CFAS 11 – Conceptual Framework and Accounting Standards

SEMI-FINALS – WEEK 2 (PAS 40, PAS 41 & PAS 37)

PAS 40 – INVESTMENT PROPERTY

Investment property – land or a building or part of a building or both held by the owner or by the lessee
under a finance lease to earn rentals or for capital appreciation or both.
NOTE: Here, the strong impact in on purpose. If you hold a building or a land for any of the
following purposes, then it cannot be classified as investment property:
 For production or supply of goods or services,
 For administrative purposes, or
 For sale in ordinary course of business.

If you’re using your building or land for the first 2 purposes, then you should apply PAS 16; and
the standard PAS 2 Inventories fits when you use them for the sale in ordinary course of business.
Owner-occupied property – held (by the owner or by the lessee under a finance lease) for use in the
production or supply of goods or services or for administrative purposes. Owner-occupied property is
classified as PPE.
Examples of Investment Property:
 Land held as an investment for long-term capital appreciation,
 Land held for future undetermined use (i.e. you don’t know yet what you’ll use it for).

NOTE: However, if you buy a land and you intend to build some production hall for your own
purposes sometime in the future, then this land is NOT an investment property.

 A building owned by the entity (or a right-of-use asset relating to a building held by the entity) and
leased out under one or more operating leases.

NOTE: This includes a building that is still vacant, but you plan to lease it out.

NOTE: Property that is leased out to another entity under a finance lease is not an investment
property.

NOTE: Property occupied by employees (whether or not the employees pay rent at market rates)
is not an investment property

 Any property that you actually construct or develop for future use as investment property.

NOTE: Be careful here again, because when you construct a building for some third party, this is
NOT an investment property, but you should apply PAS 11 Construction contracts, or PFRS 15
Revenue from Contracts with Customers.
Partly investment property and partly owner-occupied
Some properties comprise a portion that is held to earn rentals or for capital appreciation and another portion
that is held for use in the production or supply of goods or services or for administrative purposes.

If these portions could be sold separately (or leased out separately under a finance lease), an entity accounts
for the portions separately.
If the portions could not be sold separately, the property is investment property only if an insignificant
portion is held for use in the production or supply of goods or services or for administrative purposes.

Provision of ancillary services to occupants

In some cases, an entity provides ancillary services to the occupants of a property it holds. An entity treats
such a property as investment property if the services are insignificant to the arrangement as a whole. An
example is when the owner of an office building provides security and maintenance services to the lessees
who occupy the building. In other cases, the services provided are significant.

Inter-company rentals
Property leased to, and occupied by, its parent or subsidiary does not qualify as investment property in
consolidated financial statements because the property is owner-occupied from the perspective of the group.
Such property will be investment property in the separate financial statements of the lessor.

When to recognize investment property

The rules for recognition of investment property are essentially the same as stated in IAS 16 for property,
plant and equipment, i.e. you recognize an investment property as an asset only if 2 conditions are met:
1. It is probable that future economic benefits associated with the item will flow to the entity; and
2. The cost of the item can be measured reliably.

Initial Measurement (@ Cost)

The cost of investment property includes:

 Its purchase price and

 Any directly attributable expenditure, such as legal fees or professional fees, property taxes, etc.

NOTE: You should NOT include:

 Start-up expenses. However, if these start-up expenses are directly attributable to the item
of investment property, then you can include them. But do NOT include any general start-
up expenses;
 Operating losses that you incur before planned occupancy level is achieved; and
  Abnormal waste of material, labor or other resources incurred at construction.

NOTE: When payment for investment property is deferred, then you need to discount it to its
present value in order to set the cash price equivalent. The difference between the cash price
equivalent and the total payments is recognized as interest expense over the credit period, unless
it qualifies for capitalization under PAS 23.

NOTE: If an investment property is acquired in exchange for another non-monetary asset, the cost
of the investment property will be measured using the following order of priority:
1. Fair value of the asset given up;
2. Fair value of the asset received
3. Carrying amount of the asset given up

If the exchange lacks commercial substance, the investment property acquired is measured at the
carrying amount of the asset given up.

Subsequent Measurement (by way of an accounting policy and, as a general rule, be applied to all
investment properties)

 Cost Model; or
 Fair value Model
Cost Model (same as PAS 16)
Fair value Model - Under this model, an investment property is carried at fair value at the reporting date.
The fair value is determined in line with the standard PFRS 13 – Fair Value Measurement. A gain or loss
from re-measurement to fair value shall be recognized in profit or loss.

NOTE: Sometimes, the fair value cannot be reliably measurable after initial recognition. This can
happen in absolutely rare circumstances (e.g. active marked ceased existing) and in this case, PAS
40 prescribes:
 To measure your investment property at cost, if it’s not yet completed and is under
construction; or
 To measure your investment property using cost model, if it’s completed.
NOTE: Fair value model (PAS 40) is different from Revaluation model (PAS 16).
 (NOTE: IAS 16 and IAS 40 are the international counterparts of PAS 16 and PAS 40)

Revaluation model versus Fair value model

Revaluation model
You can apply this model for any assets used for more than 1 year in the production process, for rental to
others or for administrative purposes, including your buildings or machinery. Under this model, you
should revalue your assets regularly to their fair value and depreciate revalued amount over remaining
useful life. When you revalue your assets, the change is recognized in other comprehensive income (with
some exceptions). Here, the important thing is that you can use revaluation model also for machinery (unlike
fair value model) and also, you charge depreciation (not under fair value model).

Fair value model

You can apply this model only for buildings and lands held either to earn rentals or for capital appreciation
(or both). Under this model, you should value your assets at their fair value after initial recognition, with
the fair value changes recognized in profit or loss. Here, you cannot apply fair value model to your
machinery (unlike revaluation model), and also, you do NOT charge any depreciation.
QUERY: Can you actually switch from cost model to fair value model or vice versa from fair value
model to cost model? The answer is YES, but only if the change results in the financial statements
providing more relevant and more reliable information about the company’s financial position,
results and other events.

What does it mean in practice? Switching from cost model to fair value model would probably meet
the condition and therefore, you can do it whenever you’re sure that you’ll be able to determine
the fair value regularly and the fair value model fits better. However, the opposite change – switch
from fair value model to cost model – is highly unlikely to result in more reliable presentation.
Therefore, you should not really do it, and if – rarely and for good reasons.
Transfer from and to investment property (only when there’s a change in use or asset’s purpose)
If the entity uses the cost model, transfers between investment property, PPE and inventories are accounted
for at the carrying amount of the asset transferred. No gain or loss arises because the asset’s measurement
remains the same before and after the transfer.
For a transfer from investment property carried at fair value to owner-occupied property or inventories the
property’s deemed cost for subsequent accounting in accordance with IAS 16 Property, plant and equipment
or IAS 2 Inventories shall be its fair value at the date of change in use.
If an owner-occupied property becomes an investment property that will be carried at fair value, an entity
shall apply IAS 16 Property, plant and equipment up to the date of change in use. The entity shall treat any
difference at that date between the carrying amount of the property in accordance with IAS 16 Property,
plant and equipment and its fair value in the same way as a revaluation in accordance with IAS 16 Property,
plant and equipment.
For a transfer from inventories to investment property that will be carried at fair value, any difference
between the fair value of the property at that date and its previous carrying amount shall be recognized in
profit or loss.

Derecognition

 upon disposal
 when the investment property is permanently withdrawn from use and no future economic benefits
are expected.

NOTE: The difference between the carrying amount and the net disposal proceeds, if any, is
recognized as gain or loss in profit or loss.

PAS 41 – AGRICULTURE
Agricultural Activity – the management by an entity of the biological transformation and harvest of
biological assets for sale or for conversion into agricultural produce or into additional biological assets.
Common features of agricultural activities:
1. Capability of change (biological transformation);
2. Management of change;
3. Measurement of change

QUERY: Is managing animal-related recreational activities agricultural activity? No. Managing

recreational activities – for example, game parks and zoos – is not agricultural activity, as there is
no management of the transformation of the biological assets but simply control of the number of
animals.
 QUERY: Is the natural breeding of animals in zoos and game parks agricultural activity? No.
The natural breeding that takes place is not a managed activity and is incidental to the main activity
of providing a recreational facility. A managed breeding programme carried out to produce
animals for sale would be considered agricultural activity.

Biological asset – a living animal or plant.

NOTE: Living animals, whether consumable or bearer, are classified as biological assets if they
relate to agriculture activity. However, living plants are classified as biological assets only if they
are consumable. Bearer plants are classified as PPE.

Bearer plant - a living plant that:

 is used in the production or supply of agricultural produce;

 is expected to bear produce for more than one period; and
 has a remote likelihood of being sold as agricultural produce, except for incidental scrap sales.

NOTE: Plants that are to be harvested as agricultural produce are not bearer plants.

NOTE: Annual crops and similar plants that die once their produce has been harvested are
considered consumable plants, and therefore classified as biological assets.

Agricultural produce – the harvested produce of the entity’s biological assets (in their natural state and
not yet processed).
NOTE: PAS 41 applies to agricultural produce ONLY at the point of harvest. After harvest, PAS
2 – Inventories or other applicable standard is applied.

NOTE: Biological assets and agricultural produce are accounted for under PAS 41 ONLY when
they relate to agricultural activity.

Measurement

 Biological assets (initially and subsequently) - @ fair value less costs to sell. Any change in
FVLCTS will be recognized in profit or loss.

NOTE: If the fair value cannot be reliably determined, the biological asset shall be measured
initially at cost and subsequently at cost less accumulated depreciation and accumulated
impairment losses until such time when its fair value can be reliably determined.

 Agricultural produce (ONLY at the point of harvest) - @ fair value less cost to sell

Government Grants
Only government grants that are related to biological assets measured at fair value less costs to sell are
accounted for under PAS 41. Those that are related to biological assets measured at cost less accumulated
depreciation and accumulated impairment losses are accounted for under PAS 20.

PAS 37 – PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS

Provision – a liability of uncertain timing or amount. The liability may be a legal obligation or a
constructive obligation. A legal obligation is one that arises from legislation, a contract or other legal act.
A constructive obligation arises from the entity’s actions, through which it has indicated to others that it
will accept certain responsibilities, and as a result has created an expectation that it will discharge those
responsibilities.
Examples of provisions:

 warranty obligations;
 provisions for environmental damages;
 estimated liabilities on pending lawsuits;
 provisions for decommissioning costs of an item of PPE;
 obligations caused by an entity’s policy to make refunds to customers;
 obligations arising from guarantees;
 provisions on onerous contracts;
 provisions for restructuring costs.

When to recognize a provision? (all the following must be met:)

1. There must be a present obligation as a result of a past event;
2. The outflow of economic benefits to satisfy the obligation must be probable (i.e. more than 50%
probable)
3. The amount of economic benefits required to satisfy the obligation must be reliably estimated.

QUERY: What if there is one of them that is not met? Then you should either:
 Disclose a contingent liability, or

 Do nothing if the outflow of economic benefits is remote.

To summarize (in a diagram):

 NOTE: If you are unsure whether to recognize a provision in a particular situation or not, just ask
yourself a simple question: “Can the obligation be avoided by some future actions?”

If yes, then you should NOT book a provision. For example, if a government introduced new tax
legislation, does the tax consulting company need to spend cash for training of its employees and
thus recognize a provision for that training? No, it does not have to. Tax consulting company can
avoid the training and decide to stop its activities (OK, that’s a bit far-fetched and unlikely, but you
get the point).

If you cannot avoid the obligation by some future action, then you have to recognize a provision. For
example, when you promised a free warranty service for defective products at the point of sale, then
you have a present obligation. If your past statistics show that you needed to spend some cash for
warranty repairs, then you need to make a provision.

How to measure a provision?

The amount of the provision should be measured at the best estimate of the expenditures required to satisfy
the obligation at the end of the reporting period.

As you can see, here’s some judgement and estimates involved. Management should really incorporate all
available information in their estimates and they must not forget about:

 Risks and uncertainties (like inflation),

 Time value of money (discounting when the settlement is expected in the long-term future)
 Some probable future events, etc.

There are 2 basic methods of measuring a provision:

1. Expected value method: You would use this method when you have a range of possible outcomes
or you measure the provision for large amount of items. In this case, you need to weight each
outcome by its probability (for example, warranty repair costs for 10 000 products).
 2. The most likely outcome: This method is suitable in the case of a single obligation or just 1 item
(for example, provision for loss in the court case).

Provisions in Specific Circumstances

1. Future operating losses.
NOTE: No provision is recognized for future operating losses. Why? Because there is no past event.
The future operating losses can be avoided by some future actions, for example – by selling a
business. However, you should test your assets for impairment under PAS 36 Impairment of Assets.

2. Onerous contracts – a contract in which unavoidable costs of fulfilling exceed the benefits from
the contract. In other words, it is a loss contract that cannot be avoided.
NOTE: You should make a provision in the amount lower of:
 Unavoidable costs of fulfilling the contract; and
 Penalty for not meeting your obligations from the contract

3. Restructuring – a plan of management to change the scope of business or a manner of conducting

a business.
NOTE: You should recognize a provision for restructuring only when the general criteria for
recognizing provisions are met.

In the case of restructuring, an obligation to restructure arises only if:

 There is a detailed formal plan for restructuring with relevant information in it (about
business, location, employees, time schedule and expenditures)
 A valid expectation related to restructuring has been raised in the affected parties.

Contingent Liability (is either:)

 A possible obligation (not present) from past event that will be confirmed by some future event; or
 A present obligation from past event, but either:
 The outflow of economic benefits to satisfy this obligation is not probable (less than 50%),
or
 The amount of obligation cannot be reliably measured (this is very rare, in fact).

NOTE: If you identify you have a contingent liability, you do NOT recognize it – no journal entry.
You should only make appropriate disclosures in the notes to the financial statements.

Contingent Asset – is a possible asset that arises from past events, and whose existence will be confirmed
only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the
control of the entity.
NOTE: Similarly as with contingent liabilities, you should not book anything in relation to
contingent assets, but you make appropriate disclosures.

Contingent Probable Possible Remote

 Liability Recognize and
Disclose only
Disclose Ignore
(Contingent Liability)
(Provision)
 Asset Disclose only
Ignore Ignore
(Contingent Asset)