Part A: Accounting
Accounting for assets and liabilities
Key takeaways
- Financial instruments are measured at amortised cost, at fair value through surplus or deficit, or at fair value through net assets, depending on the entity's business model and the instrument's cash-flow characteristics.
- A cash-generating asset is impaired when its carrying amount exceeds its recoverable amount, the higher of fair value less costs to sell and value in use.
- A non-cash-generating asset is held to deliver a service, not to earn cash, so its impairment is measured on service potential, for example by depreciated replacement cost.
- Under the right-of-use model a lessee recognises a right-of-use asset and a lease liability for most leases, then charges interest and depreciation instead of a single rental expense.
- A lessor still classifies each lease as operating or finance, depending on whether substantially all the risks and rewards of ownership are transferred.
Authority for this chapter
IPSAS 45 (Property, Plant and Equipment, effective 1 January 2025, replacing IPSAS 17), IPSAS 12 (Inventories), IPSAS 43 (Leases, effective 1 January 2025, replacing IPSAS 13), IPSAS 21 and IPSAS 26 (impairment of non-cash-generating and cash-generating assets), IPSAS 19 (Provisions, Contingent Liabilities and Contingent Assets), IPSAS 31 (Intangible Assets), IPSAS 39 (Employee Benefits) and IPSAS 41 (Financial Instruments); section 72 of the PFM Act for the accounting officer's asset register.
Financial instruments
Building on the definitions and recognition covered in Public Sector Accounting and Reporting I, financial instruments are measured at one of the following, depending on the entity's business model and the instrument's cash-flow characteristics:
- Amortised cost
- Fair value through surplus/deficit
- Fair value through net assets
Impairment of non-cash-generating assets
Non-cash-generating assets, most public-sector infrastructure and service assets, are impaired based on their service potential rather than cash flows, since they were never held to generate cash in the first place, using indicators specific to the public sector (obsolescence, physical damage, a significant long-term decline in demand for the service the asset provides).
Impairment of cash-generating assets
Cash-generating assets, held with the primary objective of generating a commercial return, are impaired where their carrying amount exceeds their recoverable amount (the higher of fair value less costs to sell and value in use), following an approach closer to private-sector impairment testing.
Impairment loss
Impairment loss = Carrying amount - Recoverable amount; Recoverable amount (cash-generating) = higher of Fair value less costs to sell and Value in use
- Carrying amount
- The asset's amount in the statement of financial position before the impairment test
- Value in use
- The present value of the future cash flows expected from the asset
Worked computation: impairing a cash-generating and a non-cash-generating asset (not a decided case)
Cash-generating asset. A state corporation's toll-road concession asset has a carrying amount of KES 30,000,000. Its fair value less costs to sell is assessed at KES 24,000,000, and the present value of its future toll cash flows (value in use) is assessed at KES 26,000,000.
Non-cash-generating asset. A public clinic building, held purely for service delivery with no commercial return, has a carrying amount of KES 33,000,000. Because it generates no cash flows, impairment is instead assessed on the depreciated replacement cost approach: an equivalent new facility would cost KES 40,000,000 to build today, and an amount of KES 12,000,000 is deducted to reflect the existing building's age, wear and reduced remaining service capacity.
The recoverable amount of the toll-road asset is the higher of the two, KES 26,000,000, so the impairment loss is measured against it:
Cash-generating asset: impairment loss
| KES | KES | |
|---|---|---|
| Carrying amount | 30,000,000 | |
| Less: recoverable amount (value in use) | 26,000,000 | |
| Impairment loss, recognised in surplus or deficit | 4,000,000 |
Non-cash-generating asset: depreciated replacement cost
| KES | KES | |
|---|---|---|
| Cost of an equivalent new facility | 40,000,000 | |
| Less: deduction for age, wear and reduced remaining service capacity | 12,000,000 | |
| Giving a depreciated replacement cost of | 28,000,000 |
Non-cash-generating asset: impairment loss
| KES | KES | |
|---|---|---|
| Carrying amount | 33,000,000 | |
| Less: depreciated replacement cost | 28,000,000 | |
| Impairment loss | 5,000,000 |
The loss is recognised the same way, in surplus or deficit, even though the measurement approach behind it is entirely different from the cash-generating example.
Leases
Under a right-of-use model, a lessee recognises a right-of-use asset and a corresponding lease liability for most leases, replacing the older distinction between operating and finance leases for the lessee's own accounting, while a lessor continues to classify leases as operating or finance depending on whether substantially all the risks and rewards of ownership are transferred.
Worked computation: initial measurement of a lease liability and right-of-use asset (not a decided case)
A county government leases specialised medical equipment for 5 years, paying KES 3,000,000 at the end of each year; its incremental borrowing rate is 10%.
The lease liability, and the corresponding right-of-use asset, is initially measured at the present value of the lease payments: PV = 3,000,000 x [1 - (1.10)^-5] / 0.10 = 3,000,000 x 3.7908 = KES 11,372,360.
In year 1, interest expense on the lease liability = 11,372,360 x 10% = KES 1,137,236, and, if the right-of-use asset is depreciated on a straight-line basis over the 5-year lease term, annual depreciation = 11,372,360 / 5 = KES 2,274,472; the county therefore recognises both an interest expense and a depreciation expense each year, rather than a single lease rental expense as under the old operating-lease treatment.
Ask what the asset was held for before choosing an impairment approach
Cash-generating versus non-cash-generating impairment is a distinctly public-sector distinction with no clean private-sector parallel: ask first whether the asset was held to generate cash (use fair value less costs to sell or value in use) or to deliver a service (use a service-potential approach such as depreciated replacement cost). That answers which impairment approach applies before any calculation begins, exactly as the two halves of the worked example above show side by side.
Self-check
(a) A cash-generating asset has a carrying amount of KES 18,000,000, a fair value less costs to sell of KES 14,000,000 and a value in use of KES 15,500,000. Compute the recoverable amount and the impairment loss, if any. (4 marks)
(b) Explain why a non-cash-generating asset cannot be impairment-tested using value in use, and name the alternative approach commonly used instead. (3 marks)
(c) A ministry leases office equipment for 4 years at KES 2,500,000 a year, with a discount rate of 8%. Compute the initial lease liability (to the nearest shilling), using an annuity factor of 3.3121 for 4 years at 8%. (4 marks)
(d) State the accounting treatment the right-of-use model requires a lessee to apply, and how it differs from the old operating/finance lease distinction. (4 marks)
Show worked answer
(a) Recoverable amount = higher of 14,000,000 and 15,500,000 = KES 15,500,000. Impairment loss = 18,000,000 - 15,500,000 = KES 2,500,000 (4 marks).
(b) Value in use is the present value of future cash flows the asset generates, but a non-cash-generating asset is not held to generate cash at all, so no such cash flows exist to discount; the depreciated replacement cost approach (or another service-potential measure) is used instead (3 marks).
(c) Lease liability = 2,500,000 x 3.3121 = KES 8,280,250 (4 marks).
(d) The lessee recognises a right-of-use asset and a corresponding lease liability for substantially all leases, replacing the old distinction between an operating lease (off-balance-sheet, a rental expense only) and a finance lease (on-balance-sheet); under the new model almost every lease is brought onto the statement of financial position for the lessee, with separate interest and depreciation charges rather than a single rental expense (4 marks).