IND AS 16 – Capitalization of Plant & Depreciation

Ind AS 16 prescribes the accounting treatment for Property and P&E (Plant, and Equipment). The principal issues covered in the standard includes: –

Timing of recognizing an asset
Determining the carrying amounts of the assets
Depreciation to be recognized in the financial statements

What is IND AS 16

Indian Accounting Standard 16 (Ind AS 16) deals with accounting and depreciation of property, plant and equipment, which is also covered by the corresponding AS-10. Unless other accounting standards require different treatment, Ind AS 16 is applicable to all property, plant, and equipment.

Objective of IND AS 16

The objective of this standard is to prescribe an accounting solution for property, plant, and equipment so that users of financial statements can recognize information about an investment of an entity and the changes in that investment. The main issues in accounting for property, plant, and equipment are the recognition of assets, the determination of their carrying amount, and the depreciation and impairment losses to be recognized to them.

Applicability and Scope

Ind AS 16 Property Plant Equipment is applicable to all Property and P&E (Plant & Equipment) unless and until any other accounting standard asks for a different treatment. Ind AS 16 Property Plant Equipment is not applicable in the following cases: (i) Property and P&E (Plant & Equipment) which are classified as held for sale as per Ind AS 105 (ii) Biological assets which are related to agricultural activities except bearer plants (iii) The measurement and recognition of exploration and evaluation assets (iv) Mineral rights and reserves like oil, natural gas and other such non-regenerative resources

What is PPE?

PPE comprises tangible assets used in business operations, including land, buildings, machinery, vehicles, and fixtures. The classification is based on intended operational use rather than the nature of the entity, guiding its recognition in financial statements.

Cost of assets and their components as per Ind AS 16

The standard also specifies that the cost of all PPE assets would be considered assets only if the costs are reliably measurable and it is clear that the monetary benefits from those assets would benefit the business. PPE costs include:

Purchase price including import duty and other non-refundable taxes after deduction of rebates and trade discounts.
Expenses incurred to bring the property to the condition and location necessary for its operation.
An initial estimate of the cost to dismantle/remove the item and restore it where it is.

Measurement after recognition of PPE as per Ind AS 16

Companies can choose between the revaluation model and the cost model as their accounting policy and apply the same to their entire PPE class. According to the cost model, PPE should be carried at acquisition cost less depreciation and any accumulated impairment losses. Under the revaluation model, PPE for which a fair value can be reliably determined should be valued at the revalued amount, which is the fair value at the date of its revaluation, less gradually accumulated depreciation and any accumulated impairment losses.

Recognition and Initial Costs

When acquiring PPE, entities recognize them at their cash equivalent, incorporating the purchase price and directly attributable costs. For self-constructed assets, expenses include materials, labour, and overheads from construction. Let’s take a scenario where a company purchases a new manufacturing plant — the recognition of this asset includes not just the purchase cost but also expenses like transport, installation, and testing to make the plant operational (All ancillary costs in bringing the Asset to present location and condition).

Subsequent Recognition Models (2 Models):

Cost Model: Under this model, PPE is initially recognized at historical cost and subsequently decreased by accumulated depreciation and impairments, offering a simple accounting approach.
Revaluation Model: Here, assets are revalued to their fair value periodically. Any surplus from revaluation is recognized in other comprehensive income (OCI) or directly in retained earnings. However, if there’s a deficit, it’s charged to the profit or loss account.

FAQs

Depreciation and Component-Based Depreciation?

Depreciation is the systematic allocation of an asset’s depreciable amount over its useful life. IND AS 16 allows for component-based depreciation for assets with significant parts having similar useful lives. For example, consider a building with separate components like elevators, HVAC systems, and roofing. Each component can have its own useful life and depreciation rate.

Let’s take an instance of a manufacturing company that uses heavy machinery on its production floor. These machines have a limited useful life. Over time, the company systematically allocates the cost of these machines as depreciation. For instance, if a machine costs Rs.10,00,000 and has a useful life of 10 years, the annual depreciation expense would be Rs.1,00,000.

In another instance, an airline company operates fleets of aircraft. Each aircraft consists of various components like engines, avionics, and airframes. Instead of treating the entire aircraft as a single unit, they apply component-based depreciation. For instance, the engines might have a different useful life compared to the airframe. This approach provides a more accurate reflection of the asset’s wear and tear.

Treatment of Revaluation Surplus?

When revaluing assets, any surplus goes to OCI or retained earnings. However, if the asset’s carrying amount exceeds its recoverable amount, the surplus is treated as an impairment loss. Adjustments to revaluation surplus are made based on changes in asset values.

Suppose a real estate company owns a piece of land. Initially, they recorded it at historical cost. However, after several years, the land’s market value increases significantly due to urban development in the area. The company decides to revalue the land to its current fair value. The surplus arising from this revaluation is recognized in other comprehensive income (OCI).

Disposal and Derecognition of PPE Assets: When PPE assets are disposed-off or no longer provide future economic benefits, their carrying amounts are derecognized. Any difference between the sale value and book value is transferred to the profit and loss account. The standard also addresses the replacement of assets/components and compensation for impaired assets.

In our last example, A company decides to replace its old office furniture with new ergonomic chairs and desks. The old furniture is no longer useful for the business. When disposing of these assets, the company calculates the difference between the sale value (if any) and the carrying amount (book value). This difference is then recognized in the profit and loss account.

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