IAS 16 - Properties, Plant and Equipment (detailed review)

Monday, February 3, 2014 Print Email

Objective

This Standard deals with the accounting treatment of Property, Plant & Equipment  including the guidance for the main issues related to the recognition & measurement, determination of carrying value, depreciation charges, any impairment loss and de-recognition aspects for the property, plant & equipment in the financial statements of an entity.

Scope

-  The requirements of this standard are applicable for the accounting treatment of property, plant and equipment.

-   This Standard is not applicable:
(a) To the property, plant and equipment which are classified as held for sale and are covered under IFRS 5
(b) For the accounting treatment of biological assets related to agricultural activity which are covered under IAS 41
(c) For the accounting treatment of exploration and evaluation assets and mineral rights and reserves such as oil and gas and other non-regenerative resources which are covered under IFRS 6.

However, IAS 16 is applicable to the property, plant & equipments, which are used to maintain or develop the biological assets under IAS 4 and mineral rights and reserves such as oil and gas and other non-regenerative resources which are covered under IFRS 6.

Definition

1. Property, Plant & Equipment

The item which meets the following criteria will be treated as property plant and equipment as the standard prescribes:

(a)These are tangible items;
(a) That are held for use in the production, supply of goods or services, rental
to others, or use in administration and
(b) Their economic benefits are for more than one accounting period.

2. Cost

It is the amount of cash or cash equivalents paid or the fair value of the consideration transferred to acquire, purchase or construct an asset.

3. Carrying Value

It is the value at which asset will be presented in the statement of financial position and it is determined as Cost less Accumulated Depreciation and Accumulated Impairment Loss.

4. Depreciable Amount

It is the amount of asset which will be depreciated over its useful life and is determined as the cost of an asset less its residual value.

5. Residual Value

It is the estimated net disposal proceeds that an entity would currently obtain from disposal of the asset, if the asset were already in the condition and situation which is expected to be at the end of its useful life.

6. Useful Life

It is the period of time or number of production units for which asset will be used by the management.

7. Depreciation

It is the systematic allocation of the depreciable amount of an asset over its related useful life.

8. Fair value

It is amount that is expected to be received to sell an asset or required to be paid to transfer a liability, in an orderly transaction between market participants at the date of measurement (IFRS 13).

9. Impairment Loss

If the carrying value of asset exceeds its recoverable value, the excess is known as impairment loss.

Initial Recognition

An asset will be recognized as property, plant and equipment if it meets:

(a) The definition of property, plant & equipment and
(b) The recognition criteria given in IASB’s frame work i.e.

-The future economic benefits related to the asset are probable, to flow to the entity and
-   The cost of the asset is reliably measurable.

Application of Initial Recognition

The entity will apply the initial recognition rule to the following items as follows:

(1) Spare Parts & Servicing Equipment:

- Normally these are treated as inventory and their cost will be charged to the statement of profit or loss as expense when these are consumed by the entity.
- However, the cost of major spare parts will be capitalized as property, plant & equipment if these:

  • Are specialized in nature and can only be used with the specific asset;
  • Have material cost and
  • Their economic benefits are expected to be for more than one accounting period.

(2) Safety Equipments:

These do not enhance the economic benefits of related asset, therefore, their cost will be charged to statement of profit or loss as expense such as fire alarms, sound proof equipments and smoke filters.
However, if an entity indentifies that it will enhance the economic benefits of related asset then its cost will be capitalized as part of property, plant & equipment.

(3) Aggregation & Segmenting:

- This Standard does not prescribe that what items constitute property, plant & equipment. Therefore, if the cost of individually insignificant items such as tools, jigs, dies, and structures becomes material after aggregation then these may be recognized as property, plant and equipment. (Aggregation)
-  If an asset contains different components and these components are different in nature with each component having different useful life, then each component will be recognized as property, plant and equipment separately. (Segmenting)

Initial Measurement

The assets which are recognized as property, plant and equipment are initially measured at Cost which is determined as:

  • Manufacturer’s or distributor’s list price
  • Less any Trade Discount or Rebate,
  • Plus any directly related cost which includes: Transportation cost, Sales tax and Import duties (if non-refundable), any Legal charges, Handling cost, Site preparation cost, Installation cost, Professional charges, Pre-production testing cost (Net expense), any Modification cost (owner specified), any Dismantling and Restoration cost.
  • Any other cost which is necessary to bring the asset into its operating use or intended use by the management.

The capitalization of cost will cease when the asset becomes available for operating use or intended use by the management

Notes:

1. Following elements of cost will not become the part of the cost of asset and will be charged to statement of profit or loss as expense:

  • Insurance cost
  • Labor training cost
  • Rectification cost of an error
  • Cost of initial operating losses
  • Start up cost
  • Relocation cost
  • Cost related to opening of new facility
  • Any general and administrative overheads

2. Any cash discount taken for the prompt payment of cash related to asset will not affect the cost of the asset, and it will be recorded as income separately in the statement of profit or loss.

3. If an asset is purchased on extended credit period or on deferred installment basis, then the cost of such asset will be its Cash Price Equivalent any excess paid over the cash price will be treated as Interest expense which will be recognized over the period of credit.

4. The cost of the asset held by the lessee under finance lease will be determined in accordance with IAS 17.

Self Constructed Asset:

  • If an entity chooses to construct an item of property, plant & equipment using its own resources, then the cost of such self constructed asset will be determined as the cost of the asset which is constructed by the entity for sale in the normal course of the business under IAS 2, i.e. it will be the sum of Material, Labor and Overhead cost of such asset.
  • However, any cost of abnormal wasted material, labor or other resources will be charged to statement of profit or loss as expense.

Exchange of asset:

If an entity acquires an item of property, plant and equipment in exchange for a non-monetary asset, then the cost of the asset acquired in exchange will be determined as follows:

  • If Transaction of Exchange has Commercial Substance:

The transaction of exchange will deem to have commercial substance if:

  • The risk, timing and amount of cash flows related to the asset acquired are different from the asset transferred;
  • The exchange has resulted in the change in the entity specific value of that operational portion of the entity
  • The change in (a) and (b) above is material.

In such circumstances the entity will determine the cost of the asset acquired in exchange as:

(a) The fair value of asset transferred ± cash,

(b) If the fair value of asset transferred is not determinable , then it will be recognized at the fair value of asset acquired,

Any gain or loss on the exchange transaction will be charged to the statement of profit or loss.

2. If Transaction of Exchange does not have Commercial Substance:

If the transaction of exchange does not have commercial substance or the fair value of asset transferred and the asset acquired both are not determinable, then the new asset will be recognize at the carrying value of asset transferred, which will result in no gain or loss on exchange.

Subsequent Recognition

  • Property, plant and equipment may be requiring the replacement of some component parts during the useful life (such as the spare parts of a plant or walls of a building). In such circumstances, the entity will recognize the cost of replacement in the carrying value of relevant asset if it satisfies the recognition criteria given in this Standard.
  • The cost of day to day or ongoing repair and maintenance will be charged to the statement of profit or loss as expense.
  • If the asset requires an inspection after a specified interval as per industry laws (such as airline industry) then the entity will recognize the cost of such inspection in the carrying value of related asset, if its economic benefits are for more than one accounting period.

Subsequent Measurement

The entity has two options to account for the property, plant and equipment at reporting date as a choice of accounting policy;

  • Cost Model
  • Revaluation Model

1. Cost Model

If an entity chooses to measure the property, plant and equipment under Cost model at reporting date, then such assets will be measured at Cost less accumulated depreciation less accumulated impairment loss.

Depreciation:

(a) It is the systematic allocation of the depreciable amount of an asset over its related useful life.

(b) Each component of property, plant and equipment having substantial cost will be depreciated separately.

(c) The depreciation charge for the accounting period will be charged to the statement of profit or loss as an expense. However, if the asset is being used in the construction of another asset, then the depreciation charge will be added to the cost of such asset under construction or being produced, such as the depreciation of the manufacturing plant is added in the cost of inventory.

(d)The entity should review the useful life and residual value of the asset at each reporting date, if it has changed as of the original estimate the entity should also revise the useful life and residual value following the change. It will be accounted for as change in accounting estimate and it will have Prospective Application in accordance with IAS 8.

(e) The entity will continue to depreciate the asset even if fair value of asset is higher than its carrying value. However, entity will not charge any depreciation if the residual value of the asset exceeds its carrying value.

(f)  The depreciation charge will commence, when the asset is available for operating use or intended use by the management.

(g) The entity will cease depreciation charge when either the asset is classified as held for sale under IFRS5 or the asset is de-recognized from statement of financial position.

(h)The entity will depreciate the asset even if the asset is idle, until the asset is fully depreciated.

Depreciation Method:

(a) The depreciation method opted by the entity should be in accordance with the pattern of economic benefits which are to be consumed by the entity over its useful life.

(b) The entity should review the depreciation method opted at each reporting date and if there is any change in the pattern of consumption of economic benefits related to the asset, then the entity should change the depreciation method in accordance with the new pattern of consumption of economic benefits and such change will be accounted for as change in accounting estimate, which will be applied prospectively from that date.

Useful Life:

-  The entity should consider the following aspects in determination of the useful life of the asset:

    • The expected use of the asset including its production capacity or output.
    • Any expected physical wear and tear due to its operational use including its expected repair and maintenance plan.
    • Any expected change in the demand of the product related to the asset due to commercial or technical changes in the market.
    • Any legal restriction on the asset in terms of its use.

-  The useful life of the asset is a matter of judgment according to the expected use of the asset by management.

Impairment:

Any impairment will be determined as per the requirements of IAS 36.

2. Revaluation Model

If an entity chooses to measure the property, plant and equipment under Revaluation model at reporting date, then such assets will be measured at Revalued Amount less subsequent accumulated depreciation less subsequent accumulated impairment loss.

The entity should consider the following points in revaluation:

(a) Normally the revalued amount is taken as fair value of asset which is determined in accordance with IFRS 13.

(b) The frequency of revaluation depends upon the volatility of the market related to the asset.

(c) Revaluation should be performed regularly enough, so that the carrying value of asset should not be materially different from its revalued amount.

(d) When the asset is revalued, its depreciation charge to the date of revaluation will be reset to zero, as it will be reflected in the revalued amount.

(e) Once an asset is revalued, the whole class of assets to which that asset belongs has to be revalued to avoid the presentation of assets in the same category at different cost and values with different valuation dates.

(f) Any increase in the carrying value of the asset resulting from revaluation will be recognized in other comprehensive income and will be accumulated in a separate column of the statement of changes in equity. However first, it will reverse any loss related to the asset up to the extent it is recognized in the previous years.

(g) Any decrease in the carrying value of the asset resulting from the revaluation will be recognized in the statement of profit or loss as expense. However first, it will offset any revaluation surplus related to the asset up to the extent it is recognized in the previous years.

(h) If depreciation charge on the basis of revalued amount exceeds the original depreciation charge, then the excess will be transferred out of the revaluation surplus to the retained earnings as realization of the revaluation surplus. However, this transfer is optional and if opted by the entity then it will be applicable annually till the disposal of related asset. 

(i) Any remaining revaluation surplus in the statement of changes in equity will be transferred as whole to the retained earnings when the asset is de-recognized from the statement of financial position.

Disposal

An entity will de-recognize the asset from statement of financial position when:
(a) The asset is disposed off:
(b) No economic benefits are expected either from use or from sale of asset

  • Any gain or loss on the disposal of asset will be charged to the statement of profit or loss which will be the difference between carrying value and disposal proceeds.
  • If the asset is sold on extended credit period or on deferred installment basis, then the disposal proceeds will be taken as cash price equivalent and any excess over the cash price will be treated as Interest Income which will be recognized over the period of credit.

 

Disclosures

For each class of property, plant and equipment, the entity is required to disclose the following:
(a) The measurement model

(b) Method of depreciation
(c) Depreciation rate or useful life

(d) A statement reconciling the carrying value at the start of the period to the carrying value at reporting date which includes:

  • Any additions and disposals during the year
  • Any assets acquired as part of a business combination
  • Any impairment loss recognized in the current year
  • Depreciation charge for the year
  • Assets classified as held for sale under IFRS 5
  • Any exchange differences arising on translation of foreign currency assets.

(e) Any expense on the asset during the year which was capitalized as part of the carrying amount of the asset.

(f) Any compensation received from the third parties in respect of any impairment related to the asset.

(h) Any depreciation charges which are recognized as part of cost of other assets.

(i) Any change in useful life, residual value or depreciation method related to the property, plant and equipment.

(j) The entity should disclose the date of revaluation, involvement of the expert and the revaluation surplus in respect of the assets which are revalued in the current period.

(k) Carrying values of the assets which are idle.

 

Worked Examples

Example 1:

AB Ltd. acquired a plant at a cost of $15 million. The plant has two parts namely Part A with a cost of $9 million and useful life of 100,000 hours, while other Part B costing $6 million has a useful life of 5 years.

Required:
How the plant will be recognized in the financial statements of the AB Ltd.?

Solution:

As both parts of the plant have different useful lives therefore, each part will be recognized as a separate non-current asset and will be depreciated over the respective useful lives.

 

Example 2:

AB Ltd. exchanged a land with a carrying value of $15 million and fair value of $ 20 million, for an imported plant. Additionally AB Ltd. has also paid $5 million along with the land.

Required:
What will be the cost of the acquired plant in the financial statements of the AB Ltd.?

Solution:

As per IAS 16, the cost of the asset acquired in exchange will be primarily the fair value of asset transferred± Cash, therefore the cost of the acquired plant will be:

$20 million + $ 5 million = $25 million.

Example 3:

AB Ltd. has recently acquired an item of plant with the following details:

 

$

List price

480,000

Trade discount 12.5% on list price

 

Related costs:

 

Transportation costs

5,500

Pre-production testing Cost       

25,000

Repair &Maintenance contract for three years

48,000

Site preparation costs:

 

Electrical cable placement                                                    

28,000

Foundation Cost                                         

9,000

Labor costs                      

15,000

                                                                                              

52,000

AB Ltd. paid for the plant within four weeks of the order, therefore, obtained an early settlement discount of 3%.
AB Ltd. had wrongly specified the power loading of the original electrical cable to be installed by the contractor. The cost of rectifying this error of $12,000 is included in the above figure of $28,000.
The plant is expected to have a useful life of 20 years. At the end of this period there will be compulsory costs of $30,000 to dismantle the plant and $6,000 to restore the site to the original condition.

Required
Calculate the value at which the plant will be measured at initialrecognition in the financial statements of the AB Ltd.

Solution:

Cost of the Asset:

 

$

List price

480,000

Less trade discount ($480,000 × 12.5%)

(60,000)

 

420,000

Transportation costs

5,500

Estimated pre-production testing

25,000

Site preparation costs

 

Electrical cable placement (28,000 – 12,000)

16,000

Foundation cost

9,000

Labor costs

15,000

20,000

 

Dismantling and restoration costs (30,000 + 6,000)

36,000

Initial cost of plant

526,500

Note:

  • Cash discount will not affect the value of asset; it will be recorded as income separately.
  • The rectification cost of the error is charged to statement of profit or loss as expense.

 

Example 4:

AB Ltd. is a private limited company that operates an aircraft. The aircraft was acquired on 1 January 2001. The details of the cost of the aircraft’s components are as follows:

Component at cost ($ million)

Depreciation basis

Exterior Structure 600

25 years straight–line

Cabins fittings      300

12 years straight–line

Engine                  200

40,000 hours

In the year ended 31 December 2008 the aircraft engine had experienced a serious trouble which had resulted in considerable compensation costs to AB Ltd.
The aircraft log showed that existing engine has used 30,000 hours up to 31 December 2008. At the start of January 2009 a decision was taken to replace the engine at a cost of $280 million, due to the unreliability of the old engine. The expected life of the new engine is 50,000 hours and in the year ended 31 December 2009 the aircraft had used its engines for 5,000 hours.
At the same time the engine was replaced, the company took the opportunity to upgrade the cabin facilities at a cost of $120 million and the exterior structure was repainted at a cost of $40 million. After the upgrade to the cabin fittings its estimated remaining useful life was increased to five years (from the date of the upgrade).

 All the work on the aircraft can be assumed to have been completed on 1 January 2009. All residual values can be taken as nil.

Required
Calculate the carrying value of aircraft at 31 December 2009 in the statement of financial position and related expense in the statement of profit or loss for the year ended 31 December 2009.

Solution:

Statement of Profit or Loss:


  

31.12.09

     

$’m

Depreciation charge ($24+$44+$28)

(96)

Repainting Cost

(40)

Loss on replacement of engine

(50)

Total charge

(186)

Statement of Financial Position:


31.12.09

Assets:

$’m

Non-Current Assets:

 

Exterior Structure    

384

Cabin Fittings

176

Engine

252

 

(W1) Exterior Structure:

 

$’m

Cost

600

– Acc. Dep. (600 – 0 / 25yrs) × 8 yrs (192)

 

Carrying Value at 1.1.2009

408

– Current yr Dep. (600 – 0 / 25yrs)

(24)

Carrying Value at 31.12.2009

384

(W2) Cabin Fittings:


$’m

Cost

300

– Acc. Dep. (300 – 0 / 12yrs) × 8 yrs

(200)

Carrying Value at 1.1.2009

100

Addition (Upgrade)

120

New Carrying Value   

220

– Current yr Dep. (220 – 0 / 5yrs)

(44)

Carrying Value at 31.12.2009

176

(W3) Engine:

  • Existing Engine:

 

$’m

Cost

200

– Acc. Dep. (200 – 0 / 40,000 hrs) × 30,000 hrs

(150)

Carrying Value at 1.1.2009

50

– Charge to profit or loss on replacement

(50)

Carrying Value at 31.12.2009

-

  • New Engine:

 

$’m

Cost

280

– Acc. Dep. 

( - )

Carrying Value at 1.1.2009

280

– Current yr Dep. (280 – 0 / 50,000 hrs) × 5,000 hrs

(28)

Carrying Value at 31.12.2009

252

Login to ReadyRatios

 

Have you forgotten your password?

Are you a new user?

Login As
You can log in if you are registered at one of these services: