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Property,Plant & Equipment (IAS -16)


CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. )     19 June 2009

CA. Amit Daga
Finance Controller CA. CS. CFA. CIFRS. M.COM.  
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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.

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CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. )     19 June 2009

CA. Amit Daga
Finance Controller CA. CS. CFA. CIFRS. M.COM.  
 416 likes  8997 points

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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
 

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CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. )     19 June 2009

CA. Amit Daga
Finance Controller CA. CS. CFA. CIFRS. M.COM.  
 416 likes  8997 points

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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.

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CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. )     19 June 2009

CA. Amit Daga
Finance Controller CA. CS. CFA. CIFRS. M.COM.  
 416 likes  8997 points

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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.
 

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CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. )     19 June 2009

CA. Amit Daga
Finance Controller CA. CS. CFA. CIFRS. M.COM.  
 416 likes  8997 points

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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.

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CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. )     19 June 2009

CA. Amit Daga
Finance Controller CA. CS. CFA. CIFRS. M.COM.  
 416 likes  8997 points

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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
 

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CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. )     19 June 2009

CA. Amit Daga
Finance Controller CA. CS. CFA. CIFRS. M.COM.  
 416 likes  8997 points

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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.
 

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CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. )     19 June 2009

CA. Amit Daga
Finance Controller CA. CS. CFA. CIFRS. M.COM.  
 416 likes  8997 points

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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.
 

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CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. )     19 June 2009

CA. Amit Daga
Finance Controller CA. CS. CFA. CIFRS. M.COM.  
 416 likes  8997 points

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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.
 

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CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. )     19 June 2009

CA. Amit Daga
Finance Controller CA. CS. CFA. CIFRS. M.COM.  
 416 likes  8997 points

View Profile | My Other Post

 

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
 


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