AUG 2017 I S S U E 001
technical ebulletin News from Botswana Institute of Chartered Accountants
Contents
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ACCOUNTING FOR SPARE PARTS, SERVICING EQUIPMENT, STAND-BY EQUIPMENT AND SIMILAR ITEMS.
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DONATIONS TAX ON BUSINESS TRANSACTIONS
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NARROWING THE EXPECTATION GAP? THE NEW AUDITORS REPORTING STANDARDS.
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THE PUBLIC SECTOR’S ROLE IN THE ECONOMY.
Editor note It gives me great pleasure to bring you the first issue of the BICA Technical e-Bulletin which will also be published every month. With each issue, our goal is to provide you with the highest quality and relevant content applicable in today’s highly regulated technical environment, as well as to equip members and other stakeholders with important information on technical issues, standards and other pronouncements. This issue contains highlights such as: a) accounting for spare parts, servicing equipment, stand-by equipment and similar items, b) donations tax on business transactions, c) narrowing the expectation gap- the new auditors reporting standards and d) the public sector’s role in the economy. Do provide us with feedback on which articles are of interest and what you would like to see covered in this newsletter. I would also wish to urge BICA members to contribute articles to the newsletter, I thank those that have contributed to this edition.
Thank you, enjoy this great read. Send us an email at BICA-Technical@bica.org.bw or contact bica-pr&marketing@bica.org.bw
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ACCOUNTING FOR SPARE PARTS, SERVICING EQUIPMENT, STAND-BY EQUIPMENT AND SIMILAR ITEMS. By Eddie Bayen, Director Technical and Public Sector Accounting Services BICA Accounting for these items has always been a very grey area for professionals, requiring careful assessment of the situation and judgement. Two main questions arise in this area: 1. Should spare parts, servicing and stand-by equipment be classified as inventory and accounted for in accordance with IAS 2 Inventories, or should they be classified as Property, Plant and Equipment and accounted for in accordance with IAS 16 Property, Plant and Equipment? 2. Should those items be classified as PPE, how would depreciation be applied? That is, should you depreciate while it is sitting in the warehouse or wait until it is installed to replace a defective part? 01
To PPE or not to PPE? The Annual Improvements 2009–2011 Cycle, issued by the IASB in May 2012, amended paragraph 8 of IAS 16 Property, Plant and Equipment in order to shed some light on this issue. The amendments were effective for annual periods beginning on or after January 1, 2013 and the paragraph now states that:
items such as spare parts, stand-by equipment and servicing equipment are recognised in accordance with this IFRS when they meet the definition of property, plant and equipment. Otherwise, such items are classified as inventory. Implications? i. If it is a tangible item; ii. Is held for use in the production or supply of goods of services, for rental to others, or for administrative purposes; and iii. It is expected to be used during more than one period; You are dealing with an item of PPE. If it however is consumed in the process of use, cannot be used for more than
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one period, or is held as merchandise for resale, it then will be accounted for as inventory.
Materiality? Materiality judgments would be considered in making the final decision. Capitalising a screwdriver or mould would require recording it in the asset register and tracking it. This can be a hectic process so expensing it along with other small value items may be ideal. However, paragraph 9 of IAS 16 suggests that “it may be appropriate to aggregate individually insignificant items, such as moulds, tools and dies, and to apply the criteria to the aggregate value.” Whether an entity thus applies the recognition and measurement criteria to the individual asset or group is up to the entity. As mentioned before, capitalising individual screwdrivers when you have hundreds of them may not be ideal but if the total value of screwdrivers is material, (and you really consider it worthwhile - maybe profits are tight so you want to limit expenses), the whole group can therefore be capitalised as one item of PPE – a set of screwdrivers (and hope the auditor plays nice when auditing the asset’s existence).
When to Start Depreciating? The question here is, suppose you have a spare engine for your truck, do you depreciate while it is sitting in the warehouse, or do you wait and start depreciating when it has been installed and is thus in use? Paragraph 55 of IAS 16 states that “depreciation of an asset begins when it is available for use, i.e. when it is in the location and condition necessary for it to be capable of operating in the manner intended by management… depreciation does not cease when the asset becomes idle or is retired from active use…” This suggests that depreciation should start even if the asset is not in use, so long as it is available for use (sitting in the warehouse waiting to be mounted).
A depreciation charge would then be made over the useful life, including the idle period, unless a usage method like the unit of production method is adopted by the entity. Under usage methods, the depreciation charge would be zero while there is no production. To emphasise, if you have adopted a usage method of depreciation like the units of production method for that class of asset, you can defer depreciation until the spare is operating. If you are however using straight line or reducing balance method for instance, you would have to start depreciating as soon as it is available for use, even if it is not in use. In practice, in the mining industry, it is common to categorise spare parts into “critical spares” and “capital spares”. Critical spares are those that are kept in order to prevent disruptions in production, so that a replacement should always be immediately available in the event of a breakdown. If the spare is thus on standby, in the event of the one currently in use breaking down, it is a
critical spare and therefore immediately available for use. It has to be depreciated. A capital spare is one which is expected to be put into use as a replacement part at a future point in time. For example, the entity replaces its engines every three years and has a practice of buying a replacement engine in anticipation of this event. No depreciation takes place until the expected replacement period, because it can be argued that the spare is not available for use until that period. In summary therefore, whether you depreciate or wait untill the spare is installed depends on the reason for keeping the spare in stock. If it is as a risk management measure, to guard against disruptions due to part failures, then you have to depreciate. If it is as part of implementing a planned replacement schedule, with known replacement dates, then you only depreciate at the date the spare is expected to go into use.
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DONATIONS TAX ON BUSINESS TRANSACTIONS By Jonathan Hore – Managing Consultant, Aupracon Tax Consultants jhore.aupracon@btcmail.co.bw Capital Transfer Tax, which I shall call Donations Tax, is one of the least known taxes in the country. However, it affects certain transactions which businesses conduct, hence the need for you to be aware of what the tax laws require of businesses embarking on affected transactions.
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WHAT IS DONATIONS TAX? In general, donations tax encompasses any scenario where property devolves from one person to the other for free. This would include a donation of cash, immovable assets or movable property. Donations are very common between individuals. However, donations tax is also payable on certain transactions that occur between or among
companies. The Capital Transfer Tax Act (the Act) states that a donation also occurs whenever there is ‘any gratuitous waiver or renunciation of a right.’ A renunciation of a right brings into its ambit the following business transactions, among others: • The forgiveness of a debt owed by a related or third party. This means that if company A owes P1m to company B, the forgiveness of that debt by company B triggers donations tax .
• The writing off of a debt also triggers donations tax. It often happens that a client or group company fails to pay its dues and then the creditor eventually decides to write off that loan. The writing off of that loan can trigger donations tax. I should hasten to state that the above renunciations would only be subject to donations tax if the debtor does not include the forgiven amount as part of income subjected to corporate tax. So, the basic principle is this; the renunciation of a right by one company will trigger donations tax only if income tax is not payable as a result of the renunciation.
WHY REFER TO CORPORATE TAX? The issue is that in practice, a loan forgiven usually gets credited to the statement of comprehensive income (formerly ‘income statement’) of the one enjoying the forgiveness. In that event, the forgiven amount increases the taxable income of the benefiting entity and BURS collects corporate tax on that forgiven loan. So, the legislature obviously intended to make the tax burden lighter for the benefiting entity in cases where
corporate tax is paid on the renunciation of a right. Accountants will tell you that it is possible for a loan or other debt to be forgiven by one entity and not increase the income of the debtor. This may occur where the amount forgiven is passed through the statement of financial position on renunciation rather than through the statement of comprehensive income. In such cases, then donations tax kicks in.
BUT WHO PAYS THIS TAX? Donations tax is paid by the donee or beneficiary of a transaction subject to the tax. In the case of businesses where there is a renunciation of a right, it is the entity which is benefiting from the forgiveness or renunciation of the right which suffers the tax. For the avoidance of doubt, the one giving away a right or forgiving a debt does not bear any donations tax.
WHAT IS THE RATE OF TAX? Companies pay this tax at 12.5%. I should quickly mention that the Income Tax Act makes a distinction
between resident companies which suffer tax at 22% whilst non-resident companies suffer tax at 30%. Whilst the Capital Transfer Tax Act recognises such a distinction, both resident and non-resident companies pay the tax at 12.5%.
WHEN IS THIS TAX PAYABLE? Well, technically, the tax is payable by the time that the benefiting entity submits its income tax return. Late-payment of tax attracts compound interest at the rate of 1.5% per month or part thereof. So, basically, the beneficiary may actually not have the money with which to extinguish this tax burden as more than likely, it could be struggling to keep its operations afloat, which justifies the loan forgiveness. But the taxman will not lose sleep over your lack of capacity to pay; all he wants is his money. Period. The quarters whence you obtain the resources to pay tax is never the taxman’s baby! Well folks, I hope that was insightful. As yours truly says goodbye, remember to give to Caesar what belongs to him. Disclaimer: Jonathan Hore is a practicing Tax Consultant with over 17 years in Tax and Customs matters and writes on behalf of Aupracon Tax Specialists. The information contained in this article is of a general nature and is not meant to address particular circumstances of any person. 05
03 NARROWING THE EXPECTATION GAP? THE NEW AUDITORS REPORTING STANDARDS. By Aubrey Mbewe, Ag. Director, School of Business and Leisure, Botswana Accountancy College
Introduction After several years of development, the International Auditing and Assurance Standards Board (IAASB) released the new and revised auditors report standards effective for financial periods ending on or after 15 December 2016. These standards are envisaged to provide more transparent and relevant information to investors and key stakeholders alike, thus taking giant strides towards narrowing the ‘expectation gap’
Will it apply to Botswana? Since Botswana aligns with International Auditing Standards (ISA), this new change is applicable to the country too. Thus, users of financial statements should expect dramatic changes to the way the auditor’s reports look like, to 06
something more informative. This should be positive news for all since research by the IAASB hints at the following benefits; • Enhanced communication between the auditor and investors as well as between auditors and those charged with governance (TCWG);
• Increased attention by management and TCWG (e.g., the audit committee) to the disclosures in the financial statements to which reference is made in the auditor’s report; and • Renewed focus of the auditor on matters to be reported, which could indirectly result in an increase in professional scepticism.
For listed companies globally, application of the set of standards is mandatory. Other entities could voluntarily adopt some features. In Botswana, the Botswana Accountancy Oversight Authority has advised that ISA 701 Communicating Key Audit Matters in the Independent Auditor’s Report shall be applied as issued by the IAASB, except that at paragraph 5 where it is stipulated what audits the standard shall apply to, “listed entities” shall be replaced by “Public Interest Entities (PIEs)” with PIE being interpreted in accordance with the Financial Reporting Act, 2010 and the Financial Reporting (Public Interest Entities) Regulations. ISA 701’s requirement to communicate Key Audit Matters (KAM) is the most notable section or main feature in the changes to the audit report. KAM are those matters that, in the auditors’ professional judgement, were most significant in the audit of the financial statements of the current period (e.g. impairment testing, asset valuations, accounting for business acquisitions/disposals etc), selected from matters
communicated with those charged with governance. In addition, the section will require the auditor to describe how they deemed the matter to be key and how they addressed it during the audit. This will be a bonus to users of financial statements as research has shown a demand for audits to be less tick and bash affairs. Other notable features applicable to all entities are; • Opinion section required to be presented first, followed by the Basis for Opinion section, unless law or regulation prescribe otherwise • Enhanced auditor reporting on going concern, including • Description of the respective responsibilities of management and the auditor for going concern • A separate section when a material uncertainty exists and is adequately disclosed, under the heading “Material Uncertainty Related to Going Concern”
• New requirement to challenge adequacy of disclosures for “close calls “in view of the applicable financial reporting framework when events or conditions are identified that may cast significant doubt on an entity’s ability to continue as a going concern • Affirmative statement about the auditor’s independence and fulfilment of relevant ethical responsibilities, with disclosure of the jurisdiction of origin of those requirements or reference to the International Ethics Standards Board for Accountants’ Code of Ethics for Professional Accountants • Enhanced description of the auditor’s responsibilities and key features of an audit. Certain components of the description of the auditor’s responsibilities may be presented in an appendix to the auditor’s report or, where law, regulation or national auditing standards expressly permit, by reference in the auditor’s report to a website of an appropriate authority (IAASB, 2017).
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We should expect proactive approaches by audit firms to their clients informing them about such changes. TCWG should dedicate time in educating their shareholders about the new changes. With the KAM, there will be improved communication and discussion of issues between auditors and management including attending to prior year unresolved matters. A more consultative approach to address audit issues will be a value addition to the public, worthwhile for both auditor and client, perhaps a way to reduce the ‘expectations gap’. For a more detailed overview of the changes to the auditor’s report refer to the final standards and other IAASB publications at www.iaasb.org/auditor-reporting
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The Public Sector’s Role in the Economy. By Eddie Bayen, Director Technical and Public Sector Accounting Services BICA In a series of articles on public finance and accounting we will explore the role that the public sector plays in the economy. As a regulator, it’s important that we ensure our membership understands the industry we are dealing with if we are going to play a significant role in accounting reforms in this sector.
Structure of the Public Sector The public sector refers to the three arms of government, the legislative (parliament), executive (cabinet) and judiciary (court system). Under the doctrine of the separation of powers, the legislative passes laws, the executive is in charge of the day to day management of the state and the judiciary interprets and applies the laws for the state and provides a mechanism for dispute resolution. The public sector as used in this article also refers to the different levels of government: central, regional and local, and the
monetary and nonmonetary parastatals that government uses to execute policy.
Size of the Public Sector According to the 2011 Labour Statistics Report (Statistics Botswana, 2015), the Public Sector employs 51.5% of the population employed within the economy: Local Government 20.8%, Central Government 26.3%, Parastatals 4.4%. The World Bank also estimates that government expenditure accounts for about 28% of annual GDP and its tax revenue is about 26% of GDP, with revenue excluding grants being about 38% of GDP. Given the scale of government’s economic activity, it is quite surprising then that there are less than 5 professional accountants employed in the public sector. Government then is both a major consumer and producer in the economy. Public Finance Management essentially deals with how
government obtains and applies the resources it needs to function properly. The proper role of government in economic activity is something that has been subject to a lot of debate. Opinions are usually influenced by ideological views on the Social Contract, the relationship between the Individual and the State. On the revenue side of public finance are the questions of how much tax government should impose on its citizens, on what basis, and what effects the taxes have on the economy. On the expenditure side, relating to which goods and services government should provide health care, education and security. Some argue that government should have a very limited role, which would involve defence and law enforcement essentially to protect civilians. Market forces would then determine what else is produced and supplied in the economy. Others argue that government should also provide infrastructure like roads, bridges, sewers— which are
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necessary but may otherwise not be provided by the private sector due to market imperfections. A third school of thought takes it even further, insisting on government providing interventions that take such diverse forms as safety regulations for the work place, laws banning racial and sexual and other forms of discrimination, and social security for the poor. How much public sector intervention is needed is certainly a very polarising topic.
Why does the public sector intervene in the economy? All parties to the debate do certainly agree that there has to be some form of government intervention. Unregulated economic activity does not lead to a socially optimal outcome. At a very basic level, an economy could not function effectively if there were no contract laws since this would inhibit satisfactory exchange. Microeconomic theory holds that competitive market
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equilibrium is the most effective outcome for society. When supply equals demand, any good that consumers value above its cost of production will be produced and consumed; goods that consumers value less than their cost of production will not be produced or consumed. If this competitive market equilibrium is the most efficient outcome for society, why do governments then intervene in the operations of the market? There are two reasons: one is market failure, and the other is redistribution. Market failure occurs when a market system does not deliver an efficient allocation of resources due to specific problems with the market mechanism. In most cases this will mean a situation in which the price is no longer accurately reflecting consumer or producer preferences and as such is leading to a situation where goods and services are no longer being allocated in an economically efficient manner. Market failures are often associated with time-inconsistent preferences, information asymmetries, non-competitive markets, principal–agent problems, externalities, or public goods. Take the example of a public
good like national security provided by the government of Botswana. It is not possible to exclude any resident from the benefits provided by the Botswana Defence Forces’ activities, and therefore it is not possible to allow the market to determine a charge to be levied to cover its cost. Nobody would be willing to pay the charge because they benefit from the security by being in the national territory whether they pay or not. The public sector should thus intervene in the economy when markets are not efficient and when the intervention would improve efficiency. A second reason for government to intervene in the economy is in order to redistribute resources and ensure there is equity in their allocation.
Edmund Bayen, Director Technical and Public Sector Accounting Services BICA
How might the government intervene?
Having decided to intervene, the next question is how the government should do so. There are several different approaches that the government can take to intervention. Tax or subsidize private sale or purchase: government can address failures in the private market by using the price mechanism to encourage or discourage the production of some goods a good in one of two ways: • Through taxes, which raise the price for private sales or
purchases of goods that are overproduced e.g. alcohol, or, • Through subsidies, which lower the price for private sales or purchases of goods that would otherwise be underproduced e.g. education. • Public provision: The government can engage in the direct provision of a good or service in order to maintain a certain level of consumption, for instance, providing health care for the entire population.
• Public financing of privately produced goods: government may want to influence the level of consumption but may not want to directly provide the good/service. In such cases, the government can finance private entities to provide the desired level of provision. Policymakers therefore need to carefully evaluate different alternative options before deciding which option is best.
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