IAS 16: Property, Plant and Equipment

Definition:
IAS 16 defines PPE as:
-tangible item
-held for use in:
 Production or supply of goods and services
 Rental to others
 Administrative purposes
-expected to be used more than one period

Initial Measurement:
-PPE should be initially measured at ‘cost’
-Cost should be recognized only if:
 It is probable that future economic benefit will flow to the entity
 Cost of the item can be measured reliably.

Cost Components:
 Purchase price (including import duties and purchase taxes, after
reducing trade discounts)
 Directly attributable costs (bringing the asset to the location, making it
capable to be operating in the manner intended by the management)
 Dismantling and Restoration Cost (initial estimate off the cost of
dismantling and removing the item and restoring the site on which it is
located)
 Any interest on the amounts borrowed for the purpose of constructing
an asset are also included in its cost. (IAS 23)

Examples of directly attributable costs:

 cost of employee benefits arising directly from the construction or
acquisition of PPE
 cost of site preparation
 initial delivery and handling costs
 installation and assembly costs
 costs of testing whether the asset is functioning properly (here, when we
test a machine, in order to know if the machine is functioning properly,
we run the production process. Materials will be required; labour will be
required to run the whole production process. So, the material and
labour costs will be shown as expenses in SOPL, and the end products
 that we get from the production process will be sold, and the revenue
that we receive from the products sold will be shown as revenue in
SOPL)
 professional fees
 decommissioning costs
 borrowing costs

Examples of costs not included in PPE (to be charged to SOPL):

 cost of opening a new facility
 cost of introducing a new product or service (including advertising and
promotional activities)
 cost of conducting business in a new location or with a new class of
customers (including cost of staff training)
 administration and other overhead costs

Subsequent Costs:
 Subsequent costs should be capitalized if:
-it is probable that future economic benefits will flow into the entity
-the cost of the item can be measured reliably
 All the other costs should be expensed in SOPL in the period they are
incurred. Eg.: day-to-day servicing, repairs and maintenance.
 Some items of PPE may require replacements at regular intervals, or may
require major inspections. In such cases, the costs would be capitalized
(if IAS 16 recognition criteria are satisfied).
 Any remaining carrying amount of the part that has been replaced would
be derecognized.
- Derecognition: Involves removing the asset or part of asset from the
financial statements.
- Carrying amount removed: the remaining carrying amount of the
replaced part is subtracted from the total carrying amount of the asset.
- Profit or Loss: any gain or loss from the derecognition is recognized in
SOPL.
- Eg: Consider a piece of machinery that has a total carrying amount of
$10,000. Within this machinery, a specific component valued at $2,000
(carrying amount) is replaced.
 The cost of the new component is $2,500, which is capitalized.
 The $2,000 carrying amount of the replaced component is
derecognized.
 The new carrying amount of the machinery becomes $10,500
($10,000 - $2,000 + $2,500).
Subsequent Measurement:
PPE will be carried at either:
- Cost less Accumulated Depreciation and Impairment (cost model) or,
- Fair Value less Accumulated Depreciation and Impairment between
revaluations (revaluation model)
- Any Revaluation surplus on disposal remains in equity and will not be
reclassified to SOPL.

Fair Value: Estimated price at which an asset is bought or sold when both the
buyer and seller agree on a price. (you compare the carrying value of the asset
that you bought long ago with the current market prices, and fix on an agreed
price)

Revaluation Surplus: Equity account that reflects the increase in fair value of
an asset over its previous book value. Since its unrealized, it cannot be used to
distribute dividends.

Impairment Loss: Amount by which the carrying amount of an asset exceeds its
recoverable amount. (Recoverable amount is the higher of an asset’s FV-cost
to sell and VIU)

Revaluation Model:
 Considers Fair Value
 Amounts will be revalued to their market value.
 Gain  OCI  Revaluation Surplus

Conditions to use Revaluation Model:

 Market values should be reliable
 Class of assets (groups of similar assets) should be recognized at their
revalued amounts.
 Class of assets should be revalued at the same time.
 If the revaluation is done in a particular method, the same method must
be used throughout the years. (This is to ensure the principles of
consistency and comparability.)
Revaluation Gains –

Initial Recognition:
When an asset is revalued upwards (FV higher than carrying value)
-the increase is recognized in OCI
-accumulated in equity (under equity with heading ‘revaluation surplus’)

Journal Entry:
Dr. Property, Plant and Equipment (increase in value)
Cr. Revaluation Surplus (equity)

Depreciation Adjustment:
The revalued amount becomes the new carrying amount, and the depreciation
will be based on this new amount.

Subsequent Increase:
Increase will be recognized in OCI, and added to the revaluation surplus in
equity.

Revaluation Loss –

Initial Recognition:
When and asset is revalued downwards (FV lower than carrying value)
-the decrease will be recognized in P and L

Journal Entry:
Dr. Revaluation Surplus
Dr. Profit or Loss
Cr. Property, Planta and Equipment (decrease in value)

Subsequent Decrease:
Decrease will be recognized in Profit or Loss.

Eg: Upward Revaluation –

Carrying amount of the asset = $100,000
Revalued amount = $150,000
Revaluation Gain = 150,000 – 100,000 = $50,000

Journal Entry:
Dr. Property, Plant and Equipment $50,000
Cr. Revaluation Surplus $50,000

Eg: Downward Revaluation –

Carrying amount of the asset = $150,000
Revalued Amount = $120,000
Revaluation Loss = 150,000 – 120,000 = $30,000

Journal Entry:
Dr. Profit or Loss $30,000
Cr. Property, Plant and Equipment $30,000

Eg: If there was a previous revaluation surplus of $10,000

Dr. Revaluation Surplus $10,000
Dr. Profit and Loss $20,000
Cr. Property, Plant and Equipment $30,000

Overhaul/Reconditioning/Inspection Costs:
 Overhaul/Reconditioning Costs – periodic
 The costs should be capitalized when they occur, and then expense it
until the next overhaul period.
 Cannot create a provision as IAS 37 states that for a provision to be
created, there should be a present obligation.
 Inspection costs are periodic in nature a s well
 Similar to overhaul costs, even inspection costs are capitalized when they
occur, and then expensed until the next inspection period.

Derecognition of Revaluation Surplus:

When the revalued asset is eventually disposed off, any remaining balance in
the revaluation surplus related to that asset is transferred directly to retained
earnings.

Dr. Revaluation Surplus

Cr. Retained Earning
(Here retained earnings are credited, because retained earnings are a part of
equity. Increase in equity will be credited.)

Depreciation of PPE:
 Depreciation is charged systematically over the useful life of the asset.
 Components of an asset with differing patterns of benefits are
depreciated separately. (check how the pattern of the future economic
 benefits are received back. If you get the benefits back on a consistent
basis – use Straight Line Balance method. But if you get high benefits
back initially, and then later on the benefits gets lower, then use
Written Down Value method.)
 There will be instances where the carrying value of the asset will be
lower than the residual value. In such cases, depreciation will be ‘0’.
 Assets should be depreciated on the basis of their economic life (use
scrap value) or useful life (use residual value).
 PPE with finite lives should be depreciated.
 Useful life and residual values will be reviewed annually.

Derecognition of PPE:
 PPE should be derecognized upon disposal, or when no future economic
benefits are expected from its use or disposal (write off the carrying
value from the books as expense from SOPL)
 The gain or loss arising from derecognition should be included in P or L
when the item is derecognized. (Disposal proceeds less carrying amount
= gain/loss)