16.1.07 Enquiry on Paragraph 17(e) of IAS 16

Enquiry:

Generally mining or petrochemical company which has several plants, some ready for use by management and producing goods that are sold in the market and substantial revenue is derived from the same while other plants are still in the commissioning phase and not yet ready for production. The products that are sold in the market cannot be utilized internally as other plants where such products will be used as input are still not ready for use. Based on the above, generally, the proceeds from sale of products (produced from plants which are ready) with the overall capital costs of all plants netted off in accordance with paragraph 17(e) of IAS 16.

Paragraph 17(e) of IAS 16 states that:

“Examples of directly attributable costs are:

a)    ……….
b)    ………
c)    ………
d)    ………
e)    costs of testing whether the asset is functioning properly, after deducting the net proceeds from selling any items produced while bringing the asset to that location and condition (such as samples produced when testing equipment);
f)    ……….”

Paragraph 24 of IAS 23 states: “When an entity completes the construction of a qualifying asset in parts and each part is capable of being used while construction continues on other parts, the entity shall cease capitalizing borrowing costs when it completes substantially all the activities necessary to prepare that part for its intended use or sale.”

It is not uncommon in the mining or petrochemical industry for there to be a long commissioning period, sometimes over 12 months. In these situations, a key question which arises under IFRS is how the revenues and costs incurred during the commissioning period should be accounted for.

IAS 16 ‘Property, Plant and Equipment’ requires that costs can only be capitalized if they are “directly attributable” to the asset, and it also states that revenue from saleable material produced during the testing phase should be deducted from the cost of constructing the asset. So what does this mean for a company with an extended commissioning period?

It is also questionable whether all revenues earned during the commissioning period, particularly if they are substantial, should be deducted from the cost of developing the plant. This would only be appropriate if it can clearly be shown that they are directly attributable to bringing the asset to the condition necessary for it to be capable of operating in the manner intended by management. The example in IAS 16 of what might fall into this category is revenues earned from sales of samples produced when testing equipment. This would suggest that the IASB may not have envisaged a situation where more than an insignificant amount of revenue would be treated in this way.

In our view IAS 16.17(e) applies to each individual plant. Goods sold on the market are produced once the asset is operating in the manner intended by management. Revenue from those products should not give rise to ‘net proceeds’ to be offset against the costs of testing other plants that are part of the complex; rather it should be recognised in profit or loss for the period as it reflects the operations of the entity for the period.

For ease of understanding, the above matter has been illustrated through figures as follows:

Situation A

Costs of testing – 100
Other capital costs – 100
Revenue from sales during commissioning period- 50

Situation B

Costs of testing – 100
Other capital costs – 100
Revenue from sales during commissioning period – 150

Situation C

Costs of testing – 100
Other capital costs – 100
Revenue from sales during commissioning period – 250

What should be the correct accounting treatment of revenue earned and costs (including depreciation of the plant) during commissioning period in each of the above situations?

Opinion:

The Committee considered your enquiry and is of the view that paragraph 17(e) of IAS- 16 deals with capitalization of cost of testing. These costs are incurred while checking that the asset capitalized is functioning properly and are recognized after deducting the net proceeds from selling any items produced such as samples produced while testing such asset.

The Committee agrees with your views that IAS 16.17(e) apply to each individual plant. Revenue from sale of products from plants which are in operation should not netted off against the costs of testing other plants; rather cost of operation/cost of testing of plant which are not in operation and having an extended commissioning period should be capitalized after netting off with revenue of that plant (if any), if they are directly attributable to the asset as required in IAS 16.17(e). Further the Committee is also of the view that the cost of capitalization of plant should not be more than the fair value of the plant as required in paragraph 19 of IAS 36.

(May 20, 2011)