Chapter 4 - Property, plant and equipment

Question 1

What international accounting standards are we concerned with in this chapter?

Answer 1

• IAS16 - Property, Plant and Equipment
• IAS23 - Borrowing Costs
• IAS36 - Impairment of Assets
• IFRS5 - Non-current Assets Held for Sale and Discontinued Operations
• IAS20 - Accounting for Government Grants and Disclosure of Government Assistance

Question 2

Briefly outline what IAS16 establishes

Answer 2

IAS 16 establishes principles for recognising property, plant and equipment as assets, measuring their carrying amounts, and measuring the depreciation charges and impairment losses to be recognised in relation to them.

Question 3

According to IAS16, what is the definition of property, plant and equipment?

Answer 3

Tangible items held for use in the production or supply of goods or services or for administrative purposes and are expected to be used for more than one period.

Question 4

According to IAS16, what is the recognition criteria for property, plant and equipment?

Answer 4

Items of property, plant, and equipment should be recognised as assets when it is probable that:
* the future economic benefits associated with the asset will flow to the entity, and
* the cost of the asset can be measured reliably.

Question 5

According to IAS16, how should the value of property, plant and equipment be initially measured?

Answer 5

The cost directly attributable to bringing the asset to its present location and condition.

Where there is an exchange of items of PPE, with no cash price, cost should be measured at the fair value of the asset given up.

Replacement parts should be capitalised, provided the original cost of the items they replace is derecognised as the time of replacement, eg replacing the lining of a furnace.

Question 6

According to IAS16, what expenditure related to the purchase of property, plant and equipment can be included in the initial measurement of its value?

Answer 6

Any costs attributable to bringing the asset to its present location and condition, i.e.:
* Purchase price – Including import duties, non-refundable taxes, and after deducting any trade discounts.
* Delivery and handling costs – Expenses related to transporting the asset to its location.
* Installation and assembly costs – Costs for setting up the asset and making it operational.
* Testing costs – Expenses incurred to ensure the asset functions properly, minus any revenue from selling test outputs.
* Professional fees – Such as legal fees, engineering, and architecture costs necessary for asset acquisition.
* Site preparation costs – Clearing, leveling, and preparing land for construction.
* Employee costs – Wages directly attributable to the installation or construction of the asset.
* Dismantling and restoration costs – Estimated costs to remove the asset and restore the site, if required.

Question 7

According to IAS16, how should the value of property, plant and equipment be subsequently measured?

Answer 7

It gives a choice of either:
* Cost model: (initial cost less accumulated depreciation and impairment losses)
* Revaluation model: fair value less accumulated depreciation and impairment losses)

Question 8

Briefly describe the revaluation model used to subsequently measure the value of property, plant and equipment

Answer 8

The Revaluation Model under IAS 16 allows entities to measure Property, Plant, and Equipment (PPE) at fair value instead of cost, provided fair value can be reliably determined.

If the revaluation model is followed, all assets in the same class must be revalued with sufficient regularity that the carrying amount is not materially different to their fair value.

Fair value is normally taken to mean market value:
* Land & buildings: market based evidence from professionally qualified valuers
* Plant & equipment: usually market value by appraisal
* Specialised items of PPE: depreciated replacement cost as there is no market based evidence of fair value

Revaluation gains are recognised in other comprehensive income (a revaluation surplus in equity) (see later card).

Question 9

What does IAS16 specify regarding depreciation of property, plant and equipment be treated? (4)

Answer 9

• All assets (except land) should be depreciated over their useful lives, with each significant part being depreciated separately (i.e. different components of an asset depreciated seperately if have different useful lives, i.e. car and its battery)
• Depreciation commences when the asset becomes available for use not when first used
• Deprecation methods, useful lives and residual values should be reviewed at each financial year end. Any change is a change in an accounting estimate under IAS 8.
• IAS16 allows a reserves transfer of the excess depreciation on revalued assets (see later card).

Question 10

What does IAS16 specify regarding impairment of property, plant and equipment be treated?

Answer 10

IAS 16 refers to IAS 36 – Impairment of Assets for guidance on impairment. Where the recoverable amount has fallen below the carrying amount the asset has become impaired. This impairment should first be charged against other comprehensive income relating to that asset and then expensed in the profit or loss - treatment outlined further in IAS36

Question 11

Under the revaluation model of property, plant and equipment, where are the increases or decreases in value recognised in the financial statements?

Answer 11

The basic rule is that increases and decreases in value on a revaluation are recognised in other comprehensive income and form part of equity under the heading of revaluation surplus. The effect of this is that they:
* Appear under ‘other comprehensive income’ in the statement profit or loss and other comprehensive income
* Appear in the statement of changes in equity as part of ‘total comprehensive income’, and hence are part of total equity
* Are not recognised in profit or loss

Question 12

Outline the journal entries for the revaluation for property, plant and equipment if the fair value increases

Answer 12

Question 13

Outline the journal entries for the revaluation for property, plant and equipment if the fair value decreases

Answer 13

Question 14

Under IAS16 how is depreciation of revalued property, plant and equipment accounted for?

Answer 14

Where an asset has been revalued, the depreciation charge is based on the revalued amount, less residual value, from the date of revaluation. The asset’s residual value should also be re-estimated on revaluation.
This will produce a higher depreciation charge for the period and hence reduce profit for the year and distributable profits.

IAS 16 allows (but does not require) a transfer of the excess
depreciation from the revaluation surplus to retained earnings - “topping up” the retained earnings reserve to what it would have held had no revaluation taken place.

Question 15

Outline the journal entries necessary to account for depreciation of property, plant and equipment where a revaluation has taken place

Answer 15

Question 16

Briefly outline what IAS36 establishes

Answer 16

IAS36 establishes that an asset must not be carried in the financial statements at more than its recoverable amount.

If the carrying amount exceeds the recoverable amount, the asset is described as impaired.

The entity must reduce the carrying amount of the asset to its recoverable amount, and recognise an impairment loss.

Question 17

What is a non-current assets recoverable amount?

Answer 17

The recoverable amount of a non-current asset is the higher of its ‘value in use’ and its ‘fair value less costs of disposal’

Question 18

Define the ‘value in use’ of a non-current asset

Answer 18

The ‘value in use’ (VIU) of a non-current asset is the present value of the future cash flows expected to be derived from the asset’s continued use and eventual disposal - It represents the benefit that an entity expects to obtain from using the asset over its useful life.

Question 19

Define the ‘fair value less costs of disposal’ of a non-current asset

Answer 19

‘Fair value less costs of disposal’ (FVLCD) of a non-current asset is the price that would be received from selling the asset in an orderly transaction between market participants, minus any costs directly associated with the disposal (e.g. legal fees, removal costs, and taxes).

Question 20

Outline the common indicators of impairment from internal sources

Answer 20

• Evidence of obsolescence or physical damage - if an asset becomes obsolete due to technological advancements or damage this may lead to them becoming inefficient or redundant.
• Adverse changes in the use of the asset - if a company company decides to reduce reliance on a specific asset this may indicate impairtment
• Evidence that the assets performance is worse than expected - if an asset is not generating the expected revenue or cost savings, this may indicate a decline in its recoverable amount.
• Policies on sustainability impact on the use of certain assets - Companies adopting stricter sustainability policies may phase out or decommission assets that are environmentally harmful which may lead to a decline in its recoverable amount.

Question 21

Outline the common indicators of impairment from external sources

Answer 21

• Significant decline in the market value of the asset
• Significant changes in the technological, market, legal or economic environment
• Increase in market interest rates likely to affect the present value calculation of value in use - higher interest rates increase the discount rate used in present value calculations, leading to a lower value in use for assets.
• Carrying amount of company’s net assets exceeding market capitalisation - If a company’s total net assets (assets minus liabilities) exceed its market capitalization (total market value of shares), it suggests the market does not believe the assets are worth their recorded value.
• Change in government policy related to climate change - Assets associated with high carbon emissions, such as coal mines or diesel-powered equipment, may face impairment as they become less economically viable

Question 22

What is meant by a stranded asset and how is it treated under IAS36?

Answer 22

Stranded assets are assets that have lost significant economic value due to external factors such as market shifts, regulatory changes, technological advancements, or environmental policies - assets that lose value prematurely due to unforeseen changes.

Under IAS 36 – Impairment of Assets, these assets are at high risk of impairment because they are no longer expected to generate sufficient future economic benefits.

IAS36 states that companies must regularly assess impairment indicators to determine if an asset’s carrying amount exceeds its recoverable amount (higher of fair value less costs of disposal or value in use). If an asset is deemed stranded, an impairment loss must be recognized in the financial statements.

Question 23

Outline the journal entries for the impairment of property, plant and equipment if the fair value decreases

Answer 23

Question 24

Briefly outline what IFRS5 establishes

Answer 24

IFRS 5 – Non-current Assets Held for Sale and Discontinued Operations establishes the accounting treatment for assets that are either held for sale or part of a discontinued operation.

Question 25

Under IFRS5, what is meant by a 'non-current asset held for sale'?

Answer 25

A non-current asset should be classified as held for sale if the entity intends to recover its carrying amount principally through sale.

Question 26

Under IFRS5, what criteria must a non-current asset meet to be considered as 'held for sale'?

Answer 26

* It must be available for immediate sale in its current condition - no additional work must be needed to done to it before it is sold * The sale should be highly probable - more likely than not to sell * The sale should be expected to take place within a year of the reclassification

Question 27

Under IFRS5, how are 'non-current asset held for sale' accounted for

Answer 27

For non-current assets measured under the cost model, on reclassification the asset will be: * Shown separately under current assets in the statement of financial position as ‘non-current assets held for sale’ - credited out of NCA * Valued at the lower of its carrying amount and fair value less costs of disposal * No longer depreciated However, for non-current assets measured under the revaluation model, there is an additional first step: * The asset must be revalued at fair value under IAS 16 immediately before the classification * Shown separately under current assets in the statement of financial position as ‘non-current assets held for sale’ - credited out of NCA * Valued at the lower of its carrying amount and fair value less costs of disposal - as it its carrying amount is its fair value, the FVLCD will be the lower cost so , we will just charge the disposal costs to the P&L * No longer depreciated

Question 28

Outline the journal entries for the reclassification of 'non-current asset held for sale' that are measured under the cost model

Answer 28

Question 29

Outline the journal entries for the reclassification of 'non-current asset held for sale' that are measured under the revaluation model if the fair value has increased

Answer 29

Question 30

Outline the journal entries for the reclassification of 'non-current asset held for sale' that are measured under the revaluation model if the fair value has decreased

Answer 30

Question 31

Under IAS16 and IAS36, what is meant by the 'abandonment of non-current assets'?

Answer 31

Abandonment of a non-current asset is when a non-current asset is abandoned instead of being sold soit is unlikely to generate future economic benefits therefore any recovery of the carrying amounts of such assets will principally be through continued use.

Question 32

Under IAS16 and IAS36, how is the 'abandonment of non-current assets' accounted for?

Answer 32

If a non-current asset is to be classified as abandoned: * it is unlikely to generate future economic benefits, so an impairment loss must be recognized - the impairment loss is calculated as the difference between the carrying amount and the recoverable amount (which may be zero if the asset has no future use). The loss is recorded in the income statement. * Depreciation continues until abandonment - unlike assets held for sale (under IFRS 5), an asset that is to be abandoned must continue to be depreciated until it is fully removed from use. * Derecognition of the asset - once the asset is physically removed it is derecognized from the financial statements. Any remaining carrying value is written off, and any disposal costs are expensed.

Question 33

Briefly outline what IAS20 establishes

Answer 33

IAS20 establishes the accounting treatment for government grants and the disclosure requirements for government assistance received by entities.

Question 34

According to IAS20, what is the recognition criteria for government grants?

Answer 34

Government grants are recognised when there is reasonable assurance that: * The entity will comply with the conditions of the grant * The entity will receive the grant Where a series of conditions exist, the grant should be split and allocated to the different costs of meeting the conditions. Where the costs have already been incurred (or no costs are expected) the grant can be recognised immediately in the profit or loss.

Question 35

What are the two types of government grants considered under IAS20?

Answer 35

* Grants relating to assets * Grants relating to income

Question 36

Explain what a government grant relating to assets is

Answer 36

A government grant relating to assets is financial assistance provided by the government to an entity for acquiring, constructing, or purchasing a long-term asset, such as property, plant, and equipment (PPE). These grants help reduce the cost of acquiring assets and are subject to conditions on how the asset should be used.

Question 37

Outline the guidance IAS20 provides as to how to account for government grants relating to assets

Answer 37

Where grants are received for depreciating assets, the grant will be released to the profit or loss over the useful life of the asset. IAS 20 provides two methods for accounting for government grants relating to assets: 1. Deferred Income Method * The grant is recorded as deferred income (liability) when received. * It is systematically recognized as income over the asset’s useful life, matching the related depreciation expense. 2. Netting Off Method * The grant is deducted directly from the cost of the asset. * The asset is recorded at its net cost (historic cost less grant), and depreciation is based on this reduced amount.

Question 38

Outline the extracts from the statement of financial postiton and profit and loss to outline the treatment of governement grants relating to assets using the deferred income method

Answer 38

* The grant is recorded as deferred income (liability) when received. * It is systematically recognized as income over the asset’s useful life, matching the related depreciation expense.

Question 39

Outline the extracts from the statement of financial postiton and profit and loss to outline the treatment of governement grants relating to assets using the netting off method

Answer 39

* The grant is deducted directly from the cost of the asset. * The asset is recorded at its net cost (historic cost less grant), and depreciation is based on this reduced amount.

Question 40

Briefly outline what IAS23 establishes

Answer 40

IAS 23 establishes the accounting treatment for borrowing costs, specifically focusing on when such costs can be capitalized as part of the cost of a qualifying asset.

Question 41

Define borrowing costs

Answer 41

Borrowing costs are interest and other costs incurred by an entity in connection with the borrowing of funds.

Question 42

Define 'qualifying asset' in regards to borrowing costs

Answer 42

An asset that takes a substantial period of time to get ready for its intended use or sale (e.g. buildings, plants, large infrastructure).

Question 43

Outline the treatment of borrowing costs related to qualifying assets under IAS23

Answer 43

Where borrowing costs are directly attributable to the acquisition, construction, or production of a qualifying asset, these must be capitalized as part of the cost of that asset Capitalisation of borrowing costs: * Commences when the entity incurs expenditure for the asset and undertakes activities that are necessary to prepare the asset for its intended use or sale * Should cease when substantially all the activities necessary to get the asset ready for its intended use or sale are complete (i.e. when physical construction is complete) Income derived from the reinvestment of surplus funds should be deducted from the capitalised borrowing costs provided the income relates to the same periods that the borrowing costs are being capitalised. If funds are borrowed specifically for the construction, the borrowing costs should all be capitalised less any investment income received on any surplus funds. If construction is financed out of general borrowing, the amount capitalised should be a weighted average cost of the general borrowings.

Question 44

Under IAS16, what are the required dislosure necessary for PPE?

Answer 44

Find these in the IAS handbook - don't memorise just know where to find them

Question 45

Outline the key differences between UK GAAP and IFRS for the following aspects: * Property, plant and equipment * Impairment * Assets held for sale * Government grants * Borrowing costs

Answer 45