11.1.15 Revaluation of Fixed Assets and Treatment of Pagree

Enquiry:

Your attention is drawn to the following matters:

Revaluation of Fixed Assets:

At inception, the Company had only one unit, which asset was revalued with the passage of time. After few years the company has installed more units in different provinces and locations all over Pakistan. The assets that were revalued have been disposed off and surplus on revaluation on these assets has also been adjusted accordingly except land and remaining assets.

If the Company gets its assets revalued by a valuer again to meet the requirements of International Accounting Standard 16 Property, Plant and Equipment as reproduced below:

As per Paragraph no. 31: “Revaluations shall be made with sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date”, and;

As per Paragraph No. 34: “The frequency of revaluations depends upon the changes in fair values of the items of property, plant and equipment being revalued. When the fair value of a revalued asset differs materially from its carrying amount, a further revaluation is required. Some items of property, plant and equipment experience significant and volatile changes in fair value, thus necessitating annual revaluation. Such frequent revaluations are unnecessary for items of property, plant and equipment with only insignificant changes in fair value. Instead, it may be necessary to revalue the item only every three or five years”.

Based on above paragraphs reference and keeping in view the fact of first unit’s revaluation, your opinion is sought for the following:

Q.1    Either related class of assets of all units needs to be revalued or that particular unit’s assets that were previously revalued should be revalued?

Q.2    What is meant by significant variation, is there any percentage of book value?

Q.3    Except land almost all of the prior revalued assets were sold. Is it necessary to revalue the replaced assets?

As per Para No. 36: “If an item of property, plant and equipment is revalued, the entire class of property, plant and equipment to which that asset belongs shall be revalued”

Q.4    Is there any provision in company law and International Accounting Standards available by which we could make reversal of revaluation of fixed assets and state revalued assets at cost or carrying amount in balance sheet after considering any possible depreciation or impairment if required?

Treatment of Pagree

Q. 5    We intend to purchase a corporate office at one of the premier locations of the city but the space available over there is under PAGREE scheme. As nothing is available in IAS 38 Intangible Assets, however in Income Tax Ordinance, 2001 the treatment of un-adjustable amount is mentioned. According to the matching principle, matching cost should be amortized accordingly. Therefore your opinion is sought about the proper treatment and disclosure of PAGREE in the financial statements.

Opinion:

Answer 1: Apart from the paragraphs reproduced in the above enquiry your attention is also drawn to the following paragraphs of IAS 16:

37     A class of property, plant and equipment is a grouping of assets of a similar nature and use in an entity’s operations. The following are examples of separate classes:

(a)     land;
(b)     land and buildings;
(c)     machinery;
(d)     ships;
(e)     aircraft;
(f)     motor vehicles;
(g)     furniture and fixtures; and
(h)     office equipment.

38     The items within a class of property, plant and equipment are revalued simultaneously to avoid selective revaluation of assets and the reporting of amounts in the financial statements that are a mixture of costs and values as at different dates. However, a class of assets may be revalued on a rolling basis provided revaluation of the class of assets is completed within a short period and provided the revaluations are kept up to date.

In view of the above the Committee is of the view that the entire class of assets of all the units should be revalued.

Answer 2 : As far as interpretation of term “significant” is concerned, IAS has neither defined it nor enunciated any criterion for it; rather it is up to the management to decide whether change in fair value of assets is material and important after taking into account the circumstances of the entity and nature and value of asset.

Answer 3: Once an accounting policy regarding the revaluation of assets and frequency thereof has been adopted by an entity, it should be applied consistently to all assets in that class of assets.

Answer 4: In reply to question 4 your attention is drawn to the following paragraph 31 of IAS-16, Property, Plant and Equipment

31.    After recognition as an asset, an item of property, plant and equipment whose fair value can be measured reliably shall be carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses. Revaluations shall be made with sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date.

In view of the above paragraph the Committee is of the opinion that once an entity undertakes revaluations, these must continue to be made with sufficient regularity so that the carrying amounts in any subsequent balance sheet are not materially at variance with the current fair values. In other words, if an entity adopts the allowed alternative treatment, it cannot report balance sheets that contain obsolete fair values, since that would not only obviate the purpose of the allowed treatment, but would actually make it impossible for the user to meaningfully interpret the financial statements.

Further your attention is also drawn towards the following section sub-section (2) of section 235 of the Companies Ordinance, 1984,

(2)    Except and to the extent actually realized on disposal of the assets which are revalued, the surplus on revaluation of fixed assets shall not be applied to set off or reduce any deficit or loss, whether past, current or future, or in any manner applied, adjusted or treated so as to add to the income, profit or surplus of the company, or utilized directly or indirectly by way of dividend or bonus:

Provided that the surplus on revaluation of fixed assets may be applied by the company in setting off or in diminution of any deficit arising from the revaluation of any other fixed asset of the company:

Provided further that incremental depreciation arising out of revaluation of fixed assets may be charged to surplus on revaluation of fixed assets account.

It may be pertinent to note that IAS 16 does not prohibit companies from changing accounting policies i.e. from allowed alternative treatment to benchmark treatment or vice versa. However, the condition precedent remains there.

From the above it can also be inferred that once the revaluation surplus is recognized in the financial statements, Section 235 of the Companies Ordinance, 1984 does not appear to allow its reversal or its use for any other purpose other than the purpose described in the above sub-section.

However, if the management is of the opinion that an asset may be impaired and its carrying amount needs to be written downward then it should do so as per guidance provided in IAS-36 Impairment of Assets.

Answer 5: The system of pagree is more prevalent in Pakistan and India. Pagree, in common parlance, is an amount given to landlord by the pagree-tenant. Payment of such amount gives an entitlement to the pagree-tenant to the reduced or nominal rental amounts but also gives a right to receive a major portion of pagree at the time of the change of tenant from the successor tenant.

As far as form and documentation of pagree is concerned, usually it is undocumented and has no legal cover; however, the customary practices result in emanation of aforesaid rights in vogue. Analysis of nature of the rights associated with the payment of pagree exhibits that it entitles the payer to enjoy all the benefits of the property for an unascertainable period of time.

Though there is no treatment given in any IAS/IFR with regard to pagree, the Committee is of the view that it may be appropriate to disclose it as an intangible asset if the criterion given in paragraphs 107 and 108 of IAS 38 is met.

(December 10, 2005)