1 MACC7001 Financial Accounting Foundation Dr. Winnie S.C.

Leung

IAS 16 PROPERTY, PLANT AND EQUIPMENT

LEARNING OBJECTIVES

 Describe the nature of property, plant and equipment

 Demonstrate how to measure property, plant and equipment on initial recognition
 Explain the cost model of measurement and understand the nature and calculation of depreciation
 Explain the revaluation model of measurement
 Account for derecognition
 Implement the disclosure requirements

The nature of property, plant and equipment

 The relevant standard is IAS 16 Property, Plant and Equipment.
 IAS 16.6 defines property, plant and equipment as tangible items that:
a. are held for use in the production or supply of goods or services, for rental (operating lease) to
others, or for administrative purposes; and
b. are expected to be used during more than one period.
 IAS 16.7 contains the principles for recognition of property, plant and equipment. The cost of an item of
property, plant and equipment shall be recognised as an asset if, and only if:
a. it is probable that future economic benefits associated with the item will flow to the entity; and
b. the cost of the item can be measured reliably.

Initial measurement of property, plant and equipment

 IAS 16.15 contains the principles for initial measurement of property, plant and equipment: ‘An item of
property, plant and equipment that qualifies for recognition as an asset shall be measured at its cost.’ IAS
16.16 specifies three elements of cost, namely:
a. purchase price
b. directly attributable costs
c. initial estimate of the costs of dismantling and removing the item or restoring the site on which it
is located.

 Purchase price
- Purchase price 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.
- The date on which the fair values should be measured is the date on which the acquirer obtains
control of the asset or assets acquired. At this date, the acquirer must be able to reliably measure the
cost of the asset.
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- The cost of acquiring the bundle of assets shall be allocated to the individual identifiable assets and
liabilities on the basis of their relative fair values at the date of purchase.

Practice Question:
With the following information, calculate the cost of Land and the cost of Building to be
recognized on the statement of financial position.
 We buy Land and Building with a single purchase price of $100,000.
 Stand-alone market price: Land = $40,000 and Building = $80,000.
Answer:

 Directly attributable costs

The key feature of those costs included in the cost of acquisition is that they are 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 (IAS 16.6(b)). IAS 16.17 provides examples of directly attributable costs:
- costs of employee benefits arising directly from the construction or acquisition of the item of
property, plant and equipment
- costs of site preparation
- initial delivery and handling costs
- installation and assembly costs — where buildings are acquired, associated costs could be the costs
of renovation
- costs of testing whether the asset is functioning properly
- professional fees.

 Costs of dismantling, removal or restoration

- At the date an asset is initially recognised, an entity is required to estimate any costs necessary to
eventually dismantle and remove the asset and restore its site.
- The expected costs, measured on a present value basis, are capitalised into the cost. Acceptance of
the liability for dismantling and removal is an essential part of bringing the asset to a position of
intended use.
- As with directly attributable costs, the dismantling and removal costs are depreciated over the life of
the asset.

Practice Question:
With the following information, calculate the cost of the power plant to be recognized on the
statement of financial position.
 We buy a power plant with a price of $100,000.
 We have to decommission the plant with a cost of $30,000 at the end of its useful life (20
years).
 Discount rate = 5%
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Answer:

Measure subsequent to initial recognition

 IAS 16.29 recognises two possible measurement models:
 cost model and
 revaluation model
 The choice of PPE measurement model is an accounting policy decision (see IAS 8 Accounting Policies,
Changes in Accounting Estimates and Errors). That policy is not applied to individual assets but to an
entire class of property, plant and equipment.

The cost model

 Revenue and capital expenditures
- IAS 16.30 states that after recognition as an asset, an item of property, plant and equipment shall be
carried at its cost less any accumulated depreciation and any accumulated impairment losses.
- The cost includes outlays incurred up to the point where the asset is at the location and in the
working condition to be capable of operating in the manner intended by management.
- IAS 16.12 states that ‘repairs and maintenance’ costs should not be capitalised and are expensed as
incurred.
- Capitalisation requires there to be an increase in probable future economic benefits associated with
the asset; that is, it should be probable that the expenditure increases the future economic benefits
embodied in the asset in excess of its standard of performance assessed at the time the expenditure is
made.

For revenue expenditures,

DR Expense
CR Cash

For capital expenditures,

DR Asset
CR Cash

 Depreciation
- Under the cost model, after initial recognition, an asset continues to be recorded at its original cost.
The subsequent carrying amount is determined after adjustments are made only for depreciation and
impairment losses.
- IAS 16.62 describes three methods for estimating depreciation:

1. Straight-line method. This is used where the benefits are expected to be received evenly over the
useful life of the asset. The depreciation charge for the period is calculated as:
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2. Diminishing-balance method. This method is used where the pattern of benefits is such that more
benefits are received in the earlier years in the life of the asset. As the asset increases in age, the
benefits each year are expected to reduce.

3. Units-of-production method. This method is based on the expected use or output of the asset.
Variables used could be production hours or production output.

whereas:
Depreciable amount is the cost of an asset, or other amount substituted for cost, less its residual
value.

Residual value, as noted in IAS 16.6, is the estimated amount that the entity would currently obtain
from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of
the age and in the condition expected at the end of its useful life.

Useful life is the period over which an asset is expected to be available for use by an entity or the
number of production or similar units expected to be obtained from the asset by an entity.

- IAS 16.56 provides the following list of factors to consider in determining useful life:
the expected usage of the asset by the entity;
the expected physical wear and tear,
technical or commercial obsolescence arising from changes or improvements in
production, or from a change in the market demand for the product or service output of
the asset.
 legal or similar limits on the use of the asset, such as expiry dates of related leases.
- There is no necessary relationship between useful life to the entity and the economic life of the
asset.

Note:
Several factors affect the depreciation estimate, including for example,
o the choice of depreciation methods
o the assessment of residual value
o the assessment of useful life
A change of these factors will result in a change of the depreciation estimate.
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Concept Quiz #1
A plant had an original cost of $100,000, a residual value of $10,000, and a useful life of 4 years. Assume
that over the 4-year life of the asset the expected output of the asset is 17,000 units, 15,000 units, 12,000
units and 6,000 units in year 1, 2, 3 and 4 respectively. Compute and record depreciation charges for year
1, 2, 3 and 4.
Answer:
1. Assume company uses straight-line method.
Depreciation expense each year = $(100,000 - 10,000) / 4 years = $22,500
Year 1 Year 2 Year 3 Year 4
Dr. Depreciation expense- plant
Cr. Accumulated depreciation - plant

2. Assume company uses diminishing-balance method.

Year 1 Year 2 Year 3 Year 4

Dr. Depreciation expense- plant
Cr. Accumulated depreciation - plant

3. Assume company uses units-of-production method.

Total production units over 4 years =
Depreciation expense year 1 =
Depreciation expense year 2 =
Depreciation expense year 3 =
Depreciation expense year 4 =
Year 1 Year 2 Year 3 Year 4
Dr. Depreciation expense- plant
Cr. Accumulated depreciation - plant
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 IAS 16 does not specify the use of any specific method of depreciation. The method chosen by an entity
should be based on which method most closely reflects the expected pattern of consumption of the
future economic benefits embodied in the asset.

 If there has been a change in the pattern of benefits such that the current method is inappropriate, the
method should be changed to one that reflects the changed pattern of benefits.

Concept Quiz #2
A plant had an original cost of $100,000, a residual value of $10,000, and a useful life of 4 years.
Renovation costs $12,000 incurred at the beginning of Year 3 which increase the useful life of the plant
for one more year. Assume company uses straight-line method for depreciation. Compute and record
depreciation charges over the useful life of the plant.
Answer:
Year 1 and 2
Annual depreciation = $(100,000 - 10,000) / 4 years = $22,500
Year 1 Year 2
Dr. Depreciation expense- plant $22,500 $22,500
Cr. Accumulated depreciation - plant $22,500 $22,500

Year 3, 4 and 5
Revised remaining useful life =

Annual depreciation =

Year 3 Year 4 Year 5

Dr. Depreciation expense- plant
Cr. Accumulated depreciation - plant
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The revaluation model

 IAS 16.31 states:

- After recognition as an asset, an item of property, plant and equipment whose fair value can be
measured reliably shall be carried at a revalued amount, being its fair value at the date of the
revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment
losses.
- Revaluations shall be made with sufficient regularity to ensure that the carrying amount does not
differ materially from that which would be determined using fair value at the end of the reporting
period.

 IAS 16.39–40 contain the principles for applying the fair value method to revaluation increases and
decreases respectively:

Revaluation increases:

- If an asset's carrying amount is increased as a result of a revaluation, the increase shall be recognised
in other comprehensive income and accumulated in equity under the heading of revaluation surplus.
- The increase shall be recognised in profit or loss (as a gain) to the extent that it reverses a revaluation
decrease of the same asset previously recognised (as a loss) in profit or loss.

Revaluation decreases:

- If an asset's carrying amount is decreased as a result of a revaluation, the decrease shall be

recognised in profit or loss.
- However, the decrease shall be recognised in other comprehensive income to the extent of any credit
balance existing in the revaluation surplus in respect of that asset.

 Application of the revaluation model:

- If the fair value basis of measurement is chosen, IAS 16 requires it to be applied to items of property,
plant and equipment on a class-by-class basis.
- However, in accounting for revaluation increases and decreases, the accounting is done on an
individual asset basis within the class.

 Transfers from asset revaluation surplus: to Retained Earnings

- IAS 16.41 covers the accounting for the asset revaluation surplus subsequent to its creation. There
are two circumstances where the asset revaluation surplus may be transferred to retained earnings.
a. where the asset is derecognized.
b. where an asset is being used up over its useful life

 Depreciation of revalued assets:

- Even though an asset is measured at fair value, depreciation is not determined simply as the change
in fair value of the asset over a period. As with the cost method, depreciation for a period is
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calculated after considering the pattern of economic benefits relating to the asset and the residual
value of the asset.

Concept Quiz #3
Assume XYZ Group has an item of plant whose current carrying amount is $270,000 (accumulated
depreciation being $30,000). The asset had a cost of $300,000. It was revalued downwards to $220,000.
Prepare the necessary journal entries for this revaluation downwards.
Answer:
Revaluation using net method
Step 1:

Step 2:

Suppose shortly after (ignore depreciation since the previous revaluation), the asset is assessed as having a
fair value of $280,000. Prepare the necessary journal entries for this revaluation upwards.
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Derecognition
 IAS 16.67 identifies two occasions where derecognition of an item of property, plant and equipment
should occur:
- on disposal, such as the sale of the asset
- when no future economic benefits are expected, either from future use or from disposal.
 When items of property, plant and equipment are sold, regardless of whether there are many or few
remaining economic benefits, the selling entity will recognise a gain or loss on the asset, this being
determined as the difference between the net proceeds from sale and the carrying amount of the asset at
the time of sale (IAS 16.71).
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Concept Quiz #4
XYZ Group acquired an item of plant on 1 July 2020 for $100,000. The asset had an expected useful life
of 10 years and a residual value of $20,000, depreciating on a straight-line basis. On 1 January 2023, XYZ
Group sold the asset for $81,000.
Prepare the necessary journal entries for this disposal during the year ended 30 June 2023.
Answer:
Step 1:
Depreciation charge to be recognized up to the point of sale

The entry is:

Step 2:
Carrying amount at the time of sale

Step 3:
Gain on sale

The required journal entry is:

Disclosure
 IAS 16.73–79 contain the required disclosures relating to property, plant and equipment.
 According to IAS 16.73, the financial statements shall disclose, for each class of property, plant and
equipment:

a. the measurement bases used for determining the gross carrying amount;
b. the depreciation methods used;
c. the useful lives or the depreciation rates used;
d. the gross carrying amount and the accumulated depreciation (aggregated with accumulated
impairment losses) at the beginning and end of the period; and
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e. a reconciliation of the carrying amount at the beginning and end of the period.

Example: Disclosure of property, plant and equipment by Giordano International Limited (2022)
https://corp.giordano.com.hk/files/financial_reports/2022-12-31%2000.00.00.5550/e709-2022AR.pdf

Further Practice

Aphrodite Co has a year end of 31 December and operates a factory which makes computer chips for mobile
phones. It purchased a machine on 1 July 2021 for $80,000 which had a useful life of ten years and is
depreciated on the straight-line basis, time apportioned in the years of acquisition and disposal. The machine
was revalued to $81,000 on 1 July 2022. There was no change to its useful life at that date.

What is the total depreciation charge to the profit and loss account for the year ended 31 December 2022?
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A. $9,000
B. $8,000
C. $8,263
D. $8,500

Answer:

Extended questions:

(a) Prepare all necessary journal entries for the revaluation on 1 July 2022.
(b) On 1 January 2023, the machine was revalued to $60,000, prepare all necessary journal entries for
this revaluation.

Answer:
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