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Revisiting IAS 16, Property, Plant & Equipment
Continuing Learning Series
This article is a part of ACS Continuing Learning Series, which is a series of short articles, published by ACS Consulting at short regular intervals on a variety of subjects related to strategy, corporate finance, financial planning & analysis, business planning and performance management.
Subject: Financial Reporting
Relevance:
All accountants and accounting students.
Senior Reporting Personnel, CFOs & Auditors
Introduction
IAS 16 Property, Plant and Equipment provides an outline and guidelines on the accounting treatment for most types of property, plant and equipment or PP&E. Property, plant and equipment is initially measured at its cost, subsequently measured either using a cost or revaluation model, and depreciated so that its depreciable amount is allocated on a systematic basis over its useful life.
IAS 16 was reissued in December 2003 and applies to annual periods beginning on or after 1 January 2005.
Objective & Scope of IAS 16?
Objective: The objective of IAS 16 is to prescribe the accounting treatment for property, plant, and equipment. The principal issues are:
The recognition of assets
Determination of their carrying amounts, and
The depreciation charges and impairment losses to be recognized in relation to them.
Scope: IAS 16 applies to the accounting for property, plant and equipment, except where another standard requires or permits differing accounting treatments, for example:
Assets classified as held for sale in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations.
Biological assets related to agricultural activity accounted for under IAS 41 Agriculture.
Exploration and evaluation assets recognized in accordance with IFRS 6 Exploration for and Evaluation of Mineral Resources.
Mineral rights and mineral reserves such as oil, natural gas and similar non-regenerative resources.
The standard does however apply to property, plant, and equipment used to develop or maintain the last three categories of assets mentioned above.
Recognition of PP&E
Items of property, plant, and equipment should be recognized as assets when it is probable that:
The future economic benefits associated with the asset will flow to the entity.
The cost of the asset can be measured reliably.
This recognition principle is applied to all property, plant, and equipment costs at the time they are incurred. These costs include costs incurred initially to acquire or construct an item of property, plant and equipment and costs incurred subsequently to add to, replace part of, or service it.
IAS 16 does not prescribe the unit of measure for recognition i.e. what constitutes an item of property, plant, and equipment. However, if the cost model is used (see below) 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.
IAS 16 recognizes that parts of some items of property, plant, and equipment may require replacement at regular intervals. The carrying amount of an item of property, plant, and equipment will include the cost of replacing the part of such an item when that cost is incurred if the recognition criteria (future benefits and measurement reliability) are met. The carrying amount of those parts that are replaced is derecognized in accordance with the derecognition provisions of IAS 16.
Also, continued operation of an item of property, plant, and equipment (for example, an aircraft) may require regular major inspections for faults regardless of whether parts of the item are replaced. When each major inspection is performed, its cost is recognized in the carrying amount of the item of property, plant, and equipment as a replacement if the recognition criteria are satisfied.
Initial Measurement
An item of property, plant and equipment should initially be recorded at cost. Cost includes all costs necessary to bring the asset to working condition for its intended use. This would include not only its original purchase price but also costs of site preparation, delivery and handling, installation, related professional fees for architects and engineers, and the estimated cost of dismantling and removing the asset and restoring the site.
If payment for an item of property, plant, and equipment is deferred, interest at a market rate must be recognized or imputed.
If an asset is acquired in exchange for another asset (whether similar or dissimilar in nature), the cost will be measured at the fair value unless (a) the exchange transaction lacks commercial substance or (b) 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.
Measurement Subsequent to initial recognition
IAS 16 permits two accounting models:
Cost Model
The asset is carried at cost less accumulated depreciation and impairment.
Revaluation Model
The asset is carried at a revalued amount, being its fair value at the date of revaluation less subsequent depreciation and impairment, provided that fair value can be measured reliably.
The Revaluation Model
Under the revaluation model, revaluations should be carried out regularly, so that the carrying amount of an asset does not differ materially from its fair value at the balance sheet date.
If an item is revalued, the entire class of assets to which that asset belongs should be revalued.
Revalued assets are depreciated in the same way as under the cost model (see below).
If a revaluation results in an increase in value, it should be credited to other comprehensive income (OCI) and accumulated in equity under the heading "revaluation surplus" unless it represents the reversal of a revaluation decrease of the same asset previously recognized as an expense, in which case it should be recognized (to the extent that was previously recognized) in profit or loss.
A decrease arising as a result of a revaluation should be recognized as an expense to the extent that it exceeds any amount previously credited to the revaluation surplus relating to the same asset.
When a revalued asset is disposed of, any revaluation surplus may be transferred directly to retained earnings, or it may be left in equity under the heading revaluation surplus. The transfer to retained earnings should not be made through profit or loss.
Depreciation (Cost & Revaluation Models)
For all depreciable assets:
The depreciable amount (cost less residual value) should be allocated on a systematic basis over the asset's useful life.
The residual value and the useful life of an asset should be reviewed at least at each financial year-end and, if expectations differ from previous estimates, any change is accounted for prospectively as a change in estimate under IAS 8.
The depreciation method used should reflect the pattern in which the asset's economic benefits are consumed by the entity i.e. a depreciation method that is based on revenue that is generated by an activity that includes the use of an asset is not appropriate. The clarification regarding the revenue-based depreciation method was introduced by Clarification of Acceptable Methods of Depreciation and Amortization, which applies to annual periods beginning on or after 1 January 2016.
The depreciation method should be reviewed at least annually and, if the pattern of consumption of benefits has changed, the depreciation method should be changed prospectively as a change in estimate under IAS 8. Expected future reductions in selling prices could be indicative of a higher rate of consumption of the future economic benefits embodied in an asset. The guidance on expected future reductions in selling prices was introduced by Clarification of Acceptable Methods of Depreciation and Amortization, which applies to annual periods beginning on or after 1 January 2016.
Depreciation should be charged to profit or loss, unless it is included in the carrying amount of another asset.
Depreciation begins when the asset is available for use and continues until the asset is derecognized, even if it is idle.
Recoverability of the carrying amount
IAS 16 Property, Plant and Equipment requires impairment testing and, if necessary, recognition for property, plant, and equipment. An item of property, plant, or equipment shall not be carried at more than recoverable amount.
Recoverable amount is the higher of an asset's fair value less costs to sell and its value in use.
Any claim for compensation from third parties for impairment is included in profit or loss when the claim becomes receivable.
Derecognition (retirements and disposals)
An asset should be removed from the statement of financial position 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 the proceeds and the carrying amount and should be recognized in profit and loss.
If an entity rents out some assets and then ceases to rent them, the assets should be transferred to inventories at their carrying amounts as they become held for sale in the ordinary course of business.
Disclosure Information About Each Class of Property, Plant & Equipment
For each class of property, plant, and equipment, disclose:
Basis for measuring carrying amount.
Depreciation method(s) used.
Useful lives or depreciation rates.
Gross carrying amount and accumulated depreciation and impairment losses.
The standard also requires reconciliation of the carrying amount at the beginning and the end of the period, showing:
Additions.
Disposals.
Acquisitions through business combinations.
Revaluation increases or decreases.
Impairment losses.
Reversals of impairment losses.
Depreciation.
Net foreign exchange differences on translation.
other movements.
Additional Disclosures
The following disclosures are also required:
Restrictions on title and items pledged as security for liabilities.
Expenditures to construct property, plant, and equipment during the period.
Contractual commitments to acquire property, plant, and equipment.
Compensation from third parties for items of property, plant, and equipment that were impaired, lost or given up that is included in profit or loss.
IAS 16 also encourages, but does not require, a number of additional disclosures.
Revalued property, plant and equipment
If property, plant, and equipment is stated at revalued amounts, certain additional disclosures are required:
The effective date of the revaluation.
Whether an independent valuer was involved.
For each revalued class of property, the carrying amount that would have been recognized had the assets been carried under the cost model.
The revaluation surplus, including changes during the period and any restrictions on the distribution of the balance to shareholders.
Entities with property, plant and equipment stated at revalued amounts are also required to make disclosures under IFRS 13 Fair Value Measurement.