Vertical and Horizontal Analysis: Uncovering Trends and Financial Structure
Vertical and Horizontal Analysis: Uncovering Trends and Financial Structure
Buying a machine or a building is not just “Spending Cash”; it’s an investment in the company’s future capability. IAS 16 governs how companies treat these long-term assets. It determines what counts as a cost, how to depreciate it over time, and how to revalue it if prices change. In this guide, we break down the standard into practical steps: Recognition, Initial Measurement, Depreciation Methods, and Derecognition.
- Definition of Property, Plant and Equipment (PPE) under IAS 16.
- Criteria for Initial Recognition: When does an item become an asset?
- Measurement at Recognition: What costs are included? (Purchase price, direct costs, dismantling).
- Measurement after Recognition: Cost Model vs. Revaluation Model.
- Visual model (SVG) of the Asset Lifecycle.
- Depreciation: Componentization, Useful Life, and Methods.
- Interactive Tool: Compare Straight-line vs. Declining Balance depreciation.
1) Definition and Recognition Criteria
Property, Plant and Equipment are tangible items that are:
- Held for use in the production or supply of goods/services, for rental to others, or for administrative purposes.
- Expected to be used during more than one period (Long-term).
2) Measurement at Recognition (Initial Cost)
An item of PPE is initially measured at its Cost. This includes:
- Purchase Price: Including import duties and non-refundable purchase taxes, after deducting trade discounts.
- Directly Attributable Costs: Costs to bring the asset to the location and condition necessary for it to operate (e.g., Site preparation, Installation, Delivery).
- Dismantling Costs: The initial estimate of the costs of dismantling and removing the item at the end of its life (Provision).
3) Measurement after Recognition
After initial recognition, an entity must choose one of two models as its accounting policy for an entire class of assets:
| Model | Formula | Pros/Cons |
|---|---|---|
| Cost Model | Cost – Accum. Depreciation – Accum. Impairment | Simple, stable, widely used. Less volatile. |
| Revaluation Model | Fair Value – Subsequent Depreciation | Reflects current market value. More complex, creates volatility in OCI. |
4) Visual Logic: Asset Lifecycle
5) Depreciation: Concept and Methods
Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life.
Smart Journal Entries System - Excel File
- Componentization: Each part of an item of PPE with a cost that is significant in relation to the total cost must be depreciated separately (e.g., Aircraft engine vs. Body).
- Methods:
- Straight-Line: Constant charge over useful life.
- Diminishing Balance: Higher charge in early years (good for tech/vehicles).
- Units of Production: Charge based on expected usage/output.
6) Interactive Depreciation Tool
Calculate and compare depreciation schedules:
7) Derecognition (Disposal)
An item of PPE is derecognized (removed from the balance sheet) on disposal or when no future economic benefits are expected. The Gain or Loss is calculated as:
This gain/loss is included in Profit or Loss, NOT as Revenue.
8) Disclosure Requirements
Financial statements must disclose for each class of PPE:
- Measurement bases (Cost or Revaluation).
- Depreciation methods and useful lives.
- Reconciliation of carrying amount at the beginning and end of the period (Additions, Disposals, Depreciation).
- Restrictions on title and assets pledged as security.
9) Frequently Asked Questions
Is land depreciated?
No. Land usually has an unlimited useful life and is therefore not depreciated, unless it is a quarry or landfill site.
What if I change the useful life estimate?
This is a Change in Accounting Estimate (IAS 8). It is accounted for prospectively (in the current and future periods), not retrospectively.
10) Conclusion
The summary is simple: IAS 16 provides the framework for managing the company’s physical backbone. By correctly measuring cost, applying appropriate depreciation, and reviewing values regularly, you ensure that your Balance Sheet reflects the true productive capacity of the business.