Ind AS 16 – PPE : Scope, Definitions and Initial Measurement

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Scope of the standard:

This standard applies to all PPE unless another standard requires a different treatment.

The following are outside the scope:

1. NCA held for sale.

2. Biological assets.

3. Exploration asset.

4. Mineral rights and Mineral reserves.

5. Investment property.

6. Assets taken on Finance Lease

Definitions:

Property, plant and equipment (PPE) are tangible items that:

1. are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and

2. are expected to be used during more than one period.

Analysis of the definition of PPE:

• The PPE can be a tangible item only. A tangible item implies a resource which is capable of being touched and which has actual physical existence.

• A resource which is used only for production or supply of goods or services, for rental to others, or for administrative purposes, can only be termed as PPE.

• The point to be noted here is, an asset which is held to be given on rental to others can also be termed as a PPE but land and/or Building which are only held to be given on rental to others will be an “Investment Property” and not a PPE.

• Another important as aspect of the definition is that an asset can be termed as PPE only if it is “expected to be used during more than one period”. This has the following implications:

• On the date of purchase, the management has to expect to use the asset for more than one period, only then it can be termed as a PPE.

• Generally the term “period” can be interpreted as an “Accounting Period”. Thus this further implies that it can refer to an interim accounting period or a financial year.

• For example, an asset is purchased on 1 May and is expected to be used for two months, the interim period is the quarter April – June. Thus in this case the interim financial statements as on 30 June will treat this asset as PPE, as it will be used in two quarters (April-June quarter and July-September quarter) which in turn implies that this standard will be applicable and thus depreciation will be charged. With respect to the annual financial statement (April – March), this asset will not be treated as a PPE as it is not been used for more than one accounting period (in this case the accounting period is the financial year).

Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life.

Depreciable amount is the cost of an asset, or other amount substituted for cost, less its residual value.

The residual value of an asset is the estimated amount that an entity would currently obtain from the disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life.

Useful life is:

1. the period over which an asset is expected to be available for use by an entity; or

2. the number of production or similar units expected to be obtained from the asset by an entity.

At this juncture, I would like to point out the distinction between “Useful life” and “Economic Life”. Economic life refers to the life of the asset on average for all types of users of the asset, whereas Useful life refers to the life of the asset expected by that particular user. An example would be, a car of the same model, make and manufacturer, that has been bought by ABC Pvt Ltd, the entity which gives it on hire (taxi service) and another entity PQR Pvt Ltd for the use of its CEO. The car manufacturer “markets” the car saying the average life of the car is 10 years (economic life). ABC Pvt Ltd would expect the life of the said car to be much less than the economic life as their usage and thus the wear and tear on the car will be higher when compared to the average user. Usage of the car (and thus ware and tear) by PQR Pvt Ltd will be relatively lesser and thus they can expect the life of the asset almost close to the Economic Life.

Summary of the provision relating to initial recognition:

The cost of an item of property, plant and equipment shall be recognized as an asset if, and only if:

1. It is probable that future economic benefits associated with the item will flow to the entity; and

2. The cost of the item can be measured reliably.

Analysis of the initial recognition provision:

• “Probable that future economic benefits will flow to the entity”

Even though it is not stated in any Accounting standard, generally the norm is that if the probability of future economic benefits to flow in is higher than 50% then it will satisfy the condition of “Probable”.

• The inflow of economic benefit can be direct or indirect.

For example, the Machinery can be directly involved in manufacturing the finished goods which in turn can generate cash flow.

Another example is the Pollution Control Equipment, which might not be directly involved in the manufacturing of the finished goods but without them, the machinery might not be allowed to be operational (due to licensing conditions), thus it indirectly helps in getting an inflow of economic benefits.

• “Cost of the item can be measured reliably”:

This condition refers to being able to measure the cost of the item when it is purchased.

In most cases, determining the cost of an item will be straightforward, the amount at which the supplier raises the invoice.

But for example, there can be a contract entered between the supplier and the buyer stating that the purchase consideration will be a determined percentage of revenue generated from the finished goods produced by the item. For example a supplier selling screw manufacturing machinery, the contract can state – “the purchase consideration for the machinery will be 30% of the selling price of the screws manufactured and sold during the year”. In this case, it will be difficult to estimate the purchase consideration on the date of purchase as only at the yearend will the exact amount be determined.

This article has been published in the Chartered Accountant Study Circle ("CASC") Bulletin.