This is the second of two articles, and considers revaluation of property, plant and equipment (PPE) and its derecognition in accordance with International Accounting Standard (IAS®) 16, Property, Plant and Equipment (PPE). It also summarises the provisions of International Financial Reporting Standard (IFRS®) 5, Non-current assets held for sale and discontinued operations. The first part of this article (see ‘Related links’) considered the initial measurement and depreciation of PPE.
Revaluation of PPE – IAS 16 position
IAS 16 allows entities the choice of two valuation models for PPE – the cost model or the revaluation model. Each model needs to be applied consistently to all PPE of the same ‘class’. A class of assets is a grouping of assets that have a similar nature or function within the business. For example, properties would typically be one class of assets, and plant and equipment another. Additionally, if the revaluation model is chosen, the revaluations need to be kept up to date, although IAS 16 is not specific as to how often assets need to be revalued.
When the revaluation model is used, assets are carried at their fair value, defined as ‘the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction’.
Revaluation gains are recognised in equity unless they reverse revaluation losses on the same asset that were previously recognised in the statement of profit or loss. In these circumstances, the revaluation gain is recognised in the statement of profit or loss. Revaluation changes the depreciable amount of an asset so subsequent depreciation charges are also affected.
A property was purchased on 1 January 20X0 for $2m (estimated depreciable amount was $1m and it had a useful life 50 years). Annual depreciation of $20,000 was charged from 20X0 to 20X4 inclusive and on 1 January 20X5 the carrying amount of the property was $1.9m. The property was revalued to $2.8m on 1 January 20X5 (estimated depreciable amount was $1.35m and the estimated useful life was unchanged). Show the treatment of the revaluation surplus and compute the revised annual depreciation charge.
The revaluation surplus of $900,000 ($2.8m – $1.9m) is recognised in the statement of changes in equity by crediting a revaluation reserve. The depreciable amount of the property is now $1.35m and the remaining estimated useful life 45 years (50 years from 1 January 20X0). Therefore, the depreciation charge from 20X5 onwards would be $30,000 ($1.35m x 1/45).
A revaluation usually increases the annual depreciation charge in the statement of profit or loss. In the above example, the annual increase is $10,000 ($30,000 – $20,000). IAS 16 allows (but does not require) entities to make a transfer of this ‘excess depreciation’ from the revaluation reserve directly to retained earnings.
Revaluation losses are recognised in the statement of profit or loss. The only exception to this rule is where a revaluation surplus exists relating to a previous revaluation of that asset. To that extent, a revaluation loss can be recognised in equity.
The property referred to in Example 1 was revalued on 31 December 20X6. Its fair value had fallen to $1.5m. Compute the revaluation loss and state how it should be treated in the financial statements.
The carrying amount of the property at 31 December 20X6 would have been $2.74m ($2.8m – 2 x $30,000). This means that the revaluation deficit is $1.24m ($2.74m – $1.5m).
If the transfer of excess depreciation (see above) is not made, then the balance in the revaluation reserve relating to this asset is $900,000 (see Example 1). Therefore $900,000 is deducted from equity and $340,000 ($1.24m – $900,000) is charged to the statement of profit or loss.
If the transfer of excess depreciation is made, then the balance on the revaluation reserve at 31 December 20X6 is $880,000 ($900,000 – 2 x $10,000). Therefore $880,000 is deducted from equity and $360,000 ($1.24m – $880,000) charged to the statement of profit or loss.
Derecognition of PPE – the IAS 16 position
PPE should be derecognised (removed from PPE) either on disposal or when no future economic benefits are expected from the asset (in other words, it is effectively scrapped). A gain or loss on disposal is recognised as the difference between the disposal proceeds and the carrying amount of the asset (using the cost or revaluation model) at the date of disposal. This net gain is included in the statement of profit or loss – the sales proceeds should not be recognised as revenue.
Where assets are measured using the revaluation model, any remaining balance in the revaluation reserve relating to the asset disposed of is transferred directly to retained earnings. No recycling of this balance into the statement of profit or loss is permitted.
Disposal of assets – IFRS 5 position
IFRS 5 is another standard that deals with the disposal of non-current assets and discontinued operations. An item of PPE becomes subject to the provisions of IFRS 5 (rather than IAS 16) if it is classified as held for sale. This classification can either be made for a single asset (where the planned disposal of an individual and fairly substantial asset takes place) or for a group of assets (where the disposal of a business component takes place). This article considers the implications of disposing of a single asset.
IFRS 5 is only applied if the held for sale criteria are satisfied, and an asset is classified as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continued use. For this to be the case, the asset must be available for immediate sale in its present condition and its sale must be highly probable. Therefore, an appropriate level of management must be committed to a plan to sell the asset, and an active programme to locate a buyer and complete the plan must have been initiated. The asset needs to be actively marketed at a reasonable price, and a successful sale should normally be expected within one year of the date of classification.
The types of asset that would typically satisfy the above criteria would be property, and very substantial items of plant and equipment. The normal disposal or scrapping of plant and equipment towards the end of its useful life would be subject to the provisions of IAS 16. When an asset is classified as held for sale, IFRS 5 requires that it be classified separately from all other non-current assets on the statement of financial position under the heading – ‘non-current assets held for sale’. No further depreciation is charged as its carrying amount will be recovered principally through sale rather than continuing use.
The existing carrying amount of the asset is compared with its ‘fair value less costs to sell’ (effectively the selling price less selling costs). If fair value less costs to sell is below the current carrying amount, then the asset is written down to fair value less costs to sell and an impairment loss recognised. When the asset is sold, any difference between the new carrying amount and the net selling price is shown as a profit or loss on sale.
An asset has a carrying amount of $600,000. It is classified as held for sale on 30 September 20X6. At that date its fair value less costs to sell is estimated at $550,000. The asset was sold for $555,000 on 30 November 20X6. The year end of the entity is 31 December 20X6.
- How would the classification as held for sale, and subsequent disposal, be treated in the 20X6 financial statements?
- How would the answer differ if the carrying amount of the asset at 30 September 20X6 was $500,000, with all other figures remaining the same?
- On 30 September 20X6, the asset would be written down to its fair value less costs to sell of $550,000 and an impairment loss of $50,000 recognised. It would be removed from non-current assets and presented in ‘non-current assets held for sale’. On 30 November 20X6 a profit on sale of $5,000 would be recognised.
- On 30 September 20X6 the asset would be transferred to non-current assets held for sale at its existing carrying amount of $500,000. When the asset is sold on 30 November 20X6, a profit on sale of $55,000 would be recognised.
Where an asset is measured under the revaluation model then IFRS 5 requires that its revaluation must be updated immediately prior to being classified as held for sale. The effect of this treatment is that the selling costs will always be charged to the statement of profit or loss at the date the asset is classified as held for sale.
An asset being classified as held for sale is currently carried under the revaluation model at $600,000. Its latest fair value is $700,000 and the estimated costs of selling the asset are $10,000. Show how this transaction would be recorded in the financial statements.
Immediately prior to being classified as held for sale, the asset would be revalued to its latest fair value of $700,000, with a credit of $100,000 to equity. The fair value less costs to sell of the asset is $690,000 ($700,000 – $10,000). On reclassification, the asset would be written down to this value (being lower than the updated revalued amount) and $10,000 charged to the statement of profit or loss.