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What is reported as property, plant and equipment? Essay

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The term Property, Plant, and equipment describe the category of tangible assets acquired by an entity to be used as a mean to obtain future economic profit. This category generally includes items such as buildings, machinery, furniture, land, and vehicles. Items of property, plant, and equipment are presented in the financial statement on the balance sheet as the non-current asset, and since they are hardly converted into cash they can easily be distinguished from current assets. Additionally, the amount needed to acquire non-current assets and the amount obtained from the deposition of non-current assets are counted on the income statement as gains or losses and on the statement of cash flow as investing outflows or inflows. During the accounting process for items of property, plant, and equipment several issues and questions arise, including how to determine an asset useful life, which depreciation method to apply and impairment can be accounted for. Among these issues, the most relevant is deciding at which amount an asset should be evaluated (PKF, 2017).

PPE items are initially measured at cost. Cost is the amount of cash or cash equivalent paid to acquire the item ownership, including all costs deriving from making the item capable of operating, such as import duties, purchase taxes, cost of transportation and installation, and costs of dismantling and removing the item. Subsequently to the initial recognition the entity should choose the accounting policy to be applied (Retallack, 2016). The international accounting standard 16 has the objective to establish the accounting treatment for property, plant and equipment so that the user of the financial statement can identify information about the entity’s investment in its PPE and the changes in such investment. IAS 16 offers two different measurement methods. Non-current assets can be either valuated at their historical cost, which is the original cost of purchase less accumulated depreciation and impairment losses, or thorough the revaluation method, where the asset value is revaluated based on its fair value less accumulated depreciation and impairment losses. All measured assets will be recognised in the financial statement and provide the most useful information to its users (Europa, 2009). The qualitative characteristics that enhance the usefulness of financial information are comparability, verifiability, timeliness and understandability. Information should be comparable with similar information for other period in order to identify and understand similarities and differences among items. Information should also be verifiable to assure a faithful economic representation and timeless in order to be available to decision makers in time to influence their decisions. Additionally, all information should be classified and presented clearly and concisely to make the financial report understandable and accurate (Deloitte, 2017a).

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Both the historical cost method and the revaluation method provide several advantages and disadvantages, and each entity has its reasons to choose either one based on its necessities and interests. In one hand, the historical cost, defined as the aggregate price paid by the entity to obtain ownership and use of the asset including cost of allocation and installation, represent the foundation of the conventional accounting model, which is meant to be applied in situations where prices are either stable or subject to slight and slow changes. Since owners and creditors are mainly concerned about how their investment in the corporation has been used and what result they have achieved, the net worth of the corporation becomes an irrelevant measure as it provides the results of the corporation’s operations (Nur Barizah & Julia, 2007)
Historical cost is characterized by a strong objectivity. Under historical cost accounting each asset and liability must be recorded by manager at their acquisition fixed price and transaction data are supported and verified by independent evidences such as statements, receipts or vouchers. Consequently, the possibility of manipulation from managers becomes minimal making historical cost easily verifiable and secure. In addition, historical cost is a quicker and easier method of measurement if compared with others, since original costs are easy to be determined and verified, the time required to estimate and record the data is minor and it is easier for an auditor to verify them subsequently (Elliot & Elliot, 2011)

Historical cost becomes particularly relevant when it comes to marketing economic decisions due to several reasons. First of all, historical cost is directly related to past decisions and thus can affect the evaluation and selection of decision rules because managers require information related to past decisions quality. Additionally, in order to foresee future prices during the decision-making process, past prices are needed as basis. In contrast, the continued reporting of values based on historical cost leads to a misleading evaluation of changes on market values. Therefore, historical cost accounting becomes inappropriate when it comes to the decision-making process. In order to make correct decisions estimations of the future are required and, more specifically, prediction of cash flows (Nur Barizah & Julia, 2007).

Historical cost as also been subject to several criticisms. One of these concerns the fact that this method only considers the acquisition cost of a specific asset and does not take into account the market actual value. Focusing exclusively in cost allocations provides the user with the asset acquisition cost and the depreciation applied in the following years while ignoring the actual market value of the asset makes the users unaware of a possible increase or decrease in that asset actual value. Hence, the financial statement will not be able to provide a fair and true picture of the actual state of wealth of the corporation. Revenues are recorded considering current values whereas expenses are recorded at historical cost (Bhaskar, 2013). On the other hand, under the revaluation model the company’s properties, plants and equipment are carried to a revaluated value equal to their new fair values. The revaluation method can be considered more complex when compared with the historical cost method as it can only be applied when the asset’s fair value can be reliably determined. Such values are then considered for the purpose of accounting and subsequent accumulated depreciation and impairment losses are claimed and deducted (Deloitte. 2017b.). Revaluations must be made fairly regularly to ensure that the fair values of revalued assets do not differ materially from their carrying values at the end of the reporting period. This makes information available in the financial statement reliable for a limited period. If a relevant change in the market environment occurs, the company’s financial situation could be incorrect, and the actual wealth of a firm could be over or understated (Bogle, 2015).

Revaluation model also has to deal with the problem of volatility. If the asset actual value follows the market environment development, this means that the value changes with it. Volatility can thus create the unnecessary risk and could negatively influence the investment capacity of the corporation. For assets and liabilities that are held until maturity, the volatility reflected in the financial statement can be considered artificial and be conclusively misleading, as gradual compensation will be applied to any deviation from the cost during the financial instrument’s life (Betakova, Hrazdilova & Skoda, 2014).

One important feature of the revaluation model is that it provides relevant information and thus, it has a great informative value for the corporation itself since it utilizes information specific for the actual market conditions, and provide prompt corrective actions. Moreover, since revaluation requires the corporation to disclose information about assumptions made, a methodology used, risk exposure and other issues resulting in a through the financial statement the firm will be subject to an increased transparency, which will be particularly useful to potential lenders and investors (Betakova, Hrazdilova & Skoda, 2014).

Unfortunately, an often-quoted disadvantage of revaluation is the ambiguity relative to the procedure of measurement for asses for financial statements which generates loopholes for pricing decisions. Since this measurement can produce differing prices in several ways, a deviation from the expected fair value is possible (Elliott & Elliott, 2011). Additionally, it is possible that in an inefficient market, which does not reflect all publicly available information in its estimates, the values of assets observed are not indicative of their fundamental value. Ball (2006) points out that another important issue is market liquidity as it could cause substantial uncertainty about fair value and thus, it could lead to large overall value deviations.

Manipulation is another issue concerning the revaluation method. Alteration of prices by the company’s managers could affect the fair value estimations obtained as firms have the effect on both quoted and traded priced in illiquid markets (Betakova, Hrazdilova & Skoda, 2014).
Even though the historical cost method has been considered more accurate for valuing non-current assets and provides information about cost investment, the revaluation method, based upon fair value measurement, better reflects the current wealth of the entity’s assets, of the current market conditions and gives a measure of investment expected return (Onur, 2014). This provides more transparency but at the same causes, subjectivity due to reliability in illiquid markets a generates volatility which leads to uncertainty (Sarah, 2009). Both the knowledge of fair value and the cost of investment represent important information the user should be aware of. Therefore, both methods should be applied as only together they can provide investors with accurate, useful and complete information. Hence, a dual measurement and reporting system should be considered (Betakova, Hrazdilova & Skoda, 2014).

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