would flow if such expenditure had not been made. For example, a chemical
manufacturer may install new chemical handling processes to comply with
environmental requirements for the production and storage of dangerous chemicals;
related plant enhancements are recognised as an asset because without them the entity
is unable to manufacture and sell the chemicals or a plant might have to be closed down
if these safety or environmental expenditures were not made. [IAS 16.11].
An entity may voluntarily invest in environmental equipment even though it is not
required by law to do so. The entity can capitalise 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 capitalised 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 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.
Whenever safety and environmental assets are capitalised, the standard requires the
resulting carrying amount of the asset, and any related asset, to be reviewed for
impairment in accordance with IAS 36 (see 5.7 below). [IAS 16.11].
3.1.3
Property economic benefits and property developments
The standard requires that PP&E only be recognised when it is probable that future
economic benefits associated with the item will flow to the entity.
For example, in relation to property development, many jurisdictions require
permissions prior to development whilst developers, including entities developing
property for their own use, typically incur significant costs prior to such permissions
being granted.
In assessing whether such pre-permission expenditures can be capitalised – assuming
they otherwise meet the criteria – a judgement must be made at the date the
expenditure is incurred of whether it is sufficiently probable that the relevant
permission will be granted. Such expenditure does not become part of the cost of the
land; to the extent that it can be recognised it is part of the costs of a separate building.
Furthermore, if during the application and approval process of such permits it is no
longer expected that necessary permits will be granted, capitalisation of pre-permission
Property, plant and equipment 1303
expenditure should cease, any related amounts that were previously capitalised should
be written off in accordance with IAS 36 and accordingly, the carrying amount of any
related item of PP&E subject to development or redevelopment (or, if appropriate, the
cash generating unit where such an asset belongs) should be tested for impairment,
where applicable (see 5.7 below).
3.1.4
Classification as PP&E or intangible asset
The restrictions in IAS 38 – Intangible Assets – in respect of capitalising 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
capitalised as part of a tangible asset, for example as part of an accounting or
communications infrastructure. Equally, internally written software may be capitalised
as part of a tangible production facility, and so on. Judgement 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 judgement 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:
• 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 PP&E;
• 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 PP&E; 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. [IAS 38.4].
It is worthwhile noting that as the ‘parts approach’ in IAS 16 requires an entity to account
for significant parts of an asset separately, this raises ‘boundary’ problems between
IAS 16 and IAS 38 when software and similar expenditure are involved. We believe that
where IAS 16 requires an entity to identify significant parts of an asset and account for
them separately, the entity needs to evaluate whether any software-type intangible part
is actually integral to the larger asset or whether it is really a separate asset in its own
right. The intangible part is more likely to be an asset in its own right if it was developed
separately or if it can be used independently of the item of PP&E.
3.1.5
Classification of items as inventory or PP&E 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 PP&E, since each
individual item will be consumed within a single operating cycle. However, there may be
1304 Chapter 18
cases where it is difficult to judge whether an item is part of inventory or is an item of
PP&E. This may have implications on measurement because, for example, PP&E has a
revaluation option (see 6 below) that is not available for inventory.
In our view, an item of inventory is accounted for as an item of PP&E 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 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 inventory that is an item of PP&E cannot be physically
separated from the rest of inventories.
Consider the following examples:
•
An entity acquires the right to use an underground cave for gas storage purposes
for a period of 50 years. The cave is filled with gas, but a substantial part of that gas
will only be used to keep the cave under pressure in order to be able to get gas out
of the cave. It is not possible to distinguish the gas that will be used to keep the
cave under pressure and the rest of the gas.
• An entity operates an oil refining plant. In order for the refining process to take
place, the plant must contain a certain minimum quantity of oil. This can only be
taken out once the plant is abandoned and would then be polluted to such an
extent that the oil’s value is significantly reduced.
• An entity sells gas and has at any one time a certain quantity of gas in its gas
distribution network.
In the first example, therefore, the total volume of gas must be virtually split into (i) gas
held for sale and (ii) gas held to keep the cave under pressure. The former must be
accounted for under IAS 2 – Inventories. The latter must be accounted for as PP&E and
depreciated over the period the cave is expected to be used.
In the second example the part of the crude that is necessary to operate (in technical
terms) the plant and cannot be recouped (or can be recouped but would then be
significantly impaired), even when the plant is abandoned, should be considered as an
item of PP&E and amortised over the life of the plant.
In the third example the gas in the pipeline is not necessary to operate the pipeline. It
is held for sale or to be consumed in the production process or process of rendering
services. Therefore this gas is accounted for as inventory.
3.1.6
Production stripping costs of surface mines
IFRIC 20 – Stripping Costs in the Production Phase of a Surface Mine – states that costs
associated with a ‘stripping activity asset’ (i.e. the costs associated with gaining access to
a specific section of the ore body) are accounted for as an additional component of an
existing asset. Other routine stripping costs are accounted for as current costs of
production (i.e. inventory).
Property, plant and equipment 1305
The Interpretations Committee’s intention was to maintain the principle of IAS 16 by
requiring identification of the component of the ore body for which access had been
improved, as part of the criteria for recognising stripping costs as an asset. An entity will
have to allocate the stripping costs between the amount capitalised (as it reflects the
future access benefit) and the amount that relates to the current-period production of
inventory. This allocation should be based on a relevant production measure.
This component approach follows the principle of separating out parts of an asset that
have costs that are significant in relation to the entire asset and when the useful lives of
those parts are different. [IAS 16.45].
This interpretation is discussed in more detail in Chapter 39 at 15.5.
3.1.7 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). [IAS 16.6, IAS 41.5B].
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 (see Chapter 38).
[IAS 16.3(b), IAS 41.5C].
The following are not included within the definition of bearer plants:
• plants cultivated to be harvested as agricultural produce, e.g. trees 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. [IAS 41.5A].
Bearer plants are accounted for in the same way as self-constructed items of PP&E
before they are brought to the location and condition necessary to be capable of
operating in the manner intended by management. Consequently, references to
‘construction’ in IAS 16, with respect to bearer plants, cover the activities that are
necessary to cultivate such plants before they are brought in to the location and
condition necessary to be capable of operating in the manner intended by management.
[IAS 16.22A].
Bearer plants are subject to the requirements of IAS 16, and so entities will need to consider
the correct unit of account, analyse which costs can be capitalised prior to maturity, set
useful lives for depreciation purposes and consider the possibility of impairment.
1306 Chapter 18
For a more detailed discussion of the requirements, including some of the measurement
challenges for bearer plants under IAS 16, see Chapter 38 at 1, 2.2.1.A, 2.3.3, and 3.2.3.A.
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.
Example 18.1: Recognition and derecognition of parts
An entity buys a piece of machinery with an estimated useful life of ten years for €10 million. The asset contains
two identical pumps, which are assumed to have the same useful life as the machine of which they are a part.
After seven years one of
the pumps fails and is replaced at a cost of €200,000. The entity had not identified the
pumps as separate parts and does not know the original cost. It uses the cost of the replacement part to estimate
the carrying value of the original pump. With the help of the supplier, it estimates that the cost would have been
approximately €170,000 and that this would have a remaining carrying value after seven year’s depreciation of
€51,000. Accordingly it derecognises €51,000 and capitalises the cost of the replacement.
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].
Property, plant and equipment 1307
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.
Extract 18.3: Akzo Nobel N.V. (2017)
Notes to the Consolidated financial statements [extract]
1
Note 1: Summary of significant accounting policies [extract]
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 257
