IAS 16 Property Plant and Equipment - Summary

Denition
ISA 16 Property Plant and Equipment defines Property Plant and Equipment as intangible assets that 1) are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and 2) are expected to be utilized in more than one period.

Initial Recognition
A tangible non-current asset should initially be recognized at cost. The cost comprises: a) purchase price b) any costs directly attributable to bring the asset to the location and condition necessary for it to be capable of operating in the manner intended by the management i.e it is ready for use. c) The initial estimate of the costs of dismantling and removing the item and resorting the site on which it is located and commissioning costs. This might apply where, for example, and entity has to recognize a provision for the cost of decommissioning an oil or a power station The cost of an item of Property Plant and Equipment should be recognized when: 1) It is probable that future economic benefits associated with the item will flow to the entity; and 2) The cost of the item can be measured reliably. It is necessary to asses the degree of certainty attached to the flow of economic benefits and the basis of the evidence available at the time of initial recognition. The cost incurred during the initial feasibility study should be expensed as incurred, as the flow of economic benefits to the company as a result of the study would be uncertain. ISA 16 Property Plant and Equipment states that the cost of an item of Property Plant and Equipment comprises, amongst other costs, directly attributable costs of bringing the asset to the location and condition necessary to for it to be capable of operating in a manner intended by the management. Examples of costs given by ISA 16 Property Plant and Equipment are site preparation costs, installation costs and assembly costs. ISA 16 Property Plant and Equipment states that any trade discounts and rebates should be deducted from the cost of an asset and not taken to the Statement of Comprehensive Income.

Subsequent Costs
Where additional costs are incurred after the asset becomes operational, the entity applies the normal recognition criteria; is it probable that the future economic benefits will flow to the entity. a) day-to-day servicing costs, that is, repairs and maintenance should not be capitalized, instead they should be recognized in profit and loss as they are incurred. b) Cost of replacing parts of Property Plant and Equipment is normally capitalized as it meets the recognition criteria.

Measurement after Initial Recognition

ISA 16 Property Plant and Equipment allows a choice between the Cost Model and the Revaluation Model a) Cost Model: Property Plant and Equipment at Cost less Accumulated Depreciation b) Revaluation Model: Property Plant and Equipment is carried at Fair Value less any subsequent Accumulated Depreciation.

Costs NEVER to be Capitalized

a) b) c) d) e) f) administration and general overheads; abnormal costs (repairs, wastage and idle time); costs incurred after the asset is physically ready to use; costs of reallocating/reorganizing an entitys operation; costs incurred in the initial operating period; and costs of opening a new facility, introducing a new product (advertising and promotional costs) and conducting business in a new location or with a new class of customers (training costs).

Depreciation
Definition Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. Residual Value Residual Value is the amount that the entity would currently obtain from disposal, net of selling costs, if the asset were already of the age and in the condition expected at the end of its useful life. ISA 16 Property Plant and Equipment states that the cost of an asset is depreciated over its useful life. The standard requires a depreciation charge to be made if the asset is worth more than its carrying value. ISA 16 Property Plant and Equipment requires Residual Value to be reviewed at each balance sheet date, whereas local GAAP requires the Residual value of a non-current asset to be determined at the date of acquisition or latest valuation. ISA 16 Property Plant and Equipment further requires increase in an assets residual value based on current prices to be reflected in the depreciation charge, thus reducing the expense in the statement of comprehensive income. If the residual value exceeds or equals the assets carrying value then the depreciation charge reduces to zero. Thus under local GAAP, residual value increases are reflected in disposal profits rather than in lower depreciation. The effect on the financial statements will be that the depreciation charge for the year will decrease. The residual value should be based on the current prices and on the condition, at the end of the assets useful life. Any change in the residual value should be accounted for as an adjustment to future depreciation. ISA 16 Property Plant and Equipment allows two ways of estimating residual value. When the Benchmark Treatment is adopted, the residual value is estimated at the date of acquisition and is not increased subsequently. When the Allowed Alternative is followed a new estimate of the residual value must be made at each Revaluation date. ISA 16 Property Plant and Equipment does not say that depreciation does not have to be charged when the asset has a long life or the amount is not material. Also, if the Leasehold properties are held to the end of their lease term, their residual value will be very low. To avoid depreciating the long leasehold property, the asset must be revalued at each Balance sheet date whereupon its value should not have fallen from the previous revalued amount. It has been argued that depreciation may be avoided cause a company will maintain the asset such that its Fair Value is maintained at a level similar to that at which it was purchased. The argument fails cause the effect of maintaining an asset is to increase its economic life and at the end of its economic life the residual value of the asset will be unaffected. ISA 16 Property Plant and Equipment does not prescribe a depreciation method , however, the method used must reflect the pattern in which the assets future economic benefits are expected to be consumed. Revaluation There is a fundamental difference of principle between ISA 16 Property Plant and Equipment and local GAAP. Where a company opts for a revaluation, ISA 16 Property Plant and Equipment requires revaluation to fair values. The use of Existing Use Value for properties is in accordance with local GAAP. ISA 16 Property Plant and Equipment states that the Fair Value of land and building is usually the Market Value. Open market value can be greater or smaller than the existing use value, especially where the property may be developed for an alternative use or the property has been adopted for the needs of the owner and there is little prospect of finding a buyer cause of these alterations. Both GAAP and ISA 16 Property Plant and Equipment adopt that if a policy of revaluation is adopted, revaluations should be reasonably current at each Statement of Financial Position date. Local GAAP requires 3 yearly full revaluation by an external valuer, but ISA 16 Property Plant and Equipment does not specify a

maximum period between valuations, simply stating that valuations should be undertaken as frequently as is necessary. Gains and Losses Finally, the reporting of gains and losses under ISA 16 Property Plant and Equipment will be different to local GAAP. Under ISA 16 Property Plant and Equipment, if the revaluation increases the value of an asset the gains are credited directly to the Equity, under the heading of Revaluation Surplus except where a revaluation loss exceeds an existing revaluation surplus, when the excess is charged to the statement of comprehensive income. Similarly, if the revaluation decreases the value of an asset, the decrease should be recognized in Profit and Loss, unless there is a revaluation reserve representing a surplus on the same asset. Gains are not recognized in income until the asset is sold.