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IAS 16: Property, Plant and Equipment (PPE)

IFRS Training Program Day 3 – December 4, 2008

Submitted by – Mukesh Thakur

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Purpose of the Standard

To prescribe the accounting treatment for Property, Plant and Equipment (PPE)

The principal issues are

The timing of Recognition of the assets

The determination of their carrying amount and

The depreciation charge in relation to them

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Scope

Applies in accounting for PPE.

PPE are

tangible items • that are held for

use in the production or supply of goods or services or rentals to others, or for administrative purpose

AND• are expected to be used during more than one period

Standard excludes

PPE for which separate Accounting treatment has been prescribed by any other Standard.

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Recognition criteria

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Spare Parts and Servicing Equipment

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Subsequent Costs

Replacement Costs

Day to day expenses is charged to Profit and Loss Account as repair and maintenance.

Major replacement cost qualify as PPE if recognition criteria is met.

The carrying amount of those parts that are replaced is derecognised.

Inspection Cost

Where major regulation inspection is required to operate the item of PPE, the cost of such item will qualify as PPE if recognition criteria is met.

Any remaining carrying amount of the cost of previous inspection is derecognised.

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Example

- ABC & Co., has acquired a heavy road transporter at a cost of Rs. 100,000 (with no breakdown of component parts).

- The estimated useful life is 10 years.

- At the end of the sixth year, the power train requires replacement, as further maintenance is uneconomical due to the off-road time required. The remainder of the vehicle is perfectly road worthy and is expected to last for the next four years.

- The cost of the new power train is Rs. 45,000.

- Can the cost of new power train can be recognized as the asset, and if so, what treatment should be used?

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Solution

- The new power train will produce economic benefits to the ABC & Co.; and

- Cost of the power train can be measured reliably. Hence, the item should be recognized as the asset.

- The cost Rs. 45,000 of new power train will be added to the carrying amount.

- The original invoice of the transporter did not specify the cost of the power train. Therefore, the cost of replacement Rs. 45,000 will be used as indicative price and discount to year 1, i.e., (45,000/ 1.05^6) = 33,500.

It is assumed that discount rate used is 5%.

- Revised Cost = (100,000 - 33,500 + 45,000) = 111,500

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Measurement

An item of PPE is measured at COST

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Measurement cont.

Only costs that are directly attributable may be capitalised. The standard lists type that are not directly attributable

Costs of opening new facility

Costs of introducing a new product or service

Costs of conducting business in a new location or with a new class of customer

Administration and other general overhead costs

Self Constructed assets is determined using the same principles as for an acquired asset.

Exchange of Assets

If fair value can be measured – cost will be measured at fair value.

If fair value can not be measured – cost will be recognised at carrying amount of asset given up.

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Your turn!

ABC & Co., is installing a new plant at its production facility. It has incurred these costs:

- Cost of the plant Rs. 250,000.

- Initial delivery and handling cost Rs. 20,000.

- Cost of site preparation Rs. 60,000.

- Consultants used to advice on the acquisition Rs. 70,000.

- Interest charges paid to supplier for deferred credit Rs. 20,000.

- Estimated dismantling cost to be incurred after 7 years Rs. 30,000.

- Operating losses before commercial production Rs. 40,000.

Find out the costs to be capitalized as per IAS-16?

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Solution

ParticularsCost

- Cost of the plant Rs. 250,000.

- Initial delivery and handling cost Rs. 20,000.

- Cost of site preparation Rs. 60,000.

- Consultants used to advice on the acquisition Rs. 70,000.

- Interest charges paid to supplier for deferred credit Rs. 20,000.

- Estimated dismantling cost to be incurred after 7 years Rs. 30,000.

- Operating losses before commercial production Rs. 40,000.

250,000

20,000

60,000

70,000

20,000

30,000

-

Total Costs 450,000

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Measurement after recognition

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Revaluation Model

Revaluation will be made at sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the end of the reporting period.

If an item of PPE is revalued, the entire class of PPE to which that asset belongs will be revalued.

Revaluation Gain

Surplus from Revaluation is credited directly to equity under heading ‘Revaluation Surplus’. However if revaluation reverses a revaluation decrease on the same asset previously recognised as an expense, it will credited to Profit and Loss Account to that extent.

i.e. Amount to be transferred to revaluation reserve =

Revaluation increase (-) Earlier revaluation decrease recognised as expenses.

Standard states that revaluation surplus included in equity may be transferred directly to retained earnings when the surplus is realised (i.e. when asset is derecognised). This transfer is made through reserves and surplus and not through profit and loss account.

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Revaluation Model cont…

Let us take an example:

A company has a policy of revaluing its PPE. At 1.1.2007 value of asset was Rs. 1000. Its useful life is 10 years and it is depreciated on straight line basis to nil residual value. It is revalued downward to Rs. 850 at 31.12.2007.

At 31.12.2008 market value has risen to Rs. 1050.

2007 2008

Cost/Valuation Brought forward 1000 850

Depreciation charge (1000/10); (850/9) (100) (94)

900 756

(Loss)/Gain on revaluation – Profit and Loss (50) 44

Gain on Revaluation - Revaluation Surplus - 250

Carrying amount carried forward 850 1050

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Revaluation Model cont…

Revaluation Losses

Revaluation Losses is charged against earlier revaluation surplus. Any balance of decrease in charged to Profit and Loss Account.

i.e. amount to be charged to the profit and loss =

Revaluation Decrease (-) Earlier revaluation increase.

Better to take an example again!

Cost of the asset as on 1.1.2007 = 100 Useful life = 10 years

Revalued amount at 31.3.2007 = 135 Method of Dep. = SLM

Revalued amount at 31.12.2008 = 50

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Revaluation Model cont…

Alternative treatment

Standard also permits transfer to be made from revaluation surplus to retained earning as the asset is used and the surplus is realized. The surplus may be realized as the asset is depreciated. In that case, in 2008 Rs. 5 would have been transferred from revaluation reserve to retained earning. The balance left in the revaluation amount would be Rs. 40. Accordingly, out of revaluation loss of Rs. 70 , charge against revaluation reserve would be Rs. 40 and Rs. 30 would be charged to Profit and Loss Account.

2007 2008

Cost 100 135

Depreciation (10) (15)

90 120

Gain on Revaluation – Revaluation Surplus 45 (45)

(Loss)/Gain on Revaluation – Profit and Loss - (25)

Carrying amount carried forward 135 50

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Depreciation

The standard prescribe following principles for depreciation

Each part of an item of PPE with a cost that is significant in relation to the total cost of the item will be depreciated separately.

The depreciation charge for each year will be recognised in profit and loss account unless it is included in carrying amount of another asset.

The depreciable amount of an asset will be allocated on a systematic basis over useful life.

The residual value and useful life of an asset will be reviewed at least each financial year end.

Any difference in estimates from previous expectation will be accounted for as a change in accounting estimates i.e. changes will be applied prospectively.

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Depreciation Method

The standard does not prescribe any depreciation method. An entity may choose any method as per the nature of business. However method adopted by the entity should reflect the following principles:

The depreciation method will reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity.

The depreciation method applied will be reviewed at each financial year end. Any change from the previous year will be treated as change in accounting estimates.

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IFRIC 1 Changes in Existing Decommissioning,Restoration and Similar Liabilities

- Cost model:

- Changes in liability will be added/deducted from asset cost in current period.

- No negative carrying amount possible; any excess recognised immediately in profit or loss.

- Increase in carrying amount triggers consideration of impairment. Calculation of recoverable amount might be necessary.

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IFIRC 1

Revaluation model:

Change in liability does not affect valuation of asset (impact on valuation reserve)

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Change in liability: indication that asset might have to be revalued.

Decrease in liability Decrease in liabilityRevaluation surplus

(except reversal of previous revaluation deficit)

Revaluation surplus (except reversal of

previous revaluation deficit)

Increase in liability Increase in liability

Profit or loss (except credit balance

remaining in revaluation surplus)

Profit or loss (except credit balance

remaining in revaluation surplus)

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Disclosure

For each class of PPE, following should be disclosed in Financial Statement

The measurement base used for gross carrying amount

The depreciation method used

The useful lives or the depreciation rates used

The Gross Carrying amount and the accumulated loss at the beginning and at the end of the period

A reconciliation of carrying amount at the beginning and end of the period showing

Additions

Assets held for sale (IFRS 5)

Acquisition through business combination

Increase or decrease from revaluation or impairment

Depreciation

Exchange differences arising on the retranslation of the financial statement of a foreign entity

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Disclosure cont…

Other changes.

The carrying amount at the beginning and end of the period.

Other Disclosures

The existence and amount of restrictions on title, and PPE pledged as securities for liabilities.

Amount of expenditure recognised in the carrying amount of an item of PPE in the course of construction.

The amount of contractual commitments for the acquisition of PPE.

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Extracts from Model Accounts

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Extracts of Significant Accounting Policies

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Extracts of Significant Accounting Policies cont…

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Comparison with Indian GAAP

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Comparison with Indian GAAP

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Comparison with Indian GAAP

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Comparison with Indian GAAP

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Comparison with Indian GAAP

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Comparison with Indian GAAP

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Comparison with Indian GAAP

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