Property, Plant and Equipment

Property, plant and equipment (PPE) are tangible non-current assets that entity holds for a period longer than one accounting period meaning longer than a year for:

  1. use in ordinary course of business for:
    1. production or supply of goods that are later sold or used
    2. provision of services to customers or to departments
  2. rental to others i.e. outside entity
  3. administration of businsess



In simple words, PPE are not just production related assets but also include assets that support the production process of entity for example office equipment in head office is also PPE.

Examples of property, plant and equipment includes; land, building, machinery, office equipment, vehicles etc.

1 Recognition of property, plant and equipment

For an item of PPE to be recognized (recorded) in financial statements, it has to first meet the definition of asset and then the recognition criteria. An item may be an asset but if it fails the recognition criteria, it will not be recorded as entity’s asset in its statement of financial position.

An asset is defined as a resource:

  • controlled by an entity as a result of events in the past e.g. contract to use or purchase; and from which
  • future economic benefits are expected to flow to the entity e.g. by using it to produce goods, provide services or resulted in cost savings to entity.

Once an item meets the definition of asset, it will be recorded if following criteria is met:

  • future economic benefits are expected to flow to the entity
  • cost of the asset can be measured reliably

Future economic benefit is the extent of utility a resource can impart which directly or indirectly translates in cash flows or cash savings. Determination of the fact whether future benefits will flow the entity depends on the economic circumstances surrounding the transaction, terms of arrangement, expected use of asset etc.

Cost is simply the expenditures entity made to bring the asset to its intended use. It is important that entity is to able to reliably measure the cost as only then we know the value of asset. One important concept that require emphasis is that assets are initially measured at cost.

However, entity may incur additional costs even after recognition of asset usually called subsequent costs e.g. to add something, to replace a component, repairs and services. We will discuss these costs later.

2 Initial measurement of cost at recognition

An entity can acquire an asset externally from suppliers i.e. purchased asset or develop/construct an asset internally. Though situations are different but overall rules for cost measurement are relatively same.

2.1 Initial measurement of purchased asset

If an entity purchase an asset then following costs are included in the cost of asset:

  1. purchase price makes the significant port of cost of the asset;
    1. including: import duties, non-refundable taxes
    2. excluding: trade discounts, rebates, grants
  2. directly attributable costs that are incurred specifically to bring the asset in to its intended use. However, it does not include costs that could have been avoided or are simply general overheads or abnormal losses.
  3. Estimated dismantling cost if entity assumes a liability specifically to the asset at time of acquisition e.g. restoration costs

2.1.1 Examples of directly attributable costs

There is no strict rule to specify a cost as directly attributable one, however a general guideline is that all such costs that are necessary to bring the asset to intended use and state are added up as cost of the asset. Examples include:

  1. Costs of employee benefits (as defined in IAS 19 Employee Benefits) arising directly from the construction or acquisition of the item of property, plant and equipment;
  2. Costs of site preparation;
  3. Initial delivery and handling costs;
  4. Installation and assembly costs;
  5. 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); and
  6. Professional fees.

2.1.2 Examples of excluded costs

Some costs may appear to have incurred for an asset, however fail to fulfill the principle of “direct attribution” are not added up as cost of asset. Therefore, it may be necessary to evaluate each expenditure to assess if cost can be capitalized as cost of asset or not.

Major distinction is that if a cost can be avoided and still asset can be brought to intended use and purpose then it shall be excluded and recognized as expense in the income statement. Examples include:

  1. Costs of opening a new facility or business (known as pre-opening costs);
  2. Costs of introducing a new product or service (including costs of advertising and promotional activities) (known as pre-operating costs);
  3. Costs of conducting business in a new location or with a new class of customer (including costs of staff training); and
  4. Administration and other general overhead costs.

2.2 Initial measurement of internally constructed asset

Rules of cost determination for self-constructed assets are same as purchased asset. Main principle is that all such costs that are incurred specifically to bring the asset to its intended use and purpose shall form part of cost of asset.

If entity is producing an item for sale to its customers in the ordinary course of business and decided to use them internally then cost of such asset will be same as its cost of sales. In other words:

  1. Any internal profits which are charged in normal course of business to customers will be excluded to arrive at cost of production
  2. Abnormal losses incurred while production will be excluded
  3. All such costs that are excluded under a case of an acquired asset; as discussed in the above heading Excluded costs will stand excluded in self-constructed asset as well.
Borrowing Costs incurred on Non-current Assets
In order to acquire an asset or construct an asset, sometimes entities borrow money that may involve interest charges. Question is whether such interest charges that are payable on money used in asset’s acquisition or construction should be added as cost of the asset or not?

If certain conditions are fulfilled then borrowing costs can be added to the cost of the asset. However, it requires a detailed discussion on type of borrowing and the interest rate for capitalization purposes which will be discussed later in capitalization of borrowing cost section.

Example – Initial measurement of asset at cost

Lupghar Inc. has recently acquired an asset to increase production capacity. Purchase price of the asset alone was $720,000. In addition to this following costs were incurred:

(000)
Custom clearance 300
Rent of lorry (Note 1) 150
No objection certificate fee (Note 2) 35
Site planning and preparation 160
Labour (Note 3) 70
Installation (Note 4) 50
Inspection supervisor (Note 5) 20

Notes:

  1. Lorry has been acquired on rent and used by business for transporting any thing and not specifically obtained for this asset.
  2. Include 5000 with holding tax adjustable against entity’s income tax liability
  3. Include 25,000 salaries of entity’s own employees working full time
  4. Include materials that entity uses as raw material worth 12. The cost exceeded by 2 million because material was lost as subcontractor opened shuttering too early and part of platform collapsed
  5. Paid on monthy basis for other projects. Only 5 was paid specifically to make him agree to supervise installation.

Required: Calculate the cost of asset to be recognized in the balance sheet

Solution:

Treated as cost of asset
in balance sheet
Treated as expense
in income statement
(000)(000)
Purchase price
Custom clearance
Rent of lorry
No objection certificate fee
Site planning and preparation
Labour
Installation
Inspection supervisor
720
300

30
160
45
48
5


150
5

25
2
15
1308197