Accounting Standard 10 deals with Property, Plant and Equipment (PPE). The underlying purpose of this standard is to lay down or specify accounting treatment for Property, Plant and Equipment.
This is to enable the users of the financial statements to understand the investment made by the business entity in property, plant and equipment and the changes made therein.
The fundamental challenges while accounting for property, plant and equipment include:
- Recognition of assets
- Ascertaining the carrying amounts of the assets
- Determining the depreciation charges and impairment losses in respect of property, plant and equipment
Application of AS 10
AS 10 must be applied when accounting for property, plant and equipment. However, it may not be applied in cases where another accounting standard allows for different accounting treatment for property, plant and equipment.
Accordingly, following are the cases where AS 10 is not applicable:
- Biological Assets like live animals or plants pertaining to agricultural activity other than bearer plants. Bearer plant here means a plant that is:
- used in the production or supply of agricultural produce
- Is anticipated to give produce for more than 12 months
- Has a remote chance of being sold as an agricultural produce except for incidental scrap sales
Thus, AS 10 applies to Bearer plants but is not applicable to the produce on bearer plants.
- Wasting assets that include mineral rights, expenditure on the exploration for an extraction of minerals, oil, natural gas and similar other non-regenerative resources.
Recognition of Assets
The cost of an asset that comes under Property, Plant and Equipment as per AS 10 is identified as an asset only if:
- The future economic benefits expected to arise from such an asset would come to the business entity
- Cost of such an asset can be reliably measured
Also, items like spare parts, stand-by-equipment and servicing equipment are considered as Property, Plant and Equipment only when such items meet the criteria of PPE as per AS 10. If not so, such items are categorized under inventory.
Further, AS 10 does not specify any unit of measure for an item of PPE. Thus, accounting professionals need to make use of proper judgment to recognize an item as PPE under specific circumstances.
Likewise, items such as moulds, dies etc. that are not of material nature are aggregated and hence the criteria for PPE is applied to such aggregate value.
Lastly, the business entity may choose to treat an item as an expense which would otherwise have been categorized under PPE. This is because the amount of such an item is not material in nature.
Determination of Cost
As per AS 10, the cost of property, plant and equipment of a business entity may include the:
- initial cost to acquire or construct an item of property, plant and equipment
- Subsequent costs of adding, replacing or servicing the property, plant and equipment so acquired
As per AS 10, PPE covers all tangible assets that are held for use or administrative purposes. Here, administrative purposes include all business purposes other than the production or supply of goods or services or giving PPE on rent to others.
Thus, PPE used for administrative purposes include assets used for:
- selling and distribution
- Finance and accounting
- Personnel and other functions of an enterprise
Further, PPE may also include assets acquired for safety or environmental purposes.
While recording items of PPE and their carrying amount in the books of accounts, the business entity does not include the cost incurred on the day to day servicing of such items. Such costs are rather recognized in the statement of Profit and Loss at the time they are incurred.
The day – to day costs of servicing include costs such as labour, small parts and consumables. These day to day servicing costs are basically incurred on account of repairs and maintenance of an item of PPE.
Furthermore, the parts of few items categorized under PPE may need to be replaced from time to time. Such a cost of replacing part of an item under PPE shall be included in the carrying amount only if the criteria for recognition as mentioned above is met.
In addition to this, the very condition to continue utilizing an item of PPE may be to undertake regular inspection of such an item to check for any faults in such an item. This is despite the fact that parts of such an item are replaced or not. Therefore, once such an inspection is undertaken its cost is included in the carrying amount of the item of PPE as a replacement cost only if the recognition criteria mentioned above is met.
Measurement of Cost
Once assets are recognized as an item under PPE as per AS 10, the business entity can use one of the two models to determine the carrying amount of the assets so acquired.
Thus, the model chosen becomes the accounting policy which is used to calculate the carrying amount of all the assets categorized under PPE. Accordingly, the two models include the Cost Model and the Revaluation Model.
Once an asset is recognized, the item of PPE may be carried at its cost less accumulated depreciation and any accumulated impairment losses as per the Cost Model. Here cost of an item of PPE includes:
- Acquisition Cost including import duties and non-refundable purchase taxes less any trade discounts and rebates
- Costs directly associated with bringing the asset to the location as well the condition essential so as to make the asset capable of operation in a way as planned by the management.
- Costs of dismantling, removing the item and restoring the site on which the asset is located
The examples of such costs include:
- cost of preparing the site,
- Initial delivery and handling cost
- Assembly and installation cost
- Professional fees
- Employee benefit cost that can be attributed directly to the item of PPE constructed or acquired
- Cost of testing if the asset is operating properly after reducing net proceeds from items sold that were produced when the asset was brought to the location and condition necessary for operation
Under the revaluation model, after the asset is recognized, an item of PPE should be carried at a revalued amount. Provided the fair value of such an item of PPE can be reliably measured.
The revalued amount is nothing but the Fair Value of the item of PPE at the date of revaluation less any subsequent accumulated depreciation as well as impairment losses.
It must be noted that the revaluations of these items of PPE must be made at regular intervals. This is to make sure that the carrying amount does not significantly vary from the value that is so ascertained using the fair value on the balance sheet date.
As per AS 10, Depreciation is nothing but a charge that is allocated to an asset systematically over its useful life. Thus, the depreciable amount so charged for an asset in each period is typically recognized in the profit and loss statement of the business entity.
However, this depreciable amount is, at times, included in the carrying amount of any other asset. This is the case when the future economic benefits to be derived from an asset are used to produce other assets.
In such a case, the depreciation charge is included in the cost of the other asset and is identified in its carrying amount.
Furthermore, every part of an item of PPE that has a cost which is material in respect of the total cost of the item is depreciated separately.
Thus, the business entity initially allocates the cost to each significant part of an item of PPE and depreciates each part separately.
There can be cases where the depreciation method used as well as the useful life of each material part of an item of PPE may be same as the other significant parts of the same item of PPE.
In such a situation, the items should be grouped together in order to estimate the depreciation amount.
As mentioned above, the depreciation amount is nothing but a charge allocated systematically to an asset over its useful life.
Such a charge allocated in each period to an asset must demonstrate the manner in which the future economic benefits arising from an asset are expected to be utilized by the business entity.
Period Of Charging Depreciation
A business entity initiates to charge depreciation to an asset only when it is available for use. In other words, assets are depreciated only when they are brought to the location and the condition essential for making the asset operational in the manner in which it is planned by the management.
On the other hand, the business entity discontinues to depreciate an asset at a date earlier of:
- The date on which the asset is no longer actively used and is held for disposal and the
- Date at which the asset is derecognized
Useful Life of an Asset
The useful life of an asset is the time period for which the asset is estimated to provide utility to business entity. Following are the factors used to estimate the useful life of an asset:
- Anticipated usage of the asset in terms of its expected capacity or physical output
- Probable wear and tear depending on factors like repair and maintenance, number of shifts for which the asset is utilized etc.
- Commercial or technical obsolescence
- Legal limit such as expiry date
The business entity must use the depreciation method that demonstrates the manner in which the future economic benefits to be derived from an asset are anticipated to be used by the business entity.
Furthermore, the depreciation method to be applied to the assets must be checked at the end of each financial year. This is because there can be situations when the depreciation method being used by the entity no longer reflects the manner in which economic benefits expected to be derived from the assets are intended to be consumed by the business entity.
Therefore, in case of such a change in the anticipated consumption of the benefits arising from the asset, it is necessary that the business entity change the depreciation method that closely reflects such a changed pattern.
There are various depreciation methods that a business entity can choose to apply to its assets. These include:
1. Straight Line Method
This is a depreciation method under which the value of an asset is reduced uniformly over the useful life of the asset.
The depreciation expense is calculated by subtracting the residual value of the asset from the cost of the asset and further dividing this difference with the useful life of the asset.
2. Diminishing Balance Method
This method is also known as the written down value method or declining balance method. As per this method, a fixed percentage of depreciation is charged in each accounting period to the net balance of the fixed asset.
This net balance is nothing but the value of asset that remains after deducting accumulated depreciation. Thus, formula for calculating depreciation expense as per this method is as follows:
Depreciation expense = Book value of the asset at the beginning of the year x Rate of depreciation
3. Units of Production Method
Under this method, depreciation charge is estimated based on the number of units produced by an asset.
In other words, such a depreciation method is used when the value of assets is incidental to the units produced by the asset and not its useful life.
Therefore, the amount of depreciation charged is higher in the years in which the output produced by such assets is higher.
The formula for calculating depreciation as per this method is: [(Cost of the asset – Residual value)/Production capacity] x Units produced by the asset