Property Plant and Equipment Flashcards
IAS 16 vs ASPE 3061
Initial measurement
IAS 16.7
PP&E is only recognized as an asset if both of the following criteria apply:
- it is probable that FEB associated with the item will flow to the entity
- the cost of the item can be measured reliably
Subsequent measurement - cost model
Depreciation methods:
- straight line
- declining balance
- units of production
Method should approximate acutal use and begins when asset is available for use.
Subsequent measurement - revaluation model
When increase to FMV
- Gain is recognized first to net income up to amount of previous losses
- Remaining amount to OCI
Subsequent measurement - revaluation model
When decrease to FMV
- Loss is first recorded to OCI up to amount of previous gains
- Remianing amount to net income
Capitalized costs
Costs incurred up to the point the asset is available for use:
- purchase costs, including duties and unrecoverable taxes (PST), net of discounts and rebates
- costs to bring the asset to location and condition for use
- major inspection costs
- major spare parts
- standy or serviving equipment
- dismantling, removal, and restoration costs
Land building costs include commissions, legal fees, and other costs to make them usable. Allocate costs separately to land and building.
Initlal costs - IAS 16.11
Subsequent costs - IAS 16.12-14
Specifically, the cost of an asset capitalized as PP&E includes three components:
*its purchase price, including import duties, less any trade discounts and rebates (non-refundable
taxes are included in the purchase price, but refundable taxes such as goods and services tax
[GST] and harmonized sales tax [HST] are excluded)
*any 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
*the initial estimate of the costs of dismantling and removing the item and restoring the site on
which it is located (referred to as decommissioning costs [IFRS] or asset retirement obligations
[ASPE], and discussed in more detail in the Decommissioning Provisions and Costs chapter)
Excluded costs from PP&E:
- Note that general costs, such as operating costs and an allocation of general overhead, are not
included in the cost of PP&E, as they are not directly attributable to preparing the asset for use. - maintenance
- training employees
Componentization
- some PP&E have significant parts with different usage rates within the asset, with different
useful lives or residual values. - IFRS recommends that parts with
similar useful lives be grouped together for purposes of depreciation. - Cost is allocated to components in a similar manner as a bundled purchase, as described above.
Self-constructed asset
- When an asset is constructed, such as the building of a factory, all directly attributable costs of the
construction can be capitalized.
For instance, for the construction of a new building, the following costs can be capitalized as part of the building:
*construction permits
*site survey costs
*construction costs, including labour, direct management salaries, and materials
*direct borrowing costs incurred to finance the construction until the occupation permit is obtained
(note ASPE difference here — see Section 29.7)
*professional fees
However, the following cannot be capitalized as part of the cost of a self-constructed asset:
*a profit element on internal labour
*the costs of abnormal amounts of wasted material, labour, or other resources incurred in self-
constructing the asset
Borrowing costs
- IAS 23 Borrowing Costs requires the
capitalization of borrowing costs (such as interest paid on any financing arrangements) directly
attributable to the acquisition, construction, or production of a qualifying asset. - Had these acquisition,
construction, or production expenditures not been incurred, an entity’s borrowing costs would be
lower.
Qualifying assets
- Qualifying assets are those that take a substantial period of time to get ready for their intended use or
sale. - They are likely to include tangible non-current assets that are being constructed and intangible
assets during the development period. - Inventory may be a qualifying asset if the criteria are met (for example, the manufacturing of commercial airplanes for sale), but inventories manufactured
over a “short period of time” and inventory purchased for resale are specifically excluded. - As neither “substantial period of time” nor “short period of time” is defined in the standards, professional judgment must be exercised in determining whether the length of time test is met and whether interest should be capitalized
Borrowing costs example
Consider the following general borrowings for the year (assume a calendar year end):
* Bonds, 5.0%, $30,000,000 — issued on March 1
* Bank loan, 6.5%, $25,000,000 — outstanding the whole year
The capitalization rate is determined as follows:
* The numerator is the interest expense for the year: ($30,000,000 × 5.0% × 10/12
months) + ($25,000,000 × 6.5%) = $2,875,000.
*The denominator is the weighted average annual borrowings: ($30,000,000 ×
10/12 months) + $25,000,000 = $50,000,000.
The interest capitalization rate is $2,875,000 / $50,000,000 = 5.75%.
Spare parts, standby equipment, and servicing equipment
- Spare parts that are immaterial in nature or have a short lifespan are considered inventory.
- However, for major spare parts that meet the definition of PP&E (such as if an airline has a spare
engine on hand), the part would be classified as PP&E.
* The definition of PP&E is tangible items that:
** are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes*
— The spare engine would be held for use in the supply of air travel services because it will be used to replace a defective engine.
** are expected to be used during more than one period*
— If an engine would last for more than one year, it would be expected to be used for more
than one period.
Measurement options for PP&E
Companies may choose between measuring PP&E using the cost model or the revaluation model.
- Under the cost model, assets are recorded at historical cost, and depreciation is taken each year (as described in Section 29.4 below), with the asset being reported at its original cost less accumulated depreciation and any accumulated impairment losses (discussed in more detail in the Impairment chapter). Most companies choose to use the cost model.
- Under the revaluation model, assets are recorded at fair market value and are still depreciated each year. The method or application of depreciation does not change because the revaluation method is being used. However, the depreciation is based on the revalued amount, and revalued assets are subsequently measured and reported at their depreciated cost less any subsequent accumulated impairment losses (depreciation and impairment are discussed in more detail in subsequent sections).
Requirements
- The accounting policy choice must be made for each class of asset, and it cannot be made on
an asset-by-asset basis. - If an entity chooses to use the revaluation method, there must be a sufficient degree of reliability
in measuring fair market value estimates. - According to IAS 16 Property, Plant and Equipment, the revaluation will be required when there is a material difference in fair market value from the last reporting period.
- Therefore, the frequency of revaluations depends on the nature of the asset. If it is an asset
whose value changes rapidly, an annual revaluation may be needed, whereas other assets may only
require a revaluation every few years.
Revaluations
- The principal reason why an entity may choose to revalue some asset classes (such as land and
buildings) and not others is that the difference between the fair value and depreciated cost tends
to be much higher for real estate than other asset classes like equipment. - Note, however, that when a building is revalued
to reflect a substantial increase in fair value, an increase in depreciation expense in future years will
result, which in turn will reduce profits below the amount that would have otherwise been reported
without the revaluation.
Revaluation calculation
When an asset is increased to fair market value, a gain occurs, which is recognized as follows:
* The gain is first recorded to net income, up to the amount of losses that were previously recorded
to net income as a result of revaluations on the asset.
* Then the remaining gain is recorded to other comprehensive income (OCI).
When an asset is written down to fair market value, a loss occurs, which is recognized as follows:
* The loss is first recorded to OCI, up to the amount of gains that were previously recorded to
OCI as a result of revaluations on the asset.
* Then the remaining loss is recorded to net income.
When assets are adjusted for revaluations, the adjustment to the asset cost can be achieved using
one of two different approaches: the elimination method or the proportional method.
- Under the elimination method, the accumulated depreciation is first reset back to zero, and the asset cost is adjusted accordingly. After revaluation, the asset is on the books with a cost equal to fair market value and accumulated depreciation of zero.
- Under the proportional method, both the cost and accumulated depreciation are adjusted
proportionally to achieve an overall carrying amount equal to fair market value. - Both approaches show a net asset on the balance sheet recorded at fair market value.
- The OCI revaluation surplus will be transferred to retained earnings without an adjustment to profit
or loss. This transfer may be as an accumulated total when the asset is retired or sold, which is the
method used in the example questions. Alternatively, some of the surplus may be transferred to
retained earnings as the asset is used.
Subsequent measurement – depreciation
- Useful life is either the period over which an asset is expected to be available for use by an entity or the number of production or similar units expected to be obtained from the asset by an entity (such as machine hours).
There are three methods of calculating depreciation:
- **Straight-line method ** assumes the benefit from the asset occurs evenly over its useful life. For
instance, office furniture such as a desk will be used in the same way in each period of its useful
life. -
Declining balance method assumes that the benefit derived from the asset is higher in its initial
years and less as the asset ages. For instance, technology may work more efficiently and offer
better benefit when new than near the end of its useful life. -
Units of production method matches the cost of a machine with the fraction of its production
capacity used. For instance, a machine may be expected to produce 1,000,000 units over its
useful life. The depreciable value of the asset is divided by the number of units to determine a
per-unit use that can be applied to the number of units produced each period.
Justifications for use of the 3 depreciation method:
Straight-line:
*The straight-line method is widely used (which fosters comparability), is easily understood by
users, and it is easy to calculate the annual depreciation amount.
*In the absence of information to the contrary, the economic benefits from owning many
depreciable assets are much the same in each year of their useful lives.
Declining balance:
*This method may reflect the fact that the economic benefits of depreciable assets decline over
time as the assets wear out.
*It may smooth a company’s expenses to some degree as maintenance and repair expenses
tend to be lower in the early years when the depreciation expense is higher, and higher in the
later years when depreciation expense is lower. In this situation, the choice of the declining
balance method, together with the cost of repairs and maintenance, results in a total cost that is
consistent with receiving economic benefits from ownership that are much the same each year.
*It can be more difficult to calculate than the straight-line method.
Units of production:
*For assets whose useful lives can be measured in units of output rather than in number of years,
depreciation expense is more closely matched to the asset’s pattern of use than with other
depreciation methods.
*This method is more appropriate than the straight-line method when the usage is expected to
vary from period to period.
*It can be more difficult to calculate than the straight-line method.
