Cost of property, plant and equipment (‘PP&E’) comprises (IAS 16.16):
- purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates.
- 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.
- the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located.
Directly attributable costs
Paragraph IAS 16.17 provides examples of directly attributable costs that can be included in the cost of PP&E. Note that directly attributable costs do not need to be incremental. Examples of directly attributable costs include:
- labour expense (as per IAS 19) resulting from the construction or acquisition of an asset,
- direct materials used,
- systematic allocation of variable and fixed production overheads,
- delivery costs,
- site inspection and preparation,
- costs of testing whether the asset is functioning properly,
- professional fees (e.g. legal fees, stamp duty).
For self-constructed assets, IAS 2 comes useful as it is more focused on assets produced internally (IAS 16.22).
Any costs that 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 are expensed in P/L as incurred. Examples of such costs are given in IAS 16.19.
Common examples of costs that relate to acquisition or construction of PP&E, but are not included in its cost, include:
- some costs incurred before the asset is acquired or constructed,
- warranties (guarantees) that are in substance a distinct service (see more discussion on this topic),
- setting up a temporary location,
- abnormal amounts of wasted material, labour, or other resources,
- advertising and promotion,
- general administrative expenses,
- initial operating losses,
- setting up a temporary location for the time of development of existing location,
- salaries and wages of employees that remain idle due to relocation or development of existing PP&E,
- termination benefits paid to employees as a result of acquisition of PP&E that replaced their work.
Costs incurred before the asset is acquired or constructed
Significant judgement is needed when deciding how to account for costs that are incurred before the asset is acquired or before the beginning of construction. Costs relating to a research phase when the entity does not know specifically which asset will be acquired, or when/how it will be developed, should be expensed in P/L as incurred. This is due to the fact that such costs do not increase future economic benefits of the specific asset that will eventually be acquired/developed.
Variable and contingent consideration
Some payments for PP&E are not fixed and depend on future events. The most common example are contingent payments that depend on future performance of the asset.
The first question that should be answered is whether this variable/contingent part of consideration should be recognised as a liability or not. Some analogy can be derived from IFRS 3 which requires recognition of a liability for contingent consideration (for acquired business) at fair value. Subsequently, changes resulting from events after the acquisition date (e.g. meeting post-acquisition performance targets) are recognised in P/L. IFRS 16 deals with similar issue and states that variable lease payments that depend on future activity of a lessee or an underlying asset are not included in the measurement of lease liability and right-of-use asset, they are recognised in P/L in the period in which the event or condition that triggers those payments occurs (see more discussion on variable lease payments).
So these are the two rather opposing approaches to this matter, i.e. recognise a liability at fair value at acquisition with the corresponding impact on the asset vs. do not recognise a liability at all. There is also a third approach possible, where any remeasurements of initially recognised contingent consideration could have a corresponding impact on the carrying amount of PP&E, similarly to changes in decommissioning provisions.
This matter is on the IASB’s agenda and until it is resolved the accounting should follow the commercial substance of the transaction and, to some degree, be an accounting policy choice at the discretion of the reporting entity.
Location and condition necessary to be capable of operating in the manner intended by management
Directly attributable costs can be recognised as PP&E up to the point when an item of PP&E is in the location and condition necessary for it to be capable of operating in the manner intended by management. Any costs incurred after that point are expensed in P/L as incurred. Examples of such costs include (IAS 16.20):
- repairs and maintenance,
- relocating the asset,
- reorganising operations in which the asset is used,
- 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,
- initial operating losses/ start-up phase losses.
Subsequent expenditure and replacement parts
IAS 16 does not contain any specific principles for subsequent expenditure on PP&E and, consequently, the general criteria apply. Therefore, for any subsequent expenditure to be recognised as an asset, there must be additional probable future economic benefit associated with this subsequent expenditure that will flow to the entity.
The decision on how to account for subsequent expenditure will often boil down to a question of whether an existing part of PP&E is replaced or a new element/function is created. IAS 16 is more specific with replacement parts, which are included in the cost of PP&E, but the parts being replaced must be derecognised (IAS 16.13). It will often be the case that an entity will not know what is the cost of the replaced part as it was never separated when PP&E was recognised (IAS 16 requires a separation of significant parts for depreciation purposes). In such a case, the entity must estimate this cost, e.g. based on the current cost, and derecognise the old part after taking into account accumulated depreciation.
Repairs and maintenance are recognised in P/L as incurred.
See more discussion on subsequent expenditure in IAS 16.BC5-BC12.
Acquisition of group of assets
Accounting for acquisition of a group of assets that do not constitute a business is covered in IFRS 3.
Minimum value per item of PP&E
Many entities adopted a practical expedient and consider expenditures on low value assets as one-off operating/revenue expenses, even if those expenditures meet all of the criteria for recognition as assets. Such an approach is not allowed by IFRS and it can be adopted on materiality grounds only.
Income generated during development of PP&E
The treatment of income generated during development of PP&E depends on whether this income was generated as a result of processes necessary to bring the asset to location and condition necessary for it to be capable of operating in the manner intended by management. If so, such income is deducted from the cost of PP&E. An example given in paragraph IAS 16.17(e) refers to income from selling samples produced when testing equipment. Another common example includes contractual penalties received from contractors constructing an asset, which should also be deducted from the cost of PP&E.
When income is generated as a result of operations that are not necessary to bring the asset to location and condition necessary for it to be capable of operating in the manner intended by management, they are recognised in P/L and not deducted from the cost of PP&E. As an example, paragraph IAS 16.21 refers to income earned through using a building site as a car park until construction of PP&E starts.
Amendment effective from 2022: IASB amended IAS 16 so that all income generated during development of PP&E will be recognised in P/L.
The estimate of the costs of dismantling and removing the item and restoring the site on which it is located is recognised as a provision and added to the cost of PP&E. This approach applies only to obligations arising:
- when PP&E is acquired or
- as a consequence of operating PP&E for purposes other than to produce inventories.
When the obligation arises when producing inventories, decommissioning costs are added to the costs of inventory.
More discussion on accounting for decommissioning provisions, including changes in their amount, can be found in IAS 37.
Costs of major inspections or overhauls
When regular inspections are necessary for continuing use of PP&E, their cost can be added to the cost of PP&E. Similarly to replacement parts, any remaining carrying amount of the cost of the previous inspection is derecognised. If necessary, the amount relating to previous inspection that is included in the carrying amount of PP&E should be estimated (IAS 16.14).
The costs of future inspections/ overhauls cannot be anticipated and recorded as liability even if they are required by law. Such future costs are not a present obligation.
Repairs and maintenance
Repairs and maintenance costs are expensed in P/L as incurred (IAS 16.12). It may not be obvious whether an expenditure is a repair only or it enhances the asset. See the discussion on subsequent expenditure.
When payment is deferred beyond normal credit terms, the cost of PP&E is the cash price equivalent at the recognition date (IAS 16.23). Unwinding of discount is recognised as expense, unless criteria for capitalisation of borrowing costs set out in IAS 23 are met. IAS 16 does not define normal credit terms, so it is a judgement of the reporting entity and it depends on the country and industry that the entity operates in.
Additionally, IAS 23 covers capitalisation (i.e. adding to the cost of an asset) of borrowing costs that are directly attributable to the acquisition or development of PP&E.
Exchange of assets
When an item of PP&E is acquired in exchange for a non-monetary asset (or a combination of monetary and non-monetary assets), the cost of such an item of PP&E is measured at fair value (IAS 16.24). The difference between the carrying amount of asset(s) given up and the fair value of asset acquired is recognised in P/L as a gain on disposal of the asset given up.
The fair value of the asset acquired is determined with reference to the fair value of asset given up, unless only the fair value of the asset received can be measured reliably or is more clearly evident (IAS 16.26). If the fair value of neither the asset received nor the asset given up is reliably measurable, the asset received is recognised at cost that is the same as the carrying amount of the asset given up (IAS 16.24). Fair value measurements are covered in IFRS 13.
When the exchange transaction lacks commercial substance, the cost of PP&E acquired is measured at the carrying amount of the asset given up and no gain/loss is recognised in P/L (IAS 26.24). Paragraph IAS 16.25 clarifies when an exchange transaction has commercial substance. In general, a commercial substance ‘test’ compares cash flows of the assets that were exchanged or the entity’s operations that were affected, before and after the exchange of assets. IAS 16 explains that the result of these analyses may be clear without an entity having to perform detailed calculations.
The cost of PP&E may be reduced due to government grants, which are covered in IAS 20.
More about IAS 16
See other pages relating to IAS 16:
IAS 16 Property, Plant and Equipment: Scope, Definitions and Disclosure
IAS 16: Cost of Property, Plant and Equipment
IAS 16 and IAS 38: Depreciation and Amortisation of Property, Plant and Equipment and Intangible Assets
IAS 16 and IAS 38: Revaluation Model for Property Plant and Equipment and Intangible Assets