IAS 16 : Measurement at Recognition (Initial Measurement)

Question 1

IAS 16 draws a distinction between measurement at recognition (i.e. the initial recognition of an item of PP&E on acquisition) and measurement after recognition (i.e. the subsequent treatment of the item).

Answer 1

IAS 16 draws a distinction between measurement at recognition (i.e. the initial recognition of an item of PP&E on acquisition) and measurement after recognition (i.e. the subsequent treatment of the item).

Question 2

The standard states that ‘an item of property, plant and equipment that qualifies for recognition as an asset shall be measured at its cost’. [IAS 16.15].

What may be included in the cost of an item is discussed below.

Answer 2

The standard states that ‘an item of property, plant and equipment that qualifies for recognition as an asset shall be measured at its cost’. [IAS 16.15].

What may be included in the cost of an item is discussed below.

Question 3

Elements of cost and cost measurement 1

IAS 16 sets out what constitutes the cost of an item of PP&E on its initial recognition, as follows:
‘The cost of an item of property, plant and equipment comprises:

(a) its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates.
(b) any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management.
(c) the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period.’ [IAS 16.16].

Answer 3

IAS 16 sets out what constitutes the cost of an item of PP&E on its initial recognition, as follows:
‘The cost of an item of property, plant and equipment comprises:

(a) its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates.
(b) any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management.
(c) the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period.’ [IAS 16.16].

Question 4

Elements of cost and cost measurement 2

The purchase price of an individual item of PP&E may be an allocation of the price paid for a group of assets. If an entity acquires a group of assets that do not comprise a business (‘the group’), the principles in IFRS 3 – Business Combinations – are applied to allocate the entire cost to individual items.

In such cases the acquirer should identify and recognise the individual identifiable assets acquired (including those assets that meet the definition of, and recognition criteria for, intangible assets in IAS 38) and liabilities assumed. The cost of the group should be allocated to the individual identifiable assets and liabilities on the basis of their relative fair values at the date of purchase. Such a transaction or event does not give rise to goodwill. [IFRS 3.2(b)].

Answer 4

The purchase price of an individual item of PP&E may be an allocation of the price paid for a group of assets. If an entity acquires a group of assets that do not comprise a business (‘the group’), the principles in IFRS 3 – Business Combinations – are applied to allocate the entire cost to individual items.

In such cases the acquirer should identify and recognise the individual identifiable assets acquired (including those assets that meet the definition of, and recognition criteria for, intangible assets in IAS 38) and liabilities assumed. The cost of the group should be allocated to the individual identifiable assets and liabilities on the basis of their relative fair values at the date of purchase. Such a transaction or event does not give rise to goodwill. [IFRS 3.2(b)].

Question 5

Elements of cost and cost measurement 3

If an asset is used to produce inventories during a particular period, the costs of obligations that are incurred during that period to dismantle, remove or restore the site on which such asset has been located are dealt with in accordance with IAS 2, as a
consequence of having used the asset to produce inventories during that period

Answer 5

If an asset is used to produce inventories during a particular period, the costs of obligations that are incurred during that period to dismantle, remove or restore the site on which such asset has been located are dealt with in accordance with IAS 2, as a
consequence of having used the asset to produce inventories during that period

Question 6

Elements of cost and cost measurement 4

Note that all site restoration costs and other environmental restoration and similar costs
must be estimated and capitalised at initial recognition, in order that such costs can be recovered over the life of the item of PP&E, even if the expenditure will only be incurred at the end of the item’s life.

The obligations are calculated in accordance with
IAS 37 and IFRIC 1 – Changes in Existing Decommissioning, Restoration and Similar
Liabilities

Answer 6

Note that all site restoration costs and other environmental restoration and similar costs
must be estimated and capitalised at initial recognition, in order that such costs can be recovered over the life of the item of PP&E, even if the expenditure will only be
incurred at the end of the item’s life.

The obligations are calculated in accordance with
IAS 37 and IFRIC 1 – Changes in Existing Decommissioning, Restoration and Similar
Liabilities

Question 7

Elements of cost and cost measurement : ‘Directly attributable’ costs 1

This is the key issue in the measurement of cost. The standard gives examples of types of expenditure that are, and are not, considered to be directly attributable.

The following are examples of those types of expenditure that are considered to be directly
attributable and hence may be included in cost at initial recognition (a) - (f)

Answer 7

This is the key issue in the measurement of cost. The standard gives examples of types of expenditure that are, and are not, considered to be directly attributable.

The following are examples of those types of expenditure that are considered to be directly
attributable and hence may be included in cost at initial recognition

Question 8

Elements of cost and cost measurement : ‘Directly attributable’ costs 2a

(a) costs of employee benefits (as defined in IAS 19 – Employee Benefits) arising directly from the construction or acquisition of the item of PP&E. This means that the labour costs of an entity’s own employees (e.g. site workers, in-house architects
and surveyors) arising directly from the construction, or acquisition, of the specific item of PP&E may be recognised;

Answer 8

(a) costs of employee benefits (as defined in IAS 19 – Employee Benefits) arising directly from the construction or acquisition of the item of PP&E. This means that the labour costs of an entity’s own employees (e.g. site workers, in-house architects
and surveyors) arising directly from the construction, or acquisition, of the specific item of PP&E may be recognised;

Question 9

Elements of cost and cost measurement : ‘Directly attributable’ costs 2b

(b) costs of site preparation;
(c) initial delivery and handling costs;
(d) installation and assembly costs;

Answer 9

(b) costs of site preparation;
(c) initial delivery and handling costs;
(d) installation and assembly costs;

Question 10

Elements of cost and cost measurement : ‘Directly attributable’ costs 2c

(e) costs of testing whether the asset is functioning properly, after deducting the net proceeds from selling any items produced while bringing the asset to that location and condition such as samples produced when testing equipment (see Income earned while bringing the asset to the intended location and
condition below); and

(f) professional fees

Answer 10

(e) costs of testing whether the asset is functioning properly, after deducting the net proceeds from selling any items produced while bringing the asset to that location and condition such as samples produced when testing equipment (see Income earned while bringing the asset to the intended location and
condition below); and

(f) professional fees

Question 11

Elements of cost and cost measurement : ‘Directly attributable’ costs 3

Income received during the period of construction of PP&E is considered further in 4.2.2 below (Income received during the construction of property)

Answer 11

Income received during the period of construction of PP&E is considered further in 4.2.2 below (Income received during the construction of property)

Question 12

Elements of cost and cost measurement : ‘Directly attributable’ costs 4

The cost of an item of PP&E may include costs incurred relating to leases of assets that are used to construct, add to, replace part of or service an item of PP&E, such as depreciation of right-of-use assets (see Initial and subsequent expenditure above), if those lease costs are ‘directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management’. [IAS 16.16].

Answer 12

The cost of an item of PP&E may include costs incurred relating to leases of assets that are used to construct, add to, replace part of or service an item of PP&E, such as depreciation of right-of-use assets (see Initial and subsequent expenditure above), if those lease costs are ‘directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management’. [IAS 16.16].

Question 13

Elements of cost and cost measurement : ‘Directly attributable’ costs 5

Also, under IFRS 16, lessees are required to recognise all leases in their statement of financial position as lease liabilities with corresponding right-of-use assets, except for short-term leases and low-value assets if they choose to apply such exemptions.

Answer 13

Also, under IFRS 16, lessees are required to recognise all leases in their statement of financial position as lease liabilities with corresponding right-of-use assets, except for short-term leases and low-value assets if they choose to apply such exemptions.

Question 14

Elements of cost and cost measurement : Borrowing costs

Borrowing costs must be capitalised in respect of certain qualifying assets, if those assets are measured at cost. Therefore, an entity will capitalise borrowing costs on a self constructed item of PP&E if it meets the criteria in IAS 23 – Borrowing Costs. [IAS 16.22].

Answer 14

Borrowing costs must be capitalised in respect of certain qualifying assets, if those assets are measured at cost. Therefore, an entity will capitalise borrowing costs on a self constructed item of PP&E if it meets the criteria in IAS 23 – Borrowing Costs. [IAS 16.22].

Question 15

Elements of cost and cost measurement : Borrowing costs

Entities are not required to capitalise borrowing costs in respect of assets that are measured at fair value. This includes revalued PP&E which is measured at fair value
through Other Comprehensive Income (‘OCI’). Generally, an item of PP&E within scope of IAS 16 will only be carried at revalued amount once construction is completed, so capitalisation of borrowing costs will have ceased. This is not necessarily the case with investment property in the course of construction.

Answer 15

Entities are not required to capitalise borrowing costs in respect of assets that are measured at fair value. This includes revalued PP&E which is measured at fair value
through Other Comprehensive Income (‘OCI’). Generally, an item of PP&E within scope of IAS 16 will only be carried at revalued amount once construction is completed, so capitalisation of borrowing costs will have ceased. This is not necessarily the case with investment property in the course of construction.

Question 16

Elements of cost and cost measurement : Borrowing costs

The cost of the asset, before adopting a policy of revaluation, will include capitalised borrowing costs. However, to the extent that entities choose to capitalise borrowing costs in respect of assets still in the course of construction that are carried at fair value, the methods allowed by IAS 23 should be followed.

Answer 16

The cost of the asset, before adopting a policy of revaluation, will include capitalised borrowing costs. However, to the extent that entities choose to capitalise borrowing costs in respect of assets still in the course of construction that are carried at fair value, the methods allowed by IAS 23 should be followed.

Question 17

Elements of cost and cost measurement : Administration and other general overheads

Administration and other general overhead costs are not costs of an item of PP&E. This means that employee costs not related to a specific asset, such as site selection activities and general management time do not qualify for capitalisation. Entities are also not
allowed to recognise so-called ‘start up costs’ as part of the item of PP&E. These include costs related to opening a new facility, introducing a new product or service (including costs of advertising and promotional activities), conducting business in a new territory
or with a new class of customer (including costs of staff training) and similar items. [IAS 16.19]. 
These costs should be accounted for (in general, expensed as incurred) in the same way as similar costs incurred as part of the entity’s on-going activities.

Answer 17

Administration and other general overhead costs are not costs of an item of PP&E. This means that employee costs not related to a specific asset, such as site selection activities and general management time do not qualify for capitalisation. Entities are also not
allowed to recognise so-called ‘start up costs’ as part of the item of PP&E. These include costs related to opening a new facility, introducing a new product or service (including costs of advertising and promotional activities), conducting business in a new territory
or with a new class of customer (including costs of staff training) and similar items. [IAS 16.19]. 
These costs should be accounted for (in general, expensed as incurred) in the same way as similar costs incurred as part of the entity’s on-going activities.

Question 18

Elements of cost and cost measurement : Cessation of capitalisation 1

Cost recognition ceases once an item of PP&E is in the location and condition necessary for it to be capable of operating in the manner intended by management. This will usually be the date of practical completion of the physical asset. IAS 16 therefore prohibits the recognition of relocation and reorganisation costs, costs incurred in using the asset or during the run up to full use once the asset is ready to be used, and any initial operating losses. [IAS 16.20].

Answer 18

Cost recognition ceases once an item of PP&E is in the location and condition necessary for it to be capable of operating in the manner intended by management. This will usually be the date of practical completion of the physical asset. IAS 16 therefore prohibits the recognition of relocation and reorganisation costs, costs incurred in using the asset or during the run up to full use once the asset is ready to be used, and any initial operating losses. [IAS 16.20].

Question 19

Elements of cost and cost measurement : Cessation of capitalisation 2

An entity is not precluded (prevent from happening) from continuing to capitalise costs during an initial commissioning period that is necessary for running in machinery or testing equipment. By contrast no new costs should be capitalised if the asset is fully operational but is not yet achieving its targeted profitability because demand is still building up, for example in a new hotel that initially has high room vacancies or a partially let investment property. In these cases, the asset is clearly in the location and condition necessary for it to be capable of
operating in the manner intended by management.

Answer 19

An entity is not precluded (prevent from happening) from continuing to capitalise costs during an initial commissioning period that is necessary for running in machinery or testing equipment. By contrast no new costs should be capitalised if the asset is fully operational but is not yet achieving its targeted profitability because demand is still building up, for example in a new hotel that initially has high room vacancies or a partially let investment property. In these cases, the asset is clearly in the location and condition necessary for it to be capable of
operating in the manner intended by management.

Question 20

Elements of cost and cost measurement : Self-built assets

If an asset is self-built by the entity, the same general principles apply as for an acquired asset. If the same type of asset is made for resale by the business, the cost of such asset is usually the same as the cost of constructing of an asset for sale, i.e. without including
any internal profit element but including attributable overheads in accordance with IAS 2.

The costs of abnormal amounts of wasted resources, whether labour, materials or other resources, are not included in the cost of such self-built assets. IAS 23, contains criteria relating to the recognition of any interest as a component of the carrying amount of a self-built item of PP&E. [IAS 16.22].

Answer 20

If an asset is self-built by the entity, the same general principles apply as for an acquired asset. If the same type of asset is made for resale by the business, the cost of such asset is usually the same as the cost of constructing of an asset for sale, i.e. without including
any internal profit element but including attributable overheads in accordance with IAS 2.

The costs of abnormal amounts of wasted resources, whether labour, materials or other resources, are not included in the cost of such self-built assets. IAS 23, contains criteria relating to the recognition of any interest as a component of the carrying amount of a self-built item of PP&E. [IAS 16.22].

Question 21

Elements of cost and cost measurement : Deferred payment

IAS 16 specifically precludes the capitalisation of hidden credit charges as part of the cost of an item of PP&E, so the cost of an item of PP&E is its cash price equivalent at the recognition date. This means that if payment is made in some other manner, the cost
to be capitalised is the normal cash price. Thus, if the payment terms are extended beyond ‘normal’ credit terms, the cost to be recognised must be the cash price equivalent and any difference between the cash price equivalent and the total payment must be treated and recognised as an interest expense over the period of credit unless such interest is capitalised in accordance with IAS 23. [IAS 16.23].

Answer 21

IAS 16 specifically precludes the capitalisation of hidden credit charges as part of the cost of an item of PP&E, so the cost of an item of PP&E is its cash price equivalent at the recognition date. This means that if payment is made in some other manner, the cost
to be capitalised is the normal cash price. Thus, if the payment terms are extended beyond ‘normal’ credit terms, the cost to be recognised must be the cash price equivalent and any difference between the cash price equivalent and the total payment must be treated and recognised as an interest expense over the period of credit unless such interest is capitalised in accordance with IAS 23. [IAS 16.23].

Question 22

Elements of cost and cost measurement : Land and buildings to be redeveloped 1

It is common for property developers to acquire land with an existing building where the planned redevelopment necessitates the demolition of that building and its replacement with a new building that is to be held to earn rentals or will be owner occupied. Whilst IAS 16 requires that the building and land be classified as two separate items (see Land below), in our view it is appropriate, if the existing building is unusable or likely to be demolished by any party acquiring it, that the entire or a large part of the
purchase price be allocated to the land. Similarly, subsequent demolition costs should be treated as being attributable to the cost of the land.

Answer 22

It is common for property developers to acquire land with an existing building where the planned redevelopment necessitates the demolition of that building and its replacement with a new building that is to be held to earn rentals or will be owner occupied. Whilst IAS 16 requires that the building and land be classified as two separate items (see Land below), in our view it is appropriate, if the existing building is unusable or likely to be demolished by any party acquiring it, that the entire or a large part of the
purchase price be allocated to the land. Similarly, subsequent demolition costs should be treated as being attributable to the cost of the land.

Question 23

Elements of cost and cost measurement : Land and buildings to be redeveloped 2

Owner-occupiers may also replace existing buildings with new facilities for their own use or to rent to others. Here the consequences are different and the carrying amount of the existing building cannot be rolled into the costs of the new development. The existing building must be depreciated over its remaining useful life to reduce the carrying amount of the asset to its residual value (presumably nil) at the point at which
it is demolished. Consideration will have to be given as to whether the asset is impaired in accordance with IAS 36.

Answer 23

Owner-occupiers may also replace existing buildings with new facilities for their own use or to rent to others. Here the consequences are different and the carrying amount of the existing building cannot be rolled into the costs of the new development. The existing building must be depreciated over its remaining useful life to reduce the carrying amount of the asset to its residual value (presumably nil) at the point at which it is demolished. Consideration will have to be given as to whether the asset is impaired in accordance with IAS 36.

Question 24

Elements of cost and cost measurement : Land and buildings to be redeveloped 3

Many properties do not directly generate independent cash inflows (i.e. they are part of a cash-generating unit) and reducing the useful life will not necessarily lead to an impairment of the cash-generating unit, although by the time the asset has been designated for demolition it may no longer be
part of a cash-generating unit

Developers or owner-occupiers replacing an existing building with a building to be sold in the ordinary course of their business will deal with the land and buildings under IAS 2

Answer 24

Many properties do not directly generate independent cash inflows (i.e. they are part of a cash-generating unit) and reducing the useful life will not necessarily lead to an impairment of the cash-generating unit, although by the time the asset has been designated for demolition it may no longer be
part of a cash-generating unit

Developers or owner-occupiers replacing an existing building with a building to be sold in the ordinary course of their business will deal with the land and buildings under IAS 2

Question 25

Elements of cost and cost measurement : Transfers of assets from customers 1

An entity may be entitled to consideration in the form of goods, services or other non cash consideration (e.g. PP&E), in exchange for transferring goods or services to a customer.

Answer 25

An entity may be entitled to consideration in the form of goods, services or other non cash consideration (e.g. PP&E), in exchange for transferring goods or services to a customer.

Question 26

Elements of cost and cost measurement : Transfers of assets from customers 2

Examples include:
• a supplier who receives a contribution to the development costs of specific tooling equipment from another manufacturer to whom the supplier will sell parts, using that specific tooling equipment under a supply agreement;

• suppliers of utilities who receive items of PP&E from customers that are used to connect them to a network through which they will receive ongoing services (e.g.
electricity, gas, water or telephone services). A typical arrangement is one in which a builder or individual householder must pay for power cables, pipes, or other connections; and

• in outsourcing arrangements, the existing assets are often contributed to the service provider, or the customer must pay for assets, or both.

Answer 26

Examples include:
• a supplier who receives a contribution to the development costs of specific tooling equipment from another manufacturer to whom the supplier will sell parts, using that specific tooling equipment under a supply agreement;

• suppliers of utilities who receive items of PP&E from customers that are used to connect them to a network through which they will receive ongoing services (e.g.
electricity, gas, water or telephone services). A typical arrangement is one in which a builder or individual householder must pay for power cables, pipes, or other
connections; and

• in outsourcing arrangements, the existing assets are often contributed to the service provider, or the customer must pay for assets, or both.

Question 27

Elements of cost and cost measurement : Transfers of assets from customers 3

This raises questions about recognising assets for which the entity has not paid. In what circumstances should the entity recognise these assets, at what carrying amount and how is the ‘other side’ of the accounting entry dealt with? Is it revenue and if so, how and over what period is it recognised? There are a number of potential answers to this and, unsurprisingly, practice had differed.

Answer 27

This raises questions about recognising assets for which the entity has not paid. In what circumstances should the entity recognise these assets, at what carrying amount and how is the ‘other side’ of the accounting entry dealt with? Is it revenue and if so, how and over what period is it recognised? There are a number of potential answers to this and, unsurprisingly, practice had differed.

Question 28

Elements of cost and cost measurement : Transfers of assets from customers 4

When an entity (i.e. the seller or vendor) receives, or expects to receive, non-cash consideration in relation to a revenue contract that is within the scope of IFRS 15, the fair value of the non-cash consideration is included in the transaction price. [IFRS 15.66].

The IFRS 15 requirements regarding non-cash consideration are discussed in detail in Chapter 28 at 6.6. Paragraph BC253 of IFRS 15 states that ‘once recognised, any asset arising from the non-cash consideration would be measured and accounted for in accordance with other relevant requirements’ (e.g. IAS 16). As such, the fair value measured in accordance with IFRS 15 would be the deemed cost of the item of PP&E on initial recognition.

Answer 28

When an entity (i.e. the seller or vendor) receives, or expects to receive, non-cash consideration in relation to a revenue contract that is within the scope of IFRS 15, the fair value of the non-cash consideration is included in the transaction price. [IFRS 15.66].

The IFRS 15 requirements regarding non-cash consideration are discussed in detail in Chapter 28 at 6.6. Paragraph BC253 of IFRS 15 states that ‘once recognised, any asset arising from the non-cash consideration would be measured and accounted for in
accordance with other relevant requirements’ (e.g. IAS 16). As such, the fair value measured in accordance with IFRS 15 would be the deemed cost of the item of PP&E on initial recognition.

Question 29

Incidental and non-incidental income 1

Under IAS 16, the cost of an item of PP&E includes any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of
operating in the manner intended by management. [IAS 16.16(b)]. However, before or during the construction of an asset, an entity may enter into incidental operations that are not, in themselves, necessary to meet this objective. [IAS 16.21].

Answer 29

Under IAS 16, the cost of an item of PP&E includes any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of
operating in the manner intended by management. [IAS 16.16(b)]. However, before or during the construction of an asset, an entity may enter into incidental operations that are not, in themselves, necessary to meet this objective. [IAS 16.21].

Question 30

Incidental and non-incidental income 2

The standard gives the example of income earned by using a building site as a car park prior to starting construction. Because incidental operations are not required in order to bring an asset to the location or condition necessary for it to be capable of operating
in the manner intended by management, the income and related expenses of incidental operations are recognised in profit or loss and included in their respective classifications of income and expense. [IAS 16.21]. Such incidental income and related expenses are not included in determining the cost of the asset.

Answer 30

The standard gives the example of income earned by using a building site as a car park prior to starting construction. Because incidental operations are not required in order to bring an asset to the location or condition necessary for it to be capable of operating
in the manner intended by management, the income and related expenses of incidental operations are recognised in profit or loss and included in their respective classifications of income and expense. [IAS 16.21]. Such incidental income and related expenses are not included in determining the cost of the asset.

Question 31

Incidental and non-incidental income 3

If, however, some income is generated wholly and necessarily as a result of the process of bringing the asset into the location and condition for its intended use, for example from the sale of samples produced when testing the equipment concerned

In May 2020, the International Accounting Standards Board (Board) issued Property, Plant and Equipment—Proceeds before Intended Use, which made amendments to IAS 16 Property, Plant and Equipment. The amendments prohibit a company from deducting from the cost of property, plant and equipment amounts received from selling items produced while the company is preparing the asset for its intended use. Instead, a company will recognise such sales proceeds and related cost in profit or loss.

Answer 31

If, however, some income is generated wholly and necessarily as a result of the process of bringing the asset into the location and condition for its intended use, for example from the sale of samples produced when testing the equipment concerned

In May 2020, the International Accounting Standards Board (Board) issued Property, Plant and Equipment—Proceeds before Intended Use, which made amendments to IAS 16 Property, Plant and Equipment. The amendments prohibit a company from deducting from the cost of property, plant and equipment amounts received from selling items produced while the company is preparing the asset for its intended use. Instead, a company will recognise such sales proceeds and related cost in profit or loss.

Question 32

Incidental and non-incidental income 4

On the other hand, if the asset is already in the location and condition necessary for it to be capable of being used in the manner intended by management then IAS 16 requires capitalisation to cease and depreciation to start. [IAS 16.20].
In these circumstances all income earned from using the asset must be recognised as revenue in profit or loss and the related costs should include an element of depreciation of the asset.

Answer 32

On the other hand, if the asset is already in the location and condition necessary for it to be capable of being used in the manner intended by management then IAS 16 requires capitalisation to cease and depreciation to start. [IAS 16.20].
In these circumstances all income earned from using the asset must be recognised as revenue in profit or loss and the related costs should include an element of depreciation of the asset.

Question 33

Incidental and non-incidental income : Income earned while bringing the asset to the intended location and
condition 1

As noted above, the directly attributable costs of an item of PP&E include the costs of testing whether the asset is functioning properly, after deducting the net proceeds from selling any items produced while bringing the asset to that location and condition.
[IAS 16.17]. The standard gives the example of samples produced when testing equipment.

Answer 33

As noted above, the directly attributable costs of an item of PP&E include the costs of testing whether the asset is functioning properly, after deducting the net proceeds from selling any items produced while bringing the asset to that location and condition.
[IAS 16.17]. The standard gives the example of samples produced when testing equipment.

Question 34

Incidental and non-incidental income : Income earned while bringing the asset to the intended location and
condition 2

There are other situations in which income may be earned whilst bringing the asset to the intended location and condition. This issue is common in the mining and oil and gas sectors, where test production may be sold during the commission stage of a mine or oil well. In these and other examples, it is possible that the net proceeds from selling items produced while testing the plant under construction may exceed the cost of related testing. IAS 16 is not clear as to whether such excess proceeds should be recognised in profit or loss or as a deduction from the cost of the asset.

Answer 34

There are other situations in which income may be earned whilst bringing the asset to the intended location and condition. This issue is common in the mining and oil and gas sectors, where test production may be sold during the commission stage of a mine or oil well. In these and other examples, it is possible that the net proceeds from selling items produced while testing the plant under construction may exceed the cost of related testing. IAS 16 is not clear as to whether such excess proceeds should be recognised in profit or loss or as a deduction from the cost of the asset.

Question 35

Incidental and non-incidental income : Income earned while bringing the asset to the intended location and
condition 3

The Interpretations Committee received a request to clarify two specific aspects of IAS 16, including:

(a) whether the proceeds referred to in IAS 16 relate only to items produced from testing; and
(b) whether an entity deducts from the cost of an item of PP&E any proceeds that exceed the cost of testing.

Answer 35

The Interpretations Committee received a request to clarify two specific aspects of IAS 16, including:

(a) whether the proceeds referred to in IAS 16 relate only to items produced from testing; and
(b) whether an entity deducts from the cost of an item of PP&E any proceeds that exceed the cost of testing.

Question 36

Incidental and non-incidental income : Income earned while bringing the asset to the intended location and
condition 4

In May 2020, the International Accounting Standards Board (Board) issued Property, Plant and Equipment—Proceeds before Intended Use, which made amendments to IAS 16 Property, Plant and Equipment. The amendments prohibit a company from deducting from the cost of property, plant and equipment amounts received from selling items produced while the company is preparing the asset for its intended use. Instead, a company will recognise such sales proceeds and related cost in profit or loss.

Answer 36

In May 2020, the International Accounting Standards Board (Board) issued Property, Plant and Equipment—Proceeds before Intended Use, which made amendments to IAS 16 Property, Plant and Equipment. The amendments prohibit a company from deducting from the cost of property, plant and equipment amounts received from selling items produced while the company is preparing the asset for its intended use. Instead, a company will recognise such sales proceeds and related cost in profit or loss.

Question 37

Incidental and non-incidental income : Income received during the construction of property 1

One issue that commonly arises is whether rental and similar income generated by existing tenants in a property development may be capitalised and offset against the cost of developing that property.

Answer 37

One issue that commonly arises is whether rental and similar income generated by existing tenants in a property development may be capitalised and offset against the cost of developing that property.

Question 38

Incidental and non-incidental income : Income received during the construction of property 2

The relevant question is whether the leasing arrangements with the existing tenants are a necessary activity to bring the development property to the location and condition necessary for it to be capable of operating in the manner intended by management. Whilst the existence of the tenant may be a fact, it is not a necessary condition for the building to be developed to the condition intended by management; the building could have been developed in the absence of any existing tenants.

Answer 38

The relevant question is whether the leasing arrangements with the existing tenants are a necessary activity to bring the development property to the location and condition necessary for it to be capable of operating in the manner intended by management. Whilst the existence of the tenant may be a fact, it is not a necessary condition for the building to be developed to the condition intended by management; the building could have been developed in the absence of any existing tenants.

Question 39

Incidental and non-incidental income : Income received during the construction of property 3

Therefore, rental and similar income from existing tenants are incidental to the development and should not be capitalised. Rather rental and similar income should be recognised in profit or loss in accordance with the requirements of IFRS 16 together with related expenses.

Answer 39

Therefore, rental and similar income from existing tenants are incidental to the development and should not be capitalised. Rather rental and similar income should be recognised in profit or loss in accordance with the requirements of IFRS 16 together with related expenses.

Question 40

Incidental and non-incidental income : Liquidated damages during construction

Income may arise in other ways, for example, liquidated damages received as a result of delays by a contractor constructing an asset. Normally such damages received should be set off against the asset cost – the purchase price of the asset is reduced to
compensate for delays in delivery.

Answer 40

Income may arise in other ways, for example, liquidated damages received as a result of delays by a contractor constructing an asset. Normally such damages received should be set off against the asset cost – the purchase price of the asset is reduced to
compensate for delays in delivery.

Question 41

Accounting for changes in decommissioning and restoration costs 1

IAS 16 requires the initial estimate of the costs of dismantling and removing an item of PP&E and restoring the site on which it is located to be included as part of the item’s cost. This applies whether the obligation is incurred either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period. [IAS 16.16].

Answer 41

IAS 16 requires the initial estimate of the costs of dismantling and removing an item of PP&E and restoring the site on which it is located to be included as part of the item’s cost. This applies whether the obligation is incurred either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period. [IAS 16.16].

Question 42

Accounting for changes in decommissioning and restoration costs 2

However, IAS 16 does not address the extent to which an item’s carrying amount should be affected by changes in the estimated amount of dismantling and site restoration costs that occur after the estimate made upon initial measurement. This issue is the subject of IFRIC 1, which applies to any decommissioning, restoration or similar liability that has been both included as part of the cost of an asset measured in accordance with IAS 16 and recognised as a liability in accordance with IAS 37. [IFRIC 1.2].
It deals with the impact of events that change the measurement of an existing decommissioning, restoration or similar liability. Events include a change in the estimated cash flows, a change in the discount rate and the unwinding of the discount. [IFRIC 1.3].

Answer 42

However, IAS 16 does not address the extent to which an item’s carrying amount should be affected by changes in the estimated amount of dismantling and site restoration costs that occur after the estimate made upon initial measurement. This issue is the subject of IFRIC 1, which applies to any decommissioning, restoration or similar liability that has been both included as part of the cost of an asset measured in accordance with IAS 16 and recognised as a liability in accordance with IAS 37. [IFRIC 1.2]. It deals with the impact of events that change the measurement of an existing decommissioning, restoration or similar liability. Events include a change in the estimated cash flows, a change in the discount rate and the unwinding of the discount. [IFRIC 1.3].

Question 43

Exchanges of assets 1

An entity might swap an asset it does not require in a particular area, for one it does in another – the opposite being the case for the counter-party. Such exchanges are not uncommon in the telecommunications, media and leisure businesses, particularly after an acquisition. Governmental competition rules sometimes require such exchanges. The question arises whether such transactions give rise to a gain in circumstances where
the carrying value of the outgoing facility is less than the fair value of the incoming one. This can occur when carrying values are less than market values, although it is possible that a transaction with no real commercial substance could be arranged solely to boost apparent profits.

Answer 43

An entity might swap an asset it does not require in a particular area, for one it does in another – the opposite being the case for the counterparty. Such exchanges are not uncommon in the telecommunications, media and leisure businesses, particularly after an acquisition. Governmental competition rules sometimes require such exchanges. The question arises whether such transactions give rise to a gain in circumstances where
the carrying value of the outgoing facility is less than the fair value of the incoming one. This can occur when carrying values are less than market values, although it is possible that a transaction with no real commercial substance could be arranged solely to boost apparent profits.

Question 44

Exchanges of assets 2

IAS 16 requires all acquisitions of PP&E in exchange for non-monetary assets, or a combination of monetary and non-monetary assets, to be measured at fair value, subject to conditions:
‘The cost of such an item of property, plant and equipment is measured at fair value unless (a) the exchange transaction lacks commercial substance or (b) the fair value of neither the asset received nor the asset given up is reliably measurable. The acquired
item is measured in this way even if an entity cannot immediately derecognise the asset given up.’ [IAS 16.24].

Answer 44

IAS 16 requires all acquisitions of PP&E in exchange for non-monetary assets, or a combination of monetary and non-monetary assets, to be measured at fair value, subject to conditions:
‘The cost of such an item of property, plant and equipment is measured at fair value unless (a) the exchange transaction lacks commercial substance or (b) the fair value of neither the asset received nor the asset given up is reliably measurable. The acquired
item is measured in this way even if an entity cannot immediately derecognise the asset given up.’ [IAS 16.24].

Question 45

Exchanges of assets 3

The IASB concluded that the recognition of income from an exchange of assets does not depend on whether the assets exchanged are dissimilar. [IAS 16.BC19].

If at least one of the two fair values can be measured reliably, that value is used for measuring the exchange transaction; if not, then the exchange is measured at the carrying value of the asset the entity no longer owns. [IAS 16.24].
For example, if the new asset’s fair value is higher than the carrying amount of the old asset, a gain may be recognised

Answer 45

The IASB concluded that the recognition of income from an exchange of assets does not depend on whether the assets exchanged are dissimilar. [IAS 16.BC19].

If at least one of the two fair values can be measured reliably, that value is used for measuring the exchange transaction; if not, then the exchange is measured at the carrying value of the asset the entity no longer owns. [IAS 16.24].
For example, if the new asset’s fair value is higher than the carrying amount of the old asset, a gain may be recognised

Question 46

Exchanges of assets 4

This requirement is qualified by a ‘commercial substance’ test. If it is not possible to demonstrate that the transaction has commercial substance as defined by the standard, assets received in exchange transactions will be recorded at the carrying value of the asset given up. [IAS 16.24].

Answer 46

This requirement is qualified by a ‘commercial substance’ test. If it is not possible to demonstrate that the transaction has commercial substance as defined by the standard, assets received in exchange transactions will be recorded at the carrying value of the asset given up. [IAS 16.24].

Question 47

Exchanges of assets 5

If the transaction passes the ‘commercial substance’ test then IAS 16 requires the exchanged asset to be recorded at its fair value. The standard requires gains or losses on items that have been derecognised to be included in profit or loss in the period of derecognition but does not allow gains on derecognition to be
classified as revenue, except for certain assets previously held for rental. [IAS 16.68, 68A].

It gives no further indication regarding their classification in profit or loss. Such exchanges of goods and services are also excluded from the scope of IFRS 15 if the nonmonetary exchange is between entities in the same line of business to facilitate sales to customers or potential customers

Answer 47

If the transaction passes the ‘commercial substance’ test then IAS 16 requires the exchanged asset to be recorded at its fair value. The standard requires gains or losses on items that have been derecognised to be included in profit or loss in the period of derecognition but does not allow gains on derecognition to be
classified as revenue, except for certain assets previously held for rental. [IAS 16.68, 68A].

It gives no further indication regarding their classification in profit or loss. Such exchanges of goods and services are also excluded from the scope of IFRS 15 if the nonmonetary exchange is between entities in the same line of business to facilitate sales to customers or potential customers

Question 48

Exchanges of assets : Commercial substance 1

The commercial substance test was put in place as an anti-abuse provision to prevent gains from being recognised in income when the transaction had no discernible (no able to detectable) effect on the entity’s economics. [IAS 16.BC21].

The commercial substance of an exchange is to
be determined by forecasting and comparing the future cash flows budgeted to be generated by the incoming and outgoing assets. For there to be commercial substance, there must be a significant difference between the two forecasts.

Answer 48

The commercial substance test was put in place as an anti-abuse provision to prevent gains from being recognised in income when the transaction had no discernible (no able to detectable) effect on the entity’s economics. [IAS 16.BC21].

The commercial substance of an exchange is to
be determined by forecasting and comparing the future cash flows budgeted to be generated by the incoming and outgoing assets. For there to be commercial substance, there must be a significant difference between the two forecasts.

Question 49

Exchanges of assets : Commercial substance 2

The standard sets out this requirement as follows:

‘An entity determines whether an exchange transaction has commercial substance by considering the extent to which its future cash flows are expected to change as a result of the transaction.

Answer 49

The standard sets out this requirement as follows:

‘An entity determines whether an exchange transaction has commercial substance by considering the extent to which its future cash flows are expected to change as a result of the transaction.

Question 50

Exchanges of assets : Commercial substance 3

An exchange transaction has commercial substance if:

(a) the configuration (risk, timing and amount) of the cash flows of the asset received differs from the configuration of the cash flows of the asset transferred; or (b) the entity-specific value of the portion of the entity’s operations affected by the transaction changes as a result of the exchange; and (c) the difference in (a) or (b) is significant relative to the fair value of the assets
exchanged. ’ [IAS 16.25].

Answer 50

An exchange transaction has commercial substance if:

(a) the configuration (risk, timing and amount) of the cash flows of the asset received differs from the configuration of the cash flows of the asset transferred; or (b) the entity-specific value of the portion of the entity’s operations affected by the transaction changes as a result of the exchange; and (c) the difference in (a) or (b) is significant relative to the fair value of the assets
exchanged. ’ [IAS 16.25].

Question 51

Exchanges of assets : Commercial substance 4

As set out in the definitions of the standard, entity-specific value in item (b) above is the net present value of the future predicted cash flows from continuing use and disposal of the asset. Post-tax cash flows should be used for this calculation. The standard contains no guidance on the discount rate to be used for this exercise, nor on any of the other parameters involved, but it does suggest that the result of these analyses
might be clear without having to perform detailed calculations. [IAS 16.25]. Care will have to be taken to ensure that the transaction has commercial substance as defined in the standard if an entity receives a similar item of PP&E in exchange for a similar asset of its
own. Commercial substance may be difficult to demonstrate if the entity is exchanging an asset for a similar one in a similar location. However, in the latter case, the risk, timing and amount of cash flows could differ if one asset were available for sale and the entity
intended to sell it whereas the previous asset could not be realised by sale or only sold over a much longer timescale. It is feasible that such a transaction could meet conditions (a) and (c) above. Similarly, it would be unusual if the entity-specific values of similar assets
differed enough in any arm’s length exchange transaction to meet condition (c).

Answer 51

As set out in the definitions of the standard, entity-specific value in item (b) above is the net present value of the future predicted cash flows from continuing use and disposal of the asset. Post-tax cash flows should be used for this calculation. The standard contains no guidance on the discount rate to be used for this exercise, nor on any of the other parameters involved, but it does suggest that the result of these analyses
might be clear without having to perform detailed calculations. [IAS 16.25]. Care will have to be taken to ensure that the transaction has commercial substance as defined in the standard if an entity receives a similar item of PP&E in exchange for a similar asset of its
own. Commercial substance may be difficult to demonstrate if the entity is exchanging an asset for a similar one in a similar location. However, in the latter case, the risk, timing and amount of cash flows could differ if one asset were available for sale and the entity
intended to sell it whereas the previous asset could not be realised by sale or only sold over a much longer timescale. It is feasible that such a transaction could meet conditions (a) and (c) above. Similarly, it would be unusual if the entity-specific values of similar assets
differed enough in any arm’s length exchange transaction to meet condition (c).

Question 52

Exchanges of assets : Commercial substance 5

Other types of exchange are more likely to pass the ‘commercial substance’ test, for example exchanging an interest in an investment property for one that the entity uses for its own purposes. The entity has exchanged a rental stream and instead has an asset
that contributes to the cash flows of the cash-generating unit of which it is a part. In this case it is probable that the risk, timing and amount of the cash flows of the asset received would differ from the configuration of the cash flows of the asset transferred.

Answer 52

Other types of exchange are more likely to pass the ‘commercial substance’ test, for example exchanging an interest in an investment property for one that the entity uses for its own purposes. The entity has exchanged a rental stream and instead has an asset
that contributes to the cash flows of the cash-generating unit of which it is a part. In this case it is probable that the risk, timing and amount of the cash flows of the asset received would differ from the configuration of the cash flows of the asset transferred.

Question 53

Exchanges of assets : Commercial substance 6

Question 54

Exchanges of assets : Reliably measurable 1

In the context of asset exchanges, the standard contains guidance on the reliable determination of fair values in the circumstances where market values do not exist. The ‘reliable measurement’ test for using fair value was included to measure these exchanges
to minimise the risk that entities could ‘manufacture’ gains by attributing inflated values to the assets exchanged. [IAS 16.BC23].
Note that fair value is defined by reference to IFRS 13 and that the requirements below are specific to asset exchanges in IAS 16.

Answer 54

In the context of asset exchanges, the standard contains guidance on the reliable determination of fair values in the circumstances where market values do not exist. The ‘reliable measurement’ test for using fair value was included to measure these exchanges
to minimise the risk that entities could ‘manufacture’ gains by attributing inflated values to the assets exchanged. [IAS 16.BC23].
Note that fair value is defined by reference to IFRS 13 and that the requirements below are specific to asset exchanges in IAS 16.

Question 55

Exchanges of assets : Reliably measurable

‘The fair value of an asset is reliably measurable if (a) the variability in the range of reasonable fair value measurements is not significant for that asset or (b) the
probabilities of the various estimates within the range can be reasonably assessed and used when measuring fair value. If an entity is able to measure reliably the fair value of either the asset received or the asset given up, then the fair value of the asset given up is used to measure the cost of the asset received unless the fair value of the asset received is more clearly evident.’ [IAS 16.26]. If the fair value of neither the asset given up nor the asset received can be measured reliably (i.e. neither (a) nor (b) above are met), the cost of the asset is measured at the carrying amount of the asset given up; this means there is no gain on the transaction. [IAS 16.24].

Answer 55

‘The fair value of an asset is reliably measurable if (a) the variability in the range of reasonable fair value measurements is not significant for that asset or (b) the
probabilities of the various estimates within the range can be reasonably assessed and used when measuring fair value. If an entity is able to measure reliably the fair value of either the asset received or the asset given up, then the fair value of the asset given up is used to measure the cost of the asset received unless the fair value of the asset received is more clearly evident.’ [IAS 16.26]. If the fair value of neither the asset given up
nor the asset received can be measured reliably (i.e. neither (a) nor (b) above are met), the cost of the asset is measured at the carrying amount of the asset given up; this means there is no gain on the transaction. [IAS 16.24].

Question 56

Assets acquired with the assistance of government grants

The carrying amount of an item of PP&E may be reduced by government grants in accordance with IAS 20 – Accounting for Government Grants and Disclosure of Government Assistance. [IAS 16.28].

Answer 56

The carrying amount of an item of PP&E may be reduced by government grants in accordance with IAS 20 – Accounting for Government Grants and Disclosure of Government Assistance. [IAS 16.28].