INSTITUTE OF ACCOUNTANCY ARUSHA

CERTIFIED PROFESSIONAL BANKING (CPB)

FINANCIAL ANALYSIS
TOPIC: IAS 16 – PROPERTY, PLANT & EQUIPMENT (PPE)
Definition

Property, plant and equipment as tangible items that:

• are held for use in the production or supply of goods or services, for rental to
others, or for administrative purposes.
• are expected to be used during more than one period.

Tangible items have physical substance.

Initial recognition

An item of property, plant and equipment should be recognised as an asset when:

• it is probable that the asset's future economic benefits will flow to the entity
• the cost of the asset can be measured reliably.

Property, plant and equipment should initially be measured at its cost. This comprises:
• the purchase price
• costs that are directly attributable to bringing the asset to the necessary location and
condition
• the estimated costs of dismantling and removing the asset, including any site
restoration costs. This might apply where, for example, an entity has to recognise a
provision for the cost of decommissioning an oil rig or a nuclear power station.

Measurement models

There are two models:

• the cost model
• the revaluation model.

Cost model

Under the cost model, property, plant and equipment is held at cost less any accumulated
depreciation and impairment losses.

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Revaluation model

Under the revaluation model, property, plant and equipment is carried at fair value less any
subsequent accumulated depreciation and impairment losses.
If the revaluation model is adopted, then the following rules apply:
• Revaluations must be made with 'sufficient regularity' to ensure that the carrying
amount does not differ materially from the fair value at each reporting date.
• If an item is revalued, the entire class of assets to which the item belongs must be
revalued.
• If a revaluation increases the value of an asset, the increase is presented as other
comprehensive income (and disclosed as an item that will not be recycled to profit or
loss in subsequent periods) and held in a 'revaluation surplus' within other components
of equity.
• If a revaluation decreases the value of the asset, the decrease should be recognised
immediately in profit or loss, unless there is a revaluation reserve representing a
surplus on the same asset.

Depreciation

The key principles with regards to depreciation are as follows:

• All property, plant and equipment with a finite useful life must be depreciated. The
depreciable amount of an asset is its cost less its residual value.
• Residual value is an estimate of the net selling proceeds received if the asset was at
the end of its useful life and was disposed of today.
• Depreciation is charged to the statement of profit or loss.
• Depreciation begins when the asset is available for use and continues until the asset
is derecognised.
• Depreciation must be allocated on a systematic basis, reflecting the pattern in which
the asset's future economic benefits are expected to be consumed.
• The depreciation method, residual value and the useful life of an asset should be
reviewed annually and revised if necessary. Any adjustments are accounted for as a
change in accounting estimate.

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Derecognition

An asset should be derecognised when disposal occurs, or if no further economic benefits are
expected from the asset's use or disposal.
• The gain or loss on derecognition of an asset is the difference between the net disposal
proceeds, if any, and the carrying amount of the item.
• When a revalued asset is disposed of, any revaluation surplus may be transferred
directly to retained earnings, or it may be left in the revaluation surplus within other
components of equity.

Disclosures

Entities are required to disclose:

• measurement bases used
• useful lives and depreciation rates
• a reconciliation of carrying amounts at the beginning and end of the period.

If items of property, plant and equipment are stated at revalued amounts, information about
the revaluation should also be disclosed.

REVIEW QUESTIONS

QUESTION ONE

A&B incurs the following costs in relation to the construction of a new factory and the
introduction of its products to the local market.
Tsh.’000’
Site preparation costs 240
Materials used 1,500
Labor costs, including Tsh. 90,000 incurred during an industrial dispute. No construction
occurred during the period of the dispute. 3,190 Testing of
various processes in factory 150
Consultancy fees re installation of equipment 220
Relocation of staff to new factory 110
General overheads 500
Costs to dismantle the factory at end of its useful life in 10 years’ time 100 Required:
How much of the costs should be capitalized?

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 QUESTION TWO
Cap bought a building on 1 January 20X1. The purchase price was $2.9m, associated legal
fees were $0.1m and general administrative costs allocated to the purchase were $0.2m.
Cap also paid sales tax of $0.5m, which was recovered from the tax authorities.
The building was attributed a useful life of 50 years. It was revalued to $4.6m on 31
December 20X4 and was sold for $5m on 31 December 20X5.
Cap purchased a machine on 1 January 20X3 for $100,000 and attributed it with a useful
life of 10 years. On 1 January 20X5, Cap reduced the estimated remaining useful life to 4
years.
Required:
Explain how the above items of property, plant and equipment would have been accounted
for in all relevant reporting periods up until 31 December 20X5.

QUESTION THREE
The accountant of Simplex Cosmetics LLC informs the board that profits of the company
for 20X6 are much lower than expected due to heavy repairs and maintenance expenses. An
analysis of the repairs and maintenance account shows that it included:
(a) Upgrade of machinery, increasing its production capacity by 10% to Tshs175 million.
(b) Tshs 62.5 million for the replacement of major worn-out components in an old piece of
machinery. (You receive additional information that the carrying value of the old parts was
Tshs7 million. It was sold as scrap and the proceeds of Tshs4 million were credited to the
sales account.)
(c) Servicing costs: Sundry materials of Tshs 8 million and wages of Tshs1 million.
(d) Simplex Cosmetics borrowed Tshs200 million @ 10% from a financial institution for
general business. However, this loan was also used for financing the upgrading of
machinery to the tune of Tshs175 million.

The total interest of Tshs200 million was expensed to the statement of profit or loss.
Included in it was interest attributable to the upgrading of Machinery of Tshs12.52 million.
Required: Advice the accountant as to whether, these expenses are shown correctly.

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 QUESTION FOUR

Do the following classify as an asset or liability within the definitions given by the
Framework? Give reasons.

a) Mitchell Ltd has purchased machinery for Tshs100 million. It also purchased a patent for
Tshs10 million. The patent will give the company exclusive use of a particular
manufacturing process which will save Tshs9 million a year for the next four years.

b) Adams Car Sales intends to purchase four imported cars, in the coming international car
show to be held in London.

c) Poolwhirl Co provides a warranty with every refrigerator sold.