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Antonella Risi
We will now turn our attention to Session 2: Assets. In this session, we will cover some of the standards related to assets, including property, plant and equipment, intangible assets, leases service, concession arrangements, inventories, agriculture and investment property. I will now turn it over to Camila who will take you through the first half of the asset session.
Camila Santos
Thank you, Antonella. Before we get into the standards themselves, let’s look at the asset definition. An asset is a resource presently controlled by the entity as a result of a past event. The definition of an asset can be dissected into its key characteristics. First, they embody resources. A resource is an item with service potential or the ability to generate economic benefits. Physical form is not a necessary condition of a resource. Second, they are presently controlled by the entity. Third, they arise from a past event.
Antonella Risi
Can you tell us a bit more with respect to what you mean when you say that “an asset embodies resources”?
Camila Santos
Resources may be: Financial resources including cash, claims to cash, investments and any other resources that can be used to settle liabilities as they come due or to finance the provision of future goods and services.
Physical resources with the ability to generate future net cash flows or that will be consumed in the provision of future service in the normal course of operations includes land, buildings, equipment, books, etc.
Non-physical resources or intangible resources representing recognizable rights to future economic benefits and service potential. Examples of intangible assets that may be recognized by public sector entities include licenses, computer software, etc. Is it clearer now?
Antonella Risi
Yes! This clarification was very helpful. Thank you. What about control? What does “being presently controlled by the entity” entail?
Camila Santos
Control of an asset has two aspects: The entity can use or otherwise benefit from the resource in pursuit of its objectives (right to obtain the benefits from the asset); and The entity is able to exclude or otherwise regulate the access of others to benefits arising from the resource (prevent others from obtaining the benefits.)
Antonella Risi
Great! Thank you. Can you take us through the last key characteristic being that an asset arises from a past event?
Camila Santos
The occurrence of a past transaction or other event is considered to be evidence supporting the existence of a present resource. Transactions or events expected to occur in the future do not in themselves give rise to assets. This will often be the purchase, a contract or legislation. Service potential is the ability of an item to contribute to the organization’s objectives; it does not need to generate revenue. In some jurisdictions, hospitals will be resources because they can be used to generate revenue as patients are charged. In other jurisdictions, there are no charges and hence no revenue, but the hospital is still a resource because it enables the health ministry or similar organization to meet their objectives.
Once it is determined that a resource meets the definition and has the key characteristics of an asset, a determination must be made of whether the recognition criteria are met. The recognition criteria are on the slide. The concept of probability is used in the recognition criteria to refer to the degree of uncertainty that the future economic benefits associated with the asset will flow to the entity. The concept is in keeping with the uncertainty that characterizes the environment in which an entity operates. “Probable” means that an inflow of resources is more likely than not to occur. That is, the probability that the event will occur is greater than the probability that it will not. With respect to the 2nd criteria, an item may not be recognized in the financial statements because a reasonable estimate cannot be made of the amount involved. However, just because an estimate is involved, does not mean the measurement is unreliable.
Here we have a decision tree to summarize all we have discussed so far. First, consider the item in the context of the definition of an asset. If it does not meet the definition, then nothing further is required. If the item meets the definition of an asset, then you will need to determine the appropriate IPSAS to use in recognizing the asset in the financial statements.
Antonella Risi
Camila, I see on the slide that when making an assessment of whether or not an item meets the definition of an asset, the entity should consider if it’s a monetary or non-monetary asset. Can you talk a bit more about this?
Camila Santos
Excellent observation! Yes. And this slide shows we should consider whether it’s a monetary or non-monetary asset. Let’s clarify what monetary asset versus unknown monetary asset means. Monetary assets are units of currents and other assets to be received in fixed or determinable units of currency. Examples are cash accounts and loans receivable, temporary investments. All other assets are considered non-monetary. Monetary assets are accounted for using IPSAS 28, 30 and 41 on a financial instrument. The remaining assets are split between tangible assets and intangible assets. Tangible assets have physical substance. Examples include inventories and property, plant and equipment. Intangible assets lack physical substance. We will dive deeper in both tangible and intangible assets in this workshop. As it was mentioned at the beginning of the workshop, the financial instrument standards are not covered, as that could be a workshop of its own, and this workshop is intended to be an introduction.
Now let’s start looking at IPSAS, and we started with IPSAS 45, Property, Plant and Equipment. We’re going to refer to property, plant and equipment as PP&E throughout this session. On this slide, we have the definition of PP&E: tangible items that are held for use in production or supply of goods or service, for rental to others or for administrative purpose, and are also expected to be used during more than one reporting period. The specialized military equipment and infrastructure assets will normally meet this definition.
Antonella Risi
Camila, if we can pause here for just a moment. Can you tell us a bit more about specialized military equipment and infrastructure assets?
Camila Santos
Sure. Specialized military equipment includes weapon systems such as vehicles and other equipment such as warships, submarines, military aircraft, tanks, missile carriers and launchers that are used continuously in the provision of defence services, even if their peacetime use is simply to provide deterrence. With respect to infrastructure assets, while there is no universally accepted definition of infrastructure assets, these assets usually display some public sector characteristics. Part of a system or network specialize in nature and do not have alternative uses, immovable and may be subject to constraints on disposal.
Antonella Risi
Thank you, Camila. That’s very helpful. And it looks like from the slide that tangible heritage assets are also included in the definition of PP&E. Can you tell us a little bit more about this?
Camila Santos
Yes, tangible heritage assets that meet the definition of PP&E should be accounted for in accordance with IPSAS 45. This is an important topic, as it represents one of the changes introduced by IPSAS 45. The predecessor standard, IPSAS 17, did not require heritage assets to be recognized as PP&E. Now IPSAS 45 requires recognition where it’s possible to reliably measure the asset.
However, if these assets can’t be reliably measured, disclosure of information about the asset is necessary. The IPSASB decided to remove the scope exclusion for heritage assets mostly because, well: (1) Recognizing heritage assets enhanced transparency by providing more comprehensive heritage-related financial information to interested affected parties; (2) The heritage nature of an item does not disqualify it from being considered an asset for financial reporting purpose. Heritage value and financial reporting can coexist. Lastly, many heritage items meet the definition and recognition criteria of an asset, as such should be recognized in the statement of financial position when those criteria are met.
Antonella Risi
Thank you for notifying us of this important change. Can you help me understand what does this all mean to the user of financial statements?
Camila Santos
Well, if in the past under IPSAS 17 a public sector entered has elected not to recognize heritage assets as a PP&E, this very same entity will now need to recognize those assets and under IPSAS 45 to the extent that they can be reliably measured. This, in turn, allows the users to see tangible heritage assets on the face of the financial statements. We will discuss the characteristics of heritage assets later in this module. But, generally speaking, public sector entities hold heritage assets for long periods and preserve them for present and future generations due to their cultural, environmental and historical significance worth preserving perpetually. Some examples include, but are not limited to, historical buildings, monuments, museums, collections and works of art.
IPSAS 45 has a few scope limitations. IPSAS 45 does not apply to biological assets related to agricultural activity; mineral reserves such as oil, natural gas and similar non-regenerative resources; PP&E that is classified as held for sale under IPSAS 44; or the recognition and measurement of exploration and evaluation assets.
Antonella Risi
All right, if we can pause here again. And let’s break this down a bit and unpack some of the things here. First things first: Can you help me understand what a biological asset is?
Camila Santos
Yes, absolutely. A biological asset is a living animal or plant. Generally, biological assets are related to agricultural activity. These are dealt with in IPSAS 27, Agriculture, that would be covered later in this workshop. However, a biological asset could also exist outside agricultural activities. For example, a police department may use police dogs in a canine unit. IPSAS 45 does apply to PP&E used to develop and maintain biological assets and mineral reserves.
Antonella Risi
I see. Thank you for that. Can you tell us more about the other scope exclusions that you noted on the slide?
Camila Santos
Yes, of course. The scope exclusion for non-current assets held for sale and for exploration and evaluation assets were introduced by IPSAS 45. In the past, such items would be recognized under IPSAS 17, but this change is mostly because now this suite of IPSAS standards have separate standards to deal with these circumstances, which are IPSAS 44, Non-current Assets Held for Sale in Discontinued Operations, primarily derived from IFRS 5, its private sector counterpart in the IFRS framework. IPSAS 44 is effective for annual financial statements cover periods beginning on or after January 1, 2025. The other new standard that addresses the items that were previously outside of scope is IPSAS 50, Exploration for and Evaluation of Mineral Resources, which mirrors the same title and underlying principles from IFRS 6. IPSAS 50 is effective for annual physical statements covering periods beginning on or after January 1, 2027.
The general asset recognition principles apply equally for property, plant and equipment as any other assets. The cost of an item of property, plant and equipment shall be recognized as an asset if and only if it’s probable that future service potential or economic benefits associated with the asset will flow through the entity and the item can be reliably measured.
Now let’s discuss how property, plant and equipment is measured when initially recognized as an asset. An item of property, plant and equipment that qualifies for recognition should be measured as its cost, which typically is the cash price equivalent. Elements of the cost for PP&E include purchase price including import duties and non-refundable taxes net of trade discounts and rebates; directly attributable cost, meaning any cost to bring the assets to its intended location and condition, ensuring that the asset is capable of operating as management intends; dismantling and removal costs associated with retirement, disposal or abandonment of the assets. When an asset is acquired through a non-exchange transaction, its cost is measured at deemed cost. Deemed cost is determined by applying IPSAS 46, Measurement. Deemed cost is defined as an amount used as a surrogate for transaction price at the measurement date. Deemed cost is intended to reflect how the asset is used by the entity.
Now let’s take a look at the measurement options after initial recognition provided by IPSAS 45: The Historical Cost Model and the Current Value Model. Under the Historical Cost Model, after recognition, items are carried at historical cost and reduced by accumulated depreciation and any impairment losses. The Current Value Model is an allowed alternative treatment to Historical Cost that allows for revaluation. So when a PP&E whose current value can be measured reliably can be recognized at revaluated amount, the reevaluated amount is either current operational value or fair value at the date of revaluation reduced by any subsequent accumulated depreciation and subsequent accumulated impairment losses.
Antonella Risi
Thank you, Camila. I understand the difference between the Historical Cost Model and the Current Value Model. But I’m not sure I fully understand when to use the current operational value or the fair value for the purposes of revaluation. Could you elaborate further on these two measurement values?
Camila Santos
Yes, and that’s a very common question that we hear. The kind of value management basis depends on the primary objective for holding the asset. So if a PP&E item is held for operational capacity, it’s measured at the current operation of value. If it’s held at a financial capacity, then use the fair value. IPSAS 46 provides more details on measurement, current operational value and fair value.
Remember: This only applies if current value can be measured reliably and the carrying amount is the reevaluated amount minus subsequent depreciation and impairment losses. Also important to mention that entities have flexibility when making the accounting pulse choice because it doesn’t have to be used consistently across all asset classes.
Antonella Risi
That’s interesting, Camila. Could you give us an example of that?
Camila Santos
Yes, of course! I think a simple example to illustrate that would be an entity where Historical Costs might be used for a short-lived movable equipment, while the Current Value Model could be applied to a long-lived infrastructure asset. However, the chosen basis should be applied consistently for an asset class at each measurement date. So again, for example, if a PP&E item is held for operational capacity and measured at current operational value in year 1, on year 2, the same basis should be used also. The exception would be if the primary objective for which the entity holds an asset has changed. In that case, a change in the current value measurement basis from current operational value to fair value or vice versa may be appropriate.
Antonella Risi
Thank you, Camila. That is really helpful. I’m thinking as you’re speaking, and I don’t recall the Current Value Model existing under the old IPSAS 17. Am I correct? Is this a new approach introduced by IPSAS 45?
Camila Santos
Excellent observation! You’re correct. Let’s break this down to understand the evolution from IPSAS 17 to IPSAS 45. Under IPSAS 17, the models were the Cost Model, which is the same as the Historical Model under IPSAS 45, and the Revaluation Model. The Revaluation Model is, therefore, the Current Value Model in IPSAS 45. However, under IPSAS 17, the revaluation amount was based on the fair value of the asset. The selection of current value measurement basis between current operational value or fair value is a key difference between IPSAS 17 and 45. This change reflects a more nuanced approach to valuation in the public sector, recognizing that assets may be held for different purposes and, therefore, should be measured differently.
Now let’s take a closer look at the Historical Cost and Current Value Models on the next slide. Here, we have a summary of the two measuring models for PP&E under IPSAS 45: The Historical Cost Model and the Current Value Model. Our focus today will primarily be on the Historical Cost Model, as this is the one that is widely used by public sector entities because it is reliable, easy to understand, simple to apply and cost effective. Under the Historical Cost Model, a PP&E is measured at its original cost of recognition. The carrying amount is calculated as original cost minus calculated depreciation and impairment losses. While we won’t cover the Current Value Model in depth today due to its complexity, it’s important to understand some key points:
Measurement at current operational value is for operational assets, and fair value is for financial assets. The carrying amount is calculated as reevaluated amount minus subsequent depreciation and impairment losses. Depreciation is based on the reevaluated amount at the date of revaluation. On depreciation. An item of property, plant and equipment with a finite useful life is depreciated. Land usually has an indefinite useful life. There is a rebuttable presumption that non-land, property, plant and equipment has a finite useful life. So a PP&E with a finite useful life is depreciated, while PP&E with an indefinite useful life is not depreciated.
Antonella Risi
Camila, before you move forward, I’d like to ask you a question: What is useful life?
Camila Santos
Yes. That’s a very good question. Useful life is the period over which an asset is expected to be available for use by an entity or the number of production or similar units expected to be obtained from the asset by an entity.
Antonella Risi
Thank you, Camila. That is helpful to make sure that we’re all on the same page. Is there any other concepts related to depreciation that we should know?
Camila Santos
Yes. We also use the terms “depreciable amount” and “residual value.” The depreciable amount is essentially the cost of an asset or any other amount that substitutes for its cost minus its residual value. The residual value of an asset is the estimated amount that an entity would receive if it were to dispose of the asset today, taking into account the costs associated with the disposal of the asset. It also considers if the assets were already of the age and in the condition expected at the end of its useful life. The residual value and the useful life of an asset should be reviewed at least at each annual reporting date. And if expectations differ from previous estimates, the changes should be accounted for as changes in accounting estimates in accordance with IPSAS 3, Accounting Policies, Changes in Accounting Estimates and Errors. On the slide, we have a high-level summary of how depreciation charges are recognized. The depreciable amount is expensed systematically over the useful life. This means that it affects surplus or deficit directly, reflecting the wear and tear of the assets over time.
Antonella Risi
Thank you, Camila. That’s helpful. A follow-up question for you now: When does depreciation start and stop?
Camila Santos
Depreciation of an asset starts when it’s available for use. This means it must be in the right location and condition to operate as intended by management. It’s not just about when you purchase the asset, but when it’s ready to be used. Depreciation stops at the earlier of two dates: when the assets classified as held for sale or when it’s derecognized. In terms of derecognition, on this slide, we have when entities derecognized PP&E, the first one being “on disposal.” An entity may dispose of a PP&E in four common ways: sale like selling an old machinery, retirement like scraping an asset, dismantlement like breaking an asset down, or abandonment like walking away from the asset entirely. Any gain or loss is calculated as a net disposal proceeds minus the carrying amount, and this difference flows to surplus or deficit immediately upon the derecognition.
Antonella Risi
Thank you, Camila. I’d like to pause you for a moment. What if only part of an asset is replaced, like an engine, for example? Then what does one do?
Camila Santos
Great question! If a replacement’s cost meets recognition criteria, add it to the asset’s carrying amount. But you must derecognize the old part’s value, even if it wasn’t being separately depreciated. The next few slides provide a high-level overview of the additional guidance introduced by IPSAS 45 related to heritage assets.
Antonella Risi
Yes, I remember you mentioned that at the beginning of our time together today. But before we dive into it, could you help me understand how do we determine if a PP&E item is a heritage asset?
Camila Santos
Yes, of course. First of all, the PP&E item needs to meet the definition of an asset. Once that’s done, what differentiates heritage assets from the other assets is their rarity and significance. This could be due to its archaeological, architectural, agricultural, artistic, cultural, environmental, historical, natural, scientific, or technological features. Heritage assets are typically held for long periods to preserve them for future generations. Examples include historic buildings, monuments and museums’ collections.
Antonella Risi
Thank you, Camila. That’s helpful. What are some key characteristics of heritage assets that we should keep in mind?
Camila Santos
Well, heritage assets usually have restrictions on their use or disposal. They are also irreplaceable and have long or indefinite useful life. These characteristics should be considered when assessing whether or not they qualify as a heritage asset.
Antonella Risi
Thank you, Camila. Once we’ve identified a heritage asset, what’s the next step in terms of the accounting for it?
Camila Santos
The next step is to determine if the item meets its first recognition criterion for PP&E. This means asking if it’s probable that future economic benefits or service potential will flow to the entity. If not, no asset is recognized. If the economic benefits do flow to the entity, we then consider the second recognition criterion. Can the cost or current value of the item be measured reliably? If not, then we still won’t recognize the heritage asset, but we’ll need to make disclosure as required by IPSAS 45.
Antonella Risi
And, Camila, I’m assuming that hat is a requirement because it’s important for transparency purposes. Now, what happens if both criteria are met?
Camila Santos
If both criteria are met, meaning the benefits will flow to the entity and the item can be measured reliably, then we recognize the heritage asset at its cost or deemed cost. The entity must then determine if the useful life is finite or indefinite. As we mentioned earlier today, if it’s indefinite, the asset isn’t depreciated. If it’s finite, the entity will depreciate the asset over its useful life.
When an entity has recognized the heritage assets, it will need to determine whether that asset should be depreciated. This will depend on whether the asset has a finite or indefinite life. As we mentioned earlier, under IPSAS 45 there is a rebuttable presumption that most non-land PP&E have finite lives. But if a heritage asset has an indefinite useful life, an analysis of the relevant factors must show that it’s reasonable to consider that there is no foreseeable limit to the period over which it’s expected to provide service potential or be used operationally.
Antonella Risi
That’s interesting! And what are these factors that public sector entities must consider when performing this analysis?
Camila Santos
The first factor it should assess is the service potential. Basically, the entities should be able to demonstrate that an asset is expected to provide value indefinitely. The second factor is usage impact. Even if it’s used, the assets shouldn't degradate because of that usage. The third factor is preservation. What are the path and future actions to protect the asset? It’s important to note that entity applied judgment to estimate the useful life of these assets and will need to adjust if circumstances change.
Now we’re going to shift our focus to discuss the requirements for recognized land under and over infrastructure. IPSAS 17 did not provide specific guidance for infrastructure assets. This guidance was specifically introduced by IPSAS 45. Land should separately be accounted for. This requirement applies to all land, including land under and over infrastructure assets. Land under or over infrastructure assets accounted for under the current value model should be evaluated at current operational value or fair value.
Given that infrastructure assets are specialized, applying the market approach can be challenging. Instead, the cost approach is often more suitable. IPSAS 46 measurement defines the cost approach as measurement technique that reflects the amount required to replace the service capacity of an asset, commonly referred to as current replacement cost. The current replacement cost of the land is based on the current value of the land based on the existing site. For example, if the road runs through agricultural land, then the current value of the land under that section of the road will be agricultural. And if the road runs through an industrial area, then the current value placed on the land under that section of the road will be industrial.
IPSAS 45 also added guidance on how to depreciate infrastructure assets. IPSAS 45 requires that entities allocate the initial cost of a PP&E item to its significant parts. When making that determination, public sector entities will apply judgment.
Antonella Risi
That’s interesting! What’s the reason for this specific requirement?
Camila Santos
This is important because different parts of an asset may have varying useful lives, whether patterns and/or replacement cycles. This becomes more relevant to infrastructure assets because one of their characteristics is that they are networks or systems comprised by a number of assets. The indicators listed on this slide can be helpful in identifying significant parts of a PP&E item, as these should be questions that preparers should be asking themselves while considering their specific facts and circumstances and materiality. For example, is the part separately identifiable and measureable? Does the part have a significant value relative to the total asset? Does that part have a different estimate useful life? Once that analysis is made, if the parts are significant, they should be depreciated separately, as they will have material impact on annual depreciation expense.
Let’s now turn our attention to the PP&E disclosure requirements. These disclosures are intended to provide users with a deeper understanding of accounting policies used, its effects and to facilitate comparisons over time and with other entities. Our focus here is not to list all disclosure requirements in IPSAS 45 as they are detailed. The primary disclosures required for each class of PP&E reported in the financial statements include the measurement bases used for determining the gross carrying amount. Measurement bases would indicate whether the cost model or revaluation model has been used, the depreciation methods used, their useful life or the depreciation rates used, the gross carrying amount and the accumulated depreciation aggregated with accumulated impairment losses at the beginning and end of the period, a reconciliation of the gross carrying amount and accumulated depreciation at the beginning and at the end of the period. IPSAS 45 includes an illustrative example of disclosures.
An entity might incur debt and related borrowing costs associated with the acquisition, construction or production of plant, property and equipment. IPSAS 5, Borrowing Costs, is prescribed as the account treatment for borrowing costs.
Antonella Risi
Wow, Camila! That’s a full other standard for us to deal with. In the interest of time, what is important for us to know about IPSAS 5 from a PP&E perspective?
Camila Santos
I know it sounds too much, but it’s not really. IPSAS 5 allowed two alternatives for recognition of borrowing costs. One is called benchmark treatment, where borrowing costs are recognized as an expense in the period in which they are incurred, regardless of how the borrowings are applied and allowed alternative treatment. Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset are included in the cost of that asset.
Antonella Risi
Thank you, Camila. Another question, a follow-up question for you: Is the benchmark treatment preferable over the allowed alternative treatment?
Camila Santos
The preferred choice is the benchmark treatment. However, following either would still mean that an entity is compliant with IPSAS 45. When a public sector entered adopts the allowed alternative method treatment under an IPSAS, that treatment should be applied consistently to all borrowing costs that are directly attributable to the acquisition, construction or production of our qualifying assets of the entity. A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. Examples of qualifying assets include items such as office buildings, hospitals, infrastructure assets such as roads, bridges, and power generation facilities. The borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset are those borrowing costs that would have been avoided if the outlays on the qualifying asset have not been made. When an entity borrows funds specifically for the purpose of obtaining a particular qualifying asset, the borrowing costs that are directly related to that qualifying asset can be readily identified.
Impairment. Impairment is a loss in the future economic benefits or service potential of an asset over and above the systematic recognition of the loss of the asset’s future economic benefits or service potential through depreciation. At each reporting date, entities are required to assess whether there are any indicators that an item of PP&E may be impaired. An entity applies IPSAS 21, Impairment of Non-Cash-Generating Assets, or IPSAS 26, Impairment of Cash-Generating Assets. Although the definition of impairment is the same for both non-cash-generating assets and cash-generating assets, the requirement for assessing whether an asset is impaired, the measurement of impairment and its recognition are different depending on its nature.
Antonella Risi
Thank you, Camila, for the recap on the impairment concept. To make sure we’re all on the same page, could you clarify the differences between cash- and non-cash-generating assets?
Camila Santos
Yes, of course. A cash-generating asset is an asset held with primary objective of generating a commercial return. When we talk about holding an asset to generate a commercial return, we’re essentially saying that the entity intends to generate positive cash inflows from that asset. Now, if that asset becomes impaired, it means that has been a decline in the ability to deliver future economic and economic benefits or what we might call in the public sector of service potential. On the other hand, a non-cash-generating asset is simply any other asset held by a public sector and that doesn’t have this commercial cash flow objective. The key distinction here is the primary purpose of the asset, whether it’s meant to generate cash returns or serve another public sector function. Similar to other topics, judgment is needed to determine if an asset is a cash-generating or a non-cash-generating and as a result which impairment standard would apply. Given the overall objective of most public sector entities, the presumption is that assets are non-cash-generating and therefore IPSAS 21 will apply. Unlike profit-driven organizations, public sector’s goal is to primarily deliver services. So, impairment here reflects the decline in the asset’s utility, its ability to provide future economic benefits or service potential to the entity. An asset is written down to the recoverable amount if impaired and allows its recognizing surplus or deficit in the period of the write-down.
Antonella Risi
Camila, if I may interrupt you for a second. I think it would be helpful if you explained what is the recoverable amount.
Camila Santos
Yes, I agree. IPSAS 21 and IPSAS 28 define both recoverable amount and recoverable service amount as the higher of an asset’s fair value less cost of disposal or less cost to sell in the case of IPSAS 21 and its value in use. IPSAS 21 and IPSAS 26 contain a list of key indicators that an impairment loss may have occurred for non-cash-generating and cash-generating assets, respectively. On this slide, we have a few examples. So, examples of indication of impairment would be technological, legal or policy changes; obsolescence; physical damage, change in use, cessation of construction or economic service performance, increased market interest rates. In assessing whether there is any indication that an asset or group of assets may be impaired, an entity shall consider, at minimum, external and external source of information. The list of indicators are not intended to be exhaustive. An entity may identify other indicators that an asset may be impaired. And if any of those indications of impairment are present, an entity is required to make a formal assessment of the recoverable amount or recoverable service amount. If no indicators of a potential impairment loss is present, an entity is not required to make a formal estimate of recoverable amount or recoverable service amount. And this takes us to the end of the PP&E section.
Our next topic on the agenda is intangible assets. IPSAS 31 focuses on recognition of acquired or internally generated intangible assets that meet the asset definition and recognition criteria. Under IPSAS 31, an intangible asset is an identifiable non-monetary asset without physical substance. Not all the items meet this definition of an intangible asset under IPSAS 31. An identifiable intangible asset is one that is capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged or arises from binding arrangements (contracts). Intangible assets must be identifiable and in order to be recognized as an intangible asset, it must be controlled by the entity. There are cases in the public sector where an intangible asset is acquired under a binding arrangement and this definition still applies. Public sector entities often acquire computer software licenses. These generally meet the definition of an acquired intangible asset. With this exception, it is rare for public sector entities to acquire intangible assets under a binding arrangement.
Most acquired intangible assets will meet the criteria for recognition. Examples include software, brands & trademarks, in-process R&D. With the exception of software, it is rare for public sector entities to acquire intangible assets. Intangible assets are measured at cost on initial recognition. If they are acquired through a non-exchange transaction, the deemed cost is the fair value of the intangible asset at the date of acquisition. Recognition of an internally generated intangible asset has stricter criteria. Expenditure incurred during the research phase of an intangible asset cannot be capitalized. Expenditure incurred within the development phase of an intangible asset can be capitalized where the recognition criteria are met.
Antonella Risi
And can you tell us the criteria needed to demonstrate that an entity is in the development phase?
Camila Santos
Expenditure on the development phase can be capitalized as an intangible asset where the recognition criteria are met. To recognize expenditure as an intangible asset, IPSAS 31requires an entity to be able to demonstrate: The technical feasibility of completing the intangible asset so that it will be available for use or sale; Its intention to complete the intangible asset and use or sell it; Its ability to use or sell the intangible asset; How the intangible asset will generate probable future economic benefits or service potential. The availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset; and its ability to measure reliably the expenditure attributable to the intangible asset during its development.
Most subsequent additions to or replacements of intangible assets are usually expensed.
Antonella Risi
Really? I wouldn’t think so! And why does that happen?
Camila Santos
This is because they do not meet the recognition criteria. They are likely to maintain the expected future economic benefits or service potential embodied in an existing intangible asset. In addition, it is often difficult to attribute subsequent expenditure directly to a particular intangible asset rather than to the entity’s operations as a whole. However, if the expenditure clearly enhances the service potential of original asset, then the recognition criteria may be met. If so, the costs should be capitalized. Intangible assets may have a finite or an indefinite useful life. Where an intangible asset has a finite useful life, it is amortized over that useful life. Where an intangible asset has an indefinite useful life, it is not amortized. However, it is reviewed for impairment at least annually.
Public sector entities may acquire intangible assets through public sector combinations (acquisitions). The accounting for public sector combinations is set out in IPSAS 40, Public Sector Combinations. When an intangible asset is acquired through a public sector combination, the cost of the intangible assets is its fair value at the acquisition date. The probability of future economic benefits or service potential flowing to the entity is always considered to be satisfied for intangible assets acquired in a public sector combination because it expects there to be economic benefits from the combination. Intangible assets acquired in a public sector combination are recognized separately from goodwill. If an entity cannot identify the intangible asset, it forms part of goodwill and is not recognized separately. And this is the end of the Intangible Assets session.
Stella Lee-Szego
The next item on the agenda is leases. IPSAS 43, Leases, replace the previous standard IPSAS 13, Leases, for reporting periods beginning on or after January 1, 2025. IPSAS 13, Leases, has been withdrawn. IPSAS 43 introduces substantial changes for lessee accounting, and that means different requirements for what entities that prepare their financial statements in accordance with IPSAS. IPSAS 43, Leases, is essentially the public sector version of IFRS 16, the International Financial Reporting standard that provides guidance on lease accounting for private sector entities. In fact, extracts of IFRS 16 have been reproduced in IPSAS 43 with the permission of the IFRS Foundation, meaning that the core principles of lease accounting under IFRS 16 also apply under IPSAS 43 while still addressing public sector specifics. And this is what we will be exploring in more detail in this part of the module. Starting with the scope of IPSAS 43, an entity is required to apply the standard to all leases, which includes leases of right of use assets, even in the case of ubleases. IPSAS 43 does not apply to the following items: leases for minerals, oil, natural gas and other and similar non-regenerative resources; leases of biological assets covered under IPSAS 27, Agriculture, when held by a lessee; service concession arrangements addressed in IPSAS 32; and licensing agreements for items like films, patents or copyrights. These fall under the scope of IPSAS 31, Intangible Assets, that we just discussed under intellectual property rules rather than lease accounting. It is important to mention that a lessee may, but is not required to, apply IPSAS 43 to leases of intangible assets other than licensing agreements.
IPSAS 43 introduces two different accounting models: one for lessees and one for lessors. For lessees, the standard requires entities to account for the right of use asset for all leases except where IPSAS 43 permits exceptions for short-term or low-value leases on cost-benefit grounds. On the other hand, lessors continue to apply a risk-and-reward model classifying leases as either operating or finance leases, similar to the previous IPSAS 13 approach.
Antonella Risi
Stella, before we dive deep into the accounting models used in IPSAS 43, could you start by explaining what a lease is?
Stella Lee-Szego
Absolutely! This is what we’ll be looking at on our next slide. Simply put, a lease is a contract or sometimes part of a larger contract that gives one party the right to use an asset, what we call the underlying asset, for a specific period. In return, the user provides some form of payment or consideration to the owner. In addition to the definition of a lease, IPSAS 43 provides some other key definitions that will be important as we move along this module. The distinction between an underlying asset and a right-of-use asset is critical to the lessee accounting model under IPSAS 43.
Let’s break this down. The underlying asset is the tangible or intangible asset that is subject to the lease for which the right of use of that asset has been provided by a lessor to a lessee—for example, a building, vehicle or equipment. The right-of-use asset represents the lessee’s right to use an underlying asset for the lease term and only exists as a result of the lease contract. When in the process of identifying a lease, the questions entities should be asking themselves include: Is this contract a lease, or does this contract contain a lease?
Antonella Risi
That’s a great starting point, Stella. How do we determine if a contract contains a lease?
Stella Lee-Szego
Well, under IPSAS 43, at the inception of any contract, an entity should assess whether the contract is a lease. If throughout the period, there are changes to the terms and conditions of the contract, a reassessment is required. In general terms, a lease exists when the contract gives the right to control the use of an identified asset for a period of time in exchange for consideration.
Antonella Risi
Thank you, Stella, that’s helpful, and it does sound easy. However, I can see some complexity with it, like how do we determine if a contract gives control over an asset?
Stella Lee-Szego
You're absolutely right! And to help entities make that determination, IPSAS 43 provides in its application guidance two conditions that need to be met at the same time by the customer throughout the period of use. The first one is that the customer must have the right to obtain substantially all of the economic benefits or service potential from using asset. The second one, an equally important, is that the customer must have the right to direct how the asset is used. The application guidance in IPSAS 43 also provides a flow chart that may help entities in making the assessment of whether the contract is a lease or contains one. When a contract is a lease or contains a lease, we need to determine whether it includes any non-lease components that should be accounted for separately. This is important because IPSAS requires us to separately account for lease components and non-lease components in a contract.
Antonella Risi
That’s an important point, Stella. Could you give us an example of where a contract has a lease and a non-lease component?
Stella Lee-Szego
Sure! An example of a contract with both the lease component and a non-lease component would be a lease of a standalone vehicle. The lease component with servicing and breakdown recovery services included the non-lease component. In these circumstances where you have a mix of lease and non-lease components, the lessee shall allocate the total contract consideration to each component, based on the standalone price.
Antonella Risi
Is the standalone price a new concept that we should be aware of?
Stella Lee-Szego
Not really. Standalone price is similar to the concept of standalone value in IPSAS 47. Basically, it is what the lessor or similar supplier would charge for each component individually. Lessees have a practical expedient. They can elect by class of asset not to separate non-lease components from lease components, treating them as a single lease.
The lease term is a non-cancellable period of a lease that also includes options to extend the lease if the lessee is reasonably certain to exercise that option or to terminate the lease if the lessee is reasonably certain not to exercise that option.
Antonella Risi
Thank you, Stella. I think it would be helpful to understand how an entity determines what’s “reasonably certain.”
Stella Lee-Szego
Agreed. Being reasonably certain in lease options involves considering all relevant facts and circumstances that create an economic incentive for the lessee to exercise option to extend the lease or not to exercise option to terminate the lease. This includes factors like market conditions, financial benefits, and contractual obligations. When there is a significant event or change in circumstances, a lessee should reassess whether they are reasonably certain to exercise an extension option or not to exercise a termination option.
At commencement, the lessee shall recognize two items: The right-of-use asset reflecting their control of the leased asset, and The corresponding lease liability, the obligation to make payments. The commencement date will be the first date on which the lessee controls an asset under the lease agreement and is different from the date on which the lessee enters into the lease agreement, which is referred to as the inception date.
A lessee may elect not to apply the usual recognition and measurement requirements to short-term leases and leases for which the underlying asset is of low value.
Antonella Risi
Stella, if we could pause for a moment. You mentioned short-term leases. What is considered a short-term lease?
Stella Lee-Szego
A short-term lease is a lease that at the commencement date has a lease term of 12 months or less. It’s important to note that if the lease that contains a purchase option, it’s not a short-term lease. Where an entity elects to use the exception for short-term leases, this must be made by class of underlying asset. That is, the exception can be used for all short-term leases of the same type of asset or none. If the lease is later modified or extended beyond 12 months, it’s treated as a new lease.
Antonella Risi
Thank you, Stella. And you also mentioned low-value leases. Can you tell us a bit more about these?
Stella Lee-Szego
An underlying asset can be of low value only if it meets the following criteria. First, the lessee can benefit from the use of the underlying asset on its own or together with other resources that are readily available to the lessee. And second, the underlying asset is not highly dependent on or highly interrelated with other assets. Where an entity elects to use the exception for leases of low value, this can be made on a lease-by-lease basis. Examples of low-value underlying assets can include tablets, personal computers, small items of office furniture and telephones. The account and treatment for when the lessee does not apply the usual recognition and measurement requirements is that the lease payments are recognized as an expense either on a straight-line basis over the lease term or on another systematic basis.
A lessee recognizes the cost shown on this slide as part of the cost of the right-of-use asset when it incurs an obligation for those costs. The cost of the right-of-use asset is comprised of the amount of the initial measurement of the lease liability, any lease payments made at or before the commencement date less any lease incentives received, any initial direct costs incurred by the lessee, and an estimate of any cost expected to be incurred for restoring the site or asset.
At the commencement date, the lessee measures the lease liability at the present value of the lease payments that are not paid at that date. The lease payments are discounted, using interest rate implicit in the lease if that rate can be readily determined. If that rate cannot be readily determined, the lessee uses the lessee’s incremental borrowing rate.
At the commencement date, the lease payments include the measurement of the lease liability comprising the following payments for the right to use the underlying asset during the lease term that have not been paid at the commencement date. First, we have fixed payments, including in-substance fixed payments less any lease incentives that are receivable. Next, we have variable lease payments that depend on an index or rate. Some examples of these include payments linked to a consumer price index, payments linked to a benchmark interest rate or payments that vary to reflect changes in the market rental. Next, we have amounts expected to be payable under residual value guarantees, and we also have the exercise price of a purchase option if the lessee is reasonably certain to exercise that option. Finally, we also include any penalty payments for terminating the lease if the lease term reflects the lessee exercising an option to terminate the lease.
Antonella Risi
Stella, if we can pause here for another moment. This slide and the right-of-use assets slide that was shown a few moments ago show calculations. At the commencement date, would the amount recorded as a right-of-use asset be equal or different from the amount recorded as a liability?
Stella Lee-Szego
I think that the right-of-use asset amount would be different than the lease liability because the cost of the right-of-use asset starts off with the amount of initial measurement of the lease liability. However, it then adjusts for other items such as lease payments made.
Antonella Risi
Thank you, Stella, for that clarification. I appreciate it.
Stella Lee-Szego
After the commencement date, the lessee measures the right-of-use asset by applying a historical cost model, which is cost less any accumulated depreciation and any accumulated impairment losses in accordance with IPSAS 21 and IPSAS 26. In terms of depreciation, entities apply IPSAS 45, Requirements. However, the depreciation period will be based on the useful life of the underlying asset if ownership will transfer at the end of the lease. If not, the depreciation period is over the lease term or the useful life of the right-of-use asset if it is shorter. Because the cost of the right-of-use asset reflects the cost of the lease liability, changes in accounting estimates resulting in remeasurements of the lease liability also affect the estimate of the cost of the right-of-use asset.
IPSAS 16 and IPSAS 45 allow an entity to adopt an accounting policy of remeasuring assets. IPSAS 16 allows entities to adopt a Current Value Model for measuring investment property. When an entity applies the Current Value Model to own investment property, it is required to use the same model for right-of-use assets that meet the definition for investment property. IPSAS 45 also permits an entity to adopt a Current Value Model in measuring some or all classes of property, plant and equipment. If an entity uses the Current Value Model for a class of property, plant and equipment, it may, but is not required to, use the same model for the right-of-use assets related to that class. Unlike investment property, there is flexibility to choose between the Current Value Model and the Historical Cost Model for right-of-use assets.
After the commencement date, the lessee measures the lease liability by increasing the carrying amount to reflect the interest on the lease liability, reducing the carrying amount to reflect the lease payments made, and remeasuring the carrying amount to reflect any reassessment or lease modifications or to reflect revised in-substance fixed lease payments. Interest on the lease liability in each period is calculated as the amount that produces a constant periodic rate of interest on the remaining balance of the lease liability.
After the commencement date, a lessee recognizes in surplus or deficit each of the following: First, we have interest on the lease liability. Second, we have the variable lease payments that are not included in the measurement of the lease liability in the period. These are the ones that do not depend on index or rate, such as payments based on revenue or profit-sharing and payments for use of the asset above a specified threshold. Next, we have depreciation on the right-of-use asset. And finally, we have impairment of the right-of-use asset. In some circumstances, other IPSAS may permit some or all of these costs to be included in the cost of another asset rather than being recognized as an expense.
Antonella Risi
Stella, another pause. Could you provide us with an example?
Stella Lee-Szego
Of course! If a lessee uses a leased piece of equipment exclusively on the construction of an office building, the depreciation of the right-of-use asset for the leased equipment can be included in the cost of the building in accordance with IPSAS 45.
Antonella Risi
Thank you, Stella. I noticed that not all the guidance applicable to leases will be in IPSAS 43, mostly because the leased item could be a PP&E, for example.
Stella Lee-Szego
That’s a great observation! IPSAS 43 does not specify the accounting treatment for all of the costs listed on the slide. Depreciation expenses are accounted for in accordance with IPSAS 45, and impairment expenses in accordance with IPSAS 21 or IPSAS 26, whichever is relevant. After the commencement date, a lessee remeasures the lease liability to reflect any lease payment changes, including any of the following: Any remeasurements of the lease liability are recognized as an adjustment to the right-of-use asset. When the carrying amount of the right-of-use asset is reduced to zero, further reductions in the measurement of the lease liability are recognized in surplus or deficit. A revised discount rate is used if a change in the lease term or a change in the assessment of an option to purchase the underlying asset occurs, and discounting of the lease payments must be revised if there is a change in the residual payments or a change in the payments resulting from a change in the index or rate used to determine those payments. The original discount rate is used unless a change arises from a change in the floating interest rates.
Antonella Risi
Stella, could you please clarify in which circumstances the remeasurement of the lease liability is required?
Stella Lee-Szego
Sure! A lessee will need to remeasure the lease liability if either there is a change in the lease term, in which case the revised lease payments are determined on the basis of the revised lease term, or there’s a change in the assessment of an option to purchase the underlying asset, in which case the revised lease payments are determined to reflect the change in the amounts payable under the purchase option. Additionally, a lessee will need to remeasure the lease liability if either (1) there is a change in the amount expected to be payable under residual value guarantee. In this case, the lessee should determine the revised lease payments to reflect the change in the amounts expected to be payable under the residual value guarantee. Or (2), there is a change in the future lease payments resulting from a change in an index or rate used to determine those payments. For example, a change occurs in the future lease payments to reflect changes in the market rental rates, following a market rent review. In this case, the lessee should remeasure the lease liability to reflect those revised lease payments only when there is a change in the cash flows—that is, when the adjustment to the lease payments take effect. A lessee should determine the revised lease payments for the remainder of the lease term, based on the revised contractual payments.
A lessee accounts for a lease modification as a separate lease if both the modification increases the scope of the lease by adding the right to use one or more of the underlying assets, and the consideration for the lease increases by the standalone price for the increase in scope and any appropriate adjustments.
Antonella Risi
Stella, before you continue, can you tell us a bit more about what is a lease modification?
Stella Lee-Szego
Sure! A lease modification is a change in the scope of a lease or the consideration for a lease that was not part of the original terms and conditions of the lease. For example, adding or terminating the right to use one or more underlying assets, or extending or shortening the contractual lease term. Lease modifications need to be agreed between the lessee and lessor. Some modifications are accounted for as if they are a separate lease. This is the case where the modification increases the scope of lease by adding the right to use one or more underlying assets and the consideration for the lease increases by an amount commensurate with the standalone price for the increase in the scope and any appropriate adjustments to the standalone price to reflect the circumstances of that particular contract.
Where lease modification is not accounted for as a separate lease, the lessee will need to allocate the consideration in the modified contract, determine the lease term of the modified contract, and remeasure the lease liability by discounting the revised lease payments using a revised discount rate or the incremental borrowing rate where the implicit interest rate is not readily available. These actions will need to be performed at the effective date of the lease modification. Where the lease modification is not accounted for as a separate lease, the lessee will need to account for the remeasurement of the lease liability by first decreasing the carrying amount of the right-of-use asset to reflect the partial or full termination of the lease for lease modifications that decrease the scope of the lease. The lessee should recognize any gain or loss relating to the partial or full termination of the lease in surplus or deficit. And lastly, making a corresponding adjustment to the right-of-use asset for all other lease modifications.
Let’s now discuss the presentation requirements for right-of-use assets and lease liabilities. Under IPSAS 43, the requirement is to present in the statement of financial position or disclose in the notes right-of-use assets separately from other assets, and lease liabilities separately from other liabilities. If a lessee does not present their right-of-use assets separately in the statement of financial position, they will need to include them within the same line item as the corresponding underlying assets—for example within property, plant and equipment. However, disclosure is required to indicate which line items include right-of-use assets. There is an exception related to right-of-use assets meeting the definition of investment property. In these circumstances, the right-of-use assets should be presented as investment property. For lease liabilities, the presentation requirements are similar to the ones related to right-of-use assets. If not presented separately within the statement of financial position, the lessee will need to disclose the line items in which the lease liabilities are included. In the statement of financial performance, interest expense on the lease liability is presented separately from depreciation on the right-of-use asset.
Next within the cash flow statement, the requirements to classify cash payments for the principal portion within the financing activities section and cash payments for the interest portion. IPSAS 2, Cash Flow Statements, does not specify how interest paid is to be classified within the cash flow statement unless the entity is a public financial institution. Interest paid under a lease contract should be treated consistently with other interest payments. And finally, for payments of short-term leases, leases of low-value assets and variable lease payments not included in the measurement of the lease liability, these should be classified within the operating activity section of the cash flow statement.
Now we’re going to explore the disclosure requirements for lessees. Before getting into the requirements themselves, let’s just step back and remind ourselves of why entities would provide these disclosures.
Antonella Risi
Stella, my answer to that question is that it would be to provide users of financial statements with a comprehensive understanding of how leases affect a lessee’s financial position, performance and cash flows.
Stella Lee-Szego
Perfect! The information provided in the notes complement what is presented within the statement of financial position, statement of financial performance and the cash flow statement. IPSAS 43 requires that a lessee disclose lease-related information in a single note or within a separate section of the financial statements. There is no need to duplicate information already presented elsewhere, but cross references are required. On this slide, we have listed what should be disclosed for the reporting period. IPSAS 43 specifically says that these disclosures should be provided in a tabular format unless another format is more appropriate.
Antonella Risi
Thank you, Stella. It looks like this brings us to the end of the portion related to IPSAS 43 requirements applicable to a lease contract by the lessee. Now it’s time to move on to the accounting for the lease by the lessor.
Stella Lee-Szego
That’s right. We talked a lot about the accounting for the lessee. Now let’s take a look at what IPSAS 43 requirements are for the lessor. When accounting for a lease, the lessor applies the risk-and-rewards model. These requirements are similar but not identical to those provided in the previous IPSAS 13 standard. The primary issue for lessor accounting is determining whether a lease should be classified as a finance lease or as an operating lease. According to IPSAS 43, leases are accounted for based on their economic substance rather than their legal form.
Antonella Risi
Could you elaborate on how this classification is determined?
Stella Lee-Szego
Of course! the classification depends on whether the risks and rewards of ownership of the asset lie with the lessee or the lessor. Risks include potential losses from idle capacity, technological obsolescence, or changes in value due to economic conditions. Rewards include the expectation of service potential or profitable operation over the life of the asset, appreciation gained in the value of the asset or realization of a residual value. With these two concepts in mind, a lease is classified as a finance lease if it transfers substantially all of the risks and rewards incidental to ownership of an underlying asset. When the lease does not transfer substantially all of the risks and rewards incidental to ownership of an underlying asset, then it is an operating lease.
Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form of the contract. Examples of situations that individually or in combination would normally lead to a lease being classified as a finance lease are shown on this slide. The examples and indicators shown on this slide are not always conclusive, and professional judgment is required. If it is clear from other features that the lease does not transfer substantially all the risks and rewards incidental to the ownership of an underlying asset, the lease is classified as an operating lease. Lease classification is made at the inception date and is reassessed only if there is a lease modification. Changes in estimates, for example, changes in estimates of the economic life or of the residual value of the underlying asset, or changes in circumstances, for example, a default by the lessee, do not give rise to a new lease classification for accounting purposes.
At the commencement date, a lessor recognizes assets under a finance lease in its statement of financial position and presents them as a receivable at an amount equal to the net investment in the lease. The underlying asset itself is derecognized. Some important definitions to keep in mind are the following: A net investment in the lease is the gross investment in the lease discounted at the interest rate implicit in the lease. A gross investment in the lease is the sum of (1) The lease payments receivable by a lessor under a finance lease and (2) any unguaranteed residual value accruing to the lessor. This is the value that the lessor estimates it can recover from the underlying asset at the end of the lease term, whether through sale, further leasing, or use of the asset. The lessor uses the interest rate implicit in the lease to measure the net investment in the lease.
Antonella Risi
Stella, could you explain what is the interest rate implicit in the lease?
Stella Lee-Szego
Of course! The interest rate implicit in lease is the rate of interest that causes the present value of (A) the lease payments and (B) the unguaranteed residual value to equal the sum of (1) the fair value of the underlying asset and (2) any initial direct cost of the length of the lessor. In the case of a sub lease, if interest rate implicit in the sub lease cannot be readily determined, an intermediate lessor may use the discount rate used for the head lease. Initial direct costs are included in the initial measurement of the net investment in the lease and reduce the amount of revenue recognized over the lease term. At the commencement date, the lease payments included in the measurement of the net investment in the lease include the following payments not received at the commencement date: The first are any fixed payments less any lease incentives payable. Next, we have all variable lease payments that depend on an index or rate initially measured using the index or rate at the commencement date. Third, we have any residual value guarantees provided to the lessor by the lessee, a party related to the lessee or a third party. Next, we have the exercise price of a purchase option if lessee is reasonably certain to exercise that option. And finally, we have any penalty payments made for terminating the lease if the lease term reflects lessee exercising an option to terminate the lease. The payments that are included in the measurement of the net investment in the lease by the lessor are consistent with the payments that the lessee includes in its lease liability calculation. These payments are similar to the minimum payments under IPSAS 13. However, variable lease payments that depend on an index or rate were not previously included in the minimum lease payment calculations under IPSAS 13. Therefore, the net investment in the lease under IPSAS 43 may be different to the equivalent balance under IPSAS 13.
The lessor recognizes finance revenue over the lease term based on a pattern reflecting a constant periodic rate of return on the lessor’s net investment in the lease. A lessor aims to allocate finance revenue over the lease term on a systematic and rational basis. A lessor shall apply the lease payments relating to the period against the gross investment in the lease to reduce both the principal and the unearned finance revenue balances. A lessor shall apply the derecognition and impairment requirements in IPSAS 41, Financial Instruments, to the net investment in the lease receivable.
Lessor shall account for a modification to a finance lease as a separate lease if both (1) the modification increases the scope of the lease by adding the right to use one or more of the underlying assets and (2) the consideration for the lease increases by an amount that reflects the standalone price for the increase in scope and any appropriate adjustments.
For modification to a finance lease that is not accounted for as a separate lease, a lessor should account for the modification in the following manner: First, if the lease would have been classified as an operating lease had the modification been in effect at the inception date, then the modification should be accounted for as a new lease from the lease modification date. And the carrying amount of the underlying asset should be measured as the net investment in the lease immediately before the effective date of the lease modification—that is, re-recognize the underlying asset that had been previously derecognized. Otherwise, the lessor should apply the requirements of IPSAS 41, the Financial Instruments standard.
The accounting for an operating lease is generally straightforward. The lessor recognizes lease payments from operating leases as revenue on either a straight line or another systematic basis if that basis is more representative of the pattern in which the benefit from the underlying asset is used. Next, any initial direct costs incurred in obtaining an operating lease are added to the carrying amount of the underlying asset, and the costs are recognized as an expense over the lease term on the same basis as the lease revenue. Additionally, any costs, including depreciation, incurred in earning the lease revenue are recognized as an expense. The depreciation policy for depreciable underlying assets subject to operating leases will need to be calculated in accordance with IPSAS 45, Property, Plant and Equipment, and IPSAS 31, Intangible Assets. Finally, IPSAS 21 or IPSAS 26, the Impairment standards, are also applied to determine whether an underlying asset of an operating lease is impaired and if so, to account for any impairment losses identified.
All modifications to an operating lease are treated as a new lease from the effective date of the modification. The lessor will need to consider whether this new lease is an operating lease or finance lease and account for the lease accordingly. The objective of the disclosures is for lessors to disclose information in the notes that, together with information provided within the statement of financial position, statement of financial performance and cash flow statement, gives a basis for users of financial statements to assess the effect that leases have on the financial position, financial performance and cash flows of the lessor. The lessor should present the underlying assets subject to operating leases in the statement of financial position according to the nature of the underlying asset. IPSAS 43 requires lessor to disclose the following amounts for the reporting period. For finance leases, these include the following: selling surplus or deficit, finance revenue on the net investment in the lease, and revenue relating to variable lease payments not included in the measurement of the net investment in the lease. For operating leases, lease revenue separately disclosing revenue relating to variable lease payments that do not depend on an index or rate must be disclosed. A lessor may need to disclose additional qualitative and quantitative information about its leasing activities necessary to meet the disclosure objectives.
Antonella Risi
Thank you, Stella. One question: You mentioned selling surplus or deficit. Can you help me understand what this means?
Stella Lee-Szego
The “selling surplus or deficit” term is extracted from IPSAS 43, paragraph 89-A1. A possible interpretation of what selling surplus or deficit means is the gain or loss that arises when an asset subject to a finance lease is sold by the lessor.
Antonella Risi
Okay. Thank you for that clarification, Stella.
Stella Lee-Szego
The diagram on this slide illustrates the accounting for sale leaseback transactions under IPSAS 43.
Antonella Risi
Stella, before you get into the accounting, could you explain what is a sale and leaseback transaction?
Stella Lee-Szego
Sure! A sale leaseback transaction occurs when an entity transfers an asset to another entity and immediately leases the same asset back. The accounting for the sale lease back transaction depends on the substance of that transaction—that is, whether the transfer amounts to a sale or not. The entity that originally owned the asset is referred to as the seller lessee, while the entity that receives the asset under the transfer and then leases it back to the original owner is referred to as the buyer lessor.
Antonella Risi
Thank you, Stella. And how would you determine if a transfer qualifies as a sale?
Stella Lee-Szego
An entity will need to determine whether the conditions for satisfying a compliance obligation as specified in IPSAS 47, Revenue, have been met. If the transfer of an asset by the seller lessee satisfies the requirements to be accounted for as the sale of an asset, then the seller lessee measures the right-of-use asset arising from the leaseback at the proportion of the previous carrying amount of the asset that relates to the right of use retained by the seller lessee, and the buyer lessor accounts for the purchase of the asset by applying the applicable standards—for example, IPSAS 45 for property, plant and equipment and for the lease applying the lessor accounting requirements in IPSAS 43. If the fair value of the consideration for the sale of the asset does not equal the fair value of the asset, or if the payments for the lease are not at market rates, then an entity will need to make the following adjustments to measure the sale proceeds at fair value.
Any below-market terms are accounted for as a prepayment of lease payments, and any above-market terms are counted for as an additional financing provided by the buyer lessor to the seller lessee. Conversely, if the transfer of an asset by the seller lessee does not satisfy the requirements to be accounted for as the sale of an asset, then the seller lessee continues to recognize the transferred asset and also recognizes the financial liability equal to the transfer proceeds. It accounts for the financial liability by applying IPSAS 41. And the buyer lessor does not recognize the transferred asset and instead recognizes a financial asset equal to the transfer proceeds. It accounts for the financial asset by applying IPSAS 41. And this takes us to the end of the Leases module.
Camila Santos
Let’s move to IPSAS 32, Service Concession Arrangements. Service concession arrangements are concluded by way of a binding arrangement, which may include contracts or similar arrangements that confer similar rights and obligations as if they were in the form of a contract. Under the concession service arrangement, the operator uses the service concession asset to provide public services on behalf of the grantor in return for compensation. Compensation could be in the form of payments or the right to earn revenue from third-party users of the service. Let’s dig a little deeper and look at the definition of a service concession arrangement.
A service concession asset is an asset used to provide public services in a service concession arrangement that: Is provided by the operator which: The operator constructs, develops or acquires from a third party OR is an existing asset of the operator. Is provided by the grantor which: Is an existing asset for the grantor OR Is an upgrade to an existing asset of the grantor.
Under IPSAS 32, recognition is based on a determination that the grantor has control over the economic benefits and the service potential of the service concession asset. The grantor controls or regulates what services the operator must provide with the asset, to whom it must provide them, and at what price; and The grantor controls—through ownership, beneficial entitlement or otherwise—any significant residual interest in the asset at the end of the term of the arrangement Once it is determined that the grantor controls these two items the grantor recognizes an asset provided by the operator and an upgrade to an existing asset of the grantor as a service concession asset. Once the recognition criteria is met, the grantor initially measures the service concession asset that is provided by the operator and an upgrade to an existing asset of the grantor at its fair value.
If the asset is an existing asset of the grantor it is reclassified as service concession assets. Only when the service concession arrangement involves upgrading an existing asset of the grantor that results in an increase in future economic benefits or service potential of the asset, is it measured initially at fair value in accordance with IPSAS 32. After initial recognition or reclassification, service concession assets are accounted for in accordance with IPSAS 17, Property, Plant and Equipment or IPSAS 31, Intangibles, as appropriate. The nature of the liability recognized is based on the nature of the consideration exchanged between the grantor and the operator. So, looking at the diagram, the liabilities are initially measured at the same amount as the service concession asset. When the grantor compensates the operator for the service concession asset by making payments to the operator, it is a financial liability, and the “financial liability” model is used to measure it. And this is demonstrated on the left side of the diagram. When the grantor compensates the operator by granting the right to earn revenue from third-party users of the service concession asset or access to another revenue-generating asset, the liability is measured using the “grant of right model”. This is displayed on the right side of the diagram.
Antonella Risi
Before we go to the next slide, can you talk a bit more about the financial liability model and the grant of right model?
Camila Santos
There is so much I could say on these models. For the purpose of this workshop I will try to keep it brief. In a Financial Liability Model there is an unconditional obligation to pay a specified amount of cash or another financial asset to the operator. This obligation is recognized as a financial liability And measured in accordance with the financial instrument standards. In a Grant of Right to the Operator Model, the grantor does not have an unconditional obligation to pay cash or another financial asset to the operator. The service concession arrangement is an exchange transaction in which the grantor has received a service concession asset in exchange for granting a right (a license) to the operator to charge the third party users of the public service that it provides on the grantor’s behalf. Therefore, the exchange is accounted for as a revenue generating transaction by the grantor. Until the criteria for recognition of revenue have been satisfied, the grantor recognizes a liability equivalent to the unearned portion of the revenue that will arise. The earned revenue is recognized over the term of the service concession arrangement.
All aspects of a service concession arrangement are considered in determining the appropriate disclosures in the notes. There are minimum disclosure requirements as you can see on the slide. The disclosures are provided individually for each material service concession arrangement or in aggregate for service concession arrangements involving services of a similar nature (e.g., toll collections, telecommunications or water treatment services). The grantor also applies the relevant presentation and disclosure requirements in other IPSASs as they relate to assets, liabilities, revenues, and expenses recognized under IPSAS 32. That take us to the end of the Service Concession Arrangements session.
Now I’m going to pass it over to Iman who is going take us through IPSAS 12, Inventories.
Iman Sheikh
Inventories are assets: In the form of materials or supplies to be consumed in the production process. In the form of materials or supplies to be consumed or distributed in the rendering of services (for example, educational books produced by a health authority for donation to schools or educational/training course materials); Held for sale or distribution in the ordinary course of operations including land and other property held for sale; or In the process of production for sale or distribution.
A few examples of inventories found in the public sector include: Military inventories such ammunition, missiles, rockets, or bombs, strategic stockpiles such as energy reserves, stocks of unused postal stamps and currency.
Inventories should be measured at the lower of cost and net realizable value. The cost of inventories includes all costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition. However, inventories are measured at the lower of cost and current replacement cost where they are held for: Distribution at no charge or for a nominal charge; or Consumption in the production process of goods to be distributed at no charge or for a nominal charge. And lastly, in a non-exchange transaction, an entity would receive inventory items without directly giving approximately equal value in exchange. Under such circumstances, the cost of inventory is its fair value as at the date it is acquired. Fair value reflects the amount for which the same inventory could be exchanged between knowledgeable and willing buyers and sellers in the marketplace.
Antonella Risi
What is net realizable value and current replacement cost?
Iman Sheikh
Net realizable value refers to the net amount that an entity expects to realize from the sale of inventory in the ordinary course of operations. Net realizable value is the estimated selling price in the ordinary course of operations, less the estimated costs of completion and the estimated costs necessary to make the sale, exchange, or distribution. Net realizable value for inventories may not equal fair value less costs to sell. Current replacement cost is the cost the entity would incur to acquire the asset on the reporting date. When inventories are sold, exchanged, or distributed, the carrying amount of those inventories is recognized as an expense in the period in which the related revenue is recognized. If there is no related revenue, the expense is recognized when the goods are distributed or the related service is rendered. For a service provider, the point when inventories are recognized as expenses normally occurs when services are rendered, or upon billing for chargeable services.
Here on this slide, we have some of the Inventory disclosures requirements: The accounting policies adopted in measuring inventories, including the cost formula used; The total carrying amount of inventories and the carrying amount in classifications appropriate to the entity; The carrying amount of inventories carried at fair value less costs to sell; The amount of inventories recognized as an expense during the period; And that take us to the end of this session.
IPSAS 27 prescribes the accounting treatment and disclosures for agricultural activity. Agricultural activity sounds really broad!
Antonella Risi
Could you explain what that means?
Iman Sheikh
Agricultural activity is the management by an entity of the biological transformation and harvest of biological assets for: Sale; Distribution at no charge or for a nominal charge; or Conversion into agricultural produce or into additional biological assets for sale or for distribution at no charge or for a nominal charge. And biological assets are living plants or animals. IPSAS 27 deals with the accounting of biological assets except for bearer plants. I will talk a bit more about bearer pIants in the next slide. For now I did want to mention a few other things. Biological assets are used in many activities undertaken by public sector entities. If biological assets are used for research, education, transportation, entertainment, recreation, customs control or in any other activities that are not agricultural activities they are not accounted for in accordance with IPSAS 27. When they meet the definition of an asset, other IPSASs should be considered in determining the appropriate accounting (e.g., IPSAS 12, Inventories and IPSAS 17). IPSAS 27 does not deal with the processing of agricultural produce after harvest and biological assets held for provision or supply of services.
Antonella Risi
Before you go to the next slide can you talk a bit more about these two scope exclusions.
Iman Sheikh
Sure. An example of agriculture produce after harvest is the processing of grapes into wine by a vintner who has grown the grapes. While such processing may be a logical and natural extension of agricultural activity, and the events taking place may bear some similarity to biological transformation, such processing is not included within the definition of agricultural activity in IPSAS 27. With respect to biological assets held for provision or supply of services, examples of such biological assets include horses and dogs used for policing purposes and plants and trees in parks and gardens operated for recreational purposes. These biological assets are not held for use in an agricultural activity because they are not routinely managed for the purpose of measuring and monitoring the change in quality or quantity brought about by biological transformation or harvest, as described in IPSAS 27.
Antonella Risi
Thank you Iman. That information was very helpful.
Iman Sheikh
On this slide we have the definition of a bearer plant. READ THE SLIDE. Bearer plants are accounted for in accordance with IPSAS 17, Property, Plant, and Equipment. This reflects the fact that the benefits provided by bearer plants are consistent with other property, plant, and equipment.
Antonella Risi
Based on what you just said, sounds like animals, let’s say a sheep that bears produce, like wool, would meet the definition you just outlined.
Iman Sheikh
Not quite. The definition of a bearer plant does not include animals, even if the animal is expected to bear produce for more than one period. On this slide we have not only examples of biological assets but also agricultural produce and products that are the result of processing after the point harvest. Let’s review some of these examples: So, sheep are biological assets. They may be used for the production of an agriculture produce such as wool like you mentioned earlier Antonella, but it may also be processed after harvest to produce for example carpets. Similarly, biological assets may be dairy cattle, that is used for the production of agriculture produce such as milk, which can then be processed into cheese.
Antonella Risi
To make sure I understand the previous slides, biological assets (except bearer plants) and agriculture produce at the point of harvest are in scope of IPSAS 27 but the third column, the results of processing after harvest are not?
Iman Sheikh
That’s correct. After the point of harvest, IPSAS 12, or another applicable Standard, is applied. The same general recognition principles for all other assets applying this case. Let’s recap the asset recognition criteria reviewed in the beginning of the presentation. Biological assets or agriculture produce is recognized when is recognized when: An entity controls an asset that result of past event, The probably future economic benefits/service potential will flow to the entity, and the fair value or cost can be measured reliably.
Let’s look at the initial and subsequent recognition of biological assets and agricultural produce. On initial recognition, biological assets are measured at fair value less costs to sell If we are measuring assets that results from a non-exchange transaction, assets are measured at fair value less cost to sell also. Agriculture produce that is harvested from biological assets is initially measured at fair value less cost to sell at the point of harvest. The grouping of these assets can be done according to their attributes. Subsequent measurement of biological assets would involve measuring the assets at fair value less cost to sell at each reporting date. Agriculture produce is measured at fair value less cost to sell at the point of harvest. Any gains or losses are recognized in surplus or deficit for the period in which they arise.
This slide includes some of the disclosures related to IPSAS 27. Some disclosure requirements for biological assets and agriculture produce include Gain/loss on initial recognition, Consumable/bearer biological assets, biological assets held for sale and those held for distribution at no/nominal charge, Nature of activities & estimates of physical quantities, and Reconciliation. And that take us to the end of this session.
We will now look at IPSAS 16, Investment Property. IPSAS 16 applies to Investment Property, including: The measurement in a lessee’s financial statements of investment property interests held under a lease accounted for as a finance lease; and The measurement in a lessor’s financial statements of investment property provided to a lessee under an operating lease.
Definition of Investment Property Investment property is property (land or a building – or part of a building – or both) held to earn rentals or for capital appreciation, or both, rather than for: Use in the production or supply of goods or services, or for administrative purposes; or Sale in the ordinary course of operations. Investment property is distinguished from owner-occupied property. Owner-occupied property is outside the scope of IPSAS 16.
Antonella Risi
From what you just said, IPSAS 16 distinguishes investment property from owner-occupied property, which is outside the scope of the standard…And I am assuming that owner occupied property is property held by the owner where the owner conducts its business. I may not be using the right words here. But is that the message you are trying to portray?
Iman Sheikh
I understand what you are saying. To help you out a bit, IPSAS 16 defines owner-occupied property as 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. Here we have examples of investment property, and items that are not investment property. Some examples include: land held for long-term capital appreciation, a building leased out under an, operating lease on a commercial basis.
Next, some examples of items that do not meet the definition of an investment property include: property held for sale in the ordinary course of operations or property that is leased to another entity under a finance lease.
The general asset recognition principles apply equally for investment properties. Let’s take a look at how investment properties are measurement on recognition. Investment property shall be measured initially at its cost (transaction costs shall be included in this initial measurement). Where an investment property is acquired through a non-exchange transaction, its cost shall be measured at its fair value as at the date of acquisition.
Antonella Risi
What is included in the cost of an investment property?
Iman Sheikh
The cost of a purchased investment property comprises its purchase price and any directly attributable expenditure. Directly attributable expenditure includes, for example, professional fees for legal services, property transfer taxes, and other transaction costs. The cost of investment property is not increased by: Start-up costs (unless they are necessary to bring the property to the condition necessary for it to be capable of operating in the manner intended by management); Operating losses incurred before the investment property achieves the planned level of occupancy; or Abnormal amounts of wasted material, labor or other resources incurred in constructing or developing the property. An investment property may be acquired through a non-exchange transaction.
IPSAS 16 permits two approaches to subsequent measurement. An entity chooses as its accounting policy either the fair value model or the cost model, and applies that policy to all of its investment property.
Antonella Risi
What if an entity wants to change its accounting policy? Is it possible?
Iman Sheikh
IPSAS 3, Accounting Policies, Changes in Accounting Estimates and Errors, allows an entity to subsequently change its accounting policy where this will produce reliable and more relevant information. However, IPSAS 16 notes that it is highly unlikely that a change from the fair value model to the cost model will result in a more relevant presentation. After initial recognition, an entity that chooses the cost model shall measure all of its investment property in accordance with IPSAS 17’s requirements for that model, i.e., at cost less any accumulated depreciation and any accumulated impairment losses. This takes us to the end of IPSAS 16.
Antonella Risi
Before we end, we did want to highlight a few resources that may be helpful to you. This slide contains a link to the IPSASB's website that includes information on IPSASB as well as the work they're doing. The slide also contains links to both the digital version of IPSASB Handbook and the PDF version. The handbook will provide you detailed guidance and requirements on the standards highlighted during this workshop. And lastly, if you're interested in PSAB's international strategy or its responses to IPSASB’s documents for comment, please feel free to visit PSAB's International Activities page. The link is also on the slide.
Thank you all very much for attending this workshop. We hope you found it helpful and that it provided you with insights on some of the IPSASB standards related to the various items we discussed on this module. We wish you a great rest of the day. Thank you.