finally a first time adopter that applies the deemed cost exemption for oil and gas 611665
Deemed cost of property, plant and equipment
Entity A used to revalue items of property, plant and equipment to fair value under its previous GAAP, but changed its accounting policy on 1 January 2006 when it adopted a different accounting policy. Under that accounting policy, Entity A did not depreciate the asset and only recognized the maintenance costs as an expense. Entity A”s date of transition to IFRSs is 1 January 2012.
In its balance sheet under previous GAAP the carrying amount of the asset is £80 at the date of transition to IFRSs, which is equal to the last revaluation. Entity A can use the last revalued amount as the deemed cost of the asset on 1 January 2006. However, Entity A will need to apply IAS 16 to the period after 1 January 2006 because the accounting policy under its previous GAAP is not permitted under IFRSs. Assuming that the economic life of the asset is 40 years and that the residual value is nil, Entity A would account for the asset at £68 in its opening IFRS statement of financial position, which represents the deemed cost minus 6 years of depreciation.
At its date of transition to IFRSs, a first-time adopter is allowed under IFRS 1 to measure each item of property, plant and equipment, investment properties and intangible assets at an amount based on:
- historical cost determined in accordance with IAS 16, IAS 38 and IAS 40;
- fair value at the date of transition to IFRSs;
- a previous GAAP revaluation amount that is equal to:
- fair value at the date of revaluation;
- cost adjusted for changes in a general or specific index; or
- an event-driven fair value, for example, at the date of an initial public offering or privatization.
- in the case of an item acquired in a business combination:
- carrying amount under previous GAAP immediately after acquisition; or
- if the item was not recognised under previous GAAP, the carrying amount on the basis that IFRSs would require in the separate balance sheet of the acquiree.
- in the case of oil and gas assets at deemed cost ;or
- in the case of assets used or previously used in operations subject to rate regulation .
The fact that IFRS 1 offers so many different bases for measurement does not disturb the IASB as it reasons that ‘cost is generally equivalent to fair value at the date of acquisition. Therefore, the use of fair value as the deemed cost of an asset means that an entity will report the same cost data as if it had acquired an asset with the same remaining service potential at the date of transition to IFRSs. If there is any lack of comparability, it arises from the aggregation of costs incurred at different dates, rather than from the targeted use of fair value as deemed cost for some assets. The Board regarded this approach as justified to solve the unique problem of introducing IFRSs in a cost-effective way without damaging transparency. [IFRS 1.BC43]. Although this is valid, it still means that an individual first-time adopter can greatly influence its future reported performance by carefully selecting a first-time adoption policy for the valuation of its assets. Users of the financial statements of a first-time adopter should therefore be mindful that historical trends under the previous GAAP might no longer be present in an entity”s IFRS financial statements.
5.5.2 Event-driven fair value measurement as deemed cost
A first-time adopter may use fair value measurements that arose from an event such as a privatisation or initial public offering as deemed cost for IFRSs at the date of that measurement. [IFRS 1 Appendix D8].
IFRS 1 describes these revaluations as ‘deemed cost in accordance with previous GAAP. Therefore, to the extent that they related to an event that occurred prior to its date of transition or during the comparative period presented under IFRS, they can only be used as the basis for deemed cost if they were recognised in the first-time adopter”s previous GAAP financial statements. See below for an extension of the scope of this deemed cost exemption to events that occurred subsequent to the first-time adopter”s date of transition to IFRSs but during the period covered by the first IFRS financial statements.
The ‘fair value or revaluation as deemed cost exemption discussed at above, only applies to items of property, plant and equipment, investment property and certain intangible assets. [IFRS 1 Appendix D5-7]. The event-driven deemed cost exemption is broader in scope because it states when a first-time adopter ‘established a deemed cost in accordance with previous GAAP for some or all of its assets and liabilities [emphasis added] by measuring them at their fair value at one particular date … It may use such event-driven fair value measurements as deemed cost for IFRSs at the date of that measurement. [IFRS 1 Appendix D8, IFRS 1.BC46].
There are two important limitations in the scope of this exemption:
- While it applies, in principle, to all assets and liabilities of an entity, it does not override the recognition criteria in IFRSs. [IFRS 1.10]. Consequently, a first-time adopter should derecognise goodwill, assets (e.g. certain intangible assets such as brand names and research) and liabilities that do not qualify for recognition under IFRSs in the balance sheet of the entity; and
- The exemption cannot be used if the event-driven revaluation did not result in a remeasurement to full fair value (i.e. it cannot be used in the case of a partial step-up towards fair value).
Finally, although a first-time adopter may use the event-driven fair value measurements as deemed cost for any asset or liability, it does not have to use them for all assets and liabilities. [IFRS 1 Appendix D8].
A ‘Push down accounting
Under some previous GAAPs an entity may have prepared its financial statements using ‘push down accounting, that is, the carrying amount of its assets and liabilities is based on their fair value at the date it became a subsidiary of its parent. If such a subsidiary subsequently adopts IFRSs, it will often require a very significant effort to determine the carrying amount of those assets and liabilities on a historical costs basis at the date of transition.
The event-driven deemed cost exemption applies to events ‘such as a privatisation or initial public offering. [IFRS 1 Appendix D8]. This list of events is clearly not meant to be exhaustive, but rather describes events that result in re-measurement of some or all assets and liabilities at their fair value. An acquisition that results in an entity becoming a subsidiary is a change of control event similar to a privatisation or an initial public offering. In our view, the application of ‘push down accounting results in event-driven fair value measurements that may be used as deemed cost for IFRSs at the date of that measurement.
The exemption can only be used if ‘push down accounting resulted in recognising assets and liabilities at their fair value. For example, previous GAAP may not have required remeasurement to full fair value in the case of a partial acquisition or a step-acquisition, or if there was a bargain purchase that was allocated, for example, to reduce the fair values of long-lived assets.
B ‘Fresh start accounting
Some previous GAAPs require an entity that emerges from bankruptcy to apply ‘fresh start accounting, which involves recognition of assets and liabilities at their fair value at that date.
In our view, the application of ‘fresh start accounting results in an event-driven fair value measurement that may be used as deemed cost for IFRSs at the date of that measurement. [IFRS 1 Appendix D8]. The use of the exemption is limited to instances that resulted in the recognition of the related assets and liabilities at their full fair value (i.e. it cannot be used in the case of a partial step-up towards fair value).
Exemption for event-driven revaluations after the date of transition
The event-driven exemption includes events whose measurement date is after the date of transition to IFRSs but during the periods covered by the first IFRS financial statements. The ‘event-driven fair value measurements may be used as deemed cost when the event occurs. An entity shall recognise the resulting adjustments directly in retained earnings (or if appropriate, another category of equity) at the measurement date. [IFRS 1 Appendix D8(b)].
The Board explicitly considered whether or not to allow a first-time adopter that uses a revaluation subsequent to the date of transition to ‘work back the deemed cost on the date of transition to IFRSs using the revaluation amounts subsequently obtained on the date of measurement, adjusted to exclude any depreciation, amortisation or impairment between the date of transition to IFRSs and the date of that measurement. [IFRS 1.BC46B]. The Board rejected this approach ‘because making such adjustment would require hindsight and the computed carrying amounts on the date of transition to IFRSs would be neither the historical costs of the revalued assets nor their fair values on that date. [IFRS 1 Appendix D8B, BC46B]. This restriction seems to limit the usefulness of the exemption for first time adopters; however, it should provide relief from the need to keep two sets of books subsequent to the event.
5.5.3 Deemed cost for oil and gas assets
It is common practice in some countries to account for exploration and development costs for properties in development or production in cost centres that include all properties in a large geographical area, e.g. under the ‘full cost accounting method. However, this method of accounting generally uses a unit of account that is much larger than is acceptable under IFRSs. Applying IFRSs fully retrospectively would pose significant problems for first-time adopters because it would also require amortisation ‘to be calculated (on a unit of production basis) for each year, using a reserves base that has changed over time because of changes in factors such as geological understanding and prices for oil and gas. In many cases, particularly for older assets, this information may not be available. [IFRS 1.BC47A]. Even when such information is available the effort and cost to determine the opening balances at the date of transition would usually be very high.
For these entities, use of the fair value or revaluation as deemed cost exemption , however, was not considered to be suitable because: [IFRS 1.BC47B]
‘…Determining the fair value of oil and gas assets is a complex process that begins with the difficult task of estimating the volume of reserves and resources. When the fair value amounts must be audited, determining significant inputs to the estimates generally requires the use of qualified external experts. For entities with many oil and gas assets, the use of this fair value as deemed cost alternative would not meet the Board”s stated intention of avoiding excessive cost …
The IASB, therefore, decided to grant an exemption for first-time adopters that accounted under their previous GAAP for ‘exploration and development costs for oil and gas properties in the development or production phases … in cost centres that include all properties in a large geographical area. [IFRS 1 Appendix D8A]. Under the exemption, a first-time adopter may elect to measure oil and gas assets at the date of transition to IFRSs on the following basis: [IFRS 1 Appendix D8A]
(a) exploration and evaluation assets at the amount determined under the entity”s previous GAAP; and
(b) assets in the development or production phases at the amount determined for the cost centre under the entity”s previous GAAP. This amount should be allocated to the cost centre”s underlying assets pro rata using reserve volumes or reserve values as of that date.
For this purpose, oil and gas assets comprise only those assets used in the exploration, evaluation, development or production of oil and gas.
A first-time adopter that uses the exemption under (b) should disclose that fact and the basis on which carrying amounts determined under previous GAAP were allocated. [IFRS 1.31A].
To avoid the use of deemed costs resulting in an oil and gas asset being measured at more than its recoverable amount, the Board also decided that oil and gas assets that were valued using this exemption should be tested for impairment at the date of transition to IFRSs as follows: [IFRS 1 Appendix D8A]
- exploration and evaluation assets should be tested for impairment under IFRS 6; and
- assets in the development and production phases should be tested for impairment under IAS 36.
The deemed cost amounts should be reduced to take account of any impairment charge.
Finally, a first-time adopter that applies the deemed cost exemption for oil and gas assets should also apply the IFRIC 1 – Changes in Existing Decommissioning, Restoration and Similar Liabilities – exemption for oil and gas assets at deemed cost.