Ind AS 16 PDF - Property, Plant & Equipment Accounting

INDIAN ACCOUNTING STANDARD 16 6.43 UNIT 2 : INDIAN ACCOUNTING STANDARD 16 : PROPERTY, PLANT AND EQUIPMENT LEARNING OUTCOMES After studying this unit, you will be able to  State the objective and scop...

INDIAN ACCOUNTING STANDARD 16 6.43 UNIT 2 : INDIAN ACCOUNTING STANDARD 16 : PROPERTY, PLANT AND EQUIPMENT LEARNING OUTCOMES After studying this unit, you will be able to  State the objective and scope of this standard  Define various terms used in the standard  Apply the revaluation and cost models of accounting for property, plant and equipment  Interpret the differences between repairs and maintenance, replacement and major inspection  Account for the changes in depreciation method, useful life and residual value  Integrate the accounting for changes in existing, decommissioning, restoration and similar assets © The Institute of Chartered Accountants of India  6.44 a 2.44 FINANCIAL v REPORTING v UNIT OVERVIEW Ind AS 16 Measurement Measurement after Recognition Derecognition Disclosure at recognition recognition Elements of Initial costs Cost model cost Subsequent Measurement Revaluation model costs of cost Depreciation Depreciable amount and depreciation period Depreciation method Impairment Compensation for impairment © The Institute of Chartered Accountants of India  INDIAN ACCOUNTING STANDARD 16 6.45 2.1 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. The principal issues in accounting for property, plant and equipment are the recognition of the assets, the determination of their carrying amounts and the depreciation charges and impairment losses to be recognized in relation to them. 2.2 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) PPE classified as held for (b) Biological assets related to sale (as per Ind AS 105) agricultural activity other than bearer plants (Ind AS 41) (c) Recognition and (d) Mineral rights and mineral measurement of exploration reserves such as oil, natural and evaluation assets (Ind AS gas and similar non- 106) regenerative resources However, this Standard applies to property, plant and equipment used to develop or maintain the assets described in (b)–(d).  An entity accounting for investment property in accordance with Ind AS 40, Investment Property, shall use the cost model in this Standard for owned investment property. 2.3 RELEVANT DEFINITIONS The following are the key terms used in this standard:  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 © The Institute of Chartered Accountants of India  6.46 a 2.46 FINANCIAL v REPORTING v b) are expected to be used during more than one period. Held for use in production or supply/ Rental / Administrative purposes Expected to used Tangible items during more than one period PPE  A bearer plant is a living plant that: (a) is used in the production or supply of agricultural produce; (b) is expected to bear produce for more than one period; and (c) has a remote likelihood of being sold as agricultural produce, except for incidental scrap sales.  Carrying amount is the amount at which an asset is recognized after deducting any accumulated depreciation and accumulated impairment losses.  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 recognized in accordance with the specific requirements of other Indian Accounting Standards, e.g. Ind AS 102, Share- based Payment.  Depreciable amount is the cost of an asset, or other amount substituted for cost, less its residual value.  Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. © The Institute of Chartered Accountants of India  INDIAN ACCOUNTING STANDARD 16 6.47  Entity-specific value is the present value of the cash flows an entity expects to arise from the continuing use of an asset and from its disposal at the end of its useful life or expects to incur when settling a liability.  Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. (See Ind AS 113, Fair Value Measurement.)  An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount.  Recoverable amount is the higher of an asset’s fair value less costs of disposal and its value in use.  The residual value of an asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life.  Useful life is: a) the period over which an asset is expected to be available for use by an entity; or b) the number of production or similar units expected to be obtained from the asset by an entity. 2.4 RECOGNITION 2.4.1 General recognition criteria The cost of an item of property, plant and equipment shall be recognized 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. © The Institute of Chartered Accountants of India  6.48 a 2.48 FINANCIAL v REPORTING v Probable that future economic benefits will flow to entity Recognition of cost as an asset (PPE) Cost can be measured reliably 2.4.2 Recognition of Spare parts, stand-by equipment and servicing equipment Items such as spare parts, stand-by equipment and servicing equipment are recognized in accordance with this Ind AS when they meet the definition of property, plant and equipment. Otherwise, such items are classified as inventory. 2.4.3 Unit of measurement for recognition of PPE and Aggregation of individually insignificant items This Standard does not prescribe the unit of measure for recognition, ie what constitutes an item of property, plant and equipment. Thus, judgement is required in applying the recognition criteria to an entity’s specific circumstances. It may be appropriate to aggregate individually insignificant items, such as moulds, tools and dies, and to apply the criteria to the aggregate value. An entity evaluates under this recognition principle all its 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. 2.4.4 Initial Cost Items of property, plant and equipment may be acquired for safety or environmental reasons. The acquisition of such property, plant and equipment, although not directly increasing the future economic benefits of any particular existing item of property, plant and equipment, may be necessary for an entity to obtain the future economic benefits from its other assets. © The Institute of Chartered Accountants of India  INDIAN ACCOUNTING STANDARD 16 6.49 Such items of property, plant and equipment qualify for recognition as assets because they enable an entity to derive future economic benefits from related assets in excess of what could be derived had those items not been acquired. For example: A chemical manufacturer may install new chemical handling processes to comply with environmental requirements for the production and storage of dangerous chemicals; related plant enhancements are recognized as an asset because without them the entity is unable to manufacture and sell chemicals. However, the resulting carrying amount of such an asset and related assets is reviewed for impairment in accordance with Ind AS 36 Impairment of Assets. 2.4.5 Subsequent costs Repair & Maintenance (Day to Day Servicing ) Replacement at Major Inspection Regular / Overhauls Intervals 2.4.5.1 Repair and maintenance An entity does not recognize in the carrying amount of an item of property, plant and equipment the costs of the day-to-day servicing of the item. Rather, these costs are recognized in profit or loss as incurred. Costs of day-to-day servicing are primarily the costs of labour and consumables and may include the cost of small parts. 2.4.5.2 Replacement of parts of a property, plant and equipment  Parts of some items of property, plant and equipment may require replacement at regular intervals. For example, a furnace may require relining after a specified number of hours of use, or aircraft interiors such as seats and galleys may require replacement several times during the life of the airframe.  Items of property, plant and equipment may also be acquired to make a less frequently recurring replacement, such as replacing the interior walls of a building, or to make a non- recurring replacement.  Under the recognition principle, an entity recognizes in the carrying amount of an item of property, plant and equipment the cost of replacing part of such an item when that cost is © The Institute of Chartered Accountants of India  6.50 a 2.50 FINANCIAL v REPORTING v incurred if the recognition criteria are met. The carrying amount of those parts that are replaced is derecognized in accordance with the derecognition provisions of this Standard. 2.4.5.3 Major inspections or overhauls  A condition of continuing to operate an item of property, plant and equipment (for example, an aircraft) may be performing regular major inspections for faults regardless of whether parts of the item are replaced.  When each major inspection is performed, its cost is recognized in the carrying amount of the item of property, plant and equipment as a replacement if the recognition criteria are satisfied.  Any remaining carrying amount of the cost of the previous inspection is derecognized. This occurs regardless of whether the cost of the previous inspection was identified in the transaction in which the item was acquired or constructed. 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. Example - Inspection Cost A shipping company is required by law to bring all ships into dry dock every five years for a major inspection and overhaul. Overhaul expenditure might at first sight seem to be a repair to ships but it is actually a cost incurred in getting the ship back into a seaworthy condition. As such the costs must be capitalised. A ship which cost 20 million with a 20 year life must have major overhaul every five years. The estimated cost of the overhaul at the five-year point is 5 million. The depreciation charge for the first five years of the assets life will be as follows: Overhaul component Ship (other than overhaul (million) component) (million) Cost 5 15 Years 5 20 Depreciation per year 1 0.75 Total accumulated depreciation for the first five years will be 8.75 million ( 1 + 0.75) x 5), and the carrying amount of the ship at the end of year 5 will be 11.25 million ( 20 less 8.75). © The Institute of Chartered Accountants of India  INDIAN ACCOUNTING STANDARD 16 6.51 Assume that the actual overhaul costs incurred at the end of year 5 are 6 million. This amount will now be capitalised into the costs of the ship, to give a carrying amount of 17.25 million (being 11.25 million plus 6 million). The depreciation charge for years 6 to 10 will be as follows: Overhaul component Ship (other than overhaul ( in million) component) ( in million) Cost 6 11.25 Years 5 15 Depreciation per year 1.2 0.75 Annual depreciation for years 6 to 10 will now be 1.95 million [ 1.2 + 0.75)]. This process will be continued for years 11 to 15 and years 16 to 20. By the end of year 20, the capital cost of 20 million will have been depreciated plus the actual overhaul costs incurred at years 5, 10 and 15. 2.5 MEASUREMENT AT RECOGNITION 2.5.1 Measurement at cost An item of property, plant and equipment that qualifies for recognition as an asset should be initially measured at its cost. 2.5.2 Element of cost 2.5.2.1 Cost of an acquired asset 2.5.2.1.1 Component of cost  The cost of an item of property, plant and equipment comprises: a) its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates; b) any costs 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; and c) 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. © The Institute of Chartered Accountants of India  6.52 a 2.52 FINANCIAL v REPORTING v Initially measured at Cost Purchase price including import Initial estimate of the costs of duties and non - Directly dismantling and removing refundable attributable Cost the item and restoring purchase taxes  Examples of directly attributable costs are: Employee benefits cost arising directly from construction or acquisition of PPE Cost of Site Preparation Initial delivery and handling costs Installation and assembly costs Professional Fees 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). Note: Excess of net sale proceeds of items produced over the cost of testing, if any, shall not be recognized in the profit or loss but deducted from the directly attributable costs considered as part of cost of an item of property, plant, and equipment  Examples of costs that are not costs of an item of property, plant and equipment are: © The Institute of Chartered Accountants of India  INDIAN ACCOUNTING STANDARD 16 6.53 Costs of conducting business in a Costs incurred in Administrative new location or introducing a Cost of opening and other with a new class new product or a new facility general of customer service overhead costs (including costs of staff training) 2.5.2.2 Cost of self-constructed asset and Bearer Plants The cost of a self-constructed asset is determined using the same principles as for an acquired asset. If an entity makes similar assets for sale in the normal course of business, the cost of the asset is usually the same as the cost of constructing an asset for sale. Therefore, any internal profits are eliminated in arriving at such costs. 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. Bearer plants are accounted for in the same way as self-constructed 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. Consequently, references to ‘construction’ in this Standard should be read as covering activities that are necessary to cultivate the bearer plants before they are in the location and condition necessary to be capable of operating in the manner intended by management. 2.5.2.3 Cost of dismantling, removal and site restoration Cost incurred by an entity in respect of obligation for dismantling, removing and restoring the site on which an item of property, plant and equipment is located are recognized and measured in accordance with Ind AS 37, Provisions, Contingent Liabilities and Contingent Assets. © The Institute of Chartered Accountants of India  6.54 a 2.54 FINANCIAL v REPORTING v If the obligations are incurred when the asset is acquired, or during a period when the item is used other than to produce inventories, they are included in the cost of the item property, plant and equipment. 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. 2.5.2.4 Incidental operations Some operations occur in connection with the construction or development of an item of property, plant and equipment, but are not necessary to bring the item to the location and condition necessary for it to be capable of operating in the manner intended by management. These incidental operations may occur before or during the construction or development activities. For example, income may be earned through using a building site as a car park until construction starts. Because incidental operations are not necessary to bring an item to the location and condition necessary for it to be capable of operating in the manner intended by management, the income and related expenses of incidental operations are recognized in profit or loss and included in their respective classifications of income and expense. 2.5.2.5 Cessation of capitalisation Recognition of costs in the carrying amount of an item of property, plant and equipment ceases when the item is in the location and condition necessary for it to be capable of operating in the manner intended by management. Therefore, costs incurred in using or redeploying an item are not included in the carrying amount of that item.  For example, the following costs are not included in the carrying amount of an item of property, plant and equipment: a) costs incurred while an item capable of operating in the manner intended by management has yet to be brought into use or is operated at less than full capacity; b) initial operating losses, such as those incurred while demand for the item’s output builds up; and c) costs of relocating or reorganizing part or all of an entity’s operations. © The Institute of Chartered Accountants of India  INDIAN ACCOUNTING STANDARD 16 6.55 Example Moon Ltd incurs the following costs in relation to the construction of a new factory and the introduction of its products to the local market. The below table illustrates which of the items of cost can be capitalised as per Ind AS 16. Particulars 000 000 (Cost (As per incurred) Ind AS 16) Site preparation costs 150 150 Direct Material 2,000 2,000 Direct Labour cost, including 10,000 incurred during an 1,160 1,150 industrial strike Testing of various processes in factory 200 200 Consultancy fees for installation of equipment 300 300 Relocation of staff to new factory 450 - General overheads 550 - Estimated Costs to dismantle (at present value) 200 200 Total Cost to be Capitalised as per Ind AS 16 4,000 2.5.3 Measurement of cost 2.5.3.1 Payment deferred beyond normal credit terms 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 recognized as interest over the period of credit unless such interest is capitalised in accordance with Ind AS 23. Illustration 1 - Deferred Payment Credit On 1 st April, 20X1, an item of property is offered for sale at 10 million, with payment terms being three equal installments of 33,33,333 over a two-year period (payments are made on 1 April, 20X1, 31 March, 20X2 and 31 st March, 20X3). Implicit interest rate of 5.36 percent p.a. st st Pass necessary journal entries for recording the property in accordance with Ind AS 16. © The Institute of Chartered Accountants of India  6.56 a 2.56 FINANCIAL v REPORTING v Solution Ind AS 16 requires that the cost of an item of PPE is the cash price equivalent at the recognition date. Hence, the purchaser that takes up the deferred payment terms will recognize the acquisition of the asset as follows: On 1 st April, 20X1 ( ) Property, Plant and Equipment (W.N. 1) Dr. 95,00,000 To Bank A/c 33,33,333 To Accounts Payable (W.N. 2) 61,66,667 (Initial recognition of property) On 31 st March, 20X2 Interest Expense (W.N. 2) Dr. 3,30,533 Accounts payable (W.N. 2) Dr. 30,02,800 To Bank A/c 33,33,333 (Recognition of interest expense and payment of second installment) On 31 st March, 20X3 Interest Expense (W.N. 2) Dr. 1,69,467 Accounts payable (W.N. 2) Dr. 31,63,867 To Bank A/c 33,33,334 (Recognition of interest expense and payment of final installment) Working Notes: 1. Calculation of cash price equivalent at initial recognition Year Payment Discounting Present factor @ value 5.36% 1.4.20X1 33,33,333 1.000 33,33,333 31.3.20X2 33,33,333 0.949 31,63,333 31.3.20X3 33,33,334 0.901 30,03,334 Initial date cash price equivalent 1,00,00,000 95,00,000 © The Institute of Chartered Accountants of India  INDIAN ACCOUNTING STANDARD 16 6.57 2. Calculation of interest expenses Year Opening Interest @ Total payment Principal Closing balance 5.36% at year amount in balance (a) (b) = (a) x beginning the (e) = (a) - 5.36% (c) instalment (d) (d) = (c) – (b) 1.4.20X1 95,00,000 - 33,33,333 33,33,333 61,66,667 31.3.20X2 61,66,667 3,30,533 33,33,333 30,02,800 31,63,867 31.3.20X3 31,63,867 1,69,467* 33,33,334 31,63,867 Nil *Difference of 116 [(31,63,867 x 5.36%) – (33,33,334 - 31,63,867)] is due to approximation. ***** 2.5.3.2 Measurement of PPE acquired in Exchange  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 (even if an entity cannot immediately derecognize the asset given up) 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 [because of considerations mentioned in a) and b) above], its cost is measured at the carrying amount of the asset given up.  An entity determines whether an exchange transaction has commercial substance by considering the extent to which its future cash flows are expected to change as a result of the transaction. An exchange transaction has commercial substance if: a) the configuration (risk, timing and amount) of the cash flows of the asset received differs from the configuration of the cash flows of the asset transferred; or b) the entity-specific value of the portion of the entity’s operations affected by the transaction changes as a result of the exchange; and c) the difference in (a) or (b) is significant relative to the fair value of the assets exchanged.  For the purpose of determining whether an exchange transaction has commercial substance, the entity-specific value of the portion of the entity’s operations affected by the transaction shall reflect post-tax cash flows. © The Institute of Chartered Accountants of India  6.58 a 2.58 FINANCIAL v REPORTING v  The fair value of an asset is reliably measurable if: a) the variability in the range of reasonable fair value measurements is not significant for that asset or b) the probabilities of the various estimates within the range can be reasonably assessed and used when measuring fair value.  If an entity is able to measure reliably the fair value of either the asset received or the asset given up, then the fair value of the asset given up is used to measure the cost of the asset received unless the fair value of the asset received is more clearly evident.  The carrying amount of an item of property, plant and equipment may be reduced by Government grants in accordance with Ind AS 20, Accounting for Government Grants and Disclosure of Government Assistance. If PPE is acquired in exchange for other non monetary asset or for a combination of monetary and non monetary asset Measure cost at fair value Unless the exchange transaction has no Fair value of neither the asset received nor commercial substance or given up can be measured relaibly Illustration 2 – Exchange of Assets Pluto Ltd owns land and building which are carried in its balance sheet at an aggregate carrying amount of 10 million. The fair value of such asset is 15 million. It exchanges the land and building for a private jet, which has a fair value of 20 million, and pays additional 3 million in cash. Apply necessary provisions of Ind AS 16 for the above transactions and pass journal entry for the same. Solution Provided that the transaction has commercial substance, the entity should recognize the private jet at a cost of 18 million (being 15 million plus 3 million cash) and should recognize a profit on disposal of the land and building of 5 million, calculated as follow: ( 000) Recognition of fair value of asset acquired (15,000 + 3,000) 18,000 Less: Carrying amount of land and building disposed (10,000) © The Institute of Chartered Accountants of India  INDIAN ACCOUNTING STANDARD 16 6.59 Cash Paid (3,000) Profit on exchange of assets 5,000 The required journal entry is therefore as follow: Property, Plant and Equipment (Private Jet) Dr. 18,000 To Property, Plant and Equipment (Land and Building) 10,000 To Cash 3,000 To Profit on exchange of assets 5,000 ***** 2.6 MEASUREMENT AFTER RECOGNITION 2.6.1 Alternative bases available for measurement after 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. 2.6.2 Cost model After recognition as an asset, an item of property, plant and equipment shall be carried at its cost less any accumulated depreciation and any accumulated impairment losses. Accumulated Accumulated Carrying Cost Impairment Depreciation Amount Loss 2.6.3 Revaluation model After recognition as an asset, an item of property, plant and equipment whose fair value can be measured reliably is carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses. Revaluations are required to be carried out 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. © The Institute of Chartered Accountants of India  6.60 a 2.60 FINANCIAL v REPORTING v Subsequent FV at the Subsequent accumulated Carrying date of accumulated Impairment amount revaluation Depreciation loss 2.6.3.1 Frequency of revaluations  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. Some items of property, plant and equipment experience significant and volatile changes in fair value, thus necessitating annual revaluation.  Such frequent revaluations are unnecessary for items of property, plant and equipment with only insignificant changes in fair value. Instead, it may be necessary to revalue the item only every three or five years. 2.6.3.2 Accumulated depreciation at the date of revaluation  When an item of property, plant and equipment is revalued, the carrying amount of that asset is adjusted to the revalued amount. At the date of the revaluation, the asset is treated in one of the following ways: a) the gross carrying amount is adjusted in a manner that is consistent with the revaluation of the carrying amount of the asset. For example, the gross carrying amount may be restated by reference to observable market data or it may be restated proportionately to the change in the carrying amount. The accumulated depreciation at the date of the revaluation is adjusted to equal the difference between the gross carrying amount and the carrying amount of the asset after taking into account accumulated impairment losses; or b) the accumulated depreciation is eliminated against the gross carrying amount of the asset. Illustration 3: Accumulated depreciation at the date of revaluation Jupiter Ltd. has an item of property, plant and equipment with an initial cost of 100,000. At the date of revaluation accumulated depreciation amounted to 55,000. The fair value of asset, by reference to transactions in similar assets, is assessed to be 65,000. Prepare the necessary journal entries. Solution Method – I: Depreciation Elimination Approach Accumulated depreciation Dr. 55,000 To Asset Cost 55,000 © The Institute of Chartered Accountants of India  INDIAN ACCOUNTING STANDARD 16 6.61 Asset Cost Dr. 20,000 To Revaluation reserve 20,000 The net result is that the asset has a carrying amount of 65,000 (100,000 – 55,000 + 20,000). Method – II: Restatement Approach Carrying amount (100,000 – 55,000) = 45,000 Fair value (revalued amount) 65,000 Surplus 20,000 % of surplus to the carrying amount (20,000 / 45,000) 44.44% Entries to be Made: Asset (1,00,000 x 44.44%) Dr. 44,444 To Accumulated Depreciation (55,000 x 44.44%) 24,444 To Revaluation Reserve 20,000 (Being the entry to increase both the original cost and the accumulated depreciation by 44.44%) ***** 2.6.3.3 Revaluation to be made for entire class of assets If an item of property, plant and equipment is revalued, the entire class of property, plant and equipment to which that asset belongs shall be revalued. A class of property, plant and equipment is a grouping of assets of a similar nature and use in an entity’s operations. The following are examples of separate classes: Land Land And Buildings Machinery Ships Aircraft Motor Vehicles Furnitire and Fixtures Office Equipment Bearer Plants 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. © The Institute of Chartered Accountants of India  6.62 a 2.62 FINANCIAL v REPORTING v However, a class of assets may be revalued on a rolling basis provided revaluation of the class of assets is completed within a short period and provided the revaluations are kept up to date. Illustration 4: Revaluation model for entire class Venus Ltd. is a large manufacturing group. It owns a considerable 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. Venus’s Ltd. management wants to apply the Ind AS 16 revaluation model to subsequent measurement of the office buildings but continue to apply the historical cost model to the industrial buildings. Analyse the accounting treatment to be applied by the management in the light of Ind AS 16. Solution Venus's Ltd. 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. Ind AS 16 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. Separate disclosure of the two classes must be given in accordance with para 73 of Ind AS 16. ***** 2.6.3.4 Treatment of surplus or deficit arising on revaluation  If an asset’s carrying amount is increased as a result of a revaluation, the increase shall be recognized in other comprehensive income and accumulated in equity under the heading of revaluation surplus. However, the increase shall be recognized in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognized in profit or loss.  If an asset’s carrying amount is decreased as a result of a revaluation, the decrease shall be recognized in profit or loss. However, the decrease shall be recognized in other comprehensive income to the extent of any credit balance existing in the revaluation surplus in respect of that asset. The decrease recognized in other comprehensive income reduces the amount accumulated in equity under the heading of revaluation surplus. © The Institute of Chartered Accountants of India  INDIAN ACCOUNTING STANDARD 16 6.63 Treatment of revaluation gain and loss is summarized in the below diagram: Treatment of Revaluation Gain or Loss First time revaluation Subsequent revaluation Increase in the Decrease in the Increase in CA of the Decrease in CA of carrying amount carrying amount revalued asset the revalued asset (CA) of the (CA) of the revalued asset revalued asset Was there a Was there a previous increase previous in CA of the Yes decrease in CA Recogni ze Recogni ze the Yes of the revalued revaluation revalued asset? the asset? revaluation loss in P & L gain in OCI No No Recognize the Recogni ze Recognize the Recogni ze revaluation gain in P the revaluation loss in the & L to the extent that revaluation revaluation OCI to the extent it reverses a loss in P & L of any credit gain in revaluation decrease OCI balance existing in of the same asset the revaluation previously recognized surplus in respect in P & L of that asset. Remaining increase to be Remaining decrease to recognized in OCI be recognized in P & L The revaluation surplus included in equity in respect of an item of property, plant and equipment may be transferred directly to retained earnings when the asset is derecognized. This may involve transferring the whole of the surplus when the asset is retired or disposed of. 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. Transfers from revaluation surplus to retained earnings are not made through profit or loss. The effects of taxes on income, if any, resulting from the revaluation of property, plant and equipment are recognized and disclosed in accordance with Ind AS 12, Income Taxes. © The Institute of Chartered Accountants of India  6.64 a 2.64 FINANCIAL v REPORTING v Illustration 5: Utilisation of Revaluation Surplus An item of PPE was purchased for 9,00,000 on 1 st April, 20X1. It is estimated to have a useful life of 10 years and is depreciated on a straight-line basis. On 1 st April, 20X3, the asset is revalued to 9,60,000. The useful life remains unchanged as ten years. Ignore impact of deferred taxes. Calculate depreciation and revaluation surplus for 20X3-20X4 as per Ind AS 16. Solution Calculation of Additional Depreciation: ( ) Actual depreciation for 20X3-20X4 based on revalued amount (9,60,000/8) 1,20,000 Depreciation for 20X3-20X4 based on historical cost (9,00,000/10) (90,000) Additional Depreciation 30,000 In the profit or loss for 20X3-20X4, a depreciation expense of 1,20,000 will be charged. A reserve transfer, which will be shown in the statement of changes in equity, may be undertaken as follows: Revaluation surplus Dr. 30,000 To Retained earnings 30,000 The closing balance on the revaluation surplus on 31 st March, 20X4 will therefore be as follows: Balance arising on revaluation (9,60,000 – 7,20,000) 2,40,000 Transfer to retained earnings (30,000) 2,10,000 2.6.4 Depreciation  The depreciable amount of an asset should be allocated on a systematic basis over its useful life. The depreciation charge for each period should be recognized in profit or loss unless it is included in the carrying amount of another asset.  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 should be depreciated separately.  An entity allocates the amount initially recognized in respect of an item of property, plant and equipment to its significant parts and depreciates separately each such part. For example, it may be appropriate to depreciate separately the airframe and engines of an aircraft.  A significant part of an item of property, plant and equipment may have a useful life and a depreciation method that are the same as the useful life and the depreciation method of © The Institute of Chartered Accountants of India  INDIAN ACCOUNTING STANDARD 16 6.65 another significant part of that same item. Such parts may be grouped in determining the depreciation charge.  To the extent that an entity depreciates separately some parts of an item of property, plant and equipment, it also depreciates separately the remainder of the item. The remainder consists of the parts of the item that are individually not significant. If an entity has varying expectations for these parts, approximation techniques may be necessary to depreciate the remainder in a manner that faithfully represents the consumption pattern and/or useful life of its parts.  Land and buildings are separable assets and are accounted for separately, even when they are acquired together. With some exceptions, such as quarries and sites used for landfill, land has an unlimited useful life and therefore is not depreciated. Buildings have a limited useful life and therefore are depreciable assets. An increase in the value of the land on which a building stands does not affect the determination of the depreciable amount of the building.  If the cost of land includes the costs of site dismantlement, removal and restoration, that portion of the land asset is depreciated over the period of benefits obtained by incurring those costs.  In some cases, the land itself may have a limited useful life, in which case it is depreciated in a manner that reflects the benefits to be derived from it. 2.6.4.1 Residual Value 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, the change(s) should be accounted for as a change in an accounting estimate in accordance with Ind AS 8, Accounting Policies, Changes in Accounting Estimates and Errors. Illustration 6: Revision of Useful Life An asset which cost 10,000 was estimated to have a useful life of 10 years and residual value 2000. After two years, useful life was revised to 4 remaining years. Calculate the depreciation charge for the years 1,2,3. Solution: Year-1 Year-2 Year-3 Cost 10,000 10,000 10,000 Less: Accumulated (800) (1,600) (3,200) Depreciation © The Institute of Chartered Accountants of India  6.66 a 2.66 FINANCIAL v REPORTING v Carrying Amount 9,200 8,400 6,800 Charges for year 10,000- 2,000 10,000- 2,000 8,400- 2,000 10 = 800 10 = 800 4 = 1,600 *****  The residual value of an asset may increase to an amount equal to or greater than the asset’s carrying amount. If it does, the asset’s depreciation charge is zero unless and until its residual value subsequently decreases to an amount below the asset’s carrying amount.  Depreciation is recognized even if the fair value of the asset exceeds its carrying amount, as long as the asset’s residual value does not exceed its carrying amount. Repair and maintenance of an asset do not negate the need to depreciate it. 2.6.4.2 Commencement of depreciation 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. 2.6.4.3 Cessation of depreciation  Depreciation of an asset ceases at the earlier of: a) 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. b) and the date that the asset is derecognized.  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. 2.6.4.4 Factors affecting the useful life of an asset The future economic benefits embodied in an asset are consumed by an entity principally through its use. However, other factors, such as technical or commercial obsolescence and wear and tear while an asset remains idle, often result in the diminution of the economic benefits that might have been obtained from the asset. Consequently, all the following factors are considered in determining the useful life of an asset: a) expected usage of the asset. Usage is assessed by reference to the asset’s expected capacity or physical output; b) expected physical wear and tear, which depends on operational factors such as the number of shifts for which the asset is to be used and the repair and maintenance programme, and the care and maintenance of the asset while idle; © The Institute of Chartered Accountants of India  INDIAN ACCOUNTING STANDARD 16 6.67 c) technical or commercial obsolescence arising from changes or improvements in production, or from a change in the market demand for the product or service output of the asset. Expected future reductions in the selling price of an item that was produced using an asset could indicate the expectation of technical or commercial obsolescence of the asset, which, in turn, might reflect a reduction of the future economic benefits embodied in the asset; and d) legal or similar limits on the use of the asset, such as the expiry dates of related leases. 2.6.4.5 Impact of an entity’s asset management policy The useful life of an asset is defined in terms of the asset’s expected utility to the entity. The asset management policy of the entity may involve the disposal of assets after a specified time or after consumption of a specified proportion of the future economic benefits embodied in the asset. Therefore, the useful life of an asset may be shorter than its economic life. The estimation of the useful life of the asset is a matter of judgement based on the experience of the entity with similar assets. 2.6.4.6 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 is 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 should be changed to reflect the changed pattern. Such a change is accounted for as a change in an accounting estimate in accordance with Ind AS 8. Illustration 7: Change in Depreciation Method An entity acquired an asset 3 years ago at a cost of 5 million. The depreciation method adopted for the asset was 10 percent reducing balance method. At the end of Year 3, the entity estimates that the remaining useful life of the asset is 8 years and determines to adopt straight –line method from that date so as to reflect the revised estimated pattern of recovery of economic benefits. Calculate the depreciation charge for respective years in accordance with Ind AS 16. Solution Change in depreciation method shall be accounted for as a change in an accounting estimate in accordance with Ind AS 8 and hence will have a prospective effect. Depreciation charges for year 1 to 11 will be as follows: Year 1 5,00,000 © The Institute of Chartered Accountants of India  6.68 a 2.68 FINANCIAL v REPORTING v Year 2 4,50,000 Year 3 4,05,000 Year 4 to Year 11 (refer W.N.) 4,55,625 p.a. Working Note: Year Opening balance of Depreciation @ Closing balance of asset (a) 10% on (a) asset (c) = (a)- (b) 1 50,00,000 5,00,000 45,00,000 2 45,00,000 4,50,000 40,50,000 3 40,50,000 4,05,000 36,45,000 Year 3 onwards method of depreciation has been changed from reducing balance method to straight line method for which it is assessed that the remaining useful life is 8 years. Hence revised depreciation would be calculated as follows: Revised depreciation as per straight line method = (Carrying amount as at the end of the 3 rd year – Residual value) / Remaining useful life = 36,45,000 / 8 years = 4,55,625 per annum (for year 4 to year 11) ***** A variety of depreciation methods can be used to allocate the depreciable amount of an asset on a systematic basis over its useful life. These methods include: a) Straight-line depreciation method results in a constant charge over the useful life if the asset’s residual value does not change. b) Diminishing balance method results in a decreasing charge over the useful life. c) Units of production method results in a charge based on the expected use or output. The entity selects the method that most closely reflects the expected pattern of consumption of the future economic benefits embodied in the asset. That method is applied consistently from period to period unless there is a change in the expected pattern of consumption of those future economic benefits. A depreciation method that is based on revenue that is generated by an activity that includes the use of an asset is not appropriate. The revenue generated by an activity that includes the use of an asset generally reflects factors other than the consumption of the economic benefits of the asset (e.g. revenue is affected by other inputs and processes, selling activities and changes in © The Institute of Chartered Accountants of India  INDIAN ACCOUNTING STANDARD 16 6.69 sales volumes and prices). The price component of revenue may be affected by inflation, which has no bearing upon the way in which an asset is consumed. Depreciation Fair Value > Carrying Amount Asset not usable or held for sale or (Residual Value is less than Residual Value > = Carrying included in a disposal group that is Carrying Amount) Amount classified as held for sale Depreciation Depreciation Depreciation Zero Charged Ceases 2.6.5 Impairment 2.6.5.1 Identification of an impairment loss To determine whether an item of property, plant and equipment is impaired, an entity applies Ind AS 36, Impairment of Assets. Ind AS 36 explains how an entity reviews the carrying amount of its assets, how it determines the recoverable amount of an asset, and when it recognizes, or reverses the recognition of, an impairment loss. 2.6.5.2 Compensation for impairment  Compensation from third parties for items of property, plant and equipment that were impaired, lost or given up shall be included in profit or loss when the compensation becomes receivable.  Impairments or losses of items of property, plant and equipment, related claims for or payments of compensation from third parties and any subsequent purchase or construction of replacement assets are separate economic events and are accounted for separately as follows: a) impairments of items of property, plant and equipment are recognized in accordance with Ind AS 36; b) derecognition of items of property, plant and equipment retired or disposed of is determined in accordance with this Standard; © The Institute of Chartered Accountants of India  6.70 a 2.70 FINANCIAL v REPORTING v c) compensation from third parties for items of property, plant and equipment that were impaired, lost or given up is included in determining profit or loss when it becomes receivable; and d) the cost of items of property, plant and equipment restored, purchased or constructed as replacements is determined in accordance with this Standard. 2.7 DERECOGNITION 2.7.1 Derecognition- general  The carrying amount of an item of property, plant and equipment should be derecognized: a) on disposal; or b) when no future economic benefits are expected from its use or disposal.  The gain or loss arising from the derecognition of an item of property, plant and equipment is included in profit or loss when the item is derecognized (unless Ind AS 116 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. The proceeds from the sale of such assets shall be recognized as revenue in accordance with Ind AS 115, Revenue from Contracts with Customers.  The date of disposal of an item of property, plant and equipment is the date the recipient obtains control of that item in accordance with Ind AS 115. Ind AS 116 applies to disposal by a sale and leaseback.  If, under the recognition principle, an entity recognizes in the carrying amount of an item of property, plant and equipment the cost of a replacement for part of the item, then it derecognizes the carrying amount of the replaced part regardless of whether the replaced part had been depreciated separately. If it is not practicable for an entity to determine the carrying amount of the replaced part, it may use the cost of the replacement as an indication of what the cost of the replaced part was at the time it was acquired or constructed.  The gain or loss arising from the derecognition 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. © The Institute of Chartered Accountants of India  INDIAN ACCOUNTING STANDARD 16 6.71  The date of disposal of an item of property, plant and equipment is the date the recipient obtains control of that item in accordance with the requirements for determining when a performance obligation is satisfied in Ind AS 115. Ind AS 116 applies to disposal by a sale and leaseback.  The amount of consideration to be included in the gain or loss arising from the derecognition of an item of property, plant and equipment is determined in accordance with the requirements for determining the transaction price in Ind AS 115.  Subsequent changes to the estimated amount of the consideration included in the gain or loss shall be accounted for in accordance with the requirements for changes in the transaction price in Ind AS 115. 2.8 DISCLOSURE 2.8.1 Disclosure- general  The financial statements shall disclose, for each class of property, plant and equipment: a) the measurement bases used for determining the gross carrying amount; b) the depreciation methods used; c) the useful lives or the depreciation rates used; and d) the gross carrying amount and the accumulated depreciation (aggregated with accumulated impairment losses) at the beginning and end of the period.  Entity is also required to provide a reconciliation of the carrying amount at the beginning and end of the period showing: a) additions; b) assets classified as held for sale or included in a disposal group classified as held for sale in accordance with Ind AS 105 and other disposals; c) acquisitions through business combinations; d) increases or decreases resulting from revaluations and from impairment losses recognized or reversed in other comprehensive income in accordance with Ind AS 36; e) impairment losses recognized in profit or loss in accordance with Ind AS 36; f) impairment losses reversed in profit or loss in accordance with Ind AS 36; g) depreciation; © The Institute of Chartered Accountants of India  6.72 a 2.72 FINANCIAL v REPORTING v h) the net exchange differences arising on the translation of the financial statements from the functional currency into a different presentation currency, including the translation of a foreign operation into the presentation currency of the reporting entity; and i) other changes.  The financial statements shall also disclose: a) the existence and amounts of restrictions on title, and property, plant and equipment pledged as security for liabilities; b) the amount of expenditures recognized in the carrying amount of an item of property, plant and equipment in the course of its construction; c) the amount of contractual commitments for the acquisition of property, plant and equipment; and d) if it is not disclosed separately in the statement of profit and loss, the amount of compensation from third parties for items of property, plant and equipment that were impaired, lost or given up that is included in profit or loss.  Selection of the depreciation method and estimation of the useful life of assets are matters of judgement. Therefore, disclosure of the methods adopted and the estimated useful lives or depreciation rates provides users of financial statements with information that allows them to review the policies selected by management and enables comparisons to be made with other entities. For similar reasons, it is necessary to disclose: (a) depreciation, whether recognized in profit or loss or as a part of the cost of other assets, during a period; and (b) accumulated depreciation at the end of the period.  In accordance with Ind AS 8 an entity discloses the nature and effect of a change in an accounting estimate that has an effect in the current period or is expected to have an effect in subsequent periods. For property, plant and equipment, such disclosure may arise from changes in estimates with respect to: (a) residual values; (b) the estimated costs of dismantling, removing or restoring items of property, plant and equipment; (c) useful lives; and (d) depreciation methods © The Institute of Chartered Accountants of India  INDIAN ACCOUNTING STANDARD 16 6.73 2.8.2 Items stated at revalued amounts  If items of property, plant and equipment are stated at revalued amounts, the following should be disclose: a) the effective date of the revaluation; b) whether an independent valuer was involved; c) for each revalued class of property, plant and equipment, the carrying amount that would have been recognized had the assets been carried under the cost model; and d) the revaluation surplus, indicating the change for the period and any restrictions on the distribution of the balance to shareholders. 2.8.3 Additional recommended disclosure  Entities are encouraged but not required, to disclose the following amounts: a) the carrying amount of temporarily idle property, plant and equipment; b) the gross carrying amount of any fully depreciated property, plant and equipment that is still in use; c) the carrying amount of property, plant and equipment retired from active use and not classified as held for sale in accordance with Ind AS 105; and d) when the cost model is used, the fair value of property, plant and equipment when this is materially different from the carrying amount. Illustration 8 MS Ltd. has acquired a heavy machinery at a cost of 1,00,00,000 (with no breakdown of the component parts). The estimated useful life is 10 years. At the end of the sixth year, one of the major components, the turbine requires replacement, as further maintenance is uneconomical. The remainder of the machine is perfect and is expected to last for the next four years. The cost of a new turbine is 45,00,000. The discount rate assumed is 5%. Analyse whether the cost of the new turbine can be recognized as an asset, and, if yes, then apply the accounting treatment relevant to it. Solution The new turbine will produce economic benefits to MS Ltd., and the cost is measurable. Hence, the item should be recognized as an asset. The original invoice for the machine did not specify the cost of the turbine; however, the cost of the replacement 45,00,000 can be used as an indication (usually by discounting) of the likely cost, six years previously. © The Institute of Chartered Accountants of India  6.74 a 2.74 FINANCIAL v REPORTING v If an appropriate discount rate is 5% per annum, 45,00,000 discounted back six years amounts to 33,57,900 [ 45,00,000/(1.05) 6 ], i.e., the approximate cost of turbine before 6 years. The current carrying amount of the turbine which is required to be replaced of 13,43,160 would be derecognized from the books of account, (i.e., Original Cost 33,57,900 as reduced by accumulated depreciation for past 6 years 20,14,740, assuming depreciation is charged on straight-line basis.) The cost of the new turbine, 45,00,000 would be added to the cost of machine, resulting in a revision of carrying amount of machine to 71,56,840. (i.e., 40,00,000* – 13,43,160 + 45,00,000). *Original cost of machine 1,00,00,000 reduced by accumulated depreciation (till the end of 6 years) 60,00,000. ***** Illustration 9 On 1 st April, 20X1, XYZ Ltd. acquired a machine under the following terms: List price of machine 80,00,000 Import duty 5,00,000 Delivery fees 1,00,000 Electrical installation costs 10,00,000 Pre-production testing 4,00,000 Purchase of a five-year maintenance contract with vendor 7,00,000 In addition to the above information XYZ Ltd. was granted a trade discount of 10% on the initial list price of the asset and a settlement discount of 5%, if payment for the machine was received within one month of purchase. XYZ Ltd. paid for the plant on 20 th April, 20X1. Compute the cost of the asset to be recognized. Solution In accordance with Ind AS 16, all costs required to bring an asset to its present location and condition for its intended use should be capitalized. Therefore, the initial purchase price of the asset should be © The Institute of Chartered Accountants of India  INDIAN ACCOUNTING STANDARD 16 6.75 List price 80,00,000 Less: Trade discount (10%) (8,00,000) 72,00,000 Import duty 5,00,000 Delivery fees 1,00,000 Electrical installation costs 10,00,000 Pre-production testing 4,00,000 Total amount to be capitalized at 1 st April, 20X1 92,00,000 Maintenance contract is a separate contract to get service, therefore, the maintenance contract cost of 7,00,000 should be taken as a prepaid expense and charged to the profit or loss over a period of 5 years. In addition, the settlement discount received of 3,60,000 ( 72,00,000 x 5%) is to be shown as other income in the profit or loss. ***** Illustration 10 X Limited started construction on a building for its own use on 1 st April, 20X0. The following costs are incurred: Purchase price of land 30,00,000 Stamp duty & legal fee 2,00,000 Architect fee 2,00,000 Site preparation 50,000 Materials 10,00,000 Direct labour cost 4,00,000 General overheads 1,00,000 Other relevant information: Material costing 1,00,000 had been spoiled and therefore wasted and a further 1,50,000 was spent on account of faulty design work. As a result of these problems, work on the building was stopped for two weeks during November, 20X0 and it is estimated that 22,000 of the labour cost relate to that period. The building was completed on © The Institute of Chartered Accountants of India  6.76 a 2.76 FINANCIAL v REPORTING v 1 st January, 20X1 and brought in use 1 st April, 20X1. X Limited had taken a loan of 40,00,000 on 1 st April, 20X0 for construction of the building. The loan carried an interest rate of 8% per annum and is repayable on 1 st April, 20X2. Assume that the entity did not considered the construction period as substantial period of time as per Ind AS 23. Calculate the cost of the building that will be included in tangible non-current asset as an addition? Solution Only those costs which are directly attributable to bringing the asset into working condition for its intended use should be included. Administration and general costs cannot be included. Cost of abnormal amount of wasted material/ labor or other resources is not included as per para 22 of Ind AS 16. Here, the cost of spoilt materials and faulty designs are assumed to be abnormal costs. Also, it is assumed that the wastages and labor charges incurred are abnormal in nature. Hence, same are also not included in the cost of PPE. Amount to be included in Property, Plant and Equipment (PPE): Purchase price of land 30,00,000 Stamp duty & legal fee 2,00,000 Architect fee 2,00,000 Site preparation 50,000 Material (10,00,000 – 2,50,000) 7,50,000 Direct labour cost (4,00,000 – 22,000) 3,78,000 General overheads Nil Interest* Nil Total to be capitalized 45,78,000 ***** Illustration 11 XYZ Ltd. purchased an asset on 1 st January, 20X0, for 1,00,000 and the asset had an estimated useful life of ten years and a residual value of nil. The company has charged depreciation using the straight-line method at 10,000 per annum. On 1 st January, 20X4, the management of XYZ Ltd. reviews the estimated life and decides that the asset will probably be useful for a further four years and, therefore, the total life is revised to eight years. Account for the asset for the remaining years. © The Institute of Chartered Accountants of India  INDIAN ACCOUNTING STANDARD 16 6.77 Solution Change in useful economic life of an asset is change in accounting estimate, which is to be applied prospectively, i.e., the depreciation charge will need to be recalculated. On 1 st January, 20X4, when the asset’s net book value is 60,000. The company should amend the annual provision for depreciation to charge the unamortised cost (namely, 60,000) over the revised remaining life of four years. Consequently, it should charge depreciation for the next four years at 15,000 per annum. ***** Illustration 12 On 1 st April, 20X1, Sun Ltd. purchased some land for 10 million (including legal costs of 1 million) in order to construct a new factory. Construction work commenced on 1 st May, 20X1. Sun Ltd incurred the following costs in relation with its construction: – Preparation and levelling of the land – 3,00,000. – Purchase of materials for the construction – 6.08 million in total. – Employment costs of the construction workers – 2,00,000 per month. – Overhead costs incurred directly on the construction of the factory – 1,00,000 per month. – Ongoing overhead costs allocated to the construction project using the company’s normal overhead allocation model – 50,000 per month. – Income received during the temporary use of the factory premises as a car park during the construction period – 50,000. – Costs of relocating employees to work at the new factory – 3,00,000. – Costs of the opening ceremony on 31 st January, 20X2 – 1,50,000. The factory was completed on 30 th November, 20X1 (which is considered as substantial period of time as per Ind AS 23) and production began on 1 st February, 20X2. The overall useful life of the factory building was estimated at 40 years from the date of completion. However, it is estimated that the f will need to be replaced 20 years after the date of completion and that the cost of replacing the roof at current prices would be 30% of the total cost of the building. At the end of the 40-year period, Sun Ltd has a legally enforceable obligation to demolish the factory and restore the site to its original condition. The directors estimate that the cost of demolition in 40 years’ time (based on prices prevailing at that time) will be 20 million. An annual risk adjusted discount rate which is appropriate to this project is 8%. The present value of 1 payable in 40 years’ time at an annual discount rate of 8% is 0.046. © The Institute of Chartered Accountants of India  6.78 a 2.78 FINANCIAL v REPORTING v The construction of the factory was partly financed by a loan of 17·5 million taken out on 1 st April, 20X1. The loan was at an annual rate of interest of 6%. Sun Ltd received investment income of 100,000 on the temporary investment of the proceeds. Compute the carrying amount of the factory on the Balance Sheet of Sun Ltd at 31 st March, 20X2. Explain the treatment of all the amounts referred to in this part of the answer. Solution Computation of the cost of the factory Description Included Explanation in P.P.E. ’000 Purchase of land 10,000 Both the purchase of the land and the associated legal costs are direct costs of constructing the factory. Preparation and levelling 300 A direct cost of constructing the factory Materials 6,080 A direct cost of constructing the factory Employment costs of construction 1,400 A direct cost of constructing the factory workers for a seven-month period Direct overhead costs 700 A direct cost of constructing the factory for a seven-month period Allocated overhead costs Nil Not a direct cost of construction Income from use as a car park Nil Not essential to the construction so recognized directly in profit or loss Relocation costs Nil Not a direct cost of construction Opening ceremony Nil Not a direct cost of construction Finance costs 612.50 Capitalize the interest cost incurred in a seven-month period (purchase of land would not trigger off capitalization since land is not a qualifying asset. Infact, the construction started from 1 st May, 20X1) Investment income on temporary (100) offset against the amount capitalized investment of the loan proceeds Demolition cost recognized as a Where an obligation must recognize as provision 920 part of the initial cost Total 19,912.50 © The Institute of Chartered Accountants of India  INDIAN ACCOUNTING STANDARD 16 6.79 Computation of accumulated depreciation Total depreciable amount 9,912.50 All of the net finance cost of 512.50 (612.50 – 100) has been allocated to the depreciable amount. Also, acceptable to reduce by allocating a portion to the non- depreciable land element principle Depreciation must be in two parts: Depreciation of roof component 49.56 9,912.50 x 30% x 1/20 x 4/12 Depreciation of remainder 57.82 9,912.50 x 70% x 1/40 x 4/12 Total depreciation 107.38 Computation of carrying amount 19,805.12 19,912.50 – 107.38 ***** 2.9 CHANGES IN EXISTING DECOMMISSIONING, RESTORATION AND SIMILAR LIABILITIES (APPENDIX A) Many entities have obligations to dismantle, remove and restore items of property, plant and equipment after the end of particular period. The initial estimate of such costs is included in the cost of an item of property, plant and equipment. For instance, a lessee who has taken an office building on lease may do some leasehold improvements and may have an obligation under the lease agreement to dismantle the leasehold improvements at the end of the lease. Such obligations are referred to as ‘decommissioning, restoration and similar liabilities’. Ind AS 37 contains requirements on how to measure decommissioning, restoration and similar liabilities. Appendix A to Ind AS 16 provides guidance on how to account for the effect of changes in the measurement of existing decommissioning, restoration and similar liabilities. 2.9.1 When to apply guidance in Appendix A to Ind AS 16 The guidance in Appendix A to Ind AS 16 applies to changes in the measurement of any existing de-commissioning, restoration or similar liability that is both: o recognized as part of the cost of an item of property, plant and equipment in accordance with Ind AS 16 or as part of the cost of a right-of-use asset in accordance with Ind AS 116; and o recognized as a liability in accordance with Ind AS 37. 2.9.2 Issues addressed by Appendix A to Ind AS 16 This Appendix addresses how the effect of the following events that change the measurement of an existing decommissioning, restoration or similar liability should be accounted for: © The Institute of Chartered Accountants of India  6.80 a 2.80 FINANCIAL v REPORTING v a) a change in the estimated outflow of resources embodying economic benefits (e.g. cash flows) required to settle the obligation; b) a change in the current market-based discount rate as defined in paragraph 47 of Ind AS 37 (this includes changes in the time value of money and the risks specific to the liability); and c) an increase that reflects the passage of time (also referred to as the unwinding of the discount). 2.9.3 Accounting guidance in Appendix A to Ind AS 16  Appendix A to Ind AS 16 offers two different approaches to account for changes in decommissioning liability depending upon whether the entity follows cost model or revaluation model.  If the related asset is measured using the cost model: (a) subject to point (b) below, changes in the decommissioning, restoration and similar liability shall be added to, or deducted from, the cost of the asset in the current period and related provision for decommissioning and site restoration is accordingly adjusted. (b) any such decrease in the decommissioning, restoration and similar liability cannot exceed the carrying amount of the asset. In case, the said decrease in the decommissioning liability is more than the carrying amount of the asset, the excess is recognized immediately as income in statement of profit and loss. (c) if the changes in the decommissioning liability and the resultant adjustment results in an addition to the cost of an asset, the entity shall consider whether this is an indication that the new carrying amount of the asset may not be fully recoverable. If it is such an indication, the entity shall test the asset for impairment by estimating its recoverable amount, and shall account for any impairment loss, in accordance with Ind AS 36.  If the asset is measured using the revaluation model: (a) Any increase in liability arising out of changes in decommissioning liabilities is adjusted against revaluation surplus to the extent credit balance is available relating to that particular asset through 'other comprehensive income'. Any excess is, however, recognized in the statement of profit and loss. (b) Any decrease in liability arising out of changes in decommissioning liabilities, is recognized in the revaluation reserve ie equity through 'other comprehensive income'. However, if there was any revaluation deficit previously charged to profit or loss, to that extent it can be recognized as income in the statement of profit and loss. © The Institute of Chartered Accountants of India  INDIAN ACCOUNTING STANDARD 16 6.81 (c) If there is decrease in decommissioning liability in excess of the carrying amount of the asset, such excess is treated as 'deemed revaluation' and is recognized immediately in the statement of profit and loss. (d) Any change in liability would require the asset to be tested for impairment to ascertain if there is any change in fair value. (e) Change in the revaluation surplus arising from a change in the decommissioning liability shall be presented as a separate line item in the Statement of Other Comprehensive Income, as required under Ind AS 1.  The adjusted depreciable amount of the asset is depreciated over its useful life. Therefore, once the related asset has reached the end of its useful life, all subsequent changes in the liability shall be recognized in profit or loss as they occur. This applies under both the cost model and the revaluation model.  The periodic unwinding of the discount shall be recognized in profit or loss as a finance cost, as it occurs. Capitalisation under Ind AS 23 is not permitted. Illustration 13 H Limited purchased an item of PPE costing 100 million which has useful life of 10 years. The entity has a contractual decommissioning and site restoration obligation, estimated at 5 million to be incurred at the end of 10 th year. The current market-based discount rate is 8%. The company follows SLM method of depreciation. H Limited follows the Cost Model for accounting of PPE. Determine the carrying value of an item of PPE and decommissioning liability at each year end when (a) There is no change in the expected decommissioning expenses, expected timing of incurring the decommissioning expense and / or the discount rate (b) At the end of Year 4, the entity expects that the estimated cash outflow on account of decommissioning and site restoration to be incurred at the end of the useful life of the asset will be 8 million (in place of 5 million, estimated in the past). Determine in case (b), how H Limited need to account for the changes in the decommissioning liability? Solution The present value of such decommissioning and site restoration obligation at the end of 10 th year is 2.32 million [being 5 / (1.08) 10 ]. H Limited will recognize the present value of decommissioning liability of 2.32 million as an addition to cost of PPE and will also recognize © The Institute of Chartered Accountants of India  6.82 a 2.82 FINANCIAL v REPORTING v a corresponding decommissioning liability. Further, the entity will recognize the unwinding of discount as finance charge. (a) The following table shows the relevant computations, if there is no change in the expected decommissioning expenses, expected timing of incurring the decommissioning expense and / or the discount rate: ( in million) Year Opening Depreciation Carrying Opening Unwinding Closing Amount Charge (on Amount of PPE Decommissioning of Interest Decommissi of PPE SLM) for 10 at the end of Liability @ 8% oning Years the year Liability 1 102.32 10.23 92.08 2.32 0.19 2.50 2 92.08 10.23 81.85 2.50 0.20 2.70 3 81.85 10.23 71.62 2.70 0.22 2.92 4 71.62 10.23 61.39 2.92 0.23 3.15 5 61.39 10.23 51.16 3.15 0.25 3.40 6 51.16 10.23 40.93 3.40 0.27 3.68 7 40.93 10.23 30.69 3.68 0.29 3.97 8 30.69 10.23 20.46 3.97 0.32 4.29 9 20.46 10.23 10.23 4.29 0.34 4.63 10 10.23 10.23 - 4.63 0.37 5.00 Total 102.32 2.68 (b) The changes to the estimate of expected decommissioning obligation: o The present value of the decommissioning liability at the end of Year 4 works out to be 5.04 million [being 8 / (1.08) 6 ]. o As against this, the carrying amount of decommissioning liability at the end of Year 4 is 3.15 million (as computed above). o The changes in the decommissioning liability of 1.89 million (being 5.04 million less 3.15 million) shall be added to the cost of the asset in the current period and the related provision for decommissioning liability is also adjusted. The journal entry will be: PPE Dr. 1.89 million To Provision for decommissioning liability 1.89 million © The Institute of Chartered Accountants of India  INDIAN ACCOUNTING STANDARD 16 6.83 o The following table shows the calculations for years 5 - 10: Year Opening Depreciation Carrying Opening Unwinding Closing Amount Charge Amount of Decommissioning of Interest Decommissioning of PPE SLM – 10 PPE at Liability @8% Liability Years end of the year 5 63.28 10.55 52.73 5.04 0.40 5.44 6 52.73 10.55 42.19 5.44 0.44 5.88 7 42.19 10.55 31.64 5.88 0.47 6.35 8 31.64 10.55 21.09 6.35 0.51 6.86 9 21.09 10.55 10.55 6.86 0.55 7.41 10 10.55 10.55 - 7.41 0.59 8.00 Total 63.28 2.96 Note that in the above table:  Opening amount of PPE at the beginning of Year 5 is computed as 63.28 million (being carrying amount of 61.39 million at the end of Year 4 plus increase of 1.89 million arising due to increase in the present value of the decommissioning liability at the end of Year 4).  The revised carrying amount of PPE (at 63.28 million) at the beginning of Year 5 will be depreciated over the balance 6 years of the useful life).  Opening decommissioning liability at the beginning of Year 5 is computed as 5.04 million (being carrying amount of 3.15 million at the end of Year 4 plus increase of 1.89 million). Since the entity has adjusted the increase in the decommissioning liability against the carrying amount of PPE, it needs to evaluate whether the new carrying amount (in this case, 63.28 million) is recoverable. If not, it will give rise to impairment loss, to be accounted for under Ind AS 36. ***** 2.10 EXTRACTS OF FINANCIAL STATEMENTS OF LISTED ENTITIES Following is the extract from the financial statements of the listed entity ‘Cummins India Limited’ for the financial year 2021-2022 with respect to ‘Property, Plant and Equipment’ and its accounting policy thereon. © The Institute of Chartered Accountants of India  6.84 a 2.84 FINANCIAL v REPORTING v ACCOUNTING POLICY Property, plant and equipment and investment properties Property plant and equipment, capital work in progress and investment properties are stated at cost of acquisition or construction net of accumulated depreciation