Question Marks
2014 8th Issue
Reclassification between
tangible assets and
inventories Six of one and
half a dozen of the other
The topicality of this issue of our newsletter on the
rules of the Act on Accounting is provided by the
amendment to the Act on Accounting promulgated
on 26 November 2014. The amendment specifies
the date when a reclassification between tangible
assets and inventories is required.
Initial classification
Many decisions have to be made upon purchasing an asset,
including that relating to the purpose for which the asset is
purchased. Under the provisions of the Act on Accounting,
if the asset serves the companys activities on a long-term
basis, for at least one year, then it shall be recorded under
fixed assets (among intangible and tangible assets). In
contrast, if the asset is acquired for the purpose of resale
in the course of regular (normal) business operations and
it remains unaltered before being sold, it shall be recorded
as goods under inventories. If the asset is to be used for
the production of products to be sold or during the supply
of services, it shall be recorded as raw materials under
inventories. The Act on Accounting requires that tangible
assets (tools, instruments, equipment, fittings, work clothing,
uniforms, protective clothing) serving the companys
activities for a period of not more than one year, as well as
assets reclassified from fixed assets, are to be classified as
inventories. Assets acquired or produced for the purpose of
sale, which the company uses on a temporary basis prior to
their sale (disposal) have to be shown under goods from the
date of being put into use.
Based on the above, generally it is easy to decide in which
balance sheet caption the asset shall be presented; however,
there may be cases in practice over which accountants may
ponder.
One such case is when the purpose of acquisition has not yet
been determined when the asset is purchased. For example,
a company developing and trading in real estate buys land
and plans to construct a property held for lending, but it is
not yet decided whether the company will sell the property
upon completion or own/operate it going forward. Future
utilisation of the property will depend on market conditions. In
this case, should the asset be recorded in the balance sheet
as a tangible asset, considering that it was not purchased
specifically for resale?
Question Marks / 2014 8 th Issue 2014 KPMG Hungria Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent
member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
Classification may not be obvious either when the asset
is purchased for dual purpose. For example, a vehicle or
photocopier purchased is leased out for a time, then at the
end of the lease term it is sold. The asset is purchased partly
for resale, but it is used on a long-term basis to provide
services before it is sold. In light of this, should the asset
be recognised as a tangible asset during the period of lease
and sold as a tangible asset, or should it be reclassified into
inventories at the end of the lease term? Or should it be
recorded under inventories already upon purchase? Can the
companys business model be a consideration? For example,
leasing out the asset and selling it at the end of the lease term
or treating the lease as being temporary until an appropriate
buyer is found? Does it determine the case if the lessee has
an option to buy? A similar question may arise also in the
case of purchase of land, where a car park is operated until
the development of the property to be constructed for sale is
completed or the land is sold.
In the case of certain assets it may be difficult to determine
whether the asset is used for a period of less or more than
one year. Such assets may be, for example, certain tools
which may be very valuable. Depending on the intensity of
use, the tool may become worn out within one year, but it
also may remain usable after one year. If the expected period
of use cannot be determined individually with due accuracy,
should the average period of useful lives of such assets
be taken into account to determine whether it should be
capitalised as a tangible asset?
Reclassification
In practice it may sometimes happen that the use or purpose
of the asset capitalised as a tangible asset upon purchase
changes, for example the company wants to sell the
asset, but free transfer or removing from use, or scrapping
may occur. A production machine typically has to be shut
down and dismantled in order to prepare it to be sold and
transported; but does this matter if the machine has been
Question Marks / 2014 8 th Issue
shut down and dismantled only after an agreement on the
sale of the machine has been reached with the buyer? Real
estate can even be sold while used, for example, while it is
leased out; additionally, when a business is sold the use of
assets need not be discontinued in order to sell the business
together with its assets.
While it is supposed to occur less frequently, the purpose of
an asset classified as an item of inventory upon purchase may
also change and the company may decide subsequently to
use it on a long-term basis instead of selling it.
All of the above raises the question whether in these cases
the asset should be reclassified between tangible assets and
inventories and as of what date. According to the provisions
of the Act on Accounting effective so far, if the use or purpose
of an asset has changed after its initial classification, because
the asset no longer serves the relevant activities or operations
on a long term basis, or vice versa, its classification shall be
changed accordingly, i.e. the fixed asset must be reclassified
as a current asset, or vice versa. However, the Act on
Accounting does not provide any guidance as to what shall
be deemed a change in use or purpose and the date of
reclassification. For example, is the decision on sale relevant?
Consider that all sales are preceded by a decision on sale, but
then all intangible and tangible assets should be reclassified
before sale into inventories. Or does the purpose of the asset
change only if and when the previous use of the asset is
discontinued and the sale of the asset is intended afterwards?
Or should the classification be determined based on the
business model? In the above case of the asset purchased
for dual purpose, does the purpose of the asset change
at the end of the lease period, if the business reason was
already upon purchase that the asset would be sold at the
end of the lease period? If the use or purpose changes after
the reporting date but before the balance sheet preparation
date, does the asset need to be reclassified already as of the
reporting date?
The 2014 amendment to the Act on Accounting partly
responds to the question of the date of reclassification.
According to the amendment, assets must be reclassified
from fixed assets into current assets or vice versa, not later
than in the period of preparing the balance sheet and as of the
reporting date. However, the amendment still fails to provide
any guidance as to what should be deemed a change in use or
purpose, thus this should still be determined by the entities.
International Financial Reporting Standards (IFRSs) specify
more detailed rules on classification and reclassification of
assets. For example, a non-current asset can be considered
held-for-sale, if it is available for immediate sale in its present
Contact
Judit Boros Lszl Kajtr
Partner Partner
T: +36 1 887 7196 T: +36 1 887 7324
gnes Rak
Director
T: +36 1 887 7438
KPMG Hungria Kft.
Vci t 31. H-1134 Budapest
E: kerdojelek@kpmg.hu
condition and its sale is highly probable. This latter criterion
is met if the appropriate level of management is committed
to a plan to sell the asset, an active programme to locate a
buyer and complete the plan has been initiated, the price is
reasonable in relation to the assets current fair value, the
sale is expected to qualify for recognition as a completed
sale within one year and it is unlikely that significant changes
to the plan will be made or that the plan will be withdrawn.
Based on this, it is very rare that an asset used up to the sale
could qualify as held-for-sale. IFRSs also contain detailed
rules on reclassification between investment properties,
tangible assets and inventories. Evidence of change in use
and thus the circumstance giving rise to reclassification
is the commencement or end of owner-occupation, the
commencement of development of the property with a view
to sale or commencement of an operating lease to another
party. For lack of specific requirements it is questionable
to what extent these criteria can be applied when making
decisions on reclassification based on the Act on Accounting.
Finally, do not disregard that in addition to effects on
accounting and financial indicators, reclassification of assets
can also have tax consequences, as the sale of assets
recognised as purchased inventories (raw materials, goods)
may also have an impact on the amount of business tax and
innovation contribution; furthermore, reclassification may
influence the amount of corporation tax liability as well.
Endnote
Most entities purchase and use various assets necessary
for production and supply of services during their operation.
Decisions need to be made both upon purchase and
during the use of the assets on whether the asset should
be recognised as a fixed asset or under inventories in the
records. However, determining the classification is not always
easy. The decision may affect financial indicators as well, and
tax implications should not be disregarded.
This newsletter is not intended to discuss all possible
transactions related to this topic nor provide answers to all
questions which may arise. If you still have any uncertainties
or our newsletter provided you with food for thought,
we recommend that you contact your tax or accounting
advisor or contact us, since a thoroughly thought-over and
well-developed methodology can significantly contribute
to enabling financial statements to give a fair view of the
financial position of the company, its financial performance
and the results of its operations.
The next issue of our newsletter will discuss in detail the 2014
amendments to the Act on Accounting.
The information contained herein is of a general nature and is not intended to address the
circumstances of any particular individual or entity. Although we endeavour to provide accurate
and timely information, there can be no guarantee that such information is accurate as of the
date it is received or that it will continue to be accurate in the future. No one should act on
such information without appropriate professional advice after a thorough examination of the
particular situation.
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2014 KPMG Hungria Kft., a Hungarian limited liability company and a member firm of the
KPMG network of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.