LKAS 16 -Property, Plant and Equipment (PPE)

• ACF 1101- Financial Accounting

Academic Year 2020/2021

Semeter I
 Learning Outcomes
At the end of this session, you should be able to:
1. Identify the criteria for recognition of PPE and their
measurement at recognition;
2. Describe and distinguish between the cost model
and the revaluation model for measurement of PPE
after recognition;
3. Describe the nature and recognition of depreciation;
4. Accounting for disposal of PPE; and
5. Provide disclosures relevant to PPE.
 What is PPE?

LKAS 16 defines PPE as,

“tangible items that are held by an enterprise
for use in the production or supply of goods
or services or for rental to others or for
administrative purposes and are expected to
be used during more than one period”.
 LKAS 16 does not apply to;

1. Property plant and equipment classified as held

for sale in accordance with IFRS 5
2. Biological assets related to agricultural activity
3. The recognition and measurement of exploration
and evaluation assets and,
4. Mineral rights and mineral reserves such as oil,
natural gas and similar non-regenerative
resources.
Activity 1

A property developer, has a following list of assets. He wants to know

which of the following assets can be considered as PPE as per LKAS 16.
• Property for resale
• Office Building held for sale
• Factory building
• Furniture in the office
• Trade license for a period of 3 years
• Elevator of the office building
• Parapet wall
• Machinery
• Inventory of stationery

Identify the assets which fall within the definition of PPE as per LKAS
16.
Activity 1 - Answer

A property developer, has a following list of assets. He

wants to know which of the following assets can be
considered as PPE as per LKAS 16.
• Property for resale
• Office Building held for sale
• Factory building
• Furniture in the office
• Trade license for a period of 3 years
• Elevator of the office building
• Parapet wall
• Machinery
• Inventory of stationery
Recognition criteria for PPE

The cost of an item of PPE should be

recognized as an asset if, and only if
(Paragraph 7 of LKAS 16) :
• It is probable that future economic
benefits associated with the asset will
flow to the enterprise; and
• The cost of the item can be measured
reliably.
Activity 2
• QL PLC is a hand glove producing company and maintain
extra set of hand moulds of 500 units, which is estimated
to have a lifetime of over one year, worth of Rs. 25,000 in
the plant to be used in the production process whenever
a need arise.
• Air XY is in the Air line industry of which the air craft
interiors such as seats and galleys needs to be replaced
several times during the life of the air craft. The cost of
these interior has amounted to Rs. 1,200,000.
• Amal PLC has obtain an Enterprise Resource Planning
( ERP) system, an application software for Rs. 3,500,000.
• BT Textiles, a garment manufacturer has obtain two new
desktop computers for Rs. 150,000 and the operating
license has cost R.s 40,000 for two computers.
• Dex PLC is a chemical manufacturer who has done a plant
enhancement for Rs. 1,500,000 to install certain new
chemical handling processes in order to comply with
environmental requirements on the production and
storage of dangerous chemicals.
Activity 2 - Answer
1. Major spare parts and stand by equipment that are
expected to be used for more than one period, falls
under PPE definition and are recognized as per LKAS
-16. If not they are carried as inventory and
recognized in the profit or loss account as
consumed. Company has large number of moulds,
which nevertheless are used in more than one
accounting period. The standard suggests that it may
be appropriate to aggregate individually insignificant
items and to apply the criteria to the aggregate
value.

Therefore, QL Plc Can recognized the moulds

under PPE and depreciate the aggregate value
together.
 Activity 2 - Answer
2. Under paragraph 13, when parts of some PPE require
replacement at regular intervals, an entity recognizes in the
carrying amount of an item of property, plant and
equipment the cost of replacing part of such an item when
that cost is incurred if the recognition criteria are met as
per paragraph 7. The carrying amount of those parts that
are replaced is derecognized in accordance with the
derecognition provisions of LKAS 16.

3. The question is whether the software could be capitalized

under PPE? The answer to this is depends on determining
which element is more significant: the PPE element or the
intangible element. The intangible part is more likely to be
an asset in its own right if it was developed separately, or if it
can be used independently of the item of PPE of which it
forms a part. For example, operating software is an integral
part of the hardware as without it the hardware cannot
operate. Hence, it could be capitalised as PPE. However,
application software is independent of the hardware. Hence,
it is an intangible asset.
ERP is an application software where it is independent of
the hardware. Therefore, it doesn’t come under PPE.
 Activity 2 - Answer
4. The question is whether the software could be
capitalized under PPE? The answer to this is depends
on determining which element is more significant:
the PPE element or the intangible element. In this
situation, operating system is an integral part of the
computer without which it cannot be functioned
properly. Hence, it could be capitalized as PPE.

5. As per paragraph 11, Items of PPE may be acquired

for safety or environmental reasons. The
acquisition of such PPE items, although not directly
increasing the future economic benefits of any
particular existing item of PPE, may be necessary
for an entity to obtain the future economic
benefits from its other assets. Such items of PPE
qualify for recognition as assets because they
enable an entity to derive future economic benefits
from related assets in excess of what could be
derived had those items not been acquired.
Measurement at Recognition – Measured at Cost

The cost of an item of PPE comprises of;

I. Purchase price including import duties and non-
refundable purchase taxes, after deducting trade
discounts and rebates.
II. Costs directly attributable in bringing the asset to
the location and condition necessary for it to be
capable of operating in the manner intended by the
management
III. The initial estimate of the costs of dismantling and
removing the item and restoring the site on which
it is located.
Condition (ii) includes following costs;
 Costs of employee benefits arising directly from the construction or
acquisition of the item of PPE;
 Costs of site preparation;
 Initial delivery and handling costs;
 Installation and assembly costs;
 Costs of testing whether the asset is functioning properly, after
deducting the net proceeds from selling any items produced while
bringing the asset to that location and condition (such as samples
produced when testing equipment); and

 Professional fees.
Cost cannot be included in determining the cost of PPE
(Paragraph 19, 20).
 Costs of opening a new facility.
 Costs of introducing a new product or service, including
costs of advertising and promotional activities.
 Costs of conducting business in a new location or with a
new class of customer (including costs of staff training)
 Administration and other general overhead costs.
 Costs incurred while an item capable of operating in the
manner intended by management has yet to be brought into
use or is operated at less than full capacity.
 Initial operating losses, such as those incurred while
demand for the item’s output builds up.
 Costs of relocating or reorganizing part or all of the entity’s
operations.
 Activity 3
AD PLC ceremoniously opened its new factory building recently. In order to acquire the
land in which the new factory is located, company issued 10,000 ordinary shares at Rs.250
each. Company used its own funds to complete the factory building. The costs incurred are
as follows; Rs.
Cost of site preparation 300,000
Cost for architecture 150,000
Cost of construction materials 1,760,000
Cost of labour 540,000
Overheads relating to the construction of factory building 310,000
Administration costs 128,500
Cost of consultant fees 125,000
Cost of Engineer fees 350,000
Cost of installing fire extinguishers under safety regulations 88,000
Additional costs incurred for waste management practices to
comply with environmental regulations 102,000
General overheads 50,000
Initial estimation of present value of dismantling cost 125,000
Cost of opening ceremony 180,000
Total cost incurred 4,208,500

Required:
Determine the recognition cost relating to Land & Factory Building
 Activity 2 Answer
Cost of Land = Rs 250 x 10,000 shares = Rs 2,500,000
Cost of site preparation 300,000 300,000
Cost for architecture 150,000 150,000
Cost of construction materials 1,760,000 1,760,000
Cost of labour 540,000 540,000
Overheads relating to the construction of factory building 310,000 310,000
Administration costs 128,500  -
Cost of consultant fees 125,000 125,000
Cost of Engineer fees 350,000 350,000

Cost of installing fire extinguishers under safety regulations 88,000 88,000

Additional costs incurred for waste management practices 102,000 102,000
General overheads 50,000  -
Initial estimation of dismantling cost 125,000 125,000
Cost of opening ceremony 180,000  -
Total cost incurred for building   3,850,000
 Cost Model
Measurement
after
Recognition
Revaluation Model
The class of property plant and
equipment is a grouping of assets of
similar nature and use in entity’s
operations.

As per paragraph 37, followings are some

examples for separate classes of PPE.
• Land
• Land and buildings
• Machinery
• Ships
• Aircrafts
• Motor vehicles
• Furniture and fixtures
• Office equipment
 PPE should be carried at its cost less
accumulated depreciation and any
accumulated impairment losses

Cost Model
after
recognition Carrying amount
as an asset
(Paragraph
30):
= Cost – Accumulated depreciation
– Accumulated impairment losses
 Depreciation represents the
recognition of the decrease in
the service potential of an asset
across time.

Depreciation is defined as the

systematic allocation of the
Deprecation depreciable amount of an asset
over its useful life.

Depreciable Amount = Cost –

Residual Value
 • The useful life of an asset is defined in
Useful life terms of assets expected utility to the
business not in terms of economic life
of an • Useful life of an asset may be shorter
than its economic life.
asset
 Expected usage of the asset. (usage is assessed by
reference to the asset’s expected capacity or
physical output.)

Factors to be
considered in Expected physical wear and tear, (depends on
factors such as number of shifts and repair and
determining maintenance)

the useful
life of an Technical or commercial obsolescence arising from
changes or improvements in production, or from a
asset as per change in the market demand for the product or
service output of the asset.
LKAS 16
Legal or similar limits on the use of the asset, such
as the expiry dates of related leases
 • An organization uses depreciation
Depreciation method to reflect the pattern of
Methods which the asset’s future
economic benefits being
consumed by the organization.
 Straight-line method
• results in a constant charge over
the useful life if the asset’s residual
value does not change.

Depreciation Diminishing balance method

Methods • results in a decreasing charge over
the useful life

Unit of production method

• charge based on the expected use
or output.
 LKAS 16 does not prescribe a
particular depreciation method and
Depreciation instead states that the depreciation
method used should reflect the
Methods pattern in which the asset's future
(Cont’d) economic benefits are expected to
be consumed by the entity.
 Begins when it is available for use,
• When it is in the location and
condition necessary for it to be
capable of operating in the manner
intended by management.
Depreciation
Depreciation Ceases
of an asset • At the earlier of the date that the
asset is classified as held for sale or
included in a disposal group that is
classified as held for sale in
accordance with SLFRS 5
 Depreciation of an asset
 Depreciation does not cease when the asset becomes
idle or is retired from active use unless the asset is fully
depreciated.
 The depreciation charge for each period is recognized in
profit or loss unless it is included in the carrying amount
of another asset.
 Depreciation of an asset is recognized even if the fair
value of the asset exceeds its carrying amount, as long
as its residual value does not exceed its carrying
amount.
 Deprecation of PPE
 The residual value and the useful life of an
asset should be reviewed at least at each
financial year-end.
 If these estimates are changed, the changes
should be accounted as a change in an
accounting estimate in accordance with LKAS
8.
 Activity 4
Tara Ltd commenced its business on 1st April 2017. Following cost information are extracted
from the company on its cost incurred on PPE as at 31st March 2018.
  Rs (000)
Land 2,000
Building 2,500
Machinery 3,000
Factory Equipment 2,200
Office Equipment 500
Machinery is expected to produce 1,500,000 units and during the period, the company has
produced 300,000 units. The expected useful life of the machine is 4 years. The factory
equipment are used for the production department and the technology associated with them
are expected to upgrade often. The useful life of the equipment are estimated to be 5 years.
The expected useful life of the building and office equipment are 20 years and 5 years
respectively. Both the building and office equipment are expected to be used evenly during its
useful life.
Advice management in determining the appropriate depreciation method for each category of
PPE.
Calculate depreciation and its carrying amounts of Tara Limited for the financial year ending
31st March 2018.
 Activity 4- Answer

Land – No depreciation
Building – Straight line method
Machinery – Units of production method
Factory equipment – Diminishing balance method
Office Equipment – Straight line method
 Activity 4 - Answer

Depreciation
 Asset Rs Depreciation
(Rs.)
Land 2,000,000 - -
Building 2,500,000 2,500,000/20 125,000
Machinery 3,000,000 3,000,000/1,500,000x300,000 600,000
Factory Equipment 2,200,000 2,200,000x20% 440,000
Office Equipment 500,000 500,000/5 100,000
 Component Depreciation
 An entity can allocate the amount initially recognized
in respect of an item of PPE to its significant parts and
depreciates separately each such part.
 If an asset comprises two or more major components
with different economic lives, then each component
should be accounted for separately for depreciation
purposes and depreciated over its own useful
economic life.
 Professional judgment is required to decide which
parts are significant and which parts are not of an item
of PPE.
 Activity 5
Blue Sky Aviation PLC purchased an aircraft on 1st April 2017 at a
cost of Rs.650 million. The following information relates to the
aircraft.
Part Cost (Rs. Mn) Useful Life Residual Value (Rs. Mn)
Air frame 200 10 20
Engines 290 7 10
Other parts 160 5 8
 
Calculate the depreciation charge of the aircraft for the year
ending 31st March 2018 .
 Activity 5 –Answers

Component Rs. Mn.

Air Frame (200-20)/10 18.00

Engines (290-10)/7 40.00

Other Parts (160-8)/5 30.40

88.40
 Revaluation of PPE
 After recognition as an item of PPE, whose fair value can be
measured reliably, should be carried out at its revalued
amount (fair value at the date of revaluation) less any
subsequent accumulated depreciation and any subsequent
accumulated impairment losses.

Carrying Amount =
Revalued Amount - Subsequent Accumulated
Depreciation - Subsequent Accumulated Impairment
Losses
 Revaluation of PPE (Cont’d)

 The fair value of land and buildings is usually determined

from market-based evidence by appraisal that is normally
undertaken by a professionally qualified valuer
 The fair values of other items of PPE are usually their market
values determined by appraisal
 When there is no market for an asset, its fair value is
determined based on income or depreciated replacement cost
approach
 Revaluation of PPE (Cont’d)

When an asset is revaluated, its accumulated depreciation

at the date of revaluation should be treated in one of the
following methods.
 Eliminate against gross carrying amount of assets. (When
assets are revalued at market value)
 Restate proportionately with the change in the gross
carrying amount of assets. (When assets are revalued at
depreciated replacement cost)
 Activity 6
The following balances are given as at 01.04.2018

Machine (Rs.) 2,300,000

Accumulated depreciation (Rs.) 900,000

This machine was revalued on 01.04.2018 at Rs.1,500,000

based on its market value for the first time.

State the journal entries to account for revaluation.

 Activity 6 –Answers

Dr Cr

Accumulated depreciation 900,000

Machinery account 900,000

Machinery account 100,000

OCI 100,000

OCI 100,000

Revaluation Reserve 100,000

 Activity 7
The following balances are given as at 01.04.2017.
Cost (Rs.) Accumulated depreciation(Rs.)
Building 2,000,000 400,000

It was decided to revalue this building on 01.04.2017. However, there

was no active market for the building. Nevertheless, the fair value of
the building was estimated at Rs.1,800,000 using depreciated
replacement cost method.
State the journal entries to account for revaluation
State how the relevant figures to be shown in the financial statements
 Activity 7 –Answers

Cost Accumulated Carrying Amount

Depreciation
2,000,000 4,000,000 1,600,000
2,250,000 450,000 1,800,000
(1,800/1,600x2,000) ( 400/2,000X2,250)

Building 250,000

Accumulated depreciation 50,000

OCI 200,000

OCI 200,000

Revaluation Reserve 200,000

 Cost of an Asset
(Carrying Amount)
Rs. 500,000

First Time
Rs. 650,000
Rs. 400,000

Asset Dr 150,000
OCI Cr 150,000
P & L Dr 100,000
Asset Cr 100,000 OCI Dr 150,000
Revaluation Reserve Cr 150,000

Rs. 370,000 Rs. 520,000

Rs. 460,000 Rs. 750,000

Asset Dr 100,000
P & L Dr 30,000 Asset Dr 120,000 OCI Cr 100,000
Asset Cr 30,000 P&L Cr 100,000
OCI Cr 20,000 OCI Dr 100,000
Revaluation Reserve Cr 100,000
OCI Dr 20,000
Revaluation Reserve Cr 20,000
OCI ( Reval. Res) Dr 150,000
P&L Dr 40,000
Asset Cr 190,000

Revaluation Reserve Dr 150,000

OCI Cr 150,000
 Disposal of PPE

 An item of PPE should be derecognized when that

asset is disposed or no future economic benefits are
expected to flow to the entity.
 The gains and losses arising from the disposal are
recognized in to profit or loss.
 Summary of LKAS 16

Measurement at
Recognition
Cost model

Measurement after
recognition
Revaluation model

PPE (LKAS16)
Depreciation Disclosures for each PPE

Additional disclosures for PPE

Disclosures

Disclosures on revaluation on PPE