To a large extent, the accounting for fixed assets under FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland remains unchanged from outgoing FRS 15 Tangible fixed assets and the FRSSE.
However, there are some notable differences that AAT Licensed Accountants and AAT members working for companies involved in accounts preparation should bear in mind.
FRS 102 deals with property, plant and equipment in Section 17 Property, Plant and Equipment. Section 17 will also apply to investment property whose fair value cannot be measured reliably without undue cost or effort (although care must be taken where undue cost or effort exemptions are exercised).
A fixed asset is accounted for under Section 17 when the asset is held for use in the production or supply of goods or services; for rental to others; or for administrative purposes and is expected to be used for more than one accounting period. In order to qualify for recognition on the balance sheet, FRS 102 contains two strict criteria which must be met. An entity can only recognise an asset on the balance sheet if, and only if:
- it is probable (i.e. more likely than not) that future economic benefits associated with the item will flow to the entity; and
- the cost of the item can be reliably measured.
The criteria above are the same as under outgoing UK GAAP and so accountants should be familiar with the recognition criteria.
Spare parts and servicing equipment
Unlike FRS 15 and the FRSSE, FRS 102 deals with the accounting for spare parts and servicing equipment. Paragraph 17.5 recognises that such items are usually carried as inventory in the reporting entity’s accounting records and are included in profit or loss as they are consumed. Consideration must, however, be given to major spare parts and stand-by equipment because such items are considered to be fixed assets under FRS 102 when the entity expects to use them for more than one accounting period. A similar principle also applies if the spare parts and servicing equipment can only be used in connection with an item of fixed asset.
FRS 102 places more emphasis on component accounting. Component accounting would be appropriate when certain parts (i.e. components) of an item of property, plant and equipment might require replacement at regular intervals (the standard cites an example of a roof on a building). The standard requires that the cost of replacing such a component is added to the carrying amount of the asset when the cost is incurred and only if the replacement part is expected to provide incremental future benefits to the company. The carrying value of the part(s) that have been replaced are derecognised from the accounts in the usual way.
Component depreciation is also a feature of FRS 102. Component depreciation is appropriate when the major components of an item of fixed asset have a significantly different useful economic life than the rest of the asset. Examples frequently cited include the linings of blast furnaces and the engines of aircraft. When the major components of a fixed asset have significantly shorter lives than the main asset itself, FRS 102 would require the entity to depreciate each such component separately over its useful life.
Recognition and measurement
Fixed assets are always initially recognised at cost. Cost can be made up of several components, including:
- the initial purchase price;
- irrecoverable taxes;
- legal fees;
- brokerage fees; and
- other costs directly attributable to bringing the asset to its location and condition intended by management.
However, paragraph 17.11 specifically disallows certain types of expenditure from forming the part of the cost of an asset and include:
- the costs of opening a new facility;
- the costs of introducing a new product or service, including advertising costs and promotional activities;
- costs of conducting business in a new location or with a new class of customer and this includes staff training; and
- administration and other general overhead costs.
Ordinarily the cost of an item of fixed asset is the cash price equivalent at the date of recognition and this will usually be found on the supplier’s invoice. If, however, payment is deferred beyond normal credit terms, then the cost price is the present value of all future payments.
Historic cost or revaluation
Under Section 17, an entity can measure an item of property, plant and equipment under the historic cost model or the revaluation model. Again, there is no difference in this respect to the subsequent measurement models from outgoing UK GAAP.
A point worthy of note, however, is that if the entity is a micro-entity and is reporting under FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime, it is not permitted to use the revaluation model. The only permissible treatment is the historic cost model.
Under the historic cost model, fixed assets are measured at cost less accumulated depreciation less accumulated impairment losses.
Under the revaluation model, fixed assets are carried at their latest revaluation amount less any subsequent accumulated depreciation and subsequent accumulated impairment losses. Revaluation gains are taken to a revaluation reserve within equity and reported as other comprehensive income. Revaluation gains for assets accounted for under Section 17 are NOT taken to the profit and loss account. Some accountants have confused the accounting for a revaluation gain under Section 17 with a fair value gain on an investment property accounted for under Section 16 Investment Property. Fair value gains on investment property are taken to the profit and loss account instead of a revaluation reserve account, but revaluation gains on property, plant and equipment under Section 17 are no different than what took place under outgoing UK GAAP and so the concept of the revaluation reserve still exists for revalued assets accounted for under the provisions of Section 17.
If the asset subjected to revaluation suffers a revaluation loss, then the loss is also taken to the revaluation reserve to the extent that there is a surplus on the revaluation reserve. Any excess of the loss over the surplus is taken to the profit and loss account.
Under FRS 15 and the FRSSE, if an entity subjected a fixed asset to the revaluation model it was required to obtain up-to-date revaluations at least every five years, with valuations in the intervening years where there had been a material change value. This was to ensure that the carrying amount of the fixed asset in the balance sheet did not materially differ from its fair value.
Under FRS 102, the standard does not prescribe a set time limit for revaluations. Paragraph 17.15B says that revaluations shall be made with sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the end of the reporting period. Therefore, some types of fixed assets may go several years without a revaluation being undertaken, but these would tend to be assets whose fair value remains relatively static over a long period of time. Conversely, some assets (such as properties) may require revaluations on a much more regular basis. The judgement call that is required here is to consider whether the carrying value of the revalued assets is materially higher or lower than its fair value; if it is, then a revaluation is needed.
All assets must be depreciated; although in the majority of cases, land will not depreciate as this is considered to have an indefinite useful life. FRS 102 does not stipulate which assets must be subjected to which depreciation methods; however, in practice the straight-line and reducing balance (sometimes referred to as the ‘diminishing balance method’) are used. In a manufacturing company, it may be appropriate to use the ‘usage method’ of depreciation for certain types of machinery. Under the usage method, depreciation is only charged when an asset is being used; hence under this method the depreciation charge can be nil while there is no production.
If an entity changes its depreciation method (for example, depreciating an asset at 33% on a straight-line basis instead of 25% on a reducing balance basis), then this represents a change in estimation technique. The change is not applied retrospectively because changes in estimation are accounted for prospectively; only changes in accounting policy are applied retrospectively and a change in depreciation method is not a change in accounting policy.
The depreciable amount of an asset is calculated as cost less residual value. The balance is then depreciated over the asset’s useful economic life.
Under previous UK GAAP, residual values were based on historic prices (i.e. the expected value that would be fetched by disposing of the asset at the date the asset is acquired). However, under FRS 102, residual values are based on the price which an entity would currently obtain if it were to dispose of the asset less the estimated costs of disposal. This means that depreciation charges could fluctuate from one period to the next because the depreciable amount could go up or down depending on what happens with the residual value.
It is important to remember a fundamental principle that underpins financial reporting which is that assets must not be stated in the balance sheet at any more than recoverable amount. If assets are overstated this clearly results in the accounts becoming misleading. In recognition of this principle, FRS 102 requires an entity to test assets for impairment at each balance sheet date. Impairment of assets is dealt with in Section 27 Impairment of Assets and will be the subject of a future article for AAT Comment.
If the entity is going to be reimbursed for an asset that is impaired; for example, if an insurance company is going to reimburse the entity for a vehicle that has been damaged in an accident, then that compensation can only be recognised as a debtor when its receipt is virtually certain. Note the term ‘virtually certain’ is not the same as ‘probable’. The term ‘probable’ is defined as ‘more likely than not’; virtually certain is not defined in FRS 102 and in practice there would have to be official confirmation from the third party that they do intend to reimburse the entity.
The accounting principles for fixed assets do remain largely unchanged from previous UK GAAP; however, there are some subtle differences that AAT Licensed Accountants need to keep in mind, such as:
- spare parts and stand-by equipment are dealt with in FRS 102 (they were not covered in previous UK GAAP);
- more emphasis is placed on component accounting;
- while the cost model and revaluation remain the same in FRS 102, micro-entities cannot use the revaluation model;
- revaluation gains and losses on a revalued asset under Section 17 are taken to the revaluation reserve (losses to the extent that there is a surplus on the revaluation reserve); and
- depreciation charges might fluctuate on the same asset from one year to the next because residual values are based on current, not historic, prices.
Steve Collings is the audit and technical partner at Leavitt Walmsley Associates Ltd.