-Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life
-Useful life is: (a) the period over which an asset is expected to be available for use by an entity; or (b) the number of production or similar units expected to be obtained from the asset by an entity
Ready for use is not defined under the accounting standard issue by ICAI. However, as per ACCA as soon as asset is capable of operating, it is ready for use. Generally, ready for use means when the Products and/or Services are fully supplied, installed, implemented, tested, accepted and operating in accordance with the provisions of these Conditions and as more particularly described in the Specification and Statement of Work.
Para 7 Recognition Criteria for PPE:
The cost of an item of property, plant and equipment should be recognized 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.
The asset should be capitalized in book of account, when an asset is ready for use.
Element of Cost:
The cost of an item of property, plant and equipment comprises:
Depreciation – Component-wise
Para 43-45 Each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item should be depreciated separately.
An entity allocates the amount initially recognised in respect of an item of property, plant and equipment to its significant parts and depreciates separately each such part.
For example, it may be appropriate to depreciate separately the airframe and engines of an aircraft, whether owned or subject to a finance lease. The depreciation charge for each period should be recognised in profit or loss unless it is included in the carrying amount of another asset.
A significant part of an item of property, plant and equipment may have a useful life and a depreciation method that are the same as the useful life and the depreciation method of another significant part of that same item. Such parts may be grouped in determining the depreciation charge.
Understanding thorugh Ind AS – 16
Step 1: Identify the significant components of a PP&E item
Step 2: Determine the cost of the components
Step 3: Depreciate each component separately
Step 4: Replace the components
Q1 – Separate Significant part of the item & Depreciation
A manufacturing company has recently acquired a new factory, which cost Rs. 15,00,000 for the freehold land and building. The land has a fair value of Rs 5,00,000. The factory building has a residual value of Rs. 1,00,000 at the end of 30 years, which is the expected useful life of the building. This factory has a flat roof, which needs replacement after every ten years. The current cost of replacement is Rs. 1,00,000. How should the Company depreciate the entire factory?
As per paragraph 43 of Ind AS 16, each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately.
The company may consider the roof as a significant part of the item and depreciate the cost of the roof of Rs. 1,00,000 over the period of 10 years, giving a depreciation charge of Rs. 10,000 per annum and to depreciate the remaining value of the factory of Rs. 9,00,000 to its residual value of Rs. 1,00,000 over 30 years, giving depreciation charge of Rs. 26, 667.
At the end of year 10 when the roof will be replaced the carrying amount attributable to the replaced roof would be nil, with no profit or loss on disposal.
In the given case, the economic benefits arising from the factory over 30 years is reflected through charge to the statement of profit and loss of Rs. 26,667 per annum as depreciation for the building and depreciation charge of Rs. 10,000 for the flat roof over its useful life.
Q2 Separate Significant Component of an Asset
Company A has purchased a captive power plant for Rs. 75 crores. Plant consists of significant components like boiler, turbine blades and generator. Company applies component accounting and depreciate all the 3 components as per their respective useful life. Company does not have the breakup of cost component wise in the invoice. How will the total cost be allocated to the components?
In case, the separate cost of each significant component of an asset is not available in the books of account then for the purpose of determining the cost of such component, the following criteria can be used in the order given below:
(a) Break-up cost provided by the vendor.
(b) Cost break-up given by internal/external technical expert.
(c) Fair values of various components; or
(d) Current replacement cost of component of the related asset and applying the same basis on the historical cost of asset.