Mfrs 116 Ppe r561v

MFRS 116 PROPERTY, PLANT AND EQUIPMENT

 This topic will help you to:  Understand the principles and practices on ing for property, plant and equipment (PPE)  Deal with the recognition and measurement bases for PPE  Deal with revaluation of PPE

 Deal with impairment of PPE

What are Property, Plant & Equipment (PPE)? Property, plant and equipment are tangible items that: are held by an entity a. for use in the production or supply of goods or services, b. for rental to others, or c. for istrative or maintenance purposes; and are expected to be used during more than one reporting period. Sometimes termed as operating long-term assets

 MFRS 116 Property, Plant and Equipment covers all tangible non-current assets except assets held-forsale, completed investment properties, leases, biological assets, exploration and evaluation assets, and mineral rights and reserves.  MFRS 116 defines property, plant and equipment as ‘assets that are held by an entity for use in the production of goods and services, for rental to others, or for istrative or maintenance purposes; and are expected to be used during more than one reporting period’.

Scope of MFRS 116  Leasehold lands may be classified as PPE under MFRS 116 of they meet the definition of a finance lease. E.g leasehold lands with lease periods of 50 years or more  A property that is being constructed for future use as an investment property is now within the definition of investment property in MFRS 140 Investment Property  a hotel property where the owner manages the hotel is not an investment property and shall be classified as PPE

Identification of PPE  An entity has an item of PPE ed under MFRS 116 only when the answers to all of the following questions is YES.  Q1: does the reporting entity have an asset?  Q2: is the asset identified in Q1 an item of PPE?  Q3: is that item of PPE within the scope of MFRS 116? Example: Motor vehicles of a motor vehicle retailer Company X owns a number of motor vehicles. The majority of the vehicles are held to be sold to the public as part of the ordinary activities of the company. The other vehicles are used for a period of 5 years by salesmen employed by the entity to identify potential customers and to facilitate sales.

Q1: Are the motor vehicles to be sold assets?

The motor vehicles to be sold are assets of Company X – physical resources purchased by the entity (past event) to be sold at the entity’s discretion (control). Sales are expected to result in the flow of cash (future economic benefits) from the customers to Company X. Q2: Are the motor vehicles to be sold items of PPE? The motor vehicles to be sold do not satisfy the definition of PPE – they are tangible assets, but they are held to be sold in the ordinary business activity (not held for use in the production or supply of goods or services, istration or for rental)

Conclusion: The motor vehicles to be sold are not items of PPE. The vehicles are the company’s inventory.

Q1: are the motor vehicles used by the salesmen an asset? The motor vehicles held for use by the salesmen are assets – physical resources purchased (past event) to be used at the company’s discretion (control) to assist in the business, which will result in the flow of cash (future economic benefit) from the sales made. Q2: Are the motor vehicles used by the company’s salesmen items of PPE? The motor vehicles held for use by the entity’s salesmen clearly satisfy the definition of PPE – tangible items, used by entity’s salesmen to source potential customers (held for use in the supply of goods) and they are expected to be used for a period of 5 years (in more than one period). Conclusion:

The motor vehicles used by the salesmen are the company’s PPE.

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 equivalent paid or the fair value of the 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 specific requirements of other MFRSs, e.g. MFRS 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 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 participation at the measurement date’.

An impairment loss ‘is the amount by which the carrying amount of an asset exceeds its recoverable amount’. Recoverable amount ‘is the higher of an asset’s fair value less costs to sell and its value in use’.

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: 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’.

What are the main ing issues? 1. Recognition of PPE into various classes 2. Measurement of costs that can be capitalised 3. Allocating the capitalised costs to the relevant ing periods through depreciation 4. ing for revaluations of PPE

RECOGNITION CRITERIA i. It is probable that future economic benefits associated with the asset will flow to the entity; and ii. The cost or value of the asset can be measured reliably  The recognition criteria are applicable for both the initial expenditure and for subsequent expenditure incurred on an asset.  In practice, companies specify the amount below which a capital expenditure would be expensed. For eg any amount below RM10,000 will be recognised as an expense

Presentation is by classes: -

Each item of PPE shall be recorded separately in the s (usually in a fixed asset or PPE )

-

An entity may have hundreds of items of PPE in the s

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However, for presentation in the financial statements, they are aggregated and presented by classes

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MFRS clarifies that a class of PPE is a grouping of assets of a similar nature or use in the operations. Examples of separate classes are: - Land - Land and buildings - Machinery

- Ships - Aircrafts - Motor vehicles - Furniture and fittings

- Office equipment

For each of the examples below, identify items of PPE, if any, and then indicate whether that PPE is ed for in accordance with MFRS 116 or another MFRS 1. An entity owns a herd of cattle that forms the breeding stock of its agricultural activities. The entity also owns a tractor and trailer that are used to transport feed to the cattle.

2. An entity owns and manages an apple orchard (the fruit trees and the land on which they are growing).

1. A) Cattle – meet the definition of PPE – tangible, use for more than 1 year but cattle are living animals – considered as biological assets under MFRS 141. so they are outside the scope of MFRS 116. (B)tractor and trailer – physical asset used in the production during more than 1 ing period. Tractor and trailer are not biological assets. They are within the scope of MFRS 116. 2.

Even though the trees in the orchard (a biological asset ed for in accordance with MFRS 141) attached to and growing on the land, the land is classified as an item of PPE. It is a physical asset used in the supply of apples during more than 1 ing period. Land is neither a living plant nor a living animal – not a biological assets.

2. INITIAL MEASUREMENT At cost/Fair value Assets purchased: - purchase price (including import duties, taxes, after deducting trade discounts and rebates) - Other directly attributable costs to bringing the asset to location and condition for intended use (eg installation, site preparation, delivery and transport costs, professional fees, commissioning costs excluding start-up and pre-production costs)) - Initial estimate of cost of dismantling and removing and restoring the site.

Example 1: Assets Purchased On 1 January 20x6, ABC Bhd places an order for a machine from a company in Japan. The machinery is delivered on 31 January 20x6 and the invoice price is RM300,000 with a cash discount of 1% is paid within 30 days. Import duties and taxes amount to RM15,000. The following costs are also incurred: RM

Delivery and transport costs from Klang to factory

2,500

Installation and commissioning costs

11,500

istrative costs incurred in processing and inspection 5,000 Start-up and pre-production costs

10,000

Required: Determine the initial costs of the machine that can be capitalised.

Solution 1 The component costs that can be included are: Purchase price

300,000

less: 1% discount (irrespective of whether the discount is taken)

(3,000) 297,000

Import duties and taxes

15,000

Delivery and transport costs

2,500

Installation and commissioning

11,500

Cost of the machine

326,000

The istrative costs, start-up, pre-production costs and exchange loss should not be capitalised because they are NOT directly attributable to bringing the machine to the location and condition of its intended use (refer para 19 AND 21 of MFRS 116)

Dismantling, removal and restoration costs  Dismantling, removal and restoration costs are part of cost of property, plant and equipment. – the capitalised amount is the present value of the dismantling, removal and restoration cost – the capitalised amount are depreciated over the period the property, plant and equipment is used.

Self-constructed Property, Plant and Equipment  Cost recognised is determined by the same principles as for assets purchased and include all costs incurred such as material, labour, overhead and other resources that are directly attributable to complete the construction of the asset.

 Borrowing costs  Exclude: Internal profit and costs of abnormal amounts wastage.

Example 2: Self-constructed asset DEF Bhd is a mini-conglomerate with many divisions. In 20x5 the management of the company commissions its engineering and construction division to build a plant for its manufacturing division. The costs incurred for the construction of the plant are as follows: RM’000 Contractors’ costs 10,500 Direct materials and labour 8,500 Engineering and technical overheads 2,500 Interest costs incurred to finance the construction 2,000 General istrative costs allocated 3,000 26,500 Of the direct materials and labour used, RM1.5mil is attributable to cost inefficiencies caused by labour strike. Required: Determine the cost of the plant that can be capitalised.

Solution 2 The components costs that can be capitalised are: RM’000 Contractors’ cost

10,500

Direct materials and labour

8,500

Less: cost inefficiencies

(1,500)

RM’000

7,000 Engineering and technical overhead

2,500

Interest cost

2,000

Cost of the plant

22,000

Asset Exchange Transaction Item acquired in exchange for a non-monetary asset or group of non-monetary assets is measured at fair value.

If fair value is not determinable or exchange lacks commercial substance then the ‘cost’ of the asset acquired is equal to the carrying value of asset given in exchange.

Example 3: Assets exchange XYZ exchanged a 3-year old Honda City car, which was acquired for RM70,000, for a newer model of fair value RM85,000. XYZ also paid RM45,000 cash. The carrying amount of the old car was RM35,000 while its fair value was RM48,000. Required: At what value should the asset received be recorded?

Solution 3: The new car should be recorded at RM85,000 which is the fair value of the new car. (the fair value of the new car is evident). On disposal of the old car, a gain of RM5,000 will be recognised, being the difference between RM85,000 and sum of RM45,000 and RM35,000. the fair value of the old car is not relevant Fair value

85,000

Carrying amount old car

35,000

Cash received

45,000

Carrying amount

80,000

Gain

5,000

Example 4: assets exchange ABC exchanged a land with a carrying amount of RM1 mil for a plant whose fair value was determined to be RM900,000. The open market fair value of the value of the land was RM1.25 mil. The plant is a specialised asset and is not traded openly. Required: At what value should the asset received be recorded?

Solution 4: The fair value of the plant can be determined but it is not an open market value. On the other hand, the land’s fair value is clearly more evident and so the plant should be recognised at RM1.25 mil being the fair value of the asset given up

Subsequent Costs  After the initial purchase or construction, expenditure on PPE will continue to be incurred over their useful lives to maintain and repair the assets, to replace worn-out components, to upgrade and/or improve their performances  The ing issue is whether subsequent costs are to be capitalised or expense off.  If the expenditure meets the recognition criteria, then the costs incurred is capitalised and added to the carrying amount of the asset. Costs that do not meet the recognition criteria are expense off

–Maintenance – write off  Meet recognition criteria – add to the carrying amount of the asset Replacement of part/component  Replacement costs can be added to the carrying amount of PPE if they meet the recognition criteria

 The carrying value of the part replaced should be derecognised. Regular major inspection (e.g. Aircraft).

Cost recognised as replacement. Carrying amount of previous inspection should be derecognised.

Capitalise if:  Inspection – regular/major  Replacement – major component  Increase useful life  Increase quality/performance of asset

PART 2: Measurement after recognition After initial recognition, an entity is required to choose either of the following two models as its ing policy for an entire class of PPE:

a. Cost model, or b. Revaluation Model

Subsequent Measurement Cost Model: Asset is carried at:

 Its cost;  Less accumulated depreciation and  Less any accumulated impairment losses

Impairment is a situation whereby the fair value less than its expected selling costs is more than its carrying value (the asset is less than what it is actually worth).

When impairment happens, the impairment loss is immediately recognized in profit and loss. Also, the entity needs to reduce the value of PPE recorded in Statement of Financial Position. See Example 1.8: Subsequent Measurement – Cost Model

Revaluation Model Asset is carried at:  A revalued amount, being its fair value at the date revaluation date  Less any subsequent accumulated depreciation and

 Less any subsequent accumulated impairment losses Use of revaluation model depends on ability to measure fair value reliably.

 If a PPE is revalued upwards, the gain shall be recorded as a gain in other comprehensive income and as a revaluation surplus in accumulated equity.  If a PPE is revalued downwards, the loss shall be recorded as a loss in other comprehensive income and it reduces accumulated equity in revaluation surplus.  See Example 1.9: Subsequent Measurement – Revaluation Model.

Fair value -

Land and buildings – market value appraised by professionally qualified valuers

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Plant and equipment – market value by appraisal

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Regular revaluation exercise

-

Entire class of asset to be revalued

ing for Revaluation Surplus/ Deficits Surplus on Revaluation: fair value exceeds the carrying value  disclosed in the ‘other comprehensive income’

 credit into equity, under the heading of revaluation reserve  the surplus is due to a deficit in the previous revaluation – take to income statement  revaluation reserve is transferred to retained earnings:  Asset is disposed or  Through use - an amount equal to the addition depreciation is transferred to the retained earnings Deficit on Revaluation: fair value lower than the carrying value  charged in the current year’s SOPL  the decrease can be debited to the revaluation reserve (OCI) to the extent of any credit balance existing in the revaluation surplus in respect of that asset

EXAMPLE 5 Asset costing RM10 million was bought on 1.1.x4 and the useful life was determined to be 10 years. On 31.12.x5 the fair value was RM12 million.

On 31.12.x5 : Fair value RM12 (-)Carrying amount (RM10m – Depr RM10m x 2 years) = RM 8 mil 10 years RM4mil surplus Credited to Other comprehensive income/revaluation reserve. On 31.12.x6: Depreciation charge for x6 will be RM12m/8years = RM1.5m. Carrying amount at 31.12.x6 = RM12mil – RM1.5mil =RM10.5mil There will be a transfer from revaluation reserve to retained earnings of RM500,000 (RM2 mil depr (old) – RM1.5m depr (new) in x6) in x6. (**revaluation adjustment)

Depreciation  Depreciation commences when the asset is made available for use and to continue depreciating till derecognition, depreciating even during idle period.  Residual value based on expected future circumstances measured at current prices and no adjustment to be made for changing price.

 Depreciation charge is determined separately for each significant part of an item of property, plant and equipment.  Useful life and residual value to be reviewed annually. Changes are considered as change in ing estimates.

Depreciation charge Example 6 Tall Tree Bhd acquired a motor vehicle at a cost of RM85,000 on 1.1 x2 and its estimated useful life was determined to be 10 years and residual value was RM5,000. However, on 1.1.x6, the company reviewed the useful life and it was changed to 4 years. Its residual value remained unchanged. The company’s year end is 31.12. Required: Calculate the depreciation for 31.12.x6 Solution 6: Depreciation for x2- x5 = RM85,000 – RM5,000 = RM8,000 per year x 4 years 10 years = RM32,000 Carrying amount at 1.1.x6 = RM85,000 – 32,000 = RM53,000 Depreciation for x6 = RM53,000 – 5,000= RM12,000 4 years

Derecognition  An item of property, plant and equipment is derecognised when it is disposed of or when no future economic benefits are expected from its use.  asset disposed should be removed (derecognised) from the statement of financial position.  Gain or loss on disposal is the difference between the proceeds received on selling the asset and its carrying amount.  The gain or loss should be recognised in the income statement but not treated as revenue.  If the asset being sold had been revalued and there was a surplus on revaluation then the surplus remaining will be transferred to retained earnings. (Debit Revaluation Surplus; Credit Retained Earnings)

Issues in ing for PPE  Shift of focus of fair value as the fair basis for asset valuation  Even if a company chooses the cost model, the standard requires the asset to be periodically tested for impairment

 Initial measurement – professional judgment should be exercised to allocate for indirect costs which could not be specifically traced to the asset  For example, allocate indirect cost based on labour hours

 Subsequent measurement – challenge to carry out steps to determine fair value for PPE because the markets for certain assets in Malaysia are limited or non-existent