The memo

The objective of IAS 16 is to provide instructive guidelines for the accounting practice of property, plant, and equipment so that these assets will be reflected in the most appropriate value in financial statements. This document provides a basic principle for the recognition of property, plant, and equipment. Relevant issues that arise from this process are also covered in this instruction, such as the determination of carrying amount, depreciation, and contingent impairments (IASB, 2017). Nonetheless, as with many regulations, the IAS 16 encounters critics from the academic and pragmatism that this document remains some loopholes that make it impractical. In response to this notion, the IASB agenda forms a proposed amendment focusing on correct previous impractical problems.

One major proposed amendment included in the newest report is a suggestion to change the accounting treatment of attributable costs and proceeds arising from the preparation of assesses for intended uses of the manager (IAASB, 2009)(IASB, 2017). According to the newest agenda meeting of IASB, the cost and proceeds from the testing process must be recorded in the profit and loss statement, rather than capitalize the difference amount of these figures on the total value of the asset. This proposed amendment, If being implied, would transfer a proportional value of the balance sheet to income statement. Moreover, costs and proceeds must be included in the profit and loss statement under a specific category. This classification, though being considered as a better reflection of business nature, rises additional accounting procedures that require time and effort of the accountant (Deloitte, 2019).

The IAS 16 paragraph 7 set light for examples of directly attributable costs, including: (i) cost of employee benefits, (ii) cost of site preparation, (iii) initial delivery and handling cost, (iv) installation and assembly cost, (vi) cost testing, (vii) and other professional fees (IASB, 2018). At the first glance, this paragraph offers a clear and instructive classification of attributable costs. This would help to form a background to apply in accounting practices with step by step instruction of classifying and recording these cost. Accountants will find this guideline is very useful since it substantially reduces unnecessary disputes arising from accounting practice, hence, it will they will save a lot of time and effort (Deloitte, 2019). Nonetheless, these instructions are far from complete as it lacks essential merits. The first problem is difficulty in identifying these attributable costs and the operating expenses of the company. Assume a worker of a candy company has an ability in construction, and he attends in the constructing process of a new factory, this overlap would make the accounting procedures to be complex (Soderstrom and Sun, 2016). Moreover, some attributable costs are hard to record properly. Proceeds and expenses of the testing process in business nature is sales and expenses, however, under the IAS, they are both capitalized on the total value of the asset. The second problem is this paragraph offers no clear cut measurement of the time period. For example, professional fees are often misunderstood as maintenance costs (Palea, 2013). The unclear definition of reporting period also struggles accountant from giving judgments of fair value of asset, for example, when should the account record the depreciation expenses.

In response to these shortages, IASB commitment offers some proposed adjustments with the purpose of fulfilling the loopholes (IASB, 2017, 2019). Two major proposed changes attempt to correct the nature of proceeds and cost resulting from the testing process, and to offer a clear definition of “testing” in paragraph 17e. Regarding the first proposed amendment, since the sale and proceeds of the testing process are reported as an item of profits and losses statement, the accounting treatment is of course better in reflecting business nature. Moreover, the accountant is required to make additional disclosure of profits, production related costs and specify the line items regarding the sale of items that do not belong ordinary business activities. Nonetheless, this proposal will require additional work of the accountant in giving fair disclosures of these costs and proceeds (Pope and McLeay, 2011). Regarding the proposed amendment of the “testing” term, the new classification requires that the asset is verified by the technical and physical performance of the asset and not its financial performance (IASB, 2019). Again, this suggestion is superior to previous instruction in which it narrows the gap between the accounting principle and the business nature. The previous requirement states that the asset is said to be functioning properly since the proceeds surpass the production cost. However, it is irrelevant to link the capability of physical assets to product prices, which is volatile and often influenced by market demand. However, assessing physical capability and technical requirements requires additional judgments of the accountant and might contain errors.

Generally speaking, the proposed amendments contribute critical benchmark that potentially complete the original document IAS 16. Nonetheless, as its name suggests, these amendments need to reassess and further adjust to shape a sufficient and appropriate version for practical uses.

Regarding the first amendment, classifying and recording the sales of experimental product into profit and loss statement is practical under the current accounting standards. However, additional disclosure of this item requires extra works of the accountant. Moreover, specifying the items will make the users of financial statements struggle to assess the information and predict future income because proceed from the testing process is not part of ordinary business activities (Yurisandi and Puspitasari, 2015). Additionally, the frequency of this amount in the Profit and Loss statement might not regular. Investment in property, plant and equipment is not regular activities, thus proceed from them is not frequent as well. In general, this proposed amendment is indeed practical and it promises sufficient improvements to the financial statements. However, extra works due to additional disclosure might render the accountant from willingly performing this task.

Regarding the second amendment, this seems practical and effective enough to be applied in accounting practice. The current definition of “testing” relies on the financial performance of the experiment process, which is strongly volatile due to the fast-changing market demand (Martínez et al., 2014). The proposed alternative of testing criteria is using the technical and physical performance of the asset. It is indeed practical in accounting practice. However, the accountant is often not capable of giving judgments regarding technical and physical performance. Any attempts of an accountant who lacks necessary understandings in giving judgment will likely create errors, thus render the practice of this amendment. A better solution might be asking for expert’s consultancies. However, this action will raise additional costs which business will not prefer (Elbakry et al., 2017). In general, accounting practice is capable of reflecting this amendment. However, to assure the objectivity of the accounting process, an expert’s consultancy might be required.

In summary, though IAS 16 offers an instructive guideline for the accountant to record investment on property, plant, and equipment, it is important to notice its shortages. Thus, two major proposed amendments are (i) to reclassify the sales of proceeds from the testing process to profit and loss statement, and (ii) to redefine the term “testing” based on technical and physical performance rather than financial performance. Both of these amendments are proved to be practical applications, however, some adjustments and extra work must be presented to assure the objective of financial statements.

The letter

Dear, ABC

Due to the potential effects of the upcoming amendments in IAS 16, it is important to gain a broad view of this change in the financial statements of your company. One of the major changes from IAS 16 is it not allows you to record all of the costs related to the acquisition of assets into its total value. Specifically, some types of costs such as sales and cost of experiment goods once were considered to be capitalized amounts, now being removed from the total value of the asset. Rather, these figures will be included in your profit and loss statement. In a simple word, this action simply transfers a proportion of your asset from the balance sheet to sales in the profit and loss statement. Moreover, the accounting standards will require your accountant to fully disclose this amount as a specific item under IFRS to distinguish it from sales arise from ordinary business activities. Other amendment offers a new definition of “testing”. Stated in other words, the experiment process is now identified based on technical and physical performance, for example, a comparison of your expectation and actual productivity and quality, and not financial performance as previously. Often, this process might require an additional cost of expert’s consultancies. In general, these amendments improve the quality and transparency of your financial statement in which it brings the financial statement closer to your business nature. This would enhance the quality of information that you retrieve from these reports.

Regarding your current case, though the Covid pandemic delay implication of IAS 16, it is important to notice that the IAS is required to apply retrospectively at the earliest report period, which means investment in property, plant, and equipment in the last year will be under the regulation of IAS 16. As aforementioned, under the IAS 16, your company should record the acquisition cost of the item of property, plant, and equipment and cost associated with the testing process as the total value of the asset, or 200million plus 7million equal to 207million. While the cost of the sample produced during the testing process (6million) is classified as production cost and will be regulated under the IAS 2 Inventory, and proceeds from selling sample items produced during the testing phase (9million) will be treated as sales. Nonetheless, these two figures must be presented as specific items under the profit and loss statements. In particular, the sales will increase from 30 million to 33 million (30millon average annual profit plus 3 million from selling sample items produced during the testing phase). This would distort the company profits as it is now overstating 3 million compare to the normal level. Moreover, this will increase the tax liability of the company since additional profit must be taxed. Under the adverse effects of Covid 19, additional tax liability would be considered a huge burden. Transferring these amount to the profit and loss statement will reduce the total value of the asset, thereby, its annual depreciation as well. Noted that the depreciation is tax-exempt. The combined effects of these amendments might trigger an unwanted outcome for the company.