IAS 16 – Property, Plant and Equipment

6 Measurement after recognition

An entity has the option to adopt either cost model or revaluation model as its accounting policy and shall apply that policy to an entire class or property, plant and equipment.

Cost model

Under this model entity carries its assets on cost less any accumulated depreciation and any impairment losses.

Word “any” has been included to count the fact that not all assets are subject to depreciation and the same goes for impairment.

Revaluation model

Under this model entity carries its assets at fair value less any depreciation and any impairment losses.

What is fair value?

In case of land and building fair value is usually determined by considering market-based evidence of similar assets in similar state and in similar market in which they are situated now.

For plant and equipment is the value market value of these assets which can be ascertained by studying the market for the same or reasonably similar assets in the market.

If market-based evidence cannot be collected for the purpose of determination of fair value of asset then entity may need to estimate fair value using an income or a depreciated replacement cost approach.

As the valuation is sometime complex, therefore, this task is usually undertaken by professional valuers.

If entity use revaluation model then following conditions are needed to be fulfilled:

1. 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.
2. 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 frequency of revaluations depends upon the changes in fair values of the items of property, plant and equipment being revalued. When the fair value of a revalued asset differs materially from its carrying amount, a further revaluation is required. 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.

A class of property, plant and equipment is a grouping of assets of a similar nature and use in an entity’s operations. The following are examples of separate classes:

1. land;
2. land and buildings;
3. machinery;
4. ships;
5. aircraft;
6. motor vehicles;
7. furniture and fixtures; and
8. office equipment.

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. However, a class of assets may be revalued on a rolling basis provided revaluation of the class of assets is completed within a short period and provided the revaluations are kept up to date.

Accounting for revaluation

The accounting of revaluation under simple situations is done in three steps:

Step 1:    Compare cost of the asset with the fair market value of the asset to understand the increase or decrease required in the asset’s account

Step 2:    Any existing accumulated depreciation at the time of revaluation can be treated in two ways but the most followed option is to eliminate any accumulated depreciation.

Step 3A:    Compare carrying value with the fair market value to determine the amount of revaluation increase or revaluation decrease

Normally things are pretty straightforward and the accounting of revaluation concludes as mentioned above. However, if there was any previous revaluation loss before current revaluation increase OR if there was any revaluation gain before current revaluation decrease then step 3 will be amended as following:

Step 3B(i): If there is any previously recognized revaluation decrease (as revaluation loss in P&L a/c) then current revaluation increase will first be applied to reverse previous decrease and the remaining amount will then be credited to the revaluation surplus account.

Step 3B(ii): If there is any previously recognized revaluation increase (as revaluation surplus under equity) then current revaluation decrease will first be applied to reverse any revaluation surplus and the remaining amount will then be debited to the profit and loss account