Property, Plant, Equipment, Intangibles and Impairment

Introduction and context

Long-lived operating assets create economic benefits over several reporting periods. Their accounting therefore differs fundamentally from the accounting of inventory or ordinary operating expenses. The central questions are: when should expenditure be recognised as an asset; at what amount; how should that amount be allocated over time; when may it be remeasured; and when must it be reduced because expected benefits have fallen?

This chapter applies the principal logic of International Financial Reporting Standards (IFRS), especially IAS 16 Property, Plant and Equipment, IAS 23 Borrowing Costs, IAS 36 Impairment of Assets, IAS 38 Intangible Assets, IFRS 3 Business Combinations and IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Local requirements may differ, so professional practice requires checking the applicable reporting framework, tax law and regulatory guidance.

The subject is strategically important. Capitalisation decisions affect profit, assets, leverage, return on assets, covenant compliance and management performance measures. Estimates of useful life, residual value, discount rates and recoverable amount also create opportunities for bias. A finance manager must therefore combine technical accounting with engineering evidence, valuation expertise, operational forecasts and governance controls.

Learning objectives

By the end of this chapter, the learner should be able to:

1. Apply recognition and measurement principles to property, plant and equipment (PPE).
2. Distinguish capital expenditure from repairs, maintenance and other expenses.
3. Calculate depreciation and account for significant components.
4. Explain cost and revaluation models and evaluate their consequences.
5. Account for borrowing costs and asset retirement obligations.
6. Distinguish research from development and analyse intangible assets and goodwill.
7. Perform impairment testing using recoverable amount, cash-generating units and value in use.
8. Evaluate managerial, ethical and governance implications of estimates and asset valuations.

1. Property, plant and equipment: recognition and initial measurement

PPE consists of tangible items that are held for production or supply, rental to others, or administrative purposes, and are expected to be used during more than one period. An item is recognised as an asset when it is probable that future economic benefits will flow to the entity and its cost can be measured reliably. Probability is normally demonstrated by the commercial purpose of the acquisition; reliable measurement is usually supported by an invoice, contract or defensible valuation.

Initial cost includes:

• purchase price, including import duties and non-refundable taxes, net of discounts;
• directly attributable costs necessary to bring the asset to the location and condition required for intended operation;
• the initial estimate of dismantling, removal and site-restoration obligations, when a present obligation exists; and
• for qualifying assets, capitalised borrowing costs.

Directly attributable costs may include site preparation, delivery, installation, testing and professional fees. Costs of opening a new facility, introducing a new product, relocating operations, general administration, abnormal waste, training and initial operating losses are normally expensed. Testing costs are included only to the extent necessary to assess whether the asset functions properly; proceeds from items produced while testing are accounted for under the applicable standards and do not automatically reduce asset cost.

Subsequent expenditure is capitalised only when it meets the recognition criteria. Routine repairs, maintenance, consumables and servicing preserve existing performance and are expensed. A major inspection or replacement may be capitalised if it creates separately identifiable future benefits. The carrying amount of the replaced component or previous inspection is derecognised, even if its original cost was not separately recorded; it must be estimated using reasonable evidence.

Measurement formula

The formula applies only to costs that meet recognition requirements. It is not a licence to capitalise every expenditure connected with a project. Recoverable amounts include items such as refundable taxes or proceeds that accounting standards require to be recognised separately. Each amount must be measured consistently and supported by documentation.

Worked example 1: initial measurement

A company acquires a machine for $480,000. Import duty is $24,000, delivery is $8,000, installation is $16,000, staff training is $7,000 and general administration is $5,000. The present value of a legally required restoration obligation is $30,000. The machine qualifies for $10,000 of borrowing-cost capitalisation.

Capitalised cost is:

$480,000 + $24,000 + $8,000 + $16,000 + $30,000 + $10,000 = $568,000.

Training and general administration of $12,000 are expensed. The restoration obligation is recognised separately as a provision at its present value, with a corresponding increase in PPE.

2. Depreciation and component accounting

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 represent the asset’s current market price. Depreciable amount is cost or revalued amount less residual value.

The useful life is the period over which the asset is expected to be available for use, or the number of units expected to be produced. It reflects expected usage, physical wear, technological or commercial obsolescence and legal or contractual limits. Depreciation begins when the asset is in the location and condition necessary for operation, not necessarily when it reaches full production. It ceases on derecognition or classification as held for sale, whichever occurs earlier under the applicable requirements.

Common depreciation methods

For straight-line depreciation, assuming a constant pattern of consumption:

For a units-of-production method:

The units-of-production method is appropriate only when usage is the principal pattern of consumption and can be measured reliably. Revenue-based depreciation is generally inappropriate because revenue reflects pricing, demand and marketing rather than consumption of the asset.

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 cycle may require separate components. Component accounting improves matching and prevents an inexpensive short-life part from being depreciated over the life of the entire asset.

Worked example 2: components

A production line costs $1,200,000. Its main structure costs $900,000, has a residual value of $60,000 and a 15-year useful life. A replacement unit costs $300,000, has a residual value of $20,000 and a 5-year useful life. Straight-line depreciation is used.

Structure depreciation = ($900,000 − $60,000) ÷ 15 = $56,000 per year.

Replacement-unit depreciation = ($300,000 − $20,000) ÷ 5 = $56,000 per year.

Total annual depreciation for the first five years is $112,000. After five years, the replacement unit is derecognised and a new component is recognised if replaced. Useful lives, residual values and methods are reviewed at least at each reporting date; changes are changes in accounting estimates and are generally applied prospectively.

3. Subsequent measurement: cost and revaluation models

After recognition, an entity normally chooses either the cost model or the revaluation model for an entire class of PPE and applies that policy consistently.

Under the cost model:

Under the revaluation model, PPE is carried at fair value at the revaluation date, less subsequent depreciation and impairment. Revaluations must be sufficiently regular that carrying amount does not differ materially from fair value. An entire class, rather than selected favourable assets, must be revalued.

An upward revaluation is generally recognised in other comprehensive income and accumulated in equity as a revaluation surplus, except to the extent it reverses a previous decrease recognised in profit or loss. A downward revaluation is generally recognised in profit or loss, except to the extent of an existing surplus for that asset. On disposal, a surplus may be transferred directly to retained earnings; it is not recycled through profit or loss.

Revaluation changes depreciation. If an asset’s carrying amount rises, future depreciation usually increases. Management may transfer the difference between depreciation based on the revalued amount and depreciation based on historical cost within equity, where permitted, but such transfers do not affect profit or loss.

4. Derecognition and disposal

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

The result is recognised in profit or loss and is not classified as revenue unless the entity’s ordinary activities involve selling such assets. Disposal controls should reconcile proceeds, accumulated depreciation, tax effects, physical removal and the fixed-asset register.

5. Borrowing costs

IAS 23 requires borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset to form part of its cost. A qualifying asset requires a substantial period to get ready for intended use or sale. Examples include large infrastructure projects, major developments and some inventories. Routine short-term purchases are not qualifying assets.

Capitalisation begins only when all three conditions exist: expenditure is being incurred, borrowing costs are being incurred, and activities necessary to prepare the asset are in progress. Capitalisation is suspended during extended periods in which active development is interrupted, except for necessary technical or administrative work. It ceases when substantially all activities necessary to prepare the asset are complete.

For a specific borrowing, the eligible amount is the actual borrowing cost incurred, reduced by temporary investment income. For general borrowings, a weighted-average capitalisation rate is applied to qualifying expenditures, subject to the borrowing costs actually incurred.

The capitalisation rate is a weighted average of borrowing costs applicable to outstanding general borrowings during the period. The amount capitalised cannot exceed total borrowing costs incurred in that period. Care is required where expenditures occur unevenly, foreign-currency borrowings are used, or construction is funded by several facilities.

6. Asset retirement obligations

An asset retirement obligation arises when an entity has a present legal or constructive obligation to dismantle an asset, remove it or restore a site. The obligation is recognised as a provision when an outflow is probable and can be estimated reliably. Its initial measurement is normally the present value of expected future expenditure, using a discount rate that reflects current market assessments and risks not already included in cash flows.

Here, r is the appropriate discount rate per period, and n is the number of periods until settlement. The formula assumes one future cash flow and a constant rate; multiple expected cash flows require the sum of each discounted amount. The corresponding amount is included in PPE and depreciated. The provision is subsequently increased by unwinding the discount, normally recognised as a finance cost, and adjusted for changes in estimated timing, amount or discount rate under the applicable standard.

A finance manager should obtain engineering estimates, examine legal contracts, document probability assessments and conduct sensitivity analysis. Underestimating restoration costs can overstate profit and assets in early periods while creating a later shock.

7. 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. Examples include patents, licences, software, copyrights, customer relationships and brands acquired in a business combination.

Recognition requires probable future economic benefits and reliably measurable cost. Internally generated goodwill, brands, mastheads, customer lists and similar items are not recognised because their cost and future benefits cannot be separated reliably from the cost of developing the business as a whole.

Research and development

Research is original investigation undertaken to obtain new scientific or technical knowledge. Research expenditure is expensed as incurred because future benefits have not yet been demonstrated. Development applies research findings or other knowledge to a plan for producing new or substantially improved products or processes. Development expenditure is capitalised only from the date the entity can demonstrate all required criteria, including technical feasibility, intention and ability to complete and use or sell the asset, probable future benefits, adequate resources and reliable measurement of costs.

Expenditure incurred before the criteria are met is expensed and is not reinstated later. Capitalised development costs are amortised when the asset is available for use. A development project may therefore contain both an expense phase and an asset phase.

Subsequent measurement and useful lives

Finite-life intangibles are amortised systematically over their useful lives and tested for impairment when indicators exist. Indefinite-life intangibles are not amortised but are tested for impairment annually and when indicators arise. “Indefinite” does not mean infinite; it means there is no foreseeable limit to the period of expected net cash inflows.

The amortisation method should reflect consumption. If that pattern cannot be reliably determined, straight-line amortisation is used. Residual value is usually zero unless a third party is committed to purchase the asset or an active market exists at the end of its life.

8. Goodwill and business combinations

Goodwill arises only in a business combination and represents future economic benefits from assets that are not individually identified and separately recognised. Under the acquisition method, the acquirer recognises identifiable assets acquired and liabilities assumed at acquisition-date fair values, subject to specific exceptions, and measures goodwill as:

The calculation must be performed using acquisition-date measurements and consistent definitions of fair value. A bargain purchase produces a gain after reassessment of the underlying measurements. Goodwill is not amortised under IFRS; it is allocated to cash-generating units (CGUs), or groups of CGUs, expected to benefit from synergies and tested for impairment at least annually.

Goodwill cannot be tested in isolation when it does not generate independent cash inflows. Allocation must be reasonable and consistently applied. Overly broad allocation can conceal underperforming businesses, while overly narrow allocation can create artificial impairment losses.

9. Impairment under IAS 36

An asset is impaired when its carrying amount exceeds its recoverable amount. Recoverable amount is the higher of fair value less costs of disposal and value in use.

Value in use is the present value of future cash flows expected from continuing use and ultimate disposal. Cash-flow forecasts must be based on reasonable and supportable assumptions, normally consistent with approved budgets, and must exclude financing cash flows and income tax cash flows when required by IAS 36. The discount rate is a pre-tax rate reflecting time value and asset-specific risks not already reflected in cash flows.

For a series of future cash flows:

CF_t is the cash flow in period t, r is the appropriate pre-tax discount rate, n is the explicit forecast horizon and TV is terminal value when applicable. The formula assumes cash flows and the rate are expressed consistently—for example, nominal cash flows with a nominal rate—and that terminal assumptions are supportable.

Impairment indicators include falling market value, adverse technological or legal changes, physical damage, worse-than-expected performance, rising interest rates and plans to restructure or dispose. Annual testing is mandatory for goodwill, indefinite-life intangibles and intangible assets not yet available for use.

An impairment loss is recognised first against goodwill allocated to the CGU and then pro rata against other assets, subject to limits that prevent an asset falling below its own recoverable amount, fair value less costs of disposal if measurable, or zero. Goodwill impairment is never reversed. For other assets, impairment may be reversed when estimates improve, but not above the carrying amount that would have existed without the earlier impairment.

Worked example 3: impairment

A CGU has a carrying amount of $9.0 million, including $1.2 million goodwill. Its fair value less costs of disposal is $7.4 million and its value in use is $7.8 million. Recoverable amount is therefore $7.8 million, and the impairment loss is $1.2 million.

The loss first reduces goodwill from $1.2 million to zero. No further loss is allocated. If recoverable amount had been $6.5 million, the $2.5 million loss would eliminate goodwill and allocate the remaining $1.3 million among other CGU assets, subject to the allocation limits.

10. Integrated illustrative case: Northstar Energy

The following is a fictional illustrative case.

Background

Northstar Energy constructs a processing facility. Equipment costs $18 million, installation costs $1.2 million and qualifying construction-period borrowing costs are $0.8 million. The facility must be dismantled after 20 years. Engineers estimate a future dismantling payment of $5 million in year 20; the present value at commencement is $1.7 million. The main equipment component has a 10-year life and a $1 million residual value. The building has a 20-year life and no residual value. During development, Northstar spends $2 million on laboratory investigation and $3 million on a software system after technical feasibility and commercial viability have been demonstrated.

Analysis and solution

The facility’s initial PPE cost is $18m + $1.2m + $0.8m + $1.7m = $21.7m, excluding the internally generated research expenditure. The $2m research cost is expensed. The $3m qualifying development cost is capitalised as an intangible asset from the date all recognition criteria are met.

The retirement provision is initially $1.7m. It is subsequently unwound using the applicable discount rate, with changes reviewed as estimates evolve. The facility should be componentised. If the building portion is $12.7m, including the allocated restoration amount, annual building depreciation is $12.7m ÷ 20 = $0.635m. Equipment depreciation is ($9.0m − $1.0m) ÷ 10 = $0.8m, assuming the remaining cost allocation is $9.0m. These amounts illustrate the method; the allocation between building and equipment must be supported by records or valuation evidence.

The software is amortised from the date it is available for use, not from the date expenditure began. If Northstar later forecasts lower energy prices and a fall in expected cash flows, management must identify impairment indicators, update forecasts and test the relevant CGU. Goodwill would be included in the CGU only if the facility arose from a business combination.

Outcome and learning points

The case demonstrates that one project may contain expense, PPE, an intangible asset, a provision and capitalised finance cost. Classification depends on the nature and timing of expenditure, not on management’s desire to report higher assets or profit. Strong documentation of project milestones, component values, engineering estimates and approval dates is essential.

11. Professional judgement, governance and contemporary practice

The most significant risks are premature capitalisation, excessive useful lives, optimistic residual values, selective revaluation, understated restoration obligations and aggressive impairment assumptions. These risks can be reduced through:

• a capitalisation policy with examples and approval thresholds;
• project codes that separate research, development, construction and operating expenditure;
• fixed-asset registers linked to procurement and maintenance systems;
• independent engineering evidence for useful lives and components;
• valuation specialists for complex revaluations and impairment models;
• documented sensitivity analysis for discount rates, growth rates and terminal values;
• annual review of indicators and estimates by a review committee; and
• audit trails for management approvals and changes to assumptions.

Technology can improve control. Enterprise asset-management systems can link invoices, work orders, sensor data and location records. Analytical tools can identify assets with no maintenance activity, unusual capitalisation patterns or depreciation that differs from operational usage. AI may assist anomaly detection and scenario analysis, but it does not replace management’s responsibility for recognition, estimates, explainability, data quality or professional scepticism. Automated forecasts may reproduce historical bias or rely on unsupported assumptions.

Climate transition, resource scarcity and technological disruption increasingly affect useful lives, residual values, restoration costs and impairment forecasts. A facility can remain physically functional while becoming economically impaired because regulation, carbon pricing or customer preferences reduce expected cash inflows. Disclosures should therefore explain material estimation uncertainty and sensitivity where required.

Chapter Summary

PPE is recognised when future benefits are probable and cost is reliably measurable. Initial cost includes purchase price, directly attributable preparation costs, qualifying borrowing costs and the present value of qualifying restoration obligations. Routine repairs and general overhead are expensed. Significant components are depreciated separately, and depreciation allocates depreciable amount over useful life rather than measuring market value. Entities may use the cost or revaluation model consistently by asset class.

Borrowing costs are capitalised only for qualifying assets during active preparation. Asset retirement obligations are recognised at present value and subsequently updated. Intangible assets must be identifiable and meet recognition criteria; research is expensed, while qualifying development expenditure is capitalised from the date criteria are demonstrated. Goodwill arises only from a business combination and is tested through CGUs. Impairment exists when carrying amount exceeds recoverable amount, the higher of fair value less costs of disposal and value in use. Sound accounting requires disciplined estimates, evidence, governance and transparent sensitivity analysis.

Key Terms

PPE: Tangible long-term asset used in operations, production, supply, rental or administration.

Carrying amount: Amount at which an asset is recognised after accumulated depreciation and impairment.

Depreciable amount: Cost or revalued amount less residual value.

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

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

Useful life: Expected period or level of use over which an asset provides benefits.

Revaluation model: Subsequent measurement at fair value less subsequent depreciation and impairment.

Qualifying asset: Asset requiring a substantial period to become ready for use or sale.

Borrowing costs: Interest and related costs incurred in obtaining finance.

Asset retirement obligation: Present obligation to dismantle, remove or restore an asset or site.

Intangible asset: Identifiable non-monetary asset without physical substance.

Research: Original investigation undertaken to obtain new knowledge.

Development: Application of research or knowledge to a plan for producing improved products or processes.

Goodwill: Future economic benefits from unidentified assets acquired in a business combination.

Cash-generating unit: Smallest group of assets generating largely independent cash inflows.

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

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

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

Review Questions

5 Short Answer Questions

1. What conditions must be satisfied before PPE is recognised?
2. Why are significant components depreciated separately?
3. Distinguish research expenditure from development expenditure.
4. What is a qualifying asset under borrowing-cost requirements?
5. Define recoverable amount.

5 Long Answer Questions

1. Explain the accounting treatment of initial and subsequent PPE expenditure, giving examples of capital and revenue items.
2. Compare the cost model and revaluation model, including their effects on depreciation and equity.
3. Explain the recognition, measurement and subsequent accounting of an asset retirement obligation.
4. Discuss the recognition criteria for internally generated intangible assets and the treatment of research and development costs.
5. Explain goodwill impairment testing using CGUs and evaluate the risks of management bias.

3 Analytical / Application Questions

1. A company capitalises staff training, general administration and abnormal production losses as part of a new plant. Analyse whether each item should be capitalised and explain the effect on reported profit and assets.
2. A CGU has a carrying amount of $14 million, including $2 million goodwill. Its fair value less costs of disposal is $11 million and value in use is $12.5 million. Calculate the impairment loss and explain its allocation.
3. A technology asset remains physically usable, but new environmental regulation is expected to reduce its future cash inflows substantially. Design an impairment-review process identifying evidence, forecasts, discount-rate considerations and governance controls.

Multiple Choice Questions with Answers

Question 1

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

A. Staff training for operating the asset

B. General administrative overhead

C. Delivery and installation necessary to prepare the asset for use

D. Abnormal production losses

Correct Answer: C. Delivery and installation necessary to prepare the asset for use

Question 2

An asset costs $500,000, has a residual value of $50,000 and a useful life of 9 years. Using straight-line depreciation, annual depreciation is:

A. $50,000

B. $55,556

C. $61,111

D. $450,000

Correct Answer: B. $55,556

Question 3

Under component accounting, a significant component with a shorter useful life should be:

A. Ignored until the whole asset is replaced

B. Depreciated separately over its own useful life

C. Expensed immediately in all cases

D. Measured only at fair value

Correct Answer: B. Depreciated separately over its own useful life

Question 4

When does capitalisation of borrowing costs for a qualifying asset generally begin?

A. When the asset is sold

B. When expenditure and borrowing costs are incurred and preparation activities are in progress

C. When the first operating profit is earned

D. Only after construction is complete

Correct Answer: B. When expenditure and borrowing costs are incurred and preparation activities are in progress

Question 5

Which statement about research expenditure is correct under IAS 38?

A. It is always recognised as goodwill

B. It is capitalised when management expects success

C. It is expensed as incurred

D. It is recognised as PPE

Correct Answer: C. It is expensed as incurred

Question 6

Goodwill under IFRS is generally:

A. Amortised over five years

B. Tested for impairment annually through relevant CGUs

C. Recognised for internally generated brands

D. Depreciated using units of production

Correct Answer: B. Tested for impairment annually through relevant CGUs

Question 7

Recoverable amount is defined as the:

A. Lower of cost and fair value

B. Higher of fair value less costs of disposal and value in use

C. Historical cost less tax

D. Present value of financing cash flows only

Correct Answer: B. Higher of fair value less costs of disposal and value in use

Question 8

A CGU has a carrying amount of $8 million and a recoverable amount of $6.5 million, including $1 million goodwill. The first allocation of the impairment loss is:

A. $500,000 to goodwill

B. $1 million to goodwill

C. $1.5 million to goodwill

D. No allocation to goodwill

Correct Answer: B. $1 million to goodwill

Question 9

Which expenditure generally qualifies as a directly attributable cost of PPE?

A. Costs of relocating the finance department

B. Costs of staff social events

C. Professional fees necessary to install the asset

D. Initial operating losses

Correct Answer: C. Professional fees necessary to install the asset

Question 10

If value in use is $7.8 million and fair value less costs of disposal is $7.4 million, recoverable amount is:

A. $0.4 million

B. $7.4 million

C. $7.8 million

D. $15.2 million

Correct Answer: C. $7.8 million