What are the key differences between the cost model and revaluation model for PP&E under IAS 16, and how does component depreciation interact with each?

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AcadiFi · Accepted Answer

IAS 16 offers two measurement models for property, plant, and equipment after initial recognition. Understanding their mechanics — especially with component depreciation — is essential for Level II. **Cost Model** After initial recognition, PP&E is carried at **cost less accumulated depreciation and impairment losses**. Simple and straightforward. **Revaluation Model** PP&E is carried at **revalued amount** (fair value at the date of revaluation less subsequent accumulated depreciation and impairment). Revaluations must be performed with **sufficient regularity** so carrying value does not differ materially from fair value. **Worked Example — Westbrook Engineering's Power Plant:** Westbrook built a power plant for $50 million, with three components: | Component | Cost | Useful Life | Annual Depreciation | |---|---|---|---| | Turbine assembly | $25,000,000 | 20 years | $1,250,000 | | Building structure | $18,000,000 | 40 years | $450,000 | | Control systems | $7,000,000 | 10 years | $700,000 | After 5 years under the cost model, total carrying value = $50M - (5 × $2.4M) = $38 million. If Westbrook switches to the revaluation model and the fair value is $55 million: | Treatment | Amount | Location | |---|---|---| | Carrying value before revaluation | $38,000,000 | Balance sheet | | Fair value at revaluation date | $55,000,000 | | | Revaluation surplus (gain) | $17,000,000 | **OCI → Revaluation Surplus (Equity)** | \`\`\`mermaid flowchart TD A["Revaluation Gain"] --> B{"Previous Impairment
in P&L?"} B -->|"Yes"| C["Reverse Prior Impairment
Through P&L"] C --> D["Remainder to OCI
(Revaluation Surplus)"] B -->|"No"| D E["Revaluation Loss"] --> F{"Existing Surplus
for This Asset?"} F -->|"Yes"| G["Reduce Surplus
Through OCI"] G --> H["Excess Loss to P&L"] F -->|"No"| H \`\`\` **Component Depreciation Under Each Model:** Under both models, component depreciation applies identically — each significant component is depreciated separately over its own useful life. The revaluation model simply restates the depreciable base. After revaluation, Westbrook would re-allocate the $55 million fair value across the three components and depreciate each over its remaining useful life. **Key Exam Points:** 1. Revaluation gains go to **OCI** (revaluation surplus) unless reversing a prior P&L impairment. 2. Revaluation losses go to **P&L** unless there is an existing surplus for that specific asset. 3. The revaluation model must be applied to the **entire class** of PP&E, not cherry-picked assets. 4. Component depreciation applies under **both models** — revaluation does not eliminate component accounting. 5. The cost model is simpler but can significantly understate asset values for appreciating properties. Check our CFA Level II FRA module for worked revaluation scenarios.

What are the key differences between the cost model and revaluation model for PP&E under IAS 16, and how does component depreciation interact with each?

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