IAS 16, PROPERTY, PLANT AND EQUIPMENT

The accounting for International Accounting Standard (IAS ®) 16, Property, Plant
and Equipment is a particularly important area of the Financial Reporting syllabus.
You can almost guarantee that in every exam you will be required to account for
property, plant and equipment at least once.

This article is designed to outline the key areas of IAS 16, Property, Plant and
Equipment that you may be required to attempt in the Financial Reporting exam.

IAS 16, Property, Plant and Equipment overview

There are essentially four key areas when accounting for property, plant and
equipment that you must ensure that you are familiar with:

 initial recognition
 depreciation
 revaluation
 derecognition (disposals).

Initial recognition

The basic principle of IAS 16 is that items of property, plant and equipment that
qualify for recognition should initially be measured at cost.

One of the easiest ways to remember this is that you should capitalise all costs to
bring an asset to its present location and condition for its intended use.

Commonly used examples of cost include:

 purchase price of an asset (less any trade discount)

 directly attributable costs such as:
 cost of site preparation
 initial delivery and handling costs
 installation and testing costs
 professional fees
 the initial estimate of dismantling and removing the asset and restoring the
site on which it is located, to its original condition (ie to the extent that it is
recognised as a provision per IAS 37, Provisions, Contingent Assets and
Liabilities)
 Borrowing costs in accordance with IAS 23, Borrowing Costs.

Subsequent costs
Once an item of PPE has been recognised and capitalised in the financial statements,
a company may incur further costs on that asset in the future. IAS 16 requires that
subsequent costs should be capitalised if:
  future economic benefits associated with the extra costs will flow to the entity
 The cost of the item can be reliably measured and is relevant to the
recognition and faithful presentation in the financial statements.
All other subsequent costs should be recognised as an expense in the income
statement in the period that they are incurred.

Depreciation

Depreciation is defined in IAS 16 as being the systematic allocation of the depreciable

amount of an asset over its useful life. In other words, depreciation applies the
accruals concept to the capitalised cost of a non-current asset and matches this cost
to the period that it relates to.

Depreciation methods

There are many methods of depreciating a non-current asset with the most common
being:

 Straight line

 % on cost, or
 Cost – residual value divided by useful life

 Reducing balance
 % on carrying amount

Useful life and residual value

IAS 16 requires that these estimates be reviewed at the end of each reporting period.
If either changes significantly, the change should be accounted for over the useful life
remaining.

Component depreciation

If an asset comprises two or more major components with different useful lives, then
each component should be accounted for separately for depreciation purposes and
depreciated over its own useful life.

Revaluations
This is an important topic in the exam and features regularly in Question 2, so you
should ensure that you are familiar with all aspects of revaluations.

IAS 16 rules

IAS 16 permits the choice of two possible treatments in respect of property, plant and
equipment:
  The cost model (carry an asset at cost less accumulated
depreciation/impairments).
 The revaluation model (carry an asset at its fair value at the revaluation date
less subsequent accumulated depreciation impairment).

If the revaluation policy is adopted this should be applied to all assets in the entire
category, ie if you revalue a building, you must revalue all land and buildings in that
class of asset. Revaluations must also be carried out with sufficient regularity so that
the carrying amount does not differ materially from that which would be determined
using fair value at the reporting date.

Accounting for a revaluation

There are a series of accounting adjustments that must be undertaken when

revaluing a non-current asset. These adjustments are indicated below.

The initial revaluation

You may find it useful in the exam to first determine if there is a gain or loss on the
revaluation with a simple calculation to compare:

Carrying amount of non-current asset at revaluation date X

Valuation of non-current asset X
Difference = gain or loss revaluation X

Revaluation gains

A gain on revaluation is always recognised in equity, under a revaluation reserve

(unless the gain reverse’s revaluation losses on the same asset that were previously
recognised in the income statement – in this instance the gain is to be shown in the
income statement).

The revaluation gain is known as an unrealised gain which later becomes realised
when the asset is disposed of (derecognised).

Double entry:

 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)

Revaluation losses

A revaluation loss should be charged against any related revaluation surplus to the
extent that the decrease does not exceed the amount held in the revaluation surplus
in respect of the same asset. Any additional loss must be charged as an expense in the
statement of profit or loss.

Double entry:

 Dr Revaluation reserve (to maximum of original gain)

 Dr Income statement (any residual loss)
 Cr Non-current asset (loss on revaluation)

Depreciation

The asset must continue to be depreciated following the revaluation. However, now
that the asset has been revalued the depreciable amount has changed. In simple
terms the revalued amount should be depreciated over the assets remaining useful
life.

Reserves transfer

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

Be careful, in the exam a reserves transfer is only required if the examiner indicates
that it is company policy to make a transfer to realised profits in respect of excess
depreciation on revalued assets. If this is not the case then a reserves transfer is not
necessary.

This movement in reserves should also be disclosed in the statement of changes in

equity.

Exam focus

In the exam make sure you pay attention to the date that the revaluation takes place.
If the revaluation takes place at the start of the year then the revaluation should be
accounted for immediately and depreciation should be charged in accordance with
the rule above.

If however the revaluation takes place at the year-end then the asset would be
depreciated for a full 12 months first based on the original depreciation of that asset.
This will enable the carrying amount of the asset to be known at the revaluation date,
at which point the revaluation can be accounted for.

A further situation may arise if the examiner states that the revaluation takes place
mid-way through the year. If this were to happen the carrying amount would need to
be found at the date of revaluation, and therefore the asset would be depreciated
based on the original depreciation for the period up until revaluation, then the
revaluation will take place and be accounted for. Once the asset has been revalued
you will need to consider the last period of depreciation. This will be found based
upon the revaluation rules (depreciate the revalued amount over remaining useful
life). This will be the most complicated situation and you must ensure that your
working is clearly structured for this; i.e. depreciate for first period based on old
depreciation, revalue, then depreciate last period based on new depreciation rule for
revalued assets.

Derecognition

Property, plant and equipment should be derecognised when it is no longer expected

to generate future economic benefit or when it is disposed of.

When property, plant and equipment is to be derecognised, a gain or loss on disposal

is to be calculated. This can be found by comparing the difference between:

Carrying amount X
Disposal proceeds X
Profit or loss on disposal X

Tip: When the disposal proceeds are greater than the carrying amount there is a
profit on disposal and when the disposal proceeds are less than the carrying amount
there is a loss on disposal.

Disposal of previously revalued assets

When an asset is disposed of that has previously been revalued, a profit or loss on
disposal is to be calculated (as above). Any remaining surplus on the revaluation
reserve is now considered to be a ‘realised’ gain and therefore should be transferred
to retained earnings as:

 Dr Revaluation reserve
 Cr Retained earnings

In summary, it can be seen that accounting for property, plant and equipment is an
important topic that features regularly in the Financial Reporting exam. With most
of what is examinable feeding though from the Financial Accounting exam, this
should be a comfortable topic that you can tackle well in the exam.

Yustino Nyendeza is a Senior Tutor at Step Ahead Financial Consultant