Property, Plant and Equipment
IAS 16
Property, Plant and Equipment
IAS 16
Level Tested on CPA PEP
| Exam | Level Tested | Importance (low, medium, or high) |
| Core 1 Module | Level A | High |
| Assurance Elective | Level A | High |
Definition
Property, plant and equipment (PPE) are tangible assets that:
- are held for use to produce/supply goods and services, for rental to others, or for administrative purposes; and
- are expected to be used during more than one period.
The cost of PPE are recognized as PP&E asset only when:
- probable that future economic benefits* associated with the item will flow to the entity; and
- the cost of the item can be measured reliably
- *benefits can be direct or indirect
- spare parts/servicing equipment = PP&E if meets the criteria in 1 and 2 above. If not, then classify as “inventory”
- major spare parts/stand-by equipment = PPE when expected to be used more than one period or it can be used only in connection with an item of PPE
Measurement at recognition
- PPE is initially measured at cost
- 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.
- Cost includes the following:
- Purchase price import duties and non-refundable taxes, net of discounts and rebates
- Estimate costs of dismantling, removing, or restring the site on which the PPE is located (Asset Retirement Obligation)
- If land and building is acquired together. The cost should be prorated based on their relative fair market values
Directly attributable costs
- Directly attributable costs include the following:
- costs of employee benefits arising directly from the construction or acquisition of the item of property, plant and equipment;
- costs of site preparation;
- initial delivery and handling costs;
- installation and assembly costs;
- costs of testing whether the asset is functioning properly, after deducting the net proceeds from selling any items produced while bringing the asset to that location and condition (such as samples produced when testing equipment); and
- professional fees (legal, accounting)
Directly attributable costs
- the following are not capitalized:
- costs of opening a new facility;
- costs of introducing a new product or service (including costs of advertising and promotional activities);
- costs of conducting business in a new location or with a new class of customer (including costs of staff training); and
- administration and other general overhead costs.
Incidental Operations
- Incidental operations = not necessary to bring the item to the location and condition necessary for it to be capable of operating in the manner intended by management
- The revenues and expenses incurred from incidental operations are recognized in the income statement
- Example (car park until construction starts)
Borrowing Costs
- See borrowing costs notes
- Borrowing costs on qualifying assets are capitalized
Example
ABC Inc. made the following expenditures during the current fiscal year. Determine if it these expenditures should be classified as PP&E or should be included in expense account. Explain your conclusion.
| 1. | Acquisition of a piece of land that has a small building to construct a new building – do we need to separate the land and old building cost? |
| 2. | Demolition of the small building on the land to make it available for constructing a new building |
| 3. | Purchase of building permit to construct |
| 4. | Paving a parking lot |
| 5. | Landscaping around the building |
| 6. | Purchase of new equipment |
| 7. | Sales tax on new equipment (refundable) |
| 8. | Installation of the new equipment |
| 9. | Minor repairs to the old equipment |
Measurement after recognition
As discussed above, the initial recognition has to be at cost. After the initial recognition, there are two methods of measuring PPE:
- Cost Model
- Revaluation Model – Only allowed under IFRS, not ASPE
1. Cost Model
Under the cost model, the assets are recorded at their carrying value calculated as below. Most companies choose to use the cost model due to its simplicity.
- Carrying value = Historical cost less any accumulated depreciation and any accumulated impairment losses
2. Revaluation Model
Under the revaluation model, assets are recorded at fair market value (FMV). There is still depreciation each year. The method of depreciation is same for both the cost and revaluation model. The revaluation method works as below:
- At each revaluation date, the PPE is revalued to fair value
- The revalued amount is still amortized over the remaining useful life of the PPE
- Revaluations should be done with sufficient regularity to ensure that the carrying amount does not differ materially
- There is no requirement to do a revaluation every year
- Revaluations should be done at a minimum every 3 to 5 years
- There is no requirement to do a revaluation every year
- Carrying value = Fair value @ date of revaluation less accumulated depreciation and any accumulated impairment losses
- If an item of property, plant and equipment is revalued, the entire class of property, plant and equipment to which that asset belongs needs be revalued on the same date
- If one building is measured with the revaluation method; all other buildings must also be revalued on the same date that the building is revalued at.
- The fair value must be reliably available. The FMV can be obtained through an independent appraisal or an active market for such assets.
How to use the revaluation method
Initial Revaluation
- gains – goes to other comprehensive income – revaluation surplus (OCI)
- loss – goes to profit & loss (P&L)
Subsequent revaluation
- gains – goes to P&L to the extent of reversing previous losses; the remainder goes to OCI
- losses – goes to OCI to the extent of reversing gains in OCI; the remainder goes to P&L
Methods to recognize asset basis after revaluation
When assets are adjusted for revaluations, there are two methods that can be used.
- Elimination method (also called gross carrying amount): In this method, the accumulated depreciation is set to zero and the asset cost is matched with the fair market value.
- Proportional method: In this method, both the accumulated depreciation and cost are adjusted proportionately to achieve an overall asset carrying value to fair market value.
- The revaluation surplus included in accumulated other comprehensive income may be transferred directly to retained earnings when the asset is derecognised.
- This may involve transferring the whole of the surplus when the asset is retired or disposed of.
- However, some of the surplus may be transferred as the asset is used by an entity. In such a case, the amount of the surplus transferred would be the difference between depreciation based on the revalued carrying amount of the asset and depreciation based on the asset’s original cost.
- Transfers from revaluation surplus to retained earnings are not made through profit or loss
Advantages and disadvantages of using the revaluation method
| Advantages | Disadvantages |
|
|
Example
Example 1 – ABC Inc. management has decided to use the revaluation method under IFRS to value for the only land it owns. The following data is available for the land.
Original cost – $1,000,000
FMV at the end of year 1 – $800,000
FMV at the end of year 2 – $1,200,000
Required: Prepare the journal entries to adjust the value of the land for Year 1 and Year 2.
Example 2 – Elimination method
ABC Inc. also has one building and the management has decided to use the revaluation method under IFRS. The management has decided to account for using the elimination/gross carrying amount method.
Cost – $1,000,000; Residual value – $0; Life – 10 years
FMV at the end of year 1 – $950,000
FMV at the end of year 2 – $700,000
Required: Prepare all the journal entries for Year 1 and Year 2.
Deprecation
- Depreciation methods
- depreciation method should reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity
- The depreciation method applied to an asset shall be reviewed at least at each financial year-end and (changes are accounted for as a change in estimate)
- Examples of methods
- straight-line method,
- declining balance method
- units of production method/output method
- Depreciation of an asset begins when it is available for use; i.e. when it is in the location and condition necessary for it to be capable of operating in the manner intended by management.
- Depreciation does not stop when the asset becomes idle or is retired from active use unless the asset is (i) fully depreciated or (ii) in the case depreciation method used is output method. Also, when the asset becomes held for sale or derecognized, depreciation stops
- Depreciation stops when Carrying Value≤ Residual Value
- Amortization expense under straight-line= (cost – residual value)/useful life
- Useful life = period asset will be available for use or units expected to be obtained from the asset
- Residual value = amount asset is expected to be sold for @ end of useful life less the cost of disposal
- The residual value and the useful life of an asset shall be reviewed at least at each financial year-end (any changes accounted for as change in estimate)
- Amortization expense under declining balance method = (cost – accumulated depreciation)*depreciation rate
- This depreciation continues until the carrying amount equals the salvage value, and then depreciation stops.
- Amortization expense under output method = (Cost – residual value)/Estimated production in lifetime * current period production
Example
Example 1 – Straight line method with change in estimate
ABC Inc. purchased equipment for $25,0000 on January 1, 2017. The estimated useful life was determined to be 5 years. On Jan 1, 2018, the management revised the estimate of useful life to 10 years.
Salvage value = $2,500; Residual value = $5,000.
Compute depreciation expense for 2018.
Example 2 – output method with change in estimate
ABC Inc. purchased equipment for $25,000 on January 1, 2017. The estimated useful life is 150,000 units. On Jan 1, 2018, the management revised the estimate of useful life to 120,000 units. In 2017, 25000 units are produced and in 2018 30,000.
Salvage value = $2,500; Residual value = $5,000.
Compute depreciation expense for 2018.
Depreciation of significant components/parts
- 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 MUST be depreciated separately
- Compare cost of part to total cost of the PPE
- No choice but to amortize separately if it is a major component of the asset.
- An entity allocates the cost of a PPE to its significant parts and depreciates each significant part separately
- Example: Airplane (separately depreciate engine, airframe, cabin); Building (roof, windows)
- Significant parts may have different useful lives than full asset and IFRS wants us to have a more accurate amortization expense
Subsequent Costs
Major replacement
- Examples: replacing the interior wall of a building, engine of a plane
- The cost of the replacement is capitalized (as long as probable future economic benefits and cost is measurable)
- The carrying amount of the parts that are replaced (the old parts) is derecognized
- even if the old part was not separately recognized and amortized, we will still need to estimate an amount and derecognize it
Major Inspection
- Example: Air Canada performs major inspections on planes every 5 years
- Cost of major inspection is capitalized (as long as probable future economic benefits and cost is measurable)
- Any remaining carrying amount of the cost of the previous inspection is derecognized
- even if the previous inspection was not separately recognized and amortized, we will still need to estimate an amount and derecognize it
Comparison to ASPE
- incidental operations; under ASPE income from incidental operations are capitalized until substantial completion
- only cost model is allowed under ASPE i.e. revaluation method is not allowed
- Straight line depreciation calculation is different under ASPE
- Under ASPE, significant components are separately amortized only when practicable and the useful life of the significant component is estimable
- ASPE uses betterments vs. repairs in determining subsequent capitalization
- Under ASPE no requirement to derecognize the carrying value of the items replaced