Ind AS 16, Property, Plant and Equipment, Important Questions with Solutions for CA Final Financial Reporting May & Nov 2021 Exams
Question 1 –
A Ltd. purchased some Property, Plant and Equipment on 1st April, 20X1, and estimated their useful lives for the purpose of financial statements prepared on the basis of Ind AS: Following were the original cost, and useful life of the various components of property, plant, and equipment assessed on 1st April, 20X1:
|Property, Plant and Equipment||Original Cost||Estimated useful life|
|Buildings||Rs. 15,000,000||15 years|
|Plant and machinery||Rs. 10,000,000||10 years|
|Furniture and fixtures||Rs. 3,500,000||7 years|
A Ltd. uses the straight-line method of depreciation. On 1st April, 20X4, the entity reviewed the following useful lives of the property, plant, and equipment through an external valuation expert:
|Plant and machinery||7 years|
|Furniture and fixtures||5 years|
There were no salvage values for the three components of the property, plant, and equipment either initially or at the time the useful lives were revised.
Compute the impact of revaluation of useful life on the Statement of Profit and Loss for the year ending 31st March, 20X4.
The annual depreciation charges prior to the change in useful life were
|Buildings||Rs. 1,50,00,000/15 =||Rs. 10,00,000|
|Plant and machinery||Rs. 1,00,00,000/10 =||Rs. 10,00,000|
|Furniture and fixtures||Rs. 35,00,000/7 =||Rs. 5,00,000|
|Total =||Rs. 25,00,000 (A)|
The revised annual depreciation for the year ending 31st March, 20X4, would be
|Buildings||[Rs.1,50,00,000 – (Rs. 10,00,000 × 3)] / 10||Rs. 12,00,000|
|Plant and machinery||[Rs. 1,00,00,000 – (Rs. 10,00,000 × 3)] / 7||Rs. 10,00,000|
|Furniture and fixtures||[Rs. 35,00,000 – (Rs. 5,00,000 × 3)] / 5||Rs. 4,00,000|
|Total||Rs. 26,00,000 (B)|
The impact on Statement of Profit and Loss for the year ending 31st March, 20X4
= Rs. 26,00,000 – Rs. 25,00,000 = Rs. 1,00,000
This is a change in accounting estimate which is adjusted prospectively in the period in which the estimate is amended and, if relevant, to future periods if they are also affected. Accordingly, from 20X4-20X5 onward, excess of Rs. 1,00,000 will be charged in the Statement of Profit and Loss every year till the time there is any further revision.
Question 2 –
On 1st April, 20X1, an item of property is offered for sale at Rs. 10 million, with payment terms being three equal installments of Rs. 33,33,333 over a two-year period (payments are made on 1st April, 20X1, 31st March, 20X2 and 31st March, 20X3). Implicit interest rate of 5.36 percent p.a.
Show how the property will be recorded in accordance of Ind AS 16.
Ind AS 16 requires that the cost of an item of PPE is the cash price equivalent at the recognition date. Hence, the purchaser that takes up the deferred payment terms will recognise the acquisition of the asset as follows:
On 1st April, 20X1
Property, Plant and Equipment (W.N. 1) Dr.
To Bank A/c
To Accounts Payable (W.N. 2)
(Initial recognition of property)
|On 31st March, 20X2
Interest Expense (W.N. 2) Dr.
Accounts payable (W.N. 2) Dr.
To Bank A/c
(Recognition of interest expense and payment of second installment)
|On 31st March, 20X3
Interest Expense(W.N. 2) Dr.
Accounts payable (W.N. 2) Dr.
To Bank A/c
(Recognition of interest expense and payment of final installment)
1. Calculation of cash price equivalent at initial recognition
|Year||Payment||Discounting factor||Present value|
|Initial date cash price equivalent||1,00,00,000||95,00,000|
2. Calculation of interest expenses
|Interest @ 5.36%
(b) = (a) x 5.36%
|Total payment at year beginning
|Principal amount in the instalment
(d) = (c) – (b)
(e) = (a) – (d)
*Difference of Rs. 116 [(31,63,867 x 5.36%) – (33,33,334 – 31,63,867)] is due to approximation.
Question 3 –
Stars Ltd. is a multinational entity that owns three properties. All the three properties were purchased on 1st April 2016. The details of purchase price and the market values of the properties are given as follows:
|Particulars||Property 1||Property 2||Property 3|
|Market Value (31-03-2017)||32,000||22,000||27,000|
|Life||10 years||10 years||10 years|
|Subsequent Measurement||Cost Model||Revaluation Model||Revaluation Model|
Property 1 and 2 are occupied by Stars Ltd, whilst property 3 is let out to a non -related party at a market rent. The management presents all three properties in balance sheet as’ ‘Property, plant and equipment’.
The company does not depreciate any of the properties on the basis that the fair values are exceeding their carrying amount and recognise the difference between purchase price and fair value in Statement of Profit and Loss.
Evaluate whether the accounting policies adopted by the Stars Ltd. in relation to these properties is in accordance of relevant Indian Accounting Standards (Ind AS). If not, advise the correct treatment along with workings.
i. For classification of assets
As per Ind AS 16 ‘Property, Plant and Equipment’ states that Property, plant and equipment are tangible items that are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes.
As per Ind AS 40 ‘Investment property’, investment property is a property held to earn rentals or for capital appreciation or both, rather than for use in the production or supply of goods or services or for administrative purposes; or sale in the ordinary course of business.
According, to the facts given in the questions, since Proper ty 1 and 2 are used as factory buildings, their classification as PPE is correct. However, Property 3 is held to earn rentals; hence, it should be classified as Investment Property. Thus, its classification as PPE is not correct. Property 3 shall be presented as separate line item as Investment Property as per Ind AS 1.
ii. For valuation of assets
Ind AS 16 states that an entity shall choose either the cost model or the revaluation model as its accounting policy and shall apply that policy to an entire class of property, plant and equipment. Also, Ind AS 16 states that If an item of property, plant and equipment is revalued, the entire class of property, plant and equipment to which that asset belongs shall be revalued.
However, for investment property, Ind AS 40 states that an entity shall adopt as its accounting policy the cost model to all of its investment property. Ind AS 40 also requires that an entity shall disclose the fair value of investment property.
Since property 1 and 2 is used as factory building, they should be classified under same category or class ie. ‘factory building’. Therefore, both the properties should be valued either at cost model or revaluation model. Hence, the valuation model adopted by Stars Ltd. is not consistent and correct as per Ind AS 16.
In respect to property 3 being classified as Investment Property, there is no alternative of revaluation model i.e. only cost model is permitted for subsequent measurement. However, Stars Ltd. is required to disclose the fair value of the investment property in the Notes to Accounts.
iii. For changes in value on account of revaluation and treatment thereof
Ind AS 16 states that if an asset’s carrying amount is increased as a result of a revaluation, the increase shall be recognised in other comprehensive income and accumulated in equity under the heading ‘revaluation surplus’. However, the increase shall be recognised in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognised in profit or loss. Accordingly, the revaluation gain shall be recognised in other comprehensive income and accumulated in equity under the heading of revaluation surplus.
iv. For treatment of depreciation
Ind AS 16 states that depreciation is recognised even if the fair value of the asset exceeds its carrying amount, as long as the asset’s residual value does not exceed its carrying amount. Accordingly, Stars Ltd. is required to depreciate these properties irrespective of that their fair value exceeds the carrying amount.
v. Rectified presentation in the balance sheet
As per the provisions of Ind AS 1, Ind AS 16 and Ind AS 40, the presentation of these three properties in the balance sheet should be as follows:
Case 1: If Stars Ltd. has applied the Cost Model to an entire class of property, plant and equipment.
Balance Sheet extracts as at 31st March 2017
|Property, Plant and Equipment|
|Property 1 (30,000-3,000) 27,000|
|Property 2 (20,000 – 2,000) 18,000|
|Property 3 (Fair value being Rs. 27,000) (Cost = 24,000-2,400)|
Case 2: If Stars Ltd. has applied the Revaluation Model to an entire class of property, plant and equipment.
Balance Sheet extracts as at 31st March 2017
|Property, Plant and Equipment|
|Property 3 (Fair value being 27,000) (Cost = 24,000-2,400)||21,600|
|Equity and Liabilities|
|Revaluation Reserve *|
|Property 1 (32,000 – 27,000)||5,000|
|Property 2 (22,000 –18,000)||4,000||9,000|
* Revaluation reserve should be routed through Other Comprehensive Income (OCI) (subsequently not reclassified to Profit and Loss) in the Statement of Profit and Loss and shown as a separate column in the Statement of Changes in Equity.
Question 4 –
On 1st October, 2017, A Ltd. completed the construction of a power generating facility. The total construction cost was Rs. 2,00,00,000. The facility was capable of being used from 1st October, 2017 but A Ltd. did not bring the facility into use until 1st January, 2018. The estimated useful life of the facility at 1st October, 2017 was 40 years. Legally there are no requirements to restore the land on which power generating facilities stand to its original state at the end of the useful life of the facility. However, A Ltd. has a reputation for conducting its business in an environmentally friendly way and has previously chosen to restore similar land even in the absence of such legal requirements. The directors of A Ltd. estimated that the cost of restoring the land in 40 years’ time (based on prices prevailing at that time) would be Rs. 1,00,00,000. A relevant annual discount rate to use in any discounting calculations is 5%. When the annual discount rate is 5%, the present value of Rs. 1 receivable in 40 years’ time is approximately 0.142.
Analyse and present how the above events would be reported in the financial statements of A Ltd. for the year ended 31st March, 2018 as per Ind AS.
All figures are Rs. in ’000.
The power generating facility should be depreciated from the date it is ready for use, rather than when it would actually start being used. In this case, then, the facility should be depreciated from 1st October, 2017.
Although A Ltd. has no legal obligation to restore the piece of land, it does have a constructive obligation, based on its past practice and policies.
The amount of the obligation will be 1,420, being the present value of the anticipated future restoration expenditure (10,000 x 0.142).
This will be recognised as a provision under non-current liabilities in the Balance Sheet of A Ltd. at 31st March, 2018.
As time passes the discounted amount unwinds. The unwinding of the discount for the year ended 31st March, 2018 will be 35.5 (1,420 x 5% x 6/12).
The unwinding of the discount will be shown as a finance cost in the statement of profit or loss and the closing provision will be 1,455.50 (1,420 + 35.5).
The initial amount of the provision is included in the carrying amount of the non -current asset, which becomes 21,420 (20,000 + 1,420).
The depreciation charge in profit or loss for the year ended 31st March, 2018 is 267.75 (21,420 x 1/40 x 6/12).
The closing balance included in non-current assets will be 21,152.25 (21,420 – 267.75).
Question 5 –
An entity has a nuclear power plant and a related decommissioning liability. The nuclear power plant started operating on 1st April, 20X1. The plant has a useful life of 40 years. Its initial cost was Rs. 1,20,000. This included an amount for decommissioning costs of Rs. 10,000, which represented Rs. 70,400 in estimated cash flows payable in 40 years discounted at a risk- adjusted rate of 5 per cent. The entity’s financial year ends on 31st March. Assume that a market-based discounted cash flow valuation of Rs. 1,15,000 is obtained at 31st March, 20X4. This valuation is after deduction of an allowance of Rs. 11,600 for decommissioning costs, which represents no change to the original estimate, after the unwinding of three years’ discount. On 31st March, 20X5, the entity estimates that, as a result of technological advances, the present value of the decommissioning liability has decreased by Rs. 5,000. The entity decides that a full valuation of the asset is needed at 31st March, 20X5, in order to ensure that the carrying amount does not differ materially from fair value. The asset is now valued at Rs. 1,07,000, which is net of an allowance for the reduced decommissioning obligation.
How the entity will account for the above changes in decommissioning liability if it adopts revaluation model?
|At 31st March, 20X4:||Rs.|
|Asset at valuation (1)||1,26,600|
|Retained earnings (2)||(10,600)|
|Revaluation surplus (3)||5,600|
(1) When accounting for revalued assets to which decommissioning liabilities attach, it is important to understand the basis of the valuation obtained. For example:
(a) if an asset is valued on a discounted cash flow basis, some valuers may value the asset without deducting any allowance for decommissioning costs (a ‘gross’ valuation), whereas others may value the asset after deducting an allowance for decommissioning costs (a ‘net’ valuation), because an entity acquiring the asset will generally also assume the decommissioning obligation. For financial reporting purposes, the decommissioning obligation is recognised as a separate liability, and is not deducted from the asset. Accordingly, if the asset is valued on a net basis, it is necessary to adjust the valuation obtained by adding back the allowance for the liability, so that the liability is not counted twice.
(b) if an asset is valued on a depreciated replacement cost basis, the valuation obtained may not include an amount for the decommissioning component of the asset. If it does not, an appropriate amount will need to be added to the valuation to reflect the depreciated replacement cost of that component.
Since, the asset is valued on a net basis, it is necessary to adjust the valuation obtained by adding back the allowance for the liability. Valuation obtained of Rs. 1,15,000 plus decommissioning costs of Rs. 11,600, allowed for in the valuation but recognised as a separate liability = Rs. 1,26,600.
(2) Three years’ depreciation on original cost Rs. 1,20,000 × 3/40 = Rs. 9,000 plus cumulative discount on Rs. 10,000 at 5 per cent compound = Rs. 1,600; total Rs. 10,600.
(3) Revalued amount Rs. 1,26,600 less previous net book value of Rs. 1,11,000 (cost Rs. 120,000 less accumulated depreciation Rs. 9,000).
The depreciation expense for 20X4-20X5 is therefore Rs. 3,420 (Rs. 1,26,600 x 1 / 37) and the discount expense for 20X5 is Rs. 600. On 31st March, 20X5, the decommissioning liability (before any adjustment) is Rs. 12,200. However, as per estimate of the entity, the present value of the decommissioning liability has decreased by Rs. 5,000. Accordingly, the entity adjusts the decommissioning liability from Rs. 12,200 to Rs. 7,200.
The whole of this adjustment is taken to revaluation surplus, because it does not exceed the carrying amount that would have been recognised had the asset been carried under the cost model. If it had done, the excess would have been taken to profit or loss. The entity makes the following journal entry to reflect the change:
|Provision for decommissioning liability||Dr||5000|
|To Revaluation surplus||5000|
As at 31st March, 20X5, the entity revalued its asset at Rs. 1,07,000, which is net of an allowance of Rs. 7,200 for the reduced decommissioning obligation that should be recognised as a separate liability. The valuation of the asset for financial reporting purposes, before deducting this allowance, is therefore Rs. 1,14,200. The following additional journal entry is needed:
|Accumulated depreciation (1)||Dr.||3,420||
To Asset at valuation
|Revaluation surplus (2)||Dr.||8,980||
To Asset at valuation (3)
(1) Eliminating accumulated depreciation of Rs. 3,420 in accordance with the entity’s accounting policy.
(2) The debit is to revaluation surplus because the deficit arising on the revaluation does not exceed the credit balance existing in the revaluation surplus in respect of the asset.
(3) Previous valuation (before allowance for decommissioning costs) Rs. 1,26,600, less cumulative depreciation Rs. 3,420, less new valuation (before allowance for decommissioning costs) Rs. 1,14,200.
Following this valuation, the amounts included in the balance sheet are:
|Asset at valuation||1,14,200|
|Retained earnings (1)||(14,620)|
|Revaluation surplus (2)||11,620|
(1) 10,600 at 31st March, 20X4, plus depreciation expense of Rs. 3,420 and discount expense of Rs. 600 = Rs. 14,620.
(2) 15,600 at 31st March, 20X4, plus Rs. 5,000 arising on the decrease in the liability, less Rs. 8,980 deficit on revaluation = Rs. 11,620.
Question 6 –
ABC Ltd is setting up a new refinery outside the city limits. In order to facilitate the construction of the refinery and its operations, ABC Ltd. is required to incur expenditure on the construction/development of railway siding, road and bridge. Though ABC Ltd. incurs (or contributes to) the expenditure on the construction/development, it will not have ownership rights on these items and they are also available for use to other entities and public at large. Whether ABC Ltd. can capitalise expenditure incurred on these items as property, plant and equipment (PPE)? If yes, how should these items be depreciated and presented in the financial statements of ABC Ltd. as per Ind AS?
Ind AS 16 states that the cost of an item of property, plant and equipment shall be recognised as an asset if, and only if:
(a) it is probable that future economic benefits associated with the item will flow to the entity; and
(b) the cost of the item can be measured reliably.
In the given case, railway siding, road and bridge are required to facilitate the construction of the refinery and for its operations. Expenditure on these items is required to be incurred in order to get future economic benefits from the project as a whole which can be considered as the unit of measure for the purpose of capitalisation of the said expenditure even though the company cannot restrict the access of others for using the assets individually. It is apparent that the aforesaid expenditure is directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management.
In view of this, even though ABC Ltd. may not be able to recognize expenditure incurred on these assets as an individual item of property, plant and equipment in many cases (where it cannot restrict others from using the asset), expenditure incurred may be capitalised as a part of overall cost of the project. From this, it can be concluded that, in the extant case the expenditure incurred on these assets, i.e., railway siding, road and bridge, should be considered as the cost of constructing the refinery and accordingly, expenditure incurred on these items should be allocated and capitalised as part of the items of property, plant and equipment of the refinery.
Question 7 –
On 1st April, 2017 Good Time Limited purchased some land for Rs. 1.5 crore (including legal cost of Rs. 10 lakhs) for the purpose of constructing a new factory. Construction work commenced on 1st May, 2017. Good Time Limited incurred the following costs in relation to its construction.
|Preparation and levelling of the land||4,40,000|
|Purchase of materials for the construction||92,00,000|
|Employment costs of the construction workers (per month)||1,45,000|
|Overhead costs incurred directly on the construction of the factory (per month)||1,25,000|
|Ongoing overhead costs allocated to the construction project (using the company’s normal overhead allocation model) per month||75,000|
|Costs of relocating employees to work at new factory||3,25,000|
|Costs of the opening ceremony on 1st January, 2018||2,50,000|
|Income received during the temporary use of the factory premises as a store during the construction period.||60,000|
The construction of the factory was completed on 31st December, 2017 and production began on 1st February, 2018. The overall useful life of the factory building was estimated at 40 years from the date of completion. However, it is estimated that the roof will need to be replaced 20 years after the date of completion and that the cost of replacing the roof at current prices would be 25% of the total cost of the building.
At the end of the 40 years period, Good Time Limited has a legally enforceable obligation to demolish the factory and restore the site to its original condition. The company estimates that the cost of demolition in 40 year’s time (based on price prevailing at that time) will be Rs. 3 crore. The annual risk adjusted discount rate which is appropriate to this project is 8%. The present value of Rs. 1 payable in 40 years time at an annual discount rate of 8% is 0.046.
The construction of the factory was partly financed. by a loan of Rs. 1.4 crore taken out on 1st April, 2017. The loan was at an annual rate of interest of 9%. During the period 1st April, 2017 to 30th September, 2017 (when the loan proceeds had been fully utilized to finance the construction), Good Time Limited received investment income of Rs. 1,25,000 on the temporary investment of the proceeds.
You are required to compute the cost of the factory and the carrying amount of the factory in the Balance Sheet of Good Time Limited as at 31st March, 2018.
Computation of the cost of the factory
|Purchase of land||1,50,00,000|
|Preparation and levelling||4,40,000|
|Employment costs of construction workers (1,45,000 x 8 months)||11,60,000|
|Direct overhead costs (1,25,000 x 8 months)||10,00,000|
|Allocated overhead costs||Nil|
|Income from use of a factory as a store||Nil|
|Cost of the opening ceremony||Nil|
|Investment income on temporary investment of the loan proceeds||(1,25,000)|
|Demolition cost recognised as a provision (3,00,00,000 x 0.046)||13,80,000|
Computation of carrying amount of the factory as at 31st March, 2018
|Land (Non- depreciable asset)||Factory (Depreciable asset)|
|Cost of the Asset (Total cost 2,90,00,000)||1,50,00,000||1,40,00,000|
|Depreciation on roof component (1,40,00,000 × 25% × 1/20 x 3/12)||
|Depreciation on remaining factory (1,40,00,000 × 75% × 1/40 × 3/12)||
|Carrying amount of depreciable asset i.e. factory||
- Interest cost has been capitalised based on nine month period. This is because, purchase of land would trigger off capitalisation.
- All of the net finance cost of Rs. 8,20,000 (Rs. 9,45,000 – Rs. 1,25,000) has been allocated to the depreciable asset i.e Factory. Alternatively, it can be allocated proportionately between land and factory.
Question 8 –
Company X performed a revaluation of all of its plant and machinery at the beginning of 2018-2019. The following information relates to one of the machinery:
|Gross carrying amount||Rs. 200|
|Accumulated depreciation (straight-line method)||Rs. 80|
|Net carrying amount||Rs. 120|
|Fair value||Rs. 150|
The useful life of the machinery is 10 years and the company uses Straight line method of depreciation. The revaluation was performed at the end of the 4th year.
How should the Company account for revaluation of plant and machinery and depreciation subsequent to revaluation?
According to paragraph 35 of Ind AS 16, when an item of property, plant and equipment is revalued, the carrying amount of that asset is adjusted to the revalued amount. At the date of the revaluation, the asset is treated in one of the following ways:
(a) The gross carrying amount is adjusted in a manner that is consistent with the revaluation of the carrying amount of the asset. For example, the gross carrying amount may be restated by reference to observable market data or it may be restated proportionately to the change in the carrying amount. The accumulated depreciation at the date of the revaluation is adjusted to equal the difference between the gross carrying amount and the carrying amount of the asset after taking into account accumulated impairment losses; or
(b) The accumulated depreciation is eliminated against the gross carrying amount of the asset.
The amount of the adjustment of accumulated depreciation forms part of the increase or decrease in carrying amount that is accounted for in accordance with the paragraphs 39 and 40 of Ind AS 16.
If the Company opts for the treatment as per option (a), then the revised carrying amount of the machinery will be:
|Gross carrying amount||Rs. 250||[(200/120) x 150]|
|Net carrying amount||Rs.150|
|Accumulated depreciation||Rs. 100||(Rs. 250 – Rs. 150)|
|Plant and Machinery A/c (Gross Block)||Dr.||Rs. 50|
To Accumulated Depreciation
To Revaluation Reserve
If the balance of accumulated depreciation is eliminated as per option (b), then the revised carrying amount of the machinery will be as follows:
Gross carrying amount is restated to Rs.150 to reflect the fair value and Accumulated depreciation is set at zero.
|Accumulated Depreciation||Dr.||Rs. 80|
To Plant and Machinery A/c (Gross Block)
|Plant and Machinery A/c (Gross Block)||Dr.||Rs. 30|
To Revaluation Reserve
Option (a) – Since the Gross Block has been restated, the depreciation charge will be Rs. 25 per annum (Rs. 250 / 10 years).
Option (b) – Since the Revalued amount is the revised Gross Block, the useful life to be considered is the remaining useful life of the asset which results in the same depreciation charge of Rs. 25 per annum as per Option A (Rs. 150 / 6 years).