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FRS 102: Property, plant and equipment

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13th Aug 2013
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FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland becomes mandatory for accounting periods starting on or after 1 January 2015, with earlier adoption permissible, explains Steve Collings.

With the evolution of the accounting methodologies over the years, a new reporting framework is bound to bring with it some changes. This article takes a look at the area of property, plant and equipment which is dealt with in Section 17 Property, Plant and Equipment (PPE).

Section 17 is currently dealt with in FRS 15 Tangible Fixed Assets and there are some notable differences between the two. Section 17 deals with PPE that:

  • are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes
  • are expected to be used for more than one period

Recognition

The recognition criteria under FRS 102 has remained unchanged from current practice and a client can recognise PPE if (and only if):

  • it is probable that future economic benefits associated with the item will flow to the entity
  • the cost of the item can be measured reliably

Paragraph 17.5 to FRS 102 deals with spare parts and servicing equipment. This particular paragraph acknowledges that such items are usually carried in the financial statements in inventory (stock) with recognition taking place as and when such parts/equipment are used in the business (usually via cost of sales). Paragraph 17.5 requires ‘major’ spare parts and stand-by equipment to be included within the cost of the fixed asset(s) to which it/they relate(s) when the client is expected to use them for more than one year. The paragraph also goes on to require that if the spare parts and servicing equipment are only able to be used in connection with an item of PPE, then they are considered PPE.

In the past there has also been an element of confusion as to the correct accounting treatment for parts of items of PPE (for example the roof on a building) and whether to capitalise the cost of these replacement parts or to expense them as repairs and renewals expenditure. Paragraph 17.6 to FRS 102 says that a reporting entity can add such costs to the carrying amount of an item of PPE provided that the replacement part is expected to provide incremental future benefits to the entity. 

Where ‘major components’ of an item of PPE have significantly different patterns of consumption, the client must allocate the initial cost of the asset to its major components and then depreciate them separately over its useful economic life.

Illustration

An entity acquires a new property which consists of both land and buildings. 

Land and buildings are considered to be separable assets (land usually has an indefinite life whereas buildings have a limited life). As such paragraph 17.8 to FRS 102 requires both component parts to be accounted for separately regardless of the fact that they are acquired together.

Cost

On initial recognition of an item of PPE that satisfies the recognition criteria, the reporting entity will initially account for the item at cost. For the purposes of Section 17, cost will include:

  • The purchase price (to include legal/brokerage fees, non-recoverable taxes and net of trade discounts and rebates)
  • Costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of being operated in the manner intended
  • The initial estimate of dismantling and removing the item and restoring the site on which it is located
  • Borrowing costs

Costs such as advertising and general administrative costs are not to be assigned to the cost of an item of PPE.

Subsequent measurement

As with FRS 15, once the item of PPE has been recognised at cost, it can then be subsequently measured using the ‘cost’ model or the ‘revaluation’ model. There is no change to current accounting practice in this respect and all assets in the same class are subjected to the same subsequent measurement (whether it be cost or revaluation). 

Illustration

A company has an item of machinery that is very specialist to their specific business and for which there is no market-based evidence of its fair value as the machine is rarely sold but the directors wish to carry this machine in the balance sheet using the revaluation model.

In situations such as these, paragraph 17.15C says that the fair value will usually be determined by appraisal and directs users to paragraph 11.27 and 11.32 (Section 11 is Basic Financial Instruments) which will provide further guidance on determining fair value. If circumstances are such that there is no market-based evidence of fair value because of the machine’s specialist nature, then paragraph 17.15D says that the entity may need to estimate fair value using an income or depreciated replacement cost approach.

Where items are carried at revaluation, the same accounting principles contained in FRS 15 will apply in that an increase in an asset’s carrying amount due to revaluation will be recognised in equity (usually as ‘revaluation surplus’) and reported through other comprehensive income. In the case that a revaluation decrease was previously recognised in respect of that asset, the increase in fair value will go to the profit and loss account to the extent that it reverses a previous revaluation decrease.

Revaluation losses will be taken to the revaluation reserve account in equity and reported in other comprehensive income to the extent of any previous revaluation gains accumulated in equity. This is the same as under FRS 15 but this practice is not the same for investment properties accounted for under Section 16 Investment Property which requires all fair value gains and losses in respect of such property to be taken to profit or loss.

Depreciation

Section 16 continues to recognise the straight-line method, diminishing balance (commonly referred to as ‘reducing balance’) method and an alternative method based on usage and cites the use of the ‘units of production’ method. 

Illustration

A company has undertaken a review of the entity’s pattern of consumption of various items of plant used in its manufacturing process and concludes that the depreciation rate is too accelerated and so changes from a five-year straight-line method of depreciating its plant and machinery to a 10-year method.

A change in depreciation method is applied going forward, hence there is no retrospective application of the new depreciation policy as it is considered a change in estimation technique, not a change in accounting policy and the entity will account for such to comply with the requirements in paragraphs 10.15 to 10.18 (Section 10 is Accounting Policies, Estimates and Errors).

Illustration

A company produces washing powder and has four brands, EcoWash, BriteWash, CleanWash and ColorFriendly. It has four items of machinery that deal with the production of each brand and all the machinery used in the production of the washing powder are depreciated under the ‘units of production’ method. The company has a year-end of 31 October each year. In the current financial year, the company has not produced any of its BriteWash brand because of a surplus of this product that it is trying to sell. The financial accountant has not put through any depreciation charges on the plant and machinery used to manufacture this product and the financial controller is disputing this non-depreciation.

Paragraph 17.20 to FRS 102 acknowledges that depreciation does not cease when the asset becomes idle or retired from active use unless the asset is fully depreciated. However, paragraph 17.20 does confirm that under the usage methods of depreciation, the depreciation charge can be zero while there is no production.

Conclusion

This article has taken a look at some of the main components in Section 16 and preparers of financial statements under FRS 102 will not see any significant differences from the requirements in current FRS 15. The areas to watch out for are those relating to subsequent expenditure (there is not much detail on this as opposed to eight paragraphs in FRS 15 (paragraphs 34 to 41) and the areas relating to ‘major’ spare parts and servicing equipment.

Steve Collings is the audit and technical partner at Leavitt Walmsley Associates and the author of ‘Interpretation and Application of International Standards on Auditing’. He is also the author of ‘The AccountingWEB Guide to IFRS’ and ‘IFRS For Dummies’ and was named Accounting Technician of the Year at the 2011 British Accountancy Awards.

Replies (2)

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By Peteralco
14th Aug 2013 12:05

FRS102

Given the comments does this change the view of assets that have been purchased for hire now being reclassified as fixed assets rather than  current assets.  One obvious example of this is a commercial laundry business where the linen is purchased specifcally for a customer and then hired (and cleaned) out for a rental.  The common industry practice here is to treat as inventory (current asset) rather than fixed assets.

Welcome thoughts

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Replying to Peteralco:
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By Malcolm.Harris
13th Jan 2021 12:09

I'm also interested in this. there seems to be a gulf between common practice and good practice. I'd appreciate anyone's input on this as I'm currently considering how to treat a clothes rental business' clothes. I'm thinking fixed assets but would appreciate any insight.

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