FINANCIAL/CORPORATE REPORTING

IAS 16: PROPERTY,PLANT AND EQUIPMENT

DEFINITIONS

Property, plant, and equipment: Tangible assets that are

held for use in production or supply of goods and services, for
rental to others, or for administrative purposes and are
expected to be used during more than one period.

Cost. The amount paid or fair value of other consideration

given to acquire or construct an asset.

Useful life: The period over which an asset is expected to be

utilized or the number of production units expected to be
obtained from the use of the asset.
Residual value (of an asset): This is the net amount
which the entity expects to obtain for an asset at the end
of its useful life after deducting the expected costs of
disposal

Depreciable amount: The cost of an asset less its

residual value.

Depreciation: The systematic allocation of the

depreciable amount of an asset over its expected useful
life.

Fair value: The price to sell an asset or amount paid to

transfer a liability in an orderly transaction between market
participants at measurement date.
Carrying amount: This is the amount which an asset is
recognised in the statement of financial position after
deducting any accumulated depreciation and accumulated
impairment losses.

An impairment loss: This is the amount by which the

carrying amount of an asset exceeds its recoverable amount.

Entity specific value: This is the present value of the cash

flows an entity expects to derive from the continuing use of an
asset and from its disposal at the end of its useful life, or
expects to incur when settling a liability.
 
Recognition

This means the incorporation of the item in the entity’s

accounts as a non – current asset. The two recognition
criteria are:

 It is probable that the future economic benefits

associated with the asset will flow into the entity.
 The cost of the asset to entity can be measured reliably.
 
 Subsequent Expenditure

These same recognition criteria also apply to subsequent

expenditure; there are no longer any separate criteria for
recognising subsequent expenditure. In particular the following
are relevant for capitalization of subsequent expenditure:

(a) enhances economic benefits provided by the asset (e.g.

extension of asset’s life, expansion of production capacity)

(b) it relates to overhaul or required major inspection of the

asset and

(c) it replaces a component of a complex asset. This can only

be capitalized if the original component has been written off.
 
Illustration on subsequent expenditure

Road Truckers Plc has acquired a heavy road transporter at a

cost of N100,000 (with no breakdown of the component parts).
The estimated useful life is 10 years. At the end of the sixth year,
the power train requires replacement, as further maintenance is
uneconomical due to the off-road time required. The remainder of
the vehicle is perfectly roadworthy and is expected to last for the
next four years. The cost of a new power train is N45,000.

Required
Can the cost of the new power train be recognized as an asset,
and, if so, what treatment should be used?
 
 
Probable future economic benefits
The degree of certainty attached to the flow of future economic
benefits must be assessed. This should be based on the
evidence available at the date of initial recognition usually the
date of purchase. The entity should thus be assured that it will
receive the rewards attached to the asset and it will incur the
associated risks, which will only generally be the case when
the rewards and risks have actually passed to the entity.
 
Cost Measured Reliably
It is generally easy to measure the costs of an asset at the
transfer amount on purchase, that is, what was paid for it. Self
– constructed assets can also be measured easily by adding
together the purchase price of all the constituent parts, (labour,
material, and overhead) paid to external parties.
 
Separate Items

Most of the time assets will be identified individually, but this will
not be the case for smaller items, such as tools, dies and
moulds, which are sometimes classified as inventory and written
off as an expense.

Major components or spare parts, however, should be

recognised as property, plant and equipment.
For very large and specialised items, an apparently single
asset should be broken down into its composite parts. This
occurs where the different parts have different useful lives and
different depreciation rates are applied to each part, eg, an
aircraft, where the body and engines are separated as they have
different useful lives.
Safety and Environmental Equipment

Such assets when acquired qualify for recognition where

they enable the entity to obtain future economic benefits
from related assets in excess of those it would obtain
otherwise. The recognition will only be to the extent that the
carrying amount of the asset and related assets does not
exceed the total recoverable amount of these assets.
 
 Initial Measurement

An item pf property, plant and equipment that qualifies to be recognised as an

asset has cost as its initial recognition.
Component of costs
 Purchase price, less any trade discount or rebate
 Import duties and non – refundable purchase taxes
 Borrowing costs to the extent required by IAS 23 on Borrowing Costs
 Directly attributable costs of bringing the asset to working condition for its
intended use, eg
- The cost of site preparation
- Initial delivery and handling costs
- Installation costs
- Testing
- Professional fees (architects, engineering)
 Initial estimate of the unavoidable cost of dismantling and removing the
asset and restoring the site on which it is located
The revised Standard gave additional guidance on directly
attributable costs included in the cost of an item of property,
plant and equipment.

(a) These costs bring the asset to the location and working
conditions necessary for it to be capable of operating in the
manner intended by management, including those costs to
test whether the asset is functioning properly.

(b) They are determined after deducting the net proceeds from
the selling any items produced when bringing the asset to its
location and condition.
Costs not Attributable to the Assets
The revision also states that income and related expenses of operations
that are incidental to the construction or development of an item of
property, plant and equipment should be recognised in profit or loss.
The following costs will not be part of the cost of property, plant and
equipment unless they can be attributed directly to the asset’s acquisition,
or bringing it into its working condition.

 Administrative and other general overhead costs

 Start – up and similar pre-production costs
 Initial operating losses before the asset reaches planned performance.
 Advertising and promotional costs
 Costs of introducing a new product or service
 Cost of relocating, or reorganising part or all of the entity’s operations
 Training costs
All these costs will be recognised as expense rather than asset.
 
Illustration; this is concerned with directly attributable costs.
Extravagant Plc is installing a new plant at its production facility. It has
incurred these costs:
1. Cost of the plant (cost per supplier’s invoice plus taxes) N2,500,000
2. Initial delivery and handling costs N200,000
3. Cost of site preparation N600,000
4. Consultants used for advice on the acquisition of the plant N700,000
5. Interest charges paid to supplier of plant for deferred credit N200,000
6. Estimated dismantling costs to be incurred after 7 years N300,000
7. Operating losses before commercial production N400,000
Required
Please advise Extravagant Plc on the costs that can be capitalized in
accordance with IAS 16.
 
Self - Constructed Assets

In the case of self – constructed assets, the same

principles are applied as for acquired assets. If the entity
makes similar assets during the normal course of business
for sale externally, then the cost of the asset will be the
cost of its production under IAS 2 on Inventories. This also
means that abnormal costs (wasted material, labour or
other resources) are excluded from the cost of the asset.
An example of a self – constructed asset is when a
building company builds its own head office.
 
Exchange of Assets

The revised Standard specifies that exchange of items of

property, plant and equipment, regardless of whether the
assets are similar, are measured at fair value, unless the
exchange transaction lacks commercial substance or
the fair value of neither of the assets exchanged can be
measured reliably. If the acquired item is not measured
at fair value, its cost is measured at the carrying amount
of the asset given up.
Expenditure incurred in replacing or renewing

a component of an item of property, plant and equipment must

be recognised in the carrying amount of the item. The carrying
amount of the replaced or renewed component must be
derecognised. A similar approach is also applied when a
separate component item of property, plant and equipment is
identified in respect of a major component to enable the
continued use of the item.
Measurement Subsequent to Initial Recognition

The Standard offers two possible treatments here, essentially a

choice between keeping an asset recorded at cost or revaluing
it to fair value.

(a) Cost model: Carry the asset at its cost less depreciation
and any accumulated impairment loss.
(b) Revaluation model: Carry the asset at a revalued amount,
being its fair value at the date of the revaluation less any
subsequent accumulated depreciation and subsequent
accumulated impairment losses. It is made clear by the
Standard that the revaluation model is available only if the fair
value of the item can be measured reliably.
 
Revaluations

The market value of land and buildings usually represents fair

value, assuming existing use and line of business. Such
valuations are usually carried out by professionally qualified
valuers.

In the case of plant and equipment, fair value can also be

taken as market value. Where a market value is not available,
however, depreciated replacement cost should be used. There
may be no market value where types of plant and equipment
are sold only rarely or because of their specialised nature
(they would normally be sold as a part of an on-going
business).
Most importantly, when an item of property, plant and
equipment is revalued, the whole class of assets to which it
belongs, should be revalued.

All the items within a class should be revalued at the same

time, to prevent selective revaluation of certain assets and
to avoid disclosing a mixture of costs and values from
different dates in the financial statements. A rolling basis of
revaluation is allowed if the revaluations are kept up to date
and the revaluation of the whole class is completed in a
short time.
 
Accounting Treatment of Revaluation

For increase in value, the debit will be reflected as

increase in the statement of financial position. For the
credit, IAS 16 requires increase to be credited to a
revaluation surplus (part of owners’ equity), unless the
increase is reversing a previous decrease which was
recognised as an expense. To the extent that this offset is
made, the increase is recognised as income, any excess
is then taken to the revaluation surplus.
 
Illustration on revaluation

Big Ltd has an item of land carried at N13,000 in the

books. Two years ago a slump in land values led the
company to reduce the carrying value from N15,000.
This was taken as an expense in the income
statement. There has been a surge in land prices in
the current year, however, and the land it owned worth
N20,000.
Account for the revaluation in the current year.
 
Illustration on revaluation decrease

From the previous example, suppose the

original cost was N15,000 revalued upwards to
N20,000 two years ago. The value has now
fallen to N13,000.
Account for the decrease
 
A further complication arises when a revalued asset is
being depreciated. An upward revaluation will mean that
the depreciation charge will increase. Normally, a
revaluation surplus is only realised when the asset is sold,
but when it is being depreciated, part of that surplus is
being realised as the asset is used. The amount of the
surplus realised is the difference between depreciation
charged on the revalued amount and the depreciation
which would have been charged on the asset’s original
cost. This amount can be transferred to retained earnings
(realised) but not through profit or loss.
 
Illustration on revaluation and depreciation

Smally Ltd bought an asset for N20,000 at the

beginning of 2006. It had a useful life of five years.

On 1 January 2008 the asset was revalued to

N24,000. The expected useful life has remained
unchanged ie three years.

Account for the revaluation and state the treatment

for depreciation from 2008 onwards.
 
DEPRECIATION

 The depreciable amount of an item of property, plant

and equipment should be allocated on a systematic
basis over its useful life.

 The depreciation method used should reflect the

pattern in which the asset’s economic benefits are
consumed by the entity.

 The depreciation charge for each period should be

recognised as an expense unless it is included in the
carrying amount of another asset.
Land and buildings are dealt with separately even when they are
acquired together because land normally has an unlimited life
and is therefore not depreciated. In contrast buildings do have life
and must be depreciated. Any increase in the value of land on
which a building is standing will have no impact on the
determination of the building’s useful life.

Depreciation is usually treated as an expense, but not where it is

absorbed by the entity in the prices of producing other assets.
For example, depreciation of plant and machinery can be
incurred in the production of goods for sale (inventory items). In
such circumstances, the depreciation is included in the cost of the
new assets produced), in other words depreciation is included in
the cost of sales.
Review of Useful Life

A review of the useful life of property, plant and

equipment should be carried out at least at
each financial year and the depreciation
charged for the current and future periods
should be adjusted if expectations have
changed significantly from previous estimates.
Changes are changes in accounting estimates
and are accounted for prospectively as
adjustments to future depreciation.
 
Illustration on review of useful life

Kwomi Na Allah acquired a non – current asset on 1

January 2008 for N160,000. It had no residual value
and a useful life of 10 years.

On 1 January 2011 the total useful life was reviewed

and revised to seven years.
What will be the depreciation charge for 2011?
 
Review of Depreciation Method

The depreciation method should also be reviewed at least

at each financial year end, if there has been a significant
change in the expected pattern of economic benefits from
those assets, the method should be changed to suit this
changed pattern. When such a change in depreciation
method takes place, the change should be accounted for
as a change in accounting estimate and the depreciation
charge for current and future periods should be adjusted
 
Impairment of Asset Values

An impairment loss should be treated in the same was as a

revaluation decrease, i.e. the decease should be recognised as
an expense. However, a revaluation decrease (impairment loss)
should be charged directly against any related revaluation surplus
to the extent that the decrease does not exceed the amount held
in the revaluation surplus in respect of that same asset.

A reversal of an impairment loss should be treated in the same

was as a revaluation increase, ie a revaluation increase should
be recognised as income to the extent that it reverses a
revaluation decrease or an impairment loss of the same asset
previously recognised as an expense.
 
Retirements and Disposals

When an asset is permanently withdrawn from use, or sold or

scrapped, and no future economic benefits are expected from its
disposal, it should be withdrawn from the statement of financial
position.
Gains or losses are the difference between the estimated net
disposal proceeds and the carrying amount of the asset. They
should be recognised as income or expense in profit or loss.
 
Derecognition
An entity is required to derecognise the carrying amount of an item
of property, plant and equipment that it disposes of on the date the
criteria for sale of goods in IFRS 15 on Revenue Recognition in
Contracts with Customers would be met. This also applies to parts
of an asset.
 
DEPRECIATION

Definition
This is result of systematic allocation of the depreciable amount
of an asset over its estimated useful life. Depreciation for the
accounting period is charged to net profit or loss for the period
either directly or indirectly.
Depreciable assets are assets which:
 Are expected to be used during more than one accounting
period
 Have a limited useful life
 Are held by an entity for use in the production or supply of
goods and services, for rental to others, or for administrative
purposes.
 
Useful life is of two things:
 The period which a depreciable asset is expected to be used
by the entity, or
 The number of production or similar units expected to be
obtained from the asset by the entity.
 
Depreciable Amount

This is the historical cost or other amount substituted for

cost in the financial statements, less the estimated
residual value.
 
Useful Life
The following factors should be considered when
estimating the useful life of a depreciable asset:
 Expected physical wear and tear
 Obsolescence
Legal or other limits on the use of the assets
Once decided, the useful life should be reviewed at least
every financial year end and depreciation rates adjusted
for the current and future periods if expectations vary
significantly from the original estimates. The effect of the
change should be disclosed in the accounting period in
which the change takes place.

The assessment of useful life requires judgement based

on previous experience with similar assets or classes of
asset. When a completely new type of asset acquired it is
still necessary to estimate useful life, even though the
exercise will be much more difficult.
The physical life of the asset might be longer than its useful
life to the entity in question. One of the main factors to be
taken into consideration is the physical wear and tear the
asset is likely to endure. This will depend on various
circumstances, including the number of shifts for which the
asset will be used, the entity’s repair and maintenance
programme etc. Other factors to be considered include
obsolescence and legal restrictions, e.g. length of a related
lease
 
Residual Value

In most cases the residual value of an asset is likely to be

immaterial. It is likely to be of any significant value, that
value must be estimated at the date of purchase or any
subsequent revaluation. The amount of residual value
should be estimated based on the current situation with
other similar assets, used in the same way, which are now
at the end of their useful lives. Any expected costs of
disposal should be offset against the gross residual value.
Depreciation Method

Consistency is important. The depreciation method selected

should be applied consistently from period to period unless
altered circumstances justify a change. When the method is
changed, the effect should be quantified and disclosed and the
reason for the change should be stated.

Various methods of allocating depreciation to accounting

periods are available, but whichever is chosen must be applied
consistently to ensure comparability from period to period.
Change of policy is not allowed simply because of the
profitability situation of the entity.
Illustration on depreciation methods

A lorry bought for a business cost N17,000. It is expected to last

for five years and then be sold for scrap for N2,000. Usage over
the five years is expected to be:

Year 1 200 days

Year 2 100 days
Year 3 100 days
Year 4 150 days
Year 5 40 days
Required
Work out the depreciation to be charged each year under:
(a) The straight line method
(b) The reducing balance method (using a rate of 35%)
(c) The machine hour method
(d) The sum – of – the digits method
 
Illustrative question on depreciation

(a)What are the purposes of providing for

depreciation?
(b)In what circumstances is the reducing balance
method more appropriate than the straight line
method? Give reasons for your answer.
 
Illustrative question on purchase and disposal of
property, plant and equipment

A company purchased two rivet – making machines on 1

January 2005 at a cost of N15,000. Each had an
estimated life of five years and a nil residual value. The
straight line method of depreciation is used.

Owing to an unforeseen slump in market demand for

rivels, the business decided to reduce its output of rivels,
and switch to making other products instead. On 31
March 2007, one rivet making machine was sold on
credit to a buyer for N8,000.
Later, in the year, however, it was decided to
abandon production of rivets altogether, and the
second machine was sold on 1 December 2007
for N2,500 cash.

Prepare the machinery account, provision for

depreciation of machinery account and disposal
of machinery account for the accounting year to
31 December 2007.
 
Disclosures on Property, Plant and Equipment

For each class of property, plant, and equipment, disclose:

• Basis for measuring carrying amount

 depreciation method(s) used
 useful lives or depreciation rates
 gross carrying amount and accumulated depreciation and
impairment losses
 reconciliation of the carrying amount at the beginning and
the end of the period, showing:
o additions
o disposals
o acquisitions through business combinations
o revaluation increases or decreases
o impairment losses
o reversals of impairment losses
o depreciation
o net foreign exchange differences on translation
other movements
Also disclose:

• restrictions on title

 expenditures to construct property, plant, and

equipment during the period
 contractual commitments to acquire property, plant,
and equipment
 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
If property, plant, and equipment is stated at revalued amounts,
certain additional disclosures are required:

• the effective date of the revaluation

 whether an independent valuer was involved
 the methods and significant assumptions used in estimating fair
values
 the extent to which fair values were determined directly by
reference to observable prices in an active market or recent market
transactions on arm's length terms or were estimated using other
valuation techniques
 for each revalued class of property, the carrying amount that would
have been recognised had the assets been carried under the cost
model
 the revaluation surplus, including changes during the period and
any restrictions on the distribution of the balance to shareholders
Disclosures on Depreciation

An accounting policy note should disclose the valuation

bases used for determining the amounts at which
depreciable assets are stated, along with the other
accounting policies.
The Standard also requires the following to be disclosed
for each major class of depreciable assets:
 Depreciation method used
 Useful lives or the depreciation rates used
 Total depreciation allocated for the period
 Gross amount of depreciable assets and the related
accumulated depreciation
THE END