SECTION VI. ACCOUNTING FOR FIXED ASSETS
SECTION VI. ACCOUNTING FOR FIXED ASSETS
A. IAS 16, 23, 36
IAS 16 concerns Property, Plant and Equipment. IAS 36 concerns impairments of
assets. IAS 23 concerns borrowing costs for certain qualifying assets.
IAS 16 Property, Plant and Equipment
Property, plant and equipment are tangible assets owned by an enterprise for use in
production, supply of goods or services, rental, or administration purposes. They are
expected to be used for more than one period (year). Examples of property, plant
and equipment are land, buildings, machinery used in a factory, fixtures in a shop,
office equipment, furniture, and motor vehicles.
IAS 16 describes:
• Criteria for recognizing items as property, plant and equipment assets;
• How to value property, plant and equipment;
• How to account for subsequent expenditures relating to property, plant and
equipment;
• Depreciation charges to be recognized in relation to their value;
• Retirement of assets
• Disclosure required in financial statements.
Criteria for recognition
Items are recognized as Property, plant and equipment if:
• It is probable that future economic benefits will flow to the enterprise from
their use; and
• The cost of the asset can be reliably measured; and
• It is expected that they will be used for more than one year (period).
The following principles are applied when grouping or separating assets:
• Insignificant items like molds and dies can be aggregated as a single asset.
• Specialized spare parts and servicing equipment are recognized as property,
plant and equipment. (Most non-specialized spare parts are considered
inventory and are expensed as they are consumed.)
• Component parts are treated as separate items only if the related assets have
different useful lives or provide economic benefits in a different pattern. (An
example would be an aircraft and its engines.)
Value
Property, plant and equipment should be recorded at cost. Cost includes all costs
necessary to bring the asset to working condition for its intended use. Components
of necessary costs include purchase price, delivery costs, costs to prepare the site,
installation costs, and related professional fees for engineers and architects. General
and administrative expenses relating to acquisition and start-up costs are not
included.
Self-constructed assets are valued at cost including materials, labor and other inputs.
No profit is recognized on self-constructed assets.
When the property, plant or equipment is acquired in exchange for another asset, the
cost should be recorded as either:
84
SECTION VI. ACCOUNTING FOR FIXED ASSETS
•
•
Exchange involving dissimilar assets: the fair value of the asset acquired or
Exchange involving similar assets: the carrying amount of the asset given up.
Benchmark treatment in IAS 16 is to continue to carry property, plant and equipment
at historical cost less accumulated depreciation.
An allowed alternative treatment is to carry assets at revalued amounts less
subsequent depreciation.
Revaluations:
• Subsequent to initial recognition of an asset at cost, classes of property, plant
and equipment may be carried at revalued amounts.
• The revalued amount should be the fair value at the date of the revaluation
less any subsequent accumulated depreciation or subsequent accumulated
impairment losses.
• Fair value is usually the market price determined by appraisal.
• If the allowed alternative treatment is used, revaluations should be made
regularly so that the carrying amount of the asset does not differ materially
from fair value at the Balance Sheet date.
• When an asset is revalued the accumulated depreciation at that date is either
restated proportionately with the change in the gross carrying amount of the
asset or it is eliminated against the carrying amount of the asset and the net
amount is restated to the revalued amount of the asset.
• When an item of property, plant and equipment is revalued, the entire class of
assets must be revalued. Examples of classes of assets are buildings,
furniture, machinery, and office equipment.
• When a class of assets is revalued upwards, the increase should be credited
directly to equity (as revaluation surplus).
• When a class of assets is revalued downwards, the decrease should be
recognized as an expense unless it reverses a previous revaluation of the
same asset. In that case it should first reduce the amount of the revaluation
surplus included in equity; the amount remaining should be recognized as
expense.
Subsequent Expenditure
Subsequent expenditure relating to an item of property, plant and equipment should
be expensed in the period unless it is probable that it substantially improves the
performance of the existing asset. If it does substantially improve the performance of
the asset, the cost of the improvement is added to the cost of the asset. Useful life
and depreciation for the asset should be reviewed and adjusted as required.
Depreciation (see Section 6 of Guidelines)
Land is a fixed asset but is not depreciated. If the cost of land is included in the
purchase price of the building, the purchase price should be allocated between the
land and the building. The building is a depreciable asset.
As the economic benefits of property, plant and equipment are consumed, the
carrying amount of the asset is reduced to show this consumption by recording an
expense for depreciation.
• The depreciable amount of an asset is determined after deducting the
estimated residual value of the asset.
• The depreciable amount of each item of property, plant and equipment should
be allocated over its useful life in a systematic manner based on its pattern of
use.
• Allowable depreciation methods are:
o Straight-line
85
SECTION VI. ACCOUNTING FOR FIXED ASSETS
•
•
•
o Diminishing balance
o Sum-of-the-units
(Since the straight-line method is authorized by Mongolian tax regulations, it
is the one most likely to be chosen.)
Depreciation is an expense on the Income Statement or if the asset is used to
produce other assets (e.g. inventory), depreciation is included in the cost of
the assets produced.
The useful life of the assets should be reviewed periodically and if conditions
have changed the estimated useful life, then the depreciation charge for the
current and future periods should be adjusted.
The depreciation method used should be reviewed periodically. If there has
been a significant change in the pattern of economic benefits expected from
an asset then the depreciation method should be changed. The depreciation
charge for the current and future periods should be adjusted.
Retirement
Property, plant and equipment should be carried on the Balance Sheet until
permanent retirement or disposal.
When an asset is retired or disposed of the difference between net carrying amount
of the asset less disposal costs should be considered as a gain or loss and shown on
the Income Statement.
Disclosure
IAS 16 requires disclosure in the financial statements for each class of property, plant
and equipment. See summary of IAS 16.
IAS 36 Impairment of Assets
IAS 36 describes the procedures to ensure that assets are carried at no more than
their recoverable amount.
• Impairment losses may be indicated by either external or internal factors.
• IAS 36 applies to all assets except inventories, financial assets, assets arising
from construction contracts and some other specialized cases.
• Periodically assets should be reviewed to see whether or not there is an
indication that the asset may be impaired. An asset is impaired if the book
value exceeds the recoverable amount or value in use.
• Recoverable amount is the higher of an asset’s net selling price or value in
use.
• Net selling price is the amount obtainable from the sale of an asset less
incremental costs of disposal.
• Value in use is the present value of estimated future cash flows expecting to
arise from continuing use of the asset. Information regarding estimates of
future cash flows and discount rates can be found in IAS 36.
• An impairment loss occurs whenever the carrying amount of the asset
exceeds its recoverable amount or value in use. The asset should be
adjusted (credit entry) to reflect its lower value. Impairment loss for assets
carried at historical cost (less depreciation if applicable) should be recognized
on the Income Statement in non-operating expense. Impairment loss for
revalued assets should first be applied to the revaluation surplus as a
revaluation decrease until the surplus for that asset is exhausted.
• After the recognition of an impairment loss, future depreciation should be
adjusted to reflect the revised carrying amount of the asset.
• In rare instances an impairment loss recognized in prior years can be
reversed. Details can be found in IAS 36.
86
SECTION VI. ACCOUNTING FOR FIXED ASSETS
Disclosure
See summary of IAS 36.
IAS 23 Borrowing Costs
IAS 23 prescribes the accounting treatment for borrowing costs.
Borrowing costs are interest costs on short or long-term loans or overdrafts as well
as amortization of discounts or premiums related to borrowing and other costs of
borrowing.
Benchmark treatment in IAS 23 is that all borrowing costs should be expensed in the
period in which they are incurred regardless of the purpose of the borrowings.
An allowed alternative treatment is to include borrowing costs that relate to the
purchase, construction and production of qualifying assets in the cost of these
qualifying assets. This treatment can be applied in the case of self-constructed
assets that qualify.
Qualifying assets are assets that necessarily take a substantial period of time (more
than a year) to get ready for their intended use or sale. (Examples include property,
plant and equipment under construction and made-to-order inventories in process.)
IAS 23 specifies which costs to capitalize (add to the cost of the asset), when
capitalization should begin and end, and when it should be suspended.
As specified in IAS 36 above, when the carrying value of an asset, including the
amount of borrowing costs capitalized, exceeds its the recoverable amount or value
in use, the asset should be written down in accordance with IAS 36.
Disclosure
See summary of IAS 23.
87
SECTION VI. ACCOUNTING FOR FIXED ASSETS
Fixed Asset Accounting – Case Study
The following situation addresses accounting issues relating to property, plant and
equipment where the Balance Sheet date is 31 December 2001:
On 1 January 2001, Altai Company acquired production equipment for Tog 2,500,00.
The following further costs were incurred:
Togrog
• Delivery
180,000
• Installation
245,000
• General administrative costs
30,000
The installation and set up period took 3 months, and another Tog 210,000 was
spent on start-up costs directly related to bringing the asset to its working condition.
Monthly managerial reports indicated that for the first 5 months, the production
quantities from this equipment resulted in an initial operating loss of Tog 150,000
because of small quantities produced. The months afterwards show much more
positive results.
The equipment has an estimated useful life of 14 years. The residual value of the
equipment is estimated to be Tog 180,000; estimated costs to dismantle the
equipment are 125,000.
ISSUES: What value should be recorded as the historical cost of the asset? What
are the annual charges in the Income Statement related to the consumption of
economic benefits embodied in the asset?
Adapted from International Standards – A Practical Guide, 2nd edition by Hennie van
Greuning and Marius Koen, published by The World Bank, 2001
88
SECTION VI. ACCOUNTING FOR FIXED ASSETS
Fixed Asset Accounting – Case Study SOLUTION
Historical Cost of the Asset
Invoice price
Delivery
Installation
Start-up costs
Togrog
2,500,000
180,000
245,000
210,000
Total
3,135,000
Annual Charges related to the Equipment
Calculation of Net residual value
Estimated residual value
Less costs to dismantle
Net residual value
180,000
(125,000)
55,000
Historical Cost above
Less est. residual value
3,135,000
(55,000)
Depreciable amount
3,080,000
The annual charge to the Income Statement is Tog 220,000 (3,080,000/ 14 yrs).
Note that in the first year the charge will be 165,000 (9/12 X 220,000) because the
equipment was put into service on 1 April 2001 after installation and set-up.
Adapted from International Standards – A Practical Guide, 2nd edition by Hennie van
Greuning and Marius Koen, published by The World Bank, 2001
89
SECTION VI. ACCOUNTING FOR FIXED ASSETS
B. METHODOLOGY ON CONVERSION OF FIXED ASSET ACCOUNTING
Main Issues
In order to convert the fixed asset system of a company, accountants should have
knowledge of the following subjects:
•
•
•
•
•
•
Depreciation methods.
Such concepts as salvage value, book value, accumulated depreciation, and
historical cost of assets.
Accounting for repair, maintenance, and capital expenditure for fixed assets.
Methods to record depreciation expenses.
Methods to record fixed asset depreciation.
Methods to record fixed asset acquisition and disposal.
The accountant should learn about these issues by studying IAS and the guidelines
approved by the Ministry of Finance and Economy. This knowledge will be a
prerequisite for converting the fixed asset accounting system at an enterprise that
intends to implement IAS.
Main Problems and Weaknesses in Fixed Asset Accounting
The following problems and weaknesses are likely to be noticed in terms of fixed
asset accounting at an enterprise:
Problems and Weaknesses
Impact on Financial Statements
No subsidiary ledger is kept for fixed It is likely that the balance for fixed
assets.
assets is incorrect in the accounting
records as well as on the Balance
Sheet.
The depreciation expenses are calculated Reported depreciation expense and
directly based on the total fixed asset accumulated depreciation is not
amount reported on the Balance Sheet correct. Both the Balance Sheet and
Income Statement are misstated.
rather than by individual asset.
The depreciation expenses are not Due to the understated depreciation
charged for a certain time period although expenses (on the Income Statement),
fixed assets are in use and are shown on the book values of fixed assets are
the Balance Sheet.
overstated on the Balance Sheet.
No consistent application of the useful
Increased likelihood of errors in
lives and the depreciation rates for fixed
calculation.
assets.
The cost of goods sold or cost of goods
Improper allocation of depreciation
produced will not be reported correctly.
expenses. This will result in errors in the
Inventory cost will also be incorrect.
cost of goods sold as well as in
administrative and selling expenses.
Since the above weaknesses impair the fairness of financial statements, the
correction of the above weaknesses will be the major result of converting the
accounting system for fixed assets..
90
SECTION VI. ACCOUNTING FOR FIXED ASSETS
Suggested Steps for Converting the Accounting System
It is suggested that the following major steps be followed for converting fixed asset
accounting. It is useful to remember that the scope of work to convert the fixed
assets accounting system may differ from one enterprise to another depending on
the number and nature of fixed assets, procedures already in place, and whether the
fixed assets accounting has been systematically organized or maintained.
1. Review the status of the source documentation and fixed assets subsidiary
ledgers;
2. Ensure the fairness or reliability of the basic information necessary for the
fixed asset accounting. Included here are the historical cost, salvage value,
depreciation method, and useful life of the asset;
3. Select the depreciation method and the depreciation rates to be used;
4. Define the cost centers that depreciation expenses are to be charged to;
5. Ensure whether the new main and sub accounts for the fixes assets,
depreciation expenses and accumulated depreciation are set up properly, are
included in the Chart of Accounts, and are reflected correctly in the subsidiary
ledgers;
6. Analyze the information for the fixed assets;
7. Ensure the fairness or correctness of the beginning balance of accumulated
depreciation; and define necessary adjustments and record them. If there is
high likelihood of calculation errors in the past, the accumulated depreciation
for the prior periods can be recalculated and a correct amount for the
beginning balance of accumulated depreciation can be established. The
adjustment to the beginning balance of accumulated depreciation should be
made in the General Journal, and can also be reflected on the sheet for
beginning balance adjustments, if it is used.
8. Prepare new subsidiary ledgers for fixed assets. The specific use of fixed
assets needs to be reviewed so that fixed assets are identified and classified
according to their cost centers and locations (responsibility centers). The
correct balances for the beginning balance of accumulated depreciation are
indicated in the subsidiary ledgers in order to prepare the ledger for the next
accounting period.
9. Estimate the depreciation expenses for the current accounting period. The
depreciation expenses are calculated in accordance with IAS and reflected in
subsidiary ledgers. The journal entries to record and allocate depreciation
expenses are made in the General Journal.
A more detailed explanation for the above steps has been attached at the end of this
section.
Specific considerations:
It is useful to consider the following conditions when the accounting system for fixed
assets is being converted.
•
It may become necessary to conduct a physical count of fixed assets to
ensure fairness of the fixed assets records in order to fully comply with IAS. A
physical count is more likely to be needed in enterprises that have not
subsidiary ledgers or initial records for fixed asset acquisition. As a result of
the physical count, the recorded amount of fixed assets may need to be
91
SECTION VI. ACCOUNTING FOR FIXED ASSETS
•
•
increased or decreased. It is a good practice to conduct a physical count of
fixed assets at least once a year.
Also for the purpose of the identification of assets to be recorded as fixed
assets, the enterprise may need to establish some kind of a threshold for the
cost of assets. There are some cases where enterprises have recorded low
value supply items as fixed assets.
Some entities may have performed fixed asset revaluation. In this case, the
revalued amounts would be the basic information to rely on in the future
accounting for fixed assets. It may become necessary to review the
depreciation charge for the periods after the revaluation.
Results of Converting Fixed Assets Accounting to Comply with IAS
An enterprise will achieve the following results from converting its fixed assets
accounting system:
• Fixed assets are controlled through subsidiary ledgers.
• The subsidiary ledger and other forms for fixed assets are kept in complete
and correct order.
• The depreciation percentage, useful lives and depreciation method are
applied consistently.
• Depreciation expenses are estimated correctly and allocated properly
between product and period costs.
• The names and codes of accounts for fixed assets, accumulated depreciation,
and depreciation expenses are defined systematically and used properly.
Steps for Converting Payroll Accounting
Indications that Conversion is Required
Objectives and outcomes
1. Review the status of the source documentation and fixed assets subsidiary
ledgers
Weak documentation. This is likely to The source documents and
result in misstatement of asset value
ledgers need to be kept in
and depreciation.
complete and correct form in the
future.
2. Ensure the fairness or reliability of the basic information
Calculation errors occur due to
Correct the fixed assets
inconsistent and incorrect application information, and make it
of historical cost, book value, and
available for accounting in the
deprecation rates.
future.
3. Select the depreciation method and the depreciation rates
The depreciation method and rates
Select the depreciation method
are not consistently applied and there and depreciation rate that
may be confusion between rates used ensures compliance with IAS for
for tax reporting and financial
financial reporting and apply it
reporting.
consistently.
4. Define the cost centers that depreciation expenses are to be charged to
92
SECTION VI. ACCOUNTING FOR FIXED ASSETS
Due to misunderstanding concerning
asset utilization, depreciation
expenses may be misallocated
among cost centers.
Determine asset use and make
correct allocation of depreciation
expenses. The subsidiary
ledgers for fixed assets need to
be kept in such a way that
facilitates proper allocation of
depreciation expenses among
cost centers.
5. Revise accounts
New main and sub accounts
need to be defined.
6. Analyze the information on fixed assets
Verify consistency between the
The fact that a subsidiary ledger is
not used and depreciation expense is amount of accumulated
depreciation on the Balance
calculated roughly may result in
Sheet and depreciation
calculation errors and misstated
expenses on the Income
accumulated depreciation on the
Balance Sheet. A review needs to be Statement. Examine any
differences and make correcting
done to see whether depreciation
(adjusting) entries.
expenses are allocated correctly in
the prior periods.
7. Ensure the fairness or correctness of the beginning balance of
accumulated depreciation; and define necessary adjustments and record
adjustments.
Errors in calculation or recording may If there is high probability of
have been made.
errors in calculation or recording,
the depreciation charge for
certain prior periods should be
recalculated and a correct
balance for the accumulated
depreciation defined.
8. Prepare new subsidiary ledgers for fixed assets
Asset information such as
Subsidiary ledgers may be incorrect,
historical cost and beginning
incomplete or missing. The
balance of accumulated
subsidiary ledgers for fixed assets
form a sound foundation for a correct depreciation need to be reflected
in the subsidiary ledger correctly.
estimation of an asset’s book value
This will form the basis of correct
and depreciation.
accounting information to be
used in future periods.
9. To record depreciation expenses for the current accounting period
Based on the allowed
Depreciation expenses may not be
depreciation method and useful
allocated properly among cost
lives (a) the depreciation for the
centers.
current period needs to be
estimated correctly, (b) reflected
in the subsidiary ledger, and (c)
correct journal entries need to be
made to allocate depreciation
expense to the proper center.
93