Chapter 3 - PPE

Question 1

Define PPE in accordance with IAS16

Answer 1

Held for use of production or supply of goods and services, expected to be used for more than one period (thus a NCA). Can be categorised into L&B, P&M etc

Question 2

IAS16 states that PPE is recognised in the SFP when

Answer 2

It was probable that future economic benefits will flow to the entity, and costs can be reliably measured

Question 3

IAS16 states the initial cost of PPE to be recognised by?

Answer 3

The purchase price, including import duties and deduction of any rebates and discounts

Any costs directly attributable to bringing the asset to the location and condition necessary for capable operating (cost of testing and professional fees are included in this)

Question 4

Which costs are excluded from being capitalised? (thus must be expensed)

Answer 4

Admin costs, general overheads, abnormal costs e.g strikes or construction errors, costs after it is in capable condition

Question 5

Can incidental income be capitalised? E.g income from using a building site as a car park before construction commences

Answer 5

No, this is to be included in ‘other income’ within SPL

Question 6

When can borrowing (i.e interest) costs be capitalised (IAS 32)

Answer 6

Directly attributable borrowing costs can be capitalised as part of the cost of a qualifying asset. A qualifying asset is one that takes a substantial period of time to get ready for its use. These costs would have been avoided if expenditure on the qualifying asset had not occured.

Question 7

When borrowing is specific to the asset, capitalise?

Answer 7

Borrowing costs incurred x
Income from temp investment of surplus borrowings (x)

(i.e it must be solely for the asset)

**Note, this is in addition to the original cost of the whole loan

Question 8

Where funds are taken from general borrowings, capitalise?

Answer 8

weighted average cost of borrowing (times each amount by the interest and then divide by total) * expenditure on asset
this should be prorated for period of capitalisation.

Question 9

Loans outstanding;
£1million at interest 7%
£500,000 at interest 5.5%

In using some of these funds for an office block, at a cost of £250,000, how much can be capitalised?

Answer 9

weighted average cost of borrowing * cost of asset

(1,000,000 * 0.07) + (500,000 * 0.055)
/ 1,500,000

97,500 / 1,500,000 * 100%

6.5% * 250,000

Question 10

IAS23 states borrowing costs should be suspended during?

Answer 10

During extended periods in which it suspends active development of qualifying asset

Question 11

IAS 23 states that borrowing costs should cease to be capitalised when?

Answer 11

when substantially all activities necessary to prepare the asset for use are complete

Question 12

Construction of an asset was completed 30 Sept 20X5 and it was brought into use 1 January 20X6. Our reporting year end is 31 Dec 20X5. When can we capitalise costs until?

Answer 12

30 Sept 20X5

Question 13

Depreciable amount is?

Answer 13

Cost - residual value

Question 14

What are the three methods of depreciation?

Answer 14

Straight line
Reducing balance
Units output

Question 15

Depreciation commences when the asset is available for normal use. It ends when?

Answer 15

Earlier of;
Asset is fully depreciated
Asset is sold
Asset is classified as held for sale

Question 16

Land is not depreciated because?

Answer 16

It has an infinite useful life.

Question 17

What should be reviewed each year in terms of depreciation?

Answer 17

Every year, the method of depreciation should be reviewed

Residual value and useful life should also be reviewed and changed if necessary

Question 18

Cost of an asset is 100k, bought on 1 Jan 20X5. This is depreciated straight line with no residual value and UL of 5 years. The UL changes at 1 Jan 20X7 to be 8 years. What is depreciation charge for 31 Dec 20x7?

Answer 18

100k / 5 = 200k depreciation a year
1 Jan X5 - 1 Jan X6 = CA of 80k, dep 20k
1 Jan X6 - 1 Jan X7 = CA of 60k, dep 20k
New UL
60k/8 = 7500k depreciation

Question 19

What are other exceptional circumstances whereby the cost can be capitalised?

Answer 19

If a asset, such as aircraft, requires to be replaced several times over its useful life

If the asset requires regular overhauls or inspections in order to be used.

Question 20

Aircraft requires inspection every 5 years. Each inspection costs 5million. How much depreciation a year?

Answer 20

5/5 = 1mil a year

Question 21

2 methods of PPE valuation are cost and fair value. What is the difference?

Answer 21

Both must represent the CA;

Cost method;
Cost
(Acc dep)
(Acc impairment losses)

Fair value method;
Fair value
(Acc dep)
(Acc impairement losses)

Question 22

Upon revaluation, what double entries are required when the fair value is above the CA but below the historic cost?

Answer 22

Dr Acc dep
Cr Cost (to decrease to fair value)
Cr reval surp

Question 23

Overall depreciation charge of a revalued asset =

Answer 23

Revalued amount - estimated residual value / remaining useful life

Question 24

** When an asset experiences an upwards revaluation, this will result in a higher depreciation charge. This therefore reduces profits and subsequently retained earnings. In order to prevent this adversely affecting shareholders, what is allowed under IAS 16?

Answer 24

We allow for a reserve transfer.

The excess depreciation charged each year due to the revaluation is recognised as realised and thus transferred into RE from the reval surp.

Dr reval surp
Cr retained earnings

This reserves transfer into RE is therefore deducted from the revaluation surplus total figure.

Question 25

What are the entries for a downward revaluation? (where there has been no previous revaluation upwards)

Answer 25

Dr SPL (CA - fair value)
Cr CA of asset

**Note, if there has been a prior revaluation upwards, we would need to reverse the reval surp by Dr reval surp

Question 26

When should impairment reviews take place?

Answer 26

Annually for intangible NCA with an indefinite UL
Where there are indications for it. Indications include;
- Asset being obselete, damaged, left idle, or will not perform as well as expected
- Any other indication that the value of the asset is reduced to lower than expected

Question 26

What are stranded assets?

Answer 26

This is when the transition to a low carbon economy may effect the recoverable amount of an asset, resulting in an impairment.

Examples include vehicles not compliant with emission standards,energy inefficient buildings etc.

Scenario analysis is advised by the TCFD to identify these transition risks, and sustainability experts should be consulted to consider the risks presented by these stranded assets and the subsequent ways to prevent assets becoming stranded.

Question 27

*** Impairment reviews indicate if an asset has been impaired. An asset has been impaired when?

Answer 27

CA > Recoverable amount

Thus impairment loss = CA - Recoverable amount

Question 28

** The recoverable amount is the higher of?

Answer 28

Fair value - costs to sell
Value in use

Question 29

Car has an accident in year end, making it barely useable, so the value in use is £1000. Car has valuable parts, so the NRV is £3000. Opening CA is £8000, and it is depreciated on a 8 year basis. Calculate the impairment loss.

Answer 29

Impairement loss = CA - recoverable amount

Recoverable amount is the greater of value in use (probable future economic cash flows) and the fair value - selling costs

Value in use = £1000
Fair value - selling costs = £3000

Thus we take £3000 as recoverable amount

Opening CA = £8000. Closing CA will take into account depreciation of £1000. Thus closing CA = £7,000

Impairement loss = £7000 - £3000 = £4000

Question 30

*** What is the accounting treatment for an impairment loss

Answer 30

Dr SPL (expense)
Cr CA of asset

Question 31

An impairment loss may reverse any upwards revaluation of an asset. If this is the case, what are the DEs?

Answer 31

Dr Reval surp (to reverse any reval)
Cr CA of asset (to reduce value of asset)
B whatever is left over we debit to the SPL as an expense

Question 32

When should PPE be derecognised?

Answer 32

If it has been disposed of
Or is abandoned

Question 33

In the exam we are going to see PPE disposals of (NCA) inappropriately recognised as held for sale. An asset is held for sale based on what conditions?

Answer 33

Must be available for immediate sale in present condition

Sale must be highly probable

Sale is expected to be completed within 12 months of its classification of held to sale

Unlikely the plan will be significantly changed or withdrawn.

Question 34

A sale is defined to be highly probable when?

Answer 34

• Management are committed to a plan to sell the asset
• There’s an active programme to locate a buyer
• Asset is being actively marketed

Question 35

When an asset is classified as held for sale,we measure it at?

Answer 35

The lower of CA and fair value - costs to sell

Question 36

Define the steps taken place when valuing a asset classified as held for sale using the COST MODEL.

How does this differ with the REVALUATION MODEL

Answer 36

COST MODEL

1 - Value it at the lower of the CA vs fair value - costs to sell
2 - If the CA > Fair value - costs to sell, recognise an impairment loss
3 - Cease depreciation
4 - Present the asset separately under the SPL (underneath the total of current assets) as ‘Asset held for sale’
5 - Once sold, recognise any gain or loss of sale in SPL

REVALUATION MODEL

Before step 1, the asset should be revalued. The CA will therefore equal the fair value.

The asset is then classified as held for sale. Any costs to sell are an immediate impairment loss.

Remaining steps continue as above.

Question 37

If an asset is scrapped, how do we treat it?

Answer 37

Just continue to recognise it as a NCA and depreciate until it gets scrapped.