9.2 Recognition

According to IAS 16.7, a PPE item should be recognized when:

• It is probable that future economic benefits associated with the item will flow to the entity.
• The item’s cost can be measured reliably (IAS 2003a).

Notice that these conditions are similar to our basic definition of an asset. Also notice that the definition is phrased in terms of economic benefits, rather than of the item itself. This means that some expenditures not directly incurred to purchase the asset, but necessary nonetheless to guarantee the continued productive use of the asset, may still be included in the asset’s cost. For example, safety equipment mandated by legislation may not provide direct revenue to the business, but is necessary in order to continue operating the equipment legally. Thus, these costs should be capitalized as part of the asset’s cost, and if significant, may even be identified as a separate component of the asset.

The definition of PPE does not contain any guidance on how to define an individual element of PPE. This means that the accountant will need to apply professional judgment to determine the segregation of various PPE components. If we consider a large, complex piece of equipment such as an airplane, the need for proper component accounting becomes clear. An airplane contains several major elements: the fuselage, the engines, and the interior fixtures (seats, galley, and so on). As indicated in the opening story about WestJet, each of these elements may have a significantly different useful life, and may require maintenance and replacement at different intervals. Because we need to depreciate assets based on their useful lives, and because we need to consider the accounting treatment of subsequent expenditures, it is important to define the separate components of a PPE item properly at the time of recognition. Accountants will usually consider the value of the component relative to the whole asset, along with the useful life and other qualitative and practical factors when making these determinations.

IAS 16 also indicates that spare parts, stand-by equipment, and servicing equipment should be recognized as property, plant, and equipment if they meet the definition. If they don’t meet the definition, then it is more appropriate to classify these items as inventory. This is an area where materiality and the accountant’s professional judgment will come into play, as the capitalization of these items may not always be practical.

IFRS is shifting towards componentization of PPE.  Componentization considers if an asset such as a building be recognized as one amount or should each component of the building be recognized as separate assets.  Like many IFRS regulations, the degree of componentization is a matter of professional judgement.  A contributing factor is the concept of materiality.  What is the significance of the individual parts in relation to the whole asset?  Is it worthwhile separating an asset into many, many parts?