Property, Plant and Equipment: IAS 16

Property, Plant and Equipment: IAS 16
Wiecek and Young IFRS Primer Chapter 10

Property, Plant and Equipment
Related standards IAS 16 Current GAAP comparisons IFRS financial statement examples Looking ahead End-of-chapter practice

Related Standards FAS 153 Exchanges of non-monetary assets
APB 29 Accounting for non-monetary transactions FAS 146 Accounting for costs associated with exit or disposal activities FAS 144 Accounting for the impairment or disposal of long-lived assets FAS 34 Capitalization of interest cost

Related Standards IAS 17 Leases
IAS 20 Accounting for government grants and disclosure of government assistance IAS 23 Borrowing costs IAS 36 Impairment of assets IAS 40 Investment property IFRS 2 Share-based payment IFRS 5 Non-current assets held for sale and discontinued operations

IAS 16 - Overview Objective and scope Recognition
Measurement at recognition Measurement after recognition (CM, RM) Derecognition Disclosure

IAS 16 - Objective and Scope
IAS 16 objective: standards for the recognition and derecognition of PP&E assets, measurement at and after acquisition, and disclosures Scoped out: assets held for sale, agricultural biological assets, non-renewable natural resource rights and reserves Includes investment property under construction and when ready, if cost model applied

IAS 16 - Objective and Scope
Property, plant and equipment (IAS 16.6): “Tangible items that: (a) are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and (b) are expected to be used during more than one period”

IAS 16 - Recognition Costs are recognized as PP&E only if:
probable that future economic benefits associated with the item will flow to the entity, and the cost can be measured reliably. Applies to costs at acquisition and after acquisition.

IAS 16 - Recognition The government requires HTY Ltd. to affix new pollution reduction equipment to existing equipment. Is this a PP&E cost…or an expense? Apply general principle: Future economic benefits Reliable measure

IAS 16 - Recognition Meets the future economic benefits criterion if costs are incurred to obtain the economic benefits or to increase the economic benefits from other assets Cost of pollution reduction equipment = PP&E asset cost Same criteria apply to major repairs and overhauls

IAS 16 - Recognition Works in combination with a “components approach”
Recognize major components as separate PP&E assets and depreciate separately When major overhaul or replacement takes place, remove old component’s remaining undepreciated cost Recognize new component as PP&E asset Gain/loss to income statement

IAS 16 - Measurement at Recognition
Need to know: What elements of cost are included How to measure cost

Cost elements to include: Purchase price net of discounts, rebates, and add non-recoverable taxes, duties Costs to get in place and ready to use as management intended Costs of obligation to decommission asset and restore site as a result of acquiring the asset

Cost elements to exclude: Costs after asset in place and ready for use as management intended Costs to open a new facility, introduce a product, move to new location General and administrative overhead type costs

If self-constructed: Apply same principles Charge abnormal costs to P or L Interest costs during construction: IAS 23 Government assistance: IAS 20

Situation-equipment: $100 cost, 7% sales tax $10 to transport to plant, $5 storage cost (plant not ready) $3 labor, $2 materials to calibrate machine. $4 recovered from trial run production Used at 50% of capacity: costs = $50, sales = $55 $11 to consultant for services related to choice of machine and calibration $1 interest cost during one month storage

Equipment cost: Invoice and tax: = $107 Transportation Calibration: – 4 = Professional fees $129

How to measure cost? “Cost” is defined (IAS 16.6) as: Cash or cash equivalents paid or the FV of other consideration given to acquire asset when acquired or constructed… Other IFRS such as IFRS 2: Share-based payment may have other specific requirements

If non-monetary transaction, exception to FV principle if: FV cannot be reliably determined, or Transaction lacks commercial substance – i.e., transaction has no economic effect on the entity

Commercial substance exists if: Cash flows (amount, timing, risk) of new asset differ from those of old asset(s) transferred; or After-tax cash flows of part of business taking on new asset (entity specific value) have changed; and Difference in 1 or 2 is significant

IAS 16 - Measurement after Recognition
Choice of two models: Cost model Revaluation model Separate decision for each class of PP&E assets. Examples of a class: land, office equipment, machinery, buildings

Cost Model (CM): PP&E are carried after acquisition at cost, less accumulated depreciation and accumulated impairment losses Revaluation Model (RM): PP&E are carried after acquisition at fair value at date of revaluation, less any accumulated depreciation and impairment losses after revaluation

IAS 16 - Measurement after Recognition: Cost Model (CM)
Depreciation: Each major component may have a different depreciation policy Depreciable amount: carrying amount less residual value Residual value defined: - estimate of net amount entity would receive now from asset’s disposal, if asset was as old and in same condition as expected at end of its useful life

Depreciation (continued): Depreciation period begins when PP&E is in place and ready to use, continues even if not used or is retired from active use Depreciation period ends when PP&E is derecognized or classified as held for sale (IFRS 5) Depreciate over useful life to entity

Depreciation (continued): Useful life – consider capacity, wear and tear, technology changes, changes in product demand, contractual or legal limits Choose method based on pattern that asset’s economic benefits are expected to be received: SL, DB, or activity-based If change in pattern, change method prospectively (change in estimate)

IAS 16 - Measurement after Recognition: Revaluation Model (RM)
Apply only to assets whose FV can be reliably measured Revalue often enough that carrying amount is close to FV Depreciate revalued amount using same principles as for CM

RM accounting - what happens if an increase in asset’s carrying amount?

RM accounting - what happens if a decrease in asset’s carrying amount?

Debits and credits to Revaluation Surplus are reported in OCI Choice of entries to revalue assets and accumulated depreciation: Proportionately, or Eliminate existing accumulated depreciation

Situation: On January 1, Year 1, ABC Co. acquires a building at a cost of $1,000. The building is expected to have a 25-year life and no residual value. The asset is accounted for under the revaluation model and revaluations are carried out every three years. On December 31, Year 3, the fair value of the building is appraised at $900. Prepare the entries required on December 31, Year 3

New depreciation rate is needed as of January 1, Year 4: $900 carrying amount = $41 per year 25 – 3 years

Revaluation Surplus account? As asset is used, transfer difference between depreciation taken using RM and amount if CM had been used - directly to Retained Earnings, OR Transfer directly to Retained Earnings when asset derecognized

Note - Revaluation Model is not widely used. KPMG : The Application of IFRS: Choices in Practice – International Financial Reporting Standards, December 2006 : see page 16 of 44

IAS 16 - Derecognition When disposed of, or when no future economic benefits to be received from use or disposal Remove carrying amount from statement of financial position Gain or loss = difference between carrying amount of asset (or part of asset if a replacement) and net proceeds on disposal

IAS 16 - Disclosure Whether CM or RM : Depreciation methods used
Depreciation rate or useful lives Beginning and ending balances and reconciliation of the two for gross amount and total of accumulated depreciation and impairment losses

IAS 16 - Disclosure If RM used: Date of revaluation
Independent valuation? Methods, techniques used Assumptions made in determining FV Amounts if CM had been used Details of changes in Revaluation Surplus

Current GAAP Comparisons
Pages 43-45/144 of

IFRS Financial Statement Disclosures - CM
BHP Billiton Ltd. Business and geographic segments: page 16 of 108 Consolidated balance sheet: page 5 of 108 Basis of measurement: page 8 of 108 Accounting policies for PP&E: page 10 of 108 Property, plant and equipment Note 16: page 35 of 108

Looking Ahead No significant changes are expected to IAS 16 in the foreseeable future

End-of-Chapter Practice
10-1 The following assets have been recognized as items of property, plant, and equipment. Headquarter office boardroom table and executive chairs A landfill site Wooden pallets in a warehouse Forklift vehicles in a manufacturing plant Stand-alone training facility for pilot training, including a flight simulator, classrooms equipped with desks, whiteboards and electronic instructional aids Instructions For each of the items listed: Identify what specific costs are likely to be included in acquisition cost. Explain whether any components of this asset should be given separate recognition, and why. Suggest what should be taken into consideration in determining each component’s depreciable amount and depreciation period. Suggest and explain what depreciation method might be most appropriate for each component separately identified. Identify whether the periodic depreciation is recognized as an expense on the income statement, or whether another accounting treatment is more appropriate. Explain.

10-2 Vedat Corporation acquires new equipment with a list price of $100 to expand its product line, paying $50 on delivery and agreeing to pay $25 in one year’s time and the remaining $25 in two years’ time. The company extends a portion of its factory wall in order to fit the new machine in place and then rearranges existing equipment into a more efficient layout. The new equipment is dropped on installation requiring repairs prior to use. At the end of the equipment’s useful life, Vedat Corporation is required to dismantle and dispose of it, paying a special environmental tax due to hazardous materials in its construction. Vedat is licensed to manufacture products with this equipment, and is required to pay a royalty for each unit produced. Instructions Discuss how the cost of the new equipment should be determined.

10-3 Teyal Limited has just finished the construction of its new office building. About the same time, one of Teyal’s major suppliers, Layet Corporation, also moved into its new office building. Layet Corporation did not construct its own building, but contracted it out in a fixed price total contract. The total expenditures were approximately the same for both buildings. Instructions a) Assume you are a co-op student in the accounting department of Teyal Limited. You are asked to write a short report on what the chief accountant needs to consider in accounting for the cost of the new building and its subsequent depreciation policy. Write the report. b) Assume you are a co-op student in the accounting department of Layet Corporation. If you were asked to write a report similar to the one required in part (a) above, identify in what respect it might differ, and why.

10-4 Resorts Ltd. has occupied its plant facility for 15 years, about one-third of its expected useful life. Although still very functional, numerous repairs have been required in recent months. The accounts indicate the original cost of the plant building was $500. The entire inside of the plant was painted at a cost of $2; the old wooden roof was replaced with a new one at a cost of $45; and part of the plumbing system was upgraded at a cost of $25 due to a change in the manufacturing process used. The plant was closed down while the roof was replaced, but overhead and administrative costs of $10 continued to be incurred even though production was at a standstill. The original roof had been identified as a separate component of the building when it was constructed with a cost of $30 and a useful life of 20 years. No separate records were kept of the original cost of the plumbing or painting. Instructions Prepare entries to record the recent repairs.

10-5 In this chapter, flag icons identify areas where there are GAAP differences between IFRS requirements and national standards. Instructions Access the website(s) identified on the inside back cover of this book, and prepare a concise summary of the differences that are flagged throughout the chapter material.

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Property, Plant and Equipment: IAS 16

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