IAS 16
Instances where the cost of an asset cannot be measured reliably
Under IAS 16 (International Accounting Standard 16), the cost of an asset is initially measured at
its purchase price, including any costs directly attributable to bringing the asset to the location
and condition necessary for it to be capable of operating in the manner intended by management.
However, there are instances where the cost of an asset cannot be measured reliably. Here are a
few examples:
1. Donated Assets: When an asset is acquired through donation, its fair value may not be
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reliably measurable if there is no market value or the asset is unique and difficult to value
objectively.
Exchange Transactions: If an asset is acquired through a non-monetary exchange
(barter), determining the fair value of both the asset given up and the asset received can
be challenging, especially if no reliable market value exists.
Self-Constructed Assets: For assets that a company constructs for its own use, such as
buildings or machinery, the cost includes direct materials, labor, and a portion of
overheads. Allocating overheads and determining the appropriate cost allocation method
can sometimes be subjective and may not be reliably measurable.
Historical Assets: In cases where assets have been held for a long time or acquired many
years ago, the historical cost may not reflect their current fair value. Assessing the fair
value of such assets, especially when no reliable market exists, can pose challenges.
Unique Assets: Assets that are unique or specialized and have no comparable market
may lack reliable measurement of their cost. For example, specialized machinery used in
a unique manufacturing process may not have a readily available market value.
Intangible Assets: Determining the cost of intangible assets, such as internally generated
patents or copyrights, can be difficult. Often, there is no market for such assets, and their
valuation relies heavily on estimates and assumptions.
In all these cases, IAS 16 requires that if the cost of an asset cannot be measured reliably, the
asset should be initially recognized at its fair value at the date of acquisition. Fair value
represents the amount for which an asset could be exchanged between knowledgeable and
willing parties in an arm's length transaction.
The accounting treatment when an asset does not meet the recognition criteria specified in
IAS 16
When an asset does not meet the recognition criteria specified in IAS 16 (International
Accounting Standard 16), which outlines the conditions for recognizing an asset on the balance
sheet, the accounting treatment typically depends on the specific situation. Here are common
scenarios and their treatments:
1. Recognition Criteria Not Met:
○ Not Probable Future Economic Benefits: If it is not probable that future
economic benefits associated with the asset will flow to the entity, the asset
should not be recognized on the balance sheet. Instead, any expenditure incurred
in relation to such assets would be recognized as an expense in the period in
which it is incurred.
2. Already Recognized as an Expense: Sometimes, costs incurred for items that might
otherwise qualify as assets under IAS 16 have already been recognized as expenses in
previous periods. In such cases, no asset is recognized, and any further costs are expensed
as incurred.
3. Subsequent Costs: If an item has been recognized as an expense initially because it did
not meet the recognition criteria, subsequent costs incurred to improve or maintain the
asset are generally expensed as incurred. These costs do not get capitalized because the
initial recognition criteria were not met.
4. Disclosure: Even if an asset does not meet the recognition criteria under IAS 16, entities
may still need to disclose significant items of expenditure that have been recognized as
expenses in the financial statements.
It's important for entities to carefully assess whether an expenditure meets the criteria for
recognition as an asset under IAS 16. If it does not meet these criteria, the expenditure should
generally be expensed in the period it is incurred. This treatment ensures that financial
statements provide reliable information about the entity's financial position and performance in
accordance with International Financial Reporting Standards (IFRS).
How is asset held under IAS 16 for rentals different from asset held for rentals under IAS
40?
Under IAS 16 (Property, Plant and Equipment) and IAS 40 (Investment Property), assets held for
rentals are treated differently primarily based on their classification and the accounting treatment
prescribed by each standard:
1. IAS 16 - Property, Plant and Equipment:
○ Classification: Assets are classified as property, plant, and equipment if they are
held for use in the production or supply of goods or services, for rental to others,
or for administrative purposes.
○ Accounting Treatment: Assets under IAS 16 are typically depreciated
systematically over their useful lives, reflecting the consumption of economic
benefits over time. The depreciation method used should reflect the pattern in
which the asset's economic benefits are expected to be consumed by the entity.
2. IAS 40 - Investment Property:
○ Classification: Investment property is property (land or buildings) held to earn
rentals or for capital appreciation, or both. It is not used in the production or
supply of goods or services or for administrative purposes.
○ Accounting Treatment: Investment property is measured initially at cost and
subsequently at fair value, with changes in fair value recognized in profit or loss.
However, if fair value cannot be reliably measured, the property is accounted for
using the cost model (similar to IAS 16), where it is depreciated over its useful
life.
Key Differences:
Purpose: IAS 16 covers assets used in operations or rented out as part of the entity's
main business activities (like equipment rented out by a manufacturing company),
whereas IAS 40 covers properties held specifically for earning rentals or for capital
appreciation (like buildings held for leasing to third parties).
● Measurement:
○ Under IAS 16, assets are generally measured at cost less accumulated
depreciation and impairment losses.
○ Under IAS 40, investment properties are initially measured at cost and
subsequently at fair value, with changes in fair value recognized in profit or loss.
If fair value cannot be reliably measured, the property is accounted for using the
cost model, similar to IAS 16.
● Depreciation vs. Fair Value Model:
○ IAS 16 requires depreciation based on the asset's useful life.
○ IAS 40 allows for the fair value model, where investment properties are revalued
to fair value at each reporting date, with changes in fair value recognized in profit
or loss.
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In summary, the key distinction lies in the primary purpose of the asset (operational use vs. rental
income or capital appreciation), which drives the classification under either IAS 16 or IAS 40,
and subsequently determines the accounting treatment (depreciation under IAS 16 vs. fair value
measurement under IAS 40).
IAS 2 Inventories
Reversal of NRV
A common example of net realizable value reversal can be seen in the context of inventory
valuation. Let's say a company initially values its inventory at $50,000 based on cost, but due to
market conditions or other factors, the net realizable value (NRV) of the inventory drops to
$40,000. In this case, the company would recognize a loss of $10,000 ($50,000 - $40,000) to
reflect the decline in the NRV of its inventory.
Now, if the market conditions improve subsequently, and the NRV of the same inventory
increases back to $48,000, the company would then reverse part of the previous write-down. The
reversal would be $8,000 ($48,000 - $40,000), resulting in a gain on inventory valuation.
Thus, the net realizable value reversal process involves adjusting inventory values to reflect
changes in market conditions, ensuring that inventory is reported at the lower of cost or net
realizable value as required by accounting standards.
Reversal can only be upto the extent of amount of original write down.
IAS 20 Government Grants
Repayment of Grants
A government grant that becomes repayable is accounted for as a revision of the accounting
estimate.
Are all the changes in accounting estimates prospective?
No, not all changes in accounting estimates are prospective. Changes in accounting estimates can
be classified into two main categories: prospective and retrospective.
1.
Prospective Changes: These are changes that affect the current and future financial
statements, but they do not require adjustments to previously reported financial statements.
Examples include changes in estimates for bad debts, useful lives of assets, or provisions for
legal settlements. When such changes occur, they are applied prospectively from the date of the
change.
2.
Retrospective Changes: These changes require adjustments to previously reported
financial statements because they apply retrospectively, meaning they affect the current financial
statements and require adjustments to the comparative prior period financial statements.
Examples include changes in accounting policies (like switching from FIFO to average cost),
correction of errors in prior period financial statements, or changes in the method of recognizing
revenue or expenses.
Therefore, while prospective changes in accounting estimates are more common and do not
require restating prior financial statements, retrospective changes can have a significant impact
on comparative financial statements as they require adjustments to reflect the change in estimate
for all periods presented.
IAS 38 – Intangible Assets
Are training employees cost an intangible asset as per IAS 38?
Under IAS 38 (International Accounting Standard 38), which deals with intangible assets, costs
incurred for training employees do not typically qualify as intangible assets that can be
recognized on the balance sheet. Here’s why:
Recognition Criteria for Intangible Assets: According to IAS 38, an intangible asset is
recognized if it meets certain criteria, including:
It is identifiable (separable or arises from contractual or other legal rights).
It is controlled by the entity (power to obtain future economic benefits from the asset).
Training Costs: Costs incurred for training employees generally do not meet these recognition
criteria because:
They do not typically give rise to identifiable and separable assets that the entity can control.
Training programs usually result in improved skills and knowledge of employees, which are
considered as enhancing human capital rather than creating a separable asset.
The future economic benefits from training employees are uncertain and do not meet the criteria
for recognition as an intangible asset under IAS 38.
Expense Recognition: Instead of capitalizing training costs as an intangible asset, IAS 38
requires such costs to be expensed as incurred. This means the costs are recognized as expenses
in the period in which they are incurred, typically as part of employee compensation or operating
expenses.
Therefore, under IAS 38, training costs for employees are generally treated as expenses rather
than being recognized as intangible assets on the balance sheet. This treatment aligns with the
principle that intangible assets must meet specific criteria related to identifiability, control, and
expected economic benefits to be recognized as assets under international accounting standards.
Examples of Level 1,2 &3 inputs in IFRS 13
In the Indian context, examples of Level 1, Level 2, and Level 3 inputs under IFRS 13 (which is
mirrored in India's Ind AS 113) can be illustrated with specific financial instruments and market
practices in India.
Level 1 Inputs:
1. Publicly Traded Equity Securities:
- Shares of companies listed on the Bombay Stock Exchange (BSE) or the National Stock
Exchange of India (NSE). For instance, shares of Reliance Industries Limited or Tata
Consultancy Services.
2. Government Securities:
- Actively traded government bonds or treasury bills. For example, Government of India
10-year bonds that are quoted daily on exchanges.
3. Exchange-Traded Funds (ETFs):
- Prices of ETFs listed on the NSE, such as the Nippon India ETF Nifty BeES.
Level 2 Inputs:
1. Corporate Bonds:
- Prices derived from market transactions involving similar bonds, such as bonds issued by
major corporations like HDFC or Infosys, where the market for these specific bonds may not be
highly liquid but similar bonds are traded.
2. Mutual Fund Units:
- Net asset value (NAV) of mutual fund units which are based on the underlying securities that
may not have daily quoted prices but are observable through market indices or ratings.
3. Interest Rate Swaps:
- Inputs such as the Mumbai Interbank Offer Rate (MIBOR) yield curves or credit spreads
observable at commonly quoted intervals.
Level 3 Inputs:
1. Private Equity Investments:
- Investments in startups or unlisted companies where valuations are based on internal models
or discounted cash flow projections. For example, an investment in a private tech startup in
Bangalore.
2. Unlisted Equity Instruments:
- Shares in family-owned businesses or smaller companies that do not have active trading
markets, requiring valuation based on financial performance and future growth estimates.
3. Real Estate Valuation:
- Properties in less active markets or unique properties where comparable sales data is not
readily available. Valuations may be based on discounted cash flow models or other internal
appraisals. For example, a specialized commercial property in a less developed region.
Summary:
- Level 1: Quoted prices in active Indian markets for identical items (e.g., BSE/NSE listed
shares).
- Level 2: Other observable inputs in the Indian context, either directly or indirectly (e.g.,
corporate bonds, mutual fund NAVs).
- Level 3:Unobservable inputs, relying on the entity's own assumptions (e.g., private equity,
unlisted shares, certain real estate valuations).
These examples help illustrate how the fair value hierarchy can be applied within the specific
financial and market environment of India.