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IAS 16 — Accounting for proceeds and cost of testing PPE

Date recorded:

The Visiting Fellow reminded the Committee that this issue had been taken onto the agenda as per a decision in the previous meeting. The staff had since performed outreach activities with four stakeholders. The results of the outreach are summarised in Agenda Paper 3A; however, two responses were received after the agenda paper was finalised. One was from the Canadian Mining Industry Task Force on IFRS. They noted that each mining company was in a unique situation, that in practice there was no clear-cut moment at which the asset was ready for use and that under US GAAP some entities assessed that the assets were ready for use at a much earlier stage. The other was from the Canadian Oil and Gas Industry Task Force for IFRS.  In this industry, the threshold for assessing that an asset was ready to use was much lower. The Visiting Fellow asked the Committee members whether they had any comments on the issues identified through the outreach, whether there were any other issues they believed should be considered, and what issues they wanted the staff to perform further analysis on.

One Committee member agreed with the staff recommendation for further work to be performed. He noted that the interpretation of the phrase “capable of operating in the manner intended by management” was fundamental to the accounting for PPE in complex development and construction situations, and that there were varying interpretations of the phrase. He believed that it would be beneficial to perform further work to determine whether the meaning of the phrase could be clarified in order to improve consistency in practice. He also noted that he saw merit in looking at whether disclosure of amounts credited to assets was a solution if it was not going to be possible to develop coherent guidance on when capitalisation should cease, as such disclosure would provide useful information to users of financial statements about the amounts of proceeds of sales not being included in revenue. He further suggested considering the accounting for pre-commissioning revenue more generally, and looking at the approaches taken in US GAAP.

The Senior Director, Technical Activities expressed concern that the scope of the issue had become too wide. He highlighted the fact that the original request was for an interpretation of paragraph 17(e) of IAS 16, which is about the proceeds of testing. He added that his interpretation of said paragraph was that the revenue was specifically linked to the testing, and that the question that needed answering was whether or not an entity was testing. He expressed concern that the issue had moved away from looking at the proceeds of testing to when one could stop capitalising, although he acknowledged that there may be two separate issues. He noted that he believed the issue could be narrowed down quite easily through a rejection highlighting the fact that the words in paragraph 17(e) related to revenue only appear in relation to testing, and noted that this course of action could help prevent some of the bad accounting in this area in situations where it was clear that an entity was producing and offsetting revenue against that.

In response to the comments made by the Senior Director, Technical Activities, the Chairman noted that when the issue was first discussed by the Emerging Economies Group, one of the questions raised was whether testing could just be better defined.  He noted that the answer that emerged was that the issue had become “circular” – if an asset was not 100% completed, everything therefore must be testing – and that it was not clear based on that discussion, whether the issue could be tackled that narrowly.  He suggested that, if it could, it was certainly worth exploring.

A Committee member highlighted the fact that current practice differed across industries, and that the Committee needed to be conscious of the different practices in different industries, and how any guidance it might develop would impact different industries.

Another Committee member observed that the issue had strayed a long way from sales of samples during the testing phase that exceeded the costs of testing, which was a narrow fact pattern in practice. With respect to “capable of operating in the manner intended by management”, he noted that this was a judgement that was very dependent on facts and circumstances, and that he did not believe that looking at this would result in the Committee coming out with anything that was particularly effective in practice. He suggested that looking at disclosures seemed an attractive option, as did trying to introduce a principle on pre-commissioning revenue and whether this should be offset. He suggested if going down the latter route, that the testing phase should not be separated out, as doing this would just put pressure on the question what is meant by testing.

A further Committee member also expressed concern about the increased scope of the issue. With respect to the issues raised by the staff in the agenda paper, he noted that there was judgement required when applying IAS 16 in determining how to componentise, what costs to capitalise, when something was capable of operating in the manner intended by management; and that all those judgements differed across different industries and that he believed the Committee should not be trying to develop specific guidance in such areas. With respect to IFRIC 20, he noted that practices were still in the process of developing, and accordingly, that the Committee should leave IFRIC 20 alone.  He noted that the Committee should focus on the question that was asked, which was around accounting for the proceeds, and suggested issuing an agenda decision noting that there wasn’t significant diversity in practice with respect to the treatment of net proceeds. He acknowledged that disclosures could be helpful to users, and that this could be covered by pointing to the requirement in IAS 1 for disclosure of material numbers.

Another Committee member also expressed concern with respect to the increasing scope of the issue. He noted that the issue the Committee was asked to consider was about the proceeds of testing and how those should be accounted for. He noted that he did not believe there was much diversity in practice in this area, and that if the Committee did tackle that question, that the related question was when the asset was capable of operating in the manner intended by management. He noted that with respect to the latter, the outreach that had been performed had identified that there were various factors that people looked to, and that these differed across industries. Accordingly, he noted that the most relevant thing here was disclosure of the judgement management used in determining when the asset was capable of operating in the manner intended.

The Chairman brought the discussion to a close, and summarised the main points raised.

He stressed the importance of avoiding a “scope explosion”. He observed that the main proposal put forward was that of focusing on defining what testing is [as suggested by the Senior Director, Technical Activities]. He observed that this would cover paragraph 17(e) of IAS 16, but wouldn’t help people in practice who were deducting revenue that had nothing to do with testing, but during what they asserted was the period before the asset was capable of operating in the manner intended by management. He acknowledged that if the Committee focused only on testing, it would not address the follow on questions related to revenues deducted from costs for things other than testing, but that was an approach that could be taken.

He also observed that a number of Committee members had proposed that this issue could be addressed by reminding people about the disclosure requirements in IAS 1.

He proposed that the staff move forward and perform further work focusing on these areas.

All Committee members agreed with this proposal.

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