Property, Plant and Equipment (IAS 16)
Assets
Property, Plant and Equipment (IAS 16)
Syllabus tag: KASNEB CPA | Intermediate Level | CA23 Financial Reporting and Analysis | Topic 2 Property, Plant and Equipment
Lesson objectives
By the end of this topic, you will be able to:
- Decide which costs may be capitalised on initial recognition
- Apply the straight-line and reducing-balance methods
- Account for a revaluation and the reserves transfer that follows
- Compute a profit or loss on disposal
- Apply the impairment test in IAS 36
Why this matters
Non-current assets are usually the largest figure on a statement of financial position. Small differences in how they are measured move both profit and net assets substantially, which is why the standard is prescriptive about it.
One asset throughout
A machine costing KES 9,600,000, residual value KES 600,000, useful life 10 years, bought on 1 January.
Words to know
- Cost — purchase price plus everything needed to bring the asset to working condition for its intended use.
- Carrying amount — cost or valuation less accumulated depreciation and impairment.
- Depreciable amount — cost less residual value.
- Recoverable amount — the higher of fair value less costs of disposal and value in use.
- Revaluation surplus — the gain on revaluation, held in equity rather than profit.
What may be capitalised
Included: purchase price, import duties, non-refundable taxes, delivery, installation and testing, site preparation, and the estimated cost of dismantling where an obligation exists.
Excluded and expensed: administration and general overhead, staff training, launch and advertising costs, and any losses in the period before the asset reaches planned performance.
The test is whether the cost was necessary to bring the asset into working condition. Training the operator is not — the machine works without it.
Depreciation
Straight line = (Cost − Residual value) / Useful life
= (9,600,000 − 600,000) / 10 = KES 900,000 a year
After four years the carrying amount is 9,600,000 − 3,600,000 = KES 6,000,000.
Reducing balance at 20% charges 9,600,000 × 20% = KES 1,920,000 in year one, then 20% of the reduced balance each year, giving a carrying amount after three years of KES 4,915,200.
Note that reducing balance never applies the residual value directly and never quite reaches zero. It suits assets that lose most of their value early — vehicles and computers — while straight line suits assets that are used evenly, such as buildings.
Depreciation begins when the asset is available for use, not when it is first used, and continues even while it is idle.
Revaluation
At the end of year four the machine is revalued to KES 7,800,000 against a carrying amount of 6,000,000.
Revaluation surplus = 7,800,000 − 6,000,000 = KES 1,800,000
This is credited to a revaluation surplus in equity, through other comprehensive income, and not to profit or loss. Recognising it as profit would let a company report gains simply by having an asset revalued.
The revalued amount is then depreciated over the remaining six years:
(7,800,000 − 600,000) / 6 = KES 1,200,000 a year
The charge has risen by 300,000. IAS 16 permits an optional transfer of that excess from revaluation surplus to retained earnings each year, so that retained earnings are not depressed by depreciating an amount never paid.
Two rules that follow: revaluations must be kept sufficiently up to date, and the whole class of assets must be revalued, not the one asset that has risen in value.
:::checkpoint Explain why a revaluation gain is recorded in equity while a revaluation loss below original cost goes to profit or loss. What principle is at work? :::
Disposal
Profit or loss = Proceeds − Carrying amount
Selling the machine for KES 5,200,000 when its carrying amount is 6,000,000:
5,200,000 − 6,000,000 = KES 800,000 loss
The loss does not mean the sale was bad. It means depreciation charged over the four years was, with hindsight, too little — the asset lost value faster than estimated.
Any balance remaining in the revaluation surplus for that asset is transferred directly to retained earnings on disposal. It never passes through profit or loss.
Impairment (IAS 36)
An asset must not be carried above its recoverable amount.
Recoverable amount = higher of (fair value less costs of disposal) and (value in use)
A machine with a carrying amount of KES 7,400,000, fair value less costs of disposal of 6,900,000 and value in use of 7,100,000:
Recoverable amount = 7,100,000 (the higher) Impairment loss = 7,400,000 − 7,100,000 = KES 300,000
The logic of taking the higher figure: a rational company would choose the better of selling the asset or continuing to use it, so the loss is only what it cannot recover by either route.
:::checkpoint A company depreciates its delivery vans on the straight-line basis over eight years and consistently makes losses on disposal after five. What does that pattern suggest, and what should the company do about it? :::