CH 4. NCA - IAS 16 PPE

Question 1

What does Property, plant and equipment (IAS 16) apply to?

Answer 1

Property, Plant and Equipment are tangible assets that are:

• (a) Held by an entity for use in the:
  
  • Production or supply of goods or services,
  • Rental to others.
  • Administrative purposes (Head Office, or support centre)
• (b) Expected to be used during more than one period

Question 2

When is PPE(IAS 16) Recognised in the accounts?

and

How should smaller items and large complex assets be treated?

Answer 2

An item of property, plant and equipment should be recognised as an asset when:

• Probable that the asset’s future economic benefits will flow to the entity.
• The cost of the asset can be measured reliably.

*note criteria also applies to all subsequent expenditure on the asset.

Smaller Items

• Smaller items such as tools may be classified as consumables and expensed.
• Where they are capitalised, they are usually aggregated and treated as one.

Large Complex assets

• Large and complex assets should be broken down into composite parts and depreciated separately. If the parts have differing patterns of benefits and the cost of each is significant.
• Expenditure to renew or improve individual parts can then be capitalised.

Question 3

How should PPE (IAS16) be measured at initial recognition?

Answer 3

Capitalise all costs to bring an asset to its present location and condition for its intended use.

• + Purchase Price, less trade discount/rebate
• ​+ Directly attributable costs of bringing the asset to working condition for
  the intended use.
• + Finance costs, capitalised for qualifying assets
• = Cost of Asset

Initially measured at a cost:

• + Purchase Price, less trade discount/rebate ^including:
  
  • ^{​I<span>mport taxes and non-refundable purchase tax (vat)</span>}
• ​+ Directly attributable costs of bringing the asset to working condition for
  intended use.^Including:​
  
  • ^{​Employee benefit costs}
  • ^{​Site preparation}
  • ^{Initial delivery and handling costs}
  • ^{professional fees}
  • ^{costs of testing}
  • ^{Restoration provision,}
    
    • ^{only if it is not included in the cost of inventories)}
    • ^{DISCOUNTED to present value}
• + Finance costs, capitalised for qualifying assets

Costs that should never be capitalised: any costs that are not directly attributable & can not be transferred to a buyer.

• ^{_{<span>- Administration and general overheads</span>}}
• ^{_{<span>- Abnormal costs (repairs, wastage, idle time)</span>}}
• ^{_{<span>- Costs incurred after the asset is physically ready for use (e.g maintenance costs,) but improvement costs are allowed (unless these costs increase the economic benefits the asset brings)</span>}}
• ^{_{<span>- Costs incurred in the initial operating period (e.g initial operating losses before a machine is used at its full capacity)</span>}}
• ^{_{<span>- Costs of opening a new facility or introducing a new product (e.g advertising and promotional costs or training costs) </span>}}
• ^{_{<span>- Costs of relocating/reorganising an entity’s operations.</span>}}

Question 4

How are subsequent costs of a PPE treated?

Answer 4

Basically, any improvement costs or costs legally required for the use of the asset must be capitalised.

All Maintenance costs are expensed.

IAS 16 requires that subsequent costs should be capitalised if:

• it is probable that future economic benefits associated with the extra costs will flow to the entity
• the cost of the item can be reliably measured.

Once an item of PPE has been recognised and capitalised in the financial statements, a company may incur further costs on that asset in the future.

Some assets, such as machines can be upgraded for improved performance or a building can be refitted for fixtures and fittings like a new kitchen or office layout and partition walls.

Some assets, such as aircraft, can only be operated if regular inspections for faults are carried out. The cost of these inspections can be capitalised. Any remaining carrying amount relating to the previous inspection should be derecognised.

All other subsequent costs (e.g Maintenance costs) should be recognised as an expense in the income statement in the period that they are incurred.

Question 5

What are the main principles of depreciating a PPE asset?

Consider:

• Residual Amount
• Depreciable Amount
• Apportionment
• Rules?

Answer 5

• All PPE with a finite useful life must be depreciated.
• Cost of an assetorother amount substituted
• *LESS RESIDUAL VALUE**
• *= DEPRECIABLE AMOUNT**
  
  • ^​Depreciation must be determined separately for each significant part of an item.
• Depreciation is charged over its life. - Main methods
  
  • Machine hours
  • Reducing Balance
  • Straight Line

Rules:-

• The entity must annually review:
  
  • The residual value
  • The useful life of an asset
  • as well as the depreciation method.

Changes are treated as changes in accounting estimates and are accounted for prospectively as adjustments to future depreciation.

• Depreciation begins when the asset is available for use and continues until
  the asset is derecognised and does not cease:
  
  • - Even if it is idle.
  • • Retired and held for disposal unless it is classified as held for sale

Question 6

How does Componentisation affect PPE IAS16?

Consider:

• Subsequent costs
• Depreciation

Answer 6

• If an asset comprises two or more major components with different useful lives, then
  
  • Each component should be accounted for separately for depreciation purposes and
  • Depreciated over its own useful life.
• If the carrying amount of the replaced part is not known then the cost of the new replacement part can be used to estimate the cost of the replaced part when it was originally acquired.
• Some assets, such as aircraft, can only be operated if regular inspections for faults are carried out. The cost of these inspections can be capitalised. Any remaining carrying amount relating to the previous inspection should be derecognised.
• Depreciation should be charged separately on each significant component part of an item of PPE. Parts that have the same useful life can be grouped together.

Question 7

How should PPE be measured after recognition?

Answer 7

After recognition, entities can choose between two models,

• The Cost model
  
  • Dr - Cost
  • Cr - Accumulated Dep
  • Cr - Dep charged in the Year
  • = NBV or Carrying Amount
• The Revaluation model - (IFRS 13 - fair value hierarchy)

Question 8

How do you account for the revaluation method for IAS 16?

How is an increase in Fair Value Gain?

How is an increase in Fair Value Gain treated with a previous year loss?

Answer 8

The revaluation method:

An asset’s Carrying Amount/Net Book Value is compared to the Fair Value of the asset (using IFRS 13)

Carrying. Amount / Net Book Value

(less Fair Value of asset)

= Difference is the revaluation

If the difference is an INCREASE in value it should be,

Dr - Asset
Dr - Accumulated Depreciation
Cr - (OCI) (moved to Revaluation Surplus at year-end)

and when the books are closed for the year-end, the increase is treated as a revaluation surplus in equity, and not treated as a

If the previous year has a revaluation loss - (Reversing previous revaluation losses)

Dr - Asset for revaluation gain

Cr - P/L for the amount previously lost (Reversing any previous loss)

Cr - OCI and then Revaluation Surplus

Depreciation of a revalued asset -

1 . The full charge of deprecation goes through the P/L

2. Excess Depreciation - But you are allowed to transfer the deprecation amount above the Historic cost deprecation from the Revaluation surplus to Retained Earnings, this is so the deprecation on revaluation does not affect distributable profits.

Question 9

How do you account for the revaluation Loss (IAS 16)?

Answer 9

Any revaluation loss is first charged to any revaluation gains/Surplus of the same asset and then the remainder to P/L

Cr - Asset
Dr - Revaluation surplus if any
Dr - Revaluation P/L

Question 10

If the Revaluation model is adopted to PPE, what are the further rules that must be applied?

Answer 10

• (a) Revaluations must be carried out regularly, depending on volatility.
• (b) The asset should be revalued to F.V, using the fair value hierarchy in IFRS 13.
• (c) If one asset is revalued, so must be the whole class of assets at the same time.

Question 11

How should disposal of assets or derecognition be accounted for?

Answer 11

• IAS 16 says that an asset should be derecognised when:
  
  • ​Disposal occurs
  • if no further economic benefits are expected from the asset’s use or disposal. (No longer in use and unable to sell asset)
• The gain or loss on derecognition of an asset is the difference between
  
  • ​the net disposal proceeds if any,
  • and the carrying amount of the item.
  • = Gain or loss on disposal
• When a revalued asset is disposed of, any revaluation surplus may be transferred directly to retained earnings, or it may be left in the revaluation surplus within other components of equity.

Question 12

How are the fair values of exchanges of assets accounted for?

Answer 12

Exchanges of items of PPE,

Regardless of whether the assets are similar, are measured at fair value (IAS 16: para. 24).

-This means the Transaction Price will the Fair value of the consideration receivable (asset being received), and the cost of sales is the F.V of the asset transferred.

Unless the exchange transaction lacks commercial substance or the fair value of neither of the assets exchanged can be measured reliably.

Then the transaction price will be valued at the Carrying amount of the asset given up.

If the acquired item is not measured at fair value, its cost is measured at the carrying amount of the asset given up.

Question 13

What Disclosures are required for PPE IAS16?

Answer 13

IAS 16 requires entities to disclose:

• Measurement bases used
• Useful lives and depreciation methods and rates
• A reconciliation of carrying amounts at the beginning and end of the period.
• If items of PPE are stated at revalued amounts, information about the revaluation should also be disclosed.