LKAS – 16 Property Plant and Equipment

Chapter 6
ACC1340 – Financial Accounting
Department of Accounting
 Learning Outcomes
At the end of this chapter, 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 6.1

Perera, 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
• Office 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 6.1 - Answer

Perera, 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
• Office 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 6.2
State whether following scenarios give rise to
recognize an item of PPE as per LKAS 16
Scenario 1
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.
Scenario 2
Air XY is in the Air line industry of which the
aircraft interiors such as seats and galleys
needs to be replaced four times during the
twenty-year life of the aircraft. The cost of
these interior has amounted to Rs 1,200,000.
 Activity
Scenario 3
6.2
Amal PLC has obtained an Enterprise Resource
Planning ( ERP) system, an application software for
Rs 3,500,000.

Scenario 4
BT Textiles, a garment manufacturer has obtained
two new desktop computers for Rs 150,000 and the
operating license has cost Rs 40,000 for two
computers.

Scenario 5
Dex PLC is a chemical manufacturer who has done a
plant enhancement for Rs1,500,000 to install
certain new chemical handling processes in order to
comply with environmental requirements on the
production and storage of dangerous chemicals.
Activity 6.2 - Answer
Scenario 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.

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 6.2 - Answer

Scenario 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 this Standard.
 Activity 6.2 - Answer
Scenario - 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.

In this situation, ERP is an application software where it is

independent of the hardware. There for it doesn’t come
under PPE.
Activity 6.2 - Answer
Scenario – 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.
 Activity 6.2 - Answer

Scenario - 5
As per paragraph 11, Items of property, plant and equipment
may be acquired for safety or environmental reasons. The
acquisition of such property, plant and equipment, although
not directly increasing the future economic benefits of any
particular existing item of property, plant and equipment,
may be necessary for an entity to obtain the future
economic benefits from its other assets. Such items of
property, plant and equipment 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 @ 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 6.3
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
 Answer – Activity 6.3
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 extingustors 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
Activity 6.4 - Tutorial
Discussion
 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
• Bearer plant
• 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
Carrying value
Recognition
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

Deprecation systematic allocation of the
of PPE 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.

Factors to be
expected physical wear and tear,
considered in
determining
the useful technical or commercial obsolescence arising
from changes or improvements in production,
life of an or from a change in the market demand for
the product or service output of the asset.
asset as per
LKAS 16 legal or similar limits on the use of the asset,
such as the expiry dates of related leases
Depreciation • An organization uses depreciation
method to reflect the pattern of which
Methods 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
Depreciation management.
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, and the
date that the asset is derecognized.
 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.
 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.
Carrying Residual Fair value Depreciate ?
amount amount
1,000,000 500,000 800,000
1,000,000 500,000 1,200,000
1,000,000 1,200,000 1,500,000
 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.
 Depreciation of an asset
Is depreciation always an expense?

The depreciation charge for each period is

recognized in profit or loss unless it is included in
the carrying amount of another asset.
 Activity 6.5

Tara Ltd commenced its business on 1st April 2017. Cost, residual values and fair values of
PPE are given below (Rs.’000).
  Cost Residual value FV at 31.3.2018

Land 2,000 - 4000

Building 2,500 500 2400
Machinery 3,000 1000 2500
Factory Equipment 2,200 700 2000
Office Equipment 500 200 500

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 3 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 use evenly during its
useful life.
Required
I.Advice management in determining the appropriate depreciation method for each category
of PPE.
II.Calculate depreciation for the year ending 31 March 2018 and carrying amount of PPE as at
31st March 2018.
 Activity 6.5 - Answer

Land – No depreciation
Building – Straight line method
Machinery – Units of production method
Factory equipment – Diminishing balance method
Office Equipment – Straight line method
 Activity 6.5 - Answer

 Asset Rs Calculation Depreciation (Rs.)

Land 2,000,000 - -
Building 2,500,000 2,500-500,/20 100,000
Machinery 3,000,000 3,000-1000/1500x300 400,000
Factory Equipment 2,200,000 2200 x 32%** 698,000
Office Equipment 500,000 500-200/5 60,000

Diminishing rate = 1- [(Residual/ Cost)^(1/n)]

ACTIVITY 6.6 –TUTORIAL DISCUSSION
 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.
 That is, 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 Property, Plant and Equipment.
 Activity 6.7
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
  650
Calculate the depreciation charge of the aircraft for the year
ending 31st March 2018 .
 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 Value =
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 6.8
The following balances are given as at 1.04.2018

Machine (Rs.) 2,300,000

Accumulated depreciation (Rs.) 900,000

This machine was revalued on 01.04.2018 at Rs1,500,000

based on its market value for the first time.

State the journal entries to account for revaluation.

 Activity 6.9
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
 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
 Disclosures
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
(e) a reconciliation of the carrying amount at the beginning
and end of the period
 Disclosures (Cont’d)
f) Existence and amounts of restrictions on title, and
property, plant and equipment pledged as security for
liabilities;
 the amount of expenditures recognised in the carrying
amount of an item of PPE in the course of its construction;
 the amount of contractual commitments for the acquisition
of property, plant and equipment; and
 if it is not disclosed separately in the statement of
comprehensive income, the amount of compensation from
third parties for items of property, plant and equipment that
were impaired, lost or given up that is included in profit or
loss.
 Disclosures (Cont’d)

g) If PPE are stated at revalued amounts, the

following information should also be disclosed:
 The effective date of the valuation
 Whether an independent valuer was involved;
 Methods and significant assumptions used in
assessing fair values
 The extent to which fair values were measured by
reference to observable prices in an active market,
recent market transactions on an arm’s-length basis,
or were estimated using other techniques
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