Property Plant and Equipment (PPE) is one among the items of the assets element presented in the financial statements. PPE consists of building, computer equipment, office equipment, furniture, vehicle or truck, and machinery, etc… it’s also called fixed assets or tangible assets. PPE is non-current assets in nature and an entity must recognize depreciation expense in each accounting period when preparing financial statements. PPE is presented at net book value within the statement of financial position under the assets element.
Definition
The definition of PPE has been given in several ways; however, its characteristics are still identical.
IAS 16 – Property, Plant and Equipment defines PPE as tangible assets with following characteristics:
• The asset held by an entity to be used within the production or supply of goods or services
• It is held for rental to others to generate revenue, or for any administrative purposes within the day-to-day operation of the company.
• Such asset is expected to have its useful life for more than one period.
Now we are able to have a look at one example of PPE items whether it represents the 2 characteristics above. The vehicle is one item of the PPE. it’s normally used either for providing goods or services or for administrative purposes. So it represents the first characteristic. The useful lifetime of a vehicle is, for instance, 5 years as per the accounting policy of an entity. Therefore, it also represents the second characteristic. Therefore, vehicles constitute the definition of PPE.
Scope
PPE is under the scope of IAS 16. Therefore, IAS 16 shall be applied to all accounting treatments, recognition criteria, measurement both at initial recognition and after initial recognition. This application is usually applied unless there is another standard permit for such a different treatment.
IAS 16 doesn’t apply to the below assets as they’re cover in numerous standard:
- All property, plant, and equipment which are classified as held sales in accordance with IFRS5 Non-Current Asset Held for sales and Discontinued Operations.
- Any biological assets a result of all kinds of activities related to the agricultural sector. These biological assets are covered in another standard called IAS 41 Agriculture.
- The exploration and evaluation assets which are covered in another standard called IFRS6 Exploration for and Evaluation of mineral resource
- Mineral reserves or mineral rights including oil, gas, and other similar non-regenerative resources.
Recognition of PPE
As per IAS 16, the recognition of costs of the assets or property plant and equipment only applicable when the future economic benefit is expected or probable to flow to the entity, and we can measure the cost of such asset reliably. Meaning we only recognize PPE that we use in our day-to-day operation to generate revenue for the company.
For instance, the vehicle that we purchased at the value of US$60,000 including other costs and applicable taxes. This vehicle is to be used to transport goods for sales as well as for administration activities in the day-to-day operation. Meaning the future economic benefit will flow to the entity in the form of using it to transport goods or services for sales to generate revenue for the company.
Hence, such vehicle is within the recognition criteria of Property Plant and Equipment and such vehicle shall be presented under the assets section in the financial statements.
Measurement at Initial Recognition
As per IAS 16 – Property, Plant, and Equipment, an item of property, plant, and equipment that qualifies for recognition as an asset shall be measured at its cost. additionally, IAS 16 also states that costs shall include:
- The purchase price, including import duties and input tax (VAT input) or in some countries called Goods and Service Tax (GST), after deducting any trade discounts and rebates.
- Any related direct costs that help to the asset to the present location and condition.
- The costs of dismantling and removing the item and the costs to restore the site to its original condition. These costs shall be estimated in the first place and adjusted where necessary when become known.
The below are the example of costs that are directly attributable to the recognition:
- Employee benefits related costs (as defined in IAS 19 Employee Benefits) which incurred directly from the acquisition or construction of the fixed asset or property, plant, and equipment;
- Costs related to the preparation of the site;
- Initial delivery and handling costs;
- Installation and assembly costs in bringing the assets into use;
- Costs related to the testing of functioning of the assets
- And any other costs related to the professional fees where applicable.
Furthermore, IAS 16 also states that the cost of an item of PPE is the cash price equivalent to the recognition date. In case of payment is delayed beyond normal allowable credit terms, we shall recognize as interest on the difference between the original cash price equivalent against the total payment over the period of such credit unless such interest is capitalized together with the assets in accordance with IAS 23 – Borrowing Costs.
Measurement after Initial Recognition
As per IAS 16, the subsequent measurement of PPE can be carried out at cost or revaluation model.
- Cost model: After initial recognition, the asset shall be carried and presented at its cost less any accumulated depreciation and any accumulated impairment loss which is called net book value that we need to present in the statement of financial position.
- Revaluation model: After initial recognition, if the assets can be measure reliably, those assets shall be carried out at revalued amount. The revalued amount is the amount at its fair value or net book value as at the date of revaluation less any subsequent accumulated depreciation and impairment loss. Please note that if an entity adopts this model, the revaluations shall be made with sufficient regularity and consistency to ensure that the carrying amount does not materially different from what would be determined using fair value at the end of any reporting period.
In the later sections below, we cover various examples of the accounting for PPE. This includes the accounting treatment at the date of purchase, subsequent depreciation calculation, disposal of PPE, as well as the accounting treatment for revaluation.
Example 1 – Asset Purchase
ABC Co purchased a machinery plant at the cost of $60,000 on 01 January 20X1. In order to bring this machinery plant to the business premise available for use, the below costs have been incurred:
- Delivery and handling cost to bring the asset to the business premise of $5,000;
- Applicable purchase tax of $6,000;
- The assembly cost as well as related cost to test the functionality of the machinery of $2,000;
ABC Co adopts the straight-line method of depreciation and at the full year from the date of the purchase. As a result, the machinery plant is expected to have a life expectancy of 5 years with a $3,000 salvage value at the end of its life expectancy.
What is the total cost of the assets to be recorded in the Balance Sheet?
Solution:
Based on the recognition criteria above, the costs of the machinery plant would include its actual cost plus other related costs as illustrated below:
| Cost | Amount |
|---|---|
| Actual machinery plant | $60,000 |
| Purchased tax | $6,000 |
| Deliver and handling cost | $5,000 |
| Assembly and other related costs | $2,000 |
| Total costs of machinery to capitalize | $73,000 |
Therefore, at the initial recognition, ABC Co would record $73,000 as assets and record the depreciation throughout the useful life of the machinery plant.
The journal entry to record the initial recognition of the machinery plant are as follow (assuming that all the costs incurred and paid at the same time):
| Account Name | Debit | Credit |
|---|---|---|
| PPE – Machinery Plant | $73,000 | |
| Cash/Bank | $73,000 |
Now it is time to calculate the depreciation expense of the machinery plant. From the example, we can calculate the annual depreciation expense as follow:
Annual depreciation expense = (Cost – Salvage Value)/ Useful Life
Where:
Cost = $73,000
Scrap value = $3,000
Useful life = 5 years
Therefore, the annual depreciation expense = (73,000 – 3,000)/5 = $14,000
Below is the summarised table illustrating the deprecation schedule and its accumulated depreciation together with the net book value of the machinery plant at the end of each period.
| Year | The depreciation charge for the year (A) | Accumulated depreciation at the end of the year (B) | Cost of asset (C) | Carrying value at the end of year (C – B) |
|---|---|---|---|---|
| Year 1 | $14,000 | $14,000 | $73,000 | $59,000 |
| Year 2 | $14,000 | $28,000 | $73,000 | $45,000 |
| Year 3 | $14,000 | $42,000 | $73,000 | $31,000 |
| Year 4 | $14,000 | $56,000 | $73,000 | $17,000 |
| Year 5 | $14,000 | $70,000 | $73,000 | $3,000 |
Hence, below are the journal entries to record the yearly depreciation expense of the machinery plant:
| Account Name | Debit | Credit |
|---|---|---|
| Depreciation – Machinery Plant | $14,000 | |
| Accumulated depreciation | $14,000 |
Typically, the depreciation charges are recorded on a monthly basis. Therefore, the monthly depreciation expense that ABC Co needs to record monthly would be $1,666.67 ($14,000/12).
At the end of year five, the carrying value of the machinery plant equal to the salvage value, which is at $3,000.
Example 2 – Asset Disposal
Continuing from example 1 above, let us assume that at the end of year 3, ABC Co sold the machinery plant for $28,000. To make this sale, the company incurred the dismantling cost and the transportation cost of the machinery plant to the buyer’s premise, amounting to $1,500.
As you can see from the table of example 1 above, at the end of year 3, the carrying value of the machinery plant is $31,000. Therefore, there is a loss on this disposal. Below is the calculation of loss on disposal of the machinery plant.
| Description | US$ | US$ |
|---|---|---|
| PPE – Machinery plant at cost | 73,000 | |
| Less: Accumulated Depreciation | (42,000) | |
| Carrying value at the date of disposal | 31,000 | |
| Sale price | 28,000 | |
| Less: Cost incurred to make the disposal | (1,500) | |
| Net sale price | 26,500 | |
| Loss on disposal | (4,500) |
From the above calculation, we can record the journal entries for the disposal as below:
| Account Name | Debit | Credit |
|---|---|---|
| Cash/Bank | $26,500 | |
| Accumulated depreciation | $42,000 | |
| PPE – Machinery Plant | $73,000 | |
| Loss on disposal | $4,500 |
Please note that the dismantling and transportation cost of the Machinery plant to the buyer’s premise is included in the loss on disposal. In addition, the cash and bank above is the net of dismantling and transportation associated costs. You may also present a separate journal entry for this dismantling and transportation as well.
Example 3 – Revaluation of PPE
XYZ Co has begun its operation on 01 January 20X1 and bought a business premise with a value of $100,000, $16,000 of which is for land and another $84,000 for building. XYZ Co has estimated the useful life of the building at 30 years.
XYZ adopts the revaluation model on its PPE accounting. After five years of trading, the company has revalued its business premises. The land has been revalued at $30,000, whereas the building has been revalued at $100,000. The company has still estimated the remaining useful life of the business premises of 25 years. XYZ Co uses the straight-line method to recognize depreciation of its business premises.
How to account for the revaluation and its subsequent depreciation on the revalued PPE?
From the above example, we can get a summary as follow:
| Description | Amount |
|---|---|
| New business premises value | $130,000 |
| Carrying value of business premise [$16,000 + $84,000 – $14,000 ($84,000*5/30)] | $86,000 |
| Revaluation surplus | $44,000 |
The gain of $44,000 above shall be presented under other comprehensive income and recorded in the equity section under revaluation reserves.
This gain should only be recognized as a realized gain in the income statement when the asset is subsequently sold.
From the above calculation, we can record the journal entries for the revaluation of the business premises as follow:
| Account Name | Debit | Credit |
|---|---|---|
| Building ($100,000 – $84,000) | $16,000 | |
| Building – Accumulated depreciation | $14,000 | |
| Land ($30,000 – $16,000) | $14,000 | |
| Revaluation reserve | $44,000 |
Now, it is time to calculate the depreciation on the newly revalued building. As per the example above, the new building value is $100,000, with the remaining useful life of 25 years. Therefore, the depreciation from year 6 onward is calculated as follow:
Annual depreciation = 100,000/25 = $4,000
Therefore, the annual depreciation expense on the building from year 6 onward is $4,000.
Example 4 – Revaluation Downward
Let’s continue from example 3 above for the revaluation downward. XYZ Co assumes that after 5 years, the company realized that it overvalued the building. The building is now valued at $50,000, while the land portion still has $30,000. So what are the accounting entries for the revaluation downward?
From the above example, below is the summary of the revaluation downward:
| Description | Amount |
|---|---|
| New business premises value ($30,000 + $50,000) | $80,000 |
| Carrying value [$30,000 + $100,000 – ($100,000*5/25)] | $110,000 |
| Reduction in revaluation | $30,000 |
At the time of revaluation, the previous revaluation surplus shall need to be reversed; therefore, the journal entries for the revaluation downward are as follow:
| Account Name | Debit | Credit |
|---|---|---|
| Building ($100,000 – $50,000) | $50,000 | |
| Accumulated depreciation on revalue amount | $20,000 | |
| Revaluation reserve | $30,000 |
Then XYZ shall need to re-estimate the useful life of the building in order to calculate the new depreciation expense through the remaining useful life of the building.
References
- IAS 16 – Property, Plant, and Equipment: iasplus.com
- BPP ACCA F3 – Study Text