OVERVIEW
Objective
¾
To prescribe the accounting treatment for tangible non current assets.RECOGNITION ¾ Scope ¾ Exclusions ¾ Definitions DISCLOSURE INTRODUCTION SUBSEQUENT COSTS ¾ Criteria INITIAL MEASUREMENT AT COST
¾ Running costs ¾ Part replacement ¾ Major inspection or
overhaul costs
¾ For each class ¾ Others
¾ Items stated at
revalued amounts ¾ Encouraged ¾ DERECOGNITION RECOVERY OF CARRYING AMOUNT DEPRECIATION REVALUATIONS MEASUREMENT AFTER RECOGNITION
¾ Accounting policy ¾ Cost Model ¾ Revaluation Model
¾ Fair value ¾ Frequency ¾ Accumulated
Depreciation
¾ Increase/decrease
¾ Accounting standards ¾ Depreciable amount ¾ Depreciation methods ¾ Non depreciation
¾ Impairment ¾ Compensation ¾ Accounting treatment
¾ Derecognition date
1
INTRODUCTION
1.1
Scope
¾
This standard shall be applied in accounting for property, plant and equipment except when another IFRS requires or permits a different treatment.1.2
Exclusions
¾
IAS 16 does not apply to biological assets that relate to agricultural activity (IAS 41)
mineral rights and reserves such as oil, natural gas and similar non-regenerative
resources.
1.3
Definitions
¾
Property, plant and equipment are tangible assets that: are held for use in the production or supply of goods or services or for
rental or for admin purposes and
are expected to be used during more than one period.
¾
Depreciation is systematic allocation of depreciable amount of an asset over its useful life.¾
Depreciable amount is the cost (or other amount substituted for cost) less its residual value.¾
Useful life is either the period of time over which an asset is expected to be used, or the number of production or similar units expected to be obtained from the asset.¾
Cost is the amount of cash/cash equivalents paid or the fair value of other consideration given to acquire an asset at the time of its acquisition or construction.¾
Residual value is the estimated amount that an entity would currently obtain from the disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of an age and in the condition expected at the end of its useful life.¾
Fair value is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction.¾
Impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount.¾
Entity-specific value – The present value of the cash flows expected to arise from the continuing use of an asset and from its disposal at the end of its useful life.2
RECOGNITION
2.1
Criteria
¾
An item of property, plant and equipment shall be recognised when: it is probable that future economic benefits associated with the asset will flow to the
entity, (satisfied when risks and rewards have passed to entity), and
the cost of the asset to the entity can be measured reliably.
Commentary
Usually readily satisfied because exchange transaction evidencing purchase identifies cost. For self-constructed asset, a reliable measurement of cost can be made from transactions with third parties for the acquisition of materials, labour and other inputs used.
¾
In certain circumstances it is appropriate to allocate the total expenditure on an asset to its component parts and account for each component separately.3
INITIAL MEASUREMENT AT COST
¾
Property, plant and equipment shall initially be measured at cost.3.1
Components of cost
¾
Purchase price, including import duties and non-refundable purchase taxes (after deducting trade discounts and rebates.)¾
Directly attributable costs of bringing the asset to location and working condition, for example: costs of employee benefits (e.g. wages) arising directly from construction or
acquisition;
costs of site preparation;
costs of testing proper functioning (net of any sale proceeds of items produced);
and
professional fees (e.g. architects and engineers).
Borrowing costs (IAS 23 requires the capitalisation of borrowing costs related to a
qualifying asset)
¾
An initial estimate of dismantling and removal costs (i.e. “decommissioning”) the asset and restoring the site on which it is located. The obligation for this may arise either: on acquisition of the item; or
as a consequence of using the item other than to produce inventory.
3.2
Exchange of assets
¾
Cost is measured at fair value of asset received, which is equal to fair value of the asset given up (e.g. trade-in or part-exchange) adjusted by the amount of any cash or cash equivalents transferred. Except when: the exchange transaction lacks commercial substance; or
the fair value of neither the asset received nor the asset given up is reliably
measurable.
¾
Whether an exchange transaction has commercial substance depends on the extent to which the reporting entity’s future cash flows are expected to change as a result of the transaction.4
SUBSEQUENT COSTS
¾
The issue is whether subsequent expenditure is capital expenditure (i.e. to the statement of financial position) or revenue expenditure (i.e. to the profit or loss).4.1
Running costs
¾
The carrying amount of an item of property, plant and equipment does not include the costs of day-to-day servicing of the item.¾
Servicing costs (e.g. labour and consumables) are recognised in profit or loss as incurred.¾
Often described as “repairs and maintenance” this expenditure is made to restore or maintain future economic benefits.4.2
Part replacement
¾
Some items (e.g. aircraft, ships, gas turbines, etc) are a series of linked parts which require regular replacement at different intervals and so have different useful lives.¾
The carrying amount of an item of property, plant and equipment recognises the cost of¾
The carrying amount of replaced parts is derecognised (i.e. treated as a disposal).¾
A common term used to describe these type of assets that have more than one majorcomponent, with different useful life, is that of a ‘complex asset’.
4.3
Major inspection or overhaul costs
¾
Performing regular major inspections for faults, regardless of whether parts of the item are replaced, may be a condition of continuing to operate an item of property, plant and equipment (e.g. a ship).¾
The cost of each major inspection performed is recognised in the carrying amount, as a replacement, if the recognition criteria are satisfied.¾
On initial recognition an estimate will be made of the inspection costs and that amount will be depreciated over the period to the 1st inspection. This amount is part of the original cost recognised and is not an additional component of cost.¾
Any remaining carrying amount of the cost of the previous inspection (as distinct from physical parts) is derecognised.Illustration 1
An airline is required by law to perform a major overhaul on each aeroplane’s engines every five years. The engines may be identified as assets with a separate life from the rest of the aeroplane and written off to zero over five years. Overhaul expenditure might at first sight seem to be a repair to the aeroplane but it is actually a replacement of the engine. As such it must be capitalised.
5
MEASUREMENT AFTER RECOGNITION
5.1
Accounting policy
¾
An entity may choose between the cost model and the revaluation model. However, the same policy must be applied to each entire class of property, plant and equipment.¾
Classes include land, land and buildings, factory plant, aircraft, vehicles, officeequipment, fixtures and fittings’ etc
5.2
Cost Model
¾
Carry at cost less any accumulated depreciation and any accumulated impairment losses.5.3
Revaluation Model
¾
To use this model fair values must be reliably measurable.¾
All revalued assets are still depreciated, unless the asset is land.6
REVALUATIONS
6.1
Fair value
6.1.1
Land and buildings
¾
Market value is determined by appraisal normally undertaken by professionally qualified valuers.6.1.2
Plant and equipment
¾
Fair value is usually market value determined by appraisal.¾
If there is no market-based evidence of fair value (e.g. because items are of a specialised nature or rarely sold), fair value is estimated using: depreciated replacement cost; or
−
Depreciated replacement cost is what a new equivalent asset would cost (i.e. replacement cost) less depreciation. Items of plant and equipment are often insured for this amount if not for replacement cost under a “new for old” policy. an income approach.
6.2
Frequency
¾
Revaluations must be made sufficiently regularly to ensure no material difference between carrying amount and fair value at the end of the reporting period.¾
Frequency depends on movements in fair values. When fair value differs materially from carrying amount, a further revaluation is necessary.¾
Items within a class may be revalued on a rolling basis within a short period of time provided revaluations are kept up to date.6.3
Accumulated Depreciation
¾
At the date of the revaluation accumulated depreciation is either:(i) restated proportionately with the change in gross carrying amount so that the carrying amount after revaluation equals its revalued amount;
Example 1
$
Cost 1,000
Accumulated depreciation (250)
______
Net book value 750
______
Required:
Determine the accounting entries required to restate the net amount at a revalued amount of
(a) $1,100 (b) $900
Solution
(a) (b)
$ $
Cost
Accumulated depreciation
________ ______
Net amount
________ ______
$ $ Dr
Dr Cr
$ $ Dr
Cr Cr
6.4
Increase/decrease
¾
On an asset-by-asset basis: Increase shall be credited directly to a revaluation reserve and included within
“other comprehensive income”.
However a revaluation increase must be taken to profit or loss to the extent that it
reverses a revaluation decrease of the asset that was previously recognised as an expense.
Decrease shall be recognised as an expense in profit or loss for the period. However, a revaluation decrease must be charged directly against any related
Illustration 2
An asset was purchased for $100 on the 1 January 2006. The entity has adopted the revaluation model for subsequent measurement of the asset.
Asset Revaluation
reserve Profit or loss
1.1.2006 100 − −
20 20 Cr
31.12.2006 120 20 Cr The surplus is taken to revaluation reserve.
1.1.2007 120 20 Cr
(15) (15) Dr −
31.12.2007 105 5 Cr
A deficit is taken to the profit or loss unless it reverses a surplus held on the asset.
1.1.2008 105 5 Cr
(9) (5) Dr 4 Dr
31.12.2008 96 −
Again the deficit is taken to revaluation reserve but only to the extent it reverses the previously recognised surplus with the rest to profit or loss.
1.1.2009 96 −
15 11 Cr 4 Cr
31.12.2009 111 −
That part of the surplus that reverses the previously expensed deficit is taken to the profit or loss. The rest is taken to revaluation reserve.
¾
For simplicity annual depreciation has been excluded from this illustration. However, depreciation would be charged each year before the revaluation adjustment is made.¾
The revaluation surplus may be transferred directly to retained earnings when thesurplus is realised. Realisation occurs as the asset is consumed or disposed of. If the transfer is made over the remaining life of the asset then the transfer to retained
earnings will be an annual transfer based on the difference in depreciation charge under historical cost and the revalued amount.
7
DEPRECIATION
7.1
Accounting standards
¾
Depreciable amount shall be allocated on a systematic basis over the useful life of the asset. Note that the term depreciable amount is the cost or revaluation. Depreciation is based on the carrying value in the statement of financial position.¾
Depreciation method, useful life and residual value must be reviewed at least at each financial year-end. If expectations differ from previous estimates the change(s) are accounted for as a change in an accounting estimate in accordance with IAS 8.¾
The depreciation method shall reflect the pattern in which the asset’s economic benefits are consumed.¾
The depreciation charge for each period shall be recognised as an expense unless it is included in the carrying amount of another asset.¾
Each part of an item of property, plant and equipment that is significant (in relation to total cost) is separately depreciated.7.2
Depreciable amount
7.2.1
Useful life
¾
Factors to be considered: expected usage assessed by reference to expected capacity or physical output; expected physical wear and tear (depends on operational factors e.g. number of
shifts, repair and maintenance programme, etc);
technical obsolescence arising from:
−
changes or improvements in production; or−
change in market demand for product or service output; legal or similar limits on the use (e.g. expiry dates of related leases).
¾
Asset management policy may involve disposal of assets after a specified time therefore useful life may be shorter than economic life.7.2.2
Depreciation period
¾
Depreciation commences when an asset is available for use.¾
Depreciation ceases when an asset is derecognised (e.g. scrapped or sold), or when the asset is classed as held for sale in accordance with IFRS 5.Example 2
An asset which cost $1,000 was estimated to have a useful life of 10 years and residual value $200. After two years, useful life was revised to 4 remaining years. Calculate the depreciation charge for each of the first three years.
Solution
Year 1 Year 2 Year 3
$ $ $
Cost 1,000 1,000 1,000
Accumulated depreciation
_______ _______ _______
_______ _______ _______
Charge for year
7.2.3
Land and buildings
¾
These are separable assets and are dealt with separately for accounting purposes, even when they are acquired together. Land normally has an unlimited useful life and is therefore not depreciated. Buildings normally have a limited useful life and are depreciable assets.
7.3
Depreciation methods
¾
Straight-line ⇒ a constant charge over useful life.¾
Reducing/diminishing balance ⇒ a decreasing charge over useful life.¾
Sum-of-the-units ⇒ charge based on expected use or output.Illustration 3
The depreciable amount (cost less residual value) of an asset is $1,000. Its useful life is 5 years. Calculate depreciation using the sum-of-the-units basis.
Solution
n = 5
Sum = ½ × 5 × (5 + 1) = 15 (Alternatively 5+4+3+2+1 = 15)
Year Proportion Depreciation $
1 5/15 × 1,000 333
2 4/15 × 1,000 267
3 3/15 × 1,000 200
4 2/15 × 1,000 133
5 1/15 × 1,000 67
________ 1,000 ________
7.4
Non depreciation
7.4.1
Background
¾
It has long been argued that certain assets shall not be subject to the general rule that all assets should be depreciated.¾
Many companies in some jurisdictions have taken to the practice of not depreciating certain of their assets.7.4.2
Arguments employed
¾
Assets are maintained to a very high standard. This maintenance cost is charged to the profit or loss in lieu of depreciation.¾
The residual value is at least equal to the carrying value (maybe due to maintenance).¾
Assets have a very long useful economic life such that depreciation is not material.¾
Asset is not currently in use.7.4.3
IAS 16
¾
Repair and maintenance policy may affect useful life (eg by extending it or increasing residual value) but the standard says that this does not negate the need to charge depreciation. It would seem that the standard dictates that depreciation must be8
RECOVERY OF CARRYING AMOUNT
8.1
Impairment
¾
To determine whether an item of property, plant and equipment is impaired an entity applies IAS 36 – Impairment of assets¾
Impairment losses are accounted for in accordance with IAS 36.8.2
Compensation
¾
In certain circumstances a third party will compensate an entity for an impairment loss, for example, insurance for fire damage or compensation for compulsory purchase of land for a motorway.¾
Such compensation must be included in the profit or loss when it becomes receivable. Recognising the compensation as deferred income or deducting it from the impairment or loss or from the cost of a new asset is not appropriate.9
DERECOGNITION
9.1
Accounting treatment
¾
Statement of financial position – Eliminate on disposal or when no future economic benefits are expected from use (“retirement”) or disposal.¾
Profit or loss – Recognise gain or loss (difference between estimated net disposal proceeds and carrying amount) unless a sale and leaseback (IAS 17). Gains are not classified as revenue.¾
See IFRS 5 (see later session) for treatment of non-current held for sale.Illustration 4
Accounting policies (extract)
Property, plant and equipment
When assets are sold, closed down, or scrapped, the difference between the net proceeds and the net carrying amount of the assets is recognized as a gain or loss in other
operating income or expenses, respectively.
Notes to the Consolidated Financial Statements of the Bayer Group 2006
9.2
Derecognition date
10 DISCLOSURE
10.1 For each class
¾
Measurement bases used for determining gross carrying amount.¾
Depreciation methods used.¾
Useful lives or the depreciation rates used.Illustration 5
Notes to the consolidated financial statements (extract)
Property, plant and equipmentProperty, plant and equipment are stated at cost less accumulated depreciation. Depreciation is recorded on a straight-line basis over the expected useful lives of the assets as follows:
Buildings and constructions 20-33 years
Production machinery, measuring and test equipment 1–3 years
Other machinery and equipment 3–10 years
Land and water areas are not depreciated.
Nokia
in 2006
¾
Gross carrying amount and accumulated depreciation at beginning and end of period. Accumulated impairment losses are aggregated with accumulated depreciation.¾
A reconciliation of carrying amount at beginning and end of period showing: additions (i.e. capital expenditure); disposals;
acquisitions through business combinations; increases or decreases resulting from revaluations; impairment losses (i.e. reductions in carrying amount); reversals of impairment losses;
depreciation;
net exchange differences arising on translation of functional currency into
presentation currency;
other movements.
10.2 Others
¾
Existence and amounts of restrictions on title, and property, plant and equipment pledged as security.¾
Expenditures on account of property, plant and equipment in the course of construction.¾
Contractual commitments for the acquisition of property, plant and equipment.10.3 Items stated at revalued amounts
¾
Effective date of revaluation.¾
Whether an independent valuer was involved.¾
Methods and significant assumptions applied to estimate fair values.¾
The extent to which fair values were determined: directly (i.e. by reference to observable prices in an active market or recent market
transactions on arm’s length terms); or
estimated using other valuation techniques.
For example indices may be used to determine replacement cost.
¾
Carrying amount of each class of property, plant and equipment that would have been included in the financial statements had the assets been carried under the cost model.¾
Revaluation surplus, indicating movement for period and any restrictions ondistribution of balance to shareholders.
10.4 Encouraged
¾
Carrying amount of temporarily idle property, plant and equipment.¾
Gross carrying amount of any fully depreciated property, plant and equipment that is still in use.¾
Carrying amount of property, plant and equipment retired from active use and held for disposal.FOCUS
You should now be able to:
¾
define and compute the initial measurement of a non-current asset;¾
identify subsequent expenditure that may be capitalised, distinguishing between capital and revenue items;¾
discuss the requirements of relevant accounting standards in relation to the revaluation of non-current assets;¾
account for revaluation and disposal gains and losses for non-current assets;EXAMPLE SOLUTIONS
Solution 1
(a) (b)
$ $
Cost 1,100 900
Accumulated depreciation – –
________ ______
Net amount 1,100 900
________ ______
$ $ Dr Cost 100 Dr Accumulated depreciation 250 Cr Revaluation reserve 350
$ $ Dr Accumulated depreciation 250 Cr Cost 100 Cr Revaluation reserve 150
Solution 2
Year 1 Year 2 Year 3
$ $ $
Cost 1,000 1,000 1,000
Accumulated depreciation (80) (160) (320)
_______ _______ _______
Net book value 920 840 680
_______ _______ _______
