From the IFRS Institute – June 4, 2021
Effective in 2022, proceeds from the sale of items (e.g. extracted minerals, test products) before the related property, plant and equipment (PPE) is available for its intended use are no longer deducted from the cost of PPE. Instead, proceeds are recognized in profit or loss, together with the costs of producing those items. Accordingly, like US GAAP, companies will need to clearly distinguish between the costs of producing and selling items before the PPE is available for its intended use, and the costs of making the PPE available for its intended use.
Under IFRS® Standards, the cost of PPE includes both the purchase price and any costs directly attributable to bringing the asset to the location and condition necessary for its intended use. In the process of making PPE available for its intended use, a company may produce and sell items – e.g. minerals extracted in the process of constructing an underground mine, power generated during the commissioning of a new power station, or oil and gas from testing wells before starting normal production.
Before the amendments, IAS 161 specified that directly attributable PPE costs included the cost of testing whether an asset was functioning properly. These costs were determined after deducting the net proceeds from selling items produced while bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. In short, net proceeds during the period of bringing the PPE to its intended use were deducted from the capitalized cost of the PPE.
Why the need for change?
The historical guidance led to diversity in practice. Some companies deducted only proceeds from selling items produced while testing, while others deducted the proceeds of all sales until an asset was in the location and condition necessary for it to be capable of operating in the manner intended by management. For some companies, the proceeds deducted from the cost of an item of PPE could be significant and could even exceed the cost of testing.
Some financial statement users also believed that IAS 16 did not provide a clear picture of a company’s income because some sales proceeds were offset against costs; and vice versa for understanding the cost of PPE, which may have been distorted by deducting sales proceeds from costs.
In May 2020, the International Accounting Standards Board (the IASB® Board) amended IAS 162 to specify that:
- testing whether an item of PPE is functioning properly means assessing its technical and physical performance rather than assessing its financial performance – e.g. assessing whether the PPE has achieved a certain level of operating margin; and
- proceeds from selling items before the related PPE is available for its intended use are recognized in profit or loss, together with the costs of producing those items. IAS 23 is applied in identifying and measuring these production costs.
Companies will therefore need to distinguish between:
- costs specifically related to producing and selling items before the related PPE is available for use; and
- other costs generally related to making the related PPE available for its intended use.
This allocation of costs may require significant management judgment and companies may need to implement additional processes and internal controls.
Additional disclosure requirements
For sales of items that are an output of a company’s ordinary activities, the disclosure requirements of IFRS 154 and IAS 2 apply.
For the sale of items that are not part of a company’s ordinary activities, companies are required to disclose the following if not presented separately in the statement of comprehensive income:
- the sales proceeds and related production cost recognized in profit or loss; and
- the line items in which such proceeds and costs are included in the statement of comprehensive income.
The amendments apply for annual reporting periods beginning on or after January 1, 2022, with earlier application permitted. The amendments apply retrospectively, but only to PPE made available for use on or after the beginning of the earliest period presented in the financial statements in which the company first applies the amendments.
Comparison with US GAAP
Under US GAAP, proceeds from selling items before the related PPE is available for intended use are recognized in profit or loss unless the PPE is being developed for rental or sale, in which case income (but not a loss) from incidental operations is recognized as a reduction to the cost of the property.
The amendments to IAS 16 therefore better align the accounting for incidental income to that under US GAAP, except for PPE to be rented or sold.
While the IAS 16 amendments are expected to primarily affect a few industries, such as extractive and petrochemicals, all companies should consider the effect of the new guidance because judgment will be required in distinguishing between (1) costs related to items produced and sold before an item of PPE is available for use and (2) other costs incurred to make PPE available for use. Additionally, the clarification of the meaning of ‘testing’ could affect a broad range of companies.
Companies should also consider how the amendments will affect revenues (or income) each period, along with the costs of PPE items.
- IAS 16, Property, Plant and Equipment
- Property, Plant and Equipment: Proceeds before Intended Use (Amendments to IAS 16)
- IAS 2, Inventories
- IFRS 15, Revenue from Contracts with Customers