The objective of IAS 16 is to prescribe the accounting treatment for property, plant, and equipment.
Property plant and equipment are tangible assets that:
- Are held for use in the production or supply of goods or services ,for rental to others, or for administrative purposes; and
- Are expected to be used during more than one period.
Carrying amount is the amount at which an asset is recognized after deducting any accumulated depreciation and accumulated impairment losses
Depreciation is systematic allocation of the depreciable amount of assets over its useful life.
Depreciable amount is the cost of an asset less its residual value.
Residual Value is the estimated amount that an entity can obtain when disposing of an asset after its useful life has ended. When doing this the estimated costs of disposing of the asset should be deducted.
There are essentially four key areas when accounting for property, plant and equipment:
- Initial recognition and measurement
- Derecognition (disposals)
PPE are recognized if
- It is probable that future economic benefits associated with the item will flow to the entity; and
- The cost of the item can be measured reliably.
Note: This criteria is applicable for both initial and subsequent recognition.
Aggregation and segmenting: This IAS does not provide what constitute an item of property, plant and equipment and judgment is required in applying the recognition criteria to specific circumstances or types of enterprise. That is: –
- It may be appropriate to aggregate individually insignificant items, such as moulds, tools dies, etc.
- It may be appropriate to allocate total expenditure on an asset to its component parts and
- Account for each component separately e.g. an aircraft and its engines, parts of a furnace.
PPE are initially recognized at the cost.
Elements of costs comprise:
- Its purchase price
- Any costs directly attributable to bringing the asset to the location and condition necessaryfor it to be capable of operating,
- The initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located. The present value of dismantling cost will be added to the cost of asset and provision will be created and the company will have to unwind this provision at every year-end. The amount will be recognized in statement of profit or loss as finance cost and provision will be increased in statement of financial position. This treatment is as the accounting for provision as per IAS 37, Provisions, Contingent Assets and Liabilities
- Directly attributable cost of bringing the assets to the location and condition necessary for the intended performance, e.g.
- Costs of employees benefits arising directly from the construction or acquisition of property, plant and equipment
- The cost of site preparation
- Initial delivery and handling costs
- Installation costs
- Cost of testing whether the asset is functioning properly after the net proceeds from the sale of any trial production (samples produced while testing equipment)
- Professional fees (architects, engineers)
- Borrowing costs in accordance with IAS 23, Borrowing Costs.
Where these costs are incurred over a period of time (such as employee benefits), the period for which the costs can be included in the cost of PPE ends when the asset is ready for use, even if the asset is not brought into use until a later date. As soon as an asset is capable of operating it is ready for use. The fact that it may not operate at normal levels immediately, because demand has not yet built up, does not justify further capitalization of costs in this period. Any abnormal costs (for example, wasted material) cannot be included in the cost of PPE.
IAS 16 does not specifically address the issue of whether borrowing costs associated with the financing of a constructed asset can be regarded as a directly attributable cost of construction. This issue is addressed in IAS 23, Borrowing Costs. IAS 23 requires the inclusion of borrowing costs as part of the cost of constructing the asset. In order to be consistent with the treatment of ‘other costs’, only those finance costs that would have been avoided if the asset had not been constructed are eligible for inclusion. If the entity has borrowed funds specifically to finance the construction of an asset, then the amount to be capitalised is the actual finance costs incurred. Where the borrowings form part of the general borrowing of the entity, then a capitalisation rate that represents the weighted average borrowing rate of the entity should be used. (IAS 23 discussed in detail later)
The cost of the asset will include the best available estimate of the costs of dismantling and removing the item and restoring the site on which it is located, where the entity has incurred an obligation to incur such costs by the date on which the cost is initially established. This is a component of cost to the extent that it is recognised as a provision under IAS 37, Provisions, Contingent Liabilities and Contingent Assets. In accordance with the principles of IAS 37, the amount to be capitalised in such circumstances would be the amount of foreseeable expenditure appropriately discounted where the effect is material.
Measurement of self constructed and exchanged assets
- Cost of self-constructed assets will be the cost of its production
- If an asset is exchanged, the cost will be measured at the fair value unless
- The exchange transaction lacks commercial substance or
- The fair value of neither the asset received nor the asset given up is reliably measurable. If the acquired item is not measured at fair value, its cost is measured at the carrying amount of the asset given up.
SUBSEQUENT COSTS (SUBSEQUENT RECOGNITION)
Once an item of PPE has been recognised and capitalised in the financial statements, a company may incur further costs on that asset in the future. IAS 16 requires that subsequent costs should be capitalised if:
- It is probable that future economic benefits associated with the extra costs will flow to the entity
- The cost of the item can be reliably measured.
All other subsequent costs should be recognized as an expense in the statement of profit or loss in the period that they are incurred.
MEASUREMENT SUBSEQUENT TO INITIAL RECOGNITION:
IAS 16 permits two accounting models:
- Cost Model
- Revaluation Model
Under both models, the assets are reflected in statement of financial position at carrying value.
Amount at which the asset is recognized after deducting any accumulated depreciation and accumulated impairment losses.
DEPRECIATION OF PPE
IAS 16 defines depreciation as ‘the systematic allocation of the depreciable amount of an asset over its useful life’.
‘Depreciable amount’ is the cost of an asset, cost less residual value, or other amount.
Depreciation is not providing for loss of value of an asset, but is an accrual technique that allocates the depreciable amount to the periods expected to benefit from the asset. Therefore assets that are increasing in value still need to be depreciated.
The depreciation method used should reflect the pattern in which the asset’s economic benefits are consumed by the entity; a depreciation method that is based on revenue that is generated by an activity that includes the use of an asset is not appropriate.
IAS 16 requires that depreciation should be recognised as an expense in the statement of profit or loss, unless it is permitted to be included in the carrying amount of another asset.
Depreciation begins when the asset is available for use and continues until the asset is derecognised, even if it is idle.
A number of methods can be used to allocate depreciation to specific accounting periods. Two of the more common methods, specifically mentioned in IAS 16, are the straight-line method, and the reducing (or diminishing) balance method.
- Straight line
- % on cost, or
- Cost – residual value
Useful economic life
- Reducing balance
- % on carrying value
Useful economic lives and residual value
The assessments of the useful life (UL) and residual value (RV) of an asset are extremely subjective. They will only be known for certain after the asset is sold or scrapped, and this is too late for the purpose of computing annual depreciation. Therefore, IAS 16 requires that the estimates should be reviewed at the end of each reporting period. If either change significantly, then that change should be accounted for over the remaining estimated useful economic life.
If an asset comprises two or more major components with different economic lives, then each component should be accounted for separately for depreciation purposes and depreciated over its own useful economic life.
An item of PPE shall not be carried at more than the recoverable amount. Recoverable amount is the higher of an asset’s fair value less costs to sell and its value in use (Discussed in detail later).
MODELS FOR SUBSEQUENT MEASUREMENT
The asset is carried at cost less accumulated depreciation and impairment.
The asset is carried at a revalued amount, being its fair value at the date of revaluation less subsequent depreciation and impairment, provided that fair value can be measured reliably.
The change from cost model to revaluation model is a change in accounting policy but is dealt with prospectively.
If the revaluation policy is adopted this should be applied to all assets in the entire category, i.e. if you revalue a building, you must revalue all land and buildings in that class of asset. Revaluations must also be carried out with sufficient regularity so that the carrying amount does not differ materially from that which would be determined using fair value.
- Revalued assets are depreciated in the same way as under the cost model.
Accounting for a revaluation
There are a series of accounting adjustments that must be undertaken when revaluing a non-current asset. These adjustments are indicated below.
The initial revaluation
You may find it useful in the exam to first determine if there is a gain or loss on the revaluation with a simple calculation to compare:
|Carrying value of non-current asset at revaluation date||X|
|Valuation of non-current asset||X|
|Difference = gain or loss revaluation||X|
Gain on revaluation should be credited to other comprehensive income and accumulated in equity under the heading “revaluation surplus” unless it represents the reversal of a revaluation decrease of the same asset previously recognized as an expense, in which case it should be recognized as income.
- Dr Non-current asset cost (difference between valuation and original cost/valuation)
- Dr Accumulated depreciation (with any historical cost accumulated depreciation)
- Cr Revaluation reserve (gain on revaluation)
A loss on revaluation should be recognized as an expense to the extent that it exceeds any amount previously credited to the revaluation surplus relating to the same asset.
A revaluation loss should be charged against any related revaluation surplus to the extent that the decrease does not exceed the amount held in the revaluation reserve in respect of the same asset. Any additional loss must be charged as an expense in the income statement.
- Dr Revaluation reserve (to maximum of original gain)
- Dr Statement of profit or loss (any residual loss)
- Cr Non-current asset (loss on revaluation)
The asset must continue to be depreciated following the revaluation. However, now that the asset has been revalued the depreciable amount has changed. In simple terms the revalued amount should be depreciated over the assets remaining useful economic life.
The depreciation charge on the revalued asset will be different to the depreciation that would have been charged based on the historical cost of the asset. As a result of this, IAS 16 permits a transfer to be made of an amount equal to the excess depreciation from the revaluation reserve to retained earnings.
- Dr Revaluation reserve
- Cr Retained earnings
This movement in reserves should also be disclosed in the statement of changes in equity.
In the exam make sure you pay attention to the date that the revaluation takes place. If the revaluation takes place at the start of the year then the revaluation should be accounted for immediately and depreciation should be charged in accordance with the rule above.
If however the revaluation takes place at the year-end then the asset would be depreciated for a full 12 months first based on the original depreciation of that asset. This will enable the carrying amount of the asset to be known at the revaluation date, at which point the revaluation can be accounted for.
A further situation may arise if the examiner states that the revaluation takes place mid-way through the year. If this were to happen the carrying amount would need to be found at the date of revaluation, and therefore the asset would be depreciated based on the original depreciation for the period up until revaluation, then the revaluation will take place and be accounted for. Once the asset has been revalued you will need to consider the last period of depreciation. This will be found based upon the revaluation rules (depreciate the revalued amount over remaining useful economic life). This will be the most complicated situation and you must ensure that your working is clearly structured for this; i.e. depreciate for first period based on old depreciation, revalue, then depreciate last period based on new depreciation rule for revalued assets.
Property, plant and equipment should be derecognised when it is no longer expected to generate future economic benefit or when it is disposed of.
When property, plant and equipment is to be derecognised, a gain or loss on disposal is to be calculated.
This can be found by comparing the difference between:
|Profit or loss on disposal||X|
When the disposal proceeds are greater than the carrying value there is a profit on disposal and when the disposal proceeds are less than the carrying value there is a loss on disposal.
Remove the asset from statement of financial position when disposed of or abandoned. Recognize any resulting gain or loss in the statement of profit or loss.
Disposal of previously revalued assets
When an asset is disposed of that has previously been revalued, a profit or loss on disposal is to be calculated (as above). Any remaining surplus on the revaluation reserve is now considered to be a ‘realised’ gain and therefore should be transferred to retained earnings as:
- Dr Revaluation reserve
- Cr Retained earnings