Wednesday, October 29, 2008

How IAS 16 regulates the recognition of PPE

IAS 16 Property, Plant and Equipment paragraph 7 to 14 regulates the recognition of PPE.

Recognition Principle (par. 7) - 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.

Spare parts and servicing equipment are usually carried as inventory and recognized in profit and loss as consumed. However, major spare parts and stand-by equipment qualify as PPE when an entity expects to use them during more than one period.

Similarly, if the spare parts and servicing equipment can be used only in connection with an item of PPE, they are accounted for as property, plant and equipment.

This Standard does not prescribe the unit of measure of recognition, i.e. what constitutes an item of PPE. Thus, judgment 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 PPE costs at the time they incurred. These costs include costs incurred initially to acquire or construct an item of PPE and costs incurred subsequently to add to, replace part of, or service it.

Initial Costs

Items of PPE may be acquired for safety or environment reasons. The acquisition of such PPE, although not directly increasing the future economic benefits of any particular existing item of PPE, may be necessary for an entity to obtain the future economic benefits from its other assets.

Such items of PPE qualify for recognition as assets because the 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 process 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 IAS 36 Impairment of Assets.

Subsequent Costs

Under the recognition principle in par. 7, an entity does not recognize in the carrying amount of an item of PPE the costs of the day-to-day servicing of the item. Rather, these costs are recognized in profit or loss as incurred.

Cost of day-to-day servicing are primarily the costs of labor and consumables, and may include the cost of small parts. The purpose of these expenditures is often described as for the ‘repairs and maintenance’ of the item of PPE.

Parts of some items of PPE may require replacement at regular intervals. Items of PPE may also be acquired to make a less frequently recurring replacement, such as replacing the interior walls of a building, or to make a nonrecurring replacement.

Under the recognition principle in par. 7, an entity recognizes in the carrying amount of an item of PPE the cost of replacing part of such an item when that cost is incurred if the recognition criteria are met.

The carrying amount of those parts that are replaced is derecognized in accordance with the de-recognition provisions of this Standard (as regulates in par. 67-72).

A condition of continuing to operate an item of PPE (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 PPE as a replacement if the recognition criteria are satisfied.

Any remaining carrying amount of the cost of the previous inspection (as distinct from physical parts) 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 (Hrd) ***

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