Managing assets in relation to IFRS requirements by Real Asset Management

Whitepaper: Managing assets in relation to IFRS requirements

Real Asset Management

Whitepaper Managing assets in relation to IFRS requirements

Real Asset Management

White Paper

Whitepaper: Managing assets in relation to IFRS requirements

Real Asset Management

Managing assets in relation to IFRS requirements Contents 1

Organizational Acronyms & IFRS Statements

Introduction

First-time Adoption of IFRS

3.1

Opening Statement

3.2

Measurement & Recognition

3.3

Held for Sale

IFRS 5: Non-current Assets Held for Sale and Discontinued Operations

4.1

Overview

4.2

Cash-Generating Units

4.3

Classification of a Disposal Group

4.4

Excluded Assets

4.5

Discontinued Operations

4.6

International Standards Accommodation

IAS 16: Property, Plant and Equipment

5.1

Overview of Changes

5.2

Measurement & Recognition

5.3

Unit of Measure Depreciation

5.4

New Assets from IAS 17 Leases

IAS 17: Leases

6.1

Definitions

6.2

Overview of Changes

6.3

Arrangements Containing Leases

IAS 36: Impairment of Assets

7.1

Overview of Changes

7.2

Measurement

7.3

Intangible Assets

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7.4 Accounting for Impairments 7.5

Accounting for Impairment Reversals

7.6

Disclosure of Impairments

IAS 38: Intangible Assets

8.1

Definitions

8.2

Overview of Changes

8.3

Measurement & Disclosure

IFRS Asset Analysis Requirements

9.1

Overview of Changes

9.2

IFRS 5: Non-current Assets Held for Sale and Discontinued Operations

9.3

IAS 36: Impairment of Assets

9.4

IAS 38: Intangible Assets

Summary

References

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Organizational Acronyms & IFRS Statements

IFRS:

International Financial Reporting Standard

IFRIC:

International Financial Reporting Interpretations Committee

IASC:

International Accounting Standards Committee

EFRAG:

European Financial Reporting Advisory Group

SIC:

Standing Interpretations Committee

IAS:

International Accounting Standard

IASB:

International Accounting Standards Board

SAC:

Standards Advisory Council

FASB:

Financial Accounting Standards Board (US)

SFAS:

Statement of Financial Accounting Standards (US)

IPSASB:

International Public Sector Accounting Standards Board

IFRS 1:

First time Adoption of International Financial Reporting Standards

IFRS 2:

Share-based Payment

IFRS 3:

Business Combinations

IFRS 4:

Insurance Contracts

IFRS 5:

Non-current Assets Held for Sale and Discontinued Operations

IFRS 6:

Exploration for and Evaluation of Mineral Resources

IFRS 7:

Financial Instruments: Disclosures

IFRS 8:

Operating Segments

IAS 1:

Presentation of Financial Statements

IAS 2:

Inventories

IAS 7:

Cash Flow Statements

IAS 8:

Accounting Policies, Changes in Accounting Estimates and Errors

IAS 10:

Events after the Balance Sheet Date

IAS 11:

Construction Contracts

IAS 12:

Income Taxes

IAS 14:

Segment Reporting (superseded by IFRS 8 on January 1, 2008)

IAS 16:

Property, Plant and Equipment

IAS 17:

Leases

IAS 18:

Revenue

IAS 19:

Employee Benefits

IAS 20:

Accounting for Government Grants and Disclosure of Government Assistance

IAS 21:

The Effects of Changes in Foreign Exchange Rates

IAS 23:

Borrowing Costs

IAS 24:

Related Party Disclosures

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IAS 26:

Accounting and Reporting by Retirement Benefit Plans

IAS 27:

Consolidated Financial Statements

IAS 28:

Investments in Associates

IAS 29:

Financial Reporting in Hyperinflationary Economies

IAS 31:

Interests in Joint Ventures

IAS 32:

Financial Instruments: Presentation (Financial instruments disclosures are in IFRS 7 Financial Instruments: Disclosures and no longer in IAS 32)

IAS 33:

Earnings per Share

IAS 34:

Interim Financial Reporting

IAS 36:

Impairment of Assets

IAS 37:

Provisions, Contingent Liabilities and Contingent Assets

IAS 38:

Intangible Assets

IAS 39:

Financial Instruments: Recognition and Measurement

IAS 40:

Investment Property

IAS 41:

Agriculture

Introduction

Quoted from International Financial Reporting Standards (IFRSs®) Including International Accounting Standards (IASs®) and Interpretations as approved at 1 January 2008:

“The IASB achieves its objectives primarily by developing and publishing IFRSs and promoting the use of those standards in general purpose financial statements and other financial reporting.

IFRSs set out recognition, measurement, presentation and disclosure requirements dealing with transactions and events that are important in general purpose financial statements.

IFRSs are designed to apply to the general purpose financial statements and other financial reporting of all profit-oriented entities. Although IFRSs are not designed to apply to not-for-profit activities in the private sector, public sector or government, entities with such activities may find them appropriate. The International Public Sector Accounting Standards Board (IPSASB) prepares accounting standards for governments and other public sector entities, other than government business entities, based on IFRSs.”

This white paper reviews the latest IFRS publication and looks to provide a reference point of those elements relating to Asset Accounting. A review of SOX with relation to managing an entity’s systems and controls has also been covered. Simply adopting IFRS may not be enough for some entities, as they will also need to show the controls put in place to ensure the data used is secure and reliable.

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First-time Adoption of IFRS

3.1

Opening Statement

The opening IFRS statement is there to recognise a start point from which the entity will then comply with IFRSs.

This start point should identify all assets and liabilities under IFRS and also identify any assets and liabilities that are no longer compliant.

Any changes in the classes of assets or liabilities from the previous GAAP to IFRS will also need to be identified and disclosed.

3.2

Measurement & Recognition

Upon adoption of IFRS, an entity does have some flexibility when measuring an item of property, plant and equipment. An entity can use a previous GAAP revaluation as deemed cost at the date of the revaluation as long as the revaluation fairly reflected either the fair value or cost or depreciated cost under IFRSs possibly adjusted by changes in a general or specific price index. Under this process, previously reported revaluation reserves may not apply and carry forward.

An entity may also elect to measure an item of property, plant and equipment at the date of transition at its fair value and use this value as its deemed cost. However, if the entity uses fair value in its opening statement of financial position as deemed cost, the entity must disclose, for each line item in the opening statement, the sum of those fair values and any adjustment to the carrying amount formerly reported under previous GAAP.

With regards to depreciation methods, as long as those rates used under previous GAAP reflect a reasonable estimation of the asset’s useful life, they should also be acceptable to IFRS. However, if the rate was determined for other reasons, for example tax reasons and the necessary change is material, then the entity must adjust the accumulated depreciation in its opening IFRS statement retrospectively to comply with IFRS from that point forward.

IAS 16 requires each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item to be depreciated separately. However, there is also no firm definition of ‘significant’ and as such a judgement on what is required when applying the recognition criteria must relate to each entity’s specific circumstances. Although, it would be best practice to have detailed records rather than rely on a possible future clarification that could result in considerable effort on behalf of the entity.

3.3

Held for Sale

If an adopter wishes to identify held for sale (disposal groups) within the opening IFRS statement, there must be evidence that valuations

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and other information must have been available at the original time to meet the criteria required by IFRS. In most cases this is unlikely and not expected to occur often.

IFRS 5: Non-current Assets Held for Sale and Discontinued Operations

4.1

Overview

The IFRS has adopted a new classification of assets â&#x20AC;&#x2DC;held for saleâ&#x20AC;&#x2122;. This has introduced the concept of a disposal group, being a group of assets and liabilities that will be disposed by sale or other process in a single transaction. On identifying the disposal group, all assets are valued at the lower of carrying amount and fair value less costs to sell. All assets in the group must also stop depreciating. Assets and liabilities within a disposal group should be presented separately in the statement of financial position along with a description of the disposal group and details of the facts and circumstances of the sale or leading to the expected disposal and the expected manner and timing of that disposal.

4.2

Cash-Generating Units

Typically the disposal group will be either a group of cash-generating units (CGU), a single CGU or part of a CGU. The group can include both assets and liabilities from the entity including current assets and liabilities and assets that are not: deferred tax assets; assets arising from employee benefits; IAS 39 financial assets; IAS 40 accounted non-current assets; IAS 41 non-current assets and IFRS 4 contractual rights. The measurement requirements of this IFRS apply to the group as a whole so that the group is measured at the lower of carrying amount and fair value less costs to sell.

4.3

Classification of a Disposal Group

The classification of a disposal group as held for sale should occur when its carrying amount will be recovered principally through a sale transaction rather than through continuing use. For this to be the case the disposal group must be available for immediate sale in its present condition and its sale must also be highly probable and expected within one year. Although an extension to this year time-limit for sale can occur, it must be shown that the delay has been caused by circumstances beyond the entityâ&#x20AC;&#x2122;s control and that the entity remains committed to the sale.

Should there be a change to an asset or disposal group such that the IFRS criteria for held for sale no longer applies, the asset or disposal group should not be classified as held for sale. The entity should measure the non-current asset at the lower of its carrying amount before it was classified as held for sale, adjusted for any depreciation, amortization or revaluations that should have occurred and the recoverable amount on the date of the subsequent decision not to sell. The entity shall present that adjustment in the

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same caption in the statement of comprehensive income used to present a gain or loss.

4.4

Excluded Assets

Assets beyond the end of their useful lives and non-current assets that are to be closed rather than sold cannot be classed as held for sale. This includes assets that have been taken out of use as if they have been abandoned.

4.5

Discontinued Operations

With regards to discontinued operations, IFRS 5 replaces IAS 35 Discontinuing Operations and classifies an operation as discontinued at the date the operation meets the criteria as held for sale or when the entity has disposed of the operation. Again, the results of discontinued operations must be shown separately in the statement of comprehensive income. The definition detail included within IAS 35 that a discontinued operation be a major line of business or area of geographical operations has been added to IFRS 5.

4.6

International Standards Accommodation

IFRS 5 is a good example of where the convergence of accounting standards from around the world is being accommodated. The IASB and FASB entered into a memorandum of understanding, the result of which was a joint short-term project with the objective of reducing differences between IFRSs and US GAAP that are capable of resolution in a relatively short period of time and can be addressed outside major projects. In this case, IFRS 5 arises from the IASBâ&#x20AC;&#x2122;s consideration of FASB Statement No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144), issued in 2001.

For example, under SFAS 144, any gain or loss recognized on adjusting the carrying amount of the disposal group is allocated to the carrying amount of the long lived assets of the group. This is different to IAS 36 for the allocation of an impairment loss to a CGU which requires that they be allocated first to any carrying amount of goodwill and then to reduce pro rata the carrying amounts of the other assets in the unit. The IASB decided that the IAS 36 measurement standards shall be adopted as it applies to the disposal group as a whole. With regards the treatment of assets that have previously been revalued, the IASB decided to ignore any historical revaluations and treat assets in the same way as any assets that, before classification as held for sale, had not been revalued.

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IAS 16: Property, Plant and Equipment

5.1

Overview of Changes

The inclusion of property, plant and equipment required to develop or maintain biological and mineral rights or mineral reserves is new in IAS 16.

Historically, assets were all recognized based on their costs at the time they were incurred. However, it is now a requirement to include the cost of restoration, removal or dismantlement which an entity commits to when installing the item.

The use of an accurate fair value may be used against all class assets, which is the fair value less any accumulated depreciation and impairment losses. IAS 16 previously did not clearly insist that the values be measured reliably.

Any entity is also required to determine the depreciation charge separately for each significant part of an item of property, plant and equipment. Again, IAS 16 had not clearly stated this previously.

5.2

Measurement & Recognition

The measurement after recognition of an assetâ&#x20AC;&#x2122;s class can follow one of two models, the cost model and the revaluation model. The cost model simply carries the asset at its cost less any accumulated depreciation and any accumulated impairment losses. The revaluation model relies on regular valuations being its fair value at the date of valuation less any subsequent accumulated depreciation and subsequent impairment losses. The intervals of the revaluations should be regular enough to ensure that the carrying amount does not differ materially from the fair value that would be applicable at the end of any reporting period.

An entity is also expected to state on recognition what the value of an asset is expected to be when it reaches its estimated useful life based on current values for an asset in that condition and age. IAS 16 did not clarify previously whether the residual amount was this value or the amount, inclusive of inflation, that an entity expected to receive on disposal in the future at the end of the assetâ&#x20AC;&#x2122;s estimated useful life.

Idle property, plant and equipment should also continue to depreciate until it is derecognised or held for sale.

5.3

Unit of Measure Depreciation

The Unit of Measure approach to the rate of depreciation of assets came under scrutiny. Of particular concern was the fact that a weighted average could be applied to a whole item which could be made up of assets with different useful lives or consumption patterns. The result of this discussion was the requirement to differentiate all the parts of an item and have them depreciated separately using the most applicable method for each constituent part.

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5.4

New Assets from IAS 17 Leases

Property, plant and equipment can now also include IAS 17 qualified leases on the basis of the transfer of risks and rewards.

IAS 17: Leases

6.1

Definitions

There are two basic lease classes, finance and operating. The classification of a finance lease is one that substantially transfers all the risks and rewards incidental to ownership. This is clarified in the following ways:

■■

-The lease transfers ownership of the asset to the lessee at the end of the lease term.

■■

At a future point in time it is reasonably certain that the lessee can and will decide to purchase the asset for a price that is significantly lower than the fair value at that future time.

■■

The lease term is for all or at least the major part of the useful economic life of the asset even if title is not transferred at the end.

■■

At the inception date of the lease the present value of the minimum lease payments amounts to most if not all of the fair value of the leased asset.

■■

The leased asset is of a highly specialized nature that only the lessee can use it due to the excessive additional cost of returning the item or without major modifications.

IAS 17 also provides the following indicators of situations that individually or in combination could also lead to a lease being classified as a finance lease:

■■

On cancellation of the lease, any losses that would normally be attributed to the lessor are transferred to the lessee.

■■

Changes in the fair value of the residual accrued to the lessee which could be a rent rebate that equals most of the sales proceeds at the end of the lease.

■■

If the lease has a secondary rental period which allows the lessee to rent the asset at a substantially discounted or preferential rate when compared to market rates.

All other leases are operating leases.

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6.2

Overview of Changes

The changes in IAS 17 relate to the split between buildings and land in a property lease. An entity should normally split the lease into a land and building element with the land remaining an operating lease unless title is passed to the lessee at the end of the lease and the buildings element is defined as either an operating or finance lease based on the criteria above.

6.3

Arrangements Containing Leases

IFRIC 4 discusses whether an arrangement can contain a lease and provides the following summary on how to determine whether this has occurred.

■■

If the fulfilment of the arrangement is dependent on the use of a specific asset or assets (the asset); and

■■

The arrangement conveys the right to use the asset.

If a lease does exist, there has to be some estimation as to the payments associated with this lease based on the fair value of the asset and a finance charge using the purchaser’s incremental borrowing rate of interest for finance leases. In addition, all payments under this arrangement are to be disclosed as lease payments for an operating lease less any payments against non-lease elements.

IAS 36: Impairment of Assets

7.1

Overview of Changes

IAS 36 has further clarified the frequency of impairment testing outside of the requirement to test an asset whenever there is an indication that it may be impaired. These include:

■■

The recoverable amount must be measured annually for any asset with an indefinite useful life regardless of whether an impairment is suspected.

■■

Any intangible asset not yet available for use must be measured annually regardless of whether an impairment is suspected.

■■

Goodwill acquired in a business combination must be measured annually for impairment.

IAS 36 also confirms that if an active market exists for an asset or group of assets, that asset or group of assets should be identified as a cash-generating unit (CGU) and that any impairment testing should be against the CGU rather than individual assets within the group.

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Additionally, goodwill acquired in a business combination should be allocated to CGUs on a reasonable and consistent basis. The annual impairment test for a CGU, against which goodwill has been allocated, can be performed at any time during the annual reporting period. However, the anniversary for the test must be performed at the same time each year from there on. The first test must occur in the period the allocation of goodwill to the CGU was made.

7.2

Measurement

The impairment test must be treated as an annual event occurring against either a single asset or a CGU. In assessing whether there is any indication of impairment, the entity should consider the following external indications:

■■

Because of time or usage the market value is far lower than predicted.

■■

Due to changes in the business operation of the entity, there has been an adverse knock-on affecting the asset’s environment.

■■

Interest rates have increased significantly affecting the discount rate used in calculating the asset’s value in use that significantly decreases the asset’s recoverable amount.

■■

The carrying amount of the net assets of the entity is more than the market capitalization of the entity. Internally the impairment could be triggered if:

■■

There is evidence of physical damage or obsolescence of the asset.

■■

The future use of the asset is in doubt due to a change in the entity’s business.

■■

There is internal evidence that the asset’s performance is questionable.

The process of evaluating for impairment may not actually result in an impairment occurring if the difference is not significant. It may simply be necessary to review the depreciation (amortisation) or residual value of the asset instead.

When measuring the recoverable amount for an asset or CGU for the purpose of testing for impairment, it is not always necessary to determine both the asset’s fair value less costs to sell and its value in use. Simply if the first value obtained is greater than the carrying amount then no impairment has occurred and it is not necessary to complete the process further. However, the impairment test event must still be logged against the asset or CGU together with an indication that no further action was taken.

7.3

Intangible Assets

Intangible assets with indefinite useful lives must also be tested annually by comparing its carrying amount to its recoverable amount

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irrespective of any impairment indicators. However, no valuation may be necessary in the following instances:

■■

Individually, the intangible asset generates no cash flows and is part of a CGU and that the assets and liabilities that make up this CGU have not changed significantly since the most recent recoverable amount calculation.

■■

The most recent recoverable amount significantly exceeds the carrying amount of the asset.

■■

Since the most recent recoverable amount calculation and the current date it is highly unlikely that the new recoverable amount would be less than the carrying amount.

7.4

Accounting for Impairments

When the recoverable amount of an asset is significantly less than its carrying amount, an impairment must occur. The impairment loss should be first allocated against any revaluation amount that was created due to another standard (IAS 16 perhaps) and treated as a revaluation decrease. Should the impairment exceed the revaluation amount, the remainder should immediately be recognised in profit or loss. If the impairment amount exceeds the carrying amount of the asset, a separate liability is created as the value of the CGU cannot go below zero. Following the recognition of an impairment loss, depreciation (amortization) should be adjusted on a systematic basis over its remaining useful life.

When applying an impairment loss to a CGU the loss should be applied in the following order:

■■

Firstly against the carrying amount of any goodwill allocated to the CGU.

■■

Secondly to the other assets in the CGU on a pro rata basis.

However, in allocating an impairment loss to assets within a CGU, the allocation should not reduce the carrying amount of an asset below the highest of:

■■

Its fair value less costs to sell.

■■

Its value in use if determinable.

■■

Zero.

Any outstanding impairment loss should be allocated to the remaining assets in the CGU.

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7.5

Accounting for Impairment Reversals

The reversal of an impairment loss against an asset, other than goodwill, can only return the carrying amount, net of any depreciation (amortization), of the asset to that which it should have been had no historical impairments occurred. Any increase in the carrying value of the asset should be managed as a revaluation and the entity should apply the standard applicable to the asset.

With regards the reversal of impairment of an asset, any reversal of impairment should be recognised immediately in profit or loss unless the asset has previously been revalued, in which case a revaluation increase is applied.

When reversing an impairment against a CGU, the reversal shall be applied pro rata to all assets in the CGU except goodwill. This is again limited by the original carrying amount of the CGU assets less their depreciation (amortization). Any further allocation should be deemed as a revaluation in accordance with the applicable standards associated with each asset.

There are no reversals of impairment for goodwill assets.

7.6

Disclosure of Impairments

The disclosure of impairments is detailed and comprehensive, with the results of all impairments and impairment tests and the basis of these tests to be reported on, showing all movements in the measurement of an asset or CGU in relation to the entity and the reportable segment to which it belongs and how those movements have been accounted for.

In summary the disclosure standards require an entity to report on:

■■

The portion of any goodwill acquired in a business combination that has not been allocated to a CGU must be identified together with a reason as to why the allocation has not occurred.

■■

Within each CGU, the standard requires the identification of the carrying amount of any goodwill or intangible assets with indefinite useful lives.

■■

A disclosure of the carrying amount of any goodwill or intangible assets with indefinite useful lives allocated to CGUs against the total carrying amount of any goodwill or intangible assets with indefinite useful lives.

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IAS 38: Intangible Assets

8.1

Definitions

An intangible asset is an identifiable non-monetary asset without physical substance. Previously under IAS 38, this was also limited to assets held for use in the production or supply of goods or services, for rental to others, or for administrative purposes. Consequently the classification of intangible assets has widened and can be identified as:

■■

Can be identified as a distinct asset that is capable of being managed in the same way as a physical asset, i.e. sold, lent, licensed, rented or exchanged etc.

■■

Was created in the form of a contractual or other legal right providing benefit.

The new example classifications of intangible assets can be seen in section 11 of this paper.

8.2

Overview of Changes

Previously under IAS 38, the useful life of an intangible asset was considered finite with a limit of 20 years. This has been removed as it is possible that following an analysis of all relevant factors, there appears to be no foreseeable limit to the period over which the asset is expected to generate net cash inflow for the entity.

8.3

Measurement & Disclosure

An intangible asset with an indefinite useful life should not be amortised but it should be reviewed each reporting period to determine whether events and circumstances continue to support an indefinite useful life. If they do not, the change from indefinite to finite useful life should be accounted for as a change in an accounting estimate.

Although internally generated goodwill cannot be recognised as an asset, it is possible to generate other intangible assets internally. However, the research phase of any such development cannot be recognised as other than an expense, the development phase of the asset can be recognised as long as the intangible asset complies with all of the following:

■■

There are no technical reasons that preclude the completion of the intangible asset to a point at which it will be available for use or sale.

■■

There is a definite intention to complete the intangible asset and use it or sell it.

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■■

The ability to use or sell the intangible asset is apparent.

■■

That the intangible asset will generate probable future economic benefits.

■■

Resources are available to complete the development of the intangible asset.

■■

An accurate record of the expenditure attributable to the intangible asset is available.

After initial recognition, an intangible asset shall be carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated amortisation and any subsequent accumulated impairment losses. Revaluations should be made with sufficient regularity such that at the end of a reporting period the carrying amount of the asset does not differ materially from its fair value. The amortisation period and method should also be reviewed at least annually.

IFRS Asset Analysis Requirements

9.1

Overview of Changes

Within the following sections, IFRS has defined additional analysis requirements beyond those normally found for GAAP. These are primarily there to aid in the observance of the disclosure requirements of these sections. However, additional analysis capability may also be required to enable some accounting operations to occur.

9.2

IFRS 5: Non-current Assets Held for Sale and Discontinued Operations

Once a ‘Disposal Group’ has been identified it can be identified as a group of Cash Generating Units (CGU), a single CGU or part of a CGU. Although, if it is part of a CGU, it should be a CGU in its own right by this point as its value would be expected to come from the sale rather than from continuing use and as such it is less dependent on the old CGU. The implication here is that assets should already be identified within CGUs where the CGUs could also include associated liabilities.

9.3

IAS 36: Impairment of Assets

The process of performing an impairment requires a valuation against either an asset or a CGU of both fair value less costs to sell and value in use. As such, it is necessary for the Impairment event to be able to identify the group of assets within a CGU in a similar way to the process undertaken for the held for sale event. As with assets held for sale, it is possible that goodwill assets acquired in a business

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combination may, in part or in whole, be assigned to a CGU. It is then implied that all the elements of that goodwill be identified for analysis purposes together with the CGUs against which they have been allocated. Any amount of goodwill that was not allocated to a CGU must also be identifiable along with notes held against this asset as to why it has not been allocated.

9.4

IAS 38: Intangible Assets

Beyond the class categorisation for intangible assets, there is also a requirement to disclose between internally generated and other intangible assets. This is primarily due to the difficulty of determining the cost of the asset reliably when it is internally generated. Intangible assets should also be identified by whether they arise from a contractual or other legal rights basis or whether they are non-contractual. IFRS has provided examples of intangible asset categories and sub-categories suitable for use by entities as well as whether they could be termed contractual or non-contractual including: