How to account for free assets received under IFRS
The best things in life are free…
… at least that’s what Janet Jackson sang in one of her top hits.
However, when your company receives some free assets, then the question is:
Are they really received at no cost and no strings attached?
Is there something else behind?
Many years ago I attended the counting of fixed assets in one big manufacturing company.
It was a freezing December morning, huge piles of snow made it quite difficult to get around and we were sneaking in and counting various types of machines in the client’s storage.
One of my colleagues spotted some cooling units, new – still unpacked, and he could not find them in the document with the register of fixed assets, so he asked:
“ Why are these cooling units not recorded in the register?”
The boss of the warehouse, a bored grey-haired guy, murmured with the tobacco pipe between his teeth something like:
“Oh gosh. We did not buy them. We got them free when we purchased the machines.”
Sorry, I don’t remember now what machines they purchased, but I remember the discussion with the accounting manager that followed.
So what should you do in a similar situation, when you receive some free assets?
In this article I try to tackle this quite frequent issue and give you some hints.
Before you start: Is it material?
You need to apply your judgment to assess whether your free asset received is material enough to bother.
For example – when you receive pens, lighters or other promotional materials, they might not make any difference in your books, so just don’t worry about their accounting.
The same applies in a multibillion dollar company that pays monthly telecom plans for their 100 executives and receives 100 mobile phones at no cost from the network provider.
Is their aggregate amount material?
If not, just don’t bother.
If yes, continue reading.
The starting point: Why did you receive your free asset?
Let’s say you received a significant asset.
For example, some piece of equipment, free land or something like that.
The first thing you need to examine is why and who the donor was.
What is the substance of this transaction?
Even more important: Whom did you receive the free asset from?
The accounting treatment will then depend on your answer.
Let me analyze a bit here.
#1: Free asset from governmentIf you received a free asset as a form of government grant, then the accounting is clear – you need to follow IAS 20 Accounting for Government Grants and Disclosure of Government Assistance.
What counts as “a government”?
Besides government, also government agencies and similar local, national or international bodies count as “government” for the purpose of IAS 20.
So, even if you received your grant from IMF, EU, WHO or similar organizations, you need to follow IAS 20.
#2: Free asset from your supplierYou can receive free assets from your suppliers for a number of reasons and in a number of ways.
The question is: Did you receive a free asset as a part of some contract, together with the purchase of something else?
If yes, then you might need to allocate a part of total purchase price to the “free asset”.
Example: Free asset from a supplier
Let’s say you enter into a contract with a supplier to acquire 3 big pieces of machinery and the contract says that the total price is CU 3 000 for those 3 pieces (CU 1 000 each).
And, the contract says that the supplier will deliver also a cooling unit (=separate asset) at no additional cost.
A big mistake that many companies make is that they do not recognize a free asset at all.
However, the Conceptual Framework for Financial Reporting asks you to report any asset that you control.
Thus, it is a misstatement if you ignore your free asset, you use it – but you do not show it in your financial statements.
So what to do in this case?
Well, you should measure the free asset – a cooling unit in this case – at its cost.
The total cost for 3 machines and 1 cooling unit is CU 3 000, so you should allocate this total purchase price to all assets based on their fair values, or current selling prices if they are new.
Let’s say that the similar cooling unit trades for CU 300.
Then the total of selling prices is CU 3 300 (3 000 for machines and 300 for cooling unit).
Thus you allocate CU 909 to each machine (= CU 1 000/3 300 * 3 000) and CU 273 to the cooling unit (= CU 300/3 300*3 000). Total allocated cost is 909*3+273 = CU 3 000.
Now, many might think that it is not OK since the cost of one machine is CU 1 000.
Well, the standard IAS 16 says that the cost is the purchase price less discount and “free” cooling unit is a sort of a discount, don’t you think?
Another case of free assets received from suppliers is when you receive an asset as a gift for your long-term loyalty or a support of a promotional campaign.
For example, a supplier might sponsor the renovation of your shop and display area.
In this case, it would be very hard and impracticable to allocate a part of purchase price of other products to this free asset.
Therefore, you need to adopt different solution. Just go on reading.
#3: Free asset from your customerHere, there’s a similar question as with suppliers: Is a free asset received under some contract with your customer?
If yes, then you might need to apply IFRS 15 Revenue from Contracts with Customers and assess the situation carefully (IFRIC 18 applied in the past).
In this case, when you receive a free asset from your customer within some contract, is it considered as non-cash consideration.
The article IFRS 15.66 requires including the fair value of non-cash consideration in the transaction price.
Example: Free asset from customer
Let’s say that you enter into a contract with a manufacturing company to process some wood for their one-off project.
You agree that you will use the client’s wood processing machine.
The contract specifies that the price for the wood processing is CU 1 000 and you can keep the machine (since the client will not need it anymore and it is not new).
Let’s say that the fair value of a machine is CU 300.
Thus your transaction price is CU 1 300 and you will recognize the machine at its fair value of CU 300 (it then becomes machine’s cost) at the moment when you gain the full control of a machine.
When that happens?
It depends on the specifics of the contract – sometimes it may happen right in the start of executing the contract (e.g. you take the machine to your premises and work there), sometimes it may happen in a different time (e.g. when you can use the machine only at your client’s premises and take it only after the contract is executed).
If you receive a free asset from a customer outside any contract, then again, you need to find a different solution. Read on!
#4: Free asset received from your shareholderShareholders often give free assets to their investees.
We can regularly see big transfers of various types of assets, including machinery, lands and sometimes buildings from a parent to its subsidiary.
In this case, if you gain control of an asset, you should recognize it at fair value – which becomes its cost.
As this is a contribution from shareholder, you should NOT recognize it as an income in your profit or loss.
Conceptual Framework strictly excludes contributions from shareholders from the definition of income.
Instead, the shareholder increases its investment in a subsidiary and a subsidiary shows the receipt of a free asset directly in equity as a capital contribution from a shareholder.
#5: Free asset received from other partiesYes, it may occasionally happen.
You can receive a free asset from anybody as a gift, with no strings attached.
One example comes to my mind from the past: a hospital receiving USG and other machines from a cancelled hospital at no cost.
In this case, you need to develop your own accounting policy, because IFRS do not contain any guidance on how to do it.
And, I would say that this applies also to free assets received from your suppliers or customers where it is impossible or impracticable to match these free assets with any contracts.
We need to develop the accounting policy based on the similar rules in other standards and the Framework.
What are the closest similar rules?
Yes, you guessed it – the standard IAS 20 that applies for government grants.
Let me give you a few considerations here:
- First of all – you need to show assets that you control. I have already wrote that above.
- Secondly – as you have no cost, the fair value concept applies here.
- You should not show the receipt of your free asset directly in the equity because it does not come from your shareholder.
Analogically, IAS 20 strictly prohibits accounting for grants straight in equity, so we should be consistent with this rules when forming the accounting policy in this case.
Now, this is the hardest part – how should you recognize the free asset that you received?
In other words – what is the credit entry?
Here, I would show the credit entry as income in profit or loss.
Not the revenue, because the revenue comes from ordinary course of business.
The journal entry looks something like that:
- Debit PPE – asset: fair value
- Credit Profit or loss – other income: fair value
Why not deferred income with subsequent amortization of a deferred income in profit or loss?
OK, I know that it is the treatment required by IAS 20 for government grants, however:
In this case, there are no strings attached in a sense that you do not have to hold the free asset and use it.
You do not have any conditions attached to the receipt of a free asset, right?
Therefore I believe that the receipt of your free asset indeed represents an increase in your net assets at the moment when you receive the asset and your financial statements should reflect that increase.
If you recognize your free asset in deferred income (liability in the balance sheet), then you are not showing the increase in your net assets.
Also, someone might argue that you are not in line with matching concept because you are not matching the income (receipt of a free asset) with the expenses (its depreciation).
Well, let me explain that IFRS do NOT contain anything like general matching concept – not at all.
But, IFRS tell you to recognize expenses when the relevant service or asset was consumed (thus together with the depreciation).
Also, IFRS tell you that the income “is recognized in the income statement when an increase in future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably” (see Conceptual Framework).
Thus it is perfectly OK and in line with the Conceptual Framework to recognize an income from the receipt of a free asset when it is received and not over its useful life with amortization.
Why is it different from the treatment of government grants under IAS 20?
Well, exactly as I wrote above – government gives you grants (free assets or cash) for some purpose.
In most cases, you need to meet certain conditions to get the grant and afterwards.
Therefore receipt of a free asset from anyone else is different, especially if there are no strings attached.
If you receive free asset from an entity other than government and there ARE conditions attached to it, then of course, IAS 20 treatment (via deferred income) is more suitable policy choice in this case.
Any questions or comments?
Please let me know below – thank you!
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