Gross profit or gain on sale of PP&E

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pub_acco
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Gross profit or gain on sale of PP&E

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Assume an entity has a production (of something) division and a building construction division and plans to close a production factory to build an office building for sale on the factory site. The entity at some point reclassifies the land from PP&E to Inventories and then sells it together with the office building. The book value of the land is 10 while the fair value of it is 1,000,000. The construction cost of the building is 100,000 and the selling price of the land + building is 1,150,000.

My question is how to present the 1,150,000 income and 1,049,990 profit on the face of income statement. Building construction is a serious business for the entity, so the 1,150,000 income should be included in the top line revenue, but presenting the 1,049,990 profit as Gross Profit considerably misleads the readers of financial statements. We might be able to split the profit into 50,000 Gross Profit and 999,990 Gain on Sale of PP&E, but this approach sounds a little bit arbitrary, and is counterintuitive in that an inter company transfer of the land from the production division to the construction division shows up on the entity's consolidated financial statements.

I think IFRS doesn't answer to this kind of question. How would you develop an accounting policy for this sort of transactions?

This case could sound bizarre but is a real story. An old conglomerate could own unrelated businesses as well as a century-old land recorded at a historical price.
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Marek Muc
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Re: Gross profit or gain on sale of PP&E

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I would choose between two approaches:

1. Don't allocate anything to gain on disposal of PP&E. The reclassification to inventory was genuine. You could have held that land in inventory for many years as well which would result in very high margin too

2. You can allocate the price to land and building based on relative fair values, and accordingly show substantial gain on disposal of PP&E. This isn't arbitrary as long as you have unbiased estimation of fair value.

didn't get the below, what do you mean? segment reporting?:
an inter company transfer of the land from the production division to the construction division shows up on the entity's consolidated financial statements.
pub_acco
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Re: Gross profit or gain on sale of PP&E

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Thank you, Marek!

It's a good point that the construction business can also produce a very high margin by holding the land as Inventories for years. Yeah, perhaps the fluctuation of fair value of lands is a built-in risk to the construction segment and thus it might be appropriate to present the unusual gross profit on the face of income statements (though detailed explanation in Footnotes should be highly encouraged). I'm currently leaning toward this approach because I'm not fully sure if the second approach can pass IAS 1.55A(a) (subtotals be comprised of IFRS figures) to present Gross Profit.
pub_acco wrote: 14 Jan 2021, 14:53an inter company transfer of the land from the production division to the construction division shows up on the entity's consolidated financial statements.
Actually, the production and construction divisions are separate subsidiaries that prepare their respective separate financial statements, so I see the huge disposal gain in the production sub's FS and eliminate/defer it through the consolidation process until the office building is sold. That was why I just felt it counterintuitive to present the eliminated figure on the consolidated FS.
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Marek Muc
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Re: Gross profit or gain on sale of PP&E

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I'm not sure why you think that the first approach would result in gross profit being comprised of non-IFRS figures. Gain on disposal of assets (the disposal of land treated as a fixed asset all the way to the final transaction with external party) would be shown as a separate IFRS line below gross profit

re. intercompany - in the second approach, it wouldn't be an intercompany gain on fixed asset disposal that would be shown in consolidated FS. It actually does not matter at all that the land was sold from one subsidiary to another. Even if this land was held by the parent entity, but used as a production facility, the presentation dilemma would be exactly the same
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Re: Gross profit or gain on sale of PP&E

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Thanks! As for IFRS/non-IFRS figures, I was more concerned about Cost of sales in the second approach. Cost of sales is usually understood as the amount of inventories expensed, and in the example case, the book value of the land as an inventory is still 10. I don't think there is a standard that permits to state the inventory land at 1,000,000, so it could violate IAS 1.55A; otherwise, I would have to disclose the amount of inventories expensed in the footnote in accordance with IAS 2.36(d).
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Re: Gross profit or gain on sale of PP&E

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but under the second approach, you would treat the land as PP&E that is sold together with inventory (i.e. new building),

so the cost of sales would not include cost of land, because the sale of land would be shown as disposal of non-current assets together with allocated proceeds
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Re: Gross profit or gain on sale of PP&E

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Aha, I missed your point! Yeah, that's another sensible approach I hadn't thought of at all. So, now I'm convinced that there are perhaps only two possible approaches under IFRS. Now IMO the second approach better presents the economic substance but probably I need to go for the first one because the management wants the gross 1,150,000 to affect the top line revenue :? Thanks!
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Re: Gross profit or gain on sale of PP&E

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no wonder :)

but this approach is also acceptable IMO so nobody's going to go to prison ;)
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Re: Gross profit or gain on sale of PP&E

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Marek Muc wrote: 22 Jan 2021, 15:07 nobody's going to go to prison ;)
Good news :lol:
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