IAS 16 — Accounting for proceeds and costs of testing of PPE

Date recorded:

Should net proceeds reduce the cost of PPE? — Agenda paper 2


The IFRS Interpretations Committee received a request to clarify the accounting for net proceeds from selling items produced while testing an item of property, plant and equipment (PPE) under construction. The submitter asked whether an entity should recognise the amount by which the net proceeds received exceed the costs of testing in profit or loss or, instead, as a deduction from the cost of the PPE. In September 2015 several concerns were raised by the Interpretations Committee and the staff was asked to further consider this issue. Appendix A details the issues identified in previous meetings and not analysed by the staff for this meeting; and Appendix B includes background information about the history of the project. The purpose of this meeting is to discuss the analysis prepared by the staff and discuss the next steps.

Staff analysis

The staff presents their analysis for the following:

  1. Which net proceeds should an entity deduct from the cost of PPE, and should there be any limit on the proceeds deducted?
  2. How should an entity interpret ‘testing’?
  3. When is PPE capable of operating in the manner intended by management?
  4. Should there be any disclosure requirements?
  5. Alternative approach: Prohibit the deduction of income from the cost of PPE.

Staff recommendation

The staff recommended amending IAS 16 to clarify that: (i) an entity would deduct from the cost of PPE net proceeds from selling items produced only from testing whether the PPE is functioning properly; (ii) the amount of net proceeds from testing that an entity deducts from the cost of PPE would not exceed the costs of testing; and (iii) an entity would recognise any other income earned before PPE is capable of operating in the manner intended applying other relevant requirements or Standards (for example, IFRS 15).  The staff also proposed to clarify the meaning of testing. The staff indicated that an entity would identify the activities undertaken to assess whether the PPE is functioning properly. Accordingly, an entity would assess the technical and physical performance of the PPE. The assessment of the technical and physical performance of the PPE means assessing whether the PPE is capable of producing items that can be sold in the ordinary course of business. 

The staff did not recommend at this stage amending IAS 16 to clarify when a PPE is capable of operating in the manner intended by management because the staff understands that the issue is beyond the scope of the submission.  Nevertheless, the staff included in the agenda paper a list of indicators to consider in the analysis.  The staff did not recommend adding disclosure requirements if the Interpretations Committee supports the modifications to IAS 16.  However, if no such consensus is reached the staff recommended that the Committee instead amend IAS 16 to require the disclosure of the proceeds from testing.

The alternative approach, which would be consistent with US GAAP, would be to amend IAS 16 to require no longer allow the proceeds from testing to be offset against the cost of the asset.  

The staff recommended the following actions if the Interpretations Committee agrees with the proposed amendments to IAS 16: (i) discuss transition requirement in May 2016 and (ii) refer to the Board for final decision on whether to proceed with the amendments.

Committee discussion and consensus

A number of different views were expressed by the Committee members. Some members felt that application of the proposed amendments would be difficult as it would be a challenge to determine what proceeds related to testing. Others took an opposite view highlighting that companies, using their management accounting systems, could clearly differentiate between the different phases of projects and, therefore, the related costs and proceeds.

A group of members questioned whether an amendment was required as, from their experience, there is little to no diversity in practice.

The chair requested members to vote on their preferred approach and the Committee was divided between the staff recommendation (proceeds relating to the testing phase to be capitalised to the cost of the asset) and a view that would require all proceeds earned before the asset was ready for use to be capitalised.

When asked who could support the alternative approach proposed by staff (where all amounts would be recognised in P/L).  All members indicated that they could support amending IAS 16 in this way.    

The Committee then discussed whether related disclosures should be introduced.  A number of Committee members stated that the existing requirements of IFRS 15 and IAS 1 should be applied and that further disclosure requirements should not be considered.  Other members requested that the existing requirements be considered to ensure that they would suffice (given the nature of the proceeds being different to ongoing revenue streams for which disclosure requirements have been drafted) and provide sufficient information to users – there could be a material impact on margins which should be brought to users attention.

The staff will conduct the relevant research into disclosure requirements and bring their findings as well as the proposed wording for the amendment to IAS 16 back to the Committee in a future meeting.

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