IAS 16

Property, Plant and Equipment

Table of Contents
1. 2. 3. 4. 5. 6. 7. Objective ................................................................................................................................. 95 Learning outcome ................................................................................................................... 95 Definitions ............................................................................................................................... 95 Scope ..................................................................................................................................... 96 Exclusion .................................................................................................................................. 96 Introduction ............................................................................................................................. 97 Recognition of PPE as an asset ............................................................................................... 97 7.1. Treatment of spare parts ............................................................................................ 97 7.1.1. Example 1 ........................................................................................................ 97 7.2. Unit of measurement ................................................................................................. 97

Vol-1 7.3. 7.4. 8.

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Initial cost .................................................................................................................... 97 Subsequent Cost ......................................................................................................... 98

Measurement at recognition .................................................................................................. 98 8.1. 8.2. Elements of cost .......................................................................................................... 98 Cessation of recognition of cost of PPE ..................................................................... 99 8.2.1. Example 2 ........................................................................................................ 99 8.3. Measurement of cost .................................................................................................. 99 8.3.1. 8.3.2. Determination of commercial substance .................................................... 100 Reliable measurement of fair value ............................................................ 100

9.

Measurement after recognition ........................................................................................... 100 9.1. Cost model and Revaluation model ........................................................................ 100

9.1.1. Example 3 .................................................................................................................. 102 10. Depreciation .......................................................................................................................... 102 10.1. 10.2. Depreciation of parts ................................................................................................ 102 Depreciable amount and Depreciation period ....................................................... 103 10.2.1. Example 4 .................................................................................................... 104 10.3. Depreciation method ............................................................................................... 104 10.3.1. Example 5 .................................................................................................... 104 11. Impairment ............................................................................................................................ 105 11.1. 12. Compensation for impairment ................................................................................ 105

Derecognition ........................................................................................................................ 105 12.1. 12.2. 12.3. Example 6 .................................................................................................................. 106 Example 7 .................................................................................................................. 106 Example 8 .................................................................................................................. 106

13. 14. 15. 16.

Disclosure .............................................................................................................................. 106 Comparison with AS 10 ......................................................................................................... 108 Assessment ............................................................................................................................ 110 Case Study ............................................................................................................................. 111

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95 construction or, where applicable, the amount attributed to that asset when initially recognised in accordance with the specific requirements of other IFRSs, eg.: IFRS 2 Share-based Payment. Depreciable amount is the cost of an asset, or other amount substituted for cost, less its residual value. Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. Entity-specific value is the present value of the cash flows an entity expects to raise from the continuing use of an asset and from its disposal at the end of its useful life or expects to incur when settling a liability. Fair value is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arms length transaction. An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount. Property, plant and equipment are tangible items that: are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes are expected to be used during more than one period. Recoverable amount is the higher of an assets fair value less costs to sell and its value in use. The residual value of an asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life.

1 Objective
IAS 16 prescribes the accounting treatment for property, plant and equipment so that users of the financial statements can discern information about an entitys investment in the same and changes in such investment. The principal issues in accounting for property, plant and equipment are the recognition of the assets, the determination of their carrying amounts and the depreciation charges and impairment losses to be recognised in relation to them. Source: IASB

2 Learning outcome
In this topic, you will learn to: Recognise PPE as an asset State principles relating to the measurement of PPE State principles relating to depreciation of PPE State principles relating to derecognition of PPE Apply select concepts of IAS 16

3 Definition
The following terms are used in this Standard with the meanings specified: Carrying amount is the amount at which an asset is recognised after deducting any accumulated depreciation and accumulated impairment losses. Cost is the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition or

IAS 16 Property, Plant and Equipment

Vol-1 Useful life is: the period over which an asset is expected to be available for use by an entity; or the number of production or similar units expected to be obtained from the asset by an entity.

96

4 Scope
IAS 16 focuses on the accounting treatment for property, plant and equipment. The standard should be applied in accounting for all PPE except where another standard specifically requires a different treatment to be applied.

5 Exclusion
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Description PPE classified as held for sale

IAS IFRS 5 Non-current Assets Held for Sale and Discontinued Operations IAS 41 Agriculture

Remarks

PPE classified as held for sale

This Standard applies to property, plant and equipment used to develop or maintain the assets This Standard applies to property, plant and equipment used to develop or maintain the assets This Standard applies to property, plant and equipment used to develop or maintain the assets

Recognition and measurement of exploration and evaluation of assets Mineral rights and mineral reserves such as oil, natural gas and similar nonregenerative resources. Investment Property

IFRS 6 Exploration for and Evaluation of Mineral Resources

IAS 40 Investment Properties

Entities using cost model for its investment properties shall apply cost model of IAS 16

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97 major spare parts that the entity expects to use during more than one period spare parts that are specifically connected to the item of PPE.

6 Introduction
Business organizations have current and noncurrent assets. Current assets are debtors, inventories of goods that are kept for sale in the near future, loans and advances. The cost of such current assets can be set off against the revenue generated by the assets. Ownership of properties, plants and equipments (PPE) that are used for production / supply of goods or services or administrative purposes are called non current assets. Benefits of using these non current assets come over a number of years. Hence the cost of these items should be allocated to more than one period. These assets have to be recognized properly in the books of accounts. It is therefore important that users of financial statements are informed as to how the entities use their properties, plants and equipments and how they are treated in the financial statements.

7.1.1 Example 1
M/s. Procon Ltd. has purchased machinery for Rs. 3 crore. Along with the machinery, the entity also procured major spare parts worth Rs. 50 lakh, which are not readily available in the market. What is the total cost of PPE? Rs. 3.50 crore is the total carrying cost of the machinery, as the cost of major spare parts should be added to the carrying cost of the machinery.

7.2 Unit of measurement

IAS 16 does not specify unit of measurement. It is left to the judgment of the management. If 1000 numbers of small tools can be clubbed and shown as a single unit, it is allowed. The recognition principle is applied to all items of PPE at the time the costs are incurred. Costs are of two types : initial costs that are incurred to acquire / construct an asset. subsequent costs to add to, replace part of or service the PPE

7 Recognition of PPE as an asset

The cost of an item of property, plant and equipment shall be recognised as an asset if, and only if: It is probable that future economic benefits associated with the item will flow to the entity; and the cost of the item can be measured reliably.

7.3 Initial cost

An item of PPE that qualifies for recognition as asset shall be measured at cost. The elements of cost are discussed later in this chapter. In addition to the qualifying asset, there may be some assets which are acquired for specific purpose and thus they qualify as PPE. These assets may not bring any future economic benefits due to their inherent nature, but as such they are considered a part of PPE. For example, an entity may acquire some PPE for safety or environmental purpose; say for

7.1 Treatment of spare parts

Generally spare parts and servicing equipments are carried as inventory and they are recognized as consumed and shown in Profit and Loss account. However in the following circumstances, the spare parts shall be capitalized and added to the carrying cost

IAS 16 Property, Plant and Equipment

Vol-1 example, Effluent treatment plants. These PPEs may not directly increase the future economic benefits to the entity. However, such acquisitions / constructions are mandated by rules and regulations and without these PPEs the entity may not get future economic flow from its other assets. Such PPEs are recognized as assets.

98 In some cases, the entity may require regular inspection from Government and other appropriate authorities. In this connection the entity may spend money to make the PPE fit for operations. For example, the vehicle fitness certificates in case of transport operators, FDI inspection in case of drug manufacturers. These expenses are essential for using the PPE for its intended economic flow, and should be added to the carrying cost of the PPE.

7.4 Subsequent Cost

As indicated earlier, an entity may incur on its PPE, some costs subsequent to the initial recognition. They may be incurred either to add a part or replace a part or service the PPE. Following points should be noted while recognizing subsequent costs. Generally, the costs incurred for day to day servicing of PPE are not recognized in the carrying cost. Day-to-day servicing are primarily the costs of labour and consumables and small parts. These expenses are recognized in P & L under Repairs & Maintenance. Subsequent costs also include replacement of some parts at regular intervals. For example, the seats inside an aircraft, the lining of the plant etc. Such costs are added to the carrying cost of the PPE. At that time, the carrying cost of the replaced parts will be derecognised as per this standard.
The Institute of Chartered Accountants of India (ICAI)

8 Measurement at recognition
On recognising an item of a PPE as an asset, it shall be measured at its cost.

8.1 Elements of cost

The initial costs consist of its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates any costs that are directly attributable to bringing the asset to the location and condition the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located

Directly attributed costs (a) Costs of employee benefits arising directly from the construction or acquisition of the item of PPE; Costs of site preparation; Initial delivery and handling costs; Installation and assembly costs; (c) (a) (b)

Not directly attributed costs Costs of opening a new facility; Costs of introducing a new product or service (including costs of advertising and promotional activities); Costs of conducting business in a new location or with a new class of

(b) (c) (d)

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Directly attributed costs (e) Costs of testing whether the asset is functioning properly, after deducting the net proceeds from selling any items produced while bringing the asset to that location and condition (such as samples produced when testing equipment); and Professional fees.

Not directly attributed costs customer (including costs of staff training); and (d) Administration and other general overhead costs.

(f)

If an asset is constructed and used, the cost would be same as if it is acquired. Any internal profit should be eliminated while recognizing the cost. For example a manufacturer of Lift may use one in its building. The cost of such lift should be included as part of the building cost. Similarly, the cost of abnormal amounts of wasted material, labour, or other resources incurred in self-constructing an asset is not included in the cost of the asset.

8.2.1 Example 2
M/s. Unicorn Enterprises has purchased second hand machinery worth Rs. 35 lakhs that makes dyes of bottle lids during May 2007. The transportation cost was Rs. 50,000. Installation charges were: Rs. 35,000. The brokerage paid for acquiring the machinery was: Rs. 10,000. What is the total carrying cost of the machinery for FY 2007-08? Rs. 35. 95 lakhs Rs. 39.85 lakhs Rs. 35.50 lakhs All these are directly attributable to bring the machinery to the location. The carrying cost is Rs. 35.95 lakhs.

8.2 Cessation of recognition of cost of PPE

When PPEs are in the location and are capable of operation, recognition of costs of carrying ceases. The following costs are not included in the carrying amount of an item of PPE: Costs incurred while an item capable of operating in the manner intended by

8.3 Measurement of cost

Items of PPEs may be acquired through exchange of a combination of monetary or nonmonetary assets. In this context, let us see the

IAS 16 Property, Plant and Equipment

The entity may have some incidental operations and related income or expenses. These incidental operations are not necessary to bring the item to the location. All these incidental income / expenses are treated in Profit & Loss A/c and not added to the carrying cost of the asset, eg: when a building site is used as storage space or car park. All these income / expenses shall be treated in P & L.

management has yet to be brought into use or is operated at less than full capacity; Initial operating losses, such as those incurred while demand for the items output builds up; and Costs of relocating or reorganising part or all of an entitys operations.

Vol-1 100 accounting treatment of PPE acquired through exchange of one non-monetary asset. . The cost of such PPE is measured at fair value if: Such exchange transaction commercial substance has

not significant the probability of various estimates of values within a range can be reasonably assessed. Upon such reliable measurement, if the fair value of asset received is more clearly evident then this value is considered at cost. Otherwise the fair value of asset given up is used as cost. The cost of an item of PPE held by a lessee under a finance lease is determined in accordance with IAS 17. The carrying amount of an item of PPE under Government Grant will be recognised in accordance with IAS 20.

The fair value of either the asset given or the asset received is reliably measurable If the asset acquired is not measured at fair value, then it is measured at the carrying cost of the asset given. In this situation, the following two aspects have to be understood: determination of commercial substance reliable measurement of fair value

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9 Measurement after recognition

9.1 Cost model and Revaluation model
After the PPE is recognized as asset, the entity can either choose Cost model or Revaluation model as its accounting policy for the subsequent years. Cost model: An item of PPE shall be carried at cost less accumulated depreciation less any accumulated impairment losses. Revaluation model: An item of PPE shall be carried at fair value on the date of revaluation less accumulated depreciation less any accumulated impairment losses This model shall be applied where the fair value can be measured reliably. If the entity chooses revaluation model, it should be done regularly such that there is no material deviation in the fair value at the reporting date. The frequency of revaluation depends on the nature of the items. Prices of some items of PPE will have high volatility. Such items can be revalued every year. Some other PPEs which have insignificant variation in prices

8.3.1 Determination of commercial substance

An exchange transaction has commercial substance: if the configuration of the cash flows in terms of risk, timing and amount of the cash flows on the asset received is different from that of cash flows of the asset given. the entity specific value of the portion of the entitys operations is affected on account of such exchange of assets as reflected by the post-tax cash flows. the difference in (a) or (b) is significant as compared to the fair value of the assets exchanged.

8.3.2 Reliable measurement of fair value

If the asset does not have a comparable market value, then its fair value is reasonably measured if: the variability in the range of fair value is

Vol-1 101 may be revalued once in 3 or 5 years. For example, a company engaged in the manufacture of stainless steel utensils need not carry out revaluation very frequently as the variation in prices will be insignificant for such machineries. A company who is engaged in supply of micro chips should revalue the machineries very frequently as the fair price of these machineries vary very widely based on the technology changes. The following additional points should be noted while carrying out revaluation: The fair value of land and buildings should have market based evidence. This can be based on the appraisals conducted by professionally qualified valuers. The nature of the PPE, if the market based evidence is not available, fair value of items of plant and equipment is usually their market value determined by appraisal. Due to the specialized nature of PPE, an income or a depreciated replacement cost approach. may be used to estimate fair value The revaluation should be done for all assets in a class of assets, say land & buildings, machineries, ship, aircraft etc. On revaluation of the PPE, the accumulated depreciation is treated in any one of the following ways: a) Restated proportionately with the change in the gross carrying amount of the asset so that the carrying amount of the asset after revaluation equals its revalued amount. This method is often used when an asset is revalued by means of applying an index to determine its depreciated replacement cost. b) Eliminated against the gross carrying amount of the asset and the net amount restated to the revalued amount of the asset. This method is often used for buildings. The amount of the adjustment arising on the restatement or elimination of accumulated depreciation forms part of the increase or decrease in carrying amount, which is treated separately. At the time of revaluation, the carrying amount may: 1. Increase or 2. Decrease 1. If it increases, the increase shall be recognised in other comprehensive income and accumulated in equity under the heading of revaluation surplus. However, the increase shall be recognised in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognised in profit or loss. 2. If it decreases, the decrease shall be recognised in profit or loss. However, the decrease shall be recognised in other comprehensive income to the extent of any credit balance existing in the revaluation surplus in respect of that asset. The decrease recognised in other comprehensive income reduces the amount accumulated in equity under the heading of revaluation surplus. The PPE, recognised as an asset in the books may get de-recognised at some point of time, due to sale, retirement etc. In such cases, the amount standing to the credit of revaluation reserve of this PPE may be transferred directly to retained earnings. However, when the assets are in use, the difference between the depreciation based on revalued amount and the original amount shall be transferred from the revaluation surplus to P & L account. Transfers from revaluation surplus to retained earnings are not made through profit or loss. The effects of taxes of income, if any resulting from the revaluation of PPE, shall be dealt in

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Vol-1 102 accordance with IAS 12 Income Taxes.

9.1.1 Example 3
ABC Company has the following items in their books. Year 1: Bought PPE worth Rs.900 lakh. In this Land & Buildings are Rs 500 lakh and the rest are Machinery. Year 2: Company revalues its Land & Buildings to 700 lakh and Machinery to Rs.300 Lakh Year 3: company revalues Land and Buildings to Rs.400 Lakh and Machinery to Rs.350 lakh. Year 4: company sells its Machinery for Rs.300 lakh Year 5: the company sells its Land and Buildings for Rs.600 lakh How is the increase / decrease treated in the books? Ignore the changes in depreciation. Solution: Year 2: revaluation surplus on Land & Buildings: Rs. 200 lakh. Credited to property revaluation reserve and shown under owners equity. Year 2: revaluation deficit on Machinery: Rs. 100 lakh, debited to P& L A/c. Year 3: revaluation deficit of Rs. 300 lakh in land and buildings. Rs. 200 lakh debited to the property revaluation reserve and set off against earlier reserve created. The balance of Rs. 100 lakh is written off in P & L. Year 3: revaluation of increase of Rs. 50 lakh in machinery. This is treated in P & L for reversing the earlier deficit. Year 4: the deficit of Rs. 50 lakh is debited to P & L account. Year 5: surplus of Rs.200 lakh. Rs.100 lakh is credited to P & L as a reverse of earlier deficit. The balance of Rs. 100 lakh is transferred to revaluation reserve.

Finally this amount is transferred to retained earnings. When PPEs are revalued, it should be done for the entire class of PPE and simultaneously for each class to avoid selective re-valuation. Revaluation can also be done for a class of assets on a rolling basis provided it is completed within a short period of time and revaluations are kept up-to-date. The following are the examples of separate classes: Land Land & Buildings Machinery Ships Aircrafts Motor vehicles Furniture & Fixtures Office equipment

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10 Depreciation
This section deals with: Depreciation of parts of PPE Depreciation amount & period Depreciation method.

10.1 Depreciation of parts

Each item of PPE is first analysed whether it has different parts that have significant costs in relation to the total cost. If so, they should be first recognised part-wise and depreciated separately. For example, the costs of an aircraft can be attributed to the airframe, the engines and the seats etc. It is possible to recognise these parts and depreciated separately. Similarly, a lessor of an operating lease of a PPE may depreciate cost of items attributable to favourable or unfavourable lease terms separately.

Vol-1 103 While depreciating the significant parts separately, they may also be grouped with other significant parts which have the same useful life and the depreciation method for determining the depreciation charge. When some significant parts are depreciated separately, the remainder of the PPE may consist of parts that are individually not significant. While depreciating these insignificant parts, entity may choose either of the two options: Approximation techniques may be adopted so that it represents the consumption pattern or useful lives of its parts. Depreciation of insignificant parts separately. The depreciation charges of the items of PPE shall be recognised in P & L account unless it is included in the carrying amount of another asset. In certain cases, the future economic benefits of an item of PPE may result in production of other assets. In such cases, the depreciation charges form part of the cost of other asset and hence is included in its carrying amounts. of shifts, maintenance level etc. In addition, the useful life depends on technical / commercial obsolescence and legal limitations put on the use of the asset. The economic life may differ from useful life. The useful life depends on the management policy, whereas economic life depends on the economic benefits the asset may yield. For example, a company may have the policy to use its transport vehicles for 5 years. After 5 years, all vehicles shall be sold. In this case the useful life is only 5 years, though the vehicles may function even after 5 years. Land and buildings will have separate useful life, though they are bought together. Land will have unlimited useful life except in case of quarries, land fill site etc. In case the cost of land includes expenses like site dismantlement, removal & restoration, then these are separated from the cost of land and depreciated over the period of benefits received. Buildings have limited useful life and hence have to be depreciated separately. While computing depreciation, the residual value is deducted and the balance allocated during their useful life. For example, the management policy of a company is to keep all transport vehicles for 5 years and then sell them.. The estimated residual value is 20 %. In this case the depreciation is 80 % of the cost to be written off over a period of 5 years. In practice, most of the items will not have residual value hence they are ignored. Depreciation is recognised even if the fair value is higher than carrying amount, provided the residual value is not higher than the carrying amount. When the residual value is higher than the carrying amount, no depreciation is charged, till the residual value decreases below the carrying value.

10.2 Depreciable amount and Depreciation period

Depreciation of an asset begins when it is available for use, i.e. when it is in the location and condition necessary for it to be capable of operating in the manner intended by management. The following points are to be noted: The depreciable amount of an asset shall be allocated on a systematic basis over its useful life. Useful life depends on factors such as, expected usage of the asset, physical wear & tear which again depends on the operational conditions such as the number

IAS 16 Property, Plant and Equipment

Vol-1 104 Depreciation of an asset ceases earlier of the following dates: when the asset is classified as held for sale, or included in a disposal group that is classified as held for sale. when the asset itself is derecognised. Therefore, depreciation does not cease when the asset becomes idle or is retired from active use unless the asset is fully depreciated. However, under usage methods of depreciation the depreciation charge can be zero while there is no production. the pattern in which the assets future economic benefits are expected to be consumed by the entity. In some assets, the economic flow would be uniform, in some other the flow may diminish over the period. The method of depreciation shall be reviewed once a year to confirm if the pattern of economic flow is same or is there any significant change has happened. Accordingly the method of charging depreciation may be changed. Some of the methods are: Straight-line method, where the depreciation will be same for every year The diminishing balance method, where the depreciation will decrease over the period Units of production method, where the depreciation will be based on the production.

10.2.1 Example 4
Carrying amount is Rs.30 lakh, Fair value is Rs.35 lakh and Residual value is Rs. 5 lakh. Which amount you will take to compute depreciation and why? Solution: Depreciation is charged on the carrying amount of Rs.30 lakh. Why As per IAS 16, Depreciation is recognised even if the fair value is higher than carrying amount, provided the residual value is not higher than the carrying amount

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10.3.1 Example 5
A machinery is valued at Rs.150 lakh and the accumulated depreciation is Rs.30 lakh. The fair value now is Rs.180 lakh. Apply Restatement model (Method A) and Elimination model (Method B) to arrive at the depreciation and how it will appear in the books. Method A ( Rs. In lakh ) 150 75 * 225 Method B ( Rs. In lakh ) 150 30 180

10.3 Depreciation method

The depreciation method used shall reflect What Cost or valuation before revaluation Revaluation adjustment (balancing figure) After revaluation Depreciation Before revaluation Revaluation adjustment (balancing figure) After revaluation Revalued amount Allocated in the ratio of 150:30

30 15 * 45 180

30 (30) 0 180