PPE; impairment loss; features of AS-2

(i) Property, plant and equipment (AS-10 Revised)

Meaning. Property, plant and equipment (PPE) 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, and” (AS 10, para 6) are expected to be used during more than a period of twelve months: land, buildings, plant, machinery, vehicles, furniture. They are held for use, not for sale in the ordinary course of business; an item held for sale is inventory.

Recognition. An item is recognised as PPE when it is probable that future economic benefits from it will flow to the enterprise and its cost can be measured reliably.

Cost. PPE is first measured at cost, and cost includes every cost directly attributable to bringing the asset to the location and condition necessary for it to operate as intended: site preparation, initial delivery and handling, installation and assembly, testing, and professional fees.

After recognition. The enterprise chooses the cost model (cost less accumulated depreciation and impairment) or the revaluation model for each class of PPE, and depreciates the asset systematically over its useful life.

(ii) Impairment loss (AS-28, Impairment of Assets: the paper prints "AS 26")

Meaning. An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount; the carrying amount is the amount at which the asset is recognised in the balance sheet after deducting accumulated depreciation and accumulated impairment losses. The loss is therefore the excess:

Impairment loss = Carrying amount − Recoverable amount, where Recoverable amount = the higher of net selling price and value in use.

Recoverable amount is the higher of an asset's net selling price and its value in use. Net selling price is the amount obtainable from the sale of the asset in an arm's length transaction between knowledgeable, willing parties, less the costs of disposal; value in use is the present value of the cash flows expected from continuing to use the asset and from its disposal at the end of its useful life.

Indicators. At each balance sheet date the enterprise looks for signs of impairment: a sharp fall in market value, physical damage or obsolescence, adverse changes in technology, markets or law, or a rise in interest rates that lowers value in use. If there is any such sign, recoverable amount is estimated.

Treatment. The loss is recognised at once as an expense in the profit and loss statement (for a revalued asset, first against its revaluation surplus), the asset is carried at its recoverable amount, and later depreciation is based on that reduced amount. A loss may be reversed in a later year if the estimates improve, but not above the carrying amount the asset would have had without the impairment.

Illustration. A machine is carried at ₹9,00,000. Its net selling price is ₹6,80,000 and its value in use ₹7,40,000, so its recoverable amount is ₹7,40,000 (the higher). Impairment loss = 9,00,000 − 7,40,000 = ₹1,60,000, charged to profit and loss; the machine is carried at ₹7,40,000.

(iii) Main features of AS-2, Valuation of Inventories

1. What counts as inventory. Assets held for sale in the ordinary course of business (finished goods), in the process of production for such sale (raw materials and work-in-progress), or in the form of materials or supplies consumed in production or in rendering services; machinery spares usable only with a particular fixed asset are excluded and dealt with under AS-10.
2. Basic rule of measurement. Inventories are valued at the lower of cost and net realisable value.
3. “Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale” (AS 2, para 3.2).
4. Item-by-item comparison. Cost and NRV are normally compared item by item, though similar or related items may in some circumstances be grouped.
5. Cost is made up of the purchase cost, the conversion cost and any other cost of getting the inventories to where and as they now are (AS 2, para 6); abnormal wastage, storage, administrative overheads not related to production, and selling costs are excluded. Cost is assigned by FIFO or weighted average.
6. Disclosure. The financial statements disclose the accounting policy for measuring inventories, including the cost formula used, and the total carrying amount with its classification.

Illustration. Goods costing ₹50,000 can be sold for ₹52,000 but need ₹6,000 of selling costs; NRV is ₹46,000, below cost, so they are carried at ₹46,000.