IAS 16 - Help Wanted

Conffused

Hi

IAS 16 says Property, plant and equipment can only be recognised on the balance sheet when future economic benefits flow to the entity and when the benefits can be measured reliably.

How is an asset treated when the above does not apply?

For instance company "Bob the Builder Ltd" plan to buy a listed building to turn into offices. They are told work will take 6 months to complete and they can then move in. So off they trot and buy the building. The contractors move in and find there are a whole host of problems and work is now likely to take 2 years as materials need to be made specialists.

Does any one know the treatment of this building for the 2 years it is being worked on?

It is not an asset as per the definition of an asset and neither I don't think is it a liability?

Can anyone help with this please?

Many thanks

Jon

Steve Collings

Hi,

Is this a real life example?

You should still recognise the original purchase price on the statement of financial position (balance sheet) as a non-current (fixed) asset because future economic benefits will flow to the entity and the cost can be reliably measured. The rectification work will invariably be a mix of repairs/maintenance and non-current assets dependant on what the work is.

Kind regards
Steve

sdv

Thank you for that answer Steve.

I had thought that you would be the right person to answer this good question.

I thought that the investment may be treated as an investment property by Revenue and therefore IAS 40 may be applicable.

Would I be right in thinking that, because the property will not be used for another 2 years?

thanks in advance for your help

Steve Collings

sdv wrote: »

I thought that the investment may be treated as an investment property by Revenue and therefore IAS 40 may be applicable.

Would I be right in thinking that, because the property will not be used for another 2 years?

Hi SDV,

IAS 40 is only applicable where a property is held for its investment potential. The query said that Bob The Builder (the purchaser) can "move in" when the works are complete. In this instance if they are using the building then IAS 40 cannot apply here because the building is going to be used by Bob The Builder in the normal course of their trade. If Bob The Builder were planning to hold the bulding for its investment potential then, yes, IAS 40 would apply.

In real-life what would normally happen is that the initial cost would be capitalised together with all the other directly attributable costs. The schedule of works required would be undertaken by a building contractor who would then provide a schedule of works completed together with associated costs. The works would then be classified as capital/revenue depending on the various works.

Sometimes clients may appoint a valuer to then revalue the building after the works have been done but then this will mean the building is subject to the revaluation model rather than depreciated historic cost model.

Kind regards

steve

sdv

Hi Steve

Thank you very much for clarification.

We are grateful for your practical experience contribution, when tutors sometimes lack of this.

sdv

Conffused

Hello Steve

Thanks for your answer.

In response to your question, this is not a real example.

I have the Kaplan standards book for students, aimed I think at ACCA which is where I am going if I pass this year. Looking at December 09's FRS paper, the first question included property plant and eqpt. When I looked this up in the standards book, the definition was given and then a foot note explaining the conditions under which P,P & E can be included on the stmnt of financial position. I't didn't say what happens to a non-current asset when it didn't meet those conditions and this jumped out at me imeadiately.

Condition x, y and z have to apply for a non-current asset to be recognised on the stmnt of financial position and I was left thinking well what happens when you have what would ordinarily be classed as a non-current asset and it does meet those conditions.

Not part of the sylibus I've been told by my tutor and not wanting to do anyone down, I think means, "I don't know"

Thanks for your help

Jon

Steve Collings

Hi Conffused,

I can see exactly where you are coming from.

IAS 16 says that an asset should be recognised when:

1. It is "probable" that future economic benefits associated with the asset will flow to the entity; and
2. The cost of the asset can be measured reliably.

In your scenario it is "probable" that Bob The Builder will receive future economic benefits associated with the asset. IAS 16 does not stipulate a time limit for the "future" economic benefits, but one can assume that they will occupy the building once renovation work has been completed, thus it will follow that future economic benefits will be received by Bob The Builder.

The "cost" can be reliably measured because it will be the original purchase price, plus the capitalised costs of the restructuring of the building.

Notwithstanding the fact that Bob The Builder will not be occupying the building for a couple of years, the building does still meet the recognition critieria laid down in IAS 16.

I hope that clarifies the confusion for you.

Kind regards
Steve