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IAS 16 / IAS 38 — Contingent Pricing of PPE and Intangible Assets

Date recorded:

The IFRS Interpretations Committee received a request to address an issue that is related to the accounting for variable payments for the separate acquisition of property, plant and equipment and intangible assets outside of a business combination. The purchase price of an item of property, plant and equipment or an intangible asset may comprise fixed or variable payments, or both. Variable payments are contractual payments for an item of property, plant and equipment or an intangible asset that vary if facts or circumstances change after the acquisition date. Examples include where variable payments are:

  • dependent on an index or a rate
  • dependent on the purchaser’s future activity derived from the underlying assets
  • made if the asset acquired complies with agreed-upon specifications at specific dates in the future.

At its November 2012 meeting, the Committee discussed the initial accounting for variable payments. There are currently two diverging interpretations of the current requirements in IAS 32 Financial Instruments: Presentation, IAS 39 Financial Instruments: Recognition and Measurement and IFRS 9 Financial Instruments regarding the timing of recognition of the liability to make variable payments for the separate acquisition of a tangible/intangible asset:

  • Alternative 1: all variable payments meet the initial recognition criteria of a financial liability on the date of purchase of the asset (provided that the asset has been received);
  • Alternative 2: variable payments that are dependent on the purchaser’s future activity do not meet the initial recognition criteria of a financial liability until the activity requiring the payment is performed.

The Committee could not reach consensus on whether variable payments that depend on the purchaser’s future activity should be excluded from the initial measurement of the liability until the activity is performed. In all other cases (i.e. where the variable payments are not dependent on the purchaser’s future activity), the Committee tentatively agreed that the fair value of those variable payments should be included in the initial measure of the liability on the date of purchase of the assets in accordance with IAS 32, IAS 39 and IFRS 9, provided the assets have been received.

In the January and March 2013 meetings, the Committee discussed subsequent accounting for the financial liability to make variable payments and decided to recommend to the IASB that IAS 16, IAS 38 and IFRS 9 should be amended so that the subsequent adjustment of the carrying amount of a financial liability which is not a floating rate instrument is recognised as a corresponding adjustment to the cost of the assets.

Proponents of alternative 1 noted that a contract to acquire a tangible/intangible asset is not executory if the corresponding tangible asset has been delivered to the purchaser or if the intangible asset (such as a licence to operate) has been granted to the purchaser. In that case, the seller has already performed its obligations. The purchaser’s agreement to make the variable payments is the obligating event in a purchase transaction (provided that the asset has been received by the purchaser), even if the variable payments are dependent on the purchaser’s future activity. IAS 39/IFRS 9 require financial liabilities to be measured at fair value on initial recognition (plus or minus transaction costs in certain cases) and think that excluding some variable payments from the initial measurement of the financial liability is not consistent with a fair value measurement. A market participant would arguably consider those variable payments when estimating the fair value of the liability to make variable payments. In addition, in accordance with IAS 32, where variable payments are for the separate purchase of an asset, if the occurrence or non-occurrence of the future event that triggers the variable payment is under the control of the purchaser, then no liability should be recognised on the date of purchase of the asset and. Conversely, if a future event beyond the control of a purchaser can trigger a variable payment, then a liability should be recognised at fair value on the date of purchase.

Proponents of alternative 2 pointed to guidance in IAS 37 where only obligations arising from past events that exist independently of an entity’s future actions should be recognised as liabilities. They also highlighted that under IAS 39, executory contracts are those where either party has performed none of its obligations or both parties have partially performed their obligations to an equal extent. Assets and liabilities resulting from a firm commitment to purchase or sell goods or services are generally not recognised until at least one of the parties has performed under the agreement. In addition, variable payments that are linked to a future activity should be accounted for separately from the initial purchase of the asset. As a result, liabilities to make those variable payments are not within the scope of IAS 39 until the activity requiring the payment is performed.

Further, the liability to make lease payments that gives rise to an asset should be accounted for under IAS 17. The accounting for variable lease payments is discussed in the Leases Exposure draft and the Board decided that variable lease payments that are dependent on the lessee’s future activity are excluded from the initial measurement of the liability.

Consistent with the proposals in the recent leasing ED, staff concluded that variable payments that are dependent on an index or a rate would be initially included in the measurement of the liability to make variable payments on the date of purchase of the asset (provided that the asset has been received); and variable payments that are dependent on the purchaser’s activity would be initially excluded from the measurement of the liability to make variable payments until the activity is performed.

Initial accounting for variable payments affects subsequent accounting depending on the date the variable payments are recognised. When recognised on the date of purchase of the asset, the issue arises on how to account for adjustments of the financial liability that result from the revision of the estimates of payments. If the variable payments are recognised only when the activity requiring the payment is performed , then the issue is to decide how to account for those adjustments of the financial liability that result from the recognition of variable payments that were previously excluded from the initial measurement of the financial liability. The Committee’s detailed analysis regarding subsequent accounting for variable payments was presented by Staff to the Board.

Staff expressed that the initial accounting and subsequent accounting for variable payments for the separate purchase of assets are linked and should be addressed comprehensively. If the measurement of the liability initially includes, on the date of purchase of the asset, all the variable payments, then the liability would need to be adjusted at each reporting date for revisions in estimate of the variable payments, including those that are dependent on the purchaser’s future activity. In that case, the issue of whether the adjustment of the liability is an expense or a corresponding adjustment to the cost of the asset is paramount. If the measurement of the liability initially excludes, on the date of purchase of the asset, variable payments that are dependent on the purchaser’s activity, then the liability would need to be adjusted only in limited circumstances. Indeed, variable payments that are dependent on the purchaser’s future activity would be included in the measurement of the liability only when the corresponding activity requiring the payment is performed. At that date, the amount to be paid would be fixed and the issue is whether the debit of the liability (on initial recognition of that liability) is an expense or an asset.

The questions staff proposed were:

1. Does the IASB agree with the staff recommendation that the discussions regarding the initial accounting for variable payments for the separate acquisition of tangible/intangible assets should be postponed until the Leases proposals have been redeliberated?

2. If not, does the IASB agree with one of the following alternatives:

  1. Alternative 1: the fair value of all variable payments should be included in the initial measurement of the liability on the date of purchase of the asset (provided that the asset has been received); or
  2. Alternative 2: variable payments that are dependent on the purchaser’s future activity should be excluded from the initial measurement of the liability until the activity is performed.

3. Does the IASB agree with the staff recommendation that initial and subsequent accounting for variable payments should be addressed at the same time?
4. If the IASB thinks that initial accounting does not need to be addressed at the same time as subsequent accounting, does the IASB agree with the Interpretations Committee’s recommendations regarding the subsequent accounting for variable payments to amend IFRSs as part of a narrow scope project?

Overall, the board agreed that the committee should take this project and deal with the areas they can work on. The Committee should deal with this by way of an amendment, and it should be addressed once the work on the conceptual framework has been completed, as board members expressed that currently there is insufficient guidance.

With regards to leases, the basis of conclusions does not provide sufficient guidance on this and therefore board members expressed there would be very little impact.

One board member stated the Committee will only be able to look at the measurement of subsequent events once they can address the measurement of the initial transaction and therefore agreed with staff recommendation that initial accounting and subsequent accounting should be addressed at the same time. However, the board raised their concern that there a number of large projects that the board is already dealing with in the conceptual frameworks project and hence the Committee should try to address more issues themselves.

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