IAS 16: Property, Plant and Equipment


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IAS 16: Property, Plant and Equipment

  1. 1. IAS 16: Property, Plant and Equipment Roshankumar Pimpalkarroshankumar.2007@rediffmail.com
  2. 2. This standard prescribes the way property, plant and equipment (PP&E) is accounted for. IAS 16 requires that an item of property, plant and equipment be recognised as an asset when it satisfies the definition and recognition criteria for an asset in the framework for preparation and presentation of financial statement. An item of property, plant and equipment should be recognised as an asset when: It is probable that the future economic benefits associated with the asset will flow to the entity, and The cost of the asset can be reliably measured. This standard does not apply to 1. PP&E classified as held for sale in accordance with IFRS 5 2. Biological assets related to agricultural activity (IAS 41) 3. Mineral rights and reserves i.e. oil, natural gas 4. The recognition and measurement of exploration and evaluation asset (IFRS 6) 5. Investment property (IAS 40) This standard does apply to PP&E used to develop and maintain assets described in 2 & 3. Infrastructure within the scope of IFRIC 12 is not recognised as PP&E of the operator as contractual service agreement does not transfer right to control the use of public service infrastructure, but only access to operate the infrastructure. IAS 16 prescribes the cost of an item of property, plant and equipment as: Purchase price including, import duties and non-refundable purchase taxes, after deducting any trade rebates or discounts Any directly attributable costs to bring the asset to the location and working condition necessary for it to be capable of operating as intended by management The initial estimate of cost of dismantling and removing the item and dismantling the site on which it is located, the obligation for which an entity incurs either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce the inventory during that period.Revenue items that may reduce the cost of item of Property, Plant and Equipment Internal profits are eliminated from cost of self-constructed assetsroshankumar.2007@rediffmail.com
  3. 3. The carrying amount of property, plant and equipment may be reduced by applicable government grants under the relevant standard. Net proceeds from selling an item produced in bringing the asset to that location (such as sale of samples produced when testing the equipment). However, revenues and expenses incidental to construction or development, but not necessary to bring the asset to its required location or condition, would be separately recognised in the net profit or loss (e.g. the operation of car park on a building site)Methods of acquiring the Asset 1. Deferred Payment When the payment for an item of property, plant and equipment is deferred beyond normal credit terms, its cost is the cash price equivalent i.e. present value of payments. The difference between this amount and the total payments is recognised as interest payments over the period of credit, unless the capitalised in accordance with IAS 23 Borrowing Cost. 2. Exchange of Assets The cost of such item of PP&E is measured at fair value unless: The exchange transaction lacks commercial substance, or The fair value of neither the asset received nor the asset given is reliably measured Fair value is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction. An exchange transaction has commercial substance if: The risk, timing and amount of cash flows of the asset received differs from the risk, timings and amount of cash flows of asset transferred; or The entity specific value of the portion of the entity’s operations affected by transaction changes as a result of the exchange The difference in (1) or (2) is significant relative to the fair value of asset exchanged. Entity specific value is the present value of cash flows an entity expects to arise from the continuing use of an asset and from its disposal at the end of its useful life or expects to incur when settling the liability. 3. Equity Instrument If an item of Property, Plant and Equipment is acquired in exchange equity instrument of the entity, the cost of the item of the property, plant androshankumar.2007@rediffmail.com
  4. 4. equipment is its fair value. If that fair value cannot be reliably determined the fair value of the equity instrument is used.Useful LifeUseful life is either: The period of time over which the asset is expected to be available for use by the entity; or The number of production or similar units expected to be obtained from the asset by the entity.Following factors should be considered in determining the useful life of an asset: The expected usage of the asset by the entity. Usage is assessed by reference to the assets expected capacity or physical output The expected physical wear and tear Technical or commercial obsolescence arising from changes or improvements in production, or from change in market demand for the product or service output of the asset Legal or similar limits on the use of the asset, such as the expiry dates of related leases.Application of IFRIC 1IFRIC 1 is applicable when: Entities have the obligation to dismantle, remove and restore items of property, plant and equipment and Subsequent changes to cash flows, interest rates and time periods have occurred affecting changes in liability.Cost Model:Increase in liabilityDr. AssetCr. LiabilitySince the asset value is increased test the asset value for potential impairment.Decrease in LiabilityDr. LiabilityCr. Assetroshankumar.2007@rediffmail.com
  5. 5. The amount deducted from cost limited to carrying amount. Excesses areimmediately recognised in Profit or Loss.Revaluation model:Increase in LiabilityDr. Profit or Loss ORDr. Revaluation surplus (to the extent a credit balance exist in the revaluationsurplus in respect of that asset)Cr. LiabilityDecrease in LiabilityDr. LiabilityCr. Revaluation surplus ORCr. Profit or Loss (to the extent previous decrease in value of asset is recognised inProfit or Loss)If the decrease in the liability exceeds the carrying amount (as per cost model), theexcess is immediately recognised in Profit or Loss.Depreciation is the recognition of the economic benefits of the assets consumedduring each period. The depreciation method should reflect the pattern in which theassets future economic benefits are expected to be consumed by entity.Depreciable amount of an asset is its cost less its residual value. The residual valueis determined at acquisition date and reviewed at the end of each reporting period.Any significant change in the residual value will have impact on depreciable amountand depreciation charge and is accounted for prospectively.Residual value is the estimated amount that the entity would currently obtain fromdisposal of asset after deducting the estimated cost of disposal, if the asset werealready at the age and in condition expected at the end of its useful life.Depreciation of an ceases at the earlier of the date that The asset is classified as held for sale in accordance with IFRS 5 The date that asset is derecognised.Depreciation does not cease when the asset becomes idle or is retires from activeuse unless the asset is fully depreciated.roshankumar.2007@rediffmail.com
  6. 6. Measurement of items of Property, Plant and EquipmentIAS 16 prescribes two alternative methods of measuring items of Property, Plantand Equipment subsequent to initial recognition. 1. Cost Model: Subsequent to initial recognition as an asset, an item of Property, Plant and Equipment should be carried at its cost less accumulated depreciation and any accumulated impairment losses. 2. Revaluation Model: After recognition as asset, an item of property, plant and equipment whose fair value can be measured reliably shall be carried at revalued amount being its fair value at the date of revaluation less any subsequent accumulated depreciation and any accumulated impairment losses.The fair value of land, building, plant and equipment is usually its market value.However if there is no evidence of the market value because of the specialisednature of the plant and equipment and because these assets are rarely sold, exceptas a part of continuing business, they are valued at depreciated replacement cost.When an asset’s carrying amount is increased as a result of a revaluation, theincrease should be recognised in other comprehensive income and accumulated inequity under the heading revaluation surplus. However, it should be recognised asincome to the extent it reverses an impairment loss with respect to the same assetthat was previously recognised as an expense.When the carrying amount of a previously revalued asset decreases, the decreaseshould be recognised in other comprehensive income as a decrease in therevaluation surplus. To the extent that the decrease exceeds revaluation surplus withrespect to the same asset, the excess (expense) should be recognised in profit orloss.The revaluation surplus included in equity may be transferred directly to retainedearnings when the asset is derecognised. Some of the revaluation surplus may betransferred directly to retained earnings while the asset is used. Transfers fromrevaluation surplus to retained earnings are not made through profit or loss.When an entity chooses to revalue an item of property, plant and equipment it shouldrevalue all assets in its class.Revaluation: the AccountingMethod 1roshankumar.2007@rediffmail.com
  7. 7. Any accumulated depreciation at the date of revaluation is eliminated against thegross carrying amount of the asset and the net amount is restated to the revaluedamount of asset. Result: The asset is stated at revalued amount; and Accumulated depreciation reset to zero.This method is often used for buildings that are revalued to their market value.Method 2Any accumulated depreciation at the date of the revaluation is restatedproportionately with the change in the gross carrying amount of the asset so that thecarrying amount of the asset after revaluation equals its revalued amount. Result: Ratio of gross carrying amount to the accumulated depreciation will stay the same Net carrying amount will equal revalued amount Eg. gross CA = 100, acc. Dep = 20, net CA = 80. If we want to revalue the net CA to 120 and keep the gross CA to acc. Dep ratio, which is 5, the same then if revised acc. dep is x then revised gross CA will be 5x. That means 5x – x = 120, solving the equation we get x = 30.This method is often used when the asset is revalued by means of applying an indexto its depreciated replacement cost.Subsequent Expenditure:The cost of replacing a part of an item of property, plant and equipment whenincurred is recognised in the carrying amount of that item if the recognition criteriaare met, which are: It is probable that future economic benefits associated with item will flow to the entity; and The cost of the item can be measured reliablyThe carrying amount of those parts that are replaced is derecognised in accordancewith the derecognition provisions of IAS 16.Disposal or retirement of an item of property, plant and equipmentAn item of property, plant and equipment should be derecognised on: Disposal; or No future economic benefits are expected from its disposal or useThe gain or loss arising from the retirement or disposal of an item of property, plantand equipment is the difference between net disposal proceeds and the carryingroshankumar.2007@rediffmail.com
  8. 8. amount of asset. The gains or losses should be recognised in the profit or lossunless IAS 17: leases requires otherwise.If the payment to be received on disposal is deferred, the consideration received isrecognised initially at the cash equivalent (i.e. present value). The differencebetween the nominal amount and cash price equivalent of the consideration receivedis recognised as interest revenue under IAS 18: Revenue.Compensation from third parties for item of property, plant and equipment that wereimpaired, lost or given up is included in determining profit or loss for the period whenit becomes receivable. Such receipt of compensation is treated as a separateeconomic event and accounted for separately.roshankumar.2007@rediffmail.com