Property, Plant and Equipment

 
 PAS 16 applies to separable property, plant and
equipment
 PAS 16 does not apply to:
a. Property held for sale in accordance with IFRS 5;
b. Biological assets related to agricultural activity;
c. Mineral rights, and mineral reserves such as on oil,
natural gas and similar non-regenerative resources..
 However, this Standard applies to property, plant and
equipment used to develop or maintain the assets
described in (b) and (c) above.
 Also applies to property that is being constructed or
developed for future use but not yet satisfy the definition of
investment property.
Property, plant and equipment – tangible assets to be
used during more than one period and that are
held for use:
o in the production or supply of goods or services;
o For rental to others; or
o For administrative purposes
Cost is the cash or cash equivalent paid or the fair
value of the consideration given to acquire the
asset.
Depreciable amount – is cost less its residual value
Residual value – the estimated amount that an entity
would currently obtain from disposal of the asset,
after deducting the costs of disposal, if the asset
were already of the age and in condition expected
at life end of its useful life.
Useful life – is either:
o the period of time over which it is expected to be used;
or
o the number of production units expected to be obtained
from it.
Depreciation – the systematic allocation of the depreciable
amount of an asset over its useful life.
Fair Value – the amount for which the asset could be
exchanged between knowledgeable, willing parties in an
arm’s length transaction.
Carrying Amount - the amount at which an asset is recognized
after deducting any accumulated depreciation and
accumulated impairment losses.
Impairment Loss – the amount by which the carrying amount
of an asset exceeds the recoverable amount.
Recoverable Amount – the higher of an asset’s net selling
price and its value in use.
Entity - specific Value – the present value of the cash flows an
entity expects to arise from the continuing use of an asset
and from its disposal at the end of its useful life or expects
to incur when settling a liability.
 Property, plant and equipment should be recognized as an
asset when:
o It is probable that future economic benefits associated with the
asset will flow to the enterprise;
o The cost of the asset can be measured reliably.
 Property, plant and equipment should be initially measured
at cost.
 Spare parts and servicing equipment are usually carried as
inventory and recognized in profit or loss as consumed,
unless they are expected to be used during more than one
period.
 It may be appropriate to aggregate individually insignificant
items and apply the criteria to the aggregate value.
 PPE is initially recognized at cost. These costs include
o Cost initially incurred to acquire or construct an item of PPE;
o Cost incurred subsequently to add to, replace part of, or service it.
 Items of PPE may be acquired for safety or environmental
reasons. These acquisitions should form part of the cost of
PPE although not directly increasing the future economic
benefits of existing PPE.
 Purchase price (including import duties and non-refundable
purchase taxes);
 Less any discounts or rebates;
 Plus any directly attributable costs such as site preparation,
initial delivery and handling costs, installation costs,
professional fees;
 Less implicit interest in deferred payments; Borrowing costs
in certain cases; and
 The initial estimate of the costs of dismantling and
removing the item and restoring the site on which it is
located, the obligation for which an entity incurs either
o when the item is acquired; or
o as a consequence of having used the item during a particular period
for purposes other than to produce inventories during that period.
ABC Company acquired a welding machine with an invoice
price of P3,000,000 subject to cash discount of 5% which
was not taken. ABC incurred freight and insurance during
shipment of P50,000 and testing and installation cost of
P200,000. ABC also incurred cost of P20,000 in
removing the old welding machine prior to the installation
of the new one. Welding supplies were acquired at a cost
of P100,000. VAT on the acquisition is P360,000, What
will be the cost of the welding machine?

Answer: P3,100,000
 The cost of the item is the price equivalent at the
recognition date.
 If payment is deferred beyond normal credit terms, the
difference between the cash price equivalent and the
total payment is recognized as interest.
 If PPE is acquired in a non-monetary exchange, cost is
measured at fair value, unless
o The exchange transaction lack commercial substance; or
o The fair value of neither the asset received nor the asset
given up can be measured reliably
 Ifthe acquired item is not measured at fair value, its
cost is measured at the carrying amount of the asset
given up.
Cost of Land
Includes all costs to acquire land and ready it for use. Costs
typically include:
(1) purchase price;
(2) closing costs, such as title to the land, attorney’s fees, and
recording fees;
(3) costs of grading, filling, draining, and clearing;
(4) assumption of any liens, mortgages, or encumbrances on
the property; and
(5) additional land improvements that have an indefinite life.
LO 2
Cost of Land
Improvements with limited lives, such as private
driveways, walks, fences, and parking lots, are recorded
as Land Improvements and depreciated.

► Land acquired and held for speculation is classified

as an investment.

► Land held by a real estate concern for resale should

be classified as inventory.

LO 2 Identify the costs to include in initial valuation of

property, plant, and equipment.
Cost of Buildings
Includes all costs related directly to acquisition or
construction. Cost typically include:

(1) materials, labor, and overhead costs incurred during

construction and
(2) professional fees and building permits.

LO 2 Identify the costs to include in initial valuation of

property, plant, and equipment.
Cost of Equipment
Include all costs incurred in acquiring the equipment and
preparing it for use. Costs typically include:
(1) purchase price,
(2) freight and handling charges
(3) insurance on the equipment while in transit,
(4) cost of special foundations if required,
(5) assembling and installation costs, and
(6) costs of conducting trial runs.

LO 2 Identify the costs to include in initial valuation of

property, plant, and equipment.
E10-1 (variation): The expenditures and receipts below are related to
land, land improvements, and buildings acquired for use in a business
enterprise. Determine how the following should be classified:
Classification
(a) Money borrowed to pay building contractor Notes Payable
(b) Payment for construction from note proceeds Building
(c) Cost of land fill and clearing Land
(d) Delinquent real estate taxes on property Land
assumed
(e) Premium on 6-month insurance policy during Building
construction
(f) Refund of 1-month insurance premium because (Building)
construction completed early
E10-1 (variation): The expenditures and receipts below are related to
land, land improvements, and buildings acquired for use in a business
enterprise. Determine how the following should be classified:
Classification
(g) Architect’s fee on building Building
(h) Cost of real estate purchased as a plant site (land
Land
P200,000 and building P50,000)
(i) Commission fee paid to real estate agency Land
(j) Installation of fences around property Land Improvements
(k) Cost of razing and removing building Land
(l) Proceeds from salvage of demolished building (Land)
(m) Cost of parking lots and driveways Land Improvements
(n) Cost of trees and shrubbery (permanent) Land
 An entity applies PAS 2, Inventories, to the costs of
obligations for dismantling, removing and restoring the site
on which an item is located that are incurred during a
particular period as a consequence of having used the item
to produce inventories during that period.
 The obligations for costs accounted for in accordance with
PAS 2 or PAS 16 are recognized and measured in
accordance with PAS 37.
Decommissioning Provisions
A company must recognize an decommissioning liability
when it has an existing legal obligation associated with the
retirement of a long-lived asset and when it can reasonably
estimate the amount of the liability.

LO 4 Explain the accounting for different types

of provisions.
Decommissioning Provisions
Obligating Events. Examples of existing legal obligations, which
require recognition of a liability include, but are not limited to:
► Decommissioning nuclear facilities,
► Dismantling, restoring, and reclamation of oil and gas
properties,
► Certain closure, reclamation, and removal costs of mining
facilities,
► Closure and post-closure costs of landfills.

LO 4 Explain the accounting for different types

of provisions.
Decommissioning Provisions
Measurement. A company initially measures an environmental
liability at the best estimate of its future costs.

Recognition and Allocation. To record an environmental liability a

company includes

► the cost associated with the environmental liability in the

carrying amount of the related long-lived asset, and

► records a liability for the same amount.

LO 4 Explain the accounting for different types

of provisions.
Illustration: On January 1, 2010, Bear Oil Company erected an oil
platform in the Gulf of Mexico. Bear is legally required to dismantle
and remove the platform at the end of its useful life, estimated to be
five years. Bear estimates that dismantling and removal will cost
P1,000,000. Based on a 10 percent discount rate, the fair value of
the environmental liability is estimated to be P620,920 (P1,000,000 x
.62092). Bear records this liability on Jan. 1, 2011 as follows.

Drilling platform 620,920

Decommissioning liability 620,920

LO 4 Explain the accounting for different types

of provisions.
Illustration: During the life of the asset, Bear allocates the asset
retirement cost to expense. Using the straight-line method, Bear
makes the following entries to record this expense.

December 31, 2011, 2012, 2013, 2014, 2015

Depreciation expense (P620,920 / 5) 124,184

Accumulated depreciation 124,184

LO 4 Explain the accounting for different types

of provisions.
Illustration: In addition, Bear must accrue interest expense each
period. Bear records interest expense and the related increase in the
environmental liability on December 31, 2011, as follows.

December 31, 2011

Interest expense (P620,092 x 10%) 62,092

Decommissioning liability 62,092

LO 4 Explain the accounting for different types

of provisions.
Illustration: On January 10, 2016, Bear contracts with Rig
Reclaimers, Inc. to dismantle the platform at a contract price of
P995,000. Bear makes the following journal entry to
record settlement of the liability.

January 10, 2016

Decommissioning liability 1,000,000

Gain on settlement of liability 5,000
Cash 995,000

LO 4 Explain the accounting for different types

of provisions.
IFRIC 1: Changes in the measurement of decommissioning liability
shall be accounted for as follows:
1. A decrease in the liability is deducted from the cost of the asset. If
the decrease in liability is greater than the cost of the asset, the
excess is recognized in profit or loss.
2. An increase in liability is added to the cost of the asset. However,
the entity shall consider whether this is an indication that the
carrying amount of the asset may not be fully recovered. If there is
such an indication, the asset should be tested for impairment.

LO 4 Explain the accounting for different types

of provisions.
Costs typically include:
(1) Materials and direct labor
(2) Overhead can be handled in two ways:
1. Assign no fixed overhead
2. Assign a portion of all overhead to the construction
process.
Companies use the second method extensively.
Special Issues Related to Interest Capitalization
1. Expenditures for land.

► Interest costs capitalized are part of the cost of the

plant, not the land.

2. Interest revenue.

► Interest revenue should be offset against interest

cost when determining the amount of interest to
capitalized.

LO 4 Describe the accounting problems associated with interest capitalization.

Cash Discounts — Whether taken or not — generally
considered a reduction in the cost of the asset.

Deferred-Payment Contracts — Assets, purchased through

long term credit, are recorded at the present value of the
consideration exchanged.

Lump-Sum Purchases — Allocate the total cost among the

various assets on the basis of their fair market values.

Issuance of Shares — The market value of the shares issued

is a fair indication of the cost of the property acquired.
LO 5 Understand accounting issues related to acquiring and valuing plant assets.
Exchanges of Nonmonetary Assets
Ordinarily accounted for on the basis of:
► the fair value of the asset given up or
► the fair value of the asset received,
whichever is clearly more evident.

Companies should recognize immediately any gains or losses

on the exchange when the transaction has commercial
substance.

LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Meaning of Commercial Substance
Exchange has commercial substance if the future cash flows
change as a result of the transaction.

That is, if the two parties’ economic positions change, the

transaction has commercial substance.
Illustration 10-10
An exchange transaction has commercial substance if:
 The configuration of the cash flows of the asset received
differs from the configuration of the cash flows of the asset
transferred; or
 The entity – specific value of the portion of the entity’s
operations affected by the transaction changes as a result
of the exchange; and
 The difference in the first two items above is significant
relative to the fair value of the assets exchanged.

*Should reflect post – tax cash flows.

Exchanges - Loss Situation
Companies recognize a loss immediately whether the
exchange has commercial substance or not.

Rationale: Companies should not value assets at more than

their cash equivalent price; if the loss were deferred, assets
would be overstated.

LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Illustration: Information Processing, Inc. trades its used machine for a
new model at Jerrod Business Solutions Inc. The exchange has
commercial substance. The used machine has a book value of P8,000
(original cost P12,000 less P4,000 accumulated depreciation) and a fair
value of P6,000. The new model lists for P16,000. Jerrod gives
Information Processing a trade-in allowance of P9,000 for the used
machine. Information Processing computes the cost of the new asset
as follows.

Illustration 10-11

LO 5 Understand accounting issues related to acquiring and valuing plant assets.

 Illustration: Information Processing records this transaction as follows:

Equipment 13,000
Accumulated Depreciation—Equipment 4,000
Loss on Disposal of Equipment 2,000
Equipment 12,000
Cash 7,000

Illustration 10-12
Loss on
Disposal

LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Exchanges - Gain Situation

Has Commercial Substance. Company usually records the

cost of a nonmonetary asset acquired in exchange for
another nonmonetary asset at the fair value of the asset
given up, and immediately recognizes a gain.

LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Illustration: Interstate Transportation Company exchanged a number
of used trucks plus cash for a semi-truck. The used trucks have a
combined book value of $42,000 (cost $64,000 less $22,000
accumulated depreciation). Interstate’s purchasing agent,
experienced in the second-hand market, indicates that the used trucks
have a fair market value of $49,000. In addition to the trucks,
Interstate must pay $11,000 cash for the semi-truck. Interstate
computes the cost of the semi-truck as follows.

Illustration 10-13

LO 5 Understand accounting issues related to acquiring and valuing plant assets.

 Illustration: Interstate records the exchange transaction as follows:

Semi-truck 60,000
Accumulated Depreciation—Trucks 22,000
Trucks 64,000
Gain on disposal of Used Trucks 7,000
Cash 11,000

Illustration 10-14

Gain on
Disposal

LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Exchanges - Gain Situation

Lacks Commercial Substance.

Now assume that Interstate Transportation Company
exchange lacks commercial substance. That is, the
economic position of Interstate did not change significantly
as a result of this exchange. In this case, Interstate defers
the gain of $7,000 and reduces the basis of the semi-truck.

LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Illustration: Interstate records the exchange transaction as
follows:

Semi-truck 53,000
Accumulated Depreciation—Trucks 22,000
Trucks 64,000
Cash 11,000

Illustration 10-15

LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Summary of Gain and Loss Recognition on
Exchanges of Non-Monetary Assets Illustration 10-16

Disclosure include:
 nature of the transaction(s),
 method of accounting for the assets exchanged, and
 gains or losses recognized on the exchanges.

LO 5 Understand accounting issues related to acquiring and valuing plant assets.

E10-19: Santana Company exchanged equipment used in its
manufacturing operations plus $2,000 in cash for similar equipment
used in the operations of Delaware Company. The following
information pertains to the exchange.

Santana Delaware
Equipment (cost) $28,000 $28,000
Accumulated Depreciation 19,000 10,000
Fair value of equipment 13,500 15,500
Cash given up 2,000

Instructions: Prepare the journal entries to record the exchange on the

books of both companies.

LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Calculation of Gain or Loss
Santana Delaware
Fair value of equipment received $15,500 $13,500
Cash received / paid (2,000) 2,000
Less: Bookvalue of equipment
($28,000-19,000) (9,000)
($28,000-10,000) (18,000)
Gain or (Loss) on Exchange $4,500 ($2,500)

LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Has Commercial Substance
Santana:
Equipment 15,500
Accumulated depreciation 19,000
Cash 2,000
Equipment 28,000
Gain on exchange 4,500

Delaware:
Cash 2,000
Equipment 13,500
Accumulated depreciation 10,000
Loss on exchange 2,500
Equipment 28,000

LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Santana (Has Commercial Substance):
Equipment 15,500
Accumulated depreciation 19,000
Cash 2,000
Equipment 28,000
Gain on disposal of equipment 4,500

Santana (LACKS Commercial Substance):

Equipment (15,500 – 4,500) 11,000
Accumulated depreciation 19,000
Cash 2,000
Equipment 28,000

LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Delaware (Has Commercial Substance):
Cash 2,000
Equipment 13,500
Accumulated depreciation 10,000
Loss on disposal of equipment 2,500
Equipment 28,000

Delaware (LACKS Commercial Substance):

Cash 2,000
Equipment 13,500
Accumulated depreciation 10,000
Loss on disposal of equipment 2,500
Equipment 28,000

LO 5 Understand accounting issues related to acquiring and valuing plant assets.

 Trade – in is a form of exchange, where property is
acquired by exchanging another property as partial
payment and the balance payable in cash or any other
form of payment in accordance with agreed terms.
 The asset acquired is recorded at the following, in the
order of priority
o Fair value of the asset given plus cash payment
o Trade-in value of the asset given plus cash payment
 Contributions of property from shareholders
shall be recorded at the fair value of the items
received, with the credit to additional paid in
capital or donated capital, if significant.
 Expenses incurred in connection with the
donation shall be charged to the donated
capital account.
 Directly attributable costs incurred shall be
capitalized.
Grants are assistance received from a government in the form
of transfers of resources to a company in return for past or
future compliance with certain conditions relating to the
operating activities of the company.
IFRS requires grants to be recognized in income (income
approach) on a systematic basis that matches them with the
related costs that they are intended to compensate.

LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Example 1: Grant for Lab Equipment. AG Company received a
P500,000 subsidy from the government to purchase lab equipment
on January 2, 2011. The lab equipment cost is P2,000,000, has a
useful life of five years, and is depreciated on the straight-line basis.

IFRS allows AG to record this grant in one of two ways:

1. Credit Deferred Grant Revenue for the subsidy and amortize

the deferred grant revenue over the five-year period.

2. Credit the lab equipment for the subsidy and depreciate this
amount over the five-year period.

LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Example 1: Grant for Lab Equipment. If AG chooses to record
deferred revenue of P500,000, it amortizes this amount over the five-
year period to income (P100,000 per year). The effects on the
financial statements at December 31, 2011, are:
Illustration 10-17

LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Example 1: Grant for Lab Equipment. If AG chooses to reduce the
cost of the lab equipment, AG reports the equipment at P1,500,000
(P2,000,000 - 500,000) and depreciates this amount over the five-
year period. The effects on the financial statements at December 31,
2011, are:
Illustration 10-18

LO 5 Understand accounting issues related to acquiring and valuing plant assets.

When a company contributes a non-monetary asset, it should
record the amount of the donation as an expense at the fair
value of the donated asset.

Illustration: Kline Industries donates land to the City of San

Paulo for a city park. The land cost P80,000 and has a fair value
of P110,000. Kline Industries records this donation as follows.

Contribution Expense 110,000

Land 80,000
Gain on Disposal of Land 30,000

LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Recognize costs subsequent to acquisition as an asset when the
costs can be

► measured reliably and

► it is probable that the company will obtain future economic

benefits.

Future economic benefit would include increases in

1. useful life,
2. quantity of product produced, and
3. quality of product produced.

LO 6 Describe the accounting treatment for costs subsequent to acquisition.

Illustration 10-21

LO 6
Cost Model
o Property, plant and equipment should be measured at cost less
accumulated depreciation and accumulated impairment losses.
Revaluation Model
o Property, plant and equipment may be revalued to its fair value less
any subsequent accumulated depreciation and accumulated
impairment losses.
 After recognition as an asset, an item of property,
plant and equipment whose fair value cannot be
measured reliably shall be carried at a revalued
amount, being its fair value at the date of
revaluation less any subsequent accumulated
depreciation and subsequent accumulated
impairment losses.
 Revaluations shall be made with sufficient
regularity to ensure that the carrying amount does
not differ materially from that which would be
determined using fair value at the balance sheet
date.
 Fair Value – the amount for which the asset could be
exchanged between knowledgeable, willing parties in an
arm’s length transaction
 Basis for revaluation:
o Market – based appraisal by professionally qualified valuers;
o Estimated fair value using an income or a depreciated replacement
cost approach (if there is no market – based evidence of fair value)
 For volatile changes in fair value, annual revaluation is
necessary.
 If there are insignificant changes in PPE, it may be
necessary to revalue the items only every 3 to 5 years.
Two alternative treatments of accumulated depreciation:
o The accumulated depreciation may be restated proportionately so
that the carrying amount of the asset after revaluation equals its
revalued amount.
o Eliminate the accumulated depreciation against the gross carrying
amount of the asset and restate the net assets to the revalued
amount of the asset.
The entire class of property, plant and equipment
should be revalued.
 If revaluation resulted in an increase in carrying
amount, the increase is:
o credited to equity as revaluation surplus, but
o recognized in profit or loss to the extent that it reverses a
revaluation decrease.
 If
revaluation resulted in a decrease in carrying
amount, the decrease is:
o Recognized in profit or loss, but
o Debited to revaluation surplus to the extent of any credit
balance.
Recognizing Revaluations
Companies may value long-lived tangible asset after
acquisition at cost or fair value.
Network Rail (GBR) elected to use fair values to account for its
railroad network.

► Increased long-lived tangible assets by £4,289 million.

► Change in the fair value accounted for by adjusting the

asset account and establishing an unrealized gain.

► Unrealized gain is often referred to as revaluation surplus.

LO 7 Explain the accounting for revaluations.

Revaluation—Land
Illustration: Siemens Group (DEU) purchased land for
€1,000,000 on January 5, 2010. The company elects to use
revaluation accounting for the land in subsequent periods. At
December 31, 2010, the land’s fair value is €1,200,000. The
entry to record the land at fair value is as follows.

Land 200,000
Revaluation Surplus 200,000

Unrealized Gain on Revaluation—Land increases other comprehensive

income in the statement of comprehensive income.

LO 7 Explain the accounting for revaluations.

Revaluation—Depreciable Assets
Illustration: Lenovo Group (CHN) purchases equipment for
¥500,000 on January 2, 2010. The equipment has a useful life
of five years, is depreciated using the straight-line method of
depreciation, and its residual value is zero. Lenovo chooses to
revalue its equipment to fair value over the life of the
equipment. Lenovo records depreciation expense of ¥100,000
(¥500,000 5) at December 31, 2010, as follows.

Depreciation Expense 100,000

Accumulated Depreciation—Equipment 100,000

LO 7 Explain the accounting for revaluations.

Revaluation—Depreciable Assets
After this entry, Lenovo’s equipment has a carrying amount of
¥400,000 (¥500,000 - ¥100,000). Lenovo receives an
independent appraisal for the fair value of equipment at
December 31, 2010, which is ¥460,000.

Accumulated Depreciation—Equipment 100,000

Equipment 40,000
Revaluation Surplus 60,000

LO 7 Explain the accounting for revaluations.

Revaluation—Depreciable Assets Illustration 11-22
Financial Statement
Presentation—Revaluations

Lenovo reports depreciation expense of ¥100,000. The Accumulated Other

Comprehensive Income account related to revaluations cannot have a negative
balance.
LO 7 Explain the accounting for revaluations.
Revaluations Issues
Company can select to value only one class of assets, say buildings,
and not revalue other assets such as land or equipment.
Most companies do not use revaluation accounting.
► Substantial and continuing costs associated with appraisals.
► Gains associated with revaluations above historical cost are
not reported in net income but rather go directly to equity.
► Losses associated with revaluation below historical cost
decrease net income. In addition, the higher depreciation
charges related to the revalued assets also reduce net
income.

LO 7 Explain the accounting for revaluations.

Assume the following:
 An asset was acquired on January 1, 2001 for P540,000
and is expected to have a 5-year life. Straight-line
depreciation will be used.
 In January 1, 2003, the asset is appraised as having a
sound value of P486,000.
 In January 1, 2005, the asset is appraised at a sound value
of P81,000
Journal Entries:
1/1/01 Asset 540,000
Cash 540,000

12/31/01 Depn. Exp. 108,000

Acc. Depn. 108,000

12/31/02 Depn. Exp. 108,000

Acc. Depn. 108,000

1/1/03 Asset 270,000

Acc. Depn. 108,000
Revaluation surplus 162,000
Journal Entries (Continuation):
12/31/03 Depn. Exp. 162,000
and Acc. Depn. 162,000
12/31/04
Revaluation surplus 54,000
Retained earnings 54,000

1/1/05 Acc. Depn. 324,000

Revaluation surplus 54,000
Loss from impairment 27,000
Asset 405,000
 Depreciation – the systematic allocation of the depreciable
amount of the asset over its useful life.
 Depreciable amount – is the cost or revalued carrying value
less the residual value.
 Each part of an item of PPE that is significant in relation to
the total cost of the item shall be depreciated separately.
 Depreciation charge shall be recognized in profit or loss
unless it is included in the carrying amount of another asset
(e.g. depreciation of manufacturing plant and equipment is
included in the cost of inventories).
 Depreciation begins when the asset is available for use.
 Depreciation does not cease when the asset becomes idle or
retired from active use unless the asset is fully depreciated.
 Useful life should be reviewed at least each
financial year-end and if expectations differ from
previous estimates, the change is accounted for as
a change in an accounting estimate in accordance
with PAS 8.
 The depreciation charge for the current and future periods
should be adjusted.
 Residual value is the estimated amount that an entity would
currently obtain from disposal of the asset, after deducting the
estimated costs of disposal, if the asset were already of the
age and in the condition expected at the end of its useful life.
 Residual value may increase to an amount equal to or greater
than the asset’s carrying amount. If it does, the asset’s
depreciation charge is zero unless and until its residual value
subsequently decreases to an amount below the asset’s
carrying amount.
 Residual value should be reviewed at least each financial year-
end and if expectations differ from previous estimates, the
change is accounted for as a change in an accounting estimate
in accordance with IAS 8.
Equal or Uniform Charge Methods
o Straight – line method
o Composite method
o Group method

Variable Charge or Use-Factor Methods

o Working hours or service hours
o Output or production method
Decreasing charge or Accelerated Methods
‒Sum of years’ digits
‒Declining balance method
‒Double declining balance
Other Methods
‒Inventoryor appraisal
‒Retirement method
‒Replacement method
A machine was purchased for P100,000 on January 1,
2008 with an estimated useful life of 5 years and residual
value of P20,000.

What is the depreciation expense for 2008?

Annual depreciation = Cost – residual value
Est. useful life

Depreciation for 2008 = 100,000 – 20,000 = 16,000

5
 Composite method
o Assets are dissimilar in nature or assets that have different physical
characteristics and vary widely in useful life.
 Group method
o Assets are similar in nature and in estimated useful life and are
treated as a single unit.
 Asset Cost Residual Depreciable Life in Annual
Value Amount years Depreciation
Building 650,000 50,000 600,000 15 40,000
Machinery 220,000 20,000 200,000 8 25,000
Equipment 130,000 30,000 100,000 4 25,000
1,000,000 100,000 900,000 90,000

Using the information, the composite life is determined by

dividing the total depreciable amount by total annual
depreciation; thus, composite life is 10 years.

The composite rate is determined by dividing total annual

depreciation by the total cost; thus, composite rate is 9%.
 Assume that 100 similar machines are purchased on
January 1, 2009 at a total cost of P1,000,000 or at an
average cost of P10,000 per machine. The machines have
an average life of 5 years or an annual depreciation rate of
20%. Annual depreciation will be equivalent to 1,000,000
* 20% = 200,000.
A machine was purchased for P600,000 with no residual value
on January 1, 2008. The estimated life in years is 5 years, and in
terms of output is 150,000 units. The actual output in 2008 is
34,000 units.

What is the depreciation expense in 2008?

Depreciation rate = Cost – residual value = 600,000 – 0 = 4

Total estimated units 150,000

Depreciation (2008) = 34,000 * 4 = 136,000

A machine was purchased for P100,000 on January 1,
2008 with an estimated useful life of 5 years and residual
value of P20,000.
What is the depreciation expense for 2008?

SYD = Life (Life +1) = 15

2
Depreciation (2008) = 5/15 * 80,000 = 26,667
Depreciation (2009) = 4/15 * 80,000 = 21,333
Depreciation (2010) = 3/15 * 80,000 = 16,000
Depreciation (2011) = 2/15 * 80,000 = 10,667
Depreciation (2012) = 1/15 * 80,000 = 5,333
 A machine was purchased on January 1, 2008 for P500,000 with
residual value of P50,000. The estimated useful life of this machine is
5 years.

What is the depreciation expense for 2008?

_________________
Depreciation rate = 1 – n\/ residual value / cost
= 1 – 0.632 = 0.368

Depreciation (2008) = 500,000 * .368 = 184,000

Depreciation (2009) = (500,000 – 184,000) * .368 = 116,288
Depreciation (2010) = (500,000 – 184,000 – 116,288) * .368 = 73,494
IFRS requires that each part of an item of property, plant,
and equipment that is significant to the total cost of the
asset must be depreciated separately.

LO 4 Explain component depreciation.

Illustration: EuroAsia Airlines purchases an airplane for
€100,000,000 on January 1, 2011. The airplane has a useful
life of 20 years and a residual value of €0. EuroAsia uses the
straight-line method of depreciation for all its airplanes.
EuroAsia identifies the following components, amounts, and
useful lives.
Illustration 11-8

LO 4 Explain component depreciation.

Computation of depreciation expense for EuroAsia for 2011.
Illustration 11-9

Depreciation journal entry for 2011.

Depreciation Expense 8,600,000

Accumulated Depreciation—Airplane 8,600,000

LO 4 Explain component depreciation.

Arcadia HS, purchased equipment for $510,000 which was
estimated to have a useful life of 10 years with a residual value of
$10,000 at the end of that time. Depreciation has been recorded
for 7 years on a straight-line basis. In 2010 (year 8), it is
determined that the total estimated life should be 15 years with a
residual value of $5,000 at the end of that time.

Questions:
o What is the journal entry to correct No Entrythe
prior years’ depreciation? Required

o Calculate the depreciation expense for

2010.
LO 4 Explain component depreciation.
 After 7 years

Equipment cost $510,000 First, establish NBV

Salvage value - 10,000 at date of change in
Depreciable base 500,000 estimate.
Useful life (original) 10 years
Annual depreciation $ 50,000 x 7 years = $350,000

Balance Sheet (Dec. 31, 2009)

Equipment $510,000
Accumulated depreciation 350,000
Net book value (NBV) $160,000
 After 7 years

Net book value $160,000 Depreciation

Salvage value (new) 5,000 Expense calculation
Depreciable base 155,000 for 2010.
Useful life remaining 8 years
Annual depreciation $ 19,375

Journal entry for 2010

Depreciation expense 19,375

Accumulated depreciation 19,375
An impairment loss must be recognized whenever the carrying
amount exceeds its recoverable amount.
The recoverable amount is the higher of:
o Net selling price;
o Value in use; the present value of estimated future cash flows
An impairment loss should b e recognized in the income
statement for assets carried at cost. A revaluation
decrease should be recorded for assets carried at revalued
amount.
The revalued amount after impairment should be used to
calculate future depreciation.
 Compensation from third parties for items of PPE that were
impaired, lost or given up shall be included in profit or loss
when the compensation becomes receivable. It shall be
accounted for as follows:
o Impairments of items of PPE are recognized in accordance with PAS
36;
o Derecognition of items of PPE retired or disposed of is determined
in accordance with PAS 16;
o Compensation from third parties for items of PPE that were
impaired, lost or given up is included in determining profit or loss
when it becomes receivable; and
o The cost of items of PPE restored, purchased or constructed as
replacements is determined in accordance with PAS 16
Property, plant and equipment should be eliminated
from the balance sheet on disposal.
Any revaluation surplus relating to an eliminated
asset should be transferred to retained earnings.
However, fully-depreciated asset remaining in service
shall not be removed from the accounts. Entities
are encouraged but not required to disclose fully
depreciated property.
 The gain or loss arising from the derecognition of an item of
PPE shall be included in profit or los when the item is
derecognized, but not classified as revenue.
 The gain or loss arising from the derecognition of an item of
PPE shall be determined as the difference between the net
disposal proceeds, if any, and the carrying amount of the
item.
A company may retire plant assets voluntarily or dispose of
them by
 sale,
 exchange,
 involuntary conversion, or
 abandonment.

Depreciation must be taken up to the date of disposition.

LO 7 Describe the accounting treatment for the disposal

of property, plant, and equipment.
Sale of Plant Assets
BE10-15: Ottawa Corporation owns machinery that cost
$20,000 when purchased on July 1, 2007. Depreciation has
been recorded at a rate of $2,400 per year, resulting in a
balance in accumulated depreciation of $8,400 at December 31,
2010. The machinery is sold on September 1, 2011, for
$10,500.
Prepare journal entries to
a) update depreciation for 2011 and
b) record the sale.

LO 7 Describe the accounting treatment for the disposal

of property, plant, and equipment.
a) Depreciation for 2011

Depreciation expense ($2,400 x 8/12) 1,600

Accumulated depreciation 1,600

b) Record the sale

Cash 10,500
Accumulated depreciation 10,000 *
Machinery 20,000
Gain on sale 500

* $8,400 + $1,600 = $10,000 LO 7 Describe the accounting treatment for the disposal
of property, plant, and equipment.
Involuntary Conversion
Sometimes an asset’s service is terminated through some type
of involuntary conversion such as fire, flood, theft, or
condemnation.
Companies report the difference between the amount
recovered (e.g., from a condemnation award or insurance
recovery), if any, and the asset’s book value as a gain or loss.
They treat these gains or losses like any other type of
disposition.

LO 7 Describe the accounting treatment for the disposal

of property, plant, and equipment.
 Ifan item of property, plant and equipment is
available for immediate sale in its present
condition within one year, it shall be transferred to
the current assets.
 An entity shall measure it at the lower of its
carrying amount or fair value less cost to sell. The
writedown to fair value less cost to sell is treated as
impairment loss.
 Noncurrent asset classified as held-for-sale shall
not be depreciated.
 The financial statements shall disclose, for each class of
PPE:
o The measurement bases used for determining the gross carrying
amount;
o The depreciation methods used;
o The useful lives or the depreciation rates used;
o The gross carrying amount and the accumulated depreciation at the
beginning and end of the period; and
o A reconciliation of the carrying amount at the beginning and end of
the period showing:
• Additions;
• Assets classified as held for sale or included in the disposal group;
• Acquisitions through business combinations;
• Increases or decreases resulting from revaluations and impairment
losses recognized or reversed
• Impairment losses recognized in profit or loss;
• Impairment losses reversed in profit or loss;
• Depreciation
• The net exchange differences arising on the translation of the financial
statements from the functional currency into a different presentation
currency, including the translation of a foreign operation into the
presentation currency of the reporting entity; and
• Other changes