IAS 16 Property, Plant and Equipment provides guidance on how to account for tangible fixed assets used in production or supply of goods and services. A common issue arises when a new machine or plant is being tested before it is available for its intended use. During this testing phase, the entity may produce items that can be sold in the market. The question is: how should the income from selling those test items be treated in the financial statements?
Previous Practice (Before 2020 Amendment)
Before the 2020 amendment, IAS 16 allowed entities to deduct the net proceeds from selling items produced during the testing phase from the cost of the related asset. This meant:
Sale proceeds minus costs of production were used to reduce the carrying amount of the machine. Effectively, these proceeds lowered the capitalized cost of the asset.
Example:
If test items were sold for $20,000 and the related production cost was $15,000, the net $5,000 would reduce the machine’s cost.
Revised Requirement (After 2020 Amendment)
The International Accounting Standards Board (IASB) amended IAS 16 in 2020 to remove this treatment. Effective for accounting periods beginning on or after 1 January 2022, entities are no longer permitted to deduct sales proceeds from the cost of the asset. Instead:
1. Revenue Recognition: Proceeds from selling test items must be recognized as revenue or other income in profit or loss under IFRS 15.
2. Cost Recognition: Costs incurred to produce these items must also be recognized in profit or loss, in accordance with IAS 2 Inventories.
3. Machine Cost: Only costs directly attributable to bringing the asset to the condition necessary for it to operate as intended can be capitalized. The income from sales plays no role in determining the machine’s cost.
Rationale for the Change
The IASB observed that deducting test sales proceeds from the asset cost created inconsistency and reduced comparability across entities. By requiring both income and related costs to flow through profit or loss, the revised approach:
Improves transparency in reporting, Aligns with the principles of IFRS 15 and IAS 2, and Provides a clearer picture of an entity’s financial performance during the testing phase.
Conclusion
Under IAS 16 revised 2020, income from selling test items cannot be deducted from the machine’s cost. Both the income and related expenses must be presented in the income statement. This ensures better comparability and faithful representation of financial information.
