As we covered here, the IASB issued Property, Plant and Equipment: Proceeds before Intended Use, a limited-scope amendment to IAS 16.
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. Prior to the amendment, paragraph 17(e) stated 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 amended this item to read as follows:
- costs of testing whether the asset is functioning properly (i.e. 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 item of property, plant and equipment to the location and condition necessary for it to be capable of operating in the manner intended by management (such as samples produced when testing whether the asset is functioning properly). An entity recognizes the proceeds from selling any such items, and the cost of those items, in profit or loss in accordance with applicable Standards. The entity measures the cost of those items applying the measurement requirements of IAS 2.
The amendment responds to diversity found in practice (often within petrochemical and extractive industries): “Some entities deducted only proceeds from selling items produced while testing; others deducted the proceeds of all sales until an asset was in the location and condition necessary for it to be capable of operating in the manner intended by management (i.e. available for use). For some entities, the proceeds deducted from the cost of an item of property, plant and equipment could be significant and could exceed the costs of testing.” The amended IAS 16 is effective for annual reporting periods beginning on or after January 1, 2022, and is to be applied retrospectively, but only to items of PP&E made available for use from the beginning of the earliest period presented when first applying the amendments.
Canada’s IFRS Discussion Group recently discussed these amendments, noting that they affect any industry with an item of PP&E that takes a long time to prepare for its intended use – “for example, automotive original equipment manufacturers need to meet regulatory requirements for safety and compatibility and might generate pre-production sales.” They also referred to “the semi-conductor and energy sectors, which includes wind turbines, transmission and distribution lines, hydroelectric-dams and nuclear reactors.” The group noted that the amendments “can create challenges for entities in practice when allocating costs between the costs of items produced and the costs necessary to make the item of PP&E available for use.”
For example, IAS 2.12 requires that the costs of conversion of inventories include both direct costs as well as a systematic allocation of fixed and variable overheads (i.e., indirect costs), including depreciation. Under the amended IAS 16, entities need to allocate direct and indirect costs during that pre-available-for-use period between the items sold and the PP&E being developed, but as the amendments don’t specify any method for this, judgment is required to determine a rational and consistent basis of allocation. IAS 2.13 requires basing the allocation of fixed overheads on the normal capacity of the production facilities, with unallocated fixed overheads recognized as an expense when incurred; therefore, judgment is required to determine what is “normal capacity” for this purpose, which may be difficult when the PP&E isn’t yet available for its intended use.
And IAS 2.16 requires excluding certain costs from the cost of inventories: for example, abnormal amounts of wasted materials, labour or other production costs should be recognized as expenses when incurred. Determining such abnormal costs could also be challenging in the pre-production phase. It appears to follow that applying the amendments may require entities to upgrade their costing system to track costs and inputs in greater detail, for which the costs could be significant.
One group member thought that “if these costs are not material to the entity’s financial statements, the entity may consider developing a process to reasonably estimate the allocation between inventories and the PP&E instead of incurring significant costs to upgrade its financial systems.” The only surprise there is that the meeting report presents this as the musing of a single individual. One can hardly emphasize too often that if something plainly isn’t going to be material to the financial statements, then there should be no reason to expensively belabor the issue…
The opinions expressed are solely those of the author