This month’s article on International Financial Reporting Standards is by Lisa Mladenovic, CA, a independent consultant specializing in IFRS transition services, financial reporting and process improvement. She is also the presenter of our upcoming webinar IFRS - Property, Plant and Equipment.
One of the most discussed areas of impact on transitioning to IFRS is property, plant and equipment (PP&E). There are a number of changes that may impact your accounting policies and financial statement presentation.
For example, there are a number of optional exemptions available to first-time adopters and one relates to PP&E. IFRS 1 permits a first-time adopter to elect to report items of property, plant and equipment in its opening statement of financial position at fair value on that date instead of “IAS 16 original cost.”
Even if an entity does not take the exemption to apply fair value, the IFRS financial statements must comply with the PP&E section. Consider that under IFRS there are two models to value property, plant and equipment once IFRS has been adopted – the cost model and the revaluation model.
The cost model works essentially the same way as under former Canadian GAAP with items carried at cost less any accumulated depreciation and any accumulated impairment losses. The difference from former Canadian GAAP is in how cost and depreciation are determined. As mentioned previously, acquisition costs may not be included in cost under IFRS. The depreciation calculation varies between IFRS and Canadian GAAP in that former Canadian GAAP bases the calculation on cost less residual value whereas former Canadian GAAP bases it on the greater of the IFRS amount and an allocation of cost less salvage value. There is also more detail in the calculation of residual value under IFRS that may lead to differences.
The revaluation model allows for items of PP&E, whose fair value can be measured reliably, to be carried at the revalued amount. This is not permitted under former Canadian GAAP (other than for impairment). These assets are then depreciated using the revalued amounts, and gains or losses on disposal are calculated on this basis as well. Any upward revaluations are recognized in other comprehensive income (OCI), and never in operating income. The amounts accumulate in OCI, and when the asset is fully depreciated or derecognized, the total is transferred directly to retained earnings.
Additionally, there is a greater focus on componentization than in former Canadian GAAP. This involves identifying significant components of an asset that have different useful lives, separating the cost portions, and depreciating them separately. Gathering the data to determine the amounts for significant parts may be challenging for some companies, if the assets were acquired some time ago.
An example of an asset that may require componentization is an aircraft, where the useful lives of the engine, airframe, and overhaul cost components differ significantly. Some may wonder why overhaul costs are included as a component of the asset. Actually, this is one of the major areas that impacts organizations that incur major overhaul and inspection costs when they transition to IFRS.
Overhaul and maintenance costs were often expensed under former Canadian GAAP, as only costs meeting the criteria of a betterment were capitalized. This is different from IFRS, as IFRS requires all major inspections or overhaul costs to be capitalized, after derecognizing any previously capitalized inspection or overhaul costs. These overhaul costs may involve three elements: inspection, replacement of parts, and major maintenance.
Major spare parts (engines and rotables) were usually capitalized as PP&E under former Canadian GAAP where the individual part cost exceeded a materiality threshold. Any parts below this threshold were expensed as maintenance. Under IFRS, replacement parts are recognized as PP&E if they provide incremental future benefits to the entity and can be reliably measured. Per IAS 16, major spare parts and stand-by equipment qualify as property, plant and equipment when an entity expects to use them during more than one period. Similarly, if the spare parts and servicing equipment can be used only in connection with an item of property, plant and equipment, they are accounted for as property, plant and equipment. The original part is derecognized, whether or not the original part was recognized as a separate component in PP&E.
Where is it not practicable to determine the carrying amount of the replaced part, the cost of the replacement (net of depreciation) may be used as a guide for determining the depreciated cost of the replaced part [IAS 16.70]. All other subsequent costs should be recognized as an expense in the period in which they are incurred.
Thus, the Standard explains that the costs of the day-to-day servicing of an item of property, plant and equipment are not recognized as an asset. Instead, such costs are recognized in profit or loss as incurred. Day-to-day servicing costs include costs of labour and consumables, and may include the cost of small replacement parts. The purpose of this type of expenditure is often known as “repairs and maintenance.” The reason why such costs are expensed rather than capitalized is that they do not add to the future economic benefits to the item of property, plant and equipment. Rather, they maintain the asset's potential to deliver the level of future economic benefits that it was expected to provide when it was originally acquired. These subsequent repair and maintenance costs do not, therefore, qualify for recognition as an asset in their own right. Organizations should continue to expense routine maintenance, but capitalize major inspection or overhaul costs – this change is to be applied retrospectively.
Other IFRS sections may also affect PP&E depending upon their nature. These include:
A complete review of these areas, and how they will impact your financial statements and accounting policy, will form part of the upcoming webinar on this topic.
Finally, one other area of change, which is the most visible, is financial statement presentation and disclosure. Generally speaking, there is more note disclosure under IFRS than under former Canadian GAAP. The objective of this additional disclosure is to provide users with more explanation and background, so that they can better understand the financial results presented. Notes must be presented in a systematic order and be cross referenced chronologically to the financial statements, which is a different requirement than under former Canadian GAAP. Some of the differences in presentation and disclosure that you can expect under IFRS, related to PP&E, are:
more continuity schedules and reconciliations: