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:
- are held for use in the production or supply of goods or services, for rental to others or administrative purposes; and
- 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:
- Property, plant and equipment classified as held for sale – Entities account for an asset classified as held for sale under IFRS 5 Non-Current Assets Held for Sale and Discontinued Operations.
- Biological assets except bearer plants – Entities account for biological assets under IAS 41 Agriculture.
- The recognition and measurement of exploration and evaluation assets – Entities account for these assets under 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 IAS 16 Property, Plant and Equipment.
#1: When do we recognise an item of PPE?
IAS 16 requires an entity to recognise an item that meets the definition of PPE as an asset on 2 conditions:
- if it is probable that the future economic benefits associated with the item will flow to the entity; and
- 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 PPE?
On initial recognition, IAS 16 requires an entity to measure PPE at its costs. Costs of PPE comprise:
- its purchase price,
- 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, and
- 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.
How does an entity measure assets acquired in exchange for non-monetary assets or a combination of monetary and non-monetary assets? In this case, an entity measures the cost of PPE at fair value. An exception applies if the exchange lacks commercial substance or the entity cannot measure the fair value 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 account the costs of asset being replaced? Can we capitalise them as part of the cost of property, plant and equipment?
Sometimes, entities must replace certain parts of PPE as part of the item repair and maintenance activity. IAS 16 is clear that entities should not capitalise the costs incurred for repair and maintenance of PPE. Instead, entities expense off these costs to profit or loss when incurred. This is because they are the cost that entities need to incur 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. For example, seats in bus or aircraft. Entities can then use these items for a longer period once replaced. In such a situation, IAS 16 states entities can capitalise these costs as part of the cost of PPE (provided they meet the recognition criteria). Take note that entities must derecognise the costs of the replaced parts to avoid double-counting.
#4: What happened after the initial measurement of property, plant and equipment?
After the initial measurement, 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 entities must apply it 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 as follows:
- The cost model – Using this model, entities measure PPE at its cost less accumulated depreciation and accumulated impairment losses.
- The revaluation model – Under the revaluation model, entities account for PPE at its revalued amount. The amount is the fair value as at the date of the revaluation less subsequent accumulated depreciation and subsequent accumulated impairment losses.
The revaluation model require entities to perform revaluation regularly. Additionally, entities must also be able to measure the fair value of the item reliably. Entities apply the accounting policy chosen consistently from one period to another. However, when there is a need to change the accounting policy, such a change constitutes a change in accounting policy. Entities account for such change 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. IAS requires entities to group assets based on their nature and use in the operations. Example of class of asset 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. As such, entities account for them separately even if entities acquire them together. Buildings generally have a limited useful life and 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, entities may group such parts together to determine the depreciation charge.
Entities allocate the depreciation amount on a systematic basis over the useful life of the asset. For this, entities will need to use their judgment to determine:
- the appropriate depreciation method to allocate the depreciation charge; and
- the useful life of the asset.
The depreciable amount takes into consideration the residual value. This means, entities deduct the residual value 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 an entity classifies the asset as held for sale or the date when it derecognises the asset (whichever is the earlier). It is also important to note that depreciation does not stop simply because the asset becomes idle or 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, entities depreciate the car over 5 years instead of 9 years. This is to reflect 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 entities use in practice to allocate the depreciable amount on a systematic basis over the asset’s useful life. For example the straight-line method, the diminishing balance method or the units of production method. An entity needs 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.
Entities must review the depreciation method, the residual value and the useful life of the asset 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. Entities account for such changes 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. Entities account for impairment of property, plant and equipment as per 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 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. Entities include any gain or loss on de-recognition in profit or loss (except if it involved a sale and leaseback under IFRS 16 Leases). Additionally, entities should not record gains from disposal 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.