04/01/2017. Trainee Accountant Webinar. Treatment of Gains and Losses on Remeasurement of Assets. Introduction

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1 CPA Ireland Skillnet CPA Ireland Skillnet, is a training network that is funded by Skillnets, a state funded, enterprise led support body dedicated to the promotion and facilitation of training and upskilling as key elements in sustaining Ireland s national competitiveness. The CPA Ireland Skillnet provides excellent value CPE (continual Professional Education) in accountancy, law, tax and strategic personal development to accountants working both in practice and in industry. However our attendees are not limited to the accountancy field as we welcome all interested parties to our events. The CPA Ireland Skillnet is funded by member companies and the Training Networks Programme, an initiative of Skillnets Ltd. funded from the National Training Fund through the Department of Education and Skills. The Institute of Certified Public Accountants in Ireland Trainee Accountant Webinar Treatment of Gains and Losses on Remeasurement of Assets (covering parts of the Conceptual Framework, IAS 2, IAS 16, IAS 38, IAS 40, IAS 41, IFRS 5 and IFRS 9) Brendan Doyle Lecturer at Athlone IT and CPA Examiner for P1 Corporate Reporting - 14 December 2016 Introduction Several standards contain different methods of accounting for changes in the values of assets. Many of these methods appear inconsistent with each other, and with the Conceptual Framework. Measurement is an area requiring much more work at the conceptual level. It is important that the trainee accountant can distinguish between the methods currently used to record remeasurements, and knows when to apply them. 1

2 Issues Considered The main topic areas considered in this webinar include: Conceptual framework; Inventory (IAS 2); Property, plant & equipment (IAS 16); Intangible assets (IAS 38); Investment property (IAS 40); Biological assets (IAS 41); Non current assets held for sale (IFRS 5); Financial assets (IFRS 9). Conceptual Framework The overarching principle of the Conceptual Framework is that financial statements should provide information that is useful to a wide range of decision makers, focusing on the providers of capital as the primary user group. Information should meet several qualitative characteristics, divided into: fundamental (relevance and faithful representation), and enhancing (understandability, comparability, verifiability and timeliness). The Framework is weak in describing principles of measurement. It recognises that there are several methods of measurement (e.g. historic cost, current cost, realisable value, fair value, present value), but does not prefer one over others. Nor does it suggest where each one might be appropriate to use. The individual standards apply these principles to various categories of assets, with varying degrees of consistency. IAS 2 Inventory IAS 2 requires that inventory be measured at the LOWER of (1) Cost or (2) Net realisable value (NRV). Cost therefore represents a ceiling (maximum) on the reported valuation of inventory. Any downward changes in value (losses) are recognised (if they bring the NRV to an amount below cost) but upward changes are not (unless reversing previous losses). Losses are taken to P/L. This is an asymmetric policy, as it reports losses but not gains. 2

3 Property, plant & equipment (IAS 16) IAS 16 permits two models of measurement of PPE (entity s choice). Cost model, which does not permit revaluations, but requires depreciation; Revaluation model, which requires periodic revaluations and depreciation. Under the revaluation model, fair value is the valuation method used. This is recognised whether it results in a gain or a loss. However the method of recognition differs: Gains are taken to OCI (and a separate component of equity); Losses are taken to profit or loss; Reversals of each must first reverse the original treatment with the balance being accounted for as additional losses or gains. Intangible assets (IAS 38) IAS 38 permits a choice similar to IAS 16, namely the cost model or the revaluation model. Accounting treatment of revaluation gains and losses is consistent with IAS 16 requirements. However IAS 38 introduces an additional requirement that the fair value model may only be used if there is an active market in identical assets. IAS 16 does not have this requirement. The effect is that very few intangible assets qualify for the revaluation model (as many are unique assets, hence no identical assets exist). Investment Property (IAS 40) IAS 40 has two models of valuation also. Cost model, which is identical to the cost model under IAS 16; and Fair Value model, which is very different to the IAS 16 equivalent. The fair value model requires that investment property be remeasured annually to fair value, and not depreciated. Gains and losses are treated symmetrically, in that both are taken to profit or loss, and retained earnings reserve. This creates a significant inconsistency between the treatment of investment property and non investment property. Possible reasons? Business model, political pressure, flawed standard. 3

4 Agriculture (IAS 41) IAS 41 requires biological assets to be measured at fair value. Biological assets are those in the process of biological growth, such as crops in the field, live animals, and animal produce before harvesting. Once the assets are harvested, they become inventory, and are subject to IAS 2. Their fair value at this point is deemed their IAS 2 cost. Gains and losses are treated symmetrically, and taken to profit or loss (through the inventory figure affecting cost of sales). This is inconsistent with IAS 2, which does not permit increases in inventory valuation on the basis that it anticipates gains that will only occur on sale. However IAS 2 does permit the inclusion of costs. Non current assets held for sale (IFRS 5) When assets are expected to be recovered through sale (within 12 months) rather than through use, they are classified as current assets. Depreciation ceases at that point. They are transferred at their carrying value, and written down to fair value less costs to sell, if this is lower. This is similar to NRV in IAS 2. Subsequent changes in value are recognised in profit or loss subject to a ceiling equal to their carrying value immediately before transfer. This is comparable to the asymmetrical IAS 2 approach of recognising losses in value but not gains (except when reversing losses). Financial instruments (IFRS 9) There are three models of measurement in IFRS 9: Amortised cost (essentially DCF based allocation of cash flows over the life of the instrument, based on the inherent effective annual rate); Fair value through OCI; and Fair value through profit or loss. The choice of model depends on the characteristics of the instrument s cash flows and the entity s business model for holding it. There is limited choice afforded the entity. Selection of model depend on the facts of each situation. Equity instruments are measured at fair value, but the entity may choose as a policy choice whether to take the resulting gains and losses to P/L or OCI. This choice is made at purchase, and is permanent. Gains and losses are treated equally so the treatment is symmetrical. 4

5 Conclusions All IFRSs adhere to the principle that reversals in circumstances should reverse the accounting treatment that applied originally. The end result should be the same as would have been the case had the original event not happened at all. The wide variety of choices available has the advantage of making IFRS widely acceptable, for example in jurisdictions where revaluations are not legally permitted). However the inconsistencies tend to undermine the credibility of the standards as a whole. It is possible to trace the evolution of accounting thought as standards develop. IAS 2 was developed in the days when profit was king, and the measurement of profit the primary purpose of accounting. Conclusions IFRS 9 (the most recent standard) emphasises the fair valuation of assets and liabilities, and reflects the SOFP driven nature of modern IFRS accounting. Cost based policies tend to smooth out profit volatility, but at the expense of balance sheet usefulness (as values are not fair reflections of market values). Fair value based policies tend to cause more profit volatility (as values fluctuate), but the balance sheet values tend to be more reliable. Mixed systems are neither! See Question 5, April 2015 P1 Corporate Reporting for illustration. 5

F2 Financial Accounting

F2 Financial Accounting CPA Ireland Skillnet CPA Ireland Skillnet, is a training network that is funded by Skillnets, a state funded, enterprise led support body dedicated to the promotion and facilitation of training and upskilling