|
|
Cr P&L Reserves |
|
375 |
Being journal to reverse the reclassification under old GAAP of the transfer from P&L reserve to the other reserve for the deferred tax released on the depreciation on the uplift in the 2015 year
NOTE THIS JOURNAL IS ONLY REQUIRED FOR ENTITIES TRANSFERRING FROM FRS 102 – N/A FOR FRSSE/OLD GAAP
|
Dr Deferred tax in P&L – 2015 |
375 |
|
|
Cr Deferred tax liability |
|
375 |
Being journal to reverse the release of the deferred tax on the depreciation on the revalued amount in 2015 as a result of the restatement to historic cost as this is no longer applicable
NOTE THIS JOURNAL IS ONLY REQUIRED FOR ENTITIES TRANSFERRING FROM FRS 102 – N/A FOR FRSSE/OLD GAAP
In the year ended 31 December 2016:
|
|
CU |
CU |
|
Dr Opening Revaluation reserve |
150,000 |
|
|
Cr tangible fixed assets |
|
150,000 |
Being journal to restate the tangible fixed assets to cost from revalued amount at the date of transition
|
Dr Deferred tax liability |
18,750 |
|
|
Cr Revaluation Reserves |
|
18,750 |
Being journal to derecognise the deferred tax previously recognised on the uplift to other reserves at the date of transition (that being the deferred tax still to be unwound). NOTE THIS JOURNAL IS ONLY REQUIRED FOR ENTITIES TRANSFERRING FROM FRS 102 – N/A FOR FRSSE/OLD GAAP
|
Dr tangible fixed assets |
3,000 |
|
|
Cr P&L Reserves for the 2015 depreciation adjustment |
|
3,000 |
Being journal to reverse the depreciation charge posted on the revaluation uplift in the 2015 year
|
Dr P&L reserves |
3,000 |
|
|
Cr Revaluation reserve |
|
3,000 |
Being journal to reverse the previous reclassification of the depreciation on the revalued amount from profit and loss reserves to the other reserve for 2015 as required under Company law where a revaluation policy is applied
|
Dr Revaluation Reserve |
375 |
|
|
|
Cr P&L Reserves |
|
375 |
|
Being journal to reverse the reclassification under old GAAP of the transfer from P&L reserve to the other reserve for the deferred tax released on the depreciation on the uplift in the 2015 year. NOTE THIS JOURNAL IS ONLY REQUIRED FOR ENTITIES TRANSFERRING FROM FRS 102 – N/A FOR FRSSE/old GAAP)
|
Dr P&L Reserves for Deferred tax – 2015 |
375 |
|
|
Cr Deferred tax liability |
|
375 |
Being journal to reverse the release of the deferred tax on the depreciation on the revalued amount in 2015 as a result of the restatement to historic cost as this is no longer applicable. NOTE THIS JOURNAL IS ONLY REQUIRED FOR ENTITIES TRANSFERRING FROM FRS 102 – N/A FOR FRSSE/old GAAP
|
Dr tangible fixed assets |
20,000 |
|
|
Cr Deferred tax liability (CU20k*12.5%) |
|
2,500 |
|
Cr OCI/ STRGL/ revaluation reserve (CU20k-CU2.5k) |
|
17,500 |
Being journal to reverse revaluation movement recognised in the 2015 year under old GAAP as not permitted under FRS 105. (NOTE THE DEFERRED TAX ELEMENT IS ONLLY APPLICABLE UNDER FRS 102 – IT WOULD NOT BE POSTED IF AN ENTITY WAS TRANSITIONING FROM FRSSE/old GAAP)
|
|
CU |
CU |
|
Dr tangible fixed assets |
2,500 |
|
|
Cr depreciation/administrative expenses in P&L in 2016 |
|
2,500 |
Being journal to reverse the depreciation charge posted on the revaluation uplift in the current year – 2016
|
Dr Revaluation Reserve |
313 |
|
|
Cr P&L Reserves |
|
313 |
Being journal to reverse the reclassification under old GAAP of the transfer from P&L reserve to the other reserve for the deferred tax released on the depreciation on the uplift in the 2016 year. NOTE THIS JOURNAL IS ONLY REQUIRED FOR ENTITIES TRANSFERRING FROM FRS 102 – N/A FOR FRSSE/old GAAP
|
Dr Deferred tax in P&L – 2016 |
313 |
|
|
Cr Deferred tax liability |
|
313 |
Being journal to reverse the release of the deferred tax on the depreciation on the revalued amount in 2016 as a result of the restatement to historic cost as this is no longer applicable. NOTE THIS JOURNAL IS ONLY REQUIRED FOR ENTITIES TRANSFERRING FROM FRS 102 – N/A FOR FRSSE/old GAAP.
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