INTERNATIONAL ACCOUNTING STANDARD ( I A S ) 16

Property, Plant and Equipment The objective of this standard is to prescribe the accounting treatment for Property, Plant and equipment so that users of the financial statements can make out information about an entitys investment in its property, Plant and equipment and the changes in such investment. The standard gives a large number of definitions: Property, plant and equipment are tangible assets that: o Are held by an entity for use in the production or supply of goods or services for rental to others or for administrative purposes; and o Are expected to used during more than one period Cost is the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition or construction. Useful Life: The period over which an asset is expected to be utilised or the number of production units expected to be obtained from the use of the asset. Residual value is the estimated amount that an entity would currently obtain from disposal of asset, after deduction the estimated costs of disposal, if the asset were already of the age in the conditions expected at the end of its useful life. Depreciable amount: The cost of an asset less its residual value. Fair value is the amount for which an asset could be exchanged between two knowledgeable, willing parties at an arms length. Carrying amount is the amount at which an asset is recognised after deducting any accumulated deprecation and impairment losses. Recoverable amount is the amount, which the entity expects to recover from the future use of an asset, including its residual value on disposal. This is the higher of net selling price or value in use.

BACKGROUND The accounting treatment for fixed tangible assets is based on the accruals or the matching concepts, under which expenditure is capitalised until it is charged as depreciation against revenue in the period in which benefit is gained from its use. Thus, if an asset is purchased that has an economic life for two years, so that it will be used over two accounting periods to help earn profit for the company and the cost should be apportioned in a way between the two accounting periods.

Module Coordinator: Ikram Ul Haq

WHAT IS A FIXED ASSET? There are two types of fixed assets; tangible and intangible. The Companies Act, 1985 defines tangible fixed assets as those, which are intended for use on a continuing basis in the companys activities, and any assets, which are not intended for such use taken to be current assets. IAS 16, Accounting for Property, Plant and Equipment definition is assets that have a physical substance and are held for use in the production or supply of goods or services, for rental to others or for administrative purposes on a continuing basis in the reporting entitys activity, have been acquired or constructed with the intention of being used on a continuing basis; and are not intended for sale in the ordinary course of business. Whereas the Intangible fixed assets are non financial fixed assets that do not have physical substance but are identifiable and are controlled by the entity through custody or legal rights (FRS 10, para.2). For example, newspaper titles and publishing rights, patents, trade marks, Goodwill purchased and brand names purchased. EXAMPLE OF TANGIBLE FIXED ASSET Land, such as a building sites, Land improvements, such as driveways, parking lots, fences, and underground sprinkler systems. 2. Buildings, such as stores, offices, factories and warehouses. 3. Equipments, such as store check out counters, cash registers, coolers, office furniture, and factory machinery and delivery equipment.
1.

DEPRECIATION OF FIXED ASSETS What is Depreciation: Depreciation is the annual diminishing value of an asset. OR It is gradual decrease in the value of an asset due to two factors: Physical factors & Functional factors This may arise from: Use, e.g, plant and machinery or motor vehicles Physical wear and tear Passing of time, e.g. a ten-year lease of property Obsolescence through technology and market changes, e.g. plant and machinery of a specialised nature Damage and destruction, e.g. Decay and deterioration Module Coordinator: Ikram Ul Haq 2

Factors in Computing Depreciation Cost of fixed asset. Useful life is an estimate of the expected productive life, or service life of an asset; Salvage or scrap (residual) value. It is an estimate of the assets value at the end of the useful life. Depreciation Methods a) b) c) d) Straight line; Declining (reducing) balance Unit of activity Sum of the digits method

Straight Line Method This is the simplest and most popular method of calculating depreciation. Under this method the depreciation charge is constant over the life of the asset. To calculate the depreciation charge, we require three pieces of information. The original (historical) cost of the asset An estimate of its useful life to the business An estimate of its residual value at the end of its useful life. The formula is:Depreciation = Cost exp ected residual value Expected life

Example 1: A fixed asset has a cost of RO.1000 and expected life of five years and the expected residual value is nil. Calculate the depreciation value? Example 2: a fixed asset has a cost of RO.13,000 and expected life of five years and the expected residual value is RO.1000. Calculate the depreciation value? The depreciation rate is expressed as a percentage of the original cost. Accounting policy: depreciation is charged on a straight line basis at a rate of 20% of cost per annum Straight Line Depreciation, No Residual Value If a company require new premises, it may either buy a shop or rent one. Renting called leasing. When the rental agreement signed the renter may pay an agreed price for the privilege of having this lease and it is referred to as a capital cost of the lease. This price is paid in addition to the annual rental repayment.

Module Coordinator: Ikram Ul Haq

The initial payment was for the purchase of the lease, which provides benefits of the occupation for the entire period of the lease. Hence, this can be treated as a fixed asset because it has a definite life and it must be depreciated. Declining (reducing) Balance Method This method produces a decreasing annual depreciation expense over the assets useful life. The formula is: fixed depreciation percentage * net book value at the beginning of the year. Summary of the effect of depreciation: Without depreciation the full cost of the asset would appear on the balance sheet each year. With depreciation the value of the asset on the balance sheet is reduced by the amount of the cumulative annual depreciation charges The annual depreciation charge appears in the income statement each year thereby charging the income statement with a proportion of the cost of the non-current asset each year in accordance with the matching or accruals concept. REPORTING FIXED ASSETS STATEMENTS Disposing of the Fixed Asset AND DEPRECIATION IN FINANCIAL

When a non-current asset is sold, there is likely to be a profit or loss on disposal. This is the difference between the net sale of the asset and its net book value at the time of disposal. Non-current assets are not purchased by a business with the intention of reselling them in the normal course of trade. However, they might be sold off at some stage during their life, either when their useful life is over or before then. When non-current assets are disposed of, there will be a profit or loss on disposal. As it is a capital item being sold, the profit or loss will be a capital gain or a capital loss. They are reported in the income statement/ profit and loss account as Profit/Loss of disposal of Non-Current assets. Let us discuss on example to make the concept clear. 4.2 Recognition: The recognition of property, plant and equipment depends on two criteria a) It is probable that future economic benefits associated with the asset will flow to the entity. b) The cost of the asset can be measured reliably. 4.3 Initial measurement: 4

Module Coordinator: Ikram Ul Haq

Once an item of property, plant and equipment qualifies for recognition as an asset, it will initially be measured at cost. 4.3.1 Components of Cost:

The standard lists the components of the cost of an item of property, plant and equipment. Purchase price, less any trade discount or rebate Initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located. Directly attributable costs of bringing the asset to working condition for its intended use e.g., o The cost of site preparation o Initial delivery and handling costs o Installation costs o Professional fees (e.g., architects, engineers etc) 4.3.2 Examples of directly attributable costs: Employee benefits of those involved in the construction or acquisition of an asset. Cost of site preparation Initial delivery and handling costs Installation and assembly costs Professional fees Cost of testing, less the net proceeds from the sale of any product arising from test production.

4.3.3 The following costs will not be part of the cost of property, plant or equipment unless they can be attributed directly to the assets acquisition, or bringing it into its working condition. Expenses of operations that are incidental to the construction or development of the item. Administration and other general overhead costs Start-up and similar pre-production costs Initial operating losses before the asset reaches planned performances. 4.3.4 Examples of costs that are not directly attributable costs and therefore must be written (expensed) in profit & loss account. Advertising and promotional cost Cost of introducing a new product and service Training cost Cost of conducting business in a new location or with a new class of customer. Administration and other general overheads. Cost of relocating or reorganising part or all of an entitys operations. 5

Module Coordinator: Ikram Ul Haq

Cost incurred while an asset, capable of being used as intended, is yet to be brought into use, is left idle, or is operating at below full capacity. Initial operating losses.

4.4

Subsequent expenditures

How should we treat any subsequent expenditure on long-term assets, after their purchase and recognition? Subsequent expenditure is added to the carrying amount of the asset, but only when it is probable that future economic benefit, in excess of the originally assessed standard of performance of existing asset, will flow to the enterprise. All other subsequent expenditure is simply recognised as improvements. Modification of an item of plant to extend its useful life, including increased capacity Upgrade of machine parts to improve the quality of output Adoption of a new production process leading to large reductions in operating cos Normal repairs and maintenance on property, plant and equipment items merely maintain or restore value, they do not improve or increase it, so such costs are recognised as an expense when incurred. Revaluations The market value of land and building usually represents fair value assuming existing use or line of business. Professionally qualified valuers normally carry out such valuations. In case of Plant and equipment, fair value can also be taken as market value. Where market value is not available depreciated replacement cost should be used. When an item of property, plant and equipment is revalued, the whole class of assets to which it belongs should be revalued. Disclosure Impairment of Non-Current Assets The carrying amount of an item or group of identical items of property, plant and equipment should also be reviewed periodically. This is to assess whether the recoverable amount has declined below the carrying amount. When there has been such a decline, the carrying amount should be reduced to the recoverable amount. Recoverable amount should be considered on an individual basis or for groups of identical assets. Disclosure

Module Coordinator: Ikram Ul Haq

The IAS 16 has a long list of disclosure requirements for each class of property, plant and equipment. i. Measurement basis for using the gross carrying amount ii. Depreciation method used iii. Useful life iv. Gross carrying amount and accumulated depreciation at the beginning and end of period. v. Revalued assets require further disclosures a. Basis used to revalue the assets b. Effective date of revaluation c. Whether an independent valuer was involved vi. Reconciliation of the carrying amount at the beginning and end of the period showing all the necessary details.

Module Coordinator: Ikram Ul Haq

Practice Questions
Note: For all questions where relevant assume year end of the company is 31st December. Q 1: ABC Ltd purchased a truck with useful life of five years. The cost of the truck is 100,000 and scrap value is 5000. Prepare depreciation schedule using a) Straight line method b) Reducing balance method using 15% depreciation rate. Q 2: Muttrah LLC purchased a building with useful life of ten years. The cost of the building is 150,000 and scrap value is 15000. Prepare depreciation schedule using a) Straight line method b) Reducing balance method using 15% depreciation rate. Q-3: A company purchased a vehicle on 01st July 2009 for Rials 20,000. Calculate net book value at 31st December 2012 if the company uses reducing balance method for depreciation and rate of depreciation is 20%. Q-4: Beta Ltd purchased machinery on 1st October 2008 for 30,000 and decided to use straight line method of depreciation. The useful life of the machinery is 5 years. The machine was sold on 31st Nov 2009. Calculate the net book value on disposal. Q-5: ABC Ltd purchased a truck with useful life of five years. The cost of the truck is 100,000 . The company decided to use reducing balance method and to use 20% depreciation rate but in third year the company switched to straight line method. Prepare a depreciation schedule. Q-6: ABC Ltd purchased a truck with useful life of ten years. The cost of the truck is 100,000. The company decided to use straight line method for depreciation but in sixth year the company switched to reducing balance method using 15% depreciation rate. Prepare a depreciation schedule.

Module Coordinator: Ikram Ul Haq

Q -7: Muttrah LLC purchased a building with useful life of ten years. The cost of the building is 150,000 and scrap value is 15000.The Company uses straight line method of depreciation. The building was sold for Rials 120,000 after 3 years. Calculate profit/loss on disposal. Q-8: Muttrah LLC purchased a building with useful life of ten years. The cost of the building is 150,000 and scrap value is 15000.The Company uses reducing balance method of depreciation and uses depreciation rate of 15%. The building was sold for Rials 130,000 after 6 years. Calculate profit/loss on disposal.

Module Coordinator: Ikram Ul Haq