CHAPTER 2

REGULATORY FRAMEWORK
RECAP
RECAP
 Learning objectives
• Explain why a regulatory framework is needed including the advantages and disadvantages of IFRS Standards over a
national regulatory framework.

• Explain why IFRS Standards on their own are not a complete regulatory framework.

• Distinguish between a principles based and a rules based framework and discuss whether they can be complementary.

• Describe the IASB’s Standard setting process including revisions to and interpretations of Standards.

• Explain the relationship of national standard setters to the IASB in respect of the standard setting process.
OVERVIEW
Overview
about
regulatory
system
 Need for regulatory framework
The aim of a regulatory framework is to narrow the areas of difference and choice in financial reporting and to
improve comparability. This is even more important when we consider how different financial reporting can be
around the world
Principles-based versus rules-based approach
Principles- based Rules- based

IFRS US GAPP

• Written & based on the definitions accounting standards

of the elements of the financial contain rules that apply to
statements, recognition and specific scenarios.
measurement principles, as set
out in the Conceptual Framework
for Financial Reporting.

• Cover a wider variety of scenarios

without the need for very detailed
scenario by scenario guidance as
far as possible.
IFRS vs US GAAP
 Structure of
international
regulatory
system
 Structure of international regulatory system
• develop a set of global accounting
standards of high quality which are
understandable and enforceable
• promote the use and application of
these standards
• bring about the convergence of
national and international accounting
oversees the IASB
standards

To review, on a timely basis, newly

a forum used by the IASB to
identified financial reporting issues not
consult with the outside world.
specifically addressed in IFRSs
It consults with national
standard-setters, academics,
user groups, and a host of other To clarify issues where unsatisfactory or
interested parties to advise the conflicting interpretations have
IASB on a range of issues, from developed, or seem likely to develop in
the IASB’s work program for the absence of authoritative guidance,
developing new IFRSs to giving to reach a consensus on the appropriate
practical advice on the treatment
implementation of particular
standards
Standards-setting process
CHAPTER 3A
PPE & BORROWING COST
 Learning objectives
• Define and compute the initial measurement of a non-current asset (including borrowing costs and an asset
that has been self-constructed).

• Identify subsequent expenditure that may be capitalised, distinguishing between asset and expense items.

• Discuss the requirements of relevant IFRS Standards in relation to the revaluation of non-current assets.

• Account for revaluation and disposal gains and losses for non-current assets.
Overview
 IAS 16 – Property, Plant and Equipment
DEFINITION

Property, plant and equipment (PPE) are tangible assets that:

• Held for use in the production or supply of goods or services, for rental to others, or for administrative purposes.
• Are expected to be used during more than one period

No. Terminology Definition

The amount of cash or cash equivalents paid or the fair value of the other
1 Cost
consideration given to acquire an asset at the time of its acquisition or construction

2 Depreciation Systematic allocation of the depreciable amount of assets over its useful life

The net amount which the entity expects to obtain for an asset at the end of its useful
3 Residual value
life after deducting the expected costs of disposal.
The price that would be received to sell an asset or paid to transfer a liability in an
4 Fair value
orderly transaction between market participants at the measurement date
The amount by which the carrying amount of an asset exceeds its recoverable
5 Impairment loss
amount.
 IAS 16 – Property, Plant and Equipment
1. Scope

IAS 16 DOES NOT APPLY to the following:

• PPE classified as held for sale in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations.

• Biological assets related to agricultural activity other than bearer plants (see IAS 41 Agriculture). This Standard applies
to bearer plants but it does not apply to the produce on bearer plants.

• The recognition and measurement of exploration and evaluation assets (see IFRS 6 Exploration for and Evaluation of
Mineral Resources).

• Mineral rights and mineral reserves such as oil, natural gas and similar non-regenerative resources
IAS 16 – Property, Plant and Equipment
2. Recognition

• It is probable that future economic benefits associated with the asset will flow to the entity, (satisfied when
risks and rewards have passed to the entity), and;

• The cost of the asset to the entity can be measured reliably.

 IAS 16 – Property, Plant and Equipment
3. Measurement
Purchase price excluding any trade
discount and sales tax

Cost – accumulated
COST model
depreciation
costs of dismantling and
removing, restoring the site

Subsequent Initial Directly attributable costs of

measurement measurement bringing the asset to working
condition (*)

Revaluation – Borrowing cost (IAS 23)

Accumulated depreciation REVALUATION model
– Impairment loss (*) Site preparation, delivery, installation and assembly
costs, costs of testing, and professional fees (e.g, legal costs
and architects' fees
 IAS 16 – Property, Plant and Equipment
3. Measurement

Costs of dismantling and removing, restoring the site

Dismantling costs – the present value (PV) of these costs should be capitalized, with an equivalent liability set up. You
may need to use the interest rate given and apply the discount fraction where:
 IAS 16 – Property, Plant and Equipment
Test your understanding
An entity started construction on a building for its own use on 1 April 20X7 and incurred the following costs:
$000
Purchase price of land 250,000
Stamp duty 5,000
Legal fees 10,000
Site preparation and clearance 18,000
Materials 100,000
Labour (period 1 April 20X7 to 1 July 20X8) 150,000
Architect’s fees 20,000
General overheads 30,000
–––––––
583,000
The following information is also relevant: –––––––
• Material costs were greater than anticipated. On investigation, it was found that materials costing $10 million had been
spoiled and therefore wasted and a further $15 million was incurred on materials as a result of faulty design work.

• As a result of these problems, work on the building ceased for a fortnight during October 20X7 and it is estimated that
approximately $9 million of the labour costs relate to this period.

• The building was completed on 1 July 20X8 and occupied on 1 September 20X8.

You are required to calculate the cost of the building that will be included in tangible non-current asset additions.
 IAS 16 – Property, Plant and Equipment
• Only those costs which are directly attributable to bringing the asset into working condition for its intended use should be
included
• administration and other general overhead costs cannot be included
• costs included should only be normal, not abnormal, costs.
The amount included in property, plant and equipment is computed as follows:

Notes:
1 The costs of spoiled material and faulty design
are abnormal costs.

2 The $9 million labour cost incurred during the

period of the stoppage is an abnormal cost and is
excluded.
 IAS 16 – Property, Plant and Equipment
Subsequent measurement – Cost model

SUBSEQUENT EXPENDITURE

From 1st => n-1 year: Depreciation = opening balance x

Reducing balance depreciation rate

At n year: Depreciation = opening balance - residual value

Depreciation

Straight-line
 IAS 16 – Property, Plant and Equipment
Subsequent expenditure

• It enhances the economic benefits provided by the asset (this could be extending
the asset's life, an expansion or increasing the productivity of the asset)

• It relates to an overhaul or required major inspection of the asset – the costs

Recognize as
associated with this should be capitalised and depreciated over the time until the
ASSET
next overhaul or safety inspection

• It is replacing a component of a complex asset. The replaced component will be

derecognised. A complex asset is an asset made up of a number of components,
which each depreciate at different rates, e.g. an aircraft would comprise body,
engines and interior
 IAS 16 – Property, Plant and Equipment
Subsequent measurement – Cost model
An entity purchases an aircraft that has an expected useful life of 20 years with no residual value. The aircraft requires
substantial overhaul at the end of years 5, 10 and 15. The aircraft cost $25 million and $5 million of this figure is estimated
to be attributable to the economic benefits that are restored by the overhauls. In year 6, the cost of the overhaul is
estimated to be $6 million. Calculate the annual depreciation charge for the years 1–5 and years 6–10.
Solution
The aircraft is treated as two separate components for depreciation
purposes:
Years 1–5 $m
Initial overhaul value $5m depreciated over 5 years 1
Balance of $20m depreciated over 20 years 1
––––
Depreciation charge per annum 2
When the first overhaul is completed at the end of year 5 at a cost of, say, $6 million, then this cost is capitalised and depreciated
to the date of the next overhaul:
Years 6–10 $m
Overhaul $6m depreciated over 5 years 1.2
Aircraft depreciation 1.0
Depreciation charge per annum 2.2
 IAS 16 – Property, Plant and Equipment
3. Measurement – Revaluation model

Step 1: Identify carrying amount of assets before revaluation

Step 2: Identify and recognize revaluation gain/loss

• If Carrying amount > Fair value => Revaluation loss => Record in P/L
• If Carrying amount < Fair values => Revaluation gain => Record in Other comprehensive income (OCI)
 IAS 16 – Property, Plant and Equipment
3. Measurement – Revaluation model

Example: NCC Co bought an asset for $20,000 at the beginning of 20X7. It had a useful life of five years. On 31 December
20X8 the asset was revalued to $24,000. The expected useful life has remained unchanged (i.e three years remain).
Required: Account for the revaluation of PPE in NCC

Solution:

Step 1: Identify carrying amount of assets before revaluation

At 31 December 20X8 the accumulated depreciation of the asset = (2 x $20,000/5) = $8,000
=> Carrying amount of asset at 31 December 20X8 = $20,000 – $8,000 = $12,000

Step 2: Identify and recognize revaluation gain/loss

Carrying amount = $12,000 < Fair value = $24,000 => Revaluation gain = $12,000

Recognition
Debit PPE $12,000
Credit OCI $12,000
 IAS 16 – Property, Plant and Equipment
3. Measurement – Revaluation model
IAS 16 – Property, Plant and Equipment
Note:
• The revaluation gain or loss must be
disclosed in both the SOCIE and in OCI or PL.

• Offset of gains and losses between different

properties is not permitted.

• Be careful, in the exam a reserves transfer is

only required if the examiner indicates that it
is company policy to make a transfer to
realized profits in respect of excess
depreciation on revalued assets. If this is not
the case then a reserves transfer is not
necessary.

• This movement in reserves should also be

disclosed in the statement of changes in equity
(SOCIE).
 IAS 16 – Property, Plant and Equipment
Effect of revaluation on depreciation of assets

Step 1

Step 2 Compare new depreciation in step 1 to old depreciation and calculate the change in depreciation

Step 3 Compensate the effect of additional depreciation by transferring from revaluation surplus to retained earnings
If new depreciation charged > old depreciation charged => additional depreciation charged = transfer
from revaluation surplus to retained earnings

Debit Revaluation surplus $ Additional depreciation

Credit Retained earnings $ Additional depreciation

=> This transfer would be shown on the statement of change in equity

 IAS 16 – Property, Plant and Equipment
Effect of revaluation on depreciation of assets

Example : NCC Co bought an asset for $20,000 at the beginning of 20X7. It had a useful life of five years. On 31 December
20X8 the asset was revalued to $24,000. The expected useful life has remained unchanged (i.e three years remain).
Required: State the treatment for depreciation from 20X8 onwards.

Step 1: Calculate new depreciation for 20X8 = Revaluation amount/remaining useful life. New depreciation = $24,000/3 = $8,000

Step 2: Compare new depreciation in step 1 to old depreciation and calculate the change in depreciation
The change in depreciation = $8,000 – $4,000 = $4,000

Step 3: Compensate the effect of additional depreciation by transferring from revaluation surplus to retained earnings
Debit Revaluation surplus $4,000
Credit Retained earnings $4,000
 IAS 16 – Property, Plant and Equipment
4. De-recognition & Disposal

There are two (02) steps of disposing asset:

Step 1: Accounted for in the SOPL of the period in which the disposal occurs.
Step 2: Any balance on the revaluation surplus should now be transferred to retained earnings.
IAS 16 – Property, Plant and Equipment
An entity revalued its land and buildings at the start
of the year to $10 million ($4 million for the land).

The property cost $5 million ($1 million for the land)

ten years prior to the revaluation.

The total expected useful life of 50 years is

unchanged.

The entity's policy is to make an annual transfer of

realised amounts to retained earnings.

Show the effects of the above on the financial

statements for the year.
 IAS 16 – Property, Plant and Equipment
Building Land

1. CV before revaluation 3,200 1,000 4,200

2. Revaluation surplus 2,800 3,000 5,800

3. CV at year end 5,850 4,000 9,850

4. Excess depreciation 70 = 150 - 80

 IAS 16 – Property, Plant and Equipment
SOPL & OCI (extract) SOFP (extract) SOCIE (extract)

RR $’000
Depreciation (150) Non-current assets
Bal b/f 0
OCI: Land and buildings 9,850
Gain 5,800
Revaluation gain 5,800 Equity
Transfer to RE (70)
Revaluation surplus (SOCIE) 5,730
Bal c/f 5,730
IAS 16 – Property, Plant and Equipment
An entity purchased a property 15 years ago at a cost of $100,000
and have been depreciating it at a rate of 2% per annum, on the
straight line basis. The entity have had the property professionally
revalued at $500,000.

What is the revaluation surplus that will be recorded in the

financial statements in respect of this property?

A. $400,000
B. $500,000
C. $530,000
D. $430,000

Current value 500,000

Carrying amount at date of revaluation
(100,000 – (100,000 × 2% × 15 yrs)) (70,000)
–––––––
Revaluation gain 430,000
 IAS 16 – Property, Plant and Equipment
An entity owns two buildings, A and B, which are A Dr NCA $150,000
currently recorded in the books at carrying amounts of Dr SOPL $80,000
$170,000 and $330,000 respectively. Both buildings have Cr OCI (RR) $230,000
recently been valued as follows:
B Dr NCA $150,000
Building A $400,000 Dr SOPL $30,000
Building B $250,000 Cr OCI (RR) $180,000

The entity currently has a balance on the revaluation C Dr NCA $150,000

surplus of $50,000 which arose when building A was Cr OCI (RR) $150,000
revalued several years ago. Building B has not previously
been revalued. D Dr NCA $150,000
Dr SOPL $50,000
What double entry will need to be made to record the Cr OCI (RR) $200,000
revaluations of buildings A and B?
 IAS 16 – Property, Plant and Equipment
An entity owns two buildings, A and B, which are Revaluation gain/ (loss):
currently recorded in the books at carrying amounts of + Building A = 400 – 170 = 230
$170,000 and $330,000 respectively. Both buildings have + Building B = 250 – 330 = (80)
recently been valued as follows:
The gain on Building A: Credited to OCI & RR
Building A $400,000
Building B $250,000 The loss on Building B: debited to SOPL because we
do not have a balance on the revaluation surplus in
The entity currently has a balance on the revaluation respect of building B to offset the loss.
surplus of $50,000 which arose when building A was
revalued several years ago. Building B has not previously Overall debit to non-current assets of $230,000 –
been revalued. $80,000 = $150,000

What double entry will need to be made to record the

revaluations of buildings A and B?
IAS 23 – Borrowing costs
1. SCOPE

IAS 23 looks at the treatment of borrowing costs related to self-constructed assets and inventory which take a
substantial period of time to get ready for intended use or sale.

Borrowing costs that directly relate to the acquisition, construction or production of a qualifying asset must be
capitalised as a part of the cost of that asset (IAS 23: para. 26).

A qualifying asset is an asset that necessarily takes a substantial period of time to be ready for its intended use or
sale (IAS 23: para. 5).
IAS 23 – Borrowing costs
2. RECOGNITION

Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset
form part of the cost of that asset and, therefore, should be capitalized.

Other borrowing costs are recognized as an expense

 IAS 23 – Borrowing costs
3. CAPITALIZATION

3.1 PERIOD OF CAPITALIZATION

COMMENCEMENT SUSPENSION CESSATION

• Capitalization stops when

• It incurs expenditures • Active development is interrupted
physical construction of the
for the asset. for any extended periods;
asset is completed, despite
• It incurs borrowing
ongoing minor activities.
costs. • Suspension of capitalization of
• It undertakes activities borrowing costs is not necessary for
• Minor activities such as
that are necessary to temporary delays.
decoration of a building to a
prepare the asset for its
purchaser's specification do not
intended use or sale.
form part of substantial
activities, so capitalization
should cease before this work is
started
IAS 23 – Borrowing costs
3. CAPITALIZATION

3.2 DETERMINE CAPITALIZED BORROWING COSTS

 IAS 23 – Borrowing costs
Example (Specific Borrowings):
SKT Co buys asset for $4,000 - takes 2 years to build. Get a $4,000 10% loan. SKT Co reinvest any money not used in an 8%
deposit account. In year 1, SKT Co spends 2,400.

Required: How many borrowing costs (interests) to be capitalized (added to the cost of the asset)?

Step 1 No information on when construction start => assume it starts in line with the borrowing timing

Step 2 Calculate the interest paid on the specific loans. Interest paid on loan: $4,000 × 10% = $400

Step 3 Calculate any interest received on loans proceeds not used

Interest received on unused loan amount = ($4,000 - $2,400) × 8% = $128

Step 4 Calculate capitalized costs = $400 - $128 = $272.

 IAS 23 – Borrowing costs
Example (General Borrowings):
SKT Co takes 3 different current sources of borrowings for its purchase of an asset of $10,000, taking 1 year to build.
5% overdraft 2,000; 8% Loan 6,000 and 10% Loan 4,000.

Required: How much interest would go to the cost of the asset?

Step 1 No information on when construction start => assume it starts in line with the borrowing timing

Step 2

Calculate interest amount applicable

Step 3
Interest payable = $10,000 × 8.17% = $817

Step 4 Total interest to be capitalized = $817 - 0 = $817

 IAS 23 – Borrowing costs
Apex issued a $10 million unsecured loan with interest rate of 7.5% per annum on 1 April 20X8. The loan was specifically
issued to finance the building of the new store which meets the definition of a qualifying asset in IAS 23.

Construction of the store commenced on 1 May 20X8 and it was completed and ready for use on 28 February 20X9, but
did not open for trading until 1 April 20X9. During the year trading at Apex’s other stores was below expectations so Apex
suspended the construction of the new store for a twomonth period during July and August 20X8.

The proceeds of the loan were temporarily invested for the month of April 20X8 and earned interest of $40,000.

Required
Calculate the net borrowing cost that should be capitalised as part of the cost of the new store and the finance cost
that should be reported in profit or loss for the year ended 31 March 20X9
 IAS 23 – Borrowing costs
The total finance costs for the year are $750,000 ($10m x 7.5%)

However, the finance costs can only be capitalised for those periods during which the activity was taking place, not before
the development begins, while it is suspended or after it has ceased

Finance costs to be capitalised are therefore $’000

May/June 20X8 ($10m x 7.5% x 2/12) 125
Sept X8 – Feb X9 ($10m x 7.5% x 6/12) 375
500

$500,000 will be debited to PPE as part of the cost of the new store. $’000
Finance costs to be expensed (750 – 500) 250

These will be debited to profit or loss.

The period during which the funds were invested was before the development activity began, so during a period in which
finance costs were not being capitalised. Therefore the interest received of $40,000 is not deducted from the capitalised
finance costs, but is credited to profit or loss as investment income
 Practice
During the year to 30 September 20X3 Hudson built a new mining facility to take advantage of new laws regarding on-shore
gas extraction. The construction of the facility cost $10 million, and to fund this Hudson took out a $10 million 6% loan on 1
October 20X2, which will not be repaid until 20X6. The 6% interest was paid on 30 September 20X3.

Construction work began on 1 October 20X2, and the work was completed on 31 August 20X3. As not all the funds were
required immediately, Hudson invested $3 million of the loan in 4% bonds from 1 October 20X2 until 31 January 20X3.
Mining commenced on 1 September 20X3 and is expected to continue for 10 years.

As a condition of being allowed to construct the facility, Hudson is required by law to dismantle it on 1 October 20Y3.
Hudson estimated that this would cost a further $3 million.

As the equipment is extremely specialised, Hudson invested significant resources in recruiting and training employees.
Hudson spent $600,000 on this process in the year to 30 September 20X3, believing it to be worthwhile as it anticipates that
most employees will remain on the project for the entire 10 year duration.
Hudson has a cost of capital of 6%.

Required:
Show, using extracts, the correct financial reporting treatment for the above items in the financial statements for Hudson
for the year ended 30 September 20X3
Practice
SOPL & OCI (extract) SOFP (extract)

Non-current assets
• Depreciation
• PPE
• Staff recruitment & training
Non-current liabilities

• Provision
• Finance cost
• Loan
 • The interest: capitalised from 1 October to 1 September, net of the income earned
from the temporary investment of the $3 million for the 4 months
• Interest payable: $10 million × 6% = $600,000 × 11/12 = $550,000
(W1) Borrowing cost
• Interest income earned: $3 million × 4% = $120,000 × 4/12 = $40,000
• Amount to be capitalised = $550,000 – $40,000 = $510,000.
• Asset was completed on 1 September, the interest for September needs to be charged
to the SOPL as an expense ($600,000 × 1/12 = $50,000).

• The $3 million should be initially discounted to present value using Hudson’s cost of
(W2) Provision for capital of 6% and capitalised. $3 million payable in 11 years' time (from October 20X2
dismantling to October 20Y3):
$3,000,000 × 1/1.0611 = $1,580,363

• The discount on the provision must also be unwound over the year.
$1,580,363 × 6% = $94,822 to be added to finance costs and to the closing provision.
 (W3) PPE
$
Construction cost 10,000,000
Borrowing costs capitalised (W1) 510,000
Present value of dismantling costs (W2) 1,580,363
–––––––––
Total to be capitalised 12,090,363

Depreciated over the useful life of 10 years.

As mining begins on 1 September, depreciation should begin from this date.

• Depreciation = $12,090,363/10 × 1/12 = $100,753

• Carrying amount = $12,090,363 – $100,753 = $11,989,610

 Practice
Statement of profit or loss for the year Statement of financial position as at 30
ended 30 Sep 20X3 September 20X3

• Depreciation (W3) $100,753 Non-current assets

• PPE (W3) $11,989,610

• Staff recruitment & training $600,000
Non-current liabilities

• Provision $1,675,185
• Finance cost $144,822 ($1,580,363 + $94,822 (W2))
($50,000 (W1) + $94,822 (W2)
• Loan $10,000,000
SUMMARY
 BORROWING COSTS (IAS 23)

Accounting treatment Commencement,

Capitalisation
suspension, cessation
• Borrowing costs relating • Funds specifically borrowed – • Commence capitalisation when:
to a qualifying asset at actual borrowing rate less – Expenditure incurred
must be capitalised as any income – Borrowing costs incurred
part of the cost of that – Activities to get the asset ready for
asset • General funds – weighted use/sale are in progress
average of borrowing costs in
– A qualifying asset is one period – Amount capitalised • Suspend capitalisation when
that necessarily takes a long should not development is interrupted
period of time to be ready exceed actual cost
for its intended use or sale • Cease capitalisation when activities
to get the asset ready for use/sale
are complete