Property,Plant & Equipment (IAS -16)

IFRS 7430 views 45 replies

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

What is PPE :- IAS-16 defines as “ tangible items that

§ are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and

§ are expected to be used during more than one period”

The spare parts and servicing equipment are normally treated as inventory and expensed as consumed. But major spare parts and stand by equipment treated as PPE, when they are expected to be used during more than one period.

All those components which has a cost that is significant in relation to the total cost of the item, must be depreciated separately.

This does not mean that these significant component have different useful lives or provide a different pattern of benefits to the entity than the main asset.

Example:- An aircraft and its engines may need to be treated as separate depreciable assets and this will be required if they have different useful life.

Replies (45)

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Initial Cost

Some time PPE are acquired, may not generate economic benefits, but which that’s necessary to enable other assets to do so. As they enable other assets to generate economic benefits so they are also treated as assets.

However, the resultant carrying amount to those assets and the related assets is reviewed for impairment to ensure that other combined carrying amount does not exceed their combined recoverable amount.

If any cost of the assets do no meet the definition of an asset, they are an expense and should be written off to the income statement as incurred.

Once any cost has been classified as an expense, it cannot be re-classified as an asset at a later date.

This differs form the situation where a cost that was originally recognised as an assets has been written down for impairment and that impairment is subsequently reversed in accordance with IAS 36

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Subsequent Costs

IAS-16 requires that subsequent costs should be capitalised, that is recognised as an asset, only if they meet the recognition criteria in the standard

• Its probable that future economic benefits associated with the item will flow to the entity

• The cost of the item can be measured reliably

If its not meet the above criteria, all subsequent costs would be recognised as an expense in the period in which they are incurred.

Example:- Entity A, a supermarket chain, is renovating one of its major stores, The store will have more available space for in-store promotion outlets after the renovation and will include a restaurant.

Management is preparing the budgets for the year after the store re-opens, including the cost of remodeling and the expectation of a 15% increase in sales resulting from the store renovations, which will attract new customers.

The expenditure is remodeling the store will create future economic benefits and the cost of remodeling can be measured reliably, therefore it should be capitalised.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Significant Components

Under IAS-16, if an item of PPE comprises two or more significant components, with substantially different useful lives, then each component is treated separately for depreciation.

When one of the component is replaced or restored, the old component is written off, to avoid double counting and the new component capitalised, if its cost is recoverable.

The standard says that costs of a replacement component are recognised as an asset if they meet the recognition criteria

If the cost and depreciation of the replaced part or component cannot be identified its acceptable to use of the cost of the replacement as a proxy for the cost of the replaced part when it was acquired or constructed.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Significant Components

Example:- A small manufacturing company has acquired a new factory, which cost $1 M for freehold and has a residual value of $ 100 K. The factory has a flat roof, which needs replacing every ten years at a cost of $ 100 K.

The company is considering two alternative:-

• Depreciate the whole factory over its useful economic life of 30 years, charging $ 30K Per annum

• As roof is significant part of the item and depreciate the cost of the roof $ 10 K Per annum and other part depreciation charge will be $ 26.7 K. There fore total depreciation per annum will be $36.7 K.

In the first treatment, the cost and accumulated depreciation of the old roof will be $100K and $33 K. Therefore, there will be a loss of disposal to be recognised in the profit and loss account of $ 67 K

In the second treatment, carrying amount of the old roof in year 10 will be nil and the cost and accumulated depreciation of $100 K are written off with no profit or loss on disposal arising.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Initial Measurement

IAS-16 states that cost of an PPE Comprises

• Purchase Price, including import duties and non-refundable purchase taxed less any trade discounts and rebates

• Directly attributable costs of bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management.

• Initial estimate of the costs of dismantling and removing the item and restoring the site on which its located.

Examples of directly attributable costs

• Cost of employee benefits as defined in IAS-19 that arise directly from the construction of acquisition of the item

• Cost of Site preparation

• Initial delivery and handling costs.

• Installation and assembly costs

• Professional Fees

• Cost of testing whether the asset is working properly, after deduction the net proceed of sale

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Initial Measurement

Example:- Entity A has an existing freehold factory property, which it intends to knock down and redevelop. During the redevelopment period the company will move its production facilities to another (temporary) site. The following incremental costs will be incurred :

Set up costs :- $50 K to install the machinery in new location

Rent :- $ 150K

Removal costs :- $30 K to resend the machinery in the factory.

Can these costs be capitalised in to the cost of new building ?

Although construction of acquiring a new asset may result in incremental costs that would have been avoided if the asset had not been constructed or acquired.

But it should not be included in the cost of the asset because its not 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.

The costs to be incurred by the company do not meet that requirement of IAS 16 and cannot, therefore, be capitalised.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Initial Measurement

Standard lists types of the cost that are not directly attributable as follows :-

• Costs of opening a 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

Costs incurred on the asset is standing idle may not be capitalised. The standard states that costs incurred in using or redeploying an item are not included in its carrying amount

Example:- Entity A, which operates a major chain of supermarkets is plan for renovation of the stores. Management has prepared the budget for the period including expenditure related to construction and remodeling costs, salaries of staff who will be preparing the store before its opening and related utilities costs.

Management should capitalise the cost of construction and remodeling cost because its necessary to bring the store to the condition but the cost of salaries, utilities are operating expenditure will not be capitalised and it should be book as expense.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Start-up Costs

Start-up costs and similar pre-production costs do not form part of the cost of an asset. Initial operating losses incurred prior to an asset achieving its planned performance are recognised an expenses.

Where the asset is ready for use, but demand has not yet built up, costs should not be capitalised.

Example:- An amusement park has a soft opening to the public, to trial run its attraction. Tickets are sold at a 50% discount during the period and the operating capacity is 80%.

The official opening day of the park is 3 months later

Management claims that the soft opening is a trial run necessary for the amusement park to be in the condition capable of operating in the intended manner. Accordingly, the net operating costs incurred should be capitalised.

The net operating costs should not be capitalised, but should be recognised in the income statement.

Running at 80% operating capacity is sufficient evidence that the amusement park is capable of operating in the manner intended by management.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Self Constructed Assets

The cost of a self-constructed asset is determined using the same principles as for an acquired asset. Cost of producing the asset for sale, as determined according to IAS -2 “Inventories”. Any internal profits are eliminated in arriving at such costs.

IAS-16 prohibits capitalisation of General and Administrative Overheads and start up costs. Self Constructed Assets is exception of this rule.

IAS-2 specifies that the cost of inventories includes cost of conversion. Cost of conversion includes a systematic allocation of fixed and variable production overheads.

Fixed production overheads are indirect costs of production and include depreciation and maintenance of factory buildings and equipment and the cost of factory management and administration.

In this specific and special case, therefore, it would appear that a proportion of overheads relating to factory (but not office) management and administration would be included in cost.

The cost of abnormal amounts of wasted material, labour or other resources incurred in the production of a self- constructed asset are not included in the cost of the asset

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Other Incremental Costs

Constructing or acquiring a new asset may result in other incremental costs that would have been avoided only if the asset had not been constructed or acquired.

These cost should not be included in the cost of the asset if they do not bring the asset into the location and condition necessary for it to be capable of operating in the manner intended by management.

Example:- A mobile phone operator setting up a new network in a new territory, involving the construction of the network system (Transmitter tower etc).

There will be costs that would have been avoided only if the physical network system had not been constructed, as without the physical infrastructure in place there can be no business.

This Costs that do not relate to the construction of the physical asset. It relate to setting up the new business as a whole,

According to the standard this cost do no qualify to be capitalised as part of the cost of asset, even though they are incurred during the construction phase of the new network.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Decommissioning Costs

Capitalisation of Decommissioning cost is only allowed when there is a corresponding obligation recognised as a provision under IAS-37.

Sometimes the obligation in respect of such decommissioning costs does not arise until, or only becomes apparent, later in the asset’s life due, for example, due to change in the legislation in respect of environmental damage.

Example :- An asset has a life of 30 years, After 10 years there is change in legislation due to that obligation arises in respect of decommissioning costs relation to installation of the asset for which provision of $3 M is recognised. Either,

• Whole $ 3M is capitalised as part of the asset’s cost and depreciate in the remaining 20 years of life. Or,

• Only $ 2 M is capitalised and depreciated over 20 years. The remaining provision of $1M is recognised immediately as depreciation in the current year Profit & Loss A/c.

First period is more appropriate because the change arises from new information and development does not relate to past period

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Change in Estimate

Changes in estimate may be due to changes in the legislation, technology, timing of the decommissioning, management’s assumption etc. This issues are dealt with IFRIC- 1 “Change in existing decommissioning ,restoration, and similar liabilities”.

For assets measured using the cost model under IAS-16, changes in the measurement of an existing decommissioning, restoration and similar liability and changes in the discount rate should be accounted for as follows :

§ Change should be added or deducted from the cost of the related asset in the current period.

§ The amount deducted from the cost of the asset must not be greater than the carrying amount of assets. If the decrease in the liability exceeds the assets carrying amount, the excess must be recognised immediately in the Profit & loss.

§ If the adjustment results in an addition to the cost of the asset, for example where the liability has increased, the entity must consider whether the new carrying amount is fully recoverable or not. If there is an indication that the asset may not be fully recoverable the entity should carry out an impairment test and account for any loss in accordance with IAS-36

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Change in Estimate

For assets measured using the Revaluation model under IAS-16, revaluation model, changes are accounted for effectively through the revaluation reserve as follows :

§ An increase in the liability should be recognised in the Profit & loss, except that it should be debited to equity to the extent of any existing revaluation surplus in equity in respect of the asset.

§ A decrease in the liability should be credited directly to the revaluation surplus in equity, except it should be credited to profit & loss to the extent that it reverses a revaluation deficit on the same asset that was previously charged to profit & loss.

§ In the event that a decrease in the liability exceeds the carrying amount that would have been recognised had the asset been measured under the cost model, the excess over that cost based carrying amount must be recognised in profit or loss immediately.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Measurement of Cost

Deferred Payment :- Where an item is acquired on terms that payment is deferred beyond normal credit terms, its cost is the cash price equivalent, that is the discounted amount and difference amount will be treated as Interest Payable.

Leases:- Assets leased under a finance lease are recorded as per IAS -17

Government Grant:-The carrying amount of assets may be reduced by the amount of government grants.

Exchange of Assets:- An item of PPE may be acquired in exchange for another non-monetary asset or a combination of monetary or non-monetary assets. The cost of such an acquired item is measured at fair value unless :

§ the exchange transaction has no commercial substance ; or

§ the fair value of neither the asset received nor the asset given up reliably measured.

If the acquired item is not measured at fair value its measured at the carrying amount of the asset given up.

In the exchange transaction, commercial substance and reliability of measurement both the characteristics must be there.