Property, plant and equipment (Note 10) [extract]
Costs of major maintenance activities are capitalized and depreciated over the estimated useful life. Maintenance
costs which cannot be separately defined as a component of property, plant and equipment are expensed in the
period in which they occur.
Under IFRS 16 lessees are required to recognise most leases in their statement of
financial position as lease liabilities with corresponding right-of-use assets.
Paragraph 10 of IAS 16 (described above) clarifies that the cost of an item of PP&E may
include costs incurred relating to leases of assets that are used to construct, add to,
replace part of or service an item of PP&E, such as depreciation of right-of-use assets.
3.3.1
Types of parts
IAS 16 identifies two particular types of parts of assets. The first is an item that requires
replacement at regular intervals during the life of the asset such as relining a furnace
after a specified number of hours of use, or replacing the interiors of an aircraft (e.g.
seats and galleys) several times during the life of the airframe. The second type involves
less frequently recurring replacements, such as replacing the interior walls of a building,
or to make a nonrecurring replacement. The standard requires that under the
recognition principle described at 3 above, an entity recognises in the carrying amount
of an item of PP&E the cost of replacing part of such an item when that cost is incurred
and the recognition criteria are met while derecognising the carrying amount of the
parts that have been replaced (see 7 below). [IAS 16.13].
IAS 16 does not state that these replacement expenditures necessarily qualify for
recognition. Some of its examples, such as aircraft interiors, are clearly best treated as
separate assets as they have a useful life different from that of the asset of which they
are part. With the other examples, such as interior walls, it is less clear why they meet
the recognition criteria. However, replacing internal walls or similar expenditures may
extend the useful life of a building while upgrading machinery may increase its capacity,
improve the quality of its output or reduce operating costs. Hence, this type of
expenditure may give rise to future economic benefits.
1308 Chapter 18
This parts approach is illustrated by British Airways Plc in Extract 18.4 below and by
Skanska in Extract 18.7 below.
Extract 18.4: British Airways Plc (2017)
Notes to the financial statements [extract]
2 Significant
accounting
policies [extract]
Property, plant and equipment [extract]
b Fleet
All aircraft are stated at the fair value of the consideration given after taking account of manufacturers’ credits.
Fleet assets owned, or held on finance leases, are depreciated at rates calculated to write down the cost to the
estimated residual value at the end of their planned operational lives (which is the shorter of their useful life or lease term) on a straight-line basis. Depreciation rates are specific to aircraft type, based on the Group’s fleet plans, within overall parameters of seven and 29 years. For engines maintained under ‘pay-as-you-go’ contracts, the depreciation
lives and residual values are the same as the aircraft to which the engines relate. For all other engines, the engine
core is depreciated to its residual value over the average remaining life of the related fleet.
Cabin interior modifications, including those required for brand changes and relaunches, are depreciated over the
lower of five years and the remaining economic life of the aircraft.
Aircraft and engine spares acquired on the introduction or expansion of a fleet, as well as rotable spares purchased
separately, are carried as property, plant and equipment and generally depreciated in line with the fleet to which
they relate.
Major overhaul expenditure, including replacement spares and labour costs, is capitalised and amortised over the
average expected life between major overhauls. All other replacement spares and other costs relating to maintenance
of fleet assets (including maintenance provided under ‘pay-as-you-go’ contracts) are charged to the income
statement on consumption or as incurred respectively.
Note that ‘Pay-as-you-go’ contracts are not described in the financial statements above.
These are comprehensive turbine engine maintenance and overhaul contracts, usually
based on a fixed hourly fee for each hour flown and including loan engines when required.
3.3.2 Major
inspections
The standard also allows a separate part to be recognised if an entity is required to
perform regular major inspections for faults, regardless of whether any physical parts of
the asset are replaced. [IAS 16.14].
The reason for this approach is to maintain a degree of consistency with IAS 37 –
Provisions, Contingent Liabilities and Contingent Assets – which forbids an entity to
make provisions if there is no obligations. Therefore an entity is prohibited by IAS 37
from making, for example, a provision to overhaul an owned aircraft engine by annually
providing for a quarter of the cost for four years and then utilising the provision when
the engine is overhauled in the fourth year. [IAS 37 IE Example 11A, 11B]. This had been a
common practice in the airline and oil refining industries, although it had never been
universally applied in either sector; some companies accounted for the expenditure
when incurred, others capitalised the cost and depreciated it over the period until the
next major overhaul – as illustrated in Extract 18.4 above.
IAS 16 applies the same recognition criteria to the cost of major inspections. Inspection
costs are not provided for in advance, rather they are added to the asset’s cost if the
Property, plant and equipment 1309
recognition criteria are satisfied and any amount remaining from the previous
inspection (as distinct from physical parts) is derecognised. This process of recognition
and derecognition should take place regardless of whether the cost of the previous
inspection was identified (and considered a separate part) when the asset was originally
acquired or constructed. Therefore, if the element relating to the inspection had
previously been identified, it would have been depreciated between that time and the
current overhaul. However, if it had not previously been identified, the recognition and
derecognition rules still apply, but the standard allows the estimated cost of a future
similar inspection to be used as an indication of what the cost of the existing inspection
component was when the item was acquired or constructed that must be derecognised.
[IAS 16.14]. This appears to allow the entity to reconstruct the carrying amount of the
previous inspection (i.e. to estimate the net depreciated carrying value of the previous
inspection that will be derecognised) rather than simply using a depreciated
replacement cost approach.
4
MEASUREMENT AT RECOGNITION
IAS 16 draws a distinction between measurement at recognition (i.e. the initial
recognition of an item of PP&E on acquisition) and measurement after recognition (i.e.
the subsequent treatment of the item). Measurement after recognition is discussed at 5
and 6 below.<
br />
The standard states that ‘an item of property, plant and equipment that qualifies for
recognition as an asset shall be measured at its cost’. [IAS 16.15]. What may be included in
the cost of an item is discussed below.
4.1
Elements of cost and cost measurement
IAS 16 sets out what constitutes the cost of an item of PP&E on its initial recognition,
as follows:
‘The cost of an item of property, plant and equipment comprises:
(a) its purchase price, including import duties and non-refundable purchase taxes,
after deducting trade discounts and rebates.
(b) 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.
(c) the initial estimate of the costs of dismantling and removing the item and restoring
the site on which it is located, the obligation for which an entity incurs either when
the item is acquired or as a consequence of having used the item during a particular
period for purposes other than to produce inventories during that period.’
[IAS 16.16].
The purchase price of an individual item of PP&E may be an allocation of the price paid
for a group of assets. If an entity acquires a group of assets that do not comprise a
business (‘the group’), the principles in IFRS 3 – Business Combinations – are applied
to allocate the entire cost to individual items (see Chapter 9 at 2.2.2). In such cases the
acquirer should identify and recognise the individual identifiable assets acquired
(including those assets that meet the definition of, and recognition criteria for, intangible
1310 Chapter 18
assets in IAS 38) and liabilities assumed. The cost of the group should be allocated to
the individual identifiable assets and liabilities on the basis of their relative fair values at
the date of purchase. Such a transaction or event does not give rise to goodwill.
[IFRS 3.2(b)]. In its June 2017 meeting, the Interpretations Committee considered two
possible ways of applying the requirements in paragraph 2(b) of IFRS 3 (as described
above) on the acquisition of the group particularly when the sum of individual fair values
of the identifiable assets and liabilities is different from the transaction price and the
group includes identifiable assets and liabilities initially measured both at cost and at an
amount other than cost.1 These two approaches are discussed in detail in Chapter 9
at 2.2.2. See also similar discussion relating to investment property in Chapter 19 at 4.1.1.
If an asset is used to produce inventories during a particular period, the costs of
obligations that are incurred during that period to dismantle, remove or restore the site
on which such asset has been located are dealt with in accordance with IAS 2, as a
consequence of having used the asset to produce inventories during that period (see
Chapter 22). [IAS 16.18].
Note that all site restoration costs and other environmental restoration and similar costs
must be estimated and capitalised at initial recognition, in order that such costs can be
recovered over the life of the item of PP&E, even if the expenditure will only be
incurred at the end of the item’s life. The obligations are calculated in accordance with
IAS 37 and IFRIC 1 – Changes in Existing Decommissioning, Restoration and Similar
Liabilities (see 4.3 below and Chapter 27 at 4 and 6.3). [IAS 16.18]. This is illustrated in
Extract 18.5 below.
Extract 18.5: E.ON SE (2017)
Notes [extract]
(1)
Summary of Significant Accounting Policies [extract]
Property, Plant and Equipment [extract]
Property, plant and equipment are initially measured at acquisition or production cost, including decommissioning
or restoration cost that must be capitalized, and are depreciated over the expected useful lives of the components,
generally using the straight-line method, unless a different method of depreciation is deemed more suitable in certain
exceptional cases.
Provisions for Asset Retirement Obligations and Other Miscellaneous Provisions [extract]
Obligations arising from the decommissioning or dismantling of property, plant and equipment are recognized
during the period of their occurrence at their discounted settlement amounts, provided that the obligation can be
reliably estimated. The carrying amounts of the respective property, plant and equipment are increased by the same
amounts. In subsequent periods, capitalized asset retirement costs are amortized over the expected remaining useful
lives of the assets, and the provision is accreted to its present value on an annual basis.
A common instance of (c) above is dilapidation obligations in lease agreements, under
which a lessee is obliged to return premises to the landlord in an agreed condition.
Arguably, a provision is required whenever the ‘damage’ is incurred. Therefore, if a
retailer rents two adjoining premises and knocks down the dividing wall to convert the
premises into one and has an obligation to make good at the end of the lease term, the
tenant should immediately provide for the costs of so doing. The ‘other side’ of the
provision entry is an asset that will be amortised over the lease term, notwithstanding
Property, plant and equipment 1311
the fact that some of the costs of modifying the premises may also have been capitalised
as leasehold improvement assets. This is discussed in more detail in Chapter 27 at 6.9.
4.1.1
‘Directly attributable’ costs
This is the key issue in the measurement of cost. The standard gives examples of types
of expenditure that are, and are not, considered to be directly attributable. The
following are examples of those types of expenditure that are considered to be directly
attributable and hence may be included in cost at initial recognition: [IAS 16.17]
(a) costs of employee benefits (as defined in IAS 19 – Employee Benefits) arising
directly from the construction or acquisition of the item of PP&E. This means that
the labour costs of an entity’s own employees (e.g. site workers, in-house architects
and surveyors) arising directly from the construction, or acquisition, of the specific
item of PP&E may be recognised;
(b) costs of site preparation;
(c) initial delivery and handling costs;
(d) installation and assembly costs;
(e) costs of testing whether the asset is functioning properly, after deducting the net
proceeds from selling any items produced while bringing the asset to that location
and condition such as samples produced when testing equipment (see 4.2.1 below);
and
(f) professional
fees.
Income received during the period of construction of PP&E is considered further
in 4.2.2 below.
The cost of an item of PP&E may include costs incurred relating to leases of assets that
are used to construct, add to, replace part of or service an item of PP&E, such as
depreciation of right-of-use assets (see 3.3 above), if those lease costs are ‘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’. [IAS 16.16].
Also, under IFRS 16, lessees are required to
recognise all leases in their statement of
financial position as lease liabilities with corresponding right-of-use assets, except for
short-term leases and low-value assets if they choose to apply such exemptions.
4.1.2 Borrowing
costs
Borrowing costs must be capitalised in respect of certain qualifying assets, if those assets
are measured at cost. Therefore, an entity will capitalise borrowing costs on a self-
constructed item of PP&E if it meets the criteria in IAS 23 – Borrowing Costs, as
discussed at 4.1.5 below. [IAS 16.22].
Entities are not required to capitalise borrowing costs in respect of assets that are
measured at fair value. This includes revalued PP&E which is measured at fair value
through Other Comprehensive Income (‘OCI’). Generally, an item of PP&E within scope
of IAS 16 will only be carried at revalued amount once construction is completed, so
capitalisation of borrowing costs will have ceased (see 4.1.4 below). This is not necessarily
the case with investment property in the course of construction (see Chapter 19 at 2.5).
1312 Chapter 18
The cost of the asset, before adopting a policy of revaluation, will include capitalised
borrowing costs. However, to the extent that entities choose to capitalise borrowing costs
in respect of assets still in the course of construction that are carried at fair value, the
methods allowed by IAS 23 should be followed. The treatment of borrowing costs is
discussed separately in Chapter 21.
For disclosure purposes, an entity will still need to monitor the carrying amount of PP&E
measured under revaluation model, including those borrowing costs that would have been
recognised had such an asset been carried under the cost model (see 8.2 below).
4.1.3
Administration and other general overheads
Administration and other general overhead costs are not costs of an item of PP&E. This
means that employee costs not related to a specific asset, such as site selection activities
and general management time do not qualify for capitalisation. Entities are also not
allowed to recognise so-called ‘start up costs’ as part of the item of PP&E. These include
costs related to opening a new facility, introducing a new product or service (including
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