IAS 16 Property, plant and equipment

IAS 16 Property, Plant and Equipment

IAS 16 Property, Plant and Equipment outlines the accounting treatment for most types of property, plant and equipment. 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 does not apply to assets classified as held for sale in accordance with IFRS 5 exploration and evaluation assets (IFRS 6) biological assets related to agricultural activity (see IAS 41) or mineral rights and mineral reserves such as oil, natural gas and similar non-regenerative resources Recognition Items of property, plant, and equipment should be recognised as assets when it is probable that: it is probable that the future economic benefits associated with the asset will flow to the entity, and 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 states 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 derecognised 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 recognised 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 (see IAS 37 Provisions, Contingent Liabilities and Contingent Assets). If payment for an item of property, plant, and equipment is deferred, interest at a market rate must be recognised 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 and accumulated in equity under the heading "revaluation surplus" unless it represents the reversal of a revaluation decrease of the same asset previously recognised as an expense, in which case it should be recognised as income. A decrease arising as a result of a revaluation should be recognised 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. However, some of the surplus may be transferred as the asset is used by the entity. In that 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 original cost of the asset. The transfer to retained earnings should not be made through the income statement (that is, no "recycling" through profit or loss). Depreciation (cost and 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; 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. Depreciation should be charged to the income statement, 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 derecognised, even if it is idle. Derecognition (retirements and disposals) An asset should be removed from the balance sheet on disposal or when no future economic benefits are expected from its use or disposal. The gain or loss on disposal is the difference between the proceeds and the carrying amount and should be recognised in the profit or loss.

Example cost of a fixed asset according to national legislation (Country X) is different from the cost required by IAS 16 (example is without the check of the total tax). Accounting legislation in Country X does not take into account the time value of money; example relates to the deferred payment.
On December (year 1) an entity purchased a fixed asset on credit. The amount of an invoice was 1,000 but the payment was deferred for 2 years. The cost of an asset according to national legislation is 1,000. The useful life of the asset is 20 year, straight-line method, no residual value. The entity has estimated that the interest rate on similar liability would be 10%. The IFRS opening balance sheet date is January, 1st, year 2. Item National Adjustment IFRS GAAP for the cost of asset and for the liability Fixed asset 1 000 Total assets 1 000 Retained earnings Liability 1 000 Total equity and liabilities 1 000 In year 2 the entity has accounted for the depreciation of the fixed asset. The tax rate is 25%. Item National Adjustment for Deferred GAAP the cost of asset tax and for the liability Fixed asset 950 Deferred tax asset Total assets 950 Retained earnings Profit or loss of the period (50) Liability 1,000 Total equity and liabilities 950

IFRS

In year 3 the entity has accounted for the depreciation of the fixed asset. The tax rate is 25%. We will prepare the balance sheet immediately BEFORE the payment. Item National GAAP Adjustment for the cost of asset and for the liability Deferred tax IFRS

Fixed asset Deferred tax asset Total assets Retained earnings Profit or loss of the period Liability Total equity and liabilities

900 900 (50) (50) 1,000 900

Example depreciation component approach An entity has 1,000 in cash and the same amount as the Share Capital in the Balance sheet. At 1 st January of the year 1 the entity has acquired an aircraft for 1,000 in cash. The useful life of the airframe is 20 years, engines have useful lives of 5 years and the seats have useful lives of 2 years. The cost of airframe is 500, the cost of engines is 400 and the cost of seats is 100. According to the accounting rules in Country X, entire aircraft is depreciated for 20 years (i.e. Country X does not apply the component approach for depreciation). In both accounting systems, the method of depreciation used by the entity is straight-line, no residual value. In the Income statement, the entity recognises depreciation as a part of Cost of services sold. The date of IFRS Opening Balance sheet is 1st January of the year 2. For simplicity, the tax impact is ignored. Accounting entries year 1 (T accounts) Country X Cash Share Capital Property, plant and equipment

Accumulated depreciation (PPE)

Cost of services sold

(1) Purchase of the aircraft (2) Depreciation of the aircraft Depreciation in Country X, year 1 = 1,000 20 = 50; the net book value is 1,000 50 = 950 Depreciation IFRS: Airframe 500 20 = 25 Engines 400 5 = 80 Seats 100 2 = 50 Total IFRS depreciation 155 IFRS net book value is 1,000 155 = 845

Translation 1st January, year 2 Opening Balance sheet

Country X Aircraft Total assets Share Capital Retained earnings Total liabilities and equity Adjustment depreciation IFRS

Accounting entries year 2 (T accounts) Country X Cash Share Capital Property, plant and equipment

Accumulated depreciation (PPE)

Cost of services sold

Retained earnings

(1) Depreciation of the aircraft. IFRS IFRS net book value is cost 1,000 (2 depreciation 155) = 690 Translation 31st December, year 2 Balance sheet
Country X Aircraft Total assets Share Capital Retained earnings Loss for year 2 Total liabilities and equity Adjustment depreciation IFRS

Income statement for the year 2

Country X Cost of services sold Loss for the period Adjustment depreciation IFRS

Example revaluation of the land

An entity has 1,000 in cash and the same amount as the Share Capital in the Balance sheet. During year 1, the entity acquired a piece of land that it planed to use in its agricultural activities. The cost of land was 1,000 and the amount was paid in cash. During year 1, no revaluation was performed (according to IAS 16, there is no need to perform the revaluation each year). At the end of year 2, the revaluation of the land was performed. At the date of revaluation, fair value of the land was 1,200. In Country X, the revaluation of the land is not permitted. The date of IFRS Opening balance sheet is 1st January of the year 2. Accounting entries year 1 (T accounts) Country X Property, plant and equipment Share Capital Land

Cash

(1) Purchase of the land Translation 1st January, year 2 Balance sheet Country X Land Total assets Share Capital Retained earnings Total liabilities and equity Accounting entries year 2 (T accounts) Country X Property, plant and equipment Share Capital Land

Adjustment no adjustment

IFRS

Cash

No accounting entry in year 2 in Country X Translation 31st December, year 2 Balance sheet Country X Land Total assets Share Capital Revaluation reserve Retained earnings Profit or loss for the period Total liabilities and equity There is no adjustment in the Income statement in the year 2, however the change in the IFRS Revaluation reserve (Revaluation surplus) must be explained in the Statement of Comprehensive income as a part of Other comprehensive income. IFRS Statement of Comprehensive Income for the year 2 Revenue Expenses Profit or loss for the period Other comprehensive income Changes in Revaluation reserve Total comprehensive income

Adjustment revaluation of the land

IFRS