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ALL YOU NEED TO KNOW ABOUT IAS 16

The accounting for IAS 16,
Property, Plant and Equipment is a particularly important area of the Financialaccounting exams Paper B2. accountingmost guarantee that in every exam you will
be required to account for property, plant and equipment at least once.
IAS 16, Property, Plant and equipment
overview
The principal issues with this standard are timing of the recognition of assets
and depreciation of charges, and determination of the carrying amounts.
Property plant and equipment (PPE) are tangible assets that an entity holds for
its own use or for rental to others, and that the entity expects to use during
more than one period. PPE could be constructed by the reporting entity or
purchased from other entities.
Biological assets, intangible assets
and investment property are not PPE. Neither are investments in subsidiaries,
associates and joint ventures.
The
recognition and measurement of exploration and evaluation assets is set out in
IFRS 6, Exploration for and
Evaluation of Mineral Resources. Mineral rights and exploration and
evaluation assets are specifically excluded from the scope of PPE. However,
productive assets held by entities in the extractive industries are subject to
the same recognition and measurement rules as other PPE.
There
are essentially four key areas when accounting for property, plant and
equipment that you must ensure that you are familiar with:
¤ Initial recognition
¤ Depreciation
¤ Revaluation
¤ Derecognition (disposals).
Initial
recognition
An
item of PPE should be recognised as an asset, if it is probable that future
economic benefits associated with the asset will flow to the entity and the
cost of the item can be measured reliably. Future economic benefits occur when
the risks and rewards of the asset’s ownership have passed to the entity. PPE
is initially recognised at its cost, which is the fair value of the
consideration given.
The basic principle of IAS 16 is that
items of property, plant and equipment that qualify for recognition should
initially be measured at cost. One of the easiest ways to remember this is that
you should capitalise all costs to bring an asset to its present location and
condition for its intended use.
Commonly
used examples of cost include:
·
Purchase
price of an asset (less any trade discount)
·
Directly
attributable costs such as:
– cost of site preparation
– Initial delivery and handling costs
– Installation and testing costs
– Professional fees
·
the
initial estimate of dismantling and removing the asset and
·
restoring
the site on which it is located, to its original condition (i.e. to the extent that it is recognised as
a provision per IAS 37, Provisions, Contingent Assets and Liabilities)
·
Borrowing
costs in accordance with IAS 23, Borrowing Costs.
Any income earned during the
pre-production phase, which is not necessary to bring the asset into working
condition, should be recognised in the income statement.
The cost might also include transfers
from equity of gains/losses on qualifying cash flow hedges that are directly
related to the acquisition of property, plant and equipment. Where
consideration is deferred beyond normal credit terms, it should be discounted
to present value.
After initial recognition, the asset
should be measured at cost less accumulated depreciation and impairment losses
or at a revalued amount, which is its fair value less subsequent depreciation
and impairment losses. In this case, fair value must be reliably measurable.
Revaluations must be made with sufficient regularity to ensure that the
carrying amount is not materially different from fair value.
However, if an asset is revalued, then
the entire class of asset must be revalued. The fair value of property is its
market value. A professionally qualified valuer normally undertakes the
valuation. IAS 16 does not use the value to the business model. As a
consequence, IAS 16 is not prescriptive in requiring such things as
non-specialised properties to be valued at existing use value (EUV), at
depreciated replacement cost and properties surplus to requirements to be
valued at open market value.
Disclosure should be made whether the
revaluation was performed by an independent valuer or not. The same rule for
revaluation of property applies to plant and equipment. However, there are
difficulties of obtaining a market value for plant and equipment that are
recognised in IAS 16. Valuation at depreciated replacement cost is allowed when
there is no real market value, because of the specialised nature of the assets.
If a revaluation results in an
increase in value it should be credited to equity, unless it represents the
reversal of a revaluation decrease of the same asset previously recognised as
an expense, in which case it should be recognised as income. A decrease arising
as a result of a revaluation should be recognised as an expense, to the extent
that it exceeds any amount previously credited to the revaluation surplus
relating to the same asset.
When a revalued asset is disposed of,
any revaluation surplus may be transferred directly to retained earnings, or it
may be left in equity under the heading revaluation surplus. The transfer to
retained earnings should not be made through the income statement so as to
prevent ‘recycling’.
IAS 16 capitalises subsequent
expenditure on an asset using the same criteria as the initial spend; that is,
when it is probable that the future economic benefits associated with the item
will flow to the entity and the cost of the item can be measured reliably. If
part of an asset is replaced, then the part it replaces is derecognised,
regardless of whether it has been depreciated separately or not.
Example 1
On
1 March 2008 Yucca acquired a machine from Plant under the following terms:

TZS

List price of machine

82,000

Import duty

1,500

Delivery fees

2,050

Electrical installation
costs

9,500

Pre-production testing

4,900

Purchase of a five-year
maintenance contract with Plant

7,000

In addition to the above information
Yucca was granted a trade discount of 10% on the initial list price of the
asset and a settlement discount of 5% if payment for the machine was received
within one month of purchase. Yucca paid for the plant on 25 March 2008.
How should the above information be
accounted for in the financial statements?
SolutIon 1
In
accordance with IAS 16, all costs required bringing an asset to its present
location and condition for its intended use should be capitalised. Therefore,
the initial purchase price of the asset should be:

TZS ‘000’

List price

82,000

Less:
trade discount (10%)

(8,200)


73,800

Import
duty

1,500

Delivery
fees

2,050

Electrical
installation costs

9,500

Pre-production
testing

4,900

Total amount to be capitalised at 1
March

91,750

The
maintenance contract of Tshs 7,000 is an expense and therefore should be spread
over a five-year period in accordance with the accruals concept and taken to
the income statement. If the Tshs 7,000 has been paid in full, then some of
this cost will represent a prepayment. In addition the settlement discount
received of Tshs 3,690 (Tshs 73,800 x 5%) is to be shown as other income in the
income statement.
Example 2
Construction
of Deb and Ham’s new store began on 1 April 2009. The following costs were incurred on the
construction:

TZS 000

Freehold
land

4,500

Architect
fees

620

Site
preparation

1,650

Materials

7,800

Direct
labour costs

11,200

Legal fees

2,400

General
overheads

940

The store was completed on 1 January
2010 and brought into use following its grand opening on the 1 April 2010. Deb
and Ham issued a Tshs 25m unsecured loan on 1 April 2009 to aid construction of
the new store (which meets the definition of a qualifying asset per IAS 23).
The loan carried an interest rate of 8% per annum and is repayable on 1 April
2012.
Required
Calculate the amount to be included as
property, plant and equipment in respect of the new store and state what impact
the above information would have on the income statement (if any) for the year
ended 31 March 2010.
Solution 2
This is an example of a
self-constructed asset. All costs to get the store to its present location and
condition for its intended use should be capitalised. All of the expenditure
listed in the question, with the exception of general overheads would qualify
for capitalisation.
The interest on the loan should also
be capitalised from 1 April 2009 as in accordance with IAS 23 it meets the
definition of a qualifying asset. The recognition criteria for capitalisation
appears to be met ie activities to prepare the asset for its intended use are
in progress, expenditure for the asset is being incurred and borrowing costs
are being incurred. Capitalisation of the interest on the loan must cease when
the asset is ready for use, ie 1 January 2010. At this point any remaining
interest for the period should be charged as a finance cost in the income
statement.
Property,
plant and equipment
Store:

TZS ‘000’

Freehold
land

4,500

Architect
fees

620

Site
preparation

1,650

Materials

7,800

Direct
labour costs

11,200

Legal fees

2,400

Borrowing
costs (25,000 x 8%) x 9 /12

1,500

Total to
be capitalised

29,670

Income statement impact
With regards to the income statement
this should be charged with:
·
General
overheads of Tshs 940,000
·
Remaining
interest for Jan–Mar which is now an expense
Tshs 500,000 (25,000 x 8% x 3/12) and;
·
Depreciation
of the store. Even though the asset has not yet been brought into use, IAS 16
states depreciation of an asset begins when it is available for use, ie when it
is in the location and condition necessary for it to be capable of operating in
the manner intended by management.
Note: depreciation cannot be
calculated in this question as information surrounding useful economic life has
not been provided; this is for illustrative purposes only. Depreciation is
covered later in this topic.
Subsequent
costs
Once an item of PPE has been recognised
and capitalised in the financial statements, a company may incur further costs
on that asset in the future. IAS 16 requires that subsequent costs should be
capitalised if:
·
it
is probable that future economic benefits associated with the extra costs will
flow to the entity
·
the
cost of the item can be reliably measured.
All other subsequent costs should be
recognised as an expense in the income statement in the period that they are
incurred.
Example 3
On 1 March 2010 Yucca purchased an
upgrade package from Plant at a cost of Tshs 18,000 for the machine it
originally purchased in 2008 (Example 1). The upgrade took a total of two days
where new components were added to the machine. Yucca agreed to purchase the
package as the new components would lead to a reduction in production time per
unit of 15%. This will enable Yucca to increase production without the need to
purchase a new machine.
Should the additional expenditure be
capitalised or expensed?
Solution 3
The
Tshs 18,000 should be capitalised as part of the cost of the asset as the
revenue earning capacity of the machine has significantly increased, which
could in turn lead to the inflow of additional economic benefit and the cost of
the upgrade can be reliably measured
Depreciation
Depreciation is defined in IAS 16 as
being the systematic allocation of the depreciable amount of an asset over its
useful economic life. In other words, depreciation applies the accruals concept
to the capitalized cost of a non-current asset and matches this cost to the period
that it relates to depreciation methods. There are many methods of depreciating
a non-current asset with the most common being:
·
Straight
line

%
on cost or

Cost
– residual value
Useful
economic life
·
Reducing
balance

% on carrying value
The depreciable amount (cost less
prior depreciation, impairment and residual value) should be allocated on a
systematic basis over the asset’s useful life. The residual value and the
useful life of an asset should be reviewed, at least, at each financial year
end. And if expectations differ from previous estimates, any change is
accounted for prospectively as a change in estimate under IAS 8.
The residual value of an item of PPE
is based on the estimated amount that an entity would currently obtain from the
asset’s disposal, less estimated selling costs, if the asset were already of
the age and in the condition expected at the end of its useful life. Thus,
residual values take account of changes in prices up to the balance sheet date,
but not of expected future changes. Residual values are not based on prices
prevailing at the date of acquisition (or revaluation) of an asset, but take
account of subsequent price changes.
Depreciation commences when an asset
is in the location and condition that enables it to be used in the manner
intended by management. Depreciation ceases at the earlier of itsderecognition
(sale or scrapping) or its reclassification as ‘held for sale’ and should be
reviewed at least at each year end.
Temporary idle activity does not
preclude depreciating the asset, as future economic benefits are consumed not
only through usage but also through wear and tear and obsolescence. IAS 16 does
not include any reference to renewals accounting and, therefore, does not allow
any departure from the principle that the depreciation expense is determined by
reference to an asset’s depreciable amount.
Example 4
An item of plant was purchased on 1
April 2008 for Tshs 200,000 and is being depreciated at 25% on a reducing
balance basis.
Prepare the
extracts of the financial statements for the year ended 31 March 2010.
Solution 4
Income statement extract


Depreciation expense

Tshs 37,500



Statement of financial
position extract


Plant (200,000 – 50,000 – 37,500)

Tshs 112,500

Working for depreciation:



31/03/09

Cost

200,000


Depreciation– 25%

(50,000)


Carrying value

150,000

31/03/10

Carrying value

150,000


Depreciation – 25%

(37,500)


Carrying value

112,500

Useful economic lives and residual
values
IAS 16
requires that these estimates be reviewed at the end of each reporting period.
If either changes significantly, the change should be accounted for over the
useful economic life remaining.
Example 5
A machine was purchased on 1 April
2007 for Tshs 120,000. It was estimated that the asset had a residual value of
Tshs 20,000 and a useful economic life of 10 years at this date. On 1 April
2009 (two years later) the residual value was reassessed as being only Tshs
15,000 and the useful economic life remaining was considered to be only five
years.
How should the asset be accounted for
in the years ending 31 March 2008/2009/2010?
Solution 5
31
March 2008
At
the date of acquisition the cost of the asset of Tshs 120,000 would be
capitalised. The asset should then be depreciated for the years to 31 March 2008/2009
as:
Cost
– residual value
= 120,000 – 20,000 =
Tshs 10,000 per annum
Useful
economic life
10 years
Income statement extracts
2008


Depreciation expense

Tshs 10,000



Statement of financial
position extract 2008


Machine
(120,000 – 10,000)

Tshs 110,000

Income statement extract 2009


Depreciation
expenses

Tshs 10,000

Statement of financial position
extract 2009


Machine
(120,000 – 20,000)

Tshs
100,000

31 March 2010
As
the residual value and useful economic life estimates have changed during the
year ended 2010, the depreciation charge will need to be recalculated. The
carrying value will now be spread according to the revised estimates.
Depreciation charge:
100,000
– 15,000
=
Tshs 17,000 per annum
5 years
Income statement extracts 2010


Depreciation

Tshs 17,000

Statement of financial position
extract 2010


Machine
(100,000 – 17,000)

Tshs
83,000

Component
depreciation
If an asset comprises two or more
major components with different economic lives, then each component should be
accounted for separately for depreciation purposes and depreciated over its own
useful economic life.
Example 6
A company purchased a
property with an overall cost of Tshs 100m on 1 April 2009. The property elements
are made up as follows:

Tshs 000

Estimated life

Land
and buildings

(Land
element Tshs 20,000)

65,000

50
years

Fixtures
and fittings

24,000

10
years

Lifts

11,000

20
years

Calculate the annual
depreciation charge for the property for the year ended 31 March 2010.
Solution 6

Tshs 000

Land
and buildings (65,000 – 20,000)/50 years))

900

Fixtures
and fittings (24,000/10 years)

2,400

Lifts
(11,000/20 years)

550

Total property
depreciation

3,850

Revaluations
This is an important topic in the exam
and features regularly in Question 2, so you should ensure that you are
familiar with all aspects of revaluations.
IAS 16 rules
IAS 16 permits the choice of two
possible treatments in respect of property, plant and equipment:
·
The
cost model (carry an asset at cost less accumulated depreciation/impairments).
·
The
revaluation model (carry an asset at its fair value at the revaluation date
less subsequent accumulated depreciation impairment).
If the revaluation policy is adopted
this should be applied to all assets in the entire category, ie if you revalue
a building, you must revalue all land and buildings in that class of asset.
Revaluations must also be carried out with sufficient regularity so that the
carrying amount does not differ materially from that which would be determined
using fair value at the reporting date.
Accounting for a revaluation
There are a
series of accounting adjustments that must be undertaken when revaluing a
non-current asset. These adjustments are indicated below.
The initial
revaluation
You may find it useful in the exam to
first determine if there is a gain or loss on the revaluation with a simple
calculation to compare:
Carrying value of non-current asset at
revaluation date
X
Valuations of non-current asset
X
Difference = gain orloss on
revaluation
X
Revaluation
gains
A gain on revaluation is always
recognised in equity, under a revaluation reserve (unless the gain reverse’s
revaluation losses on the same asset that were previously recognised in the
income statement – in this instance the gain is to be shown in the income
statement).
The revaluation gain is known as an
unrealised gain which later becomes realised when the asset is disposed of
(derecognised).
Double entry:
Dr
Non-current asset cost
(Difference between valuation and original
cost/valuation)
Dr
Accumulated depreciation
(With any historical cost accumulated
depreciation)
Cr
Revaluation reserve
(Gain on revaluation)
Example 7
A company purchased a building on 1
April 2007 for Tshs 100,000. The asset had a useful economic life at that date
of 40 years. On 1 April 2009 the company revalued the building to its current
fair value of Tshs 120,000.
What is the double entry to record the
revaluation?
Solution
7
Gain on revaluation:
Carrying value of non-current asset at revaluation date
(100,000 – (100,000/40 years x 2 years))


95,000

Valuation

120,000

Gain on revaluation

25,000

Double entry:
Dr Building cost
(120,000 – 100,000) 20,000
Dr Accumulated depreciation
(100,000/40 years x 2
years) 5,000
Cr Revaluation reserve 25,000
Revaluation losses
A
revaluation loss should be charged against any related revaluation surplus to
the extent that the decrease does not exceed the amount held in the revaluation
reserve in respect of the same asset. Any additional loss must be charged as an
expense in the income statement.
Double entry:
Dr
Revaluation reserve (to maximum of original gain)
Dr Income
statement (any residual loss)
Cr
Non-current asset (loss on revaluation)
Example 8
The carrying value of Zen’s
property at the end of the year amounted to Tshs 108,000. On this date the
property was revalued and was deemed to have a fair value of Tshs 95,000. The
balance on the revaluation reserve relating to the original gain of the property
was Tshs 10,000.
What is the double entry to
record the revaluation?
Solution 8
Loss on
revaluation:
Carrying value of
non-current asset at revaluation date

108,000


Valuation

95,000

Loss on revaluation

13,000

Double entry:
Dr Revaluation reserve 10,000
(to maximum of original
gain)
Dr Income statement
3,000
Cr Non-current asset 13,000
The revaluation gain or loss must be disclosed in both the statement
of changes in equity and in other comprehensive income
.
Depreciation
The asset
must continue to be depreciated following the revaluation. However, now that
the asset has been revalued the depreciable amount has changed. In simple terms
the revalued amount should be depreciated over the assets remaining useful
economic life.
Reserves transfer
The
depreciation charge on the revalued asset will be different to the depreciation
that would have been charged based on the historical cost of the asset. As a
result of this, IAS 16 permits a transfer to be made of an amount equal to the
excess depreciation from the revaluation reserve to retained earnings.
Double entry:
Dr Revaluation reserve
Cr Retained earnings
Be careful, in the exam a reserves
transfer is only required if the examiner indicates that it is company policy
to make a transfer to realised profits in respect of excess depreciation on
revalued assets.
If this is not the case then a
reserves transfer is not necessary.This movement in reserves should also be
disclosed in the statement of changes in equity.
Example 9
A company revalued its property on 1
April 2009 to Tshs 20m (Tshs 8m for the land). The property originally cost
Tshs 10m (Tshs 2m for the land) 10 years ago. The original useful economic life
of 40 years is unchanged. The company’s policy is to make a transfer to
realised profits in respect of excess depreciation.
How will the property be accounted for
in the year ended 31 March 2010?
Solution 9
Statement
of comprehensive income extract for the year ended 31 March 2010



Tshs
000

Depreciation
expense

400

Other comprehensive
income:


Revaluation
gain

12,000

Statement
of financial position extract as at 31 March 2010


Non-current
assets Property (20,000 – 400)

19,600

Equity


Revaluation
reserve

(12,000 – 200)

11,800

Statement of changes in equity
extracts

Revaluation reserve
Retained earnings
Tshs 000
Tshs 000
Revaluation gain 12,000
Reserves transfer
(200) 200
Workings:
Gain on revaluation:
Tshs 000
Carrying value of non-current asset at
revaluation date
(10,000 – ((10,000 – 2,000)/40 years x
10 years)) 8,000
Valuation 20,000
Gain on
revaluation
12,000
Double entry:
Dr Property
(20,000 – 10,000) 10,000
Dr Accumulated depreciation
((10,000 – 2,000)/40 years x 10
years)
2,000
Cr Revaluation reserve 12,000
Depreciation charge for year to 31
March 2010:
Dr Depreciation expense
((20,000 – 8,000)/30 years)
400
Cr Accumulated depreciation
400
Reserves
transfer:
Historical cost depreciation charge
((10,000 – 2,000)/40 years)
200
Revaluation depreciation charge
400
Excess depreciation to be
transferred
200
Dr Revaluation reserve 200
Cr Retained earnings
200
Exam Focus
In the exam make sure you pay
attention to the date that the revaluation takes place. If the revaluation
takes place at the start of the year then the revaluation should be accounted
for immediately and depreciation should be charged in accordance with the rule
above.
If however the revaluation takes place
at the year-end then the asset would be depreciated for a full 12 months first
based on the original depreciation of that asset. This will enable the carrying
amount of the asset to be known at the revaluation date, at which point the
revaluation can be accounted for.
A further situation may arise if the
examiner states that the revaluation takes place mid-way through the year. If
this were to happen the carrying amount would need to be found at the date of
revaluation, and therefore the asset would be depreciated based on the original
depreciation for the period up until revaluation, then the revaluation will
take place and be accounted for. Once the asset has been revalued you will need
to consider the last period of depreciation. This will be found based upon the
revaluation rules (depreciate the revalued amount over remaining useful
economic life). This will be the most complicated situation and you must ensure
that yourworking is clearly structured for this; i.e. depreciate for first
period based on old depreciation, revalue, then depreciate last period based on
new depreciation rule for revalued assets.
Example 10
A company purchased a building on 1
April 2005 for Tshs 100,000 at which point it was considered to have a useful
economic life of 40 years. At the year-end 31 March 2010 the company decided to
revalue the building to its current value of Tshs 98,000. How will the building
be accounted for in the year ended 31 March 2010?
Solution 10
Statement
of comprehensive income extract 31 March 2010
Depreciation
charge 2,500
Other
comprehensive income:
Revaluation
gain
10,500
Statement
of financial position extract 31 March 2010
Building
at valuation
98,000
Statement
of changes in equity extract
Revaluation
reserve
Revaluation
gain
10,500
Working
paper:
Note:
revaluation takes place at year end, therefore a full year of depreciation must
first be charged.

(W1)
Depreciation year ended 31 March 2010
100,0000 = Tshs 2,500
40
years
(W2) Revaluation
The carrying value of the asset at 31
March 2010 can now be found and revalued.
Carrying value of non-current asset at
revaluation date
(100,000 – (100,000/40 years x 5
years))
87,500
Valuation of non-current asset
98,000
Gain or loss
on revaluation
10,500
Double entry:
Dr Accumulated depreciation
12,500
Cr NCA cost
2,500
Cr Revaluation reserve
10,500
Example 11
At 1 April 2009 HD Ltd carried its
office block in its financial statements at its original cost of Tshs 2 million
less depreciation of Tshs 400,000 (based on its original life of 50 years). HD
Ltd decided to revalue the office block on 1 October 2009 to its current value
of Tshs 2.2m. The useful economic life remaining was reassessed at the time of
valuation and is considered to be 40 years at this date. It is the company’s
policy to charge depreciation proportionally.
How will the office block be accounted
for in the year ended 31 March 2010?
Solution 11
Statement of comprehensive income
extract 31 March 2010
Depreciation charge
(20,000 (W1) + 27,500 (W2)
47,500
Other comprehensive income:
Revaluation gain 620,000
Statement of financial position
extract 31 March 2010
Office blocks (carrying value at 31
March):
Valuation
2,200,000
Depreciation
(27,500)
Carrying
value
2,172,500
Statement of changes in equity extract
Revaluation
reserve
Revaluation gain
620,000
Working paper:
Note: Revaluation takes
place part way through the year and therefore depreciation must first be
charged for the period 1 April 09 – 30 September 09, then the revaluation can
be recorded and then depreciation needs to be charged for the period 1 October
2009 – 31 March 2010.
(W1) Depreciation 1 April–30 September
2009
2,000,000 x 6/12 = Tshs 20,000
50 years
(W2) Revaluation
The carrying value of the asset at 1
October 2009 can now be found and revalued.
Carrying value of non-current asset at
revaluation date
(2,000,000 – (400,000 – 20,000)) 1,580,000
Valuation of non-current asset
2,200,000
Gain on
revaluation
620,000
Double entry:
Dr NCA cost (2,200,000 – 2,000,000) 200,000
Dr Accumulated depreciation
420,000
Cr Revaluation reserve
620,000
(W3) Depreciation 1 October – 31 March
2010
2,200,000 x 6/12 = Tshs 27,500
40 years
Derecognition
Property,
plant and equipment should be derecognised when it is no longer expected to
generate future economic benefit or when it is disposed of. When property,
plant and equipment is to be derecognised, a gain or loss on disposal is to be
calculated. This can be found by comparing the difference between:
Carrying value X
Disposal proceeds X
Profit or loss on disposal X
Tip: When the disposal proceeds are
greater than the carrying value there is a profit on disposal and when the
disposal proceeds are less than the carrying value there is a loss on disposal.
When an entity purchases or constructs
an asset, it may take on a contractual or statutory obligation to decommission
the asset or restore the asset site. These costs should be capitalised at the
date on which the entity becomes obligated to incur them. The amount
capitalised as part of the asset’s cost will be the amount estimated to be
paid, discounted to the date of initial recognition.
The related credit is recognised in
provisions. There may be significant changes in the initial (and subsequent)
estimates of decommissioning costs of an asset, particularly where asset lives
are long. These changes in estimate may be because of changes in legislation,
technology and timing of the decommissioning and or management’s assumptions.
An entity that uses the cost model
records changes in the existing liability and changes in the discount rate,
adjusting the cost of the related asset in the current period. An entity using
the revaluation model accounts for changes effectively through the revaluation
reserve.
Example 12
An asset that originally cost Tshs 16,000
and had accumulated depreciation on it of Tshs 8,000 was disposed of during the
year for Tshs 5,000 cash. How should the disposal be accounted for in the
financial statements?
Solution 12
The asset and its
associated depreciation should be removed from the statement of financial
position and a profit or loss on disposal should be recorded in the income
statement.
The loss on
disposal is:
Carrying value at disposal date
(16,000 – 8,000)
8,000
Disposal proceeds
5,000
Loss on disposal
3,000
Disposal of
previously revalued assets
When an asset is disposed of that has
previously been revalued, a profit or loss on disposal is to be calculated (as
above). Any remaining surplus on the revaluation reserve is now considered to
be a ‘realised’ gain and therefore should be transferred to retained earnings
as:
Dr Revaluation reserve
Cr Retained earnings
Impairment of assets
Impairments
should be accounted for in accordance with IAS 36, Impairment
of Assets
. An impairment loss under the revaluation model is
treated as a revaluation decrease to the extent of previous revaluation
surpluses. Any loss that takes the asset below historical depreciated cost is
recognised in the income statement.
Where there is a reversal of an
impairment loss, the amount of the reversal that can be recognised is
restricted to increasing the carrying value of the asset to the carrying value
that would have been recognised had the original impairment not occurred. In
other words, after taking account of normal depreciation that would have been
charged had no impairment occurred. Compensation may be received in the form of
reimbursements and is recorded in the income statement when the compensation
becomes receivable.
Impairment indicators are more likely
to be prevalent at the present time, therefore requiring assets to be evaluated
for impairment. Owing to the current economic environment, it may be more
likely that impairment indicators exist. Impairment must be considered at both
interim and annual reporting dates.

Recoverability

When PPE is tested for recoverability,
it might also be necessary to review depreciation and amortisation estimates
and methods. The manufacturing sector is likely to be severely affected. For
instance, there could be cancelled sales orders. This would cause some of the
PPE to become idle and the utilisation rate of the machinery is likely to drop.
As a result of the lower utilisation
rate, there is an implication for the impairment of plant, given that the plant
will be idle and not be involved in generating cash flows to the entity.
Non-cash generating units are an indication of impairment, as the return on
assets in this situation is significantly reduced.
In summary, it can be seen that
accounting for property, plant and equipment is an important topic that
features regularly in the financial accounting exam. With most of what is
examinable feeding though from the basic accounting courses, this should be a
comfortable topic that you can tackle well in the exam.

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