Financial Accounting

Objective of IAS 16
The objective of IAS 16 is to prescribe the accounting treatment for property, plant, and equipment.
The principal issues are the recognition of assets, the determination of their carrying amounts, and
the depreciation charges and impairment losses to be recognised in relation to them.
Scope
IAS 16 applies to the accounting for property, plant and equipment, except where another standards
requires or permits differing accounting treatments.
The cost model in IAS 16 also applies to investment property accounted for using the cost model
under IAS 40 Investment Property. [IAS 16.5]

Recognition
Items of property, plant, and equipment should be recognised as assets when it is probable that:
[IAS 16.7]
• it is probable that the future economic benefits associated with the asset will flow to the entity,
and
• The cost of the asset can be measured reliably.
This recognition principle is applied to all property, plant, and equipment costs at the time they are
incurred. These costs include costs incurred initially to acquire or construct an item of property,
plant and equipment and costs incurred subsequently to add to, replace part of, or service it.
IAS 16 does not prescribe the unit of measure for recognition – what constitutes an item of property,
plant, and equipment. [IAS 16.9] Note, however, that if the cost model is used (see below) 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 must be depreciated separately. [IAS 16.43]
IAS 16 recognises that parts of some items of property, plant, and equipment may require
replacement at regular intervals. The carrying amount of an item of property, plant, and equipment
will include the cost of replacing the part of such an item when that cost is incurred if the
recognition criteria (future benefits and measurement reliability) are met. The carrying amount of
those parts that are replaced is derecognised in accordance with the derecognition provisions of IAS
16.67-72. [IAS 16.13]
Also, continued operation of an item of property, plant, and equipment (for example, an aircraft)
may require regular major inspections for faults regardless of whether parts of the item are
replaced. When each major inspection is performed, its cost is recognised in the carrying amount of
the item of property, plant, and equipment as a replacement if the recognition criteria are satisfied.
If necessary, the estimated cost of a future similar inspection may be used as an indication of what
the cost of the existing inspection component was when the item was acquired or constructed. [IAS
16.14]
Initial measurement
An item of property, plant and equipment should initially be recorded at cost. [IAS 16.15] Cost
includes all costs necessary to bring the asset to working condition for its intended use. This would
include not only its original purchase price but also costs of site preparation, delivery and handling,
installation, related professional fees for architects and engineers, and the estimated cost of
dismantling and removing the asset and restoring the site (see IAS 37 Provisions, Contingent
Liabilities and Contingent Assets). [IAS 16.16-17]
If payment for an item of property, plant, and equipment is deferred, interest at a market rate must
be recognised or imputed. [IAS 16.23]
If an asset is acquired in exchange for another asset (whether similar or dissimilar in nature), the cost
will be measured at the fair value unless (a) the exchange transaction lacks commercial substance or
(b) the fair value of neither the asset received nor the asset given up is reliably measurable. If the
acquired item is not measured at fair value, its cost is measured at the carrying amount of the asset
given up. [IAS 16.24]
 Measurement subsequent to initial recognition
IAS 16 permits two accounting models:
• Cost model. The asset is carried at cost less accumulated depreciation and impairment. [IAS 16.30]
• Revaluation model. The asset is carried at a revalued amount, being its fair value at the date of
revaluation less subsequent depreciation and impairment, provided that fair value can be measured
reliably. [IAS 16.31]
The revaluation model
Under the revaluation model, revaluations should be carried out regularly, so that the carrying
amount of an asset does not differ materially from its fair value at the balance sheet date.
If an item is revalued, the entire class of assets to which that asset belongs should be revalued.
Revalued assets are depreciated in the same way as under the cost model (see below).
If a revaluation results in an increase in value, it should be credited to other comprehensive income
and accumulated in equity under the heading "revaluation surplus" unless it represents the reversal
of a revaluation decrease of the same asset previously recognised as an expense, in which case it
should be recognised in profit or loss. [IAS 16.39]
A decrease arising as a result of a revaluation should be recognised as an expense to the extent that
it exceeds any amount previously credited to the revaluation surplus relating to the same asset.
When a revalued asset is disposed of, any revaluation surplus may be transferred directly to retained
earnings, or it may be left in equity under the heading revaluation surplus. The transfer to retained
earnings should not be made through profit or loss. [IAS 16.41]
Depreciation (cost and revaluation models)
For all depreciable assets:
The depreciable amount (cost less residual value) should be allocated on a systematic basis over the
asset's useful life [IAS 16.50].
The residual value and the useful life of an asset should be reviewed at least at each financial year-
end and, if expectations differ from previous estimates, any change is accounted for prospectively as
a change in estimate under IAS 8. [IAS 16.51]
The depreciation method used should reflect the pattern in which the asset's economic benefits are
consumed by the entity [IAS 16.60]; a depreciation method that is based on revenue that is
generated by an activity that includes the use of an asset is not appropriate. [IAS 16.62A]

The depreciation method should be reviewed at least annually and, if the pattern of consumption of
benefits has changed, the depreciation method should be changed prospectively as a change in
estimate under IAS 8. [IAS 16.61
Depreciation should be charged to profit or loss, unless it is included in the carrying amount of
another asset [IAS 16.48].
Depreciation begins when the asset is available for use and continues until the asset is derecognised,
even if it is idle. [IAS 16.55]
Recoverability of the carrying amount
IAS 16 Property, Plant and Equipment requires impairment testing and, if necessary, recognition for
property, plant, and equipment. An item of property, plant, or equipment shall not be carried at
more than recoverable amount. Recoverable amount is the higher of an asset's fair value less costs
to sell and its value in use.
Any claim for compensation from third parties for impairment is included in profit or loss when the
claim becomes receivable. [IAS 16.65]
Derecognition (retirements and disposals)
An asset should be removed from the statement of financial position on disposal or when it is
withdrawn from use and no future economic benefits are expected from its disposal. The gain or loss
on disposal is the difference between the proceeds and the carrying amount and should be
recognised in profit and loss. [IAS 16.67-71]
If an entity rents some assets and then ceases to rent them, the assets should be transferred to
inventories at their carrying amounts as they become held for sale in the ordinary course of
business. [IAS 16.68A]
Dec 2010 F7 Question
The directors of Tunshill are disappointed by the draft profit for the year ended 30 September 2010.
The company’s assistant accountant has suggested two areas where she believes the reported profit
may be improved:
(i) A major item of plant that cost $20 million to purchase and install on 1 October 2007 is being
depreciated on a straight-line basis over a five-year period (assuming no residual value). The plant is
wearing well and at the beginning of the current year (1 October 2009) the production manager
believed that the plant was likely to last eight years in total (i.e. from the date of its purchase). The
assistant accountant has calculated that, based on an eight-year life (and no residual value) the
accumulated depreciation of the plant at 30 September 2010 would be $7·5 million ($20 million/8
years x 3). In the financial statements for the year ended 30 September 2009, the accumulated
depreciation was $8 million ($20 million/5 years x 2). Therefore, by adopting an eight-year life,
Tunshill can avoid a depreciation charge in the current year and instead credit $0·5 million ($8
million – $7·5 million) to the income statement in the current year to improve the reported prof t.
Required:
Comment on the acceptability of the assistant accountant’s suggestions and quantify how they
would affect the financial statements if they were implemented under IFRS. Ignore taxation.
Dec 2008
June 2013 F7 Question
Speculate owns the following properties at 1 April 2012:

Property A: An office building used by Speculate for administrative purposes with a

depreciated historical cost of $2 million. At 1 April 2012 it had a remaining life of 20 years.
After a reorganisation on 1 October 2012, the property was let to a third party and
reclassified as an investment property applying Speculate’s policy of the fair value model.
An independent valuer assessed the property to have a fair value of $2·3 million at 1
October 2012, which had risen to $2·34 million at 31 March 2013.

Property B: Another office building sub-let to a subsidiary of Speculate. At 1 April 2012, it

had a fair value of $1·5 million which had risen to $1·65 million at 31 March 2013.

Required:
Prepare extracts from Speculate’s entity statement of profit or loss and other
comprehensive income and statement of financial position for the year ended 31 March
2013 in respect of the above properties. In the case of property B only, state how it would
be classified in Speculate’s consolidated statement of financial position.

Dec 2012 F7 Question

Shawler is a small manufacturing company specialising in making alloy castings. Its main item of
plant is a furnace which was purchased on 1 October 2009. The furnace has two components: the
main body (cost $60,000 including the environmental provision – see below) which has a ten-year
life, and a replaceable liner (cost $10,000) with a five-year life.
The manufacturing process produces toxic chemicals which pollute the nearby environment.
Legislation requires that a clean-up operation must be undertaken by Shawler on 30 September
2019 at the latest.
Shawler received a government grant of $12,000 relating to the cost of the main body of the furnace
only.
The following are extracts from Shawler’s statement of financial position as at 30 September 2011
(two years after the acquisition of the furnace):
Carrying amount
$
Non-current assets
Furnace: main body 48,000
replaceable liner 6,000
Current liabilities
Government grant 1,200
Non-current liabilities
Government grant 8,400

Environmental provision 18,000 (present value discounted at 8% per annum)

Required:
(i) Prepare equivalent extracts from Shawler’s statement of financial position as at 30 Sept 2012;
(ii) Prepare extracts from Shawler’s income statement for the year ended 30 September 2012
relating to the items in the statement of financial position.
F7 June 2014

Dec 2010 F7 Question

The directors of Tunshill are disappointed by the draft profit for the year ended 30 September 2010. The
company’s assistant accountant has suggested two areas where she believes the reported profit may be
improved:
(i) A major item of plant that cost $20 million to purchase and install on 1 October 2007 is being depreciated
on a straight-line basis over a five-year period (assuming no residual value). The plant is wearing well and at
the beginning of the current year (1 October 2009) the production manager believed that the plant was likely
to last eight years in total (i.e. from the date of its purchase). The assistant accountant has calculated that,
based on an eight-year life (and no residual value) the accumulated depreciation of the plant at 30 September
2010 would be $7·5 million ($20 million/8 years x 3). In the financial statements for the year ended 30
September 2009, the accumulated depreciation was $8 million ($20 million/5 years x 2). Therefore, by
adopting an eight-year life, Tunshill can avoid a depreciation charge in the current year and instead credit $0·5
million ($8 million – $7·5 million) to the income statement in the current year to improve the reported prof t.
Required:
Comment on the acceptability of the assistant accountant’s suggestions and quantify how they would affect
the financial statements if they were implemented under IFRS. Ignore taxation.
June 2009

December 2008
A company purchased some heavy machinery. The invoice for the machinery showed the following
items:
Rs.000
Cost of machinery 46,000
Cost of delivery 900
Cost of 12-month warranty on the machinery 1,600
Total amount payable 48,500
In addition, the company incurred Rs.3.4 million in making modifications to its factory so that the
heavy machinery could be installed.
What should be the cost of the machinery in the company’s machinery account in the ledger?

A business acquired new premises at a cost of Rs.400 million on 1 January 2015.

In the period to the year end of 31 March 2015 the following further costs were incurred.
Rs.000
Costs of initial adaptation of the building 12,000
Legal costs relating to the purchase 2,500
Monthly cleaning contract 3,400
Cost of air conditioning unit necessary for machinery to be used 2,800
Cost of machinery 12,300
What amount should appear as the cost of premises in the company’s statement of financial
position at 31 March 2015?