ACCOUNTING FOR FIXED ASSETS AND IMPAIRMENT PRESENTATION BY JAYESH GANDHI AT WIRC 9 AUGUST 2014

ACCOUNTING FOR FIXED ASSETS AND IMPAIRMENT PRESENTATION BY JAYESH GANDHI AT WIRC 9 AUGUST 2014

AS-10 - Accounting for Fixed Assets Scope This statement does not deal with accounting for the following items; forests, plantations and similar regenerative natural resources; wasting assets including mineral rights, expenditure on the exploration for and extraction of minerals, oils, natural gas and similar non regenerative resources; expenditure on real estate development; and livestock Government grants & subsidies and assets under leasing rights.

Definitions Fixed Assets : is an asset held with the intention of being used for the purpose of producing or providing goods or services and is not held for sale in the normal course of business. Any asset which meets this definition should be recognised as a fixed asset. Para 8.1 recognises that certain assets may not be capitalised, considering materiality. As per Ind - AS, two more conditions to be satisfied for the asset to be capitalised, i.e. (a) it is probable that future economic benefits associated with the asset will flow to the enterprise; and (b) the cost of the asset can be measured reliably. AS-10

Definitions (contd.) Fair market value: is the price that would be agreed to in an open and unrestricted market between knowledgeable and willing parties dealing at arm s length who are fully informed and are not under any compulsion to transact. Gross book value of a fixed asset is its historical cost or other amount substituted for historical cost. AS-10

Component Approach provided in The Companies Act, 2013 and in Ind - AS Improvement in accounting if total cost allocated to major component parts, if in practice they are separable, and estimates can be made of the useful lives of these parts. Such parts to be depreciated separately. AS-10 The cost of replacing such parts to be capitalised with the consequent derecognition of the replaced parts.

Components of cost Cost of a fixed asset should comprise of : purchase price any attributable cost of bringing the asset to its working condition Non monetary consideration: AS-10 when fixed asset is acquired in exchange or in part exchange for another asset, the cost should be either the fair market value or the net book value of the asset given up. When fixed asset is acquired in exchange for shares or other securities, the cost should be its fair market value or the fair market value of the securities whichever is more clearly evident.

Components of cost (cont.) Expenses AS-10 subsequent expenditure related to an item of fixed asset to be capitalised only if they increase the future benefits from the asset beyond its previously assessed standard of performance. Administration and other general overhead expenses are excluded as they do not relate to any specific fixed asset. Expenditure incurred on start ups and test runs can be capitalised till the plant commences commercial production. Expenditure incurred after the plant has begun commercial production cannot be capitalised.

Components of cost (cont.) Expenses AS-10 Expenses incurred during the interval between the date a project is ready to commence production and date it actually commences production has to be expensed. Though para 9.5 mention that expenses sometimes can be deferred, however reading this with para 55 & 56 of AS 26 it would be difficult to treat it as deferred revenue expenses. Initial costs as well as the subsequent costs are evaluated on the same recognition principles. It is not necessary that it should add to the original envisaged capacity / efficiency.

Components of cost (cont.) Expenses AS-10 The expenditure incurred on start-up and commissioning of the project, including the expenditure incurred on test runs and experimental production, is usually capitalised as an indirect element of the construction. If the interval between the date a project is ready to commence commercial production and the date at which commercial production actually begins is prolonged, all expenses incurred during this period are charged to the profit and loss statement.

Components of cost (cont.) Expenses AS-10 In arriving at the gross book value of self-constructed fixed assets, the gross book value are costs of construction that relate directly to the specific asset and costs that are attributable to the construction activity in general and can be allocated to the specific asset. Any internal profits are eliminated in arriving at such costs.

Components of cost (cont.) Expenses AS-10 The borrowing cost on qualifying assets is accounted as per AS 16 instead of AS 10 and the GN on Expenditure during construction period stands withdrawn. The impact of the above is there is no deferment in expense to be charged to the profit and loss statement and such Greenfield project would now charge to profit and loss statement from day 1 instead of deferment.

Components of cost (cont.) Expenses AS-10 Machinery spares are usually charged to the profit and loss statement as and when consumed. However, if such spares can be used only in connection with an item of fixed asset and their use is expected to be irregular, it may be appropriate to allocate the total cost on a systematic basis over a period not exceeding the useful life of the principal item.

Revaluation of fixed assets. Selection of assets for revaluation should be made on a systematic basis. An entire class of assets should be revalued and not only selective items as it can lead to unrepresentative amounts being reported Revaluation should not result in the net book value of that class being greater than the recoverable amount of assets of that class. Any increase in the net book value on revaluation should be credited to owners interest under the head revaluation reserves. Any decrease in the net book value on revaluation is to be charged to profit and loss account, except to the extent that the decrease is considered to be related to a previous increase and is included in the revaluation reserve. In such a case it may be adjusted against the reserve AS-10

AS-10 Retirement and disposals Fixed asset should be eliminated from the books if no further benefit is expected from its use and disposal Gains or losses on disposal are generally recognised in the profit and loss account. Items of fixed assets that are held for disposal are to be stated at the lower of the net realisable value and book value are to be shown separately in the financial statements. On disposal of previously revalued item, any loss can be adjusted against the revaluation reserve if any. Any amount standing in revaluation reserve, following the disposal of an asset, which relates to that asset may be transferred to general reserve.

AS-10 Valuation in special cases Fixed assets acquired on hire purchase basis should be recorded as per AS 19 In case of joint ownership, the extent of the enterprise s ownership and the proportion in the original cost, accumulated depreciation and written down value are stated in the balance sheet Alternatively, the pro rata cost of such assets may be grouped with similar fully owned assets with an appropriate disclosure. where several assets are purchased for a consolidated price, the consideration is apportioned on a fair basis as determined by competent valuers.

Goodwill Definition: Excess of the purchase consideration paid in consideration for the fair value of assets acquired. Goodwill on amalgamation: The goodwill arising on amalgamation should be amortised to income on a systematic basis over its useful life. The amortisation period should not exceed five years unless a somewhat longer period can be justified. Amortisation of Goodwill paid in cash is only permitted. Practical challenges: For Companies which carries goodwill at cost in the books need to amortise or need to ascertain the fair value of goodwill and provide for impairment along with CGU.

Disclosures AS-10 Gross and net book values at the beginning and end of an accounting period showing additions, disposals, acquisitions and other movements, Expenditure incurred on account of fixed assets in the course of construction or acquisition, The useful lives or the depreciation rates used, if they are different from the principal rates specified in the statute governing the enterprise. In case of revalued assets: revalued amounts substituted for historical costs of fixed assets, the method adopted to compute the revalued amounts, the nature of indices used, the year of appraisal made, whether any external valuer was involved.

Depreciation AS-6 and Schedule II Depreciation is to be provided based on useful lives as per Schedule II wef April 1, 2014. A residual value of not more than 5% of the cost of assets to be deducted from the cost of assets for computing depreciation. In case of lives different from Schedule II and residual value higher than 5%, disclosure to be made in the financial statements justifying the reason for difference. Transitional provision: the carrying amount of the asset as on that date: (a) shall be depreciated over the remaining useful life of the asset as per this Schedule; (b) after retaining the residual value, shall be recognised in the opening balance of retained earnings where the remaining useful life of an asset is nil

Depreciation cont d Example of transitional provision: AS-6 and Schedule II (I) WDV-100, remaining useful life as per Schedule II Nil 100 to be charged to retained earnings (II) WDV-100, remaining useful life as per Schedule II one year 100 to be charged to current year profit and loss statement (III) WDV-100, remaining useful life as per Schedule II more than one year 100 to be charged to profit and loss statement over the remaining useful lives either straight lined depreciation or linear depreciation based on the depreciation method adopted by the Company.

PRACTICAL ISSUES ON AS-6 & AS-10 Can the Company have lower or higher useful life then prescribed by schedule II As per the scheme of company Motor car is given to certain employees for their use and the same can be purchased by them at 5% of original cost of the end of 3 years. What depreciation should be provided in such case? In case of a Furnace the bricklaying needs to be changed in every 4 to 5 years. Can be bricklaying expenditure be treated as per separate asset for depreciation purpose? For Capital stores and spares which have been capitalised whether depreciation needs to be provided though the same is lying in the stores? Will it make any difference if such spares were purchased after 3 years of capitalisation of plant?

PRACTICAL ISSUES ON AS-6 & AS-10 (Contd.) In case of impaired assets whether the depreciation shall be provided on historical cost? Whether the entire Textile mill can be treated as continuous process plant? Can the deprecation on revalued assets can be charged to Profit & Loss a/c without corresponding adjustments with revaluation reverse? In case of merger the company merging follows WDV method and the acquiring company is following SLM method. Whether the company can continue to apply WDV method for the merged company?

PRACTICAL ISSUES ON AS-6 & AS-10 (Contd.) X Ltd. Purchased a machine in the year 2012 for Rs. 100 lacs and cleared by Customs without levy of custom duty. In 2014 Custom authorities alleged willful misrepresentation and suppression of facts. The Company paid the custom duty with penalties of Rs. 40 lacs. Advise your client on how to charge depreciation on the addition to fixed asset in 2014? Can a few assets from the entire class of asset be revalued? X Ltd. has completed construction of factory. Due to market condition X Ltd. will start operating the factory only in next year. Can it capitalised overhead and interest expense incurred after completion of construction but before starting operation?

COMMONLY OBSERVED NON-COMPLIANCES IN AS - 6 PRESENTED BY JAYESH GANDHI

Depreciation Accounting - AS 6 Treatment of leasehold land and its amortisation. Depreciation provided as per Schedule VI to the Companies Act. Depreciation for the year for each class of assets are required to be disclosed.

Depreciation Accounting - AS 6 Historical cost Represents the asset s money outlay, or its equivalent in connection with its acquisition, installation, commissioning and for improvement may undergo a change due to subsequent changes in long term liability on account of exchange fluctuations price adjustments, changes in duties etc. CNC if historical cost of an asset changes, depreciation on the revised value to be provided over the residual useful life.

Depreciation Accounting - AS 6 CNC Useful life should be reviewed periodically. in case of revision, unamortised depreciation should be charged over the revised remaining useful life.

Depreciation Accounting - AS 6 Change in Method of Depreciation should be made only if required by statute to comply with an accounting standard or it would result in a more appropriate presentation of financial statements. in case of change in method, the deficiency or surplus depreciation of the past period shall be debited/credited to the profit and loss account in the year in which the change is made. As per AS-5 the effect of change should be quantified.

IMPAIRMENT OF ASSETS - AS 28 OVERVIEW Applicability & Scope Objective Computation Accounting Treatment Disclosure Transitional Provision

IMPAIRMENT OF ASSETS - AS 28 Applicability & SCOPE For Level I enterprises with effect from 1.4.2004 For SMEs with effect from 1.4.2006 / 1.4.2008 Applied to all assets other than : Inventories (AS - 2) Assets arising from construction contract (AS - 7) Financial Assets / Investments (AS - 13) Defered Tax Assets (AS - 22)

IMPAIRMENT OF ASSETS - AS 28 OBJECTIVE To identify the assets which are sick / unhealthy To ensure that enterprise assets are carried at not more than their recoverable amount. Impairment loss may have to be identified for individual asset if it has independent cash flows generation. If not, concept of CGU needs to be used whereby loss is identified for the group of assets.

IMPAIRMENT OF ASSETS - AS 28 Indications of Impairment Assessment of impairment should be made at each Balance Sheet date taking into consideration following factors: Internal Sources of Information Physical damage to an asset When the enterprise plans to discontinue or restructure the operation. Internal reporting on economic performance of an asset Decision to dispose off / scrap

IMPAIRMENT OF ASSETS - AS 28 External Sources of Information An asset s market value has declined significantly due to passage of time or normal use. Change in technology, market, economic or legal environment in which the enterprise operates. Rising Market interest rate. (as it is used for discounting). Carrying amount of the net assets of the enterprise is more than its market capitalization.

IMPAIRMENT OF ASSETS - AS 28 IMPAIRMENT LOSS If carrying amount < = Recoverable amount ---- Asset is not impaired If carrying amount > Recoverable amount ---- Asset is impaired Impairment Loss = Carrying Amount Recoverable Amount

IMPAIRMENT OF ASSETS - AS 28 Recoverable Amount Recoverable amount is the higher of net selling price and its value in use Net selling price = The asset s market price less cost of disposal. Value in use = Present Value Factor *(estimated future net cash flows arising from use of the asset + disposal value) For SMEs there is a relaxation by which PV can be ignored to arrive at value in use.

IMPAIRMENT OF ASSETS - AS 28 Cash Generating Unit If it is not possible to estimate cash flow of an individual assets, same is grouped under a cashgenerating unit to which the asset belongs. A cash generating unit is the smallest identifiable group of assets that generates cash inflow from continuing use that are largely independent of the cash inflow from other assets or group of assets.

IMPAIRMENT OF ASSETS - AS 28 Future Cash Flow Future cash flow should be based on financial budgets/forecasts approved by management (not more than 5 years) Extrapolation of data may be used beyond the period of approved budget Steady or declining growth rate may be used for the purpose of extrapolation

IMPAIRMENT OF ASSETS - AS 28 Composition of Future Cash Flow Future cash flow shall include: Cash inflows from continuing use of the asset Cash outflows necessarily incurred to generate the cash inflows, including cash outflows to prepare the asset for use Changes in working capital and normal capital expenditure to continue operations. Net cash flows expected from disposal of the asset In case of inter-transfer of material, it is advisable to consider market value rather than transfer price.

IMPAIRMENT OF ASSETS - AS 28 Composition of Future Cash Flow (Contd ) Future cash flow shall exclude: Cash inflows or outflows from financing activities (as discount rates used will take care of the same) Income tax receipts or payments Cash flow arising from future restructuring except when the same is committed Cash flow arising from capital exp. unless incurred In case of cash flow in FC, rate prevailing on the balance sheet date is used for conversion.

IMPAIRMENT OF ASSETS - AS 28 Discount Rate May be determined considering the following rates: weighted average cost of capital to the enterprise Enterprise s incremental borrowing rate Other market borrowing rate The rate should be adjusted for all associated risks of the business / industry.

IMPAIRMENT OF ASSETS - AS 28 Corporate Assets Do not generate separate cash flows Recoverable amount cannot be determined unless the management has decided to dispose off the asset. Hence, if there is an indication that a corporate asset may be impaired, recoverable amount is determined for the cash generating unit to which the corporate asset belongs and compared to the carrying amount of the cash generating unit and any impairment loss is recognised.

IMPAIRMENT OF ASSETS - AS 28 Treatment of Impairment Loss An impairment loss should be recognized against the revaluation reserve, if any, and balance, if any, as an expense in the P/L A/c Impairment loss for a Cash Generating Unit should be allocated in the following order Goodwill, if any. Balance, if any, to individual assets in proportion to their carrying cost After the recognition of impairment loss, depreciation charge for the asset should be adjusted in future periods to allocate the asset s revised carrying amount, less its residual value, on a systematic basis over its remaining useful life.

IMPAIRMENT OF ASSETS - AS 28 Reversal of an Impairment Loss At any balance sheet date if management assess that the impairment loss considered in prior accounting periods may no longer exist or is decreased, the loss may be reversed. Reversal is not required if value in use increases in subsequent year merely due to pattern of cash flow but not due to increase in the earning potential of the asset.

IMPAIRMENT OF ASSETS - AS 28 DISCLOSURE - The amount of impairment loss charged to P/L for each class of asset; - The reversal of impairment loss considered in P/L for each class of asset; - The amount of impairment loss adjusted against revaluation surplus; - The reportable segment to which the asset belongs; - The reasons for changing the Cash Generating Unit for an asset and the description of the earlier & the changed Cash Generating Unit; - The discount rate used in reckoning of value in use.

IMPAIRMENT OF ASSETS - AS 28 TRANSITIONAL PROVISIONS On the date this Standard becomes mandatory, an enterprise should assess whether there is any indication that an asset may be impaired. If any such indication exists, the enterprise should determine impairment loss, if any and recognise the loss so determined against the opening balance of revaluation reserve/revenue reserves.

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