Lecture 7

Intermediate Corporate Reporting: Revaluation of PPE and Accounting for Intangible Assets

Lecture Overview

• Instructor: Dr. Cuthbert Muza

• Context: University of Nottingham

• Course: BUSI2143 - Intermediate Corporate Reporting

• Session Focus: Revaluation of Property, Plant, and Equipment (PPE) and accounting principles for Intangible Assets

Part 1: IAS 16 Property, Plant and Equipment

Introduction to IAS 16

• Key Models: Cost model vs Revaluation model
    - Cost Model: Assets carried at historical cost less accumulated depreciation and impairment.
    - Revaluation Model: Regular re-measurement of asset to its fair value.

• Each model has its implications on financial reporting and asset valuation, influencing the balance sheet and depreciation expenses.

Fair Value Definition (Covered by IFRS 13)

• Fair Value = Price received to sell an asset or paid to transfer a liability in an orderly transaction.
    - Market-based valuation preferred; specialized assets may require valuation models (e.g., depreciated replacement cost).

Key Points Regarding the Revaluation Model

• Fair value must be measurable reliably.

• Policy must be applied to entire class of PPE; revaluations must be conducted for all assets in that class simultaneously.

• Regular updates are necessary to keep carrying amount close to fair value.

Advantages and Disadvantages of the Revaluation Model

• Advantages:
    - Typically increases reported asset values in financial statements.

• Disadvantages:
    - Costly expert valuations needed for extensive portfolios and regular updates.
    - Unrealized gains cannot be paid as dividends.
    - Mainly adopted for property assets.

Accounting for Revaluation Gains and Losses

• Revaluation Gains:
    - Recognized in Other Comprehensive Income (OCI).
    - Increases the revaluation reserve.

• Losses:
    - Recognized as an expense in profit or loss, leading to decreases in retained earnings.
    - If reversing a prior gain, losses recognized in OCI to decrease revaluation reserve.

Example Statements of Profit or Loss and OCI

• Demonstrates the components of income statement, including gross profit, operating profit, and profit after tax, along with the impact of OCI items and comprehensive income.
    - Example:
      - Revenue: £217,000
      - Cost of Sales: £152,800
      - Other Comprehensive Income: Revaluation gain on property: £10,000.
      - Total Comprehensive Income: £13,740.

Detailed Example: Fly Ltd

• Asset Valuation and Calculation:
    - Property Purchase Price: £200,000 on 31 Dec 2016.
    - Revaluation Amount: £250,000 as of 31 Dec 2018.
    - Depreciation Calculation:
      - Annual Depreciation = £200,000 ÷ 50 = £4,000.
      - For 2 years: £4,000 × 2 = £8,000.
    - Net Book Value (NBV) Calculation:
      - NBV at 31 Dec 2018 = £200,000 - £8,000 = £192,000.
      - Revaluation Gain Calculation:
        - Revaluation Gain = Fair Value - Net Book Value = £250,000 - £192,000 = £58,000.
        - Accounting Entries:
          - Dr Accumulated Depreciation £8,000
          - Dr PPE at Cost/Valuation £50,000
          - Cr Revaluation Gain £58,000.

Further Revaluation Examples

• Disposal of revalued items of PPE, emphasizing the accounting for gains/losses depending on previously recognized reserves.
    - Practical Scenario: Two companies purchasing land and experiencing fluctuating valuations.

Part 2: IAS 38 Intangible Assets

Introduction to Intangible Assets

• Definition: An identifiable non-monetary asset without physical substance.
    - Must be controlled by the entity and expected to bring future economic benefits.

Characteristics of Intangible Assets

• Separable: Can be sold or licensed independently.

• Examples: Software, trademarks, patents, etc.

• Recognition Criteria:
    - Must meet the definition and recognition criteria; probable economic benefits and reliable measurement of cost.

Types of Intangible Assets

• Purchased Intangibles: Recognized if controlled and identifiable;

• Internally Generated Intangibles: Examples include patents, software, and brand loyalty.
    - Goodwill: Only recognized when purchased, not when internally generated.

Research and Development (R&D) Costs

• Phases:
    - Research Phase: Original investigation for new knowledge.
    - Development Phase: Application of research findings.

• Costs: Research costs must be expensed; development costs may qualify for recognition if criteria are met:
    - Technical feasibility, availability of resources, intention to complete the project, and ability to measure costs reliably.

Initial Measurement of Intangibles

• Recognized at cost, including directly attributable costs. Excludes general overheads and advertising costs.

Amortization of Intangibles

• Based on finite useful lives; depreciable amount less residual value, typically amortized on a straight-line or reducing balance basis. Indefinite life intangibles are tested for impairment.

Disposal of Intangibles

• Derecognized upon disposal, with gains or losses recorded in the statement of profit/loss. Each step involves elimination and recognition entries for accumulated amortization and sale proceeds.

Suggested Reading

• Melville, A. (7th ed.). International Financial Reporting, Chapters 5 & 6, covering PPE and Intangible Assets respectively.