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Property, Plant and

IAS 16 Equipment 01
DEFINITION AND RECOGNITION |1

Property, plant and equipment (PPE) are tangible items that:


(a) are held for use in the production or supply of goods or services, for
Definition
rental to others, or for administrative purposes; and
(b) are expected to be used during more than one period.
The cost of an item of PPE shall be recognised as an asset if, and only if:
(a) it is probable that future economic benefits associated with the
Recognition
item will flow to the entity; and
(b) the cost of the item can be measured reliably.
IMPORTANT The IFRSs are intended to be applied on material items.

QUESTION 01
Complete the following table by stating whether the items listed below can be recognised as
property, plant and equipment and reason if they cannot be so recognised there for:
Items Y/N Reason
Small tools and spare parts
Standby generator expected to be used for 7
years
An office building.
A trademark
An office printer.
A plot of land held for resale
A factory including building and machineries.
A bus for pick-and-drop of staff members.
A generator given to another company on rent

INITIAL MEASUREMENT
The cost of an item of PPE comprises:
(a) its purchase price, including import duties and non-refundable
Initial purchase taxes, after deducting trade discounts and rebates.
Measurement: (b) any costs directly attributable to bringing the asset to the location
Initial and condition necessary for it to be capable of operating in the
expenditure manner intended by management.
(c) the initial estimate of the costs of dismantling and removing the
item and restoring the site on which it is located (IAS 37)
Examples of directly attributable costs are:
(a) costs of employee benefits arising directly from the construction or
acquisition of the item of PPE;
Directly
(b) costs of site preparation;
attributable
(c) initial delivery and handling costs;
costs
(d) installation and assembly costs;
(e) costs of testing whether the asset is functioning properly; and
(f) professional fees.
The cost of a self-constructed asset is determined using the same
Self principles as for an acquired asset. If an entity makes similar assets for
constructed sale in the normal course of business, the cost of the asset is usually the
asset same as the cost of constructing an asset for sale. However, profit
element and abnormal costs should be excluded.
ICMAP M4 Financial Accounting

The borrowing costs may be included (see IAS 23 later)


Any subsequent expenditure on PPE should only be capitalised if it
results in increase in total expected economic benefits from the asset.
Subsequent For example, increase in production, reduction in cost etc.
expenditure
2| The cost of general repairs should be recognised as expense
immediately.

QUESTION 02
B Co started construction on a building for its own use on 1 April 2007 and incurred the
following costs:
Rs. 000
Purchase price of land 250,000
Stamp duty 5,000
Legal fees (registry cost) 10,000
Site preparation and clearance 18,000
Materials 100,000
Labour (1 April 2007 to 1 July 2008) 150,000
Architect’s fees 20,000
General overheads 30,000
583,000

The following information is also relevant:


 Material costs were greater than anticipated. On investigation, it was found that
materials costing Rs. 10 million had been spoiled and therefore wasted and a further
Rs. 15 million was incurred as a result of faulty design work.
 As a result of these problems, work on the building ceased for a fortnight during
October 2007 and it is estimated that approximately Rs. 9 million of the labour costs
relate to this period.

Required:
Calculate the cost of the land and building that will be included in property, plant and
equipment.

QUESTION 03
A machine is serviced at an annual cost of Rs. 10,000. During the most recent service, it
was decided to replace an important part which would result in faster work and the machine
will produce more units of product per hour. The cost of the replacement part is Rs. 20,000.

How this expenditure should be treated?

QUESTION 04 Initial cost (IAS 16) – D01


Broadoak has recently purchased an item of plant from Plantco, the details of this are:
Rs. Rs.
Basic list price of plant 240,000
Trade discount applicable to Broadoak 12.5% of list
price
Ancillary costs:
Shipping and handling costs 2,750
Estimated pre- production testing 12,500
Maintenance contract for 3 years 24,000
Site preparation costs:
Electrical cable installation 14,000
Concrete reinforcement 4,500
Own labour costs 7,500 26,000

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Class Notes

Broadoak paid for the plant (excluding the ancillary costs) within four weeks of order, thereby
obtain an early settlement discount of 3%.Broadoak had incorrectly specified the power
loading of the original electrical cable to be installed by the contractor. The cost of correcting
this error of Rs. 6,000 is included in the above figure of Rs. 14,000.

The plant is expected to last for 10 years. At the end of this period there will be compulsory
costs of Rs. 15,000 to dismantle the plant and Rs. 3,000 to restore the site to its original use |3
condition.

Required:
Calculate the amount at which the initial cost of the plant should be measured. (Ignore
discounting). (5 marks)

DEPRECIATION
IMPORTANT DEFINITIONS
Carrying amount = Cost – accumulated depreciation
Depreciable = Cost – residual value
amount
is the systematic allocation of the depreciable amount of an asset
Depreciation
over its useful life.
The residual value of an asset is the estimated amount that an
entity would currently obtain from disposal of the asset, after
Residual value
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.
Useful life is:
(a) the period over which an asset is expected to be available for
Useful life use by an entity; or
(b) the number of production or similar units expected to be
obtained from the asset by an entity.
QUESTION 05
An asset costs Rs. 100,000 and can be easily used for ten years. The company intends to
use the asset for six years at which point expected residual value will be Rs. 40,000 (at
current prices).

Required:
What is the depreciable amount?
What is the amount of depreciation for first year using straight line method?

Depreciation must be charged from the date the asset is available for
use, i.e. it is capable of operating in the manner intended by
management.
Commencement
of depreciation
This may be earlier than the date it is actually brought into use, for
example, when staff need to be trained to use it. Depreciation is
continued even if the asset is idle.
End of The depreciation is no more charged when the asset is derecognized or
depreciation disposed of.

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QUESTION 06
A company constructed a building for its own use. The building was completed on 1 July
2008 and occupied on 1 September 2008. The company used the building for a long time
but then due to expansion in its business it decided on 1 July 2015 it decided to shift in new
rented premises. The company shifted to new premises on 1 August 2015 and disposed of
the old building on 31 December 2015.
4|
Required:
When the depreciation charge should be commenced on the building?
When the depreciation charge should be ceased on the building?

CHANGE IN ESTIMATES
DEPRECIATION METHODS
There are various methods of charging depreciation. IAS 16 specifically
mentions three:
Available
 Straight line
methods
 Reducing balance
 Sum of unit (sometimes called machine hour method)
Which The depreciation method used should reflect as fairly as possible the pattern
method to in which the asset’s economic benefits are consumed by the entity.
choose?
CHANGE IN DEPRECIATION METHOD
A change from one method of providing depreciation to another method is
When
permissible only on the grounds that the new method will give a fairer
allowed?
presentation of the results and of the financial position.
The change in depreciation method is change in accounting estimate and
Nature
does not constitute change in accounting policy.
The carrying amount should be written off over the remaining useful life,
Treatment
commencing with the period in which the change is made.

QUESTION 07
On 1 January 2001, Air Limited purchased an asset for Rs. 10,000 with nil residual value
and is intended to be used for 10 years. The company uses straight line method.

On 1 January 2003, Air Limited reconsidered the use of its depreciation methods and
concluded that the straight line method is not appropriate for this type of asset instead 25%
depreciation on reducing balance method is appropriate.

Required:
Calculate the depreciation charge for the year 2001, 2002, 2003 and 2004.
REVIEW OF USEFUL LIFE AND RESIDUAL VALUES
Useful life and residual value of PPE should be reviewed at end of each
Requirement reporting period and revised if expectations are significantly different from
previous estimates.
The carrying amount of the asset at the date of revision less any residual
Treatment
value should be depreciated over the revised remaining useful life.

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Class Notes

QUESTION 08
On 1 January 2001, Water Limited purchased an asset for Rs. 12,000 with estimated
residual value of Rs. 2,000 and is intended to be used for 10 years. The company uses
straight line method.

In 2003, Water Limited reviewed the useful life and residual value of the asset. It was
estimated that the asset’s remaining useful life is now only 5 years, however, the estimate of |5
residual value has been increased to Rs. 3,000.

Required:
Calculate the depreciation charge for the year 2001, 2002, 2003 and 2004.

QUESTION 09 Initial cost & estimates (IAS 16) – D08


On 1 October 2005 Dearing acquired a machine under the following terms:
Hours Rs.
Manufacturer’s base price 1,050,000
Trade discount (applying to base price only) 20%
Early settlement discount taken (on the payable amount only) 5%
Freight charges 30,000
Electrical installation cost 28,000
Staff training in use of machine 40,000
Pre-production testing 22,000
Purchase of a three-year maintenance contract 60,000
Estimated residual value 20,000
Estimated life in machine hours 6,000
Hours used – year ended 30 September 2006 1,200
– year ended 30 September 2007 1,800
– year ended 30 September 2008 (see below) 850

On 1 October 2007 Dearing decided to upgrade the machine by adding new components at
a cost of Rs. 200,000. This upgrade led to a reduction in the production time per unit of the
goods being manufactured using the machine. The upgrade also increased the estimated
remaining life of the machine at 1 October 2007 to 4,500 machine hours and its estimated
residual value was revised to Rs. 40,000.

Required:
Prepare extracts from the income statement and statement of financial position for
the above machine for each of the three years to 30 September 2008.
(10 marks)

SEPARATE COMPONENTS AND MAJOR OVERHAULS


COMPLEX ASSETS AND SEPARATE COMPONENTS
Some assets are complex assets. These assets contain separate major
ISSUE components within a single asset. For example, an airplane consists of air
frame, engine and interiors (all having different useful life).
Each separate component is depreciated over its respective useful life
TREATMENT
separately.

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ICMAP M4 Financial Accounting

INSPECTION OR OVERHAUL COSTS


Routine These costs are generally expensed in the period in which they are
inspections incurred.
and
overhauls
These costs are capitalised if:
6| Major  These relate to PPE
Inspections  The benefit is expected to last for more than one accounting period.
and
overhauls If above conditions are fulfilled, then these costs are depreciated over their
useful lives.

QUESTION 10
Wind Limited purchased a small aircraft that has an expected useful life of 20 years with no
residual value. The aircraft requires substantial overhaul at the end of year 5, 10 and 15. The
aircraft costs Rs. 25 million and Rs. 5 million of this amount is attributable to the economic
benefits that are restored by the overhauls.

At start of year 6, the overhaul is done at a cost of Rs. 6 million.


At start of year 11, the overhaul is done at a cost of Rs. 8 million.
At start of year 16, the overhaul is done at a cost of Rs. 10 million.

Required:
Calculate the annual depreciation charge for the years 1 to 5, years 6 to 10, years 11- 15
and years 16 to 20. The company uses straight line method.

QUESTION 11 Flightline (IAS 16) – J09


Flightline is an airline which treats its aircraft as complex non-current assets. The cost and
other details of one of its aircraft are:
Rs. ’000 estimated life
Exterior structure – purchase date 1 April 1995 120,000 20 years
Interior cabin fittings – replaced 1 April 2005 25,000 5 years
Engines (2 at Rs. 9 million each) – replaced 1 April
2005 18,000 36,000 flying hours

No residual values are attributed to any of the component parts.

At 1 April 2008 the aircraft log showed it had flown 10,800 hours since 1 April 2005. In the
year ended 31 March 2009, the aircraft flew for 1,200 hours for the six months to 30
September 2008 and a further 1,000 hours in the six months to 31 March 2009.

On 1 October 2008 the aircraft suffered a ‘bird strike’ accident which damaged one of the
engines beyond repair. This was replaced by a new engine with a life of 36,000 hours at cost
of Rs. 10·8 million. The other engine was also damaged, but was repaired at a cost of Rs. 3
million; however, its remaining estimated life was shortened to 15,000 hours. The accident
also caused cosmetic damage to the exterior of the aircraft which required repainting at a
cost of Rs. 2 million. As the aircraft was out of service for some weeks due to the accident,
Flightline took the opportunity to upgrade its cabin facilities at a cost of Rs. 4·5 million. This
did not increase the estimated remaining life of the cabin fittings, but the improved facilities
enabled Flightline to substantially increase the air fares on this aircraft

Required:
Calculate the charges to the income statement in respect of the aircraft for the year
ended 31 March 2009 and its carrying amount in the statement of financial position as
at that date. Note: the post accident changes are deemed effective from 1 October 2008.
(10 marks)

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Class Notes

SUBSEQUENT MEASUREMENT
IAS 16 allows choice of accounting treatment:
Cost model The PPE are presented at Cost less accumulated depreciation
The PPE are presented at
Revaluation Revalued amount less subsequent accumulated depreciation.
model |7
Revalued amount is fair value (FV) at the date of revaluation.

CONDITIONS FOR REVALUATION MODEL


If the revaluation model is adopted, the following two conditions need to be fulfilled:
When an item of PPE is revalued, the entire class of assets to which the items
Class wise
belongs must be revalued. For example, if a plant is revalued all the plant and
application
machineries held by entity should be revalued.
After first revaluation, subsequent revaluations muse be made with sufficient
regularity to ensure that the carrying amount does not differ materially from the
Sufficient
fair value at each reporting date.
regularity
Revaluations need not necessarily be made at each year – end.
RECORDING REVALUATION
Elimination of Dr. Accumulated depreciation
1.
depreciation Cr. Asset
Recording gain or Dr. Asset Dr. Loss on revaluation
2.
loss Cr. Gain on revaluation Cr. Asset

SPL OR OCI – WHERE THE GAIN OR LOSS SHOULD BE RECOGNISED?


Loss SPL
Gain OCI
OCI [up to the balance in revaluation surplus account (usually after
Reversal of gain incremental depreciation)]
SPL [Remaining amount]
SPL [up to the asset’s carrying amount had the
Reversal of loss impairment/revaluation loss never occurred]
OCI [Remaining amount]

QUESTION 12
On 1 January 2001, M Limited purchased a building for Rs. 100,000 with nil residual value
and 10 years useful life. On 31 December 2001, the building was revalued to Rs. 108,000.

On 31 December 2002, due to slump in the property market, the building was again revalued
but this time the worth was only Rs. 55,000.

REQUIRED
Pass the journal entries from 1 January 2001 to 31 December 2002.

QUESTION 13
On 1 January 2001, J Limited purchased a building for Rs. 100,000 with nil residual value
and 10 years useful life. On 31 December 2001, the building was revalued to Rs. 63,000.

On 31 December 2002, due to surge in the property market, the building was again revalued
but this time the worth was Rs. 92,000.

REQUIRED
Pass the journal entries from 1 January 2001 to 31 December 2002.

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QUESTION 14 Depreciation and valuation (IAS 16) – J07


The trainee accountant has been reading some literature written by a qualified surveyor on
the values of leasehold property located in the area where Toogood owns leasehold
property. The main thrust is that historically, annual increases in property prices more than
compensate for the fall in the carrying amount caused by annual amortisation until a
leasehold property has less than 10 years of remaining life. Therefore the trainee accountant
8| suggests that the company should adopt a policy of carrying its leasehold properties at cost
until their remaining lives are 10 years and then amortising them on a straight-line basis over
10 years. This would improve the company’s reported profit and cash flows as well as
showing a faithful representation of the value of the leasehold properties.

Required:
Comment on the validity and acceptability of the trainee accountant’s suggestion.
(7 marks)

DEPRECIATION & DISPOSAL OF REVALUED ASSETS


Depreciation The depreciation is charged on revalued amount.
Incremental The extra depreciation charged on the revalued amount (as compared to
depreciation cost) may be transferred from revaluation surplus to retained earnings (and
this is shown in statement of changes in equity).

QUESTION 15
Consider each of the following cases separately:

Case 1: a plant had cost of Rs. 10,000 (nil residual value) and accumulated depreciation of
Rs. 2,000 and remaining useful life of 8 years as at 1 January 2011. The plant was revalued
to Rs. 12,000 on 1 January 2011.

Case 2: a building had cost of Rs. 100,000 (nil residual value) and accumulated depreciation
of Rs. 20,000 and remaining useful life of 8 years as at 1 January 2011. The building was
revalued to Rs. 120,000 on 31 December 2011.

Case 3: a machinery had cost of Rs. 50,000 (nil residual value) and accumulated
depreciation of Rs. 10,000 and remaining useful life of 5 years as at 1 January 2011. The
machinery was revalued to Rs. 54,000 on 30 June 2011.

The straight line method is to be used in each case. The company does not transfer any
extra depreciation to realised profits.

Required:
Calculate the depreciation charge for the year 2011 and revaluation surplus arising in each
case.

QUESTION 16
A company revalued its buildings at the start of the year to Rs. 6 million. The property cost
was Rs. 4 million and it was bought 10 years ago. Its total useful life of 50 years is
unchanged. The company policy is to make an annual transfer of realised amounts to
retained earnings.

Required:
Show the effects of the above on the financial statements for the year.

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Class Notes

DISPOSAL
Gain or Gain / loss on disposal = net sale proceeds – carrying amount
loss The gain or loss is recognised in profit or loss.
Revaluation The revaluation surplus related to the asset disposed of is transferred to
surplus retained earnings.

QUESTION 17 |9
A revalued asset with a carrying amount of Rs. 70,000 (after deducting accumulated
depreciation of Rs. 30,000) was sold for Rs. 95,000. There is a Rs. 40,000 revaluation
surplus relating to this asset.

Required:
Pass the journal entries on disposal.

QUESTION 18 PE February 2013 Q4 (a)


Subhan Associates purchased an asset for Rs.2 million on January 1, 2009. The asset had a
useful life of 5 years and being depreciated using straight-line method. On January 1, 2011,
the asset was revalued to Rs.2.1 million. The remaining useful life is the same i.e., three
years.

Required:
Prepare Journal entries for the revaluation of asset and depreciation for the year ended
December 31, 2011. (06 marks)

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