In this article, we will share with you the accounting requirements in IAS 16 Property, Plant and Equipment. IAS 16 defines property, plant and equipment (“PPE”) as tangible items that (i) are held for use in the production or supply of goods or services, for rental to others or administrative purposes and (ii) are expected to be used during more than one period. There are some items, which meet this definition but are not in the scope of IAS 16. They are:
- When PPE is classified as held for sale – an asset classified as held for sale is governed under IFRS 5 Non-Current Assets Held for Sale and Discontinued Operations.
- Biological assets related to agricultural activity, except for bearer plants – biological assets are governed under IAS 41 Agriculture.
- The recognition and measurement of exploration and evaluation assets – this is covered in IFRS 6 Exploration for and Evaluation of Mineral Resources.
- Mineral rights and mineral reserves such as oil, natural gas, and others.
Here are 10 quick facts on the accounting requirements for PPE in IAS 16.
#1: When do we recognise an item as property, plant and equipment?
IAS 16 states that an item that meets the definition of PPE is recognised as an asset only on 2 conditions – (1) if it is probable that the future economic benefits associated with the item will flow to the entity and (2) the cost of the item can be measured reliably. This is consistent with the general recognition principle of an asset in the Conceptual Framework for financial reporting. We have covered this in Accounting for non-financial assets.
#2: How do we measure an item of property, plant and equipment?
On initial recognition, IAS 16 requires an entity to measure PPE at its costs. Costs of PPE comprise (i) its purchase price, (ii) any costs directly attributable to bringing the asset to the location and condition necessary for it to operate in the manner intended by the management, as well as (iii) the estimated amount of the costs to dismantle and removing the PPE and restoring the site in which the item is located, the obligation incurred when the item is acquired or as a consequence of using the item.
What if the asset is acquired in exchange for non-monetary assets or a combination of monetary and non-monetary assets? In this case, the cost of PPE is measured at fair value, unless if the exchange lacks commercial substance or fair value cannot be measured reliably (both for asset received and asset given up). Paragraph 25 of IAS 16 provides further guidance on how to determine if the exchange transaction lacks commercial substance. This assessment revolves around the extent to which an entity’s future cash flows are expected to change because of the transaction.
#3: How do we treat the costs of asset being replaced? Can we capitalise them as part of the cost of property, plant and equipment?
Sometimes, entities are required to replace certain parts of the property, plant and equipment as part of the items’ repair and maintenance activity. IAS 16 is clear that entities should not capitalise the costs incurred for repair and maintenance of PPE. Instead, these costs are expensed off to profit or loss when incurred as they are the cost incurred for the day-to-day servicing of the item. Examples of repair and maintenance costs are labour and consumables. However, there are also some items of PPE which requires replacement at regular intervals – such as seats in bus or aircraft. These items then can be used for a longer period once replaced. In such a situation, IAS 16 states that these costs can be capitalised (provided that the recognition criteria are met) as part of the cost of PPE. Take note that the costs of the parts being replaced must be de-recognised to avoid double-counting of the costs of items no longer in used.
#4: What happened after the initial measurement of property, plant and equipment?
After the initial measurement of an item of PPE, entities have the choice either to use the cost model or the revaluation model to measure the PPE. This choice will then become the entity’s accounting policy and must be applied to the entire class of PPE. This is to avoid selective revaluation of assets and the reporting of amounts which consist of the mixture of costs and values at different dates.
The two models to measure PPE are explained below:
- Under the cost model, PPE is carried at its cost less accumulated depreciation and accumulated impairment losses.
- Under the revaluation model, PPE is carried at its revalued amount – being the fair value as at the date of the revaluation less subsequent accumulated depreciation and subsequent accumulated impairment losses.
The revaluation model will require entities to perform revaluation regularly and the fair value of the item must also be able to be measured reliably. The accounting policy chosen is expected to be applied consistently from one period to another. However, when there is a need to change the accounting policy from one policy to another, such a change constitutes a change in accounting policy and be accounted for as per the requirements of IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.
#5: What does it mean by “class of asset”? How do we determine a class of asset?
Class of asset is grouping of various assets together. Assets are grouped based on their nature and use in the entity’s operation. Example of class of asset included in IAS 16 are land, motor vehicle, furniture and fixtures, office equipment and bearer plants.
There is a specific paragraph in IAS 16 which states that land and buildings are separable assets and are accounted for separately even if they are acquired together. Buildings generally have a limited useful life and are therefore depreciated. Land on the other hand, generally has unlimited useful life and therefore is not depreciated. However, in some cases, the land itself may have a limited useful life. Entities will need to exercise judgments to determine the useful of land.
#6: How do we depreciate property, plant and equipment?
IAS 16 requires entities to depreciate each part of an item of PPE with a cost that is significant separately. However, when a significant part of an item of PPE has the same useful life and depreciation method with another significant part of the same item, such parts may be grouped together to determine the depreciation charge.
The depreciation amount must be allocated on a systematic basis over the useful life of the asset. For this, entities will need to use their judgment to determine: (i) the appropriate depreciation method to allocate the depreciation charge; and (ii) the useful life of the asset. The depreciable amount of an item of PPE takes into consideration the residual value (i.e., residual value is deducted in arriving at the depreciable amount). Residual value reflects the estimated amount that an entity could obtain from disposal of the asset. The residual value may increase to an amount equal or greater than the asset’s carrying amount. In such a situation, the asset’s depreciation charge is zero, until and unless the residual value is below the asset’s carrying amount.
Entities start depreciating an item of PPE when the asset is available for use – specifically when the asset is in the location and condition necessary for it to be capable of operating in the manner intended by management. Depreciation stops when the asset is classified as held for sale or the date that the asset is de-recognised (whichever is the earlier). It is also important to note that depreciation does not stop simply because the asset becomes idle or is retired from active use.
#7: How do we determine the useful life of an item of property, plant and equipment?
Useful life of an asset reflects the asset’s expected utility to the entity – the period an entity could obtain future economic benefits from using the asset. The concept of asset’s expected utility to an entity may be different from the asset’s economic life. For example, an entity has a policy of disposing its company car after 5 years of use. Although the economic life of the car may go beyond 5 years (commonly 9 years), in this situation, the car is depreciated over 5 years instead of 9 years as it reflects the car’s expected utility or economic benefit to the entity.
#8: How do we account if there is a change in depreciation method, the residual value, or the useful life of property, plant and equipment?
There are various methods used in practice to allocate the depreciable amount on a systematic basis over the asset’s useful life such as the straight-line method, the diminishing balance method or the units of production method. Entity will need to use Its judgement to determine the appropriate method that closely reflects the expected pattern of consumption of the future economic benefit in the asset. The depreciation method will be change only when there is a significant change in the expected pattern of consumption of the future economic benefits in the asset.
The depreciation method, the residual value and the useful life of the asset must be reviewed at each reporting period. When there is a change in the asset’s depreciation method, the residual value, or the useful life, such a change constitutes a change in an accounting estimates and is accounted in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.
#9: What is the requirement for impairment of property, plant and equipment?
Property, plant and equipment is subject to impairment when there is any indication that the asset may be impaired. The impairment assessment for property, plant and equipment is governed under IAS 36 Impairment of Assets.
In certain situation, it is also possible that an entity gets compensation from third party for items of property, plant and equipment that were impaired, lost or given up. In such a situation, entities are required to include such compensation in profit or loss when the compensation becomes receivable.
#10: What are the requirements for de-recognition of property, plant and equipment?
IAS 16 states that an item of property, plant and equipment is de-recognised either on disposal or when no future economic benefits are expected from its use or disposal. Any gain or loss on de-recognition is included in profit or loss (except if it involved a sale and leaseback under IFRS 16 Leases). Gains from disposal should not be recorded as revenue in the entity’s financial statements unless the sale is part of the entity’s ordinary activities. Gain or loss is the difference between the net disposal proceeds and the carrying amount of the item.
The 10 key take always above summarises the accounting requirements in IAS 16. Stay tuned for our upcoming factsheet articles on other standards. Meantime, enjoy other articles on Financial Accounting section or ask your queries by Joining us on Community. It is free and open to join for all, now.