Intermediate Accounting — Property, Plant and Equipment: Government Grants, Borrowing Costs and Revaluation

Principles of Accounting chapter 9 covered the basics of cost and depreciation. This chapter takes up four intermediate-level issues: government grants (K-IFRS 1020, IAS 20), capitalization of borrowing costs (K-IFRS 1023, IAS 23), the revaluation model (K-IFRS 1016, IAS 16) and acquisition by exchange. Impairment is covered separately in chapter 5.

1. Government grants

Government grants related to assets are recognized when there is reasonable assurance that the grant will be received. There are two presentation methods, with the same effect on profit either way.

A company buys equipment for ₩10 million and receives a government grant of ₩4 million. Useful life five years, no residual value, straight-line.

Annual profit effect by presentation method (unit: ₩10,000)
Method	Statement of financial position	Depreciation	Grant income	Net expense
Deduct from cost	Equipment 1,000 − grant 400 = 600	120	—	120
Deferred income	Equipment 1,000; deferred grant income (liability) 400	200	80	120

Under the cost-deduction method, the grant is a contra account to the asset and offsets depreciation. Under the deferred-income method, the grant is a liability transferred to income over the useful life. If the grant becomes repayable, this is treated as a change in estimate.

2. Capitalizing borrowing costs

Borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset (one that necessarily takes a substantial period to get ready for its intended use or sale) are included in its cost. Factories, power plants and investment property under long construction are typical. Inventories produced over a short period do not qualify.

A. Specific and general borrowings

Specific borrowings: funds borrowed for the qualifying asset. Capitalize the actual borrowing costs less any investment income on temporary investment.
General borrowings: funds borrowed without a specific purpose. Apply the capitalization rate (weighted average rate on general borrowings) to expenditure on the asset not financed by specific borrowings, limited to actual interest on general borrowings.

B. Worked example

Company N builds a factory from 1 January to 31 December 20X1, with average accumulated expenditure of ₩20 million. On 1 January 20X1 it borrowed ₩10 million at 5% specifically for the factory and earned ₩100,000 by depositing it temporarily before use. General borrowings of ₩20 million at 6% and ₩10 million at 9% were outstanding all year.

Capitalization rate

\text{Capitalization rate} = \frac{2{,}000 \times 6\% + 1{,}000 \times 9\%}{2{,}000 + 1{,}000} = \frac{210}{3{,}000} = 7\%

Total interest on general borrowings divided by average general borrowings (unit: ₩10,000).

Borrowing costs capitalized (unit: ₩10,000)
Type	Working	Amount
Specific borrowings	1,000 × 5% − temporary investment income 10	40
General borrowings	(Average expenditure 2,000 − average specific borrowings 1,000) × 7% = 70 (limit 210)	70
Total		110

₩1.1 million is added to the factory’s cost, and the remaining ₩1.4 million of general borrowing interest is expensed. If construction is suspended for an extended period, capitalization stops for that period.

3. The revaluation model

For each class of property, plant and equipment (land, buildings, etc.), either the cost model or the revaluation model is chosen. The revaluation model measures at fair value less subsequent accumulated depreciation and impairment, with revaluations made regularly enough that the carrying amount does not differ materially from fair value.

Revaluation of land (cost ₩10 million, unit: ₩10,000)
Date	Fair value	Treatment	Profit or loss	OCI
End of 20X1	1,300	Revaluation surplus of 300 recognized	0	+300
End of 20X2	900	Surplus of 300 reduced first; remaining 100 is a loss	−100	−300
End of 20X3	1,050	Prior loss of 100 reversed; remaining 50 to surplus	+100	+50

An increase goes in principle to other comprehensive income (revaluation surplus), but to the extent it reverses a decrease previously recognized in profit or loss for the same asset, it is recognized in profit. A decrease first reduces any revaluation surplus for that asset, with the remainder recognized as a loss. The revaluation surplus may be transferred directly to retained earnings when the asset is derecognized; it is not reclassified to profit or loss. For a depreciable asset, the difference between depreciation on the revalued amount and on original cost may also be transferred each year while the asset is used.

4. Acquisition by exchange

An asset acquired in exchange for another non-monetary asset is in principle measured at the fair value of the asset given up, with the difference recognized as a gain or loss on disposal. However, if the exchange lacks commercial substance or fair values cannot be measured reliably, cost is the carrying amount of the asset given up. Commercial substance depends on whether the exchange significantly changes the risk, timing or amount of future cash flows.

Check your understanding

Company O acquired a building for ₩30 million at the beginning of 20X1 (useful life ten years, no residual value, straight-line). It uses the revaluation model, and fair value at the end of 20X1 is ₩31.5 million. What are depreciation and the revaluation surplus for 20X1? What is depreciation for 20X2?

Depreciation for 20X1 is $3{,}000 / 10 = 300$ (₩10,000), i.e. ₩3 million, leaving a carrying amount of ₩27 million. The ₩4.5 million difference from fair value of ₩31.5 million is the revaluation surplus. In 20X2 the revalued ₩31.5 million is depreciated over the remaining nine years, so depreciation is ₩3.5 million. The ₩500,000 difference from depreciation on cost of ₩3 million may be transferred from the revaluation surplus to retained earnings.

References

Korea Accounting Standards Board, K-IFRS 1016 Property, Plant and Equipment
Korea Accounting Standards Board, K-IFRS 1020 Accounting for Government Grants and Disclosure of Government Assistance
Korea Accounting Standards Board, K-IFRS 1023 Borrowing Costs