Property,Plant & Equipment (IAS -16)

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Subsequent Measurement

Subsequent to initial recognition IAS-16 permits an entity to adopt either the cost model or the revaluation model as its accounting policy

Cost Model requires that, after initial recognition PPE should be carried at cost less accumulated depreciation and accumulated Impairment losses.

Revaluation model requires that, subsequent to initial recognition PPE whose fair value can be reliably measured should be carried at a revalued amount, being fair value and the date of revaluation less subsequent accumulated deprecation and any subsequent accumulated impairment loss.

IAS-16 requires that if a single item of PPE is revalued then the entire class of PPE has to be revalued although policy need not to be applied to all classes.

Example:- Entity A, has number of industrial building and official building in several capital cities. Management wants to apply revaluation model on office building and cost model or industrial building.

In the IAS-16, Management can apply different model to different set of buildings because there function, nature and general location all are different.

Separate disclosure of the two classes must be given.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Frequency of Valuation

One of the requirements of IAS 16 is that valuation should remain up-to-date, as old valuation that do not reflect current values are meaningless.

IAS-16 does not specifically requires valuations to be performed every year, if values have not materially changed from one year to the next. There is no specific time interval for valuation but provides a practical rule that the interval is determined by the movements in fair value

Where fair values are volatile, such as is often the case with land and buildings, frequent revaluation may be necessary.

Where fair values are stable over a long period, such as is often the case with plant and machinery, valuation may be required less frequency.

Where significant and volatile movement, the standard suggest that annual revaluation may be needed. In the other case, where movements in fair value are insignificant, revaluation every three or five year may be sufficient.

In making the judgment, management would probably consult their valuers for changes in general market, the condition of the asset, changes to the asset and its location.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Valuers

Valuation of land and buildings is normally undertaken by professionally qualified valuer. A qualified valuer would normally be a person who :-

§ Holds a recognised and relevant professional qualification

§ Has recent relevant post – qualification experience.

§ Has sufficient knowledge of the state of the market in the location and category of the asset being valued

Normally, valuer would be independent of the entity (external valuer), but internal valuers might also be used.

For example :- an entity might have a policy of commissioning external valuations every three years, with a review by internal valuers each year.

An internal valuer would normally be a director, officer or employee of the entity. In contrast and external valuer should not be a director officer or employee of the entity, nor have a significant financial interest in the entity.

Market value will reflect the highest and best use of the assets, which will usually be its existing use but may be for some other use.

For example :- An entity owns a land in a city centre on which it has a warehouse, the site have a potential for residential development, due to market value can increase significantly. In that case cost of the land will be residential cost instead of warehouse cost.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Bases of valuation

If a policy of revaluation is adopted the basis of valuation is used is fair value.

The fair value of land and buildings is usually determined from market based evidence by an appraisal that is normally undertaken by a qualified valuer. The fair value of plant and equipment is usually a market value of the item determined by appraisal.

Where there is no market based evidence or fair value, because of the specialised nature of item of PPE and because the items are rarely sold except as part of a continuing business, they are valued using an income or a replacement cost approach.

When second hand PPE is sold due to business closure and the market value achieved for the pant and equipment is often far below what its value would be in a continuing operation. There fore, plant and equipment will often be valued on a depreciated replacement cost basis.

Specialised property is defined by International Valuation Standard Committee (IVSC), a property that is rarely, if ever, sold in the market, except by way of sale of the business or entity of which its part, due to uniqueness arising from its specialised nature and design its configuration, size location or otherwise.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Depreciated Replacement Cost (DRC)

Depreciated replacement cost (DRC) :- DRC is the basis of valuation used for specialised items of PPE, as there is no means of ascertaining a market value for such assets.

According to IVSC “…The current cost of reproduction or replacement of an asset less deductions for physical deterioration and all relevant forms of obsolescence and optimisation”

Specialised property might include :-

§ Oil refineries and chemical works

§ Power station and dock installations

§ Standard property of abnormal size in particular geographic areas that are isolated

§ School, colleges, Museums, libraries, hospital, and research centre

Where suitable market is not available, PPE and other non-property assets are also normally valued on a DRC basis.

DRC of an asset, account should be taken of the age, condition, economic and functional obsolescence and environmental and other factors including residual value at the end of the asset’s useful life.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Treatment of Depreciation in revalued Assets

When an item of PPE is revalued, IAS-16 requires that accumulated depreciation is treated in one of two ways :

§ Eliminated against the gross carrying amount of the asset with the net amount restated to equal the revalued amount. This method is normally used for building.

§ Restated proportionately with the change in the gross carrying amount of the asset such that the net book value of the asset after revaluation equals its revalued amount. This method is often used where an asset is revalued using an index to its DRC.

The amount of the adjustment to accumulated depreciation forms part of the revaluation increase or decrease, which is dealt with “ Revaluation gain and losses”.

Example:- PPE at Cost :- $ 1,000 Accumulated Depreciation :- $ 400

Net book value :- $ 600 Asset is revalued at $ 1,500

PPE Revalued Cost :- $ 1500 Increase on Revaluation :- $ 500

Accumulated Depreciation :- 400 Increase on Revaluation :- $ 400

Accumulated Depreciation after revaluation :- 0

Increase on Revaluation gain is $ 900

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Revaluation Gains and Losses

Example:- Entity A, has a policy of revaluing its PPE. An asset cost of $ 1000 at the start of year 1. It has a useful life of 10 years and being depreciated on SLM to nil residual value. It was revalued downwards at the end of year 1 to $ 850. which was assumed to be asset’s recoverable amount. The loss on revaluation in year 1 is recognised in the profit and loss account, because it is fall in value below depreciated historical cost.

At the end of the following year (year 2) market value had risen to $ 1,050.

Year-1 Year-2

Cost. Valuation brought forward 1,000 850

Depreciation charge 100 94

Balance 900 756

(Loss)/ gain on revaluation – P/L A/c (50) 44

Gain on Revaluation – to revaluation surplus ---- 250

Carrying amount carried forward 850 1050

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Depreciation

IAS-16 states that the depreciable amount of an asset should be allocated on a systematic basis over its useful life.

The method of depreciation that is used should reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity.

Depreciation charges should be recognised as an expense unless they are included in the carrying amount of another asset.

Depreciation applies to all PPE whether held at historical cost or revalued amount with two exceptions :-

§ Investment properties carried as a matter of policy at fair value in accordance with IAS-40 “ Investment Property” which is not depreciated.

§ Land, where it can be demonstrated that the asset has an unlimited useful life.

Economic benefits are consumed mainly through the use of an asset.

However, other factors, such as technical obsolescence, wear and tear, asset remain idle may reduce the economic benefits.

Another factor that might reduce the expected economic benefit is a fall in demand for, or price of, the product produced by the asset.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Methods of Depreciation

IAS-16 notes that there is a variety of acceptable depreciation methods. Some of the most common methods are :-

§ Straight – line Method

§ Diminishing Balance Method

§ Sum of the digits ( or rule of 78)

§ Sum of units (unit of production) method

§ Annuity Method or Reverse declining method

IAS-16 requires that where an entity revalues assets, and gives effect to the revaluation in its financial statements, the depreciation charge should be recognised as an expense.

No, depreciation previously charged should be written back to the profit and loss account on revaluation of an asset.

IAS-16 states also that a depreciation charge is made even if the value of an asset exceed its carrying amount.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Component Depreciation

IAS 16 requires that each part of an item of PPE that has a significant cost when compared to the total cost of the item, should be depreciated separately.

IAS-16 states that an infrastructure asset cannot be accounted for as one asset. The asset must be allocated to its significant parts – even if the depreciation charges for each part are the same.

The factors below provide guidance on how to determine the significant parts of an infrastructure asset to arrive at a reasonable allocation.

§ The cost of the asset and materiality

§ Management’s operational decisions

§ Physical location of the asset

§ Design and flow characteristics

The infrastructure asset is physical asset with a finite life. The useful life should be determined on a significant part basis and will be a matter of judgment. Repair and maintenance may be extend the useful life of the asset from say, 50-100 years, but at some stage in the future it will need to be replaced. Hence there must be a depreciation charge.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Changes in estimates

Change in estimate of Useful life :- IAS-16 requires that the useful lives of PPE should be reviewed at least at each year end and, if expectations are different from previous estimates, the change should be accounted for as a change in estimate. Effect of a change in estimated useful life should be accounted for by adjusting the depreciation charge for the current period insofar as the change affects the current period and by adjusting the charge for future periods to the extent that it affects the future period

Change in estimate of residual value :- IAS-16 requires that the residual values should be reviewed at least at each year end. Reviews of residual value would take account, for example of reasonably expected technological changes, and of price change and inflation since the last balance sheet date. If expectation differ from previous estimates the change should be accounted for in the same way as change in useful lives.

Change in method of Depreciation :- The depreciation method applied to an asset should be reviewed at each year end and, if there has been significant change in the expected patter of consumption of the assets future economic benefits. And it also accounted for in the same way as change in useful lives.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Impairment of PPE

An entity should assess each year whether there is any indication that an asset is impaired. If such indication exists the entity should estimate the asset’s recoverable amount. If the recoverable amount is below the carrying amount, the asset should be written down to its recoverable amount

Example:- Entity A, made acquisition during the year. The acquired entity has a large computer system that the acquirer now intends to replace in a few years time. The fair value of the computer has been based on DRC. Within in the context of the CGU, there is no impairment. Management agrees that the decision to replace the equipment is a post- acquisition decision but would like to charge additional depreciation immediately. Can it do this if the CGU is not impaired ?

The decision is post- acquisition decision, therefore, no impairment provision to be made in the fair value exercise.

Further more, there is no immediate impairment even after the decision has been made because future cash flows of the CGU support the carrying value of its assets.

However, as the decision has been made to scrap the equipment in a few years, the carrying value should now be depreciated in the post- acquisition income statement over its revised, shorter, useful life.

IAS-16 requires the residual value and useful life to be reviewed at least at each F.Y end. If its revised, the change should be accounted for as a change in an accounting estimate – that is, the effect of the change should be recognised in the depreciation charge in the current and future period

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Compensation for Impairment

IAS -16 deals with how to account for the receipt of monetary and non-monetary compensation from third parties for the impairment of items of PPE. It states that compensation from third parties should be included in Profit or loss when it becomes receivable. Reimbursement might take a number of different forms :

§ Reimbursement by insurance companies

§ Indemnities from govt for expropriation of assets or for compulsory purchase of land

§ Compensation for compulsory relocation of PPE

§ Physical replacement in whole or in part of an impaired or lost asset

Example:- Entity A carried PPE in its books at $ 1M. These were destroyed in a fire. The assets were insured “new for old” and were replaced by the insurance company with the new machines that cost $ 5M. The machines were acquired by the insurance company and the company did not receive the $5M for their purchase

Entity A should account for loss in the Income statement on derecognition of the carrying value of PPE.

Separately recognise a receivable and gain in the income statement resulting from the insurance proceeds under IAS-37 once the proceeds are virtually certain.

The receivable should be measured at the fair value of the assets that will be provided by the insurer.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Derecognition of PPE

An item of PPE should be derecognised when :

§ Its disposed of

§ No future economic benefits are expected from its use or disposal

Gain or loss on derecognition of an item of PPE is the difference between the estimated net disposal proceeds and the carrying amount.

The consideration receivable is recognised at fair value. Therefore, if payment is deferred the consideration is recognised at the cash price equivalent. The difference between this figure and actual receivable is treated as interest receivable under IAS-18 over the period of credit given.

The gain or loss on derecognition should be recognised in the income statement for the period in which derecognition occurs.

The only exception is “Leases” requires a different treatment on a sale and leaseback. Gain and loss should not be recognised as revenue. Where items of income and expense are material, the nature and amount of the item should be disclosed separately.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Difference between IGAAP & IFRS

IFRS	Indian GAAP
IAS-16 mandates component accounting.	AS 10 recommends but does not force component accounting.
Depreciation is based on useful life.	Depreciation is based on higher of useful life or Schedule XIV rates.
Major repairs and overhaul expenditure are capitalized as replacement if it satisfies recognition criteria.	Major repair and overhaul expenditure are expensed.
Under IAS 16, if subsequent costs are incurred for replacement of a part of an item of fixed assets, such costs are required to be capitalized and simultaneously the replaced part has to be de-capitalized regardless of whether the replaced part had been depreciated separately.	AS 10 provides that only that expenditure which increases the future benefits from the existing asset beyond its previously assessed standard of performance is included in the gross book value, e.g. an increase in capacity. There is no requirement as such for decapitalising the carrying amount of the replaced part under AS 10.