1. A business acquires a new item of machinery. It pays CU80,000 for the machine itself, CU3,000 for delivery, CU5,000 for installation and testing, CU1,200 for a one-year maintenance contract covering the first year of use, and CU2,000 in staff training costs to operate the new machine. The accountant capitalises all five amounts, totalling CU91,200, as the cost of the machine under IAS 16. Assess this treatment.

A) The accountant is correct; every cost incurred as a direct consequence of acquiring the machine, including the maintenance contract and training, forms part of its cost under IAS 16
B) The accountant is incorrect; only the CU80,000 purchase price, CU3,000 delivery cost and CU5,000 installation and testing cost (total CU88,000) are directly attributable costs of bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management, and are correctly capitalised under IAS 16 -- the CU1,200 maintenance contract (a cost of a future period of use/servicing, not of getting the asset ready for use) and the CU2,000 staff training cost (not a cost of the asset itself, but a cost of preparing staff to operate it) must both be excluded from the cost of the asset and expensed as incurred
C) The accountant is incorrect, but only because the CU3,000 delivery cost must be excluded from cost and expensed immediately, since delivery is a selling cost of the supplier, not a cost to the buyer
D) The accountant is incorrect, but only because installation and testing costs of CU5,000 must also be excluded from cost and expensed immediately, leaving only CU83,000 capitalised

Correct: B difficult IAS 16 Property, Plant and Equipment, paras 16-19 (elements of cost)

IAS 16 requires the cost of an item of property, plant and equipment to include its purchase price and any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management -- this includes costs such as delivery and handling, and installation and testing (assembly and testing that the asset is functioning properly). It explicitly excludes costs that are not necessary to bring the asset to that condition, such as costs of introducing a new product (which would include related staff training) and administration and other general overhead costs. A maintenance/servicing contract covering a future period of use is a cost of operating the asset during that period, not a cost of acquiring it, and staff training costs are also excluded, since they do not relate to preparing the physical asset itself for its intended use. The correctly capitalised cost is therefore CU88,000 (80,000 + 3,000 + 5,000); the CU1,200 and CU2,000 should be expensed as incurred.

2. A business purchased a machine on 1 January 20X1 for CU60,000, with an estimated useful life of 10 years and no residual value, depreciated on the straight-line basis. On 1 January 20X4 (three years later, after CU18,000 of depreciation has been charged), the business reassesses the machine's REMAINING useful life at 5 years (rather than the originally expected 7 years remaining) due to heavier than expected usage, with no change to the estimated residual value. The accountant continues to charge depreciation of CU6,000 per year (CU60,000/10 years), reasoning that 'the original useful life estimate of 10 years was fixed at acquisition and cannot be revised part-way through an asset's life.' Assess this reasoning and determine the correct depreciation charge for the year ended 31 December 20X4.

A) The accountant's reasoning is incorrect, but only because the entire remaining carrying amount of CU42,000 should be expensed immediately in 20X4 as an impairment loss, rather than depreciated over the remaining useful life
B) The accountant's reasoning is correct; once a useful life estimate is set at acquisition under IAS 16, it remains fixed for the entire depreciation period regardless of new information, so CU6,000 per year continues to be correct
C) The accountant's reasoning is incorrect; IAS 16 requires the useful life (and residual value) of an asset to be reviewed at least at each financial year end, and if expectations differ from previous estimates, the change is accounted for as a change in accounting estimate -- applied prospectively, not retrospectively; the carrying amount at 1 January 20X4 (CU60,000 - CU18,000 = CU42,000) is depreciated over the NEW remaining useful life of 5 years, giving a revised annual depreciation charge of CU42,000/5 = CU8,400 for 20X4 onwards, not CU6,000
D) The accountant's reasoning is incorrect, but only because the change should be applied retrospectively, restating the depreciation charged in 20X1-20X3 as if the 5-year remaining life had been known from the start

Correct: C difficult IAS 16 Property, Plant and Equipment, para 51 (review of useful life); IAS 8 (changes in accounting estimates)

IAS 16 requires an asset's useful life and residual value to be reviewed at least at each financial year end; if current expectations differ from previous estimates, the change(s) must be accounted for as a change in accounting estimate, applied prospectively over the current and future periods, not retrospectively (prior periods' financial statements and depreciation already charged are not restated). At 1 January 20X4, the carrying amount is CU60,000 - (3 x CU6,000) = CU42,000. This carrying amount is now depreciated over the revised remaining useful life of 5 years, giving depreciation of CU42,000/5 = CU8,400 per year for 20X4 onwards. Continuing to charge the original CU6,000 ignores the required reassessment and would understate depreciation expense (and overstate the carrying amount) going forward.

3. A business sells a non-current asset that originally cost CU40,000, on which accumulated depreciation of CU28,000 has been charged to the date of sale, for cash proceeds of CU15,000. The bookkeeper records only: DEBIT cash CU15,000; CREDIT non-current asset cost account CU15,000, treating the difference between original cost and proceeds as if it were simply a partial disposal, with no entry made to remove the accumulated depreciation relating to the asset or to recognise any gain or loss on disposal. Assess this treatment and identify the correct accounting.

A) The bookkeeper's treatment is incorrect, but only because the cash proceeds of CU15,000 should have been credited directly to accumulated depreciation instead of to the cost account
B) The bookkeeper's treatment is correct, because crediting the asset cost account with the cash proceeds received automatically achieves the correct removal of the asset from the accounts
C) The bookkeeper's treatment is incorrect, but only because a LOSS of CU25,000 (CU40,000 cost less CU15,000 proceeds) should have been recognised, ignoring accumulated depreciation entirely
D) The bookkeeper's treatment is incorrect; on disposal, the asset's FULL original cost (CU40,000) must be removed from the non-current asset cost account, and its full accumulated depreciation (CU28,000) must also be removed from the accumulated depreciation account, giving a carrying amount at disposal of CU12,000 (40,000 - 28,000); comparing the CU15,000 cash proceeds received with this CU12,000 carrying amount gives a GAIN on disposal of CU3,000, which must be recognised in the statement of profit or loss -- the bookkeeper's approach neither derecognises the correct amounts nor identifies the gain

Correct: D difficult IAS 16 Property, Plant and Equipment, paras 67-71 (derecognition)

When a non-current asset is disposed of, both its full original cost and its full accumulated depreciation to the date of disposal must be removed (derecognised) from the respective ledger accounts -- typically via a disposal account: DEBIT disposal account CU40,000, CREDIT asset cost account CU40,000 (removing cost); DEBIT accumulated depreciation CU28,000, CREDIT disposal account CU28,000 (removing accumulated depreciation); DEBIT cash CU15,000, CREDIT disposal account CU15,000 (recording proceeds). The resulting balance on the disposal account represents the gain or loss: here, disposal account credits (28,000 + 15,000 = 43,000) exceed the debit (40,000) by CU3,000, a GAIN on disposal, recognised in the statement of profit or loss. The bookkeeper's approach of merely crediting the cost account with the cash received neither correctly derecognises the asset and its accumulated depreciation nor identifies this gain.

4. A company owns a building that it measures using the REVALUATION MODEL under IAS 16 (rather than the cost model). The building was originally purchased for $500,000 and has accumulated depreciation of $100,000 at the date of a professional revaluation, giving a carrying amount of $400,000. The revaluation determines the building's fair value to be $550,000. How should this revaluation be accounted for, and what happens to depreciation going forward?

A) The $150,000 increase is recognised as a liability, representing amounts potentially repayable if the valuation is later found to be incorrect
B) The revaluation has no accounting effect at all until the asset is eventually sold, at which point the full difference between original cost and sale proceeds is recognised as a single gain
C) The $150,000 increase ($550,000 - $400,000) is recognised in OTHER COMPREHENSIVE INCOME and accumulated in a separate revaluation surplus within equity (not recognised in profit or loss, since this is an unrealised gain arising from a change in the carrying amount rather than a transaction), and the accumulated depreciation is eliminated against the gross carrying amount (or the asset is restated) so that the asset is now carried at its revalued amount of $550,000; going forward, depreciation is charged on this NEW revalued amount of $550,000 over the asset's remaining useful life, resulting in a higher depreciation expense than would have arisen under the original cost-based carrying amount
D) The $150,000 increase ($550,000 - $400,000) is recognised as a gain in profit or loss for the period, and depreciation continues to be based on the original $500,000 cost

Correct: C difficult IAS 16 Property, Plant and Equipment - revaluation model, revaluation surplus

Under the revaluation model in IAS 16, when an asset's fair value increases above its carrying amount, the increase is recognised in OTHER COMPREHENSIVE INCOME and accumulated in equity under the heading of a revaluation surplus -- it is not recognised in profit or loss, because it reflects an unrealised holding gain rather than income from an actual transaction (an exception applies only if the increase reverses a previous revaluation decrease that had been charged to profit or loss, in which case that portion is recognised in profit or loss to the extent of the earlier decrease). The asset's carrying amount is restated to its new fair value of $550,000 (with the existing accumulated depreciation typically eliminated against the gross cost, or the gross cost and accumulated depreciation both proportionately restated). Critically, DEPRECIATION CONTINUES going forward, now based on the NEW revalued amount of $550,000 (less any residual value) spread over the asset's remaining useful life -- not the original $500,000 cost -- which will result in a higher periodic depreciation charge than under the cost model, and many entities additionally make a transfer of the 'excess' depreciation (the extra depreciation caused by the revaluation) from the revaluation surplus directly to retained earnings each period, though this transfer is optional under IAS 16.

5. A machine is purchased for $80,000 and is depreciated using the REDUCING BALANCE (diminishing balance) method at a rate of 25% per annum, with no residual value assumed. Calculate the depreciation charge for the SECOND year of the asset's life (i.e. the year following the first full year of depreciation).

A) $15,000 -- under the reducing balance method, depreciation is calculated as a fixed percentage applied to the asset's CARRYING AMOUNT (net book value) at the start of each year, not to the original cost; Year 1 depreciation = 25% x $80,000 = $20,000, giving a carrying amount at the start of Year 2 of $80,000 - $20,000 = $60,000; Year 2 depreciation = 25% x $60,000 = $15,000
B) $20,000 (25% applied to the original cost of $80,000 in both years, as under the straight-line method)
C) $11,250 (calculated by applying 25% twice in succession to the original cost, i.e. 25% x 25% x $80,000)
D) $20,000 (the depreciation charge remains constant at $20,000 every year regardless of the method used)

Correct: A difficult IAS 16 Property, Plant and Equipment - depreciation methods, reducing balance

The reducing balance (diminishing balance) method applies a fixed depreciation rate to the asset's CARRYING AMOUNT (net book value) at the beginning of each period, rather than to the original cost -- this means the depreciation charge decreases each year as the carrying amount falls, in contrast to the straight-line method, which charges a constant amount each year based on the original cost (less residual value). Year 1: depreciation = 25% x $80,000 (original cost, since this is the carrying amount at the very start) = $20,000, leaving a carrying amount of $80,000 - $20,000 = $60,000 at the end of Year 1 / start of Year 2. Year 2: depreciation = 25% x $60,000 (the carrying amount at the start of Year 2) = $15,000. This declining pattern of depreciation charges is often considered to better match an asset's actual pattern of economic benefit consumption for assets that generate more value, or lose more value, earlier in their lives (such as vehicles or certain machinery), compared with the constant charge produced by the straight-line method.

6. A business trades in an old delivery van, which has a carrying amount of $4,000 (original cost $20,000, accumulated depreciation $16,000), toward the purchase of a new delivery van with a list price of $30,000. The supplier grants a part-exchange (trade-in) allowance of $6,000 for the old van against the new van's price, and the business pays the remaining $24,000 in cash. How should this part-exchange transaction be accounted for?

A) The new van should be recorded at $30,000, and the old van's carrying amount of $4,000 should simply be added to the new van's cost, ignoring the part-exchange allowance altogether
B) The new van should be recorded at only $24,000 (the cash paid), and no gain or loss should be recognised on the old van at all, since it was not sold for cash
C) No entries are required for the old van, since a part-exchange is not considered a disposal under IAS 16
D) The old van should be derecognised at its carrying amount of $4,000, with a GAIN ON DISPOSAL of $2,000 recognised (part-exchange allowance of $6,000 received minus the old van's carrying amount of $4,000 given up), and the new van should be recognised at its full cost of $30,000 (made up of the $6,000 part-exchange allowance treated as the 'proceeds' from disposing of the old van, plus the $24,000 cash paid) -- the disposal of the old asset and the acquisition of the new asset are both recorded, rather than simply netting the cash paid against the new asset's cost

Correct: D difficult IAS 16 Property, Plant and Equipment - disposals, part-exchange transactions

A part-exchange (trade-in) is treated as two combined elements for accounting purposes: a DISPOSAL of the old asset (with the part-exchange allowance treated as the disposal 'proceeds') and a SEPARATE ACQUISITION of the new asset at its full cost. The old van, with a carrying amount of $4,000, is derecognised, and the part-exchange allowance of $6,000 is treated as its disposal proceeds, giving a gain on disposal of $6,000 - $4,000 = $2,000 (recognised in profit or loss, as a gain arising because the allowance exceeded the old asset's carrying amount). The new van is recognised at its full cost of $30,000, which is the sum of the part-exchange allowance ($6,000, effectively the non-cash consideration given) and the cash paid ($24,000). It would be incorrect simply to record the new van at the cash paid alone, or to add the old van's carrying amount to the new van's cost without recognising the disposal -- both the disposal of the old asset (and any resulting gain or loss) and the acquisition of the new asset at its full cost must be separately recognised.

7. An item of land was previously revalued upward, creating a revaluation surplus of $30,000 for that asset (credited to other comprehensive income and accumulated in equity). In the current year, the land is revalued again and its fair value has fallen, resulting in a total revaluation decrease of $45,000 relative to its current carrying amount. How should this $45,000 decrease be recognised under IAS 16?

A) The decrease is recognised in two parts: first, $30,000 (the amount of the existing revaluation surplus relating to this specific asset) is debited to other comprehensive income, eliminating that surplus; the remaining $15,000 excess (the amount by which the decrease exceeds the previously recognised surplus for the same asset) is recognised as an expense in profit or loss
B) The decrease is spread evenly over the asset's remaining useful life rather than being recognised in the year it occurs
C) The entire $45,000 decrease is recognised in profit or loss, since revaluation decreases are always expensed regardless of any previous revaluation surplus for the same asset
D) The entire $45,000 decrease is debited to other comprehensive income (reducing the revaluation surplus), even though the surplus is insufficient to absorb it, resulting in a negative balance within that component of equity

Correct: A difficult IAS 16 Property, Plant and Equipment, paragraph 40 - revaluation decreases

Under IAS 16's revaluation model, a revaluation decrease is recognised in profit or loss, EXCEPT to the extent that it reverses a revaluation surplus previously recognised in other comprehensive income for that SAME asset -- in which case the decrease is debited to other comprehensive income (reducing the revaluation surplus in equity) up to the amount of that surplus. Only once the specific asset's own accumulated surplus is exhausted does any further, excess decrease get recognised as an expense in profit or loss. Here, the asset had a $30,000 surplus specifically attributable to it, so $30,000 of the $45,000 decrease is offset against that surplus (eliminating it, taken to OCI), and the remaining $15,000, which exceeds the available surplus, is recognised as an expense in profit or loss. This asset-by-asset tracking (rather than netting across all revalued assets) is a key feature of the revaluation model's treatment of increases and decreases.

8. An airline purchases an aircraft for $60 million. The aircraft's engines have a useful life of 10 years before requiring replacement, while the rest of the airframe has a useful life of 25 years. The engines cost $15 million of the total purchase price, with the remaining $45 million relating to the airframe. How should this asset be depreciated under IAS 16's requirements for significant parts of an asset?

A) The entire $60 million is depreciated as a single asset over a single useful life (e.g., 25 years), since the aircraft is legally and physically one asset with one registration
B) IAS 16 requires each significant PART of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item to be depreciated SEPARATELY -- here, the $15 million engine component should be depreciated separately over its own 10-year useful life, and the $45 million airframe component should be depreciated separately over its 25-year useful life, since the two components have materially different useful lives and depreciating them as a single unit over one useful life would not faithfully reflect the pattern of consumption of each significant part
C) The asset must be split into as many separate components as there are individually identifiable physical parts, no matter how insignificant each part's cost is relative to the total
D) Only the airframe is depreciated; engines are treated as inventory and expensed immediately upon purchase

Correct: B difficult IAS 16 Property, Plant and Equipment, paragraph 43-47 - depreciation of significant parts (componentisation)

IAS 16 requires an entity to allocate the amount initially recognised for an item of property, plant and equipment to its significant parts and depreciate each such part separately, when a part has a cost that is significant in relation to the total cost of the item AND has a useful life (or depreciation method) that differs from the other parts. This 'component depreciation' approach ensures that assets made up of parts with genuinely different consumption patterns -- such as an aircraft, where engines typically wear out and require replacement well before the airframe -- are depreciated in a way that faithfully reflects how each significant part is actually used up. Depreciating the whole $60 million over a single useful life (say, 25 years) would systematically understate depreciation on the engines during their shorter useful economic life and overstate the airframe's charge, distorting the pattern of expense recognition. The requirement applies specifically to parts that are both significant in cost and different in useful life/depreciation pattern -- not to every physically distinguishable component regardless of materiality.

9. An entity borrows $2 million specifically to finance the construction of a new factory building, which takes 18 months to build and clearly meets the definition of a 'qualifying asset' (one that necessarily takes a substantial period of time to get ready for its intended use). Interest of $120,000 accrues on this borrowing during the construction period, before the factory is ready for use. How should this $120,000 of borrowing costs be treated?

A) Borrowing costs are capitalised only if the entity elects to do so as an accounting policy choice; expensing them immediately is an equally acceptable alternative under IAS 23
B) The $120,000 must be expensed immediately in profit or loss as incurred, since IAS 23 prohibits capitalising any borrowing costs under any circumstances
C) Only 50% of the borrowing costs can ever be capitalised, regardless of the facts, with the remainder always expensed
D) The $120,000 of borrowing costs that are directly attributable to the acquisition, construction, or production of this qualifying asset must be CAPITALISED as part of the cost of the factory building (added to its carrying amount), because IAS 23 requires capitalisation of borrowing costs directly attributable to a qualifying asset, up until the point the asset is substantially ready for its intended use; only borrowing costs incurred after the asset is ready for use (or on borrowings not related to a qualifying asset) are expensed as incurred

Correct: D difficult IAS 23 Borrowing Costs, paragraphs 8, 17, 22 - capitalisation of borrowing costs

IAS 23 Borrowing Costs requires (not merely permits, as under the standard's superseded, pre-2009 alternative treatment) an entity to capitalise borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset -- an asset that necessarily takes a substantial period of time to get ready for its intended use or sale -- as part of the cost of that asset. Capitalisation begins when expenditure and borrowing costs are being incurred and activities necessary to prepare the asset for its intended use are in progress, and ceases when substantially all the activities necessary to prepare the qualifying asset for its intended use are complete. Here, the factory building clearly qualifies (18 months to construct is a substantial period), and the $2 million borrowing is specifically raised to finance it, so the $120,000 of directly attributable borrowing costs incurred during the construction period must be added to the cost of the factory, increasing the amount that will subsequently be depreciated over the factory's useful life -- rather than being expensed immediately as a finance cost in profit or loss.

10. A company purchases a new production machine on 1 October. The machine is fully installed and tested by 1 November, ready for use as management intends, but production does not actually begin until 1 December, once a new supply contract commences. On 1 August of the following year, the machine is formally classified as held for sale following a decision to close the production line, and is sold on 1 October. From what date should depreciation commence, and from what date should it cease?

A) Depreciation commences on 1 October, the original purchase date, and continues without interruption until the asset is scrapped, regardless of any subsequent sale or held-for-sale classification
B) Depreciation commences on 1 December, when production actually begins, and ceases on 1 October of the following year, when the machine is actually sold
C) Depreciation commences on 1 November, the date the asset is available for use in the manner intended by management (installed and tested, ready for its intended use), REGARDLESS of the fact that production did not actually begin until a month later; depreciation ceases at the EARLIER of the date the asset is classified as held for sale (1 August) and the date it is derecognised (on sale, 1 October) -- here, that is 1 August, since classification as held for sale occurs before the actual sale date, and IFRS 5 requires such assets to cease being depreciated once classified as held for sale, being instead carried at the lower of carrying amount and fair value less costs to sell
D) Depreciation is suspended entirely between 1 November and 1 December, since the asset was not actually used for production during that period, then resumes normally

Correct: C difficult IAS 16 Property, Plant and Equipment / IFRS 5 - depreciation start and cessation dates

IAS 16 requires depreciation of an asset to begin when it is AVAILABLE FOR USE -- that is, when it is in the location and condition necessary for it to be capable of operating in the manner intended by management -- which is NOT the same as the date it is actually first used or brought into production. Here, the machine was installed and tested, and therefore available for use, by 1 November, even though actual production did not commence until 1 December; depreciation should begin from 1 November. On the other end, depreciation continues throughout an asset's use, without suspension merely because it is temporarily idle, UNLESS the asset is fully depreciated or derecognised, OR, under IFRS 5, once it is classified as HELD FOR SALE, at which point IFRS 5 specifically requires that depreciation cease (the asset instead being measured at the lower of its carrying amount and fair value less costs to sell, and no longer depreciated while held in that classification, even though it has not yet actually been sold). Since the machine was classified as held for sale on 1 August, before its actual sale on 1 October, depreciation should cease from 1 August, the earlier of the two dates -- continuing to depreciate an asset already classified as held for sale would be inconsistent with IFRS 5's specific measurement requirements for such assets.

11. A company exchanges an old delivery van (carrying amount $8,000, fair value $11,000) for a piece of office equipment owned by another business (fair value $11,500), with no cash changing hands. Separately, in an unrelated transaction, the company exchanges an old forklift (carrying amount $5,000) for an identical replacement forklift from a related company within the same group, as part of an internal asset-reshuffling arrangement with no genuine change in the company's future cash flows. Explain how each exchange should be measured under IAS 16.

A) Both exchanges are always measured at the carrying amount of the asset given up, with no gain or loss ever recognised on any exchange of non-monetary assets
B) The van-for-office-equipment exchange has COMMERCIAL SUBSTANCE (the configuration, and expected future cash flows, of the asset received genuinely differ from the asset given up) and is therefore measured at FAIR VALUE -- the office equipment received is recognised at the fair value of the asset given up ($11,000, being more clearly evidence than the equipment's own fair value in this case), with a gain on exchange of $11,000 - $8,000 = $3,000 recognised. The forklift-for-identical-forklift exchange, by contrast, LACKS commercial substance (the company's future cash flows are not expected to change as a result of this internal reshuffling), so it is measured at the CARRYING AMOUNT of the asset given up ($5,000), with NO gain or loss recognised
C) Both exchanges must be measured at the fair value of the asset RECEIVED only, with the fair value of the asset given up being entirely irrelevant in every case
D) An exchange of non-current assets can never be recognised in the financial statements at all, since no cash consideration was paid in either transaction

Correct: B difficult IAS 16 Property, Plant and Equipment - exchanges of assets and the commercial substance test

IAS 16 requires an asset acquired in exchange for a non-monetary asset (or a combination of monetary and non-monetary assets) to be measured at FAIR VALUE, unless (a) the exchange transaction lacks commercial substance, or (b) the fair value of neither the asset received nor the asset given up can be measured reliably -- in either of these cases, the acquired asset is instead measured at the CARRYING AMOUNT of the asset given up, and no gain or loss is recognised. A transaction has commercial substance when the entity's future cash flows are expected to change significantly as a result of the exchange (as with the van-for-office-equipment swap, which brings genuinely different assets, uses, and expected cash flow patterns into the business) -- such a transaction is measured at fair value, using the fair value of the asset given up unless the fair value of the asset received is more clearly evident, with any difference between that fair value and the carrying amount of the asset given up recognised as a gain or loss. By contrast, an exchange that does not meaningfully alter the entity's economic position or future cash flows -- such as swapping one forklift for an essentially identical one within the same group purely for internal administrative reasons -- lacks commercial substance, and IAS 16 requires it to be measured at the carrying amount of the asset given up, recognising no gain or loss, since fair value measurement in such a case would not reflect any genuine change in the entity's economic circumstances.

12. A company purchases a piece of manufacturing equipment costing $200,000 and receives a government grant of $50,000 towards the purchase, conditional on the equipment being kept in use for at least five years (its estimated useful life, with no residual value, depreciated on a straight-line basis). Explain the TWO acceptable methods permitted under IAS 20 for presenting this grant, and how each affects the annual depreciation charge.

A) IAS 20 permits two acceptable presentation methods for a grant related to an asset. Under the NET (deduction from asset cost) method, the grant is deducted from the asset's cost, reducing it to $200,000 - $50,000 = $150,000, which is then depreciated over 5 years at $30,000 per year. Under the GROSS (deferred income) method, the asset continues to be recognised and depreciated at its full cost of $200,000 (giving an annual depreciation charge of $40,000), while the $50,000 grant is separately recognised as DEFERRED INCOME (a liability) and released to profit or loss on a systematic basis over the same 5-year period ($10,000 per year), matching the periods over which the related depreciation expense is recognised. Both methods result in the SAME NET effect on profit each year ($30,000 net expense: either a $30,000 depreciation charge alone, or a $40,000 depreciation charge less $10,000 grant income), but present the statement of financial position differently (a reduced asset cost under the net method, versus a full-cost asset alongside a separate deferred income liability under the gross method)
B) The grant is recognised as a permanent increase to equity (through other comprehensive income), with no effect on either the asset's carrying amount or profit or loss in any period
C) The grant must always be recognised immediately as income in full in the year of receipt, with no effect whatsoever on the asset's depreciation charge in any period
D) The two acceptable methods differ only in which reporting period the grant is recognised, one method recognising it entirely upfront and the other spreading it over 10 years rather than the asset's 5-year useful life

Correct: A difficult IAS 20 Accounting for Government Grants - grants related to assets, net versus gross presentation

IAS 20 permits a government grant related to the acquisition of an asset to be presented under either of two methods, both giving the same net effect on annual profit, but differing in statement of financial position presentation. The NET method deducts the grant from the cost of the asset, so depreciation is charged on the grant-reduced carrying amount ($150,000 over 5 years = $30,000 per year); the asset is presented at its lower, net cost, with no separate liability recognised for the grant. The GROSS method instead keeps the asset recognised at its full, un-reduced cost ($200,000, depreciated at $40,000 per year), while separately recognising the grant as DEFERRED INCOME (a liability, since the grant is conditional and being earned/released over time), released to profit or loss on a systematic basis matching the pattern over which the related asset's depreciation expense is recognised (here, $10,000 per year over the same 5 years). In both cases, the NET effect on profit or loss for each year is identical (a $30,000 net expense), since the gross method's higher depreciation charge is exactly offset by the grant income recognised in the same period -- the choice between the two methods is a matter of presentation, not of the ultimate profit impact, and IAS 20 permits either, provided the choice is applied consistently.

13. An entity owns a fleet of delivery trucks. During the year it incurs CU80,000 replacing worn brake pads and tyres across the fleet (routine maintenance restoring trucks to their previously assessed standard of performance), and separately CU250,000 fitting new refrigeration units to five trucks, which increases their capacity to carry temperature-sensitive goods and is expected to generate additional future economic benefits beyond those originally assessed for those trucks. Applying IAS 16's recognition principle for subsequent expenditure, how should these two amounts be treated?

A) The CU80,000 should be capitalised because it is the larger recurring cost over the life of the fleet, while the CU250,000 should be expensed because refrigeration units are consumable items
B) Both amounts must be capitalised as additions to the cost of the trucks, since any expenditure on a non-current asset after its initial recognition is always added to its carrying amount
C) The CU80,000 of routine maintenance is recognised as an expense in profit or loss as it is incurred, because it merely restores the trucks to their previously assessed standard of performance rather than enhancing the economic benefits expected from them; the CU250,000 spent on the refrigeration units is capitalised as part of the cost of the relevant trucks, because it meets the recognition criteria for subsequent expenditure by increasing the future economic benefits expected from those assets beyond their originally assessed standard of performance
D) Both amounts must be expensed immediately, because IAS 16 prohibits capitalising any subsequent expenditure on an asset once it has been brought into use

Correct: C difficult IAS 16 Property, Plant and Equipment, paras 12-13 (subsequent costs, day-to-day servicing versus enhancement)

IAS 16 applies its general recognition principle to subsequent expenditure on an item of property, plant and equipment: the cost is recognised as an asset only if it is probable that future economic benefits associated with the item will flow to the entity and the cost can be measured reliably. Day-to-day servicing costs, such as replacing brake pads and tyres to keep an asset performing to its previously assessed standard, are recognised in profit or loss as incurred because they do not enhance future economic benefits beyond what was originally expected. Expenditure that increases the capacity or capability of an asset -- such as fitting refrigeration units that let the trucks carry a new class of goods -- meets the recognition criteria for capitalisation, because it generates additional future economic benefits beyond those originally assessed, and is added to the carrying amount of the relevant assets.

14. A specialised item of production machinery, with a remaining carrying amount of CU600,000 and a remaining useful life of 6 years, is taken out of active use for 9 months while the entity temporarily halts the product line it supports due to a fall in market demand, with a clear intention to resume production once demand recovers. The asset is not classified as held for sale and has not been scrapped. The finance team stops charging depreciation on this machine for the 9 months it sits idle, arguing that 'an asset that is not being used cannot be wearing out, so depreciation would misrepresent its condition.' Applying IAS 16, is the finance team's approach correct?

A) Yes, IAS 16 requires depreciation to cease automatically whenever an asset is temporarily not in active use, resuming only once the asset returns to service
B) No, but only because IAS 16 requires all idle assets to be immediately reclassified as investment property, at which point a completely different depreciation regime applies
C) Yes, and in addition the useful life of the asset should automatically be extended by exactly 9 months to compensate for the idle period
D) No; IAS 16 requires depreciation of an asset to continue even when it is idle, unless the asset is fully depreciated or has been classified as held for sale (or is included in a disposal group classified as held for sale) in accordance with IFRS 5 -- depreciation reflects the consumption of the asset's future economic benefits over its useful life, including through obsolescence and the passage of time as well as physical wear from use, so the 9 months of idle time do not, by themselves, justify suspending the depreciation charge

Correct: D difficult IAS 16 Property, Plant and Equipment, para 55 (depreciation does not cease when an asset is idle)

IAS 16 states that depreciation does not cease when an asset becomes idle or is retired from active use unless the asset is fully depreciated, and does not cease when an asset is temporarily taken out of use, unless it meets the held-for-sale criteria under IFRS 5. This is because depreciation is a systematic allocation of the depreciable amount over an asset's useful life, reflecting the pattern in which the asset's future economic benefits are expected to be consumed by the entity; useful life is affected by expected physical wear and tear, but also by technical or commercial obsolescence and legal or similar limits, which continue to run during a temporary idle period. Suspending depreciation simply because an asset is not currently being used would understate the consumption of its service potential and misstate both profit and the asset's carrying amount.

15. An entity revalues a building upward, recognising a revaluation surplus of CU1,200,000. The building has a remaining useful life of 20 years at the revaluation date. On the original cost basis, annual depreciation would have been CU150,000; on the revalued amount, annual depreciation is CU210,000, an excess of CU60,000 per year attributable solely to the revaluation. The entity's accounting policy is to make an annual transfer of this 'excess depreciation' from the revaluation surplus to retained earnings as the surplus is realised through use of the asset. Applying IAS 16's guidance on revaluation surpluses, which statement correctly describes this transfer?

A) The CU60,000 annual transfer must be recognised in profit or loss as a credit each year, increasing reported profit, since transferring an amount out of a surplus is always an item of income
B) The transfer of CU60,000 each year is made directly within equity, from the revaluation surplus to retained earnings, and is not recognised in profit or loss -- it reflects the portion of the surplus that has, in effect, been realised through the entity's use of the asset (the extra depreciation charged as a result of the revaluation), and IAS 16 permits, but does not require, such a transfer; if made, it must be based on the difference between depreciation charged on the revalued carrying amount and the depreciation that would have been charged on the asset's original cost
C) The full CU1,200,000 revaluation surplus must be transferred to retained earnings immediately in the year of revaluation, rather than being transferred gradually over the asset's remaining useful life
D) No transfer of any kind is permitted between the revaluation surplus and retained earnings under IAS 16 under any circumstances, whether the asset is being depreciated, sold, or retired

Correct: B difficult IAS 16 Property, Plant and Equipment, para 41 (transfer of revaluation surplus as asset is used)

IAS 16 permits (as an accounting policy choice, not a requirement) an entity to transfer part of a revaluation surplus to retained earnings as the related asset is used, with the amount transferred being the difference between depreciation based on the revalued carrying amount and depreciation based on the asset's original cost -- here, CU210,000 minus CU150,000, that is, CU60,000 per year. This transfer is made directly within equity (debiting revaluation surplus and crediting retained earnings) and is never recognised in profit or loss, because it is simply a movement between two equity reserves reflecting that part of the previously recognised surplus has, in an economic sense, now been realised through the entity's continued use and depreciation of the asset, not a new item of income or expense for the period.

16. A manufacturing entity carries out a major overhaul of a production machine every four years, replacing key wear components, at a cost of CU40,000. This major inspection and overhaul is expected to provide the entity with future economic benefits, and its cost was not separately identified as a distinct component when the machine was originally purchased eight years ago. The carrying amount of the machine has never included any separately identified amount for the previous, now-superseded overhaul. How should the CU40,000 overhaul cost be treated under IAS 16?

A) The CU40,000 is added to the cost of the machine but no amount is ever derecognised for the previous overhaul, since only the current, most recent overhaul cost matters for capitalisation purposes
B) The CU40,000 is expensed immediately in full, since only costs identified as a separate component at the original date of purchase can ever be capitalised, and no such component was identified here
C) The CU40,000 major inspection/overhaul cost is capitalised as a separate component of the machine (since it meets the recognition criteria -- it is probable that future economic benefits will flow to the entity and the cost can be measured reliably), with any remaining carrying amount of the cost of the previous inspection/overhaul derecognised, regardless of whether that previous cost was identified separately at the time of the original purchase; the derecognition of the estimated remaining carrying amount of the earlier inspection is not precluded merely because that amount was not separately identified when the asset was first acquired
D) The CU40,000 must be treated as a prepaid maintenance expense and released to profit or loss evenly over the following four years, rather than capitalised as part of the asset's cost

Correct: C difficult IAS 16 Property, Plant and Equipment, para 14 (major inspections and overhauls as a separate component)

IAS 16 permits (and, where the recognition criteria are met, requires) the cost of a major inspection or overhaul to be recognised in the carrying amount of an item of property, plant and equipment as a replacement, provided the recognition criteria (probable future economic benefits and reliable measurement) are satisfied, irrespective of whether the cost of the previous inspection was identified as a separate component of the asset at the time it was acquired. IAS 16 explicitly notes that the entity may use the estimated cost of a future similar inspection as an indication of what the cost of the existing inspection component was when the item was acquired or constructed, for the purpose of derecognising the remaining carrying amount of the earlier inspection -- so the absence of an originally identified separate component does not prevent capitalisation of the new overhaul cost and derecognition of the (estimated) remaining amount relating to the old one.

17. An entity purchases a freehold property for a single combined price of CU2,000,000, comprising land with a fair value of CU800,000 and a building with a fair value of CU1,200,000 at the date of purchase. The building has an estimated useful life of 40 years with no residual value; the land is not expected to be subject to any extraction, quarrying or lease arrangement that would give it a limited useful life. How should this property be depreciated?

A) The CU2,000,000 is allocated between land (CU800,000) and buildings (CU1,200,000) based on their relative fair values at acquisition; the building element is depreciated over its 40-year useful life, but the land element is not depreciated at all, because land normally has an indefinite useful life -- unless the land itself is subject to depletion (for example, a quarry or landfill site) or held under a lease with a limited term, in which case an appropriate method is applied to allocate the land's cost, or a portion of it, over its limited useful life
B) The full CU2,000,000 combined cost is depreciated over 40 years, since land and buildings acquired together for a single price must always be depreciated as a single, undivided asset
C) Neither the land nor the building is depreciated, since a freehold property purchased for a single combined price is always presumed to have an indefinite useful life as a whole
D) Only the land is depreciated, since land generates the underlying value of the property, while the building is treated as a repair and maintenance cost expensed as incurred

Correct: A difficult IAS 16 Property, Plant and Equipment, para 58-59 (land and buildings accounted for separately; land not depreciated unless it has a limited useful life)

IAS 16 requires land and buildings to be accounted for separately, even when acquired together, because land normally has an indefinite useful life and therefore is not depreciated, while a building has a limited useful life and so is depreciated. When land and buildings are purchased for a single price, the price is allocated between the two elements based on their relative fair values (or another reasonable basis) at the date of acquisition. The exception to non-depreciation of land arises where the land itself has a limited useful life, such as a quarry or a site used for landfill, or land held under a lease, in which case it is depreciated in a manner that reflects the benefits to be derived from it.

18. A factory owned by an entity is severely damaged in a flood. The entity's insurer confirms, before the year end, that a claim of CU250,000 will be paid in respect of the damage, and the amount becomes receivable (virtually certain) in the same period as the flood damage occurs. The entity separately recognises an impairment loss of CU300,000 on the factory as a result of the flood damage, and, in a later period, incurs CU280,000 replacing the damaged component of the factory. How should the CU250,000 insurance compensation be recognised, in relation to the impairment loss and the replacement expenditure?

A) The CU250,000 compensation is deducted from the CU280,000 cost of the replacement expenditure when it is capitalised, so only CU30,000 of replacement cost is added to the asset's carrying amount
B) The CU250,000 compensation is netted directly against the CU300,000 impairment loss, so only a net impairment loss of CU50,000 is recognised in profit or loss, with no separate income line for the compensation
C) The CU250,000 compensation cannot be recognised at all until the CU280,000 replacement expenditure has actually been incurred and completed, since the two are treated as a single combined transaction
D) The CU250,000 compensation from the insurer is included in profit or loss as income when it becomes receivable, recognised separately from -- and not netted against -- the CU300,000 impairment loss on the factory or the CU280,000 cost of replacing the damaged component, since IAS 16 requires compensation from third parties for items of property, plant and equipment that were impaired, lost or given up to be included in profit or loss when the compensation becomes receivable, as a distinct transaction from the impairment and the subsequent replacement expenditure (which is separately capitalised if it meets the recognition criteria)

Correct: D difficult IAS 16 Property, Plant and Equipment, para 65-66 (compensation from third parties for impairment, loss or give-up of items of PP&E)

IAS 16 requires compensation from third parties (such as insurance proceeds) for items of property, plant and equipment that were impaired, lost or given up to be included in profit or loss when the compensation becomes receivable. This is treated as a separate economic event from the impairment itself (which is recognised in accordance with IAS 36) and from any subsequent expenditure incurred to restore, replace or repair the affected item (which is assessed for capitalisation under the normal PP&E recognition criteria). None of the three amounts -- the impairment loss, the insurance compensation, and the replacement expenditure -- are netted against one another; each is recognised on its own terms and in the period in which the relevant recognition criteria for that item are met.

19. A machine originally cost CU60,000, has an estimated residual value of CU5,000, and has now reached the end of its useful life, with accumulated depreciation of CU55,000 (so its carrying amount equals its CU5,000 residual value). The machine remains in good working order and continues to be used productively in the business, with no immediate plans to dispose of it. Should any further depreciation be charged on this machine while it continues to be used?

A) No; once an asset's carrying amount has been reduced to its residual value (in other words, its depreciable amount, being cost less residual value, has been fully depreciated), no further depreciation is charged, even though the asset remains in productive use -- depreciation is a systematic allocation of an asset's DEPRECIABLE amount over its useful life, and once that depreciable amount has been fully allocated, there is nothing further to depreciate, regardless of how much longer the asset continues to be physically used; the carrying amount also is not increased or written back up simply because the asset remains usable
B) The machine's carrying amount is written back up to its original CU60,000 cost, and a fresh depreciation schedule is started over an extended new estimated useful life, since the asset remaining usable beyond its original estimate is treated as a change in accounting estimate requiring a full restart
C) Yes, depreciation continues to be charged for as long as the machine remains in use, regardless of whether its carrying amount has already been reduced to its residual value, since depreciation is based purely on continued physical use rather than on the asset's remaining depreciable amount
D) Depreciation continues to be charged, but calculated on the CU5,000 residual value itself as the new depreciable base, spread over a further estimated period of continued use

Correct: A difficult IAS 16 Property, Plant and Equipment - depreciation ceases once the depreciable amount (cost less residual value) is fully allocated

Depreciation is the systematic allocation of an asset's depreciable amount (cost less residual value) over its useful life. Once accumulated depreciation has reduced an asset's carrying amount to its estimated residual value, the entire depreciable amount has been allocated, and there is no further depreciable amount left to charge, regardless of whether the asset remains in productive, physical use beyond that point. IAS 16 does not require (or permit) an asset to be depreciated below its residual value, nor does continued use trigger a write-up of the carrying amount or an automatic restart of a new depreciation schedule; the asset simply continues to be carried at its (unchanged) residual value for as long as it remains in use, with depreciation only resuming if the residual value estimate itself is subsequently revised downward as a change in accounting estimate.

20. An entity has, for many years, measured a class of property, plant and equipment (its office buildings) using the cost model. This year, the entity decides to change to the revaluation model for this class of asset, obtaining an independent valuation as at the current year end. Should this change from the cost model to the revaluation model be applied retrospectively, restating prior period figures as though the revaluation model had always been used (as most changes in accounting policy would otherwise require), or applied only from the current year end onward?

A) The change is not permitted at all; once an entity adopts the cost model for a class of assets, it can never subsequently change to the revaluation model for that class under any circumstances
B) The change is applied by restating only the immediately preceding comparative period, but not any earlier periods, representing a partial (rather than full) retrospective restatement unique to this specific type of accounting policy change
C) The change must be applied fully retrospectively, restating every prior period presented in the financial statements as though the office buildings had always been measured under the revaluation model, exactly as any other voluntary change in accounting policy would be treated
D) A change from the cost model to the revaluation model for a class of property, plant and equipment is specifically treated as an exception to the normal retrospective treatment of a voluntary change in accounting policy -- it is applied PROSPECTIVELY, as at the date of the revaluation (here, the current year end), with the asset simply revalued to its fair value at that date and the resulting surplus or deficit accounted for under the normal revaluation rules going forward, without restating prior period cost-model figures at all

Correct: D difficult IAS 16 Property, Plant and Equipment, para 31 (change from cost model to revaluation model applied prospectively as at the revaluation date)

Although a voluntary change in accounting policy is normally applied retrospectively, restating prior periods as though the new policy had always applied, a change from the cost model to the revaluation model for a class of property, plant and equipment is a specifically recognised exception to this general rule. IAS 16 requires such a change to be accounted for as a revaluation, applied prospectively as at the date the revaluation is performed -- the asset (or class of assets) is simply revalued to fair value at that date, with the resulting surplus or deficit accounted for under the normal revaluation model rules from that point forward, without any restatement of prior period figures that were correctly prepared under the cost model at the time.

21. A piece of specialised equipment, with a carrying amount of CU9,000, becomes obsolete and unusable following a change in the entity's production process. The equipment has no scrap value, cannot be sold, and is simply scrapped (physically disposed of and written off), with the entity receiving no proceeds of any kind. How is this scrapping of the equipment recognised in the entity's financial statements?

A) The CU9,000 carrying amount is transferred to inventory at its existing carrying amount, to be held indefinitely as scrap inventory with no further accounting consequence
B) The equipment is derecognised (removed from the statement of financial position) at the date it is scrapped, with its full CU9,000 carrying amount recognised as a loss on disposal in profit or loss for the period -- because there are no sale proceeds of any kind to offset against the carrying amount (unlike a disposal where the asset is actually sold), the entire remaining carrying amount represents the loss recognised on derecognition
C) The CU9,000 carrying amount continues to be carried on the statement of financial position indefinitely, without any depreciation or write-off, until the entity formally decides on a future use for the scrapped equipment
D) No loss is recognised at all, since a loss on disposal can only be recognised where the asset is actually sold for cash proceeds; scrapping an asset with no proceeds is simply disclosed in a note with no effect on profit or loss

Correct: B difficult IAS 16 Property, Plant and Equipment, para 67-71 (derecognition and gain/loss calculation where an asset is scrapped with no disposal proceeds)

An item of property, plant and equipment is derecognised on disposal or when no future economic benefits are expected from its use or disposal. Where an asset is scrapped -- physically disposed of with no sale proceeds received at all -- the general principle for calculating a gain or loss on derecognition still applies: the difference between any net disposal proceeds and the asset's carrying amount is recognised in profit or loss. Since there are no proceeds whatsoever in a scrapping scenario, the full remaining carrying amount (CU9,000) represents the loss recognised on derecognition, in contrast to a disposal where actual sale proceeds are received and only the shortfall (or excess) between proceeds and carrying amount is recognised as the loss (or gain).

22. Gazipur Petrochemicals Ltd constructs a new chemical storage facility on land it owns. Under the terms of its operating licence, the company has a legal obligation to dismantle the facility and restore the site to its original condition at the end of the facility's 25-year useful life. The estimated present value of this future dismantling and restoration obligation, at the date the facility is brought into use, is CU14,000,000. The finance team proposes to recognise this CU14,000,000 as an expense in the year the facility is completed, on the basis that 'it relates to a cost the company will only actually pay in 25 years' time, so it cannot be part of the cost of the asset today.' Applying IAS 16 together with IAS 37, is this treatment correct?

A) The CU14,000,000 should be recognised immediately as a prepaid expense (a current asset) and released to profit or loss on a straight-line basis over the first year only, since decommissioning costs must always be recognised as an operating expense rather than a capital cost
B) No -- IAS 16 paragraph 16(c) specifically requires the initial estimate of the costs of dismantling and removing an item and restoring the site on which it is located to be included in the cost of the asset, where the entity incurs an obligation for those costs either on acquisition or as a consequence of using the asset for purposes other than producing inventories during that period; the CU14,000,000 should therefore be capitalised as part of the storage facility's cost (debiting property, plant and equipment) with a corresponding decommissioning provision recognised under IAS 37 at the same present value, and the capitalised amount is then depreciated over the facility's 25-year useful life alongside the rest of the asset's cost, rather than expensed immediately
C) The CU14,000,000 should be added directly to retained earnings as a reserve for future decommissioning, bypassing both the statement of financial position asset recognition and the statement of profit or loss entirely, since the obligation is not yet a present cash outflow
D) The finance team is correct: dismantling and restoration costs can never be included in the cost of an asset under IAS 16, since only costs already paid or invoiced at the date of initial recognition qualify, and any future obligation must instead be disclosed only as a contingent liability in the notes

Correct: B complex IAS 16 Property, Plant and Equipment (paragraph 16(c) -- dismantling and restoration costs), IAS 37 Provisions, Contingent Liabilities and Contingent Assets (recognition and measurement of the provision)

IAS 16 paragraph 16(c) explicitly includes, within the cost of an item of property, plant and equipment, the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, to the extent that a present obligation exists for those costs, recognised and measured in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets. The rationale is that the obligation to dismantle and restore arises as an unavoidable consequence of constructing and using the asset -- it is part of the total cost of obtaining the future economic benefits the asset provides, even though the cash outflow itself will not occur until far in the future. The correct entry is to debit property, plant and equipment (increasing the facility's cost by the present value of the estimated future obligation, CU14,000,000) and credit a decommissioning provision (a liability under IAS 37, measured at present value and subsequently unwound through a finance cost as the discount unwinds over the 25 years). The capitalised CU14,000,000 is then depreciated over the facility's useful life along with the rest of its cost, not expensed immediately. The finance team's reasoning conflates the timing of the cash outflow with the timing of cost recognition, which IAS 16 explicitly does not require to coincide for this category of cost. Option D incorrectly denies any capitalisation is ever permitted; option A wrongly treats it as a short-term prepayment; option C incorrectly bypasses both the asset and the provision entirely, contrary to the explicit double entry IAS 16/IAS 37 require.

23. Munshiganj Fabrication Ltd self-constructs a specialised production machine for use in its own factory, rather than purchasing one from a supplier. During construction, the project incurs: CU2,400,000 of directly attributable direct materials and direct labour; CU180,000 of internal profit margin that the production division would normally add if it had sold an equivalent machine to an external customer (calculated purely for internal management reporting comparison purposes); and CU95,000 of abnormal costs arising from a batch of materials that was wasted due to an employee's rework error unrelated to the normal, expected level of construction wastage. What is the correct total amount to be capitalised as the cost of the self-constructed machine, and why are the other two amounts excluded?

A) The full CU2,675,000 (CU2,400,000 + CU180,000 + CU95,000) should be capitalised, since all costs identified in connection with the construction project, however characterised, form part of the total cost the company invested in bringing the asset into existence
B) CU2,495,000 (CU2,400,000 + CU95,000) should be capitalised, including the abnormal wastage because all costs actually paid in cash during construction are capitalisable by definition, while only the notional CU180,000 internal profit is excluded as it was never a cash cost
C) Only CU2,400,000 should be capitalised as the cost of the self-constructed machine; the CU180,000 of internal (notional) profit margin must be excluded because IAS 16 prohibits recognising internal profits on self-constructed assets -- cost is what was genuinely incurred, not an imputed market value the entity would have earned had it sold the item externally -- and the CU95,000 of abnormal wastage from the rework error must also be excluded and expensed as incurred, consistent with the same principle (applied by analogy from IAS 2's treatment of abnormal costs) that abnormal, avoidable costs do not form part of the cost of bringing an asset to its intended condition and location for use
D) CU2,580,000 (CU2,400,000 + CU180,000) should be capitalised, including the internal profit margin because it represents the fair value the company could have realised, while only the CU95,000 abnormal wastage is excluded

Correct: C complex IAS 16 Property, Plant and Equipment (paragraph 22 -- cost of self-constructed assets, exclusion of internal profits and abnormal costs)

IAS 16 paragraph 22 explicitly states that the cost of a self-constructed asset is determined using the same principles as for an acquired asset, and specifically prohibits the inclusion of any internal profits in that cost -- self-construction cost must reflect what was genuinely incurred (direct materials, direct labour, and other directly attributable costs of bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management), not an imputed margin the entity would have charged a third party. The CU180,000 notional internal profit margin therefore has no place in the machine's capitalised cost, however useful it may be for internal management comparison. Separately, IAS 16 paragraph 22 also states that the cost of abnormal amounts of wasted material, labour, or other resources incurred in self-constructing an asset is not included in the cost of the asset -- mirroring the treatment IAS 2 applies to abnormal wastage in inventory production. The CU95,000 rework-driven abnormal wastage, being outside the normal, expected level of construction cost, must be expensed as incurred rather than capitalised. Only the CU2,400,000 of directly attributable direct materials and labour, genuinely incurred and necessary to bring the machine to its intended working condition, qualifies for capitalisation. Options A, D and B each incorrectly include one or both of the excluded amounts.

24. Narsingdi Textile Mills Ltd holds a stock of major spare parts and standby (backup) equipment for its weaving machines. One category of spare part -- a set of critical replacement motors -- is expected to be used only in connection with a specific item of weaving machinery, has an expected useful life of 6 years (matching the remaining life of the machinery it services), and would itself require depreciation over that period if put into use. A second category -- a routine stock of small drive belts and bearings -- is consumed within a few weeks of being issued to the factory floor as part of ordinary, recurring maintenance, with no expectation any individual item will be held or used beyond the short term. How should each category be classified, and why does the classification differ?

A) The critical replacement motors should be classified as property, plant and equipment under IAS 16, because IAS 16 specifically states that major spare parts and standby equipment qualify as PP&E when an entity expects to use them during more than one period, and separately identifies and depreciates them over a period not exceeding the useful life of the related asset; the routine drive belts and bearings, in contrast, are correctly classified as inventory under IAS 2, since they are ordinarily consumed within a short period after being issued for use in the ordinary course of routine maintenance and are not individually significant standby items expected to be used over multiple periods
B) Both categories must always be classified as inventory under IAS 2 regardless of their expected pattern of use, since all spare parts and servicing equipment are, without exception, explicitly excluded from the definition of property, plant and equipment under IAS 16
C) Both categories should be classified as property, plant and equipment under IAS 16 and depreciated, since any item held in connection with maintaining a non-current asset automatically takes on the classification of that non-current asset regardless of its own individual useful life or consumption pattern
D) The critical replacement motors should be classified as inventory since they are not yet in use, while the routine drive belts and bearings should be classified as property, plant and equipment since they relate to ongoing maintenance of an existing non-current asset -- the classification is determined by whether the item is currently installed and operating, not by its expected period of use

Correct: A difficult IAS 16 Property, Plant and Equipment (paragraph 8 -- spare parts and servicing equipment classification)

IAS 16 paragraph 8 addresses this precise distinction: spare parts, stand-by equipment and servicing equipment are ordinarily carried as inventory and recognised in profit or loss as consumed, but major spare parts and stand-by equipment qualify as property, plant and equipment when an entity expects to use them during more than one period; similarly, if the spare parts and servicing equipment can be used only in connection with an item of PP&E, they are accounted for as PP&E. Here, the critical replacement motors meet this test -- they are tied to a specific item of machinery, have a multi-year expected useful life matching the machinery's remaining life, and would themselves require depreciation once put into use -- so they should be recognised as property, plant and equipment and depreciated over a period not exceeding the useful life of the related asset (beginning once available for use, per general IAS 16 principles). The routine drive belts and bearings, by contrast, are consumed within a short period of being issued as part of ordinary recurring maintenance and are not individually significant, multi-period standby items -- these remain correctly classified as inventory under IAS 2, expensed to profit or loss as consumed. The classifying factor is the expected period and pattern of use and significance of the item, not simply whether it happens to be currently installed (option D incorrectly focuses on installation status) nor a blanket rule excluding or including all spare parts regardless of characteristics (options B and C).

25. Sirajganj Manufacturing Ltd revalues a piece of production machinery. Immediately before the revaluation, the machinery has a cost of CU12,000,000 and accumulated depreciation of CU4,500,000, giving a carrying amount of CU7,500,000. The independent valuer assesses the machinery's fair value (depreciated replacement cost, reflecting its current condition and remaining useful life) at CU9,600,000. IAS 16 permits two different methods for restating the asset's cost and accumulated depreciation accounts to reflect this revaluation. What are these two methods, and how would each be applied to this specific revaluation?

A) IAS 16 requires that, regardless of which restatement method is used, the accumulated depreciation balance must always remain at exactly CU4,500,000 unchanged, with only the gross cost figure ever being adjusted to reconcile to the CU9,600,000 revalued carrying amount
B) IAS 16 prohibits any restatement of the accumulated depreciation account on revaluation entirely, requiring the CU2,100,000 revaluation gain (CU9,600,000 less CU7,500,000) to instead be recorded as a direct increase to the accumulated depreciation account itself, reducing it below zero
C) IAS 16 permits only a single method for restating cost and accumulated depreciation on revaluation: accumulated depreciation must always be eliminated entirely against the asset's cost, with the asset then restated to its revalued amount as a fresh 'cost' figure and depreciation restarted from that figure as if the asset were newly acquired, with no alternative method ever available under any circumstances
D) IAS 16 permits two methods. Under the elimination method, the CU4,500,000 accumulated depreciation is eliminated (written off) against the CU12,000,000 gross cost, and the resulting net amount (CU7,500,000 carrying amount) is then restated directly to the CU9,600,000 revalued amount, effectively treating the revalued figure as a new gross carrying amount with accumulated depreciation reset to nil. Under the proportionate (gross-up) restatement method, both the gross cost and the accumulated depreciation are restated proportionately, in the same ratio as the change in the net carrying amount (CU9,600,000 / CU7,500,000 = a factor of 1.28), so gross cost becomes CU12,000,000 x 1.28 = CU15,360,000 and accumulated depreciation becomes CU4,500,000 x 1.28 = CU5,760,000, giving the same net revalued carrying amount of CU9,600,000 (CU15,360,000 - CU5,760,000) but preserving a non-zero, proportionately scaled accumulated depreciation balance and a gross cost figure that continues to reflect the asset's full depreciation history rather than resetting it to the revalued amount

Correct: D difficult IAS 16 Property, Plant and Equipment (paragraph 35, treatment of accumulated depreciation at the date of revaluation)

IAS 16 paragraph 35 explicitly permits two alternative methods for treating accumulated depreciation when an item of property, plant and equipment is revalued. The first (elimination) method restates the accumulated depreciation to nil against the gross carrying amount of the asset, with the net amount then restated to the revalued amount -- so the asset's gross cost is effectively reset to equal its revalued carrying amount, with depreciation starting fresh from that new base. The second (proportionate restatement, sometimes called the gross-up) method instead restates both the gross carrying amount and the accumulated depreciation proportionately, so that the net carrying amount after restatement equals the revalued amount, while preserving a scaled record of the asset's cumulative depreciation history rather than resetting it to zero -- calculated here by applying the same scaling factor (revalued amount / pre-revaluation carrying amount = 9,600,000/7,500,000 = 1.28) to both the CU12,000,000 gross cost (giving CU15,360,000) and the CU4,500,000 accumulated depreciation (giving CU5,760,000), with the difference between the two restated figures again equalling the CU9,600,000 revalued carrying amount. Both methods are permitted under IAS 16, and the choice between them is a matter of accounting policy (though the elimination method is more commonly seen in practice for its relative simplicity); either way, the resulting revaluation surplus recognised (CU9,600,000 - CU7,500,000 = CU2,100,000, generally recognised in other comprehensive income, subject to any prior impairment reversal considerations) is identical regardless of which restatement method is chosen -- the methods differ only in how the gross cost and accumulated depreciation figures are subsequently presented and tracked, not in the net revalued carrying amount itself. Option C wrongly claims only the elimination method is permitted; option A wrongly holds accumulated depreciation artificially fixed, which neither permitted method actually does; option B wrongly and nonsensically proposes crediting the revaluation gain directly into accumulated depreciation, which is not how either permitted method operates.