Depth – Property plant and equipment

Property, plant and equipment

Section 17 of FRS 102 sets out the accounting treatment and disclosure for property, plant and equipment. It also applies to those investment properties where a fair value cannot be measured reliably without undue cost or effort.

What is property, plant and equipment?

“Property, plant and equipment” (PPE) includes tangible assets that are expected to be used by the entity for more than one period and are held:

  • for use in the production or supply of goods or services;
  • for rental to others; or
  • for administrative purposes.

However, it should be noted that PPE does not include the following:

  • biological assets which relate to agricultural activity;
  • heritage assets; or
  • mineral rights and mineral reserves, such as oil, natural gas.         

These assets are all dealt with in Section 34 of FRS 102.

How is PPE initially recognised and measured?

Entities are required to recognise an item of PPE if it is probable that future economic benefits associated with the item will flow to the entity; and the cost of the item can be measured reliably.

PPE will initially be measured at cost (including all directly-attributable costs, and any initial estimate for dismantling). Borrowing costs can also be capitalised (as under old GAAP). NB land and buildings are regarded as separable assets and as such entities should account for them separately, even if they are acquired together.

[[[FRSE 102 requires that major spare parts and stand-by equipment should be recognised as PPE if an entity expects them to be used for more than one period.]]]

In general, spare parts and servicing equipment are carried as inventory and recognised in profit or loss as consumed. However, FRSE 102 requires that major spare parts and stand-by equipment should be recognised as PPE if an entity expects them to be used for more than one period. Also, where spare parts and servicing equipment can be used only in connection with an item of PPE, then they should also be regarded as PPE.

Parts of some items of PPE may require replacement at regular intervals, or major components may have significantly different patterns of consumption. An entity shall capitalise the cost of replacement parts as a separate item of PPE if they will give incremental future benefits. Depreciation should be charged accordingly. The carrying amount of those parts that are replaced should be derecognised.

The standard also allows major inspections of PPE to be capitalised, in a similar way to old GAAP.

What about any later expenditure?

Subsequent expenditure is capitalised if:

  • It enhances the economic benefits; or
  • A component of the asset that is being depreciated is replaced or restored; or
  • The expenditure relates to a major inspection or overhaul, restoring economic benefits consumed to date and reflected in the depreciation charge.          

How is PPE subsequently measured?

A choice is available between the cost model and the revaluation model. Where the revaluation model is selected, this shall be applied to all items of PPE in the same class.

An entity shall recognise the costs of day-to-day servicing of an item of PPE in profit or loss in the period in which the costs are incurred.

Under the cost model, an entity shall measure an item of PPE at cost less any accumulated depreciation and any accumulated impairment losses.

[[[Revaluations shall be made with sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the end of the reporting period.]]]

Under the revaluation model, an item of PPE whose fair value can be measured reliably shall be carried at a revalued amount, being its fair value at the date of revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses. Revaluations shall be made with sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the end of the reporting period.

The fair value of land and buildings is usually determined from market-based evidence by appraisal that is normally undertaken by professionally qualified valuers. The fair value of items of plant and equipment is usually their market value determined by appraisal.

If market-based evidence of fair value is not available (possibly because of the specialised nature of the item of PPE or similar items are rarely sold) entities should use an income or a depreciated replacement cost approach.

How is this different to ‘old GAAP’?

Under FRS 15, the revalued amount should reflect the asset’s current value at the balance sheet date. For properties this means a full valuation at least every five years, with an interim valuation in year 3, and in other years if it is likely that there has been a material change in value. For other assets, a full valuation is needed at least every five years.

Under FRS 15, the basis of property valuation is strictly set out:

  • Specialised properties are valued at depreciated replacement cost;
  • Properties surplus to requirements are valued at open market value;
  • Otherwise, non-specialised properties should be included based on the existing use value.

How are gains and losses on revaluation shown?

If the carrying amount of an asset is increased as a result of a revaluation, the increase shall be recognised in other comprehensive income and accumulated in equity. The Companies Act 2006, which will apply alongside FRS 102, requires (for companies) that a separate revaluation reserve is maintained. This is similar to old GAAP.

If the increase reverses a revaluation decrease of the same asset previously recognised in profit or loss, the increase should be recognised in profit or loss to the extent that it reverses the revaluation deficit.

Revaluation losses caused by a clear consumption of economic benefits are recognised in the profit and loss account. Other losses are recognised first in the STRGL until the asset reaches depreciated historic cost at which point the loss is recognised in the profit and loss account.

What about deferred tax?

Deferred tax is chargeable on timing differences that arise between tax allowances for PPE and the depreciation charged. Deferred tax relating to a non-depreciable asset that is measured using the revaluation model shall be measured using the tax rates and allowances that apply to the sale of the asset.

Are there any exemptions on transition?

Yes – an important exemption (for PPE and for investment property whose fair value is not obtainable without undue cost and effort). Para 35.10(c) and (d) allow a first-time adopter to measure assets at fair value or at a previous GAAP revaluation and to use these as ‘deemed cost’. This allows entities which have previously revalued but wish to use a cost model to use the latest valuation rather than reverting to the depreciated historic cost. It also allows entities which have used the cost model to continue to do so but using a (usually much higher) deemed cost base. This can bring valuable strength to the entity’s balance sheet, although at a price of higher depreciation charges in future years.