The cost of property, plant and equipment (also known as ‘PP&E’) is composed of the following elements according to IAS 16.16:
- The purchase price, which includes import duties and non-refundable purchase taxes. Trade discounts and rebates should be deducted from this amount.
- 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 costs associated with the eventual removal and dismantling of the item, and the restoration of the site where it’s located.
Let’s dive in.
Directly attributable costs
IAS 16.17 provides a list of examples for costs that can be directly attributed to the acquisition or construction of PP&E. Note, these costs are not necessarily incremental. Examples of such costs include:
- Labour expenses, as outlined in IAS 19, incurred during the construction or acquisition of an asset.
- Direct materials used in construction.
- A systematic allocation of variable and fixed production overheads.
- Delivery expenses.
- Site inspection and preparation charges.
- Installation fees.
- Costs associated with testing the asset’s functionality.
- Professional fees, for instance, legal fees or stamp duty.
Contractual penalties received from contractors involved in constructing an asset are typically subtracted from the cost of PP&E.
For self-constructed assets, IAS 2 is particularly useful, given its focus on internally produced assets (IAS 16.22).
Costs 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 charged to P/L as incurred. Examples of such costs can be found in IAS 16.19.
The following are typical costs associated with the acquisition or construction of PP&E, yet they are not included in its cost:
- Some costs incurred prior to the asset’s acquisition or construction.
- Warranties or guarantees classified as distinct services.
- Abnormal quantities of wasted materials, labour or other resources.
- Advertising and promotional costs.
- General administrative expenses.
- Initial operating losses.
- Training costs.
- Setting up a temporary location during the development of an existing location.
- Salaries and wages of employees rendered idle due to the relocation or development of existing PP&E.
- Termination benefits paid to employees as a result of acquiring PP&E that replaces their roles.
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Costs incurred before the asset is acquired or constructed
A considerable degree of judgement is required when determining the treatment of costs incurred before the asset’s acquisition or the commencement of construction. Any costs related to a research phase, during which the entity doesn’t know specifically which asset will be acquired or how it will be developed, should be expensed in P/L as incurred. This is because such costs do not contribute to the future economic benefits of the specific asset that will eventually be acquired or developed.
Variable and contingent consideration
Certain payments for PP&E are not predetermined but rather contingent on future events. A typical example is contingent payments that are dependent on the future performance of the asset.
The initial matter to consider is whether this variable or contingent part of the consideration should be recognised as a liability. Some parallels can be drawn from IFRS 3, which mandates the recognition of a liability for contingent consideration (for an acquired business) at fair value. Subsequently, changes resulting from events after the acquisition date (such as meeting post-acquisition performance targets) are recognised in P/L.
IFRS 16 addresses a similar issue, stating that variable lease payments dependent on a lessee’s future activity or an underlying asset are not included in the measurement of lease liability and right-of-use asset. Instead, they are recognised in P/L in the period in which the triggering event or condition occurs.
These two contrasting approaches to the issue are to either recognise a liability at fair value at acquisition, with a corresponding impact on the asset, or not to recognise a liability at all. There is also a third possible approach: any remeasurements of the initially recognised contingent consideration could have a corresponding impact on the carrying amount of PP&E, in a manner similar to changes in decommissioning provisions under IFRIC 1.
This issue is on the IASB’s agenda. Until it’s resolved, the accounting should reflect the commercial substance of the transaction and, to an extent, be a matter of 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 part of the PP&E up until the point when the item is in the location and condition necessary for it to be capable of operating in the manner intended by management. Costs incurred beyond that point are charged to P/L as they occur.
Such costs can include (IAS 16.20):
- Repairs and maintenance.
- Relocation of the asset.
- Reorganisation of operations in which the asset is deployed.
- Costs incurred while an item capable of operating as intended by management is yet to be put into use or is operating at less than full capacity,
- Initial operating or start-up phase losses.
Subsequent expenditure and spare parts
IAS 16 does not provide specific principles concerning subsequent expenditure on PP&E. Therefore, the general criteria apply. To recognise any subsequent expenditure as an asset, there needs to be a probable future economic benefit associated with this expenditure flowing to the entity.
The decision on accounting for subsequent expenditure frequently depends on whether an existing part of PP&E is replaced or if new functionality is added. IAS 16 gives more specific direction with spare parts, which are incorporated into the cost of PP&E. However, the replaced parts must be derecognised (IAS 16.13). Often, an entity may not know the cost of the replaced part, as it wasn’t separated when the PP&E was recognised (IAS 16 necessitates a separation of significant parts for depreciation purposes). In this instance, the entity must estimate this cost, for example, based on the current cost, and derecognise the old part, taking into account accumulated depreciation.
Repair and maintenance costs are recognised in P/L as they are incurred. For further discussion on subsequent expenditure, please refer to IAS 16.BC5-BC12.
Acquisition of group of assets
The accounting for the acquisition of a group of assets that do not constitute a business is addressed in IFRS 3.
Minimum value per item of PP&E
Many entities have adopted a practical approach and categorise expenditures on low-value assets as one-time operating/revenue expenses, even if those expenditures fulfil all the criteria for asset recognition. Such a method is not permitted by IFRS and can only be adopted on the basis of materiality.
Income generated during development of PP&E
Income generated during the development of PP&E is recognised in P/L rather than being deducted from the cost of PP&E (IAS 16.20A-21).
Decommissioning costs
The estimated costs of dismantling and removing the item, and restoring the site on which it’s located, are recognised as a provision and added to the cost of PP&E (IAS 16.16(c)). When obligations arise during inventory production, decommissioning costs are added to inventory costs. Please see this discussion on accounting for decommissioning provisions, including changes in their amount.
Costs of major inspections or overhauls
If regular inspections are needed for the continued use of PP&E, their costs can be added to the cost of PP&E. Similar to spare parts, any remaining carrying amount from the cost of the previous inspection is derecognised. If necessary, the amount associated with the previous inspection included in the carrying amount of PP&E should be estimated (IAS 16.14).
The costs of future inspections or overhauls cannot be anticipated and recognised as a liability, even if they are legally required. Such future costs do not constitute a present obligation.
Repairs and maintenance
Repairs and maintenance costs are treated as expenses in P/L as they occur, according to IAS 16.12. However, it may not always be clear if an expenditure is merely a repair or it enhances the asset. Please refer to the discussion on subsequent expenditure for further details.
Borrowing costs
When payment is deferred beyond standard credit terms, the cost of PP&E is recognised as the cash price equivalent at the date of initial recognition (IAS 16.23). Note that this amount is different from discounting the future cash flows using a market rate of interest.
The unwinding of discount is recognised as finance costs unless it meets the criteria for capitalisation of borrowing costs set out in IAS 23. It’s worth noting that IAS 16 doesn’t define standard credit terms. Therefore, it’s up to the reporting entity’s judgement, which can depend on the industry and country in which the entity operates.
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 is measured at fair value (IAS 16.24). The difference between the carrying amount of the assets given up and the fair value of the asset acquired is recognised in P/L as a gain on the disposal of the asset given up.
The fair value of the acquired asset is determined with reference to the fair value of asset given up, unless the fair value of the asset received can be measured more reliably or is more clearly evident (IAS 16.26). If the fair value of neither the received asset nor the given-up asset can be reliably measured, the received asset is recognised at the cost that is the same as the carrying amount of the given-up asset (IAS 16.24). Fair value measurements are covered in IFRS 13.
When an exchange transaction lacks commercial substance, the cost of the PP&E acquired is measured at the carrying amount of the given-up asset, and no gain or loss is recognised in P/L (IAS 26.24). IAS 16.25 clarifies when an exchange transaction has commercial substance. Generally, a commercial substance ‘test’ compares the cash flows of the exchanged assets or the affected entity’s operations before and after the asset exchange. IAS 16 explains that detailed calculations may not be necessary if the result of these analyses is clear.
Government grants
The cost of PP&E can be reduced by 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 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