An article on PPE is very much required as it is totally a new concept for all of us, so just sharing my understanding regarding the same.
PROPERTY PLANT EQUIPMENT
Property, plant and equipment are tangible items that are held by an entity for use in the production or supply of goods or services, for rental to others, or for any administrative purposes; and are expected to be used during more than one period.
Initial Measurement of cost of Property Plant and Equipment
The items that are to included into the initial cost of PPE are as follows:
> Purchase Price, considered after deducting trade discounts and rebates and adding duties and non-refundable taxes
> Costs directly attributable to bringing the asset to its location and in the condition so as to make it available for its intended use
> Initial estimate of the costs of dismantling and removing the item and restoration of site
Subsequent Measurement of cost of Property Plant and Equipment
Subsequent measurement of cost of PPE whether revenue or capital will be treated as follows:
> Cost of day-to-day servicing of an assets is treated as revenue expenditure and charged to Statement of Profit and Loss and not included in carrying amount of the asset
> Cost of replacements:
– at regular intervals
– at less frequent intervals
– at occasional intervals i.e. non recurring replacements.
Example:
A section of a mall is renovated by constructing a food court and gaming zone so as to increase the footfall in the mall. The food court and gaming zone are expected to result in a significant increase in sales for the shops and outlets of the mall. Whether this cost of construction of food court and gaming zone should be capitalised as property, plant and equipment or expensed off in the Statement of Profit and Loss?
Solution
Paragraph 7 of Ind AS 16 requires that the cost of an item of property, plant and equipment shall be recognised as an asset if, and only if:
(a) it is probable that future economic benefits associated with the item will flow to the entity; and
(b) the cost of the item can be measured reliably.
Further as per paragraph 10 of Ind AS 16, an entity evaluates under this recognition principle all its property, plant and equipment costs at the time they are incurred. These costs include costs incurred initially to acquire or construct an item of property, plant and equipment and costs incurred subsequently to add to, replace part of, or service it. In view of the above, since it is probable that the construction of food court and gaming zone will result into flow of future economic benefits to the entity in the form of increase in sales and the cost of construction can be measured reliably, accordingly, the subsequent cost of construction of food court and gaming zone should be capitalised in the cost of mall as an item of property, plant and equipment.
Revaluation of Property Plant and Equipment
An entity is allowed to choose either cost model or revaluation model as its accounting policy.
Comparison of the two methods: Cost and revaluation model
| Cost model | Revaluation model |
| Valuation of carrying amount
Cost is taken as starting point |
Valuation of carrying amount
Revalued amount is taken as starting point since it replaces cost |
| Accumulated depreciation and impairment losses are deducted from initial recognition of carrying value | Accumulated depreciation and impairment losses are deducted subsequent to the revaluation date |
Cost Model
| Items | Amounts(Rs.) |
| Original Cost of Asssets | XXX |
| Less: Depreciation | (XXX) |
| Less: Impairment | (XXX) |
| Net Value of asset | XXX |
Revaluation Model
The fair value of an asset is required to be determined under the revaluation model.
After recognizing an asset as item of PPE whose fair value can be reliably measured should be carried at fair value.
Revaluation should be made at regular intervals to ensure that the carrying amount does not differ materially from that which would be determined using fair value.
Accounting for revaluation adjustment:
> If an asset’s carrying amount is increased – it should be recognised in other comprehensive income and accumulated in equity under the heading revaluation surplus. However, if there is a revaluation decrease of the same asset earlier – which was recognised in Statement of Profit and Loss as per Ind AS 16 – then the increase should be credited in Statement of Profit and Loss to the extent it reverses the revaluation decrease.
> If an asset’s carrying amount is decreased – it should be recognised in Statement of Profit or Loss(income statement). However, if there is a balance in the revaluation surplus under equity for the same asset based on revaluation performed earlier, such decrease is
> Recognised in other comprehensive income.
Depreciation Methods
Standard depreciation methods prescribed under are highlighted as under:
♦ The straight line method: This result is a constant change over the useful life if the asset’s residual value does not change
♦ The reducing (diminishing) balance method: This results in decreasing change over the useful life
♦ The units of production method: This results in a change based on expected use or output
Each part of an item of property, plant and equipment with a cost that is significant in relation with the total cost of the item should be depreciated separately. This is also called “component” method of accounting.
Depreciation under cost model
Depreciation under cost model is simple and straightforward, wherein we identify the estimated useful life of the asset and spread the capital cost into the number of years.
Depreciation under revaluation model
When an item is revalued, we get its fair value, which is compared to its carrying value i.e. gross value minus depreciation. This leads to the treatment of accumulated depreciation
(a) The accumulated depreciation needs to be restated proportionately so that the carrying amount of the asset after revaluation equals its revalued amount. The method is used normally when an asset is revalued by applying an index to its depreciated replacement cost.
(b) The accumulated depreciation is eliminated against the gross carrying amount of the asset, with the net amount restated to its revalued amount. This method is more in use.
Example:
The net book value of a building owned by Alpha is INR 50000. Its gross value is INR 60000 and accumulated depreciation is INR 10000.
There is 40% increase in the net book value (INR 50000 + 40% of INR 50000) = INR 70000.
Solution
Accordingly the gross book value and accumulated depreciation needs to be increased by 40% i.e. gross book value INR 84000 (INR 60000 + 40% of INR 60000) and accumulated depreciation INR 14000 (INR 10000 + 40% of INR 10000). The carrying amount works out to INR 70000 (INR 84000 – INR 14000) which is equal to the revalued amount.
Talk about Investment property
Ind AS 40 defines investment property as property (Land or building) held with an intention to earn rentals or for capital appreciation or both.
Examples of Investment Property
- Land held for long term capital appreciation.
- Land held for currently undetermined future use.
- Building leased out under operating lease.
- Property that is being constructed or developed for future use as investment property.
Ind AS 40 deals investment property in details w.r.t its recognition, measurement, disposal, disclosures etc.
Key differences between Ind As 16 and AS 10
> Ind AS 16 is based on component approach i.e. each item of assets that has significant value has to be capitalize separately, whereas no such approach is followed under previous GAAP.
> Ind AS 16 specifically requires that cost of major inspections and cost of
> subsequent demolition should be capitalized initially whereas previous GAAP does not deals with any such aspects.
> Under previous GAAP, depreciation accounting is dealt in separate Accounting Standard i.e. AS-6 “Depreciation Accounting” but now it is included in Ind AS 16.
> Ind AS 16 provides that if payment is deferred beyond normal credit terms, the difference between the cash price equivalent and the total payment is recognised as an interest over the period of credit unless such interest is capitalized in accordance with Ind AS 16.
> Ind AS 16 requires that the residual value, depreciation method and useful life of an asset be reviewed at least at each financial year-end and, if expectations differ from previous estimates. Under previous GAAP such review is not obligatory.
> Ind AS 16 does not deal with the assets ‘held for sale’ because the treatment of such assets is covered in Ind AS 105 Non-current Assets Held for Sale and Discontinued Operations. Existing AS 10 deals with accounting for items of fixed assets retired from active use and held for sale.
> Under previous GAAP, any change in depreciation method is treated as change in accounting policy and applied retrospectively. Under Ind AS, it is treated as change in accounting estimate and applied prospectively.
Conclusion
Ind AS 16 “Property Plant and Equipment” deals with recognition, measurement, depreciation, disclosures and various other aspects regarding classification of PPE in the financials. Presentation of an asset classified as PPE will lead Financial statements to reflect much better position of an entity. It will help users of financial statements to understand better and fair. It is evident that recognition and measurement of Property, Plant and Equipment is always simple and straightforward under cost model. However, to ensure various kinds of possibilities are addressed, the Ind AS deals with revaluation model as well as explained above. In practical scenario where inflation grows beyond manageable levels revaluation model is adopted.
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