International Financial Reporting Standard (IFRS) 5 «Non-current Assets Held for Sale and Discontinued Operations»

IFRS 5 BC

Basis for Conclusions on IFRS 5 Non-current Assets Held for Sale and Discontinued Operations

This Basis for Conclusions accompanies, but is not part of, IFRS 5.

Introduction____________________________________________________________________________________

BC1 This Basis for Conclusions summarises the International Accounting Standards Board’s considerations in reaching the conclusions in IFRS 5 Non-current Assets Held for Sale and Discontinued Operations. Individual Board members gave greater weight to some factors than to others.

BC2 In September 2002 the Board agreed to add a short-term convergence project to its active agenda. The objective of the project is to reduce differences between IFRSs and US GAAP that are capable of resolution in a relatively short time and can be addressed outside major projects. The project is a joint project with the US Financial Accounting Standards Board (FASB).

BC3 As part of the project, the two boards agreed to review each other’s deliberations on each of the selected possible convergence topics, and choose the highest quality solution as the basis for convergence. For topics recently considered by either board, there is an expectation that whichever board has more recently deliberated that topic will have the higher quality solution.

BC4 As part of the review of topics recently considered by the FASB, the Board discussed the requirements of SFAS 144 Accounting for the Impairment or Disposal of Long-Lived Assets, as they relate to assets held for sale and discontinued operations. The Board did not consider the requirements of SFAS 144 relating to the impairment of assets held for use. Impairment of such assets is an issue that is being addressed in the IASB research project on measurement being led by the Canadian Accounting Standards Board.

BC5 Until the issue of IFRS 5, the requirements of SFAS 144 on assets held for sale and discontinued operations differed from IFRSs in the following ways:

(a) if specified criteria are met, SFAS 144 requires non-current assets that are to be disposed of to be classified as held for sale. Such assets are remeasured at the lower of carrying amount and fair value less costs to sell and are not depreciated or amortised. IFRSs did not require non-current assets that are to be disposed of to be classified separately or measured differently from other non-current assets.

(b) the definition of discontinued operations in SFAS 144 was different from the definition of discontinuing operations in IAS 35 Discontinuing Operations and the presentation of such operations required by the two standards was also different.

BC6 As discussed in more detail below, the Board concluded that introducing a classification of assets that are held for sale would substantially improve the information available to users of financial statements about assets to be sold.

BC7 The Board published its proposals in an Exposure Draft, ED 4 Disposal of Non-current Assets and Presentation of Discontinued Operations, in July 2003 with a comment deadline of 24 October 2003. The Board received over 80 comment letters on the Exposure Draft.

Scope of the IFRS__________________________________________________________________________________________

BC8 In ED 4, the Board proposed that the IFRS should apply to all non-current assets except:

(a) goodwill,

(b) financial instruments within the scope of IAS 39 Financial Instruments: Recognition and Measurement,

(c) financial assets under leases, and

(d) deferred tax assets and assets arising from employee benefits.

BC9 In reconsidering the scope, the Board noted that the use of the term ‘non-current’ caused the following problems:

(a) assets that are acquired with the intention of resale were clearly intended to be within the scope of ED 4, but would also be within the definition of current assets and so might be thought to be excluded. The same was true for assets that had been classified as non-current but were now expected to be realised within twelve months.

(b) it was not clear how the scope would apply to assets presented in accordance with a liquidity presentation.

BC10 The Board noted that it had not intended that assets classified as non-current in accordance with IAS 1 Presentation of Financial Statements would be reclassified as current assets simply because of management’s intention to sell or because they reached their final twelve months of expected use by the entity. The Board decided to clarify in IFRS 5 that assets classified as non-current are not reclassified as current assets until they meet the criteria to be classified as held for sale in accordance with the IFRS. Further, assets of a class that an entity would normally regard as non-current and are acquired exclusively with a view to resale are not classified as current unless they meet the criteria to be classified as held for sale in accordance with the IFRS.

BC11 In relation to assets presented in accordance with a liquidity presentation, the Board decided that non-current should be taken to mean assets that include amounts expected to be recovered more than twelve months after the balance sheet date.

BC12 These clarifications ensure that all assets of the type normally regarded by the entity as non-current will be within the scope of the IFRS.

BC13 The Board also reconsidered the exclusions from the scope proposed in ED 4. The Board noted that the classification and presentation requirements of the IFRS are applicable to all non-current assets and concluded that any exclusions should relate only to the measurement requirements. In relation to the measurement requirements, the Board decided that non-current assets should be excluded only if (i) they are already carried at fair value with changes in fair value recognised in profit or loss or (ii) there would be difficulties in determining their fair value less costs to sell. The Board therefore concluded that only the following non-current assets should be excluded from the measurement requirements of the IFRS:

Assets already carried at fair value with changes in fair value recognised in profit or loss:

(a) financial assets within the scope of IAS 39 Financial Instruments: Recognition and Measurement*.

(b) non-current assets that have been accounted for using the fair value model in IAS 40 Investment Property.

(c) non-current assets that have been measured at fair value less estimated point-of-sale costs in accordance with IAS 41 Agriculture.

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* The Board acknowledges that not all financial assets within the scope of IAS 39 are recognised at fair value with changes in fair value recognised in profit or loss but it did not want to make any further changes to the accounting for financial assets at this time.

Assets for which there might be difficulties in determining their fair value

(a) deferred tax assets.

(b) assets arising from employee benefits.

(c) assets arising from insurance contracts.

BC14 The Board acknowledged that the scope of the IFRS would differ from that of SFAS 144 but noted that SFAS 144 covers the impairment of non-current assets held for use as well as those held for sale. Furthermore, other requirements in US GAAP affect the scope of SFAS 144. The Board therefore concluded that convergence with the scope of SFAS 144 would not be possible.

Classification of non-current assets to be disposed of as held for sale__________________________________________________________________________________________

BC15 Under SFAS 144, long-lived assets are classified as either (i) held and used or (ii) held for sale. Before the issue of this IFRS, no distinction was made in IFRSs between non-current assets held and used and non-current assets held for sale, except in relation to financial instruments.

BC16 The Board considered whether a separate classification for non-current assets held for sale would create unnecessary complexity in IFRSs and introduce an element of management intent into the accounting. Some commentators suggested that the categorisation ‘assets held for sale’ is unnecessary, and that if the focus were changed to ‘assets retired from active use’ much of the complexity could be eliminated, because the latter classification would be based on actuality rather than what they perceive as management intent. They assert that it is the potential abuse of the classification that necessitates many of the detailed requirements in SFAS 144. Others suggested that, if existing IFRSs were amended to specify that assets retired from active use are measured at fair value less costs to sell and to require additional disclosure, some convergence with SFAS 144 could be achieved without creating a new IFRS.

BC17 However, the Board concluded that providing information about assets and groups of assets and liabilities to be disposed of is of benefit to users of financial statements. Such information should assist users in assessing the timing, amount and uncertainty of future cash flows. The Board understands that this was also the assessment underpinning SFAS 144. Therefore the Board concluded that introducing the notion of assets and disposal groups held for sale makes IFRSs more complete.

BC18 Furthermore, although the held for sale classification begins from an intention to sell the asset, the other criteria for this classification are tightly drawn and are significantly more objective than simply specifying an intention or commitment to sell. Some might argue that the criteria are too specific. However, the Board believes that the criteria should be specific to achieve comparability of classification between entities. The Board does not believe that a classification ‘retired from active use’ would necessarily require fewer criteria to support it. For example, it would be necessary to establish a distinction between assets retired from active use and those that are held as back-up spares or are temporarily idle.

BC19 Lastly, if the classification and measurement of assets held for sale in IFRSs are the same as in US GAAP, convergence will have been achieved in an area of importance to users of financial statements.

BC20 Most respondents to ED 4 agreed that a separate classification for non-current assets that are no longer held to be used is desirable. However, the proposals in ED 4 were criticised for the following reasons:

(a) the criteria were too restrictive and rules-based.

(b) a commitment to sell needs to be demonstrated, consistently with the requirements of IAS 37 Provisions, Contingent Liabilities and Contingent Assets relating to restructuring provisions.

(c) the classification should be for assets retired from active use.

(d) assets to be abandoned should be treated in the same way as assets to be sold.

BC21 The Board noted that a more flexible definition would be open to abuse. Further, changing the criteria for classification could cause divergence from US GAAP. The Board has, however, reordered the criteria to highlight the principles.

BC22 The Board also noted that the requirements of IAS 37 establish when a liability is incurred, whereas the requirements of the IFRS relate to the measurement and presentation of assets that are already recognised.

BC23 Finally, the Board reconfirmed the principle behind the classification proposals in ED 4, which is that the carrying amount of the assets will be recovered principally through sale. Applying this principle to assets retired from active use, the Board decided that assets retired from active use that do not meet the criteria for classification as assets held for sale should not be presented separately because the carrying amount of the asset may not be recovered principally through sale. Conversely, the Board decided that assets that meet the criteria to be classified as held for sale and are being used should not be precluded from being separately classified. This is because, if a non-current asset is available for immediate sale, the remaining use of the asset is incidental to its recovery through sale and the carrying amount of the asset will be recovered principally through sale.

BC24 Applying the same principle to assets to be abandoned, the Board noted that their carrying value will never be recovered principally through sale.

Assets to be exchanged for other non-current assets

BC25 Under SFAS 144, long-lived assets that are to be exchanged for similar productive assets cannot be classified as held for sale. They are regarded as disposed of only when exchanged. The Basis for Conclusions on SFAS 144 explains that this is because the exchange of such assets is accounted for at amounts based on the carrying amount of the assets, not at fair value, and that using the carrying amount is more consistent with the accounting for a long-lived asset to be held and used than for a long-lived asset to be sold.

BC26 Under IAS 16 Property, Plant and Equipment, as revised in 2003, an exchange of assets is normally measured at fair value. The SFAS 144 reasoning for the classification of such assets as held for sale does not, therefore, apply. Consistently with IAS 16, the IFRS treats an exchange of assets as a disposal and acquisition of assets unless the exchange has no commercial substance.

BC27 The FASB has published an exposure draft proposing to converge with the requirements in IAS 16 for an exchange of assets to be measured at fair value. The exposure draft also proposes a consequential amendment to SFAS 144 that would make exchanges of assets that have commercial substance eligible for classification as held for sale.

Measurement of non-current assets held for sale__________________________________________________________________________________________

BC28 SFAS 144 requires a long-lived asset or a disposal group classified as held for sale to be measured at the lower of its carrying amount and fair value less costs to sell. A long-lived asset classified as held for sale (or included within a disposal group) is not depreciated, but interest and other expenses attributable to the liabilities of a disposal group are recognised.

BC29 As explained in the Basis for Conclusions on SFAS 144, the remaining use in operations of an asset that is to be sold is incidental to the recovery of the carrying amount through sale. The accounting for such an asset should therefore be a process of valuation rather than allocation.

BC30 The FASB further observed that once the asset is remeasured, to depreciate the asset would reduce its carrying amount below its fair value less costs to sell. It also noted that should there be a decline in the value of the asset after initial classification as held for sale and before eventual sale, the loss would be recognised in the period of decline because the fair value less costs to sell is evaluated each period.

BC31 The counter-argument is that, although classified as held for sale, the asset is still being used in operations, and hence cessation of depreciation is inconsistent with the basic principle that the cost of an asset should be allocated over the period during which benefits are obtained from its use. Furthermore, although the decline in the value of the asset through its use would be reflected in the recognised change in fair value, it might also be masked by an increase arising from changes in the market prices of the asset.

BC32 However, the Board noted that IAS 16 requires an entity to keep the expected useful life and residual values of property, plant and equipment up to date, and IAS 36 Impairment of Assets requires an immediate write-down to the higher of value in use and fair value less costs to sell. An entity should, therefore, often achieve a measurement effect for individual assets that are about to be sold under other IFRSs similar to that required by this IFRS as follows. Under other IFRSs, if the fair value less costs to sell is higher than carrying amount there will be no impairment and no depreciation (because the residual value will have been updated). If fair value less costs to sell is lower than carrying amount, there will be an impairment loss that reduces the carrying amount to fair value less costs to sell and then no depreciation (because the residual value will have been updated), unless value in use is higher than fair value less costs to sell. If value in use is higher than fair value less costs to sell, there would be small differences between the treatment that would arise under other IFRSs and the treatment under IFRS 5. Under other IFRSs there would be an impairment loss to the extent that the carrying amount exceeds value in use rather than to the extent that the carrying amount exceeds fair value less costs to sell. Under other IFRSs, there would also then be depreciation of the excess of value in use (the new carrying amount of the asset) over fair value less costs to sell (its residual value). However, for assets classified as held for sale, value in use will differ from fair value less costs to sell only to the extent of the net cash flows expected to arise before the sale. If the period to sale is short, this amount will usually be relatively small. The difference in impairment loss recognised and subsequent depreciation under other IFRSs compared with the impairment loss and no subsequent depreciation under IFRS 5 would, therefore, also be small.

BC33 The Board concluded that the measurement requirements of IFRS 5 for individual assets would often not involve a significant change from the requirements of other IFRSs. Furthermore, the Board agreed with the FASB that the cash flows arising from the asset’s remaining use were incidental to the recovery of the asset through sale and, hence, concluded that individual assets classified as held for sale should be measured at the lower of carrying amount and fair value less costs to sell and should not be depreciated.

BC34 For disposal groups, there could be greater differences between the requirements in other IFRSs and the requirements of IFRS 5. For example, the fair value less costs to sell of a disposal group may reflect internally generated goodwill to the extent that it is higher than the carrying value of the net assets in the disposal group. The residual value of the non-current assets in the disposal group may, nonetheless, be such that, if they were accounted for in accordance with IAS 16, those assets would be depreciated.

BC35 In such a situation, some might view the requirements in IFRS 5 as allowing internally generated goodwill to stop the depreciation of non-current assets. However, the Board does not agree with that view. Rather, the Board believes that the internally generated goodwill provides a buffer against the recognition of an impairment loss on the disposal group. The same effect arises from the impairment requirements in IAS 36. The non-depreciation of the non-current assets in the disposal group is, as with individual assets, a consequence of the basic principle underlying the separate classification, that the carrying amount of the asset will be recovered principally through sale, not continuing use, and that amounts recovered through continuing use will be incidental.

BC36 In addition, it is important to emphasise that IFRS 5 permits only an asset (or disposal group) that is to be sold to be classified as held for sale. Assets to be abandoned are classified as held and used until disposed of, and thus are depreciated. The Board agrees with the FASB’s observation that a distinction can be drawn between an asset that is to be sold and an asset that is to be abandoned, because the former will be recovered principally through sale and the latter through its continuing use. Therefore, it is logical that depreciation should cease in the former but not the latter case.

BC37 When an asset or a disposal group held for sale is part of a foreign operation with a functional currency that is different from the presentation currency of the group, an exchange difference will have been recognised in equity arising from the translation of the asset or disposal group into the presentation currency of the group. IAS 21 The Effects of Changes in Foreign Exchange Rates requires the exchange difference to be ‘recycled’ from equity to profit or loss on disposal of the operation. The question arises whether classification as held for sale should trigger the recycling of any exchange differences. Under US GAAP (EITF 01-5 Application of FASB Statement No. 52 to an Investment Being Evaluated for Impairment That Will Be Disposed Of) the accumulated foreign currency translation adjustments previously recognised in other comprehensive income that are expected to be recycled in income at the time of sale are included in the carrying amount of the asset (or disposal group) being tested for impairment.

BC38 In its project on reporting comprehensive income, the Board may reconsider the issue of recycling. Therefore, it did not wish to make any interim changes to the requirements in IAS 21. Hence, the IFRS does not permit any exchange differences to be recycled on the classification of an asset or a disposal group as held for sale. The recycling will take place when the asset or disposal group is sold.

The allocation of an impairment loss to a disposal group

BC39 Under SFAS 144 and the proposals in ED 4, assets within the disposal group that are not within the scope of the IFRS are adjusted in accordance with other standards before measuring the fair value less costs to sell of the disposal group. Any loss or gain recognised on adjusting the carrying amount of the disposal group is allocated to the carrying amount of the long-lived assets of the group.

BC40 This is different from the requirements of IAS 36 for the allocation of an impairment loss arising on a cash-generating unit. IAS 36 requires an impairment loss on a cash-generating unit to be allocated first to reduce the carrying amount of goodwill and then to reduce pro rata the carrying amounts of the other assets in the unit.

BC41 The Board considered whether the allocation of an impairment loss for a disposal group should be consistent with the requirements of IAS 36 or with the requirements of SFAS 144. The Board concluded that it would be simplest to require the same allocation as is required by IAS 36 for cash-generating units. Although this is different from SFAS 144, the disposal group as a whole will be measured at the same amount.

Newly acquired assets

BC42 SFAS 144 requires, and ED 4 proposed, newly acquired assets that meet the criteria to be classified as held for sale to be measured at fair value less costs to sell on initial recognition. So, in those instances, other than in a business combination, in which an entity acquires a non-current asset that meets the criteria to be classified as held for sale, a loss is recognised in profit or loss if the cost of the asset exceeds its fair value less costs to sell. In the more common cases in which an entity acquires, as part of a business combination, a non-current asset (or disposal group) that meets the criteria to be classified as held for sale, the difference between fair value and fair value less costs to sell is recognised in goodwill.

BC43 Some respondents to ED 4 noted that measuring newly acquired assets not part of a business combination at fair value less costs to sell was inconsistent with the general proposal that assets classified as held for sale should be measured at the lower of carrying amount and fair value less costs to sell. The Board agreed and amended the requirement so that it is clear that the newly acquired assets (or disposal groups) are measured on initial recognition at the lower of what their carrying amount would be were they not classified as held for sale (ie cost) and fair value less costs to sell.

BC44 In relation to business combinations, the Board noted that conceptually the assets should be recognised initially at fair value and then immediately classified as held for sale, with the result that the costs to sell are recognised in profit or loss, not goodwill. In theory, if the entity had factored the costs to sell into the purchase price, the reduced price would lead to the creation of negative goodwill, the immediate recognition of which in profit or loss would offset the loss arising from the costs to sell. Of course, in practice, the reduced price will usually result in lower net positive goodwill rather than negative goodwill to be recognised in profit or loss. For that reason, and for the sake of convergence, the Board concluded that in a business combination non-current assets that meet the criteria to be classified as held for sale on acquisition should be measured at fair value less costs to sell on initial recognition.

BC45 The Board and the FASB are considering which items should form part of the business combination transaction more generally in their joint project on the application of the purchase method. This consideration includes whether the assets and liabilities recognised in the transaction should be based on the acquirer’s or the acquiree’s perspective. The outcome of those deliberations may affect the decision discussed in paragraph BC44.

Recognition of subsequent increases in fair value less costs to sell

BC46 The Board considered whether a subsequent increase in fair value less costs to sell should be recognised to the extent that it reversed previous impairments. SFAS 144 requires the recognition of a subsequent increase in fair value less costs to sell, but not in excess of the cumulative loss previously recognised for a write-down to fair value less costs to sell. The Board decided that, under IFRSs, a gain should be recognised to the extent that it reverses any impairment of the asset, either in accordance with the IFRS or previously in accordance with IAS 36. Recognising a gain for the reversal of an impairment that occurred before the classification of the asset as held for sale is consistent with the requirement in IAS 36 to recognise reversals of impairment.

Recognition of impairment losses and subsequent gains for assets that, before classification as held for sale, were measured at revalued amounts in accordance with another IFRS

BC47 ED 4 proposed that impairment losses and subsequent gains for assets that, before classification as held for sale, were measured at revalued amounts in accordance with another IFRS should be treated as revaluation decreases and increases according to the standard under which the assets had previously been revalued, consistently with the requirements of IAS 36, except to the extent that the losses and gains are caused by the initial recognition of, or changes in, costs to sell. ED 4 also proposed that costs to sell should always be recognised in profit or loss.

BC48 Many respondents disagreed with these proposals, because of their complexity and because of the resulting inconsistent treatment of assets classified as held for sale. The Board considered the issues raised and decided that assets that were already carried at fair value with changes in fair value recognised in profit or loss should not be subject to the measurement requirements of the IFRS. The Board believes that, for such assets, continued measurement at fair value gives better information than measurement at the lower of carrying amount and fair value less costs to sell. The Board did not, however, believe that such treatment was appropriate for assets that had been revalued in accordance with IAS 16 and IAS 38, because those standards require depreciation to continue and the revaluation change would not necessarily be recognised in profit or loss. The Board concluded that assets that had been revalued in accordance with IAS 16 and IAS 38 should be treated in the same way as any assets that, before classification as held for sale, had not been revalued. Such an approach results in a consistent treatment for assets that are within the scope of the measurement requirements of the IFRS and, hence, a simpler standard.

Measurement of assets reclassified as held for use

BC49 Under SFAS 144, when an entity changes its plan to sell the asset and reclassifies a long-lived asset from held for sale to held and used, the asset is measured at the lower of (a) the carrying amount before the asset (or disposal group) was classified as held for sale, adjusted for any depreciation (or amortisation) that would have been recognised had the asset (or disposal group) been continuously classified as held and used and (b) its fair value at the date of the decision not to sell.

BC50 The underlying principle is to restore the carrying value of the asset to what it would have been had it never been classified as held for sale, taking into account any impairments that may have occurred. In fact, SFAS 144 requires that, for held and used assets, an impairment is recognised only if the carrying amount of the asset exceeds the sum of the undiscounted cash flows expected to result from its use and eventual disposal. Thus, the carrying amount of the asset if it had never been classified as held for sale might exceed its fair value. As a result, SFAS 144 does not necessarily lead to the asset reverting to its original carrying amount. However, the Basis for Conclusions on SFAS 144 notes that the FASB concluded it would be inappropriate to write up the carrying amount of the asset to an amount greater than its fair value solely on the basis of an undiscounted cash flow test. Hence, it arrived at the requirement for measurement at the lower of (a) the asset’s carrying amount had it not been classified as held for sale and (b) fair value at the date of the decision not to sell the asset.

BC51 IAS 36 has a different measurement basis for impaired assets, ie recoverable amount. The Board concluded that to be consistent with the principle of SFAS 144 and also to be consistent with the requirements of IAS 36, an asset that ceases to be classified as held for sale should be measured at the lower of (a) the carrying amount that would have been recognised had the asset not been classified as held for sale and (b) its recoverable amount at the date of reclassification. Whilst this is not full convergence, the difference arises from differences in the US GAAP and IFRS impairment models.

Removal of exemption from consolidation for subsidiaries acquired and held exclusively with a view to resale_________________________________________________________________________________________

BC52 SFAS 144 removed the exemption from consolidation in US GAAP for subsidiaries held on a temporary basis on the grounds that all assets held for sale should be treated in the same way, ie as required by SFAS 144 rather than having some assets consolidated and some not.

BC53 The Board agreed that all subsidiaries should be consolidated and that all assets (and disposal groups) that meet the criteria to be classified as held for sale should be treated in the same way. The exemption from consolidation in IAS 27 Consolidated and Separate Financial Statements for subsidiaries acquired and held exclusively with a view to resale prevents those assets and disposal groups within such subsidiaries that meet the criteria to be classified as held for sale from being treated consistently with other assets and disposal groups. ED 4 therefore proposed that the exemption in IAS 27 should be removed.

BC54 Some respondents disagreed with this proposal, on the grounds that the information provided by consolidation of such subsidiaries would be less useful than that provided by the current requirement to measure the investment in such subsidiaries at fair value. The Board noted that the impact of the proposals in ED 4 would be limited to the following:

(a) the measurement of a subsidiary that currently is within the scope of the exemptions would change from fair value as required by IAS 39 to the lower of cost and fair value less costs to sell.

(b) any change in fair value of the investment in the subsidiary would, in accordance with the current requirements in IAS 27, be presented as a single amount in profit or loss as a held-for-trading financial asset in accordance with IAS 39. As discussed in paragraph BC72, the subsidiary would be a discontinued operation and, in accordance with the IFRS’s requirements (see paragraphs BC73-BC76), any recognised change in the value of the disposal group that comprises the subsidiary would be presented as a single amount in profit or loss.

(c) the presentation in the balance sheet would change from a single amount for the investment in the subsidiary to two amounts—one for the assets and one for the liabilities of the disposal group that is the subsidiary*.

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* Greater disaggregation of the disposal group on the face of the balance sheet is permitted but not required.

BC55 The Board reaffirmed its conclusion set out in paragraph BC53. However, it noted that the limited impact of the proposals apply only to the amounts required to be presented on the face of the balance sheet and the income statement. Providing the required analyses of those amounts in the notes could potentially involve the entity having to obtain significantly more information. The Board therefore decided not to require the disclosure of the analyses of the amounts presented on the face of the balance sheet and income statement for newly acquired subsidiaries and to clarify in an example the computational short cuts that could be used to arrive at the amounts to be presented on the face of the balance sheet and income statement.