Welcome to Non-Current Assets!
Hello there! Welcome to one of the most important chapters in your F1 – Financial Reporting journey. In this section, we are going to explore Non-current assets. These are the heavy lifters of a business—major items such as land, buildings, and machinery that a company retains for long-term use to generate economic value.
Don't worry if the numbers look intimidating at first. We’ll break everything down into simple steps. Think of this chapter as learning how to track the life story of an asset, from the day it is purchased to the day it is revalued, checked for impairment, or prepared for sale.
1. Property, Plant, and Equipment (IAS 16)
IAS 16 is the standard governing tangible assets. These are items that have physical substance and are expected to be used during more than one accounting period for producing goods, supplying services, or administrative purposes.
What goes into the "Cost"?
When an entity acquires an asset, it records all expenditures necessary to bring the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. This is called initial recognition.
Included in Cost:
• Purchase price (net of trade discounts and rebates).
• Directly attributable delivery and handling costs.
• Installation and assembly costs.
• Professional fees directly incurred (e.g. architects or engineers).
• Initial estimates of dismantling, removing the item, and restoring the site.
Excluded (Recognised as Expenses):
• Ongoing maintenance contracts and routine servicing.
• Staff training costs (even if training relates to operating the new equipment).
• General administration and overhead costs.
• Costs of opening a new facility or advertising a new product.
Example: If a bakery buys a commercial oven for \$5,000, pays \$500 for delivery, and \$200 for a specialist technician to install and test it, the total initial cost capitalised is \$5,700. If the business spends \$100 on promotional flyers for opening day, that \$100 is expensed immediately to profit or loss.
Depreciation: Allocating the Cost
Depreciation is the systematic allocation of the depreciable amount of an asset over its estimated useful life. It reflects the consumption of economic benefits, not a valuation to reflect what the asset could fetch on the market today.
Method 1: Straight Line
The asset is charged with a constant depreciation expense each year over its useful life:
\( \text{Annual Depreciation} = \frac{\text{Cost} - \text{Residual Value}}{\text{Useful Life}} \)
Method 2: Reducing Balance
The depreciation charge decreases each period by applying a fixed percentage to the carrying amount:
\( \text{Annual Depreciation} = \text{Carrying Amount} \times \text{Depreciation Rate \%} \)
Quick Review: Key Terms
Carrying Amount: The net amount at which an asset is recognised in the Statement of Financial Position: \( \text{Cost} - \text{Accumulated Depreciation} - \text{Accumulated Impairment Losses} \).
Residual Value: The estimated net amount the entity would currently obtain from disposal of the asset if it were already of the age and condition expected at the end of its useful life.
Key Takeaway:
Always capitalise all direct costs required to bring the asset into working condition, but never capitalise staff training or initial operating losses. Depreciation systematically matches the asset's cost against the periods that benefit from its use.
2. Revaluation: The Revaluation Model
IAS 16 permits entities to choose between the cost model and the revaluation model for entire classes of property, plant, and equipment. Under the revaluation model, assets are carried at fair value at the date of revaluation less subsequent accumulated depreciation and impairment.
When an asset is revalued upward:
1. Increase the asset's carrying amount on the Statement of Financial Position.
2. Credit the gain to Other Comprehensive Income (OCI) and accumulate it in equity under the heading Revaluation Surplus, rather than recognising it in profit or loss (unless reversing a previous revaluation deficit on the same asset that was charged to profit or loss).
Subsequent Depreciation: After a revaluation, depreciation is calculated based on the revised carrying amount divided by the remaining useful life of the asset.
3. Impairment of Assets (IAS 36)
Impairment ensures an entity's assets are not carried at an amount higher than their true economic worth to the business. An impairment loss occurs whenever an asset's Carrying Amount exceeds its Recoverable Amount.
Determining Recoverable Amount:
The recoverable amount is the higher of two figures:
1. Fair Value less costs of disposal: The price that would be received to sell an asset in an orderly transaction between market participants, minus direct incremental disposal costs.
2. Value in Use: The present value of the future cash flows expected to be derived from the continuing use of the asset and its ultimate disposal.
The Impairment Loss Calculation:
\( \text{Impairment Loss} = \text{Carrying Amount} - \text{Recoverable Amount} \)
An impairment loss is recognised immediately in profit or loss as an expense (unless it offsets a previous revaluation surplus for the same asset, in which case it is debited to the revaluation surplus via OCI).
Example: An asset has a carrying amount of \$400. Its fair value less costs of disposal is \$300, and its value in use is \$350. The recoverable amount is \$350 (the higher of the two). Because the carrying amount (\$400) exceeds the recoverable amount (\$350), an impairment loss of \$50 must be recognised immediately.
Key Takeaway:
Assets must never be stated above their recoverable amount. When an impairment occurs, write down the carrying amount and adjust future depreciation charges over the remaining useful life.
4. Non-current Assets Held for Sale (IFRS 5)
When a business decides to sell a non-current asset rather than continue using it in operations, IFRS 5 sets specific criteria for reclassification and measurement.
Classification Criteria
An asset is classified as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continuing use. The sale must be highly probable, meaning:
• Management is committed to a plan to sell.
• The asset is available for immediate sale in its present condition.
• An active programme to locate a buyer has begun.
• The asset is marketed at a reasonable price in relation to its current fair value.
• The sale is expected to be completed within one year of classification.
Measurement and Presentation under IFRS 5
• Measurement: Non-current assets held for sale are measured at the lower of carrying amount and fair value less costs to sell.
• Depreciation ceases: As soon as an asset is classified as held for sale, depreciation stops immediately.
• Presentation: The asset is presented separately under current assets on the face of the Statement of Financial Position, not offset against other balances.
5. Derecognition and Disposals
When an asset is finally sold, scrapped, or abandoned, it must be derecognised from the financial statements. The gain or loss arising from derecognition is included in profit or loss when the asset is derecognised.
Calculating Gain or Loss on Disposal:
1. Determine the net disposal proceeds (if any).
2. Deduct the carrying amount of the asset at the date of disposal.
\( \text{Profit or Loss on Disposal} = \text{Net Disposal Proceeds} - \text{Carrying Amount} \)
• If Proceeds > Carrying Amount: Profit on disposal (reported in operating profit or other income).
• If Proceeds < Carrying Amount: Loss on disposal (reported as an operating expense).
Quick Summary:
Initial Measurement (IAS 16): Purchase cost plus all direct expenses to bring the asset into working condition.
Subsequent Measurement (IAS 16): Cost model or revaluation model (surplus to OCI/equity).
Impairment (IAS 36): Write down to recoverable amount (higher of fair value less costs of disposal and value in use).
Held for Sale (IFRS 5): Lower of carrying amount and fair value less costs to sell; stop depreciation; present under current assets.
Disposal: Derecognise carrying amount and record the difference against sale proceeds in profit or loss.