FINANCIAL ACCOUNTING & REPORTING 1

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Property, Plant and Equipment (Part 1)

Module 022 Property, Plant and Equipment

(Part 1)

IAS 16 Property, Plant, and Equipment outline the accounting treatment for
most types of property, plant, and equipment.
Property, plant, and equipment (PPE) is initially measured at its cost,
subsequently measured either using a cost or revaluation model and
depreciated so that its depreciable amount is allocated on a systematic basis
over its useful life.
At the end of this module, you are expected to:
1. Define what is PPE, and know the nature and classes of PPE as set out in
IAS 16;
2. Enumerate the recognition principles of PPE; and
3. Apply the concepts related to the initial measurement of PPE when it is
acquired through a Cash purchase, Purchase on a deferred payment
contract, Issuance of securities, Donation or discovery, Self-construction,
Exchange of non-monetary and monetary assets)

Definition, nature, and classes

All PPE is within the scope of IAS 16 except as follows:

✓ When another standard requires or permits a different accounting treatment (for

example, IAS 40 for investment properties held at fair value);

✓ PPE is classified as held for sale in accordance with IFRS 5;

✓ biological assets related to agricultural activity (covered by IAS 41 – Agriculture) other

than bearer plants; and

✓ mineral rights and mineral reserves such as oil, gas, and similar 'non-regenerative'
resources. [IAS 16.2-3, 5].

Although the standard scopes out non-bearer plant biological assets and mineral
resources, it includes any PPE used in developing or maintaining such resources.

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 Based on IAS 16, Property, plant, and equipment are tangible assets that are:

✓ held by an enterprise for use in the production or supply of goods or services, for rental
to others, or for administrative purposes; and

✓ expected to be used during more than one period

Assets of this nature include:

✓ Property ordinarily not subject to depreciation or depletion, such as land;

✓ property subject to depreciation or amortization, such as land improvements, buildings,

machinery, equipment, furniture, improvements to leased facilities, bookplates, and
breeding animals; and

✓ property subject to depletion, such as timber tracts and mineral and oil deposits.

Recognition
An item of PPE should be recognized (i.e., its cost included as an asset in the statement of
financial position) only if it is probable that future economic benefits associated with
the item will flow to the entity and its cost can be measured reliably. This requirement
for recognition is directly taken from the IASB's Conceptual Framework for Financial
Reporting ('Framework').

▪ Spare parts and minor items

Items such as spare parts, stand-by equipment, and servicing equipment are
inventory unless they meet the definition of PPE.
Materiality judgments are considered when deciding how an item of PPE should be
accounted for. Major spare parts, for example, qualify as PPE, while smaller spares
would be carried as inventory, and as a practical matter, many companies have a
minimum value for capitalizing assets.
Some types of business may have a very large number of minor items of PPE, such as
spare parts, tools, pallets, and returnable containers, which nevertheless are used in
more than one accounting period. There are practical problems in recording them
on an asset-by-asset basis in an asset register; they are difficult to control and
frequently lost. The main consequence is that it becomes very difficult to depreciate
them. Generally, entities write off such immaterial assets as expenses in the period
of addition.
The standard notes that there are issues concerning what actually constitutes a
single item of PPE. The 'unit of measurement' for recognition is not prescribed, and
entities have to apply judgment in defining PPE in their individual circumstances.
The standard suggests that it may be appropriate to aggregate some parts (such as
tools, molds, and dies) and to apply the standard to the aggregate amount
(presumably without having to identify the individual assets). [IAS 16.9].
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Property, Plant and Equipment (Part 1)

▪ Environmental and safety equipment

The standard acknowledges that there may be expenditures forced upon an entity
by legislation that requires it to buy 'assets' that do not meet the recognition criteria
because the expenditure does not directly increase the expected future benefits
expected to flow from the asset. Examples would be safety or environmental
protection equipment. IAS 16 explains that these expenditures qualify for
recognition as they allow future benefits in excess of those that would flow if the
expenditure had not been made; for example, a plant might have to be closed down
if these environmental testing expenditures were not made.
An entity may voluntarily invest in environmental equipment even though it is not
required by law to do so. The entity can capitalize on those investments in
environmental and safety equipment in the absence of a legal requirement as long
as:
✓ the expenditure meets the definition of an asset; or
✓ there is a constructive obligation to invest in the equipment.
If the entity can demonstrate that the equipment is likely to increase the economic
life of the related asset, the expenditure meets the definition of an asset. Otherwise,
the expenditure can be capitalized when the entity can demonstrate all of the
following:
✓ the entity can prove that a constructive obligation exists to invest in
environmental and safety equipment (e.g., it is standard practice in the industry,
environmental groups are likely to raise issues, or employees demand certain
equipment to be present);
✓ the expenditure is directly related to the improvement of the asset's
environmental and safety standards; and
✓ the expenditure is not related to repairs and maintenance or forms part of
period costs or operational costs.

▪ Classification of items as inventory or PPE when minimum levels are maintained

Entities may acquire items of inventory on a continuing basis, either for sale in the
ordinary course of business or to be consumed in a production process or when
rendering services.
This means there will always be a core stock of that item (i.e., a minimum level of
inventory is maintained). This does not in itself turn that inventory into an item of
PPE since each individual item will be consumed within a single operating cycle.
However, there may be cases where it is difficult to judge whether an item is part of
inventory or is an item of PPE. This may have implications on measurement
because, for example, PPE has a revaluation option that is not available for
inventory.

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 In our view, an item of inventory is accounted for as an item of PPE if it:
✓ is not held for sale or consumed in a production process or during the process of
rendering services;
✓ is necessary to operate or benefit from an asset during more than one operating
cycle; and
✓ cannot be recouped through the sale (or is significantly impaired after it has
been used to operate the asset or benefit from that asset).
This applies even if the part of the inventory that is an item of PPE cannot be
physically separated from the rest of the inventories.

▪ Classification as PPE or intangible asset

The restrictions in IAS 38 – Intangible Assets – in respect of capitalizing on certain
internally-generated intangible assets focus attention on the treatment of many
internal costs. In practice, items such as computer software purchased by entities
are frequently capitalized as part of a tangible asset, for example, as part of an
accounting or communications infrastructure. Equally, internally written software
may be capitalized as part of a tangible production facility, and so on. Judgment
must be exercised in deciding whether such items are to be accounted for under IAS
16 or IAS 38, and this distinction becomes increasingly important if the two
standards prescribe differing treatments in any particular case. IAS 16, unlike IAS
38, does not refer to this type of asset. IAS 38 states that an entity needs to exercise
judgment in determining whether an asset that incorporates both intangible and
tangible elements should be treated under IAS 16 or as an intangible asset under IAS
38, for example:
✓ the computer software that is embedded in computer-controlled equipment that
cannot operate without that specific software is an integral part of the related
hardware and is treated as PPE;
✓ application software that is being used on a computer is generally easily
replaced and is not an integral part of the related hardware, whereas the
operating system normally is integral to the computer and is included in PPE;
and
✓ a database that is stored on a compact disc is considered to be an intangible
asset because the value of the physical medium is wholly insignificant compared
to that of the data collection.
✓

▪ Bearer plants
Bearer plants, defined as living plants that are used in the production or supply of
agricultural produce, are expected to bear produce for more than one period and
have a remote likelihood of being sold as a plant or harvested as agricultural
produce (except for incidental scrap sales such as for use as firewood).

Bearer plants are within the scope of IAS 16 and subject to all of the requirements
therein. This includes the ability to choose between the cost model and revaluation
model for subsequent measurement. Agricultural produce growing on bearer plants,
e.g., the fruit growing on a tree, remains within the scope of IAS 41, Biological assets.
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Property, Plant and Equipment (Part 1)

The following are not included within the definition of bearer plants:
✓ Plants are cultivated to be harvested as agricultural produce, e.g., trees are
grown for use as lumber;
✓ plants cultivated to produce agricultural produce when there is more than a
remote likelihood that the entity will also harvest and sell the plant as
agricultural produce, other than as incidental scrap sales, e.g., trees that are
cultivated both for their fruit and their lumber; and
✓ annual crops such as maize and wheat.
✓
Bearer plants are subject to the requirements of IAS 16, and so entities will need to
consider the correct unit of account, analyze which costs can be capitalized prior to
maturity, set useful lives for depreciation purposes, and consider the possibility of
impairment.

▪ Accounting for parts ('components') of assets

IAS 16 has a single set of recognition criteria, which means that subsequent
expenditure must also meet these criteria before it is recognized.
Parts of an asset are to be identified so that the cost of replacing a part may be
recognized (i.e., capitalized as part of the asset) and the previous part derecognized.
These parts are often referred to as 'components.' 'Parts' are distinguished from
day-to-day servicing, but they are not otherwise identified and defined; moreover,
the unit of measurement to which the standard applies (i.e., what comprises an item
of PPE) is not itself defined.
IAS 16 requires 'significant parts' of an asset to be depreciated separately. These are
parts that have a cost that is significant in relation to the total cost of the asset. An
entity will have to identify the significant parts of the asset on initial recognition in
order for it to depreciate the asset properly. There is no requirement to identify all
parts. IAS 16 requires entities to derecognize an existing part when it is replaced,
regardless of whether it has been depreciated separately, and allows the carrying
value of the part that has been replaced to be estimated, if necessary:

'If it is not practicable for an entity to determine the carrying amount of the replaced
part, it may use the cost of the replacement as an indication of what the cost of the
replaced part was at the time it was acquired or constructed.'
As a consequence, an entity may not actually identify the parts of an asset until it
incurs the replacement expenditure.

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Initial and subsequent expenditure
IAS 16 makes no distinction in principle between the initial costs of acquiring an asset and
any subsequent expenditure upon it. In both cases, any and all expenditure has to meet the
recognition rules and be expensed in profit or loss if it does not.
IAS 16 states:

'An entity evaluates under this recognition principle all its property, plant, and
equipment costs at the time they are incurred. These costs include costs incurred
initially to acquire or construct an item of property, plant, and equipment and costs
incurred subsequently to add to, replace part of, or service it.' [IAS 16.10].

The standard draws a distinction between servicing and more major expenditures. Day-to-
day servicing, which is meant the repair and maintenance of PPE, and which largely
comprises labor costs and minor parts, should be recognized in profit or loss as incurred.
However, if the expenditure involves replacing a significant part of the asset, this part
should be capitalized as part of the PPE if the recognition criteria are met. The carrying
amount of the part that has been replaced should be derecognized.
Initial measurement
IAS 16 draws a distinction between measurement at recognition (i.e., the initial recognition
of an item of PPE on acquisition) and measurement after recognition (i.e., the subsequent
treatment of the item).
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.
Elements of cost and cost measurement
IAS 16 sets out what constitutes the cost of an item of PPE 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.
The purchase price of an individual item of PPE 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 principles in IFRS 3 – Business Combinations – are applied
to allocate the entire cost to individual items.
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Property, Plant and Equipment (Part 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 the cost at initial recognition:
(a) costs of employee benefits (as defined in IAS 19 – Employee Benefits) arising
directly from the construction or acquisition of the item of property, plant, and
equipment. This means that the labor 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 PPE may be recognized;
(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); and
(f) professional fees.
Administration and other general overheads
Administration and other general overhead costs are not costs of an item of PPE.
This means that employee costs not related to a specific asset, such as site selection
activities and general management time, do not qualify for capitalization. Entities
are also not allowed to recognize so-called 'start-up costs as part of the item of PPE.
These include costs related to opening a new facility, expenditure incurred by an
entity to carry out a feasibility study or survey to decide whether to acquire,
construct or invest in an asset, and introducing a new product or service (including
costs of advertising and promotional activities), conducting business in a new
territory or with a new class of customer (including costs of staff training) and
similar items. These costs should be accounted for (in general, expensed as
incurred) in the same way as similar costs incurred as part of the entity's ongoing
activities.
Incidental and non-incidental income
Under IAS 16, the cost of an item of PPE includes 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 standard gives the example of income earned by using a building site as a car
park prior to starting construction. Because incidental operations such as these are
not required in order for the asset to be capable of operating in the manner
intended by management, the income and related expenses of incidental operations
are recognized in profit or loss and included in their respective classifications of
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 income and expense. Such incidental income is not offset against the cost of the
asset.
If, however, some income is generated wholly and necessarily as a result of the
process of bringing the asset into the location and condition for its intended use, for
example, from the sale of samples produced when testing the equipment concerned,
then the income should be credited to the cost of the asset.
On the other hand, if the asset is already in the location and condition necessary for
it to be capable of being used in the manner intended by management, then IAS 16
requires capitalization to cease and depreciation to start. In these circumstances, all
income earned from using the asset must be recognized as revenue in profit or loss,
and the related costs should include an element of depreciation of the asset.

▪ Acquisition of Multiple Assets

The aggregate price is allocated to individual assets based on the best available
indicator of relative values of assets, such as market value or current appraised
values. Costs directly attributable to specific assets are not allocated but rather
charged in full to such an asset.
Sample problem 1:
The lump sum purchase price of land, building, and equipment is P30 million.
Installation costs of the equipment were P500,000. Building renovation costs
amounted to P800,000.
Appraised values of the property at the time of acquisition were:
Land – P12.25 million; Building – P17.5 million; Equipment – P5.25 million

Allocation for multiple assets will be as follows:

Allocated costs Additional costs Total Costs
Land 30 M x 12.25/35 = 10.5M 0 P10,500,000
Building 30 M x 17.5/35 = 15 M 800,000 15,800,000
Equipment 30 M x 5.25/35 = 4.5 M 500,000 5,000,000
The assets will be recorded on the entity’s books at their total costs.

▪ Purchase on cash and on a deferred payment contract

IAS 16 specifically precludes the capitalization of hidden credit charges as part of
the cost of an item of PPE, so the cost of an item of PPE is its cash price equivalent at
the recognition date. This means that if payment is made in some other manner, the
cost to be capitalized is the normal cash price. Thus, if the payment terms are
extended beyond 'normal' credit terms, the cost to be recognized must be the cash
price equivalent, and any difference must be treated as an interest expense.
The cost of an asset acquired through a deferred payment plan is either of the
following, whichever is more objective and reliable.
✓ Cash equivalent price of the asset; or
✓ The present value of the future cash payments required by the debt arrangement
is discounted at the prevailing interest rate for that type of obligation.
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Sample problem 2: (Cash equivalent price is known; note issued is interest bearing)
The cash price of an equipment purchase is P 2,000,000. Cash paid at the time of
purchase is P 500,000, and the balance is payable in three equal annual payments
with interest at 10% on the unpaid balance.
The acquisition of the equipment and the payment of the note for the next three
years are recorded as follows:
Equipment P2,000,000
Cash 500,000
Notes payable 1,500,000

Notes payable P500,000

Interest expense (10% of 1,500,000) 150,000
Cash 650,000

Notes payable P500,000

Interest expense (10% of 1,000,000)100,000
Cash 600,000

Notes payable P500,000

Interest expense (10% of 500,000) 50,000
Cash 550,000

Sample problem 3: (Cash equivalent price is not known; note issued is interest bearing)
A piece of equipment is acquired, and the terms of the purchase are as follows:
Down payment of P500,000 and issued a 10% note with a face value of P1,500,000
payable after one year.
The cost of the asset is P2,000,000 ( P500,000 down payment plus P1,500,000 face
value of the interest-bearing note). Journal entries for the purchase of the
equipment and payment of the note in maturity are:
Equipment P2,000,000
Cash 500,000
Notes payable 1,500,000
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 Notes payable P1500,000
Interest expense (10% of 1,500,000) 150,000
Cash 1,650,000

Sample problem 4: (Cash equivalent price is not known; note issued is non-interest
bearing)
On April 30, 2017, a piece of equipment was acquired, and the terms of the purchase
were as follows: Down payment of P500,000 and issued non-interest bearing note
with a face value of P1,500,000 payable after one year. The prevailing interest rate
for a similar obligation is 10%. Assume that the company's accounting year ends on
December 31. The cost of the asset is P1,865,000, computed as follows:
Down payment P 500,000
Present value of the note (1,500,000x .9091) 1,363,650
Cost of equipment 1,863,650
The Journal entries to record the purchase of the equipment, year-end adjustment,
and payment of the note on maturity are:
Equipment P 1,863,650
Discount on notes payable 136,350
Cash 500,000
Notes payable 1500,000

Interest expense (136,350 x8/12) P 90,900

Discount on notes payable 90,900

Notes payable P 1,500,000

Interest expense (136,350 x 4/12) 45,450
Cash 1,500,000
Discount on notes payable 45,450

▪ Issuance of securities
The cost of an asset acquired by the issuance of securities is the asset's fair value. In
rare cases when the fair value of the asset received cannot be reliably determined,
reference is made to the fair value of the equity instruments issued.
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Property, Plant and Equipment (Part 1)

▪ Donation or discovery

Assets received as donations are recorded at the fair values at the time of donation.

If the donor is a shareholder, the donation is recorded by crediting an additional

paid-in capital account appropriately titled.

If the donor is a non-governmental unit other than a shareholder, a revenue or gain

is recognized at an amount equal to the value of the donated asset.
Assets acquired with the assistance of government grants.
The carrying amount of an item of PPE may be reduced by government grants in
accordance with IAS 20, Accounting for Government Grants, and Disclosure of
Government Assistance. If the asset is received from a government unit, the
company recognizes income over the periods necessary to match with the related
costs they are intended to compensate on a systematic basis. The amount may be
credited to a deferred credit amount, Unearned Income from Government Grant.

▪ Self-construction
If an asset is self-built by the entity, the same general principles apply to an acquired
asset. If the same type of asset is made for resale by the business, it should be
recognized at the cost of production, without including any profit element but
including attributable overheads.
The cost of a self-constructed asset includes all costs of materials, labor, and
overhead directly associated with the construction, as well as interest costs on
borrowing actually incurred during the construction period.
Profit from self-construction is not allowed to be recognized in the accounts. If the
actual construction cost is less than the normal cost of the asset (bid price or cash
purchase price), the profit emerges in the accounts through lesser depreciation
charges throughout the asset’s useful life.
Allocation of manufacturing overhead may be equivalent to
(1) its fair share, using the same basis of allocation for manufacturing inventory; or
(2) the incremental amount of indirect manufacturing overhead.

Borrowing costs
Borrowing costs must be capitalized in respect of certain qualifying assets if those
assets are measured at cost. Therefore, an entity will capitalize borrowing costs on a
self-constructed item of PPE if it meets the criteria in IAS 23 – Borrowing Costs. [IAS
16.22].
Entities are not required to capitalize on borrowing costs in respect of assets that
are measured at fair value. This includes revalued PPE, which is measured at fair

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value through Other Comprehensive Income ('OCI'). Generally, an item of PPE
within the scope of IAS 16 will only be carried at revalued amount once construction
is completed, so capitalization of borrowing costs will have ceased.
For disclosure purposes, an entity will still need to monitor the carrying amount of
PPE measured under the revaluation model, including those borrowing costs that
would have been recognized had such an asset been carried under the cost model.

Generally, borrowing costs are treated as expenses in the period incurred. However,
if the borrowing costs (interest cost) pertain to a borrowing that was utilized for
qualifying assets, the interest is capitalized and forms part of the asset cost. A
qualifying asset is a discrete project of an enterprise that takes a substantial period
of time to get ready for sale or use.
Specific borrowing
-The interest on specific borrowing actually incurred during the construction period
is capitalized. Any interest revenue on the temporary investments of those
borrowing proceeds is deducted.
-The average accumulated expenditures may not be calculated if the construction of
an asset is financed solely by a specific borrowing.
General borrowing
✓ Interest on the excess of the average accumulates expenditures over the amount
of the specific borrowing, if any, is capitalizable. If there is more than one general
borrowing, the weighted average interest rate is used.
✓ Computation of average accumulated expenditures (AAE).
When construction costs are incurred evenly during the construction period, the
AAE is computed by dividing the total expenditures by two (2).
Example: The total expenditures incurred evenly during the one-year construction
period is P 50 million. AAE is P 25 million, computed as P 50 million divided by 2.
When the expenditures were incurred on an uneven basis, the weighted average of
each expenditure is taken by considering the dates that they were incurred.
Example: The total expenditures incurred during the one-year construction period
is P 50 million as follows:
January 1 - P 15 million;
April 1- P 20 million;
August 1 - P 15 million
AAE is P 36.25 million computed as:
(P 15 million x 12/12) + (P 20 million x 9/12) + (P 15 million x 5/12).
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Income received during the construction of the property

One issue that commonly arises is whether rental and similar income generated by
existing tenants in a property development may be capitalized and offset against the
cost of developing that property.
The relevant question is whether the leasing arrangements with the existing tenants
are a necessary activity to bring the development property to the location and
condition necessary for it to be capable of operating in the manner intended by
management. Whilst the existence of the tenant may be a fact, it is not a necessary
condition for the building to be developed to the condition intended by
management; the building could have been developed in the absence of any existing
tenants.
Therefore, rental and similar income from existing tenants are incidental to the
development and should not be capitalized. Rather rental and similar income
should be recognized in profit or loss together with related expenses.
Liquidated damages during construction
Income may arise in other ways, for example, liquidated damages received as a
result of delays by a contractor constructing an asset. Normally such damages
received should be set off against the asset cost – the purchase price of the asset is
reduced to compensate for delays in delivery.
Land and buildings to be redeveloped.
It is common for property developers to acquire land with an existing building
where the planned redevelopment necessitates the demolition of that building and
its replacement with a new building that is to be held to earn rentals or will be
owner-occupied. Whilst IAS 16 requires that the building and land be classified as
two separate items, in our view, it is appropriate, if the existing building is unusable
or likely to be demolished by any party acquiring it, that the entire or a large part of
the purchase price be allocated to the land. Similarly, subsequent demolition costs
should be treated as being attributable to the cost of the land.
Owner-occupiers may also replace existing buildings with new facilities for their
own use or to rent to others. Here the consequences are different, and the carrying
amount of the existing building cannot be rolled into the costs of the new
development. The existing building must be depreciated over its remaining useful
life to reduce the carrying amount of the asset to its residual value (presumably nil)
at the point at which it is demolished. Many properties do not directly generate
independent cash inflows (i.e., they are part of a cash-generating unit), and reducing
the useful life will not necessarily lead to an impairment of the cash-generating unit,
although by the time the asset has been designated for demolition it may no longer
be part of a cash-generating unit.

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▪ Exchanges of non-monetary and monetary assets
An entity might swap an asset it does not require in a particular area; for one, it does
in another – the opposite being the case for the counterparty. The question arises
whether such transactions give rise to a gain in circumstances where the carrying
value of the outgoing facility is less than the fair value of the incoming one. This can
occur when carrying values are less than market values, although it is possible that a
transaction with no real commercial substance could be arranged solely to boost
apparent profits.
IAS 16 requires all acquisitions of PPE in exchange for non-monetary assets, or a
combination of monetary and non-monetary assets, to be measured at fair value,
subject to conditions:
'The cost of such an item of property, plant, and equipment is measured at fair value
unless
(a) the exchange transaction lacks commercial substance, or
(b) the fair value of neither the asset received nor the asset given up is reliably
measurable.
The acquired item is measured in this way even if an entity cannot immediately
derecognize the asset given up.' [IAS 16.24].
The IASB concluded that the recognition of income from an exchange of assets does
not depend on whether the assets exchanged are dissimilar. [IAS 16.BC19].
If at least one of the two fair values can be measured reliably, that value is used for
measuring the exchange transaction; if not, then the exchange is measured at the
carrying value of the asset the entity no longer owns.
This requirement is qualified by a 'commercial substance' test. [IAS 16.24]. If it is
not possible to demonstrate that the transaction has commercial substance as
defined by the standard, assets received in exchange transactions will be recorded
at the carrying value of the asset given up.
If the transaction passes the 'commercial substance' test, then IAS 16 requires the
exchanged asset to be recorded at its fair value.

Commercial substance
The commercial substance test was put in place as an anti-abuse provision to
prevent gains in income from being recognized when the transaction had no
discernible effect on the entity's economics.
The commercial substance of an exchange is to be determined by forecasting and
comparing the future cash flows budgeted to be generated by the incoming and
outgoing assets. For there to be commercial substance, there must be a significant
difference between the two forecasts.
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The standard sets out this requirement as follows:

'An entity determines whether an exchange transaction has commercial substance
by considering the extent to which its future cash flows are expected to change as a
result of the transaction. An exchange transaction has commercial substance if:
(a) the configuration (risk, timing, and amount) of the cash flows of the asset
received differs from the configuration of the cash flows of the asset transferred; or
(b) the entity-specific value of the portion of the entity's operations affected by the
transaction changes as a result of the exchange; and
(c) the difference in (a) or (b) is significant relative to the fair value of the assets
exchanged.'
Care will have to be taken to ensure that the transaction has commercial substance
as defined in the standard if an entity receives a similar item of property, plant, and
equipment in exchange for a similar asset of its own.
Reliably measurable
In the context of asset exchanges, the standard contains guidance on the reliable
determination of fair values in circumstances where market values do not exist.
Note that while fair value is defined by reference to IFRS 13, these requirements are
specific to asset exchanges in IAS 16.
'The fair value of an asset for which comparable market transactions do not exist is
reliably measurable if
(a) the variability in the range of reasonable, fair value estimates is not significant
for that asset, or
(b) the probabilities of the various estimates within the range can be reasonably
assessed and used in estimating fair value.
If an entity is able to measure reliably the fair value of either the asset received or
the asset given up, then the fair value of the asset given up is used to measure the
cost of the asset received unless the fair value of the asset received is more clearly
evident.'.
If the fair value of neither the asset given up nor the asset received can be measured
reliably (i.e., neither (a) nor (b) above are met), the cost of the asset is measured at
the carrying amount of the asset given up; this means there is no gain on the
transaction.
No guidance is given in IAS 16 on how to assemble a 'range of reasonable, fair value
estimates.

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Glossary
Carrying amount: Amount at which an asset is recognized after deducting any
accumulated depreciation and accumulated impairment losses.
Cost: Amount of cash or cash equivalents paid or the fair value of other consideration
given to acquire an asset at the time of its acquisition or construction or, where
applicable, the amount attributed to that asset when initially recognized in accordance
with the specific requirements of other IFRSs, e.g., IFRS 2 – Share-based Payment.
Depreciable amount: Cost of an asset, or other amount substituted for cost, less its
residual value.
Depreciation: The systematic allocation of the depreciable amount of an asset over its
useful life.
Entity-specific value: The present value of the cash flows an entity expects to arise from
the continuing use of an asset and from its disposal at the end of its useful life or expects
to incur when settling a liability.
Fair value: The price that would be received to sell an asset or paid to transfer a liability
in an orderly transaction between market participants at the measurement date.
Impairment loss: The amount by which the carrying amount of an asset exceeds its
recoverable amount.
Recoverable amount: The higher an asset's fair value, the fewer costs to sell and its
value in use.
Residual value: The estimated amount that an entity would currently obtain from the
disposal of the asset, after deducting the estimated costs of disposal, if the asset were
already of age and in the condition expected at the end of its useful life.
Useful life:
(a) the period over which an asset is expected to be available for use by an entity; or
(b) the number of production or similar units expected to be obtained from the asset by
an entity.
 FINANCIAL ACCOUNTING & REPORTING 1
17
Property, Plant and Equipment (Part 1)

References and Supplementary Materials

Books and Journals
IAS 16, Property, Plant and Equipment
Cabrera, M. B., & Ocampo, R. R. (n.d.). Financial Accounting & Reporting - Standards &
Application (2014-2015 ed., Vol. 2). Manila, Philippines.
Robles, N. S., & Empleo, P. M. (2014). Intermediate Accounting (2014 ed., Vol. 1). Manila,
Philippines.
Valix, C. T., Peralta, J. F., & Valix, C. M. (2017). Financial Accounting (2017 ed., Vol. 2).Manila,
Philippines.

Online Supplementary Reading Materials

1. IAS 16 — Property, Plant, and Equipment
http://www.ifrs.org/issued-standards/list-of-standards/ias-16-property-plant-and-
equipment/ ; October 10, 2017

2. The Reporting of Property and Equipment;

http://open.lib.umn.edu/financialaccounting/chapter/10-1-the-reporting-of-property-
and-equipment/; October 23, 2017

3. Reporting Land Improvements and Impairments in the Value of Property and

Equipment; http://open.lib.umn.edu/financialaccounting/chapter/10-6-reporting-
land-improvements-and-impairments-in-the-value-of-property-and-equipment/;
October 23, 2017

4. Depreciation, impairments, and depletion;

https://www.accountingformanagement.org/explanation/depreciation-impairments-
and-depletion/; October 23, 2017

Online Instructional Videos

1. IAS 16 Property, Plant and Equipment - Summary;
https://www.youtube.com/watch/VgP1kakxmB4; 23 October 2017
2. Introduction to PPE: http://www.investopedia.com/video/play/property-plant-and-
equipment-ppe/; October 10, 2017
3. In a Set of Financial Statements, What Information Is Conveyed about Property and
Equipment?; http://open.lib.umn.edu/financialaccounting/part/chapter-10-in-a-set-of-
financial-statements-what-information-is-conveyed-about-property-and-equipment/;
October 10, 2017
4. IAS 16 - Property, plant and Equipment / Exchanges of assets;
https://www.youtube.com/watch/ScjB-9mgKIk; 23 October 2017
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