IAS-16 Property Plant and Equipment

Difference between capital expenditure and revenue expenditure:

Capital Expenditure:
It is cost of buying fixed assets. It includes all expense incurred in bringing asset in workable
condition. Further all those expenditures incurred at any time in life of asset which increase
output or capacity of asset will also be considered as capital expenditure.
For Example: buying van, buying machinery, painting outside of new building etc.
Revenue Expenditure:
Expenditure which is incurred in running the business on a day-to-day basis and its benefit is
not spread over more than one year.
For Example: Petrol cost for van, Repairs of van, Electricity bill paid for using machinery etc.

Determining Cost of Asset:

Fair Value is the amount for which an asset could be exchanged between:

 Knowledgeable
 Willing parties
 in an arm’s length transition.
Property plant and equipment are tangible items that:
a) are held for use in the production or for supply of goods or services, for rental to others,
or for administrative purposes; and
b) are expected to be used during more than one period.

Recognition:
The cost of an item of property, plant and equipment shall be recognized as an asset if and only
if:
a) It is probable that future economic benefits associated with the item will flow to the
entity; and
b) The cost of the item can be measured reliably.

Initial Measurement or Measurement at Recognition:

An item of property, plant and equipment that qualifies for recognition as an asset shall be
measured at its cost.
Cost: Cost is the amount of:

 Cash or cash equivalents paid or

 The fair value of the other consideration given to acquire an asset,
at the time of its acquisition or construction.
Elements of Cost:
The cost of an item of property, plant and equipment comprises.
a) Its purchase price, including import duties and non-refundable sales taxes after
deducting trade discounts and rebates.
b) Any costs necessary to bring the asset into current location and condition which is
intended by management.
c) The initial estimates of the costs of dismantling and removing the item and restoring the
site.
Examples of directly attributable costs are:
a) Costs of employee benefits arising directly from the construction or acquisition of an
item of PPE.
b) Costs of site preparation.
c) Initial delivery and handling charges.
d) Installation and assembly cost.
e) Cost of testing whether the asset is functioning properly, after deducting the net
proceeds from selling any items produced (such as samples produced when testing
equipment); and
f) Professional fees.
Examples of costs that are not costs of an item of PPE are:
a) Costs of opening a new facility.
b) Cost of introducing a new product or service (including costs of advertising and
promotional activities);
c) Costs of conducting business in a new location or with a new class of customer
(including cost of staff training); and
d) Administration and other general overhead costs.
Recognition of costs in he carrying amount of an item of PPE ceases when the item is ready for
use (i.e., it is capable of operating in manner intended by management). Following costs are not
included in the carrying amount e.g.,
a) Costs paid while an item is yet to be brought into use or is operated at less than full
capacity.
b) Initial operating losses while demand for the product’s output builds-up; and
 c) Costs of relocating/re-organizing part or all of entity’s operations.
Cost of self-constructed asset
The cost of a self-constructed asset is determined by adding up raw material, labor and
overhead costs incurred on that asset.

Subsequent Expenditure:
Subsequent expenditure on non-current assets, after their initial acquisition, should be
capitalized if it meets the criteria for recognition of an asset. Any subsequent expenditure is
capitalized if it,

 improves the asset (for example, by enhancing useful life, output or performance).
 is for a replacement part (provided that old part id disposed of)
Repairs and maintenance expenditure is revenue expenditure. It is recognized as an expense as
it is incurred.

Depreciation and Methods of Depreciation:

Depreciation of tangible fixed assets:
Tangible fixed assets such as machinery, motor vehicle, fixtures and even building do not last
forever. If the value at which asset is expected to be sold at the end of its useful life is less than
the cost of the asset, the asset is said to have ‘depreciated in value’. For example, if a van was
bought for Rs. 10,000 and sold five years later for Rs. 2,000 then its value has depreciated over
the period of its use by Rs. 8,000.
Depreciation is an Expense:
Depreciation is that part of the original cost of a fixed asset that is consumed during its period
of use by the business. It needs to be charged to profit and loss every year. For example, if a PC
cost Rs. 1,200 and was expected to be used for 3 years, it might be estimated at the end of the
first year that one-third of its overall usefulness had been consumed. Depreciation would then
be charged at an amount equal to one-third of the cost of the PC, i.e., Rs. 400. Profit would be
reduced by Rs. 400 and the value of the PC in the balance sheet would be reduced from Rs.
1,200 to Rs. 800.
Depreciation: is the systematic allocation of the depreciable amount of an asset over its useful
life.
Depreciable amount: is the cost of an asset, or other amount substituted for cost, less its
residual value.
Residual Value: of an asset is the estimated amount that an entity would currently obtain from
disposal of the asse, after deducting the estimated costs of disposal. Note: if residual value is
equal to or greater than cost then no depreciation is charged.
Carrying amount: is the amount at which an asset is recognized after deducting any
accumulated depreciation and accumulated impairment losses. (Commonly known as Book
Value).
Useful Life: is the period over which:
a) an asset is expected to be available for use by an entity; or
b) the number of production or similar units expected to be obtained from the asset by an entity.

Depreciation:
a) Each part of an item of PPE with a cost that is significant in relation to the total cost shall
be depreciated separately.
b) The Depreciation charge for each period shall be recognized in profit and loss unless it is
included in the carrying amount of another asset. (e.g., the depreciation of
manufacturing plant and equipment is included in the costs of conversion of
inventories).
c) The depreciable amount of an asset shall be allocated on a systematic basis over its
useful life.
d) The residual value and the useful life of an asset shall be reviewed at least at each
financial year-end and, if expectations differ from previous estimates, the changes shall
be accounted for as a change in accounting estimate.
e) Commencement and Cessation of depreciation:
Depreciation of an asset begins when it is available for use, i.e., when it is in the location
and condition necessary for it to be capable of operating in the manner intended by
management. Depreciation of an asset ceases the date when the asset is disposed off.
Therefore, depreciation does not cease when the asset becomes idle or is retired from
active use unless the asset is fully depreciated. However, under usages methods of
depreciation the depreciation charge can be zero while there is no production.
f) The following factors are considered in determining the useful life of an asset
a. Expected usage of the asset. Usage is assessed by reference to asset’s expected
capacity or physical output.
b. Expected useful wear and tear.
c. Technical or commercial obsolescence.
d. Legal or similar limits on the use of the asset.
 g) Land and building are separable assets and are accounted for separately even when
they are acquired together. Land is not normally depreciated because it has indefinite
life.
h) The depreciation method used shall reflect the pattern in which the asset’s future
economic benefits are expected to be consumed by the entity.

Depreciation Method:
Following are the depreciation methods to be used during the period an asset is used by an
entity:
1. Straight line Method:
It requires allocation of an equal amount to each period. Since this method assumes
that the cost of the asset expires at a steady (straight line) function of time, the cost less
residual value is divided by the estimated useful life. The rate of depreciation is the
reciprocal of the estimated useful life. If the useful life of an asset is 10 years, the
depreciation rate will be 1/10 or 10%.
Depreciation = Cost – Residual value/Useful life OR
(Cost – Residual Value) * Rate of Depreciation.
(Whenever depreciation is charged on cost each year, it means the entity is following
straight line method assuming that residual value is nil). This method is appropriate for
those assets which give same benefit in each year e.g., building, furniture etc.
2. Diminishing balance Method:
Under this method, instead of a fixed amount, a fixed rate on the reduced balance of
the asset is charged as depreciation every year. Since a constant percentage applied to
the written down value, the amount of depreciation charged every year decreases over
the life of the asset. This method is appropriate for those assets which give benefits on a
reducing pattern each year e.g., Machines.
Depreciation = WDV * Rate of depreciation

Points of differences between straight line and WDV method:

Description Straight line Method WDV Method

Calculation of depreciation Cost -Residual value

Cost * Rate of depreciation
for 1st year Useful life

Calculation of depreciation Cost -Residual value

WDV * Rate of Depreciation
for subsequent years Useful life

Conversion of Life to Rate Rate in % = 1/Useful Life N/A

 1. On cost of opening assets less cost
1. On WDV of opening
of disposal and fully depreciated
assets
assets.
at start of the year less
2. On cost of Additions
WDV
Calculation of depreciation 3. On cost of Disposals
of disposal at the start of
each year 4. On cost of full depreciated
year
In case if asset has residual value it
2. On cost of Additions
will be deducted from cost to
3. On WDV on disposal at
calculate
the start of the year
depreciation.

1. It can be calculated through a

shortcut working. It will be calculated through
Calculation of Acc dep at 2. Acc dep at the time of disposal = manual working from the
the time of disposal (Cost-RV)*rate*no of years used date of purchase till date of
3. No of years will be calculated from disposal.
date of purchase till date of disposal.
Concept of fully
depreciated Applicable N/A
asset

3. Output Method:
This is a method of providing depreciation on annual machine’s output in use compared
with total anticipated machine’s output over the life of the machine.
Depreciation = Cost – RV/Total output expected over useful life * units produced during
the year.
4. Sum of year digit method:
This method assumes that the depreciation charges should be more in the early years of
the life of the asset. Under this method, the depreciation expense is calculated by
multiplying the depreciable amount by a fraction based on the sum of the number of
periods of the useful economic life.
Depreciation = Cost – RV * Respective digit sum of all year’s digits
Note:
i. Diminishing balance method and year digit method are often termed as “accelerated
depreciation method” because both of the methods give more depreciation in the
earlier years than the later one.
ii. At the end of life of asset, the WDV of asset will be equal to its residual value.
iii. No depreciation will be charged on asset after they have completed their life whether in
terms of years, units, hours etc.
iv. In the year of acquisition and disposal depreciation will be charged only for the months
asset is used.
 Important issue regarding calculation of depreciation:
It is not fair to assume that a fixed asset is always purchased on the very first day of a
month. Assets are generally purchased in the course of the accounting period whenever
required. When an asset is purchased in mid of a month, it is not necessary to compute the
amount of depreciation to be charged to the nearest day or week. As we know, the charge
for depreciation is a mere estimate, therefore depreciation is calculated in whole months. In
this case you can give a note that:
“Full month’s depreciation is charged in the month of purchase while no depreciation is
charged in the month of disposal.”

Recording depreciation in the books of Accounts:

The depreciation for the period is debited to ‘Depreciation expense account’ and credited
to ‘Accumulated depreciation account’. Instead of crediting asset account another account
styled Accumulated Depreciation account is credited so that at any time during the life of an
asset we can easily determine what is the total depreciation of asset on a specific reporting
date. In the balance sheet, asset appears at its original cost and the accumulated
depreciation is shown as a deduction from the asset account.
Depreciation Expense A/c Dr.
Accumulated Depreciation A/c Cr.

Change in accounting estimate during the period of use:

At the end of an accountancy year an entity may estimate a change in following as
compared to what was expected at the time of purchase and may need to revise the
following:

 Useful Life
 Depreciation Method
 Residual Value

Scenarios Formula to be used in the year of change

1. If new method is WDV at the time the estimate is revised - New residual
Straight line value/Remaining Useful Life
2. If new method is WDV WDV at the time the estimate is revised * New rate

Derecognition:
The item of PPE shall be derecognized;
a) On disposal; or
 b) When no future economic benefits are expected from its use.
The gain/loss arising from the derecognition of an item of PPE shall be included in P&L when
the item is derecognized. Gains shall not be classified as revenue. The gain and loss arising from
the derecognition of an item of PPE shall be determined as the difference between the disposal
proceeds and the carrying amount of the item.

Disposal by Sale/Destroy:
If a fixed asset is sold or it is destroyed because of accident, fire or flood, we have to remove it
from our ledger accounts. This means that the cost of that asset needs to be taken out of the
asset account. In addition, the accumulated depreciation on the asset which has been sold will
have to be taken out of the accumulated depreciation account. Finally, the profit and loss on
sale, if any, will have to be calculated and posted to the profit and loss account.
Entry for Disposal of Asset:
Accumulated Depreciation a/c Dr.
Cash/Insurance claim receivable Dr.
Profit/Loss a/c (balancing) Dr.
Asset a/c – at cost Cr.
(In case there is loss on disposal)
Disposal Account appear as follow;

Dr. Disposal Account Cr.

Asset
Accumulated Depreciation
a/c(Cost
a/c
)
Cash/Insurance claim receivable
Profit/Loss (Balancing)

Note: Insurance claim receivable will appear when an asset is destroyed and insurance
company has acknowledged the claim and money is still receivable.
Note: Insurance claim receivable will not be considered as “other income” rather a reduction in
loss on disposal.

Disposal Through Exchange:

Sometimes instead of selling we exchange the old asset with new one. In this case normally we
will receive new asset and will hand over the old asset to the person from whom new asset is
bought. Obviously, some cash will also be paid to settle the transaction. In this case following
steps will be performed while passing the journal entry.
Step 1. The old asset will be removed from books by creating old asset and by debiting
accumulated depreciation a/c.
Step 2. The cash paid to settle the transaction will be credited.
Step 3. The cost of new asset will be debited in books.
Step 4. The balancing figure will be gain or loss.
Entry on Exchange of asset
Asset a/c (New) Dr.
Accumulated Depreciation a/c Dr.
Profit and Loss (Balancing) Dr.
Asset a/c (old) Cr.
Cash Cr.
In case there is loss on disposal

Dr. Asset Account Cr.

B/d Disposal (cost old asset)
Disposal (cost New asset)
c/d

Dr. Disposal Account Cr.

Accumulated Depreciation a/c (old
Asset a/c (cost old asset)
asset)
Asset a/c (cost new
Cash asset)
Profit/Loss (Balancing)

Revaluation of Property, Plant and Equipment:

Measurement after initial recognition:
Two measurement models after acquisition of no-current asset are as follow;
a) Cost model: After recognition as an asset, an item of PPE shall be carried at its cost less
any accumulated depreciation and any accumulated impairment losses.
b) Revaluation model: After recognition as an asset, an item of PPE whose fair value can
be measured reliably shall be carried at a revalued amount which is its fair value at the
 date of the revaluation less any subsequent accumulated depreciation and accumulated
impairment losses.
The fair value of land and buildings is usually determined from market-based evidence by
appraisal that is normally undertaken by professionally qualified valuers.
If an item is revalued, the entire class of assets to which that asset belongs should be revalued.
Revalued assets are depreciated in the same way as under the cost model.
Frequency of revaluation:
Under the revaluation model, revaluations should be carried out regularly, so that the carrying
amount of an asset does not differ materially from its fair value at the balance sheet date.
Accounting treatment of revaluation increase/decrease
Change in carrying
amount Initial Subsequent

Included in OCI and increases

Included in other comprehensive revaluation surplus unless it
Increases income (Heading "Revaluation reverses a revaluation decrease
Surplus") of the same asset previously
recognized in profit or Loss

debit to profit or loss unless

Decreases Debited to profit and loss any credit balance exists in
the revaluation surplus.

Accounting treatment of accumulated depreciation a/c at the time of revaluation:

It is eliminated against the gross carrying amount of the asset and the net amount is restated to
the asset’s revalued amount.
Treatment of Revaluation Surplus:
Transfer revaluation surplus on yearly basis to retained earnings (it will be the difference
between depreciation based on the revalued carrying amount and depreciation based on
original cost).
Treatment of Revaluation Surplus on disposal of asset:
Transfer full amount appearing in balance sheet to retained earnings.

Impairment:
Impairment loss: The amount by which the carrying amount of an asset exceeds its recoverable
amount. As per IAS 38 ensures that assets are carried in the FS at not more than their
recoverable amount.
The recoverable amount of an asset is higher of its:

 Fair value less costs to sell (the amount receivable from disposal of asset in a transaction
between market participants less costs to sell it): and
 Value in use (the present value of future cash flows from using an asset, including
disposal proceeds).
Machine Machine Machine Machine
A B C D
Carrying Amount A 250,000 100,000 360,000 25,000

Fair value less cost to

sell B 200,000 75,000 300,000 20,000
Value in Use C 150,000 80,000 370,000 30,000

Recoverable Amount
(Higher of B and C) D 200,000 80,000 370,000 30,000
Impairment Loss(A-D) 50,000 20,000 0 0
Amount to be taken to
Balance Sheet 200,000 80,000 360,000 25,000
Impairment loss will not be recorded if recoverable amount > Carrying amount.

Disclosures:
The FS shall disclose, for each class of PPE:
a) The measurement bases used (i.e., cost model or revaluation model).
b) The depreciation method used;
c) The useful lives or the depreciation rates used;
d) The gross carrying amount and the accumulated depreciation at the beginning and end
of the period; and
e) A reconciliation of the carrying amount at the beginning and end of the period showing:
i. Additions;
ii. Acquisitions through business combinations;
iii. Impairment losses
iv. Disposals;
v. Depreciation;
The financial statements shall also disclose:
  The existence and amounts of restrictions on title and PPE pledged as security for
liabilities.
 The amounts of expenditures recognized in the carrying amount in the course of its
construction;
 The amounts of contractual commitments for the acquisition of PPE and
Disclosures for assets stated at revalued amounts:
When items of PPE are stated at revalued amounts following must be disclosed:

 The effective date of the revaluation.

 Whether an independent valuer was involved;
 The revaluation surplus indicating the change for the period.
Additional disclosures encouraged by IAS 16
IAS 16 encourages disclosure of the following information as users of FS might find it to be
useful.

 The carrying amount of temporarily idle PPE;

 The gross carrying amount of any fully depreciated PPE that is still in use.
 The carrying amount of PPE retired from active use and held for disposal; and
 When the cost model is used, the fair value of PPE when this is materially different from
the carrying amount.