Chapter 3 Property, plant, and equipment

Question 1

1.1 What is PPE

Answer 1

IAS 16 states PPE are defined as tangible items that are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes and are expected to be used during more than one period.

Question 2

2.1 Recognition of PPE

Answer 2

IAS 16 requires items of PPE are recognised in the statement of financial position where it is probable that future economic benefits will flow to the entity and the cost can be reliably measured.

Question 3

3.1 Measurement of PPE

Answer 3

PPE meeting the measurement criteria should initially be measured at cost, this includes the purchase price including import duties and non-refundable purchase taxes (after deducting trade discounts and rebates) and any costs directly attributable to bringing the asset to the location and condition necessary to operate (includes site preparation, delivery, installation and assembly, costs of testing and professional costs).
- Excluded costs: administration costs, general overheads, abnormal costs, and costs incurred after the asset is capable of normal operation should not be capitalised.
- Incidental income is not deducted from the cost and is treated as other income in the P+L.
- Subsequent costs on an item of PPE may only be capitalised if it enhances the economic benefit

Question 4

4.1 Borrowing costs

Answer 4

Borrowing costs are interest costs incurred in connection with borrowing funds to construct an asset. IAS 23 requires borrowing costs to be capitalised as part of the cost of a qualifying asset. A qualifying asset is an asset that takes a substantial period of time to get ready for its use or intended use.
An entity may only capitalise those borrowing costs which would have been avoided if the expenditure on the qualifying asset had not been made. The calculation is borrowing costs incurred less income from temporary investment of surplus borrowings (when borrowing for specific asset).
Where funds are taken from general borrowings, capitalise weighted average cost of borrowing x expenditure on asset.

Question 5

4.2 Period of capitalisation

Answer 5

IAS 23 states capitalisation for borrowing costs commence when expenditure on asset is being incurred and costs are incurred and activities to prepare the asset for use or sale are in progress. Capitalisation should be suspended during extended periods in which it suspends active development of a qualifying asset. Capitalisation should cease when substantially all activities to prepare the asset for use or sale are complete.

Question 6

5.1 Depreciation

Answer 6

IAS 16 defines depreciation as the systematic allocation of the depreciable amount of an asset over its useful life. Depreciable amount is cost, or valuation, of an asset less its residual value. Useful life is the period over which an asset is expected to be available for use by an entity.
Depreciation can be calculated using the straight line, reducing balance or units output method.

Question 7

5.2 Accounting for depreciation

Answer 7

Depreciation is charged to the P+L except where accounting standards allow it to be within the cost of another asset. Depreciation commences when the asset is available for normal use and continues until the earlier of the date that the asset is fully depreciated, sold or classified as ‘held for sale’.

Question 8

5.4 Land and buildings

Answer 8

When land and a building are acquired together, these should be separated for accounting purposes. Land has an infinite useful life and should not be depreciated. Buildings have a finite useful life and should be depreciated over this period.

Question 9

5.5 Changes to depreciation

Answer 9

The method of depreciation is reviewed at year end and changed if it does not reflect the pattern of use of the asset. The residual value and useful life can also be reviewed and changed. When a change arises, the new method or estimate is applied to the carrying value at the date of change.

Question 10

5.6 Separate components

Answer 10

Some items of PPE are made up of different components with different useful lives. The cost of replacing components may be capitalised. Prior to the capitalisation of new component, the old component must be derecognised. This will be achieved if each component is depreciated separately over its useful life.

Question 11

5.7 Major overhauls and inspections

Answer 11

The cost of an overhaul or inspection of an asset may be capitalised as a separate component of the asset. Prior to this, the earlier costs should be derecognised. If the overhaul/inspection is carried out at predetermined intervals, derecognition can be achieving by making the useful life of the asset equal to the inspection interval.

Question 12

6.1 Measurement after recognition

Answer 12

IAS 16 allows an entity to choose valuation models from the cost model and the revaluation model. The model should be applied consistently to an entire class of assets. The cost model means the value of an item should be its cost, minus any accumulated depreciation and any accumulated impairment losses.
The revaluation model means the value of an asset should be its fair value at revaluation, minus any subsequent accumulated depreciation and subsequent accumulated impairment losses.

Question 13

7.1 Accounting for revaluations

Answer 13

The double entry for an upwards revaluation is:
- Dr Cost (increase the cost of the asset to fair value)
- Dr Accumulated depreciation (eliminate the depreciation to date)
- Cr Revaluation surplus (balancing figure of fair value less the carrying amount)
Credit entry is to the revaluation surplus rather than the P+L to reflect that the gain is not yet realised. Once a revaluation has taken place, carry on depreciating the asset over its remaining useful life.

Question 14

7.2 Presentation in the statement of comprehensive income

Answer 14

• Profit for the year X
• Other comprehensive income X
• Gain on property revaluation X
• Total comprehensive income X

Question 15

7.3 Depreciation of a revalued asset

Answer 15

Depreciation charge = (revalued amount – estimated residual value) / remaining useful life

Question 16

7.4 Reserves transfer

Answer 16

Depreciation based on a revalued amount will exceed depreciation based on historical cost. Therefore, as a result of an upwards revaluation, subsequent periods’ profit will decrease. This reduces retained earnings out of which dividends may be paid. IAS 16 allows that the amount of excess depreciation charged each year due to revaluation is transferred into retained earnings from the revaluation surplus:
- Dr Revaluation surplus
- Cr Retained earnings

Question 17

7.5 Downwards revaluation

Answer 17

Where the asset has not previously been revalued upwards the decrease in the value of the asset is recognised in the P+L. Dr P+L (balancing figure: CA – fair value) and Cr Carrying amount of an asset (to reduce the asset’s carrying amount to fair value).
Where the asset has previously been revalued upwards the debit entry should first be charged to the revaluation surplus to the extent that it relates to the asset in question, any balance is charged to the P+L. Dr Revaluation surplus (to extent the surplus relates to the asset) Dr P+L (balancing figure) and Cr Carrying amount of asset (to reduce the asset’s carrying amount to fair value).

Question 18

8.1 Impairments

Answer 18

IAS 36 states when it is appropriate to reduce (impair) the statement of financial position value of assets, how much they should be impaired by and how impairment should be accounted for. An impairment review should be carried out annually for certain assets (intangible non-current assets with an indefinite useful life) and where there are indications of impairment for other assets (including PPE). External indications include:
- Decline in the market value of an asset
- Adverse changes to the environment in which the entity operates (may reduce future economic benefits expected of the asset)
- Increases in interest rates
- Value of the entity as a whole is less than its net asset value
Internal indications include:
- An asset is obsolete or damaged
- Changes have occurred within the entity which mean that an asset will not generate the benefits previously expected of it
- Evidence is available to suggest an asset will not perform as well as expected

Question 19

8.2 Impairment review

Answer 19

An impairment review will identify whether an asset is impaired. Impairment has occurred if carry amount is greater than the recoverable amount (greater of fair value less costs to sell and value in use which is the value of future cash flows expected to be generated by the asset).

Question 20

8.3 Accounting for an impairment loss

Answer 20

Assets value using the cost model: the impairment is recognised in the P+L as an expense immediately. Dr P+L and Cr Carrying amount of asset.
Assets valued using the revaluation model: the impairment loss is charged to the revaluation surplus to the extent that it reverses any previous upward revaluation of the asset. Any excess is charged to the P+L: Dr Revaluation surplus, Dr P+L and Cr Carrying amount of asset.

Question 21

8.4 Depreciation of an impairment asset

Answer 21

Depreciation charge = (new carrying amount – estimated residual value) / remaining useful life

Question 22

9.1 Derecognition

Answer 22

An item of PPE is derecognised from the statement of financial position either through disposal or abandonment (scrapping).
IFRS 5 provides the rules relating to non-current assets held for sale. An entity is held for sale if its carrying amount will be recovered principally through a sale transaction rather than though continuing use. For this to be the case:
- The asset must be available for immediate sale in its present condition
- The sale must be highly probable, meaning management committed to selling the asset, active programme to locate a buyer and the asset is being actively marketed.
- The sale is expected to be completed within 12 months of its classification as held for sale
- It is unlikely the plan will be significantly changed or will be withdrawn
Assets using the cost model:
- When classified as held for sale measure an asset at the lower of carrying amount and fair value less costs to sell
- Results in immediate recognition of an impairment loss if fair value less costs to sell is less than the carrying amount
- Cease depreciation
- Present the asset separately on the statement of financial position
- When the asset is sold, calculate, and record any gain or loss as normal in the P+L
Assets valued using the revaluation model:
- Same treatment as above but before step one, the asset should be revalued, so the carrying amount equal. When held for sale, this results in immediate recognition of the costs to sell as an impairment loss

Question 23

9.2 Abandonment

Answer 23

If an asset is scrapped continue to classify it as a non-current asset, continue to depreciate until scrapped and when the asset is scrapped, recognise any profit or loss on the disposal as the difference between the proceeds and carrying amount.

Question 24

10.1 Disclosure

Answer 24

IAS 16 requires disclose should be made of the measurement bases used for each class of PPE, depreciation methods used, useful lives/depreciation rates used, changes in accounting estimates, and a PPE reconciliation.

Question 25

10.2 IAS 36 Impairment of assets

Answer 25

IAS 36 requires disclosure should be made for each class of assets of:
- The amount of impairment loss charged to the statement of profit or loss for the period and the line in the statement of profit or loss in which this is included
- The amount of impairment loss on revalued assets recognised as a reduction in the revaluation surplus
For each material impairment loss there should be a disclosure of the nature and amount of loss.

Question 26

10.3 Ethical and judgement issues

Answer 26

The ethical principles of objectivity professional competent and due care need to be demonstrated when accounting for PPE.