IFRS Training Program Day 3 – December 4, 2008 Submitted by – Mukesh Thakur IAS 16: Property, Plant and Equipment (PPE)
Purpose of the Standard • To prescribe the accounting treatment for Property, Plant and Equipment (PPE) The principal issues are • The timing of Recognition of the assets • The determination of their carrying amount and • The depreciation charge in relation to them
Scope • Applies in accounting for PPE. • PPE are • tangible items • that are held for • use in the production or supply of goods or services or • rentals to others, or • for administrative purpose AND • are expected to be used during more than one period • Standard excludes • PPE for which separate Accounting treatment has been prescribed by any other Standard.
Subsequent Costs • Replacement Costs • Day to day expenses is charged to Profit and Loss Account as repair and maintenance. • Major replacement cost qualify as PPE if recognition criteria is met. • The carrying amount of those parts that are replaced is derecognised. • Inspection Cost • Where major regulation inspection is required to operate the item of PPE, the cost of such item will qualify as PPE if recognition criteria is met. • Any remaining carrying amount of the cost of previous inspection is derecognised.
Example • ABC & Co., has acquired a heavy road transporter at a cost of Rs. 100,000 (with no breakdown of component parts). • The estimated useful life is 10 years. • At the end of the sixth year, the power train requires replacement, as further maintenance is uneconomical due to the off-road time required. The remainder of the vehicle is perfectly road worthy and is expected to last for the next four years. • The cost of the new power train is Rs. 45,000. • Can the cost of new power train can be recognized as the asset, and if so, what treatment should be used?
Solution • The new power train will produce economic benefits to the ABC & Co.; and • Cost of the power train can be measured reliably. Hence, the item should be recognized as the asset. • The cost Rs. 45,000 of new power train will be added to the carrying amount. • The original invoice of the transporter did not specify the cost of the power train. Therefore, the cost of replacement Rs. 45,000 will be used as indicative price and discount to year 1, i.e., (45,000/ 1.05^6) = 33,500. It is assumed that discount rate used is 5%. - Revised Cost = (100,000 - 33,500 + 45,000) = 111,500
Measurement • An item of PPE is measured at COST
Measurement cont. • Only costs that are directly attributable may be capitalised. The standard lists type that are not directly attributable • Costs of opening new facility • Costs of introducing a new product or service • Costs of conducting business in a new location or with a new class of customer • Administration and other general overhead costs • Self Constructed assets is determined using the same principles as for an acquired asset. • Exchange of Assets • If fair value can be measured – cost will be measured at fair value. • If fair value can not be measured – cost will be recognised at carrying amount of asset given up.
Your turn! ABC & Co., is installing a new plant at its production facility. It has incurred these costs: • Cost of the plant Rs. 250,000. • Initial delivery and handling cost Rs. 20,000. • Cost of site preparation Rs. 60,000. • Consultants used to advice on the acquisition Rs. 70,000. • Interest charges paid to supplier for deferred credit Rs. 20,000. • Estimated dismantling cost to be incurred after 7 years Rs. 30,000. • Operating losses before commercial production Rs. 40,000. Find out the costs to be capitalized as per IAS-16?
Revaluation Model • Revaluation will be made at sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the end of the reporting period. • If an item of PPE is revalued, the entire class of PPE to which that asset belongs will be revalued. • Revaluation Gain • Surplus from Revaluation is credited directly to equity under heading ‘Revaluation Surplus’. However if revaluation reverses a revaluation decrease on the same asset previously recognised as an expense, it will credited to Profit and Loss Account to that extent. i.e. Amount to be transferred to revaluation reserve = Revaluation increase (-) Earlier revaluation decrease recognised as expenses. • Standard states that revaluation surplus included in equity may be transferred directly to retained earnings when the surplus is realised (i.e. when asset is derecognised). This transfer is made through reserves and surplus and not through profit and loss account.
Revaluation Model cont… Let us take an example: • A company has a policy of revaluing its PPE. At 1.1.2007 value of asset was Rs. 1000. Its useful life is 10 years and it is depreciated on straight line basis to nil residual value. It is revalued downward to Rs. 850 at 31.12.2007. At 31.12.2008 market value has risen to Rs. 1050.
Revaluation Model cont… • Revaluation Losses • Revaluation Losses is charged against earlier revaluation surplus. Any balance of decrease in charged to Profit and Loss Account. i.e. amount to be charged to the profit and loss = Revaluation Decrease (-) Earlier revaluation increase. Better to take an example again! Cost of the asset as on 1.1.2007 = 100 Useful life = 10 years Revalued amount at 31.3.2007 = 135 Method of Dep. = SLM Revalued amount at 31.12.2008 = 50
Revaluation Model cont… • Alternative treatment • Standard also permits transfer to be made from revaluation surplus to retained earning as the asset is used and the surplus is realized. The surplus may be realized as the asset is depreciated. In that case, in 2008 Rs. 5 would have been transferred from revaluation reserve to retained earning. The balance left in the revaluation amount would be Rs. 40. Accordingly, out of revaluation loss of Rs. 70 , charge against revaluation reserve would be Rs. 40 and Rs. 30 would be charged to Profit and Loss Account.
Depreciation The standard prescribe following principles for depreciation • Each part of an item of PPE with a cost that is significant in relation to the total cost of the item will be depreciated separately. • The depreciation charge for each year will be recognised in profit and loss account unless it is included in carrying amount of another asset. • The depreciable amount of an asset will be allocated on a systematic basis over useful life. • The residual value and useful life of an asset will be reviewed at least each financial year end. • Any difference in estimates from previous expectation will be accounted for as a change in accounting estimates i.e. changes will be applied prospectively.
Depreciation Method The standard does not prescribe any depreciation method. An entity may choose any method as per the nature of business. However method adopted by the entity should reflect the following principles: • The depreciation method will reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity. • The depreciation method applied will be reviewed at each financial year end. Any change from the previous year will be treated as change in accounting estimates.
IFRIC 1 Changes in Existing Decommissioning,Restoration and Similar Liabilities • Cost model: - Changes in liability will be added/deducted from asset cost in current period. - No negative carrying amount possible; any excess recognised immediately in profit or loss. - Increase in carrying amount triggers consideration of impairment. Calculation of recoverable amount might be necessary.
IFIRC 1 • Revaluation model: • Change in liability does not affect valuation of asset (impact on valuation reserve) • Change in liability: indication that asset might have to be revalued. Revaluation surplus (except reversal of previous revaluation deficit) Decrease in liability Profit or loss (except credit balance remaining in revaluation surplus) Increase in liability
Disclosure • For each class of PPE, following should be disclosed in Financial Statement • The measurement base used for gross carrying amount • The depreciation method used • The useful lives or the depreciation rates used • The Gross Carrying amount and the accumulated loss at the beginning and at the end of the period • A reconciliation of carrying amount at the beginning and end of the period showing • Additions • Assets held for sale (IFRS 5) • Acquisition through business combination • Increase or decrease from revaluation or impairment • Depreciation • Exchange differences arising on the retranslation of the financial statement of a foreign entity
Disclosure cont… • Other changes. • The carrying amount at the beginning and end of the period. • Other Disclosures • The existence and amount of restrictions on title, and PPE pledged as securities for liabilities. • Amount of expenditure recognised in the carrying amount of an item of PPE in the course of construction. • The amount of contractual commitments for the acquisition of PPE.