IAS/NAS 16: Property, Plant and Equipment
Guidance on the accounting treatment for property, plant, and equipment, including depreciation.
Property, Plant and Equipment are tangible items that:
- are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and
- are expected to be used during more than one period.
In case of ‘rental to others’, this excludes land and buildings that are classified as investment property under IAS/NAS 40.
The cost of an item of property, plant and equipment shall be recognised as an asset if, and only if:
- it is probable that future economic benefits associated with the item will flow to the entity; and
- the cost of the item can be measured reliably.
Author's Note: Future Economic Benefits are not necessarily cash inflows. They can also include cost savings or an improved public perception for the company.
A transport company uses trailers for hauling, and has purchased a spare trailer that can only be used with its specific model of truck. Both the trailer and the truck can be classified as either three separate properties or one single property. The standard does not prescribe a specific unit of measure.
E.g. brake pads for cars, blades for saws, and bucket teeth for excavators.
Classified as inventories and written off as expense on consumption.
E.g. Trailer for Truck, Spare Engine (can be used only with the particular asset.)
Classified as Separate Property, Plant and Equipment.
[Ref: Para 8] Items such as spare parts, stand-by equipment and servicing equipment are recognised in accordance with this IFRS when they meet the definition of property, plant and equipment. Otherwise, such items are classified as inventory.
This standard does not prescribe a specific unit of measure for recognition. Judgement is required, and it may be appropriate to aggregate individually insignificant items like moulds, tools, and dies, and apply the recognition criteria to their aggregate value.
[Ref: Para 9] This Standard does not prescribe the unit of measure for recognition, ie what constitutes an item of property, plant and equipment. Thus, judgement is required in applying the recognition criteria to an entity’s specific circumstances. It may be appropriate to aggregate individually insignificant items, such as moulds, tools and dies, and to apply the criteria to the aggregate value.
Measurement on Initial Recognition
An item of property, plant and equipment that qualifies for recognition as an asset shall be measured at its cost.
- Its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates.
- Any costs 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 (see Sec. A).
- The initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located (see Sec. B).
Section A: Directly Attributable Costs
Examples of directly attributable costs include:
- Costs of employee benefits arising directly from the construction or acquisition.
- Costs of site preparation.
- Initial delivery and handling costs.
- Installation and assembly costs.
- Costs of testing whether the asset is functioning properly (see Sec. D).
- Professional fees.
Section B: Decommissioning Liability (Asset Retirement Obligation - ARO)
This is the obligation a company has to dismantle, remove, or restore a site or asset at the end of its useful life.
The following costs are recognized as expenses in profit or loss and are not capitalized as part of PPE:
- Costs of opening a new facility.
- Costs of introducing a new product or service (including advertising and promotional activities).
- Costs of conducting business in a new location or with a new class of customer.
- Administration and other general overhead costs.
Section D: Testing Costs
Costs of testing whether the asset is functioning properly are capitalized, but only after deducting the net proceeds from selling any items produced during testing.
Author's Note: If the proceeds from selling test items are higher than the testing costs, the net gain is recognized in the Statement of Profit or Loss, not deducted from the asset's cost.
Incidental Income
Income from incidental operations is recognized in profit or loss, not deducted from the cost of PPE, if that operation is not necessary to bring the asset to its required location and condition. For example, earning income from using a building site as a car park before construction starts.
Inspection and Overhaul
The cost of a major inspection or overhaul can be capitalized as a separate component of the asset and depreciated over the period until the next inspection. For example, a cargo ship costing $2,000,000 requires a major overhaul every 5 years at a cost of $200,000. This $200,000 cost is capitalized and depreciated over 5 years.
An energy company builds a wind farm on leased land. The lease requires them to remove the turbines and restore the land in 20 years. Even though the cost is in the future, the obligation exists from day one.
Initial Estimate of Site Restoration:
$500,000.00
Present Value of Liability:
$107,274.10
The liability is added to the asset's cost and recorded. The entry is:
PPE (Wind Farm) A/c Dr. 107,274.10
To Decommissioning Liability A/c 107,274.10The liability is then "un-winded" each year by recognizing interest expense:
Finance Charges A/c Dr. 7,432.18
To Decommissioning Liability 7,432.18A manufacturing company buys new machinery for $3,500,000 and incurs the following costs during initial testing:
| Material Cost (Raw Materials) | $2,500 |
| Professional Costs (operator) | $3,500 |
| Re-calibration charges | $4,500 |
| Total Testing Costs | $10,500 |
The test product was sold to a local distributor for $3,400.
Net Cost to Capitalize:
$10,500 (Costs) - $3,400 (Income) = $7,100
This net cost of $7,100 is added to the cost of the machinery.
// Initial Recognition
PPE (Wind Farm) A/c Dr. 107,274.10
To Decommissioning Liability A/c 107,274.10
// Interest Accretion
Finance Charges A/c Dr. 7,432.18
To Decommissioning Liability 7,432.18An entity can choose one of two models for an entire class of PPE:
PPE is carried at: Cost less Accumulated Depreciation less Accumulated Impairment.
Example: A plant costing $500,000 with a 10-year life is depreciated by $50,000 annually. After 5 years, its carrying amount is $250,000.
PPE is carried at: Fair Value at the date of revaluation less subsequent depreciation and impairment.
Revaluation gains are credited to a Revaluation Surplus in Other Comprehensive Income (OCI).
Example: After 3 years, the plant's carrying amount is $350,000. It is revalued to its fair value of $450,000. A gain of $100,000 is recognized in OCI.
An asset was revalued upwards by $10,000 in Year 2, creating a revaluation reserve. In Year 3, the asset was revalued downwards by $13,125.
The loss is first offset against the existing revaluation reserve. The remaining loss is charged to Profit or Loss.
| Revaluation Loss for Year 3 | $13,125 |
| Offset against Revaluation Reserve (OCI) | ($10,000) |
| Charged to Profit or Loss | $3,125 |
Revaluation Reserve (OCI) A/c Dr. 10,000
Profit or Loss A/c Dr. 3,125
To PPE 13,125Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life.
Depreciable Amount is the total cost less the amount estimated to be recovered on disposal of the asset (residual value).
Example: A machine costs $100,000. The company estimates that after its 5-year useful life, it can be sold for $5,000. The depreciable amount is $100,000 – $5,000 = $95,000.
Author's Note: Both the useful life of the asset and the depreciable amount are based on estimates. Therefore, they can be changed on reasonable grounds, and their effects are to be considered prospectively (i.e., for future periods).
Where an item of property, plant, or equipment (PPE) has significant components with different useful lives, each component must be depreciated separately. This ensures a more accurate matching of expenses and a faithful representation of the asset's consumption.
An airline buys a private plane for $5,000,000. The aircraft's components are identified as:
| Component | Cost | Useful Life | Annual Depreciation |
|---|---|---|---|
| Aircraft Body | $3,000,000 | 20 years | $150,000 |
| Engine | $2,000,000 | 10 years | $200,000 |
| Total Annual Depreciation (Years 1-10) | $350,000 | ||
After 10 years, the engines will be replaced, and depreciation will be calculated for the new engines, while the aircraft body continues to be depreciated over its remaining life.
The carrying amount of an item of PPE is removed from the balance sheet on disposal or when no future economic benefits are expected from its use or disposal. The gain or loss on derecognition is the difference between the net disposal proceeds and the carrying amount and is recognized in profit or loss.
A production company sells filmmaking equipment. The details are:
| Original cost | $500,000 |
| Accumulated depreciation (after 10 years) | ($350,000) |
| Carrying Amount | $150,000 |
The machine is sold for $185,000. The gain on disposal is $35,000 ($185,000 - $150,000).
[Ref: Para 67] The carrying amount of an item of property, plant and equipment shall be derecognized:
a) on disposal; or
b) when no future economic benefits are expected from its use or disposal
Cash/Bank A/c Dr. 185,000
Accumulated Depreciation A/c Dr. 350,000
To Machinery (Asset) A/c 500,000
To Gain on Disposal of Asset A/c 35,000