Standard IAS 16 prescribes the accounting treatment for property, plant and equipment and therefore it is one of the most important and commonly applied standards.
The main issues dealt in IAS 16 are recognition of property, plant and equipment, measurement at and after recognition, impairment of property, plant and equipment (although IAS 36 deals with impairment in more detail) and derecognition.
Recognition of Property, Plant and Equipment
Property, plant and equipment are 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.
IAS 16 states that the cost of an item of property, plant and equipment shall be recognized as an asset if, and only if:
- it is probable that future economic benefits associated with the item will flow to the entity; and
- the cost of the item can be measured reliably.
This recognition principle shall be applied to all costs at the time they are incurred, both incurred initially to acquire or construct an item of property, plant and equipment and incurred subsequently after recognition to add to, replace part of or service it.
Initial costs
Some items of property, plant and equipment might be necessary to acquire for safety or environmental reasons.
Although they do not directly increase the future economic benefits, they might be inevitable to obtain future economic benefits from other assets and therefore, should be recognized as an asset.
For example, water cleaning station might be necessary in order to proceed with some chemical processes within chemical manufacturer.
Subsequent costs
Day-to-day servicing of the item shall be recognized in profit or loss as incurred, because they just maintain (not enhance) item’s capacity to bring future economic benefits.
However, some parts of the item of property, plant and equipment may require replacement at regular intervals, for example, aircraft interiors.
In such a case, an entity derecognizes carrying amount of older part and recognizes the cost of new part into the carrying amount of the item. The same applies to major inspections for faults, overhauling and similar items.
Measurement
Initial Measurement
An item of property, plant and equipment that qualifies for recognition as an asset shall be measured at its cost.
The cost of an item of property, plant and equipment comprises:
- its purchase price including import duties, non-refundable purchase taxes, after deducting trade discounts and rebates
- 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. Examples of these costs are: costs of site preparation, professional fees, initial delivery and handling, installation and assembly, etc.,
- the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located.
The cost of an item of property, plant and equipment is the cash price equivalent at the recognition date.
If payment is deferred beyond normal credit terms, the difference between the cash price equivalent and the total payment is recognized as interest over the period of credit (unless such interest is capitalized in accordance with IAS 23).
If an asset is acquired in exchange for another non-monetary asset, the cost will be measured at the fair value unless:
- the exchange transaction lacks commercial substance or
- the fair value of neither the asset received nor the asset given up is reliably measurable.
If the acquired item is not measured at fair value, its cost is measured at the carrying amount of the asset given up.
Subsequent Measurement
An entity may choose 2 accounting models for its property plant and equipment:
- Cost model: An entity shall carry an asset at its cost less any accumulated depreciation and any accumulated impairment losses.
- Revaluation model:An entity shall carry an asset at a revalued amount. Revalued amount is its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses.
An entity shall revalue its assets with sufficient regularity so that the carrying amount does not differ materially from its fair value at the end of the reporting period. If an item of property, plant and equipment is revalued, the entire class of property, plant and equipment to which that asset belongs shall be revalued.
The change of asset’s carrying amount as a result of revaluation shall be treated in the following way:
| Change in Carying Amount | Where | |
|---|---|---|
| Increase | Other comprehensive income (heading “Revaluation surplus”) | Profit or loss if reverses previous revaluation decrease of the same value |
| Decrease | Profit or loss | Other comprehensive income if reduces previously recognized revaluation surplus (heading “Revaluation surplus”) |
You can learn more about the revaluation model in this video:
Depreciation (both models)
Depreciation is defined as the systematic allocation of the depreciable amount of an asset over its useful life.
The items of property, plant and equipment are usually depreciated in order to maintain matching principle – as they are in operation for more than 1 year, they assist in producing the revenues in more than 1 year and therefore, their cost shall be spread among those years in order to match the revenue they help to produce.
When dealing with the depreciation please do have 3 basic things in mind:
- Depreciable amount: Depreciable amount is simply HOW MUCH you are going to depreciate. It is the cost of an asset, or other amount substituted for cost, less its residual value.
- Depreciation period: Depreciation period is simply HOW LONG you are going to depreciate and it is basically asset’s useful life.
Useful life is 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.
IFRS16 lists several factors that shall be considered when establishing item’s useful life:
- expected usage of the item,
- expected physical wear and tear,
- technical or commercial obsolescence of the item, and
- legal or other limits on the use of the asset.
Useful life and asset’s residual value (input to depreciable amount) shall be reviewed at least at the end of each financial year.
If there is a change in the expectations comparing to previous estimates, then change shall be accounted for as a change in an accounting estimate in line with IAS 8 (no restatement of previous periods).
- Depreciation method: Depreciation method is simply HOW, IN WHAT MANNER you are going to depreciate.
The depreciation method used shall reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity.
An entity may select from variety of depreciation methods, such as straight-line method, diminishing balance method and the units of production methods.
Selected method shall be reviewed at least at the end of each financial year. If there is a change in the expected pattern of asset’s usage, then the depreciation method shall be changed and be accounted for as a change in an accounting estimate in line with IAS8 (no restatement of previous periods).
Depreciation shall be recognized in profit or loss unless it is capitalized into the carrying amount of another asset (for example, inventories, or another item of property, plant and equipment).
Each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately. For example, aircraft interior cost might be depreciated separately from the remaining airplane cost.
Impairment
Here, IAS 16 refers to another standard, IAS 36 Impairment of Assets that prescribes rules for reviewing the carrying amount of assets, determining their recoverable amount and impairment loss, recognizing and reversing impairment loss and more.
IAS 16 states that compensation from third parties for items of property, plant and equipment that were impaired, lost or given up shall be included in profit or loss when the compensation becomes receivable.
For example, claim for compensation of damage on insured property from insurance company is recognized to profit or loss when insurance company accepts claim, closes the case and agrees to compensate (or after whatever procedure is agreed in the insurance contract).
Derecognition
IAS 16 prescribes that the carrying amount of an item of property, plant and equipment shall be derecognized on disposal; or when no future economic benefits are expected from its use or disposal.
The gain (not classified as revenue!) or loss arising from the derecognition of an item of property, plant and equipment shall be included in profit or loss when the item is derecognized. The gain or loss from the derecognition is calculated as the net disposal proceeds (usually income from sale of item) less the carrying amount of the item.
Further reading
The following articles about IAS 16 were published on CPDbox (worth to read):
- Fully depreciated assets still in use – what to do? – If you own assets with zero carrying amount, but they are still in use, there’s something wrong about it. Learn more in this article.
- How to account for spare parts – spare parts are a difficult area and the accounting depends on their character.
- How to account for artwork – as there’s no standard specific for artwork, sometimes it’s necessary to develop your own accounting policy.
- What are directly attributable costs? – what can you capitalize? What can you not capitalize?
- When to start depreciation? – If you don’t use an asset, but it’s available for use, it’s the right time. This article explains it all.
- How to capitalize borrowing costs?
- 3 biggest myths in accounting for PPE
- Can you capitalize it as PPE or not?
- Podcast 003: Can we capitalize demolition cost and carrying amount of old buildings?
Please check out IAS 16 in the following video:
