IAS16

Question 1

Property, plant and equipment (PPE) are tangible items that are:

Answer 1

• held for use in the production or supply of goods or services, for rental to others, or for
  administrative purposes.
• expected to be used during more than one period.

PPE includes freehold and leasehold land and buildings and plant and machinery.

Question 2

The recognition criteria for PPE depends on two criteria, both of which must be satisfied:

Answer 2

• It is probable that future economic benefits associated with the item will flow to the entity.
  i. e. risks and rewards of ownership have passed to the entity. (Usually when irrevocable contract is in place).
• The item’s cost can be measured reliably.

Question 3

What subsequent costs can and can’t be recognised as part of PPE and why?

Answer 3

1. Repairs and maintenance expenditure should not be included in the value of the asset, because it is not probable that there will be future economic benefits flowing from it. Instead, it must be recognised in profit or loss as an expense in the period incurred.
2. Replacement parts (for complex assets such as airplanes or drilling rigs) should be capitalised,
   provided the original cost of the items they replace is derecognised at the time of the replacement.
   The part is then depreciated over its own useful life, separately from the main asset. (See section 3.6.3
   below).
3. Any costs of additions to or enhancements of an item of PPE should be capitalized as they will result in an increase in the flow of future economic benefits. The cost of refurbishment of an asset (such as repainting a property, etc) should not be capitalized.

Question 4

How to measure and initial recognition.

Answer 4

An item of PPE qualifying for recognition is initially measured at its cost.

• Cost: This is the amount of cash or cash equivalents paid or the fair value of the other consideration
  given to acquire an asset at the time of its acquisition or construction.
• Fair value: The price that would be received to sell an asset or paid to transfer a liability in an orderly
  transaction between market participants at the measurement date.

Question 5

The cost of an item of PPE includes:

Answer 5

• its purchase price, including all non-recoverable duties and taxes but net of trade discounts,
• 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 the management, and
• the initial estimate of dismantling and site restoration costs.

Question 6

Directly attributable costs include:

Answer 6

employee benefits arising directly from construction or acquisition of the item,

a) site preparation costs, b) delivery costs,
c) installation and assembly costs,
d) costs of testing,
and
e) professional fees.

Question 7

What costs are not added to cost base of PPE at initial recognition?

Answer 7

• Costs of opening a new facility
• Costs of introducing new products
• Costs of conducting business in a new location or with a new class of customer
• Administration and general overheads

Question 8

When do you stop recognising cost as part of initial recognition?

Answer 8

Costs that are incurred after the date when the item is capable of operating in the manner
intended must be excluded, such as:

• Costs incurred when the item is not yet in use (but is ready for use) or is operated at less than full capacity
• Operating losses while demand builds up (as asset is ready)
• Reorganisation costs

Question 9

What does IS 23 Borrowing Costs state for IAS16?

Answer 9

IAS 23, Borrowing Costs requires borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset to be capitalised and included in the cost of that asset.

Question 10

When do you stop capitalising borrowing costs?

Answer 10

Capitalisation of borrowing costs should be stopped when substantially all the activities necessary to
prepare the asset for its intended use or sale are complete.

Question 11

What borrowing costs should be capitalised?

Answer 11

Only the borrowing costs which would have been avoided if the expenditure on the qualifying asset
had not been made should be capitalised.

This is only as a result of acquiring asset.

Question 12

How to treat borrowed amounts where part of the borrowings are invested for short period?

Answer 12

If specific borrowings are not all immediately required and some are invested, the capitalised
borrowing costs are reduced by the income earned on the investment of the surplus funds.

Question 13

How do you capitalise borrowing cases for general borrowing amounts?

Answer 13

If the funds required for construction are taken out of the general borrowings of the entity, then the
amount of borrowing costs to be capitalised is calculated with reference to the weighted average cost of the general borrowings.

Question 14

Capitalisation of borrowing costs should begin when the entity first meets all three of the following conditions:

Answer 14

• It incurs expenditures for the asset
• It incurs borrowing costs
• It undertakes activities that are necessary to prepare the asset for its intended use or sale (e.g.
  construction, drawing up plans, obtaining permissions)

Note: point out the date that all three start to happen.

Question 15

What disclosure is required with reference to borrowing costs?

Answer 15

The entity should disclose in notes of FS:

• the costs which have been capitalised in the current period,
• the capitalisation rate (waited average cost of borrowing, or interest on the loan) used to determine the amount of borrowing costs eligible for capitalisation.

Question 16

What judgements are required on the part of management when calculating borrowing costs?

Answer 16

• ‘A substantial period of time to get ready’ (to determine whether qualifying asset)
• Borrowing costs which are ‘directly attributable’
• ‘Activities necessary to prepare the qualifying asset’ (for commencement of capitalisation)
• When ‘substantially all the activities necessary… are complete’ (for cessation of capitalisation)

Question 17

IAS 16, “Property, Plant and Equipment” allows a choice between two models for subsequent recognition? Explain these

Answer 17

A) The cost model:

• An item of PPE is carried at cost less accumulated depreciation and impairment
  losses.

b) The revaluation model.

• An item of PPE is carried at the revalued amount, being fair value less
  subsequent accumulated depreciation and impairment losses.
• Revaluation must be carried out regularly. The maximum interval between revaluations is
  typically 5 years – a longer interval must be justified.

Note: The choice of model is an accounting policy choice, which must be applied across an entire class of
PPE.

Class of PPE: A grouping of assets of a similar nature and use in an entity’s operations (e.g. land, motor
vehicles, furniture and fixtures, office equipment)

Question 18

What is the objective of depreciation?

Answer 18

An application of the accruals concept, the objective of depreciation is to spread the cost of owning PPE over its useful life, thus matching the net expenditure on the asset against the total revenue earned through its use.

Question 19

When must the residual value and useful life of an asset be reviewed?

Answer 19

The residual value and useful life of an asset must be reviewed at least each year end; any change is
a change in accounting estimate and must be accounted for prospectively (see chapter 10 of these
notes).

Question 20

When does depreciation commence?

Answer 20

Depreciation should commence when the asset is in the location and condition necessary for it to be capable of operating in the manner intended. This is the case even if the asset is actually put into use
at a later date.

Question 21

When do you depreciate assets separately?

Answer 21

The different parts of a bigger asset are treated as separate components, with separate lives. These
are then depreciated separately over their individual useful life rather than over the useful life of the bigger asset.

For example, an aircraft’s engines will be depreciated separately from its airframe when
they have different useful lives.

Question 22

How to treat major inspections required for assets:

Answer 22

Regular major inspections of an asset are a condition of continuing to use it, the cost of each inspection is treated as a separate item of PPE and recognised in profit or loss over the period to the next inspection.

e.g. Airplane inspection every 5 years. You can capitalise amount in PPE figure and depreciated over until the next inspection.

Question 23

How does IAS 16 say depreciation should be calculated? What are the potential depreciation methods?

Answer 23

IAS 16, Property, Plant and Equipment requires that a systematic basis should be used to choose the depreciation method, which should reflect the pattern in which the future economic benefits are consumed. Identified methods are:

• Straight-line
• Diminishing (or reducing) balance
• Units output

Question 24

Is a change in the depreciation method a change in accounting policy? When do you review and how do you treat this?

Answer 24

Any changes are changes
in an accounting estimate and are accounted for prospectively.

Depreciation methods must be reviewed at least at each financial year end.

Question 25

How is the asset measured under revaluation model?

Answer 25

Under the revaluation model permitted by IAS 16, Property, Plant and Equipment, an item of PPE is carried at its fair value at revaluation less subsequent accumulated depreciation and impairment losses.

Question 26

What is fair value?

Answer 26

Fair value is generally the price that would be received to sell an asset in an orderly transaction
between market participants at the measurement date (market value).

Question 27

What is the maximum period for revaluation?

Answer 27

IAS 16 requires that revaluations to determine fair value should be carried out regularly, so that the carrying amount does not differ materially from the fair value at the balance sheet date.

• The maximum allowable period between revaluations is typically 5 years.

Note: Revaluations can be expensive!

Question 28

How to treat upward revaluations?

Answer 28

Increases in value on a revaluation are recognised in other comprehensive income and form part of
equity under the heading of revaluation surplus.

Question 29

When can the amounts in the revaluation surplus be distributed to shareholders as dividends?

Answer 29

When they are subsequently transferred to retained earnings.

This happens in one of two ways:

1. on disposal of the asset,

or

2. through an annual transfer of excess depreciation into retained earnings (see section 3.7.3).

Question 30

What are the journal entries for upward revaluation?

Answer 30

DR PPE cost account [fair value – original cost]

DR Accumulated depreciation

CR Revaluation surplus

Question 31

How to recognise downward revaluations?

Answer 31

Downward revaluation is not shown in revaluation reserve

• -> DR PIL
• -> CR PPE

Upward revaluation:

• -> DR PPE
• -> CR OCI

Question 32

How to treat excess depreciation arising as a result of upward revaluation?

Answer 32

IAS 16 permits a transfer between reserves of the ‘excess’ depreciation as a result of an upwards
revaluation.

Question 33

How can you move values from revaluation surplus to retained earnings when excess depreciation occurs?

Answer 33

The effect of this is that distributable profits (those out of which dividends may be declared) are not
affected by extra depreciation on revalued assets.

Question 34

Journal entry for reserves transfer to account for excess depreciation.

Answer 34

DR Revaluation surplus

CR Retained earnings

Question 35

Journal entry for downward revaluation asset was not previously revalued upwards?

Answer 35

DR Profit or loss (admin expenses)

CR Asset value (carrying amount)

Question 36

Journal entry asset was previously revalued upwards

Answer 36

DR Revaluation surplus

DR Profit or loss (balancing figure)

CR Asset value (carrying amount)

Question 37

When to impair asset?

Answer 37

The basic principle of IAS 36, Impairment of assets is that if an asset’s value in the financial statements
is higher than its realistic value, measured as its ‘recoverable amount’, the asset is judged to have
been impaired. The standard deals with:

• Identification of an impairment loss (indications of impairment)
• Measurement of recoverable amount
• Accounting for an impairment loss

Question 38

What shows that the assets should be impaired?

Answer 38

An entity should assess at the end of each reporting period whether there are any indications of
impairment to any assets, applying the concept of materiality.

Question 39

When should impairment reviews be carried out?

Answer 39

Annual impairment reviews must always be carried out for intangible assets with an indefinite useful life, such as goodwill, regardless of whether there are any indications of impairment.

Question 40

What are the external indications of impairment?

Answer 40

• A fall in the asset’s market value that is more significant than would normally be expected.
• A significant change in the environment (technological, market, legal or economic) of the
  business in which the assets are employed.
• An increase in market interest rates or market rates of return on investments likely to affect the discount rate used in calculating value in use.
• The carrying amount of the entity’s net assets being more than its market capitalisation.

Question 41

What are the internal indications of impairment?

Answer 41

• Evidence of obsolescence or physical damage.
• Adverse changes in the use to which the asset is put.
• Indications that the economic performance of an asset is, or will be, worse than expected.

Question 42

The recoverable amount of an asset is the higher of:

Answer 42

• its fair value less costs of disposal and

- its value in use.

Question 43

What is fair value less cost of disposal?

Answer 43

Fair value: The price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date.

Question 44

Define ‘fair value in use’:

Answer 44

Value in use: The present value of the future cash flows expected to be derived from an asset.

Question 45

What happens if recoverable amounts is greater than carrying amount?

Answer 45

No impairment /change required.

Question 46

When do you impair and what is the amount?

Answer 46

The impairment loss is the difference between the carrying amount and the recoverable amount.

Question 47

How to recognise an impairment under cost model?

Answer 47

Impairment loss is recognised in the same way as a decrease on revaluation (i.e. as an expense in
profit or loss).

DR Profit or loss
CR Asset value (carrying amount)

Question 48

How to show impairment under revaluation model

Answer 48

Impairment is treated as a revaluation decrease and not as an impairment loss. It can first be set
against any balance relating to the same asset in the revaluation surplus, with any excess being
recognised in profit or loss.

DR Revaluation surplus

DR Profit or loss (balancing figure)

CR Asset value (carrying amount) - answer net off against revaluation surplus as much as possible and rest against P&L

Question 49

When to derecognise PPE:

Answer 49

An item of PPE shall be removed from the statement of financial position (i.e. derecognised) when it is disposed of or when no future economic benefits are expected from its use or disposal (i.e. it is
abandoned).

Question 50

For classification as held for sale to be made, the following criteria must be met:

Answer 50

• The asset must be available for immediate sale in its present condition
• Its sale must be highly probable

Question 51

The sale is highly probable when all of the following conditions hold true:

Answer 51

• Management is committed to a plan to sell the asset
• There is an active programme to locate a buyer
• The asset is marketed for sale at a price that is reasonable in relation to its current fair value
• The sale expected to take place within one year from the date of classification
• Significant changes or withdrawal of the plan are unlikely

Question 52

When you are disposing of an asset held under the cost model, what do you do?

Answer 52

1) Measure the asset held for sale at the lower of a) carrying amount and b) fair value less costs to
sell, recognising an impairment loss if a) is greater than b).

2) Stop charging depreciation on held for sale asset.
3) Present non-current asset held for sale separately from all other assets on the SOFP (recommended to present immediately below the sub-total for current assets).

4) On ultimate disposal, treat any difference between carrying amount and disposal proceeds as
normal loss or gain.

Question 53

How do you account for assets held for sale under the revaluation model?

Answer 53

1) Revalue asset under normal rules of revaluation model, therefore bringing carrying amount to fair
value.

2) Recognise costs to sell immediately in profit or loss as an impairment loss.
3) Stop charging depreciation on held for sale asset.

4) Present non-current asset held for sale separately from all other assets (recommended to present
immediately below sub-total for current assets).

5) On ultimate disposal, treat any difference between carrying amount and disposal proceeds as
normal loss or gain.

6) If there is still a revaluation surplus relating to an asset that has been disposed of, this balance
should be transferred to retained earnings as a reserve transfer.

Question 54

What are the UK GAAP comparison differences from IFRS?

Answer 54

• Capitalisation of borrowing costs is required under IAS 23. However, under FRS 102 entities have a
  choice whether to capitalise borrowing costs or to recognise them as an expense.
• Under FRS 102, there is no ‘held for sale’ category; assets of a discontinued operation continue to be
  depreciated up to the date of disposal and continue to be classified as part of tangible fixed assets.
  Under IFRS 5, depreciation ceases when an asset is classified as ‘held for sale’ and they are classified
  separately below current assets.