IAS 16: PROPERTY, PLANT AND EQUIPMENT
IAS 16 establishes principles for recognising property, plant and equipment as assets, measuring
their carrying amounts, and measuring the depreciation charges and impairment losses to be
recognised in relation to them.
Property, plant and equipment are tangible non- current assets that include the following: land,
buildings, machinery, vehicles, fixtures, fittings, furniture etc.
Non- current assets are classified as property, plant and equipment if they meet the following
criteria:
1. are held for use in the production or supply of goods or services, for rental to others, or for
administrative purposes; and
2. are expected to be used during more than one period.
Important definitions relating to IAS 16
1. COST: Cost includes:
its purchase price, including import duties and non-refundable purchase taxes, after deducting
trade discounts and rebates;
any costs directly attributable to bringing the asset to the location and condition necessary for
it to be capable of operating in the manner intended by management. Directly attributable
costs include:
o costs of employee benefits arising directly from the construction or acquisition of the
item of PPE
o costs of site preparation
o initial delivery and handling costs
o installation and assembly costs
o the cost of testing whether the asset is functioning properly, and
o professional fees.
the estimated costs of dismantling and removing the item and restoring the site on which it is
located.
2. DEPRECIATION:
IAS 16 defines depreciation as ‘the systematic allocation of the depreciable amount of an
asset over its useful life’.
The ‘depreciable amount’ is the cost of an asset or other amount substituted for cost (for
example the fair value of an asset following a revaluation), less its residual value. i.e.
depreciable amount = cost/ fair value following revaluation – residual/ scrap value
By providing for depreciation, an entity will be following the accruals/ matching concept
which requires that revenue for a particular period is matched against expenditure for that
period.
The depreciable amount of PPE is spread over the period of useful life of the PPE item in
recognition of the fact that it will be earning revenue throughout its useful life.
IAS 16 requires that depreciation should be recognised as an expense in the statement of
profit or loss.
A number of methods can be used to allocate depreciation to specific accounting periods.
Two of the more common methods, specifically mentioned in IAS 16, are the straight-line
method, and the reducing (or diminishing) balance method.
3. CARRYING AMOUNT:
This is the net book value of PPE, i.e.
Carrying amount = Cost/ Fair value following a revaluation – Accumulated depreciation –
Impairment loss.
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Causes of depreciation
3. wear and tear
4. erosion, rot, rust and decay
5. obsolescence (outdated)
6. passage of time for assets with a legal lifespan eg patents, leases etc.
7. depletion due to extraction of raw materials e. land for mining, oil rigs etc.
Reasons for providing depreciation
Prudence concept: Profit will be overstated if depreciation is not charged against income during
an accounting period.
Matching concept: Depreciation is an expense and must be properly matched against income
generated during a financial year.
Methods of calculating depreciation
Straight line method
According to this method depreciation is calculated as a fixed percentage on cost.
It is mostly used for non-current assets such as fixtures & fittings which are consistently
used over their useful life.
Under this method depreciation can also be calculated using the following formula.
(𝐂𝐨𝐬𝐭 − 𝐑𝐞𝐬𝐢𝐝𝐮𝐚𝐥 𝐕𝐚𝐥𝐮𝐞)
Depreciation = 𝐔𝐬𝐞𝐟𝐮𝐥 𝐥𝐢𝐟𝐞
The residual value of a non-current asset is the estimated amount that an entity would obtain from
the disposal of the asset.
Advantages of straight line depreciation method
It is simple to understand and apply.
Asset value can be made zero value at the end of useful life.
The asset value can be completely written off using this method.
It is useful for those assets whose usage is made on a constant basis and the useful life of the asset
can be determined easily.
It is easier to compare profits as an equal amount of depreciation is charged every year.
Disadvantages of straight line depreciation method
- Does not reflect accurately the difference in usage of an asset from one period to the other
- Does not necessary match costs with revenues in different types of long-term assets
- Might not be appropriate for some depreciable assets due to rapidly developing technology, such as
computers
Reducing balance method
According to this method depreciation is a fixed percentage on its net book value
each year.
It is mostly used for machinery since it produces more during its first years of trading.
e.g. A machine was bought on 1 January 2010 for $100 000 and is to be depreciated
at 20% reducing balance method.
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$
Cost 1st January 2010 100 000
Depreciation for the year 2010
20/100 * 100 000 20 000
Net book value 2010 80 000
Depreciation for the year 2011
20/100 * 80 000 16 000
Net book value 2011 64 000
Advantages of the Diminishing Balance method:
This method is considered relevant for income tax purposes.
Under this method of depreciation, higher depreciation is calculated in the initial years with
matching revenue generated during the initial years. Similarly, when the asset becomes less
productive at the end of its useful life, the depreciation charged is less.
Limitations of Diminishing Balance method:
The assets cannot be completely written off using the diminishing balance method.
The rate of depreciation cannot be determined appropriately.
The actual use of assets is not taken into account.
Revaluation method
According to this method, depreciation is the difference between the value at start and the
value at end.
This method is appropriate for businesses that have many small items of non-current assets
(example loose tools).
Depreciation = Balance at start + acquisition – disposal – Balance at end
Double entry for depreciation
Transaction Account debited Account credited
Purchase of asset (at cost) Asset Cash, Bank, Creditor
Disposal of asset (at cost) Asset Disposal Asset
Accumulated depreciation of Asset provision for Asset disposal
disposed asset depreciation
Depreciation charge for the year Profit and Loss Asset provision for
depreciation
Proceeds from asset disposal (at Bank, Cash, Debtor Asset disposal
selling/ disposal price)
Asset traded in (at trade in value) Asset account Asset Disposal account
Profit on disposal (balancing figure Asset disposal Profit and loss
in disposal account)
Loss on disposal (balancing figure in Profit and loss Asset diposal
disposal account)
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Presented in ledger format
ASSET ACCOUNT
DR CR
ITEM DETAILS ITEM DETAILS
OPENING BALANCE BALANCE DISPOSED ASSET ASSET DISPOSAL
B/D (AT COST)
PURCHASE OF ASSETS CASH, CLOSING BALANCE BALANCE C/D
(AT COST) BANK,
CREDITOR
ASSET TRADED IN ASSET
(@TRADE IN VALUE) DISPOSAL
ASSET PROVISION FOR DEPRECIATION ACCOUNT
DR CR
ITEM DETAILS ITEM DETAILS
ACCUMULATED ASSET OPENING BALANCE BALANCE B/D
DEPRECIATION OF DISPOSAL
DISPOSED ASSET
CLOSING BALANCE BALANCE DEPRECIATION PROFIT & LOSS
C/D CHARGE FOR THE
YEAR
ASSET DISPOSAL ACCOUNT
DR CR
ITEM DETAILS ITEM DETAILS
ASSET AT COST ASSET ACCUMULATED ASSET PROVISION
(NAME) DEPRECIATION FOR
DEPRECIATION
PROFIT ON DISPOSAL PROFIT PROCEEDS FROM CASH/ BANK/
(BALANCING FIGURE) AND LOSS DISPOSAL DEBTOR
ASSET TRADED IN ASSET ACCOUNT
(@TRADE IN VALUE)
LOSS ON DISPOSAL PROFIT AND LOSS
(BALANCING
FIGURE)
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