Purchase of Property Plant and Equipment on “Deferred Credit Terms” – Ind AS 16 & IAS 16

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Many manufacturing and other start-ups get into a transaction in which they seek additional credit terms while purchasing goods and services. Entities especially seek additional credit terms while purchasing a property plant and equipment (“PPE”).

Let’s understand the impact of “deferred credit terms” or indirect financing arrangement, on the initial recognition of the cost of a PPE, through a case study:

A. Facts of the case:

An Entity ABC Ltd, purchases machinery for INR 50 Lakhs (cash price) from its supplier PQR Ltd. PQR Ltd generally provides 1 month credit period to its customers and provides a 2% cash discount on payment within 15 days. In the given case, ABC Ltd requests an additional credit period of 6 months (“deferred credit terms” or financing arrangement) from PQR Ltd on the purchase. PQR Ltd, seeing the potential of ABC Ltd being a customer from which material future revenue can be generated, accepts the proposal and gives a credit period of 7 months.

B. Query:

At what amount will the machinery be initially recognized in the books of ABC Ltd in the following cases:

(i) If the sale price is increased to INR 51.5 Lakhs by PQR Ltd as a response to the increased credit period provided.

(ii) If the sale price remains the same ie INR 50 Lakhs, even after providing the additional credit period.

C. Analysis and Conclusions:

Ind AS 16 defines PPE as tangible items that:

1. are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and

2. are expected to be used during more than one period.

Ind AS 16 requires a PPE to be recognized at “cost” at the time of initial recognition. The elements of “cost” comprises of the following:

1. The purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates.

2. Any costs are 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.

3. The initial estimate of the cost of dismantling and removing the item and restoring the site on which it is located.

The first element of “cost”, the “purchase price” generally comprises the amount at which a PPE is invoiced by the supplier to the entity.

Paragraph 23 of Ind AS 16 and IAS 16 states that “If payment is deferred beyond normal credit terms, the difference between the cash price equivalent and the total payment is recognized as interest over the period of credit unless such interest is capitalized in accordance with Ind AS 23 & IAS 23 – Borrowing Cost”.

In the given facts of the case PQR Ltd gives an additional credit period of 6 months (“deferred credit terms”), which is beyond its normal credit terms.

Query B(i):

The amount charged for the machinery is INR 51.5 Lakhs i.e., INR 1.5 Lakhs above the normal cash price (at normal credit terms). This additional amount cannot be capitalized as the cost of PPE but will be taken to the statement of Profit and Loss as interest expense over the period of 7 months and the PPE will be initially recognized at INR 50 Lakhs.

This recognition of interest cost will be done even if the contract between ABC Ltd and PQR Ltd does not specifically talk about the deferred / additional credit period or any financing arrangement. Also, the provision of Ind AS 23 & IAS 23 - Borrowing cost will have to be applied if the machinery is a “qualifying asset” as per the standard.

Query B(ii):

The amount charged for the machinery is INR 50 Lakhs i.e., at the cash price (at normal credit terms), in spite of the additional / deferred credit terms. In this case, the PPE will be initially recognized at INR 50 Lakhs and no interest cost will be recognized.

Note to Auditors:

While verifying the additions to PPE in a financial year, also verify and document the credit period received from the supplier, enquire if any deferred/additional credit period is received from the supplier and the corresponding accounting is done correctly. As an additional procedure for material additions in PPE, we also need to accumulate corroborative evidence for the normal credit period provided by the supplier, from its website or any other source. It would be an effective procedure to confirm with the supplier about the deferred / additional credit period provided by the supplier or find out the credit period provided by the supplier and compare it with the credit period received by the entity.

This article has been published in the Chartered Accountant Study Circle ("CASC") Bulletin.