In continuation of my previous article, this write-up brings out the brief differences between the two GAAPs and shares the industry impact analysis. Takes away from this article are part of the way forward section at the end.
Major differences between AS and Ind AS on Accounting of Fixed Assets:
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Ind AS 16 |
AS 10 & AS 6 |
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Component approach IAS 16 mandates component accounting. Each major part of an item of property plant and equipment with a cost that is significant in relation to the total cost of the item is depreciated separately. |
Component approach is present but is more of recommendatory. |
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Cost & Revaluation Historical cost or revalued amounts are used. Regular valuations of entire classes of assets are required when revaluation option is chosen. |
Historical cost or revalued amounts are used. No specific requirements on frequency of revaluation. Revaluation for the whole class of assets is not required. |
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Depreciation on Revaluation Depreciation on revalued portion is debited to income statement without recouping out of revaluation reserve. |
Depreciation on revalued portion may be recouped out of revaluation reserve, thus reserve reduces over the period and depreciation charge represent the original cost |
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Revaluation Reserve Revaluation Reserve is directly transferred to retained earnings on derecognition. |
Revaluation Reserve is transferred to Income Statement on derecognition. |
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Useful Life of PPE Depreciation to be calculated based on useful life. |
Depreciation amount is based on useful life of the assets or Schedule XIV rates, whichever is higher. |
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Major overhauling or Shut down Cost Cost of major inspections and overhauls are recognised in the carrying amount of property plant & equipment and amortised till next major maintenance date. |
Costs of major repairs are expensed when incurred. |
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Review of Useful Life, Residual Value, Depreciation Method IAS 16 mandates review of useful life, residual value and depreciation method at each year end. It is an estimate and any change is accounted prospectively. |
Depreciation method is a policy decision, which can be reviewed only if certain criteria are met. Any change is to be accounted retrospectively. |
Industry Impact Analysis – Ind AS 16 Property Plant & Equipment:
Industry will be impacted due to Component Approach in Ind AS 16. Since the Schedule XIV rates are not split into various parts of heavy duty machinery, companies will have to go through a detailed exercise of breaking down its fixed asset line item into various components and assess each items independent useful life.
Mining and Construction
Assets in Mining and Construction industry include heavy duty trucks, vehicles, dozers, excavators, loaders & unloaders, tunneling machinery, etc. These heavy duty machineries are made up of various assembled parts which are high in value and also have a different useful life as compared to the other parts such as chassis, rollers, body, electrical systems, etc. These items will have to be broken in to their components.
Entities will also have to estimate mine restoration liabilities and capitalise with the initial cost of the mine.
Excerpts from Mining major, Xstrata Plc’s Annual Report 2011: “Where parts of an asset have different useful lives, depreciation is calculated on each separate part. Each asset or part’s estimated useful life has due regard to both its own physical life limitations and the present assessment of economically recoverable reserves of the mine property at which the item is located, and to possible future variations in those assessments. Plant & equipment have useful lives from 4-30 years.”
“Provision is made for close down, restoration and environmental rehabilitation costs. At the time of establishing the provision, a corresponding asset is capitalised, where it gives rise to a future benefit, and depreciated over future production from the operations to which it relates”.
Commodity manufacturing Industry – Crude, Ore, Power
These industries include oil and ore refineries, smelters that are used to melt the ore, and power plants among others. These plants carry huge investments with complex designs and take years to build. They are made of various facilities that can be identified as first level components such as Water treatment, Gas tapping, Conveyors, Turbines, Roters, Shafts, Grids, Tankages, Ovens, Casters, Moulds, Furnaces, Rolling mills, etc.. More often one component that is left out in the analysis is the Pipelines, which have material value and different useful life.
Second level components will need a detailed analysis of each identified first level component with their individually assessed useful lives. Each unit will need separate line items for identification.
Entities will need to estimate its asset retirement obligations at the time of initial capitalisation. A Nuclear Power Plant will have to estimate its related decommissioning liabilities and capitalise with power plants.
Another impact will be on account of capital repairs that are incurred during shut down, cell realignment, etc. This will be capitalised under fixed assets and amortised till the next overhauling date.
By virtue of assessment of useful life, entities get a chance to increase the useful life for depreciating the assets to its true useful lives.
Shipping
Main parts of a ship include hull and engine. Further, hull is made up of deck, chassis, propeller, funnel, stern and super structure. A modern ship includes a fair component of electronic and automatic control systems. Entities will have to carry out a detailed exercise and use its judgment for capitalizing each component.
Dry dock expenses in shipping industry which carried out periodically will need capitalisation and amortisation.
Similar to the commodity industry, entities will get a chance to increase the useful life for depreciating the assets to its true useful lives. International peers such as B+H Ocean Carrier Plc have estimated useful life of 30 years for its vessels from the date of construction and capital improvements are amortised over a period of 5 years.
Hotel Industry
A restaurant maintains a minimum stock of silverware and dishes. Some entities treat cutlery, crockery, linen, etc, as stores and spares and group them under inventory. Any increase decrease is accounted as consumption in profit and loss account. Moreover, Schedule XIV does not lay down any rate for depreciating such items and hence companies in India adopt inventory and consumption approach to account these items.
For a restaurant, cutlery is similar to a plant, without which it cannot operate. Under Ind AS 6, these items fall into the definition of tangible assets and hence need to be capitalised as such and depreciated based on its useful life. Considering the nature of these assets, the estimation of their useful life may involve a significant amount of judgment. The management should consider factors such as physical wear and tear, commercial obsolescence, asset management policy of an entity that may involve replacement of such assets after a specified period, etc for such assessment. John Keels Hotels Plc, depreciates its Cutlery, Crockery, Glassware & Linen in a period of 3 years as per its 2010 annual report.
Way forward:
1. It is advisable to start updating the fixed asset records in SAP or any other ERP with major component details. This can be done by opening various sub group codes for the master asset.
2. Any new capitalisation should be based on component approach assessing specific useful life of each component and then applying the aggregate rule.
3. Expect changes or clarifications for Section 350 or Schedule XIV or both to avoid conflict with depreciation principles under Ind AS 16.
4. Assessment of useful life and residual value will have to be done by the management on a regular basis.
5. Estimate dismantling, decommissioning, restoration liabilities valued at discounted cash flow basis at the beginning and continue to reassess on a regular basis.
6. Entities following revaluation approach for accounting fixed assets, will be impacted more, as Ind AS 16 does not allow an entity to plough back the reserve in profit and loss account to match the additional depreciation on revaluation. Ind AS 16 will come with first time exemptions under Ind AS 101 and hence entities may decide an appropriate policy when they first time adopt Ind AS.
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