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Expenditure incurred between after ready to use and actual use

➔ All expenses (including borrowing cost as per Ind AS 23) incurred between the date of ready to
use and actual commencement of commercial production should be charged to profit and loss
statement irrespective of the amount involved.
➔ There are NO inflows of future economic benefits from the expenditure incurred during the
period, Hence it does not satisfy the "asset" definition (irrespective of materiality of transaction)
and it should not be capitalised.

CONCEPT PROBLEM
Ravana Ltd. completed the construction of the cement plant on 1-6-2011 and the plant is ready to be
used. However, due to market conditions, the entity started actual production in 2012-13. The
overheads incurred from the date of ready to use to date of actually use are capitalised along with
the cost of plant. Is this accounting treatment correct? Discuss
Answer
As per Ind AS 16, any cost directly attributable to bring the PPE to working condition for its intended
use should be capitalised along with the PPE.

In the given situation, the overheads are incurred after the plant is ready to use for its intended
purpose, hence these overheads should NOT be capitalised.

CONCEPT PROBLEM
A company is in the process of setting up a production line for manufacturing a new product. Based
on trial runs conducted by the company, it was noticed that the production lines output was not of
the desired quality. However, the company has taken a decision to manufacture and sell the sub-
standard product over the next one year due to the use investment involved. In the background of
the relevant accounting standard, advice the company on the cut off date for capitalization (i.e till
what date the expenditure incurred should be capitalized) of the project cost.

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Answer
As per Ind AS 16, expenditure incurred on start-up and commissioning of the project till the time it
is ready for commercial production should be capitalized. However, the expenditure incurred after
the plant has begun commercial production i.e. production intended for sale or captive
consumption, is NOT capitalized and is treated as revenue expenditure even though the contract
my stipulate that the plant will not be finally taken over until after the satisfactory completion of
the guarantee period.
In the present case, the company did not stop production even if the output was not of the desired
quality, and continued the sub-standard production due to use investment involved in the project.
Capitalization should cease at the end of trial run, since the cutoff date would be the date when
the trial run was completed.

Component Accounting
➔ An asset may consist of several different and significant physical components.
➔ If an item of PPE comprises two or more significant components, with substantially different
useful lives, usage or flow of economic benefits then each component should be recognized and
depreciated separately over its individual useful life.
➔ When a significant component is replaced or restored, the old component is derecognised (remove
from the books of account i.e. ensuring the carrying amount of that will be NIL) and the cost of
new component is capitalised, if the cost is recoverable (asset).
➔ This accounting leads to fair presentation of financial statements.

CONCEPT PROBLEM
X Limited acquired an aircraft for Rs 50 crore. The life of the engine is 20 years and the body of
the aircraft should be changed in 10 years. How should the entity account the same if the proportion
of engine and body is 70:30? Record the journal entry, when the body of the aircraft is replaced with
new one during the 10th year at a cost of Rs 20 crore.
Answer
As per Ind AS 16, if an item of property plant and equipment comprises two or more significant
components with substantially different useful lives, usage or flow of economic benefits then each
component should be recognised and depreciated separately over its individual useful life.
In the given case, the useful lives of two significant parts are different hence each components
should be recognised separately and depreciated over its useful life.
The following journal entry should be recorded at the time of acquisition:
Aircraft engine A/c Dr Rs 35 Cr (Rs 50 Cr x 70%)
Aircraft body A/c Dr Rs 15 Cr (Rs 50 Cr x 30%)
To Bank A/c Rs 50 Cr

Depreciation of Aircraft body per annum = Rs 15 Cr./10 years = 1.5 Crs

Net carrying amount of Aircraft body after 9 years = Rs 15 Crs - (Rs 1.5 Cr x 9 years) = Rs 1.5 Cr

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As the company is replacing on the 10th year - the Entity should derecognise (remove from the books
of account) the Asset and recognise the new asset as a separate component.

P&L…………………….. Dr Rs 1.5 Cr
To Aircraft body A/c Rs 1.5 Cr
(Being the old aircraft
body replaced)

On replace of old body with new body it should record the following Journal entry:-
Aircraft body A/c Dr Rs 20 Cr
To Bank A/c Rs 20 Cr
(Being a significant part replaced which satisfies the
asset and PPE definition)

Subsequent expenditure to add to existing asset, replace or service it

Subsequent expenditure is the expenditure, which is incurred after the initial recognition i.e. after
the asset is ready to use or being used. In this topic we discuss whether subsequent expenditure should
be capitalised along with PPE or charged to P&L. It depends on the nature of and benefits from the
expenditure incurred.

Does subsequent expenditure increase the future economic a

benefit i.e. satisfies the recognition criteria?

Capitalise along with Charge to P&L

PPE statement

Generally, it is difficult to determine whether subsequent expenditure amounts to improvements or

repairs. It depends on each situation and circumstance.
If the subsequent expenditure increases the future economic benefits i.e. it satisfies the
recognition criteria of an asset and PPE- such expenditure should be recognised as a separate
component and depreciated over its useful life. Example increase in the number of goods produced,
reduction in cost, etc..
Cost of date to day servicing are primarily the cost of labour and consumables, and me include
cause of small parts. The purpose *of such expenditure is often described as repairs and maintenance

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of the item of PPE and hence these expenses should be charged to P&L immediately in the period in
which it is incurred.

Replacement of PPE

• Parts of some items of PPE may requirement at regular intervals. For example of furnace may
require re-lining specified number of hours of use, or aircraft interior such as seats and galleys
may require replacement several times during the life of the aircraft. Similarly, major parts of
conveyor system such as conveyor belts, wire ropes etc., may require replacement several times
during the life of the conveyor system.
• Item of property plant and equipment may also be acquired to make a less frequent recurring
replacement, such as replacing the interior walls of a building, or to make a non-recurring
replacement.
• Under the recognition criteria given in the standard, an entity should capitalise cost of
replacement as a component of PPE and depreciate such cost over its useful life
• The carrying amount of those parts that are replaced should be derecognised.

Major inspections

• A condition of continuing to operate an item of PPE may be performing regular inspections for faults
regardless of whether parts of items are replaced.
• When each major inspection is performed, its cost is capitalised as part of PPE as a replacement
if the recognition criteria are satisfied.
• Any remaining carrying amount of the cost of the previous inspection (as distinct from physical
parts) is derecognised

CONCEPT PROBLEM
Sun Limited acquired a heavy road trailer at a cost of Rs 100,000 (No component accounting followed).
The estimated useful life is 10 years. At the end sixth year, the engine requires replacement, as
further maintenance is uneconomical due to the off-road time required. The remainder of the vehicle
is perfectly roadworthy and is expected to last for the next 4 years. The cost of the new engine is Rs
45,000. The discount rate assumed is 5%.
Whether the cost of new engine can be recognised as the asset, and if so, what treatment should be
followed?
Answer
For recognition of an item as property, plant and equipment, the recognition condition needs to be
satisfied:
(a) future economic benefits associated with the asset should flow to the entity; and
(b) cost can be measured reliably

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The new engine will produce economic benefits to the company and cost of the engine can be measured
reliably. Hence, the items should be recognised as the asset.
The cost of Rs 45,000 new engine will be added to the carrying amount.
The original invoice of the trailer did not specify the cost of engine. Therefore, the cost of
replacement Rs 45,000 (year 6) will be used as indicative price and discount to the year 0, i.e. (45,000
x (1/1.05)6 = 33,580. i.e., original engine cost before 6 years would be Rs 33,580 i.e. at the year 0.

Total Machine Only Engine

Original Cost at the beginning 1,00,000 33,580
Life 10 years 10 years
Per annum depreciation 10,000 3,358
6 years depreciation 60,000 20,148
Carrying amount at the end of 6th year 40,000 13,432

So Rs 40,000 includes Rs 13,432 related to engine. This amount should be removed from the carrying
amount and the new cost should be added to the carrying amount.
Revised caring amount at year 6 = (40,000-13,432+45,000) = Rs 71,658 (without considering the
depreciation)

CONCEPT PROBLEM
A shipping company is required by law to bring all ships into dry dock every five years for a major
inspection and overhaul. Overall expenditure might at first sight seem to be a repair to the ships but
it is actually a cost in getting the ship back into a seaworthy condition. As such the cost must be
capitalised.

A ship which cost Rs 20 million with a 20 year life must have major overhaul every five years. The
estimated cost of the overhaul at the five year point is Rs 5 million. Assume at the 6th year the entity
spent Rs 6 million for overhaul, how will be the depreciation be accounted for the first 1 to 5 years
and 6th to 10 year.
Answer
As per Ind AS 16, each major inspection is performed, its cost should be capitalised as a part of PPE
as a replacement if there recognition criteria are satisfied. Any remaining caring amount of the cost
of previous inspection (as distinct from physical parts) is derecognised.

In the given case, initially the entity should recognise the asset in the following manner (applying
component accounting) (Rupees in millions)

Ship a/c (other than overhaul element) ....Dr 15

Overhaul component a/c.....................Dr 05
To Bank .................................Cr 20

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(Being ship and overhaul component is recognised separately)

Overhaul Component Ship (other than overhaul)
Cost 5 15
Life 5 years 20 years
Depreciation per annum 1 0.75

So, per annum depreciation = 1+0.75=1.75; total depreciation for first 5 years = 1.75x5=8.75;
At the end of 5th year - carrying amount of overhaul component would be 'zero' and ship would be Rs
11.25.
The actual overhaul cost incurred at the end of 5 year Rs 6 million. This amount will now be capitalised
into the cost of ship, to give a carrying amount of Rs 17.25 million (Rs 11.25+6). Depreciation for the
next 5 years would be like this.
Overhaul Component Ship (other than overhaul)
Cost 6 11.25
Life 5 years 15 years
Depreciation per annum 1.2 0.75

Annual depreciation for the years 6 to 10 will now be Rs 1.95 million. This process will be continued for
years 11 to 15 and years 16 to 20. By the end of year 20, the capitalised cost of Rs 20 million will have
been depreciated plus the actual overhaul cost incurred at the years 5,10 and 15.

CONCEPT PROBLEM
Buddha Limited acquired a machine and a conveyor belt along with the machine in 2010. Both of them
were capitalised separately i.e., component accounting, at the time of initial acquisition. During 2012,
due to technical problems the conveyor belt had to be replaced with new one amounting to Rs 7 lakh.
The book value of conveyor belt is Rs 3 lakhs. The Accountant of the entity would like to defer the
expenditure as it is a material expenditure and amortise over 3 years. Is this accounting treatment
appropriate as per Ind AS 16?
Answer
As per Ind AS 16, subsequent expenditure should be capitalised when its satisfies the recognition
criteria. Replacement of conveyor belt will fetch future economic benefits hence Rs 7 lakh should be
capitalised as a separate component and it should be depreciated over its useful life.
The remaining book value of conveyor belt (Rs 3 lakh) should be charged to P&L.

CONCEPT PROBLEM
Jain Limited acquired a building which had non-moving tenants. Subsequently the company paid
compensation of Rs 50 lakh to these tenants, so that the property could be leased to a third party at
much higher rate. How to deal with this subsequent expenditure as per Ind AS 16?
Answer

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Compensation paid to the tenants enhances the value of the building and increases the future economic
hence it satisfies the asset recognition criteria; hence Rs 50 lakh should be added to the gross book
value of the building.

CONCEPT PROBLEM – ICMAI MODULE – ILLUSTRATION 6

A Ltd. Purchased an aircraft at a price of ₹6,300 crores that requires major inspection and overhauling
every 4 years. The estimated life of the aircraft is 15 years. The aircraft was purchased in 2015 and
major inspection and overhauling made in 2019 at a cost of ₹100 crores. In 2020 A Ltd. Further
incurred repair and maintenance in the engine to raise it capacity by 10% amounting to ₹70 crores. One
worn out component in the wing was replaced in 2020 at a cost of ₹80 crores. The carrying amount of
the old component was ₹30 crores. Scrap realized₹ 12 crores. find the amount to be recognized as
expense and as asset in 2019 and in 2020 and also show the carrying amount. The aircraft residual
value is estimated at ₹300 crores.

Answer
Asset
Expense
Recognised Carrying amount
In 2018
Depreciation ₹(6,300 - 300)/15 400
Carrying amount 4,700
(6300 – 4×400)

In 2019
Depreciation =₹400 + (₹100/4) 425
Major Inspection overhauling 100
Carrying amount [₹4,700 +₹100 –₹425] 4,375

In 2020

Depreciation 425

Repair & Maintenance (Capacity increase) 70

Replacement 80

Old component derecognized (30)

loss on disposal of old component₹(30 – 12) 18 4,058

Carrying amount (₹4,375 +₹70 +₹80 –₹30 –₹437)

Notes :
1. Depreciation At straight line for 15 years useful life.
2. Major inspection and overhauling capitalized and depreciated at straight line for 4 years.
3. Repair & maintenance and replacement of old component depreciated at straight line for

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residual life i.e. 15–5=10 years.

4. Full depreciation is charged in the year it is recognized.

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