In May 2020, the International Accounting Standards Board (IASB) issued an amendment to IAS 16 Property, Plant and Equipment, changing the accounting treatment for proceeds from sales before an asset’s intended use. Common in the extractive industry, energy and industrial sectors, a company may produce and sell output in order to construct and make an asset ready for use. An example of such an asset is minerals extracted in the process of developing a mine. Companies in industries with significant investment in property, plant and equipment (PPE) should not underestimate the impact and challenges of applying the changes to the accounting treatment for proceeds before the intended use of an asset. The recognition of profit will change, and enhanced cost monitoring processes may need to be developed.
Previously, proceeds from sales would be deducted from the cost of the asset. Under the new guidance, proceeds are no longer deducted from the cost of the asset. Instead they are recognized in profit and loss, together with the costs of producing those items. IAS 2 Inventories should be applied in identifying and measuring the costs of producing items that are recognized in profit and loss.
To illustrate the impact, consider the following:
- The total cost of an item of PPE, up to the date of intended use, is USD 10 million
- Proceeds from the sale of output, prior to intended use, is USD 1 million
- The IAS 2 costs of producing the output, prior to intended use, is USD 600,000
Under the previous rules, the company would capitalize USD 9 million as PPE – the cost of PPE, less the proceeds from the sale.
Under the new guidance the company will recognize:
- A profit from the sale of output, before intended use, of USD 400,000; and
- A cost of the PPE of USD 9.4 million being the total costs less the amount allocated to profit and loss under IAS 2.
In subsequent periods, after the assets are brought into use, depreciation charges will be higher to reflect the higher cost of the asset.
As a result of this treatment, there are several practical challenges to address:
- Allocation of costs under IAS 2 may not be straightforward. Prior to the intended use of the asset, there could be inefficiencies and abnormal production costs, with little information about what constitutes a normal level of production.
- There may be a need to monitor and classify construction costs in more granular detail than previously required.
- There may be tax and deferred tax consequences of recognizing profit in different periods and potentially as trading profit, as opposed to through any allowances on the assets.
- There can still be challenges in determining the date assets brought into use. The changes to IAS 16 do not address this area.
- Companies will need to consider whether any sales of output are within the ordinary activities of the company, and therefore fall under IFRS 15 Revenue from Contracts with Customers. If not part of the ordinary activities, additional disclosures are required for the sales proceeds and production costs, as well as for the line items where they are recognized.
The amendments apply from 1 January 2022, with earlier application permitted. The amendments apply retrospectively, but only to items of PPE made available for use on or after the beginning of the earliest period presented in the financial statements in which the company first applies the amendments.