Accounting for tangible assets (current issues)IntroductionTwo standards are usually used to account for tangible assets. These are international accounting standard 16 (IAS 16) used internationally and Financial Reporting Standard 15 (FRS 15) used commonly in UK (International Accounting Standards Board, 2008.). Tangible fixed assets are defined under FRS 15 as those assets which have physical substance and are held by an entity for use in either production or supply of goods or services, for rental or for administrative functions on continuous basis in the reporting of activities of an entity (Catty, 2010).
The aspect of having a physical substance differentiates tangible assets from intangible ones while the aspect of being used on continuous basis differentiates fixed assets from current assets held by an entity. On the other hand IAS 16 considers any property, plant and equipment to be an asset only if the item has a probability of having future economic benefit associated with it which will flow to the entity and that its cost can be measured reliably. Thus, property, plant and equipment under IAS 16 are equivalent to tangible fixed assets under FRS 15.
This paper describes how these tangible assets are accounted for in both IAS 16 and FRS 15 standards. International Accounting Standards 16 (IAS 16)Initial recognitionIAS is recognized internationally and covers tangible fixed assets such as property, plant and equipment. It covers the initial measurement, valuation and subsequent depreciation of these assets. Initially IAS 16 stated that the land and buildings fair value was normally the market value and that the equipment and plant fair value was the market value or if specialized depreciated replacement cost (DRC).
The latest standard does not provide bases definition but instead provides description of the process. Fair value is no longer synonymous to market value in the new standard (Catty, 2010). The standard allows the use of either a depreciated replacement cost or a profit’s test approach for both plant and property where there is no market evidence. The change was not accompanied by reason and debate has been ongoing since 1998 concerning the appropriate basis of determining owner occupied property fair value after references to market value for existing use was removed from IAS 16.
This debate is still going on as fundamental reviews are being undertaken by IASB on the measurement of assets and liabilities in financial statements. In the new IAS, disclosure of the method used for deriving the fair value and the extent of deriving this based on market evidence is required. The use of profit test or depreciated replacement cost is only used in cases where there is no market based evidence that is reliable. Preparation of valuation under new IAS requires valuers to provide much justification for adopting a certain approach than in previous IAS.
Members carrying out valuation using IAS are required by the RICS Red Book to follow IV A1 in which valuation is covered in IAS 16.Depreciation Under IAS 16, is based on componentization in which each part of the plant, property and equipment with a cost which is significant in relation to the cost of the item is separately depreciated. For instance, buildings which are significantly different on a site may be depreciated separately as may significant parts of a building that can be identified readily.
The standard requires that the frequency of depreciation on items be done at least once annually. The allocation of depreciable amount of an asset is done on systematic baiss over the useful life of property, plant and equipment. The method used to depreciate the item is required to reflect the pattern in which the future economic benefits of the asset are expected to be consumed by the business. Land is not depreciated since it has an indefinite economic life. Thus, buildings and land are depreciated separately (International Accounting Standards Board 2008).
This implies that an increase in the value of land on which the building stands does not have an effect on how th depreciable amount of the building is determined. When valuing for depreciation, the market based evidence is not reflected (Catty, 2010). The residual value is assessed based on the useful life of the asset to the business entity which is usually determined by the enterprise and is specific to that particular entity. Valuers are required to discuss the componentization of the major assets when providing valuation for depreciation.
The intentions of the entity are reflected in the residual value under IAS 16 and hence components which cannot be sold or bought separately in their current state are required to be assessed.