The following is a summary of what I have learned from IAS 16 in FRK 201:
In paragraph 6, along with other definitions, the standard defines property, plant and equipment as;
– 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.
Recognition requirement states that it must be probable that future economic benefits are expected to flow to the entity and that the cost thereof can be measured reliably.
property, plant and equipment can be recognised in the financial statements of an entity when the above definition and recognition requirements have been met.
1. Components of property, plant and equipment
When each separate component of property, plant and equipment is significant enough, they can each be recognised and depreciated separately.
2. Spare parts
Spare parts, stand-by or servicing equipment can be capitalised to property, plant and equipment if they meet the definition of property, plant and equipment, otherwise, they will be recognised as inventory in the financial statements of the entity.
3. Safety and environmental costs
These costs do not directly increase the future economic benefits that flow to the entity, but it does enable the property, plant and equipment item to produce future economic benefits in excess. After the carrying amount of the property, plant and equipment item has increased due to these costs, they need to be reviewed for impairment loss under IAS 36. This stops the entity form overstating their property, plant and equipment every time they capitalise safety and equipment costs.
Carrying amount + safety and environmental costs = new increased carrying amount
New increased carrying amount compare to the recoverable amount, adjust the new carrying amount with the impairment loss (recoverable amount – new carrying amount) to accurately disclose the carrying amount and to ensure that it is not overstated.
1. Day to day servicing and replacement costs
Everytime property, plant and equipment costs are incurred, the entity must identify whether these costs meet the definition of property, plant and equipment and the recognition requirement before they can be capitalised to property, plant and equipment.
Par 12 states that the day to day costs are not to be capitalised as they are seen as repair and maintenance expenditure that is expensed in the Statement of Profit and Loss and Other Comprehensive Income.
Par 13 states that when parts of property, plant and equipment are replaced, the carrying amount of the replaced part must be derecognised and the cost of the new replacement is to be recognised. This prevents overstatement of property, plant and equipment in the financial statements. The cost of the present replacement can be used as an indicator of what the cost of replacement was at the time of initial recognition. This ‘deemed carrying’ amount must then be derecognised.
A property, plant and equipment item can be derecognised either at the disposal of the item or when no future economic benefits are expected to flow to the entity form that specific item anymore. The proceeds received form realisation of this item is deducted from the carrying amount of this item.
2. Major inspection costs
These major inspections are necessary to ensure that the asset can continue in a condition to operating optimally. Major inspection costs get treated the same way as replacements.
The cost of the new inspection is capitalised to property, plant and equipment and the carrying amount of the previous inspection must be derecognised to prevent overstatement.
Par 15 – 17
All property, plant and equipment items are initially measured at cost price
The cost price includes the purchase price, purchase duties, non refundable taxes and other deductible rebates and discounts. Basically, all the costs that are necessary to incur in order to bring the property, plant and equipment item to the condition and location to ensure that it is capable of being used in the manner intended by management.
1. Dismantling, removing and restoration costs
As per Par 16 where the elements of what costs comprise are listed, these costs are also to be included in the cost of the property, plant and equipment item on initial measurement.
Only when there is a current obligation that exists for the entity to incur these costs – when the requirements of IAS 37 are met – does the entity capitalise these costs to the property, plant and equipment item.
Dismantling costs can be seen as a provision (IAS 37 apply) = current obligation
(cost price + dismantling cost) – residue value
Dismantling costs not seen as a provision for future expenditure (IAS 37 not apply) = no current obligation at initial measurement.
cost price – (residue value-dismantling cost)
*The depreciable amount in both instances stay the same
*Depreciation expense in both instances stay the same
*But cost prices differ, thus the carrying amounts will differ
2. Incidental operations
When the property, plant and equipment item has reached it’s current location and condition that will allow it to be capable of use as intended by management, then further costs thereon should not be capitalised ( a loss made on the use thereof, relocating and reorganising costs or costs incurred when the asset is not used to its full potential).
Costs that are in connection to construction and development of the property, plant and equipment item, but is not necessary to get the item to its current condition and location to be used as intended by management = incidental operations – the costs and income thereof has nothing to do with the costs of the property, plant and equipment and it will be taken through to profit and loss like normal income and expenditure.
3. Self-constructed assets
When property, plant and equipment are used to construct other property, plant and equipment items, these new item’s cost will be determined the same way according to IAS 2 as inventories are valued.
For example, Machine A with a current year depreciation expense of R120 000 constructs Machine B for 2 months during the current financial year at a cost of R50 000.
Thus Machine B’s costs will be as follows:
R50 000 + (R120 000 x 2/12) = R70 000
[Because IAS 2 states that the depreciation of the machine used to construct the inventory forms part of the cost of that inventory]
4. Deferred settlement
The cost of the property, plant and equipment item must be the cash price equivalent, but when settlement/payment is deferred beyond normal payment terms, the interest amount which is the difference between FV and PV should not be included in the cost of the item.
5. Exchange transactions
New property, plant and equipment can be bought by exchanging it for another. The new property, plant and equipment item must be measured at fair value when acquired, unless:
– the exchange lacks economic substance
– or if the fair value cannot be determined = in which case the cost price of the new item received will then be the carrying amount of the asset given up.
All other amounts given up during this exchange transaction (like extra cash) is capitalised to the fair value/ carrying amount.
The entity can now choose to measure their property, plant and equipment after recognition either on the cost model or on the revaluation model. Whichever model the entity chooses, it is to be applied to their accounting policy per class of property, plant and equipment items. The model that the entity chooses must also accurately represent the manner of how the item is being used (deprecated)
1. Change in accounting estimates
Par 50 + 51, 60 + 61
The entity may change the residue value and the useful life of a property, plant and equipment item any time it needs a review. These estimates are based on current facts and circumstances at the time of acquisition of the asset and therefore economic circumstances may change leading to these estimates that need to be reviewed.
This change in accounting estimates are not seen as an error and IAS 8 applies that states that these changes must be recognised prospectively – form the current period and thereon future periods.
So if the entity acquires a property, plant and equipment item at the beginning of 20X1, and it’s residue value and useful life changes during 20X3, the following steps are to be taken to account for this change accurately:
1. Determine the depreciable amount of the item as it would be initiated before the changes.
2. Determine the initial depreciation expense per year as it would be before any changes.
3. Determine the carrying amount of this item at the beginning of 2013 before any changes occur.
4. Use this carrying amount as the ‘new’ cost of the item for the beginning of 20X3.
5. Determine the new depreciable amount for 20X3:
‘New’ cost – new residue value for the change made
6. Determine the new depreciation expense for this current year in 20X3:
New depreciable amount divided by the REMAINING amount of the new useful life (total new useful life – years already used before changes made)
7. This new depreciation will be the expense for 20X3 and onwards as this change in accounting estimates are to be applied prospectively (IAS 8).
Different methods of depreciation used according to this Standard:
– Straight line method
– Reducing balance method
– Units of production method
Property, plant and equipment will initially be recognised at cost (ALWAYS) and the subsequent to that the entity can recognise the assets according to the revaluation model.
Revaluation amount: Fair value @ date of revaluation – accumulated depreciation – accumulated impairment losses on this item.
This ‘change’ in accounting policy (from initial measurement at a cost to revaluation for subsequent measurement) will be treated according to IAS 16 and NOT IAS 8.
Net replacement cost:
Fair value of an asset already used
Gross replacement cost:
New item’s fair value
NB! Par 35 states that when we use the revaluation model, we must eliminate the accumulated depreciation and accumulated impairment losses against the GROSS replacement cost of the asset so that it can from then on be carried in the books of the entity at the NET replacement cost ( whereon the revaluation will be made)
1. Revaluation SURPLUS or DEFICIT
Net replacement cost (revalued amount) > carrying amount at the date of revaluation
= revaluation SURPLUS à Other Comprehensive Income in SPL and SCE
Net replacement cost (revalued amount) < carrying amount at the date of revaluation
= revaluation DEFICIT à Profit and Loss as an expense
When there is a surplus during the first revolution on that asset and then during a subsequent revaluation, a deficit occurs, this deficit must first be set off against the surplus, thus debiting the surplus in OCI in the SPL and SCE before the remaining deficit can be debited to the P/L as an expense.
Likewise, if a deficit is achieved initially and then a surplus in the subsequent year, then the surplus must first be offset against the deficit but crediting this deficit in the P/L before the remaining surplus can go to OCI.
2. The realisation of revaluation surplus
This realisation is only available is a surplus arises and not for a deficit.
The revaluation surplus can be realised to Retained Earnings either when it is derecognised once off when sold OR as it is being used.
When it is being realised as the asset is used, the amount goes directly in equity as a line item in the Statement of Changes in Equity.
This amount of surplus to be realised as it is being used for a specific period can be determined by following these steps:
a) Depreciation for the year from the date of revaluation
b) Depreciation for the year is the item wasn’t revealed
c) The difference between a) and b) will give us the revaluation surplus to be realised according to use.
A property, plant and equipment item will be derecognised either when it is being disposed of or when the entity can no longer expect any future economic benefits to flow from the item to the entity.
According to this standard, the amount to be derecognised when the item is disposed of is the carrying amount of disposal deducted by the proceeds from disposing of it with must be the cash price equivalent. This is seen one economic event and the net effect must be disclosed with will be the profit or loss.
Par 68+71 states that a profit or loss can be realised from this disposal of the asset.
When a 3rd party compensates the entity for an impairment loss, this amount will be disclosed as a separate economic event in the SPL along with other such events like the cost incurred to restore or construct the asset or day to day servicing costs.
Presentation and disclosure
Please see the entry on this website, “#008 Google Classroom Assignment’, where a model of the financial statement of an entity is created. Here I show the disclosure and presentation of the effect of this Standard. See where I have marked “IAS 16”.