2 IAS 16 – Property, Plant and Equipment
2.1 Definition and Recognition
IASs recognize most of the tangible non-current assets with the name Property, Plant and Equipment and discuss them under IAS 16.
Property Plant and Equipment are tangible items that:
- are held for
- use in the production or supply of goods or services
- rental to others
- for administrative purposes
- are expected to be used during more than one period.
According to IAS 16 the cost of an item of Property, Plant and Equipments shall be recognized as an asset if:
- Future economic benefits associated with the item are probably to flow to the entity
- Cost of the item can be measured reliably
An entity uses this recognition principle to evaluate all costs incurred related to Property, Plant and Equipment whether they should be recognized or not and how their accounting is done. Costs include:
- Costs incurred initially (at the time of recognition) to acquire or construct an item of Property, Plant and Equipment
- Costs incurred subsequently (after recognition and brought into usable condition) to add to, replace part of, or service it. We will discuss subsequent costs in more detail later.
NOTE: Previously under IAS 16 there used to be two recognition principles one for initial costs and second for subsequent costs. But now the criteria has been unified for all the costs incurred
2.2 Measuring Initial Cost – Measurement at recognition
An entity can either purchase an asset or construct the item on its own. Even though the situations are different but rules regarding which costs to be included and excluded are almost similar. But we will deal with them one-by-one for better understanding.
2.2.1 Costs to be included and excluded – Purchased
Costs to be included
- Purchase price
- Including (added to purchase price):
i. import duties
ii. non-refundable purchase taxes
- excluding (deducted out of purchase price):
i. trade discounts and
- Directly attributable costs; which also include all such costs that were incurred to bring the asset for it to be capable of operating as intended.
- Initial estimates of dismantling / restoration costs which became an obligation of the company at the time of acquisition of the asset.
Where the amount is significant then present value of the provision will be calculated and added at the time of recognition which in subsequent period will be increased by the unwinding of the discount. Such costs are treated according to the provisions of IAS 37.
Examples of directly attributable costs
- 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;
- Costs of site preparation;
- Initial delivery and handling costs;
- Installation and assembly costs;
- 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
- Professional fees.
Costs to be excluded
Simply, all such costs that are not directly attributable or that can be avoided and the asset still would have been brought into useable condition than such costs cannot be capitalized and will be recognized in the profit and loss account.
- Costs of opening a new facility or business (known as pre-opening costs);
- Costs of introducing a new product or service (including costs of advertising and promotional activities) (known as pre-operating costs);
- Costs of conducting business in a new location or with a new class of customer (including costs of staff training); and
- Administration and other general overhead costs.
2.2.2 Costs to be included and excluded – Self-constructed
According to IAS 16, if an entity has constructed an asset in-house instead of buying it, even then same principles are applicable as are applicable for acquired assets i.e. costs that are to be included and excluded mentioned above will apply to self-constructed assets as well.
And if entity produces such assets in normal course of business then cost of acquisition will be same as cost of sales (as determined under IAS 2). In simple words:
- Any internal profits which are charged in normal course of business to customers will be excluded to arrive at cost of production
- Abnormal losses incurred while production will be excluded
- 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.
2.2.3 Dealing with Interest costs and Incidental costs/revenues
Interest charged for delayed payments will not be added as cost of the asset as cost is measured at cash equivalents and interest will be charged as an expense unless that cost fulfills the capitalization criteria according to IAS 23
Incidental costs and incomes
Some costs might be incurred or incomes earned while asset is being made available to be used. Such incidental costs or incomes will not be adjusted in the cost of the asset as these incidental operations are (usually) not necessary to bring the asset into working condition and thus recognized in the profit and loss account in their respective classification of income and expense