OBJECTIVE
The Objective of IAS 16 is to set out the accounting treatment for Property, Plant and Equipment. The main areas dealt with in the standard are:
- Recognition of non-current assets(fixed assets),
- Determination of the carrying amount,
- Determination of the depreciation charges
- Determination of the impairment losses to be recognised in the financial statements.
DEFINITIONS
Property, Plant and Equipment: Tangible assets held for use in production or supply of goods or services or for rental or administration purposes and are expected to be used during more than one accounting period.
Depreciation: Systematic allocation of depreciable amount, the cost (or re-valued amount) less residual value over an asset’s useful life
Carrying amount is the amount at which the asset is recognised after deducting any accumulated depreciation and accumulated impairment losses.
An Impairment Loss is the amount by which the carrying amount of an asset exceeds its recoverable amount.
Fair Value: The amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction.
Recoverable Amount: The higher of the asset’s net selling price and its value in use.
Value in Use (IAS 36): The present value of estimated future cash flows expected from the continuing use of an asset and from its disposal at the end of its useful life.
DEPRECIATION
The assessment of depreciation and its allocation to accounting periods involves the consideration of three factors:
- The carrying amount of the asset – whether cost or valuation
- The length of the asset’s expected useful economic life to the business of the enterprise, having due regard to the incidence of obsolescence
and
The estimated residual value of the asset at the end of its useful economic life in the business of the enterprise
The useful economic life of an asset is the period over which the present owner will derive economic benefits from its use. The following factors need to be considered in determining the useful life of an asset:
- The expected usage of the asset by the enterprise. The usage is of an asset is determined by the expected capacity of the asset or its physical output.
- The expected physical wear and tear is affected by operational factors such as the number of shifts for which the asset is to be used and the repair and maintenance programme of the enterprise and the care and maintenance of the asset when idle.
- Technical obsolescence arising from changes or improvements in production or from a change in the market demand for the product or service output of the asset
- Legal or similar limits on the use of the asset, such as expiry dates of related leases.
The useful economic lives and depreciation methods of assets should be reviewed regularly and, where necessary, revised and accounted for as a change in estimate.
ACCOUNTING FOR DEPRECIATION
Provision for depreciation of non-current asset having a finite useful economic life should be made by allocating the cost or re-valued amount less the estimated residual value of the assets as fairly as possible to the periods expected to benefit from their use. The depreciation methods used should be the one which is the most appropriate having regard to the type of asset and their use in the business.
Methods of Calculation
There are a number of different methods used in calculating the depreciation charge. The most common methods are:
- The Straight line method
- The Reducing balance method
The Straight Line Method
Under this method, the total depreciable amount is charged in equal instalments to each accounting period over the expected useful life of the asset. Formula:
Cost of Asset – the Residual Value (e.g. scrap value)
Expected useful life of the asset
The Reducing Balance Method
Under this method, the annual depreciation charge is a fixed percentage of the net book value of the asset at the end of the previous accounting period.
DISPOSAL OF PROPERTY, PLANT AND EQUIPMENT
A profit/loss on the disposal of property, plant and equipment is calculated as the difference between the net disposal proceeds and the net book value. The profit / loss on disposal is included in the Statement of Comprehensive Income in the year in which the disposal occurs
LEDGER ACCOUNTS AND JOURNAL ENTRIES
Property, Plant and Equipment – Additions
When a tangible fixed asset is bought the cost is entered into a tangible fixed asset account in the nominal ledger….
The journal entries for the depreciation charge for the year is:
Debit Plant and Machinery Depreciation Expense Account
Credit Accumulated Depreciation Account
The Depreciation Expense account is cleared out at the end of the year to the Statement of Comprehensive Income .
Debit Statement of Comprehensive Income – Depreciation
Credit Plant & Equipment – Depreciation Expense Account
The balance in the Accumulated Depreciation account represents the total amount of depreciation charged against the asset since the purchase date.
Property, Plant and Equipment – Disposal
When property, plant and equipment is sold or scrapped the cost is transferred to a disposal account. Also the accumulated depreciation to date should be transferred from the accumulated depreciation account to the disposal account.
Lastly the proceeds of sale should be credited to disposal account.
The journal entries for the disposal of property, plant and equipment are:
- Debit Disposal Account
Credit Property, Plant and Equipment Cost Account
To transfer the original cost of the asset to the disposal account
- Debit Accumulated Depreciation Account
Credit Disposal Account
To transfer the accumulated depreciation charged to the Statement of Comprehensive Income from date of purchase to date of disposal.
- Debit Bank
Credit Disposal Account
To record the cash received on sale/disposal of the asset
Trade in Allowance
Often when a motor vehicle is being replaced it is traded in against a new vehicle. The double entry for this transaction is debit motor vehicles cost account and credit motor vehicles disposal account with the trade in value of the motor vehicle.
RECOGNITION AND MEASUREMENT
An item of property, plant and equipment should be recognised as an asset when:
- It is probable that future economic benefits associated with it will flow to the entity and;
- Cost of the asset can be measured reliably.
Initial Measurement
Property, plant and equipment should initially be measured at cost. Cost is the purchase price, import duties and non-deductible purchase taxes/VAT. Cost should also include directly attributable costs of bringing the asset to working condition for its intended use.
Examples of directly attributable costs include initial delivery and handling costs, site preparation, installation costs, and cost of employee wages arising directly from construction or acquisition.
Exchange of Assets
Cost is measured at fair value of asset received which is equal to fair value of the asset given up e.g. trade-in allowance, plus cash transferred.
Measurement Subsequent to Initial Recognition
An entity may choose between the cost model and the revaluation model. The choice of measurement is applied consistently to the entire class of property, plant and equipment.
Cost Model
In this model the assets are carried at cost less accumulated depreciation and any accumulated impairment losses.
Revaluation Model
In this model the assets are carried at their re-valued amount, being fair value at date of revaluation, less any subsequent depreciation and any accumulated impairment losses.
Accounting Treatment of Revaluation
Any revaluation increase is normally credited directly to the revaluation surplus in equity. However, if the asset had previously been the subject of a revaluation decrease then the entity reverses the amount of the decrease previously taken to the Statement of Comprehensive Income .
DISCLOSURE
The financial statements should disclose, for each class of property, plant and equipment:
- The measurement bases used for determining the gross carrying amount.
- The depreciation methods used
- The useful lives or depreciation rates used
- The gross carrying amount and the accumulated depreciation at the beginning and end of the period
- A reconciliation of the carrying amount at the beginning and end of the period showing:
- Additions
- Disposals
- Increases or decreases during the period resulting from revaluations
- Depreciation
