IAS-16 (PPE)

Introduction

International Accounting Standards (IAS) introduces many internationally accepted accounting standards and principals. Among them a section of  IAS that is indicated as IAS-16 describes about Property, Plant & Equipment. We will discuss various principles and standards of IAS-16.
  
Objective
The goal of this standard is to prescribe the accounting treatment of tangible fixed assets, so that users of financial statements may know information about the investment that the institution has in its property and equipment as well as the changes that have occurred in that investment. The main problems in the accounting recognition of tangible fixed assets are the accounting for assets, the determination of its amount and charges for amortization and impairments to be recognized with respect to them.


Scope
This standard applies in the accounting for elements of tangible fixed assets, except when another International Accounting Standard requires or permits a different accounting treatment.  

This standard does not apply to-

• Property ,plant & equipment that is for sale
• Biological assets related to agricultural activity
• Mineral rights and mineral reserves
• Recognition and valuation of exploration and evaluation asset

Definitions

The following terms are used in this Standard with the meanings specified below:

Depreciation is the systematic allocation of the depreciable amount of an asset
over its useful life.

Cost is the amount of cash or cash equivalents to cash paid or the fair value of the consideration given to buy an asset at the time of its acquisition, construction or, where applicable, the amount attributed to that asset when initially recognized in accordance with the specific requirements

Depreciable amount is the cost of an asset or the amount that has replaced it,less its residual value.

Amount is the amount at which an asset is recognized, less accumulated depreciation and impairment losses on the accumulated value.

Recoverable amount is the largest among the net sales price of an asset and its value in use.

Carrying amount is the amount at which an asset is recognized after deducting any  accumulated depreciation or losses.
    
        Formula of carrying amount:
        Carrying amount = Acquisition cost – Accumulated depreciation


Tangible assets are assets that:

(a) has an entity for use in the production or supply of goods and services, for lease to third parties or for administrative purposes, and

(b) are expected to use for more than a year.

The impairment loss is the amount that exceeds the amount of an asset to its recoverable amount.

Specific value for the entity is the present value of the cash flows that the entity expects to receive by the continued use of an asset and the sale or other disposition by the same route at the end of its useful life. In the case of a liability, is the present value of the cash flows that are expected to incur to cancel.

Fair value is the amount for which an asset could be exchanged, canceled or a liability, among stakeholders and duly informed in a transaction conducted at arm's length.

The residual value of an asset is the estimated amount that the entity could now get on disposal or disposition of assets by another means, after deducting the estimated costs of such sale or disposition, if the assets had already reached the age and other conditions expected at the end of its useful life.

Useful life is:

(a) the period during which it is expected to use the depreciable assets by the entity, or

(b) the number of production or similar units that are expected of it by the entity.
Recognition

An item of Property, Plant & Equipment that qualifies for recognition as an asset shall be measured at its cost.
Elements of Cost:

• Its purchase price and duties paid.
• Directly attributable costs.
• Initial estimate of the cost of dismantling and removing the item and restoring the site.
• Materials, labor and other inputs for self constructed assets.

The cost of Property, Plant & Equipment shall be recognized as an asset if, and only if:

• It is probable that future economic benefits associated with the item will flow to the entity; and
• The cost of the item can be measured reliably.

Cost Never be Capitalized

• Costs of opening new facility;
• Costs of introducing new product or service;
• Costs of conducting business in new location or with new class of  customer;
• Administration and other general overhead costs;
• Costs incurred in using or redeploying an item;
• Amounts related to certain incidental operations.

Subsequent Cost

Additional costs are incurred after the asset becomes operational is called subsequent costs.

Example of this cost includes-
Expense day-to-day servicing cost.
Capitalize replacement or renewal components and major  inspection costs.


Cost Model

Carrying amount is= Cost less Any accumulated Depreciation less Any accumulated impairment losses


Revaluation Model

Carrying amount is= Fair value less Subsequent accumulated depreciation less Subsequent accumulated impairment losses


Depreciation Method

There are four commonly used depreciation methods. They are-

1.Straight line method
2. Sum of the years digits method
3. Double declining balance method
4. Units of production method


Straight Line Method
Straight line method considers depreciation function of time rather than a function of usage.
                     

Sum of the Year Digit
Each fraction uses the sum of the years as a denominator (5 + 4 + 3 + 2 + 1 = 15).  The numerator is the number of years of estimated life remaining as of the beginning of the year.

Double declining method

• Double declining depreciation rate is a fixed percentage which is equal to double of the straight line rate.
•  If the straight line rate is 20% then twice of the straight line rate would be 40% that is double declining rat

Units of production method :

• Units of production method measures the amount of depreciation dividing the total estimated units by total estimated hours.
• Here the total estimated hours is identified by subtracting salvage value from cost multiplying specific working hours.

Impairments                     

An impairment is the amount by which the carrying amount of an asset exceeds its recoverable amount. Recoverable amount is the higher of an asset’s net selling price and its value in use.

When impairment occurs-

• Significant decrease in the market value of an asset
• Significant changes in the usage of an asset
• The significant adverse effects of climate change in the value of an asset

Asset exchange transactions:
Assets are exchanged for two reasons-
1.    Acquired asset will be measured at fair  value
2.    Given up asset will be measured at carrying amount

Acquired asset will be measured at fair value if:

• Exchange has commercial substance.
• Fair value of the asset acquired can be measured reliably

When no future benefits expected from use or disposal-

• Difference between carrying amount and net disposal proceeds recognised as gain/loss in profit or loss.
• Gains not classified as revenue
• Consideration receivable measured at fair value

De-recognition

When no future benefits expected from use or disposal-
   

• Difference between carrying amount and net disposal proceeds recognised as gain/loss in profit or loss.
• Gains not classified as revenue
• Consideration receivable measured at fair value

Presentation & Disclosure

Measurement basis-

• Depreciation methods
• Useful lives or depreciation rates
• Gross carrying amount and accumulated depreciation at beginning and end of period
• Reconciliation at beginning and end of period showing:
• Comparative information required

Disclosure basis
Disclosure of the nature & effectiveness of change in Accounting estimate with respect to-

• Residual values
• Estimated cost of removing or restoring items
• Useful lives
• Depreciation methods

At the revaluation of PPE, the followings must be disclosed:

•  Effective date of revaluation
•  Independent  valuator involvement 
•  Methods and significant assumptions applied
•  Carrying amount should be recognized under cost model
•  Revaluation surplus

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