Difference Between IAS 16 Under Going Concern and IAS 16 Under Liquidation

Introduction

IAS 16, “Property, Plant and Equipment,” prescribes the accounting treatment for property, plant, and equipment (PPE). It provides guidance on the recognition, measurement, and depreciation of these assets. This report explores the key differences in applying IAS 16 under a going concern assumption and during liquidation.

IAS 16 Under Going Concern

Core Principle

Under IAS 16, the core principle is to recognize property, plant, and equipment as assets when it is probable that future economic benefits associated with the asset will flow to the entity and the cost of the asset can be measured reliably.

Initial Recognition

PPE is initially recognized at cost, which includes the purchase price, import duties, and non-refundable purchase taxes, as well as any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management.

Example: A company purchases machinery for R1,000,000. Additional costs of R50,000 are incurred for transportation and installation. The machinery is recognized at an initial cost of R1,050,000.

Subsequent Measurement

After initial recognition, PPE is measured using either the cost model or the revaluation model:

• Cost Model: PPE is carried at cost less accumulated depreciation and any accumulated impairment losses.

• Revaluation Model: PPE is carried at a revalued amount, being its fair value at the date of revaluation less any subsequent accumulated depreciation and impairment losses.

Example: A building initially recognized at R5,000,000 is revalued to R5,500,000. The carrying amount is adjusted to reflect the revaluation surplus of R500,000.

Depreciation

Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. The depreciable amount is the cost of an asset, or other amount substituted for cost, less its residual value. Depreciation begins when the asset is available for use and continues until it is derecognized or classified as held for sale.

Example: Machinery with a cost of R1,000,000 and an estimated useful life of 10 years is depreciated on a straight-line basis, resulting in an annual depreciation expense of R100,000.

Impairment

An impairment loss is recognized when the carrying amount of an asset exceeds its recoverable amount. The recoverable amount is the higher of an asset’s fair value less costs of disposal and its value in use.

Example: If machinery with a carrying amount of R600,000 has a recoverable amount of R500,000, an impairment loss of R100,000 is recognized.

IAS 16 Under Liquidation

Core Principle

During liquidation, the primary objective is to dispose of PPE quickly to maximize cash flows. The measurement focus shifts from long-term use to the expected liquidation proceeds.

Initial Recognition

Initial recognition remains the same, but the relevance of initial cost diminishes as the focus shifts to net realizable value under liquidation conditions.

Example: The same machinery purchased for R1,000,000 is initially recognized at cost, but the current focus is on its liquidation value rather than its historical cost.

Subsequent Measurement

Under liquidation, PPE is measured at the lower of carrying amount and fair value less costs to sell. This conservative approach ensures assets are not overstated.

Example: Machinery with a carrying amount of R600,000 has an estimated liquidation value of R450,000. The carrying amount is adjusted to R450,000 to reflect the lower fair value less costs to sell.

Depreciation

Depreciation may be accelerated or ceased, depending on the liquidation timeline. The useful life of assets is reassessed to reflect the shorter duration of use before disposal.

Example: If machinery originally had a remaining useful life of 5 years, but liquidation is expected within one year, depreciation is accelerated, or the asset is assessed for immediate sale without further depreciation.

Impairment

Frequent reassessment of asset values is necessary to reflect the lower expected disposal values. Impairment losses are more likely to be recognized as assets are written down to their recoverable amounts.

Example: If the same machinery has a carrying amount of R500,000 but can only be sold for R300,000 in a liquidation sale, an impairment loss of R200,000 is recognized.

Liquidation Proceeds

During liquidation, the focus is on the net realizable value or liquidation proceeds. This value is often lower due to forced sale conditions and the urgency to liquidate assets quickly.

Example: A company sells office equipment with a carrying amount of R200,000 for R150,000 in a liquidation auction. The carrying amount is adjusted to reflect the lower sale proceeds.

Inventory Management and Sales Strategy

Assets are often sold at a discount or through bulk sales to expedite liquidation. Entities prioritize cash generation over optimal price realization.

Example: A manufacturing company sells its machinery and equipment at auction for lower-than-market prices to ensure quick sale and cash inflow.

Conclusion

The application of IAS 16 under a going concern assumption and during liquidation involves the same fundamental principles but different practical considerations. Under going concern, the focus is on sustainable asset management and depreciation over useful lives. In contrast, during liquidation, the emphasis shifts to immediate realization of assets at net realizable values, reflecting the urgency to generate cash flows. Entities must carefully reassess their PPE values and write-downs to ensure accurate and transparent financial reporting during liquidation. This adjustment ensures that stakeholders receive a true and fair view of the entity’s financial position and performance during the liquidation process.

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