SBR Notes IAS 16

IAS 16: Property, plant and equipment

Ø  Definition

Ø  Initial Measurement

Ø  Subsequent Measurement

1.       Cost

2.       Revaluation

Ø  Subsequent expenditure

Ø  Depreciation

Ø  Derecognition

Ø  Disclosure

Definition: IAS 16 defines property, plant and equipment as tangible items that:

• 'are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes

• are expected to be used during more than one period' and on profit over more than one accounting period.

Tangible items have physical substance and can be touched and used continuously in the company’s activities to provide access to economic benefits. Common examples of PPE are land and buildings, plant and machinery, motor vehicles, and fixtures and fittings.

IAS will not be applied to Biological assets and Mineral rights and reserves.

Initial recognition: An item of property, plant and equipment should be recognised as an asset when:

• It is probable that the asset's future economic benefits will flow to the entity.

• The cost of the asset can be measured reliably.

 For recognition:

Asset Dr: xxx

Cash Cr: xx

Property, plant and equipment should initially be measured at its cost. Cost is not simply the purchase price of the asset. According to IAS 16, this comprises:

• Purchase costs, including import duties and non-refundable purchase taxes (for example, non-refundable value added tax: however, purchase taxes are not included in cost if they are refundable to the entity).

• Costs that are directly attributable to bringing the asset to the necessary location and condition, including:

¾     Professional fees (for example, the fees of architects or surveyors, and legal costs)

¾     Costs of site preparation (getting a site ready for installation; for example, the costs of levelling a factory floor before new machinery is installed)

¾     Installation costs

¾     Costs of testing the asset (e.g. the costs of safety test flights for a new aeroplane or cost of production runs during the testing period).

¾     Freight charges

Where the asset has been constructed by the entity, rather than purchased from an external supplier, the cost should also include the employee costs that directly relate to the construction and production overhead costs, but not administration and general overhead costs.

• For self-constructed assets (non-current assets that are constructed by the entity itself):

¾     Internal profits and abnormal costs should be excluded from cost

¾     Administrative expenses and other similar overheads should be excluded from cost

¾     Interest costs incurred in the course of construction might be included, in accordance with IAS 23 Borrowing costs.

Costs of testing an asset: Costs of testing an asset to see whether it is functioning properly for its intended use are capitalised. Items might be produced when testing a production facility. In this case the testing cost capitalised is after deducting the net proceeds from the sale of these items.

Dismantling costs: When a company acquires an asset it may have an obligation to dismantle the asset and restore the site once the asset reaches the end of its life. The obligation must be included in the cost of the asset, at the time that the asset is first recognised.

For example, a company that builds an oil rig in the sea may have an obligation to restore any damage to the sea-bed once it has finished drilling for oil. A cost for future site restoration work should be included in the cost of the oil rig, when the rig is initially recognised as an asset: this cost should be the present value of the estimated future costs. As a part of the cost of the asset, it will then be depreciated over the asset’s life.

This treatment ensures that the restoration costs are matched to the associated income earned from the rig during the rig’s useful life. (Unless the future restoration costs are capitalised and depreciated, the cost would eventually have to be accounted for as a ‘one-off’ item of expense at the end of the asset’s life. This would be inconsistent with the accruals concept of accounting.)

Which cost to capitalise in the Initial cost of recognition?

List Price	xxx
Less: Trade Discount	(xxx)
Add: Freight charges	xxx
Add: Import duties	xxx
Add: Dismantling cost	xxx
Add: Installation cost	xxx
Add: Pre production testing	xxx
Add: Handling cost	xxx

Example: Entity H has incurred the following costs prior to bringing a machine into full production:

	$
Purchase price before trade rebate and tax	12,200
Trade rebate	600
Refundable purchase taxes	1,200
Architects’ fees	700
Installation costs	100
Operating losses prior to achieving planned performance	250

Required: Calculate the amount at which the machine should be stated in the accounting records of Entity H in accordance with IAS 16.

Answer: The cost of the machine should be stated in the statement of financial position as:

	$
Purchase price less trade rebate (12,200 – 600)	11,600
Architects’ fees	700
Installation costs	100
Total cost	12,400

IAS 16 says that the following costs should never be capitalised:

• Administration and general overheads

• Abnormal costs (repairs, wastage, idle time)

• Costs incurred after the asset is physically ready for use (unless these costs increase the economic benefits the asset brings)

• Costs incurred in the initial operating period (such as initial operating losses and any further costs incurred before a machine is used at its full capacity).

• Costs of opening a new facility, introducing a new product (including advertising and promotional costs) and conducting business in a new location or with a new class of customer (including training costs).

• Costs of relocating/reorganising an entity’s operations.

• Start up and similar pre-production cost.

All of these costs will be recognised as an expense in Profit and loss statement.

Note: All exchange of Property plant and equipment are measured at fair value including exchange of similar assets unless exchange transaction lacks commercial substance or fair value of assets received cannot be measured reliably.

Subsequent measurement/Measurement after initial recognition: IAS 16 allows a choice between:

• The cost model

• The revaluation model.

The cost model: When the cost model is used, the depreciation of the asset is based on its cost, and the asset is carried in the statement of financial position at cost minus accumulated depreciation and any accumulated impairment.

Impairment:

Dr. Expenses

Cr. Property, plant and equipment

Impairment can be carried back, however that should be limited to its recoverable amount.

The revaluation model: Under the revaluation model, property, plant and equipment is carried at fair value less any subsequent accumulated depreciation. The market value of land and building usually represent their fair value. If there is no reliable market value (for example, because the asset is specialised or because sales are rare), depreciated replacement cost can be used.

According to IAS 16 revaluation test should be carried out annually. And if there is any revaluation indication asset should be revalued immediately. Revaluation model is available only if the fair value of the item can be measured reliably. Where there is no market value available, depreciated replacement amount should be used.

If the revalued amount is more than the carrying value of the asset at the time of the revaluation, there is a revaluation gain. If the revalued amount is lower than the carrying amount, there is a revaluation loss.

• If a revaluation increases the value of an asset, the increase is presented as other comprehensive income (and disclosed as an item that will not be recycled to profit or loss in subsequent periods) and held in a 'revaluation surplus' within other components of equity.

• Any loss on revaluation is included in profit or loss, as a loss in the period, unless the loss reverses a previous revaluation gain. In this case, the loss is reported in other comprehensive income and set off against the gain in the revaluation reserve, and is not reported through profit or loss.

If the revaluation model is adopted, then IAS 16 provides the following rules:

• Revaluations must be made with ‘sufficient regularity’ to ensure that the carrying amount does not differ materially from the fair value at each reporting date but IAS 16 does not define any fixed intervals for revaluations.

• If an item is revalued, the entire class of assets to which the item belongs must be revalued. A class would usually be defined as land and buildings, or machinery, or fixtures and fittings. Generally, companies choose to revalue land and buildings whilst using the cost model for all other classes of assets.

• Increase in value which represent initial impairment should initially be offset with expenses deducting excess depreciation and remaining amount credited to revaluation surplus.

Valuation should normally be performed by a professionally qualified valuer.

Example: An asset was purchased for $500,000, and was believed to have a useful economic life of ten years and no residual value. At the end of year 8 the asset is revalued and found to have a fair value of $150,000.

Required: Explain the accounting treatment of the revaluation and the subsequent depreciation of the asset.

Answer: At the date of revaluation, but before the revaluation is made, the asset is stated in the statement of financial position as follows:

	$000
Cost	500
Accumulated depreciation (500/10) × 8 years	(400)
Net book value	100

There are three elements to dealing with a revaluation:

• The asset cost must be adjusted to its revalued amount

• The accumulated depreciation must be eliminated

• The increase in the carrying value of the asset is taken directly to the revaluation reserve in equity.

The double entry will therefore be as follows:

	$000	$000
CR Asset (500 – 150)		350
DR Accumulated depreciation	400
CR Revaluation reserve		50

These adjustments will alter the carrying value of the asset to $150,000 (from $100,000), accumulated depreciation is $0 and the revaluation reserve for the asset is increased by $50,000.

Depreciation after revaluation: Depreciation charges after revaluation, for inclusion in profit or loss, must be based on the revised value (= revalued amount).

In the example above, the $150,000 carrying value will be depreciated over its remaining life of two years, at $75,000 per year. This will be the depreciation charge each year in profit or loss.

An annual reserve transfer may be made each year from the revaluation reserve directly to accumulated profits, for the difference between depreciation based on historical cost and depreciation on the revalued amount. This transfer is made directly between the reserves and is not reported in profit or loss:

	$
Depreciation based on historical cost ($500,000/10 years)	50,000
Depreciation based on the revalued amount	75,000
Transfer from revaluation reserve to accumulated profit (for the excess depreciation charge)	25,000

In this example, the effect after two years is that the asset will be fully depreciated and the balance on the revaluation reserve for the asset will have been reduced to $0.

Revaluations using an index: An alternative way of expressing the change in the asset’s value is to use a cost index or price index. Using the above example, and an index of 150 for the revaluation, the revaluation could instead be recorded as follows:

	Original Value	Index	Revalued
Cost	$500,000	150%	$750,000
Accumulated depreciation	$400,000	150%	$600,000
Net book value	$100,000	150%	$150,000

As the net book value has increased, it is assumed that the replacement cost of the asset has increased. The cost is therefore adjusted, together with the accumulated depreciation. The journal entry to record this adjustment should be:

	$000	$000
DR Cost	250,000
CR Accumulated depreciation		200,000
CR Revaluation reserve		50,000

Revaluation losses: A revaluation may indicate that an asset has dropped in value rather than increased. The accounting treatment is exactly the same as for the treatment of impairment.

There are four cases in revaluation model:

(1)    Increase in value of asset

(2)    Decrease in value of asset

(3)    Initially increase in value of asset then decrease in value of asset

(4)    Initially decrease in value of asset then increase in value of asset

(1) Increase in value of asset

Dr. Property, plant and equipment

Cr. Revaluation surplus (Other comprehensive income)

Or

• Dr Non-current asset cost (difference between valuation and original cost/valuation)

• Dr Accumulated depreciation (with any historical cost accumulated depreciation)

• Cr Revaluation reserve (gain on revaluation)

Example: Plant value on 1 January 2010 = $50,000

Life = 5 years,

 1 January 2012 revalued to $60,000

So Depreciation = $50,000/5 = $10,000 p.a.

Net Book Value as on 31^st December 2011 = $30,000 ($50,000 - $20,000).

Entries:

• Dr Non-current asset cost (difference between valuation and original cost/valuation): $10,000 ($60,000 - $50,000).

• Dr Accumulated depreciation (with any historical cost accumulated depreciation): $20,000

• Cr Revaluation reserve (gain on revaluation): $30,000

Example:  On 1^st January 2010 land was bought for $1000 and at 31^st Dec 2010 it upward revalued to 1500.

Answer: 1^st January2010:

 Asset Dr: 1000

Cash Cr: 1000

31^st December 2010:

Asset Dr: 500

Revaluation reserve Cr: 500 (Revaluation reserve is equity component)

(2) Decrease in value of asset

Dr. Expenses (P/L)

Cr. Property, plant and equipment

Example 2: Land was bought on 1^st January 2010 for $1000 and on 31^st December it downward valued to $750.

Answer: 1^st January 2010

Asset Dr: 1000

Cash Cr: 1000

31^st December 2010:

P&L Dr: 250

Asset Cr: 250

(3) Initially increase in value of asset then decrease in value of asset

• Dr Revaluation reserve (to maximum of original gain)

• Dr Income statement (any residual loss)

• Cr Non-current asset (loss on revaluation)

Examples: Purchase price of asset = 100 million

Date of purchase = 1 January 20X1

Life = 10 years

Revalued at 31 January 20X1 = 120 million

Revalued at 31 December 20X2 = 50 million.

Solution: Carrying value of asset on 31 December 20X1 = 100 million – Depreciation

= 100 million – 10 million = 90 million

Revalued to 120 million so gain on revaluation = 30 million

On 20X2: Before depreciation = 120 million

Depreciation = 120/9 = 13.3

After depreciation = 106.7 (120 – 13.3)

Revalued to 50 million so decrease in value = 56.7 (106.7 – 50)

Journal entries

Dr. Revaluation surplus = 30 (Whole amount of revaluation surplus)

Dr. Expenses = 26.7

Cr. Property, plant and equipment = 56.7

Example: On 1^st January 2010 land was bought for $1000 on 31 December 2010 it was got revalued to $1500 and on 31^st December 2011 it got revalued to 750.

Answer: 1^st January 2010

 Asset Dr: 1000

Cash Cr: 1000

 31 December 2010:

Asset Dr: 500

Rev Res Cr: 500

31^st Dec 2011:

P&L Dr: 250

Rev Res Dr: 500

Asset Cr: 750

(4) Initially decrease in value of asset then increase in value of asset

Examples: Purchase price of asset = 100 million

Date of purchase = 1 January 20X1

Life = 10 years

Revalued at 31 January 20X1 = 70 million

Revalued at 31 December 20X2 = 120 million.

Solution: Carrying value of asset on 31 December 20X1 = 100 million – Depreciation

= 100 million – 10 million = 90 million

Revalued to 70 million so loss on revaluation = 20 million

On 20X2: Before depreciation = 70 million

Depreciation = 70/9 = 7.7

After depreciation = 62.3 (70 – 7.7)

Revalued to 120 million so increase in value = 57.7 (120 – 62.3)

Journal entries:

Dr. Revaluation surplus = 57.7

Dr. Expenses = 17.7(Remaining life 20/9*8)

Cr. Revaluation surplus = 40

Example: Land was bought for $1000 on 1^st January2010 it revalued downward on 31^st December 2010 to $750 and on 31 December 2011 it got upward revalued to 31^st December 2011.

Answer: 1^st Jan 2010

Asset Dr: 1000

Cash Cr: 1000

31^st Dec 2010:

P&L Dr: 250

Asset Cr: 250

31^st Dec 2011:

Asset Dr: 750

P&L Cr: 250

Rev.Res Cr: 500

Example: Revaluation and Depreciation: CoCo Company bought an asset for $10000 at the beginning of 2005. It had a useful life of five years. On 1^st January 2007 the asset was revalued to $12000. The asset life is remain unchanged i.e. three years remain.

Account for revaluation and state treatment for depreciation from 2008 onwards.

Answer

On 1^st January 2007 the carrying value of the asset is:

10000/5=2000 per year depreciation

Two year depreciation 2000 x 2= 4000

Asset carrying value = 6000

Acc. Depreciation Dr: 4000

Asset Dr: 2000

Revaluation Reserve Cr: 6000

Depreciation for next three years will be 12000/3=4000, compared to depreciation on cost extra $2000 can be treated as part of surplus

Revaluation Surplus Dr: 2000

Retain earning Cr: 2000

Complex Asset: Asset which has more than one component and every component has different useful life. For example assets like Aircraft, Ships, Train etc has different components and their life is different such assets are known as complex Asset.

Subsequent expenditure: Subsequent expenditure can be capitalised if it meets recognition criteria. Overhaul expenditure can be capitalised and should be depreciated till next overhaul. Such costs which incurred during the life of the asset and due to them:

1. It increases the efficiency of the asset

2. It increases the useful life of the asset or

3. It decreases the operating cost of the asset.

These costs need to capitalise in the cost of the asset and such expenditures are known as subsequent expenditure. Where a part of an asset (a ‘component’) is replaced, the cost of the replacement should be capitalised and the net book value of the component replaced should be removed from the statement of financial position.

Example: Aircrafts interiors require replacement at regular intervals.

Example: A shipping company is required to put its ships into dry dock every three years for an overhaul, at a cost of $300,000. The ships have a useful life of 20 years. A ship is purchased from a shipbuilder at a cost of $20 million.

When the ship is first acquired, $300,000 of the asset cost should be treated as a separate component and depreciated over three years. The rest of the cost of the ship ($19.7 million) should be depreciated over 20 years. By the end of the third year an overhaul will be required. The cost of the overhaul is capitalised and added to the asset’s cost. The cost ($300,000) and accumulated depreciation of the depreciated component is removed from the accounts.

Example: A building is constructed. The cost of the building includes the cost of the main construction work, plus the costs of air conditioning, the cost of elevators and the cost of wall partitions.

The cost of the building should be allocated between component elements, and each component element should be depreciated separately. For example, the cost of the elevators should be capitalised and depreciated over their expected useful life. When the elevators are replaced (whenever this actually happens), the cost of the new elevators should be capitalised and included in the cost of the building. The net book value of the old elevators should be taken out of the carrying value of the building and written off (unless they have a disposal value).

Depreciation: Depreciation is systematic allocation of cost over its useful life and it should be charged to depreciable asset only. Depreciation does not measure the change in the value of a non-current asset. It is simply an accounting method for allocating the cost of an asset to profit or loss over the asset’s expected useful life. The depreciation charge has the effect of spreading the cost/fair value of the asset over the periods that will benefit from its use. All tangible non-current assets must be depreciated. The only exception to this rule is land, which normally has an indefinite useful life (unless it is used in mining or similar industries).

Dr. Depreciation

Cr. PPE/Accumulated Depreciation

Charged to Cost of goods sold (COGS) is question is silent.

Depreciation methods based on the revenue generated by an activity are not appropriate. This is because revenue reflects many factors, such as inflation, sales prices and sales volumes, rather than the economic consumption of an asset. In practice, many entities depreciate property, plant and equipment on a straight line basis over its estimated useful economic life.

While considering depreciation method, company should consider factors like expected physical wear and tear, legal or other relevance, past and similar nature industry method and revenue generation from assets.

The residual value and the useful life, depreciation method, depreciation rate and pattern of consumption of benefit of an asset should be reviewed at least at each financial year-end and revised if necessary. If expectation differ from previous estimates it is change in accounting estimates are accounted for as a change in accounting estimate (under IAS 8 Accounting  Policies, Changes in Accounting  Estimates and Errors), rather than as a change in accounting policy. This means that they are reflected in the current and future statements of profit or loss and other comprehensive income.

Residual value is likely to me immaterial in most of the case. However, when the amount is significant, the value must be estimated and should be based on current situation.

IAs 16 does not prescribe the depreciation method but it should reflect the pattern in which economic benefit of asset is consumed by the entity.

Depreciation begins when the asset is available for use and continues until the asset is derecognised, even if it is idle.

The depreciation charge on the revalued asset will be different to the depreciation that would have been charged based on the historical cost of the asset. As a result of this, IAS 16 permits a transfer to be made of an amount equal to the excess depreciation from the revaluation reserve to retained earnings.

Double entry:

• Dr Revaluation reserve

• Cr Retained earnings

Note: Building being constructed is shown as Capital Work in Progress.

Depreciation of separate components: Component of asset with differing pattern of benefits are depreciated differently.

Even regular overhauls occur in order to continue operation, the cost of overhaul should be treated as additional component and depreciate over the period of next overhaul.

If asset is measured at historical cost depreciation charged is based on historical cost and if asset are measured at revalued amount the depreciation charged should be based on revalued amount.

Example: An asset is purchased for $200,000 and is believed to have a useful life to the company of five years before it is scrapped for an expected $50,000.

Required

(a) Calculate the annual depreciation charge.

(b) At the start of the third year, the company restructures its operations and as a result the total asset life is believed to be only four years, with the residual value unchanged. Explain the impact on the depreciation expense.

Answer

(a) Annual depreciation:  =  =$30,000 per annum.

(b) If estimates are revised, the carrying value of the asset at the date of the new assessment should be written off over its remaining expected life, using the new estimates. The new remaining expected life is two years. The change in estimate is not applied retrospectively. A prior year adjustment must not be made when dealing with the revision of an estimate.

Net book value at the start of year 3 = $200,000 – (2 years × $30,000) = $140,000

This net book value will be written off over the remaining useful life of 2 years.

Revised depreciation =  = $45, 000 per year

Depreciation and components of non-current assets: A non-current asset may have several components.

For example, a property has two elements, the land and the buildings. IAS 16 requires that the land and building element must be treated as separate assets.

• The land element is (usually) not depreciated as it has an indefinite useful life.

• The building must be depreciated, even if its value has increased, as it does have a finite useful life.

• However, if the expected residual value of a building is expected to equal or exceed the cost, then depreciation will be zero as there is no ‘depreciable cost’ to the company.

Some assets contain several components with very different useful lives. For example an aeroplane consists of the external structure, the avionics system, engine and cabin interior. Depreciation must therefore be calculated on each of these components over their individual useful lives, using their individual residual values.

Derecognition: IAS 16 says that an asset should be derecognised (its carrying amount is removed from the statement of financial position) when disposal occurs, when the life of asset is completed or if no further economic benefits are expected from the asset's use or disposal. In addition, it should be derecognised when it is transferred as held for sale under IFRS 5.

Entity has routinely sale item of Property, plant and equipment that have previously held for rental or other purposes should transfer to inventory at carrying value. Conversely, if inventories are transferred from stock to Property, plant and equipment, if they are used as per the definition of IAS 16.

If an entity rents some assets and then ceases to rent them, the assets should be transferred to inventories at their carrying amounts as they become held for sale in the ordinary course of business.

Gain or loss on derecognition is charged to Profit and Loss. The gain or loss on derecognition of an asset is the difference between the net disposal proceeds, if any, and the carrying amount of the item.

The gain or loss on the disposal is calculated as:

	$
Net disposal proceeds	X
Minus: Carrying amount	(X)
Gain/(loss) on disposal	X/(X)

IAS 16 does not allow the gain on disposal to be included in the revenue line of the statement of profit or loss, but it does not specify where it should be shown. It simply states: ‘The gain or loss arising from derecognition of an item of property, plant and equipment shall be included in profit when the item is derecognised…Gains shall not be classified as revenue.’

Disposal of a revalued asset: On disposal of a revalued asset it must be remembered that the revaluation gain has already been recognised in the revaluation reserve. Therefore the gain on disposal is calculated based on the revalued carrying value.

Any balance on the revaluation reserve relating to an asset that has been disposed of should be transferred directly to the retained earnings, or it may be left in the revaluation surplus within other components of equity.

• Dr Revaluation reserve

• Cr Retained earnings

It is not permitted to release the revaluation reserve to profit or loss for the year in which the asset is disposed of. This practice is called ‘recycling’ and is not permitted by IAS 16.

Example: On 1 April Year 1, a company buys an asset with an expected life of 20 years. By the end of 31 March Year 5, the carrying value is as follows:

	$
Cost	180,000
Accumulated depreciation (4 years × $9,000)	(36,000)
Net book value	144,000

The asset is revalued to $200,000 on 1 April Year 5, resulting in a gain on revaluation. The gain of $56,000 ($200,000 – $144,000) is credited to the revaluation reserve on this date. On 1 April Year 7, the asset is sold for $229,000.

The financial year of the company ends on 31st March.

After the revaluation, annual depreciation is based on the revalued amount of the asset ($200,000) and its remaining useful life (16 years). The annual depreciation charge is therefore $12,500, which is $3,500 higher than the depreciation charge based on the historical cost of the asset.

Required: How should the disposal be accounted for?

Answer: The disposal on 1 April Year 7 would be recorded as follows:

(a) Carrying amount prior to disposal on 1 April Year 7

	$
Machinery at valuation at 1 April Year 7	200,000
Accumulated depreciation ($200,000 /16 years) × 2 yrs.	(25,000)
Net book value	175,000

(b) Revaluation reserve: On 1 April Year 5, when the asset was revalued, the revaluation reserve was $56,000. The company is allowed to make a reserve transfer each year following revaluation for the amount of the additional depreciation arising from the revaluation.

The historical cost of depreciation was $9,000 per annum, and the revised depreciation is $12,500. Therefore over the past two years since the revaluation, the entity will have transferred $3,500 each year from the revaluation reserve to accumulated profits, to offset the additional depreciation effect on profit or loss.

The revaluation reserve at 1 April Year 7 is therefore $56,000 – (2 years × $3,500) = $49,000.

(c) Profit on disposal – included in profit or loss for year to 31 March Year 8.

	$
Sale proceeds	229,000
Minus: Net book value on disposal	( 175,000)
Profit on disposal	54,000

(d) Other comprehensive income for year to 31 March Year 8 and transfer from revaluation reserve to retained earnings reserve on 1 April Year 7.

	Revaluation reserve $	Retained earnings $
At 1 April Year 7	49,000	X
Transfer on disposal of non-current asset	(49,000)	49,000
At 31 March Year 8	0	Y

Disclosure requirements: Information about each class of property, plant and equipment

For each class of property, plant, and equipment, disclose:

• Basis for measuring carrying amount

• Depreciation method(s)

• Used useful lives or depreciation rates

• Gross carrying amount and accumulated depreciation and impairment losses

• Reconciliation of the carrying amount at the beginning and the end of the period, showing:

¾     Additions

¾     Disposals

¾     Acquisitions through business combinations

¾     Revaluation increases or decreases

¾     Impairment losses

¾     Reversals of impairment losses

¾     Depreciation

¾     Net foreign exchange differences on translation

¾     Other movements

Additional disclosures: The following disclosures are also required:

• Restrictions on title and items pledged as security for liabilities

• Expenditures to construct property, plant, and equipment during the period

• Contractual commitments to acquire property, plant, and equipment

• Compensation from third parties for items of property, plant, and equipment that were impaired, lost or given up that is included in profit or loss.

IAS 16 also encourages, but does not require, a number of additional disclosures.

Revalued property, plant and equipment: If property, plant, and equipment is stated at revalued amounts, certain additional disclosures are required:

• The effective date of the revaluation

• Whether an independent valuer was involved

• For each revalued class of property, the carrying amount that would have been recognised had the assets been carried under the cost model

• The revaluation surplus, including changes during the period and any restrictions on the distribution of the balance to shareholders.

Entities with property, plant and equipment stated at revalued amounts are also required to make disclosures under IFRS 13 Fair Value Measurement.

Illustration: Change in depreciation estimates: An asset was purchased for $100,000 on 1 January 20X5 and straight line depreciation of $20,000 per annum was charged (five year life, no residual value). A general review of asset lives was undertaken and the remaining useful life of this asset as at 1 January 20X7 was deemed to be eight years.

Required: What is the annual depreciation charge for 20X7 and subsequent years?

Solution:

Carrying amount as at 1 January 20X7 (3/5 × $100,000): $60,000

Remaining useful life as at 1 January 20X7: 8 years

Annual depreciation charge ($60,000/8 years): $7,500

Depreciation of separate components: Certain large assets are in fact a collection of smaller assets, each with a different cost and useful life. For example, an aeroplane consists of an airframe (which may last for 40 years or so) plus engines, radar equipment, seats, etc. all of which have a relatively short life. Instead of calculating depreciation on the aeroplane as a whole, depreciation is charged on each component (airframe, engines, etc.).

For example, an entity buys a ship for $12m. The ship as a whole should last for 25 years. The engines, however, will need replacing after 7 years. The cost price of $12m included about $1.4m in respect of the engines.

The annual depreciation charge will be $624,000 made up as follows:

Engines: $1.4m over seven years = $200,000 pa, plus

The rest of the ship: $10.6m over 25 years = $424,000 pa.

The impact on the financial statements: IAS 16 Property, Plant and Equipment permits entities to use a cost model or a revaluation model. This choice will have a big impact on the financial statements.

Example: Entities A and B are identical in all respects, except for their accounting policy for property, plant and equipment.

Both entities purchased an asset four years ago for $200,000. This was deemed to have a useful economic life of 10 years. Its fair value at the start of the current reporting period was $350,000.

Entity A uses the cost model. The current year depreciation charge on the asset is $20,000 ($200,000/10). The carrying amount of the asset in the statement of financial position at the year-end is $120,000 (6/10 × $200,000).

Entity B uses the revaluation model. The asset was revalued at the start of the year by $210,000 ($350,000 – (7/10 × $200,000)). The depreciation charge on the asset in the current year is $50,000 ($350,000/7). The asset has a carrying amount in the statement of financial position of $300,000 ($350,000 – $50,000).

Extracts from the financial statements of both entities are provided below:

Statement of profit or loss

	A $000	B $000
Revenue	220	220
Operating costs	(180)	(210)
Profit from operations	40	10

Statement of financial position

	A $000	B $000
Share capital	50	50
Retained earnings	90	60
Other components of equity	–	210
Total equity	140	320
Borrowings	100	100
Total equity and liabilities	240	420
Operating profit margin	18.2%	4.5%
Return on capital employed	16.7%	2.4%
Gearing (debt/debt + equity)	41.7%	23.8%

Entity B's upwards revaluation has increased equity in the statement of financial position. This reduces its ROCE, making entity B appear less efficient than entity A. However it also means that entity B's gearing is lower than entity A's, making it seem like a less risky investment.