Back in June, the IASB issued an exposure draft of proposed amendments to IAS 16 Property, Plant and Equipment— Proceeds before Intended Use
The comment period has closed already, but I’m only getting round now to writing about it (there’s always so much to cover!) It focuses on one of the examples provided in IAS 16.17 of “directly attributable costs” of an item of property, plant and equipment, which are included within the amount recognized as an asset. Paragraph 17(e) currently states that these include “costs 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 (such as samples produced when testing equipment).”
The IASB proposes amending this item to read as follows:
- costs of testing whether the asset is functioning properly (ie assessing whether the technical and physical performance of the asset is such that the asset is capable of being used in the production or supply of goods or services, for rental to others, or for administrative purposes)
(that is, to eliminate the reference to deducting the net proceeds of selling any items)
and to add the following:
- Items may be produced while bringing an asset to the location and condition necessary for it to be capable of operating in the manner intended by management, such as inventories produced when testing an asset. An entity recognizes the proceeds from selling any such items, and the costs of producing those items, in profit or loss in accordance with applicable Standards.
The amendment responds to diversity found in practice (often within petrochemical and extractive industries): “Some entities deduct only proceeds from selling items produced from testing; others deduct all sales proceeds until the asset is in the location and condition necessary for it to be capable of operating in the manner intended by management (ie available for use). For some entities, the proceeds deducted from the cost of an item of property, plant and equipment can be significant and can exceed the costs of testing.” The following essentially sums up the reasoning:
- The Board concluded that the proposed amendments would provide relevant information to users of financial statements by requiring entities to recognize all sales as income (including revenue) when they occur. The existing requirements in IAS 16 make it difficult for a user to have a clear picture of an entity’s total revenue in the period because some sales proceeds might be offset against the cost of property, plant and equipment. Those requirements also make it difficult to have a clear picture of the actual cost of some items of property, plant and equipment. The cost of those assets can be distorted by deducting sales proceeds before the assets are available for use.
Of course, some judgment will be required in identifying and separating out the costs that relate to such items produced and sold before an item of property, plant and equipment is available for use, but no more so, in the IASB’s view, than that already required by various aspects of this and other standards. Still, comment letters from both the Canadian Accounting Standards Board and from CPA Canada focused in on this issue among others, suggesting more guidance is required on how to exercise such judgment, if the proposal’s worth finalizing at all. A further review of the comment letters suggests the exposure draft may experience a bumpier ride to finalization than many – Financial Executives International Canada also disagreed with it, suggesting that it’s adequate simply to disclose any amounts deducted from the cost of the asset, and the major accounting firms also failed to express much enthusiasm (the Swedes liked it though).
In this, the respondents are following the lead of the one dissenting member of the IASB, whose alternate view – as often happens – perhaps makes for more stimulating reading than the proposals themselves. Although rather overwritten in some respects – “One of the basic accounting principles that has prevailed for a century is the cost principle…” – the dissenting member systematically sets out his view that the proposals basically amount to applying a flamethrower to an issue that only required nail scissors (one imagines that having reviewed the comment letters, he may be contentedly anticipating the prospects of a rare Lone Ranger victory over the rest of the Board…)
This isn’t to say the issue isn’t real though: I’ve come across it a few times myself from multiple perspectives – sometimes in cases where deducting net sale proceeds from the cost of the asset appeared questionable given the asset’s state of functioning, sometimes the opposite, and with patchy effectiveness on clarifying matters through disclosure. Still, at least in the cases I saw, the issue wasn’t sufficiently material or fundamental to affect any user’s understanding of performance or prospects. The IASB may have to reconsider whether that’s often enough the case that it can just leave well enough alone, especially if the current proposal, as the dissenting member warns, might result in “more severe earnings manipulation” than occurs at present…
The opinions expressed are solely those of the author