IAS-16 Property, Plant & Equipment

Objective:

The objective of IAS 16 is to prescribe the accounting treatment for property, plant, and equipment. The
principal issues are;
 Recognition of assets
 Determination of their carrying amounts
 Depreciation charges, and
 Impairment losses to be recognized in relation to them.

Scope:

This standard should be applied in accounting for property plant and equipment except when another
IAS requires or permits a different accounting treatment.

IAS 16 does not apply to

 Assets classified as held for sale in accordance with IFRS 5
 Exploration and evaluation assets (IFRS 6)
 Biological assets related to agricultural activity (see IAS 41) or

Definitions:

Property, Plant and Equipment: Tangible assets that:

a) are held by an enterprise for use In the production or supply of goods or services; For rental to
others, or For administrative purposes; and
b) are expected to be used for more than one accounting period.

Depreciation: It is the systematic allocation of the depreciable amount of an asset over its useful life.

Depreciable amount: It is the cost of an asset or the amount that has replaced it, less its residual value.

Recoverable amount: It is the higher of an asset’s fair value less costs to sell and its value in use.

Useful Life is:

a) the period during which it is expected to use the depreciable assets by the entity, or
b) the number of production or similar units that are expected of it by the entity.

Residual Value: The estimated amount that an entity would currently obtain from disposal of the asset,
after deducting the estimated cost of disposal.

Carrying Amount (Book Value): The amount at which an asset is recognized in the statement of financial
position, after deducting any accumulated depreciation and accumulated impairment losses thereon.

Fair Value: The amount for which an asset could be exchanged between knowledgeable, willing parties
in an arm’s length transaction.

Impairment Loss: The amount by which the carrying amount of an asset exceeds its recoverable
amount.

Recognition:

Initial expenditure on the asset:

The cost of an item of property, plant, and equipment should be recognized as asset if, and only if:
 a) It is probable that the future economic benefits associated with the asset will flow to the entity,
((more than 50% chance) probability of inflow of future economic benefits)
b) The cost of the asset can be measured reliably;
 If the item is purchased the cost can be measured easily (the cash paid for item),
 If the item is self-constructed asset, the cost can be measured reliably by examining the cost of
material, labor and other inputs used during construction process.

Subsequent expenditure on the asset:

If subsequent expenditure has been incurred on the item of property plant and equipment, which is
already recorded in our books, we have two options:

a) Recognize the expenditure as an expense: Costs of repair and maintenance, which includes the
costs of day to day servicing, are expensed out. Cost of labor and consumables, cost of small
parts and routine repair etc.
b) Capitalize the expenditure: Certain parts of plant and machinery may require replacement at
regular intervals. For example, a furnace may require relining after a specific number of hours.
The replacement of the parts may be capitalized if it meets the following two criteria.
i) The replacement will increase the current level of economic benefits. and
ii) The costs of the items can be measured reliably. “Carrying amount of those parts that are
replaced should be de-recognized.”

Example:

Wasif Ltd. purchased a knitting machine for Rs. 320,000 on 01 January 2019. The company incurred
expenses of Rs. 30,000 including freight and tax. Repair and maintenance would amount to Rs. 5000 per
month. On 01st October 2019, the machine broke down and some parts of the machine had to be
replaced. The company decides to replace the existing parts of the machine with new parts, which
would cost the company Rs. 40,000. It is assumed that the replaced parts will result in inflow of future
economic benefits. The NBV of the old parts at the date of replacement was Rs. 10,000. If the year end
of the company is 31st Dec, determine the amount to be:
i. Expensed out
ii. Capitalized

Solution:

Amount to be expensed out: $

Maintenance costs (Rs.5000 x 12) 60,000

Amount to be capitalized:
Price of machine 320,000
Freight and taxes 30,000
Cost of machine 350,000
Cost of new parts 40,000
De-recognition of old parts (10,000)
380,000
Measurement at recognition:

1. Cost of an asset acquired

An item of property, plant and equipment that qualifies for recognition as an asset shall be
measured at its cost.
i. Elements of cost
a) Its purchase price, including import duties and non-refundable purchase taxes,
after deducting trade discounts and rebates.
b) Any cost directly attributable to bring the asset into current location and
condition necessary for it to be capable of operating it, in the manner intended
 by management. E.g. Costs of site preparation, initial delivery and handling
charges, installation and assembly costs, cost of testing and professional fees.
c) The initial estimates of the costs of dismantling and removing the item and
restoring the site on which it is located.

Example:

Asif Limited imported a machinery with following details:

Basic list price of plant 240,000

Trade discount applicable to Broadax 12.5% on list price
Other cost:
Shipping and handling costs 2,750
Estimated preproduction testing 12,500
Maintenance contract for three years 24,000
Site preparation costs:
Electrical cable installation 14,000
Concrete reinforcement 4,500
Wages 7,500

Asif Limited paid for plant within four weeks of order, thereby obtaining an early settlement discount of
3%.

Required: Calculate the initial cost of plant.

Solution: Initial measurement of the cost at which the plant would be capitalized is calculated as
follows: Rs.
Basic list price of plant 240,000
Less trade discount (12.5%) (30,000)
210,000
Other cost:
Shipping and handling costs 2,750
Estimated pre-production sampling 12,500
Site preparation costs:
Electrical cable installation 14,000
Concrete reinforcement 4,500
Wages 7,500
Initial cost of plant 251,250

2. Cost of self-constructed asset:

The cost of a self- constructed asset is determined using the same principles as for an acquired
asset. If an entity makes similar assets for sale in the normal course of business, the cost of the
asset is usually the same as the cost of constructing an asset for sale. The cost of abnormal
amounts of wasted material, labor, or other resources incurred in self- constructing as asset is
not included in the cost of the asset.

Example:
Imran Ltd. is engaged in the manufacturing of chilling plants. During production the normal cost per unit
of material, labor and overheads is Rs. 5,000, Rs. 3,000 and Rs. 2,000 respectively. The sale price is Rs.
15,000. During the month the company manufactured three plants for internal use. The company spent
Rs. 15,500 on materials, Rs. 9,200 on labor and Rs. 6,000 on overheads. These actual costs include the
effect of abnormal wastage.

Required: What cost should be recognized by the company in respect of property, plant and
equipment?
Solution:

The cost recognized is:

Material (5,000x3) = Rs. 15,000
Labor (3,000x3) = 9,000
Overhead (2,000x3) = 6,000
Total cost Rs. 30,000

Note: abnormal amount of wasted material and wasted labor are not to be capitalized.

Exchange of an asset

a) If an asset is acquired in exchange for another asset (whether similar or dissimilar in nature),
the cost will be measured at the fair value of the asset acquired.

Example

K Ltd. engaged in manufacturing of sports goods. K Ltd. exchanged one of its plants with M Ltd.
Asset of K Ltd. Asset of M Ltd.
Cost 50,000 60,000
Accumulated Depreciation 30,000 32,000
Fair value of the asset 24,000 36,000
Rs. 12,000 was also paid by K Ltd. to settle the transaction.

Required: Pass Journal entries in the books of K Ltd. and M Ltd.

Solution:

In the books of K Ltd. In the books of M Ltd.

New Asset 36,000 New Asset 24,000
Accumulated depreciation 30,000 Accumulated depreciation 32,000
Old Asset 50,000 Cash 12,000
Cash 12,000 Old Asset 60,000
Profit & Loss 4,000 Profit & Loss 8,000

b) If the fair value of asset acquired is not determinable then new asset will be recognized at the
fair value of an asset given up plus cash paid to acquire new asset.

Example:

A Ltd. exchanged its asset with the asset of B Ltd. A Ltd. had paid Rs. 3,000 further to acquire the asset.
The following detail is available in respect of assets.
Asset of A Ltd. Asset of B Ltd.
Cost 22000 40000
Accumulated Depreciation 13000 21000
Fair value of the asset given up 12000
Required: Pass Journal entries in the books of A Ltd. and B Ltd.

Solution:
In the books of A Ltd. In the books of B Ltd.
New Asset *15000 New Asset 12000
Accumulated depreciation 13000 Accumulated depreciation 21000
Old Asset 22000 Cash 3000
 Cash 3000 Profit & Loss 4000
Profit & Loss 3000 Old Asset 40000
* Cost of asset acquired by A Ltd.
Fair value of the asset given up Rs.12,000
Add: Cash Paid 3000
Rs. 15,000

c) If fair value of neither asset (given up or received) is determinable then measure the acquired
asset at the Carrying value of the asset given up, in this case no loss or gain will arise.

Example:

P Ltd. exchanged its plant with the plant of Q Ltd. The following detail is available in respect of plants.
Plant of P Ltd. Plant of Q Ltd.
Cost 40000 50000
Accumulated Depreciation 18000 23000
Required: Pass Journal entries in the books of P Ltd. and Q Ltd.

Solution:
In the books of P Ltd. In the books of Q Ltd.
New Plant 22000 New Plant 27000
Accumulated depreciation 18000 Accumulated depreciation 23000
Old Plant 40000 Old Plant 50000

* Carrying cost of asset given up.

P Ltd. Q Ltd.
Cost 40000 Cost 50000
Less Accumulated Depreciation 18000 Less Accumulated Depreciation 23000
Carrying cost 22000 Carrying cost 27000

Measurement after recognition

IAS-16 allows two treatments for Property, Plant and Equipment;

1. Cost model (Assets valued at cost – Depreciation)
2. Revaluation Model (Assets valued at their fair value – Depreciation)

Cost Model

It is by far the most common method. After recognition as an asset, an item of property, plant and
equipment shell be carried at its cost less any accumulated depreciation and any accumulated
impairment losses.

Example:

Axe Ltd. purchased a building worth $200,000 on January 1, 2008. It records the building using the
following journal entry.

Equipment 200,000
Cash 200,000

The building has a useful life of 20 years and the company uses straight line depreciation. Yearly
depreciation is hence $200,000/20 or $10,000. Accumulated depreciation as at December 31, 2010 is
$10,000*3 or $30,000 and the carrying amount is $200,000 minus $30,000 which equals $170,000.
Example:

Farooq Limited acquired an asset costing Rs. 30,000. The company estimates its useful life for 5 years
with a residual value of Rs. 5,000. The company charges depreciation using straight-line method on such
type of assets. In second year, the company estimates its residual value Rs. 7,000 & remaining useful life
of 3 years.

Required: Compute the depreciation charge for the second year.

Solution

Year Cost Residual Value Useful Life Depreciation Book Value

1st Year 30,000 5,000 5 Years 5,000 (W-1) 25,000
2nd Year 7,000 3 Years 6,000 (W-2) 19,000

Working Notes:
(W-1) Depreciation = Book Value/ Useful life = 25,000/5 = Rs. 5,000
(W-2) Depreciation = Book Value/ Useful life = 18,000/3 = Rs. 6,000

Example

A manufacturing firm purchased on 1st January 2013 certain machinery for Rs. 200,000 and spent Rs.
4,000 on its erection. On 1st July in the same year, additional machinery costing Rs. 60,000 was acquired.
On 1st January 2015, the machinery purchased on 1 st January, 2013 having become obsolete was
auctioned for Rs. 50,000 and on the same date fresh machinery was purchased at a cost of Rs. 25,000.

Deprecation was provided at the rate of 10%, on the original cost. In 2015 however, this method was
changed and that of written off 15% on the written down value was adopted.

Required: Give the Machinery account, Provision for depreciation account and Machinery disposal
account as it would stand at the end of each year from 2013 to 2016.

Solution:
Plant
Date Particulars Rs. Date Particulars Rs.
204,00
1/1/2003 Cash 0 31-12-03 Balance c/d 264,000
1/7/2003 Cash 60,000
 
264,00
0 264,000
 
264,00
1/1/2004 Balance b/d 0 31-12-04 Balance c/d 264,000
 
264,00
0 264,000
 
264,00
1/1/2005 Balance b/d 0 1/1/2005 Disposal 204,000
1/6/2005 Cash 25,000 Balance c/d 85,000
 
 289,00
0 289,000
 
1/1/2006 Balance b/d 85,000 31-12-06 Balance c/d 85,000
 
85,000 85,000

Accumulated Depreciation
Date Particulars Rs. Date Particulars Rs.
31-12-03 Balance c/d 23,400 1/1/2003 Depreciation (W-1) 23,400
 
23,400 23,400
 
1/1/2004 Balance c/d 49,800 1/1/2004 Balance b/d 23,400
  Depreciation (W-2) 26,400
 
49,800 49,800
 
1/1/2005 Disposal 48,800 1/1/2005 Balance b/d 49,800
31-12-05 Balance c/d 20,400 Depreciation (W-3) 11,400
 
61,200 61,200
 
31-12-06 Balance c/d 30,090 1/1/2006 Balance b/d 20,400
  Depreciation (W-4) 9,690
 
30,090 30,090

Machiney Disposal
Date Particulars Rs. Date Particulars Rs.
204,00
1/1/2005 Machinery 0 1/1/2005 Acc. Dep. 40,800
  Cash 50,000
  Profit & Loss 113,200
 
204,00
0 204,000

Working Notes:
W-1
Depreciation in 2003
204,000 x 10% 20,400
60,000 x 10% x 6/12 3,000
Total Deprecation 23,400

W-2
Depreciation in 2004
204,000 x 10% 20,400
60,000 x 10% 6,000
Total Deprecation 26,400

W-3
Depreciation in 2005
 51,000 x 15 % 7,650
(60,000-9,000)
25,000 x 15% 3,750
Total Deprecation 11,400

W-4
Depreciation in 2006
(85,000-20,400) x 15 % 9,690

Revaluation Model

Revaluation method is used by companies where the market value of an asset is significantly higher than
its cost less depreciation. For instance, Land and buildings are the type of assets that are most
commonly revalued as they tend to go up in value over time.

Conditions for Revaluation

Once an asset is revalued the following conditions shall be fulfilled;

1. It must be revalued on a regular basis
2. All the assets in the same class must be revalued (e.g. all buildings)

Treatments of Revaluation

In revaluation model an asset is initially recorded at cost but subsequently its carrying amount is
increased to account for any appreciation in value. The difference between cost model and revaluation
model is that revaluation model allows both downward and upward adjustment in value of an asset
while cost model allows only downward adjustment due to impairment loss.

Example:

Consider the example of Axe Ltd. as quoted in case of cost model. Assume on December 31, 2010 the
company intends to switch to revaluation model and carries out a revaluation exercise which estimates
the fair value of the building to be $190,000 as at December 31, 2010. The carrying amount at the date
is $170,000 and revalued amount is $190,000 so an upward adjustment of $20,000 is required to
building account. It is recorded through the following journal entry:

Building 20,000
Revaluation Surplus 20,000

Revaluation Surplus

Upward revaluation is not considered a normal gain and is not recorded in income statement rather it is
directly credited to an equity account called revaluation surplus. Revaluation surplus holds all the
upward revaluations of a company's assets until those assets are disposed of.

Depreciation after Revaluation

The depreciation in periods after revaluation is based on the revalued amount. In case of Axe Ltd.
depreciation for 2011 shall be the new carrying amount divided by the remaining useful life or
$190,000/17 which equals $11,176.

Reversal of Revaluation

If a revalued asset is subsequently valued down due to impairment, the loss is first written off against
any balance available in the revaluation surplus and if the loss exceeds the revaluation surplus balance
of the same asset the difference is charged to income statement as impairment loss.
Example:

Suppose on December 31, 2012 Axe Ltd. revalues the building again to find out that the fair value should
be $160,000. Carrying amount as at December 31, 2012 is $190,000 minus 2 years depreciation of
$22,352 which amounts to $167,648.

The carrying amount exceeds the fair value by $7,648 so the account balance should be reduced by that
amount. We already have a balance of $20,000 in the revaluation surplus account related to the same
building, so no impairment loss shall go to income statement. The journal entry would be:

Revaluation Surplus 7,648

Building Account 7,648
Had the fair value been $140,000 the excess of carrying amount over fair value would have been
$27,648. In that situation the following journal entry would have been required.

Revaluation Surplus 20,000

Impairment Losses 7,648
Building 20,000
Accumulated Impairment Losses 7,648

Practice Problems
Problem No 01:

On 1 March 2018 Farooq acquired a machine from Yousaf under the following terms:
Rs.
List price of machine 82,000
Import duty 1,500
Delivery fees 2,050
Electrical installation costs 9,500
Pre-production testing 4,900
Purchase of a five-year maintenance contract with Plant 7,000
In addition to the above information Farooq was granted a trade discount of 10% on the initial list price
of the asset and a settlement discount of 5% if payment for the machine was received within one month
of purchase. Farooq paid for the plant on 25 March 2018.

Required: How should the above information is accounted for in the financial statements?

Problem No. 02:

Construction of Deb and Ham’s new store began on 1 April 2009.

The following costs were incurred on the construction:
Rs.000
Freehold land 4,500
Architect fees 620
Site preparation 1,650
Materials 7,800
Direct labor costs 11,200
Legal fees 2,400
General overheads 940
The store was completed on 1 January 2010 and brought into use following its grand opening on the 1
April 2010. Deb and Ham issued a Rs. 25m secured loan on 1 April 2009 to aid construction of the new
store (which meets the definition of a qualifying asset per IAS 23). The loan carried an interest rate of 8%
per annum and is repayable on 1 April 2012.
Required:
Calculate the amount to be included as property, plant and equipment in respect of the new store and
state what impact the above information would have on the income statement (if any) for the year
ended 31 March 2010.

Problem No 03:

On 1 March 2010 Yucca purchased an upgrade package from Plant at a cost of $18,000 for the machine
it originally purchased in 2008 (Problem 1). The upgrade took a total of two days where new
components were added to the machine. Yucca agreed to purchase the package as the new components
would lead to a reduction in production time per unit of 15%. This will enable Yucca to increase
production without the need to purchase a new machine.

Required: Should the additional expenditure be capitalized or expensed?

Problem No 04:

Ismail Ltd. purchased a spinning machine for Rs. 400,000 on 01 January 2018. The company incurred
expenses of Rs. 25,000 including freight and tax. Repair and maintenance would amount to Rs. 4500 per
month. On 01 September 2018, the machine broke down and some parts of the machine had to be
replaced. The company decides to replace the existing parts of the machine with new parts, which
would cost the company Rs. 50,000 It is assumed that the replaced parts will result in inflow of future
economic benefits. The NBV of the old parts at the date of replacement was Rs.27,000. If the year end of
the company is 31st December.

Required: Determine the amount to be:

a) Expensed out
b) Capitalized

Problem No 05:

Mohsin Ltd. has recently purchased an item of plant from plant co, the details of this are:
Basic list price of plant 600,000
Trade discount applicable to Broadax 15% on list price
Other cost:
Shipping and handling costs 7,500
Estimated preproduction testing 25,000
Maintenance contract for three years 35,000
Site preparation costs:
Electrical cable installation 35,000
Concrete reinforcement 6,000
Wages 10,500
Broadax paid for plant within four weeks of order, thereby obtaining an early settlement discount of 3%.

Required: Calculate the initial cost of plant.

Problem No 06:

Moon Ltd. purchased a plant for its operations of Rs. 500,000 on July 1 st 2014. It has the policy to revalue
its assets every year. At December 31st, 2104, it revalued its plant to Rs. 350,000. At the years ended
2015 & 2016, the revalued amounts were Rs. 450,000 and 375,000 respectively.
At the year ended December, 2017, it exchanged the plant for a new one having the cost of Rs. 500,000
and the trade-in-allowance was settled at Rs. 350,000.

The company charges depreciation @ 10% on straight line basis, and decided to transfer the surplus to
retained earnings on disposal of the asset.

Required: Prepare Plant account, accumulated depreciation account, disposal account for the 4 years
ending December 31st, 2014, 2015, 2016, and 2017.

Problem No 07:

Problem No 08:

Following information relates to Machinery used in the production department of Osama Limited.
The machinery was purchased on 1st July 2010 for Rs. 1,000,000. Revalued amount of machinery as on
30th June 2012 and 2013 is Rs. 500,000 and Rs. 600,000 respectively.

The machinery was exchanged for a new one costing Rs. 1,500,000 on 30 th June 2014. The part exchange
value of the old machine was agreed at Rs. 400,000.

Depreciation is charged @ 20% on straight line basis. It is the policy of the company to charge full year
deprecation in the year of purchase and no depreciation in the year of sale.

Osama Ltd. closes its accounts on 30th June every year.

Required: Prepare the ledger accounts of Machinery, Accumulated depreciation and Disposal.