INVENTORIES IAS 2

CALCULATIONS ON INVESTMENT PROPERTY

Question 1

A business owns a building which it has been using as a head office. In order to reduce cost, on 30 June 20X9 it moved its head office functions to one of its production centres and is now letting out its head office. Company policy is to use the fair value model for investment property.

The building had an original cost on 1 January 20X0 of $250,000 and was being depreciated over 50 years. At 30 June 20X9 its fair value was judged to be $350,000.

Required:

How will this appear in the financial statements at 31 December 20X9?

Solution

Question 2

An entity purchased an investment property on 1 January 2004, for a cost of $400,000. The property has a useful life of 50 years, with no residual value, and at 31 December 2006 had a fair value of $560,000. On 1 January 2007 the property was sold for net proceeds of $540,000.

Required:

How will the disposal be treated using the Cost Model and the Fair Value Model.

INVESTMENT PROPERTY IAS 40

Investment property is property (land or a building or part of a building or both) held (by the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or both. [IAS 40.5]

Examples of investment property: [IAS 40.8]

• land held for long-term capital appreciation
• land held for a currently undetermined future use
• building leased out under an operating lease
• vacant building held to be leased out under an operating lease
•   property that is being constructed or developed for future use as investment property

The following are not investment property and, therefore, are outside the scope of IAS 40: [IAS 40.5 and 40.9]

•       Property held for use in the production or supply of goods or services or for administrative purposes
•      Property held for sale in the ordinary course of business or in the process of construction of development for such sale (IAS 2 Inventories)
•     Property being constructed or developed on behalf of third parties (IAS 11 Construction Contracts)
•        Owner-occupied property (IAS 16 Property, Plant and Equipment), including property held for future use as owner-occupied property, property held for future development and subsequent use as owner-occupied property, property occupied by employees and owner-occupied property awaiting disposal
•        Property leased to another entity under a finance lease

An entity may make the foregoing classification on a property-by-property basis.

·         Partial own use. If the owner uses part of the property for its own use, and part to earn rentals or for capital appreciation, and the portions can be sold or leased out separately, they are accounted for separately. Therefore the part that is rented out is investment property. If the portions cannot be sold or leased out separately, the property is investment property only if the owner-occupied portion is insignificant. [IAS 40.10]

·         Ancillary services. If the entity provides ancillary services to the occupants of a property held by the entity, the appropriateness of classification as investment property is determined by the significance of the services provided. If those services are a relatively insignificant component of the arrangement as a whole (for instance, the building owner supplies security and maintenance services to the lessees), then the entity may treat the property as investment property. Where the services provided are more significant (such as in the case of an owner-managed hotel), the property should be classified as owner-occupied. [IAS 40.13]

·        Intracompany rentals. Property rented to a parent, subsidiary, or fellow subsidiary is not investment property in consolidated financial statements that include both the lessor and the lessee, because the property is owner-occupied from the perspective of the group. However, such property could qualify as investment property in the separate financial statements of the lessor, if the definition of investment property is otherwise met. [IAS 40.15]

Recognition

Investment property should be recognized as an asset when it is probable that the future economic benefits that are associated with the property will flow to the entity, and the cost of the property can be reliably measured. [IAS 40.16]

Measurement subsequent to initial recognition

IAS 40 permits entities to choose between: [IAS 40.30]

·         a fair value model, and

·         a cost model.

However, property held under an operating lease shall be measured initially using the principles contained in IAS 17, Leases—at the lower of the fair value and the present value of the minimum lease payments. A key matter here is that the item accounted for at fair value is not the property itself but the lease interest.

One method must be adopted for all of an entity's investment property. Change is permitted only if this results in a more appropriate presentation. IAS 40 notes that this is highly unlikely for a change from a fair value model to a cost model.

Fair value model

Investment property is remeasured at fair value, which is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. [IAS 40.5] Gains or losses arising from changes in the fair value of investment property must be included in net profit or loss for the period in which it arises. [IAS 40.35]

Fair value should reflect the actual market state and circumstances as of the balance sheet date. [IAS 40.38] The best evidence of fair value is normally given by current prices on an active market for similar property in the same location and condition and subject to similar lease and other contracts. [IAS 40.45] In the absence of such information, the entity may consider current prices for properties of a different nature or subject to different conditions, recent prices on less active markets with adjustments to reflect changes in economic conditions, and discounted cash flow projections based on reliable estimates of future cash flows. [IAS 40.46]

There is a rebuttable presumption that the entity will be able to determine the fair value of an investment property reliably on a continuing basis. However: [IAS 40.53]

If an entity determines that the fair value of an investment property under construction is not reliably determinable but expects the fair value of the property to be reliably determinable when construction is complete, it measures that investment property under construction at cost until either its fair value becomes reliably determinable or construction is completed.

 If an entity determines that the fair value of an investment property (other than an investment property under construction) is not reliably determinable on a continuing basis, the entity shall measure that investment property using the cost model in IAS 16. The residual value of the investment property shall be assumed to be zero. The entity shall apply IAS 16 until disposal of the investment property.

Where a property has previously been measured at fair value, it should continue to be measured at fair value until disposal, even if comparable market transactions become less frequent or market prices become less readily available. [IAS 40.55]

Cost model

After initial recognition, investment property is accounted for in accordance with the cost model as set out in IAS 16 Property, Plant and Equipment – cost less accumulated depreciation and less accumulated impairment losses. [IAS 40.56]

Transfers to or from investment property classification

Transfers to, or from, investment property should only be made when there is a change in use, evidenced by one or more of the following: [IAS 40.57 (note that this list was changed from an exhaustive list to an non-exhaustive list of examples by Transfers of Investment Property in December 2016 effective 1 January 2018) ]

•      commencement of owner-occupation (transfer from investment property to owner-occupied   property)
•     commencement of development with a view to sale (transfer from investment property to   inventories)
•        end of owner-occupation (transfer from owner-occupied property to investment property) 
•        commencement of an operating lease to another party (transfer from inventories to investment   property) 
•   end of construction or development (transfer from property in the course of    construction/development to investment property

When an entity decides to sell an investment property without development, the property is not reclassified as inventory but is dealt with as investment property until it is derecognised. [IAS 40.58]

The following rules apply for accounting for transfers between categories:

•    for a transfer from investment property carried at fair value to owner-occupied property or inventories, the fair value at the change of use is the 'cost' of the property under its new classification [IAS 40.60]
•       for a transfer from owner-occupied property to investment property carried at fair value, IAS 16 should be applied up to the date of reclassification. Any difference arising between the carrying amount under IAS 16 at that date and the fair value is dealt with as a revaluation under IAS 16 [IAS 40.61]
•      for a transfer from inventories to investment property at fair value, any difference between the fair value at the date of transfer and it previous carrying amount should be recognised in profit or loss [IAS 40.63]
•    when an entity completes construction/development of an investment property that will be carried at fair value, any difference between the fair value at the date of transfer and the previous carrying amount should be recognised in profit or loss. [IAS 40.65]

EVENTS AFTER REPORTING PERIOD – IAS 10

Events may occur between the year-end (end of the reporting period) and the date when financial statements are authorized for publication to the public. Such events may provide evidence there existed certain conditions before the reporting period which were not taking into account during the preparation of the financial statements. IAS 10 Events after the Reporting Period provides guidance as to which events should lead to adjustments in the financial statements and which events shall be disclosed in the notes to financial statements.

Date of Authorization for Issue

Events after Reporting Period are those that occur between the end of the reporting period and when the financial statements are authorized for issue.

The date of authorization for issue is usually taken to be the date when the board of directors authorizes the issue of financial statements. Where management is required to issue its financial statements to a supervisory board or shareholders for approval, the authorization is considered to be complete upon the management's authorization for issue of financial statements rather than when the supervisory board or shareholders give their approval.

Events after the Reporting Period

Events after the end of reporting period may be classified into two types:

• Adjusting Events - Those events that provide further evidence about conditions that existed at the end of reporting period.
• Non-Adjusting Events - Those events that reflect conditions that arose after the end of reporting period.

Adjusting Events

If any events occur after the end of the reporting period that provide further evidence of conditions that existed at the end of reporting period (i.e. Adjusting Events), then the financial statements must be adjusted accordingly.

Examples of Adjusting Events include:

• Settlement of litigation against the entity after the reporting date, in respect of events that occurred before the end of reporting period, may provide evidence of the existence and amount of liability at the reporting date. A liability in respect of the litigation may be recorded in the financial statements if not recognized initially or the amount of liability may be adjusted in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets.
• Declaration of bankruptcy by a long outstanding receivable after the reporting date may provide evidence that the receivable was impaired at the reporting date. Impairment may be recognized in the financial statements by reducing the amount of receivable to its recoverable amount, if any.
• Detection of fraud or errors after the reporting period may indicate that the financial statements are misstated. Financial statements may be adjusted to reflect accounting for those errors or frauds that relate to the present or prior reporting periods in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.

Example 1

Ding Dong Limited financial year ends on 31 December. On 20 December 2013,, Ding Dong was involved in a court case with a customer who sued the company for delivering products where there was a dispute over the exact ingredients included in the products manufactured by Ding Dong. These products were delivered to the customer in October 2013. The details of the case were heard by 22 December but the judge decided to reserve her judgment until 8 January 2014. On 8 January 2014, the judge ruled in favour of the customer, awarding it damages of GHS100,000.

Solution.

The event took place during the reporting period and the settlement after the reporting period of the court case confirms that Ding Dong Limited had a present obligation at the end of the reporting period. The entity adjusts any previously recognized provision related to this court case in accordance with IAS 37.

Example 2

Ding Dong Limited has an investment worth GHS1,000,000 in its financial statements at 31 December 2013. Due to the continuing recession, the investment reduced in value to GHS900,000 BY 15 January 2014.

Solution:

This is a non-adjusting event. The decline in fair value does not normally relate to conditions of the investments at the end of the reporting period, but reflects circumstances that have arisen subsequently. Similarly, the entity does not update the amounts disclosed for the investments as at the end of the reporting period, although it may need to give additional disclosure.

Example 3

On January 2014, Ding Dong sold some inventory for GHS80,000. This inventory had been included in the year-end count as cost of GHS100,000.

Solution.

This is an adjusting event. The sale of inventories after the reporting period can give evidence about the net realizable value of the inventory at the end of the reporting period. Using the IAS 2 inventory rule that inventory should be valued at the lower of cost and net realizable value, The amount that should be included in the income statement is GHS80,000

On 8 January 2014, one of the accountants left Ding Dong suddenly. On further investigation, the company realized that this employee had been paying himself money from the bank account in relation to false rental invoices. The amount of the overpayment was found to be GHS86,000.00. With the help of the police, the accountant was tracked down and repaid all the money on 18 January 2014.

Solution

The discovery of fraud indicates that the financial statement has been misstatement, that is some amount has been included which in fact does not exist. The rental balance has been overstated and the bank balance is understated. This has to be corrected.

Entity shall not adjust the financial statements in respect of those events after the end of reporting period that reflect conditions that arose after the end of reporting period (i.e. Non-Adjusting Events).

Examples of Non-Adjusting Events include:

Declaration of dividends after the reporting date does not indicate existence of liability to pay dividends at the reporting date and shall not therefore trigger the recognition of liability in financial statements in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets.

Destruction of assets of the entity by floods occurring after the reporting period does not indicate that the assets of the entity were impaired at the end of reporting period. Hence, the financial statements should not be adjusted to account for the impairment loss that arose after the end of reporting period.

Initiation of litigation against the company arising out of events that occurred after the reporting period does not indicate the existence of liability at the reporting date and shall not therefore trigger the recognition of liability in the financial statements in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets.

The nature and estimate of the financial impact of material non-adjusting events shall be disclosed in the financial statements.

Non-Adjusting Events are considered material if they could influence the economic and financial decisions of the users of financial statements.

Examples of material non-adjusting events include:

Management's plan to discontinue or significantly curtail its activities in major geographic segments.

Initiation of a major litigation against the company arising out of events that occurred after the reporting period.

Major losses suffered as a result of a natural disaster occurring after the end of reporting period.

References 

https://accounting-simplified.com/standard/ias-10-events-after-the-reporting-period/

Conor Foley, CPA Ireland, (Article) . Events After the Reporting Period

CALCULATION OF BORROWING COST

EXAMPLE 1

1. On December 1, 20X4, Compassionate Inc. began construction of homes for those families that were hit by the tsunami disaster and were homeless. The construction is expected to take 3.5 years. It is being financed by issuance of bonds for GHS7 million at 12% per annum. The bonds were issued at the beginning of the construction. The bonds carry a 1.5% issuance cost. The project is also financed by issuance of share capital with a 14% cost of capital. Compassionate Inc. has opted under IAS 23 to capitalize borrowing costs. Required Compute the borrowing costs that need to be capitalized under IAS 23.

EXAMPLE 2

On 1 January 20X6 Stremans Co borrowed $1.5m to finance the production of two assets, both of which were expected to take a year to build. Work started during 20X6. The loan facility was drawn down and incurred on 1 January 20X6, and was utilised as follows, with the remaining funds invested temporarily.

EXAMPLE 3

Acruni Co had the following loans in place at the beginning and end of 20X6.

                                                       1 January                                  31 December

                                                                         20X6                                         20X6

                                                                             $m                                           $m

10% Bank loan repayable 20X8                     120                                           120

9.5% Bank loan repayable 20X9                    80                                             80

8.9% debenture repayable 20X7                      –                                             150

The 8.9% debenture was issued to fund the construction of a qualifying asset (a piece of mining equipment), construction of which began on 1 July 20X6.

On 1 January 20X6, Acruni Co began construction of a qualifying asset, a piece of machinery for a hydroelectric plant, using existing borrowings. Expenditure drawn down for the construction was: $30m on 1 January 20X6, $20m on 1 October 20X6.

Required

Calculate the borrowing costs that can be capitalized.

Suspension of Capitalization of Borrowing Cost:

If during the period of construction, the activities necessary to complete the asset are interrupted or suspended due to particular reasons, the borrowing cost of such period will be accounted for as follows:

If the period of interruption is material, the borrowing cost of such period will not be capitalized and will be charged to statement of profit and loss as an expense.

If the period of interruption is immaterial or temporary such as (Material shortage or labor strikes), then entity may continue to capitalize the borrowing cost during such period. 

Cessation of Capitalization:

The capitalization of the borrowing cost will cease, when activities necessary to complete the asset are finished i.e. the completion of the physical structure of the qualifying asset, although some administrative or decorative work may still continue.

If a qualifying asset contains different component parts such as (Industrial plant which has several processes) and the entity will complete the construction of such qualifying asset by constructing each part or component on individual basis in a sequence, where each part or component can be used individually while the construction work is in progress on other parts or components, the capitalization of the borrowing cost will cease when activities necessary to complete that part for its intended use or sale has been finished.

BORROWING COST - IAS 23

BORROWING COST - IAS 23

Borrowing cost refers to the interest and other cost incurred by an entity in connection to the borrowing of funds. Companies borrow funds from financial institutions for different reasons. Some of them are:

1. To purchase real estate and expand operations

2. To purchase machinery

3. To purchase inventory

4. To improve working capital

5. To construct buildings. E.g Office building, factories etc.

An entity can borrow funds from financial institutions and individual investors. The entity can go for bank loan, bonds, debentures, etc., to raise funds.

How is the cost of borrowing accounted for?

The standard accounting treatment for borrowing costs is that each borrowing cost should be expensed in the specific period in which they were incurred. To expense an item means to recognize it in the income statement. The allowable alternative treatment is that the borrowing costs related to the acquisition, production, and construction of a qualifying asset should be treated as part of the relevant asset’s cost.

Before we move, let learn the definition of a qualifying asset.

A qualifying asset are those assets which take substantial time to be ready for the intent of sale or use.  Generally, a period of 12 months is considered as a substantial. Examples of qualifying assets are:

--Inventories (that are not produced over a short period of time)

- Manufacturing plants

- Power generation facilities

- Intangible assets

- Investment properties.

Types of borrowing cost

1. Interest on short term loans or long-term debts should be included as part of borrowing cost. Example: Interest paid to financial institutions for loan taken to acquire the asset.

2. If an enterprise has incurred any discounts or premiums related to the borrowing cost, then it will also be amortised. Ex: Amount paid to the financial institutions as loan processing cost

3. If an enterprise has incurred any finance/ancillary cost in connection with the borrowings, then it will also be amortised. Ex: Amount to the professionals for preparation of project reports, etc.

4.  If an enterprise has acquired any asset under finance lease or any other similar arrangement, then those finance cost will also be amortised. Ex: Leasing cost paid to the lessor every year.

5. If an enterprise has taken any borrowing in foreign currency, then the exchange rate fluctuation will also be amortised to the extent they are regarded as an adjustment of interest costs. Ex: An enterprise has taken a loan from foreign financial institutions when the rate of US $ was 64, while at the end of the financial year the rate of US $ was 65. The rate difference of US $ 1 will be treated as Borrowing Cost.