valuable use. On the other hand, the present owner may enjoy some benefits that could
not be passed on in a sale, such as planning consents that are personal to the present
occupier. Market value in existing use will be presumed to be fair value under IFRS 13 for
many types of business property unless market or other factors suggest that open market
value is higher (i.e. open market value represents highest and best use). For most retail
sites market value in existing use will be fair value; if there is market evidence that certain
types of property have an alternative use with a higher value, e.g. pubs or warehouses that
can be converted to residential use, this will have to be taken into account.
The fair value of an item of PP&E will either be measured based on the value it would
derive on a standalone basis or in combination with other assets or other assets and
liabilities, i.e. the asset’s ‘valuation premise’. ‘Valuation premise’ is a valuation concept
that addresses how a non-financial asset derives its maximum value to market
participants. The highest and best use of an item of PP&E ‘might provide maximum
value to market participants through its use in combination with other assets as a group
or in combination with other assets and liabilities (e.g. a business)’ or it ‘might have
maximum value to market participants on a stand-alone basis’. [IFRS 13.31(a)-(b)].
The following example is derived from IFRS 13 and illustrates highest and best use in
establishing fair value. [IFRS 13.IE7-IE8].
Property, plant and equipment 1333
Example 18.4: Highest and best use
An entity acquires land in a business combination. The land is currently developed for industrial use as a site
for a factory. The current use of land is presumed to be its highest and best use unless market or other factors
suggest evidence for a different use.
Scenario (1): In the particular jurisdiction, it can be difficult to obtain consents to change use from industrial
to residential use for the land and there is no evidence that the area is becoming desirable for residential
development. The fair value is based on the current industrial use of the land.
Scenario (2): Nearby sites have recently been developed for residential use as sites for high-rise apartment
buildings. On the basis of that development and recent zoning and other changes that facilitated the residential
development, the entity determines that the land currently used as a site for a factory could also be developed
as a site for residential use because market participants would take into account the potential to develop the
site for residential use when pricing the land.
This determination can be highly judgemental. For further discussion on highest and
best use and valuation premise see Chapter 14 at 10.
6.1.1.B Valuation
approaches
Prior to the adoption of IFRS 13, IAS 16 had a hierarchy of valuation techniques for
measuring fair value. Only if there was no market-based evidence could an entity
estimate fair value using an income or a depreciated replacement cost approach under
IAS 16. However, the implementation of IFRS 13 removed these from IAS 16, which
now refers to the valuation techniques in IFRS 13.
IFRS 13 does not limit the types of valuation techniques an entity might use to measure fair
value but instead focuses on the types of inputs that will be used. The standard requires the
entity to use the valuation technique that maximises the use of relevant observable inputs
and minimises the use of unobservable inputs. [IFRS 13.61]. The objective is that the best
available inputs should be used in valuing the assets. These inputs could be used in any
valuation technique provided they are consistent with the three valuation approaches in the
standard: the market approach, the cost approach and the income approach. [IFRS 13.62].
The market approach uses prices and other relevant information generated by market
transactions involving identical or comparable (i.e. similar) assets, liabilities or a group
of assets and liabilities, such as a business. [IFRS 13.B5]. For PP&E, market techniques will
usually involve market transactions in comparable assets or, for certain assets valued as
businesses, market multiples derived from comparable transactions. [IFRS 13.B5, B6].
The cost approach reflects the amount that would be required currently to replace the
service capacity of an asset (i.e. current replacement cost). It is based on what a market
participant buyer would pay to acquire or construct a substitute asset of comparable
utility, adjusted for obsolescence. Obsolescence includes physical deterioration,
functional (technological) and economic (external) obsolescence so it is broader than
and not the same as depreciation under IAS 16. [IFRS 13.B8, B9].
The income approach converts future amounts (e.g. cash flows or income and expenses)
to a single discounted amount. The fair value reflects current market expectations about
those future amounts. In the case of PP&E, this will usually mean using a present value
(i.e. discounted cash flow) technique. [IFRS 13.B10, B11].
See Chapter 14 at 14 for a further discussion of these valuation techniques.
1334 Chapter 18
IFRS 13 does not place any preference on the techniques. An entity can use any
valuation technique, or use multiple techniques, as long as it applies the valuation
technique consistently. A change in a valuation technique is considered a change in an
accounting estimate in accordance with IAS 8. [IFRS 13.66].
Instead, the inputs used to measure the fair value of an asset have a hierarchy. Level 1
inputs are those that are quoted prices in active markets (i.e. markets in which
transactions take place with sufficient frequency and volume to provide pricing
information on an ongoing basis) for identical assets that the entity can access at the
measurement date. [IFRS 13.76]. Level 1 inputs have the highest priority, followed by
inputs, other than quoted prices, that are observable for the asset either directly or
indirectly (Level 2). The lowest priority inputs are those based on unobservable inputs
(Level 3). [IFRS 13.72]. The valuation techniques, referred to above, will use a combination
of inputs to determine the fair value of the asset.
As stated above, land and buildings are the most commonly revalued items of PP&E.
These types of assets use a variety of inputs such as other sales, multiples or discounted
cash flows. While some of these maybe Level 1 inputs, we generally expect the fair value
measurement as a whole to be categorised within Level 2 or Level 3 of the fair value
hierarchy for disclosure purposes (see 8.2 below).
IFRS 13 also requires additional disclosure in the financial statements that are discussed
at 8.2 below of this chapter and in Chapter 14 at 20.
6.1.1.C
The cost approach: current replacement cost and depreciated
replacement cost (DRC)
IFRS 13 permits the use of a cost approach for measuring fair value, for example current
replacement costs. Before using current replacement cost as a method to measure fair
value, an entity should ensure that both:
• the highest and best use of the assets is consistent with their current use; and
• the principal market (or in its absence, the mo
st advantageous market) is the same
as the entry market.
The resulting current replacement cost should also be assessed to ensure market
participants would actually transact for the asset in its current condition and location at
this price. In particular, an entity should ensure that both:
• the inputs used to determine replacement cost are consistent with what market
participant buyers would pay to acquire or construct a substitute asset of
comparable utility; and
• the replacement cost has been adjusted for obsolescence that market participant
buyers would consider so that the depreciation adjustment reflects all forms of
obsolescence (i.e. physical deterioration, technological (functional) and economic
obsolescence and environmental factors), which is broader than depreciation
calculated in accordance with IAS 16.
Before IAS 16 was amended by IFRS 13, DRC was permitted to measure the fair value
of specialised properties. In some ways DRC is similar to current replacement cost. The
crucial difference is that under IAS 16 entities were not obliged to ensure that the
resulting price is one that would be paid by a market participant (i.e. it is an exit price).
Property, plant and equipment 1335
The objective of DRC is to make a realistic estimate of the current cost of constructing
an asset that has the same service potential as the existing asset. DRC therefore has a
similar meaning to current replacement cost under IFRS 13 except that current
replacement cost is an exit price and its use is not restricted to specialised assets as
IFRS 13 requires entities to use the best available inputs in valuing any assets.
DRC can still be used, but care is needed to ensure that the resulting measurement is
consistent with the requirements of IFRS 13 for measuring fair value. Since DRC
measures the current entry price, it can only be used when the entry price equals the
exit price. For further discussion see Chapter 14 at 14.3.1.
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].
Example 18.5: Effect of depreciation on the revaluation reserve
On 1 January 2016 an entity acquired an asset for €1,000. The asset has an economic life of ten years and is
depreciated on a straight-line basis. The residual value is assumed to be €nil. At 31 December 2019 (when the
1336 Chapter 18
cost net of accumulated depreciation is €600) the asset is valued at €900. The entity accounts for the revaluation
by debiting the carrying value of the asset (using either of the methods discussed below) €300 and crediting €300
to the revaluation reserve. At 31 December 2019 the useful life of the asset is considered to be the remainder of
its original life (i.e. six years) and its residual value is still considered to be €nil. In the year ended 31 December
2020 and in later years, the depreciation charged to profit or loss is €150 (€900/6 years remaining).
The usual treatment thereafter for each of the remaining 6 years of the asset’s life, is to transfer €50 (€300/6 years)
each year from the revaluation reserve to retained earnings (not through profit or loss). This avoids the revaluation
reserve being maintained indefinitely even after the asset ceases to exist, which does not seem sensible.
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 29.
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.
Example 18.6: Revaluation
by eliminating accumulated depreciation
On 31 December, a building has a carrying amount of €40,000, being the original cost of €70,000 less
accumulated depreciation of €30,000. A revaluation is performed and the fair value of the asset is €50,000.
The entity would record the following journal entries:
Dr
Cr
€
€
Accumulated depreciation
30,000
Building 20,000
Asset revaluation reserve
10,000
Before
After
€
€
Building at cost
70,000
Building at valuation
50,000
Accumulated depreciation
30,000
–
Net book value
40,000
50,000
Property, plant and equipment 1337
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,
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 263
