Recording, Classification and Reporting of Property Plant and Equipment / Fixed Assets is governed by IAS 16 – Property Plant and Equipment
IAS 16, Property Plant and Equipment
This standard covers all aspects of accounting for property, plant and equipment. This represents the bulk of items which are “tangible” non-current assets.
IAS 16 should be followed when accounting for property, plant and equipment unless another International Accounting Standard requires a different treatment.
IAS 16 does not apply to the following:
- Biological assets related to agricultural activity.
- Mineral rights and mineral reserves, such as oil, gas and other non-regenerative resources.
- However, the standard applies to property, plant and equipment used to develop these assets.
Property, plant and equipment:
Property, plant and equipment are tangible assets that:
- Are held for use in the production or supply of goods or services, for rental to others, or for administrative purpose; and
- Are expected to be used during more than one period.
Cost is the amount of cash or cash equivalent paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition or construction.
Residual value is the net amount which the entity expects to obtain for an asset at the end of its useful life after deducting the expected costs of disposal.
Fair value is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction.
Carrying amount is the amount at which an asset is recognized in the balance sheet after deducting any accumulated depreciation and accumulated impairment losses.
Impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount.
Recording of Property, Plant and Equipment:
Recording of property plant and equipment can be categorized into following activities.
- Initial recognition
- Measurement of cost
- Subsequent expenditure
- Measurement subsequent to initial recognition
Recognition simply means incorporation of the items in the business’s accounts, in this case as a non-current asset.
The recognition of property, plant and equipment depends on two criteria.
- The enterprise expects to obtain future economic benefit from the asset.
- The value of the asset can be measured reliably.
These recognition criteria apply to subsequent expenditure as well as costs incurred initially. Property, Plant and equipment can amount to substantial amounts in financial statements, affecting the presentation of the company’s financial position (in the balance sheet) and the profitability of the entity, through depreciation and if an asset is wrongly classified as an expense and taken to the income statement.
First Criterion: Future Economic Benefits
The degree of certainty attached to the flow of future economic benefits must be assessed. This should be based on the evidence available at the date of initial recognition (usually the date of purchase). The entity should thus be assured that it will receive the rewards attached to the asset and it will incur the associated risks, which will only generally be the case when the rewards and risks have actually passed to the entity. Until then, the asset should not be recognized.
Second Criterion: Cost Measured Reliably:
It is generally easy to measure the cost of an asset at the transfer amount on purchase, i.e. what was paid for it. Self constructed assets can also be measured easily by adding together the purchase price of all the constituent parts (labour, material, etc) paid to external parties. In other words, In case of a purchased asset the consideration paid for the acquisition of the asset identifies its cost.
Otherwise the expenditure should be treated as revenue expenditure and charged to current period.
Most of the times assets will be identified individually, but this will not be the case for smaller items, such as tools, dies and moulds, which are sometimes classified as inventory and written off as an expense.
Major components or spare parts, however, should be recognized as property, plant and equipment.
For very large and specialized items, an apparently single asset should be broken down in to its composite parts. This occurs where the different parts have different useful lives and different depreciation rates are applied to each part, e.g. an aircraft, where the body and engines are separated as they have different useful lives.
Initial Measurement of property plant and equipment
An item of property plant and equipment that qualifies for recognition should be measured at its cost.
Components of Cost
The cost of an item of property plant and equipment includes all costs incurred in bringing the asset to working condition for its intended use.
The standard lists the components of the cost of an item of property, plant and equipment.
The components of cost include:
- Purchase price, less trade discount or rebate
- Import duties,
- Other non-refundable taxes,
- Cost of site preparation
- Initial delivery and handling costs
- Installation costs
- Professional fees (architects, engineers)
- Administration and other costs (incurred on the construction / development of the assets)
- Borrowing costs
The following costs will not be part of the cost of property, plant and equipment unless they can be attributed directly to the asset’s acquisition, or bringing it into its working condition.
- Administration and other general overhead costs
- Start-up and similar pre-production costs
- Initial operating losses before the asset reaches planned performance
All of these will be recognized as an expense rather than an asset.
In the case of self constructed assets, the same principles are applied as for acquired assets. If the entity makes similar assets during the normal course of business for sale externally, then the cost of the asset will be the cost of its production under IAS 2 inventories. This also means that abnormal costs (wasted material, labour or other resources) are excluded from the cost of the asset. An example of a self-constructed asset is when a building company builds its own head office.
Exchange of Assets (Dissimilar Assets):
In case an item of property plant and equipment is exchanged or part exchanged for a dissimilar asset of the enterprise, the cost of the new asset is measured at the fair value of the asset received.
The cost of such an item is equivalent to:
- Fair value of the asset given up, plus
- Value of any cash or cash equivalent transferred.
Exchange of Assets (Similar Assets):
In case an item of property plant and equipment is exchanged for similar asset of the enterprise, the cost of the new asset is measured at the carrying value of the old asset.
The fair value of the asset received may provide evidence of an appreciation or impairment in the asset given up.
A subsequent expenditure on an asset already recognized should only be added to the carrying cost of the asset if:
“It is probable that future economic benefits, in excess of the originally assessed standards of performance of the asset, will flow to the enterprise”
All other subsequent expenditures should be recognized as an expense in the period in which they are incurred.
Subsequent expenditure on property plant and equipment is only recognized as an asset when the expenditure improves the condition of the asset beyond its originally assessed standard of performance.
Examples of subsequent expenditure that can be capitalized:
- Modification of an item of plant to extend its useful life or capacity
- Up gradation in plant to achieve a substantive improvement quality of output.
- Adoption of new production processes enabling a substantial reduction in previously assessed operating costs.
Expenditure on repairs or maintenance of property, plant and equipment is made to restore or maintain the future economic benefits that an enterprise can expect from the originally assessed standard of performance of the asset. As such it is usually recognized as an expense when incurred.
Examples of subsequent expenditure that should not be capitalized:
Expenditure on repairs and maintenance of property plant and equipment that is made to restore or maintain the economic benefit from it
Major components of some items of property, Plant and equipment may require replacement at regular intervals. For example, a furnace may require relining after a specified number of hours of usage or aircraft interiors such as seats and galleys may require replacement several times during the life of the airframe. The components are accounted for as separate assets because they have useful lives different from those of the items of property, plant and equipment to which they relate. Therefore, the expenditure incurred in replacing or renewing the component is accounted for as the acquisition of a separate asset and the replaced asset is written off.
Measurement Subsequent to Initial Recognition
The standard offers two possible treatments here, essentially a choice between keeping an asset recorded at cost OR revaluing it to fair value.
Subsequent to initial measurement an asset is carried at:
Cost less accumulated depreciation and any accumulated impairment loss.
Subsequent to initial measurement an asset is carried:
At a revalued amount, being its fair value at the date of revaluation less any subsequent accumulated depreciation and any subsequent accumulated impairment losses.
Depreciation is a systematic allocation of depreciable amount of an asset over its estimated useful life.
Depreciation is usually treated as an expense, but not where it is absorbed by the entity in the process of producing other assets. For example, depreciation of plant and machinery is incurred in the production of goods for sale (inventory items). In such circumstances, the depreciation is included in the cost of the new assets produced.
Land and buildings are dealt with separately even when they are acquired together because land normally has an unlimited life and is therefore not depreciated. In contrast buildings do have a limited life and must be depreciated. Any increase in the value of land on which a building is standing will have no impact on the determination of the building’s useful life.
Depreciable amount of an asset is its cost or other amount substituted for cost (revalued) amount less its expected disposal value.
The number of years over which an enterprise expects to use an asset.
The number of production or similar units expected to be obtained from an asset.
January 06, 2018