Proceeds from selling items before property, plant and equipment is ready for intended use – Deduct off cost or recognise as income?
An amendment to NZ IAS 16 Property, Plant and Equipment, Onerous Contracts — Cost of Fulfilling a Contract, includes changes that could impact the cost of items of property, plant and equipment (PPE) where:
- An entity incurs testing costs which are capitalised to the cost of PPE as a directly attributable cost
- An entity earns proceeds from selling samples produced using PPE that was not ready for its intended use.
Testing costs - When is an item of PPE functioning properly?
Costs of testing whether an item of PPE is functioning properly are capitalised to the cost of the item as a directly attributable cost. An entity ceases capitalising costs when the item of PPE is in the location and condition necessary for it to be capable of operating in the manner intended by management (available for use). Therefore, once the asset is available for use, testing costs can no longer be capitalised to the cost of the asset. Determining when testing is complete is therefore important because it helps entities to decide when the asset is available for use.
NZ IAS 16 does not provide guidance to help entities determine when the PPE item is ‘available for use’. This is a matter of judgement. Nevertheless, the changes contained in Onerous Contracts — Cost of Fulfilling a Contract clarify the meaning of ‘testing’, and therefore which costs can be capitalised as testing costs and which cannot.‘Testing whether the asset is functioning properly’ means assessing whether the technical and physical performance of the asset is such that it is capable of being used in the production or supply of goods or services, for rental to others, or for administrative purposes.
Net proceeds from selling samples no longer deducted off the cost of PPE
When testing whether an item of PPE is functioning properly, entities may produce, and in some cases sell, those samples. Previously, the net proceeds from selling such test items were deducted off the cost of that item of PPE. That is, they reduced the costs of testing capitalised.Changes contained in Onerous Contracts — Cost of Fulfilling a Contract require that the entity now recognises the proceeds of selling these items as income, and the related cost of those items, as expenses in profit or loss. NZ IAS 2 Inventories must be applied to measure the costs relating to samples sold.
Which types of entities are likely to be affected by the changes?
Manufacturers, mining entities and petrochemical entities are likely to be affected by these changes.
If not disclosed separately in the statement of comprehensive income, entities affected by these changes must disclose in their 31 December 2022 financial statements:
- The amount of proceeds and costs included in profit or loss that relate to items produced that are not output of the entity’s ordinary activities
- Which line item in the statement of comprehensive income includes such proceeds and costs.
The amendments apply to annual periods beginning on or after 1 January 2022.
The amendments apply retrospectively, but only to items of PPE that are brought to the location and condition necessary for them to be capable of operating in the manner intended by management on or after the beginning of the earliest period presented in which the entity first applies the amendments. The cumulative effect of applying the amendments is recognised as an adjustment to opening balances of retained earnings at the beginning of the earliest period presented. If there is a material impact, a third statement of financial position (opening balance sheet) must also be presented. If there is a material impact, a third statement of financial position (opening balance sheet) must also be presented. (RDR reporters have an exemption from having to provide the third statement of financial performance.)
The following example demonstrates how the transitional requirements work.
Entity A has a 31 December year-end. It completed construction of a manufacturing facility which became available for use on 15 April 2021. During the testing phase, the following samples were produced:
Period of testing and production of samples
Sale proceeds ($)
Net proceeds ($)
October to December 2020
1 January to 14 April 2021
At 31 December 2020, Entity A deducted net proceeds of $15,000 from PPE in progress, and at 14 April 2021, it deducted a further $35,000 net proceeds from PPE in progress.
These amendments will impact the accounting treatment for the net proceeds from selling testing samples because the amendments apply to PPE brought to the location and condition ready for use on or after the beginning of the earliest period presented in which the entity first applies these amendments.
Entity A first applies these amendments for the annual period beginning 1 January 2022. The beginning of the earliest period presented is 1 January 2021. The manufacturing facility became ready for use on 15 April 2021, which is on or after the beginning of the earliest period presented (1 January 2021).
On 1 January 2021, Entity A increases PPE in progress and retained earnings by $15,000 (excluding any tax effects).
Comparatives for the year ended 31 December 2021 require a restatement to profit or loss, being an increase in income of $100,000, an increase in costs of $65,000, and an increase in any additional depreciation required for the additional $50,000 of PPE in progress (less any tax effects). Entity A also increases its PPE by $50,000 in its statement of financial position at 31 December 2021 (less any additional depreciation).
Please contact our IFRS Advisory Team if you require assistance implementing these amendments.
For more on the above, please contact your local BDO representative.
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