IAS 16, IAS 20, IAS 23, and IAS 40: Tangible Non-Current Assets and Investment Assets Study Guide

IAS 16 Property, Plant and Equipment

Definition and Recognition

Property, plant and equipment (PPE) are defined as tangible assets held by an entity for use in the production or supply of goods or services, for rental to others, or for administrative purposes, and which are expected to be used during more than one accounting period.

According to IAS 16, paragraph 7, an item of PPE should be recognised as an asset only when:

1. It is probable that future economic benefits associated with the asset will flow to the entity.

2. The cost of the asset can be measured reliably.

Initial Measurement

An item of PPE should initially be measured at its cost. This cost includes all expenditure involved in bringing the asset into its working condition at its intended location.

Capital Costs (Included in Initial Cost)

• Cost of site preparation.

• Delivery costs.

• Installation costs.

• Borrowing costs (in accordance with IAS 23).

• Dismantling Costs: The present value of future costs to dismantle the asset. A corresponding liability is recognized. The discount on this liability must be unwound over the period until the dismantling occurs, with the increase taken to finance costs in the statement of profit or loss.

Expense Items (Excluded from Initial Cost)

• Fuel.

• Training costs for staff.

• Warranty costs.

• General administration and overheads.

• Costs of faulty design or wasted materials.

Formula for Present Value (Dismantling Costs)

$\text{PV} = \text{Future Cost} \times \frac{1}{(1 + r)^n}$

Where:

• $r$ is the interest rate.

• $n$ is the number of years until settlement.

Illustration 1: Dismantling Costs (Oil Rig)

An oil rig cost $\$10\text{ million}$ to construct. Due to environmental regulations, it will cost $\$4\text{ million}$ to remove in $20$ years. The interest rate is $5\%$.

• Present Value Calculation: $\$4,000,000 \times \frac{1}{1.05^{20}} = \$1,507,558$

• Total Capitalized Cost: $\$10,000,000 + \$1,507,558 = \$11,507,558$

• Annual Depreciation: $\$11,507,558 \times \frac{1}{20} = \$575,378$

• Year 1 Finance Cost: $\$1,507,558 \times 0.05 = \$75,378$

• Year-End Liability Balance: $\$1,507,558 + \$75,378 = \$1,582,936$

Subsequent Expenditure

Subsequent expenditure is only capitalized (treated as part of the asset cost) if it meets specific criteria:

1. Enhancement: It enhances the economic benefits provided by the asset (e.g., extending its life, expansion, or increasing productivity).

2. Overhaul/Inspection: It relates to a major inspection or overhaul required for continued operation. These are depreciated over the time until the next scheduled inspection.

3. Component Replacement: It replaces a component of an asset that is made of multiple parts with different lives (e.g., an aircraft engine). The carrying amount of the replaced component is derecognised.

General repairs and maintenance should be written off to the statement of profit or loss as they merely maintain the original expected benefits.

Depreciation

Key Definitions (IAS 16, para 6)

• Depreciation: The systematic allocation of the depreciable amount of an asset over its useful life.

• Depreciable Amount: The cost of an asset (or other amount substituted for cost) less its residual value.

Timing and Methods

Depreciation must be charged from the date the asset is available for use (capable of operating as intended by management). This continues even if the asset is idle. Methods include:

• Straight line.

• Reducing balance.

• Machine hours.

Change in Estimates

A change in depreciation method is treated as a change in accounting estimate, not a change in accounting policy. It is only permissible if it provides a fairer presentation. The carrying amount is written off over the remaining useful life starting from the period of the change.

Review of Estimates

Useful life and residual value should be reviewed at the end of each reporting period. If expectations differ significantly from previous estimates, the remaining carrying amount (less any residual value) is depreciated over the revised remaining life.

Revaluation of Non-Current Assets

IAS 16 allows entities to choose between the Cost Model and the Revaluation Model.

The Cost Model

Assets are valued at cost less accumulated depreciation and any impairment losses.

The Revaluation Model

Assets are carried at a revalued amount (fair value at revaluation date) less subsequent accumulated depreciation.

Conditions for using the Revaluation Model:

• Revaluations must be made with sufficient regularity so that the carrying amount does not differ materially from fair value.

• If one item is revalued, the entire class of assets to which it belongs must be revalued.

Accounting for Revaluation Gains and Losses

• Gains: Recorded in Other Comprehensive Income (OCI) and accumulated in the Revaluation Surplus (a non-distributable capital reserve in equity).

• Losses: Generally recognized in the statement of profit or loss as an impairment. However, a loss can be deducted from a previous revaluation gain for that same asset in OCI.

• Note: Offsetting gains/losses between different properties is not permitted.

Journal Entries for Revaluation

• Dr Non-current assets cost (increase to new valuation)

• Dr Accumulated depreciation (eliminate balance)

• Cr Other Comprehensive Income (Revaluation surplus)

Depreciation of Revalued Assets

Depreciation is charged based on the revalued amount over the remaining useful life. To address the reduction in retained earnings caused by higher depreciation, an annual transfer may be made from the revaluation surplus to retained earnings for the "excess depreciation" (the difference between depreciation on valuation and depreciation on original cost). This transfer is shown in the Statement of Changes in Equity (SOCIE), not OCI.

Disposal of Revalued Assets

1. Calculate profit/loss on disposal as Sales Proceeds minus Carrying Amount.

2. Transfer any remaining balance in the revaluation surplus directly to retained earnings (this transfer does not affect OCI).

IAS 20 Government Grants

Principles

• Prudence: Grants are not recognized until there is reasonable assurance that conditions will be met and the grant will be received.

• Accruals: Grants must be matched with the expenditure they are intended to contribute toward.

Revenue Grants (Grants Related to Income)

These are contributions toward items such as payroll or general expenses. They are matched with the identifiable costs of achieving the objectives they fund.

Presentation Options:

1. Credit in the statement of profit or loss (separate line).

2. Deducted from the related expense.

Capital Grants (Grants Related to Assets)

These are for the purchase or construction of non-current assets.

Accounting Treatments:

1. Method 1 (Netting off): Deduct the grant from the cost of the asset. Depreciation is then calculated on the reduced cost.

2. Method 2 (Deferred income): Treat the grant as a deferred credit (liability) and release it to revenue (profit or loss) over the useful life of the asset to offset the higher depreciation charge.

Repayment of Grants

If a grant becomes repayable (e.g., breach of conditions):

• If Method 2 was used, the remaining deferred income is used to repay the grant. Any excess is recognized as an expense.

• If Method 1 was used, the cost of the asset is increased by the repayment amount. A liability is set up for the repayment.

IAS 23 Borrowing Costs

Core Requirement

Borrowing costs must be capitalized if they are directly attributable to the acquisition, construction, or production of a qualifying asset (an asset that necessarily takes a substantial period of time to get ready for use or sale).

Commencement of Capitalization

Capitalization begins when:

1. Expenditure for the asset is being incurred.

2. Borrowing costs are being incurred.

3. Activities necessary to prepare the asset are in progress.

Rate of Interest

• Specific Borrowings: The actual borrowing costs incurred minus any investment income earned on the temporary investment of those funds.

• General Borrowings: Use a weighted average cost of general borrowings applied to the expenditure on the asset.

Cessation of Capitalization

Capitalization stops when substantially all activities necessary to prepare the asset are complete, or if construction is suspended (e.g., due to disputes).

IAS 40 Investment Property

Definition

Investment property is land or a building held to earn rentals, for capital appreciation, or both. It excludes owner-occupied property (PPE) or property held for sale in the ordinary course of business (inventory).

Consolidated Accounts Rule

If a parent rents a building to a subsidiary, the building is Investment Property in the parent's individual accounts. However, in the consolidated accounts, it is treated as PPE (IAS 16) because it is owner-occupied from the perspective of the group.

Accounting Treatment

Initially measured at cost. For subsequent measurement, an entity must choose one of two models for all its investment properties:

1. Cost Model: Follows the IAS 16 cost model (Cost less depreciation and impairment).

2. Fair Value Model:

   • Asset is revalued to fair value at each year-end.

   • Changes in fair value are taken directly to the statement of profit or loss.

   • No depreciation is charged.

Transfers

• PPE to Investment Property (FV Model): Revalue per IAS 16 first (surplus to OCI), then transfer at fair value.

• Investment Property (FV Model) to PPE: Revalue per IAS 40 (gain/loss to P&L) first, then transfer at fair value.

• Cost Model Transfers: Transfer at carrying amount; depreciation continues.

Questions & Discussion

Test Your Understanding 1: Building Cost Calculation

Scenario: An entity started construction on 1 April 20X7. Costs incurred:

• Land: $\$250,000$

• Stamp duty: $\$5,000$

• Legal fees: $\$10,000$

• Site preparation: $\$18,000$

• Materials: $\$100,000$

• Labour: $\$150,000$

• Architect's fees: $\$20,000$

• Overheads: $\$30,000$

• Total: $\$583,000$

Additional info: $\$10\text{ million}$ materials spoiled; $\$15\text{ million}$ wasted on faulty design; building ceased for 2 weeks in October (labour cost $\$9\text{ million}$).

Calculation for Additions:

• Total costs: $\$583,000$

• Less Spoiled materials: $(\$10,000)$

• Less Wasted design materials: $(\$15,000)$

• Less Inefficient labour (stoppage): $(\$9,000)$

• Less General overheads: $(\$30,000)$

• Final Cost: $\$519,000$

Test Your Understanding 6: Borrowing Costs

Scenario: $\$18\text{ million}$ loan at $5\%$ received 1 January 20X8. $\$6\text{ million}$ invested in $2\%$ bonds until 31 May. Construction from 1 March to 31 December.

Calculation:

• Capitalization period: 1 March to 31 December ($10\text{ months}$).

• Loan interest: $\$18\text{ million} \times 5\% \times \frac{10}{12} = \$750,000$

• Less Investment income (1 March to 31 May = $3\text{ months}$): $\$6\text{ million} \times 2\% \times \frac{3}{12} = \$30,000$

• Interest to capitalize: $\$720,000$

Test Your Understanding 11: Knowledge Check

1. Revaluation surplus calculation: Cost $\$100k$, 15 years depreciation at $2\% = 30\%$. Carrying amount = $\$70k$. Valuation = $\$500k$. Surplus = $\$430,000$ (Option D).

2. Building A revalued upward (gain to surplus). Building B revalued downward (loss to P&L as no previous surplus exists) (Option B).

3. Reducing balance depreciation: Cost $\$312k$, Acc. Dep $\$66k$. Disposed cost $\$28k$, Acc. Dep $\$16.8k$ (since carrying amount was $\$11.2k$).

   • Opening CA of remaining assets: $(\$312k - \$28k) - (\$66k - \$16.8k) = \$235,200$.

   • Depreciation: $\$235,200 \times 40\% = \$94,080$.