Cañaveral, Rhia Pixie T.

2nd Yr. BS Accountancy

Reviewer: Intermediate Accounting 1

Lesson: Investment
Investment
 is essentially an asset that is created with the intention of allowing money to
grow. The wealth created can be used for a variety of objectives such as
meeting shortages in income, saving up for retirement, or fulfilling certain
specific obligations such as repayment of loans, payment of tuition fees, or
purchase of other assets.
 One, if you invest in a saleable asset, you may earn income by way of profit.
Second, if Investment is made in a return generating plan, then you will earn an
income via accumulation of gains.

Reasons investments are held

1. To keep money safe
2. To help money grow
3. To earn a steady stream of income
4. To minimize the burden of tax
5. To save up for retirement

Examples of investments
1. Ownership Investments, as the name clearly suggests, are assets that
are purchased and owned by the investor.
2. Lending Investments, invest in lending instruments, you’re essentially
behaving like the bank. Corporate bonds, government bonds, and even
savings accounts
3. Cash Equivalents, investments that are highly liquid and can easily be
converted into cash.

Characteristics of Financial Instrument

1. Financial Assets
 is a liquid asset that gets its value from a contractual right or
ownership claim. Cash, stocks, bonds, mutual funds, and bank
deposits are all are examples of financial assets.
 categorized as either real, financial, or intangible.
 valuable property that is not physical in nature. They include
patents, trademarks, and intellectual property.
 unlike land, property, commodities, or other tangible physical assets,
financial assets do not necessarily have inherent physical worth or
even a physical form. 
 Examples: cash, stocks, bonds, certificate of deposit, equity of an
entity (share certificate), contractual right to receive a financial asset
from another entity (receivable), contractual right to exchange
financial assets or liabilities with another entity under favorable
conditions, contract that will settle in an entity’s own equity
instruments, etc.
 How are financial asset initially measured?
 Under IFRS 9, a financial asset is initially measured at fair
value plus transaction costs, unless it is carried at fair value
through profit or loss, in which case transaction costs are
immediately expensed.  There is an exemption to this
requirement – trade receivables without a significant financing
component are initially recognised at the transaction price.

How is it subsequently measured?

 (1) ‘Contractual cash flow characteristics’, (2) ‘Hold to collect’,
(3) ‘Hold to collect and sell’. Even if a non-equity financial
asset meets the criteria for measurement at amortised cost or at
fair value through other comprehensive income, the entity can
elect to carry it at fair value through profit or loss to eliminate
an accounting mismatch.

2. Equity Security
 An equity security is a financial instrument that represents an
ownership share in a corporation.
 The typical equity security is common stock, which also gives its
owner the right to a share of the residual value of the issuing entity,
in the event of a liquidation.

3. Debt Security
 type of financial asset that is created when one party lends money to
another. For example, corporate bonds are debt securities issued by
corporations and sold to investors. 

Distinguish Equity Security and Debt Security

 Equity securities indicate ownership in the company whereas debt
securities indicate a loan to the company. Equity securities do not have a
maturity date whereas debt securities typically have a maturity date.

Illustration from acquisition, to change in fair value at year-end to sale of

trading securities
On Jan. 1, 2021, an investor acquired a 10% interes in an investee for
P3,000,000. The fair value of the investment on Dec. 1, 2021 is P4,000,000. On
Jan. 1, 2022, the investor acquired a further 30% interest in the investee for
P8,500,000. On such date, the carrying amount of the net assets of the investee
is P25,000,000. The fair value of the net assets of the investee is equal to
carrying amount. Any excess of the cost over carrying amount is attributable to
goodwill.

The investee reported the following net income and cash dividend:
Net Cash
income Dividend
2021 5,000,000 3,500,000
2022 6,000,000 4,000,000
Journal Entries (2021)
Financial Asset - FVOCI 3,000,000
 Cash 3,000,000
Cash (10% x 3,500,000) 350,000
Dividend Income 350,000
Financial Asset FVOCI 1,000,000
Unrealized Gain - OCI 1,000,000
Fair Value - Dec. 31, 2021 4,000,000
Carrying Amount 3,000,000
Unrealized Gain - other comp. Inc. 1,000,000

Impairment
 is a permanent reduction in the value of a company asset. It may be
a fixed asset or an intangible asset.
 most commonly used to describe a drastic reduction in the recoverable
value of a fixed asset. The impairment may be caused by a change in the
company's legal or economic circumstances or by a casualty loss from an
unforeseeable disaster.

Investment in Equity Security

Order of priority in acquisition by exchange
 when a financial asset is recognized initially, an entity shall measure it at
fair value plus transaction cost that are directly attributable to the
acquisition.

What is lump sum acquisition?

 occurs when several assets are acquired for a single price. Each of the
assets must be recorded separately as a fixed asset in the accounting
records; to do so, the purchase price is allocated among the various
acquired assets based on their fair market values.

What are investment categories?

 major categories: stocks, bonds and cash equivalents.

What are dividends? Cash dividends, property dividends, share dividends,

liquidating dividends?
 Dividends, often refers to the cash dividends that a corporation pays to
its stockholders (or shareholders).
 Cash Dividends, is the distribution of funds or money paid to
stockholders generally as part of the corporation's current earnings or
accumulated profits. 
 Property Dividends, is an alternative to cash or stock dividends, where
a company gives shareholders property in lieu of cash or cash
equivalents.
 Share Dividens,d is an alternative to cash or stock dividends, where a
company gives shareholders property in lieu of cash or cash equivalents.
 Liquidating Dividends, is a type of payment that a corporation makes to
its shareholders during a partial or full liquidation. 

What are the 3 important dates related to the dividends?

 Declaration date, is the date on which the board of directors announces
and approves the payment of a dividend. The declaration includes the
 size of the dividend being issued and outlines the record date and
payment date.
 Record date, also known as the date of record, is the date on which the
investor must be on the company’s books in order to receive a dividend.
 Date of payment, is the date which the dividends declared shall be paid.

Differentiate share split, split up and split down, give example.

 Share split a corporation may restructure its capital by effecting a change
in the number of the shares without capitalizing retained earnings or
changing the amount of its legal capital. A split-up is a transaction
whereby the outstanding shares are called in and replaced by a larger
number, accompanied by a reduction in the pat or stated value of each
share. While a split-down is a transaction whereby the outstanding shares
are called in and replaced by smaller number, accompanied by an
increase in the par or stated value.

Special assessments
 Are additional capital contribution of the shareholders. On the part of the
shareholders, special assessments are recorded as additional cost of the
instrument.

Stock rights
 Is a legal right granted to shareholders to subscribe for new shares issued
by a corporation at a specified price during a define period.

Investment in associate
Intercorporate share investment
 Is the purchase of the equity shares of one entity by another entity.

Define: significant influence, control, associate, subsidiary

 Significance Influence, is the power to participate in the financial and
operating olicy decisions of the investee but not control or joint control
over those policies.
 Investment in Control, can refer to the process of monitoring the
performance of an asset management firm. The aim is to ensure that
standards are high and the client’s money is being invested correctly.
 Investment in Associate, refers to the investment in an entity in which
the investor has significant influence but does not have full control like a
parent and a subsidiary relationship.
 Investment in Subsidiary, is an asset with the subsidiary. The
ownership is determined by the percentage of shares held by the parent
company, and that ownership stake must be at least 51%.

Investment in associate (other accounting issues)

Treatment of upstream and downstream transactions
 Upstream transactions are sales of assets from an associate to the
investor
 Down stream transactions are sales of assets from the investor to an
associate.
 Procedures when investor ceases to have significant influence
a) Representation in the board of directors
b) Participation in policy making process
c) Material transactions between the investor and the investee
d) Interchange of managerial personnel
e) Provition of essential technical information

What are the circumstances when an investment in associate is not

accounted for the under the equity method
 PAS 28, paragraoh 17, provides that an investment in associate shall not
be accounted for using the equity method if the investor is a parent that
is ecempt from preparing consolidated financial statements.

Fair value approach?

 The existing interest in the associate is remeasurement at fair value with
any change in fair value included in profit or loss
 However, if the existing interest is accounted for at fair value through
other comprehensive income, any unrealized gain or loss at the date the
investee becomes as associate in reclassified to retain earnings
 The fair value of the existing interest plus the cost of the additional
interest acquired constitutes the total cost of the investment for the initial
application of the equity
 The total cost of the investment for the initial application of the equity
method minus the carrying amount of the net assets acquired at the date
significant influence is obtained equals excess of cost over carrying
amount or excess net fair value.

Lesson: Bond Investment

Financial assets at amortized cost (bond investment)
Definition of a bond
 Is a formal unconditional promise made under seal to pay a specified sum of money at
a determinable future date, and to make periodic interest payments at a stated rate until
the principal sum is paid.
Initial measurement of bond investment
 In accordance with PFRS 9, paragraph 5.1.1, bond investments are recognized initially
at fair value plus transaction costs that are directly attributable to the acquisition.
However, transaction costs attributable to the acquisition of bond investments held for
trading or at fair value through profit or loss are expensed immediately.
Amortization of premium or discount
 Investment in bonds shall be measured subsequently at amortized cost. This means that
any premium or discount on the acquisition of long-term investment in bonds must be
amortized. Bond premium or discount is amortized over the remaining life of the bonds
from the date of acquisition to the date of maturity. Amortization may be made on
interest dates or at the end of the reporting period. It is more convenient to record
amortization at the end of the reporting period.
Straight line method of amortization
 Provides for an equal amount of premium or discount amortization each accounting
period. Following the straight line method, the annual amortization of discount and
premium as simply computed by dividing the amount of discount and premium by the
life of the bonds.
Bond outstanding method of amortization
 Applicable to serial bonds and provides for a decreasing amount of amortization.
Effective interest method
Nominal interest rate
 Is the coupon rate or stated rate appearing on the face of the bond.
 Refers to the interest rate before taking inflation into account. Nominal can also refer to
the advertised or stated interest rate on a loam, without taking into account any fees or
compounding of interest.
Effective interest rate
 Effective interest or scientific method simply requires the comparison between the
interest earned or interest income and the interest received.
 Interest rate on a loan or financial product restated from the nominal interest rate and
expressed as the equivalent interest if compound interest was payable annually in
arrears.
Effective interest method of amortization
 Is an accounting practice used to discount a bond. This method is used for bonds sold at
a discount or premium; the amount of the bond discount or premium is amortized to
interest expense over the bond’s life.
Bond investment - FVOCI
 PFRS 9, paragraph 4.1.2A, provides that a financial asset shall be measured at fair
value through other comprehensive income if both of the following conditions are met:
a. The business model is achieved both by collecting contractual cash flows and
by selling or trading the financial asset.
b. The contractual cash flows are solely payments of principal and interest on
the principal outstanding.
Fair value option
 PRFS 9, paragraph 4.1.5, provides that an entity at initial recognition may irrevocably
designate a financial asset as measured at fair value through profit or loss even if the
financial asset satisfies the amortized cost or FVOCI measurement.
Market price of bonds
 The market price of bonds is equal to the present value of the principal plus the present
value of future interest payments using the effective rate.
 The present value of an ordinary annuity of 1 us determined for the number of interest
periods using the effective rate.

Reclassification of financial asset

Requirement for reclassification
 PFRS 9, paragraph 4.4.1, provides that an entity shall reclassify financial assets only
when it changes the business model for managing the financial assets. Where
reclassification occurs, paragraph 5.6.1 provides that an entity shall apply the
reclassification prospectively from the reclassification date. The entity shall not restate
any previously recognized gains, losses and interest.
Exemptions from reclassification
a) Equity investment held for trading or measured at FVPL cannot be reclassified by
reason of the consequential requirement of PFRS 9.
All equity investment cannot be classified.
b) Equity investment measured at FVOCI by irrevocable election cannot be reclassified
simply because the election is irrevocable.
c) Only debt investment can be reclassified because the change in business model applies
appropriately to debt investment. However, debt investment measured at FVPL by
irrevocable election cannot be reclassified simply because the election is irrevocable.
Reclassification from FVPL to amortized cost
 PFRS 9, paragraph 5.6.3, provides the following if a financial asset is reclassified from
FVPL to amortized cost:
a. The fair value at the reclassification date becomes the new carrying
amount of the financial asset at amortized cost.
b. The difference between the new carrying amount of the financial asset
at amortized cost and the face amount of the financial asset shall be
amortized through profit or loss over the remaining life of the financial
asset using the effective interest method.
 c. A new effective interest rate must be determined based on the new
carrying amount or fair value at reclassification.
Reclassification from amortized cost to FVPL
 PFRS 9, paragraph 5.6.2, provides that when an entity reclassifies a financial asset from
amortized cost to fair value through profit or loss, the fair value is determined at
reclassification date. The difference between the previous carrying amount and fair value is
recognized in profit or loss.
Reclassification from FVOCI to amortized cost
 PFRS 9, paragraph 5.6.5, provides the following if a financial asset is reclassified from
FVOCI to amortized cost:
a. The fair value at reclassification date becomes the new amortized cost
carrying amount.
b. The cumulative gain or loss previously recognized in other
comprehensive income is eliminated and adjusted against the fair value
at reclassification date. As a result, the investment is reverted back to
amortized cost measurement.
c. The original effective rate is not adjusted.
Reclassification from FVPL to FVOCI
 PFRS 9, paragraph 5.6.6, provides the following if a financial asset is reclassified from
FVPL to FVOCI:
a. The financial asset continued to be measured at fair value.
b. The fair value at reclassification date becomes the new carrying
amount.
c. A new effective rate must be determined based on the new carrying
amount or fair value at reclassification date.
Reclassification from FVOCI to FVPL
 PFRS 9, paragraph 5.6.7, provides the following if a financial asset is reclassified from
FVOCI to FVPL:
a. The financial asset continues to be measured at fair value.
b. The fair value at reclassification date becomes the new carrying
amount.
c. The cumulative gain or loss previously recognized in other
comprehensive income is reclassified to profit or loss at reclassification
date.

Lesson: Invetment Property

Investment Property
 Defined as property (land pr building or part of a building or both) held by an owner or
by the lessee under a finance lease to earn rentals or for capital appreciation or both.
 Only land and building can qualify as investment property.
 Any movable property cannot qualify as investment property.
 The property held by an owner for use in the production or supply of goods or services,
or for administrative purposes is known as owner-occupied property.
An investment property is not held:
a. For use in the production or supply of goods or services or administrative
purposes.
b. For sale in the ordinary course of business.
Owner-occupied Property
 is property held by its owner for its own productive purposes, such as administration or
the production of goods or services. The concept is used in the international financial
reporting standards framework.
Partly Investment and Partly Owner-occupied
 When a property is partially owner occupied and partially held for rental/capital gain, the
property is not an investment property unless the non-investment part is insignificant
(IAS 40.10).
Property lease to an affiliate
 From the perspective of the individual entity that owns it, the property leased to another
subsidiary or its parent is considered an investment property. However, from the
perspective of the group as a whole and for purposes of consolidated financial
statements, the property is treated as owner-occupied property.
Recognition of Investment Property
Investment property shall be recognized as an asset when and only when:
a. It is probable that the future economic benefits that are associated with the
investment property will flow to the entity.
b. The cost of the investment property can be measured reliably.
Initial measurement of Investment Property
 An investment property shall be measured initially at its cost. Transaction costs shall be
included in the initial measurement.
 The cost of a purchased investment property comprises the purchase price and any direct
attributable expenditure.
 Directly attributable expenditure includes professional fees for legal services, property
transfer taxes and other transaction costs.
Fair value of Investment Property
 Fair value of an asset is the price that would be received to sell an asset in an orderly
transaction between market participants at the measurement date. The price in the
principal market used to measure fair value shall not be adjusted for transaction cost.
 Equipment such as lift or air-conditioning is often an integral part of a building and is
generally included in the fair value of the investment property.
Transfers of Investment Property
Transfers to and from investment property shall made when and only when
there is a change of use evidenced by:
a. Commencement of owner occupation or development with view to owner-
occupation, transfer from investment property to owner-occupied property.
b. Commencement of development with a view to sale, transfer from investment
property to inventory.
c. End of owner occupation, transfer from owner-occupied property to investment
property.
d. Inception of an operating lease to another entity, transfer from owner-occupied
property to investment property.
Disclosures related to Investment Property
The general disclosures are:
a. Whether the entity uses the cost model or fair value model
b. The amount of rental income with the related expense
c. Restrictions on the investment property
d. Contractual obligations to purchase or construct investment property
When the fair value model is used, the disclosures are:
a. Detailed reconciliation between carrying amount of investment property at the
beginning and end of the period.
b. The method of determining the fair value of investment property and whether
the valuation is carried out by an independent qualified valuer
c. Net gains or losses from fair value adjustments
d. Whether significant fixtures, such as lift and office furniture within an
investment property, have been separately recognized
When the cost model is used, the disclosures are:
a. The depreciation method or rate and useful life
b. Detailed reconciliation of the gross cost of investment property and the related
accumulated depreciation
c. Fair value of the investment property where possible. If it is not possible, such
fact shall be explained.
Cash Surrender Value
 Is the amount which the insurance firm will pay upon the surrender and cancellation of
the life insurance policy.
Cash surrender value arises if the following are present:
a. The policy is a life policy. There is no cash surrender value in fire, accident and
other non-life policies.
b. Premiums for three full years must have been paid.
c. The policy is surrendered at the end of the third year or anytime thereafter.

Lesson: Property, Plant and Equipment

Property, plant and equipment are tangible assets that are held for use in production or supply of
goods or services, for rental to others, or for administrative purposes, and are expected to be used
during more than one period.
The major characteristics of property, plant and equipment are:
a. The property, plant and equipment are tangible assets, meaning with physical substance.
b. The property, plant and equipment are used in business meaning used in production or supply of
goods or services, for rental purposes and for administrative purposes.
c. The property, plant and equipment are expected to be used over a period of more than one year.
Examples of property, plant and equipment
1. Land 7. Motor vehicle
2. Land improvements 8. Furniture and fixtures
3. Building 9. Office equipment
4. Machinery 10. Patterns, molds and dies
5. Ship 11. Tools
6. Aircraft 12. Bearer plant
Recognition of property, plant and equipment
a. It is probable that future economic benefits associated with the asset will flow to the entity
b. The cost of the asset can be measured reliably.
Spare parts and servicing equipment
Most spare parts and servicing equipment are used usually carried as inventory and recognized as an
expense when consumed. However, major parts and stand-by equipment qualify as property, plant and
equipment when the entity expects to use them during more than one period.
Measurement at recognition
An item of property, plant and equipment that qualifies for recognition as an asset shall be measured
initially at cost. Cost is the amount of cash or cash equivalent paid and the fair value of the other
consideration given to acquire a:, asset at the time of acquisition or construction.
Elements of cost
a. Purchase price, including import duties and nonrefundable purchase taxes, after deducting trade
discounts and rebates.
b. Cost directly attributable to bringing the asset to the location and condition necessary for it to be
capable of operating in the manner intended by management
c. Initial estimate of the cost of dismantling and removing the asset and restoring the site on which it
is located and for which an entity has a present obligation as required by law or contract.
Directly attributable cost
d. Cost of employee benefits arising directly from the acquisition of property, plant and equipment
e. Cost of site preparation
f. Initial delivery and handling cost
g. Installation and assembly cost
h. Professional fees
i. Costs of testing whether the asset is functioning properly
Proceeds from samples
Pas 16 has been amended such that proceeds from selling samples produced and the cost of such
samples when testing whether the asset is functioning properly shall be included in profit or loss. The
proceeds are no longer deducted from the cost of property, plant and equipment. If not yer sold, the
samples are accounted for as inventory.
Cost not qualifying for recognition
a. Costs of opening a new facility
b. Cost of introducing a new product or services, including costs of advertising and promotion
c. Cost of conducting business in a new location or with a new class of customer, including cost of
staff training
d. Administration and other general overhead costs
e. Costs incurred while an item capable of opening in the manner intended by management has yet
to be brought into use or is operated at less than full capacity
f. Initial opening cost
g. Cost of relocating or reorganizing part or all of an entity’s operations.
Measurement after recognition
After initial recognition, an entity shall chose either the cost model or the revaluation model as the
accounting policy for property, plant and equipment.
The entity shall apply such accounting policy to an entire class of property, plant and equipment.
Cost model, property, plant and equipment are carried at cost less any accumulated depreciation and
any accumulated impairment loss.
Revaluation model, property, plant and equipment are carried at revalued carrying amount. Is the fair
value at the date of revaluation less any subsequent accumulated depreciation and subsequent
accumulated impairment loss.
Acquisition of property
1. Cash basis
2. On account subject to cash discount
3. Installment basis
4. Insurance of share capital insurance of bonds payable
5. Exchange
6. Donation
7. Government grant
8. Construction
Acquisition on cash basis
Cost on item or property, plant and equipment is the cash price equivalent at the recognition date.
The cost of asset acquired on a cash basis simply includes the cash paid plus directly attributable costs
such as freight, installation cost and other cost necessary in bringing the asset to the location and
condition for the intended use.
When several asset at a “basket price” or “lump sum price”, it is necessary to apportion the single price
to the assets acquired on the basis of relative fair value.
Acquisition on account
When an asset is acquired on account subject to a cash discount, the cost of the asset is equal to the
invoice price minus the discount, regardless of whether the discount is taken or not.
If the discount is not taken, the same is charged to purchase discount lost account
Acquisition on installment basis
the cost is the cash price equivalent. If an asset is offered at a cash price and at an installment price and
is purchased at the installment price, the asset shall be recorded at the cash price.
No available cash price
If an asset is acquired by installment and there is no available cash price, the asset is recorded at an
amount equal to present value of all payments using an implied interest rate.
Amortization of discount on note payable
The effective interest method is used in amortizing the discount on notes payable as interest expense.
Statement classification and presentation
If a statement of financial position is prepared at the end of the first year, the note payable is classified
as partly current and partly non-current.
Issuance of share capital
Philippine GAAP provides that if shares are issued for consideration other than actual cash, the
proceeds shall be measured at the fair value of the consideration received.
Accordingly, where a property is acquired through the issuance of share capital, the property shall be
measured at an amount equal to the following in the order of priority:
a. Fair value of the property received
b. Fair value of the share capital 
c. Par value or stated value of the share capital
Issuance of bonds payable
When an entity acquires an asset by issuing bonds payable, PFRS 9, paragraph 5.1.1, provides that the
entity shall measure the financial liability at fair value plus transaction costs that are directly
attributable to the issue of the financial liability. Accordingly, the asset acquired by issuing bonds
payable is measured in the following order:
 a. Fair value of bonds payable
b. Fair value of asset received 
c. Face amount of bonds payable
Exchange
PAS 16, paragraph 24, provides that the cost of an item of property, plant and equipment acquired in
exchange for 1 non-monetary asset or a combination of monetary and non-monetary asset is measured
at fair value. However, the exchange is recognized at carrying amount under the following
circumstances:
a. The exchange transaction lacks commercial substance.
b. The fair value of the asset given or the fair value of the asset received is not reliably
measurable.
Definition of commercial substance
new notion and is defined as the event or transaction causing the cash flows of the entity to change
significantly by reason of the exchange. An exchange transaction has commercial substance when the
cash flows of the asset received differ significantly from the cash flows of the asset transferred.
The entity shall consider if the amount, timing and risk of the cash flows from the new asset are
different from the cash flows of the old asset. The entity-specific value of the portion of the entity's
operations affected by the transaction changes as a result of the exchange.
Entity-specific value is the present value of the cash flows an entity expects to arise from the
continuing use of an asset and from the disposal at the end of useful life or expects to incur when
settling a liability.
Exchange - with commercial substance
If a property is acquired in an exchange, the cost of the property is equal to the following:
a. Fair value of asset given plus any cash payment on the part of the payor.
b. Fair value of asset given minus any cash received - on the part of the recipient.
Exchange - no commercial substance
If the exchange transaction lacks commercial substance, the acquired item of property, plant and
equipment is measured at the carrying amount of the asset given.
No gain or loss is recognized when the exchange lacks commercial substance.
Any cash involved is added to the carrying amount on the part of the payor and deducted from carrying
amount on the part of the recipient.
Trade in
Trade in is a form of exchange, a property is acquired by exchanging another property as part payment
and the balance payable in cash or any other form of payment in accordance with agreed terms. Trade
in involves a non-dealer acquiring the asset from a dealer, usually involves a significant amount of cash
and the transaction has commercial substance.
As an exchange with commercial substance, the new asset is recorded at the following in the order of
priority:
a. Fair value of asset given plus cash payment
b. Trade in of asset given plus cash payment (in effect, this is the fair value of the asset
received)
Fair value approach
The new asset is recorded at the fair value of the asset given plus cash payment.
Donation
Philippine GAAP provides that contributions received from shareholders shall be recorded at the fair
value with the credit going to donated capital.
Expenses incurred in connection with the donation, like payment of registration fees and legal fees
shall be charged to the donated capital account. For such reason, expenses do not increase or enhance
the value of the asset. However, directly attributable costs incurred subsequently.
entities sometimes receive from non-shareholders gifts or grants of funds or other assets that are
restricted for property and equipment additions.
Capital gifts or grants shall be recorded at fair value when received or receivable.
Capital gifts or grants are generally subsidies and therefore recognized as income. In the rare case when
capital gifts or grants are not subsidies, the offsetting credit is a liability account until the initial
restrictions are met. When the initial restrictions are met, the liability is transferred to income.
Construction
The cost of self-constructed asset is determined using the same principles as for an acquired asset.
The cost of self-constructed property, plant and equipment shall include:
a. Direct cost of materials
b. Direct cost of labor
 c. Indirect cost and incremental overhead specifically identifiable or traceable to the
construction.
If the incremental overhead is not specifically identifiable, allocation of overhead may be done on the
basis of direct labor cost or direct labor hours.
Saving or loss on construction
Where the actual cost of construction is less than the price at which the constructed asset can be
purchased from outside parties, the difference is not income but saving. The saving is realized in future
periods by reason of lower depreciation charges on the asset.
Any internal profit is eliminated in arriving at the cost of self-constructed asset.
PAS 16, paragraph 22, provides that the cost of abnormal amount of wasted material, labor or
overhead incurred in the production of self-constructed asset is not included in the cost of the asset.
Intervening operations
Some operations occur in connection with the construction or development of an item of property,
plant and equipment but are not necessary to bring the asset to the location and condition for the
intended use. These operations may occur before or during the construction or development activities.
Derecognition
the cost of the property, plant and equipment together with the related accumulated depreciation shall
be removed from the accounts.
PAS 16, paragraph 67, provides that the carrying amount of an item of property, plant and equipment
shall be derecognized on disposal or when no future economic benefits are expected from the use or
disposal.
Fully depreciated property
A property is said to be fully depreciated when the carrying amount is equal to zero, or the carrying
amount is equal to the residual value. In such a case, the asset account and the related accumulated
depreciation account are closed and the residual value is set up in a separate account.
Property classified as held for sale
PFRS 5, paragraph 7, provides that an item of property,plant and equipment is classified as "held for
sale" if the asset is available for immediate sale in the present condition. within one year from the date
of classification as held for sale. 
Such asset shall be excluded from property, plant and equipment but presented separately as current
asset.
PFRS 5, paragraph 15, further provides that an entity shall measure a non-current asset classified as
held for sale at the lower between carrying amount and fair value less cost of disposal.
The write-down to fair value less cost of disposal is treated as an impairment loss.
PFRS 5, paragraph 25, further provides that a non-current asset classified as held for sale shall not be
depreciated.
Idle or abandoned property
PFRS 5, paragraph 13, provides that an entity shall not classify as held for sale a non-current asset
that is to be abandoned. This is because the carrying amount would be recovered principally through
continuing use.
Temporary idle activity or abandonment does not prelude depreciating the asset as future benefits
are consumed not only through usage but also through wear and tear and obsolescence.
Non-current asset to be abandoned includes an item of property, plant and equipment that is to be used
until the end of the economic life.
Optional disclosures
Entities are encouraged to disclose the following information which may prove relevant to the needs of
financial statement users:
a. The carrying amount of temporarily idle property, plant and equipment.
b. The gross carrying amount of any fully depreciated property, plant and equipment still in
use.
c. The carrying amount of property, plant and equipment retired from active use and classified
as held for sale.
d. When the cost model is used, the fair value of property, plant and equipment when this is
materially different from the carrying amount.

Lesson: Government Grant

Government Grant
PAS 20, paragraph 3, defines government grant as assistance by government in the form of transfer of
resources to an entity in return for part or future compliance with certain conditions relating to the
operating activities of the entity. Government grant is sometimes called by other names such as
subsidy, subvention or premium.

Recognition and Measurement

Government grant, including non-monetary grant at fair value, shall be recognized when there is
reasonable assurance that:
a. The entity will comply with the conditions attaching to the grant.
b. The grant will be received.

Government grant shall not be recognized on a cash basis as this is not consistent with generally
accepted accounting practice. In other words, the government grant shall be recognized on the accrual
basis when received or receivable.

Classifications of Government Grant

a. Grant related to asset
This is government grant whose primary condition is that an entity qualifying for the
grant shall purchase, construct or otherwise acquire long-term asset.
b. Grant related to income
By residual definition, this is government grant other than grant related to asset.

Accounting for government grant

Government grant shall be recognized as income on a systematic basis over the periods in which an
entity recognizes as expenses the related costs for which the grant is intended to compensate.

In other words, the grant is taken to income over one or more periods in which the related cost is
incurred.

Presentation of Government Grant

1. Government grant related to asset shall be presented in the statement of financial position in either
of two ways:
a. By setting the grant as deferred income.
b. By deducting the grant from the cost of the asset.
2. Government grant related to income is presented in the income statement, either separately or
under the general heading “other income” or deducted from the related expense.

Repayment of Government Grant

A government grant that becomes repayable because of non-compliance with conditions shall be
accounted for as a change in accounting estimate.
Repayment of a grant related to income shall be applied first against any unamortized deferred income
and any excess shall be recognized immediately as an expense.
Repayment of a grant related to an asset shall be recognized by increasing the carrying amount of the
asset.
The cumulative additional depreciation that would have been recognized to date in the absence of the
grant shall be recognized immediately as an expense.

Grant of Interest-Free Loan

A forgivable loan from government is treated as a government grant when there is reasonable assurance
that the entity will meet the terms for forgiveness of the loan.
PAS 20, paragraph 10, provides that the benefit of a government loan with a NIL or below-market rate
of interest is treated as a government grant.
Paragraph 10A further provides that the benefit is measured as the difference between the face amount
and the present value of the loan.

Government Assistance
Government assistance is action by government designed to provide an economic benefit specific to an
entity or range of entities qualifying under certain criteria.
The essence of government assistance is that no value can reasonably be placed upon it. Examples of
government assistance are:
 a. Free technical or marketing advice
b. Provision of guarantee
c. Government procurement policy that is responsible for a portion of the entity's sales.

Government assistance does not include the following indirect benefits or benefits not specific to an
entity:
a. Infrastructure in development areas such as improvement to the general transport and
communication network.
b. Imposition of trading constraints on competitors.
c. Improved facilities such as irrigation for the benefit of an entire local community.

Disclosures about Government Grant

a. The accounting policy adopted for government grant, including the method of presentation
adopted in the financial statements.
b. The and extent of government grant recognized in the financial statements and an indication
of other forms of government assistance from which the entity has directly benefited.
c. Unfulfilled conditions and other contingencies attaching to government assistance that has
been recognized.

It is not required to disclose the name of the government agency that gave the grant along with the date
of sanction of the grant by such government agency and the date when cash was received in case of
monetary grant.

Lesson: Land, Building, Machinery, Depreciation, Depletion, Revaluation, Impairment of Asset

Land Account
Land used as a plant site shall be treated as property, plant and equipment. Land held for a currently
undetermined use is treated as an investment property. However, if the land is held definitely as a
future plant site, it is classified as owner-occupied property and not an investment property and
therefore shall be included in property, plant and equipment.
Land held for long-term capital appreciation is treated as an investment property. Land held for current
sale by a real estate developer as in the case of subdivided lots is treated as current asset as part of
inventory.
Costs chargeable to land
a. Purchase price
b. Legal fees and other expenditures for establishing clean title
c. Broker or agent commission
d. Escrow fees
e. Fees for registration and transfer of title
f. Cost of relocation or reconstruction of property belonging to others in order to acquire
possession
g. Mortgages, encumbrances and interest on such mortgages assumed by buyer
h. Unpaid taxes up to date of acquisition assumed by buyer
i. Cost of survey
j. Payments to tenants to induce them to vacate the land in order to prepare the land for the
intended use but not to make room for the construction of new building
k. Cost of permanent improvements such as cost of clearing, cost of grading, leveling and
landfill
l. Cost of option to buy the acquired land. If the land is not acquired, the cost of option is
expensed outright.
Land improvements
Land improvements not subject to depreciation are charged to the land account. On the other hand,
depreciable land improvements are charged to a special account "land improvements.". Land
improvements of this type should be depreciated over their useful life.
Special assessments
Special assessments are taxes paid by the landowner as a contribution to the cost of public
improvements. Special assessments are treated as part of the cost of the land. Special assessments are
capitalized as cost of land because public improvements increase definitely the value of the land.
Real property taxes
As a rule, real property taxes are treated as outright expense. However, if unpaid real property taxes are
assumed by the buyer in acquiring land, the taxes are capitalized but only up to the date of acquisition.
The real property taxes subsequent to the date of acquisition should be treated as expense.
Building Account
The following expenditures are normally charged to the building account when building is acquired by
purchase:
a. Purchase price
b. Legal fees and other expenses incurred in connection with the purchase
c. Unpaid taxes up to date of acquisition d. Interest, mortgage, liens and other encumbrances on
the building assumed by the buyer
d. Payments to tenants to induce them to vacate the building f. Any renovating or remodeling
costs incurred to put a building purchased in a condition suitable for the intended use such as
lighting installations, partitions and repairs.
The following expenditures are normally charged to the building when acquired by means of
construction:
a. Materials used, labor employed and overhead incurred during the construction
b. Building permit or license
c. Architect fee
d. Superintendent fee.
e. Cost of excavation
f. Cost of temporary buildings used as construction offices and tools or materials shed
g. Expenditures incurred during the construction period such as interest on construction loans
and insurance. h. Expenditures for service equipment and fixtures made a permanent part of
the structure.
h. Cost of temporary safety fence around construction site and cost of subsequent removal
thereof.
However, the construction of a permanent fence after the completion of the building is recognized as
land improvement. Safety inspection fee
Sidewalks, pavements, parking lot, driveways
a. If the such expenditures are part of the blueprint for the construction of a new building, these
are charged to the building account.
b. On the other hand, the expenditures that are occasionally made or incurred not in connection
with the construction of a new building are charged to land improvements.
Claims for damages
Where insurance is taken during the construction of a building, the cost of insurance is charged to the
building because it is a necessary and a reasonable cost of bringing the building into existence.
However, where insurance is not taken and the entity is required to pay claims for damages for injuries
sustained during the construction, the payment for damages should be expensed outright because the
damages represent management failure or negligence in procuring insurance and are not a reasonable
and necessary cost of construction. To charge the damages to the building would be tantamount to
concealment of the management failure or negligence.
Building fixtures
Expenditures for shelves, cabinets and partitions that are immovable in the sense that these are attached
to the building in such a manner that the removal thereof may destroy the building should be charged to
the building account. On the other hand, expenditures for shelves, cabinets and partitions that are
movable should be charged to furniture and fixtures and depreciated over their useful life.
Ventilating system, lighting system, elevator
a. If installed during construction, the ventilating system, lighting system and elevator should
be charged to the building account.
b. Otherwise, the expenditures should be charged to building improvements and depreciated
over their useful life or remaining life of the building, whichever is shorter.
PIC Interpretation on land and building
1. Land and an old building are purchased at a single cost:
a) If the old building is usable, the single cost is allocated to land and building based on relative
fair value.
b) If the old building is unusable, the single cost is allocated to land only.
2. The old building is demolished immediately to make room for construction of a new building:
a) Any allocated carrying amount of the usable old building is recognized as a loss if the new
building is accounted for as property, plant and equipment or investment property.
 b) Any allocated carrying amount of the usable old building is capitalized as cost of the new
building if the new building is accounted for as inventory.
c) The demolition cost minus salvage value is capitalized as cost of the new building whether
the new building is accounted for as property, plant and equipment, investment property or
inventory.
d) Needless to say, the net demolition cost is capitalized as cost of the land if the old building is
demolished to prepare the land for the intended use but not to make room for the
construction of new building.
3. A building is acquired and used in a prior period but demolished in the current period to make
room for construction of a new building:
a) The carrying amount of the old building is recognized as a loss, whether the new building is
property, plant and equipment, investment property or inventory.
b) The net demolition cost is capitalized as cost of the new building whether the new building is
accounted for as property, plant and equipment, investment property or inventory.
c) If the old building is subject to a contract of lease, any payments to tenants to induce them to
vacate the old building shall be charged to the cost of the new building.

Machinery
When machinery is purchased, the cost normally includes the following:
a. Purchase price
b. Freight, handling, storage and other cost related to the acquisition
c. Insurance while in transit HATS HD
d. Installation cost, including site preparation and assembling
e. Cost of testing and trial run, and other cost necessary in preparing the machinery for its
intended use.
f. Initial estimate of cost of dismantling and removing the machinery and restoring the site on
which it is located and for which the entity has a present obligation as required by law or
contract.
g. Fee paid to consultants for advice on the acquisition of the machinery.
h. Cost of safety rail and platform surrounding machine. i. Cost of water device to keep
machine cool.
If machinery is removed and retired to make room for the installation of a new one, the removal cost
not previously recognized as a provision is charged to expense. The value added tax or VAT on the
purchase of machinery is not capitalizable but charged to input tax to be offset against output tax.
However, any irrecoverable or nonrefundable purchase tax is capitalized as cost of the machinery.
Tools
Tools are classified as machine tools and hand tools. Machine tools include drills and punches. Hand
tools include hammer and saws. Tools should be segregated from the machinery account.
Patterns and dies
Patterns and dies are used in designing or forging out a particular product. Patterns and dies used for
the regular product are recorded as assets. Patterns and dies are depreciated over the useful life.
However, patterns and dies used for specially ordered product form part of the cost of the special
product.
Equipment
The term "equipment" includes delivery equipment, store equipment, office equipment and furniture
and fixtures. The cost of such equipment includes the purchase price, freight and other handling
charges, insurance while in transit, installation costs and other costs necessary in preparing them for the
intended use.
Delivery equipment includes cars, trucks and other vehicles used in business operations. Motor vehicle
registration fees should be expensed and not be included as part of the cost of the delivery equipment.
Store and office equipment include computers, typewriters, adding machines, cash register and
calculator.
Assets identified with the selling function are classified as store equipment. Otherwise, the assets are
charged to office equipment. Furniture and fixtures include showcases, counters, shelves, display
fixtures, cabinets, partitions, safes, desks and tables. In a broad sense, furniture and fixtures may
include store and office equipment.
Returnable containers
Returnable containers include bottles, boxes, tanks, drums and barrels which are returned to the seller
by the buyer when the contents are consumed or used. Containers in big units or of great bulk as in the
case of tanks, drums and barrels are classified as property, plant and equipment.
On the other hand, containers that are small and individually involve small amount as in the case of
bottles and boxes are classified as other non-current assets. Needless to say, containers that are not
returnable are charged outright to expense.
Capital expenditure and revenue expenditure
An expenditure that benefits only the current period is a revenue expenditure and therefore reported as
an expense. An expenditure that benefits the current period and future periods is a capital expenditure
and therefore reported as an asset.
Recognition of subsequent cost
The recognition of subsequent cost is subject to the same recognition criteria for the initial cost of
property, plant and equipment.
Accordingly, the subsequent cost incurred for property, plant and equipment shall be recognized as an
asset when:
a. It is probable that future economic benefits associated with the subsequent cost will flow to
the entity.
b. The subsequent cost can be measured reliably.
In other words, if the subsequent cost will increase the future service potential of the asset, the cost
should be capitalized. If the subsequent cost merely maintains the existing level of standard
performance, the cost should be expensed when incurred.
Future economic benefit
In general, a subsequent cost on an item of property, plant and equipment will benefit future periods or
increase the future service potential of an asset when:
a. The expenditure extends the life of the property.
b. The expenditure increases the capacity of the property and quality of output, for example, by
upgrading machine parts.
c. The expenditure improves the efficiency and safety of the property, for example, by adopting
a new production process leading to large reduction in operating cost.
Subsequent cost
Generally, the following expenditures are incurred during ownership of existing property, plant and
equipment.
a. Additions
b. Improvements or betterments
c. Replacements
d. Repairs e. Rearrangement cost
Additions
Additions are modifications or alterations which increase the physical size or capacity of the asset.
Such expenditures are of two types, namely:
a. An entirely new unit
b. An expansion, enlargement or extension of the old asset
The construction of a new building is an addition of the first type but the addition of a wing to a
building or the construction of a third storey on a two-storey building is an addition of the second type.
In either case, the cost is capitalized in the usual manner. The cost of an addition which is a new unit is
depreciated over the useful life. But the cost of an expansion should be depreciated over the useful life
of the expansion or remaining useful life of the asset of which it is part, whichever is shorter.
Improvements or betterments
Improvements or betterments are modifications or alternations which increase the service life or the
capacity of the asset. Improvements may represent replacement of an asset or part thereof with one of a
better or superior quality. Such expenditures are normally capitalized. The improvements that do not
involve replacement of parts are simply added to the cost of the existing asset.
Examples of improvements are:
a. A tile roof is substituted for wooden shingles
b. A shatter proof glass is substituted for ordinary glass
c. An old motor in a machine is replaced by a new and powerful one
d. Galvanized iron roofing is substituted for nipa roofing
e. Replacement of wooden floor by concrete flooring
Replacements
Replacements also involve substitution but the new asset is not better than the old asset when acquired.
The basic difference between an improvement and replacement is that an improvement is a substitution
of a better or superior quality whereas a replacement is a substitution of an equal or lesser quality.
Replacements may be classified into three:
a. Replacement of the old asset by a new one. This is the replacement contemplated.
 b. Replacement of major parts or extraordinary repairs.
c. Replacement of minor parts or ordinary repairs.
Repairs
Repairs are those expenditures used to restore assets to good operating condition upon their breakdown
or replacement of broken parts. Repairs may be classified as extraordinary repairs and ordinary repairs.
Extraordinary repairs are material replacement of parts, involving large sums and normally extend the
useful life of the asset. Extraordinary repairs are usually capitalized.
Ordinary repairs are minor replacement of parts, involving small sums and are frequently encountered.
Ordinary repairs are normally charged to expense when incurred. Accordingly, an entity does not
include in the carrying amount of property, plant and equipment the cost of day-to-day servicing of the
property. Rather, such cost of day-to-day servicing is recognized as expense when incurred.
Repair and maintenance
Repair is different from maintenance in that repair restores the asset in good operating condition while
maintenance keeps the asset in good condition. Thus, repair is or curative while maintenance is
preventive. The theoretical distinction is difficult to maintain in practice, hence the two are combined
in a single account "repair and maintenance."
Rearrangement cost
Rearrangement cost is the relocation or redeployment of an existing property, plant and equipment.
PAS 16, paragraph 20, provides that recognition of costs in the carrying amount of property, plant and
equipment ceases when the asset is in the location and condition for the intended use.
In other words, IFRS expressly mandates that the costs of relocating existing property, plant and
equipment or costs of reorganizing part or all of an entity's operations are not capitalized but expensed
as incurred. The rearrangement merely maintains the existing level of standard performance of the
asset.
Accounting for major replacement
An important consideration in determining the appropriate accounting treatment for a replacement is
whether the original part of an existing asset is separately identifiable. If separate identification is
practicable, the major replacement is debited to the asset account. The cost of the part eliminated and
the related accumulated depreciation are removed from the accounts and the remaining carrying
amount of the old part is treated as a loss.
If it is not practicable for an entity to determine the carrying amount of the replaced part, it may use the
cost of the replacement as an indication of the "likely original cost of the replaced part at the time it
was acquired or constructed. However, the current replacement cost shall be discounted.

Depreciation
Introduction
Property, plant and equipment, except land, normally are usable for a number of years after which the
assets have relatively little value either for service or for sale. The difference between the original cost
of a property and any remaining value when it is retired or worn out is an expense that should be
distributed to the periods during which the asset is used. The portion that is allocated to expense in a
particular period is referred to by three different terms namely:
a. Depreciation
b. Depletion
c. Amortization
The three terms are similar in meaning. The only difference lies in the type of asset involved.
Technically, depreciation refers to property, plant and equipment, depletion to wasting assets and
amortization to intangible assets.
CONCEPT OF DEPRECIATION
Depreciation is defined as the systematic allocation of the depreciable amount of an asset over the
useful life. Depreciation is not so much a matter of valuation. Depreciation is a matter of cost allocation
in recognition of the exhaustion of the useful life of an item of property, plant and equipment. The
objective of depreciation is to have each period benefiting from the use of the asset bear an equitable
share of the asset cost.
Depreciation in the financial statements
Depreciation is an expense. It may be a part of the cost of goods manufactured or an operating expense.
The depreciation charge for each period shall be recognized as expense unless it is included in the
carrying amount of another asset. Except for non-exhaustible land, all property shall be depreciated on
a systematic basis over the useful life of the asset irrespective of the earnings of the entity. The
financial statements would be misstated if depreciation is omitted when the entity has a loss and
recognized when the entity has a gain. The omission of depreciation may somehow impair legal capital
if and when dividends are declared out of earnings before provision for depreciation.
Depreciation period
Depreciation of an asset begins when it is available for use, meaning, when the asset is in the location
and condition necessary for it to be capable of operating in the manner intended by management.
Depreciation ceases when the asset is derecognized. Therefore, depreciation does not cease when the
asset becomes idle temporarily. Temporary idle activity does not preclude depreciating the asset as
future economic benefits are consumed not only through usage but also through wear and tear and
obsolescence.
PFRS 5, paragraph 25, provides that if the asset is classified as held for sale depreciation shall be
discontinued.
Kinds of depreciation
There are two kinds of depreciation, namely physical depreciation and functional or economic
depreciation. Physical depreciation is related to the depreciable asset's wear and tear and deterioration
over a period.
Physical depreciation may be caused by:
a. Wear and tear due to frequent use
b. Passage of time due to non-use
c. Action of the elements such as wind, sunshine, rain or dust natural disaster animals and
wooden buildings.
d. Casualty or accident such as fire, flood, earthquake and other
e. Disease or decay - This physical cause is applicable to animals and wooden buildings.
Accordingly, physical depreciation results to the ultimate retirement of the property or termination of
the service life of the asset. Functional or economic depreciation arises from inadequacy, supersession
and obsolescence. Inadequacy arises when the asset is no longer useful to the entity because of an
increase in the volume of operations. Supersession arises when a new asset becomes available and the
new asset can perform the same function more efficiently and economically or for substantially less
cost. Obsolescence is the catchall for economic or functional depreciation. Obsolescence encompasses
inadequacy and supersession. An asset becomes obsolete if it is inadequate or superseded.
Factors of depreciation
In order to properly compute the amount of depreciation, three factors are necessary, namely
depreciable amount, residual value and useful life.
Depreciable amount
Depreciable amount or depreciable cost is the cost of an asset or other amount substituted for cost, less
the residual value.
Each part of an item of property, plant and equipment with a cost that is significant in relation to the
total cost of the item shall be depreciated separately. The entity also depreciates separately the
remainder of the item and the remainder consists of the parts of the item that are individually not
significant.
Residual value
Residual value is the estimated net amount currently obtainable if the asset is at the end of the useful
life. The residual value of an asset shall be reviewed at least at each financial year-end and if
expectation differs from previous estimate, the change shall be accounted for as a change in an
accounting estimate. In practice, the residual value of an asset is often insignificant and therefore
immaterial in the calculation of the depreciable amount. The residual value of an asset may increase to
an amount equal to or greater than the carrying amount. If it does, the depreciation charge is zero
unless and until the residual value subsequently decreases to an amount below the carrying amount.
Depreciation is recognized even if the fair value of the asset exceeds the carrying amount as long as the
residual value does not exceed the carrying amount.
Useful life
Useful life is either the period over which an asset is expected to be available for use by the entity, or
the number of production or similar units expected to be obtained from the asset by the entity.
Accordingly, the useful life of an asset is expressed as:
a. Time periods as in years
b. Units of output or production
c. Service hours or working hours
Factors in determining useful life
a. Expected usage of the asset - Usage is assessed by reference to the asset's expected capacity
or physical output.
 b. Expected physical wear and tear depends on the operational factors such as the number of
shifts the asset is used, the repair and maintenance program, and the care and maintenance of
the asset while idle.
c. Technical or commercial obsolescence arises from changes or improvements in production,
or change in the market demand for the product output of the asset.
d. Legal limits for the use of the asset, such as the expiry date of the related lease.
Incidentally, the service life of an asset should be distinguished from physical life. Service life is the
period of time an asset shall be used by an entity. The service life is the equivalent of useful life.
Physical life refers to how long the asset shall last.
Depreciation method
The depreciation method shall reflect the pattern in which the future economic benefits from the asset
are expected to be consumed by the entity. The depreciation method shall be reviewed at least at every
year-end. The method shall be changed if there is a significant change in the expected pattern of future
economic benefits. Such change in depreciation method shall be accounted for as change in accounting
estimate.
Methods of depreciation
1. Equal or uniform charge methods
a) Straight line
b) Composite method
c) Group method
2. Variable charge or use-factor or activity methods
a) Working hours or service hours
b) Output or production method
3. Decreasing charge or accelerated or diminishing balance methods
a) Sum of years' digits
b) Declining balance method
c) Double declining balance
4. Other methods
a) Inventory or appraisal
b) Retirement method
c) Replacement method
Straight line method
Under the straight line method, the annual depreciation charge is calculated by allocating the
depreciable amount equally over the number of years of estimated useful life. In other words, straight
line depreciation is a constant charge over the useful life of the asset. The formula for the computation
of the annual depreciation following the straight line method is as follows:
Annual depreciation =Cost minus residual value/Useful life in years
Cost minus residual value equals depreciable amount.
Straight line rate
Depreciable amount multiplied by the straight line rate of depreciation also gives the amount of annual
depreciation. The straight line rate is determined by dividing 100% by the life of the asset in years.
Rationale for straight line
The straight line method is adopted when the principal cause of depreciation is passage of time. The
straight line approach considers depreciation as a function of time rather than as a function of usage.
Although use and obsolescence contribute to the depreciation of such assets, such causes are
insignificant compared to the effects of time. The straight line method is widely used in practice
because of simplicity.
Composite and group method
Large entities own various individual depreciable assets. For these entities, making detailed
depreciation computation for each individual asset referred to as unit depreciation is time consuming
and costly. Therefore, large entities find it more practical to compute depreciation by treating many
individual assets as though they were a single asset. The two methods of depreciating various
individual assets as a single asset are composite method and group method.
Under the composite method, assets that are dissimilar in nature or assets that have different physical
characteristics and vary widely in useful life, are grouped and treated as a single unit.
Under the group method all assets that are similar in nature and in estimated useful life are grouped and
treated as a single unit. The accounting procedure and the method of computation for the composite
and group method are essentially the same.
In other words, the average useful life and the composite or group rate are computed, and the assets in
the group are depreciated on that basis.
Accounting procedures
a. Depreciation is reported in a single accumulated depreciation account. Thus, the
accumulated depreciation account is not related to any specific asset account.
b. The composite or group rate is multiplied by the total cost of the assets in the group to get
the periodic depreciation.
c. When an asset in the group is retired, no gain or loss is reported. The asset account is
credited for the cost of the asset retired and the accumulated depreciation account is debited
for the cost minus salvage proceeds.
d. When the asset retired is replaced by a similar asset, the replacement is recorded by debiting
the asset account and crediting cash or other appropriate account. Subsequently, the
composite or group rate is multiplied by the balance of the asset account to get the periodic
depreciation.
Variable charge or activity methods
The variable or activity methods assume that depreciation is more a function of use rather than passage
of time. The useful life of the asset is considered in terms of the output it produces or the number of
hours it works. Thus, depreciation is related to the estimated production capability of the asset and is
expressed in a rate per unit of output or per hour of use.
There are two variable methods, namely:
a. Working hours method
b. Output or production method
Rationale for variable depreciation
The variable methods are adopted if the principal cause of depreciation is usage.
The use of these methods is based on the following:
a. Assets depreciate more rapidly if they are used full time or overtime.
b. There is a direct relationship between utilization of assets and realization of revenue. If
assets are used more intensively in production, greater revenue is expected.
The variable methods are found to be appropriate for assets such as machineries. The major objection
to these methods is that the units of output or service hours which serve as the basis of depreciation
may be difficult to estimate.
Decreasing Charge or Accelerated Methods
The decreasing charge or accelerated methods provide higher depreciation in the earlier years and
lower depreciation in the later years of the useful life of the asset. Thus, these methods result in a
decreasing depreciation charge over the useful life.
Rationale for accelerated depreciation
The accelerated depreciation is on the philosophy that new assets are generally capable of producing
more revenue in the earlier years than in the later years.
Another argument for the use of decreasing charge method is that the cost of using an asset includes
not only depreciation but also repairs on such assets. Such repair cost should be allocated over the
useful life of the asset on a systematic and uniform basis. It has been observed that repairs tend to
increase with the age of the asset, hence repairs are small in the earlier years and large during the later
years.
Therefore, following the decreasing charge method, the overall effect would be a uniform charge
because the decreasing amount of depreciation and the increasing repairs will tend to equalize each
other.
There are three decreasing charge methods, namely:
a. Sum of years' digits
b. Declining balance
c. Double declining balance
Sum of years' digits
The sum of years' digits method provides for depreciation that is computed by multiplying the
depreciable amount by a series of fractions whose numerator is the digit in the useful life of the asset
and whose denominator is the sum of the digits in the useful life of the asset. The fractions are
developed by getting the sum of the digits in the useful life of the asset.
sum of years' digit (SYD) as follows:
SYD = Life (Life +1 / 2)
Sum of half years' digits
If the useful life of the asset is 2 1/2 years, the procedure is to multiply the useful life by 2 in order to
get the useful life of the asset in half years. Thus, the useful life of the asset in half years would be 5 (2
1/2 years x 2). The sum of half years' digits would then be 15 or 1+2+3+4+5.
First year Two fractions: 5/15 and 4/15 (each fraction pertaining to half year or six months)

Second year Two fractions: (3/15 and 2/15)

Third year One fraction: 1/15

Declining balance method
Under the declining balance method, a fixed or uniform rate is multiplied by the declining carrying
amount of the asset in order to arrive at the annual depreciation. Because of the use of a fixed rate, this
method is also known as fixed rate on diminishing carrying amount method. The problem in this
method is the determination of the fixed rate to be applied against the carrying amount.
Formula for fixed rate
Rate = 1- √n Residual value ÷Cost
The "n" in the formula is the useful life of the asset. Observe that the nature of the method is such that
the value of the asset cannot be reduced to zero and that the formula cannot be used unless there is a
residual value. Thus, a residual value must always be assigned to the asset. In the absence of any
residual value, a nominal amount of P1should be assumed.
Double declining balance method
The common application of the declining balance method is the double declining balance. The
procedure for the double declining balance method is the same as the declining balance method in that
a fixed rate is multiplied by the declining carrying amount of the asset to arrive at the annual
depreciation. Actually, the double declining balance method is an approximation of the declining
balance method. The difference between the two lies in the determination of the rate to be used.
Under the declining balance method, the fixed rate is determined following a mathematical formula.
But under the double declining balance method, the straight line rate is simply doubled to get the fixed
rate. The term "double declining balance" came to its name because the straight line rate is simply
doubled. This method is also known as "200% declining balance method".
Inventory method
The inventory method consists of merely estimating the value of the asset at the end of the period. The
difference between the balance of the asset account and the value at the end of the year is then
recognized as depreciation for the year:
In recording depreciation, no accumulated depreciation account is maintained. The depreciation is
credited directly to the asset account.
This depreciation approach is applied generally to assets which are small and relatively inexpensive
such as hand tools or utensils. The approach is defended on practical grounds.
Retirement and replacement method
Under the retirement method of depreciation, no depreciation is recorded until the asset is retired. The
amount of depreciation is equal to the original cost of the asset retired minus salvage proceeds. Under
the replacement method, no depreciation is recorded until the asset is retired and replaced. The amount
of depreciation is equal to the replacement cost of the asset retired, minus salvage proceeds. If the asset
retired is not replaced, the original cost of the asset retired but not replaced is recognized as
depreciation. The retirement and replacement method may be used in much the same situations as the
inventory method.
Change in useful life
Unexpected physical deterioration or technological improvement may indicate that the useful life of the
asset is less than that originally estimated. On the other hand, improved maintenance procedures or
revision of operating procedures may prolong the useful life of the asset beyond the original estimate.
The useful life of an item of property, plant and equipment shall be reviewed at least at each financial
year-end and if expectations are significantly different from previous estimate, the change shall be
accounted for as a change in accounting estimate. Therefore, the depreciation charge for the current and
future periods shall be adjusted.
Change in depreciation method
Depreciation method used shall reflect the pattern in which the asset's economic benefits are expected
to be consumed by the entity. The depreciation method shall be reviewed at least at each financial year-
end and if there has been a significant change in the expected pattern of economic benefits embodied in
the asset, the method shall be changed to reflect the new pattern. When such a change in depreciation
method is necessary, the change shall be accounted for as a change in accounting estimate, and the
depreciation charge for the current and future periods shall be adjusted.

Depletion
IFRS 6
The objective of this standard is to specify the financial reporting for the exploration and evaluation of
mineral resources. Mineral resources include minerals, oil, natural gas and similar non-regenerative
resources.
Exploration and Evaluation
The term exploration and evaluation of mineral resources is defined as the search for mineral resources
after the entity has legal right to explore in a specific area as well as the determination of the technical
feasibility and commercial viability of extracting the mineral resources. The expenditures incurred by
an entity in connection with the exploration and evaluation of mineral resources before the technical
feasibility and commercial viability of extracting a mineral resource are known as exploration and
evaluation expenditures. Accordingly, exploration and evaluation expenditures do not include
expenditures incurred:
a. Before an entity has obtained the legal right to explore a specific area.
b. After the technical feasibility and commercial viability of extracting a mineral resource are
demonstrable.
This pertains to development expenditure.
Expenditures related to development of mineral resources, for example, preparation for commercial
production, such as building roads and tunnels, cannot be recognized as exploration and evaluation
expenditures.
Exploration and evaluation expenditures
a. Acquisition of rights to explore
b. Topographical, geological, geochemical and geophysical studies
c. Exploratory drilling
d. Trenching
e. Sampling
f. Activities in relation to evaluating the technical feasibility and commercial viability of
extracting a mineral resource.
g. General and administrative costs directly attributable to exploration and evaluation activities.
Exploration and evaluation asset
The exploration and evaluation expenditures may qualify as exploration and evaluation asset. However,
the standard does not provide a clearcut guidance for the recognition of exploration and evaluation
asset. Accordingly, an entity must develop its own accounting policy for the recognition of such asset.
As a matter of fact, IFRS 6 permits an entity to continue to apply its previous accounting policy
provided that the resulting information is relevant and reliable.
Measurement and classification
Exploration and evaluation asset shall be measured initially at cost. After initial recognition, an entity
shall apply either the cost model or the revaluation model. Exploration and evaluation asset is classified
either as tangible asset or an intangible asset.
Wasting Assets
Wasting assets are material objects of economic value and utility to man produced by nature. Actually,
wasting assets are natural resources. Natural resources usually include coal, oil, ore, precious metals
like gold and silver, and timber. Wasting assets are so called because these are physically consumed
and once consumed, the assets cannot be replaced anymore. If ever, the wasting assets can be replaced
only by the process of nature. Natural resources cannot be produced by man.
Thus, wasting assets are characterized by two main features:
a. The wasting assets are physically consumed.
b. The wasting assets are irreplaceable.
Cost of wasting asset
Entities follow a wide variety of practices in accounting for an extractive industry. At present, IFRS
does not address wasting assets. There is no comprehensive standard that is applicable to the extractive
or mining industry. The only standard related to the mining industry is IFRS 6 on the reporting of
exploration and evaluation expenditures. In general, the cost of wasting asset can be divided into four
categories, namely:
a. Acquisition cost
b. Exploration cost
c. Development cost
d. Estimated restoration cost
Acquisition cost
Acquisition cost is the price paid to obtain the property containing the natural resource.
Unquestionably, this is the initial cost of the wasting asset. Generally, the acquisition cost is charged to
any descriptive natural resource account. If there is a residual land value after the extraction of the
natural resource, the portion of the acquisition cost applicable to the land may be included in the
natural resource account. The land may be set up in a separate account and the remaining cost should
be charged to the natural resource account. Actually, the land value is the residual value of a wasting
asset for purposes of computing depletion. Thus, the land value should be deducted from the total
acquisition cost to get the depletable amount.
Exploration cost
Exploration cost is the expenditure incurred before the technical feasibility and commercial viability of
extracting a mineral resource are demonstrated. Simply stated, the exploration cost is the cost incurred
in an attempt to locate the natural resource that can economically be extracted or exploited. Exploration
cost includes acquisition of right to explore, geological study, exploratory drilling, trenching and
sampling. The exploration may result in either success or failure.
Two methods of accounting for exploration cost
1. Successful effort method
The exploration cost directly related to the discovery of commercially producible natural
resource is capitalized as cost of the resource property. The exploration cost related to "dry holes"
or unsuccessful discovery is expensed in the period incurred.
2. Full cost method
All exploration costs, whether successful or unsuccessful, are capitalized as cost of the
successful resource discovery. This is on the theory that any exploration cost is a "wild goose
chase" and therefore necessary before any commercially producible and profitable resource can be
found. The cost of drilling dry holes is part of the cost of locating productive holes.
Both methods are used in practice. Most large and successful oil entities follow the successful effort
method. The full cost method is popular among small oil entities.
Development cost
Development cost is the cost incurred to exploit or extract the natural resource that has been located
through successful exploration. Development cost may be in the form of tangible equipment and
intangible development cost. Tangible equipment includes transportation equipment, heavy machinery,
tunnels, bunker and mine shaft. The cost of tangible equipment is not capitalized as cost of natural
resource but set up in a separate account and depreciated in accordance with normal depreciation
policies. Intangible development cost is capitalized as cost of the natural resource. Such cost includes
drilling, sinking mine shaft and construction of wells.
Restoration cost
Estimated restoration cost is the cost to be incurred in order to bring the property to its original
condition. Such restoration cost may be added to the cost of resource property or "netted" against the
expected residual value of the resource property.
PAS 16, paragraph 16, provides that the estimated cost of restoring the property to its original
condition is capitalized only when the entity incurs the obligation when the asset is acquired. In other
words, the estimated restoration cost must be an existing present obligation required by law or contract.
The estimated restoration cost must be "discounted".
Depletion
The removal, extraction or exhaustion of a natural resource is called depletion. Depletion is the
systematic allocation of the depletable amount of a wasting asset over the period the natural resource is
extracted or produced. In essence, however, depletion is recognized as the cost of the material used in
production and thus becomes the finished product of the extractive entity since the wasting asset is
conceived as the total cost of the materials available for production.
Depletion method
Normally, depletion is computed using the output or production method. The depletable amount of the
wasting asset is divided by the units estimated to be extracted to obtain a depletion rate per unit. The
depletion rate per unit is then multiplied by the units extracted during the year to arrive at the depletion
for the period.
Revision of depletion rate
Not frequently, the original estimate of the resource deposit has to be changed either because new
information is available or because production processes have become more sophisticated. The revision
of the original estimate of recoverable resource deposit gives rise to the same problem faced in
accounting for change in estimate concerning the useful life of property, plant and equipment. Changes
in estimate are to be handled currently and prospectively, if necessary. Accordingly, the procedure is to
revise the depletion rate on a prospective basis, that is, by dividing the remaining depletable cost of the
wasting asset by the revised estimate of the productive output.
Depreciation of mining property
Tangible equipment such as transportation equipment, heavy machinery, mine shaft and other
equipment used in mining operations shall be reported in separate accounts and depreciated following
normal depreciation policies.
Generally, the depreciation of equipment used in mining operations is based on the useful life of the
equipment or the useful life of the wasting asset, whichever is shorter. If the useful life of the
equipment is shorter, the straight line method of depreciation is normally used. But if the useful life of
the wasting asset is shorter, the output method of depreciation is frequently used.
However, if the mining equipment is movable and can be used in future extractive project, the
equipment is depreciated over its useful life using the straight line method.
Shutdown
When the output method is used in depreciating mining property, in the event of shutdown, such
method cannot be used. In this case, the depreciation in the year of shutdown is based on the remaining
life of the equipment following the straight line method.
The remaining carrying amount of the equipment is divided by the remaining life of the equipment to
arrive at the depreciation in the year of shutdown.
Trust fund doctrine
Under the trust fund doctrine, the share capital of a corporation is conceived as a trust fund for the
protection of creditors. Consequently, such capital cannot be returned to shareholders during the
lifetime of the corporation. However, the corporation can pay dividends to shareholders but limited
only to the balance of retained earnings. Accordingly, the corporation cannot pay dividends if it has a
deficit because this would be tantamount to a return of capital to shareholders.
Wasting asset doctrine
Under the wasting asset doctrine, a wasting asset corporation or an entity engaged in the extraction of a
natural resource, can legally return capital to shareholders during the lifetime of the corporation.
Accordingly, a wasting asset corporation can pay dividend not only to the extent of retained earnings
but also to the extent of accumulated depletion. The amount paid in excess of retained earnings is
accounted for as a liquidating dividend or return of capital.
Philosophy of the wasting asset doctrine
The wasting asset doctrine authorizes the declaration of dividends in excess of the retained earnings of
the corporation. This is based on the legal philosophy that to limit dividend declaration to the retained
earnings balance would have the effect of retaining in the business funds which are not needed because
the wasting asset is irreplaceable.
The funds then would only be given to the shareholders when the corporation is finally dissolved and
liquidated. The unnecessary and undue retention of funds is unfair to shareholders because such funds
actually represent costs already recovered. Moreover, the creditors are aware of the decreasing capital
requirements which are peculiar to corporations engaged in the exploitation or extraction of natural
resources.

Revaluation
Measurement Of Property, Plant And Equipment
Initially, an item of property, plant and equipment that qualifies for recognition shall be measured at
cost. After recognition, an entity shall choose either the cost model or revaluation model as an
accounting policy and shall apply that policy to an entire class of property, plant and equipment.
Cost model
An item of property, plant and equipment shall be carried at cost less any accumulated depreciation and
any accumulated impairment losses.
Revaluation model
After recognition as an asset, an item of property, plant and equipment whose fair value can be
measured reliably can be carried at a revalued amount. The revalued amount is the fair value at the date
of the revaluation less any subsequent accumulated depreciation and subsequent accumulated
impairment losses.
Frequency of revaluation
Under IFRS, there is no clearcut rule on the frequency of revaluation. The frequency of revaluation
depends upon the changes in the fair value of property, plant and equipment being revalued. When the
fair value of a revalued asset differs materially from the carrying amount, a further revaluation is
necessary. Some property, plant and equipment may experience significant and volatile changes in fair
value thus necessitating annual revaluation. Such frequent or annual revaluations are unnecessary for
property, plant and equipment with only insignificant changes in fair value. Revaluation every three to
five years may be sufficient. IFRS does not mandate that revaluation must be done every three to five
years.
Revaluation of all items in an entire class
When property, plant and equipment are revalued, the entire class of property, plant and equipment
should be revalued. A class of property, plant and equipment is a grouping of assets of a similar nature
and use in an entity's operations.
Examples of separate classes are:
a. Land
b. Aircraft
c. Land and buildings
d. Machinery
e. Motor vehicles
f. Furniture and fixtures
g. Office equipment
h. Ships
The assets within a class of property, plant and equipment are revalued simultaneously in order to
avoid selective revaluation of assets and the reporting of amounts which are a mixture of cost and value
at different dates. However, a class of assets may be revalued on a rolling basis provided revaluation of
the class of assets is completed within a short period of time and provided the revaluations are kept up
to date.
Basis of revaluation
The revalued amount of property, plant and equipment is based on the following:
a. Fair value - The fair value is determined by appraisal normally undertaken by professional
qualified valuers. Fair value is the price that would be received to sell an asset in an orderly
transaction between market participants at the measurement date.
b. Depreciated replacement cost - Where market value is not available, depreciated
replacement cost shall be used.
Depreciated replacement cost is the replacement cost or current purchase price of the asset minus the
corresponding accumulated depreciation. The depreciated replacement cost is actually the sound value
of the asset.
Two approaches in recording the revaluation
a. Proportional approach - The accumulated depreciation at the date of revaluation is restated
proportionately with the change in the gross carrying amount of the asset so that the carrying
amount of the asset after revaluation equals the revalued amount.
b. Elimination approach - The accumulated depreciation is eliminated against the gross
carrying amount of the asset and the net amount restated to the revalued amount of the asset.
Carrying amount
is equal to historical cost minus the corresponding accumulated depreciation.
Appreciation or revaluation
increase is the excess of the replacement cost over the historical cost. 
Net appreciation
is equal to appreciation minus corresponding accumulated depreciation
Revaluation surplus
is equal to the fair value or depreciated replacement cost or sound value minus the carrying amount of
the property, plant and equipment. The revaluation surplus is also known as the revaluation increment.
Proportional approach
is the preferable method because it preserves the gross and net amounts after revaluation. Moreover,
this will prove useful in providing subsequent annual depreciation on cost and on the revaluation
increase and the consequent piecemeal realization of the revaluation surplus.
Elimination approach
The accumulated depreciation is eliminated or offset against the gross carrying amount of the
machinery.
Query
What is the treatment of the revaluation surplus?
When an asset's carrying amount is increased as a result of the revaluation, the increase shall be
credited to revaluation surplus as a component of other comprehensive income. The revaluation surplus
may be transferred directly to retained earnings when the surplus is realized.
The whole surplus may be realized on the retirement or disposal of the asset. However, if the revalued
asset is being depreciated, part of the surplus is being realized as the asset is used. The revaluation
surplus is allocated or realized over the remaining useful life of the asset and reclassified through
retained earnings
Reversal of a revaluation surplus
A revaluation decrease shall be charged directly against any revaluation surplus to the extent that the
decrease is a reversal of a previous revaluation and the balance is charged to expense.
Sale of revalued asset
When a revalued asset is sold, all accounts relating thereto shall be closed. The difference between the
sale price and the carrying amount of the revalued asset is recognized as gain or loss on the sale.
Disclosures related to revaluation
a. The effective date of revaluation.
b. Whether an independent valuer was involved.
c. Method and assumptions applied in estimating fair value.
d. Whether the fair value was determined directly by reference to observable prices in an active
market or recent market transactions using other valuation technique.
e. Historical cost and carrying amount of each class of revalued property, plant and equipment.
 f. Revaluation surplus, indicating the movement for the period and any restrictions on the
distribution of the balance to shareholders.

Impairment
Impairment is a fall in the market value of an asset so that the recoverable amount is now less than the
carrying amount in the statement of financial position. The carrying amount is the amount at which an
asset is recognized in the statement of financial position after deducting accumulated depreciation and
accumulated impairment loss.
Basic principle
The basic principle underlying impairment of asset is relatively straightforward. There is an established
principle that an asset shall not be carried at above the recoverable amount. An entity shall write down
the carrying amount of an asset to the recoverable amount if the carrying amount is not recoverable in
full. If the carrying amount is higher than the recoverable amount, the asset is judged to have suffered
an impairment loss. The asset shall therefore be reduced by the amount of the impairment loss.
Accounting for impairment
In this regard, there are three main accounting issues to consider, namely:
a. Indication of possible impairment
b. Measurement of the recoverable amount
c. Recognition of impairment loss
Indication of impairment
An entity shall assess at each reporting date whether there is any indication that an asset may be
impaired. If any such indication exists, the entity shall estimate the recoverable amount of the asset.
However, irrespective of whether there is any indication of impairment, a an entity shall test an
intangible asset with an indefinite useful life or an intangible asset not yet available for use for
impairment annually by comparing the carrying amount with the recoverable amount.
The events and changes in circumstances that lead to an impairment of assets may be classified as
external and internal sources of information.
External sources
a. Significant decrease or decline in the market value of the asset as a result of passage of time
or normal use or a new competitor the market.
b. Significant change in the technological, market, legal or economic environment of the
business in which the asset is employed.
This could be as simple as a change in customer taste.
c. An increase in the interest rate or market rate of return on investment which will likely affect
the discount rate used in calculating the value in use.
d. The carrying amount of net assets of the entity is more than the "market capitalization." In
other words, the carrying amount exceeds the fair value of the net assets. The market
capitalization simply means the fair value of the net assets of the entity.
Internal sources
a. Evidence of obsolescence or physical damage of an asset.
b. Significant change in the manner or extent in which the is used an adverse effect on the
entity.
c. Evidence that the economic performance of a asset will be worse than expected.
The external and internal sources of information are not exhaustive. An entity may identify other
indications that an asset may be impaired.
Measurement of recoverable amount
After establishing evidence that an asset has been impaired, the next step is to determine the
recoverable amount preparatory to the recognition of an impairment loss. The recoverable amount of an
asset is the fair value less cost of disposal or value in use, whichever is higher.
Fair value less cost of disposal
Fair value of an asset is the price that would be received to sell the asset in an orderly transaction
between market participants at the measurement date. Cost of disposal is an incremental cost directly
attributable to the disposal of an asset or cash generating unit, excluding finance cost and income tax
expense. In simple terms, fair value less cost of disposal is equal to the exit price or selling price of an
asset minus cost of disposal.
Value in use
Value in use is measured as the present value or discounted value of future net cash flows (inflows
minus outflows) expected to be derived from an asset. The cash flows are pretax cash flows and pretax
discount rate is applied in determining the present value.
Calculation of value in use
The following should be considered in determining value in use:
a. Cash flow projections shall be based on reasonable and supportable assumptions.
b. Cash flow projections shall be based on the most recent budgets on financial forecasts,
usually up to a maximum period of 5 years, unless a longer period can be justified.
c. Cash flow projections beyond the 5-year period shall be estimated by extrapolating the 5-
year projections using a steady or declining growth rate each subsequent year, unless an
increasing rate can be justified.
Composition of estimates of future cash flows
Estimates of future cash flows include:
a. Projections of cash inflows from the continuing use of the asset.
b. Projections of cash outflows necessarily incurred to generate the cash inflows from the
continuing use of the asset.
c. Net cash flows received on the disposal of the asset at the end of the useful life in an arm's
length transaction.
Estimates of future cash flows do not include:
a. Future cash flows relating to restructuring to which the entity is not yet committed
b. Future costs of improving or enhancing the asset's performance
c. Cash inflows or outflows from financing activities
d. Income tax
Reversal of an impairment loss
PAS 36, paragraph 114, provides that an impairment loss recognized for an asset in prior years shall be
reversed if there has been a change in the estimate of the recoverable amount
In other words, if the recoverable amount of an asset that has previously been impaired turns out to be
higher than the current amount, the carrying amount of the asset shall be increased to new recoverable
amount.
However, PAS 36, paragraph 117, provides that "the increased carrying amount of an asset due to a
reversal of an impairment loss shall not exceed the carrying amount that would have been determined
had no impairment loss been recognized for the asset in prior years."
As a simple guide, the increased carrying amount is the carrying amount had no impairment loss been
recognized or the recoverable amount, whichever is lower.
The reversal of the impairment loss shall be recognized immediately as income in the income
statement. But any reversal of an impairment loss on a revalued asset shall be credited to income to the
extent that it reverses a previous revaluation decrease and any excess credited directly to revaluation
surplus.
Cash generating unit (CGU)
A cash generating unit is the smallest identifiable group of assets that generate cash inflows from
continuing use that are largely independent of the cash inflows from other assets or group of assets. In
practice, a cash generating unit may be a department, a product line, or a factory for which the output
of product and the input of raw materials, labor and overhead can be identified.
As a basic rule, the recoverable amount of an asset shall be determined for the asset individually.
However, if it is not possible to estimate the recoverable amount of the individual asset, an entity shall
determine the recoverable amount of the cash generating unit to which the asset belongs.
The cash generating unit must be the smallest aggregation of assets for which cash flows can be
identified and which are independent of cash flows from other assets or group of assets.
An aggregation that is "too high" is prohibited. If aggregation is done at the "entity level", there would
be no impairment to be recognized.
On the other hand, if the impairment testing is done at the "department or product line level", then
some "loss-producing assets" would be written down to recoverable amount. The "cash generating
assets" would continue to be accounted for at carrying amount.
Allocation of impairment loss
Since there is no goodwill, the impairment loss is allocated across the assets based on carrying amount.
Cash generating unit with goodwill
Goodwill does not generate cash flows independently from other assets or group of assets, and
therefore, the recoverable amount of goodwill as an individual asset cannot be determined.
As a consequence, if there is an indication that goodwill may be impaired, recoverable amount is
determined for the cash generating unit to which goodwill belongs.
Determination of impairment
PAS 36, paragraph 90, provides that a cash generating unit to which goodwill has been allocated shall
be tested for impairment at least annually by comparing the carrying amount of the unit, including the
goodwill, with the recoverable amount.
 a. If the recoverable amount of the unit exceeds the carrying amount of the unit, the unit and
the goodwill allocated to that unit shall be regarded as not impaired.
b. If the carrying amount of the unit exceeds the recoverable amount of the unit, the entity must
recognize an impairment loss.
Carrying amount of CGU
Observe that the liabilities of the cash generating unit are ignored in determining carrying amount of
the CGU.
PAS 36, paragraph 76, provides that the carrying amount of a cash generating unit includes the
carrying amount of only those assets that can be attributed directly or allocated on a reasonable and
consistent basis to the cash generating unit and can generate the future cash inflows used in
determining the value in use of the cash generating unit.
Paragraph 76 further provides that the carrying amount of the cash generating unit does not include the
carrying amount of any recognized liability, unless the recoverable amount of the cash generating unit
cannot be determined without consideration of this liability.
The reason is stated in Paragraph 43 of PAS 36 which mandates that to avoid double counting,
estimates of future cash flows do not include cash outflows that relate to obligations that have been
recognized as liabilities by the cash generating unit, such as payables and provisions.
Corporate assets
Corporate assets are assets other than goodwill that contribute to the future cash flows of both the cash
generating unit under review and other cash generating units. Corporate assets are group or divisional
assets such as head office building, EDP, equipment or a research center.
Essentially, corporate assets are assets do not generate cash inflows independently from other assets.
Thus, the recoverable amount of an individual corporate asset cannot be determined unless
management has decided to dispose of the asset.
As a consequence, if there is an indication that a corporate asset may be impaired, the recoverable
amount of the cash generating unit to which the corporate asset belongs is determined and compared
with the carrying amount of the cash generating unit.

Lesson: Intangible Assets

Intangible Asset
PAS 38, paragraph 8, simply defines an intangible asset as an identifiable nonmonetary asset without
physical substance. Paragraph 8 further states that "the intangible asset must be controlled by the entity
as a result of past event and from which future benefits are expected to flow to the entity."

Accordingly, there are three essential criteria in the definition of an intangible asset, namely:
a. Identifiability
b. Control
c. Future economic benefits

Identifiability
The definition of an intangible asset requires that an intangible asset must be identifiable in order to
distinguish it clearly from goodwill. With nonphysical items, there may be a problem with
identifiability.

An asset is identifiable when:

a. It is separable. This means that the asset is capable of being separated from the entity and
sold, transferred, licensed, rented or exchanged, either individually or together with a related
asset or liability.
b. It arises from contractual or other legal rights. This is regardless of whether these rights are
transferable or separable from the entity or from other rights and obligations.

Control
Another element in the definition of an intangible asset is that "it must be under the control of the entity
as a result of a past event." Control is the power of the entity to obtain the future economic benefits
flowing from the intangible asset and restrict the access of others to those benefits.

In other words, the entity must be able to enjoy the future conomic benefits from the asset and prevent
others from enjoying the same benefits. The capacity of an entity to control the future economic
benefits from an intangible asset normally would stem from legal rights that are enforceable in a court
of law.

The capacity to control future economic benefits is much pronounced in the case of trademark,
copyright and patent. In the absence of legal rights, it is more difficult to demonstrate control.
However, legal enforceability of a right is not always a necessary condition for control since an entity
may be able to control the future benefits in some other way.

Future economic benefits

Future economic benefits may include revenue from the sale of products or services, cost savings or
other benefits resulting from the use of the asset by the entity.

An intangible asset shall be recognized if the following conditions are present:

a. It is probable that future economic benefits attributable to the asset will flow to the entity.
b. The cost of the intangible asset can be measured reliably.

Judgment is usually exercised in assessing the degree of certainty of the future economic benefits. The
judgment is based on external evidence.

Initial measurement of intangible asset

PAS 38, paragraph 24, provides that an intangible asset shall be measured initially at cost. The cost of
an intangible asset depends on the following:

a. Separate acquisition
b. Acquisition as part of a business combination
c. Acquisition by way of a government grant
d. Acquisition by exchange
e. Acquisition by self-creation or internal generation

Separate acquisition
If an intangible asset is acquired separately, the cost of the intangible asset can be, measured reliably,
particularly so if the purchase consideration is in the form of cash or other monetary assets.

The cost of a separately acquired intangible asset comprises:

a. Purchase price
b. Import duties and nonrefundable purchase taxes
c. Directly attributable costs of preparing the asset for the intended use

Directly attributable costs include the following:

a. Costs of employee benefits arising directly from bringing the asset to its working condition.
b. Professional fees arising directly from bringing the asset to its working condition.
c. Costs of testing whether the asset is functioning properly.

Costs which are not capitalizable

Examples of costs that are not included in the cost of an intangible asset but expensed immediately are:
a. Costs of introducing a new product or service, including costs of advertising and
promotional activities
b. Costs of conducting business in a new location or with a new class of customer, including
costs of staff training
c. Administration and other general overhead costs
d. Costs incurred while an asset capable of operating in a manner intended by management has
yet to be brought into use
e. Initial operating loss

Acquisition as part of business combination

If an intangible asset is acquired in a business combination, the cost of the intangible asset is based on
the fair value on the date of acquisition.

Acquisition by government grant

An intangible asset may be acquired by way of a government grant, free of charge or for nominal
consideration. This may occur when a government transfers or allocates to an entity intangible assets
such as:
a. Airport land rights
b. Licenses to operate radio or television stations
c. Import licenses or quotas or rights to access restricted resources.
The intangible asset acquired by way of government grant may be initially recorded at either:
a. Fair value
b. Nominal amount or zero, plus any expenditure that is directly attributable to preparing the
asset for its intended use.

Acquisition by exchange
The cost of the intangible asset is measured at fair value of the asset given up plus any cash payment,
unless the exchange transaction lacks commercial substance. If the exchange transaction lacks
commercial substance, the intangible asset is measured at the carrying amount of the asset given up
plus any cash payment. An exchange transaction lacks commercial substance when the cash flows of
the asset received do not differ significantly from the cash flows of the asset transferred.

Internally generated intangible asset

The cost of an internally generated intangible asset comprises all directly attributable costs necessary to
create, produce and prepare the asset to be capable of operating it in the manner intended by
management.
Examples of directly attributable costs are:
a. Cost of materials and services used or consumed in generating the intangible asset.
b. Costs of employee benefits arising from the generation of the intangible asset.
c. Fees to register a legal right.
d. Amortization of patents and licenses that are used to generate the intangible asset.
However, the following expenditures are not components of the cost of an internally generated
intangible asset:
a. Selling, administrative and other general overhead, unless this expenditure can be directly
attributed to preparing the asset for use.
b. Clearly identified inefficiencies and initial operating losses incurred before an asset achieves
planned performance.
c. Expenditure on training staff to operate the asset.
PAS 38, paragraph 63, explicitly provides that "internally generated brands, mastheads, publishing
titles, customer lists and items similar in substance shall not be recognized as intangible assets".

Recognition as an expense
An expenditure on an intangible item that does not meet the recognition criteria for an intangible asset
shall be expensed when incurred.
Examples of expenditures that are expensed when incurred include:
a. Start up costs
Start up costs may consist of organization costs such as legal and secretarial costs incurred in
establishing a legal entity. Start up costs also include preopening costs or expenditures to open a new
facility or business, and preoperating costs or expenditures for commencing new operation or
launching new product.
b. Training costs
c. Advertising and promotional costs
d. Business relocation or reorganization costs

Subsequent expenditure
As a rule, a subsequent expenditure on an intangible asset shall be recognized as expense. The reason is
that most subsequent expenditures are likely to maintain only the expected future economic benefits
embodied in the intangible asset. However, the subsequent expenditure may be capitalized or added to
the cost of the intangible asset if the following recognition criteria for an intangible asset are met:
a. It is probable that future economic benefits that are attributable specifically to the subsequent
expenditure will flow to the entity.
b. The subsequent expenditure can be measured reliably.
The nature of an intangible asset is such that, in many cases, it is not possible to determine whether
subsequent expenditure is likely to enhance the economic benefits that will flow to the entity from the
intangible asset. Therefore, only rarely will a subsequent expenditure on an intangible asset result to an
addition to the cost of the intangible asset.

Identifiable intangible assets

PAS 38 specifically pertains to identifiable intangible assets. If the intangible asset is acquired through
purchase, there is a transfer of legal right that would make the asset identifiable. Moreover, if the asset
could be sold, transferred, licensed, rented or sold separately, the intangible asset is identifiable.

Examples of identifiable intangible assets are:

a. Patent
b. Copyright
c. Franchise
d. Trademark or brandname
e. Customer list £ Computer software
f. Broadcasting license, airline right and fishing right
Unidentifiable intangible asset
An intangible asset is unidentifiable if it cannot be sold, transferred, licensed, rented or exchanged
separately. The intangible asset is inherent in a continuing business and can only be identified with the
entity as a whole. This unidentifiable intangible asset squarely describes a goodwill.

Classification of intangible assets

a. Intangible assets with definite life
Typical examples include patent, copyright, franchise with fixed term, computer software, customer list
and license.
b. Intangible assets with indefinite life
Typical examples include goodwill, trademark and perpetual franchise.

Measurement after recognition

An entity shall choose either the cost model or revaluation model as an accounting policy.
1. Cost model-An intangible asset shall be carried at cost, less any accumulated amortization
and any accumulated impairment loss.
2. Revaluation model - An intangible asset shall be carried at a revalued amount, less any
subsequent amortization and any subsequent accumulated impairment loss.
The revalued amount is the fair value at the date of revaluation and is determined by reference to an
active market. Thus, an intangible asset can only be carried at revalued amount if there is an active
market for the asset.

Amortization and impairment of intangible assets

PAS 38, paragraph 97, states that intangible assets with limited or finite life are amortized over their
useful life. Intangible assets with finite useful life are tested for impairment whenever there is an
indication of impairment at the end of reporting period. Paragraphs 107 and 108 state that intangible
assets with indefinite life are not amortized but are tested for impairment at least annually and
whenever there is an indication that the intangible asset may be impaired. An impairment loss on an
intangible asset is recognized if the recoverable amount is less than the carrying amount. The
recoverable amount of the intangible asset is the higher between fair value less cost of disposal and
value in use.

Amortization
Amortization is the systematic allocation of the amortizable amount of an intangible, asset over the
useful life. The amortizable amount is the cost of the intangible asset less residual value. The
amortization is recorded by debiting amortization expense and crediting the intangible asset account.
Normally, the intangible asset account is credited directly for the periodic amortization but an
accumulated amortization account may be maintained.

Amortization period
The amortizable amount of an intangible asset shall be amortized on a systematic basis over the useful
life. Amortization shall begin wher the asset is available for use, meaning, when the asset is in the
location and condition for the intended use. Amortization shall cease when the intangible asset is
derecognized or when the asset is classified as "held for sale".
Useful life
The useful life of an intangible asset must be assessed as either indefinite or finite. If finite, the useful
life may be expressed in terms of years or the number of units to be produced. The useful of an
intangible asset is indefinite when there is no foreseeable limit to the period over which the asset is
expected to generate net cash flows.

Factors affecting useful life

a. Technical, technological, commercial or other type of obsolescence
b. Expected action by competitors or potential competitors
c. Expected usage of the asset by the entity
d. Typical product life cycle for the asset
e. Stability of the industry in which the asset operates
f. Level of maintenance expenditure required to obtain the expected future economic benefits
from the asset
g. The useful life of the asset may be dependent on the useful life of other assets of the entity.
h. Period of control over the asset and legal or similar limits on the use of the asset, such as
expiry dates of related leases.

Amortization method
The method of amortizatio shall reflect the pattern in which the future economic benefits from the asset
are expected to be consumed by the entity. However, if such pattern cannot be determined reliably, the
straight line method of amortization shall be used.

Residual value
The residual value of an intangible asset shall be presumed to be zero, except:
a. When a third party is committed to buy the intangible asset at the end of the useful life.
b. When there is an active market for the intangible asset so that the expected residual value
can be measured and it is probable that there will be a market for the asset at the end of the
useful life.
The residual value is reviewed at each financial year-end. A change in the residual value is accounted
for as a change in accounting estimate. The residual value of an intangible asset may increase to
amount equal to or greater than the carrying amount.

Change in amortization method and useful life

The amortization method and the useful life of an intangible asset shall be reviewed at each financial
year-end. If the expected useful life of the intangible asset is significantly different from previous
estimate, the amortization period shall be changed accordingly.
If there has been a significant change in the expected pattern of economic benefits from the asset, the
amortization method shall be changed to reflect the new pattern. Such changes shall be accounted for
as changes in accounting estimates and therefore, shall be treated currently and prospectively.

Derecognition of an intangible asset

An intangible asset shall be derecognized or eliminated from the statement of financial position:
a. On disposal of the asset
b. When no future economic benefits are expected from use and disposal of the asset
Gain and loss arising from the derecognition of an intangible asset shall be determined as the difference
between the net disposal proceeds and the carrying amount of the asset.

Disclosures related to intangible assets

1. Whether useful lives are indefinite or finite, and if finite, the useful lives or the amortization
rate.
2. The amortization method.
3. The carrying amount and any accumulated amortization at the beginning and end of the
period.
4. The line item in the income statement in which any amortization of intangible asset is
included.
5. Additions, separately showing those internally generated, acquired separately and acquired
through business combination.
6. Intangible assets classified as held for sale
7. Increases and decreases in intangible assets resulting from revaluations.
 8. Impairment losses and reversal of impairment losses.
9. Net exchange differences on translation.
10. The carrying amount of intangible asset with indefinite life and the reason for the indefinite
life.
11. The carrying amount and remaining amortization period of intangible assets that are material
12. The carrying amount of intangible asset whose title is restricted or pledged as collateral
security.
13. Contractual commitments for intangible assets.
14. Intangible assets acquired by way of government grant and initially recognized at fair value.
15. The amount of research and development expenditure recognized as expense during the
period.

Goodwill
Goodwill is undeniably a unique asset presented in the financial statements. Goodwill is often referred
to as the most intangible of all intangible assets. Goodwill is unique in the sense that goodwill standing
alone cannot be bought and sold. The goodwill can only be identified with the entity as a whole.
Goodwill is an intangible asset that is not specifically identifiable, has an indeterminate life, is inherent
in a continuing business and relates to the entity as a whole.

What is goodwill?
Goodwill arises when earnings exceed normal earnings by reason of good name, capable staff and
personnel, high credit standing. reputation for fair dealings, reputation for superior products, favorable
location and a list of regular customers.
In other words, goodwill is created by a good relationship between an entity and the customers:
a. By building up a reputation by word of mouth for high quality products or high standard of
service.
b. By responding promptly and helpfully to queries and complaints of customers.
c. Through the personality of the staff and their attitude to the customers.
d.
Recognition of goodwill
In recognizing goodwill, distinction should be made between developed goodwill and purchased
goodwill.
Developed goodwill or internal goodwill is that goodwill which is generated internally because of good
name, capable staff and personnel, superior quality of products, favorabie location and high credit
standing.

PAS 38, paragraph 48, provides that internally generated goodwill shall not be recognized as an asset.
Purchased goodwill is the goodwill that has been paid for.

Purchased goodwill arises when a business is purchased. People wishing to set up a business either
would start the business from scratch or buy an existing business. When an enti acquires an existing
business, it will have to pay not only for the net tangible and identifiable intangible assets but also the
goodwill of the business. Purchased goodwill is recognized as an asset because it has been paid for.

Measurement of goodwill
The measurement of goodwill is not really a problem for accountants who will simply record the
goodwill in the accounts of the new business. The value of goodwill is a matter for the purchaser and
seller to agree upon in fixing the purchase price of the business. Two approaches may be followed in
measuring goodwill, namely residual approach and direct approach.

Residual approach
Under the residual approach, goodwill is measured by comparing the purchase price for the entity with
the net tangible and identifiable assets, meaning total assets excluding goodwill minus liabilities
assumed. The net assets acquired must be measured at fair value. The excess of the purchase price over
the fair value of net tangible and identifiable assets is considered as goodwill.

Direct approach
Under this approach, goodwill is measured on the basis of the future earnings of the entity. An attempt
is made to value the anticipated excess earnings which are the essential component of goodwill.
This approach seems to be a systematic and logical way of measuring goodwill because if future
earnings exceed normal earnings, the excess earnings are indicative of the fact that there is an
unidentifiable intangible asset that is causing the excess earnings. Such unidentifiable intangible asset
is called goodwill.

A sophisticated application of this approach requires the following information:

a. A normal rate of return for representative entities in the industry. The normal rate of return is
that rate of return which usually attracts investors in a particular industry.
b. The fair value of tangible assets and any identifiable intangible assets.
c. The estimated future normal earnings of the entity.
d. The probable duration of any "excess earnings" attributable to goodwill.

Impairment of goodwill
PAS 38, paragraph 107, mandates that goodwill shall not be amortized because the useful life is
indefinite. However, goodwill shall be tested for impairment at least annually and whenever there is an
indication that it may be impaired.
Moreover, goodwill shall be tested for impairment at the operating segment level or any lower level.
An impairment loss recognized for goodwill shall not be reversed in a subsequent period.

Negative goodwill
If the purchase price or consideration transferred for the entity is less than the net fair value of the
identifiable assets acquired and liabilities assumed, the difference is negative goodwill.
PFRS 3, paragraph 34, provides that such negative goodwill is recognized in profit or loss as "gain on
bargain purchase".