Scope of IAS 16
IAS 16 should be followed when accounting for property, plant and equipment unless another international accounting standard requires a different treatment. 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 purposes and are expected to be used during more than one period.
IAS 16 does not apply to: –
(a) Biological assets related to agricultural activity
(b) 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
The recognition of property, plant and equipment depends on two criteria.
(a) It is probable that future economic benefits associated with the asset will flow to the entity; and
(b) The cost of the asset to the entity can be measured reliably.
These recognition criteria apply to subsequent expenditure as well as costs incurred initially. There are no separate
criteria for recognizing subsequent expenditure. Property, plant and equipment can amount to substantial amounts in financial statements, affecting the presentation of the company’s financial position and the profitability of the entity, through depreciation and also if an asset is wrongly classified as an expense and taken to profit or loss.
Once an item of property, plant and equipment qualifies for recognition as an asset, it will initially be measured at cost.
Components of cost
The standard lists the components of the cost of an item of property, plant and equipment.
- Purchase price, less any trade discount or rebate
- Import duties and non-refundable purchase taxes
- Directly attributable costs of bringing the asset to working condition for its intended use, e.g.:
- The cost of site preparation
- Initial delivery and handling costs
- Installation costs
- Professional fees (architects, engineers)
- Initial estimate of the unavoidable cost of dismantling and removing the asset and restoring the site on which it is located
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.
(a) Cost model: – Carry the asset at its cost less depreciation and any accumulated impairment loss.
(b) Revaluation model: – Carry the asset at a revalued amount, being its fair value at the date of the revaluation less
any subsequent accumulated depreciation and subsequent accumulated impairment losses. The revised IAS 16 makes clear that the revaluation model is available only if the fair value of the item can be measured reliably.
The market value of land and buildings usually represents fair value, assuming existing use and line of business. Such
valuations are usually carried out by professionally qualified valuers.
In the case of plant and equipment, fair value can also be taken as market value. When a market value is not available, however, depreciated replacement cost should be used. There may be no market value where types of
plant and equipment are sold only rarely or because of their specialized nature (i.e. they would normally only be sold as part of an ongoing business).
The frequency of valuation depends on the volatility of the fair values of individual items of property, plant and equipment. The more volatile the fair value, the more frequently revaluations should be carried out. Where the current fair value is very different from the carrying value then a revaluation should be carried out.
Most importantly, when an item of property, plant and equipment is revalued, the whole class of assets to which it belongs should be revalued.
All the items within a class should be revalued at the same time, to prevent selective revaluation of certain assets and
to avoid disclosing a mixture of costs and values from different dates in the financial statements.
IAS 16 requires the increase in value to be credited to a revaluation surplus (i.e. part of owners’ equity), unless the increase is reversing a previous decrease which was recognized as an expense. To the extent that this offset is made, the increase is recognized as income; any excess is then taken to the revaluation surplus.
The standard states:
- The depreciable amount of an item of property, plant and equipment should be allocated on a systematic basis over its useful life.
- The depreciation method used should reflect the pattern in which the asset’s economic benefits are consumed by the entity.
- The depreciation charge for each period should be recognized as an expense unless it is included in the carrying amount of another asset.
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.
Review of useful life
A review of the useful life of property, plant and equipment should be carried out at least at each financial year end and the depreciation charge for the current and future periods should be adjusted if expectations have changed significantly from previous estimates. Changes are changes in accounting estimates and are accounted for prospectively as adjustments to future depreciation.
Review of depreciation method
The depreciation method should also be reviewed at least at each financial year end and, if there has been a significant change in the expected pattern of economic benefits from those assets, the method should be changed to
suit this changed pattern. When such a change in depreciation method takes place the change should be accounted for as a change in accounting estimate and the depreciation charge for the current and future periods should be adjusted.
Impairment of asset values
An impairment loss should be treated in the same way as a revaluation decrease i.e. the decrease should be recognized as an expense. However, a revaluation decrease (or impairment loss) should be charged directly against any related revaluation surplus to the extent that the decrease does not exceed the amount held in the revaluation surplus in respect of that same asset.
A reversal of an impairment loss should be treated in the same way as a revaluation increase, i.e. a revaluation increase should be recognized as income to the extent that it reverses a revaluation decrease or an impairment loss of the same asset previously recognized as an expense.
Where an asset requires regular overhauls in order to continue to operate, the cost of the overhaul is treated as an additional component and depreciated over the period to the next overhaul.
The standard has a long list of disclosure requirements, for each class of property, plant and equipment.
a) Measurement bases for determining the gross carrying amount (if more than one, the gross carrying amount for that basis in each category)
b) Depreciation methods used
c) Useful lives or depreciation rates used
d) Gross carrying amount and accumulated depreciation (aggregated with accumulated impairment losses) at the beginning and end of the period
e) Reconciliation of the carrying amount at the beginning and end of the period showing:
3. Acquisitions through business combinations
4. Increases/decreases during the period from revaluations and from impairment losses
5. Impairment losses recognized in profit or loss
6. Impairment losses reversed in profit or loss
8. Net exchange differences (from translation of statements of a foreign entity)
9. Any other movements.
The financial statements should also disclose the following.
1. Any recoverable amounts of property, plant and equipment
2. Existence and amounts of restrictions on title, and items pledged as security for liabilities
3. Accounting policy for the estimated costs of restoring the site
4. Amount of expenditures on account of items in the course of construction
5. Amount of commitments to acquisitions
Revalued assets require further disclosures.
1. Basis used to revalue the assets
2. Effective date of the revaluation
3. Whether an independent valuer was involved
4. Nature of any indices used to determine replacement cost
5. Carrying amount of each class of property, plant and equipment that would have been included in
6. The financial statements had the assets been carried at cost less accumulated depreciation and accumulated impairment losses.
7. Revaluation surplus, indicating the movement for the period and any restrictions on the distribution of the balance to shareholders.