TOPIC 11 - IAS 16 PROPERTY, PLANT & EQUIPMENT

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1 TOPIC 11 - IAS 16 PROPERTY, PLANT & EQUIPMENT Objective of IAS 16 to prescribe the accounting treatment for property, plant and equipment in the financial statements Recognition Property, plant & equipment can only be recognised as an asset in the financial statements 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 Any item of property, plant & equipment that satisfies the definition of an asset should initially be measured at cost. What is cost? Cost comprises;- (a) Cost of Purchase - The purchase price, including import duties and non-refundable taxes (Vat is reclaimable by business and is therefore excluded from Purchase Price) and after deducting trade discounts and rebates. (b) Any other costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management ( Key Phrase That is costs which would only have been avoided if the asset had not been constructed or acquired ) (c) Initial estimate of costs of dismantling and removing the asset and restoring the site on which it is located. Ask yourself if the conditions for a provision exist (PO-PO-RE!) If conditions exist, then create provision and capitalise the discounted cost of the provision Note: Entity should not recognise in the carrying amount of an asset the cost of its day-today servicing. (revenue expenditure) Initial cost = Purchase cost (minus any purchase discount and excluding recoverable tax) Directly attributable costs professional fees delivery costs (carriage inwards) site preparation costs 1

2 costs of testing whether the asset is functioning properly (i.e. pre production testing), 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) Labour Costs on a normal basis Ignore increased costs due to strike action Borrowing Costs incurred with the item See IAS 23 Initial estimate of dismantling costs and site cleaning/restoration costs at the end of the asset s life - Excluded from cost are items of revenue expenditure such as Cost of Training staff to use the plant & equipment (Cr Bank, Dr Staff Training Expense) Early settlement discounts (Dr Liability, Cr Statement of profit or loss ) Purchase of maintenance contracts in respect of the plant & equipment (Cr Bank, Dr Prepayments/Statement of profit or loss ) Administration or Other General Overheads All of the above items are accounted for through statement of profit or loss the cost of abnormal amounts of wasted material, labour, or other resources is not included in the cost of the asset. (e.g. the increased labour cost due to an industrial dispute the increase is not capitalised) Subsequent Measurement of Property, Plant & Equipment Entity can choose either Cost Model OR Revaluation Model Whichever model is chosen, will be the company s accounting policy with respect to property, plant and equipment and must be applied consistently to an entire class of property, plant & equipment. Cost Model Property, plant & equipment should be carried at;- COST Less Accumulated depreciation and impairment losses 2

3 Revaluation Model Property, plant & equipment should be carried at ;- Fair value at date of revaluation less Any subsequent accumulated depreciation and impairment losses. (Therefore if an asset is revalued at the year end date, subsequent depreciation will not occur until the next year. So carrying amount of asset will be its fair value at reporting date) Note: Revaluations should be sufficiently regular to ensure that carrying amount doesn't differ materially from fair value. Fair Value is usually the market value. In the case of specialised assets, depreciated replacement cost can be used instead of fair value, when adopting the revaluation model, because for specialised assets, a market value may not exist. Gains on Revaluation (Revalued Amt Carrying Amount) Where an asset is revalued upwards from its carrying amount 1. Dr Asset; Cr Revaluation Reserve 2. The gain on revaluation is disclosed as other comprehensive income in the statement of profit or loss and other comprehensive incomeand is not included in profit or loss for the period. The amount of the unrealised gain reported will be the gross gain (i.e. before any adjustments in respect of deferred tax if applicable in the question) 3. There is an exception to the rule in No 2 if the gain on revaluation reverses a previous loss on revaluation, where the loss was recognised in profit or loss (i.e. Statement of profit or loss ) the revaluation gain should be recognised in profit or loss not other comprehensive income (Dr Asset; Cr Statement of profit or loss ) Loss on Revaluation (Revalued Amt Carrying Amount) Where an asset is revalued down from its carrying value 1. Cr Asset; Dr Revaluation Reserve 2. Decrease on Revaluation is disclosed in Other Comprehensive Income assuming that the loss on revaluation reverses a previous gain on revaluation, where the gain was recognised in other comprehensive income the decrease should be reported in other comprehensive income 3

4 3. If the conditions in number 2 do not apply, then the loss is recognised through profit or loss (Cr Asset; Dr Statement of profit or loss ) e.g. For a decrease on revaluation where there was no previous revaluation gain Note that when a revaluation takes place, the depreciation for the period up to the date of revaluation should be deducted from the carrying value before calculating the revaluation surplus. This is a common mistake made by students Note: Under the Revaluation Model, increases in the value of assets should be accounted for in the statement of financial position under Revaluation Reserves as follows;- Dr. Asset Cost Dr. Acc Depr Cr. Revaluation Reserve x x x BUT If there is a revaluation decrease in an asset this decrease should be included as an expense in statement of profit or loss (unless the decrease reverses a previous gain as described above) as follows;- Dr. SOPL x Cr. Asset Cost x Cr. Acc Depr x Depreciation Depreciation begins when the asset is available for use!!! (Think of a newly built hospital unit that it not being used) (Per IAS 16, consumption of future economic benefits occurs not only through use but also through obsolescence and wear and tear) This contrasts with IAS 38 - Amortisation of Capitalised Development Expenditure Should be allocated on a systematic basis over assets useful life Charge for each year is recognised in Statement of profit or loss Method of depreciation used should reflect the pattern in which the asset s future economic benefits are expected to be consumed. Land is not depreciated because it has an indefinite useful life (unless the land is used in mining or similar industries) 2 depreciation methods (a) Straight Line and (b) Reducing Balance IAS 16 allows for a change in the method of depreciation where this results in a fairer presentation of the entity s results 4

5 Change in depreciation method = Change in Accounting Estimate not accounting policy (IAS 8) Change in depreciation method is not applied retrospectively Review of Useful Economic Life Should be reviewed at the year-end and revised if necessary. If useful life is revised carrying amount at date of revision should be depreciated over revised useful life. Change in useful life and change in residual value is a change in accounting estimate Depreciation and the Revaluation Reserve If an asset is revalued upwards, then its carrying value increases and a revaluation reserve is created. 2 points should be noted as a result of this: i. As the depreciation charge is based on a higher revalued amount, then the charge to the SOPL will typically be higher, then if the cost model was applied ii. As the asset is depreciated, its carrying value declines but the revaluation reserve remains the same Consequently, IAS 16 gives companies the option of transferring some of the gain from the revaluation reserve to offset the additional depreciation. The amount of the surplus transferred is the difference between the depreciation based on the revalued carrying amount of the asset, and depreciation based on the asset s original cost (or transfer from the revaluation reserve to retained earnings in line with the depreciation policy being adopted for the revalued asset) De-recognition Asset should be de-recognised on;- (a) Disposal (b) When no more future economic benefits are expected from asset Any gain or loss should be included in statement of profit or loss as gain/loss on disposal (not included in Sales Revenue!!) Also Disposal proceeds should not be included in Sales Revenue Gain/Loss calculated as follows;- 5

6 Disposal Proceeds less Carrying Amount N.b. : Any revaluation reserve standing to the credit of a disposed asset should be transferred directly to retained earnings as a reserve movement. N.B. Subsequent Expenditure Subsequent expenditure on non current assets should be capitalised where The subsequent expenditure improves the asset ( for example by enhancing its performance or extending its useful life) i.e. Adds value to the asset above and beyond its original condition provides enhanced future economic benefits matching concept!!! The subsequent expenditure is for a replacement part (provided that the part it replaces is treated as an item that has been disposed of) Examples of Subsequent expenditure on a building Constructing an extension to the building Replacing the Elevators or the heating/air conditioning system N.B. Subsequent Expenditure Subsequent Expenditure which does not meet the criteria for capitalisation is instead expensed to statement of profit or loss as incurred Other Issues Separate Components: Some items of property, plant and equipment comprise separate components with different useful lives. For example, an airplane might have a useful life of 30 years, while the seats and fabric in the interior only have a life of 5 years. In such a situation, the separate components should be capitalised as separate assets and each depreciated over its useful life Key Disclosures - IAS 16 For each class of depreciable asset, these include - Depreciation method used - UEL s or depreciation rates used - Total depreciation charged for the period, and - Gross amount of depreciable assets and related accumulated depreciation - If material, the reason for any change in depreciation method For revalued assets these include - Name and qualification of valuer - Basis of valuation - Date and amount of valuations 6

7 Illustration Property, Plant & Equipment Land& Building m Plant m Total m Cost or Valuation: At 1 October Additions Revaluation (15) nil (15) At 30 Sept Accumulated Depreciation At 1 October Charge for Year Revaluation (40) nil (40) At 30 Sept Carrying Value 30 September The Land and buildings were revalued by an appropriately qualified valuer on an existing use basis on 1 October They are being depreciated on a straight line basis over a 25 Year Life. Plant is depreciated at 20% per annum on cost 7

8 REVALUATIONS OF PROPERTY, PLANT & EQUIPMENT IAS 16 OVERVIEW 1. Increase/Gain on Revaluation Increase/Gain in value which is not reversing a previous loss/decrease Where the Gain is reversing a previous decrease which was recognised as an expense i.e. through profit or loss Dr Asset Cr Revaluation Reserve Note: Disclose in OCI! Dr Asset Cr Statement of profit or loss Cr Revaluation Reserve (if the gain is greater than the original loss/decrease on revaluation) Note: Only the excess carried to Revaluation Reserve (if applicable) will the excess will be disclosed in OCI 8

9 2. Decrease/Loss on Revaluation Decrease/Loss in value which is not reversing a previous gain/increase Where the Loss is reversing a previous increase which was recognised as an increase in the revaluation reserve Cr Asset Dr Statement of profit or loss Note: No Disclosure in OCI because the loss is accounted for through profit or loss! Cr Asset Dr Revaluation Reserve (*OCI*) Dr Statement of profit or loss (if applicable!) Dr Revaluation Reserve with the amount of the loss which is reversing the previous gain taken to revaluation reserve (and Disclose in OCI) Dr Statement of profit or loss with the excess of the loss on revaluation over the previous gain on revaluation if this applies No Impact on OCI 9

10 IAS 16 VS IAS 40 IAS 16 Property, Plant and Equipment Subsequent Measurement Cost Model Cost less ACC Depr & Impairment Revaluation Model Fair Value at Date of Revaluation less subsequent depreciation and impairment IAS 40 Investment Property Property held to earn rentals or for capital appreciation or both Subsequent Measurement Cost Model Property valued at cost with Subsequent Depreciation Land is not depreciated Fair Value Model Value at Fair Value Through Profit or Loss No depreciation Consistent with IFRS 9 10

11 Questions to practice 11

12 Solution Past Exam Questions IAS 16 Q5 April 2015 Q3 (7) August 2013 Q2 Aug 2013 Q3 (6) April 2013 Q3 August 2011 Q2, Q4 April

Property, Plant and equipment

Property, Plant and equipment IAS 16 Objective Scope of IAS 16 Definition Recognition Initial measurement Subsequent measurement Derecognition Special topics Spare parts Exchange of assets Changes in decommissioning