Measurement of Property, Plant and Equipment (PPE) – Overview

Contents:

1. Introduction
2. Initial Measurement of PPE
   • In Case of Purchase of PPE
   • In Case of Self-Construction of PPE
   • In Case of Exchange of PPE
3. Subsequent Measurement of PPE
   • Subsequent Measurement when PPE is Held for Sale
4. Conclusion

1. Introduction

Property, Plant, and Equipment (PPE) are fixed assets that are used in business to generate revenue. Accounting Standard 10 lays down the principles related to recognition of PPE, measurement of carrying amounts initially & subsequently, a charge of depreciation, revaluation thereon, and derecognition of PPE.

An item of Property, Plant, and Equipment (PPE) that qualifies for recognition as an asset shall be measured at its cost. The cost of an item of property, plant, and equipment will be equal to cash price equivalent at the date of recognition.

2. Initial Measurement

Initial measurement would mean how the PPE would be recognized for the first time in the books of accounts. PPE may be acquired by way of purchase, self-construction, or exchange with any other asset. Therefore the initial measurement of PPE cost depends upon the way such PPE is acquired.

• Cost Components

The cost of PPE comprises its purchase price, duties, and taxes which are non-recoverable, and all directly attributable costs incurred to make the asset ready for use in the manner as intended by the management of an entity. It includes the initial estimate of costs to be incurred on dismantling & removing the PPE and restoring the site on which it is located. Such dismantling costs are referred to as decommissioning, restoration, and other liabilities. Trade discounts and rebates, if any, shall be reduced while computing actual costs.

Examples of directly attributable costs are site preparation costs, installation & assembly costs, salaries, and wages, etc.

• Principle

In principle, all expenditure incurred to bring a PPE to the location and condition necessary for it to be capable of operating in the manner intended by the management should be capitalized as a cost of the PPE in the books. Examples of expenditure that are not included in the cost are inauguration expenditure, advertisement & promotional expenditure, expenditure on staff training and administration, and other general overheads.

2.1 In Case of Purchase of PPE

PPE acquired by way of purchase is initially measured and recognized at its cost. The cost of PPE 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 recognized as interest over the period of credit unless such interest is capitalized in accordance with the provision of ‘Borrowing Costs’.

Where payment is deferred beyond normal credit terms, the cash price equivalent can be determined by discounting the total amount payable by the current market rate of interest. The payable amount is increased by the amount of interest at the end of each period.

2.2. In Case of Self-Construction of PPE

The cost of self-constructed PPE is determined in the same manner in which the cost of a purchased asset is determined. Therefore, all the expenditures directly related to the construction of an asset and general expenditures that are attributable to the construction activities shall be included in the cost of a self-constructed fixed asset. Further, if an entity makes similar assets for sale in the normal course of business, the cost of the asset is the same as the cost of constructing an asset for sale in accordance with AS 2 Inventories. Therefore, any internal profits are eliminated in arriving at such cost. General expenditures are capitalized on an apportionment basis.

2.3. In Case of an Exchange of PPE

Where any PPE is acquired in exchange for another asset or in exchange for shares or other securities, the fair market value of the asset so acquired shall be considered as its cost. The fair market value of an asset means the amount for which the asset could be exchanged between knowledgeable parties in an arm’s length transaction.

For example, Mr. A acquired a car in exchange for existing machinery. The book value of the machinery is Rs. 17 lakh and the fair market value of the car is Rs. 15 lakh. In such case, the car shall be capitalized in the books of account at Rs. 15 lakh being its fair market value.

However, where the fair value of PPE so acquired is not available, the fair value asset given up is considered as the cost of the new asset. Further, if the fair value of the asset given up is also not available then the carrying amount of asset given up is taken as the cost of the net asset.

Dive Deeper:
Beginners Guide to Accounting Standard (AS) 10 – Property, Plant and Equipment
Ind AS 16 | Property, Plant and Equipment (PPE) with Illustrations

3. Subsequent Measurement

Subsequent measurement would mean how PPE costs initially recognized should be affected for change in value or conditions. Subsequent to initial recognition, PPE is measured as per either cost model or revaluation model.

Under the cost model, the carrying amount of PPE is measured at its costs less any accumulated depreciation and any accumulated impairment losses.

Under the revaluation model, the carrying amount of PPE whose fair value can be measured reliably should be measured using the revaluation model. Under this model, the carrying value is taken at the fair value of PPE at the date of revaluation less any subsequent accumulated depreciation and impairment loss.

3.1. Subsequent Measurement when PPE is Held for Sale

PPE held for sale or disposal are those assets that are retired from active use and held by an entity to dispose-off as soon as it finds the buyer. Such assets are measured at lower of their carrying amount and net realizable value. Any difference arising between existing carrying and updated carrying amount of such assets are recognized in the statement of profit and loss as income or expense, as the case may be.

4. Conclusion

As soon as an item of PPE qualifies to be recognized as an asset, it shall be initially measured at its cost. The cost of an item of PPE shall include all the expenditure directly attributable to bringing the asset to its present location and working condition for its intended use including the cost of dismantling and removing the item and restoring the site. The initial measurement of PPE depends on the way such PPE is acquired.

Subsequent to initial measurement, an entity may choose any method cost model, under which the item of PPE shall be measured at cost less accumulated depreciation and any impairment losses or revaluation model, under which the carrying value is taken at fair value at the date of revaluation less any subsequent accumulated depreciation and impairment losses as its accounting policy and shall apply to the entire class of PPE.