IFRS for SMEs:
Property, plant and equipment
Definitions
Property, plant and equipment (PPE) are tangible assets expected to be used for more than 12 months for operational purposes. It is a non-current asset.
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It also includes Investment Property that cannot be measured at fair value without undue cost or effort.
Other definitions
- Useful life: The time period over which a PPE is expected to provide an inflow of economic benefits
- Disposal: It is when a PPE is destroyed, sold or gotten rid of, and the value of the PPE is removed from the balance sheet.
- Residual value: The estimated amount that would be earned by disposing a PPE, minus any estimated costs of disposing it, at the end of its useful life.
- Depreciable amount: The initial cost of obtaining a PPE, minus its residual value
- Depreciation: The systematic allocation of the depreciable amount of a PPE over its useful life.
- Net book value: The cost of the asset minus any accumulated depreciation and impairment losses.
Recognition
A PPE is recognized if:
- It is probable that future economic benefits associated with it will flow to the entity for more than 12 months
- Its cost can be measured reliably
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Cost of a PPE
The cost of a PPE includes:
- All the costs required to purchase/construct and bring the asset to the condition and location for its intended use (borrowing costs, refundable taxes and general overhead costs are excluded).
- Estimated costs of dismantling, removing the asset and restoring the site on which it is located (discounted to present value), if there is an obligation to do so.
Note: If payments made to acquire the asset is deferred, then the present value of the payments should be added as the cost. Amounts paid in excess of the present value are finance/interest costs that need to be expensed. The market interest rate for similar transactions shall be used as the discount rate.
Exchange of assets
If PPE is exchanged for other non-monetary assets, then the cost of the asset(s) received is its fair value. The net book value of the PPE given up is expensed, and the fair value of the asset(s) received is recorded as an income. The difference is either a gain or loss on disposal.
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The above should be done only if the exchange transaction has commercial substance, and if the fair value can be measured reliably. If the assets being exchanged are similar, then there is no commercial substance. In these situations, the cost of the asset(s) acquired will be equal to the net book value of the PPE given up.
Regular replacement and major inspections
If a significant part of a PPE is replaced, and this replacement will increase the future economic benefits expected to flow from the PPE, then:
- The net book value of the replaced part of the PPE should be derecognized
- The cost of the replacement part should be added to the cost of the PPE.
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The net book value of the replaced part should be determined and derecognized, even if its value wasn't tracked separately. If it's not possible to determine this value, then the cost of the replacement part should be used as an indication of what the cost of the replaced part was at the time that the replaced part was acquired. Then, this cost should be depreciated to find the cost of the replaced part at the time of replacement.
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If a major inspection was done for a PPE, and the major inspection will increase the future economic benefits expected to flow from the PPE, then:
- The net book value of the previous major inspection of the PPE should be derecognized
- The cost of the current major inspection should be added to the cost of the PPE.
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The net book value of the previous major inspection should be determined and derecognized, even if its value wasn't tracked separately. If it's not possible to determine this value, then the estimated cost of a future similar inspection should be used as an indication of what the cost of the previous inspection was at the time the previous inspection was done. Then, this value should be depreciated to find the value of the previous inspection at the time of the current inspection.
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Spare parts, stand-by and servicing equipment
These must be classified as PPE when they meet the criteria of PPE. If they can be used only in connection with another item of PPE, they are considered as PPE. They should be depreciated even if they are not in use, as long as it's available for use.
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Land and buildings
Land and buildings should be recorded separately, even if they are acquired together. The purchase price must be allocated between the two on a systematic basis. Land should not be depreciated.
Measurement after initial recognition
After initial recognition, PPE should be measured using cost model or revaluation model. If you choose a model for one PPE, then the same model must be applied for the whole class of PPE.
Cost Model
PPE must be measured at initial cost less accumulated depreciation less accumulated impairment losses.
Depreciation
This is the systematic allocation of an asset's depreciable amount over its useful life.
There are different methods of systematic allocation (depreciation). The two most common ones are straight-line method and reducing balance method. The method chosen should be the one that best reflects how the economic benefits from the PPE is expected to flow to the entity.
- Straight-line method divides the depreciable amount by the number of years of useful life to find the depreciation expense for each year.
- Reducing balance method applies an appropriate percentage to the net book value of a PPE at the end of each period(year) to be expensed as depreciation. This chosen percentage shouldn't be changed from year to year.
Depreciation begins when the PPE comes to the condition and location of its intended use, even if it's not used yet. Depreciation stops when the PPE is derecognized. Depreciation doesn't stop or pause when it is idle, or kept without being used.
The depreciation method can only be changed if the pattern by which economic benefits are expected to flow to the entity changes significantly, and changing the depreciation method could affect the decisions made by the users of financial statements.
Useful life
The useful life of a PPE should be determined based on the following factors:
- Expected usage of the asset, based on its expected capacity or physical output
- Expected physical wear and tear of the asset, which depends on operational factors
- Technical or commercial obsolescence which arises from changes in market conditions
- Legal or similar limits on the use of the asset, such as expiry dates
The useful life of a PPE which has already been decided can only be changed if any of the following situations are met, and changing the useful life could affect the decisions made by the users of financial statements.
- Change in the manner in which the asset is used
- Significant unexpected wear and tear
- Technological advancement
- Change in market value of the PPE.
Residual value is an estimate based on the current prices of the PPE as if it was of the age and condition at the end of its expected useful life.
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Componentisation
If major parts of PPE have significantly different patterns of consumption of economic benefits, those parts should be depreciated separately.
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Revaluation Model
PPE must be measured at the revalued amount after initial recognition. The revalued amount is the fair value. The value recorded as PPE can go up or down.
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This model can be chosen only if fair value of the whole class of the PPE can be measured reliably. If an item of PPE is revalued at a point in time, then the whole class of the PPE must be revalued with it. Revaluation must be done at regular time intervals.
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If the value of PPE is being increased, the PPE should be debited, and Other Comprehensive Income should be credited. Other Comprehensive Income from revaluation should be accumulated in Equity as Revaluation Surplus. However, if this PPE's value was decreased (impaired) before, then the revaluation amount should be credited to the Income Statement (P&L) to the extent that the value of PPE was charged as an expense to the Income Statement (P&L) before, and any excess should be credited to Other Comprehensive Income.
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If the value of PPE is being decreased, the PPE should be credited, and the decreased amount should be expensed in the income statement (P&L). However, if this PPE's value was increased before, then the revaluation amount should be debited to Other Comprehensive Income to the extent of the credit balance in the Revaluation Surplus account in respect of that PPE, and any excess should be expensed in the Income Statement (P&L)
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The PPE must be depreciated even under revaluation model. Depreciation amount should be re-calculated after revaluation based on the revalued amount of the PPE and its remaining useful life.
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Derecognition
PPE must be derecognized when it is no longer controlled by the entity (disposed) or doesn't meet the recognition criteria of probable future economic benefits.
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Disposal is recognized at the time that control of the PPE is lost. The book value of the PPE is expensed. If it is sold, then the receipts from disposal are recorded as an income. This leads to either a gain on disposal (if sold above PPE value) or loss on disposal (if sold below PPE value).