How IAS 16 regulates the Depreciation of PPE ?

IAS 16 Property, Plant and Equipment Par. 43 states that 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 shall be depreciated separately, and such depreciation charge shall be charged to the income statement unless it is included in the cost of producing another asset.

Depreciation shall be applied to the depreciable amount of an asset on a systematic basis over its expected useful life.

Expected useful life is the period used, not the asset’s economic life, which could be appreciably longer (IAS 16 Par. 57 states that the useful life of an asset is defined in terms of the asset’s expected utility to the entity. The asset management policy of the entity may involve the disposal of assets after a specified time or after consumption of a specified proportion of the future economic benefits embodied in the asset. Therefore, the useful life of an asset may be shorter that its economic life. The estimation of the useful life of the asset is a matter of judgement based on the experience of the entity with similar assets).

The depreciable amount takes account of the expected residual value of the assets. Both the useful life and the residual value shall be reviewed annually and the estimates revised as necessary in accordance with IAS 8.

Depreciation still needs to be charged even if the fair value of an asset exceeds its residual value. The rationale for this is the definition of residual value, detailed above.

Residual value is the estimated amount, less estimated disposal costs, that could be currently realized from the asset’s disposal if the asset were already of an age and condition expected at the end of its useful life. This definition precludes the effect of inflation and, in all likelihood, will be less than fair value.

Depreciation commences when an assets is in the location and condition that enables it to be used in the manner intended by management. Depreciation shall cease at the earlier of its derecognition (sale or scrapping) or its reclassification as “held for sale”. Temporary idle activity does not preclude depreciating the asset, as future economic benefits are consumed not only through usage but also through wear and tear and obsolescence.

Useful life, therefore needs to be carefully determined based on use, maintenance programs, expected capacity, expected output, expected wear and tear, technical or commercial innovations, and legal limits.

(Source : IFRS Practical Implementation Guide and Workbook 2^nd Edition)

Revenue Recognition, the latest update from IASB

The International Accounting Standards Board met in London on 14 - 18 September 2009, when it discussed:

• Financial crisis
  
  • - Derecognition
    
  • - Financial instruments: replacement of IAS 39
    
  • - Classification of rights issues
    
• Conceptual framework
  
• Financial instruments with characteristics of equity
  
• Financial statement presentation
  
• Insurance contracts
  
• Leases
  
• Liabilities: Amendments to IAS 37
  
• Post-employment benefits
  
• Related party disclosures
  
• Revenue recognition
  

REVENUE RECOGNITION

Here is the summary from the IASB meeting regarding on Revenue Recognition.

The Board discussed:

• the definition of control for determining when goods and services are transferred to a customer; and
  
• options to acquire additional goods and services.
  

Control

In the Discussion Paper Preliminary Views on Revenue Recognition in Contracts with Customers the Board proposed that an entity should recognise revenue when it satisfies its performance obligations to a customer by transferring goods and services to the customer. An entity has transferred a good or a service when the customer obtains control of it.

At this meeting, the Board:

• Considered the following working definition of control: 'control of a good or a service is an entity's present ability to direct the use of and receive the benefit from that good or service'.
  
• Decided tentatively that an entity should assess the transfer of control from the perspective of the customer.
  
• Considered the following indicators that the customer has obtained control of the promised asset and examples applying those indicators:
  
  • The customer has an unconditional obligation to pay for the asset (and the payment is non-refundable).
    
  • The customer has legal title to the asset.
    
  • The customer can sell the asset to (or exchange the asset with) another party.
    
  • The customer has physical possession of the asset.
    
  • The customer has the practical ability to take possession of the asset.
    
  • The customer specifies the design or function of the asset.
    
  • The customer has continuing managerial involvement with the asset.
    
  • The customer can secure or settle debt with the asset.
    

The staff will continue to refine the definition of control and the indicators for discussion at future meetings. For example, one of the concerns expressed by the Board was how the control definition would be applied to an asset under construction.

Options to acquire additional goods and services

The Board considered how an entity would determine whether options to acquire additional goods and services are part of a present contract with a customer, and, if so, how the entity would account for them.

The Board decided tentatively as follows:

• An entity should account for an option to acquire additional goods and services granted in a contract with a customer as a performance obligation in that contract if that option provides a material right to the customer that the customer would not receive without entering into that contract. An example would be a material discount on additional goods and services that the customer would not otherwise receive. An entity should account for that performance obligation by allocating to it a portion of the transaction price relative to the standalone selling price of the option.
  
• In some cases, an entity may estimate the standalone selling price of the option by reference to:
  
  • the discount the customer would obtain when exercising the option, adjusted for:
    
  • the discount that the customer could receive without exercising the option; and
    
  • the likelihood that the option would be exercised.
    

The staff proposed that an entity should apply this approach when the standalone selling price of the option is not directly observable. However, the Board directed the staff to consider this further, noting that there may be circumstances in which the time value component of an option should not be ignored.

• If a customer has an option to acquire additional goods and services, and those goods and services are:
  
  • similar in nature to the other goods and services in the contract; and
    
  • provided in accordance with terms and conditions (including pricing) in the contract the allocation of the transaction price should reflect the optional goods and services (and corresponding customer consideration), on an expected (ie probability-weighted) basis.
    

the allocation of the transaction price should reflect the optional goods and services (and corresponding customer consideration), on an expected (ie probability-weighted) basis.

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