items on the statement of financial position, non-current assets. Intangible assets are covered later in Chapter 7. This chapter deals with IAS 16, IAS 36 and IAS 23.
IAS 16 should be familiar to you from your earlier
studies, as should the mechanics of accounting for depreciation, revaluations of non-current assets and disposals of non-current assets. Some questions are given here for revision purposes.
IAS 36 on impairment is an important and very
examinable standard.
IAS 23 deals with the treatment of funds used in self-
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6: Accounting for non-current assets PART B SINGLE COMPANY FINANCIAL ACCOUNTS1 IAS 16 Property, plant and equipment 5/10, 11/10, 5/11,
9/11, 11/11, 3/12, 5/12
Introduction
This section looks at IAS 16 Property, plant and equipment which covers all aspects of accounting for property, plant and equipment. This represents the bulk of items which are 'tangible' non-current assets. Here we will consider the rules for recognition, derecognition, measurement and depreciation. We will also cover what happens when an asset is revalued.
1.1 Definitions
IAS 16 gives a large number of definitions which you should be familiar with for your exam.
PROPERTY, PLANT AND EQUIPMENT are 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.
CARRYING AMOUNT is the amount at which an asset is recognised in the statement of financial position after deducting any accumulated depreciation and accumulated impairment losses.
COST is the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition or construction.
DEPRECIATION is the result of systematic allocation of the depreciable amount of an asset over its useful life.
DEPRECIABLE AMOUNT of a depreciable asset is the cost of an asset or other amount substituted for cost, less its residual value.
FAIR VALUE is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
An IMPAIRMENT LOSS is the amount by which the carrying amount of an asset exceeds its recoverable amount.
RECOVERABLE AMOUNT Is the higher of an asset’s fair value less costs to sell and its value in use.
The RESIDUAL VALUE is the net amount which the entity expects to obtain for an asset at the end of its useful life after deducting the expected costs of disposal.
USEFUL LIFE is one of two things.
The period over which an asset is expected to be available for use by an entity
The number of production or similar units expected to be obtained from the asset by the entity. (IAS 16) An 'amount substituted for cost' will normally be a current market value after a revaluation has taken place.
Exam skills
These definitions are important. Make sure you know them all for the exam.
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1.2 Recognition
In this context, recognition simply means incorporation of the item in the business's accounts, in this case as a non-current asset. The recognition of property, plant and equipment depends on two criteria: (a) It is probable that future economic benefits associated with the asset will flow to the entity (b) The cost of the asset to the entity can be measured reliably
These recognition criteria apply to subsequent expenditure as well as costs incurred initially.
Property, plant and equipment can amount to substantial amounts in financial statements, affecting the presentation of the company's financial position and the profitability of the entity, through depreciation and also if an asset is wrongly classified as an expense and taken to profit or loss.
1.3 Initial measurement
Once an item of property, plant and equipment qualifies for recognition as an asset, it will initially be measured at cost.
1.3.1 Components of cost
The standard lists the components of the cost of an item of property, plant and equipment: Purchase price, less any trade discount or rebate
Import duties and non-refundable purchase taxes
Directly attributable costs of bringing the asset to working condition for its intended use, eg: – The cost of site preparation
– Initial delivery and handling costs – Installation costs
– Testing
– Professional fees (architects, engineers)
Initial estimate of the cost of dismantling and removing the asset and restoring the site on which it is locatedIAS 16 provides additional guidance on directly attributable costs included in the cost of an item of property, plant and equipment.
(a) These costs bring the asset to the location and working conditions necessary for it to be capable of operating in the manner intended by management, including those costs to test whether the asset is functioning properly.
(b) These are determined after deducting the net proceeds from selling any items produced when bringing the asset to its location and condition.
The standard also states that income and related expenses of operations that are incidental to the construction or development of an item of property, plant and equipment should be recognised in profit or loss.
The following costs will not be part of the cost of property, plant or equipment unless they can be attributed directly to the asset's acquisition, or bringing it into its working condition.
Administration and other general overhead costs Start-up
Initial operating losses before the asset reaches planned performance All of these will be recognised as an expense rather than an asset.
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6: Accounting for non-current assets PART B SINGLE COMPANY FINANCIAL ACCOUNTSIn the case of self-constructed assets, the same principles are applied as for acquired assets. If the entity makes similar assets during the normal course of business for sale externally, then the cost of the asset will be the cost of its production under IAS 2 Inventories. This also means that abnormal costs (wasted material, labour or other resources) are excluded from the cost of the asset. An example of a self- constructed asset is when a building company builds its own head office.
1.3.2 Exchanges of assets
IAS 16 specifies that exchanges of items of property, plant and equipment, regardless of whether the assets are similar, are measured at fair value, unless the exchange transaction lacks commercial substance or the fair value of neither of the assets exchanged can be measured reliably. If the acquired item is not measured at fair value, its cost is measured at the carrying amount of the asset given up.
1.3.3 Subsequent expenditure
Subsequent expenditure can be recognised when
(a) It is probable that future economic benefits associated with the asset will flow to the entity (b) The cost of the asset to the entity can be measured reliably
Expenditure incurred in replacing or renewing a component of an item of property, plant and equipment must be recognised in the carrying amount of the item. The carrying amount of the replaced or renewed component must be derecognised. If part of an item of property, plant and equipment is depreciated separately, when it is replaced, the new part is treated as an acquisition and the replaced part is treated like a disposal.
A similar approach is also applied when an item of property, plant and equipment, such as an aircraft, has to undergo a major inspection to enable the continued use of the item, 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 (eg to the previous inspection) if the recognition criteria are met. Any remaining carrying amount of the previous inspection is
derecognised. This occurs regardless of whether the cost of the previous inspection was identified in the transaction in which the item was acquired or constructed.
Repairs and maintenance costs should be recognised as an expense when they are incurred.
1.4 Measurement subsequent to initial recognition
IAS 16 allows two possible treatments here, a choice between keeping an asset recorded at cost or revaluing it to fair value.
(a) Cost model. Carry the asset at its cost less accumulated depreciation and any accumulated impairment losses.
(b) Revaluation model. Carry the asset at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses. The revised IAS 16 makes clear that the revaluation model is available only if the fair value of the item can be measured reliably. Revaluations are considered below.
1.5 Depreciation
The need to depreciate non-current assets arises from the accruals assumption. If money is expended in purchasing an asset then the amount expended must at some time be charged against profits. If the asset is one which contributes to an entity's revenue over a number of accounting periods it would be
inappropriate to charge any single period (eg the period in which the asset was acquired) with the whole of the expenditure. Instead, some method must be found of spreading the cost of the asset over its useful economic life.
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1.5.1 Requirements of IAS 16 for depreciation
IAS 16 requires the depreciable amount of a depreciable asset to be allocated on a systematic basis to each accounting period during the useful life of the asset. Depreciable amount is the cost or valuation of the asset less its residual value. If the residual value is greater than the carrying amount of the asset, then the depreciation charge is zero.
One way of defining depreciation is to describe it as a means of spreading the cost of a non-current asset over its useful life, and so matching the cost against the full period during which it earns profits for the business.
There are situations where, over a period, an asset has increased in value, ie its current value is greater than the carrying value in the financial statements. You might think that in such situations it would not be necessary to depreciate the asset. The standard states, however, that this is irrelevant, and that
depreciation should still be charged to each accounting period, based on the depreciable amount, irrespective of a rise in value.
An entity is required to begin depreciating an item of property, plant and equipment when it is available for use and to continue depreciating it until it is derecognised even if it is idle during the period. Some assets require routine repairs and maintenance, however, depreciation should still be charged on these assets.