IAS 16. PROPERTY PLANT AND EQUIPMENT Property, plant and equipment (“PP&E’) are assets held for more than on accounting period for use in the production or supply of goods or services, rental to others, or for administrative purposes. Initial Recognition An item of PP&E should be recognized as an asset when: It is probable that future economic benefits associated with the asset will flow to the entity. The cost of the asset can be measured reliably. Initial measurement Property, plant and equipment should initially be measured at its cost. The cost comprises of: its purchase price, including duties and non-refundable purchase taxes, after deducting trade discounts, 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 e.g. site preparation, delivery cost, installation costs, and borrowing costs as per IAS 23. The initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired. If an entity was importing an equipment from India below is how to arrive at initial cost Purchase price XX Trade Discount on the price (XX) Shipping cost to Mombasa XX Clearing charges at the port XX Duties to KRA XX Transport to Nairobi XX Site preparation for installation purposes XX Installation cost XX Testing to check if the equipment operates properly XX Initial cost of the equipment XX Note: All expenses incurred up to the point where the equipment is ready for use are included as part of the cost of the asset. The inclusion is called capitalization of costs and the cost are considered as capital expenditures. They are taken to the statement of financial position Costs that are taken to statement of profit or loss as an expense rather than being capitalized as referred to as revenue expenditures e.g. repair costs Illustration 1- Initial measurement Makena Ltd bought a production equipment from Eldoret. Purchasing price was Sh. 1 M. The following information is relevant Trade discount at 10% Early payment discount Transportation cost Installation cost Testing cost Expenses incurred during the launch of the equipment 10% 6% 200,000 150,000 90,000 30,000 Required: Determine the amount capitalized in the books on initial recognized Depreciation Is systematic allocation of depreciable amount over the economic useful life of an asset Useful life is the period over which an asset is expected to be available for use by an entity Depreciable amount is cost of the asset less residual value. Residual value is the value of the asset after its useful life. There are two main depreciation methods i.e., a. Straight line method Depreciation is on cost i.e., a percentage of cost or cost divided by useful lives. If the asset has residual value, depreciation is depreciable amount divided by useful life Useful life can at times be based on machine hours. b. Reducing balance method Depreciation is on carrying amount or net book value e.g., carrying amount X depreciation rate Depreciation method selected should fairly reflect the pattern in which the asset's benefits are consumed by the entity. An entity should review depreciation method and useful life on an annual basis. If there is need to change, the changes should be applied in the current financial year going forward. This is an example of a change in accounting estimates to be discussed under IAS 8 Accounting Policies, Changes in Accounting estimates and Errors. Illustration 2- Depreciation In reference to illustration 1, assume: The equipment had useful life of 10 years After year 5, Makena ltd established that the equipment was becoming inefficient hence changing the remaining useful life to 2 years Required: Compute carrying amount of the asset as at end of year 5, 6 and 7 Subsequent Measurement After initial measurement of PP&E at cost, an entity has two alternatives going forward: Cost model Revaluation models i. Cost model The asset is carried at cost less any subsequent accumulated depreciation and any subsequent accumulated impairment losses ii. Revaluation model An asset is carried at its revalued amount being its fair value at the date of revaluation less any subsequent accumulated depreciation and any accumulated impairment losses This requires comparison of carrying amount vs the revalued amount. The difference between the two is either revaluation gain or loss. Treatment of revaluation gains or losses Revaluation gains arises when revalued amount is higher than the carrying amount. The gain is usually recognized in revaluation reserve account in equity and other comprehensive income. Revaluation loss arises when revalued amount is lower than the carrying amount. The loss is usually recognized as an expense in the statement of profit or loss. Exceptions to above treatment If revaluation gain arises from an asset which had revaluation loss in the past, current year’s gain should be taken to profit or loss as an income to the extent of previously recognized loss. Excess gain is what will be recognized in the revaluation reserve account and other comprehensive incomes. If revaluation loss arises from an asset which had a revaluation gain in the past, the current year loss should first be taken to revaluation reserve account (as a debit) to the extent of the gain previously recognized. The excess loss if any, is taken to P&L as an expense. Illustration 3- Revaluation In 2019, a piece of land had a carrying amount of Sh. 6,000,000. It was revalued to Sh. 4,500,000 as at 31 December 2019. However, as at 31 December 2020, the land was revalued to Sh.10,000,000. Required: Account for revaluation in 2019 and 2020 Illustration 4- Revaluation In 2019, a piece of land had a carrying amount of Sh. 6,000,000. It was revalued to Sh. 10,000,000 as at 31 December 2019. However, as at 31 December 2020, the land was revalued to Sh.4,500,000. Required: Account for revaluation in 2019 and 2020 Note: Revaluations should be made with sufficient regularity to ensure that the carrying amount does not differ materially from that which it would be determined using fair value at the end of the reporting period When an asset is revalued, the entire class of that asset should be revalued Once is revalued, the revalued amount should be depreciated over the remaining useful life Transfer of revaluation gains to retained earnings Revaluation gains normally remains in revaluation reserve a/c until the date of disposal when the amount the amount is transferred to retained earnings i.e. realized Dr: Revaluation reserve Cr: Retained earnings However, an entity can elect to transfer the amount in small portion to retained earnings on an annual basis. This is at the same rate as depreciation. Illustration 5. Adopted from December 2014 Q1 (Extract) Bartek ltd, a company quoted on the securities exchange has prepared the following trial balance extract as at 31 December 2013 Cost of sales Land and buildings at cost (land Sh.12 Million) Plant and equipment at cost Accumulated depreciation as at 1 January 2013: Buildings Plant & Equipment Sh.000 164,160 60,000 100,440 Sh.000 9,600 40,440 Additional information: 1. The company policy is to value land and buildings at depreciated cost (net book values). Due to recent rise in property prices, the company revalued its property on 1 January 2013 to market value. An independent valuer attached the value of the property at sh. 72million (land 14.4million) as at that date. Buildings had a remaining useful life 16 years as at the date of revaluation. The company will make a transfer from the revaluation reserve to retained earnings in respect of realization of revaluation reserve. 2. Plant and equipment are depreciated at the rate of 15% per annum using reducing balance method. Depreciation of non-current assets has not been provided for the year ended 31 December 2013. Depreciation is to be classified under cost of sales expense. Required: Prepare extracts of: a. Statement of comprehensive income for the year ended 31 December 2013 b. Statement of financial statement as at 31 December 2013 Subsequent expenditures After initial recognition of an asset, an entity may incur costs on the asset e.g. expansion, upgrade or repair cost. These are called subsequent expenditures. They are expensed unless they: Enhances economic benefits to be provided by the asset i.e. increase in useful life, expansion or increase in productivity Relate to major overhaul or inspection of the asset, capitalize and depreciate until the next inspection Relate to replacement of a component of a complex asset Based on above, repair costs will always be expensed since the intention is to maintain current state of the asset and not to increase its efficiency. Illustration 6. Subsequent expenditure An entity has a restaurant building with a cost of Sh. 20 million. The construction was completed on 31st December 2017 and the hotel was available for use on 1 January 2018. Its useful life is 40 years. On 1 January 2020, it incurred Sh.6 Million to expand the kitchen due to increase in demand. It also incurred 500,000 to repair and paint the restaurant. Required: Compute the carrying amount of the building as at 31 December 2020 Disposal of property, plant and equipment Asset is derecognized from the books Profit or loss on disposal Is determined by comparing sales proceeds vs carrying amount Sales proceeds Carrying amount profit or loss XX (XX) XX/(XX) Note; Sales proceeds from disposal of PP&E is not part of revenue Illustration 7. Adopted from September 2015 Q2 The following trial balance extract relates to B ltd as at 30 June 2015. Sh. ‘000’ Revenue Leasehold property at valuation 1 July 2014 Plant and equipment at cost Accumulated depreciation –Plant and Equipment Leasehold property revaluation reserve Sh. ‘000’ 450,000 75,000 114,900 36,900 15,000 Additional information: 1. Leasehold property had a remaining useful life of 30 years as at 1 July 2014. The company policy is to revalue its property at each year end. As at 30 June 2015, leasehold property was valued at Sh. 64.5 million. 2. On 1st July 2014, an item of plant was disposed of for Sh. 3.75 million cash. The proceeds were treated as sales revenue. The plant was still included in the trial balance at a cost of Sh.12 million with the accumulated depreciation of sh. 6million. Plants are depreciated at a rate of 20% per annum on using reducing balance method. 3. Depreciation of all non-current assets is charged to cost of sales and the amounts for the year has not been provided. Required: Prepare extracts of: a. Statement of comprehensive income for the year ended 30 June 2015 b. Statement of financial statement as at 30 June 2015 Presentation in financial statements All items of property plant and equipment are reported as a single line item titled Property Plant & Equipment under the subheading of non-current assets in the statement of financial position. They are reported at their net book values. Depreciation is disclosed in the statement of profit or loss under the heading of cost of sales or administration costs as required. Exam purpose, unless instructed otherwise Plant depreciation, impairment & loss on disposal to cost of sales Depreciation for other administrative assets e.g. building, furniture etc. to administrative cost Disclosures relevant to Property, Plant and Equipment Depreciation method used. Useful lives of assets Reconciliation of opening balances to closing balances i.e. PP&E movement schedule Expenditure incurred to construct property plant and equipment during the year. In case of a revaluation: o o o o Effective date of revaluation Whether an independent value was involved For each class revalued, disclose the amount that would have been recognized if cost model were applied Revaluation surplus and any change during the year.
