IAS 16 Property, Plant and Equipment: key requirements and examples

When an item is recognised as PPE

Paragraph 7 of IAS 16 has two recognition conditions: it is probable that future economic benefits associated with the item will flow to the entity, and the cost of the item can be measured reliably. The standard sets no monetary threshold — the unit of measure is a matter of judgement (para. 9). Individually insignificant items such as moulds, tools and dies may be aggregated and assessed on their combined value.

Spare parts, stand-by and servicing equipment are recognised as PPE when they meet the definition; otherwise they are inventories (para. 8).

• Day-to-day servicing — labour, consumables, small parts — is not added to the carrying amount and is recognised in profit or loss as incurred (para. 12).
• Replacement of major parts (a furnace lining, aircraft interiors, interior walls of a building) is capitalised if the recognition criteria are met, and the carrying amount of the replaced part is derecognised (para. 13).
• Costs of major regular inspections are recognised in the carrying amount as a replacement; any remaining cost of the previous inspection is derecognised (para. 14).

Cost: what to include and what not

An item is initially measured at cost. Under para. 16 cost comprises the purchase price including import duties and non-refundable purchase taxes, after trade discounts; costs of bringing the asset to the location and condition necessary for it to operate as intended; and the initial estimate of the costs of dismantling and removing the item and restoring the site.

Note the 2020 amendments: the Board prohibited deducting from the cost of PPE the proceeds from selling items produced while the asset is being prepared for its intended use. Such proceeds and the related cost are recognised in profit or loss.

• Included: employee benefits arising directly from construction or acquisition, site preparation, delivery and handling, installation and assembly, testing, professional fees (para. 17).
• Excluded: costs of opening a new facility, advertising and promoting new products, conducting business in a new location or with a new class of customer, including staff training (para. 19).
• Recoverable VAT is not part of cost — only non-refundable taxes are.

Component depreciation

Paragraph 43 requires each part of an item with a cost that is significant in relation to the total cost of the item to be depreciated separately. In practice a building is split into structure, roof, building services and lifts, and an aircraft into airframe, engines and interior, where their useful lives differ noticeably.

Example: a production line costing 1,000 currency units consists of a press worth 600 with a 15-year life and a control system worth 400 with a 5-year life. Depreciating the whole line over 15 years understates the expense in the early years; the component approach shows the fast wear of the electronics at once. When the control system is replaced, its carrying amount is derecognised and the new one capitalised.

Cost model or revaluation model

After recognition the entity chooses an accounting policy — the cost model or the revaluation model — and applies it to an entire class of PPE (para. 29). If one item is revalued, the entire class to which it belongs is revalued (para. 36).

The revalued amount is fair value at the revaluation date less subsequent accumulated depreciation and impairment losses. Revaluations are made regularly enough that the carrying amount does not differ materially from fair value at the reporting date (para. 31). Assets with volatile prices may need annual revaluation; for stable ones every 3–5 years may be enough (para. 34).

• An increase goes to other comprehensive income and is accumulated in equity as revaluation surplus; to profit or loss only to the extent it reverses a decrease of the same asset previously recognised there (para. 39).
• A decrease goes to profit or loss, except to the extent of any credit balance in revaluation surplus for that asset (para. 40).
• The surplus may be transferred directly to retained earnings when the asset is derecognised, bypassing profit or loss (para. 41).

Depreciation: useful life, residual value, method

The depreciable amount — cost less residual value — is allocated on a systematic basis over the useful life (paras. 50, 53). Residual value and useful life are reviewed at least at each financial year-end, and changes are accounted for as a change in an accounting estimate under IAS 8 (para. 51). The depreciation method is also reviewed annually (para. 61).

Depreciation begins when the asset is available for use and ceases at the earlier of the date it is classified as held for sale under IFRS 5 and the date it is derecognised. An idle asset continues to be depreciated (para. 55).

• Permitted methods: straight-line, diminishing balance, units of production; the method should reflect the pattern of consumption of benefits (paras. 60, 62).
• A revenue-based method is prohibited by the 2014 amendment.
• Impairment is tested under IAS 36 (para. 63).

Derecognition and typical conversion errors

The gain or loss on derecognition is the difference between net disposal proceeds and the carrying amount (para. 71); it is recognised in profit or loss but is not classified as revenue (para. 68).

• Copying useful lives from tax rules instead of estimating expected use.
• No components for buildings and complex equipment.
• Zero residual value by default and estimates left unchanged for years.
• Stopping depreciation of idle equipment.
• Capitalising repairs that are day-to-day servicing under para. 12.