4.international financial reporting topic 1 - ias 16...

CPA P2 Advanced Corporate Reporting

1 © Cenit Online 2015

4.INTERNATIONAL FINANCIAL REPORTING

TOPIC 1 - IAS 16 PROPERTY, PLANT & EQUIPMENT

Objective of IAS 16 – to prescribe the accounting treatment for property, plant and

equipment in the financial statements

Recognition

Property, plant & equipment can only be recognised as an asset in the financial statements 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

Any item of property, plant & equipment that satisfies the definition of an asset should

initially be measured at cost.

What is cost?

Cost comprises;-

(a) The purchase price, including import duties and non-refundable taxes (Vat is

reclaimable by business and is therefore excluded from Purchase Price) and after

deducting trade discounts and rebates.

(b) Any costs directly attributable to bringing the asset to the location and condition

necessary for it to be capable of operating in the manner intended by management

(c) Initial estimate of costs of dismantling and removing the asset and restoring the site

on which it is located. Ask yourself if the conditions for a provision

exist (PO-PO-RE!) – If conditions exist, then create provision and capitalise the

discounted cost of the provision

Note: Entity should not recognise in the carrying amount of an asset the cost of its day-to-

day servicing. (revenue expenditure)



Initial cost =

Purchase cost (minus any purchase discount and excluding recoverable tax)

Directly attributable costs

– professional fees

– delivery costs (carriage inwards)

– site preparation costs

– costs of testing whether the asset is functioning properly (i.e. pre production

testing) , after deducting the net proceeds from selling any items produced

while bringing the asset to that location and condition (such as samples

produced when testing equipment)

– Labour Costs on a normal basis

– Borrowing Costs incurred with the item – See IAS 23

Initial estimate of dismantling costs and site cleaning/restoration costs at the end

of the asset’s life -

Excluded from cost are items of revenue expenditure such as

Cost of Training staff to use the plant & equipment (Cr Bank, Dr Staff Training

Expense)

Early settlement discounts (Dr Liability, Cr Statement of Profit or Loss)

Purchase of maintenance contracts in respect of the plant & equipment (Cr Bank, Dr

Prepayments/Statement of Profit or Loss)

Administration or Other General Overheads

All of the above items are accounted for through the Statement of Profit or Loss

the cost of abnormal amounts of wasted material, labour, or other resources is not

included in the cost of the asset. (e.g. the increased labiur cost due to an industrial dispute

– the increase is not capitalised)



Subsequent Measurement of Property, Plant & Equipment

Entity can choose either

Cost Model

OR

Revaluation Model

Whichever model is chosen, will be the company’s accounting policy with respect to

property, plant and equipment and must be applied consistently to an entire class of property,

plant & equipment..i.e no “cherry picking” of just the assets which have gone up in value

Cost Model

Property, plant & equipment should be carried at;-

COST

Less

Accumulated depreciation and impairment losses

Revaluation Model

Property, plant & equipment should be carried at ;-

Fair value at date of revaluation

less

Any subsequent accumulated depreciation and impairment losses.

(Therefore if an asset is revalued at the year end date, subsequent depreciation will

not occur until the next year. So carrying amount of asset will be its fair value at reporting

date)

Note: Revaluations should be sufficiently regular to ensure that carrying amount doesn't

differ materially from fair value. Fair Value is usually the market value.

In the case of specialised assets where no open market operates, depreciated replacement

cost will be used, when adopting the revaluation model



Gains on Revaluation (Revalued Amt – Carrying Amount)

Where an asset is revalued upwards from its carrying amount

1. Dr Asset; Cr Revaluation Reserve

2. The gain on revaluation is disclosed as other comprehensive income in the

statement of comprehensive income and is not included in profit or loss for the

period. The amount of the unrealised gain reported will be the gross gain (i.e.

before any adjustments in respect of deferred tax if applicable in the question)

3. There is an exception to the rule in No 2 – if the gain on revaluation reverses a

previous loss on revaluation , where the loss was recognised in profit or loss

(i.e. Statement of Profit or Loss) the revaluation gain should be recognised in

profit or loss not “other comprehensive income” (Dr Asset; Cr Statement of

Profit or Loss)

Loss on Revaluation (Revalued Amt – Carrying Amount)

Where an asset is revalued down from its carrying value

1. Cr Asset; Dr Revaluation Reserve

2. Decrease on Revaluation is disclosed in “Other Comprehensive Income”

assuming that the loss on revaluation reverses a previous gain on revaluation,

where the gain was recognised in “other comprehensive income” the decrease

should be reported in other comprehensive income

3. If the conditions in number 2 do not apply, then the loss is recognised through

profit or loss (Cr Asset; Dr Statement of Profit or Loss) – e.g. For a decrease

on revaluation where there was no previous revaluation gain

Note that when a revaluation takes place, the depreciation for the period up to the date

of revaluation should be deducted from the carrying value before calculating the

revaluation surplus. This is a common mistake made by students

Note: Under the Revaluation Model, increases in the value of assets should be

accounted for in the statement of financial position under Revaluation Reserves as

follows;-

Dr. Asset Cost x

Dr. Acc Depr x

Cr. Revaluation Reserve x



BUT

If there is a revaluation decrease in an asset – this decrease should be included as an expense

in the Statement of Profit or Loss (unless the decrease reverses a previous gain as

described above) as follows;-

Dr. Expenses x

Cr. Asset Cost x

Cr. Acc Depr x

Depreciation

Depreciation begins when the asset is available for use !!! (Think of a newly built

hospital unit that it not being used) (Per IAS 16, consumption of future economic

benefits occurs not only through use but also through obsolescence and wear and tear)

– This contrasts with IAS 38 - Amortisation of Capitalised Development Expenditure

where amortisation does not commence until commercial production commences

Should be allocated on a systematic basis over assets useful life

Charge for each year is recognised in Statement of Profit or Loss

Method of depreciation used should reflect the pattern in which the asset’s future

economic benefits are expected to be consumed.

Land is not depreciated because it has an indefinite useful life (unless the land is used

in mining or similar industries)

2 depreciation methods – (a) Straight Line and (b) Reducing Balance

Depreciation (cont’d)

IAS 16 allows for a change in the method of depreciation where this results in a fairer

presentation of the entity’s results

Change in depreciation method = Change in Accounting Estimate not accounting

policy (IAS 8)

Change in depreciation method is not applied retrospectively



Review of Useful Economic Life

Should be reviewed at the year-end and revised if necessary.

If useful life is revised – carrying amount at date of revision should be depreciated

over revised useful life.

Change in useful life is a change in accounting estimate

De-recognition

Asset should be de-recognised on;-

(a) Disposal

(b) When no more future economic benefits are expected from asset

Any gain or loss should be included in the Statement of Profit or Loss as gain/loss on

disposal (not included in Sales Revenue!!)

Also Disposal proceeds should not be included in Sales Revenue

Gain/Loss calculated as follows;-

Disposal Proceeds less Carrying Amount

Any revaluation reserve standing to the credit of a disposed asset should be

transferred directly to retained earnings as a reserve movement.

Depreciation and the Revaluation Reserve

If an asset is revalued upwards, then its carrying value increases and a revaluation reserve is

created. 2 points should be noted as a result of this:

1. As the depreciation charge is based on a higher revalued amount,

then the charge to the SOPL will typically be higher, then if the

cost model was applied

2. As the asset is depreciated, its carrying value declines but the

revaluation reserve remains the same

Consequently, IAS 16 gives companies the option of transferring some of the gain from the

revaluation reserve to offset the additional depreciation. The amount of the surplus



transferred is the difference between the depreciation based on the revalued carrying amount

of the asset, and depreciation based on the asset’s original cost (or transfer from the

revaluation reserve to retained earnings in line with the depreciation policy being adopted for

the revalued asset)

N.B. Subsequent Expenditure

Subsequent expenditure on non current assets should be capitalised where

– The subsequent expenditure improves the asset ( for example by enhancing its

performance or extending its useful life) i.e. Adds value to the asset above and

beyond its original condition – provides enhanced future economic benefits –

matching concept!!!

– The subsequent expenditure is for a replacement part (provided that the part it

replaces is treated as an item that has been disposed of)

– Examples of Subsequent expenditure on a building

– Constructing an extension to the building

– Replacing the Elevators or the heating/air conditioning system

N.B. Subsequent Expenditure

Subsequent Expenditure which does not meet the criteria for capitalisation is instead

expensed to the Statement of Profit or Loss as incurred

Other Issues

Separate Components: Some items of property, plant and equipment comprise separate

components with different useful lives. For example, an airplane might have a useful life of

30 years, while the seats and fabric in the interior only have a life of 5 years. In such a

situation, the separate components should be capitalised as separate assets and each

depreciated over its useful life



Key Disclosures - IAS 16

For each class of depreciable asset, these include

- Depreciation method used

- UEL’s or depreciation rates used

- Total depreciation charged for the period, and

- Gross amount of depreciable assets and related accumulated

depreciation

- If material, the reason for any change in depreciation method

For revalued assets these include

- Name and qualification of valuer

- Basis of valuation

- Date and amount of valuations

Illustration

Property, Plant &

Equipment

Land& Building

€m

Plant

€m

Total

€m

Cost or Valuation:

At 1 October 2013 280 150 430

Additions 50 50

Revaluation (15) nil (15)

At 30 Sept 2014 265 200 465

Accumulated

Depreciation

At 1 October 2013 40 105 145



Charge for Year 9 35 44

Revaluation (40) nil (40)

At 30 Sept 2014 9 140 149

Carrying Value 30

September 2014

256 60 316

The Land and buildings were revalued by an appropriately qualified valuer on an existing use

basis on 1 October 2013. They are being depreciated on a straight line basis over a 25 Year

Life. Plant is depreciated at 20% per annum on cost



REVALUATIONS OF PROPERTY, PLANT & EQUIPMENT

IAS 16

OVERVIEW

1. Increase/Gain on Revaluation

Increase/Gain in

value which is not

reversing a

previous

loss/decrease

Dr Asset

Cr Revaluation Reserve

Note: Disclose in OCI!

Where the Gain is

reversing a previous

decrease which was

recognised as an expense

i.e. through profit or loss

Dr Asset

Cr Statement of Profit or Loss

Cr Revaluation Reserve (if the

gain is greater than the original

loss/decrease on revaluation)

Note: Only the excess carried to

Revaluation Reserve (if

applicable) will be disclosed in

OCI



2. Decrease/Loss on Revaluation

Decrease/Loss in

value which is not

reversing a

previous

gain/increase

Cr Asset

Dr Statement of Profit or

Loss

Note: No Disclosure in

OCI because the loss is

accounted for through

profit or loss!

Where the Loss is

reversing a previous

increase which was

recognised as an increase

in the revaluation reserve

Cr Asset

Dr Revaluation Reserve

(*OCI*)

Dr Statement of Profit or Loss

(if applicable!)

Dr Revaluation Reserve with the

amount of the loss which is

reversing the previous gain

taken to revaluation reserve –

Disclose in OCI)

Dr Statement of Profit or Loss

with the excess of the loss on

revaluation over the previous

gain on revaluation if this

applies – No Impact on OCI



IAS 16 VS IAS 40

IAS 16 – Property, Plant and Equipment

IAS 40 – Investment Property

“Property held to earn rentals or for capital appreciation or both”

Subsequent Measurement

Revaluation Model

Fair Value at Date of Revaluation less subsequent depreciation and impairment

Cost Model

Cost less ACC Depr & Impairment

Subsequent Measurement

Cost Model

Property valued at cost with Subsequent Depreciation

Land is not depreciated

Fair Value Model

Value at “Fair Value”

Through Profit or Loss

No depreciation

Consistent with IFRS 9



Deferred Tax and Non Current Asset Revaluations

IAS 12 – Income Taxes

IAS 16 – Property, Plant and Equipment

Per IAS 12, when an asset is revalued to fair value, a difference then arises between

(a) The Carrying Amount of the Asset (i.e. its fair value)

AND

(b) The TWDV of the asset

It is this difference that gives rise to a deferred tax liability/asset on revaluation.

When an asset is revalued upwards, depreciation increases and consequently accounting

profit decreases leading to a deferred tax liability.

The Unrealised gain taken to Revaluation Reserve should be net of deferred tax (wherever

such information is provided).

The amount of the unrealised gain reported in Other Comprehensive Income will be the gross

gain (i.e. before any adjustments in respect of deferred tax if applicable in the question)

Exam Note: The examiner will usually instruct as to whether or not the gain/loss taken to

revaluation reserve should be net of deferred tax.

Exam Note: Where an entity makes a transfer to retained earnings in respect of revaluation

reserve realised through depreciation , then the Unrealised Gain reported in OCI is before any

movement between Revaluation Reserve and Retained Earnings



Questions to practice



Past Exam

Questions – P1 –

IAS 16

Past Exam

Questions – P2 –

IAS 16

Q5 April 2015 Q1 August 2014

Q2 Aug 13 ; Q3 (7)

Aug 13

Q (A) April 2014

Q3 (6) April 13 Q1 Aug 2011

Q2, Q4 April 2011

4.international financial reporting topic 1 - ias 16...

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