15/10/2015. The nature of PP&E. Initial recognition of PP&E. Chapter 7. Property, Plant & Equipment

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1 Chapter 7 Property, Plant & Equipment Prepared by Emma Holmes The nature of PP&E AASB 116 defines property, plant & equipment (PP&E) as: tangible items Tangible vs. intangible distinction discussed in Chapter 9 with a specific use within the entity that are expected to be used during more than one period (ie. they are non-current in nature) AASB 116 specifically excludes assets held for re-sale PP&E is normally divided into classes. Common classes include land, buildings, machinery, motor vehicles. Initial recognition of PP&E Cost of an item is recognised as an asset if: it is probable that economic benefits will flow to the entity, and the cost can be reliably measured Where future economic benefits are not expected to flow to the entity, costs incurred should be expensed. Component parts (with different useful lives) are required to be separately accounted for. Eg. An aircraft the engine, frame and fittings of an aircraft are likely to have different useful lives. 1

2 Initial measurement of PP&E PP&E is initially measured at cost, which includes: Purchase price (at fair value) Purchase price includes duties and taxes but excludes rebates and discounts Directly attributable costs required to bring the asset to the location and condition necessary for it to operate Refer section of text for detailed lists of items specifically included and excluded from this component Initial estimate of costs of dismantling, removing the item or restoring the site Eg- an offshore oil platform Measurement subsequent to initial recognition AASB 116 allows a choice of two possible measurement models: Cost model Revaluation model Each model will be discussed in detail in the following slides Accounting policy choice of this decision based primarily on relevance of information. The policy that is chosen must be applied to a whole class of assets May change policy, but only if results in more relevant/ reliable information The cost model AASB 116 requires that assets are carried at cost less any accumulated depreciation impairment losses discussed in detail in Chapter xx Repair and maintenance costs are expensed as incurred, not capitalised eg, replacement of car tyres Capitalisation requires (at time of expenditure) increased probable future economic benefit eg, replacement of car engine 2

3 Depreciation AASB 116 includes the following definitions: Depreciation: the systematic allocation of the depreciable amount of an asset over its useful life Depreciable amount: the cost of an asset less its residual value (or other appropriate amounts substituted for cost eg. fair value) Residual value: the estimated value of the asset at the end of its useful life to the entity Useful life: the period over which an asset is expected to be used by an entity/ the number of production (or similar) units expected to be obtained by the entity Depreciation Depreciation is an allocation process designed to reflect the fall in the value of the asset in a pattern consistent with the consumption of economic benefits by the entity. AASB 116 does not specify how this allocation process should be undertaken. Various depreciation methods are used in practice. Common methods are discussed on the following slide. In all cases, depreciation expense is recognised with the following journal: DR Depreciation expense CR Accumulated depreciation Depreciation Commonly used depreciation methods include: Straight-line method asset used evenly throughout its life Diminishing balance method more benefits received in earlier years of the life of asset Units of production method based on expected use or output of asset The method chosen should be the method which most closely reflects the expected pattern of consumption of the future economic benefits embodied in the asset. 3

4 Depreciation Useful life Management should consider the following factors when estimating the useful life of an asset: expected use physical wear and tear technical or commercial obsolescence legal or similar limits Useful life is subject to periodic review Land is not subject to depreciation as it does not have a limited useful life The revaluation model As an alternative to the cost model AASB 116 allows the revaluation model to be used for classes of assets Measurement basis is fair value (FV) Frequency of revaluations is not specified, but must be performed with sufficient regularity such that the carrying amount of assets is not materially different from their FV Revaluation performed on a class basis Accounting performed on an asset-by-asset basis The revaluation model Accounting on an asset-by-asset basis ABC Ltd has decided to change from the cost model to the revaluation model to account for plant. At 30 June 2012 ABC Ltd owned the following plants: Cost Accum dep n Carrying value Fair value Increment/ (decrement) Plant A 200, ,000 80, ,000 Plant B 140,000 40, ,000 80,000 TOTAL 340, , , ,000 70,000 (20,000) 50,000 A revaluation increment will be recorded for Plant A and a revaluation decrement will be recorded for Plant B. 4

5 Revaluation increments Revaluation increments and their related tax effects are initially recorded in other comprehensive income and then transferred to equity. The revaluation increment for Plant A would be recorded as follows: Dr Accum. depreciation 120,000 Cr Plant 120,000 Removal of existing accumulated depreciation prior to revaluation Dr Plant 70,000 Cr Revaluation gain OCI 70,000 Revaluation of plant to fair value These entries can be combined into a single entry Revaluation increments Dr Income tax expense - OCI 21,000 Cr Deferred tax liability 21,000 Tax effect of revaluation gain The entry to transfer the gain to equity is as follows: Dr Revaluation gain OCI 70,000 Cr Income tax expense - OCI 21,000 Cr Asset revaluation surplus 49,000 Accumulation of net revaluation gain in equity Revaluation decrements The accounting treatment of a revaluation decrement is as follows: Immediate recognition of an expense No extra tax-effect entries beyond the tax-effect worksheet The revaluation of Plant B would be recorded as follows: Dr Accum. depreciation 40,000* Dr Loss on devaluation - P&L 20,000*** Cr Plant 60,000** Devaluation of plant to fair value *Removal of existing accumulated depreciation **Cost- Fv (140,000 80,000) = 60,000 ***Amount of decrement 5

6 Reversing previous increments A decrement reversing a previous increment eliminates any surplus before recognising an expense. In relation to Plant B, assume that a gross revaluation increment of $15,000 had been made in The journal entries required are as follows: Dr Accum. depreciation 40,000 Cr Plant 40,000 Removal of existing accumulated depreciation prior to revaluation Dr Loss on devaluation - OCI 15,000 Dr Loss on devaluation P&L 5,000 Cr Plant 20,000 Devaluation of plant to fair value Reversing previous increments Dr Deferred tax liability 4,500 Cr Income tax expense - OCI 4,500 Tax effect of devaluation loss The entry to remove the revaluation gain from equity is as follows: Dr Asset revaluation surplus 10,500 Dr Income tax expense - OCI 4,500 Cr Loss on devaluation - OCI 15,000 Removal of net revaluation gain from equity Reversing previous decrements An increment reversing a previous decrement is recognised as a gain. In relation to Plant A, assume that a gross revaluation decrement of $100,000 had been made in The journal entries required are as follows: Dr Accum. depreciation 120,000 Cr Plant 120,000 Removal of existing accumulated depreciation prior to revaluation Dr Plant 70,000 Cr Revaluation gain P&L 70,000 Revaluation of plant to fair value 6

7 Transfers from ARS Transfers may be made from the Asset Revaluation Surplus (ARS) in the following circumstances: When a revalued asset is derecognised (ie scrapped or sold) > the balance in the ARS may be transferred to retained earnings. DR ARS CR Retained earnings When a revalued asset is being depreciated > the ARS may be progressively transferred to retained earnings over the useful life of the asset. Bonus share issues may be made from the ARS DR ARS CR Share capital Depreciation of revalued assets When an asset is revalued, the depreciation charge to be recorded over the remaining useful life of the asset is recalculated by reference to the fair value of the asset. Assume that plant A was acquired on 1 July At that time it was assessed to have a useful life of ten years and a residual value of zero. Prior to revaluation the annual depreciation charge was: $200,000/10 years = $20,000 After revaluation the annual depreciation charge will be: $150,000/5 years = $30,000 FV/ Remaining useful life Choosing between the models Revaluation model provides more relevant information However, there is a cost disincentive of adopting the revaluation model Cost model harmonises with US GAAP Differing impacts on profit & loss 7

Derecognition A Ltd acquired a machine on 1 July 2010 for $50,000 Useful life = 4 years; Residual value = $10,000 On 1 July 2012 the machine was sold for $45,000 The journal entries to account for

8 Derecognition A Ltd acquired a machine on 1 July 2010 for $50,000 Useful life = 4 years; Residual value = $10,000 On 1 July 2012 the machine was sold for $45,000 The journal entries to account for the sale are: Dr Cash 45,000 Dr Accum. depreciation 20,000 Cr Machine 50,000 Cr Gain on sale 15,000 Disclosure Paras of AASB 116 contain required disclosures Illustrative example contained in text at end of chapter 8

S 17- PROPERTY PLANT AND EQUIPMENT P R E S E N T E D B Y F AT I M A O M AR J E E C A ( S A )

S 17- PROPERTY PLANT AND EQUIPMENT P R E S E N T E D B Y F AT I M A O M AR J E E C A ( S A ) LEARNING OBJECTIVES Distinguish items of PPE from other assets of an entity Identify when items of PPE qualify