Any cost that is not capitalized as part of setting up the factory will be expensed to the income statement as incurred. Capitalized costs can be accumulated over a period and finally expense to the income statement at end of accounting period.

Example 3

On 1 January 2010, G-Star acquired factory machinery for £300,000. The estimated useful life of the machinery was 15 years; however, its lining requires to be replaced every five years. The cost of the lining on 1 January 2010 was £80,000. The lining was replaced on 1 January 2015 at a cost of £90,000.

Solution:

There are two depreciable components related to the asset:

• The lining component (allocated cost £80,000 with a useful life of five years),
• The remaining cost [allocated cost of £220,000 (£300,000 – £80,000) with a useful life of 15 years].

Thus, the annual depreciation is £30, 666.67 [(£80,000 x 1/5) + (£220,000 x 1/15)]. On 31 December 2014, the lining component has a carrying value of zero.

From 2015:

The £90,000 expended on the new lining is treated as the replacement of a different component of an asset and capitalizes a part of PPE. The annual depreciation charge for the machinery is now £32,666.67  [(£90,000 x 1/5) + (£220,000 x 1/15)].

Revaluation of Property, Plant and Equipment (IAS 16)

IAS 16 permits entities the choice of two valuation models for PPE, namely the cost model or the revaluation model.

• The cost model is treated as asset cost less accumulated depreciation and any accumulated impairment losses.
• The revaluation model is treated as asset at its fair value at the revaluation date less subsequent depreciation and subsequent impairment losses).
• Revaluation Gain

Revaluation gain is an increase in asset value recorded when it is revalued to their fair value, rather than their original costs. This gain is typically recognized in the ‘other comprehensive income’ and accumulated in equity under a ‘revaluation surplus’ heading. However, it can also be recognized in the statement of profit or loss if it reverses a previous revaluation loss recognized in the same statement.

Journal entry for revaluation gain:

• Revaluation surplus account            Cr
• Asset account                                           Dr

Example 4

A property was acquired on 1 January 2005 for £4m (estimated depreciable amount £2m -useful economic life 50 years). Annual depreciation of £40,000 was charged from 2005 to 2009. On 1 January 2010 the carrying value of the property was £3.8m. The property was revalued to £5.6m on 1 January 2010 (estimated depreciable amount £2.7m – the estimated useful economic value life was unchanged).

Solution:

The revaluation surplus of £5.6 – £3.8 = £1.8 is recognized in the statement of change in equity by crediting a revaluation reserve account and debiting property account. The depreciable amount of property is now £2.7m and the remaining estimated useful economic life is 45 years (50 years from 1 January 2005). Thus, the depreciation charge from 2010 onwards would be £60,000 (2.7m x 1/45).

A revaluation often increases the annual depreciation charge in the income statement. In the example above, the annual increase is £20,000 (£60,000 – £40,000).

The IAS 16 permits (but does not require) entities to make a transfer of ‘excess depreciation’ from the revaluation reserve directly to retained earnings.

• Revaluation loss

A revaluation loss is referred to as the decrease in value of an asset, namely property, plant and equipment, when its fair value is lower than its carrying value (book value) after revaluation. This revaluation loss is recognized as an expense in the income statement, and it is also recognized in equity and deducted from a previous revaluation surplus.

Example 5

If the property referred to in example 1 was revalued on 31 December 2011. Its fair value had fallen to £3m.

Solution:

The carrying value of the property on 31 December 2011 would have been £5.36m  (£5.6m – 4 x £60,000). This means that the revaluation deficit is £2.36m  (£5.36m – £3m).

If the transfer of excess depreciation (see above) is not made, then the balance in the revaluation reserve relating to this asset £1.8 (see example 1). Thus, £1.8 is deducted from equity and £560,000 (£2.36 – £1.8) is charged to the income statement.

If the transfer of excess depreciation is  made, then the balance on the revaluation reserve on 31 December 2011 is £1.72m  (£1.8m – 4 x £20,000). Thus, £1.72m is deducted from equity and £640  (£2.36 – £1.72) is charged to the income statement.

Derecognition of PPE, The IAS 16

The PPE should be derecognized; that is, removed/scrapped from PPE, either on disposal or when no future economic benefit is expected from the asset. A gain or loss is recognized as the differential between the disposal value and the carrying value of the asse (applying the cost or revaluation model) at the date of disposal. Consequently, the net gain is transferred to income statement as “Other revenue or Expense”.

Disposal of Assets, IFRS 5

Under IFRS 5, a non-current asset or a disposal group is classified as “held for sale” when its carrying amount will be recovered basically through a sale instead of continuing use. A disposal group is a group of assets, possibly with related liabilities, that an entity intends to dispose of in a single transaction. 

The Journal Entry for Disposable Assets:

• Gain on Disposal:
• If the selling price exceeds the asset’s book value, the difference is a gain.
• The journal entry will include:
• Debit: Cash (amount received from the sale)
• Debit: Accumulated Depreciation (to remove the asset’s accumulated depreciation)
• Credit: Asset (to remove the asset’s original cost)
• Credit: Gain on Disposal (for the difference between the selling price and book value)

• If the selling price is less than the asset’s book value, the difference is a loss.
• The journal entry will include:
• Debit: Cash (for the amount received from the sale)
• Debit: Accumulated Depreciation (to remove the asset’s accumulated depreciation)
• Debit: Loss on Disposal (for the difference between the selling price and book value)
• Credit: Asset (to remove the asset’s original cost)

Example 6

An asset has a carrying value of £900,000. It is classified as held for sale on 30 September 2011. At that date its fair value minus costs to sell is estimated at £950,000. The asset was sold for £955,000 on 30 November 2011. The year end of the entity is 31 December 2011.

Solution:

The classification as held for sale, and subsequent disposal, be treated as follows:

• On 30 September 2011, the asset would be treated as: its fair value less costs to sell £950,000 and an impairment loss of £50,000 is recognised. This amount would be removed from non-current assets and presented in “non-current assets held for sale”. On 30 November 2011 a profit on sale of £5,000 would be recognised.
• On 30 September 2011, the asset would be transferred to non-current assets held for sale at its existing carrying value of £900,000. When the asset is sold on 30 November 2011, a profit on sale of £55,000 would be recognised.