Property, Plant and Equipment, often abbreviated as PPE, represent one of the most important categories of assets in financial reporting. These are tangible assets that are not meant for sale in the ordinary course of business but are used for production, supply of goods or services, rental to others, or administrative purposes. Unlike intangible assets such as patents or goodwill, PPE includes physical items that can be seen and touched.
Typical examples include land, buildings, plant and machinery, office equipment, furniture, and fittings. These assets are expected to be used for more than one accounting period, which makes them different from inventories or consumables. Understanding the recognition, measurement, and subsequent treatment of PPE is vital for accurate financial statements, and this is precisely what Accounting Standard 10 deals with.
Objective of AS-10
The primary purpose of Accounting Standard 10 is to establish principles for accounting treatment of property, plant and equipment. It provides guidelines on when an item should be recognized as an asset, how to determine its cost, how to allocate depreciation, and how to deal with impairment losses. By following this standard, organizations ensure consistency, comparability, and reliability in financial statements.
The standard also aims to make sure that assets are neither overstated nor understated. Recognition at the right cost, regular depreciation, and impairment recognition prevent inflated asset values that could mislead stakeholders. Similarly, it ensures assets are not undervalued, which could negatively affect investment decisions and business evaluations.
Scope of AS-10
The scope of AS-10 covers accounting for property, plant and equipment, but there are important exclusions. Biological assets related to agricultural activity are outside its coverage, except for bearer plants. For instance, tea bushes, rubber trees, or grapevines that are used to produce agricultural produce are included under this standard, but the crops or fruits growing on them are excluded.
Wasting assets such as mineral rights, oil reserves, and natural gas resources are also not part of this standard, since they fall under other specific accounting frameworks. However, assets used to develop or maintain these resources, such as drilling machinery or infrastructure, are within the scope of AS-10.
Another area requiring clarity is investment property. Land or buildings held purely for investment purposes, without being used in the business operations, are not treated as property, plant and equipment. They are accounted for under specific provisions that mandate the use of the cost model only.
Key Definitions under AS-10
To understand the standard better, some important definitions must be considered.
A biological asset refers to a living plant or animal. Agricultural activity involves the management of these assets until they are transformed into agricultural produce. Agricultural produce represents the harvested output from biological assets, such as crops or fruits.
A bearer plant is a special category under this standard. It is a plant that is used in the production of agricultural produce, has a life exceeding twelve months, and is not intended to be sold except as scrap at the end of its life. This definition is important because it helps to classify long-term productive plants under property, plant and equipment rather than inventories.
Recognition of Property, Plant and Equipment
An item of property, plant and equipment is recognized as an asset if two main criteria are satisfied. First, it should be probable that future economic benefits will flow to the enterprise as a result of holding that asset. Second, the cost of the asset should be reliably measurable.
For example, a manufacturing company purchasing a new machine will recognize it as an asset because the machine will produce goods for many years and the purchase cost is clearly identifiable. However, minor tools or consumables with short useful lives would not meet the recognition criteria for PPE.
Safety and Environmental Equipment
An interesting aspect of recognition under AS-10 is the inclusion of safety and environmental equipment. Even if such equipment does not directly generate revenue, it is recognized as property, plant and equipment when it is necessary for other assets to operate effectively.
For example, a chemical factory may install pollution control devices to comply with environmental laws. Although these systems do not directly contribute to production, they enable the factory to operate its main machinery. Therefore, they are capitalized as assets.
Initial Measurement of PPE
Once an item qualifies for recognition as PPE, it must be measured initially at cost. The cost of an asset is not limited to the purchase price alone but includes all expenses directly attributable to bringing the asset to its intended location and condition for use.
Components of Cost
The total cost of a property, plant and equipment item includes the purchase price, import duties, and non-refundable taxes after deducting discounts and rebates. It also includes costs such as site preparation, delivery charges, installation expenses, and professional fees related to the acquisition.
For example, if a company purchases machinery from abroad, the cost would include customs duty, shipping charges, installation, and testing costs. Only after the asset is ready for use does capitalization stop, and further expenses are charged to revenue.
Decommissioning Costs
Sometimes, the acquisition of an asset comes with an obligation to dismantle it or restore the site at the end of its useful life. These costs are estimated at the time of acquisition and included in the initial cost of the asset. The obligation is recognized as a provision in line with Accounting Standard 29.
A good example is an oil company setting up drilling rigs with a legal obligation to restore the land after operations. The expected cost of dismantling and restoration is estimated and added to the cost of the drilling equipment.
Self-Constructed Assets
Organizations often build their own assets instead of purchasing them. In such cases, the cost is determined using the same principles as for acquired assets. Direct costs such as materials, labor, and site preparation are included, but abnormal wastages and internal profits are excluded.
Borrowing costs directly attributable to the construction of the asset may also be capitalized in accordance with Accounting Standard 16. This ensures the cost of the asset reflects all necessary expenditures to bring it to usable condition.
Exchange of Assets
Property, plant and equipment may also be acquired in exchange for another asset. In such cases, the fair value of the asset given up or the asset received is considered, whichever is more clearly evident. If the exchange has no commercial substance or fair value cannot be measured reliably, the asset is recorded at the carrying amount of the asset given up.
For instance, if a company exchanges an old machine for a new one, and the fair value of the new machine is easier to determine, the new machine is recorded at that value. If the transaction lacks substance, then the value of the old machine carried forward becomes the cost of the new one.
Deferred Payments
Sometimes, assets are purchased on deferred payment terms. In such cases, the asset is recorded at its cash price equivalent at the time of acquisition. The difference between the total payment and the cash price is treated as interest and recognized separately over the payment period unless it qualifies for capitalization under borrowing costs.
For example, if equipment worth one million is purchased with payment due after two years, its present value is recorded as cost, and the additional amount paid later is treated as interest expense.
Bearer Plants
Bearer plants are accounted for in the same way as self-constructed assets until they are ready for intended use. The cost of cultivating and preparing them for bearing produce is capitalized. Once they start producing, further cultivation costs are treated as expenses.
Practical Illustrations
Consider a factory that purchases land, constructs a building, and installs machinery. The purchase price of land, registration charges, and legal fees form part of the land cost. The building construction includes materials, labor, architect fees, and site clearance. For machinery, purchase price, freight charges, installation, and testing costs are included.
If the company is legally obliged to remove the building after twenty years, the estimated dismantling cost is added to the building’s cost and recognized as a liability. If payment for machinery is deferred for three years, its present value is recorded as cost, and the balance is treated as interest.
Through these examples, it becomes clear that the initial measurement of property, plant and equipment requires careful evaluation of all related costs to ensure the financial statements present a true picture of asset values.
Subsequent Costs of Property, Plant and Equipment
After an item of property, plant and equipment is recognized and initially measured, enterprises frequently incur additional costs during its useful life. The treatment of these costs depends on whether they increase the future economic benefits derived from the asset or merely maintain its current operating capacity.
Day-to-Day Servicing
Routine servicing and maintenance costs, such as repairs, consumables, and minor parts replacement, are treated as revenue expenditure. They are charged to the profit and loss account when incurred, as they do not enhance the future economic benefits of the asset.
For example, the costs of lubricating a machine, replacing bolts, or routine maintenance of vehicles are treated as expenses because they are necessary to keep the asset functioning at its current capacity rather than improve it.
Capital Expenditure on Enhancements
On the other hand, costs that extend the useful life of an asset, increase production capacity, improve output quality, or reduce operating costs are capitalized. These are added to the carrying amount of the asset because they increase the future economic benefits expected from the asset.
For instance, upgrading an old machine with new components that enhance production efficiency qualifies as capital expenditure. Similarly, an extension added to a building or technology upgrades that extend asset life must be capitalized.
Part Replacement
Many assets consist of parts that require replacement at regular intervals. Aircraft engines, turbines, or major machinery components are typical examples. When such parts are replaced, the cost of the new part is capitalized, while the carrying amount of the old part is derecognized.
This approach ensures that the balance sheet reflects the current value of the asset and avoids double counting. The recognition criteria applied to new parts are the same as those used for the initial recognition of property, plant and equipment.
Major Inspections and Overhauls
Certain assets require significant inspections or overhauls at intervals during their life. These inspections may be necessary to continue operating the asset safely and effectively. The cost of major inspections is capitalized if recognition criteria are met, and any remaining carrying value of earlier inspections is derecognized.
For example, airlines capitalize the cost of mandatory aircraft inspections because they are necessary to continue using the aircraft. Any previous inspection costs carried in the books are written off when new inspections are capitalized.
Changes in Liabilities
Sometimes, the cost of property, plant and equipment changes due to revisions in liabilities. This happens when there are changes in duties, prices, or estimates related to dismantling, removal, or site restoration obligations. When such changes occur, the asset’s carrying amount is adjusted accordingly.
If the liability increases, the asset cost is increased, and if the liability decreases, the asset cost is reduced. These adjustments ensure that the financial statements continue to represent the true financial position.
Measurement After Recognition
Once an item of property, plant and equipment is recognized and capitalized, enterprises must adopt a consistent accounting policy for measuring assets in subsequent years. Accounting Standard 10 provides two models: the cost model and the revaluation model.
Cost Model
Under the cost model, property, plant and equipment are carried at their original cost less accumulated depreciation and accumulated impairment losses. This approach is simple and widely used because it avoids the complexities of frequent revaluations.
For example, if a company purchases machinery for one million and after five years the accumulated depreciation amounts to three hundred thousand, the carrying amount under the cost model will be seven hundred thousand.
Revaluation Model
The revaluation model allows entities to carry property, plant and equipment at a revalued amount, which is the fair value of the asset at the revaluation date less subsequent depreciation and impairment losses. Fair value is generally determined by market-based evidence or professional valuations.
The revaluation model must be applied consistently to an entire class of assets, such as all buildings or all machinery, to prevent selective application. If revaluation is adopted, it must be performed regularly to ensure that carrying values do not differ materially from fair values.
Choosing the Appropriate Model
The choice between the cost model and the revaluation model depends on the entity’s financial reporting objectives, industry practices, and regulatory requirements. While the cost model is straightforward and provides stability, the revaluation model ensures that assets are reflected closer to their current market value.
Entities that hold significant real estate often prefer the revaluation model, as it provides a more realistic view of the asset base. Conversely, businesses with rapidly depreciating machinery may find the cost model more practical.
Revaluations of Property, Plant and Equipment
When an entity adopts the revaluation model, several specific rules apply to ensure transparency and consistency.
Determining Fair Value
For land and buildings, fair value is generally determined by professional valuers using market-based evidence. For plant and equipment, market value is used where available. In cases where specialized assets exist with no active market, fair value is determined using depreciated replacement cost or income-based approaches.
Frequency of Revaluation
Revaluations must be frequent enough to ensure that the carrying amount does not differ materially from fair value at the balance sheet date. Assets subject to significant changes in market value require more frequent revaluation, while those with relatively stable values may be revalued less often.
Treatment of Accumulated Depreciation
When revaluation is performed, accumulated depreciation on the asset is adjusted in one of two ways. It can either be proportionately restated along with the gross carrying amount or eliminated against the gross carrying amount so that the net amount equals the revalued figure. Both methods are acceptable, and the choice depends on the entity’s accounting policies.
Accounting for Revaluation Surplus or Deficit
Increases in the value of assets upon revaluation are credited to equity under the heading of revaluation surplus. However, if the increase reverses a previous revaluation decrease recognized in profit and loss, the increase is credited to profit and loss to that extent.
Conversely, decreases in value are charged to profit and loss unless there is a balance in revaluation surplus relating to the same asset, in which case the decrease is debited to the surplus.
Transfer of Revaluation Surplus
Revaluation surplus is not available for distribution as dividends. However, it may be transferred directly to retained earnings as the asset is used, either on disposal or gradually as depreciation is charged. This ensures that the surplus is eventually realized in the books.
Impact of Revaluations on Financial Reporting
Revaluations significantly affect financial reporting by altering both the balance sheet and income statement.
On the balance sheet, the carrying amount of assets increases, improving the financial position of the entity. On the income statement, depreciation charges increase because they are based on the revalued amount. This may reduce reported profits in subsequent years, even though asset values appear stronger.
For example, if a building initially recorded at two million is revalued to three million, the additional one million is credited to revaluation surplus. Depreciation for future years is calculated on the higher value, thereby increasing the expense and reducing net income.
Practical Applications and Examples
A manufacturing company with a large fleet of machinery may choose the cost model to maintain consistency, as machinery values decline steadily with use. However, a property development company may choose the revaluation model because land and buildings frequently appreciate in value, and revaluation provides stakeholders with updated asset values.
Another practical example is seen in infrastructure companies that incur significant dismantling and restoration costs at the end of asset life. These costs must be estimated at acquisition and included in asset cost, with subsequent changes in estimates reflected in carrying amounts.
Depreciation of Property, Plant and Equipment
Depreciation represents the systematic allocation of the depreciable amount of an asset over its useful life. The purpose of depreciation is to match the cost of an asset with the benefits derived from its use in generating revenue.
Determining the Depreciable Amount
The depreciable amount of an asset is calculated as the cost of the asset or its revalued amount, less the residual value expected at the end of its useful life. Residual value is the estimated amount an entity would currently obtain from the disposal of an asset after deducting estimated costs of disposal, assuming the asset is already of the age and condition expected at the end of its useful life.
For example, if a machine is purchased for 1,000,000 and its residual value at the end of its useful life is expected to be 100,000, the depreciable amount will be 900,000.
Useful Life of an Asset
Useful life is the period over which an asset is expected to be available for use or the number of production units expected to be obtained from the asset. Determining useful life requires judgment and consideration of several factors:
- Expected usage based on capacity or output
- Expected wear and tear from operational use
- Legal or contractual limits such as lease terms
- Technical or commercial obsolescence
The useful life and residual value of assets must be reviewed annually. If expectations differ from previous estimates, the change is accounted for as a revision of accounting estimates in accordance with relevant standards.
Methods of Depreciation
AS-10 does not prescribe a specific method of depreciation but requires that the method reflect the pattern in which economic benefits are consumed. Common methods include:
- Straight-Line Method (SLM): Allocates equal depreciation expense across each year of the useful life.
- Written Down Value Method (WDV): Allocates higher depreciation in earlier years, reflecting faster consumption of benefits initially.
- Units of Production Method: Allocates depreciation based on actual usage, such as machine hours or units produced.
Entities are free to select any method that best represents the consumption of benefits. The chosen method must be applied consistently, and any change requires disclosure.
Depreciation on Revalued Assets
When assets are revalued, depreciation must be calculated based on the revalued amount rather than the original cost. This results in higher depreciation charges, which reduce profits but provide a more accurate reflection of the asset’s value consumption.
For instance, if a building originally costing 2,000,000 is revalued to 3,000,000, depreciation must be charged on the new base. This ensures that expenses match the enhanced value reflected in the balance sheet.
Allocation of Depreciation
Depreciation is generally recorded as an expense in the profit and loss account. However, if it is included in the cost of another asset, such as inventory or construction projects, it is absorbed into that cost instead of being directly expensed.
For example, depreciation on machinery used in producing goods is part of inventory valuation, while depreciation on construction equipment may be included in the cost of a building project.
Impairment of Assets
Impairment occurs when the carrying amount of an asset exceeds its recoverable amount. The recoverable amount is the higher of an asset’s fair value less costs to sell and its value in use.
Identifying Indicators of Impairment
Entities must assess at each reporting date whether there are indicators of impairment. Indicators may include:
- Significant declines in market value
- Technological changes leading to obsolescence
- Changes in laws or regulations restricting asset use
- Physical damage to the asset
- Cash flow performance significantly below expectations
Measuring Impairment Loss
If indicators suggest impairment, the recoverable amount must be estimated. If the carrying amount exceeds this recoverable amount, the asset is written down to its recoverable amount, and the impairment loss is recognized in the profit and loss account.
For example, if machinery has a carrying amount of 800,000 but the recoverable amount is only 600,000, an impairment loss of 200,000 is recognized.
Reversal of Impairment Loss
If conditions that caused impairment improve and recoverable amount increases, a reversal of impairment loss may be recognized. However, the carrying amount after reversal should not exceed what it would have been had no impairment loss been recognized.
Derecognition of Property, Plant and Equipment
An item of property, plant and equipment is derecognized upon disposal or when no future economic benefits are expected from its use. Derecognition ensures that assets no longer providing value are removed from the financial statements.
Disposal of Assets
When assets are sold, exchanged, or scrapped, the carrying amount is derecognized, and any difference between the disposal proceeds and carrying amount is recognized in the profit and loss account.
For example, if equipment with a carrying amount of 400,000 is sold for 450,000, a gain of 50,000 is recorded. Conversely, if sold for 350,000, a loss of 50,000 is recognized.
Replacement and Derecognition of Parts
When a significant part of an asset is replaced, the cost of the new part is capitalized, and the carrying amount of the replaced part is derecognized. This prevents duplication and ensures accurate reporting of asset values.
Abandonment or Retirement
If an asset is abandoned or retired without generating disposal proceeds, the carrying amount is written off, and a loss is recognized. For instance, scrapping obsolete machinery with no resale value requires derecognition at its carrying amount.
Presentation and Disclosure Requirements
Clear presentation and disclosure of property, plant and equipment are essential for transparency in financial reporting. AS-10 specifies the minimum information that must be disclosed in financial statements.
Presentation on the Balance Sheet
Property, plant and equipment are presented under non-current assets. They are typically classified by category such as land, buildings, plant and machinery, furniture, vehicles, and office equipment.
Disclosure in the Notes
Entities must disclose for each class of assets:
- The measurement basis used (cost model or revaluation model)
- Depreciation methods and useful lives or rates
- Gross carrying amount and accumulated depreciation at the beginning and end of the period
- Reconciliation of carrying amount at the beginning and end of the period, showing additions, disposals, depreciation, revaluations, and impairment adjustments
- Restrictions on title, pledged assets, or contractual commitments for purchase of PPE
Revaluation Disclosures
If the revaluation model is applied, entities must disclose:
- The effective date of revaluation
- Whether an independent valuer was involved
- The methods and assumptions used in estimating fair value
- The carrying amount of each class of revalued assets
- Revaluation surplus movements during the period
Importance of Proper Accounting for PPE
Accurate accounting for property, plant and equipment ensures that financial statements present a true and fair view of the entity’s financial position. Proper recognition, measurement, depreciation, and impairment accounting:
- Help investors and stakeholders assess asset values and future earning capacity
- Provide reliable data for decision-making and resource allocation
- Ensure compliance with regulatory standards and consistency across reporting periods
- Prevent overstatement of profits by ensuring depreciation and impairment are appropriately recognized
Practical Industry Scenarios
Manufacturing Industry
In manufacturing, machinery and equipment form the largest part of property, plant and equipment. Regular maintenance costs are expensed, while overhauls and upgrades are capitalized. Depreciation is often charged using the written down value method to reflect higher wear and tear in early years.
Airlines and Shipping
Airlines and shipping companies capitalize the cost of major inspections and dry-docking expenses as part of property, plant and equipment. These industries must also carefully manage impairment assessments due to volatile market conditions affecting asset values.
Real Estate and Construction
Real estate companies often adopt the revaluation model for land and buildings to reflect fair values. Construction firms capitalize costs of plant and equipment used in projects and allocate depreciation to project costs.
Technology Companies
Technology companies face rapid obsolescence of equipment. They frequently review useful lives and residual values, and impairment is a common adjustment when assets lose relevance due to new technologies.
Conclusion
Accounting Standard 10 on property, plant and equipment plays a vital role in ensuring that tangible assets are recognized, measured, and presented in a way that reflects their true economic substance. From the moment an item of property, plant or equipment is acquired, its cost, directly attributable expenditures, and obligations relating to dismantling or restoration must be carefully measured and recorded. Subsequent costs, replacements, and inspections are distinguished between revenue and capital expenditure to avoid misstatement of profits.
The choice between the cost model and the revaluation model for subsequent measurement provides flexibility but also requires consistency across asset classes. Revaluations ensure assets are aligned with fair values, while depreciation allocates the depreciable amount systematically over useful lives. Impairment testing ensures assets are not overstated when recoverable amounts decline, while derecognition policies maintain accuracy when assets are disposed of, replaced, or abandoned.
Together, these requirements enhance transparency in financial statements by providing users with reliable and comparable information about an entity’s property, plant and equipment. For businesses, careful compliance with AS-10 not only ensures adherence to regulatory standards but also provides a more accurate reflection of their long-term operational capacity and financial health. Proper application of this standard enables stakeholders to make informed decisions, manage resources efficiently, and evaluate the sustainability of future cash flows.