FINANCIAL ACCOUNTING & REPORTING

IAS – 16 PROPERTY, PLANT & EQUIPMENT

Property, Plant and Equipment

1. are held for
• use in the production or
• supply of goods or services,
• for rental to others, or
• for administrative purposes; and
2. are expected to be used during more than one period.
Components of Cost of PPE

1. Purchase price
Purchase price,
• import duties and
• non-refundable purchase taxes,
after deducting
• trade discounts and
• rebates
2. Directly attributable Cost
Any costs directly attributable to bringing the asset to the intended location and condition

• costs of employee benefits

• costs of site preparation;
• initial delivery and handling costs;
• installation and assembly costs;
• costs of testing whether the asset is functioning properly, after deducting the net proceeds
from selling any items produced while bringing the asset to that location and condition (such
as samples produced when testing equipment
• professional fees.
3. Certain Future Cost The
initial estimate of the costs of dismantling and removing the item and restoring the site on which it is
located, the obligation for which an entity incurs either when the item is acquired or as a
consequence of having used the item during a particular period for purposes other than to produce
inventories during that period.
Don’t Include in Costs

Examples of costs that are not costs of an item of property, plant and equipment are:

• costs of opening a new facility;

• costs of introducing a new product or service (including costs of
• advertising and promotional activities
• costs of conducting business in a new location or with a new class of customer
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 • costs of staff training; and
• administration and other general overhead costs
Cost incurred after PPE reaching intended location and condition

Recognition of costs in the carrying amount of an item of property, plant and equipment ceases when
the item is in the location and condition necessary for it to be capable of operating in the manner
intended by management.

The following costs are not included in the carrying amount of an item of property, plant and
equipment:

• costs incurred while an item capable of operating in the manner intended by management has yet
to be brought into use or is operated at less than full capacity;
• Initial operating losses, such as those incurred while demand for the item’s output builds up; and
• Costs of relocating or reorganizing part or all of an entity’s operations.
Major inspections
When an asset requires ‘regular major inspections as a condition to its continued use’, then the cost
thereof, (or an estimate thereof), must be capitalized as soon as the cost is incurred or an obligation arises.
This inspection will be recognised as an asset.

If an entity buys an asset that, on the date of purchase, has already been inspected and thus does not
require another inspection for a period of time, the cost must be separated into:
− The cost that relates to the physical asset (or its separate significant parts), and
− The cost that relates to the balance of the previous major inspection purchased.
Incomes from and Expenses on Incidental Operations
Some operations occur in connection with the construction or development of an item of property, plant
and equipment, but are not necessary to bring the item to the location and condition necessary for it to
be capable of operating in the manner intended by management. These incidental operations may
occur before or during the construction or development activities. For example, income may be earned
through using a building site as a car park until construction starts. Because incidental operations are not
necessary to bring an item to the location and condition necessary for it to be capable of operating in
the manner intended by management, the income and related expenses of incidental operations are
recognized in profit or loss and included in their respective classifications of income and expense.
Internal Profits on self-constructed assets
The cost of a self-constructed asset is determined using the same principles as for an acquired asset. If an
entity makes similar assets for sale in the normal course of business, the cost of the asset is usually the
same as the cost of construction an asset for sale (see IAS 2). Therefore, any internal profits are
eliminated in arriving at such costs.
Abnormal Losses
the cost of abnormal amounts of wasted material, labour, or other resources incurred in self-constructing
an asset is not included in the cost of the asset.
Borrowing Cost
Included in the cost of the assets if the criteria given in IAS 23 is fulfilled.
Deferred Payments
The cost of an item of property, plant and equipment is the cash price equivalent at the recognition date.
If payment is deferred beyond normal credit terms, the difference between the cash price equivalent and
the total payment is recognized as interest over the period of credit unless such interest is capitalized in
accordance with IAS 23.

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i.e. The amount to be paid – Present Value of that time = Interest Expense recognized over the payment period
Cost of Separately recognizing significant part
A part is considered to be significant in relation to the total cost of the asset. The idea behind recognizing
each part separately is that we will then be able to depreciate each part separately (significant parts often
have different useful lives and residual values to the remainder of the item of PPE.)
RECORDING OF DEPRECIATION EXPENSE
Method 1: Allowance Method or Indirect method: (Most commonly used)
Depreciation expense (Dr.)
Accumulated depreciation (Cr.)
Depreciation expense is an expense account and is reported in the Profit and loss account. Due to the
closing process, balance of Depreciation expense become nil at each year end and always show one year
depreciation at a time.
Accumulated depreciation (also known as Allowance / provision for depreciation) is a contra asset
account and is shown as a deduction from the cost of the related asset account in the balance sheet.
Balance of the account shows the depreciation that has been charged against the asset during the life of
the asset.

Method 2: Direct write off method or Net Book Value method: (not widely used and usually referred in
questions of incomplete records)
Depreciation Expense (Dr.)
Asset Account (Cr.)
In this method the asset account is directly credited with the depreciation for the year. So the asset account
directly shows the book value of the asset.
METHODS OF CALCULATING DEPRECIATION
1. Straight line method or Fixed installment method:
This method recognizes equal periodic depreciation charges over the useful life of an asset, thereby
making depreciation a function solely of time without regard to asset productivity, efficiency, or
usage.
Depreciation charge per period = Cost - residual value
Useful life

Rate of depreciation = 100

Useful life

Depreciation for the year = (Cost - residual value) * Rate of depreciation

Rate of depreciation as %age of cost = 100 - % age of Residual value

Useful life
Where residual value is not given, depreciable cost and cost are the same amounts.
Alternate way to calculated depreciation when book value given:

Depreciation charge per period = Book value - residual value

Remaining Useful life

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3. Reducing balance or Fixed Percentage of Declining Balance Method or Written down value method:
The fixed percentage of declining balance method multiplies a fixed rate times a declining balance.
The rate is calculated by means of the following formula, where n equals the useful life in years:
Re sidual _ value
Rate of deprecation = 1- n
Cost

Depreciation for the year = (Cost - Accumulated depreciation) * Rate of depreciation

✓ The result is to reduce the cost of the asset to its estimated net salvage value at the end of the asset’s
useful life.
✓ To calculate the rate of depreciation by this formula, some salvage value must be assigned to the
asset, since it is not possible to reduce an amount to zero by applying a constant rate to a successively
smaller remainder
✓ Usually a rate of depreciation is already given in the question for the reducing balance method which
is to be used.
Another way of calculating the rate of depreciation is to double the rate of straight line method, in this
case the method is named as Double declining balance method.

4. Service Hour Method:

This method assumes that if an asset is used twice as much in period 1 as in period 2, the depreciation
charge should differ accordingly.

Rate of depreciation per hour of use = Cost - residual value

Useful life in hours

Depreciation for the year = Rate of depreciation * Hours used during the year

The service hour method usually is appropriate when obsolescence is not a primary factor in depreciation
and the economic service potential of the asset is used up primarily by running time.
5. Productive Output Method:
This method is essentially the same as the service-hours method, except that useful life is expressed in
terms of units of production rather than hours of use.

Depreciation

Begins
When an asset is available for use
(not when it was brought into use).
Ceases
At the earlier of date that the asset is
classified as held for sale in accordance
with IFRS 5 and the date that the asset is
derecognized.
Depreciation does not cease if an asset is
idle (unless the sum of the units method
is used to calculate the depreciation).

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 DEPRECIATION FOR PARTIAL PERIODS:
Since assets are acquired and disposed of throughout the year, entities must compute depreciation for
partial periods. Computation alternatives are found in practice (in the order of preference):
a. A full year’s depreciation is recognized on assets acquired during the year; none is recognized on
assets retired during the year.
b. Depreciation is recognized on proportional basis i.e. from the date of addition to the date of disposal.
c. One-half year’s depreciation only is recognized on all assets purchased or sold during the year (half
year convention).
Which method to use in the examination questions?
a. Use the policy given in the question if any
b. If no policy given then:
✓ If the dates of additions and disposals are given then calculate proportionate depreciation on the
additions and disposals
✓ Otherwise yearly basis.
REVISING THE USEFUL LIFE
The useful life of an asset shall be reviewed at least at each financial year-end and, if expectations differ
from previous estimates, the changes shall be accounted from the current and subsequent periods
(prospectively).
In case of revision of life, the deprecations already charged in previous years on the basis of old life are not
re-stated
After the revision of life, the depreciation for the year is calculated as follows:
Straight line method: Remaining depreciable cost (Cost - Acc. dep. -Net salvage value)
Remaining Useful life

Reducing balance method:

The book value is multiplied by the new rate which is determined as follows:
Re sidual _ value
Rate of deprecation = 1- n
Book _value (where n is remaining life)

REVISING THE RESIDUAL VALUE

The residual value of an asset shall be reviewed at least at each financial year-end and, if expectations
differ from previous estimates, the changes shall be accounted from the current and subsequent periods.
After the revision of residual value, the depreciation for the year is calculated as follows:

Straight line method: Remaining depreciable cost (Cost – Acc. Dep. - New residual value)
Remaining Useful life
Reducing balance method:
The book value is multiplied by the new rate which is determined as follows:
New _ Re sidual _ value
Rate of deprecation = 1- n
Book _ value (where n is remaining life)

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 REVIEW OF DEPRECIATION METHOD
The depreciation method applied to property, plant and equipment must be reviewed periodically and, if
there has been a significant change in the expected pattern of economic benefits from those assets, the
method is changed to reflect the changed pattern.
Where there is a change in the depreciation method used, this is a change in accounting estimate. A
change of accounting estimate is applied from the time of the change, and is not applied retrospectively.
The carrying amount (cost minus accumulated depreciation) of the asset at the date of the change is
written off over the remaining useful life of the asset.
DISPOSAL OF ASSET
Gain or (loss) from disposal = Net Sale proceeds or Trade in allowance or Fair value of the asset - Book
value at the time of disposal
✓ When asset is destroyed or retired without any sale, then take nil sale proceeds and whole book value
is loss.
✓ When an asset is disposed off, the cost of the asset and the related amount of accumulated
depreciation must be removed from the books.
✓ If the entity follows the policy to charge depreciation till date of disposal then ensure that the book
values are updated.
Entries for disposal (including exchange):
Dr. Cash / New asset (at fair value)
Dr. Accumulated depreciation of old asset
Cr. Cost of old asset
Cr. Cash (any net payment for new asset)
The difference if any on the debit side is the loss and on the credit side is the gain on disposal.

Rules for exchange of assets:

An asset may be acquired in exchange for another asset. The cost of such an asset is measured at its fair
value unless:
✓ the exchange transaction lacks commercial substance; or
✓ the fair value of neither the asset received nor the asset given up is reliably measurable.

If the new asset is measured at fair value, the fair value of

✓ the asset given up is used to measure the cost of the asset received
✓ unless the fair value of the asset received is more clearly evident.

If the new asset is not measured at fair value, its cost is measured at the carrying amount of the asset given
in exchange for it. This would be the case when the exchange lacked commercial substance or when the
fair value of either asset cannot be measured.
Lack of commercial substance
The determination of whether an exchange transaction has commercial substance depends on the extent
to which future cash flows are expected to change as a result of the transaction. If there is minimal impact
on future cash flows then the exchange lacks commercial substance.

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Specimen of T-AccoUnts

FIXED ASSET ACCOUNT AT COST

Opening cost Cost of items disposed off
Additions dUring the year Closing balance

ACCUMULATED DEPRECIATION
Acc. dep of items disposed off Opening balance
Closing balance Depreciation for the year

FIXED ASSET ACCOUNT AT NBV

Opening NBV NBV of items disposed off
Additions dUring the year Depreciation
Closing NBV

DISPOSAL ACCOUNT
Cost of item disposed off AccUMULATEd depreciation of item
disposed off
Gain on disposal Net Sales proceed / Trade in allowance
in exchange / InsURANce claim
Loss on disposal

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 INITIAL RECOGNITION OF COST

COMPONENTS OF PURCHASE PRICE AND DIRECTLY ATTRIBUTABLE COST

Price of asset Xxx
Less:
Trade discounts (xxx)
Refundable taxes (VAT) (xxx)
Net Purchase Price xxx
Add:
Import duties xxx
Non-refundable duties xxx
Cost of preparing the site xxx
Initially delivery and handling cost xxx
Installation and assembly cost xxx
Salary (directly attributable for construction) xxx
Professional fees xxx
Cost of testing that the asset – net of proceeds xxx
Total cost to be capitalized xxx
QUESTION 1:
ABC limited acquired an asset on 1 Jan 2008 and incurred the following costs:

Purchase price (List Price) 124,500

Import Duties 7,470
Capital Value Tax 6,000 (40% refundable)
Sales Tax 2,490 (Recoverable)
Trade Discount 8,715

On 31 Jan the supplier of the plant send a debit note that our account has been
debited by Rs 1,850 on account of subsequent rebate.

Useful life of the asset is 10 years and it residual value has a current estimate of Rs
12,000 at the end of its life.

Required
Calculate the cost of the asset
Calculate the carrying amount of the asset at 31 December 2008.

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QUESTION 2:
ABC limited acquired an asset and incurred the following costs in bringing the
asset to its present location and condition:

Purchase price (list price) 1,700,000 1 Sept 2015

Trade Discount 4% of list price 1 Sept 2015
Taxes on acquisition 7% on net price 10 Sept 2015
60% taxes and refundable and adjustable

Early settlement discount of 2% is offered if payment is made in 1 month.

The asset was delivered by the supplier at main factory on 28 Oct 2015. The
supplier incurred a delivery cost of Rs 30,000. 40% of such costs are to be
reimbursed by the company

Initial handling charges 7,895 28 Oct 2015

The asset needs adjustments in order to be compatible with the main

plant the company currently has. Cost of modification of the asset to bring
it in working condition is as under:

Salary to own employee for working 45,000 Up to 31 December

Retirement benefits for the employee 4,500 Up to 31 December
Cost of external labor 15,000 Up to 31 December
Fee against professional Advice 12,500 07 November 2015
Installation and assembly charges 70,000 Up to 31 December
Test run charges 14,000 05 Jan 2016
NRV of test run production 4,350 7 Jan 2016
Staff training cost 6,400 Up to 31 December

The asset was fully functional on 1 February 2016. Useful life of the asset is 15
years and Depreciation shall be charged using straight line method assuming a
residual value of Rs 187,500
The Company made and received all the payments and receipts on the same
date the expense is incurred or income is generated, except for purchase price
which the company paid 20 days later.
Required
Calculate the cost of PPE
Journalize all the reporting events at relevant date
Prepare extracts from:
Statement of Financial Position
Statement of Comprehensive Income

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 COMPUTATION OF DEPRECIATION

QUESTION 1:
Books of Sarim Traders showed balance of Rs 840,000 in Machinery account and Rs 280,000 in
Accumulated depreciation account as on January 1, 2012.
The following transactions took place during 2012.
a. A new machine costing Rs 120,000 was purchased on March 1, 2012.
b. A machine costing Rs 140,000 purchased on July 1, 2010 was disposed off for Rs 96,000 on May
31, 2012.
c. A new machine costing Rs 205,000 was acquired on August 1, 2012 and was installed at a cost of
Rs 35,000 on September 1, 2012.
d. A machine purchased on March 1, 2009 having a book value of Rs 45,000 was sold for Rs 55,000
on November 1, 2012.
Required:
Prepare Machinery, Accumulated depreciation and Disposal account in each of the following cases
separately:
1. Depreciation is provided on Straight line basis @ 10% with full year’s depreciation in the year of
addition and none in the year of disposal
2. Depreciation is provided on reducing balance method @ 15% with full year’s depreciation in the
year of addition and none in the year of disposal
3. Depreciation is provided on Straight line basis @ 10% with proportional depreciation in the year of
addition as well as disposal
4. Depreciation is provided on reducing balance method @ 15% with proportional depreciation in
the year of addition as well as disposal

QUESTION 2:
The following information is available in respect of fixed assets of MJ Enterprises (MJE):
a. The opening balances of cost and accumulated depreciation of fixed assets as on January 1, 2009
were Rs. 100,000 and Rs. 33,000 respectively.
b. Assets costing Rs. 20,000 were acquired on July 1, 2008. The remaining fixed assets were acquired
when MJE commenced business on January 1, 2005. There were no disposals of fixed assets upto
January 1, 2009.
c. MJE provides for depreciation on the cost of assets at the rate of 10% per annum using the straight
line basis. Depreciation is calculated on a monthly basis.
d. Assets acquired on January 1, 2005 whose net book value on June 30, 2009 was Rs. 2,750 were
sold for Rs. 1,500.
e. On July 1, 2009, an asset which was acquired at a cost of Rs. 2,000 when MJE commenced
business, was exchanged for a new asset. The balance of the purchase price was settled with a
cheque for Rs. 800. The list price of the new asset was Rs. 1,200.
f. On October 1, 2009 MJE transferred to its factory an asset which had been included in its trading
stock and which bore a price label of Rs. 15,400 in the showroom. MJE makes a gross profit of 40%
of cost, on sale of such assets.
Required:

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 Prepare the following ledger accounts for the year ended December 31, 2009:
a. Fixed assets
b. Accumulated depreciation
c. Profit/loss on sale of fixed assets

QUESTION 5:
A sole trader provides depreciation on vehicles on the straight-line method at the rate of 10% per annum.
A full year’s depreciation is provided at the end of each year on all vehicles purchased during the year. No
depreciation is provided in the year in which the vehicle is sold. The book value of Vehicles at December
31, 2002 was Rs. 3,512,700. Subsidiary records showed that the cost of vehicles then on hand was made
up as follows:
Vehicles bought in the year 1992 (or earlier) 1,044,000
Vehicles bought in the year 1993 558,000
Vehicles bought in the year 1994 306,000
Vehicles bought in the year 1995 (or later) 4,536,000

During the year 2003, a new vehicle was bought at a cost of Rs. 531,000, and a vehicle which had cost
Rs. 99,000 in the year 1991 was sold as scrap for Rs. 6,300.
During the year 2004 there were additions costing Rs. 324,000, and a vehicle which had cost Rs. 126,000
in the year 2000 was sold for Rs. 28,000.
Required:
Vehicles Account, Accumulated Depreciation account and Disposal Vehicle for the years 2003 and
2004.

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 REVALUATION MODEL
OPTIONS FOR SUBSEQUENT MEASUREMENT:
An entity shall choose either
❖ the cost model or
❖ the revaluation model
as its accounting policy and shall apply that policy to an entire class of property, plant and equipment.

REVALUATION MODEL
After recognition as an asset, an item of property, plant and equipment whose fair value can be measured
reliably shall be carried at a revalued amount, being its fair value at the date of the revaluation less any
subsequent accumulated depreciation and subsequent accumulated impairment losses.
EXTENT OF REVALUATION:
If an item of property, plant and equipment is revalued, the entire class of property, plant and equipment
to which that asset belongs shall be revalued. The items within a class of property, plant and equipment
are revalued simultaneously to avoid selective revaluation of assets and the reporting of amounts in the
financial statements that are a mixture of costs and values as at different dates.
ADJUSTMENT TO CARRYING VALUE:
When an item of property, plant and equipment is revalued, the carrying amount of that asset is adjusted
to the revalued amount. At the date of the revaluation, the asset is treated in one of the following ways:
− the gross carrying amount is adjusted in a manner that is consistent with the revaluation of the
carrying amount of the asset.; or
− the accumulated depreciation is eliminated against the gross carrying amount of the asset.

INCREASE DUE TO A REVALUATION:

If an asset’s carrying amount is increased as a result of a revaluation, the increase shall be recognised in
other comprehensive income and accumulated in equity under the heading of revaluation surplus.
However, the increase shall be recognised in profit or loss to the extent that it reverses a revaluation
decrease of the same asset previously recognised in profit or loss.
DECREASE DUE TO REVALUATION:
If an asset’s carrying amount is decreased as a result of a revaluation, the decrease shall be recognised in
profit or loss. However, the decrease shall be recognised in other comprehensive income to the extent of
any credit balance existing in the revaluation surplus in respect of that asset. The decrease recognised in
other comprehensive income reduces the amount accumulated in equity under the heading of
revaluation surplus.
TREATMENT OF RESULTING REVALUATION SURPLUS:
The revaluation surplus included in equity in respect of an item of property, plant and equipment may be
transferred directly to retained earnings when the asset is derecognised. This may involve transferring the
whole of the surplus when the asset is retired or disposed of. However, some of the surplus may be
transferred as the asset is used by an entity. In such a case, the amount of the surplus transferred would
be the difference between depreciation based on the revalued carrying amount of the asset and
depreciation based on the asset’s original cost. Transfers from revaluation surplus to retained earnings are
not made through profit or loss.

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FREQUENCY OF REVALUATION
Revaluations shall be made with sufficient regularity to ensure that the carrying amount does not differ
materially from that which would be determined using fair value at the end of the reporting period. Some
items of property, plant and equipment experience significant and volatile changes in fair value, thus
necessitating annual revaluation. Such frequent revaluations are unnecessary for items of property, plant
and equipment with only insignificant changes in fair value. Instead, it may be necessary to revalue the
item only every three or five years.

QUESTION 1: Q4 of Autumn 2014 (15 marks)

Shahzad Textile Mills Limited (STML) purchased a plant for Rs. 500 million on 1 July 2010. The plant has an
estimated useful life of 10 years and no residual value.
STML uses revaluation model for subsequent measurement of its property, plant and equipment and
accounts for revaluations on net replacement value method. The details of revaluations performed by an
independent firm of valuers are as follows:
Revaluation date Fair value
1 July 2011 Rs. 575 million
1 July 2012 Rs. 390 million
1 July 2013 Rs. 380 million

Required:
Prepare journal entries to record the above transactions from the date of acquisition of the plant to the
year ended 30 June 2014. (Ignore tax implications)
QUESTION 2: Q3 of Autumn 2009 (16 marks)

Faraday Pharmaceutical Limited (FPL) acquired a building for Rs. 200 million on July 1, 2005. The following
information relating to the building is available:
a. It is being depreciated on the straight line basis, over 20 years.
b. FPL uses the revaluation model for subsequent measurement of its property, plant and equipment
and accounts for revaluations on the net replacement value method. The details of revaluation
carried out by the independent valuers during the past years are as follows:
Revaluation date Fair value
Rupees in million
July 1, 2006 230
July 1, 2007 170
July 1, 2008 180
c. FPL transfers the maximum possible amount from the revaluation surplus to retained earnings on an
annual basis.
d. There is no change in the useful life of the building.
Required:
Prepare the journal entries to record the above transactions from the date of acquisition of the
building to the year ended June 30, 2009. (Ignore deferred tax)

QUESTION 3: Q2 of Autumn 2013 (16 marks)

French Power Limited (FPL) uses the revaluation model for subsequent measurement of its property, plant
and equipment and has a policy of revaluing its assets on an annual basis using the net replacement value
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method.
The following information relates to FPL’s plant:
a. The plant was purchased on 1 July 2009 at a cost of Rs. 360 million.
b. It is being depreciated on straight line basis, over 10 years.
c. The details of previous revaluations carried out by the independent valuers are as follows:
Revaluation date Fair value
Rupees in million
1 July 2010 400
1 July 2011 280
1 July 2012 290
d. FPL transfers the maximum possible amount from the revaluation surplus to retained earnings on an
annual basis.
e. There is no change in the useful life of the plant.
Required:
Prepare journal entries to record the above transactions from the date of acquisition of the plant to the
year ended 30 June 2013. (Ignore deferred tax)

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