Beyond the First Glance: Subsequent Measurement Models for Property, Plant, and Equipment
Introduction
Imagine your business just bought a brand-new delivery van or a shiny piece of machinery. These big-ticket items, known as Property, Plant, and Equipment (PPE), are crucial for keeping your operations running smoothly. But once you’ve got these assets, how do you keep track of their value over time?
In the world of accounting, there are specific rules on how to measure and report the value of PPE after you’ve initially bought them. These rules help ensure your financial statements are accurate and up-to-date. If you're an accountant helping clients manage their books, understanding these rules is essential.
Let’s dive into the basics of these subsequent measurement models for PPE, using practical, everyday examples that make sense without any accounting jargon.
Initial Recognition and Measurement
When a business buys PPE, it first records these assets at their purchase cost. This cost includes not only the price tag but also any extra expenses to get the asset up and running, like installation fees or transportation costs. Read our recent article posted in Accounting Weekly about initial recognition.
Subsequent Measurement Models
After the initial purchase, IFRS for SMEs gives us two ways to measure these assets over time:
Cost Model
Revaluation Model
Cost Model
With the cost model, after buying the PPE, you keep recording it at its original cost but subtract any depreciation and impairment losses over time. This model is simple and easy to apply.
Revaluation Model
The revaluation model lets businesses adjust the value of PPE to its current market value, subtracting any depreciation and impairment losses. This needs to be done regularly to make sure the asset's value is always close to its fair market value.
Practical Application and Examples
Applying the Cost Model
Example 1:
Let’s say your small manufacturing company buys a machine for R200,000. You expect it to last for 10 years and have a resale value of R20,000 at the end.
Initial Recognition:
Purchase Price: R200,000
Installation Costs: R10,000
Total Initial Cost: R210,000
Annual Depreciation Calculation:
Depreciable Amount: R210,000 - R20,000 (residual value) = R190,000
Useful Life: 10 years
Annual Depreciation: R190,000 / 10 = R19,000
Subsequent Measurement:
After Year 1:
Carrying Amount: R210,000 - R19,000 = R191,000
Depreciation is R19 000
Accumulated depreciation at end of year R19 000
After Year 2:
Carrying Amount: R191,000 - R19,000 = R172,000
Depreciation is R19 000
Accumulated depreciation at end of year R38 000
Applying the Revaluation Model
Example 2:
Imagine your retail company owns a building initially bought for R2,000,000. It’s supposed to last 40 years. After 5 years, you find out the building’s market value is now R2,500,000.
Initial Recognition:
Cost of Building: R2,000,000
Annual Depreciation (Before Revaluation):
Depreciable Amount: R2,000,000 (assuming no residual value)
Useful Life: 40 years
Annual Depreciation: R2,000,000 / 40 = R50,000
Carrying Amount After 5 Years:
Cost: R2,000,000
Accumulated Depreciation: R50,000 x 5 = R250,000
Carrying Amount: R2,000,000 - R250,000 = R1,750,000
Revaluation:
Fair Value: R2,500,000
Revaluation Surplus: R2,500,000 - R1,750,000 = R750,000
Subsequent Depreciation (After Revaluation):
New Carrying Amount: R2,500,000
Remaining Useful Life: 35 years
Annual Depreciation: R2,500,000 / 35 = R71,429
Practical Considerations
Choosing the Right Model
When deciding between the cost model and the revaluation model, think about the following:
Cost Model:
It’s simple and easy to use.
Lower administrative costs.
Consistent values over time.
Revaluation Model:
Reflects current market values.
Can significantly affect financial statements.
Requires regular revaluations, which can be costly.
Keeping Accurate Records
No matter which model you choose, keeping detailed records of your PPE is essential. This includes:
Descriptions of each asset.
Purchase and disposal dates.
Costs associated with acquiring and maintaining the asset.
Depreciation methods and rates used.
Dates and results of revaluations.
Impact on Financial Statements
Each model affects financial statements differently:
Cost Model:
Stable and predictable values.
Simpler to prepare financial statements.
Revaluation Model:
Values can fluctuate with the market.
More complex but provides more relevant information.
Conclusion
Understanding how to measure PPE after their initial purchase is crucial for accountants helping clients in South Africa. Choosing between the cost model and the revaluation model depends on the specific needs and circumstances of the business. By using practical examples and keeping detailed records, accountants can ensure accurate financial reporting and provide valuable insights to their clients. Whether you stick with the straightforward cost model or opt for the more dynamic revaluation model, the key is consistency and accuracy in application.
Refer here to the IFRS® Foundation—Supporting Material for the IFRS for SMEs Standards - Module 17—Property, Plant and Equipment
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