IAS 16 Property Plant and Equipment Prepared by: Salman Saeed Opentuition Study Sessions for December 2010

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1 IAS 16 Property Plant and Equipment Prepared by: Salman Saeed Opentuition Study Sessions for December 2010 Syllabys Guide a) Define and compute the initial measurement of a non-current (including a self-constructed) asset. b) Identify subsequent expenditure that may be capitalised (including borrowing costs), distinguishing between capital and revenue items. c) Discuss the requirements of relevant accounting standards in relation to the revaluation of noncurrent assets. d) Account for revaluation and disposal gains and losses for non-current assets. e) Compute depreciation based on the cost and revaluation models and on assets that have two or more significant parts (complex assets). Objective of IAS 16 PPE: The standard is there to prescribe the accounting treatment for property, plant and equipment. Property, plant and equipment are tangible assets held by an entity for more than one accounting period for use in production and supply of goods and services, for rental or for office use. It gives us guidelines for: Recognition of Assets. Determination of carrying amounts, and Depreciation charges and impairment losses to be recognised. The IAS 16 standard does not apply to the assets Held For Sale i.e IFRS 5. Recognition of Asset: Property, plant and equipment (PPE) is recognised when the cost of an asset can be reliably measured and it is probable that the entity will obtain future economic benefits from the asset. PPE is measured initially at cost. Cost includes the fair value of the consideration given to acquire the asset (net of discounts and rebates) and any directly attributable cost of bringing the asset to working condition for its intended use (inclusive of import duties and non-refundable purchase taxes). Directly attributable costs include the cost of 1. Site preparation, 2. Delivery, 3. Installation costs, 4. Relevant professional fees, and 5. The estimated cost of dismantling and removing the asset and restoring the site (to the extent that such a cost is recognised as a provision). P.T.O

2 Classes of PPE are carried at historical cost less accumulated depreciation and any accumulated. impairment losses (the cost model), or at a revalued amount less any accumulated depreciation and subsequent accumulated impairment losses (the revaluation model). The depreciable amount of PPE (being the gross carrying value less the estimated residual value) is depreciated on a systematic basis over its useful life. The standard recognises that parts of some assets may require replacement at regular intervals (complex assets e.g aircraft engines). Also, continued operation of an asset may require regular inspections, this cost is recognised in the carrying amount of PPE as a replacement cost (if recognition criteria are satisfied). A complex asset is an asset that has seperate components within a single asset, airfcraft, each seperate part should be depreciated over their Useful Economic Life. The major inspection or ourhaul are the usual expenses incurred. But, they are capitalised as Non Current Asset if they satisfy IAS 16 seperate components, and depreciated over Useful Economic Life. Revenue costs should be written off as incurred. Subsequent Expenditure relating to an item of PPE is capitalised if it meets the recognition criteria. i.e Capital costs. It should be capitalised if it results in the total economic benifit expected from the asset to increase above expected on original recognition, more/improved production capacity, eg, cost of an extension should be capitalised as capital expenditure(capex) because economic benefits will increase with more space. All other subesequent expenditure goes to SOCI because it only maintains the economic benefits, a general repair, revenue expenditure, expensed. Question 1. Initial cost recognition: Purchase a new machine during year. Related costs as follows: List price 100 Installation 20 Pre production testing 10 Insurance 2 Warranty 2 Maintenance 3 The company received 10% trade discount on the list price and then a further 3% discount for payment on delivery. Supplier offers 3 months credit but the company chose to take the settlement discount. Installation should have cost 18,000 but the co wasted 2,000 by installing wrong parts.maintenance occurred after start of production and was required by warranty. Warranty & insurance are for 1 year only. Requirement: Calculate initial cost to be recognised? Question 2. Subsequent Expenditure: A piece of machiner has an annual service costing $10,000. During a recent service it was decided to replace part of the engineering meaning it will work faster and produce more units per hour. The cost of replacement is $20,000. Requirement: State the treatment of these costs.

3 Question 3. Subsequent Expenditure. In each cases justify wether or not the expenditure should be capitalised? A) A new Engine is fitted to a machine increasing production from 100,000 to 140,000 units per annum. B) Replacement of rotting windows in head office. C) Replacement of an aircraft engine every 5 years Depreciation: The aim of depreciation is to spread the cost of the asset over its life in the business. The depreciation method used should reflect as fairly as possible the pattern in which the asset s economic benefits are consumed by the entity. Possible methods include: straight line reducing balance machine hours. A change from one method to another is permissible if the new method will give a fairer presentation of the results and of the financial position and is not a change in accounting policy. The net book value (NBV) of the asset is then depreciated using the revised method over the remaining UEL, beginning in the period in which the change is made. The UEL should be reviewed at the end of each reporting period and revised if expectations are significantly different from previous estimates. The NBV of the asset at that date should then be epreciated over the revised remaining UEL. Where the residual value is material: it should be reviewed at the end of each reporting period to take account of reasonably expected technological changes based on prices prevailing at the date of acquisition (or revaluation) any change should be accounted for prospectively over the asset s remaining UEL. Revaluation: IAS 16 allows two kind of accounting models: The Cost Model: asset is carried at; cost accumulated depreciation and impairment. Revaluation Mode: asset is carried at revalued ammount, its fair value at the date of revaluation less subsequent depreciation and impairment, provided that Fair Value can be measured reliably. If the Revaluation Model is adopted, then two conditions must be satisfied: 1. Revaluation carried out regularly, so that the carrying amount of an asset does not differ materially from the Fair Value at reporting date. 2. If an item is revalued, the entire class of assets to which it belongs, should be revalued. P.T.O

4 Accounting for revaluation: Steps: (1) Restate asset from cost to valuation. (2) Remove any existing accumulated depreciation provision. (3) Include increase in carrying value in revaluation reserve. Journal: Dr Non current asset s cost/valuation (Cr if valuation < cost) Dr Accumulated depreciation (eliminate all of existing provision) Cr Revaluation reserve (valuation less previous NBV) If a revaluation results in an increase in value, Cr Other Comprehensive Income and accumulate the increase in Equity under the heading Revaluation Reserve. If the revaluation reverses a revaluation decreses,(dr Expense) of the same asset previously recognised as expense, then it should be recognised as income (Cr Income) so Dr Expense becomes Cr Income. When a revalued asset is disposed of, any revaluation surplus may be transferred directly to retained earnings, or it may be left in euqity under the heading revaluation surplus. The transfer to retained earnings should not be made through the income statement (no recyclying through profit or loss). Question 4: Revaluation A company land & buildings at start of the year to 10m ( 4m for land). Property cost 5m ( 1m for land) 10 years prior to revaluation. Total expected UEL is 50 years unchanged. Required : show effects these would have on the financial statements for the year? Depreciation on Revalued Assets: Revalued assets are depreciated in the same way as under cost model. The depreciation charge on revalued asset should be calculated on the carrying amount of asset(the revalued amount) and all charged to the SOCI. A transfer may be made from revaluation reserve to retained earnings of the extra depreciation charge arising from the revaluation. Measured as the difference between the depreciation charge on the revalued amount and the original cost. This represents the amount of the revaluation surplus realised during the period. Depreciation must be charged on revalued assets and based on valuation less residual value, over remaining UEL. The whole charge must go to profit and loss account for year. An annual reserve transfer may be made for extra depreciation on the revalued amount compared to a depreciation charge based on cost.

5 Journals: $$ Dr Profit and loss account depreciation charge (full charge) Cr Accumulated depreciation Dr Revaluation reserve (depreciation on valuation depreciation on cost) Cr Profit and loss reserve Question 5: Account for revaluation & subsequent depreciation of revalued asset: A company having a year end to 31 December Buys asset on 1st January 01 for 10,000 Asset has UEL of 10 years with no residual value, and therefore straight line depn will be 1,000 p/a and, on 31 December 02 the asset will be included in SoFP as follows: Fixed asset at cost : 10,000 Accumulated depn : (2,000) Net Book Value : 8,000 On 1st January 03 the co revalue asset to 16,000. UEL remains at 10 years. Required: A). Show journal to record revaluation. B). Show journal to record revised depreciation charge and reserves transfer. C). The company sells asset on 1st January 04 for 15,000. Show how disposal should be recorded Disposal of Non current assets An asset should be removed from the SoFP on disposal or when it is withdrawn from use and no future economic benefits are expected from its disposal. The gain or loss on disposal is the difference between (proceeds crrying amount) recognised in the Other Comprehensive Income. The profit or loss on disposal of a revalued fixed asset should be: The remainder of the revaluation reserve relating to this asset should now be transferred to the profit and loss reserve, as it is now realised. calculated as the difference between the net sale proceeds and the carrying amount accounted for in the profit and loss account of the period in which the disposal occurs. P.T.O

6 Disclosures The basis for measuring carrying amount Depreciation method Useful Economic Life or depreciation rates Gross Carrying amount and accumulated depreciation and impairment losses. Reconciliation of the carrying amount at the beginning and the end of the period, showing: 1. Additions 2. Disposals 3. Acquisitions through business combinations 4. Revaluation increases or decreases 5. Impairment losses 6. Reversals of impairment losses 7. Depreciation Also Disclose: Restrictions on title. Expenditures to construct Property, Plant and Equipment during the period. Contractual commitments to acquire Property, Plant and Equipment. THE END Copyrights: Salman Saeed