GAAP vs. IFRS for property, plant and equipment

In the area of fixed assets and the resultant depreciation there are some major differences between the GAAP rules codified in ASC Topic 360 and the IFRS rules in IAS 16.

In GAAP there is only one way to initially record a fixed asset and that is the cost method. The cost method involves recording the acquisition cost of the fixed asset, plus the costs of bringing the fixed asset to the condition and location required for its use. That would include interest on any loans, physical construction of the asset, demolition of any preexisting structures, renovation of a preexisting structure, administrative and technical activities in designing the asset and obtaining permits, and administrative activities incurred during construction.

In IFRS an entity should record the initial costs of the fixed asset as its cost using essentially the same criteria as GAAP. There is a difference, though, in what IFRS considers to be costs of the fixed asset in the condition and location for its use. Some of those are benefits of employees constructing the asset, the purchase price, dismantling of items at the site, import duties, installation and assembly costs, nonrefundable purchase taxes, professional fees, site preparation, testing costs and wages.

GAAP includes a provision on how to measure “nonmonetary exchanges” for assets, while IFRS does not. A nonmonetary exchange uses the fair market value of the asset given up in the transaction or the asset received, whichever is more clearly evident.

Subsequent to recording the cost of the asset, under IFRS there are two ways to continue recording the fixed asset: the cost model and the revaluation model. The cost model must be applied consistently to classes of assets. The revaluation model is very dynamic, but more difficult to use. To use the revaluation model, an entity must be able to determine fair value reliably. So, the fair value should be adjusted either upward or downward as required. And what is a major break from GAAP, an upward adjustment can be recorded in the books. An increase in value is measured in “comprehensive income” and in the equity section of the balance sheet. A decrease in value is posted to the profit and loss statement. One author I studied considered the equity section value to be a “memo entry,” but I consider it to be a flowdown from comprehensive income. In other words, instead of posting it to retained earnings, an account called “revaluation surplus” should be used.

Under IFRS, if an entity uses the revaluation model, accumulated depreciation must be adjusted in two possible ways. The first is to force the net asset value to equal its fair value by adjusting the value, minus accumulated depreciation, to equal the fair value at that time. The second method is to eliminate the accumulated depreciation entirely so the fair value of the asset is all that is left. Then depreciation and accumulated depreciation resume at the higher or lower amount.

Depreciation and amortization are the same for both sets of standards, but some of the rules are different. An entity can use straight line, sum of the year’s digits, declining balance, the depletion method or the units of production method. And both rules are the same for the determination of useful lives and salvage value. Both sets of rules employ the “matching concept” of recording depreciation, and IFRS states that depreciation does not stop during an idle period except when using the units of production method. GAAP also includes this provision, except there are rules for asset impairments, disclosure and useful life. All of these events require an adjustment of some kind. Asset impairment should be reviewed for a possible loss. An entity is required to disclose the idle asset by setting up a separate account for it on the balance sheet, writing a note disclosure as to why it is idle, and adjusting the useful life if it has changed.

The treatment of land as an asset has some similarities between the two sets of rules, but also some differences in approach. Under both sets of rules, land is not depreciated. GAAP, however, states that the cost of demolishing an existing building, clearing and leveling the land and other similar costs are added to the value of the land and are not depreciated. IFRS does not contain such a provision. Land improvements that have a useful life and add to the functionality of the land should be booked in a separate asset account and depreciated under GAAP and IFRS.

GAAP includes a section on “Fixed Asset Impairment” and IFRS does not. IFRS contains a provision on “Compensation for Impaired Assets” such as insurance. This compensation should be recognized in profit or loss as soon as the receivable is recorded. Under GAAP, a loss on an impaired asset should be recognized in the income statement. GAAP addresses a concept that IFRS does not: how to treat asset “held for sale.” Assets held for sale are essentially treated as inventory. They are not depreciated.

IFRS includes a section on “Decommissioning Liabilities,” while GAAP has a section on “Fixed Asset Disposal.” Again, assets held for sale are treated differently and should be recorded on the balance sheet separately.

I won’t go into the issue of property, plant and equipment disclosures under GAAP and IFRS, but there are differences. One of the main differences is that IFRS deals with a “decommissioning fund” that should be recorded and disclosed in the notes. GAAP does not have such a provision on decommissioning funds.