Fully Depreciated Assets

Have you come across a situation when you find that the block of assets are fully depreciated in the books but the company is still using them in its operation to generate revenue? 

In this case, the original estimate of assets useful life proved to be incorrect.

These assets are used beyond their useful life, they are fully depreciated and their carrying amount in the books is zero. What depreciation expense can you recognize in the profit or loss?

None, of course – because the carrying amount of the assets cannot be sub zero. As a result, the matching principle does not work here. The expenses simply do not match the benefits gained from these assets.

The standard IAS 16 Property, Plant and Equipment defines the useful life as either:

· The period over which an asset is expected to be available for use by an entity, or

· The number of production or similar units expected to be obtained from the asset by an entity.

Now this is extremely important: IAS 16 requires entities to review assets’ useful lives at least at each financial year-end.

A survey proves that more than 95% of the companies do not revise the useful lives of their assets and book the depreciation charge based on the original rates determined for the block of assets. As a result, the companies are using fully depreciated assets for their production processes.

What is the solution then?

When faced with such a kind of situation the company can either:

1. Review the useful life of its assets at the end of each financial year; (IAS 8 - Change in Accounting Estimate) or

2. Use Revaluation Model (IAS 8 - Change in Accounting Policy)

Review the useful life of its assets at the end of each financial year:

If you change useful life of the assets then it is treated as a Change in Accounting Estimate as per IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. If the revised useful life is different from the original life then, set the new remaining useful life, take the carrying amount and recognize the depreciation charge based on the carrying amount and new remaining useful life.

No restatement of previous periods’ financial statements is required. IAS 8 requires recognizing change in accounting estimates prospectively.

Revaluation Model:

IAS 16 permits 2 models for subsequent measurement of your property, plant and equipment: cost model and revaluation model.

Revaluing assets with zero carrying amount will effectively mean that there is a Change in the Accounting Policy and hence the company will need to apply IAS 8.

IAS 8 mentions that an Accounting Policy can be changed in the following scenario: 

1. The change is required by an IFRS. With our situation, this definitely is not the case.

2. The change results in the financial statements providing reliable and more relevant information about the effects of transactions, other events or conditions on the entity’s financial position, financial performance or cash flows.

In our case, the second situation will match to an extent. But are we really considering the after effects of moving from a cost model to revaluation model for our block of assets? 

Accounting policy means using the prescribed rules and standards how you will report certain transactions in the financial statements – not only now, but also in the future.

So, do you think that changing your accounting policy from cost model to revaluation model would make you provide better information about your assets, not only now but also in the future?

· Revaluation model is used for buildings and land in most of the cases, because it’s easy to get the fair value of these assets regularly. In case of movable assets like plant or machine getting fair value from the market gets a bit difficult. 

· Revaluation of the assets have to be done with sufficient regularity, i.e. atleast annually. 

· Entire class of assets and not an individual assets needs to be revalued. 

· To determine the fair value of the class of assets, IFRS 13 Fair Value Measurement standard needs to be applied. This standard is complex and difficult for movable assets. 

If after considering the above concerns if it is still beneficial for your company to switch from cost model to revaluation model, the new depreciation accounting policy need not be applied retrospectively, just prospectively – no restatement of previous periods.

Other Comprehensive Income (OCI)

 

Prior to the introduction of IFRS 9, OCI had 5 components and the easier way to remember was the acronym CAART – which is:

• C – The effective portion of gains/losses on hedging instruments in a Cash flow hedge
• A - Actuarial gains and losses on defined benefit pension plans 
• A - Gains and losses on Available-for-sale financial assets
• R - Revaluation surplus related to property, plant and equipment
• T - Gains and losses arising from Translating the financial statements of a foreign operation

Now with IFRS 9 earlier adoption, the acronym has changed from CAART to CRAAFT

• C – The effective portion of gains and losses on hedging instruments in a Cash flow hedge
• R - Revaluation surplus related to property, plant and equipment
• A - Actuarial gains and losses on defined benefit pension plans 
• A - Gains and losses on Available-for-sale financial assets
• F - Financial liabilities designated as at fair value through profit or loss: fair value changes attributable to changes in the liability’s credit risk (IFRS 9)
• T - Gains and losses arising from Translating the financial statements of a foreign operation

There are many doubts as accountants are not sure whether a particular item is OCI or P&L and why other comprehensive income is also called as equity account, if it has anything to do with statement of changes in equity. What is the difference between other comprehensive income and profit or loss? What is the difference between other comprehensive income and changes in equity?

The answers to the above questions is in "Net Assets" of an organization. Net assets are contracts’ evidencing total assets less total liabilities of a company. It is the same as Equity which is the residual interest in the assets of an entity after deducting all of its liabilities. So equity will therefore consists of share capital, share premium, reserves, retained earnings or losses, etc.

Net assets or equity changes because of the following: 

• shareholders contribute cash to the company (share application money)
• profit or loss of the company for the year 
• buy back of own shares back from the market
• dividend payment to shareholders
• revaluation of certain assets directly through equity (e.g. available for sale financial assets) and not through profit or loss

The key to understand the difference between profit or loss, other comprehensive income and changes in equity is to understand where these changes are coming from. 

We can classify changes in net assets or equity into 2 main categories:

1. Capital changes – these are all changes related to owners of the company:

• Issuance of new shares
• Dividends payment to shareholders
• Buy-back of own shares from the market

All capital changes must be reported in the statement of changes in equity.

2. Revenue changes – these are all changes coming from the activities of the company and not from the owners. Revenue changes are further sub divided into 2 categories: 

• Changes resulting from main operating activities of the company that are reported in profit or loss. For example:
• Revenue from sales of goods or services 
• Expenses incurred to make sales of goods or services 
• All other income and expenses, such as finance, administrative, marketing, personnel, etc. 
• Gains related to primary performance (sale of property, plant and equipment, etc.) 

All these changes are reported in profit or loss.

• Changes resulting from other, non-primary or non-revenue producing activities of the company that are not reported in profit or loss as required or permitted by other IFRS standard. For example:
• The effective portion of gains and losses on hedging instruments in a Cash flow hedge
• Revaluation surplus related to property, plant and equipment
• Actuarial gains and losses on defined benefit pension plans 
• Gains and losses on Available-for-sale financial assets
• Financial liabilities designated as at fair value through profit or loss: fair value changes attributable to changes in the liability’s credit risk
• Gains and losses arising from Translating the financial statements of a foreign operation

This list is exhaustive and the standard setters do not think of other items that should potentially belong here. All these changes are reported in other comprehensive income.

The reason for introducing other comprehensive income and merging it with profit or loss into the statement of comprehensive income was to distinguish between capital and revenue changes.

The company needs to show clearly why its net assets go up or down – is it due to capital change or revenue change? 

If you answer these questions, you will exactly understand why OCI has only 6 components. Remember CRAAFT..