Introduction

International Accounting Standard (IAS) 16, Property, Plant and Equipment prescribes that an item of Property Plant and Equipment (PPE) should be measured at its cost. Paragraph 16(b) of IAS 16 explains that the cost of PPE includes 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 the management (available for use). Paragraph 17 of IAS 16 cites examples of directly attributable costs. One such example cited is the cost of testing whether the asset is functioning properly, after deducting the net proceeds from selling any items produced while bringing the asset to that location and condition.

New development

The IFRS Interpretations Committee (the Committee), in July 2014 considered a request for clarification on accounting for net proceeds received during the course of testing PPE, in case the net proceeds exceed the costs of testing. However, after extensive discussion on this topic, the Committee recommended to the International Accounting Standards Board (IASB) to propose an amendment to IAS 16 to prohibit deducting sales proceeds from the cost of PPE.

Accordingly, on 20 June 2017, the IASB issued an Exposure Draft on Property, Plant and Equipment – Proceeds before Intended Use (the Exposure Draft) proposing a narrow-scope amendment to IAS 16.

The last date for comments on the exposure draft is 19 October 2017.

This issue of IFRS Notes provides an overview of the proposed amendments in the Exposure Draft.

Overview of Exposure Draft

The IASB, in its Exposure Draft proposes to:

• Amend the example of directly attributable costs in paragraph 17(e) of IAS 16 related to the costs of testing whether the asset is functioning properly. The Exposure Draft clarifies that such testing involves assessing whether the technical and physical performance of the asset is such that the asset is capable of being used for its intended purpose. The proposed amendment also removes the requirement to deduct net proceeds from sale of items produced before the asset is available for use, from the cost of PPE.
• Clarify that the proceeds from the sale of items produced while making an asset available for use (such as inventories produced when testing an asset), and the costs of producing such items should be recognised in profit or loss, in accordance with applicable standards.

Effective date and transition

The Exposure Draft does not specify an effective date, which will be determined at a later stage by the IASB. It proposes to apply the amendment retrospectively only to those PPE which were available for use on or after the beginning of the earliest period presented in the financial statements in which the entity first applies the amendments. Early application would be permitted.

Our comments

The proposed amendment is narrow-in-scope and, once notified, is expected to have an impact on the manufacturing, extractive, and other similar industries. Currently, diverse reporting methods have been applied by these industries. Some entities deduct only proceeds from selling items produced from testing, while others deduct all sales proceeds until the asset is available for use. For some entities, the proceeds deducted from the cost of PPE can be significant and exceed the costs of testing. The proposed amendment intends to eliminate this diversity in practice.

For first time adopters of IFRS, the exemptions in IFRS 1, First-time Adoption of International Financial Reporting Standards provide a deemed cost exemption for PPE, specific deemed cost exemptions for entities operating in the oil and gas sector and for entities involved in rate-regulated operations. Accordingly, if a first-time adopter of IFRS does not avail of the deemed cost exemption, it would be required to apply all the requirements of IAS 16 retrospectively.

Applicability under Indian Accounting Standards (Ind AS)

In India, this guidance would be applicable to companies that have transitioned or are transitioning to Indian Accounting Standards (Ind AS) only if a corresponding amendment is proposed and notified by the Ministry of Corporate Affairs (MCA) to Ind AS 16, Property, Plant and Equipment.

To access the text of the exposure draft on amendment to IAS 16, please click here.