Property, Equipment, Intangibles and Asset Impairment

Introduction and context

Long-term operating assets determine an entity’s productive capacity, technological capability and future cash-generating potential. Their accounting is therefore not merely a matter of recording historical cost. It requires judgements about recognition, useful lives, residual values, depreciation methods, fair values, impairment and derecognition. These judgements affect profit, asset values, equity, tax planning, performance measures and investment decisions.

This chapter applies primarily to the principles in IAS 16 Property, Plant and Equipment, IAS 38 Intangible Assets, IAS 40 Investment Property and IAS 36 Impairment of Assets. Local legislation, sector-specific standards and jurisdictional requirements must also be consulted in practice.

The central accounting question is whether an expenditure creates a controlled resource from which future economic benefits are probable and whose cost or value can be measured reliably. If so, the expenditure may qualify for recognition as an asset. If not, it is normally recognised as an expense.

Learning objectives

After studying this chapter, you should be able to:

1. Explain the recognition and measurement principles for property, plant and equipment, investment property and intangible assets.
2. Distinguish capital expenditure from repairs, maintenance, research and development expenditure.
3. Calculate depreciation, amortisation, carrying amount and gain or loss on disposal.
4. Analyse cost and revaluation models and their effects on financial statements.
5. Apply impairment-testing principles, including recoverable amount and cash-generating units.
6. Evaluate professional judgements, governance risks and reporting implications.

1. The asset concept and classification architecture

An asset is a present economic resource controlled by an entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits. Physical existence is not essential: a patent, licence or software right can be an asset, while an obsolete machine may no longer qualify for recognition at its former carrying amount.

Classification matters because different standards prescribe different measurement and disclosure requirements.

Investment property is distinguished from owner-occupied property by use, not legal title. Property occupied by the entity, used in production or administration, is PPE. Property held to earn rentals or for capital appreciation is investment property. Property held for sale in the ordinary course of business is generally inventory.

2. Property, plant and equipment

Recognition

An item of PPE is recognised when:

• future economic benefits associated with the item are probable; and
• its cost can be measured reliably.

The recognition test applies to major replacement parts, stand-by equipment and servicing equipment when they meet the definition of PPE. Routine repairs and maintenance do not create a separately controlled future resource and are expensed as incurred.

Initial measurement

PPE is initially measured at cost. Cost includes:

• purchase price, including import duties and non-refundable purchase taxes, after discounts;
• directly attributable costs of bringing the asset to the location and condition necessary for intended operation;
• the initial estimate of dismantling, removal and site-restoration obligations, when a present obligation exists; and
• certain directly attributable employee and professional costs.

Examples of directly attributable costs include site preparation, delivery, installation, testing and professional fees. Costs of opening a new facility, advertising, staff training, general administration, abnormal wastage and initial operating losses are normally expensed.

A self-constructed asset is measured using the same principles as an acquired asset. Internal profit is eliminated. Borrowing costs directly attributable to constructing a qualifying asset may be capitalised under IAS 23, subject to the standard’s conditions.

Component accounting

Significant parts of an asset with different useful lives or consumption patterns are depreciated separately. For example, an aircraft’s airframe, engines and major inspection components may be separate components. Component accounting prevents the cost of a short-lived major part from being depreciated over the life of the entire asset.

Subsequent expenditure

Expenditure after acquisition is capitalised only when it meets the recognition criteria and improves the asset’s future economic benefits beyond its originally assessed standard of performance. Replacement of a significant component can be capitalised if the replaced component is derecognised. Day-to-day servicing is expensed.

3. Depreciation and subsequent measurement

Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. It is not a valuation technique and does not necessarily represent a fall in market value.

The depreciable amount is allocated from the date the asset is available for use until derecognition or classification as held for sale. Depreciation does not stop merely because an asset is idle, unless it has been fully depreciated or derecognised.

Under the cost model:

Under the revaluation model, the carrying amount is the fair value at the revaluation date, less subsequent depreciation and impairment.

Useful life and residual value

Useful life is the period over which the asset is expected to be available for use, or the number of production units expected to be obtained. It depends on expected usage, physical wear, technological or commercial obsolescence and legal limits such as lease terms.

Residual value is the estimated amount the entity would currently obtain from disposal of the asset, after deducting disposal costs, assuming the asset were already of the age and condition expected at the end of its useful life. It is often zero, but not automatically so.

Useful life, residual value and depreciation method are reviewed at least at each financial year-end. Changes resulting from new information are changes in accounting estimates and are applied prospectively under IAS 8.

Depreciation methods

The straight-line method is appropriate where benefits are consumed evenly:

The units-of-production method is appropriate when usage drives consumption:

A diminishing-balance method allocates a greater amount in earlier periods and may be suitable where benefits are consumed more rapidly at the beginning. A depreciation method based solely on revenue is generally inappropriate because revenue reflects price, demand and other factors, not necessarily consumption of the asset’s economic benefits.

Worked example: cost model

On 1 January 20X1, Delta acquires a machine for CU120,000. Delivery and installation cost CU10,000. The machine has an estimated residual value of CU10,000 and a useful life of five years. It is available for use immediately.

Cost = CU120,000 + CU10,000 = CU130,000.

At 31 December 20X3, assuming no impairment:

• accumulated depreciation = CU24,000 × 3 = CU72,000;
• carrying amount = CU130,000 − CU72,000 = CU58,000.

If the machine is sold for CU62,000 on that date, the gain is CU4,000. If it is sold for CU55,000, the loss is CU3,000.

4. Revaluation of PPE

An entity may choose either the cost model or the revaluation model as its accounting policy for a class of PPE. The revaluation model must be applied to the entire class, not selectively to assets whose values have increased.

Revaluations must be sufficiently regular that carrying amounts do not differ materially from fair value. An upward revaluation is normally recognised in other comprehensive income and accumulated in equity as a revaluation surplus. However, it is recognised in profit or loss to the extent that it reverses a previous revaluation decrease recognised in profit or loss.

A downward revaluation is normally recognised in profit or loss. It is recognised in other comprehensive income to the extent of an existing surplus for the same asset.

After revaluation, depreciation is based on the revalued amount. An entity may transfer the difference between depreciation based on the revalued amount and depreciation based on original cost from revaluation surplus to retained earnings; this transfer is made directly in equity and is not presented as profit or loss.

Worked example: revaluation

A building has an original cost of CU1,000,000, a 20-year useful life and no residual value. After five years, its carrying amount is CU750,000. Its fair value is CU900,000.

The revaluation increase is:

Assuming no previous decrease, CU150,000 is recognised in other comprehensive income and accumulated in revaluation surplus. If the remaining useful life is 15 years, annual depreciation after revaluation is:

Under the cost model, annual depreciation would have been CU50,000. The additional CU10,000 may be transferred within equity, subject to applicable policy and taxation considerations.

Revaluation introduces estimation uncertainty and may increase reported equity without creating cash. It can also increase future depreciation and reduce later profit. Management should therefore explain valuation methods, significant assumptions and the effect on performance.

5. Investment property

Investment property is land or a building, or part thereof, held to earn rentals, for capital appreciation or both. Examples include a building leased to independent tenants and land held for long-term appreciation.

Owner-occupied property, property held for sale in the ordinary course of business and property occupied by employees when used in operations are not investment property. Mixed-use property is separated when portions can be sold or leased separately. If separation is not possible, the property is investment property only when the owner-occupied portion is insignificant.

On initial recognition, investment property is measured at cost. Subsequently, an entity chooses a policy of either:

• the fair value model, under which changes in fair value are recognised in profit or loss; or
• the cost model, under which IAS 16 cost-model principles apply, subject to investment-property disclosures.

Under the fair value model, investment property is not depreciated. This does not mean that value changes are ignored: changes in fair value are recognised in profit or loss each reporting period. Fair value measurement requires appropriate valuation expertise and transparent assumptions concerning rents, vacancy, yields, market evidence and development potential.

Transfers to or from investment property occur only when there is a change in use, evidenced by events such as commencement of owner-occupation, commencement of development for sale or the end of owner-occupation. A management intention without supporting evidence is not normally sufficient.

6. Intangible assets

An intangible asset is an identifiable non-monetary asset without physical substance. Identifiability exists when the asset is separable or arises from contractual or other legal rights. Control means the entity can obtain future economic benefits and restrict others’ access to those benefits.

Examples include patents, copyrights, licences, franchises, customer relationships acquired in a business combination and computer software. Internally generated goodwill, brands, mastheads, customer lists and publishing titles are not recognised because their costs cannot be distinguished reliably from the cost of developing the business as a whole.

Initial measurement

A separately acquired intangible asset is initially measured at cost. In a business combination, an identifiable intangible asset is recognised separately from goodwill at fair value when the recognition conditions are met, even if the acquiree had not previously recognised it.

An intangible asset with a finite useful life is amortised systematically. An intangible asset with an indefinite useful life is not amortised, but is tested annually for impairment and whenever indicators arise. “Indefinite” does not mean infinite; it means there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows.

The cost model is generally cost less accumulated amortisation and impairment. The revaluation model is permitted only when fair value can be measured by reference to an active market, which is uncommon for many unique brands, patents and customer relationships.

7. Research and development accounting

Research is original and planned investigation undertaken to obtain new scientific or technical knowledge. Research expenditure is expensed when incurred because future economic benefits cannot yet be demonstrated reliably.

Development is the application of research findings or other knowledge to a plan or design for producing new or substantially improved products, processes or systems before commercial production or use.

Development expenditure is capitalised only when the entity can demonstrate all of the following:

1. technical feasibility of completing the asset;
2. intention to complete it and use or sell it;
3. ability to use or sell it;
4. probable future economic benefits, including evidence of a market or internal usefulness;
5. availability of adequate technical, financial and other resources; and
6. ability to measure the expenditure reliably.

Capitalisation begins only when all criteria are satisfied. Earlier expenditure cannot subsequently be reinstated as an asset. After recognition, development costs are amortised from the date the asset is available for use and tested for impairment.

The distinction is economically important. Expensing all development costs may understate assets and current profit; capitalising uncertain projects may overstate both. Documentation of technical milestones, budgets, market evidence, resource availability and time records is therefore a governance requirement.

8. Impairment of assets

An asset is impaired when its carrying amount exceeds its recoverable amount. IAS 36 applies to PPE, intangible assets, goodwill and several other non-current assets, subject to specific exclusions.

Fair value less costs of disposal is the price obtainable in an orderly transaction between market participants, less incremental disposal costs. Value in use is the present value of future cash flows expected from continuing use and ultimate disposal, using assumptions consistent with the asset and the entity’s condition.

For value in use, a simplified present-value relationship is:

where CF_t is the estimated net cash flow in period t, r is the pre-tax discount rate reflecting current market assessments of time value and asset-specific risks, and t ranges over the forecast periods. Cash flows must be supportable, avoid double-counting risks in both cash flows and the discount rate, and normally exclude financing cash flows and income tax effects when applying the IAS 36 value-in-use model.

Impairment indicators

At each reporting date, an entity assesses whether indicators exist. External indicators include a major fall in market value, adverse technological or economic changes, rising market interest rates and a market capitalisation below net assets. Internal indicators include physical damage, obsolescence, restructuring, underperformance and evidence that an asset will be disposed of earlier than expected.

Annual testing is required for goodwill, intangible assets not yet available for use and intangible assets with indefinite useful lives, even when no indicator exists.

Cash-generating units

Where an individual asset does not generate largely independent cash inflows, impairment is tested at the cash-generating unit (CGU), the smallest identifiable group generating largely independent inflows. Goodwill is allocated to CGUs or groups of CGUs expected to benefit from the combination, subject to the required management level and aggregation limits.

A CGU impairment loss is allocated first to goodwill and then pro rata to other assets, but no asset is reduced below the highest of its fair value less costs of disposal, value in use if determinable, and zero.

Reversal of impairment

An impairment loss for an asset other than goodwill is reversed when estimates used to determine recoverable amount change. The reversal cannot increase the carrying amount above the amount that would have existed, net of depreciation or amortisation, had no impairment been recognised. Impairment losses for goodwill are never reversed.

Worked example: impairment

A machine has a carrying amount of CU400,000. Its fair value less costs of disposal is CU330,000. Forecast net cash flows have a present value of CU360,000. The recoverable amount is therefore CU360,000, the higher of CU330,000 and CU360,000.

The loss is recognised in profit or loss unless the asset is carried under the revaluation model, in which case the treatment follows the revaluation rules.

9. Derecognition and disposal

PPE and intangible assets are derecognised on disposal or when no future economic benefits are expected from their use or disposal. The gain or loss is:

The gain or loss is recognised in profit or loss, except that sale-and-leaseback transactions and other standards may impose additional requirements. Gains are not classified as revenue unless the entity’s ordinary activities involve selling such assets.

For disposal, depreciation or amortisation is recorded up to the date the asset is derecognised, unless another standard requires a different treatment. The asset’s accumulated depreciation, accumulated impairment and cost are removed from the accounts. Proceeds, transaction costs and any deferred consideration must be measured consistently with the applicable standard.

10. Integrated illustrative case

Background

Orion Medical Devices, an illustrative listed manufacturer, purchases specialised production equipment for CU2,400,000 on 1 January 20X1. Delivery and installation cost CU120,000. It also incurs CU180,000 on training staff and CU90,000 on abnormal start-up losses. The equipment has a residual value of CU120,000 and a useful life of eight years.

During 20X1, Orion spends CU500,000 on research into a new diagnostic platform. On 1 July 20X2, technical feasibility, commercial intention, market demand, funding and reliable measurement are demonstrated. Development expenditure from that date to 31 December 20X2 is CU360,000, and the platform is available for use on 1 January 20X3. Its useful life is six years.

At 31 December 20X3, the equipment’s carrying amount is CU1,800,000 and its recoverable amount is CU1,620,000. The platform has a carrying amount of CU300,000 before impairment testing, and its recoverable amount is CU250,000.

Analysis and solution

The equipment’s cost is:

• purchase price: CU2,400,000;
• delivery and installation: CU120,000;
• capitalised cost: CU2,520,000.

Training and abnormal start-up losses are expensed. Straight-line annual depreciation is:

The CU500,000 research expenditure is expensed in 20X1. Development expenditure before 1 July 20X2 is also expensed because the recognition criteria were not yet demonstrated. The CU360,000 incurred after that date is capitalised. Platform amortisation begins on 1 January 20X3:

The equipment impairment loss at 31 December 20X3 is:

The platform impairment loss is:

Outcome and learning points

Orion must distinguish expenditures by economic substance rather than by project label. The same development project can contain an expense phase and a capitalisation phase. Impairment testing must use recoverable amount, not management’s preferred carrying value. The case also shows why project documentation, technical sign-off, budgets and independent valuation review are essential.

11. Professional judgement, governance and contemporary practice

Asset accounting is particularly vulnerable to earnings management. Common risks include delaying impairment, extending useful lives without evidence, inflating residual values, capitalising repairs, commencing development capitalisation too early and using optimistic cash-flow forecasts.

Effective governance includes:

• an asset register linked to purchasing and disposal systems;
• documented approval of capital expenditure;
• periodic physical verification;
• component-level records for significant assets;
• independent review of valuations and impairment models;
• sensitivity analysis for discount rates, growth rates and useful lives;
• audit trails for research-development stage gates; and
• segregation of operational, valuation and financial-reporting responsibilities.

Technology can improve control. Enterprise asset-management systems, barcode or RFID verification, predictive-maintenance analytics and satellite or sensor data can provide evidence about utilisation, condition and useful life. Artificial intelligence may assist in analysing maintenance records and forecasting obsolescence, but it does not remove management responsibility. AI-generated forecasts must be explainable, validated against historical outcomes and reviewed for biased or unsupported assumptions.

Climate change may affect useful lives, residual values, impairment indicators, restoration obligations and the viability of carbon-intensive assets. Regulatory changes can make equipment obsolete before physical deterioration occurs. Financial statements should therefore connect asset assumptions with climate scenarios, transition plans and other material risk disclosures.

Challenges and limitations

Measurement is difficult when assets are specialised, markets are inactive or cash flows are uncertain. Fair value models may depend heavily on unobservable inputs. Value-in-use models are sensitive to small changes in discount rates and terminal assumptions. Depreciation is systematic, but it remains an estimate of consumption rather than a direct observation. Revaluation can improve relevance while reducing comparability between entities. Capitalisation of development expenditure can improve matching but may delay recognition of uncertainty.

No single model eliminates judgement. High-quality reporting depends on faithful representation, consistency, transparent assumptions and timely recognition of losses.

Chapter Summary

PPE is recognised when future benefits are probable and cost is reliably measurable, and is initially measured at cost. Directly attributable costs and restoration obligations may be capitalised, while routine maintenance, training and abnormal losses are normally expensed. Significant components are depreciated separately.

Depreciation allocates depreciable amount systematically over useful life. Cost and revaluation models produce different carrying amounts and future depreciation, while revaluation gains and losses follow specific equity and profit-or-loss rules. Investment property is classified by use and may be measured using either the fair value or cost model.

Intangible assets must be identifiable and controlled. Research expenditure is expensed, whereas development expenditure is capitalised only after all prescribed criteria are demonstrated. Finite-life intangibles are amortised; indefinite-life intangibles are tested annually for impairment.

Impairment exists when carrying amount exceeds recoverable amount, defined as the higher of fair value less costs of disposal and value in use. CGUs are essential when assets do not generate independent cash inflows. Goodwill impairment losses cannot be reversed. Finally, assets are derecognised on disposal or when no future benefits are expected, with the resulting gain or loss recognised appropriately.

Key Terms

Asset: A present economic resource controlled by an entity as a result of past events.

Carrying amount: The amount at which an asset is recognised after accumulated depreciation, amortisation and impairment.

Component accounting: Separate depreciation of significant parts having different useful lives or consumption patterns.

Cost model: Measurement at cost less accumulated depreciation or amortisation and impairment losses.

Depreciable amount: Cost or revalued amount less residual value.

Development: Application of research findings to a plan or design before commercial production or use.

Fair value: The price received to sell an asset in an orderly transaction between market participants.

Impairment loss: The excess of an asset’s carrying amount over its recoverable amount.

Indefinite useful life: A useful life with no foreseeable limit, not an infinite life.

Intangible asset: An identifiable non-monetary asset without physical substance.

Investment property: Property held for rental income, capital appreciation or both.

Property, plant and equipment: Tangible assets held for production, supply, rental or administration and used for more than one period.

Recoverable amount: The higher of fair value less costs of disposal and value in use.

Residual value: Estimated disposal proceeds at the end of useful life, less disposal costs.

Research: Original and planned investigation undertaken to obtain new knowledge.

Revaluation model: Measurement at fair value at revaluation date less subsequent depreciation and impairment.

Useful life: Expected period of use or expected production capacity of an asset.

Value in use: Present value of future cash flows expected from continuing use and disposal.

Review Questions

Short Answer Questions

1. What two recognition conditions must be satisfied before PPE is recognised?
2. Distinguish research expenditure from development expenditure.
3. Define recoverable amount under IAS 36.
4. Why are significant components of PPE depreciated separately?
5. State the difference between owner-occupied property and investment property.

Long Answer Questions

1. Explain the initial and subsequent measurement of PPE under the cost and revaluation models.
2. Discuss the recognition criteria for internally generated development expenditure and the governance evidence needed to support capitalisation.
3. Explain impairment testing for an individual asset and for a cash-generating unit.
4. Compare the fair value and cost models for investment property, including their effects on profit and financial position.
5. Evaluate the role of useful-life, residual-value and depreciation-method estimates in faithful financial reporting.

Analytical / Application Questions

1. A company capitalises staff training and start-up losses as part of a new factory. Analyse whether this treatment is appropriate and explain the consequences for profit and asset carrying amount.
2. A cash-generating unit has goodwill, specialised machinery and inventory, and its recoverable amount is below its carrying amount. Explain the order and limitations for allocating the impairment loss.
3. Management wishes to capitalise all expenditure on a software project from its commencement because the project is expected to be profitable. Critically assess this proposal using the research-development distinction and discuss the audit evidence required.

Multiple Choice Questions with Answers

Question 1

Which expenditure is normally included in the initial cost of PPE?

A. Routine staff training

B. Abnormal start-up losses

C. Direct installation costs

D. General administrative overheads

Correct Answer: C. Direct installation costs

Question 2

A machine costs CU130,000, has a residual value of CU10,000 and a five-year useful life. What is annual straight-line depreciation?

A. CU20,000

B. CU24,000

C. CU26,000

D. CU28,000

Correct Answer: B. CU24,000

Question 3

Under IAS 36, recoverable amount is the higher of:

A. Cost and fair value

B. Value in use and carrying amount

C. Fair value less costs of disposal and value in use

D. Net realisable value and replacement cost

Correct Answer: C. Fair value less costs of disposal and value in use

Question 4

Which statement about research expenditure is correct?

A. It is always capitalised when a project is commercially promising

B. It is expensed when incurred because the recognition criteria are not yet demonstrated

C. It is recognised as goodwill

D. It is deferred until the related product is sold

Correct Answer: B. It is expensed when incurred because the recognition criteria are not yet demonstrated

Question 5

An upward PPE revaluation with no previous downward revaluation is normally recognised initially in:

A. Profit or loss

B. Trade payables

C. Other comprehensive income and revaluation surplus

D. Revenue

Correct Answer: C. Other comprehensive income and revaluation surplus

Question 6

Which property is generally investment property?

A. A factory used by the reporting entity

B. A warehouse held for sale in the ordinary course of business

C. An office building leased to independent tenants

D. A headquarters occupied by employees

Correct Answer: C. An office building leased to independent tenants

Question 7

An asset has a carrying amount of CU400,000, fair value less costs of disposal of CU330,000 and value in use of CU360,000. What impairment loss is recognised?

A. CU30,000

B. CU40,000

C. CU70,000

D. CU360,000

Correct Answer: B. CU40,000

Question 8

Which condition is required before development expenditure can be capitalised?

A. The project has incurred at least one year of costs

B. Technical feasibility of completing the asset has been demonstrated

C. The project has generated revenue

D. A competitor has launched a similar product

Correct Answer: B. Technical feasibility of completing the asset has been demonstrated

Question 9

What is the appropriate formula for gain or loss on disposal?

A. Carrying amount minus original cost

B. Net disposal proceeds minus carrying amount

C. Original cost minus accumulated depreciation

D. Fair value minus residual value

Correct Answer: B. Net disposal proceeds minus carrying amount

Question 10

Which statement about goodwill impairment is correct?

A. Goodwill is amortised under all accounting models

B. Goodwill impairment losses may always be reversed

C. Goodwill is tested through the cash-generating unit or units to which it is allocated

D. Goodwill is excluded from impairment testing when profits are forecast

Correct Answer: C. Goodwill is tested through the cash-generating unit or units to which it is allocated