IAS 16: Accounting for Property, Plant, and Equipment

IAS 16 is an accounting standard that provides guidelines on how to account for Property, Plant, and Equipment (PPE). This includes recognizing, measuring, and depreciating assets like buildings, machinery, and equipment, which are essential for a company’s operations.

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What is Property, Plant, and Equipment (PPE)?

PPE refers to tangible (physical) assets that:

1. Are held for use in the production of goods or services, for rental to others, or for administrative purposes.
2. Are expected to be used for more than one accounting period (more than a year).

Examples of PPE include buildings, land, machinery, office equipment, vehicles, furniture, etc.

Recognition of PPE

Recognition means when to include an item as a PPE on the company’s financial statements. Two conditions must be met:

1. Future economic benefits: The asset is expected to bring future benefits to the company, like generating revenue or saving costs.
2. Reliable measurement: The cost of the asset can be measured reliably.

For example, if a company buys a machine for its factory, the company should record the machine as a PPE on its balance sheet if and only if it meets the above conditions. That is, it will help produce goods and its cost is known.

Initial Measurement of PPE (Cost of PPE)

When a company first acquires PPE, it should be recorded at its cost. The cost of PPE includes:

• Purchase price: The actual cost of buying the asset, minus any discounts or rebates.
• Direct costs: Costs directly related to bringing the asset to working condition, like transportation, installation, or legal fees.
• Dismantling and restoration costs: If required, the estimated cost of dismantling the asset and restoring the asset after use (e.g., for certain buildings).

Example:

If a company buys a machine for ₦50,000, pays ₦2,000 for transportation, and ₦1,000 for installation, the total cost of the machine would be ₦53,000 (i.e., ₦50,000 + ₦2,000 + ₦1,000).

Subsequent Measurement of PPE (After Initial Recognition)

After PPE is initially recognized, companies have two options for measuring PPE over time:

• Cost Model: The PPE is carried at cost, minus accumulated depreciation and any impairment losses.

Depreciation is the reduction in the asset’s value over time due to factors like wear and tear of body parts of the asset (e.g. machine), changes in technology that render the asset obsolete or outdated, etc.

Impairment is a reduction in value if the asset’s value falls below its carrying amount.

• Revaluation Model: The PPE is revalued to its fair value (current market value), and this value is updated periodically.

Any increase in value goes to other comprehensive income (OCI) and is added to a revaluation surplus in equity.

If the value decreases, it’s treated as a loss in the income statement.

Most companies use the cost model because it’s simpler.

Depreciation

Depreciation is the process of allocating the cost of PPE over its useful life. Every year, we assume that a portion of the asset’s cost is being used up (because the asset loses value as time passes) and this usage is recorded as an expense to reflect its use. Depreciation begins when the asset is available for use, not when it’s actually being used.

Note: Not all assets depreciates. Land, for example, appreciates in value.

Key Concepts in Depreciation:

• Useful life: The period the company expects to use the asset.
• Residual value: The expected amount the company will receive when it disposes of the asset at the end of its useful life.
• Depreciation method: Companies can choose methods such as the straight-line method, reducing balance method, etc.

Read also: Explanation of the most common depreciation methods used by different companies

Subsequent Costs

If a company incurs costs after the initial purchase of PPE, these costs can only be capitalized (added to the value of the asset) if they:

• Improve the asset’s performance or extend its useful life.
• Replace a part of the asset that needs replacement.

Example: If the company spends money to upgrade a machine to increase its efficiency, the cost can be added to the machine's value. But if the company spends money on routine maintenance, that should be recorded as an expense, not added to the asset's value.

Derecognition of PPE (Disposal or Retirement)

When a company sells or gets rid of PPE, it should:

• Remove the asset from the balance sheet.
• Record any gain or loss on disposal in the income statement.

Gain or Loss on Disposal = Selling Price – Carrying Amount of Asset

Example: If a company sells a machine for ₦5,000 and the machine’s current carrying amount is ₦3,000, the company would record a gain of ₦2,000.

Disclosure Requirements

Companies must provide certain information about their PPE in the financial statements, including:

• Depreciation methods used.
• Useful lives or depreciation rates.
• The gross carrying amount and accumulated depreciation.
• A reconciliation of changes in the carrying amount of PPE (e.g., additions, disposals, depreciation, etc.).

Summary of Key Points:

• Recognition: Record PPE when future benefits and costs are measurable.
• Initial Measurement: Record PPE at the purchase price of the asset, including all costs to get the asset ready for use (e.g., delivery, installation).
• Subsequent Measurement: Use either the cost model or revaluation model.
• Depreciation: Spread the cost of PPE over its useful life using an appropriate method.
• Subsequent Costs: Only capitalize costs that improve the asset or extend its life.
• Derecognition: Remove PPE from the balance sheet when sold or retired, and record any gain or loss.
• Disclosure: Provide details on PPE, such as depreciation methods and carrying amounts.