Saturday, April 11, 2009

How to treat the costs incurred subsequent to purchase or self-construction of PPE

IAS 16 par. 7 states that the cost of an item of Property, Plant and Equipment (PPE) shall be recognized as an asset if, and only if :

  1. it is probable that future economic benefits associated with the item will flow to the entity; and
  2. the cost of the item can be measured reliably.

Further, par. 12 states that 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. Costs 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.

Costs that are incurred subsequent to the purchase or construction of the long-lived asset, such as those for repairs, maintenance, or betterments, may involve an adjustment to the carrying value, or may be expensed, depending on the precise facts and circumstances.

To qualify for capitalization, costs must be associated with incremental benefits. Costs can be added to the carrying value of the related asset only when it is probable that future economic benefits beyond those originally anticipated for the asset will be received by the entity. For example, modifications to the asset made to extend its useful life or to increase its capacity would be capitalized.

It can usually be assumed that ordinary maintenance and repair expenditures will occur on a ratable basis over the life of the asset and should be charged to expense as incurred. Thus, if the purpose of the expenditure is either to maintain the productive capacity anticipated when the asset was acquired or constructed, or to restore it to that level, the costs are not subject to capitalization.

A partial exception is encountered if an asset is acquired in a condition that necessitates that certain expenditures be incurred in order to put it into the appropriate state for its intended use. For example, a deteriorated building may be purchased with the intention that it be restored and then utilized as a factory or office facility. In such cases, costs that otherwise would be categorized as ordinary maintenance items might be subject to capitalization, subject to the constraint that the asset not be presented at a value that exceeds its recoverable amount. Once the restoration is completed, further expenditures of similar type would be viewed as being ordinary repairs or maintenance, and thus expensed as incurred.

However, costs associated with required inspections (e.g., of aircraft) could be capitalized and depreciated. These costs would be amortized over the expected period of benefit (i.e., the estimated time to the next inspection). As with the cost of physical assets, removal of any un-depreciated costs of previous inspections would be required. The capitalized inspection cost would have to be treated as a separate component of the asset. (Hrd)

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