The objective of IAS 16 is to prescribe the accounting treatment for property, plant and equipment (PPE), so that users of the financial statements can understand the nature of the entities investment in such assets and any changes that have occurred in that investment.
The standard indicates that the main issues to be dealt with are:
- The recognition of assets
- The determination of their carrying amount
- Depreciation and impairment losses
- Disclosure requirements
The standard does not apply to:
- Property, plant and equipment classified as held for sale under IFRS 5
- Mineral rights and reserves
- Biological assets
Property, plant and equipment are tangible items that:
- Are held for use in the production or supply of goods or services, for rental to others or for administration purposes; and
- Are expected to be used during more than one period.
The carrying amount refers to the amount at which an asset is recognised after deducting accumulated depreciation and accumulated impairment losses, i.e. its net book value.
An item of property, plant and equipment should be recognised as an asset in the Statement of Financial Position if, and only 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.
The Framework for the Preparation and Presentation of Financial Statements also states that having control over as asset is an important feature in the recognition of that asset in the accounts (for example, legal ownership of an asset is not essential in establishing the existence of the asset, as long as the entity can show that it controls the benefits which are expected to flow from that asset, e.g. Finance Lease).
An entity controls an asset if it has the power to obtain the future economic benefits flowing from that asset and also restrict the access of others to those benefits.
If an asset qualifies for recognition, then it should initially be measured at its cost.
Cost is the amount of cash or cash equivalents paid or the fair value of other consideration given to acquire an asset at the time of acquisition or construction.
The cost of an asset comprises:
The Purchase Price less trade discounts and rebates
+ Import duties and non-refundable purchase taxes
+ Any costs that are directly attributable to bringing the asset to the location and condition necessary for the asset to be used as intended, for example:
- Site preparation costs
- Initial delivery and handling costs
- Installation and assembly costs
- Professional fees
- Costs of testing whether the asset is functioning properly (after deducting the sales proceeds of any samples produced during testing)
+ The initial costs of dismantling and removing the item and restoring the site, if such an obligation is placed on the entity (legally or constructively)
Administration and other general overheads are not included in the cost of the asset.
Likewise, the following are also excluded: training costs, advertising and promotional costs, and costs incurred while an asset, capable of being used as intended, is yet to be brought into use, is left idle or is operating below full capacity.
[Note that in the case of self-constructed assets, the following are excluded from the cost of the asset:
- Internal profits
- Abnormal amounts of wasted material, labour or other resources]
In certain circumstances, IAS 23 allows part of the borrowing cost to be capitalised.
If an asset is acquired in exchange for another asset, the acquired asset is measured at its fair value unless the exchange lacks commercial substance or the fair value cannot be measured reliably. If this is the case, the acquired asset should be measured at the carrying value of the asset given up (carrying amount being equal to cost less accumulated depreciation and impairment losses).
The cost of day-to-day servicing of an asset is not included in the carrying amount of an asset. This expenditure is referred to as “repairs and maintenance” and should be charged to the income statement in the period it is incurred.
However, if part of an asset is replaced, e.g. new engine in a plane or new lining in a furnace, then the cost of this replacement can be capitalised if the recognition criteria mentioned earlier are met.
The part of the asset that is replaced must then be derecognised (with any resulting profit or loss on disposal being calculated and recognised).
Some assets require ongoing and substantial expenditure for overhauling and restoring components of an asset, for example:
- Overhaul of Airplane, to keep it airworthy
- Dry docking of a ship
- Replacing the lining of a furnace
A provision for this expenditure cannot be made. Rather, the cost is capitalised and depreciated separately over its individual useful economic life. It is important to note that this variety of subsequent expenditure can only be treated in this way if the asset is treated as separate components for depreciation purposes.
If the asset is not accounted for as several different components, this kind of subsequent expenditure must be treated as normal repairs and renewals and charged to the income statement as it is incurred.
SHNK Limited purchases a plane that has an expected useful life of 20 years, and has no residual value. The plane requires a substantial overhaul every 5 years (i.e. at the end of years 5, 10, and 15). The plane cost RWF45 million and RWF5 million of this figure is estimated to be attributable to the economic benefits that are restored by the overhauls.
The annual depreciation charge would be calculated as follows:
The plane is treated as two separate components for depreciation purposes:
- The RWF5 million is depreciated over 5 years (i.e. RWF1 million per annum)
- The balance of RWF40 million is depreciated over 20 years (i.e. RWF2 million per annum).
- The total annual depreciation charge is RWF3 million.
When the first overhaul is carried out at the end of year 5 at a cost of, say, RWF10 million, this cost is capitalised and depreciated to the date of the next overhaul.
This means that total depreciation for years 6 to 10 will be RWF4 million (RWF10m/5 years + RWF40m/20 years).
MEASUREMENT AFTER RECOGNITION
IAS 16 provides two options when accounting for property, plant and equipment after their initial recognition.
- Cost Model
After recognition, the asset should be carried in the Statement of Financial Position at:
Less Accumulated Depreciation
Less Accumulated Impairment Losses
- Revaluation Model
After recognition, an asset, whose fair value can be measured reliably, should be carried at a revalued amount.
The revalued amount is the fair value of the asset at the date of revaluation less subsequent accumulated depreciation and impairment losses.
The fair value of property is based on its market value, as assessed by a professionally qualified valuer.
The fair value of plant and equipment is usually their market value, determined by appraisal.
If there is no market based evidence of fair value because the asset is of a specialised nature and is rarely sold, then the fair value of that asset will have to be estimated using an income or a depreciated replacement cost approach.
All revaluations should be made with such frequency so that the carrying amount does not differ materially from the fair value at the Statement of Financial Position date.
If an item of property, plant and equipment is revalued, then the entire class of property, plant and equipment to which the asset belongs shall be revalued.
If an asset is revalued upwards:
Credit Revaluation Surplus
With the amount of the increase
However, if the revaluation gain reverses a previous revaluation loss, which was recognised as an expense, then the gain should be recognised in the income statement (but only to the extent of the previous loss of the same asset). Any excess over the amount of the original loss goes to the Revaluation Surplus.
If an asset is sold, scrapped or withdrawn from use (so that no future economic benefits are expected) then the asset must be removed from the Statement of Financial Position.
Any gain or loss arising on disposal must be calculated and included as part of profit or loss for period.
The gain or loss on disposal is the difference between: The carrying amount of the asset; and The net sales (disposal) proceeds.
[Note: any consideration receivable on disposal of an item of property, plant and equipment is measured at its fair value.]
Each part of an item of property, plant and equipment that has a cost that is significant in relation to the total cost of the item should be depreciated separately.
This means that an entity should allocate the amount initially recognised in respect of an item of property, plant and equipment and each part should be separately depreciated.
The depreciation charge for a period should be recognised in the profit or loss for the period. It is usually an expense item. But if the asset is used in the process of producing goods for sale, then the depreciation of that asset is included in the cost of sales.
There are situations however, when the depreciation of any asset should be included in the carrying amount of another asset. For example, under IAS 38 Intangible Assets, depreciation of assets used for development purposes may be included in the cost of the intangible asset (development costs) capitalised in the Statement of Financial Position.
So, if the future economic benefits embodied in an asset are absorbed in producing other assets, then the depreciation charge constitutes part of the cost of the other asset and thus is included in its carrying amount.
The depreciable amount of an asset should be allocated on a systematic basis over its useful life. The method of depreciation should reflect the pattern in which the asset is used in the entity. Whichever method is chosen by the entity, it should be applied consistently from period to period unless there is a change in the expected pattern of consumption of the assets future economic benefits.
The entity should review both the residual value of the asset and its expected useful life on an annual basis. If necessary, these should be revised (as a change in estimate, in accordance with IAS 8).
Because an asset is being repaired or maintained does not mean it should avoid depreciation.
Depreciation begins when the asset is available for use and ceases at the earlier date of: (a) When it is classified as held for resale under IFRS 5; and
(b) When the asset is derecognised.
Land, with some exceptions, has an unlimited useful life and so it is not subject to depreciation. Buildings have a useful life and, thus, are depreciated.
If an asset is revalued, the revalued amount should be depreciated over its remaining useful life, starting at the date of its revaluation.
If the useful life of an asset is revised, the carrying value of the asset should be written off over the remaining life, starting with the period in which the change is made.
For each class of property, plant and equipment, the following information must be disclosed:
(1) The measurement bases for calculating the gross carrying amount
- Depreciation method used
- The useful lives or the depreciation rates used
- The gross carrying amount and the accumulated depreciation at the beginning of the period
- A reconciliation of the carrying amount at the beginning and end of the period showing: (i) Additions
- Assets held for sale in accordance with IFRS 5
- Acquisitions through business combinations
- Increases or decreases arising from revaluations
- Impairment losses
- Reversals of impairment losses
- Other changes, including foreign currency exchange differences
The following, if they arise, should also be disclosed:
- Existence of restrictions on title and whether assets have been pledged as security for liabilities and the amounts involved
- Amount of expenditure recognised in the course of the assets construction
- Amount of contractual commitments to acquire property, plant and equipment
- The amount of compensation from third parties for assets that were impaired, lost or given up included in profit or loss (if not disclosed separately on the face of the income statement)
If assets have been revalued, the following should be disclosed:
- Date of revaluation
- Whether an independent valuer was used
- Methods and assumptions used in estimated fair value
- The extent to which estimates were based on active markets or other techniques which were used
- The carrying amount of the asset if the cost model had been used
- The revaluation surplus
IAS 16 encourages the disclosure of:
- The carrying amount of idle property, plant and equipment
- The gross carrying amount of fully depreciated assets still in use
- The carrying amount of assets retired from active use and not classified as held for sale (iv) It the cost model is used, then disclose the fair value of the assets if materially different.