PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment

• PPE are (a) tangible assets (b) used in normal operations and (c) long-term in nature.
• The elements of cost of a PPE are (a) purchase cost, (b) direct costs, and (c) present
value of decommissioning and restoration costs.
• The cost of an item of PPE is the cash price equivalent at the recognition date.
• Recognition of costs in the carrying amount of an item of PPE ceases when the item is in
the location and condition necessary for it to be capable of operating in the manner
intended by management.
• The acquisition cost of items of PPE purchased on a lump-sum price is allocated to the
individual items based on their relative fair values. old

• The accounting treatment for demolition costs (net of any salvage proceeds) depends on
the reason for the demolition. ) other Income/Revenue

• Income earned from incidental operations before an asset is put to use is immediately
recognized in profit or loss, together with the related expense.
• Savings on self-construction are not recognized.
• The cost of option on properties not acquired is expensed.
• Cost of uninsured hazards or claims for uninsured accidents during construction are
recognized as expense.
• PPE acquired in an exchange with commercial substance is measured at the (a) fair
value of asset given plus cash paid/minus cash received, (b) fair value of asset received,
or (c) carrying amount of asset given plus cash paid/minus cash received.
• PPE acquired in an exchange with no commercial substance is measured at the
carrying amount of asset given plus cash paid/minus cash received. No gain or loss is
recognized on the exchange.
• Trade-ins are accounted for similarly to exchanges with commercial substance.
• PPE acquired through issuance of securities is measured at the (a) fair value of asset
received or (b) fair value of securities issued.
THEORIES
1. Property, plant and equipment are defined as
A. Tangible assets held for sale in the ordinary course of business.
B. Tangible assets held to earn rentals or for capital appreciation or both.
C. Tangible assets held for use in the production or supply of goods or services and expected to be used during more than
one reporting period.
D. Tangible assets held for use in the production or supply of goods or services, for rental to others, or for administrative
purposes and expected to be used during more than one reporting period.

2. An item of property, plant and equipment shall be recognized as an asset when

I. It is probable that future economic benefits associated with the asset will flow to the entity.
II. The cost of the asset to the entity can be measured reliably.
A. I only C. Both I and II
B. II only D. Either I or II

3. Which of the following statements is true concerning recognition of property, plant and equipment?
I. Most spare parts and servicing equipment are usually carried as inventory and recognized as expense when consumed.
II. If the spare parts and servicing equipment can be used only in connection with an item of property, plant and equipment
and their use is expected to be irregular, they are accounted for as property, plant and equipment and are depreciated
over their useful life or useful life of the related asset, whichever is shorter.
A. I only C. Both I and II
B. II only D. Neither I nor II

4. The single cost of acquiring land and a usable old building is

A. Charged to the land only
B. Charged to the building only
C. Allocated between land and building based on carrying amount
D. Allocated between land and building based on relative fair value

5. If an entity purchased a lot and an old building and immediately demolished the old building and used the property as a
parking lot, the proper accounting treatment of the carrying amount of the old building would depend on
A. The contemplated future use of the parking lot.
B. The length of time for which the building was held prior to demolition.
C. The intention of management for the property when the building was acquired.
D. The significance of the cost allocated to the building in relation to the combined cost of the lot and building.

Property, plant and equipment Page 1 of 32

 PPE
-
earn rent income

-
car > movable - inc in PPE

land >
- immorable - investment property

PROBLEMS

Problem 1: (Classification of property, plant and equipment) ABC Company has the following data:
Land held for capital appreciation investment
property P1,000,000
Manufacturing equipment leased under finance lease Right of use
3,000,000
Building held under operating lease, used in production of goods 1,000,000
Patents 1,000,000
Land used in business 5,000,000
Land held for resale 1,000,000
Building owned, used as warehouse 1,500,000
Service equipment – used in building maintenance estimated to have as 20-year useful life 3,000,000
Small tools and minor spare parts-used in equipment maintenance major
-

capitalize
if tools ,
-

1,000,000
Safety and environment equipment-required for ISO and DENR accreditation 450,000
Cost incurred while an item capable of operating in the manner intended by management has yet to be 10,000
brought into use or is operating at less than full capacity. expense
Initial operating losses, such as those incurred while demand for the item’s output build up. 10,000
Costs of relocating or reorganizing part or all of an entity’s operations 10,000
Required: How much would be classified as property, plant and equipment in the Company’s year-end balance sheet?
Manufacturing equipment leased under finance lease 3,000,000
3m
Land used in business 5,000,000
5 M

Building owned 1,500,000

1 5 M .

Servicing equipment – used in building maintenance 3,000,000

3m

Safety and environmental equipment 4 50K

450,000
12950 000
Total PPE 12,950,000

Problem 2: (Lump-sum purchase of items of PPE) On May 1, 20x8, Lenny Corporation purchased for P690,000 a tract of land
on which a warehouse and office building were located. The following data were collected concerning the property:
Current Assessed Vendor's
Valuation Original Cost
Land ............................. P280,000 P180,000
Warehouse ........................
Office Building ..................
320,000
200,000
P800,000
315,000
129,000
P624,000
V
Shortly after acquisition, modifications were made on the office building at a cost of P100,000.

Required: Determine the appropriate amounts that Lenny should record for the land, warehouse, and office building.

Land .................... P280,000/P800,000 = 35%

Warehouse ............... P320,000/P800,000 = 40%
Office Building ......... P200,000/P800,000 = 25%
P800,000 100%
Allocation:
241588
.35 P690,000 = P241,500 Land
2. 76008
2
.40 P690,000 = 276,000 Warehouse
272568
.25 P690,000 = 172,500 Office Building+100,000
P690,000
Answer
241,500
276,000
272,500

Problem 3: (Initial Measurement) One of the most critical steps in recording the acquisition of assets is the determination of the
cost assigned to the asset. Data related to assets acquired by Mentor Manufacturing Company are as follows:
VAT registered

(1) (On cash basis) The Mentor Company acquired a factory equipment overseas on cash basis for P112,000 (inclusive of VAT).
Additional costs incurred include the following: Factory Equipment 100 006

Commissions paid to brokers for the purchase of the equipment P5,000 0001000
Import duties nonrefundable taxes 25,000
Non-refundable purchase taxes of 10,000
Freight cost of transferring the equipment to Mentor Company premises 1,000
Cost of assembling and installing the equipment 2,000
Cost of testing the equipment 1,500 expense
Administration and other general overhead costs 4,200
Advertisement and promotion costs of the new product to be produced by the equipment 3,800
Cost of option on equipment not acquired expense 5,000
Cost of option on equipment acquired 3,000
Samples generated from testing the equipment were sold a 500 Other Income

146008

Answer:
1. 100,000 (VAT exclusive) + 5,000 + 25,000+10,000+1,000+2,000+1,500+3,000-500 = P147,000

Inventory
/ net method
Gross method

Purch D i s c l o st-
.

cash discount whether

PPE-snet of

taken or not

/ net
Gross
~

Beyond ~

Property, plant and equipment GROSS net

Page 2 of 32
purch
PRE 100 POEAp 100
Ap

Ab
Beyond cash
(2) (On account) Machine A was purchased at a list price of P92,000; terms 1/10, net 30. The machine invoice was paid after the
discount period. Transportation charges were P1,270; installation costs were P920; and the cost of a trial run was P960. Normal
repairs and maintenance for the first year were P410. included since income no

(2)
Cost of machine (₱92,000 x .99) ....................... ₱91,080
Transportation costs .................................. 1,270
Installation costs .................................... 920
Trial run .............................................
(included pag walang
other
income) 960
Cost basis for Machine A .............................. ₱94,230

The ₱410 for normal repairs and maintenance is a period cost; the ₱920 (₱92,000 - ₱91,080) is recorded as Discounts Lost or
Interest Expense.

(3) (Deferred settlement –cash price equivalent) Machine B could be purchased for five annual payments of P6,332 or P29,400
in cash. Mentor elected to purchase Machine B under the installment plan. Other related acquisition costs totaled P175.

(3)
Cash price of machine ................................. ₱29,400
Other acquisition costs ............................... 175
Cost basis for Machine B .............................. ₱29,575

(4) (Deferred settlement –no cash price equivalent)The company purchased equipment under a deferred payment contract--
P40,000 down payment and 30 semiannual payments of P5,000. (Assume a 12 percent interest rate.)

Down payment .......................................... ₱ 40,000

Semiannual payments (₱5,000 x 13.7648)* ............... 68,824
*Present value of an ordinary annuity @ 6%, n = 30
₱108,824

(5) (Acquisition through issuance of own equity instrument)On May 12, 20x8, Alabama Company offered to sell land to
Mentor for P62,000; the offer was rejected. On June 29, 2,125 shares of Mentor common stock were issued in exchange for the land.
The par value of the stock was P20 per share; the market value of the stock was P32 per share at the time of purchase. Mentor's
management was confident the land would be worth at least P64,000 to the company.
RIP
1 Fair Value of Assets Received

Cost basis for land: .

2 Fair value of stock Issued

2,125 shares @ ₱32 FV = ₱68,000 .

3 Fair value of stock Par value

(6) (Acquisition through issuance of bonds payable) On January 1, 20X1, Mentor Company acquired land by issuing a bonds
payable with face amount of P5,000,000. At the time of acquisition, the fair value of the land is P6,000,000 and quoted price of the
bonds is P5,800,000.
1 Fair Value of Liab

Land 5,800,000 .
2 Fair Value of Asset Received

Face value Liability

Bonds payable P5,000,0000
.
3

Premium 800,000

(7) (With Dismantling obligation). An equipment with a list price of P 800,000 was acquired with the following terms: Trade
discount of 10% 2/10; n/30. The account was paid at the end of 30 days. Dismantling cost of P 50,000 are expected to be incurred
at the end of its useful life of 8 years. The company’s incremental borrowing rate is 9%.

Require: Determine the acquisition cost for each of the assets.

Cash price
800,000 x .90 x .98 P705,600
Present value of the disposal costs
50,000 x 0.5019 79 % of 8 grs) 25,095
Cost of equipment P730,695

730695 Dismantling Obligation

PPE 2259
Int Exp 25095
705608
Cash 2259

25895
Dismantling Oblig 2259
Obli
Dismantling 27354
(25095x9 % ) Y

Property, plant and equipment Page 3 of 32

Problem 4: (Cost of self-constructed) ABC Corporation constructed machinery for its own use. The following information is given
relative to the costs of the machinery constructed and products manufactured.
Products Manufactured Machinery Constructed
Materials used P4,000,000 P1,250,000
Direct labor incurred 1,000,000 250,000
Factory Overhead P2,000,000

Additional information:
• Income earned from incidental operations P100,000
• Savings on self constructed assets P500,000

REQUIRED: Determine the cost of the machinery constructed, assuming that

(a) Product manufactured is charged with overhead at the normal rate of 150% of direct labor cost. Excess overhead is charged to
machinery constructed.
(b) Overhead is allocated between production and construction activities based on direct labor cost.

a.
Materials P1,250,000
Direct labor 250,000
Overhead 2,000,000 – (150% x 1,000,000) 500,000
Total P2,000,000

b.
Materials P1,250,000
Direct labor 250,000
Overhead (2,000,000 x 250/1,250) 400,000
Total P1,900,000

Problem 5: (Acquisition through exchange) Beeman Company exchanged machinery with an appraised value of P1,755,000, a
recorded cost of P2,700,000 and Accumulated Depreciation of P1,350,000 with Lacey Corporation for machinery Lacey owns. The
machinery has an appraised value of P1,695,000, a recorded cost of P3,240,000, and Accumulated Depreciation of P1,782,000.
Lacey also gave Beeman P60,000 in the exchange. Assume depreciation has already been updated.

Instructions
(a) Prepare the entries on both companies' books assuming that the exchange had commercial substance.
(b) Prepare the entries on both companies' books assuming that the exchange lacked commercial substance.

(a) Commercial Substance

Beeman
Machinery ............................................ 1,695,000 Cost P2,700,000
Cash .................................................... 60,000 A/D 1,350,000
Accum. Depreciation— BV 1,350,000
Machinery ........................................ 1,350,000 FV 1,755,000
Gain on Exchange of Gain P 405,000
Plant Assets ....................... 405,000
Machinery ............................. 2,700,000

Lacey
Machinery ............................................ 1,755,000 Cost P3,240,000
Accum. Depreciation— A/D 1,782,000
Machinery ........................................ 1,782,000 BV 1,458,000
Gain on Exchange of FV 1,695,000
Plant Assets ....................... 237,000 Gain P 237,000
Machinery ............................. 3,240,000
Cash .................................... 60,000

(b) No Commercial Substance

Beeman
Machinery ........................................................................................... 1,290,000
Cash .................................................................................................... 60,000
Accumulated Deprecation—Machinery ...................................................... 1,350,000
Machinery ............................................................................. 2,700,000

Lacey
Machinery ........................................................................................... 1,518,000
Accumulated Depreciation—Machinery ..................................................... 1,782,000
Machinery ............................................................................. 3,240,000
Cash .................................................................................... 60,000

Property, plant and equipment Page 4 of 32

Problem 6: (Acquisition through trade-in) At the beginning of current year, Wizard Company traded in an old machine for a
newer model. Data relative to the old and new machines on the date of exchange follow:
Old machine
Original cost P800,000
Accumulated depreciation 600,000
Average published retail value 170,000

New machine
List price 1,000,000
Cash price without trade in 900,000
Cash paid with trade in 780,000
Required: What amount should be recognized as cost of the new machine acquired in the exchange?

Since the old machine has no available fair value, the new machine received in exchange is recorded at its cash price without
trade in of P900,000. The average published retail value of the old machine is not necessarily its fair value. Incidentally, the
loss on exchange is computed as follows:
Cash price without trade in 900,000
Less: Cash paid with trade in 780,000
Trade in value of old machine 120,000
Less: Carrying amount 200,000
Loss on exchange ( 80,000)

Problem 7: (Acquisition by donation) ABC Co. received donation of equipment from XYZ, Inc., an unrelated foreign corporation.
The equipment has a fair value of P1,000,000. Necessary cost incurred by ABC Co. to bring the asset to the intended condition for
use amounted to P10,000.

Required:
a. Prepare the entry to record the receipt of the donation.
b. Assuming the donor is a shareholder of ABC Co, prepare the entry to record the receipt of the donation.

Equipment P1,000,000
Cash P10,000
Income from donation 990,000

Equipment P1,000,000
Cash P10,000
Donated capital P990,000

Government Grant
• Government grants are recognized only when there is reasonable assurance that (a)
the entity will comply with the conditions attaching to them and (b) the grants will be
received.
• Receipts of a grant does not of itself provide conclusive evidence that the conditions
attaching to the grant have been or will be fulfilled.
• Grants related to assets are grants whose primary condition is that an entity qualifying
for them should purchase, construct or otherwise acquire long-term assets. Grants
related to income are grants other than those related to assets.
• Non-monetary grants are normally measured at the fair value of non-monetary asset
received. Alternatively, non-monetary grants are measured at nominal amount.
• Forgivable loans and the benefit of loans at below-market interest rate are considered
government grants.
• Government grants shall be recognized in profit or loss on a systematic basis over the
periods in which the entity recognizes as expenses the related costs for which the grants
are intended to compensate. (Matching Concept)
• Grants related to depreciable assets are recognized as income over the periods and in
the proportions in which depreciation expense on a depreciable asset related to the non-
depreciable asset is recognized.
• Grants related to non-depreciable assets are usually recognized income over the
periods and in the proportions in which depreciation expense on a depreciable asset
related to the non-depreciable asset is recognized.
• Grants that become receivable as compensate for expense or losses already incurred
Property, plant and equipment Page 5 of 32
 or for the purpose of giving immediate financial support to the entity are recognized
immediately as income.
• Government grants may be presented in the financial statements, except cash flows, on a
gross or net basis.
• Repayment of government grants are accounted for prospectively.
• The following are not government grants:
• (1) Tax benefits
• (2) Free technical or marketing advice
• (3) Provision of guarantee
• (4) Government procurement policy that is responsible for a portion of the entity’s sales,
and
• (5) Public improvements that benefit the entire community

THEORIES
1. Which of the following statements is true regarding the accounting for government grant related to an asset?
A. Depreciation expense will be higher if the grant is recorded as an adjustment to the asset.
B. Depreciation expense will be higher and net income lower if the grant is recorded as deferred income.
C. Depreciation expense will be higher and net income lower if the grant is accounted for as an adjustment to the asset.
D. Depreciation expense will be higher if the grant is recorded as deferred income but net income will be the same under the
deferred income approach and deduction from asset approach.

2. In the case of grant related to income, which of the following accounting treatment is prescribed?
A. Credit the grant to "retained earnings" on the balance sheet.
B. Credit the grant to "general reserve" under shareholders' equity.
C. Credit the grant to sales or other revenue from operations in the income statement.
D. Present the grant in the income statement as "other income" or as a separate line item, or deduct it from the related
expense.

3. A government grant that becomes receivable as compensation for expenses or losses already incurred or for the purpose of
giving immediate financial support to the entity with no future related costs should be recognized as income
A. When received.
B. Of the period in which it becomes receivable.
C. Over a maximum of 5 years using straight line.
D. Over a maximum of 10 years using straight line.

4. In the case of a nonmonetary grant, which of the following accounting treatment is prescribed?
A. Record the grant at a value estimated by management.
B. Record the asset at replacement cost and the grant at a nominal value.
C. Record both the grant and the asset at fair value of the nonmonetary asset.
D. Record only the asset at fair value and not recognize the fair value of the grant.

5. Repayment of grant related to an asset shall be recorded by

A. Increasing the carrying amount of the asset if the deduction approach is used.
B. Reducing the deferred income balance to zero if the deferred income approach is used.
C. Recognizing as expense the cumulative additional depreciation that would have been recorded to date in the absence of
the grant if the deduction approach is used.
D. All of these

PROBLEMS

Problem 1: (Grant related to asset: Gross vs Net Presentation) Winsor Corp. received a grant from the government of
P160,000 to acquire P800,000 of delivery equipment on January 2, 20x1. The delivery equipment has a useful life of 4 years. Winsor
Corp. uses the straight-line method of depreciation. The delivery equipment has a zero residual value.

Instructions
(a) If Winsor Corp. reports the grant as a reduction of the asset, answer the following questions.
(1) What is the carrying amount of the delivery equipment at December 31, 20x1?
(2) What is the amount of depreciation expense related to the delivery equipment in 20x2?
(3) What is the amount of grant revenue reported in 20x1 on the income statement?

(b) If Winsor Corp. reports the grant as deferred grant revenue, answer the following questions.
(1) What is the balance in the deferred grant revenue account at December 31, 20x1?
(2) What is the amount of depreciation expense related to the delivery equipment in 20x2?
(3) What is the amount of grant revenue reported in 20x1 on the income statement?

(a) 1. Carrying amount =P480,000 (640,000 –P160,000)

2. Depreciation expense =P160,000 (640,000 ÷ 4yrs.)
3. Grant revenue = 0
(b) 1. Deferred grant revenue balance = 120,000(160,000 –P40,000)
2. Depreciation expense =P200,000 (800,000 ÷ 4yrs.)
3. Grant revenue =P40,000

PAS 20, paragraph 17, provides that "grants related to depreciable assets are usually recognized as income over the periods
and in proportion to the depreciation of the related assets".

Property, plant and equipment Page 6 of 32

Problem 2: (Grant related to income) On January 1, 20x4, Manila Company received a grant of P25,000,000 from the American
government in order to defray safety and environmental costs within the area where the entity is located. The safety and
environmental costs are expected to be incurred every four years, respectively, P2,000,000, P4,000,000, P6,000,000 and
P8,000,000. What amount of grant income should be recognized in 20x4?

Year Costs Fraction Income

20x4 2,000,000 2/20 2,500,000
20x5 4,000,000 4/20 5,000,000
20x6 6,000,000 6/20 7,500,000
20x7 8,000,000 8/20 10,000,000
20,000,000 25,000,000
PAS 20, paragraph 12, provides that "government grants are recognized as income over the periods necessary to match them
with the related costs which they are intended to compensate on a systematic basis".

Problem 3: (Grant related to non-depreciable asset) On January 1,20x4, Bantay Company is granted a large tract of land in
the Cordillera region by the Philippine government. The fair value of the land is P40,000,000. The entity is required by the grant to
construct chemical research facility and employ only personnel residing in the Cordillera region. The estimated cost of the facility is
P45,000,000 with useful life of 10 years. The chemical research facility was completed and ready for the intended use on January 1,
20x5. What amount of grant income should be recognized in 20x5?

Grant income (40,000,000 / 10) 4,000,000

PAS 20, paragraph 18, provides that "grants related to nondepreciable assets requiring fulfillment of certain conditions are
recognized as income over the periods which bear the cost of meeting the conditions".

Problem 4: (Compensation for losses incurred/ Financial aid) On January 1, 20x4, Pusa Company received a grant of
P6,000,000 from the British government to compensate for massive losses incurred because of a recent tsunami. The grant was
made for the purpose of giving immediate financial support to the entity. It will take the entity two years to reconstruct the assets
destroyed by the tsunami. What amount of grant income should be recognized in 20x4?

P6,000,000. PAS 20, paragraph 20, provides that "a government grant that becomes receivable as compensation for
expenses already incurred or for the purpose of giving financial support to the entity with no related future costs is recognized
as income of the period in which it becomes receivable or when received."

Problem 5: (Forgivable loans) On January 1, 20X1, because of an exemplary accomplishment that brought international
recognition to the community, the government waived the repayment of ABC Co.’s loan payable with a carrying amount of P200,000.
What amount of grant income should be recognized in 20X1?

P200,000 (PAS 20.10) states that a forgivable loan from government is treated as a government grant when there is a reasonable
assurance that the entity will meet the terms for forgivness of the loan.

Problem 6: (Loans at below market-interest rate) On January 1, 20x4, Cebu City agreed to provide Probity Company with a
P5,000,000 three-year, zero-interest bearing loan evidenced by promissory note. The prevailing rate of interest for a loan of this
type is 10% and the present value of 1 at 10% for three years is .7513.
Required:
1. What is the interest expense for 20x4?
2. What is the deferred grant income on December 31,20x4?
3. What is the carrying amount of the note payable on December 31, 20x5?

Note payable 5,000,000

Present value (5,000,000 x.7513) 3,756,500
Discount on note payable and deferred grant income 1,243,500
Journal entry
Cash 5,000,000
Discount on note payable 1,243,500
Note payable 5,000,000
Deferred grant income 1,243,500

Number 1.
Interest expense (10% x 3,756,500) 375,650
Discount on note payable 375,650

Number 2.
Deferred grant income - January 1, 20x4 1,243,500
Grant income in 20x4 ( 375,650)
Deferred grant income - December 31, 20x4 867,850

Number 3.
Present value - January 1, 20x4 3,756,500
Interest for 20x4 375,650
Present value - December 31,20x4 4,132,150
Interest for 20x5 (10% x 4,132,150) 413,215
Present value - December 31, 20x5 4,545,365
Another approach:
Note payable 5,000,000
Discount on note payable - December 31, 20x5
(1,243,500 - 375,650 - 413,215) ( 454,635)
Carrying amount - December 31, 20x5 4,545,365

Property, plant and equipment Page 7 of 32

Problem 7: (Repayment of grant related to income) On January 1,20x4, Easy Company received a grant of P1,500,000 from
the government to subsidize tuition fees for a period of 5 years. On January 1,20x6, the entity violated certain conditions attached to
the grant, and therefore had to repay fully such grant to the government. What amount should be recognized as loss resulting from
the repayment of the grant in 20x6?

Total grant received 1,500,000

Income recognized in 20x4 and 20x5 (1,500,000 / 5 x 2) ( 600,000)
Deferred grant income - December 31, 20x5 900,000

PAS 20, paragraph 32, provides that repayment of government grant shall be accounted for as a change in accounting
estimate. The repayment of grant related to income shall be applied first to the unamortized deferred income and any balance
shall be recognized in profit or loss.
Deferred grant income 900,000
Loss on repayment of grant 600,000
Cash 1,500,000

Problem 8: (Repayment of grant related to asset) DEF Company purchased a machine for P6,600,000 on January 1, 20x4 and
received a government grant of P600,000 towards the capital cost. The policy is to treat the grant as a reduction in the cost of the
asset. The machine is to be depreciated on a straight line basis over 10 years with a residual value of P500,000. On January 1, 20x6,
the grant became fully repayable because of noncompliance with conditions.
Required:
1. What is the depreciation for 20x4?
2. What is the depreciation for 20x6?

1.
Depreciation for 20x4 (6,000,000 – 500,000) / 10 550,000

2.
Original depreciation 550,000
Additional depreciation (600,000 / 10 x 3) 180,000
Total depreciation for 20x6 730,000

Land, Building and Machinery

What are directly attributable costs?

When you acquire a long-term asset, you can include directly attributable costs to the initial measurement of its
cost.

Although IFRS define directly attributable expenses quite clearly and provide a few examples, there are many
different items we are not sure about.

In this article, I decided to look at directly attributable expenses with a magnifier and to give you some guidance
for your future use.

I’d like to focus on acquisition of tangible assets under IAS 16 Property, Plant and Equipment, but the same
principles apply for intangibles and other assets, too.

What do the rules say?

IAS 16 says that we can capitalize any costs 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 (IAS 16.16(b)).

In the paragraph 17 of IAS 16 there are the examples of what expenses are considered to be directly attributable
and therefore, can be capitalized (or included in the cost of an asset):

• Costs of employee benefits (IAS 19 Employee benefits) arising directly from the construction or the
acquisition of the item of PPE,
• Costs of site preparation,
• Initial delivery and handling costs,
• Installation and assembly costs,
• Costs of testing whether the asset is functioning properly, after deducting the net proceeds from selling
any items produced while bringing the asset to that location and condition, and
• Professional fees.

Property, plant and equipment Page 8 of 32

As opposed to that, the paragraph 19 of IAS 16 lists examples of costs that are not costs of an item of PPE and
therefore, cannot be capitalized:

• Costs of opening a new facility

• Costs of introducing a new product or service
• Costs of conducting a business in a new location or with a new class of customer, and
• Administration and other general overhead costs.

On top of that, IAS 16 clarifies in the paragraph 20 that costs of operation below full capacity, initial operating
losses and relocating or reorganizing entity’s operations are not to be capitalized.

Clear enough.

Yet in practice, there are many items that require our careful judgment and we are not sure whether to include
them in the cost of an asset or not. These doubts arise especially when your company constructs a big asset,
such as a plant or a mine.

Let’s break it down.

Cost of employee benefits

As written above, you can capitalize only those employee benefits that
arise from the construction or the acquisition of the asset.

Here, two principal questions arise:

1. Which employee categories arise from the construction or the acquisition of the asset?

The answer is no admin, no general functions, no research activities, no marketing & advertising, no
training employees.

It means that:

oYou can capitalize the employee benefits provided to site workers, in-house architects and
surveyors or production supervisors. To some extent, you can also capitalize quality controls and
testing (if these activities are inevitable in order to put an asset into use).
o You cannot capitalize any portion of employees benefits paid to general managers, accountants
taking care solely about ship’s accounting, etc.
2. Which expenses related to these employees can be capitalized?

The answer is all employee benefits under IAS 19 and that is:

o Short-term employee benefits (salaries, wages, paid vacation…)

o Post-employment benefits
o Other long-term benefits and
o Termination benefits.

The following types of expenses are NOT employee benefits under IAS 19 and therefore, they shall be
considered separately:
Property, plant and equipment Page 9 of 32
 o Travel expenses of your employees,
o Training of your employees,

How should you include the expenses for the employee benefits into the cost of your asset?

The answer is based on some reasonable allocation method.

For example, you build a ship. Based on timesheet reports you find out that in 20X1 John worked:

• 1 500 hours on the ship construction,

• 300 hours on other projects or work, and
• he took 100 hours of paid vacation.

Your company incurred the following expenses for employee benefits in relation to John’s work:

• Salary: CU 18 000
• Compensation for paid vacation (in line with law): CU 1 000
• Expense for contribution into a pension fund (defined contribution plan): CU 2 000

How much of these benefits can you include into a cost of a ship?

You can include all of these expenses for employee benefits allocated on a reasonable basis.

In this case, we can allocate it based on time spent on a ship construction (1 500 hours) and total time worked (1
500+300=1 800 hours).

Here, we do not take the paid vacation time into account for allocation purposes. It means that a compensation
for paid vacation will be allocated to the cost of a ship. The reason is that a company is obliged to provide this
vacation to its employees and a vacation is simply another cost of worked hours.

The calculation:

• Allocation of salary: CU 18 000*1 500/1 800 = CU 15 000

• Compensation for paid vacation: CU 1 000*1 500/1 800 = CU 833
• Contribution to a pension fund: CU 2 000*1 500/ 1 800 = CU 1 667
• TOTAL: CU 17 500

Note: you include only current year’s expenses; or the expenses incurred during ship’s construction.

Cost of relocating the asset to the new location

Let’s say you construct a new plant and you decided to relocate some
machines from an older plant to the new premises. As machines are quite heavy, you paid CU 1 000 to relocate
them.

Can you capitalize these expenses to the cost of a machine?

In short, no – this is a relocation cost and IAS 16 specifically says it cannot be capitalized, but expensed as
incurred.

Property, plant and equipment Page 10 of 32

Insurance of an asset

Insurance premiums paid to the insurance companies cannot be

capitalized, but expensed in profit or loss in line with an insurance policy terms.

The reason is that these costs are not inevitable to bring the assets to the condition and location to operate as
desired by the management.

In fact, these costs are incurred to protect an asset against some risks during some period and therefore, it would
not be correct to take these costs to the cost of an asset and put them in profit or loss via depreciation over
asset’s useful life.

Some time ago, one CFO raised a point to this matter. He said:

“We take a loan to finance the acquisition of a plant, but our bank insists on insurance policy for this plant.
Otherwise we won’t get a loan. Without an insurance policy we cannot acquire a plant, therefore I think the
insurance cost can be capitalized as it’s inevitable”.

Hmmm, a good argument, but the truth is that the CFO needed an insurance policy to get a loan and not to
acquire an asset. In other words, that company could have acquired a plant without a loan, with a cash payment
and in such a case, no insurance policy would be necessary.

Operating lease expenses for land

You can incur some lease expenses during construction of your asset.
For example, you can pay rentals for the land you build your plant on.

Can you capitalize these expenses?

This question is quite controversial and really, an answer depends on how well you can justify your own view in
front of your auditors.

I’d like to give you arguments for YES and NO here:

YES, capitalize:
Property, plant and equipment Page 11 of 32
Operating lease charges can be considered directly attributable costs and included into cost of an item of PPE, if
these lease costs are necessary to bring the asset to the desired condition and location. Therefore, rentals paid
for land under operating lease on which you build a building can be capitalized into a cost of a building during a
construction stage.

NO, don’t capitalize:

I am more in favor of no capitalization, but recognizing these expenses in profit or loss.

The reason is that it produces quite inconsistent impact on profit or loss. If you include just rentals during the
construction period into the cost of PPE and you expense the subsequent rentals as they incur, then the first
rentals will be expensed via depreciation over asset’s useful life, and the remaining rentals will be expensed
immediately. This means that matching principle is shattered.

Also, I always see a land as a separate asset, because its useful life is different from the life of a building on it.
The rental payments relate to the “acquisition of a land”, not to a building itself.

Anyway, this is one of the reasons why I like the new IFRS 16 Leases. Under the new standard, you will have
to recognize a right-to-use asset instead of dealing with operating lease payments and therefore, this dilemma
will not exist anymore.

Travel expenditures

Can you capitalize travel expenses (hotel, transport) when a trip

happened to acquire an item of PPE?

Or, can you capitalize travel expenses of a consultant who came to your site to perform professional work
related to PPE?

Unless you have a great argumentation ready for your auditor, then no, you should not do it.

The reason is that these expenses relate more to personal services than to bring an asset to the desired location
and condition. At least, that’s what I experienced in the practice.

However, this area is quite unclear and you might be successful to provide good arguments to your auditor for
capitalizing.

If you hire a consultant and you agree to pay travel cost for him, you should try to negotiate the higher price for
his services with inclusion of all his expenses (to hide his travel expenses into the cost of service) – just to be on
a safe side.

Other expenses you CAN capitalize

• Fees for environmental permits, certifications whether an asset works properly
Property, plant and equipment Page 12 of 32
 • Expenses for necessary repairs during the construction phase
• Expenses for removing hurdles on the site (e.g. demolition of old building)

Do not capitalize:
• Training expenses (never!)
• Expenses for searching an appropriate site, evaluation of a site, feasibility study
• Advertising and marketing expenses
• Expenses to hire employees

OK, guys, I’ve just tried to bring more light to the most common types of expenses and feel free to ask in the
comments if you need help with something else. I might update this article and add some more explanations!

THEORIES
1. The cost of land shall include all of the following, except
A. Cost of survey
B. Commission related to acquisition
C. Property tax to date of acquisition assumed by the purchaser
D. Property tax after date of acquisition assumed by the purchaser

2. Fence and parking lot are reported as

A. Current assets C. Land improvements
B. Land D. Property, plant and equipment

3. The cost of building usually includes all, except

A. Cost of excavation
B. Expenditure for movable equipment and fixture
C. Any renovating cost incurred to put the building purchased in a condition for the intended use
D. Cost incurred to have existing building removed to make room for construction of new building

4. The term "betterment" refers to

A. An expenditure made for new facilities which increase "capacity".
B. An expenditure made to help insure continuity of service capacity.
C. An expenditure made to improve existing facilities by increasing "capacity".
D. An expenditure made to restore "capacity" after abandonment or retirement.

5. An entity incurred costs to modify a building and to rearrange a production line. As a result, an overall reduction in production
cost is expected. However, the modification did not increase the market value of the building and the rearrangement did not
extend the life of the production line. Should the building modification cost and the production line rearrangement cost be
capitalized?
A. Only the building modification cost should be capitalized.
B. Only the production line rearrangement cost should be capitalized.
C. The building modification cost and production line rearrangement cost should be expensed.
D. Both the building modification cost and production line rearrangement cost should be capitalized.

PROBLEMS

Problem 1:(Land (property), Building (plant), Machinery

Case A: Mindanao Company acquired a machine at the beginning of the current year.
Cash paid for machine, including VAT of P96,000 P896,000
Cost of transporting machine 30,000
Labor cost of installation by expert fitter 50,000
Labor cost of testing machine 40,000
Insurance cost for the current year 15,000
Cost of training for personnel who will use the machine 25,000
Cost of safety rails and platform surrounding machine 60,000
Cost of water device to keep machine cool 80,000
Cost of adjustment to machine to make it operate more efficiently 75,000
Estimated dismantling cost to be incurred as required by contract 65,000

Required: What total amount should be capitalized as cost of the machine?

Cash paid (896,000 - 96,000) 800,000

Cost of transporting machine 30,000
Installation cost 50,000
Testing cost 40,000
Safety rails and platform 60,000
Water device 80,000
Cost of adjustment 75,000
Estimated dismantling cost 65,000
Total cost of machine 1,200,000
Note that the estimated dismantling cost is capitalized because the entity has a present obligation as required by contract. In
the absence of a present obligation, the estimated dismantling cost is not capitalized.
Property, plant and equipment Page 13 of 32
Case B: (Lump-sum acquisition – building not demolished)
ABC Company carried out a number of transactions involving the acquisition of several assets. All expenditures were recorded in the
following single asset accounted identified as “ Property, plant and equipment”.
Acquisition price of land and several building P7,200,000
Option taken out on several pieces of property 240,000
List price of machinery purchased 1,500,000
Freight on machinery purchased 50,000
Repair to machinery resulting from damage during shipment 10,000
Cost of removing old machinery (recognized as liability) 20,000
Driveways and sidewalks 200,000
Building remodelling 500,000
Utilities paid since acquisition of building 30,000
Draining, clearing, grading, levelling and filling, surveying, subdividing and other permanent improvements 100,000

The fair value of the building is twice as much as the land. The machinery was subject to a 2% cash discount, which was taken and
credited to purchase discount. Of the two options, P180,000 related to the building and land purchased and P60,000 related to those
not purchased. The old machinery was sold at carrying amount.

Required: Compute for the following:

a. Cost of the land
b. Cost of the land improvement
c. Cost of the building
d. Cost of the new machinery

Land
Land Improvement Building Machinery
Acquisition price
(7.2M x 1/3); (7.2M x 2/3) 2,400,000 4,800,000
Options (180K x 1/3); (180K x 2/3) 60,000 120,000
Machinery purchased (1.5M x 98%) 1,470,000
Freight on machinery purchased 50,000
Repair to machinery -
Cost of removing old machinery -
Driveways and sidewalks (land improvement) 200,000
-
Building remodelling 500,000
Utilities paid since acq’n. of bldg.. - -
Draining 100,000
Total costs 2,560,000 200,000 5,420,000 1,520,000

Notes:
**1. Private driveways, walks, fences, parking lots, drainage and water system (land improvement) if not included in
blueprints, otherwise charged to self-constructed building.
2. Movable fixtures classified furniture and fixtures e.g. signage; Immovable fixtures attached to the building (Building
improvement)
3. Land improvements cost of trees, shrubs, plants and other landscaping.

Property, plant and equipment Page 14 of 32

Problem 2: (Lump-sum acquisition – building demolished) On February 1, 20x7, Reardon Corporation purchased a parcel of
land as a factory site for P320,000. An old building on the property was demolished and construction begun on a new warehouse that
was completed April 15, 20x8. Costs incurred on the construction project are listed below.

Demolition of old building ........................... P 21,000

Architect's fees ..................................... 31,700
Legal fees--title investigation ...................... 4,100
Construction costs (including insurance paid to workers of P50,000 and excluding
cost incurred on injuries not covered by insurance of
P250,000)............................... 950,000
Imputed interest based on stock financing ............ 14,000
Landfill for building site ........................... 19,300
Clearing of trees from building site ................. 9,600
Temporary buildings used for construction activities . 29,000
Land survey .......................................... 4,000
Excavation for basement .............................. 13,200
(Salvage materials from demolition sold for P1,800)
(Timber sold for P3,300)

Required: Compute for the allocated costs of the different classes of PPE assuming:

Case A: The fair values of land and old building on acquisition date were P297,000 and P33,000, respectively.
Case B: The old building is unusable and has an insignificant fair value.

Case A:
Land Old bldg. New bldg.
Acquisition cost
(320K x 297/330); (320K x 33/330) 288,000 32,000
Demolition of old building 21,000
Architect's fees 31,700
Legal fees--title investigation 4,100
Construction costs 950,000
Imputed interest -
Landfill for building site 19,300
Clearing of trees from building site
Temporary buildings
Land survey
Excavation for basement
Salvage materials from demolition
Timber sold
Total costs

Notes: if (option paid for the land and old bldg acquired) (payments to tenants to vacate premises) -→ allocate to land and
old bldg.
Land xxx
Building – old xxx
Cash xxx
to record the lump sum purchase of land with old building

Land xxx
Cash xxx
to record the additional costs of land

Property, plant and equipment Page 15 of 32

Building – new xxx
Cash xxx
to record the costs of the new building

Loss on derecognition of asset xxx

Building – old xxx
to record the allocated costs of the old building demolished as loss

Case B:
Land Old bldg. New bldg.
Acquisition cost
Demolition of old building
Architect's fees
Legal fees--title investigation
Construction costs
Imputed interest
Landfill for building site
Clearing of trees from building site
Temporary buildings
Land survey
Excavation for basement
Salvage materials from demolition
Timber sold
Total costs

Borrowing Costs
• Borrowing costs that are directly attributable to the acquisition, construction or production
of a qualifying asset are capitalized. Other borrowing costs are expensed.
• Borrowing costs may include: (a) interest expense calculated using the effective interest
method; (b) finance charges on finance leases; (c) exchange differences.
• Qualifying asset is an asset that necessarily takes a substantial period of time to get
ready for its intended use or sale. It may be an (a) inventory, (b) PPE, (c) investment
property measured at cost, or (d) intangible asset.
• The following are not qualifying assets: (a) assets produced over short period of time, (b)
assets that are ready for their intended use or sale, (c) assets produced routinely and in
large quantities and (d) assets measured at fair value.
• The capitalization of borrowing costs starts when the entity (a) incurs expenditures for
the asset, (b) incurs borrowing costs, and (c) necessary activities are being undertaken.
• Capitalization of borrowing costs is suspended during extended periods of suspension of
active development of a qualifying asset.
• The capitalization of borrowing costs ceases when the qualifying assets is substantially
completed.
• Only avoidable borrowing costs are eligible for capitalization.
• Capitalizable borrowing costs on specific borrowing = (interest expense less investment
income).
• Capitalizable borrowing costs on general borrowing = (average expenditure x
capitalization rate).
• Capitilization rate = Total interest expense on general borrowings divided by Total general
borrowings.
• Qualifying assets are not segregated from other assets in the financial statements.

BORROWING COSTS

THEORIES
1. Which of the following should not be considered a qualifying asset?
A. An expensive jet that can be purchased from a vendor.
B. A ship that normally takes one to two years to complete.
C. A toll bridge that usually takes more than a year to build.
D. A power generation plant that normally takes two years to construct.

2. When computing the amount of interest cost to be capitalized, the concept of "avoidable interest" refers to
A. A cost of capital.
B. The total interest cost actually incurred.
C. That portion of average accumulated expenditures on which no interest cost was incurred.
D. That portion of total interest cost which would not have been incurred if expenditures for asset construction had not been
made.

3. Which of the following costs may not be eligible for capitalization as borrowing cost?
A. Imputed cost of equity.
Property, plant and equipment Page 16 of 32
 B. Interest on bonds issued to finance the construction of a qualifying asset.
C. Amortization of discount or premium relating to borrowings that qualify for capitalization.
D. Exchange difference arising from foreign currency borrowing to the extent that it is regarded as an adjustment to interest
cost pertaining to a qualifying asset.

4. Which of the following is required for borrowing costs incurred that are directly attributable to the construction of a qualifying
asset?
A. Capitalize as part of the cost of the asset.
B. Recognize as an expense in the period incurred.
C. Recognize as a deferred charge and amortize over the useful life of the asset.
D. Either recognize as an expense in the period incurred or capitalize as part of the cost of the asset.

5. Which of the following is the recommended approach in accounting for interest incurred in financing the construction of
property, plant and equipment?
A. Capitalize no interest during construction.
B. Capitalize only the actual interest incurred during construction.
C. Charge construction with all costs of funds employed, whether identifiable or not.
D. Capitalize interest equal to the prime interest rate times the estimated cost of the asset being constructed

PROBLEMS

Problem 1: (Specific Borrowing)

Case A: On January 1, 20x5, the company obtained a loan for P4,000,000 at an interest rate of 10%, specifically for the
construction of the building. Prior to their disbursement, the proceeds of the loan were temporarily invested and earned interest
income amounting to P125,000.
Required: How much is the capitalized interest?

Case B: The company obtained a loan for P5,000,000 at an interest rate of 10%, specifically for the construction of the building.
Availments from the loan were made at the beginning of each quarter in equal amounts. Prior to their disbursement, the proceeds of
the loan were temporarily invested and earned interest income amounting to P40,000.
Required: What is the total cost of the building constructed?

a. P4,000,000 x 10% P400,000

Less interest income earned on temporary investment of loan ( 125,000)
Capitalized interest P275,000
b. 1,250,000 x 10% P 125,000
1,250,000 x 10% x 9/12 93,750
1,250,000 x 10% x 6/12 62,500
1,250,000 x 10% x 3/12 31,250
Total interest P 312,500
Less interest income earned on temporary investment of loan 40,000
Capitalized interest P272,500
Total construction costs 5,000,000
Total cost of building P5,272,500

Problem 2: (General borrowing) ABC Company had the following loans in place at the beginning and end of 20X1:
Description January 1, 20X1 December 31, 20X1
Bank loan 6% p.a. P200,000
Bank loan, 8% p.a. P130,000 130,000
Bank loan, 5.5% p.a. 50,000 50,000
• The bank loan at 6% p.a. was taken in July 20X1 to finance the construction of a new production hall (construction began
on March 1, 20X1).
• The bank loan at 8% p.a. and bank loan at 5.5% p.a. were taken for no specific purpose and ABC used them to finance
general spending and the construction of a new machinery.
• ABC used P60,000 for the construction of the machinery on February 1, 20X1 and P25,000 on September 1, 20X1.
Required: What borrowing cost should be capitalized for the new machinery?

The capitalization rate is computed as follows:

(130,000 x 8%) + (50,000 x 5.5%) ÷ (130,000 + 50,000) = (13,150 ÷ 180,000) = 7.31%

The “Bank loan, 6% p.a.” is ignored because it is a specific borrowing for another asset (i.e., “production hall” rather than
“machinery”).

The weighted average expenditures is computed as follows:

(60,000 x 11/12) + (25,000 x 4/12) = 63,333

Borrowing cost = 7.31% x 63,333 = 4,630

The borrowing cost eligible for capitalization is 4,630 because it is lower than the actual borrowing cost of 13,150 (see computation
above).

Problem 3: (General borrowing –expenditures incurred evenly) Elephant Company borrowed P15,000,000 at 12% to finance
in part the construction of a new building on January 1, 20x4 and in part for general purposes. The loan is to be repaid commencing
the month following completion of the building. Expenditures for the completed structure total P10,000,000 during the year ended
December 31, 20x4. These expenditures were incurred evenly throughout the year. The entity earned interest of P200,000 for
the year on the unexpended portion of the loan.
Required:
1. What amount of interest is capitalized on December 31, 20x4?
2. What is the interest expense for 20x4?

Property, plant and equipment Page 17 of 32

 Average expenditures (10,000,000 / 2) 5,000,000
Interest capitalized on average expenditures (5,000,000 x 12%) 600,000

Average expenditures (10,000,000 / 2) 5,000,000

Interest capitalized on average expenditures (5,000,000 x 12%) 600,000
Interest expense (1,800,000 – 600,000) 1,200,000

Problem 4: (Specific and General Borrowing) On January 1, 20x5, Metro Company started the construction of its new building.
The company follows the policy of capitalizing allowable interest costs. Construction costs were incurred as follows:
January 1 P1,400,000 September 20 P1,000,000
March 31 1,000,000 December 31 400,000
July 1 1,200,000
The building was completed on December 31, 20x5.

On January 1, 20x5, Metro Co., borrowed P1,800,000 at an interest rate of 10% specifically for the construction of its new building.
Interest earned from the temporary investment of the proceeds of the loan prior to their disbursement amounted to P10,000. Metro
Co., also had the following other loans in 20x5 which were borrowed for general purposes.

The proceeds of these loans were used in part for the construction of the building.
10%, 2-year note -P1,600,000
12%, 5-year note -P2,000,000

Required: How much is the capitalized interest?

Computation of average accumulated expenditures:

1,400,000x 12/12 P1,400,000
1,000,000 x 9/12 750,000
1,200,000 x 6/12 600,000
1,000,000 x 3/12 250,000
400,000 x 0/12 ----------
Average accumulated expenditures P3,000,000
Computation of weighted average interest rate:
(10% x 1,600,000) + (12% x 2,000,000) 11.11%
1,600,000 + 2,000,000
Interest of specific borrowing:
1,800,000 x 10% P180,000
Less interest earned 10,000 P170,000
Interest on general borrowing:
3,000,000 – 1,800,000 = 1,200,000
1,200,000 x 11.11% 133,320
Capitalized interest P303,320

Problem 5: (Extended period of construction) Jardine Company had the following loans outstanding during 20x0 and 20X1
Specific Construction Loan @ 15% P2,000,000
General Loan @ 12% 15,000,000

The entity began the self-construction of a building on January 1, 20x0 and was completed on August 31, 20X1. The following
expenditures were made during 20x0 and 20X1:
January 1, 20x0 P2,000,000
July 1, 20x0 4,000,000
November 1, 20x0 3,000,000
July 1, 20x1 1,000,000
Total P10,000,000

Required: What is the cost of building?

(2M x 12/12) + (4M x 6/12) + (3M x 2/12) = P4,500,000

2,000,000 x 15% =P300,000

(4.5 – 2M ) x 12% = P300,000

(9,600,000 x 8/8) + (1M x 2/8) = P9,850,000

2M x 15% x 8/12
(9,850,000 – 2M) x 12% x 8 /12

= P828,000

(9,000,000 + 300,000 + 300,000 +828,000 + 1,000,000) = P11,428,000

Depreciation and Depletion

Depreciation
• Subsequent to initial recognition, an entity shall choose either the cost model or the
revaluation model as its accounting policy and shall apply that policy to an entire class
of PPE.
• Depreciation is the systematic allocation of the depreciable amount of an asset over its

Property, plant and equipment Page 18 of 32

 estimated useful life.
• Each part of an item of PPE with a cost that is significant in relation to the total cost of
the item shall be depreciated separately.
• Changes in depreciation method, useful life, or residual value are changes in accounting
estimate accounted for prospectively.
• Depreciation begins when the asset is available for use and ceases when it is
derecognized.
• SYD denominator is computed as “ Life ÷ 1 divided by 2 multiplied by life.”
• Double declining rate is computed as “ 2 divided by life.”
• Composite Life = DC over AD; while AD over TC is = Composite Rate. No gain or loss is
recognized when one asset belonging to a group is disposed or replaced.
• Leasehold improvement is depreciated over the shorter of its (a) useful life and the (b)
remaining lease term.
• Assets that are idle, retired from active use, temporarily taken out of use, or abandoned
are still be depreciated.
• An asset is said to be fully depreciated when its carrying amount is zero or equal to its
residual value.
• Revaluation surplus = Fair value less Carrying amount
• Revaluation may be recorded using the proportional or elimination method.
• If the revalued asset is depreciable, a portion of the revaluation surplus may be
transferred periodically to retained earnings.
• Gain or loss on disposal is the difference between the net proceeds and the carrying
amount.

Depletion
• Exploration for and evaluation of mineral resources is the search for mineral resources
after the entity has obtained legal rights to explore in a specific area.
• Exploration and evaluation expenditures start to be incurred only after the legal right to
explore a specific area is obtained.
• Exploration and evaluation expenditures cease to be incurred when the existence of
reserves is in fact established.
• PFRS 6 permits entities to develop their own accounting policy for exploration and
evaluation assets which results in relevant and reliable information based entirely on
management’s judgment.
• Exploration and evaluation assets shall be measured at cost.
• Exploration and evaluation assets are exploration and evaluation expenditures recognized
as assets in accordance with the entity’s accounting policy.
• After recognition, an entity shall apply either the cost model or the revaluation model
to the exploration and evaluation assets.
• An entity may change its accounting policies for exploration and evaluation
expenditures if the change makes the financial statements more relevant and no less
reliable, or more reliable and no less relevant.
• An entity shall classify exploration and evaluation assets as tangible or intangible
according to the nature of the assets acquired and shall apply the classification
consistently.
• An exploration and evaluation asset shall no longer be classified as such when the
technical feasibility and commercial viability of extracting a mineral resource are
demonstrable.
• Natural resources (wasting assets) are physically consumed and are irreplaceable.
• The cost of natural resources include (a) purchase costs including direct costs and
decommissioning and restorations costs, (b) exploration costs to the extent that they are
capitalized in accordance with an entity accounting policy, (c) intangible development
costs.
• Depletion is normally computed using the units-of-production method.
• The depletion charge for each period shall initially form part of the cost of inventory and
charged to expense only when the inventory is sold.
• Tangible development costs (tangible equipment costs) costs are not capitalized as cost
of natural resource but capitalized as equipment and depreciated separately.
• Liquidating dividends are dividends declared in excess of the balance in unrestricted
retained earnings. Liquidating dividends are return of capital, rather than return on

Property, plant and equipment Page 19 of 32

 capital.
• Provisions for restoration and decommissioning costs are recognized when the entity
incurs present obligation.
• The periodic unwinding of the discount on the liability recognized for the decommissioning
or restoration cost is recognized in profit or loss as a finance cost as it occurs.

DEPRECIATION AND DEPLETION

THEORIES
1. As generally used in accounting, what is depreciation?
A. It is a process of asset valuation.
B. It applies only to long-lived intangible asset.
C. It is used to indicate a decline in market value of a long-lived asset.
D. It is an accounting process which systematically allocates long-lived asset cost to accounting periods.

2. Depreciation is best described as a method of

A. Asset valuation C. Current value allocation
B. Cost allocation D. Useful life determination

3. Does PFRS 6 require an entity to recognize exploration and evaluation expenditure as an asset?
A. No, such expenditure is always expensed as incurred.
B. Yes, but only to the extent such expenditure is recoverable in future periods.
C. Yes, but only to the extent required by the entity's accounting policy for recognizing exploration and evaluation asset.
D. Yes, but only to the extent the technical feasibility and commercial viability of extracting the associated mineral resource
have been demonstrated.

4. Which measurement model applies to exploration and evaluation asset subsequent to initial recognition?
A. The cost model
B. The revaluation model
C. The recoverable amount model
D. Either the cost model or the revaluation model

5. Which of the following facts or circumstances would not trigger a need to test an evaluation and exploration asset for
impairment?
A. The absence of budgeted or planned substantive expenditure on further exploration and evaluation activities in the specific
area.
B. The expiration of the period for which the entity has the right to explore in the specific area unless the right is expected to
be renewed.
C. Lack of sufficient data to determine whether the carrying amount of the exploration and evaluation asset is likely to be
recovered in full from successful development or by sale.
D. A decision to discontinue exploration and evaluation activities in the specific area when those activities have not led to the
discovery of commercially viable quantities of mineral resources.

PROBLEMS

Problem 1: (Calculate depreciation)

Case A: A machine cost P500,000 on April 1, 20x10. Its estimated residual value is P50,000 and its expected life is eight years.

Instructions: Calculate the depreciation expense (to the nearest peso) by each of the following methods, showing the figures used.
(a) Straight-line for 20x10
(b) Double-declining balance for 20x11
(c) Sum-of-the-years'-digits for 20x11

(a) 1/8 × P450,000 × ¾ = P42,188

(b) 20x11: 25% × P406,250 = P101,563

(c) 8/36 × P450,000 × ¼ = P25,000

7/36 × P450,000 × ¾ = 65,625
P90,625

Case B: (Output Method) Lion Company acquired a machine on July 1,20x14 and paid the following bills:
Invoice price P5,000,000
Freight in 50,000
Installation cost 150,000
Cost of removing the old machine preparatory
to the installation of the new machine 100,000
The estimated life of the machine is 8 years or a total of 100,000 working hours with no residual value. The operating hours of the
machine total 5,000 hours in 20x14 and 12,000 hours in 20x15. The entity followed the working hours method of depreciation. On
December 31, 20x15, what is the carrying amount of the machine?

Cost (5,000,000 + 50,000 + 150,000) 5,200,000

Accumulated depreciation - December 31, 20x15 (17,000 hours x 52) 884,000
Carrying amount - December 31, 20x15 4,316,000

Rate per hour (5,200,000/100,000) 52

Problem 2: (Adjustment of Depreciable Base) A truck was acquired on July 1, 20x8, at a cost of P216,000. The truck had a six-
year useful life and an estimated residual value of P24,000. The straight-line method of depreciation was used. On January 1, 20x11,
the truck was overhauled at a cost of P20,000, which extended the useful life of the truck for an additional two years beyond that

Property, plant and equipment Page 20 of 32

originally estimated (residual value is still estimated at P24,000). In computing depreciation for annual adjustment purposes,
expense is calculated for each month the asset is owned.

Instructions: Prepare the appropriate entries for January 1, 20x11 and December 31, 20x11.

Cost P216,000
Less residual value 24,000
Depreciable base, July 1, 20x8 192,000
Less depreciation to date [(P192,000 ÷ 6) × 2 1/2] 80,000
Depreciable base, Jan. 1, 20x11 (unadjusted) 112,000
Overhaul 20,000
Depreciable base, Jan. 1, 20x11 (adjusted) P132,000

January 1, 20x11
Accumulated Depreciation............................................................................ 20,000
Cash ............................................................................................. 20,000

December 31, 20x11

Depreciation Expense .................................................................................. 24,000
Accumulated Depreciation (P132,000 ÷ 5.5 yrs) 24,000

Problem 3: (Component Depreciation) Presented below are the components related to an office building that Lockard Company
is considering purchasing for P8,700,000.

Component Useful Life Value

Building structure 60-year life P5,400,000
Building engineering 30-year life 2,400,000
Building external works 30-year life 900,000

Instructions
(a) Compute depreciation expense for 20x10, assuming that Lockard uses component depreciation.
(b) (Carrying amount of replaced part is determinable) Assume that the building engineering (original useful life 30
years) was replaced in 20 years the cost of the old part that is replaced is P2,400,000. Prepare the entry to record
the replacement of the old component with the new component at a cost of P2,600,000.
(c) (Carrying amount of replaced part is indeterminable) Assume that the building engineering (original useful life
30 years) was replaced in 20 years it is impracticable to determine the cost of the old part that is replaced.
Prepare the entry to record the replacement at a cost of P2,600,000.

(a) Component Depreciation Expense

Building structure 5,400,000 ÷ 60 = 90,000
Building engineering 2,400,000 ÷ 30 = 80,000
Building external works 900,000 ÷ 30 = 30,000
P200,000

(b) Building engineering........................................ 2,600,000

Accumulated Depreciation
(P2,400,000 X 20/30)....................................... 1,600,000
Loss on replacement or loss on disposal................ 800,000
Building Engineering............................. 2,400,000
Cash...................................................... 2,600,000

(c) Building engineering........................................ 2,600,000

Accumulated Depreciation
(P2,600,000 X 20/30)....................................... 1,733,333
Loss on replacement or loss on disposal........... 866,667 (squeeze)
Building Engineering............................. 2,600,000
Cash...................................................... 2,600,000

Problem 3: (Change in useful life and method)

Case A: On January 1, 20x10, Fish Company acquired equipment for P1,000,000 with a 10-year useful life and P100,000 residual
value. The straight line method of depreciation is used. During 20x14, after the 20x13 financial statements had been issued, the
entity determined that this equipment's remaining useful life was only four more years and the residual value would be P40,000.
What is the carrying amount of the equipment on December 31,20x14?

Cost-January 1, 20x10 1,000,000

Accumulated depreciation on January 1, 20x14 (900,000/10x4) 360,000
Carrying amount on January 1, 20x14 640,000
Depreciation for 20x14 (640,000 - 40,000 / 4) 150,000
Carrying amount - December 31,20x14 490,000

Case B: Turtle Company purchased equipment on January 1, 20x12 for P5,000,000. The equipment had an estimated 5-year
service life. The depreciation policy for 5-year assets is to use the 200% double declining balance method for the first two years and
then switch to the straight line depreciation method. In the December 31,20x14 statement of financial position, what amount should
be reported as accumulated depreciation for the equipment?

Straight line rate (100%/5 years) 20%

Fixed rate (20% x 2) 40%
20x12 depreciation (5,000,000 x 40%) 2,000,000
20x13 depreciation (3,000,000x40%) 1,200,000
Accumulated depreciation - December 31,20x13 3,200,000
Depreciation for 20x14 - straight line (5,000,000-3,200,000/3) 600,000
Accumulated depreciation - December 31,20x14 3,800,000

Problem 4: (Derecognition) Lalaine Company acquired an aeroplane three years ago. At the time of acquisition, the cost of the
Property, plant and equipment Page 21 of 32
jet frame was P46,000,000 and the additional cost of the engine was P6,000,000.

During the current year, the engine was sold at P5,000,000. At the time of sale, the accumulated depreciation to date on the jet
frame was P17,500,000 and on the engine was P4,000,000. What amount should be derecognized at the date of replacement?

Cost of old engine 6,000,000

Accumulated depreciation 4,000,000
Carrying amount 2,000,000

P5,000,000 – 2,000,000 =P3,000,000 gain on sale

Problem 5: (Composite method) Goldfis Company provided the following:

Total cost Residual value Estimated life
Machine A P5,500,000 P500,000 20
Machine B 2,000,000 200,000 15
Machine C 400,000 5
The entity computed depreciation on the straight-line method. What is the composite life and composite rate of the assets?

Residual Depreciable Annual

Cost Value amount Life depreciation
A 5,500,000 500,000 5,000,000 20 250,000
B 2,000,000 200,000 1,800,000 15 120,000
C 400,000 400,000 5 80,000
7,900,000 7,200,000 450,000

Composite life - 7,200,000 / 450,000 16 years

Composite rate = Total annual depreciation / total cost = 450,000/7,900,000 = 5.7%

Problem 6: (Composite method @ sale) Flying Fish Company used the composite method of depreciation based on a composite
rate of 25%. At the beginning of 20x14, the total cost of equipment was P5,000,000 with a total residual value of P600,000. The
accumulated depreciation was P3,000,000 at that time. In January 20x14, the entity purchased an equipment for P2,500,000 with no
residual value. At the end of 20x14, the entity sold an equipment with an original cost of P1,000,000 and a residual value of
P200,000 for P350,000. This asset was acquired on January 1,20x12.

Required:
1. What is the depreciation for 20x14?
2. What is the gain or loss from the derecognition of the asset on December 31,20x14?

Required 1
Total cost - January 1, 20x14 5,000,000
Cost of new asset acquired 2,500,000
Cost of asset sold (1,000,000)
Remaining cost - December 31,20x14 6,500,000
Depreciation for 20x14 (25% x 6,500,000) 1,625,000

Required 2: Under the composite method, no gain or loss is recognized on the derecognition of an asset. The journal entry for the
derecognition is:
Cash 350,000
Accumulated depreciation 650,000
Equipment 1,000,000

Problem 7: (Retirement method vs Replacement method) Meralco has a balance in the electric meters account of P3,000,000
on January 1, 20x10. During 20x10, Meralco installed new meters as follows:
May August November
Cost of new meters installed P500,000 P800,000 P400,000
Cost of old meters replaced 360,000 - 300,000
Proceeds from sale of old meters 40,000 - 30,000
Required:
1. Using the retirement method, what is the amount of depreciation that should be recognized in year 20x10?
2. Using the replacement method, what is the amount of depreciation that should be recognized in year 20x10?

Retirement
360,000 (40,000) 320,000
300,000 (30,000) 270,000 590,000

Replacement
500,000 (40,000) 460,000
400,000 (30,000) 370,000 830,000

Property, plant and equipment Page 22 of 32

Problem 8: (Inventory method) Happy Company uses the inventory method to account for numerous small tools. The balance of
the tool account on January 1, 20x10 was P364,000. The following transactions occurred with respect to the small tools during
20x10: Purchases during the year, P156,000; sale of used tools at salvage value in December, P10,400; Inventory of small tools on
December 31, 20x10, P390,000. What is the amount of tools depreciation for the year 20x10?

Beg 364,000
Purchases 156,000
Sales (10,400)
End (390,000)
119,600

Problem 9: (Leasehold improvement) On January 1, 20x12, the Remedios Company leased a portion of the building owned by
Royal Commercial Company. The lease expires on December 31, 20x21. Extensive work was done on the leased property for the
construction of the staff working area. The improvements, costing P1,200,000, were completed on March 31, 20x12. The estimated
useful life of the improvement was 12 years.

During 20x16, because of favourable business operations in the area, Remedios Company negotiated for the extension of the lease
term by an additional 5 years.

Remedios Company provides full year depreciation during the year of acquisition and no depreciation in the year of
disposal.

REQUIRED:
(a) Compute the carrying value of the leasehold improvements on December 31, 20x15.
(b) Compute the depreciation expense on the leasehold improvements for the year ended December 31, 20x16.

(a) Cost of Leasehold Improvements P1,200,000

Less Accumulated Depreciation
1,200,000/10 years = 120,000 x 4 years
Lease term is 10 years; Useful life is 12 years
Shorter period is 10 years 480,000
Carrying value, December 31, 2015 P 720,000

(b) Carrying value, December 31, 2015 P 720,000

Revised remaining lease term is 11 years (10 – 4 + 5)
Remaining useful life is 8 years (12 – 4)
Shorter period is ÷ 8 years
Depreciation expense for 2016 P 90,000

Problem 10: (Exploration cost) Delb Company is an oil and gas exploration firm. During 20x8, Delb engaged in five different
exploration projects. The costs associated with these projects are as follows:
Project 1 ............................................ P 325,000
Project 2 ............................................ 178,000
Project 3 ............................................ 423,000
Project 4 ............................................ 240,000
Project 5 ............................................ 96,000
Total .............................................. P1,262,000

Only Projects 2 and 5 were successful. As of the end of the year, production had not yet started at either of these two sites.

Assuming that all exploration costs were paid for in cash, make the journal entry to record the expenditures for the year using
(1) the successful efforts method.
(2) the full cost method.

ANS:
(1)

Exploration Expense .......................... 988,000

Capitalized Exploration Cost ................. 274,000
Cash ....................................... 1,262,000

(2)

Capitalized Exploration Cost .............. 1,262,000

Cash .................................... 1,262,000

Problem 11: (Depletion and Change in estimate) Ong Exploration Company purchased in 20x14 a property that contain certain
mineral deposits for P45,000,000. Estimated recovery was 10,000,000 metric tons of deposits. Development costs of P1,500,000
were also incurred in the same year, and these were properly capitalized by the company. The mining property was expected to be
worth P6,000,000 after the mineral deposits had all been removed, but will require restoration costs of P2,500,000. Based on the
assessment of the company at the end of 20x14, the extraction of resources from the site will last up to December 31, 20x24. The
company established a provision for restoration, discounting the expected restoration costs at the prevailing interest rate of 8%.

During 20x15, the company extracted and sold 1,000,000 metric tons of mineral. Further development costs P750,000 were incurred
and capitalized in 20x16, and the estimate of total recoverable deposits (including the amount extracted in 20x15) was revised to
9,250,000 metric tons. During 20x16, the company recovered 1,500,000 metric tons.

Property, plant and equipment Page 23 of 32

REQUIRED: Determine the depletion expense for 20x15 and 20x16. (Round off unit depletion rate to the nearest centavo and
round off final total depletion expense to the nearest peso)
Purchase price P45,000,000
Development costs 1,500,000
Salvage value ( 6,000,000)
Restoration costs at present value (2,500,000 x 0.4632) 1,158,000
Depletable cost P41,658,000
Estimated recovery from the property ÷10,000,000
Depletion rate per metric ton P 4.1658
Resources extracted during 2015 x 1,000,000
Depletion expense for 2015 P 4,165,800

Depletable cost, 2015 (see above) P41,658,000

Depletion expense for 2015 ( 4,165,800)
Development costs in 2016 750,000
New depletable cost for 2016 P38,242,200
Remaining number of metric tons (9,250,000-1,000,000) ÷ 8,250,000
Revised depletion per metric ton (rounded) P 4.64
Number of metric tons removed during 2016 x 1,500,000
Depletion expense for 2016 P 6,960,000

Problem 12: (Depreciation of mining equipment and Liquidating dividend) In connection with your audit of the Gold Mining
Corporation for the year ended December 31, 20x12, you noted that the company purchased for P16,640,000 mining property
estimated to contain 12,800,000 tons of ore. The residual value of the property is P1,280,000.

Building used in mine operations costs P1,280,000 and have estimated life of 15 years with no residual value. Mine machinery costs
P2,560,000 with an estimated residual value P512,000 after its physical life of 4 years.

The building and machinery has no further use after the natural resource is fully depleted.

Following is the summary of the company’s operations for first year of operations.
Tons mined 1,280,000 tons
Tons sold 1,024,000 tons
Unit selling price per ton P4.40
Direct labor 1,024,000
Miscellaneous mining overhead 204,800
Operating expenses (excluding depreciation) 921,600

Inventories are valued on a first-in, first-out basis. Depreciation on the building is to be allocated as follows: 20% to operating
expenses, 80% to production. Depreciation on machinery is chargeable to production.

REQUIRED: Based on the above, answer the following:

1. How much is the depletion for 20x12?
2. Total inventoriable depreciation for 20x12?
3. How much is the Inventory as of December 31, 20x12?
4. How much is the cost of sales for the year ended December 31, 20x12?
5. How much is the maximum amount that may be declared as dividends at the end of the company’s first year of operations?

Requirement No. 1
Acquisition cost 16,640,000
Less residual value 1,280,000
Depletable cost 15,360,000
Divide by total estimated reserves 12,800,000
Depletion rate 1.20
Tons mined in 20x12 1,280,000
Depletion for 20x12 1,536,000

Requirement No. 2
Depreciation - Building [(P1,280,000/12,800,000 tons) x 1,280,000 tons x 80%] 102,400
Depreciation - Machinery [(P2,560,000-P512,000/4] 512,000

Total 614,400

Requirement No. 3
Depletion (see no. 1) 1,536,000
Direct labor 1,024,000
Depreciation (see no. 2) 614,400
Miscellaneous mining overhead 204,800
Total available for sale 3,379,200
Divide by tons mined 1,280,000
Cost per ton 2.64
Tons remaining (1,280,000 - 1,024,000) 256,000

Property, plant and equipment Page 24 of 32

Inventory, 12/31/12 675,840

Requirement No. 4
Cost of sales (1,024,000 tons x P2.64) 2,703,360

Requirement No. 5
Sales (1,024,000 x P4.4) 4,505,600
Cost of sales (see no. 4) (2,703,360)
Gross profit 1,802,240
Operating expenses (921,600)
Depreciation - Building [(P1,280,000/12,800,000 tons) x 1,280,000 tons x 20%] (25,600)
Net income 855,040
Realized depletion (1,024,000 tons x P1.2) 1,228,800
Maximum amount that may be declared as dividends 2,083,840

Explain the "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.
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.

Explain the "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. The wasting asset doctrine is
therefore an exception to the trust fund doctrine.

What is the formula in determining the maximum dividend that can be declared by a wasting asset corporation?

The formula in determining the maximum dividend that can be declared by a wasting asset corporation is as follows:
Retained earnings xx
Add: Accumulated depletion xx
Total xx
Less: Capital liquidated in prior years xx
Unrealized depletion in ending inventory xx xx
Maximum dividend xx

Problem 13: (No production in a period/Shut down) Dungeon Mining constructed a building costing P7,500,000 on a mine
property. The building has an estimated useful life of twelve years with no residual value. After all the resources are removed, the
building will be of no use and will be demolished by the entity. The estimated recoverable output from the mine is 1,000,000 tons.

During the first two years, the company extracted 100,000 tons per year. Changes in the surrounding environment forced the entity
to shut down its operation for the succeeding two years. Thus, there were no extractions during the third and fourth year. In the fifth
year, the company resumed extractions and produced 150,000 tons. With improvements in production methods, it is now expected
that the company will extract 150,000 tons per year.

REQUIRED:
(a) Depreciation expense for the first two years
(b) Carrying value of the building at the end of fourth year from the date of acquisition of the building
(c) Depreciation expense for the fifth year
(d) Carrying value of the building at the end of sixth year from the date of acquisition

(a) 7,500,000/1,000,000 = 7.50/ton; 7.50 x 100,000 = P750,000 each year

(Note: mining period, which is 10 years, 1,000,000/ 100,000, is shorter than the useful
life in years; hence, unit of output method is used.)

(b) Cost P7,500,000

Less depreciation expense for the 1st and 2nd years (1,500,000)
Less depreciation for the 3rd and 4th years
6M/8yrs = 750,000; 750,000 x 2 years (1,500,000)
Carrying value at the end of the 4th year P4,500,000

(During shutdown period, the depreciation shall be computed based on remaining life, on
a time-factor basis, generally straight-line.)

(c) 150,000 tons/ year x 6 years = 900,000

4,500,000/900,000 = 5/ton; 5 x 150,000 P 750,000

With new estimate of annual production, mining period is shorter, at the beginning of the
fifth year. The company shall compute depreciation using unit of output.

(d) Carrying value at the end of the 4th year P4,500,000

Less depreciation expense for the 5th and 6th years (1,500,000)
Carrying value at the end of the 6th year P3,000,000

Property, plant and equipment Page 25 of 32

 FULL PFRS SMES
(PPE) Useful life, residual Review useful life, residual value, depreciation rate- Review useful life, residual value, depreciation
value, depreciation rate annually rate only if there is a significant change in
the asset or how it is used. Any adjustment is
a change in estimate (prospective).

Extractive industry Under full PFRS, if an entity’s accounting policy Under PFRS for SMEs, an exploration
results in the recognition of an exploration and expenditure may be classified as tangible asset
evaluation asset, such asset shall be measured or intangible asset and shall be measured
initially at cost. using the cost model only.

The exploration and evaluation asset may be

classified as tangible asset or intangible asset and
shall be measured subsequently using either the
cost model or fair value model.

Revaluation and Impairment

Revaluation
• Subsequent to initial recognition, an entity shall choose either the cost model or the
revaluation model as its accounting policy and shall apply that policy to an entire class
of PPE.
• Depreciation is the systematic allocation of the depreciable amount of an asset over its
estimated useful life.
• Each part of an item of PPE with a cost that is significant in relation to the total cost of
the item shall be depreciated separately.
• Changes in depreciation method, useful life, or residual value are changes in accounting
estimate accounted for prospectively.
• Depreciation begins when the asset is available for use and ceases when it is
derecognized.
• SYD denominator is computed as “ Life ÷ 1 divided by 2 multiplied by life.”
• Double declining rate is computed as “ 2 divided by life.”
• Composite Life = DC over AD; while AD over TC is = Composite Rate. No gain or loss is
recognized when one asset belonging to a group is disposed or replaced.
• Leasehold improvement is depreciated over the shorter of its (a) useful life and the (b)
remaining lease term.
• Assets that are idle, retired from active use, temporarily taken out of use, or abandoned
are still be depreciated.
• An asset is said to be fully depreciated when its carrying amount is zero or equal to its
residual value.
• Revaluation surplus = Fair value less Carrying amount
• Revaluation may be recorded using the proportional or elimination method.
• If the revalued asset is depreciable, a portion of the revaluation surplus may be
transferred periodically to retained earnings.
• Gain or loss on disposal is the difference between the net proceeds and the carrying
amount.

Impairment
• When the carrying amount of an asset exceeds its recoverable amount, the excess
represents impairment loss.
• Recoverable amount is the higher of an asset’s (or CGU’s) (a) fair value less costs of
disposal and its (b) value in use.
• An asset is tested for impairment only when an indication of impairment exists. However,
the following assets are tested for impairment at least annually even if an indication of
impairment does not exist:
• (1) Intangible assets with indefinite useful life.
• (2) Intangible asset not yet available for use, and
• (3) Goodwill acquired in a business combination.
• Indications of possible impairment of an asset are classified into (a) external resources
(e.g. market-related changes) and (b) internal sources.
• The fair value of an asset is measured in accordance with the principles set forth under
PFRS 13 Fair Value Measurement.
• Cost of disposal exclude (a) restoration and decommissioning benefits and other costs
associated with reducing or reorganizing a business following the disposal of an asset.
• Value in use is the present value of estimated future cash flows expected to arise from the
Property, plant and equipment Page 26 of 32
 continuing use of an asset (or CGU) and from its disposal at the end of its useful life.
• Cash flow projections exclude cash flows from (a) Future restructuring not yet
committed, (b) Improving or enhancing the asset’s performance, (c) income taxes, and
(d) Financing activities.
• Projections of cash outflows include costs of day-today servicing of the asset as well as
directly attributable future overheads.
• Projections shall cover a maximum period of 5 years. Projections beyond 5 years are
extrapolated using a steady or declining growth rate for subsequent years.
• The discount rate shall be a current pre-tax rate.
• Impairment loss is recognized in profit or loss, unless it represents a revaluation
decrease which is recognized in other comprehensive income.
• After impairment loss, the recoverable amount is depreciated over the remaining useful
life of the impaired asset.
• Cash-generating unit (CGU) is the smallest identifiable group of assets that generates
cash inflows that are largely independent of the cash inflows from other assets or groups
of assets.
• Assets whose recoverable amount can be determined reliably are tested for impairment
individually.
• Assets whose recoverable amount cannot be determined reliably (e.g. assets that do not
generate their own cash flows) are included in a CGU. The CGU is the one tested for
impairment.
• If the CGU is not impaired, no impairment loss is recognized for an asset whose
recoverable amount cannot be determined.
• Goodwill acquired in a business combination shall be allocated to each of the acquirer’s
CGU in the year of business combination. If the allocation is not completed in the year of
business combination, the allocation should be completed in the year of business
combination, the allocation should be completed before the end of the next period
following the year of business combination.
• Impairment loss on a CGU is allocated first to goodwill. Any remaining amount is
allocated to the other assets based on their carrying amounts.
• In allocating an impairment loss, an entity shall not reduce the carrying amount of an
asset below the highest of: (a) its FVLCS, (b) its VIN, and (c) Zero. Any amount
exceeding the threshold is allocated to the other assets.
• On reversal of impairment loss

Recoverable amount on date of

d reversal

CA if no IL had been recognized

c
previously

b CA on date of reversal
• Reversal of impairment loss recognized in other comprehensive income = d – c
• Reversal of impairment loss recognized in profit or loss = c – b
• Impairment loss on goodwill shall not be reversed in a subsequent period.

Property, plant and equipment Page 27 of 32

REVALUATION AND IMPAIRMENT

THEORIES
1. What is impairment of asset?
A. A change in the estimated useful life of an asset.
B. An allocation of cost over the useful life of an asset.
C. A decline in value of an asset so that the recoverable amount is more than carrying amount.
D. A fall in the market value of an asset so that the recoverable amount is less than carrying amount.

2. Long-lived assets are required to be reviewed for impairment

A. When the asset is fully depreciated.
B. Every year at the end of reporting period.
C. Every three years at the end of reporting period.
D. When circumstances indicate that the carrying amount of an asset might not be recoverable.

3. Costs of disposal include all of the following, except

A. Cost of removing the asset C. Legal cost
B. Finance cost D. Stamp and similar transaction tax

4. If a depreciable property is revalued at the middle of the current year, how is the depreciation expense for the year determined
when the entity has a calendar year-end?
A. Depreciation for the entire year is based on cost.
B. Depreciation for the entire year is based on revalued amount.
C. Depreciation for the year is based on the average of the depreciation based on cost and on revalued amount.
D. Depreciation for the first half of the year is based on cost and for the second half on revalued amount.

5. Which statement is true about the revaluation model for property, plant and equipment?
A. The frequency of revaluation depends upon the changes in fair value of the property, plant and equipment.
B. Property, plant and equipment with significant and volatile changes in fair value necessitate annual revaluation.
C. Property, plant and equipment with insignificant changes in fair value may be revalued only every three to five years.
D. All of these statements are true about the revaluation model.

REVALUATION MODEL (PPE)

Problem 1: (Revaluation of non-depreciable asset; Reversal of revaluation –non depreciable asset; revaluation increase
representing reversal of impairment loss) Sizemore Company owns land that it purchased at a cost of P600,000 in 20x09. The
company chooses to use revaluation accounting to account for the land. The land’s value fluctuate as follows (all amounts as of
December 31): 20x09,P675,000; 20x10,P540,000; 20x11,P580,000; and 20x12,P615,000. Ignoring income tax rate.

Instructions: Prepare the journal entries to record the revaluation of the land in each year.

December 31,20x09
Land (675,000-600,000) 75,000
Revaluation surplus 75,000

December 31, 20x10

Revaluation surplus 75,000
Loss on impairment (600,000-540,000) 60,000
Land (675,000-540,000) 135,000

December 31, 20x11

Land (580,000-540,000) 40,000
Recovery of impairment loss 40,000

December 31, 20x12

Land (615,000-580,00) 35,000
Recovery of impairment loss (60,000 – 40,000) 20,000
Revaluation surplus 15,000
Problem 2: (Revaluation of depreciable asset with tax rate) A building with historical cost of P20,000,000 and accumulated
depreciation of P7,200,000 has an actual age of 10 years and an estimated effective age of 10 years, and a remaining economic life
of 30 years. The replacement cost is P34,000,000. The building is being depreciated using the straight line method. The income tax
rate is 30%.
Required:
1. Provide the entry to record the revaluation under each of the following methods:
a. Proportional method
b. Elimination method

2. Compute for the annual depreciation in periods subsequent to the revaluation date.
3. Prepare the journal entry to record the piecemeal realization

Requirement (a):
The revaluation surplus, gross of tax, is computed as follows:
(34,000,000 x 30/40) – (20M – 7.2M) = 12,700,000

Case #1: Proportional method

Building (34M – 20M) 14,000,000
Accumulated depreciation (34M x 10/40) – 7.2M 1,300,000
Deferred tax liability (12.7M x 30%) 3,810,000
Revaluation surplus (12.7M x 70%) 8,890,000

Case #2: Elimination method

Accumulated depreciation 7,200,000
Building (squeeze) 5,500,000
Deferred tax liability (12.7M x 30%) 3,810,000
Revaluation surplus (12.7M x 70%) 8,890,000

Property, plant and equipment Page 28 of 32

Requirement (b):
(34,000,000 x 30/40) ÷ 30 = 850,000

Revaluation surplus (8,890,000 ÷ 30) 296,333

Retained earnings 296,333

Step 1: Replacement cost

Step 2 : total economic life = effective life + remaining life

Percentage deprecation = effective life divide total economic life

Notice that the actual life is ignored in the computation of the depreciation above. “ the actual age is NEVER USED in
the age/life method of estimating depreciation” (John M. Bryant, School Director/Appraiser Instructor and Consultant,
John M. Bryant , INC)

Step 3: Fair value = Replacement cost – depreciation

Problem 3 (Depreciated replacement cost with residual value and derecognition) Katherine Company provided the following
information relating to the revaluation of an equipment on January 1, 20x4.
Cost Replacement cost
Equipment P6,500,000 P9,200,000
Residual value 500,000 200,000
Useful life 12
Age of the equipment 2
Accumulated depreciation ? ?

The equipment was sold on January 1, 20x5 for P8,000,000.

Required: (Ignoring income tax)

1. What is the revaluation surplus on January 1, 20x4?
2. What is the depreciation for 20x4?
3. What is the revaluation surplus on December 31, 20x4?
4. What is the gain on sale of equipment on January 1, 20x5?

1
Cost Replacement cost Appreciation
Equipment 6,500,000 9,200,000 2,700,000
Residual value ( 200,000) (200,000)
Depreciable amount 6,300,000 9,000,000
Accumulated depreciation
(6,000.000/12 x 2) (1,000,000)
(9,000,000/12 x 2) . (1,500,000) ( 500,000)
Remaining depreciable amount 5,300,000 7,500,000 2,200,000

2
Depreciation for 20x4 (7,500,000/10 years remaining) 750,000

3
Revaluation surplus - January 1, 20x4 2,200,000
Realization in 20x4 (2,200,000/10) (220,000)
Revaluation surplus - December 31, 20x4 1,980,000

4
Replacement cost of equipment 9,200,000
Accumulated depreciation – Dec. 31, 20x4 (1,500,000 + 750,000) (2,250,000)
Carrying amount - December 31, 20x4 6,950,000
Sale price 8,000,000
Carrying amount (6,950,000)
Gain on sale of equipment 1,050,000

Problem 4 (Reversal of revaluation – depreciable asset) Lakers, Inc. purchased a machine on January 1, 20x6, at a cost of
P100,000. It is being depreciated using the straight-line method over its projected useful life of 10 years. At December 31, 20x6,
the asset’s fair value was P112,500. Accordingly, an entry was made on that date to recognize the revaluation surplus. It is the
company policy to transfer a portion of revaluation surplus to retained earnings every period.

An impairment was detected on December 31, 20x8 and the recoverable amount of the asset was determined to be P67,375. At
December 31, 20x9, the fair value of the asset was determined to be P73,000. How much is revaluation surplus recognized on
December 31, 20x9?

Property, plant and equipment Page 29 of 32

 (a) Cost P100,000
Accumulated depreciation 12/31/x6(100,000/10) ( 10,000)
Net 90,000
Revalued amount 112,500
Revaluation surplus 12/31/x6 P 22,500

(b) Carrying amount 12/31/x8(112,500 x 7/9) P 87,500

Recoverable amount 67,375
Decrease in value P 20,125
Remaining balance of Revaluation Surplus (22,500 x 7/9) ( 17,500)
Impairment loss in profit or loss P 2,625

(c) As of 1/1/x9 P67,375

Depreciation expense for 20x9 (67,375/7) ( 9,625)
Net before revaluation on 12/31/x9 57,750
Revalued amount 73,000
Increase in value P15,250
Unrecovered impairment loss (2,625 x 6/7) ( 2,250)
Revaluation surplus, December 31, 20x9 P13,000

FV P73,000
Or NBV no impairments loss (100,000 6/10) ( P60,000)
Revaluation surplus P13,000

To check: CV without impairment, cost model

100,000 x 6/10 P60,000
Revaluation surplus, December 31, 20x9 13,000
Revalued amount, December 31, 20x9 P73,000

Answer P13,000

IMPAIRMENT LOSS (PPE)

Problem 1—Impairment Presented below is information related to equipment owned by Marley Company at December 31, 20x0.
Cost P7,000,000
Accumulated depreciation to date 1,500,000
Value-in-use 5,000,000
Fair value less cost of disposal 4,400,000

Assume that Marley will continue to use this asset in the future. As of December 31, 20x0, the equipment has a remaining useful of
4 years.
Instructions
(a) Prepare the journal entry (if any) to record the impairment of the asset at December 31, 20x0.
(b) Prepare the journal entry to record depreciation expense for 20x1.

(a) December 31, 20x0

Loss on impairment.......................................... 500,000
Accumulated Depreciation––Equipment..... 500,000

Cost.......................................... P7,000,000
Accumulated Depreciation....... (1,500,000)
Carrying amount...................... 5,500,000
Fair value less cost of disposal (5,000,000)
Loss on impairment.................. P 500,000

(b) December 31, 20x1

Depreciation Expense.......................................... 1,250,000
Accumulated Depreciation––Equipment........ 1,250,000

New carrying amount.................. P5,000,000

Useful life....................................÷ 4 years
Depreciation per year................. P1,250,000

Problem 2 :(Value in use – with residual value) Presented below is information related to equipment owned by Island
Souvenirs, Inc. as of December 31, 20X1:
Equipment P9,000,000
Accumulated depreciation 1,500,000

Island Souvenirs will continue to use the asset for its remaining 5-year life, at the end of which it is expected to be sold at P500,000.

Expected future net cash flows from the use of the asset is P100,000 per year. The estimate of future cash flows includes cash out
flows from income taxes and financing activities, totalling P700,000 per year.

Fair value P3,400,000 and cost to sell P200,000.

Appropriate discount rate is 10% (current market risk-free rate of interest) before tax.

Appropriate discount rate is 9% (current market risk-free rate of interest) after tax.

Required: (Round of PV factors to 4 decimal places)

(a) What is the equipment’s value in use?
Property, plant and equipment Page 30 of 32
(b) How much impairment loss, if any, shall be recognized on this asset?
(c) What is the revised annual depreciation after recording impairment loss?

(a) Value in use (100,000 + 700,000) x 3.7908 P3,032,640

Residual value (500,000 x 0.6209) 310,450
Total P3,343,090

(b) Carrying value (9,000,000 – 1,500,000) P7,500,000

Recoverable amount (higher between P3,200,000 and
P3,343,090) 3,343,090
Impairment loss P4,156,910

(c) Revised annual depreciation (3,343,090–500,000)/5 P 568,618

Problem 3: (Reversal) On January 1,20x4, Elite Company purchased equipment with cost of P11,000,000, useful life of 10 years
and no residual value. The entity used straight line depreciation. On December 31,20x4 and December 31,20x5, the entity
determined that impairment indicators are present. There is no change in the useful life or residual value.
December 31, 20x4 December 31, 20x5
Fair value less cost of disposal P8,100,000 P8,400,000
Value in use 8,550,000 8,200,000
Required:
1. What is the impairment loss for 20x4?
2. What is the gain on reversal of impairment for 20x5?

1
Cost-January 1,20x4 11,000.000
Accumulated depreciation (11,000,000 /10) (1,100,000)
Carrying amount - December 31, 20x4 9,900,000
Value in use - higher than fair value 8,550,000
Impairment loss for 20x4 1,350,000

2
Carrying amount - January 1, 20x5 8,550,000
Depreciation for 20x5 (8,550,000/9) . ( 950,000)
Carrying amount- 12/31/20x5 with impairment 7,600,000
Cost - January 1, 20x4 11,000,000
Accumulated depreciation – Dec. 31,20x5 (11,000,000/10x2) ( 2,200,000)
Maximum carrying amount - 12/31/20x5 no impairment 8,800,000
Fair value less cost of disposal - 12/31/20x5, higher than value in use 8,400,000
Carrying amount - 12/31/20x5 with impairment 7,600,000
Gain on reversal of impairment for 20x5 800.000

Problem 4: (Compensation for Impairment Loss of PPE) On November 1, 20X1, the building of ABC Co. with a carrying
amount as of that date of P1,200,000 was completely destroyed by fire. The building has a historical cost of P2,000,000. Claim for
a P1,000,000 insurance was filed on November 15, 20X1. On January 5, 20X2, after due investigation by the insurance company, it
was found out that ABC Co. is free of negligence and the insurance company agreed to pay ABC Co. the P1,000,000 insurance policy.

Required: Prepare the necessary journal entry.

November 20X1
Loss on fire P1,200,000
Accumulated depreciation 800,000
Building P2,000,000

January 20X2
Claims receivable on insurance P1,000,000
Gain on insurance P1,000,000

Problem 5: (Decommission) Seafarer Company has an oil platform in the sea. The entity has to decommission the platform at
the end of the useful life, and a provision was set up at the commencement of production. The carrying amount of the provision for
decomissioning is P5,000,000. The entity has received an offer of P8,000,000 for the rights to the platform which reflects the fact
that Seafarer Company has to decommission it at the end of the useful life. Disposal costs would be P500,000. The value in use of
the oil platform is P12,000,000 ignoring the decommissioning cost. The carrying amount of the oil platform is P15,000,000. What
amount should be recognized as impairment loss for the current year in relation to the oil platform?

Offer price 8,000,000

Disposal cost (500,000)
Fair value less cost of disposal 7,500,000
Value in use 12,000,000
Carrying amount of provision (5,000,000)
Adjusted value in use 7,000,000
Carrying amount of old platform 15,000,000
Carrying amount of provision (5,000,000)
Adjusted carrying amount 10,000,000
Recoverable amount – equal to fair value less cost of disposal
being the higher amount 7,500,000
Impairment loss 2,500,000

Property, plant and equipment Page 31 of 32

 FULL PFRS SMES
Property, plant and Measured by using either cost model or revaluation Same under Full PFRS (either cost or
equipment model. There is a choice. revaluation model)

Impairment of assets PPE PPE

Intangible assets Intangible assets
Inventories
Other assets

Non-financial assets (including intangible assets and goodwill) are tested for impairment only when there is an indication that
the asset may be impaired, i.e., there are no instances of mandatory impairment testing. There are significant
disclosure reliefs for SMEs compared with the disclosures required under full IFRSs.
Topic Classificati Full IFRSs FRS for SMEs
on
Impair Recognition IAS 36 requires that an entity measure the Non-financial assets (including all intangible
ment of and recoverable amount of the following assets assets and goodwill) are tested for
non- Measureme annually, regardless of whether there is an impairment only when there is an indication
financial nt; indication of impairment: goodwill, indefinite-live that the asset may be impaired, i.e. there are
assets Presentatio intangible assets and intangible assets not yet no instances of mandatory annual
(Section n and available for use. impairment testing.
27) Disclosure
There are significant disclosure reliefs for SMEs
compared with the disclosures required under full
IFRS.

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