Property, Plant and Equipment

Property, Plant and Equipment http://www.cc.cec/budg/

Overview of session 1. Scope of application and key concepts 2. Recognition 3. Measurement 4. Additional learning points 5. Disclosures 6. E.C. specific implications 7. Questions

Property, Plant and Equipment 1. Scope of application and key concepts

P,P&E • Assets = Resources • Controlled by the E.C. as a result of past events; and • From which future economic benefits or service potential are expected to flow to the E.C. • Property, plant and equipment = tangible assets that: • Are held by the E.C. for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and • Are expected to be used during more than one reporting period.

Classes of P,P&E • Assets of a similar nature or function in theE.C.s’ operations are grouped into classes of property, plant and equipment for the purpose of disclosure in the financial statements: • Land and buildings; • Plant and equipment; • Furniture and vehicles; • Computer hardware; • Other tangible (non-financial) assets; • Pre-financing and tangible assets under construction; and • Leased assets.

Cost and Fair value • Cost = the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition or construction • Fair value = the amount for which an asset could be exchanged (or a liability settled) between knowledgeable, willing parties in an arm’s length transaction

Useful life and Depreciation • Useful life = the period of time over which an asset is expected to be used by the entity • Depreciation = the systematic allocation of the depreciable amount of an asset over its useful life • Depreciable amount = the cost of an asset (or other amount substituted for cost in the financial statements) less its residual value • Residual value = the net amount which the entity expects to obtain for a asset at the end of its useful life after deducting the expected costs of disposal

Owner-occupied property Of general application Property held (by the owner or by the lessee under a finance lease) for use in the production or supply of goods or services or for administrative purposes Owner-occupied V. Investment property • Investment property • Of specific application • Property (land or a building – or part of a building – or both) held to earn rentals or for capital appreciation or both

Property, Plant and Equipment 2. Recognition

Initial recognition • An item of property, plant, equipment and investment property should be recognised as an asset when: • Future economic benefits or service potential are expected to flow to the E.C.; and • The cost or fair value of the asset can be measured reliably.

P,P&E or not? Can be measured reliably? No Resource controlled by the E.C.? Yes EXPENSE No Future economic benefits are expected? Yes ASSET No To be used for production, commercial or administrative purposes? ANOTHER ASSET Yes No Expected to be used during more than one reporting period? Yes No ? Yes Materiality threshold: € 420 P,P&E

Timing of initial recognition • Date of acquisition = the date on which the risks pertaining to ownership get transferred to the E.C. – generally corresponds to the acceptance of delivery of the asset • Consider cut-offat year-end • Delivered not billed: recognise asset and accrue invoice • Billed not delivered: transfer asset to a suspense account

Property, Plant and Equipment 3. Measurement

Initial measurement • An item of property, plant, equipment and investment property which qualifies for recognition as an asset should initially be measured at cost • Where an asset is acquired at no cost, or for a nominal cost, its cost is its fair value at the date of acquisition

Components of cost • The cost of an item = its purchase price, plus • Import duties and non-refundable purchase taxes (including property transfer taxes); and • Any directly attributable costs of bringing the asset to working condition for its intended use, such as: • Cost of site preparation; • Initial delivery and handling costs; • Installation costs; • Professional fees such as architects and engineers, legal services; and • The estimated cost of dismantling the asset and restoringthe site (set up of a provision). • Any trade discounts or rebates are deducted.

Specific initial measurement issues • Self-constructed asset: • Cost is determined using the same the same principles as for an acquired asset • Where an asset is acquired at no cost, or for a nominal cost, cost is the fair value at the date of acquisition • Exchange of assets: • Cost is measured at the fair value of the asset received (equivalent to: Fair value of the asset given up + cash transferred)

Subsequent expenditure • Subsequent related expenditure should be addedto the carrying amount of the asset, when: • It is probable that futureeconomic benefits, in excess of the originally assessed standard of performance of the existing asset will flow to the European Communities; and • They improve the condition of the asset; • Otherwise subsequent expenditures must be recognised as expenses

Subsequent expenditure • Examples of improvements which result in increased future economic benefits or service potential include: • Modification of an item of plant to extend its useful life, including an increase in its capacity; • Upgrading machine parts to achieve a substantial improvement in the quality of output; • Adoption of new production processes enabling a substantial reduction in recently assessed operating costs.

Subsequent expenditure ASSET EXPENSE Repairs, renovations and maintenance are made to restore or maintain the future economic benefits

Subsequent measurement - Depreciation • All assets entered as tangible assets shall be depreciated, except for: • Land; • Fixed asset under construction; • Pre-financing on property; • Work of art. • The depreciable amount should be allocated on a systematic basis over useful life (costs subsequently capitalised over the remaining useful life) • The depreciation method used should reflect the pattern in which the asset’s economic benefits or service potential is consumed by the E.C. • Monthly pro rata temporis depreciation from the date of acquisition • The depreciation charge of each period expense

Subsequent measurement - Useful life Useful life and depreciation basis should be reviewed on a regular basis Estimation of the useful life of an item Judgement based on the experience of the E.C. with similar assets Where a change is justified  Accounted for as a change in accounting estimates with no prior year restatement

Subsequent measurement Benchmark treatment Allowed alternative treatment • Subsequent to initial recognition as an asset, an item of property, plant and equipment should be carried at • Its cost less any accumulated depreciation and any accumulated impairment losses • A revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses The E.C. will elect to apply the benchmark treatment

Measurement – Accounting summary Balance sheet Economic outturn account Net tangible asset Revaluation Depreciation Repairs & Maintenance Initial amount+ Costs improving condition+ Revaluation <Accumulateddepreciation><Accumulatedimpairment>Carrying amount Revaluationdecrease

Worked example The E.C. acquire a mainframe computer on July 1, N (delivery date). The following costs are incurred: • Costs on consultancy helping the E.C. specify the nature and performance level of the mainframe: € 4,000 • Purchase price: € 50,000 • Import duties: € 2,000 • Transportation expenses: € 3,000 • Installation expenses: € 5,000 The estimated useful life is initially 5 years

Worked example Cost of acquisition = € 60,000 (50,000 + 2,000 + 3,000 + 5,000) Cost of acquisition excludes the costs on consultancy because they are not directly attributable to the system that was bought Monthly depreciation expense: € 1,000 (= 60,000 / 60) Depreciation expense: N: € 6,000 (= 1,000 * 6) - N+1: € 12,000 (= 1,000 * 12) Balance sheet Economic outturn a/c Gross carrying amount Depreciation expense Accumulated depreciation Net carrying amount

Worked example On 1/1/N+2 the E.C. revise useful life, which is decreased to 4 years Carrying amount: € 42,000 Remaining useful life: 30 months (= 48 – 18) Revised monthly depreciation expense: € 1,400 (= 42,000 / 30) Balance sheet Economic outturn a/c Gross carrying amount Depreciation expense Accumulated depreciation Net carrying amount

Worked example On 1/1/N+3 the E.C. incur expenses of € 9,000 to increase the mainframe computer’s CPU and € 6,000 to fix various bugs Capitalise: € 9,000 – to be depreciated over the remaining useful life (18 months) Expense: € 6,000 Revised monthly depreciation expense: € 1,900 = € 1,400 + € 500 (= 9,000 / 18) Balance sheet Economic outturn a/c Gross carrying amount Depreciation expense Accumulated depreciation Net carrying amount R&M expense

Subsequent measurement - Impairment • An impairment is a loss in the future economic benefits or service potential of an asset, over and above the systematic recognition of the loss of the asset’s future economic benefits or service potential through depreciation • IAS 36 is the current text addressing impairment of assets • E.C. accounting rule based on ED 23 (issued for comment by the IFAC), which recognises the specificities of the public sector and addresses impairment of non-cash generating assets, i.e. those assets that are not held to generate a commercial rate of return

Subsequent measurement - Impairment If indicators are present that suggest that Carrying amount of the asset > Recoverable service amount Impairment testing should be performed

External sources of information: Cessation of the demand or need for services provided by the asset Significant long-term changes with an adverse effect on the entity have take place during the period or will take place in the near future, in the technological, legal or government policy environment Internal sources of information: Physical damage of an asset Significant long-term changes with an adverse effect on the entity have taken place during the period or are expected to take place in the near future, in the extent to which, or manner in which, an asset is used or expected to be used A decision to halt the construction of the asset before it is complete or in a usable condition Evidence from internal reporting that indicates that the service performance of an asset is/will be worse than expected Indicators of impairment

Recoverable service amount • Recoverable service amount = Max(net selling price, value in use) Net selling price: Price in a binding sale agreementin an arm’s length transaction, lesscosts attributable to the disposal of the asset Market price (bid price) less costs attributableto the disposal of the assetInformation from similar sale transactions Value in use: Depreciated replacement cost or Restoration cost approachorService units approach

Impairment loss • If, and only if, the recoverable service amount of an asset is less than its carrying amount, the carrying amount of the asset should be reduced to its recoverable amount • That reduction is an impairment loss to be immediately recognised as an expense in the economic outturn account • If the estimated impairment loss is greater than the carrying amount of the asset, the carrying amount of the asset is reduced to zero

Measurement – Accounting summary Balance sheet Economic outturn account Net tangible asset Revaluation Depreciation Repairs & Maintenance Initial amount+ Costs improving condition+ Revaluation <Accumulateddepreciation><Accumulatedimpairment>Carrying amount Revaluation decrease Impairment loss

Worked example - Impairment • It was estimated when the mainframe computer was purchased that on average 80% of CPU would be used (a buffer of excess CPU time of 20% was expected and needed to accomodate peak period deadlines). • CPU declined to 20% in N+4 because many applications were converted to run on desktop computers or servers. • A computer is available on the market at a price of € 24,000 that can provide the remaining service potential of the mainframe computer using the remaining applications. • A broker is offering € 4,500 for the mainframe computer • The indicator of impairment is the significant long-term change in technological environment resulting in conversion of applications from the mainframe to other platforms and therefore decreased usage of the mainframe computer.

Worked example - Impairment • Evaluation of impairment: To be depreciated over the remaining useful life (6 months) An expense

Subsequent measurement- Investment property • Subsequent to initial recognition as an asset, all investment property should be measured following the: Fair value model Cost model or IPSAS 17 – Benchmark treatment

Property, Plant and Equipment 4. Additional learning points

Retirements and disposals • An item of property, plant and equipment should be eliminated from the balance sheet: • On disposal; or • When the asset is permanently withdrawn from use. • Gain or losses arising from the retirement or disposal should be determined as: Retirement or disposal value – Carrying amount of the asset Recorded as a gain or a loss in the Economic Outturn Accountas incurred

On 28/2/N+4 the computer mainframe is disposed of to Oxfam for free. Worked example

Property, Plant and Equipment 5. Disclosures

Key disclosures • Key disclosures required for each class of property, plant and equipment: • Measurement bases used for determining the gross carrying amount • Depreciation method used and estimated useful lives • The gross carrying amount and accumulated depreciation at the beginning and at the end of the period • A reconciliation of the carrying amount at the beginning and the end of the period

Key disclosures (cont’d) • Existence and amounts of restrictions on title for property, plant and equipment pledged as securities for liabilities • The amount commitments for the acquisition of property, plant and equipment • If applicable, the basis used to revalue a class of property, plant and equipment • When the benchmark treatment is used, the fair value of the assets should be disclosed if it is materially different from the carrying amount • Information on impairment

Investment property –Additional specific disclosures • The criteria developed to distinguish investment property from owner-occupied property • The methods and significant assumptions applied in determining the fair value of investment property, including a statement whether the determination of fair value was supported by market evidence or was more heavily based on other factors because of the nature of the property and lack of comparable market data • The extent to which the fair value of investment property is based on a valuation by an independent appraiser who holds a recognised and relevant professional qualification and who has recent experience in the location and category of the investment property being valued. If there has been no such valuation, that fact should be disclosed.

Property, Plant and Equipment 6. E.C. specific implications

Key differences with the current E.C. practices Individualisation of assets i.o.Global depreciation of assets with similar characteristics Prorata temporis depreciation i.o.Full year in the year of acquisition Required segregation ofland and buildings Components approach Impairment testing Need for the reconciliation of a physical inventory withthe fixed assets ledger

Property, Plant and Equipment 7. Questions http://www.cc.cec/budg/

Property, Plant and Equipment