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IND AS 16 PROPERTY, PLANT AND EQUIPMENT

Ind AS 16 :Property, Plant and Equipment

  1. Corresponding IFRSs :

IAS 16 Property, Plant and Equipment

IFRIC 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities

IFRIC 20 Stripping Costs in the Production Phase of a Surface Mine

  1. Executive Summary of Ind AS 16 Property, Plant and Equipment

a)      Ind AS 16 Property, Plant and Equipment (PPE) is a converged standard to LAS 16 Including IFRIC 1 and IFRIC 26.

Bearer plant is accounted for applying this standard but other biological assets are accounted for as per Ind AS 41. Investment property is accounted for applying Ind AS 40.

b)      At initial recognition, PPE is recognised at cost, cost excludes finance charge of defer payment. Initial estimate of decommissioning liability is capitalised.

cost of a complex PPE is identified component-wise.

If an item of PPE is acquired IN exchange transaction, it is recognised at fair value.

c)      At subsequent measurement of PPE either cost model or revaluation model is followed.

d)      Depreciation is charged component-wise.

e)      Residual value and useful llfe are reviewed annually. Change residual value or useful life is treated as change in accounting estimate and given effect prospectively.

f)       Similarly, change in depreciation method is treated as change in accounting estimate and given prospective effect.

g)      When a component is replaced, the carrying amount of the old component is derecognised and the cost of the new component is recognised.

h)      Inspection cost is capitalised and depreciated over the period till next inspection.

i)        Revaluation reserve is recognised in other comprehensive income and deferred tax liability is also recognised on revaluation surplus in accordance with Ind AS 12.

j)        Revaluation surplus is carried in a separate component of equity and transferred directly to retained earnings when the concerned PPE is derecognised. However, some of the surplus may be transferred as the asset is used by an entity. IN such a case, the amount of the surplus transferred would be the difference between depreciation based on the revalued carrying amount of the asset and depreciation based on the asset's original cost.

k)      PPEs are grouped into a class of assets. Illustrative classes are -

(i) land, (ii) land and buildings, (iii) machinery, (iv) ships, (v) aircraft, (vi) motor vehicles, (vii) furniture and fixtures, (viii) office equipment, and (ix) bearer plants.

l)        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.

m)    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.

n)      Bearer plants are accounted for in the same way as self-con- structed items of property, plant and equipment before they are in the location and condition necessary to be capable of operating in the manner intended by management.

o)      Appendix A to Ind AS 16 Changes in Existing Decommissioning, Restoration and Similar Liabilities (IFRIC 1) explains how to give effect to change IN estimated liability arising out of decommissioning, restoration and similar liabilities. Refer to chapter 25 for a detailed discussion.

p)      Appendix B to Ind AS 16 Stripping Costs in the Production Phase of a Surface Mine (IFRIC 20) applies to waste removal costs that are incurred IN surface mining activity during the production phase of the mine.

3.     Introduction

Property, plant and equipment are tangible items that:

(a)     are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and

(b)     are expected to be used during more than one period.

Land and Building which are given on rental are classified as investment property in which case Ind AS 40 Investment property will apply.

Tangible fixed asset items having useful life of more than one period are only treated as PPE as per Ind AS 16. The expression ''more than one period” would generally imply more than one accounting period of 12 months.

Also an entity shall determine a threshold limit commensurate to its size for recognizing a tangible item as PPE. For example, a tangible item of insignificant amount although satisfies definition of PPE may be ex­pensed.

  1. Objective

The objective of this Standard is to prescribe the accounting treatment for property, plant and equipment so that users of the financial statements can discern information about an entity‘s investment in its property, plant and equipment and the changes in such investment.

5.     Scope

This Standard shall be applied in accounting for property, plant and equipment except when another Standard requires or permits a different accounting treatment.

This Standard does not apply to:

(a)      property, plant and equipment classified as held for sale in accordance with Ind AS 105 Non-current Assets Held for Sale and Dis- continued Operations', [Refer to chapter 36]

(b)      biological assets related to agricultural activity as per Ind AS 41 (refer to chapter 28);

(c)      the recognition and measurement of exploration and evaluation assets as per Ind AS 106 Exploration for and Evaluation of Mineral Resources (refer to chapter 32); or

(d)      Mineral rights and mineral reserves such as oil, natural gas and similar non-regenerative resources.

 

This Standard applies to property, plant and equipment used to develop or maintain the assets described above.

For example: Ind AS 17 ‘Leases‘ requires an entity to evaluate its recognition of an item of leased property, plant and equipment on the basis of the transfer of risks and rewards. However, in such cases other aspects of the accounting treatment for these assets, including depreciation, are prescribed by this Standard.

An entity accounting for investment property in accordance with Ind AS 40 ‘Investment Property‘ shall use the cost model in this Standard.

6.     Property, Plant and Equipment

6.1               Definition

Property, plant and equipment are tangible items that:

(a)       are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and

(b)       are expected to be used during more than one period.

6.2               Recognition

The cost of an item of property, plant and equipment shall be recognised as an asset if, and only if:

(a)       it is probable that future economic benefits associated with the item will flow to the entity; and

(b)       the cost of the item can be measured reliably.

An entity evaluates under this recognition principle all its property, plant and equipment costs at the time they are incurred. These costs include:

(a)       Initial Costs: Costs incurred initially to acquire or construct an item of property, plant and equipment and

(b)       Subsequent Costs: Costs incurred subsequently to add to, replace part of, or service it.

Items such as spare parts, stand-by equipment and servicing equipment are recognised in accordance with this Ind AS when they meet the definition of property, plant and equipment. Otherwise, such items are classified as inventory.

7.     Measurement at Initial Recognition

An item of property, plant and equipment that qualifies for recognition as an asset shall be measured at its cost.

The cost of an item of property, plant and equipment is the cash price equivalent at the recognition date. If payment is deferred beyond normal credit terms, the difference between the cash price equivalent and the total payment is recognised as interest over the period of credit unless such interest is capitalised in accordance with Ind AS 23.

Cost is:

  • The amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset
  • At the time of its acquisition or construction or, where applicable, the amount attributed to that asset when initially recognised in accordance with the specific requirements of other Indian Accounting Standards, e.g. Ind AS 102 ‘Share-based Payment'.
  1. Elements of Cost

The cost of an item of property, plant and equipment comprises:

 

 

8.1      Cost of Dismantling, Removal and Restoration

The obligation for which an entity incurs either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period.

An entity applies Ind AS 2‘Inventories'to the costs of obligations for dismantling, removing and restoring the site on which an item is located that are incurred during a particular period as a consequence of having used the item to produce inventories during that period.

Examples of Directly Attributable Costs

  • costs of employee benefits (as defined in Ind AS 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.

8.2      The following items of cost are not included in the cost of property, plant and equipment:

  • costs of opening a new facility;
  • cost of introducing new product or service, ie. promotional costs of the produce not of the asset;
  • costs of conducting business in a new location or with a new class of customer;
  • administrative and other general overheads; and
  • staff training costs.
  1. Self-constructed Asset

The cost of a self-constructed asset is determined using the same principles as for an acquired asset. Therefore, any internal profits are eliminated in arriving at such costs.

For Example: A transfer from one division of an organisation to another at a transfer price including profit margin. In such a case we will consider only the cost of transfer and not transfer price.

Similarly, the cost of abnormal amounts of wasted material, labour, or other resources

incurred in self-constructing an asset is not included in the cost of the asset.

Ind AS 23 ‘Borrowing Costs' establishes criteria for the recognition of interest as a component of the carrying amount of a self-constructed item of property, plant and equipment.

  1. Asset Exchange Transaction

One or more items of property, plant and equipment may be acquired in exchange for:

  • A non-monetary asset or assets, or
  • A combination of monetary and non-monetary assets.

The cost of such an item of property, plant and equipment is measured at 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.

  1.  Component-wise recognition of PPE

A complex PPE is segregated by significant parts. Accordingly, at the time of initial recognition costs are allocated to various components. An entity may adopt the following policy for componentisation of PPE :

(i) a component is separately identifiable and measureable, and can be separated from the complex asset:

(ii) the useful life of component is shorter than that of the main asset such that it requires replacement during the life of the complex asset to which it belongs:

(iii) the cost of the component exceeds the capitalization threshold of the entity.

(iv) the cost of the component is significant in relation   

  1. TREATMENT OF SPARE PARTS AND STAND-BY EQUIPMENT

 

Type of spares parts

Accounting Treatments

1. Major spares and stand by equipments which are expected to used for period over more than one accounting periods

To be recognised as property, plant and equipment and depreciated over their useful lives.

2. Spares parts and servicing equipment which can be used only in connection with a particular item of property, plant and equipment (i.e. non-inter change- able items)

To be recognised as property, plant and equipment and depreciated over the pe­riods not exceeding the remaining use­ful life of the related asset.

3. other items of spare parts and service equipment

Expense on use

Unused items form part of inventory.

 

  1. CHECKLIST OF COSTS TO BE INCLUDED AND EXCLUDED IN PPE

Items to be included

Items to be excluded

(a)   Purchase price net of discounts and rebates, including import duties and non-refundable purchase taxes,

(b)    directly attributable costs of bring- ing the asset to working condition and

(c)    the initial estimate of the costs of dismantling and removing the item and restoring the site.

Break-up of directly attributable costs: (i) employee benefit costs,

(ll) site preparation cost,

(iii)   initial delivery and handling costs,

(iv)    installation and assembly costs,

(v)   cost of testing net of sale proceeds of any goods produced in the testing process, and

(vi)    professional fees.

  1. Costs of opening a new facility;
  2. cost of introducing new product or service, i.e. promotional costs of the pro- duce not of the asset;

ill. costs of conducting business in a new location or with a new class of customer;

  1. administrative and other general overheads; and
  2. staff training costs.

Also exclude interest expense included in defer payment except allowable capitalization of borrowing costs

No costs are added to the carrying amount after the assets becomes operational in its location as intended by the management :

i. initial operating losses ll. dislocation expenses

Special points for determining cost of self-constructed assets :

Include cost of materials, labour, and directly attributable overheads

Exclude : Abnormal wastage and internal profit

Include : Borrowing costs in accordance with Ind AS 23 if the self-constructed is a qualifying asset under that standard

Include : Present value of estimated site restoration costs.

Special point for measurement of cost of assets under finance lease :

Cost of any asset held under finance lease is determined applying Ind AS 17 Leases.

Special point for measurement of cost of assets for which there is government grant :

The carrying amount of an asset is not reduced by the amount of any government grant in accordance with Ind AS 20 Accounting for Government Grants and Dis­closure of Government Assistance.

14.  Capitalisation of decommissioning expenses

Ind AS 16 Property, Plant and Equipment requires capitalization of expenses for decommissioning, site restoration and similar liabilities. Para- graph 16(c) of ind AS 16 is of critical significance. The cost of an item of PPE inter alia comprises of :

“The initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inven­tories during that period."

  Therefore, an entity shall estimate expenses for decommissioning, site restoration etc. at the time of initial recognition. Of course, expenses of decommissioning, removal of wastes and site restoration that relates to production of inventories are inventorised (i.e. included in the cost of production).

Decommissioning expenses are capitalized in cases of mining, oil explo­ration, nuclear plant, hydro-electricity plant, etc. where there are liability for site restoration.

Decommissioning expenses are estimated based on current expenses of decommissioning and inflated to the time of decommissioning as per the estimated useful life of the asset. Expenses are projected applying average inflation rate at the time of estimation. Then the projected expenses are discounted to its present value applying current risk-free rate, current risk free rate shall be government bond rate for a period that matches with the useful life of the asset.

Unwinding of discount is treated as interest expense and charged to the Statement of income. But it is not capitalised as per Ind AS 23.

Example: Hydro-electricity Ltd. has estimated current site restoration expenses at ? 5,00,000. Estimated rate of inflation is 9% and risk-free rate is 11%. The estimated useful life of the project is 40 years. As on 1.1.2013, the date of initial recognition, the company estimates that ? 5,00,000 as the current cost of site restoration.

(a) How would the company apply the requirements of Paragraph 16(c) of Ind AS 16?

(b) Show unwinding of discount.

  1. Measurement after Initial Recognition

An entity shall choose either:

  • The cost model or
  • The revaluation model

As its accounting policy and shall apply that policy to an entire class of property, plant and equipment.

15.1            Cost Model

After recognition as an asset, an item of property, plant and equipment shall be carried at its cost less any accumulated depreciation less any accumulated impairment losses.

 

15.2            Revaluation Model

After recognition as an asset, an item of property, plant and equipment whose fair value can be measured reliably shall be carried at revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation less subsequent accumulated

impairment losses.

Revaluations should 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.

If an asset‘s carrying amount is increased as a result of a revaluation, the increase should be

recognised in other comprehensive income and accumulated in equity under the heading of revaluation surplus. However, the increase should be recognised in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognised in profit or loss.

If an asset‘s carrying amount is decreased as a result of a revaluation, the decrease should be

recognised in profit or loss. However, the decrease shall be recognised in other comprehensive income to the extent of any credit balance existing in the revaluation surplus in respect of that asset. The decrease recognised in other comprehensive income reduces the amount accumulated in equity under the heading of revaluation surplus.

16.  Depreciation

Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. The depreciable amount of an asset should be determined after deducting its residual value.

16.1           Component Cost Approach

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 shall be depreciated separately.

An entity allocates the amount initially recognised in respect of an item of property, plant and equipment to its significant parts and depreciates separately each such part.

The depreciation charge for each period shall be recognised in profit or loss unless it is included in the carrying amount of another asset.

The depreciation charge for a period is usually recognised in profit or loss.

 

[Depreciation Begins]: Depreciation of an asset begins when it is available for use, i.e. when it is in the location and condition necessary for it to be capable of operating in the manner intended by management.

[Depreciation Ceases: Depreciation of an asset ceases at the earlier of the date that the asset is classified as held for sale (or included in a disposal group that is classified as held for sale) in accordance with Ind AS 105 and the date that the asset is derecognised.

Therefore, depreciation does not cease when the asset becomes idle or is retired from active use unless the asset is fully depreciated. However, under usage methods of depreciation the depreciation charge can be zero while there is no production.

16.2            Depreciation Method

  • The depreciation method used shall reflect the pattern in which the asset‘s future

economic benefits are expected to be consumed by the entity.

  • The depreciation method applied to an asset shall be reviewed at least at each financial year-end and, if there has been a significant change in the expected pattern of consumption of the future economic benefits embodied in the asset, the method shall be changed to reflect the changed pattern. Such a change shall be accounted for as a change in an accounting estimate in accordance with Ind AS 8.
  1. Impairment

 

To determine whether an item of property, plant and equipment is impaired, an entity applies

Ind AS 36 'Impairment of Assets‘.

18.  Derecognition

The carrying amount of an item of property, plant and equipment shall be derecognised:

(a)      on disposal; or

(b)      when no future economic benefits are expected from its use or disposal.

The gain or loss arising from the de-recognition of an item of property, plant and equipment shall be included in profit or loss when the item is derecognised (unless Ind AS 17 requires otherwise on a sale and leaseback). Gains shall not be classified as revenue.

However, an entity that, in the course of its ordinary activities, routinely sells items of property, plant and equipment that it has held for rental to others shall transfer such assets to inventories at their carrying amount when they cease to be rented and become held for sale.

18.1    Ways of Disposal

 

18.2    Gain or Loss

The gain or loss arising from the de-recognition of an item of property, plant and equipment shall be determined as the difference between

  • The net disposal proceeds, if any, and
  • The carrying amount of the item.

18.3    Consideration Receivable

  • The consideration receivable on disposal of an item of property, plant and equipment is recognised initially at its fair value.
  • If payment for the item is deferred, the consideration received is recognised initially at the cash price equivalent.

19.  Major Changes in Ind AS 16 vis-a-vis IAS 16 Not Resulting in Carve Outs

a)        Reduction in the Carrying Amount of PPE: Paragraph 28 has been shown as deleted since Ind AS 20 ‘Accounting for Government Grants and Disclosure of Government Assistance' does not permit the option of reducing the carrying amount of an item of property, plant and equipment by the amount of government grant received in respect of such an item, as permitted in IAS 20.

b)        Fair Value Model: Paragraph 5 of Ind AS 16 has been modified, since Ind AS 40, ‘Investment Property’, prohibits the use of fair value model.

c)        Guidance for Allocation Basis: Paragraph 12 of Appendix B has been modified by giving example of types of costs that would be included as directly attributable overhead costs of the stripping activity asset. Paragraph 13A has been added in Appendix B to provide guidance on allocation basis.

Problems : AS 10: Property, Plant and Equipment

Question 1

Entity A, a supermarket chain, is renovating one of its major stores. The store will have more available space for in store promotion outlets after the renovation and will include a restaurant. Management is preparing the budgets for the year after the store reopens, which include the cost of remodelling and the expectation of a 15% increase in sales resulting from the store renovations, which will attract new customers. State whether the remodeling cost will be capitalized or not.

Solution

The expenditure in remodelling the store will create future economic benefits (in the form of 15% of increase in sales) and the cost of remodelling can be measured reliably, therefore, it should be capitalised.

Question 2

What happens if the cost of the previous part/inspection was/was not identified in the transaction in which the item was acquired or constructed? (Related to Issue 2 and 3) Solution

De-recognition of the carrying amount occurs regardless of whether the cost of the previous part/inspection was identified in the transaction in which the item was acquired or constructed.

Question 3

What will be your answer in the above question, if it is not practicable for an enterprise to determine the carrying amount of the replaced part/inspection?

Solution

It may use the cost of the replacement or the estimated cost of a future similar inspection as an indication of what the cost of the replaced part/existing inspection component was when the item was acquired or constructed.

Question 4

Entity A has an existing freehold factory property, which it intends to knock down and redevelop. During the redevelopment period the company will move its production facilities to another (temporary) site. The following incremental costs will be incurred:

  1. Setup costs of '5,00,000 to install machinery in the new location.
  2. Rent of '15,00,000
  3. Removal costs of ' 3,00,000 to transport the machinery from the old location to the temporary location.

Can these costs be capitalised into the cost of the new building?

Solution

Constructing or acquiring a new asset may result in incremental costs that would have been avoided if the asset had not been constructed or acquired. These costs are not to be included in the cost of the asset if they are not directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. The costs to be incurred by the company do not meet the requirement of AS 10 and therefore, cannot be capitalised.

Question 5

Entity A, which operates a major chain of supermarkets, has acquired a new store location. The new location requires significant renovation expenditure. Management expects that the renovations will last for 3 months during which the supermarket will be closed.

Management has prepared the budget for this period including expenditure related to construction and remodelling costs, salaries of staff who will be preparing the store before its opening and related utilities costs. What will be the treatment of such expenditures? Solution

Management should capitalise the costs of construction and remodelling the supermarket, because they are necessary to bring the store to the condition necessary for it to be capable of operating in the manner intended by management. The supermarket cannot be opened without incurring the remodelling expenditure, and thus the expenditure should be considered part of the asset.

However, the cost of salaries, utilities and storage of goods are operating expenditures that would be incurred if the supermarket was open. These costs are not necessary to bring the store to the condition necessary for it to be capable of operating in the manner intended by management and should be expensed.

Question 6

An amusement park has a 'soft' opening to the public, to trial run its attractions. Tickets are sold at a 50% discount during this period and the operating capacity is 80%. The official opening day of the amusement park is three months later. Management claim that the soft opening is a trial run necessary for the amusement park to be in the condition capable of operating in the intended manner. Accordingly, the net operating costs incurred should be capitalised. Comment. Solution

The net operating costs should not be capitalised, but should be recognised in the Statement of Profit and Loss.

Even though it is running at less than full operating capacity (in this case 80% of operating capacity), there is sufficient evidence that the amusement park is capable of operating in the manner intended by management. Therefore, these costs are specific to the start-up and, therefore, should be expensed as incurred.

Question 7

Entity A exchanges surplus land with a book value of ' 10,00,000 for cash of '20,00,000 and plant and machinery valued at ' 25,00,000. What will be the measurement cost of the assets received?

Solution

Since the transaction has commercial substance. The plant and machinery would be recorded at ' 25,00,000, which is equivalent to the fair value of the land of' 45,00,000 less the cash received of' 20,00,000.

Question 8

Entity A exchanges car X with a book value of'13,00,000 and a fair value of'13,25,000 for cash of ' 15,000 and car Y which has a fair value of ' 13,10,000. The transaction lacks commercial substance as the company's cash flows are not expected to change as a result of the exchange. It is in the same position as it was before the transaction. What will be the measurement cost of the assets received?

Solution

The entity recognises the assets received at the book value of car X. Therefore, it recognises cash of' 15,000 and car Y as PPE with a carrying value of' 12,85,000.

Question 9

Entity A is a large manufacturing group. It owns a number of industrial buildings, such as factories and warehouses and office buildings in several capital cities. The industrial buildings are located in industrial zones, whereas the office buildings are in central business districts of the cities. Entity A's management want to apply the revaluation model as per AS 10 to the subsequent measurement of the office buildings but continue to apply the historical cost model to the industrial buildings.

State whether this is acceptable under AS 10 or not with reasons?

Solution

Entity A's management can apply the revaluation model only to the office buildings. The office buildings can be clearly distinguished from the industrial buildings in terms of their function, their nature and their general location. AS 10 permits assets to be revalued on a class by class basis.

The different characteristics of the buildings enable them to be classified as different PPE classes. The different measurement models can, therefore, be applied to these classes for subsequent measurement.

All properties within the class of office buildings must, therefore, be carried at revalued amount.

Question 10

Entity A has a policy of not providing for depreciation on PPE capitalised in the year until the following year, but provides for a full year's depreciation in the year of disposal of an asset. Is this acceptable?

Solution

The depreciable amount of a tangible fixed asset should be allocated on a systematic basis over its useful life. The depreciation method should reflect the pattern in which the asset's future economic benefits are expected to be consumed by the entity.

Useful life means the period over which the asset is expected to be available for use by the entity. Depreciation should commence as soon as the asset is acquired and is available for use.

Question 11

Entity A purchased an asset on 1st January 2013 for ' 1,00,000 and the asset had an estimated useful life of 10 years and a residual value of nil.

On 1st January 2017, the directors review the estimated life and decide that the asset will probably be useful for a further 4 years.

Calculate the amount of depreciation for each year, if company charges depreciation on Straight Line basis.

Solution

The entity has charged depreciation using the straight-line method at ' 10,000 per annum i.e (1,00,000/10 years).

On 1st January 2017, the asset's net book value is [1,00,000 - (10,000 x 4)] ' 60,000.

The remaining useful life is 4 years.

The company should amend the annual provision for depreciation to charge the unamortised cost over the revised remaining life of four years.

Consequently, it should charge depreciation for the next 4 years at ' 15,000 per annum i.e. (60,000/4 years).

Note: Depreciation is recognised even if the Fair value of the Asset exceeds its Carrying Amount. Repair and maintenance of an asset do not negate the need to depreciate it.

Question 12

Entity B constructs a machine for its own use. Construction is completed on 1st November 2016 but the company does not begin using the machine until 1st March 2017. Comment Solution

The entity should begin charging depreciation from the date the machine is ready for use - that is, 1st November 2016. The fact that the machine was not used for a period after it was ready to be used is not relevant in considering when to begin charging depreciation.

Question 13

A property costing Rs. 10,00,000 is bought in 2016. Its estimated total physical life is 50 years. However, the company considers it likely that it will sell the property after 20 years.

The estimated residual value in 20 years' time, based on 2016 prices, is:

Case (a) Rs.10,00,000

Case (b) Rs.9,00,000.

Calculate the amount of depreciation.

Solution

Case (a)

The company considers that the residual value, based on prices prevailing at the balance sheet date, will equal the cost.

There is, therefore, no depreciable amount and depreciation is correctly zero.

Case (b)

The company considers that the residual value, based on prices prevailing at the balance sheet date, will be Rs. 9,00,000 and the depreciable amount is, therefore, Rs. 1,00,000.

Annual depreciation (on a straight line basis) will be Rs. 5,000 [{10,00,000 - 9,00,000} + 20].

Question 14

Entity B manufactures industrial chemicals and uses blending machines in the production process. The output of the blending machines is consistent from year to year and they can be used for different products.

However, maintenance costs increase from year to year and a new generation of machines with significant improvements over existing machines is available every 5 years. Suggest the depreciation method to the management.

Solution

Management should determine the depreciation method based on production output. The straight-line depreciation method should be adopted, because the production output is consistent from year to year.

Factors such as maintenance costs or technical obsolescence should be considered in determining the blending machinesRs. useful life.

Question 15

Entity A carried plant and machinery in its books at Rs. 2,00,000. These were destroyed in a fire. The assets were insured 'New for old' and were replaced by the insurance company with new machines that cost Rs.20,00,000. The machines were acquired by the insurance company and the company did not receive the Rs. 20,00,000 as cash compensation. State, how Entity A should account for the same?

Solution

Entity A should account for a loss in the Statement of Profit and Loss on de-recognition of the carrying value of plant and machinery in accordance with AS 10.

Entity A should separately recognise a receivable and a gain in the income statement resulting from the insurance proceeds under AS 29 once receipt is virtually certain. The receivable should be measured at the fair value of assets that will be provided by the insurer.

Question 16

In the year 2016-17, an entity has acquired a new freehold building with a useful life of 50 years for Rs.70,00,000. The entity desires to calculate the depreciation charge per annum using a straight-line method. It has identified the following components (with no residual value of lifts & fixtures at the end of their useful life) as follows:

Component

Useful life (Years)

Cost

Land

Infinite

Rs.20,00,000

Roof

25

Rs.10,00,000

Lifts

20

Rs.5,00,000

Fixtures

10

Rs.5,00,000

Remainder of building

50

Rs.30,00,000

Rs.70,00,000

Calculate depreciation for the year 2016-17.

Solution

Statement showing amount of depreciation as per Componentisation Method

Component

Depreciation (Per annum)

(Rs.)

Land

Nil

Roof

40,000

Lifts

25,000

Fixtures

50,000

Remainder of Building

60,000

 

1,75,000

Note: When the roof requires replacement at the end of its useful life the carrying amount will be nil. The cost of replacing the roof should be recognised as a new component.


Question 17

An entity acquires an item of PPE for Rs. 50,000, which is depreciated over 20 years. Three years later, the asset is revalued to Rs.60,000. Compute the amount of Revaluation Surplus?

Solution

Calculation of Revaluation surplus:

Revaluation Amount

Less: Carrying amount = Rs. 50,000 -Rs. 7,500 =

Revalue Surplus at the end of 3rdyear

Rs. 60,000

(Rs. 42,500)

Rs. 17,500

Working note:

Depreciation for first 3 years = (' 50,000/20 years) x 3 years = ' 7,500.

 

Question 18

XYZ Ltd. has acquired a heavy road transporter at a cost of Rs.1,00,000 (with no breakdown of the component parts). The estimated useful life is 10 years. At the end of the sixth year, the power train (one of its component) requires replacement, as further maintenance is uneconomical due to the off-road time required. The remainder of the vehicle is perfectly roadworthy and is expected to last for the next four years. The cost of a new power train is Rs.45,000.

Can the cost of the new power train be recognized as an asset, and, if so, what treatment should be used?

Answer

The new power train will produce economic benefits to XYZ Ltd., and the cost is measurable. Hence the item should be recognized as an asset as per AS 10 (Revised) as the recognition criteria is satisfied.

The original invoice for the transporter did not specify the cost of the power train. However, its cost of the replacement is Rs. 45,000 which can be used as an indication (usually by discounting factor) of the likely cost, six years previously.

If an appropriate discount rate is 5% per annum, Rs. 45,000 discounted back six years amounts to Rs. 33,570 (45,000 x 0.746), which would be written out of the asset records.

The cost of the new power train, Rs. 45,000, would be added to the asset record, resulting in a new asset cost ofRs. 1,11,430 (Rs. 1,00,000 - Rs. 33,570 + Rs. 45,000).

Question 19

ABC Ltd. is installing a new plant at its production facility. It has incurred these costs:

 

Cost of the plant (cost per supplier’s invoice plus taxes)

Rs.25,00,000

 

Initial delivery and handling costs

Rs.2,00,000

 

Cost of site preparation

Rs.6,00,000

 

Consultants used for advice on the acquisition of the plant

Rs.7,00,000

 

Interest charges paid to supplier of plant for deferred credit

Rs.2,00,000

 

Estimated dismantling costs to be incurred after 7 years

Rs.3,00,000

 

Operating losses before commercial production

Rs.4,00,000

Please advise ABC Ltd. on the costs that can be capitalized in accordance with AS 10 (Revised).

Answer

According to AS 10 (Revised), these costs can be capitalized:                                                Rs.

 

Cost of the plant

' 25,00,000

 

Initial delivery and handling costs

' 2,00,000

 

Cost of site preparation

' 6,00,000

 

Consultants' fees

' 7,00,000

 

Estimated dismantling costs to be incurred after 7 years

' 3,00,000

 

 

' 43,00,000

 

Note: Interest charges paid on “Deferred credit terms” to the supplier of the plant (not a qualifying asset) of' 2,00,000 and operating losses before commercial production amounting to ' 4,00,000 are not regarded as directly attributable costs and thus cannot be capitalized. They should be written off to the Statement of Profit and Loss in the period they are incurred.

Question 20

A Ltd. has an item of plant with an initial cost of ' 1,00,000. At the date of revaluation, accumulated depreciation amounted to Rs55,000. The fair value of the asset, by reference to transactions in similar assets, is assessed to be Rs.65,000.

Pass Journal Entries with regard to Revaluation?

Answer

The entries to be passed would be:

 

 

'

'

Accumulated depreciation

To Asset A/c

(Being elimination of accumulated depreciation against the cost of the asset)

 

55,000

55,000

Asset A/c

To Revaluation Surplus

(Being increase of net asset value to Fair value)

Dr

20,000

20,000

Note: The net result is that the asset has a carrying amount of' 65,000 [1,00,000 - 55,000 + 20,000.]

 

Question 21

B Ltd. owns an asset with an original cost of Rs.2,00,000. On acquisition, management determined that the useful life was 10 years and the residual value would be Rs.20,000. The asset is now 8 years old, and during this time there have been no revisions to the assessed residual value.

At the end of year 8, management has reviewed the useful life and residual value and has determined that the useful life can be extended to 12 years in view of the maintenance program adopted by the company. As a result, the residual value will reduce to Rs.10,000.

How would the above changes in estimates be made by B Ltd.

The above changes in estimates would be effected in the following manner:

The asset has a carrying amount of Rs. 56,000 at the end of year 8 [Rs. 2,00,000 - Rs. 1,44,000]

  1.  Accumulated Depreciation.

Accumulated depreciation is calculated as

Depreciable amount {Cost less residual value} = Rs. 2,00,000 - Rs. 20,000 = Rs. 1,80,000. Annual depreciation = Depreciable amount/Useful life = 1,80,000/10 = Rs. 18,000. Accumulated depreciation = 18,000 x No. of years (8) = Rs. 1,44,000.

Revision of the useful life to 12 years results in a remaining useful life of 4 years (12 - 8). The revised depreciable amount is Rs. 46,000. (56,000 - 10,000)

Thus, depreciation should be charged in future atRs. 11,500 per annum (Rs. 46,000/4 years).

Question 22

Determine if the following costs can be added to the invoiced purchase price and included in the initial recognition of the cost of the asset:

  1. Consultants fees for choosing the new asset
  2. A trade discount received of 5% of the purchase price of the asset
  3. A discount received for paying the invoice within 90 days
  4. Interest paid on a short term loan taken to provide the necessary cash for payment of the purchase price
  5. Import duties paid
  6. Shipping costs and cost of road transport
  7. Insurance for the shipping
  8. An economic development rebate from the state
  9. VAT paid on the purchase
  10. Cost of laying a new concrete slab and installing special rubber mounted footings for the new press in order to reduce vibration during use
  11. Hire of a crane to transfer the press from the vehicles into the factory
  12. Costs associated with removing a section of the factory roof to allow the machine to be dropped into place and subsequently refitting the roof
  13. Cost of installing soundproofing in the roof at the same time in order to provide protection for workers in other parts of the factory building
  14. Professional fees charged by consulting engineer for overseeing the installation process
  15. Electricians fees for connecting the press to the power supply
  16. A portion of the operating costs (salaries, office expenses) of the purchasing department
  17. Costs of materials (papers and inks) used in calibrating the machine and setting it up for operation
  18. Costs of training the operators of the new machine
  19. A portion of the inefficiencies in production for the first month of use while the operators became comfortable with using the machine

 

Answer

Included in Cost:

Point No. 1,2, 5, 6, 7, 8,10, 11, 12, 14, 15 and 17 (icai Answers says point 1 is to be Excluded from Cost:                                                                                                        excluded, which is incorrect)

PointNo. 3,4,9,13,16,18 and 19

Question 23

A Ltd. has carried out certain works on various machines in their engineering plant, which manufactures high quality metal patterns and templates for use in industry.

Determine in each case whether the costs of the improvements can be added to the existing carrying value of the assets concerned?

1. The cost of an annual machine overhaul which will maintain the originally assessed standard of performance of the machine for the coming 12 months.

  1. The cost of repairs to a press machine, which was damaged by the emergency services while trying to extricate the arm of a worker who had become trapped in the press.
  2. Modifications to a cutting machine which will increase its rate of output from 500 to 560 patterns per shift.
  3. Modifications to a lathe which will replace the current water cooling system with an oil­based system, thereby extending the life of the lathe by a forecast 2 years.
  4. The upgrading of a cutting machine with new software which will improve the accuracy of its measurement and cutting tolerances by a number of microns, thereby raising the quality of output.
  5. Alterations to a production line which will allow automatic feeding from a machine to the next one in the production process, thereby removing the need for an employee to manually load the second machine.

Answer

Point 1: No. This may not be capitalized as subsequent expenditure, since it merely maintains the originally assessed standard of performance of the asset.

Point 2: Yes. An impairment loss should have been recognized when the damage occurred and any insurance payment received as compensation should have been recognized as income in the Statement of Profit and Loss when received.

When expenditure is incurred to restore the asset, such expenditure is added to the carrying amount of the asset to the extent that it is probable that future economic benefits will flow to the enterprise.

Point 3: Yes. The cost of such modifications may be added to the carrying amount of the asset. Point 4: Yes. Such costs may be capitalized.

Point 5: Yes. Such costs may be capitalized. Point 6: Yes. Such costs may be capitalized.

Question 24

An entity bought a plot of land for development of office buildings. Development of the land was scheduled into six phases. The land scheduled for development in phases five and six was leased to another entity on a short-term basis as a parking lot for heavy vehicles.

What is the treatment of rental income from car parking lot?

Answer

Rental income from the car park lease is recognized in the Statement of Profit and Loss for the period.

The car park activity is incidental to the entity's principal activity of property development. Operations that are incidental to the construction or development of property, plant and equipment are not necessary to bring the asset to its working condition for its intended use.

The income and related expenses of incidental operations are recognized in the Statement of Profit and Loss for the period.

Question 25

An entity acquires the right to use an underground cave for gas storage purposes for a period of 50 years. The cave is filled with gas, but a substantial part of that gas will only be used to keep the cave under pressure in order to be able to get gas out of the cave. It is not possible to distinguish the gas that will be used to keep the cave under pressure and the rest of the gas.

Evaluate whether AS 10 would apply or AS 2?

Answer

The total volume of gas must be virtually split into

(i)      Gas held for sale, and

(ii)      Gas held to keep the cave under pressure.

The former must be accounted for under AS 2 as Inventories. The latter must be accounted for as PPE under AS 10 and depreciated over the period the cave is expected to be used.

Question 26

An entity operates an oil refining plant. For the refining process to take place, the plant must contain a certain minimum quantity of oil. This can only be taken out once the plant is abandoned and would then be polluted to such an extent that the plant's value is significantly reduced.

Evaluate whether AS 10 would apply or AS 2?

Answer

The part of the crude that is necessary to operate the plant and cannot be recouped (or can be recouped but would then be significantly impaired), even when the plant is abandoned, should be considered as an item of PPE under AS 10 and amortized over the life of the plant.

Question 27

PPE is revalued to Rs. 1,500 consisting of Rs. 2,500 Gross cost and Rs. 1,000 Depreciation based on observable market data.

Details of the PPE before and after revaluation are as follows:

Particulars

Cost/Revalued Cost

Accumulated depreciation

Net book value

PPE before revaluation

1,000

400

600

Fair Value

 

 

1,500

Revaluation Gain

 

 

900

Gain allocated proportionately to cost and depreciation

1,500

600

900

PPE after revaluation

2,500

1,000

1,500

The increase on revaluation is Rs. 900 (i.e., Rs. 1,500 - Rs. 600).

 

 

 

 

 

 

Question 28

(Taking the information given in the above Example)

Details of the PPE before and after revaluation are as follows:

Particulars

Cost/Revalued Cost

Accumulated depreciation

Net book value

PPE before revaluation

1,000

400

600

PPE after revaluation

1,500

 

1,500

Revaluation gain

500

400

 

The increase on revaluation is Rs. 900 (i.e., Rs. 500 + Rs. 400).

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