Chapter 8 HKAS 16 Property, Plant and Equipment

1.
1.1 1.2 1.3 1.$ 1.% 1."

Objectives
Define property, plant and equipment (). Explain all the cost elements and initial measurement of property, plant and equipment. Discuss the requirements of HK ! 1" in respect of the reco#nition criteria for property, plant and equipment. ccount for the exchan#e of assets. Discuss the accountin# treatment of re&aluation, diminution in carryin# &alue and depreciation of property, plant and equipment. Descri'e the disclosure requirements under HK ! 1".
!cope + D e fi n i ti o n

( e c o # n i ti o n

,n i ti a l ) easurem ent

! u'sequent E x p e n d i tu r e

E xchan#e o f s s e ts

! u'sequent ) easurem ent

D e p r e c i a ti o n

( e ti r e m e n t + D isp o sa ls

( e & a l u a ti o n s

* a rryin# m ount

2.
2.1

Scope and Definition

HK ! 1" addresses the follo-in# issues. (i) reco#nition criteria for property, plant and equipment/ (ii) costs -hich can 'e included in the &alue of a non0current asset/ (iii) exchan#e of assets/ (i&) transfer 'et-een different types of assets, e.#. 'et-een non0current assets and in&entories/ (&) re&aluation/
1201

2.2

2.3

(&i) accepta'le depreciation methods/ and (&ii) the accountin# treatment of diminution in &alue of assets. 3he !tandard does not apply to. (i) 'iolo#ical assets related to a#ricultural acti&ity (HK ! $1 4 #riculture5)/ or (ii) mineral ri#hts and mineral reser&es such as oil, natural #as and similar non0 re#enerati&e resources/ and Ho-e&er, the !tandard applies to property, plant and equipment used to de&elop or maintain the assets descri'ed a'o&e. DEFINI I!NS (a) Property, plant and equipment are tan#i'le assets that. (i) are held 'y an enterprise for u"e in the produ#tion or "upply o$ %ood" or "er&i#e", $or rental to other", or $or admini"trati&e purpo"e"/ and (ii) are expected to 'e u"ed durin# more than one period. Depre#iation is the systematic allocation of the deprecia'le amount of an asset o&er its estimated useful life. Depre#ia'le amount is the cost of an asset, or other amount su'stituted for cost in the financial statements, less its estimated residual &alue. (e"idual &alue is the net amount -hich the enterprise expects to o'tain for an asset at the end of its useful life after deductin# the expected costs of disposal. Fair &alue is the amount for -hich an asset could 'e exchan#ed 'et-een 6no-led#ea'le, -illin# parties in an arm7s len#th transaction. Carryin% amount is the amount at -hich an asset is included in the 'alance sheet after deductin# any accumulated depreciation and accumulated impairment losses. (e#o&era'le amount ( ) is the hi#her of an asset7s net sellin# price and its &alue in use.

2.$

(') (c) (d) (e) (f)

(#)

3.
3.1

Recognition of Property, Plant and Eq ip!ent

(EC!)NI I!N C(I E(IA HK ! 1" states that an item of property, plant and equipment should 'e re#o%ni*ed as an asset in the 'alance sheet -hen. (i) it is pro'a'le that $uture e#onomi# 'ene$it" associated -ith the asset -ill $lo+ to the enterpri"e (satisfied -hen ris6s and re-ards ha&e passed to enterprise)/ and
1202

(ii) 3.2

the #o"t of the asset to the enterprise can 'e mea"ured relia'ly.

3.3

3he $ir"t #riterion is satisfied -hen there is a hi#h de#ree of certainty attached to the flo- of future economic 'enefits at the time of the initial reco#nition. ,t is "ati"$ied #enerally +hen the ri"," and re+ard" in#ident to the o+ner"hip o$ the a""et ha&e pa""ed to the entity. 3he "e#ond #riterion is easily "ati"$ied for items of property, plant and equipment a#quired $rom the mar,et 'ecause of the existence of an external transaction. 8or internally #on"tru#ted items of property, plant and equipment, a relia'le mea"urement of the costs in#urred in the #on"tru#tion is also often readily a&aila'le.

".
$.1

#o!ponent of #ost
C!-P!NEN !F C!S ./ P0(CHASE 3he cost of an item of property, plant and equipment comprises. (i) its pur#ha"e pri#e, includin# import duties and non0refunda'le purchase taxes, after deductin# trade discounts and re'ates/ (ii) any #o"t" dire#tly attri'uta'le to 'rin%in% the a""et to the lo#ation and #ondition necessary for it to 'e capa'le of operatin# in the manner intended 'y mana#ement/ and (iii) the initial e"timated o$ the #o"t" o$ di"mantlin% and remo&in% the item and re"torin% the "ite on +hi#h it i" lo#ated , the o'li#ation for -hich an entity incurs either -hen the item is acquired or as a consequence of ha&in# used the item durin# a particular period for purposes other than to produce in&entories durin# that period.

$.2

$.3

,n most cases, the purchase price is easily determina'le, #i&en that there is a purchase transaction. Ho-e&er, -here the purchase price is not quoted or paya'le in cash, 4cash price equi&alent5 of the purchase price -ould 'e rele&ant. 9here items of property, plant and equipments are purchased and to 'e paid for 'eyond normal #redit term", the concept of 4#a"h pri#e equi&alent5 should a#ain 'e used. 3he cash price equi&alent -ill 'e equal to the pre"ent &alue o$ the #a"h payment". 3he di$$eren#e 'et+een the #a"h pri#e equi&alent and the total payment is reco#nised a" intere"t co&er the period of credit unless such interest is reco#nised in the carryin# amount of the item in accordance -ith the allo-ed alternati&e treatment
1203

$.$

$.%

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in HK ! 23 4:orro-in# *osts5. Dire#tly attri'uta'le #o"t", for example, are. (i) costs of employee 'enefits (as defined in HK ! 1; 4Employee :enefits5) arisin# from the construction or acquisition of the item of property, plant and equipment/ (i) the cost of site preparation for land/ (ii) initial deli&ery and handlin# costs for plant/ (iii) installation costs of plant/ (i&) professional fees such as for la-yers, architects and en#ineers/ and (&) costs of testin# -hether the asset is functionin# properly, after deductin# the net proceeds from sellin# any items produced -hile 'rin#in# the asset to that location and condition (such as samples produced -hen testin# equipment). 3he !tandard specifically pro&ides that the $ollo+in% are not the #o"t" o$ an item of property, plant and equipment. (i) costs of openin# a ne- facility/ (ii) costs of introducin# a ne- product or ser&ice/ (iii) costs of conductin# 'usiness in a ne- location or -ith a ne- class of customer/ and (i&) administration and other #eneral o&erhead costs. <and and 'uildin#s are usually purchased to#ether and the total cost must 'e apportioned 'et-een the land account and the 'uildin# account. !ometimes land and 'uildin#s are acquired to#ether -hen the purchaser7s real purpose is =ust to acquire the land. ,n this case the entire cost should 'e char#ed to the land account and the 'uildin#s are to 'e demolished. 3he cost of the demolition should 'e char#ed to the land as these costs are necessary to #et the asset into the desired condition. E1A-P2E 1 *ost of land may comprise. @urchase price of land and 'uildin#s (emo&al cost of existin# 'uildin#s ttorney7s fee :ro6er7s commission !tamp duty ? AA AA AA AA AA AA

$.>

120$

$.2

9hen machinery or equipment is purchased, the cost normally includes the purchase price, tax, frei#ht char#es and installation costs. 3he testin# cost should also 'e included in the purchase cost if the equipment needs to 'e tested 'efore proper operation. )oreo&er, any discount or re'ate should 'e deducted from the acquired cost. E1A-P2E 3 *ost of equipment may comprise. Bross in&oice price <ess. cash discount ,ncidental expenditures 8rei#ht char#es ,nstallation char#es 3estin# of installed equipment ,nsurance char#es ? AA AA ?

$.;

AA AA AA AA AA AA AA

$.1C

E1E(CISE 1 :* <td purchased a ne- machine durin# the year. 3he related costs -ere as follo-s. ?CCC <ist price 1CC ,nstallation costs 2C @re0production testin# 1C ,nsurance premium 2 9arranty 2 )aintenance 3 3he company recei&ed a 1CD trade discount on the list price and then a further 3D discount for payment on deli&ery. 3he supplier offers three months7 credit, 'ut :* <td chose to ta6e the settlement discount. 3he installation should ha&e cost of ?12,CCC 'ut :* <td -asted ?2,CCC on installin# the -ron# machine supports at first. 3he maintenance occurred after the start of production and -as required 'y the
120%

-arranty. :oth the -arranty and the insurance -ere for one year only. *alculate the initial cost at -hich :* <td should reco#niEe the machine. Solution4

$.11

,n the case of a self0constructed asset, a relia'le measurement of the cost should 'e made. *onstruction cost in#lude" the #o"t o$ ra+ material", #on"uma'le" and other dire#t #o"t" o$ produ#tion (such as la'our). ,n addition, a reasona'le proportion of indirect production costs and the intere"t on 'orro+ed #apital to $inan#e the produ#tion of that asset may 'e added, 'ut only in so far as they relate to the period o$ produ#tion. E1E(CISE 3 n entity started construction on a 'uildin# for its o-n use on 1 incurred the follo-in# costs. @urchase price of land !tamp duty <e#al fees !ite preparation and clearance )aterials <a'our (period 1 pril 2CC> to 1 Fuly 2CC2) rchitect7s fees Beneral o&erheads pril 2CC> and ?CCC 2%C,CCC %,CCC 1C,CCC 12,CCC 1CC,CCC 1%C,CCC 2C,CCC 3C,CCC %23,CCC 3he follo-in# information is also rele&ant.
120"

$.12

(a)

(')

(c)

)aterials costs -ere #reater than anticipated. Gn in&esti#ation, it -as found that materials costin# ?1C million had 'een spoiled and therefore -asted and a further ?1% million -as incurred as a result of faulty desi#n -or6. s a result of these pro'lems, -or6 on the 'uildin# ceased for a fortni#ht durin# Gcto'er 2CC> and it is estimated that approximately ?; million of the la'our costs relate to this period. 3he 'uildin# -as completed on 1 Fuly 2CC2 and occupied on 1 !eptem'er 2CC;.

(equired4 Hou are required to calculate the cost of the 'uildin# that -ill 'e included in tan#i'le non0current asset additions. Solution4

120>

$.13

E1E(CISE 5
ns-er the follo-in# questions -ith reference to HK ! 1" 4@roperty, @lant and Equipment5. (a) Explain. (i) (ii) (') the meanin# of property, plant and equipment and the criteria for reco#nition of property, plant and equipment as an asset/ and ($ mar6s) ($ mar6s) 3he follo-in# schedule of the mo&ement of plant has 'een drafted for Hanford <td the year to 31 Decem'er 2CC;. *ost ?7CCC :alance at 1 Fanuary 2CC; dditions at cost (note 1) Depreciation for the year Disposal (note 2) :alance at 31 Decem'er 2CC; 1otes. (1) 3he addition to plan is made up of the follo-in#. ?7CCC :asic list price of plant <ess. 3rade discount Early settlement discount (efunda'le sales tax ncillary costs. !hippin# and handlin# costs ,nstallation costs @re0production testin#
1202

ho- the initial cost of property, plant and equipment should 'e measured.

Depreciation ?7CCC "%C 3;".2

1,"2$ $"C (1CC) 1,;2$

1,C$".2

?7CCC

$2C ("3) (>) 3%C 1C.% $.% 1C 12.%

3hree0year maintenance contract !ite preparation cost Electrical ca'le installation *oncrete reinforcement G-n la'our costs 21 ".2% 11.2%

3$

32.% $"C

Hanford had incorrectly specified the po-er loadin# of the ori#inal electrical ca'le to 'e installed 'y the contractor. 3he company incurred ?;,%CC to correct this error/ this is included in the a'o&e fi#ure of ?21,CCC. 3he plant is expected to last for 1C years. t the end of this period compulsory costs of ?2C,CCC -ill 'e incurred to dismantle the plant and ?%,CCC to restore the site to its ori#inal condition. (2) 3he disposal fi#ure of ?1CC,CCC is the proceeds from the sale of an item of plant durin# the year. 3he plant had cost ?3CC,CCC on 1 Fanuary 2CC" and had 'een correctly depreciated prior to disposal. (3) Hanford char#es depreciation of 1CD per annum on the cost of plant held at the year end. (equired4 (i) (ii) *alculate the amount at -hich the initial cost of the addition to the plant should 'e measured. *alculate the accumulated depreciation on the plant disposed of. plant. ( dapted HK (1C mar6s) (1 mar6) (" mar6s) (3otal 2% mar6s) 3 @aper > d&anced ccountin# Decem'er 2CC2 *2)

(iii) @repare a corrected schedule of the mo&ements on the cost and depreciation of

Solution4

120;

1201C

6A7 $.1$

Su'"equent #o"t" fter the date of acquisitionIexchan#eIconstruction, additional (su'sequent) cost relatin# to property, plant and equipment -ill normally ha&e to 'e incurred. 8or example, after a motor &ehicle is acquired, cost on the replacement of motor oil and tyre, installation of air0conditionin# system, and ma=or o&erhaul mi#ht ha&e to 'e incurred. 3he 'asic question arises is -hether such cost should 'e reco#nised in the carryin# amount of the asset, or in profit or loss as an expense -hen incurred. ,n accordance -ith HK ! 1", circumstances in -hich "u'"equent e8penditure on those assets 'ein# #apitali*ed should depend on -hether the expenditure incurred -ill result in a pro'a'le $uture e#onomi# 'ene$it in e8#e"" o$ the amount ori%inally a""e""ed for the asset. ll other su'sequent expenditure should 'e reco#niEed in the income statement as it is incurred. Examples of circumstances -here su'sequent expenditure should 'e capitaliEed are. (i) modification to the asset enhances the production capacity of an asset. (ii) 3he up#radin# of an asset that -ill impro&e the quality of production or output. (iii) n impro&ement of the existin# production process -hich results in cost sa&in#s. (i&) ma=or component of an asset that has 'een treated separately is replaced or restored/ for example, ne- en#ines for a machine. (&) ma=or o&erhaul of an asset that restores its pre&ious life/ therefore, the consumption of the pre&ious economic 'enefits has 'een reflected 'y past depreciation char#es. Day-to-day servicing costs 3he !tandard pro&ides that an entity should not re#o%ni*e in the carryin# amount of an item of property, plant and equipment the #o"t" o$ the day9to9day "er&i#in% (often referred as 4repair and maintenance5) of the item. (ather, these costs are re#o%ni"ed in pro$it or lo"" as incurred. Major components requiring regular replacements @arts of some items of property, plant and equipment may require replacement at re#ular inter&als. 8or example, a furnace ( ) may require relinin# after a specified num'er of hours of use, or aircraft interiors such as seats and #alleys may require replacement se&eral times durin# the life of the airframe. ,tems of property, plant and equipment may also 'e acquired to ma6e a less frequently recurrin# replacement, such
12011

$.1%

$.1"

(a) $.1>

(b) $.12

$.1;

as replacin# the interior -alls of a 'uildin#, or to ma6e a non0recurrin# replacement. Jnder the #eneral reco#nition principle, an entity reco#nises in the carryin# amount of an item of property, plant and equipment the #o"t o$ repla#in% part of such an item -hen that cost is incurred i$ the re#o%nition #riteria are met. 3he carryin# amount of those parts that are replaced is dereco#nised in accordance -ith the dereco#nition pro&isions. Major inspections or overhauls () condition of continuin# to operate an item of property, plant and equipment (for example, an aircraft) may 'e performin# re#ular ma=or inspections for faults re#ardless of -hether parts of the item are replaced. 9hen each ma=or inspection is performed, its cost is reco#nised in the carryin# amount of the item of property, plant and equipment as a replacement if the reco#nition criteria are satisfied. ny remainin# carryin# amount of the cost of the pre&ious inspection (as distinct from physical parts) is dereco#nised. 3his occurs re#ardless of -hether the cost of the pre&ious inspection -as identified in the transaction in -hich the item -as acquired or constructed. ,f necessary, the estimated cost of a future similar inspection may 'e used as an indication of -hat the cost of the existin# inspection component -as -hen the item -as acquired or constructed. E1A-P2E 5 Entity purchases a ne- ship for HK?$C million. 3his ship -ill 'e required to under#o a dry doc6 o&erhaul e&ery fi&e years to restore its ser&ice potential. t the time of purchase, the cost of the existin# inspection component, estimated 'y the cost of an inspection if it had 'een performed at the time of the purchase of the ship, -as HK?$ million. 3herefore, the cost of HK?3" million, excludin# the o&erhaul cost of HK?$ million, -ill 'e depreciated o&er the -hole estimated useful life of the ship, for example 3C years, resultin# in an annual depreciation char#e of HK?1.2 million. 3he cost on o&erhaul of HK?$ million -ill 'e depreciated o&er % years, resultin# in an annual depreciation of HK?C.2 million. ,n year " -hen a dry0doc6in# is carried out, the inspection expenditure is capitalised (assumin# that the reco#nition criteria are satisfied), -hich is then depreciated o&er the period of fi&e years to the next o&erhaul. ,f Entity is not a'le to estimate relia'ly the cost an existin# inspection -hen it acquired the ne- ship, the -hole of HK?$C million should 'e depreciated o&er 3C years.
12012

(c) $.2C

$.21

$.22

$.23

$.2$

E1E(CISE : ,n each of the follo-in# cases =ustify -hether or not the expenditure should 'e capitaliEed and 'e included in the carryin# amount of an item of property, plant and equipment. (a) ne- en#ine is fitted to a machine -hich -ill increase its production capacity from 1CC,CCC units a year to 1$C,CCC units a year. (') (eplacement of rottin# -indo-s in the head office. (c) (eplacement of an aircraft en#ine e&ery fi&e years. Solution4

$.
%.1

E%c&ange of 'ssets
9hen an item of property, plant and equipment is acquired in exchan#e for a non0 monetary asset, the cost of the asset acquired should 'e mea"ured 'a"ed on the $air &alue unless (a) the exchan#e transaction lac6s commercial su'stance or (') the fair &alue of neither the asset recei&ed nor the asset #i&en up is relia'ly measura'le. ,f an entity is a'le to determine relia'ly the $air &alue o$ either the a""et re#ei&ed or the a""et %i&en up, then the $air &alue o$ the a""et %i&en up is u"ed to mea"ure the #o"t o$ the a""et re#ei&ed unless the fair &alue of the asset recei&ed is more
12013

%.2

%.3

clearly e&ident. ,f an exchan#e la#," #ommer#ial "u'"tan#e or $air &alue #annot 'e mea"ured relia'ly, the acquired item in the exchan#e is not measured at fair &alue and is mea"ured at the #arryin% amount o$ the a""et %i&en up. E1A-P2E : ssume that *ity <td trades in the truc6 for an office equipment (a dissimilar item). t the time of the exchan#e, the truc6 has a 'oo6 &alue of ?%,CCC as follo-s. ? *ost of truc6 1C,CCC ccumulated depreciation %,CCC %,CCC ? *ost of ne- office equipment 3rade0in allo-ance for old truc6 *ash payment 1%,CCC %,%CC ;,%CC

%.$

3he trade0in &alue constitutes part of the sale price of the ne- office equipment and #enerates a #ain of ?%CC (?%,%CC K ?%,CCC). 3he fair &alue may refer to the cost of ne- office equipment in this case and the accountin# entries to record such an exchan#e -ould 'e. Dr. (?) 1%,CCC %,CCC *r. (?)

Gffice equipment ccumulated depreciation K truc6 *ash Bain on disposal of fixed assets 3ruc6

;,%CC %CC 1C,CCC

(.
".1

)eas re!ent after Recognition

fter reco#nition as an asset, an entity should choose either the cost model or the re&aluation model as its accountin# policy and should apply that policy to an entire class of property, plant and equipment.

1201$

6A7 ".2

Co"t model 6 7 Co"t -odel fter reco#nition as an asset, an item of property, plant and equipment should 'e carried at its #o"t le"" any a##umulated depre#iation and any a##umulated impairment lo""e".

6.7 ".3

(e&aluation model 6 7 (e&aluation -odel fter reco#nition as an asset, an item of property, plant and equipment -hose fair &alue can 'e mea"ured relia'ly should 'e carried at a re&alued amount, 'ein# its fair &alue at the date of the re&aluation le"" any "u'"equent a##umulated depre#iation and "u'"equent a##umulated impairment lo""e".

(a) ".$

Basis and frequency of valuation ,f re&aluation is adopted, the asset should 'e &alued at its fair &alue. 3he fair &alue of land and 'uildin#s is usually determined from mar,et9'a"ed e&iden#e 'y appraisal that is normally underta6en 'y professionally qualified &aluers, and the fair &alue of other items of property, plant and equipment is usually their mar6et &alue determined 'y appraisal. ,n compliance -ith the !tandard, items of property, plant and equipment that experience si#nificant and &olatile mo&ements in fair &alues -ould ha&e to 'e re&alued annually. Ho-e&er, for property, plant and equipment -ith only insi#nificant mo&ements in fair &alues, annual re&aluations -ould 'e unnecessary. ,nstead a re&aluation e&ery three or fi&e years may 'e sufficient. Item" +ithin a #la"" of property, plant and equipment should 'e re&alued "imultaneou"ly. lternati&ely, a class of assets may 'e re&alued on a rollin# 'asis, pro&ided that the re&aluation of the class of assets is completed -ithin a short period of time and that the indi&idual re&aluations are 6ept up to date. Accounting for revaluation (e&aluation surpluses or deficits are measured as the difference 'et-een the re&alued amounts and the carryin# amounts at the date of the &aluation.
1201%

".%

"."

(b) ".>

".2

".;

".1C

".11

".12

Jpon an initial re&aluation, an increase in net carryin# amount (re&aluation surplus) should 'e credited directly to equity under a separate headin#, 4 re&aluation "urplu" 6or re"er&e75, and a decrease in net carryin# amount (deficit on re&aluation) should 'e reco#nised in profit or loss. Ho-e&er, upon a su'sequent re&aluation, a re&aluation surplus should 'e reco#nised in profit or loss to the extent that it re&erses a re&aluation decrease in respect of the same asset pre&iously reco#nised in profit or loss. Gn the other hand, a deficit on re&aluation should 'e de'ited directly to the re&aluation reser&e to the extent that of any credit 'alance existin# in the re&aluation reser&e in respect of that (same) asset. ,t is important to note that the term 4that same asset5 refers to an indi&idual item of property, plant and equipment. portfolio approach to re&aluation is therefore precluded. 3o record the effects of the re&aluation, the !tandard pro&ides for t-o methods. (i) 'oth the #ross carryin# amount and the accumulated depreciation are restated proportionately in order to #i&e a net carryin# amount equal to the net re&alued amount. 3his method is often used -hen an asset is re&alued 'y means of applyin# an index to its depreciated replacement/ and (ii) the a##umulated depre#iation i" eliminated and the net re&alued amount is treated a" the ne+ %ro"" #arryin% amount. 3he #eneral accepted practice in Hon# Kon# is to use the second method. 3he rationale for this method is that after re&aluation, the asset is deemed to 'e a 4ne-5 asset. E1A-P2E ; ssume the follo-in#s. *ost of machine at 1.1.1;;$ Depreciation method (e&alued amount in 31.12.2CC3 ?2C,CCC !trai#ht line $C years ?12C,CCC

".13

".1$

3he accountin# entries to record the re&aluation -ould 'e. 31.12.2CC3 )achine ccumulated depreciation (?2C,CCCI$C x 1C)
1201"

Dr. (?) $C,CCC 2C,CCC

*r. (?)

sset re&aluation reser&e

"C,CCC

".1%

E1A-P2E 6 3he cost and fair &alue of land is #i&en as follo-s. *ost of land 8air &alue of land t 2CC2 t 2CC3 t 2CC$ Dr. (?m) 2CC2 <and (e&aluation reser&e 2CC3 @rofit and loss account (e&aluation reser&e <and 2CC$ <and (e&aluation reser&e @rofit and loss account 1CC 1CC 1C 1CC 11C "C %C 1C ?m 1CC 2CC ;C 1%C *r. (?m)

1ote that ?1Cm pre&iously 'een reco#niEed as an expense, is no- re&ersed. (c) ".1" Depreciation of revalued assets Depre#iation o$ (e&alued A""et" 3he deprecia'le amount of an item of property, plant and equipment for the purposes of depreciation is defined as its cost, or other amount su'stituted for cost, less its residual &alue. 3hus, +hen an a""et ha" 'een re&alued, the re&alued amount, instead of its cost, -ill $orm the 'a"i" $or #al#ulatin% the depre#ia'le amount. n annual re"er&e" tran"$er may 'e made (re&aluation reser&e to retained earnin#s)

1201>

$or e8tra depre#iation on the re&alued amount compared to cost (measured as the difference 'et-een depreciation char#e 'ased on re&alued amount and the char#e 'ased on historic cost). ,t depends on the company policy. Fournals Dr Depreciation char#e K @+< *r ccumulated depreciation (3he follo-in# is optional entries, depends on company policy) Dr (e&aluation reser&e *r (etained earnin#s ? A ? A

A A

".1> ".12

lso, the re"idual &alue of the asset should 'e re&ie+ed at lea"t at ea#h $inan#ial year9end. 3herefore, -hen an a""et is re&alued, the depre#ia'le amount ha" to 'e re#al#ulated, 'ased on the re&alued amount and the ne-ly estimated residual &alue. 3he ne- deprecia'le amount thus calculated is then allocated o&er the remainin# useful life of the asset. E1A-P2E < : <td 'ou#ht a 'uildin# at a cost of ?%,CCC,CCC. 3he 'uildin# -as expected to ha&e a useful life of %C years -ith no residual &alue, and -as depreciated usin# the strai#ht0line method. fter ten years, -hen the 'uildin# -as carried in the 'oo6s at ?$,CCC,CCC, it -as re&alued to its fair mar6et &alue of ?2,CCC,CCC. t the date of re&aluation, the 'uildin# -as estimated to ha&e another $C years of useful life and no residual &alue. ,n this case, the depreciation char#e for the 'uildin# for each of the next $C years -ould 'e ?2CC,CCC (?2,CCC,CCCI$C). 1ote that 'efore the re&aluation, the annual depreciation char#e for the 'uildin# for each of the first ten years had 'een ?1CC,CCC (?%,CCC,CCCI%C).

".1;

(d) ".2C

Disposals of revalued assets 3he re&aluation reser&e included in equity may 'e transferred directly to retained
12012

profits -hen the reser&e is realiEed. 3he reser&e may 'e realiEed on the retirement or disposal of the asset. Ho-e&er, part of the reser&e may 'e realiEed as the asset is used 'y the enterprise/ in such a case, the amount of the reser&e is the difference 'et-een depreciation 'ased on the re&alued carryin# amount of the asset and depreciation 'ased on the asset7s ori#inal cost. 3he transfer from re&aluation reser&e to retained profits is not made throu#h the profit and loss account. ".21 E1A-P2E 8 ssume the follo-in#s. *ost of machine at 1.1.1;;$ Depreciation method (e&alued amount in 31.12.2CC3 Disposed in 31.12.2CC$ 3he accountin# entries -ould 'e. 31.12.2CC3 )achine ccumulated depreciation (?2C,CCCI$C x 1C) ssets re&aluation reser&e Hear 2CC$ Depreciation ccumulated depreciation (?12C,CCCI3C) Dr. (?) $C,CCC 2C,CCC *r. (?) ?2C,CCC !trai#ht line $C years ?12C,CCC ?13C,CCC

"C,CCC

$,CCC $,CCC

1ote that additional ?2,CCC (?"C,CCCI3C) depreciation is char#ed to profit and loss account due to re&aluation. 3he re&aluation reser&e included in equity may 'e transferred directly to retained earnin#s (and is distri'uta'le) -hen the reser&e is realiEed. 3he accountin# entries on disposal -ould 'e. Dr. (?) 31.12.2CC$ ssets re&aluation reser&e (etained profits :an6
1201;

*r. (?)

2,CCC 2,CCC 13C,CCC

ccumulated depreciation )achine Bain on disposal of assets (e&aluation reser&e (etained profits

$C,CC 12C,CCC 1$,CCC %2,CCC %2,CCC

1ote that the total #ain on disposal of assets 'ased on the historical cost &alue should 'e ?>2,CCC (?%2,CCC L ?1$,CCC) and the assets re&aluation reser&e is realiEed on disposal of the asset.

*.
>.1

Depreciation
HK ! 1" does not "pe#i$y the u"e o$ any method in particular, 'ut states that the methods used should reflect the pattern in -hich the asset7s economic 'enefits are consumed 'y the entity. Deprecia'le amounts are allocated to accountin# periods usin# &arious systematic methods of allocation, of -hich the three most commonly used methods are. (i) 3he strai#ht line method, under -hich periodic depreciation is computed 'y di&idin# the deprecia'le amount of the asset 'y the expected num'er of accountin# periods durin# its useful life/ (ii) 3he reducin# 'alance method, under -hich periodic depreciation is computed as a constant proportion of the asset7s historical cost or su'stituted amount, less accumulated depreciation/ and (iii) 3he production or ser&ice output method, under -hich periodic depreciation is computed 'y reference to the use or output of the asset period 'y period. Gther methods include the sum of the years di#its method and the sin6in# fund and annuity methods, -hich include the imputed interest in the computations. E8ample" o$ depre#iation method" E1A-P2E = > -a#hine hour" method 6or output method7 3he useful life of a motor &ehicle is estimated to 'e 1CC,CCC miles, -ith a nil residual &alue at the end of this milea#e. 3he purchase cost of the &ehicle is ?"C,CCC. 3he depreciation char#es are as follo-s.
1202C

>.2

>.3

6A7 >.$

Hear 1 2

)ilea#e 3%,CCC 3C,CCC (3%,CCC 1CC,CCC) ?"C,CCC (3C,CCC 1CC,CCC) ?"C,CCC

Depreciation (?) M 21,CCC M 12,CCC

and so on in later years. >.% E1A-P2E 1? > Sum o$ the year di%it" method *ost of assets (esidual &alue Estimated useful life !um of year di#its. Depreciation, year 1 M $I1C (?1C,%CC K ?%CC) Depreciation, year 2 M 3I1C ?1C,CCC Depreciation, year 3 M 2I1C ?1C,CCC Depreciation, year $ M 1I1C ?1C,CCC ?1C,%CC ?%CC $ years $ L 3 L 2 L 1 M 1C $,CCC 3,CCC 2,CCC 1,CCC 1C,CCC

>."

3he depre#iation method applied to an asset "hould 'e re&ie+ed at lea"t at ea#h $inan#ial year9end. ,f there has 'een a si#nificant chan#e in the expected pattern of consumption of the future economic 'enefits em'odied in the asset, the method should 'e chan#ed to reflect the chan#ed pattern. 3he !tandard pro&ides that a chan#e in depreciation method should 'e accounted for as a chan#e in an accountin# estimate in accordance -ith the pro&isions of HK ! 2. Not to depre#iate frequently as6ed question is -hether there is a need to pro&ide for depreciation if the fair &alue of the asset concerned is #reater than its cost. 3his question arises 'ecause depreciation is often misconstrued as a &aluation process. ,t should 'e noted that depre#iation i" de$ined a" "imply a pro#e"" o$ allo#atin% the depre#ia'le amount o$ the a""et to the &ariou" a##ountin% period" durin% +hi#h the a""et i" u"ed to earn re&enue. ,t is not a process of accountin# for the chan#e in the &alue of assets.
12021

6.7 >.>

>.2

>.;

>.1C

>.11

>.12

,f the &alue of an asset is #reater than its cost (or net carryin# amount) and it is decided that the &alue of the asset 'e ta6en into account, then -hat needs to 'e done is a separate re&aluation exercise. fter the re&aluation exercise, depreciation -ould still ha&e to 'e accounted for to allocate the re&alued amount o&er the remainin# life of the re&alued asset. Ho-e&er, it is possi'le that, at a certain point in time, the residual &alue of the deprecia'le asset may 'e lar#er than its carryin# amount, such that the deprecia'le amount is Eero or ne#ati&e and therefore no depreciation is required. 3he a'o&e ar#ument is ta6en into account in the !tandard. 3he residual &alue of an asset may increase to an amount equal to or #reater than the asset7s carryin# amount. ,f it does, the asset7s depreciation char#e is Eero unless and until its residual &alue su'sequently decreases to an amount 'elo- the asset7s carryin# amount. nother ar#ument commonly used to support not to depreciate an asset is that if an entity has an effecti&e repair and maintenance policy, the useful life of the asset may 'e extended indefinitely andIor the residual &alue -ill increase. 3he !tandard specifically pro&ides that repair and maintenance of an asset do not ne#ate the need to depreciate it. 3hus, depreciation should 'e continued, not-ithstandin# an effecti&e repair and maintenance policy.

+.
6A7 2.1

,and and - ildings

Freehold land ,n countries other than HK, land is normally freehold land and has indefinite useful life and, in most cases, it retains its &alue indefinitely/ it is accordin#ly not re#arded as a deprecia'le asset. 2ea"ehold land and 'uildin%" <easehold land is to 'e depreciated. :uildin#s ha&e limited useful li&es and therefore are deprecia'le assets. 2and and 'uildin%" in the #our"e o$ de&elopment or re9de&elopment Held for re-sale
12022

6.7 2.2

6C7 (a)

2.3

9here land and 'uildin#s in the course of de&elopment or re0de&elopment are held for re0sale, they should 'e re#arded as in&entories of an enterprise and as such, should 'e accounted for in accordance -ith HK ! 2 4,n&entories5. Held for other purposes 9here land and 'uildin#s in the course of de&elopment or re0de&elopment are held for production, rental or administrati&e purposes or -here no decision has yet 'een ta6en to re0sell the land and 'uildin#s, they should 'e included in the financial statements as property, pro&ided that the reco#nition criteria for an asset are satisfied.

(b) 2.$

..
;.1

Disclos re Req ire!ents

3he financial statements should disclose, in respect of each class of property, plant and equipment. (i) the measurement 'ases used for determinin# the #ross carryin# amount. 9hen more than one 'asis has 'een used, the #ross carryin# amount for that 'asis in each cate#ory should 'e disclosed/ (ii) the depreciation methods used/ (iii) the useful li&es or the depreciation rates used/ (i&) the #ross carryin# amount and the accumulated depreciation at the 'e#innin# and end of the period/ (&) a reconciliation of the #ross carryin# amount and the accumulated depreciation at the 'e#innin# and end of the period sho-in#. (a) additions/ (') disposals/ (c) acquisitions throu#h 'usiness com'inations/ (d) increases or decreases resultin# from the re&aluations and from impairment losses reco#niEed or re&ersed directly in equity under HK ! 3"/ (e) impairment losses reco#niEedIre&ersed in the profit and loss account under HK ! 3"/ (f) depreciation char#e/ (#) the net exchan#e differences arisin# on the translation of the financial statements of a forei#n entity/ (h) the net exchan#e differences arisin# on the translation of the financial statements of a forei#n entity/ (i) transfers 'et-een different types of assets/ (=) transfers 'et-een different classes of property, plant and equipment/ and
12023

;.2

;.3

(6) other mo&ements. 3he financial statements should also disclose. (i) the existence and amounts of restrictions on title, and property, plant and equipment pled#ed as security for lia'ilities/ (ii) the accountin# policy for costs of restorin# the site of items of property, plant or equipment/ (iii) the amount of expenditures on account of and the amount of 'orro-in# costs capitaliEed on property, plant and equipment in the course of construction/ (i&) the amount of commitments for the acquisition of property, plant and equipment/ and (&) the #ains or losses arisin# from the retirement or disposal of property, plant and equipment, and ho- the amounts are arri&ed at. 9hen items of property, plant and equipment are stated at re&alued amounts, the follo-in# should 'e disclosed. (i) the 'asis used to re&alue the assets/ (ii) the effecti&e date of the re&aluation/ (iii) the names and qualifications of persons ma6in# the re&aluation/ (i&) -hether the &aluer -as independent of or connected to the enterprise concerned/ (&) the nature of any indices used to determine replacement costs/ (&i) the carryin# amount of each class of property, plant and equipment that -ould ha&e 'een included in the financial statements had the assets 'een carried under the treatment in para#raph 22/ and (&ii) the re&aluation reser&e, indicatin# the mo&ement for the period and any restriction on the distri'ution of the 'alance to shareholders.

1202$

E8amination Style @ue"tion" @ue"tion 1 3he 'road principles of accountin# for property, plant and equipment in&ol&e distin#uishin# 'et-een capital and re&enue expenditure, measurin# the cost of assets, determinin# ho- they should 'e depreciated and dealin# -ith the pro'lems of su'sequent measurement and su'sequent expenditure. HK ! 1" @roperty, plant and equipment has the intention of impro&in# consistency in these areas. (equired4 (a) Explain (i) Ho- the initial cost of property, plant and equipment should 'e measured. ($ mar6s) (ii) 3he circumstances in -hich su'sequent expenditure on those assets should 'e capitaliEed. (3 mar6s) Explain HK ! 1"Ns requirements re#ardin# the re&aluation of non0current assets and the accountin# treatment of surpluses and deficits on re&aluation and #ains and losses on disposal. (2 mar6s) (i) :roadoa6 has recently purchased an item of plant from @lantco, the details of this are. ? 2$C,CCC 12.%D on list price 2,>%C 12,%CC 2$,CCC 1$,CCC $,%CC >,%CC ?

(')

(c)

:asic list price of plant 3rade discount applica'le to :raodoa6 ncillary costs. !hippin# and handlin# costs Estimated pre0production testin# )aintenance contract for three years !ite preparation costs Electrical ca'le installation *oncrete reinforcement G-n la'our costs

2",CCC :roadoa6 paid for the plant (excludin# the ancillary costs) -ithin four -ee6s of order, there'y o'tainin# an early settlement discount of 3D. :roadoa6 had incorrectly specified the po-er loadin# of the ori#inal electrical
1202%

ca'le to 'e installed 'y the contractor. 3he cost of correctin# this error of ?",CCC is included in the a'o&e fi#ure of ?1$,CCC. 3he plant is expected to last for 1C years. t the end of this period there -ill 'e compulsory costs of ?1%,CCC to dismantle the plant and ?3,CCC to restore the site to its ori#inal use condition. (equired4 *alculate the amount at -hich the plant -ill 'e measured at reco#nition. (,#nore discountin#.) (% mar6s) (ii) :roadoa6 acquired a 12 year lease on a property on 1 Gcto'er 2CAC at a cost of ?2$C,CCC. 3he company policy is to re&alue its properties to their mar6et &alues at the end of each year. ccumulated amortisation is eliminated and the property is restated to the re&alued amount. nnual amortisation is calculated on the carryin# &alues at the 'e#innin# of the year. 3he mar6et &alues of the property on 3C !eptem'er 2CA1 and 2CA2 -ere ?231,CCC and ?1>%,CCC respecti&ely. 3he existin# 'alance on the re&aluation surplus at 1 Gcto'er 2CAC -as ?%C,CCC. 3his related to some non0deprecia'le land -hose &alue had not chan#ed si#nificantly since 1 Gcto'er 2CAC.

(equired4 @repare extracts of the financial statements of :roadoa6 (includin# the mo&ement on the re&aluation reser&e) for the years to 3C !eptem'er 2CA1 and 2CA2 in respect of the leasehold property. (% mar6s) (3otal 2% mar6s) ( ** 2.%(HKB) 8inancial (eportin# Decem'er 2CC1) @ue"tion 3 Elite <eisure is a pri&ate limited lia'ility company that operates a sin#le cruise ship. 3he ship -as acquired on 1 Gcto'er 1;;". Details of the cost of the ship7s components and their estimated useful li&es are.

1202"

t 3C !eptem'er 2CC$ no further capital expenditure had 'een incurred on the ship. ,n the year ended 3C !eptem'er 2CC$ the ship had experienced a hi#h le&el of en#ine trou'le -hich had cost the company considera'le lost re&enue and compensation costs. 3he measured expired life of the propulsion system at 3C !eptem'er 2CC$ -as 3C,CCC hours. Due to the unrelia'ility of the en#ines, a decision -as ta6en in early Gcto'er 2CC$ to replace the -hole of the propulsion system at a cost of ?1$C million. 3he expected life of the ne- propulsion system -as %C,CCC hours and in the year ended 3C !eptem'er 2CC% the ship had used its en#ines for %,CCC hours. t the same time as the propulsion system replacement, the company too6 the opportunity to do a limited up#rade to the ca'in and entertainment facilities at a cost of ?"C million and repaint the ship7s fa'ric at a cost of ?2C million. fter the up#rade of the ca'in and entertainment area fittin#s it -as estimated that their remainin# life -as fi&e years (from the date of the up#rade). 8or the purpose of calculatin# depreciation, all the -or6 on the ship can 'e assumed to ha&e 'een completed on 1 Gcto'er 2CC$. ll residual &alues can 'e ta6en as nil. (equired4 *alculate the carryin# amount of Elite <eisure7s cruise ship at 3C !eptem'er 2CC% and its related expenditure in the income statement for the year ended 3C !eptem'er 2CC%. Hour ans-er should explain the treatment of each item. (12 mar6s) ( ** 2.%(HKB) 8inancial (eportin# Decem'er 2CC% O%(a)) @ue"tion 5 Gn 1 Gcto'er 2CC% Dearin# acquired a machine under the follo-in# terms.

1202>

Gn 1 Gcto'er 2CC> Dearin# decided to up#rade the machine 'y addin# ne- components at a cost of ?2CC,CCC. 3his up#rade led to a reduction in the production time per unit of the #oods 'ein# manufactured usin# the machine. 3he up#rade also increased the estimated remainin# life of the machine at 1 Gcto'er 2CC> to $,%CC machine hours and its estimated residual &alue -as re&ised to ?$C,CCC. (equired4 @repare extracts from the income statement and statement of financial position for the a'o&e machine for each of the three years to 3C !eptem'er 2CC2. (1C mar6s) ( ** 8> (HKB) 8inancial (eportin# Decem'er 2CC2 O%) @ue"tion : 8li#htline is an airline -hich treats its aircraft as complex non0current assets. 3he cost and other details of one of its aircraft are.

1o residual &alues are attri'uted to any of the component parts. t 1 pril 2CC2 the aircraft lo# sho-ed it had flo-n 1C,2CC hours since 1 pril 2CC%. ,n the year ended 31 )arch 2CC;, the aircraft fle- for 1,2CC hours for the six months to 3C !eptem'er 2CC2 and a further 1,CCC hours in the six months to 31 )arch 2CC;. Gn 1 Gcto'er 2CC2 the aircraft suffered a P'ird stri6e7 accident -hich dama#ed one of the
12022

en#ines 'eyond repair. 3his -as replaced 'y a ne- en#ine -ith a life of 3",CCC hours at cost of ?1CQ2 million. 3he other en#ine -as also dama#ed, 'ut -as repaired at a cost of ?3 million/ ho-e&er, its remainin# estimated life -as shortened to 1%,CCC hours. 3he accident also caused cosmetic dama#e to the exterior of the aircraft -hich required repaintin# at a cost of ?2 million. s the aircraft -as out of ser&ice for some -ee6s due to the accident, 8li#htline too6 the opportunity to up#rade its ca'in facilities at a cost of ?$Q% million. 3his did not increase the estimated remainin# life of the ca'in fittin#s, 'ut the impro&ed facilities ena'led 8li#htline to su'stantially increase the air fares on this aircraft. (equired4 *alculate the char#es to the income statement in respect of the aircraft for the year ended 31 )arch 2CC; and its carryin# amount in the statement of financial position as at that date. 1ote. the post accident chan#es are deemed effecti&e from 1 Gcto'er 2CC2. (1C mar6s) ( ** 8>(HKB) 8inancial (eportin# Fune 2CC; O%)

1202;