IAS 16 Property, Plant and Equipment
For most businesses property, plant and equipment is the largest number on the statement of financial position, and the one that takes the most judgement to arrive at. IAS 16 Property, Plant and Equipment answers four questions about it: what may be capitalised as part of the cost, how the cost is spread over the asset's life, whether the asset may be carried at a revalued amount, and what happens when it is sold.
Property, plant and equipment
Tangible items that are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes, and are expected to be used during more than one period.
Two points the definition does not say out loud. You do not have to own the item — what matters is that you control the economic benefits, which is the conceptual framework's definition of an asset (Chapter 4). And an asset still under construction is within IAS 16 from the start: it is property, plant and equipment being built, not something else.
These recordings predate IFRS 18 and say nothing about where their amounts land in the 2027 statement of profit or loss. That is this chapter’s closing section, “Where the numbers appear in the financial statements”.
Depreciation: in the change-of-method example, where the lecture divides the $26,214 carrying value by the five remaining years, deduct the $10,000 residual value first: $16,214 ÷ 5 = $3,243 (see “Changes in estimate”). $5,243 is the trap answer.
Accounting for a revaluation: this matters here, because the revaluation gain bypasses every profit-or-loss subtotal. The revaluation-surplus formula the recording narrates is set out in full in these notes.
1 Initial recognition
The cost of an item of property, plant and equipment is made up of:
The purchase price, including any irrecoverable taxes and after deducting trade discounts
Directly attributable costs of bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management
The initial estimate of dismantling and removal costs, and of restoring the site, where a present obligation to do so exists — measured at present value
Directly attributable costs are the unavoidable costs of getting the asset ready. The ones that come up in questions are site preparation, delivery and handling, installation and assembly, testing that the asset works as intended, and professional fees such as legal and surveyors' costs on a property purchase.
Dismantling costs are the exception that looks odd at first. An oil rig that must be removed from the seabed in fifty years' time creates an obligation today, so the present value of that future cost is capitalised as part of the rig now. You will always be given the present value; you are not asked to discount it yourself at F1.
1.1 What is not capitalised
Costs that are incidental to the construction, such as putting right an error
Start-up and pre-opening costs, including the marketing of a new facility
General overheads — although overheads incurred specifically on constructing the asset are directly attributable and may be capitalised
Operating losses incurred before the asset reaches its planned level of performance
Read discounts carefully. A trade discount is deducted at the point of sale, so it reduces the amount you capitalise. A settlement (cash or prompt-payment) discount is a reward for paying early — it has nothing to do with the cost of the asset and is never deducted from it. Questions put both in the same sentence precisely to see whether you deduct the wrong one.
Initial recognition
Jones purchases a machine that had a list price of $100,000 but was offered a trade discount of 10%. A further settlement discount of 5% is available if payment is made within 15 days.
Jones also incurred the following charges in getting the asset ready for its intended use:
$ | |
Shipping and handling charges | 3,500 |
Pre-production testing | 12,000 |
Site preparation costs | 17,000 |
General overheads | 4,500 |
Included in the site preparation costs is $3,000 which arose because Jones provided incorrect requirements for the asset.
Calculate the initial cost of the machine to be recorded in accordance with IAS 16 Property, Plant and Equipment.
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2 Subsequent expenditure
Money spent on an asset after it is in use is capitalised only if it improves the asset beyond its originally assessed standard of performance — a factory extension, or a modification that makes a machine produce more units or better-quality units. Anything that merely restores the asset to the performance already expected of it is repairs and maintenance, and is expensed.
2.1 Separate components
Where an item of property, plant and equipment is made up of components with different useful lives, each component is capitalised and depreciated separately. An aircraft is the standard illustration: the airframe, the engines and the cabin interior all wear out over very different periods, so the total cost is split and each part is depreciated over its own life.
2.2 Inspection and overhaul costs
Routine repairs and maintenance are expensed as incurred. A major inspection or overhaul is different: where the asset cannot legally or practically go on being used without it, the cost of the inspection is capitalised as a separate component and depreciated over the period to the next inspection. Any amount still held for the previous inspection is derecognised at that point.
3 Depreciation
Depreciation is the systematic allocation of an asset's depreciable amount — cost (or revalued amount) less residual value — over its useful life. The two methods you need are:
Straight line — (cost less residual value) ÷ useful life, giving the same charge every year
Reducing balance — carrying value × a fixed percentage, giving a large charge early in the asset's life and a small one late
Straight line suits an asset that delivers even benefits across its life; reducing balance suits one that delivers most of its benefit early.
Depreciation starts when the asset is ready for its intended use, not when it is first used. An asset ready in August but not switched on until November is depreciated from August.
3.1 Changes in estimate
Useful life, residual value and depreciation method are estimates, and IAS 16 requires them to be reviewed at least at each reporting date. Revising one is a change in accounting estimate, not the correction of an error, so it is applied prospectively: you never go back and restate earlier years. The rule to hold on to is one line long — apply the new estimate to the carrying value at the date of change, over the remaining useful life.
When you switch to the straight-line method, remember the residual value. The charge is (carrying value at the date of change − residual value) ÷ remaining life. Dividing the carrying value by the remaining life and forgetting the residual value is the single most common slip in this area, and it is exactly what Example 3 is built to catch.
Change in useful life
Ecuador bought an item of property, plant and equipment for $25 million on 1 January 20X2 and depreciated it on a straight-line basis over its useful life of 10 years.
On 31 December 20X4 the asset's remaining life was estimated as 5 years.
Calculate the amounts to be shown in the financial statements of Ecuador for the year ended 31 December 20X5.
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Change in method
A lorry was purchased for $80,000 on 1 January 20X4 when its useful life was estimated to be ten years with a residual value of $10,000. A depreciation policy of 20% reducing balance was selected.
On 1 January 20X9 the directors decided that, to give a fair presentation, a straight-line policy over the useful economic life should be followed instead. There has been no change in the estimated useful economic life as a result.
What is the depreciation charge for the year ended 31 December 20X9?
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4 Subsequent measurement: cost model or revaluation model
After initial recognition an entity chooses, for each class of asset, between two models:
Cost model | Revaluation model |
The asset is carried at cost less accumulated depreciation and accumulated impairment losses. | The asset is carried at its revalued amount — fair value at the date of revaluation — less subsequent accumulated depreciation and accumulated impairment losses. |
The revaluation model comes with conditions, all aimed at stopping companies from picking and choosing the flattering numbers:
Revaluations must be kept up to date, so they are reviewed regularly enough that carrying value does not differ materially from fair value
The policy applies to a whole class of asset — you cannot revalue one favourable building and leave the rest at cost
Assets are revalued to fair value
The revalued amount, less residual value, is then depreciated over the remaining useful life
5 Accounting for a revaluation
On revaluation the asset is written up to fair value and the accumulated depreciation held against it is eliminated. The double entry is:
Dr | Non-current assets – cost/valuation | X |
Dr | Accumulated depreciation | X |
Cr | Other comprehensive income – revaluation surplus | X |
You rarely need the individual debits. The credit — the gain — can be calculated in one step, using the fair value and the carrying value at the date of the revaluation:
Revaluation surplus = Fair value − Carrying value
An upward revaluation is recognised in other comprehensive income and accumulates in the revaluation surplus. It does not go through profit or loss, because the gain has not been realised — nothing has been sold. Reporting a revaluation gain as profit is a genuine error, not a policy choice.
There is one exception, and it is the mirror image of the next rule. If the same asset had previously been written down and that decrease was charged to profit or loss, a later increase is recognised in profit or loss to the extent that it reverses that earlier charge; only the excess goes to other comprehensive income.
A downward revaluation works the other way round: it is charged against any revaluation surplus previously recognised for that same asset through other comprehensive income, and only the excess goes to profit or loss.
After the revaluation, depreciation is charged on the new, higher carrying value, so the annual charge rises. The entity may — it is optional — transfer that excess depreciation from the revaluation surplus to retained earnings each year, making the gain distributable as it is earned:
Dr | Revaluation surplus | X |
Cr | Retained earnings | X |
The excess is the depreciation on the revalued amount less the depreciation that would have been charged on the original cost. This transfer is a movement between reserves shown in the statement of changes in equity (Chapter 5). It is not income, so it appears in neither profit or loss nor other comprehensive income.
Revaluation
Charlie bought a building on 1 January 20X5 for $500,000 with an estimated useful economic life of twenty-five years and no residual value. A straight-line method of depreciation was adopted.
On 1 January 20X7 Charlie decided to revalue all non-current assets in line with IAS 16. The building was revalued at $600,000. The useful economic life is unchanged. Charlie makes the annual transfer of excess depreciation.
Show how the revaluation would be accounted for in the financial statements for the year ended 31 December 20X7.
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6 Disposal of a previously revalued asset
The profit or loss on disposal is calculated exactly as it always was — proceeds less the carrying value at the date of sale — and goes to profit or loss. The revaluation surplus still held for that asset is now realised, so it is transferred to retained earnings:
Dr | Revaluation surplus | X |
Cr | Retained earnings | X |
That transfer is a movement within equity. It never passes through profit or loss, so the gain on revaluation is never reported as profit — not even on disposal.
Disposal of a revalued asset
William bought a building on 1 January 20X5 for $400,000 with an estimated useful economic life of twenty-five years and no residual value. A straight-line method of depreciation was adopted.
On 1 January 20X7 William decided to revalue all non-current assets in line with IAS 16. The building was revalued at $500,000. The useful economic life is unchanged, and William makes the annual transfer of excess depreciation.
On 1 January 20X9 William disposed of the building for $550,000.
Calculate the profit or loss on disposal of the building at 1 January 20X9 and record the journal entry transferring the previously held gains within reserves.
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7 Where the numbers appear in the financial statements
IAS 16 is unchanged by IFRS 18, but where its figures land is worth fixing in your mind, because presentation questions and preparation questions are marked on exactly this:
Depreciation, and any impairment of an asset used in the business, are expenses of the main business activities, so they sit in the operating category — above operating profit, the first of the two required subtotals (Chapter 5)
A gain on revaluation is other comprehensive income. It sits below profit for the year and therefore affects none of the profit-or-loss subtotals
The transfer of excess depreciation, and the transfer of the realised surplus on disposal, are movements between reserves and appear only in the statement of changes in equity
A profit or loss on disposal is part of profit or loss, in the operating category for an asset used in the business
The disclosure that pulls it all together is a reconciliation, for each class of asset, of the opening to the closing carrying amount — showing additions, disposals, revaluations, depreciation and impairment losses for the year.
8 Test your knowledge
Two quick checks before you move on: work through the flashcards to fix this chapter’s terms and definitions, then sit the objective questions for exam-style practice. Both mark themselves and explain the answers as you go.
IAS 16 Property, Plant and Equipment
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