Indian Accounting Standard (Ind AS) and the current Indian income tax regime requires management to think about fair valuation of Property, Plant & Equipment (PP&E) as a strategic exercise. Adopting a fair value based approach can help in reflecting the true worth of the company’s tangible assets on the balance sheet, thereby showing true balance-sheet leverage to investors and other stakeholders. At the same time, this might have an impact on the quantum of depreciation going forward which will in turn have an impact on profitability. Ind AS also provides an option to consider fair value as deemed cost for first time adoption, and it doesn’t mandate the company to continue with the fair value model for future reporting.
Ind AS - 16
The objective of this Standard is to prescribe the accounting treatment for PP&E so that users of financial statements can discern information about an entity’s investment in its PP&E and the changes in value of such investment.The principal issues in accounting for the PP&E are the recognition of the assets, the determination of their carrying amounts and the depreciation charges and impairment losses to be recognized in relation to them.
Ind AS 16 permits two accounting models:
After recognition as an asset, an item of PP&E shall be carried at its cost less any accumulated depreciation and any accumulated impairment losses.
After recognition as an asset, an item of PP&E whose fair value can be measured reliably shall be carried at a revalued amount, being its fair value at the date of revaluation less subsequent depreciation and accumulated impairment losses, if any.
Indian entities, which have selectively revalued fixed assets or intend to revalue the fixed assets, will have to determine whether they want to continue with the revaluation model or not. If an entity wants to continue with the revaluation model they must consider the following:
- If the market value is not available, the fair value is estimated by income or depreciated replacement cost approach.
- Accumulated depreciation of a revalued asset is restated proportionately.
- If an item of the PP&E is revalued, the entire class of the PP&E to which that asset belongs shall be revalued.
- The increase in carrying amount due to revaluation shall be recognized in the Profit & Loss Statement (“P&L”) to the extent that it reverses a prior revaluation decrease of the same asset. Any increase over and above that amount is recorded in Other Comprehensive Income (“OCI”).
- Total revaluation surplus is accumulated under the head “equity” and converted to retained earnings when the asset is derecognized.
Use of fair value as deemed cost
An entity may elect to measure an item of PP&E at the date of transition to Ind AS at its fair value and use that fair value as its deemed cost at that date.
Deemed Cost is defined as “an amount used as a surrogate for cost or depreciated cost at a given date. Subsequent depreciation or amortization assumes that the entity had initially recognized the asset or liability at the given date and that its cost was equal to the deemed cost.”
If an entity uses fair value in its opening Ind AS Balance Sheet as deemed cost for an item of PP&E, an investment property or an intangible asset, the entity’s first Ind AS financial statements shall disclose, for each line item in the opening Ind AS Balance Sheet:
- the aggregate of those fair values; and
- the aggregate adjustment to the carrying amounts reported under previous GAAP
Effect of taxes on income due to revaluation
The effects of taxes on income, if any, resulting from the revaluation of PP&E are recognized and disclosed in accordance with Ind AS 12, Income Taxes.
In relation to the above revaluation, stakeholder concerns of Minimum Alternate Tax (MAT) on First Time Adoption (“FTA”) adjustments recorded in retained earnings have been addressed by the Central Board of Direct Taxes (CBDT) in the second interim report dated July 23, 2016. The recommendations of CBDT in the second interim report related to PP&E (Ind AS 16) and Intangible Assets (Ind AS 38) are as follows:
- Existing MAT provisions ignore the impact of revaluation.
- Similarly, FTA adjustments to PPE/ Intangible Assets recorded in retained earnings should be ignored.
- Depreciation on FTA and other FTA adjustments like decommissioning liability, Foreign exchange capitalization/decapitalization, borrowing cost adjustments, etc. should also be similarly ignored.
- Gain/loss on realization/ disposal/ retirement shall be computed for MAT purposes by ignoring FTA i.e., they will be picked up for MAT in the year of realization/ disposal/ retirement.