IAS 16 :Measurement at Recognition

Measurement at Recognition

Property, plant and equipment will be measured at cost.

Elements of cost

The cost comprises:

(1)  buying price, including import duties and non-refundable taxes, after deducting trade discounts and rebates;

(2)  any costs directly attributable to bringing the asset to the location, and installation, necessary for it to be capable of operating in the manner intended by management.

(3)   the initial estimate of the costs of dismantling, and removing the item, and restoring the site on which it is located.

Examples of directly attributable costs are:

q staff costs arising directly from the construction, or acquisition, of the item of property, plant and equipment;

q site preparation costs;

q initial delivery and handling costs;

q installation and assembly costs;

q costs of testing whether the asset is functioning properly, after deducting the net proceeds from any samples, or sundry income; and

q professional fees.

EXAMPLE        Components of cost of property, plant and equipment Issue Property, plant and equipment shall initially be measured at cost. The cost of an item includes any directly attributable costs of bringing the asset to the location and condition for enabling operation as intended by management. The following are examples of the types of costs that can or cannot be included in the cost of property, plant and equipment. Solution Costs included Costs necessary for the construction of PPE should be capitalised. i) Legal costs specific to the purchase and construction of the specific asset; ii) Initial delivery and handling costs; iii) Import duties; iv) Installation costs; v) Purchase transaction costs; vi) Property transfer taxes; vii) Architect and engineering costs specific to the asset (costs of alternative designs that were subsequently rejected should not be capitalised); viii) Site clearance costs; ix) Construction labour and materials; x) Interest during period of construction (see IAS 23); and xi) Start-up costs necessary for working condition of asset (including plant commissioning and test production). Costs excluded Costs associated with the planning stages, while necessary for good governance of an undertaking’s resources, may not be necessary for the construction of the final asset.  Such costs, for example costs concerned with the selection of designs, identification of sites and requirements, etc, are not directly necessary for the construction of the final asset. Costs that are not necessary are expensed and not capitalised. i) Feasibility study costs; ii) Start-up costs (unless necessary for working condition of the asset); iii) Initial operating losses before planned operating levels; iv) Abnormal wasted materials, labour or other resources; v) Interest or other costs after the property, plant and equipment is available for use even if not yet in use in the business; vi) Staff training; vii) Cost of relocating certain equipment in the plant to allow installation of the new equipment; and viii) General administrative costs not directly attributable to the acquisition, construction or commissioning of the asset.

EXAMPLE        Capitalisation of rental expenses Issue The cost of an item of PP&E comprises, inter alia, any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner that management intends.      Should an operator capitalise rental expenses? Background X is constructing a computer network between its head office and branches.  X has entered into rental agreements with various providers for line rentals.  X pays 1,000 a month for the rental of the telephone lines.  X will pay the same level of rental expense after the network is launched. Solution Operator X should expense the rental of 1,000 as incurred throughout the network’s construction stage. Line rental costs will be incurred before and during the network operating stage. The costs are not incremental and they are not directly attributable to the process of bringing the network to its working condition. Therefore, they should be expensed as incurred. The rentals are part of the start-up costs, which should be expensed as incurred. Lease payments under an operating lease should be recognised on a straight-line basis over the lease term unless another systematic basis is representative of the time pattern of the user’s benefit. X derives benefit from the lease from day one, because it has access to the lines in order to install its equipment. Therefore, the straight-line basis of recognising the lease payments is appropriate.  Rentals incurred before the network is operational should not be capitalised.

Expensed Costs

Costs that should be expensed in the income statement (and not capitalised), include:

(1)     costs of opening a new facility;

(2)    costs of introducing a new product, or service (including advertising and promotional activities);

(3)    costs of running a business in a new location, or with a new class of customer (including staff training); and

(4)    administration and other general overhead costs.

Stopping cost recognition

Recognition of costs ceases when the item is in the location, and capable of operating in the manner intended by management.

Therefore, costs incurred in using, relocating, or redeploying are not included in the carrying amount of the item.

For example, the following costs are not included in the carrying amount :

(1)      costs incurred while an operation, capable of operating in the manner intended by management, has yet to be brought into use, or is operated at less than full capacity;

(2)      initial operating losses, such as those incurred while business in  the operation builds up; and

(3)      costs of relocating, or reorganising part, or all, of a bank’s operations.

EXAMPLE        Capitalisation of pre-opening costs Issue The cost of an item of property, plant and equipment includes directly attributable expenditure necessary to bring the asset to the location and condition for it to be capable of operating in the manner intended by management. Should management capitalise the expenditure made before opening a branch? Background K, which operates a major branch network of banks, has acquired a new branch location. The new location requires significant renovation expenditure. Management expects that the renovations will last for 3 months during which the branch will be closed. Management has prepared the budget for this period including expenditure related to construction and remodelling costs, salaries of staff who will be preparing the branch before its opening, and related utilities costs. Solution Yes. Management should capitalise the costs of construction, security, communications and remodelling the branch, because they are necessary to bring the branch to the condition necessary for it to be capable of operating in the manner intended by management. The branch cannot be opened without incurring the remodelling expenditure, and thus the expenditure should be considered part of the asset. However, the cost of salaries, utilities and storage of goods are operating expenditures which would be incurred if the branch was open. These costs are not necessary to bring the branch to the condition necessary for it to be capable of operating in the manner intended by management and should be expensed.

Incidental costs / income

Some incidental operations may occur before, or during, the construction, or development activities.

For example, income may be generated by using a building site as a car park, until construction starts.

The income and related expenses of incidental operations are recorded in the income statement, and included in their respective classifications of income and expense.

Self Constructed Assets

The cost of a self-constructed asset is determined using the same principles as for an acquired asset.

If an undertaking makes similar assets for sale in the normal course of business, the cost of the asset is usually the same as the cost of constructing an asset for sale.

Any internal profits are eliminated from such costs.

EXAMPLE        Salaries recognised as part of an asset’s cost Issue The cost of an item of property, plant and equipment includes any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. Should management capitalise or expense the salaries of employees who are constructing an asset? Background M’s management has started to construct a new branch. Part of the ordinary workforce will be working full time on the project of constructing the plant.  The estimated time of construction is 3 months. The total salary costs for these employees, including the cost of pension benefits and annual leave, totals 500,000 a year. Solution Management should capitalise 125,000 (3/12 x 500,000) as part of the cost of the branch. The salary cost of the employees working full time on the project can be directly attributable to the construction of the asset. Administration and other general overheads are examples of costs that are not a component of the cost of property, plant and equipment.

Similarly, the cost of abnormal amounts of wasted material, labour, or other resources incurred in self-constructing an asset, is not included in the cost of the asset.

IAS 23 Borrowing Costs details the criteria for the recognition of interest as a component of the carrying amount of a self-constructed asset.

Measurement of cost

The cost is the cash-price equivalent at the recognition date. If payment is deferred beyond normal credit terms, the difference between the cash price equivalent and the total payment is recorded as interest over the period of credit, unless such interest is recorded as a borrowing cost in the carrying amount of the item, in accordance with IAS 23.

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EXAMPLE cost measurement You can pay $1mln cash for a building, or pay for it over 3 years for a total cost of $1,3 mln. Using either payment method, the cost will be $1mln. If the second payment option is used (see above), the $0,3 mln. will be treated as interest.
	I/B	DR	CR
Property, plant & equipment	B	$1 mln.
Accounts payable	B		$1 mln.
Being the buying of the building
Interest expense	I	$0,1 mln.
Interest payable	B		$0,1 mln.
Annual interest charge

The cost held by a lessee under a finance lease is determined under IAS 17 Leases.

The carrying amount may be reduced by government grants, in accordance with IAS 20 Government Grants.