2.1 Scope

All PP&E 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 (but investment properties held using the cost model under IAS 40 should use the cost model in IAS 16 which is discussed at 5 below);
• PP&E 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 (see 3.1.7 below);
• the recognition and measurement of exploration and evaluation assets (covered by IFRS 6 – Exploration for and Evaluation of Mineral Resources); 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 rights and reserves, it includes any PP&E used in developing or maintaining such resources. [IAS 16.3]. Therefore, exploration PP&E is included in the scope of the standard (see Chapter 43), as is agricultural PP&E (see Chapter 42).

Other standards may require an item of PP&E to be recognised on a basis different from that required by IAS 16. For example, under IFRS 16 – Leases, lessees will recognise most leases in their statement of financial position as lease liabilities with corresponding right-of-use assets (see 2.3 below). Consequently, accounting for right-of-use assets should be in accordance with IFRS 16 (see Chapter 23).

2.2 Definitions used in IAS 16

IAS 16 defines the main terms it uses throughout the standard as follows: [IAS 16.6]

Bearer plant is a living plant that:

• is used in the production or supply of agricultural produce;
• is expected to bear produce for more than one period; and
• has a remote likelihood of being sold as agricultural produce, except for incidental scrap sales (see 3.1.7 below).

Carrying amount is the amount at which an asset is recognised after deducting any accumulated depreciation and accumulated impairment losses.

Cost is the 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 recognised in accordance with the specific requirements of other IFRSs, e.g. IFRS 2 – Share-based Payment.

Depreciable amount is the cost of an asset, or other amount substituted for cost, less its residual value.

Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life.

Entity-specific value is 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 is 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. (See IFRS 13 – Fair Value Measurement – discussed in Chapter 14).

An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount.

Property, plant and equipment are tangible items that:

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

Recoverable amount is the higher of an asset's fair value less costs to sell and its value in use.

The residual value of an asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life.

Useful life is:

1. the period over which an asset is expected to be available for use by an entity; or
2. the number of production or similar units expected to be obtained from the asset by an entity.

These definitions are discussed in the relevant sections below.

2.3 IFRS 16 and the presentation of right-of-use assets

Lessees can present right-of-use assets in the statement of financial position either;

1. separately from other assets; or
2. include them within the same line item as that within which the corresponding assets would be presented if they were owned. [IFRS 16.47].

Lessees can, therefore, include the leased right-of-use assets within PP&E on the face of the statement of financial position.

If right-of-use assets are not presented separately from other assets in the statement of financial position, an entity must disclose which line items include the right-of-use assets. [IFRS 16.47].

The requirements above do not apply to right-of-use assets that meet the definition of investment property, which is presented in the statement of financial position as investment property. [IFRS 16.48].

Presentation of right-of-use assets are discussed further in Chapter 23 at 5.7.

3.1 Aspects of recognition

3.2 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 recognised.

Parts of an asset are to be identified so that the cost of replacing a part may be recognised (i.e. capitalised as part of the asset) and the previous part derecognised. 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 PP&E) 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 each such part of the asset properly. [IAS 16.43, 44]. There is no requirement to identify all parts. IAS 16 requires entities to derecognise 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.’ [IAS 16.70].

As a consequence, an entity may not actually identify the parts of an asset until it incurs the replacement expenditure, as in the following example.

If the entity has no better information than the cost of the replacement part, it appears that it is permitted to use a depreciated replacement cost basis to calculate the amount derecognised in respect of the original asset.

3.3 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, by which is meant the repair and maintenance of PP&E that largely comprises labour costs, consumables and other minor parts, should be recognised in profit or loss as incurred. [IAS 16.12]. However, if the expenditure involves replacing a significant part of the asset, this part should be capitalised as part of the PP&E, if the recognition criteria are met. The carrying amount of the part that has been replaced should be derecognised (see 7 below). [IAS 16.13]. Examples of this treatment of major maintenance expenditure are shown in Extract 18.1 above and in Extract 18.3 and Extract 18.4 below.

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.

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:

1. its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates.
2. 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.
3. 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 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 26 at 4 and 6.3). [IAS 16.18]. This is illustrated in Extract 18.5 below.

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 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 26 at 6.9.

4.2 Incidental and non-incidental income

Under IAS 16, the cost of an item of PP&E 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. [IAS 16.16(b)]. However, before or during the construction of an asset, an entity may enter into incidental operations that are not, in themselves, necessary to meet this objective. [IAS 16.21].

The standard gives the example of income earned by using a building site as a car park prior to starting construction. Because incidental operations are not required in order to bring an asset to the location or condition necessary for it to be capable of operating in the manner intended by management, the income and related expenses of incidental operations are recognised in profit or loss and included in their respective classifications of income and expense. [IAS 16.21]. Such incidental income and related expenses are not included in determining 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 (see 4.2.1 below). [IAS 16.17].

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 capitalisation to cease and depreciation to start. [IAS 16.20]. In these circumstances all income earned from using the asset must be recognised as revenue in profit or loss and the related costs should include an element of depreciation of the asset.

4.3 Accounting for changes in decommissioning and restoration costs

IAS 16 requires the initial estimate of the costs of dismantling and removing an item of PP&E and restoring the site on which it is located to be included as part of the item's cost. This applies whether the obligation is incurred 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]. See 4.1 above. However, IAS 16 does not address the extent to which an item's carrying amount should be affected by changes in the estimated amount of dismantling and site restoration costs that occur after the estimate made upon initial measurement. This issue is the subject of IFRIC 1, which applies to any decommissioning, restoration or similar liability that has been both included as part of the cost of an asset measured in accordance with IAS 16 and recognised as a liability in accordance with IAS 37. [IFRIC 1.2]. It deals with the impact of events that change the measurement of an existing decommissioning, restoration or similar liability. Events include a change in the estimated cash flows, a change in the discount rate and the unwinding of the discount. [IFRIC 1.3]. This is discussed in detail in Chapter 26 at 6.3.

4.4 Exchanges of 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. Such exchanges are not uncommon in the telecommunications, media and leisure businesses, particularly after an acquisition. Governmental competition rules sometimes require such exchanges. 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 PP&E 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 derecognise 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. [IAS 16.24]. For example, if the new asset's fair value is higher than the carrying amount of the old asset, a gain may be recognised.

This requirement is qualified by a ‘commercial substance’ test. If it is not possible to demonstrate that the transaction has commercial substance as defined by the standard (see 4.4.1 below), assets received in exchange transactions will be recorded at the carrying value of the asset given up. [IAS 16.24].

If the transaction passes the ‘commercial substance’ test then IAS 16 requires the exchanged asset to be recorded at its fair value. As discussed in 7 below, the standard requires gains or losses on items that have been derecognised to be included in profit or loss in the period of derecognition but does not allow gains on derecognition to be classified as revenue, except for certain assets previously held for rental. [IAS 16.68, 68A]. It gives no further indication regarding their classification in profit or loss. Such exchanges of goods and services are also excluded from the scope of IFRS 15 if the non-monetary exchange is between entities in the same line of business to facilitate sales to customers or potential customers (see Chapter 27 at 3). [IFRS 15.5(d)].

4.5 Assets held under leases

IFRS 16 requires lessees to initially measure the right-of-use asset at the amount of lease liability, adjusted for lease prepayments, lease incentives received, initial direct costs and an estimate of restoration, removal and dismantling costs. IFRS 16 is discussed in detail in Chapter 23.

4.6 Assets acquired with the assistance of government grants

The carrying amount of an item of PP&E may be reduced by government grants in accordance with IAS 20 – Accounting for Government Grants and Disclosure of Government Assistance. [IAS 16.28]. This is one of the accounting treatments available which are discussed further in Chapter 24.

5.1 Significant parts of assets

IAS 16 links its recognition concept of a ‘part’ of an asset, discussed at 3.2 above, with the analysis of assets for the purpose of depreciation. Each part of an asset with a cost that is significant in relation to the total cost of the item must be depreciated separately, which means that the initial cost must be allocated between the significant parts by the entity. [IAS 16.43, 44]. The standard once again refers to the airframe and engines of an aircraft but also sets out that if an entity acquires PP&E subject to an operating lease in which it is the lessor, it may be appropriate to depreciate separately amounts reflected in the cost of that item that are attributable to favourable or unfavourable lease terms relative to market terms. [IAS 16.44].

A determination of the significant parts of office buildings can be seen in Extract 18.7 below from Skanska. This policy may have been based on the construction methods used for the particular buildings as it is unusual to see a separation between foundation and frame for office buildings. In addition, Extract 19.1 in Chapter 19 shows an example of the allocation for investment property, although favourable or unfavourable lease terms are not identified as a separate part.

Because parts of an item of PP&E are identified by their significant cost rather than their effect on depreciation, they may have the same useful lives and depreciation method and the standard allows them to be grouped for depreciation purposes. [IAS 16.45]. It also identifies other circumstances in which the significant parts do not correspond to the depreciable components within the asset. To the extent that an entity depreciates separately some parts of an item of PP&E, it also depreciates separately the remainder of the item. The remainder of such asset that has not separately been identified into parts may consist of other parts that are individually not significant and if the entity has varying expectations for these parts, it may need to use approximation techniques to calculate an appropriate depreciation method for all of these parts in a manner that faithfully represents the consumption pattern and/or useful life of such parts. [IAS 16.46]. The standard also allows an entity to depreciate separately such parts that are not significant in relation to the total cost of the whole asset. [IAS 16.47].

The depreciation charge for each period is recognised in profit or loss unless it forms part of the cost of another asset and included in its carrying amount. [IAS 16.48]. Sometimes, the future economic benefits embodied in an asset are absorbed in producing other assets, for example, the depreciation of manufacturing plant and equipment is included as part of the cost of conversion of finished manufactured goods held in inventory in accordance with IAS 2, and similarly, depreciation of PP&E used for development activities may be included as part of the cost of an intangible asset recognised in accordance with IAS 38. [IAS 16.49].

5.2 Depreciable amount and residual values

The depreciable amount of an item of PP&E is its cost, or other amount substituted for cost (e.g. valuation), less its estimated residual value. [IAS 16.6]. The standard states that an entity should review the residual value of an item of PP&E, and therefore all parts of it, at least at each financial year-end. If the estimated residual value differs from the previous estimate, the change should be accounted for prospectively as a change in accounting estimate in accordance with IAS 8 (see Chapter 3 at 4.5). [IAS 16.51].

The residual value of an item of PP&E is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and assuming that it was already in the condition it will be in at the end of its useful life. [IAS 16.6]. Therefore, IAS 16 contains an element of continuous updating of one component of an asset's carrying value because it is the current disposal amount (e.g. value at financial reporting date) of an asset's future state (i.e. asset's condition in the future when the entity expects to dispose of it). This means that only the changes up to the financial reporting date are taken into account and that expected future changes in residual value other than the effects of expected wear and tear are not taken into account. [IAS 16.BC29].

As any change in the residual value directly affects the depreciable amount, it may also affect the depreciation charge. This is because the depreciable amount (i.e. the amount actually charged to profit or loss over the life of the asset) is calculated by deducting the residual value from the cost (or other amount substituted for cost, such as valuation) of the asset. Sometimes, the residual value of an asset may increase to an amount equal to or greater than the asset's carrying amount. If it does, the residual value is capped at the asset's carrying amount. This means that in such a case, the asset's depreciation charge is zero unless and until its residual value subsequently decreases to an amount below the asset's carrying amount. [IAS 16.53, 54].

In practice, many items of PP&E have a negligible residual value. This is usually because they are kept for significantly all of their useful lives. Residual values are of no relevance if the entity intends to keep the asset for significantly all of its useful life. If an entity uses residual values based on prices fetched in the market for a type of asset that it holds, it must also demonstrate an intention to dispose of that asset before the end of its economic life.

The requirement concerning the residual values of assets highlights how important it is that residual values are considered and reviewed in conjunction with the review of useful lives. The useful life is the period over which the entity expects to use the asset, not the asset's economic life.

5.3 Depreciation charge

The standard requires the depreciable amount of an asset to be allocated on a systematic basis over its useful life. [IAS 16.50].

The standard makes it clear that depreciation must be charged on all items of PP&E, including those carried under the revaluation model, even if the fair value of an asset is higher than its carrying amount, as long as the residual value of the asset is lower than its carrying amount. [IAS 16.52]. If the residual value exceeds the carrying amount, no depreciation is charged until the residual value once again decreases to less than the carrying amount (see 5.2 above). [IAS 16.54]. IAS 16 makes it clear that the repair and maintenance of an asset do not, of themselves, negate the need to depreciate it. [IAS 16.52].

There is no requirement in IAS 16 for an automatic impairment review if no depreciation is charged.

5.4 Useful lives

One of the critical assumptions on which the depreciation charge depends is the useful life of the asset. The standard requires the useful life of an asset to be estimated on a realistic basis and reviewed at least at the end of each financial year. The effects of changes in useful life are to be recognised prospectively as changes in accounting estimates in accordance with IAS 8 (see Chapter 3 at 4.5), over the remaining useful life of the asset. [IAS 16.51].

As described in 2.2 above, the useful life of an asset is defined in terms of the asset's expected utility to the entity. [IAS 16.57]. It is the period over which the present owner will benefit from using the asset and not the total potential life of the asset; the two will often not be the same.

It is quite possible for an asset's useful life to be shorter than its economic life. The estimation of the useful life of the asset is a matter of judgement based on the experience of the entity with similar assets. Many entities have an asset management policy that may involve disposal of assets after a specified time or after consumption of a specified proportion of the future economic benefits embodied in the assets. [IAS 16.57]. This often occurs when disposing of assets when they still have a residual value, which means that another user can benefit from the asset. This is particularly common with property and motor vehicles, where there are effective second-hand markets, but less usual for plant and machinery. For example, an entity may have a policy of replacing all of its motor vehicles after three years, so this will be their estimated useful life for depreciation purposes. The entity will depreciate them over this period down to the estimated residual value. The residual values of motor vehicles are often easy to obtain and the entity will be able to reassess these residuals in line with the requirements of the standard. Thus, the estimation of the useful life of the asset is a matter of judgement based on the experience of the entity with similar assets. [IAS 16.57].

The future economic benefits embodied in an asset are consumed principally through usage. Other factors, however, should be taken into account such as technical or commercial obsolescence and wear and tear while an asset remains idle because they often result in the diminution of the economic benefits expected to be obtained from the asset. Consequently, IAS 16 provides guidance that all the following factors are to be considered when estimating the useful life of an asset:

1. expected usage of the asset. Usage is assessed by reference to the asset's expected capacity or physical output;
2. expected physical wear and tear, which depends on operational factors such as the number of shifts for which the asset is to be used and the repair and maintenance programme, and the care and maintenance of the asset while idle (see 5.4.1 below);
3. technical or commercial obsolescence arising from changes or improvements in production, or from a change in the market demand for the product or service output of the asset. Expected future reductions in the selling price of an item that was produced using an asset could indicate the expectation of technical or commercial obsolescence of the asset, which, in turn, might reflect a reduction of the future economic benefits embodied in the asset (see 5.4.3 below); and
4. legal or similar limits on the use of the asset, such as the expiry dates of related leases. [IAS 16.56].

Factor (d), above, states that the ‘expiry dates of related leases’ is considered when determining the asset's useful life. Generally, the useful life of the leasehold improvement is the same or less than the lease term. The interaction between the useful life of leasehold improvements and the term of the associated lease was discussed by the Interpretations Committee in June 2019, but at the time of writing, an agenda decision has not been finalised.⁸ This issue is discussed in Chapter 23 at 4.4.1 in the context of cancellable leases. ‘Lease term’ under IFRS 16 is discussed in Chapter 23.

ArcelorMittal is an example of an entity depreciating an asset over its expected usage by reference to the production period.

5.5 When depreciation starts

The standard is clear on when depreciation should start and finish, and sets out the requirements succinctly as follows:

• Depreciation of an asset begins when it is available for use, which is defined by the standard as occurring when the asset is in the location and condition necessary for it to be capable of operating in the manner intended by management. This is usually the point at which capitalisation of costs relating to the asset ceases as the physical asset is operational or ready for intended use (see 4.1.4 above).
• Depreciation of an asset ceases at the earlier of the date that the asset is classified as held for sale (or included in a disposal group that is classified as held for sale) in accordance with IFRS 5 and the date that the asset is derecognised (see 7 below). [IAS 16.55].

Therefore, an entity does not stop depreciating an asset merely because it has become idle or has been retired from active use unless the asset is fully depreciated. However, if the entity is using a usage method of depreciation (e.g. the units-of-production method), the charge can be zero while there is no production. [IAS 16.55]. Of course, a prolonged period in which there is no production may raise questions as to whether the asset is impaired because an asset becoming idle is a specific example of an indication of impairment in IAS 36 (see Chapter 20 at 2.1). [IAS 36.12(f)].

Assets held for sale under IFRS 5 are discussed below at 7.1 below.

5.6 Depreciation methods

There is a variety of depreciation methods that can be used to allocate the depreciable amount of an asset on a systematic basis over its useful life. The standard is not prescriptive about what methods of depreciation should be used. It simply says that ‘the depreciation method used shall reflect the pattern in which the asset's future economic benefits are expected to be consumed by the entity’, mentioning the possible methods that can be used such as the straight-line method (which is the most common method where the depreciation results in a constant charge over the useful life if the asset's residual value does not change), the diminishing balance method (see 5.6.1 below) and the units of production method (see 5.6.2 below). The overriding requirement is to select the depreciation method that most closely reflects the expected pattern of consumption of the future economic benefits the asset brings over its useful life; and that the selected method is applied consistently from period to period unless there is a change in the expected pattern of consumption of those future economic benefits. [IAS 16.60‑62].

IAS 16 contains an explicit requirement that the depreciation method be reviewed at least at each financial year-end to determine if there has been a significant change in the pattern of consumption of an asset's future economic benefits. If there has been such a change, the depreciation method should be changed to reflect it. [IAS 16.61]. However, under IAS 8, this change is a change in accounting estimate and not a change in accounting policy. [IAS 8.32(d), IAS 16.61]. This means that the consequent depreciation adjustment should be made prospectively, i.e. the asset's depreciable amount should be written off over current and future periods using the new and more appropriate method of depreciation. [IAS 8.36].

A revenue-based approach, e.g. using the ratio of revenue generated to total revenue expected to be generated, is not a suitable basis for depreciation. Depreciation is an estimate of the economic benefits of the asset consumed in the period. The revenue generated by an activity that requires the use of an asset generally reflects factors other than the consumption of the economic benefits of the asset. Revenue reflects the output of the asset, but it also reflects other factors that do not affect depreciation, such as changes in sales volumes and selling prices, the effects of selling activities and other inputs and processes. The price component of revenue may be affected by inflation or foreign currency exchange rates. This means that revenue does not, as a matter of principle, reflect how an asset is used or consumed. [IAS 16.62A]. While revenue-based methods of depreciation are considered inappropriate under IAS 16, the standard does permit other methods of depreciation that reflect the level of activity, such as the units of production method (see 5.6.2 below).

5.7 Impairment

All items of PP&E accounted for under IAS 16 are subject to the impairment requirements of IAS 36. Impairment is discussed in Chapter 20. [IAS 16.63].

The question has arisen about the treatment of any compensation an entity may be due to receive as a result of an asset being impaired. For example an asset that is insured might be destroyed in a fire, so repayment from an insurance company might be expected. IAS 16 states that these events – the impairments or losses of items of PP&E, the related claims for or payments of compensation from third parties and any subsequent purchase or construction of replacement assets – are ‘separate economic events’ and should be accounted for separately as follows:

• impairments of PP&E are recognised in accordance with IAS 36 (see Chapter 20);
• derecognition of items of PP&E retired or disposed of should be determined in accordance with IAS 16 (see 7 below);
• compensation from third parties for items of PP&E that were impaired, lost or given up is included in determining profit and loss when it becomes receivable; and
• the cost of items of PP&E restored, purchased or constructed as replacements is determined in accordance with IAS 16 (see 3 and 4 above). [IAS 16.65, 66].

6.1 The meaning of fair value

Fair value is defined in IFRS 13. IFRS 13 does not prescribe when to measure fair value but provides guidance on how to measure it under IFRS when fair value is required or permitted by IFRS.

IFRS 13 clarifies that fair value is an exit price from the perspective of market participants. ‘Fair value’ is defined as ‘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’. [IAS 16.6, IFRS 13 Appendix A].

6.2 Accounting for valuation surpluses and deficits

Increases in the carrying amount of PP&E as a result of revaluations should be credited to OCI and accumulated in a revaluation surplus account in equity. To the extent that a revaluation increase of an asset reverses a revaluation decrease of the same asset that was previously recognised as an expense in profit or loss, such increase should be credited to income in profit or loss. Decreases in valuation should be charged to profit or loss, except to the extent that they reverse the existing accumulated revaluation surplus on the same asset and therefore such decrease is recognised in OCI. The decrease recognised in OCI reduces the amount accumulated in equity under revaluation surplus account. [IAS 16.39, 40]. This means that it is not permissible under the standard to carry a negative revaluation reserve in respect of any item of PP&E.

The same rules apply to impairment losses. An impairment loss on a revalued asset is first used to reduce the revaluation surplus for that asset. Only when the impairment loss exceeds the amount in the revaluation surplus for that same asset is any further impairment loss recognised in profit or loss (see Chapter 20 at 11.1). [IAS 36.61].

IAS 16 generally retains a model in which the revalued amount substitutes for cost in both statement of financial position and statement of profit or loss and on derecognition there is no recycling to profit and loss of amounts taken directly to OCI. The revaluation surplus included equity in respect of an item of PP&E may be transferred directly to retained earnings when the asset is derecognised (i.e. transferring the whole of the surplus when the asset is retired or disposed of). [IAS 16.41].

IAS 16 also allows some of the revaluation surplus to be transferred to retained earnings as the asset is used by an entity. In such a case, the difference between depreciation based on the revalued carrying amount of the asset and depreciation based on its original cost may be transferred from revaluation surplus to retained earnings in equity. This is illustrated in the Example 18.5 below. This recognises that any depreciation on the revalued part of an asset's carrying value has been realised by being charged to profit or loss. Thus, a transfer should be made of an equivalent amount from the revaluation surplus to retained earnings. Any remaining balance may also be transferred when the asset is disposed of. These transfers should be made directly from revaluation surplus to retained earnings and not through the statement of profit or loss. [IAS 16.41].

Any effect on taxation, both current and deferred, resulting from the revaluation of PP&E is recognised and disclosed in accordance with IAS 12 – Income Taxes. [IAS 16.42]. This is dealt with in Chapter 33.

When an item of PP&E is revalued, the carrying amount of that asset is adjusted to the revalued amount. As alluded to in Example 18.5 above, there are two methods of accounting for accumulated depreciation when an item of PP&E is revalued. At the date of revaluation, the asset is treated in one of the following ways:

• the accumulated depreciation is eliminated against gross carrying amount of the asset; or
• the gross carrying amount is adjusted in a manner that is consistent with the revaluation of the carrying amount of the asset. For example, the gross carrying amount may be restated by reference to observable market data or it may be restated proportionately to the change in the carrying amount. The accumulated depreciation at the date of the revaluation is adjusted to equal the difference between the gross carrying amount and the carrying amount of the asset after taking into account accumulated impairment losses. [IAS 16.35].

The first method available eliminates the accumulated depreciation against the gross carrying amount of the asset. After the revaluation, the gross carrying amount and the net carrying amount are same (i.e. reflecting the revalued amount). This is illustrated in Example 18.6 below.

Under the observable market data approach, the gross carrying amount will be restated and the difference compared to the revalued amount of the asset will be absorbed by the accumulated depreciation. Using the example above, assuming the gross carrying amount is restated to €75,000 by reference to the observable market data, the accumulated depreciation will be adjusted to €25,000 (i.e. the gross carrying amount of €75,000 less the carrying amount adjusted to its revalued amount of €50,000). The revaluation gain recognised is the same as the first method above at €10,000.

Alternatively, the gross carrying amount is restated proportionately to the change in carrying amount (i.e. a 25% uplift) resulting in the same revaluation gain as the methods above but the cost and accumulated depreciation carried forward reflect the gross cost of the asset of €87,500 and accumulated depreciation of €37,500. This method may be used if an asset is revalued using an index to determine its depreciated replacement cost (see 6.1.1.C above).

Notice that the revaluation gain recognised remained at €10,000 whichever method described above is used.

6.3 Reversals of downward valuations

IAS 16 requires that, if an asset's carrying amount is increased as a result of a revaluation, the increase should be credited directly to OCI and accumulated in equity under the heading of revaluation surplus. However, the increase should be recognised in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognised in profit or loss (see 6.2 above). [IAS 16.39].

The same rules apply to a reversal of an impairment loss – see discussion in Chapter 20 at 11.4.2.

If the revalued asset is being depreciated, we consider that the full amount of any reversal should not be taken to profit or loss. Rather, the reversal should take account of the depreciation that would have been charged on the previously higher book value. The text of IAS 16 does not specify this treatment but other interpretations would be inconsistent with IAS 36, which states:

• ‘The increased carrying amount of an asset other than goodwill attributable to a reversal of an impairment loss shall not exceed the carrying amount that would have been determined (net of amortisation or depreciation) had no impairment loss been recognised for the asset in prior years.’ [IAS 36.117].

The following example demonstrates a way in which this could be applied.

In the example the amount of the revaluation that is credited to the revaluation surplus in OCI represents the difference between the net book value that would have resulted had the asset been held on a cost basis (£400,000) and the net book value on a revalued basis (£500,000).

Of course, this is an extreme example. Most assets that are subject to a policy of revaluation would not show such marked changes in value and it would be expected that there would be valuation movements in the intervening years rather than dramatic losses and gains in years 3 and 6. However, we consider that in principle this is the way in which downward valuations should be recognised.

There may be major practical difficulties for any entity that finds itself in the position of reversing revaluation deficits on depreciating assets, although whether in practice this eventuality often occurs is open to doubt. If there is any chance that it is likely to occur, the business would need to continue to maintain asset registers on the original, pre-write down basis.

6.4 Adopting a policy of revaluation

Although the initial adoption of a policy of revaluation by an entity that has previously used the cost model is a change in accounting policy, it is not dealt with as a prior period adjustment in accordance with IAS 8. Instead, the change is treated as a revaluation during the current period as set out in 6.2 above. [IAS 8.17]. This means that the entity is not required to obtain valuation information about comparative periods.

6.5 Assets held under leases

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. A lessee subsequently measures the right-of-use asset using a cost model under IFRS 16 (applying the depreciation requirements in IAS 16, but subject to the specific requirements in paragraph 32 of IFRS 16), unless it applies one of the following measurement models allowed by IFRS 16 (see Chapter 23):

• the fair value model in IAS 40, but only if the lessee applies this to its investment property and the right-of-use asset meets the definition of investment property in IAS 40; or
• if the lessee applies the revaluation model in IAS 16 to a class of PP&E, the lessee would also have the option to revalue all of the right-of-use assets that relate to that class of PP&E. [IFRS 16.29‑35]

7.1 IFRS 5 – Non-current Assets Held for Sale and Discontinued Operations

IFRS 5 introduced a category of asset, ‘held for sale’, and PP&E within this category is outside the scope of IAS 16, although IAS 16 requires certain disclosures about assets held for sale to be made, as set out at 8.1 below.

IFRS 5 requires that an item of PP&E should be classified as held for sale if its carrying amount will be recovered principally through a sale transaction rather than continuing use, though continuing use is not in itself precluded for assets classified as held for sale. [IFRS 5.6]. An asset can also be part of a ‘disposal group’ (that is a group of assets that are to be disposed of together), in which case such group can be treated as a whole. Once this classification has been made, depreciation ceases, even if the asset is still being used, but the assets must be carried at the lower of their previous carrying amount and fair value less costs to sell. For assets (or disposal group) to be classified as held for sale, they must be available for immediate sale in their present condition, and the sale must be highly probable. [IFRS 5.7].

Additionally, the sale should be completed within one year from the date of classification as held for sale, management at an ‘appropriate level’ must be committed to the plan, and an active programme of marketing the assets at current fair value must have been started. [IFRS 5.8].

The requirements of IFRS 5 are dealt with in Chapter 4. IFRS 5 does not apply when assets that are held for sale in the ordinary course of business are transferred to inventories (see 7.2 below). [IAS 16.68A].

7.2 Sale of assets held for rental

If an entity, in the course of its ordinary activities, routinely sells PP&E that it has held for rental to others, it should transfer such assets to inventories at their carrying amount when they cease to be rented and are then held for sale. The proceeds from the sale of such assets should be recognised as revenue in accordance with IFRS 15. [IAS 16.68A]. In contrast, the sale of investment property is generally not recognised as revenue. The rationale and possible treatment of investment property in such cases is discussed in detail in Chapter 19 at 9 and 10.

A number of entities sell assets that have previously been held for rental, for example, car rental companies that may acquire vehicles with the intention of holding them as rental cars for a limited period and then selling them. An issue was whether the sale of such assets, which arguably have a dual purpose of being rented out and then sold, should be presented gross (revenue and cost of sales) or net (gain or loss) in profit or loss.

The IASB concluded that the presentation of gross revenue, rather than a net gain or loss, would better reflect the ordinary activities of some such entities and amended IAS 16 accordingly.

The IASB also made a consequential adjustment to IAS 7 – Statement of Cash Flows – to require that both (i) the cash payments to manufacture or acquire assets held for rental and subsequently held for sale; and (ii) the cash receipts from rentals and sales of such assets are presented as from operating activities. [IAS 7.14]. This amendment to IAS 7 is intended to avoid initial expenditure on purchases of assets being classified as investing activities while inflows from sales are recorded within operating activities.

7.3 Partial disposals and undivided interests

IAS 16 requires an entity to derecognise ‘an item’ of PP&E on disposal or when it expects no future economic benefits from its use or disposal. [IAS 16.67].

Items of PP&E are recognised when their costs can be measured reliably and it is probable that future benefits associated with the asset will flow to the entity. [IAS 16.7]. The standard ‘does not prescribe the unit of measure for recognition, i.e. what constitutes an item of property, plant and equipment’. [IAS 16.9].

However, items that are derecognised were not necessarily items on initial recognition. The item that is being disposed of may be part of a larger ‘item’ bought in a single transaction that can be subdivided into parts (i.e. separate items) for separate disposal; an obvious example is land or many types of property. The principle is the same as for the replacement of parts, which may only be identified and derecognised so that the cost of the replacement part may be recognised (see 3.2 above). The entity needs to identify the cost of the part disposed of by allocating the carrying value on a systematic and appropriate basis.

In these cases, the part disposed of is a physical part of the original asset. The standard assumes that disposal will be of a physical part (except in the specific case of major inspections and overhauls – see 3.3.2 above). However, some entities enter into arrangements in which they dispose of part of the benefits that will be derived from the assets.

Although IAS 16 defines an asset by reference to the future economic benefits that will be controlled by the entity as a result of the acquisition, it does not address disposals of a proportion of these benefits. An entity may dispose of an undivided interest in the whole asset (sometimes called an ownership ‘in common’ of the asset). This means that all owners have a proportionate share of the entire asset (e.g. the purchaser of a 25% undivided interest in 100 acres of land owns 25% of the whole 100 acres). These arrangements are common in, but are not restricted to, the extractive and property sectors. Vendors have to determine how to account for the consideration they have received from the purchaser. This will depend on the details of the arrangement and, in particular, whether the entity continues to control the asset or there is joint control.

7.4 Derecognition and replacement of insured assets

Situations may arise where insured assets are destroyed in a fire, or similar destructive incident, and compensation (either in the form of cash or a replacement asset) from an insurance company is expected.

IAS 16 states that these events – the losses of items of PP&E, the related claims for or payments of compensation from third parties and any subsequent purchase or construction of replacement assets – are ‘separate economic events’ and should be accounted for separately as follows:

• derecognition of the items of PP&E that are destroyed with a corresponding loss recognised in profit and loss;
• compensation from the insurer or other third parties for the items of PP&E that are destroyed is recognised as an asset when it becomes receivable with a corresponding gain recognised in profit and loss; and
• the cost of items of PP&E restored, purchased or constructed as replacements are recognised in accordance with the requirements of IAS 16 (see 3 and 4 above). [IAS 16.65, 66].

The items of PP&E that are destroyed will be reflected in the financial statements as a write-off rather than an impairment. Extract 18.9 below illustrates these requirements.

8.1 General disclosures

For each class of PP&E the following should be disclosed in the financial statements:

1. the measurement bases used for determining the gross carrying amount (e.g. cost or revaluation). [IAS 16.73(a)]. When more than one basis has been used, the gross carrying amount for that basis in each category may have to be disclosed (however the standard requires that if revaluation is adopted the entire class of PP&E must be revalued);
2. the depreciation methods used. Selection of the depreciation method adopted is a matter of judgement and its disclosure provides information that allows users of financial statements to review the policies selected by management and enables them to compare with other entities. For similar reasons, it is necessary to disclose depreciation (in item (e)(vii) below), whether recognised in profit or loss or as a part of the cost of other assets, during a period; and accumulated depreciation at the end of the period (in item (d) below); [IAS 16.73(b), 75]
3. the useful lives or the depreciation rates used. Selection of the useful lives or depreciation rates used is a matter of judgement and its disclosure provides information that allows users of financial statements to review the policies selected by management and enables them to compare with other entities; [IAS 16.73(c), 75]
4. the gross carrying amount and the accumulated depreciation (aggregated with accumulated impairment losses) at the beginning and end of the period; [IAS 16.73(d)] and
5. a reconciliation of the carrying amount at the beginning and end of the period showing:
   1. additions;
   2. disposals, and assets classified as held for sale or included in a disposal group held for sale in accordance with IFRS 5;
   3. acquisitions through business combinations;
   4. increases or decreases resulting from revaluations and from impairment losses recognised or reversed directly in other comprehensive income under IAS 36;
   5. impairment losses recognised in profit or loss during the period under IAS 36;
   6. impairment losses reversed in profit or loss during the period under IAS 36;
   7. depreciation;
   8. the net exchange differences arising on the translation of the financial statements from the functional currency into a different presentation currency, including the translation of a foreign operation into the presentation currency of the reporting entity; and
   9. other changes. [IAS 16.73(e)].

Extract 18.10 below illustrates an accounting policy on PP&E together with the movement and reconciliation note (a comparative is provided in the financial statements but is not reproduced here).

IAS 16 also requires the disclosure of the following information, which is useful to gain a fuller understanding of the entire position of the entity's holdings of and its commitments to purchase property plant and equipment:

1. the existence and amounts of restrictions on title, and PP&E pledged as security for liabilities;
2. the amount of expenditures recognised in the carrying amount of an item of PP&E in the course of construction;
3. the amount of contractual commitments for the acquisition of PP&E; and
4. if it is not disclosed separately in the statement of comprehensive income, the amount of compensation from third parties for items of PP&E that were impaired, lost or given up that is included in profit or loss. [IAS 16.74].

In addition there is a reminder in the standard that, in accordance with IAS 8, the nature and effect of any change in an accounting estimate (e.g. depreciation methods, useful lives, residual values, and the estimated cost of dismantling, removing or restoring items of PP&E) that has an effect on the current period or is expected to have an effect in future periods must be disclosed. [IAS 16.76].

8.2 Additional disclosures for revalued assets

In addition to the disclosures required by IFRS 13, the disclosure requirements in IAS 16 if the revaluation method is adopted are:

1. the effective date of the revaluation;
2. whether an independent valuer was involved;
3. for each revalued class of PP&E, the carrying amount that would have been recognised had the assets been carried under the cost model; and
4. the revaluation surplus, indicating the change for the period and any restrictions on the distribution of the balance to shareholders. [IAS 16.77].

In particular the requirement under (c) is quite onerous for entities, as it entails their keeping asset register information in some detail in order to meet it.

In May 2014, the Interpretations Committee received a request to clarify whether an entity is required to reflect the capitalisation of borrowing costs to meet the disclosure requirement of IAS 16 for assets stated at revalued amounts and for which borrowing costs are not capitalised. Since the capitalisation of borrowing costs for such assets is not required (see Chapter 21 at 3.2), the determination of the amount of borrowing costs that would have been capitalised under a cost model – solely to meet a disclosure requirement – might be considered burdensome.

The Interpretations Committee noted that the requirements in paragraph 77(e) of IAS 16 (i.e. item (c) above) are clear. This paragraph requires an entity to disclose the amount at which assets stated at revalued amounts would have been stated had those assets been carried under the cost model. The amount to be disclosed includes borrowing costs capitalised in accordance with IAS 23 (see Chapter 21).¹²

IFRS 13 has a number of disclosure requirements for assets measured at fair value. Some of the significant disclosures under IFRS 13 which would apply to revalued PP&E are: [IFRS 13.93]

• if the highest and best use differs from its current use, an entity must disclose that fact and why the asset is being used in a manner different from its highest and best use;
• the fair value measurement's categorisation within the fair value measurement hierarchy (i.e. Level 1, 2 or 3);
• if categorised within Level 2 or 3 of the fair value hierarchy (which most revalued PP&E is likely to be):
  1. a description of the valuation technique(s) used in the fair value measurement;
  2. the inputs used in the fair value measurement;
  3. if there has been a change in the valuation technique (e.g. changing from a market approach to an income approach or use of an additional technique):
     • the change; and
     • the reason(s) for making it;
• quantitative information about the significant unobservable inputs used in the fair value measurement for those categorised within Level 3 of the fair value measurement hierarchy;
• if categorised within Level 3 of the fair value measurement hierarchy, a description of the valuation processes used by the entity (including, for example, how an entity decides its valuation policies and procedures and analyses changes in fair value measurements from period to period).

In addition to these requirements, an entity must also provide the disclosures depending on whether the fair value measurement is recurring or non-recurring. Revalued PP&E are considered recurring fair value measurements and are subject to additional disclosure requirements, which include a qualitative sensitivity analysis. The disclosures for revalued PP&E categorised under Level 3 include a reconciliation from the opening balance to the closing balance, disclosing separately changes during the period to the following:

1. total gains and losses for the period recognised in profit or loss, and the line item(s) in profit or loss in which these gains or losses are recognised;
2. total gains and losses for the period recognised in other comprehensive income, and the line item(s) in other comprehensive income in which those gains or losses are recognised;
3. purchases, sales, issues and settlements (separately disclosing each of those types of changes); and
4. transfers into or out of Level 3 of the fair value hierarchy (separately disclosing and discussing transfers into Level 3 from those out of Level 3) including:
   • the amounts of any transfers into or out of Level 3;
   • the reasons for those transfers; and
   • the entity's policy for determining when transfers between levels are deemed to have occurred. [IFRS 13.93].

These requirements and examples of the requirements are discussed in more detail in Chapter 14 at 20.

8.3 Other disclosures

In addition to the disclosures required by IAS 1, IAS 16 (i.e. those discussed in 8.1 and 8.2 above) and IFRS 13, the standard emphasises that entities are also required to disclose information on impaired PP&E in accordance with IAS 36 (see Chapter 20 at 13.2.1 and 13.2.2). [IAS 16.78].

As users of financial statements may find other information relevant to their needs, the standard encourages, but does not require, entities to disclose other additional information such as the carrying amount of any temporarily idle PP&E, the gross carrying amount of any fully depreciated PP&E that is still in use and the carrying amount of any PP&E retired from active use but not classified as held for disposal in accordance with IFRS 5. For any PP&E measured using the cost model, the disclosure of its fair value is also encouraged when this is materially different from the carrying amount. [IAS 16.79].