Accounting for tangible non-current assets

This chapter introduces the accounting treatment for non-current assets, with particular emphasis on tangible non-current assets (Property, Plant and Equipment - PPE) as guided by IAS 16.

Learning objectives

By the end of this chapter, you should be able to:

• Define non-current assets
• Compare the difference between current and non-current assets.
• Explain the difference between asset (capitalised) and expense items.
• Classify expenditure as asset expenditure or expenses charged to profit or loss.
• Apply the IAS 16 recognition criteria for PPE.
• Determine the initial cost of an item of PPE.
• Record the acquisition of a tangible non-current asset in the general ledger.
• Explain the purpose and function of a non-current asset register.

Non-current and current assets

In an earlier module, an asset was discussed as one of the elements of the financial statements. Assets are commonly classified into:

• Current assets
• Non-current assets

Definitions

Current assets

These are assets that are expected to be converted into cash, sold, or consumed within one year or within the entity’s normal operating cycle, whichever is longer.

Non-current asset

An asset that does not meet the definition of a current asset.

Non-current assets, among other classifications, could be classified as:

• Tangible non-current assets - These are non-current assets that have physical form.
• Intangible non-current assets - These are non-current assets without physical form.

Capital and revenue expenditures

In an earlier module, expense was highlighted as one of the elements of the financial statements. Building on that idea, expenditures are often classified into:

• Capital expenditure
• Revenue expenditures

This classification helps explain why some costs are recorded as assets (capitalised) while others are recorded as expenses.

Definitions

Capital expenditure

These are expenditures that result in the creation or acquisition of a long-term investment (i.e., non-current asset) or improve the earning capacity of the investment.

Usually, an expenditure whose benefits to the business extend beyond one financial year is treated as a non-current asset - this links directly to the definition of a non-current asset above. Since the asset will be used over several periods, its cost is not charged as an expense all at once; instead, only the portion of value consumed each period is charged to profit or loss. This periodic charge is known as depreciation (discussed later). If the asset is later sold, it is removed from the books (derecognised), and the difference between the sale proceeds and its carrying amount is recognised as a gain or loss on disposal in profit or loss (covered in the disposal chapter).

Definitions

Revenue expenditure

Also called recurrent expenditure, refers to costs incurred in the normal course of trade (e.g., purchase of inventory) and in maintaining non-current assets (e.g., repairs and supplies).

Revenue expenditure is fully charged to the statement of profit or loss in the year it is incurred, since its benefits don’t extend beyond that period.

Expenditure type	Examples
Capital expenditure	Acquiring land, constructing a building, purchasing a vehicle
Revenue expenditure	Vehicle servicing and maintenance, wages and salaries, administrative costs

The same test applies to spending on an asset the business already owns. Building an extension to a factory, or upgrading a machine so it produces more, is capital expenditure. Repainting the factory, or replacing worn parts so the machine runs as before, is revenue expenditure.

Accounting for tangible non-current assets

International Accounting Standard (IAS) 16 provides the framework for accounting for the acquisition and disposal of tangible non-current assets. A group of tangible non-current assets is termed property, plant and equipment (PPE).

Definitions

Property, plant and equipment (PPE)

They are tangible assets that are

• held for use to produce or supply goods and services, for rental to others, or for administrative purposes; and
• expected to be used for more than one accounting period.

Property, plant and equipment (PPE): recognition

Definitions

Recognition

Refers to including an item such as PPE in the financial statements when it meets the recognition criteria.

Derecognition

Refers to the removal of the item from the books of accounts when it no longer satisfies those criteria.

According to IAS 16, an item of PPE is recognised only if:

1. It is probable that future economic benefits will flow to the entity, and
2. Its cost can be measured reliably.

Property, plant and equipment (PPE): measurement

Once an asset meets the recognition criteria, it must be recorded in the financial statements at a monetary value. This process is called measurement.

PPE is measured at:

1. Initial measurement - the first recognition, usually at purchase, creation, or construction cost.
2. Subsequent measurement - after initial recognition, using either the cost model or the revaluation model.

Initial measurement

When an item of PPE meets the recognition criteria, it is initially measured at cost.

Definitions

Cost

IAS 16 defines cost as the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition or construction.

Cost includes:

• Purchase price (plus import duties and non-refundable taxes, less discounts or rebates)
• Directly attributable costs to bring the asset to the location and condition for use, such as:
  • Employee benefits directly linked to construction/acquisition
  • Site preparation
  • Delivery, handling, installation, and assembly
  • Testing costs to ensure proper functioning
  • Professional fees (e.g., legal, architects)
  • Present value of dismantling or restoration obligations.

The following are not to be included when determining the cost of the asset. They are expensed through the statement of profit or loss.

• Administration and general overheads
• Advertising and promotional costs
• Costs of opening a new facility or introducing a business in a new location

Once determined, the cost is recorded in the non-current asset ledger.

The journal entry for acquisition of a non-current asset is:

Debit: Non-current asset

Credit: Cash or payables

Example: Determining initial cost

Gyabaku Ltd purchased a specialised manufacturing machine from a supplier on credit. The invoice price was $500,000, but the company received a 5% trade discount. The company incurred shipping costs of $15,000 and import duties of $35,000. Installation required hiring specialists who charged $12,000, while site preparation cost $6,000. During the setup phase, $2,500 was spent training the employees on how to use the machine. The company also purchased a one-year maintenance contract for $4,000.

Required: Determine the initial cost at which this machine should be recognised and prepare the journal entry for the initial recognition.

Costs excluded from the initial cost:

Computation of the initial cost of the machine:

The journal entry would be:

The non-current asset register

Definitions

Non-current asset register

A detailed record maintained for each item of property, plant and equipment, including its description, location, cost, date of acquisition, useful life, accumulated depreciation, and carrying amount.

The register supports internal control by making it possible to physically verify that assets recorded in the accounts actually exist, and it helps track additions and disposals for each individual asset. Its totals are reconciled periodically to the PPE and accumulated depreciation balances in the general ledger.