Dirty Laundry – PPE or Inventory?

 Inventory is defined as assets:

(a) held for sale in the ordinary course of business;

(b) in the process of production for such sale; or

(c) in the form of materials or supplies to be consumed in the production process or in the rendering of services. (IAS 2.6)

Property, plant and equipment is defined as:

(a) are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and

(b) are expected to be used during more than one period. (IAS 16.6)

The key difference is the period over which the items are expected to be used.

Other items commonly used in hotels where the classification between inventory and PPE may be unclear include: cutlery, glassware and crockery.

If the item is expected to be used for longer than one period (being the 12 months or a financial period) then the item should be classified as PPE.

When assessing the period of use, one should take into consideration

-         the replacement cost

-        obsolescence of the item purchased; and/or

-        any legal requirements relating to replacement periods.

Hotels may have policies to replace its entire glassware category every 5 years for an updated version or a different brand to keep up with the latest trends.

Upon initial recognition the entity should consider capitalising the category of assets and not each individual item.

For example, a hotel buys 500 glasses in the latest range available from their supplier.

Throughout the year, glasses that are chipped or broken are taken out of circulation and replaced in order to keep the number of glasses available for use at the base of 500.

Replacements should be capitalised to this asset category and not expensed individually as the sum of these replacements may be material in aggregate over the course of the year. The revised carrying value should then be depreciated over the assets remaining useful life.

An item of PPE should be derecognised when it is disposed of or when no future economic benefits are expected from its use or disposal.

Thus, when items of the above PPE category are replaced in line with hotel policy, it should be accounted for in the financial records as follows:

The carrying amount of the items disposed of would be calculated based on the asset category’s carrying amount divided by the number of items in the category.  A profit or loss would be calculated and recorded based on whether the items were retired from use or sold.

Example

Glasses purchased at the beginning of the financial year

Cost: R 1,000 for 10 items

Useful life: 5 years

Carrying amount as at the end of year 1: R 800

5 items disposed of for R 100 each

Carrying amount of assets disposed of:

(R 800/10)*5= R 400

Profit

R 500 – R 400 = R 100

The carrying amount of the items would be based on the ratio of the carrying amount to the number of items.

For tax purposes, a section 11(e) allowance can be claimed in terms of the Income Tax Act. If items cost less than R 7,000 individually, in terms of interpretation note 47, the full allowance may be claimed in the first year of purchase.

Hotels use these various items in the rendering of services, as do many other industries. However, since these items are generally used for longer than one period these items fall within the scope of IAS 16 and should be classified as PPE and not inventory.

19/07/2022