Cost-based measurement for assets

Cost-based measurement for assets
Joint World Bank and IFRS Foundation ‘train the trainers’ workshop hosted by the ECCB, 30 April to 4 May 2012

What is historical cost?
WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK |

Historical cost ‘concept’
3 Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances (for example, income taxes), at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business. © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 3

Cost-based IFRS measures
4 Few things measured at historical cost unimpaired land (IAS 16 + IAS 40 cost model) unimpaired indefinite life intangibles (IAS 38) unimpaired inventories (IAS 2) Cost-based measures are more common unimpaired depreciated historic cost (IAS 16) unimpaired amortised historical cost (IAS 38) amortised cost (IFRS 9) Impairment changes to a fair value or other measure © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 4

When are cost-based measures used for assets?
WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Asset Classification, recognition and measurement Assets 6 6 CM or RM
Nil Cost Cost Nil Lower of C or NRV some FVM CM or FVM Cost PP&E Intangible Cost Inv Property Inventory Assets Etc Financial Defined Benefit Fair value Deferred Tax Various AmC or FVM Various FV plan assets less PUC plan obligation & arbitrary rules Tax rates & undiscounted FV plan assets less PUC plan obligation & arbitrary rules Tax rates & undiscounted © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 6 6

MEASUREMENT AT INITIAL RECOGNITION BASIS OF IMPAIRMENT TEST
ASSET TYPE MEASUREMENT AT INITIAL RECOGNITION COST MODEL BASIS OF IMPAIRMENT TEST IAS 2 Inventory Cost of purchase and/or conversion costs and costs to get the item to the location and condition for sale Cost unless impaired Lower of cost (initial recognition) and net realisable value IAS 16 Property, Plant and Equipment Purchase costs + construction costs + costs to bring to the location and condition necessary to be capable of operating in the manner intended by management. Accounting policy choice: cost less accumulated depreciation and impairment, if any Compare carrying amount to recoverable amount. Recoverable amount is greater of value in use and fair value less disposal costs (IAS 36) IAS 38 Intangibles Assets Purchase costs + development costs + costs to bring to the location and condition necessary to be capable of operating as intended by management Accounting policy choice: cost less accumulated amortisation (unless indefinite life asset) and amortisation, if any IAS 40 Investment Property Cost including transaction costs Accounting policy choice: cost less accumulated depreciation (unless land) and impairment (if any) IFRS 9 Financial Instruments Fair value For particular business models amortised cost IAS 39 specifies impairment rules © 2010 IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK.

IAS 2 Inventories WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Measurement Inventories are initially measured at cost.
The cost of inventory includes costs of purchase and production or conversion. cost does not include abnormal wastage, administrative overheads that are not production costs and selling costs. Cost is assigned to each item of unique inventory using specific identification. FIFO or weighted average cost are used for ordinarily interchangeable inventory items. LIFO is prohibited. Inventory can be a qualifying asset in terms of IAS 23 Borrowing Costs MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Example—cost of purchase
10 A buys a good priced at CU500 per unit from Z. Z awards A a 20% discount on orders of units and 10% discount when A buys units in 1 year. The discounts apply to all units acquired in a year. A buys as follows: 800 units on 1/1/20X1 and 200 units on 24/12/20X1. On 31/12/20X1, 150 units were unsold (ie inventories of A). © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 10

Example—cost of purchase
11 A measures the cost of the inventories in 20X1 at CU350,000 [ie 1,000 units × (CU500 list price less 30%(CU500) volume discount)], because all units purchased in the year get the full 30% discount. A recognises: expense (cost of sales) of CU297,500 [ie 850 units sold × (CU500 list price less 30%(CU500) volume discount)] in profit or loss in 20X1 asset (inventories) of CU52,500 [ie 150 units unsold × (CU500 less 30%(CU500) discount)] at 31/12/20X1. © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 11

Example—conversion costs
12 A makes concrete blocks in reusable moulds. Blocks dry in a drying room for 2 weeks. Dried blocks & raw mat’s stored in separate rooms. A front-end loader (man 1) adds materials to the mixing machine operated by man 2. Casual labourers remove blocks from moulds. Man 3 supervises the factory. Man 4 does admin, finance and sales. A operates from rented premises (fixed payments). © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 12

Example—conversion costs
13 Costs of conversion include direct costs: casual labour. production overheads: factory rent (incl. raw mat’s area & drying room but excl. finished goods room); staff cost of man 1,2 & 3; depreciation of equipment (front end loader, mixing machine and moulds). © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 13

Write-down to net realisable value (NRV)
Inventories are reduced to NRV when this is lower than cost. NRV is estimated selling price less estimated costs to complete and sell (entity specific value). The write-down is made on an item by item basis. The write-down of groups of items may occur when the grouped items have similar uses, are produced or marketed in the same area and cannot be practicably evaluated separately from other items in that product line. Write-downs can be reversed. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Examples—NRV write-down
15 Ex 1: At reporting date CA (cost) of raw materials = 100 replacement cost = 80 est. selling price of finished good = 200 est. costs to convert the raw material into finished good = 60 est. costs to sell the finished good = 30 Ex 2: Same as Ex 1 except est. selling price = 180 © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 15

Example—reverse impairment
16 At 31/12/20X1 because of a decline in economic circumstances recognised an impairment loss on an item of inventory of 30 (ie cost = 100 & SP-CTC&S = 70) At 31/12/20X2 – because of an improvement in economic circumstance the SP-CTC&S of that item is 120 © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 16

Comparison to IFRS for SMEs
Inventory may qualify as a qualifying asset in accordance with IAS 23—borrowing costs incurred on qualifying assets may be considered for capitalisation. Unlike IAS 23, Section 25 Borrowing Costs of the IFRS for SMEs prohibits the capitalisation of borrowing costs—all borrowing costs are expensed. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Judgements and estimates
Calculating the cost of a manufacturer’s inventory involves a number of judgements, including: normal wastage allocating overheads (including plant depreciation) allocating joint costs to joint products. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Judgements and estimates continued
Impairment identifying impaired inventories estimating net realisable value. Net realisable value is an entity-specific measure and therefore judgement is required in order to determine the amounts expected to be realised upon sale of the inventory. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

IAS 16 Property, Plant and Equipment

Measurement PPE is initially recognised at cost Cost includes:
purchase costs construction costs costs to bring to the location and condition necessary to be capable of operating in the manner intended by management Subsequent costs qualify for capitalisation if they meet the asset recognition criteria WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Measurement continued
After initial recognition entity chooses to measure PPE either: at cost less accumulated depreciation and accumulated impairment (cost model); or at fair value less subsequent accumulated depreciation and accumulated impairment (revaluation model). WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Depreciation: PPE with a finite useful life is depreciated. land usually has an indefinite useful life and consequently land is not usually depreciated. Depreciation is the systematic allocation of the depreciable amount of an asset over its estimated useful life The depreciable amount of an asset is its cost (or substitute) less its residual value Different methods may be used but should best reflect the pattern of benefits associated with the asset WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Example—depreciation
24 On 1/1/20X1 buy machine for CU100,000. Initial estimates & judgements: useful life = 10 yrs & residual value = 0 straight‑line depreciation is appropriate At 31/12/20X5 year‑end reassess: useful life = 24 yrs (from the date of acq) and residual value = CU20,000 © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 24

Comparison to the IFRS for SMEs
Full IFRSs require an annual review of residual value, useful life and depreciation method of property, plant and equipment. Section 17 Property, Plant and Equipment of the IFRS for SMEs requires a review only if there is an indication that there has been a significant change since the last annual reporting date. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Cost of some items includes significant estimates costs of dismantling, removal, restoration costs of self constructed PPE Depreciation requires: identifying significant components to be depreciated separately estimating useful life and residual value identifying the depreciation method that reflects most closely the consumption of the service potential of the item of PPE MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Determining the classes of property, plant and equipment for presentation purposes. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

IAS 38 Intangible Assets WU
© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Measurement Intangible assets are measured initially at cost.
Thereafter, intangible assets are usually measured using the cost model—cost less accumulated amortisation (unless indefinite life) and impairment, if any. An intangible asset with a finite useful life is amortised and tested for impairment similarly to PPE. An intangible asset with an indefinite useful life is not amortised, but is tested annually for impairment or where evidence of impairment exists. WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Examples—estimating useful life
30 Ex 1: A acquires a customer list. Expects to benefit from list for 1–3 years. Ex 2: B acquires a 5-year airline route authority (ARA) that is renewable every 5 years at no cost renewal is routine if specified rules and regulations are complied with B is compliant and expects to fly the route indefinitely an analysis of demand and cash flows supports those assumptions © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 30

Comparison with the IFRS for SMEs
The main differences between IAS 38 and Section 18 Intangible Assets other than Goodwill of the IFRS for SMEs include that, in accordance with Section 18: all intangible assets are considered to have definite useful lives and, therefore, must all be amortised amortisation estimates need only be reviewed where there is an indication of a significant change WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Control of an asset arises when the entity has the power to obtain future economic benefits from the underlying resource and to restrict the access of other to those benefits. Intangible items of value to an entity may not be controlled by it, eg the assembled workforce and customer relationships. Research phase expenditures cannot be capitalised as assets. Development phase expenditures are capitalised when the specified criteria for asset recognition are satisfied. WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Amorisation requires: identifying a finite useful life intangible asset estimating useful life (residual value is usually assumed to be zero unless there is an active market) identifying the amortisation method that reflects most closely the consumption of the service potential of the item of the intangible asset. Impairment testing requires many estimates (see IAS 36). MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

IAS 40 Investment Property

Initial measurement An investment property is measured initially at cost. The cost of a property interest held under a lease is measured in accordance with IAS 17 Leases at the lower of the fair value of the property interest and the present value of the minimum lease payments. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Subsequent measurement
For subsequent measurement an entity must adopt either the fair value model or the cost model for all investment properties. All entities must estimate the fair value of investment property, either for measurement (if the entity uses the fair value model) or for disclosure (if it uses the cost model). Measure fair value in accordance with IFRS 13 Fair Value Measurement. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Cost model Investment property is measured at cost less accumulated depreciation and any accumulated impairment losses (ie using the cost model in IAS 16 Property, Plant and Equipment). Similar impairment consideration and principles must be applied. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

The main differences between IAS 40 and Section 16 Investment Property of the IFRS for SMEs include: the IFRS for SMEs does not have an accounting policy choice for measurement. The accounting for investment property is driven by circumstances. If an entity knows or can measure the fair value of an item of investment property without undue cost or effort on an ongoing basis, it must use the fair value through profit or loss model for that investment property. It must use the cost- depreciation-impairment model unlike IAS 40, the IFRS for SMEs does not require disclosure of the fair values of investment property measured on a cost basis. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Sometimes it is difficult to identify investment property. In such cases an entity develops criteria so that it can exercise that judgement consistently eg, owner of a hotel transfers some responsibilities to third parties under a management contract (PPE or investment property?) In some cases measuring fair value (see IFRS 13) When cost model used measuring depreciation (see IAS 16 for estimating residual value, depreciation method and useful life) MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

IAS 23 Borrowing Costs WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Introduction IAS 23 prescribes the accounting treatment for borrowing costs. Borrowing costs are interest and other costs incurred in connection with borrowing. WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Recognition An entity shall capitalise borrowing costs that are directly attributable to the acquisition, construction or production of an asset that takes a substantial time to get ready for its intended use or sale (a qualifying asset). Other borrowing costs are recognised as an expense in the period in which they are incurred. WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Recognition continued
Borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset are those that would have been avoided if the expenditure on the asset had not been made. They may be borrowing costs incurred on funds borrowed specifically for obtaining a qualifying asset or a calculated amount based on a weighted average borrowing rate applied to expenditure on the asset. WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Recognition continued
Capitalisation of borrowing costs takes place during the development of the asset, and ends when the asset is ready for its intended use or sale. When the asset is completed in parts, capitalisation of borrowing costs ceases when each part is ready for intended use or sale. WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Comparison to IFRS for SMEs
Unlike IAS 23, Section 25 Borrowing Costs of the IFRS for SMEs prohibits the capitalisation of borrowing costs—all borrowing costs are expensed. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Determining the amount of borrowing costs that are directly attributable to the acquisition of a qualifying assets requires judgement. For example: it might be difficult to identify a direct relationship between particular borrowings and a qualifying asset and to determine the borrowings that could otherwise have been avoided, particularly when financing is co- ordinated centrally. WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

IAS 36 Impairment of Assets

Which assets? IAS 36 applies to all assets other than those not within the scope of the Standard (IAS 36.2) Assets not within the scope include: Inventories Deferred tax assets Financial assets within the scope of IFRS 9 Investment property measured at fair value WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

When to test for impairment?
An entity must, at the end of every reporting period, assess whether there is any indication that an asset (or cash-generating unit) is impaired Irrespective of whether an indication of impairment exists, annual impairment tests must be conducted for: Intangible assets with an indefinite useful life; Intangible assets not yet available for use; and Goodwill acquired in a business combination. WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Measurement Impairment (IAS 36):
Comparison of the asset’s (or cash-generating unit’s) carrying amount to its recoverable amount Recoverable amount is the higher of fair value less costs to sell and value in use. Fair value less costs to sell is the arm’s length sale price between knowledgeable, willing parties less the costs of disposal. The value in use of an asset is the expected future cash flows the asset in its current condition will produce, discounted to present value using an appropriate pre-tax discount rate. WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Measurement Impairment (per IAS 36):
An impairment loss is recognised immediately in the statement of comprehensive income. When an impairment loss is recognised, the carrying amount of the asset (or cash-generating unit) is reduced. In a cash-generating unit, goodwill is reduced first, then other assets are reduced pro rata. The depreciation charge is adjusted in future periods to allocate the asset’s revised carrying amount over its remaining useful life. WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Example—CGU impairment
53 At 31/12/20X1 CA of a CGU’s assets = 210 (ie 150 taxis, 50 taxi licence & 10 goodwill) Impairment indicated & RA = 170. Fair value of taxis = 140. Impairment loss = 40 (ie 210 CA less 170 RA) 1st allocate 10 loss to goodwill 2nd allocate remaining 30 loss, ie 22.5 to taxis & 7.5 to licence (pro rata on CA) 3rd reallocate 12.5 loss from taxis to licence © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 53

Reversing an impairment loss (per IAS 36) Consistent with the ‘principle’ of not recognising an asset for internally generated goodwill, an impairment loss for goodwill is never reversed. For other assets, when the circumstances that caused the impairment loss are resolved, the impairment loss is reversed. However, the reversal is limited to the amount that the asset would have been had there been no impairment loss in prior years. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Example—impairment reversal
55 Facts from CGU impairment example. At 31/12/20X2 CA of CGU = 120 (ie 100 taxis & 20 licence) Impairment reversal indicated & RA estimated = 150 Potential impairment reversal = 30 (ie 150 RA less 120 CA) but limited to 20 (as follows) 1st allocate to assets pro rata on CAs, ie 5 to licence & 25 to taxis 2nd limit amt allocated to taxis to 7 (if no impairment in 20X1, CA at 20X2 = 107) © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 55

Example—impairment reversal
56 3rd reallocate 18 reversal from taxis to licence Total reversal provisionally allocated to licence = 23 (ie ) 4th limit amt allocated to licences to 13 (if no impairment in 20X1, CA at 20X2 = 33) 5th as there are no other assets to reallocate the unallocated 10 (ie 23 less 13) reversal to, limit the total impairment reversal to (ie 7 for taxis and 13 for licence) © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. 56

IAS 36 and Section 27 Impairment of Assets of the IFRS for SMEs share similar principles, but the IFRS for SMEs is drafted in simplified language. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Identifying some indicators of impairment requires judgement (eg decline in an asset’s market value; adverse changes in the technological, market, economic or legal environment; increase in market interest rates, among others). Identifying the lowest level of independent cash inflows for some groups of assets (ie cash- generating unit) requires judgement. Allocating goodwill to cash-generating units requires judgement. WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Measuring the value in use (an entity-specific measure) of an asset or group of assets involves estimating future cash flows that the entity expects to derive from the assets (its use and subsequent disposal) taking account of expectations about possible variations in the amount or timing of those cash flows adjusting for risks specific to the asset that market participants would reflect in pricing the asset identifying appropriate discount rates. WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Measuring the fair value less costs to sell of an asset or group of assets involves judgement see IFRS 13 for judgements and estimates in measuring fair value. estimating costs to sell can involve significant estimates. WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

IFRS 9 Financial Instruments

Financial assets at ‘cost’ measurement
Financial assets are initially measured at their fair value (which may be cost) adjusted for transaction costs if the subsequent measurement of the financial asset is not at fair value Amortised cost is the amount initially recognised for the financial asset less principal repayments and adjusted for cumulative amortisation using the effective interest rate method less any impairment losses (see paragraph 9 of IAS 39) WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

Financial assets at ‘cost’ measurement continued
Impairment if there is evidence of impairment, the impairment loss is the difference between the financial asset’s carrying amount and the present value of the estimated future cash flows discounted at the financial asset’s original effective interest rate. the reduction of the asset’s carrying amount is reflected directly to the asset or through an allowance account. the impairment loss is recognised in profit or loss. WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

64 64 The requirements are set out in International Financial Reporting Standards (IFRSs), as issued by the IASB at 1 January 2012 with an effective date after 1 January but not the IFRSs they will replace. The IFRS Foundation, the authors, the presenters and the publishers do not accept responsibility for loss caused to any person who acts or refrains from acting in reliance on the material in this PowerPoint presentation, whether such loss is caused by negligence or otherwise. © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK | 64

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