You are reminded that the Conceptual Framework (CF) identifies five elements that make up
the double-entry accounting system. The first step is therefore to decide which of these
elements PPE will fall under. After our studies during the first semester, we should clearly
recognise it as an asset (or a collection of assets). WHY?
Because of the definition of the element “assets” in the CF, of course. Paragraph 4.3 states:
“An asset is a present economic resource controlled by the entity resulting from past
events. An economic resource is defined as a right that has the potential to produce
economic benefits.
Now that we have established that it is an asset, we have to decide whether it is a current or
non-current asset. Here we have to refer to International Accounting Standard 1 (IAS1).
Paragraph 66 defines a current asset particularly,(Pg 91 of your text book) and a non-current
asset as simply an asset which cannot qualify as a current asset. In terms of the IAS1
definition, PPE items are clearly non-current.
Next we have to determine whether there is an international reporting standard that
specifically deals with this unique element. Then we find, YES. There is indeed a standard
published by the International Accounting Standards Board (IASB) called “Property, Plant
and Equipment”, namely IAS16. Therefore, for items identified as possibly PPE, this
standard must be contemplated.
IAS16, in paragraph 6, defines PPE as ASSETS (pre-determined) that are:
Firstly tangible and:
(a) are held for use in the production or supply of goods or services; for rental
to others; or for administrative purposes;
and
(b) are expected to be used during more than one period.
STOP for the moment. Haven’t we forgotten something? Oops, BEFORE any item may be
recorded, it must also comply with the recognition criteria of an element. We shall have to
refer back to the CF for that…
Paragraph 4.38 of the CF states:
An item that meets the definition of an element should be recognised if:
(a) it is probable that any future economic benefit associated with the item
will flow to or from the entity; (Faithful representation) and
(b) the item has a cost or value that can be measured with reliability. (Relevance)
, 2
FREQUENTLY ASKED QUESTIONS:
Q: What is depreciation?
A: Depreciation is the systematic allocation of the depreciable amount of an asset
over its useful life. (IAS16 par.6)
Q: Why is depreciation necessary?
A: The value of assets deteriorate over time.
A2: According to the definition of an asset [CF par.4.4 (a)] future economic benefits will
become less as time goes by.
Q: What is an impairment loss?
A: IAS 36 Par. 6 describes it as the amount by which the carrying amount of an asset or
cash-generating unit exceeds its recoverable amount.
A2: In essence, it means if depreciation has not (systematically) reduced the carrying
amount of an asset to a reasonable value, the additional loss in value should be
recognised as an impairment loss.
OTHER MATTERS
1. Impairment losses
To record the decrease in value of an asset, we would want to reduce the value in the
general ledger. Instead of crediting the asset cost directly, we credit a “contra asset
account” called Accumulated Depreciation and Impairment losses.
This account is a “contra” because its only function is to be linked to the asset’s “cost”
account to reduce the cost of the asset to a reasonable carrying value.
We do not credit the asset’s Cost account directly because we need to have a record
of the original cost of the asset in the general ledger. When we disclose the asset in
the SFP, we show the net effect of these two general ledger accounts; the asset’s cost
less the asset’s Accumulated Depreciation and Impairment losses account.
2. Reversal of impairment losses
When the circumstance that led to the impairment of the asset no longer exists and
the value of the asset is increased, the effect of the impairment may be reversed.
We have to reverse the impairment of the asset because the circumstance requiring
such impairment no longer exists. We debit the Accumulated depreciation and
impairment losses account, increasing the carrying value of the asset, and credit an
income account (called Reversal of Impairment).
3. Recoverable amount:
The recoverable amount is an estimation of the asset’s value to the entity, either by
continuing to use it as originally intended, or by selling it. An asset is therefore
impaired if it can neither produce future economic benefits as envisaged, nor be sold
at its carrying value. The carrying value should therefore be reduced to a realistic
value (not “pie in the sky”).
, 3
QUESTION 1 (ASSET EXCHANGE)
The following information appeared in the trial balance of BB Ltd as at
31 December 20X5:
DR CR
Machine A: Cost 50 000
Machine A: Accumulated depreciation 20 000
On 31 December 20X5 machine A was exchanged (given up) for machine B.
REQUIRED:
In each of the following cases supply the relevant journal entries (if necessary.)
1. Machine A had a fair value of R32 000 and machine B had a fair value of R33 000.
1 The difference in fair values is considered to be immaterial.
1. Machine A had a fair value of R32 000 and machine B had a fair value of R36 000.
2 The difference in fair values is considered to be material and the fair value of
machine B is more clearly evident than the fair value of machine A.
1. The fair value of machine A is not reliably determinable. Machine B had a fair value
3 of R35 000.
1. The fair value of machine A is R25 000. The difference in the carrying amount and
4 the fair value of machine A is considered to be material. The fair value of machine B
(a similar type of machine), is not reliably determinable.
The exchange is considered to have no impact on future cash flows of the business
as a whole.
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